**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

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** **

**FORM 10-Q**

**(Mark One)**

 

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**For the quarterly period ended June 30, 2006**

 

**OR**

 

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**For thetransition period from        to        **

**CommissionFile Number: 000-30289**

**PRAECIS PHARMACEUTICALS INCORPORATED**

(Exact name of registrant as specified in its charter)

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

 

**830Winter Street, Waltham, MA 02451-1420**(Address of principal executive offices 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 the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.              Yes x   No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act.  (Checkone):

Largeaccelerated filer  o                   Accelerated filer  o             Non-acceleratedfiler  x

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

As of July 31, 2006, there were 10,684,217 shares of theregistrant’s common stock, $.01 par value, outstanding.

Allshare and per share amounts, including all common stock equivalents (stockoptions and the exercise prices thereof), reported in this Quarterly Report onForm 10-Q have been have adjusted for all periods presented to reflect a1-for-5 reverse split of the registrant’s common stock effected on November 1,2005.

 

 

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**PRAECISPHARMACEUTICALS INCORPORATEDFORM 10-QFOR THE QUARTER ENDED JUNE 30, 2006**

**INDEX**
|                   | ** ** | ** **                                                                                                | **PAGE  NUMBER** |     |
|-------------------|------------|-----------------------------------------------------------------------------------------------------------|------------------|----------|
| ** **        | ** ** | ** **                                                                                                | ** **       |     |
| **PART  I.**      | ** ** | **FINANCIAL  INFORMATION**                                                                                |             | 3        |
| ** **        | ** ** | ** **                                                                                                |             |     |
| Item  1.          |       | Financial  Statements (Unaudited)                                                                         |             | 3        |
|              |       |                                                                                                      |             |     |
|              |       | Condensed Consolidated Balance Sheets —  December 31, 2005 and June 30, 2006                         |             | 3        |
|              |       |                                                                                                      |             |     |
|              |       | Condensed Consolidated Statements of Operations —  three and six months ended June 30, 2005 and 2006 |             | 4        |
|              |       |                                                                                                      |             |     |
|              |       | Condensed Consolidated Statements of Cash Flows —  three and six months ended June 30, 2005 and 2006 |             | 5        |
|              |       |                                                                                                      |             |     |
|              |       | Notes to Condensed Consolidated Financial Statements                                                      |             | 6        |
|              |       |                                                                                                      |             |     |
| Item 2.           |       | Management’s Discussion and Analysis of Financial  Condition and Results  of Operations              |             | 16       |
|              |       |                                                                                                      |             |     |
| Item 3.           |       | Quantitative and Qualitative Disclosures About Market  Risk                                               |             | 26       |
|              |       |                                                                                                      |             |     |
| Item 4.           |       | Controls and Procedures                                                                                   |             | 26       |
|              |       |                                                                                                      |             |     |
| **PART  II.**     | ** ** | **OTHER  INFORMATION**                                                                                    |             |     |
| ** **        | ** ** | ** **                                                                                                |             |     |
| Item  1.          |       | Legal  Proceedings                                                                                        |             | 27       |
|              |       |                                                                                                      |             |     |
| Item 1A.          |       | Risk Factors                                                                                              |             | 28       |
|              |       |                                                                                                      |             |     |
| Item 2.           |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                              |             | 38       |
|              |       |                                                                                                      |             |     |
| Item 4.           |       | Submission of Matters to a Vote of Security Holders                                                       |             | 39       |
|              |       |                                                                                                      |             |     |
| Item 6.           |       | Exhibits                                                                                                  |             | 39       |
|              |       |                                                                                                      |             |     |
| **SIGNATURE**     |       |                                                                                                      |             | 41       |
| ** **        |       |                                                                                                      |             |     |
| **EXHIBIT INDEX** | * *   | * *                                                                                                  | * *         | * * |
|                   |            |                                                                                                           |                  |          |  |

 

2

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** **

**PART I. FINANCIAL INFORMATION**

**ITEM1.  FINANCIAL STATEMENTS.**

**PRAECIS PHARMACEUTICALS INCORPORATED****Condensed ConsolidatedBalance Sheets(In thousands, except share data)(Unaudited)**
| ** **                                                                                                                                     | ** ** | **December 31,  2005** | ** ** | **June 30,   2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
|                                                                                                                                           |       |                        |       |                          |       |
| **Assets**                                                                                                                                     |       |                        |       |                          |       |
| Current assets:                                                                                                                                |       |                        |       |                          |       |
| Cash and cash  equivalents                                                                                                                     |       | $                           | 57,088     |                          | $          | 46,170 |   |
| Marketable  securities                                                                                                                         |       | 5,492                       |       | —                        |       |
| Accounts  receivable                                                                                                                           |       | 184                         |       | 65                            |       |
| Inventory                                                                                                                                      |       | 154                         |       | —                        |       |
| Prepaid expenses  and other current assets                                                                                                     |       | 742                         |       | 1,108                         |       |
| Total current  assets                                                                                                                          |       | 63,660                      |       | 47,343                        |       |
| Property and equipment,  net                                                                                                                   |       | 3,559                       |       | 1,775                         |       |
| Inventory                                                                                                                                      |       | 1,532                       |       | —                        |       |
| Restricted cash                                                                                                                                |       | 793                         |       | 793                           |       |
| Total assets                                                                                                                                   |       | $                           | 69,544     |                          | $          | 49,911 |   |
|                                                                                                                                           |       |                             |       |                               |       |
| **Liabilities and Stockholders’  Equity**                                                                                                 |       |                        |       |                          |       |
| Current liabilities:                                                                                                                           |       |                        |       |                          |       |
| Accounts payable                                                                                                                               |       | $                           | 780        |                          | $          | 999 |   |
| Accrued expenses                                                                                                                               |       | 3,373                       |       | 2,229                         |       |
| Accrued  restructuring                                                                                                                         |       | 3,608                       |       | 4,154                         |       |
| Deferred gain on  sale-leaseback of building                                                                                                   |       | 1,818                       |       | 1,818                         |       |
| Total current  liabilities                                                                                                                     |       | 9,579                       |       | 9,200                         |       |
|                                                                                                                                           |       |                        |       |                          |       |
| Long-term accrued  restructuring                                                                                                               |       | 1,834                       |       | 3,105                         |       |
| Long-term deferred gain  on sale-leaseback of building                                                                                         |       | 6,968                       |       | 6,059                         |       |
|                                                                                                                                           |       |                        |       |                          |       |
| Commitments and  contingencies                                                                                                                 |       |                        |       |                          |       |
|                                                                                                                                           |       |                        |       |                          |       |
|  Stockholders’ equity:                                                                                                               |       |                        |       |                          |       |
| Common Stock,  $0.01 par value; 200,000,000 shares authorized; 10,494,174 shares in 2005 and  10,632,564 shares in 2006 issued and outstanding |       | 105                         |       | 106                           |       |
| Additional paid-in  capital                                                                                                                    |       | 356,234                     |       | 358,652                       |       |
| Accumulated  other comprehensive loss                                                                                                          |       | (90                         | )          | —                        |       |
| Accumulated  deficit                                                                                                                           |       | (305,086                    | )          | (327,211                      | )          |
| Total  stockholders’ equity                                                                                                               |       | 51,163                      |       | 31,547                        |       |
| Total liabilities and  stockholders’ equity                                                                                               |       | $                           | 69,544     |                          | $          | 49,911 |   |

 

*Seeaccompanying notes.*

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**PRAECIS PHARMACEUTICALS INCORPORATED****Condensed Consolidated Statementsof Operations****(In thousands, except per sharedata)****(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| **Revenues:**                                                           | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product sales                                                           |       | $                                               | 350        |                                          | $          | 73 |   | $ | 1,154 |   | $ | 209 |   |
| Licensing and other revenues                                            |       | 42                                              |       | —                                        |       | 119 |   | 35 |   |
| Total revenues                                                          |       | 392                                             |       | 73                                            |       | 1,273 |   | 244 |   |
| **Costs  and expenses:**                                                | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of goods sold                                                      |       | 3,611                                           |       | 5,513                                         |       | 3,792 |   | 5,570 |   |
| Research and development                                                |       | 6,276                                           |       | 6,130                                         |       | 13,559 |   | 12,547 |   |
| Sales and marketing                                                     |       | 2,128                                           |       | —                                        |       | 5,785 |   | — |   |
| General and administrative                                              |       | 1,989                                           |       | 2,028                                         |       | 3,967 |   | 3,873 |   |
| Restructuring and asset impairment                                      |       | 28,680                                          |       | 2,075                                         |       | 28,680 |   | 1,578 |   |
| Total costs and expenses                                                |       | 42,684                                          |       | 15,746                                        |       | 55,783 |   | 23,568 |   |
|                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Operating loss                                                          |       | (42,292                                         | )          | (15,673                                       | )          | (54,510 | ) | (23,324 | ) |
|                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Interest income                                                         |       | 407                                             |       | 595                                           |       | 767 |   | 1,194 |   |
| Interest expense                                                        |       | (485                                            | )          | —                                        |       | (972 | ) | — |   |
| Gain on sale of  property and equipment                                 |       | —                                          |       | 5                                             |       | — |   | 5 |   |
| Net loss                                                                |       | $                                               | (42,370    | )                                             | $          | (15,073 | ) | $ | (54,715 | ) | $ | (22,125 | ) |
|                                                                    |       |                                                 |       |                                               |       |  |   |  |   |
| Basic and  diluted net loss per common share                            |       | $                                               | (4.04      | )                                             | $          | (1.42 | ) | $ | (5.22 | ) | $ | (2.10 | ) |
|                                                                    |       |                                                 |       |                                               |       |  |   |  |   |
| Weighted average number  of basic and diluted common shares outstanding |       | 10,485                                          |       | 10,586                                        |       | 10,485 |   | 10,546 |   |

 

*Seeaccompanying notes.*

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**PRAECIS PHARMACEUTICALS INCORPORATED****Condensed Consolidated Statementsof Cash Flows****(In thousands)****(Unaudited)**

 
| ** **                                                                    | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                                      | ** ** | **2006** | ** ** |
|                                                                          |       |                                          |       |   |   |
| **Operating  activities:**                                                    |       |                                          |       |   |   |
| Net loss                                                                      |       | $                                             | (54,715    | ) | $ | (22,125 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities:      |       |                                          |       |   |   |
| Non-cash restructuring and asset impairment                                   |       | 19,676                                        |       | 6,999 |   |
| Amortization of deferred gain on sale-leaseback of  building                  |       | —                                        |       | (909 | ) |
| Gain on sale of property and equipment                                        |       | —                                        |       | (5 | ) |
| Depreciation                                                                  |       | 1,747                                         |       | 632 |   |
| Stock-based compensation                                                      |       | —                                        |       | 1,842 |   |
| Changes in operating assets and liabilities:                                  |       |                                          |       |   |   |
| Accounts receivable                                                           |       | 372                                           |       | 119 |   |
| Inventory                                                                     |       | 2,693                                         |       | — |   |
| Prepaid expenses, other current assets and other  assets                      |       | (262                                          | )          | (366 | ) |
| Accounts payable                                                              |       | (1,189                                        | )          | 219 |   |
| Accrued expenses                                                              |       | (2,342                                        | )          | (1,144 | ) |
| Accrued restructuring                                                         |       | 7,817                                         |       | (1,618 | ) |
| Deferred revenue                                                              |       | (83                                           | )          | — |   |
| Net cash used in  operating activities                                        |       | (26,286                                       | )          | (16,356 | ) |
| ** **                                                                    | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Investing  activities:**                                                    |       |                                          |       |   |   |
| Purchase of  available-for-sale securities                                    |       | (13,094                                       | )          | — |   |
| Sales and  maturities of available-for-sale securities                        |       | 75,797                                        |       | 5,582 |   |
| Proceeds from  disposition of property and equipment                          |       | —                                        |       | 5 |   |
| Purchase of  property and equipment                                           |       | (555                                          | )          | (726 | ) |
| Net cash  provided by investing activities                                    |       | 62,148                                        |       | 4,861 |   |
| ** **                                                                    | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Financing  activities:**                                                    |       |                                          |       |   |   |
| Repayments of  long-term debt                                                 |       | (294                                          | )          | — |   |
| Proceeds from  the issuance of Common Stock under employee compensation plans |       | 95                                            |       | 77 |   |
| Proceeds from  the sale of Common Stock in connection with pilot study        |       | —                                        |       | 500 |   |
| Net cash (used  in) provided by financing activities                          |       | (199                                          | )          | 577 |   |
|                                                                          |       |                                          |       |   |   |
| Increase  (decrease) in cash and cash equivalents                             |       | 35,663                                        |       | (10,918 | ) |
| Cash and cash  equivalents at beginning of period                             |       | 11,178                                        |       | 57,088 |   |
| Cash and cash  equivalents at end of period                                   |       | $                                             | 46,841     |   | $ | 46,170 |   |

 

*See accompanyingnotes.*

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**PRAECIS PHARMACEUTICALSINCORPORATED**

**Notes to CondensedConsolidated Financial Statements**

**(Unaudited)**

**1.**                 Basis ofPresentation

The accompanying condensed consolidated financialstatements have been prepared by PRAECIS PHARMACEUTICALS INCORPORATED (the “Company”)in accordance with accounting principles generally accepted in the UnitedStates and pursuant to the rules and regulations of the Securities and ExchangeCommission (the “SEC”). Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States have been condensed oromitted pursuant to such rules and regulations. It is suggested that thefinancial statements be read in conjunction with the audited financialstatements and the accompanying notes included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2005.

The information furnished reflects all adjustmentswhich, in the opinion of management, are considered necessary for a fairpresentation of results for the interim periods. Such adjustments consist onlyof normal recurring items. It should also be noted that results for the interimperiods are not necessarily indicative of the results expected for the fullyear or any future period.

All share and per share amounts, including all commonstock equivalents (stock options and the exercise prices thereof) have been adjustedfor all periods presented to reflect a 1-for-5 reverse split of the Company’scommon stock, par value $.01 per share (“Common Stock”), effected on November1, 2005. The number of authorized shares of Common Stock was not changed by thereverse stock split and remains at 200,000,000. The par value of the CommonStock was also not affected by the reverse stock split.

**2.**                 Summary ofSignificant Accounting Principles

***Use of Estimates***

The preparation of financial statements in accordancewith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Such estimates relate to the usefullives of fixed assets, the net realizable value of inventory, accruedrestructuring expenses, other accrued expenses, other reserves, and assumptionsused in valuing stock-based compensation awards. Actual results could differfrom those estimates and such differences may be material to the Company’scondensed consolidated financial statements.

***Principles of Consolidation***

The accompanying condensed consolidated financialstatements include the Company’s accounts and the accounts of its wholly ownedsubsidiaries, 830 Winter Street LLC and PRAECIS Europe Limited. All significantintercompany account balances and transactions between the companies have beeneliminated.

***Inventory***

Inventory is stated at the lower of cost or marketwith cost determined under the first-in, first-out method. The Company writesdown any obsolete, excess or otherwise unmarketable inventory to its estimatednet realizable value, as necessary. Inventory for all periods presentedconsists of materials used to produce Plenaxis®.

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The components of inventory are as follows (inthousands):

|                       | ** ** | **December 31,  2005** | ** ** | **June 30,  2006** | ** ** |
|-----------------------|------------|-----------------------------|------------|-------------------------|------------|
| Work-in-process       |       | $                           | 1,532      |                    | $          | — |   |
| Finished goods        |       | 154                         |       | —                  |       |
| Total inventory       |       | 1,686                       |       | —                  |       |
| Less current  portion |       | (154                        | )          | —                  |       |
| Long-term inventory   |       | $                           | 1,532      |                    | $          | — |   |

 

Raw materials, work-in-process and finished goodsinventories consist of materials, labor and manufacturing overhead. The Companyclassifies any inventory that is estimated to be sold in the next twelve monthsas current inventory, with the remaining amount classified as long-terminventory.

In connection with the Company’s strategicrestructuring announced in May 2005, the Company voluntarily discontinuedpromotional activities related to Plenaxis® andthe sale of Plenaxis® for new patients in the United States. As aresult, the Company wrote down approximately $3.5 million of inventory duringthe three months ended June 30, 2005 that it estimated to be in excess of itsexpected requirements. This amount was classified in cost of goods sold in theconsolidated statement of operations for that period. The remaining inventorybalance, approximately $1.7 million at December 31, 2005, consisted ofmaterials that were expected to be used in connection with the commercializationof Plenaxis® by a third party in Europe and otherterritories following a license or sale transaction relating to the product. InSeptember 2005, the Company received marketing authorization for Plenaxis® in Germany. As previously disclosed, the Companyretained an investment banking firm to actively pursue the disposition of theCompany’s Plenaxis® assets through a license or sale transaction. InJune 2006, the Company announced that it would cease its active efforts tolicense or sell its Plenaxis® assets. As a result, the Company recorded anon-cash impairment charge of approximately $1.7 million during the threemonths ended June 30, 2006 to write down the remaining inventory balance tozero. This amount was classified in cost of goods sold in the condensed consolidatedstatement of operations for that period.

***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 of theundiscounted future cash flows expected to result from a company’s asset, netof 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 flow technique. TheCompany evaluates its property, plant and equipment for impairment wheneverindicators 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.

***Stock-Based Compensation***

In December 2004, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 123R, *Share-Based Payment—AnAmendment of FASB Statements 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. Generally, theapproach in SFAS No. 123R is similar to the approach described in SFAS No. 123,*Accounting for Stock-Based Compensation*(“SFAS No. 123”). However, SFAS No. 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the financial statements based on their fair value over therequisite service period. Pro forma disclosure is no longer an alternative.  In March 2005, the SEC issued Staff AccountingBulletin (“SAB”) No. 107 (“SABNo. 107”), which expressed the views of the SEC regarding the interactionbetween SFAS No. 123R and certain rules and regulations of the SEC. SAB No. 107provides guidance related to the valuation of share-based payment arrangementsfor public companies, including assumptions such as expected volatility andexpected term.

7

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Effective January 1, 2006, the Company adopted thefair value recognition provisions of SFAS No. 123R, using the modifiedprospective transition method. Under this transition method, compensation costrecognized in the statement of operations during 2006 includes: (a)compensation cost for all share-based payments granted prior to, but not yetvested as of January 1, 2006, based on the grant-date fair value estimated inaccordance with the original provisions of SFAS No. 123; and (b) compensationcost for all share-based payments granted, modified or settled subsequent toJanuary 1, 2006, based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123R. In accordance with the modifiedprospective transition method, results for prior periods have not beenrestated.

For the three months ended June 30, 2006, the Companyrecorded stock-based compensation expense of approximately $962,000 for stockoptions granted under the Company’s Fourth Amended and Restated 1995 Stock Plan(the “Plan”) and approximately $8,000 related to the Company’s Second Amendedand Restated Employee Stock Purchase Plan, as amended (the “ESPP”), of which$720,000 was included in research and development expenses and $250,000 wasincluded in general and administrative expenses. The stock-based compensationexpense for the three months ended June 30, 2006 includes approximately $78,000recorded in connection with the acceleration of vesting of the unvested portionof two outstanding option grants to purchase an aggregate of 33,998 shares ofCommon Stock at a weighted average exercise price of $5.80 per share. For thesix months ended June 30, 2006, the Company recorded stock-based compensationexpense of approximately $1,826,000 for stock options granted under Plan andapproximately $16,000 related to the ESPP, of which $1,367,000 was included inresearch and development expenses and $475,000 was included in general andadministrative expenses. No amounts relating to stock-based compensation havebeen capitalized.

The Company currently has the following stock-basedemployee compensation plans which are subject to the provisions of SFAS No.123R:

*StockOption Plan* - The Plan allows for the granting of incentiveand nonqualified options, restricted stock awards and awards of, or awards topurchase, shares of Common Stock. Historically, incentive options granted toemployees under the Plan generally vested over a five-year period, with 20%vesting on the first anniversary of the date of grant and the remainder vestingin equal monthly installments thereafter. During 2005 and thereafter, theCompany began granting options to employees which generally vest over afour-year period, with 25% vesting on the first anniversary of the date ofgrant and the remainder vesting in equal monthly installments thereafter.Nonqualified options issued to non-employee directors and consultants under thePlan generally vest during their period of service with the Company. Optionsgranted under the Plan have a maximum term of ten years from the date of grant.In March 2006, the Company’s Board of Directors approved the Plan, subject tostockholder approval, which was obtained in May 2006. The Plan amends andrestates the Company’s Third Amended and Restated 1995 Stock Plan to increaseby 500,000 the number of shares of Common Stock authorized for issuance underthe Plan, permit the grant of restricted stock awards and include certainperformance goals for purposes of Section 162(m) of the Internal Revenue Codeof 1986, as amended. At June 30, 2006, a total of 3,675,000 shares of CommonStock were authorized for issuance under the Plan, 1,667,151 of which werereserved for issuance upon the exercise of outstanding stock options and1,016,057 of which remained available for issuance of new awards under thePlan.

*EmployeeStock Purchase Plan* - Under the ESPP, eligible employees maypurchase shares of Common Stock at a price per share equal to 85% of the lowerof the fair market value per share of Common Stock at the beginning or the endof each six-month period during the term of the ESPP. Participation is limitedto the lesser of 10% of the employee’s compensation or $25,000 in any calendaryear. In May 2005, the Company’s Board of Directors approved an amendment andrestatement of the employee stock purchase plan to extend its term through June25, 2007 and provide for withdrawal by employees during a six-month exerciseperiod. In March 2006, the Company’s Board of Directors approved an amendment,subject to stockholder approval, which was obtained in May 2006, to increase by80,000 shares the number of shares of Common Stock reserved for issuance underthe ESPP. At June 30, 2006, a total of 82,645 shares of Common Stock had beenissued under the ESPP and 77,355 shares remained available for issuance.

The Company usesthe Black-Scholes option pricing model to calculate the fair value on the grantdate of stock-based compensation for both stock options granted under the Planand options to purchase shares granted under the ESPP. The fair value of stockoptions granted during the three and six months ended June 30, 2005 and 2006was calculated using the following estimated weighted-average assumptions:

8

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|                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Expected term  (years)   |       | 6.2                                             |       | 4.5                                           |       | 6.2 |   | 4.5 |   |
| Volatility               |       | 87.1                                            | %          | 65.6                                          | %          | 86.5 | % | 66.0 | % |
| Risk-free  interest rate |       | 3.8                                             | %          | 5.0                                           | %          | 3.8 | % | 5.0 | % |

 

Expected term:The expected term of options granted represents the period of time for whichthe options are expected to be outstanding and is derived from the Company’shistorical stock option exercise experience and option expiration data. Toestimate the expected term, the Company excluded options granted to employeeswhose employment was terminated in connection with the Company’s strategicrestructuring announced in May 2005, which included a reduction of the Company’sthen 182-person headcount by approximately 60%. The Company believes that thisadjusted historical data is currently the best estimate of the expected term ofa new option. In addition, for purposes of estimating the expected term, theCompany has aggregated all individual option awards into one group as theCompany does not expect substantial differences in exercise behavior among itsemployees.

Expectedvolatility: The expected volatility is a measure of theamount by which the Company’s stock price is expected to fluctuate during theexpected term of options granted. The Company determines the expectedvolatility based solely upon the historical volatility of the Company’s CommonStock over a period commensurate with the option’s expected term. The Companydoes not believe that the future volatility of its Common Stock over an option’sexpected term is likely to differ significantly from the past.

Risk-free interestrate: The risk-free interest rate is the implied yieldavailable on U.S. Treasury zero-coupon issues with a remaining term equal tothe option’s expected term on the grant date.

Expected dividendyield: The Company has never declared or paid any cashdividends on any of its capital stock and does not expect to do so in theforeseeable future. Accordingly, the Company uses an expected dividend yield ofzero to calculate the grant-date fair value of a stock option.

The assumptions used to calculate the grant-date fairvalue for options to purchase shares granted under the ESPP for the three andsix months ended June 30, 2006 include the following: an expected term of sixmonths, representing the current exercise period for purchases under the ESPP;an expected annual volatility of 64.5%; an annualized risk-free interest rateof 4.4%; and a zero expected dividend yield. The weighted-average per sharefair value of options to purchase shares granted under the ESPP during thethree and six months ended June 30, 2006 was $1.30.

The Companyrecognizes compensation expense on a straight-line basis over the requisiteservice period based upon options that are ultimately expected to vest, andaccordingly, such compensation expense has been adjusted by an amount ofestimated forfeitures. Forfeitures represent only the unvested portion of asurrendered option. SFAS No. 123R requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Prior to the adoption of SFAS No.123R, the Company accounted for forfeitures upon occurrence as permitted underSFAS No. 123. Based on an analysis of historical data, excluding the impact ofoptions granted to employees whose employment was terminated in connection withthe Company’s strategic restructuring announced in May 2005, the Company hascalculated a 6.0% annual forfeiture rate, which it believes is a reasonableassumption to estimate forfeitures. However, the estimation of forfeituresrequires significant judgment, and to the extent actual results or updatedestimates differ from the Company’s current estimates, such amounts will berecorded as a cumulative adjustment in the period estimates are revised.

The weightedaverage per share fair value of stock options granted under the Plan was $2.48and $3.31 during the three months ended June 30, 2005 and 2006, respectively,and $2.84 and $3.34 during the six months ended June 30, 2005 and 2006,respectively.

Prior to January 1, 2006, the Company applied the proforma disclosure requirements under SFAS No. 123 and accounted for itsstock-based employee compensation plans using the intrinsic value method underthe recognition and measurement provisions of Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees*andrelated interpretations. Accordingly, no stock-based employee compensation costwas recognized in the statement of operations for the three and six monthsended June 30, 2005, as all stock options 

9

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granted under the Planhad an exercise price equal to the fair market value of the underlying CommonStock on the date of grant as determined in accordance with the Plan.

The following table illustrates the effect on net lossand net loss per share if the Company had applied the fair value recognitionprovisions of SFAS No. 123 to options granted under the Plan for the three andsix months ended June 30, 2005. Since stock-based compensation expense for thethree and six months ended June 30, 2006 was recorded under the provisions ofSFAS No. 123R, there is no disclosure of pro forma net loss and net loss pershare for these periods. For purposes of the pro forma disclosure for the threeand six months ended June 30, 2005 set forth in the table below, the value ofthe options is estimated using a Black-Scholes option pricing model andamortized on a straight-line basis to expense over the options’ vestingperiods.
| ** **                                                                                                                                                                           | ** ** | **Three Months Ended  June 30, 2005**          | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **(in thousands, except per share data)** | ** ** |
| Net loss, as  reported                                                                                                                                                               |       | $                                                                  | (42,370    | )                                                       | $          | (54,715 | ) |
| 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 |       | (1,536                                                             | )          | (3,080                                                  | )          |
| Pro forma net  loss                                                                                                                                                                  |       | $                                                                  | (43,906    | )                                                       | $          | (57,795 | ) |
| Basic and  diluted net loss per common share, as reported                                                                                                                            |       | $                                                                  | (4.04      | )                                                       | $          | (5.22 | ) |
| Basic and diluted net  loss per common share, pro forma (1)                                                                                                                          |       | $                                                                  | (4.19      | )                                                       | $          | (5.51 | ) |

 

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(1)             Theamounts for the three and six months ended June 30, 2005 were originallyreported as $(4.30) and $(5.75), respectively, and have been adjusted due to anerror in the calculations.

Information regarding option activity for the threemonths ended June 30, 2006 under the Plan is summarized below (in thousands,except price per share data):

|                                       | ** ** | **Options  Outstanding** | ** ** | **Weighted-  Average  Exercise  Price Per Share** | ** ** |
|---------------------------------------|------------|--------------------------|------------|-------------------------------------------------------------|------------|
| ** **                            | ** ** | ** **               | ** ** | ** **                                                  | ** ** |
| Options  outstanding at April 1, 2006 |       | 1,651                    |       | $                                                           | 26.77      |   |
| Granted                               |       | 69                       |       | 5.81                                                        |       |
| Exercised                             |       | —                   |       | —                                                      |       |
| Forfeited                             |       | (38                      | )          | 12.53                                                       |       |
| Expired                               |       | (5                       | )          | 48.00                                                       |       |
| Options  outstanding at June 30, 2006 |       | 1,677                    |       | $                                                           | 26.18      |   |

 

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Information regardingoption activity for the six months ended June 30, 2006 under the Plan issummarized below (in thousands, except price per share data):
| ** **                                           | ** ** | **Options  Outstanding** | ** ** | **Weighted-  Average  Exercise  Price Per  Share** | ** ** | **Weighted-  Average  Remaining  Contractual  Term (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------------------|------------|--------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------|------------|
|                                                 |       |                     |       |                                                    |       |                                                              |       |                            |       |
| Options outstanding  at January 1, 2006              |       | 1,682                    |       | $                                                       | 26.62      |                                                              |       |                            |       |   |
| Granted                                              |       | 82                       |       | 5.80                                                    |       |                                                              |       |                            |       |
| Exercised                                            |       | (10                      | )          | 1.33                                                    |       |                                                              |       |                            |       |
| Forfeited                                            |       | (50                      | )          | 11.28                                                   |       |                                                              |       |                            |       |
| Expired                                              |       | (27                      | )          | 28.63                                                   |       |                                                              |       |                            |       |
|                                                 |       |                     |       |                                                    |       |                                                              |       |                            |       |
| Options  outstanding at June 30, 2006                |       | 1,677                    |       | $                                                       | 26.18      |                                                              | 5.8        |                            | $          | 201 |   |
|                                                 |       |                          |       |                                                    |       |                                                              |       |                            |       |
| Options  exercisable at June 30, 2006                |       | 1,166                    |       | $                                                       | 31.17      |                                                              | 4.7        |                            | $          | 200 |   |
| Options vested or  expected to vest at June 30, 2006 |       | 1,628                    |       | $                                                       | 26.76      |                                                              | 5.8        |                            | $          | 201 |   |

 

The aggregate intrinsic value in the table aboverepresents the total pre-tax intrinsic value (the difference between theclosing price of the Common Stock on June 30, 2006 of $3.04 and the exerciseprice of each in-the-money option) that would have been received by the optionholders had all option holders exercised their vested and unvested options onJune 30, 2006. Total intrinsic value of stock options exercised under the Planfor the three and six months ended June 30, 2006 was $44,000.

As of June 30, 2006,there was $5,035,000 of total unrecognized compensation cost related tounvested share-based awards. That cost is expected to be recognized over aperiod of 4.0 years with a weighted-average of 1.2 years.

***Revenue Recognition***

The Company follows the provisions of SAB No. 104, *Revenue Recognition*. The Company recognizes revenues fromproduct sales in the period when the product is delivered, provided there ispersuasive evidence that an arrangement exists, the price is fixed ordeterminable and collection of the related receivable is reasonably assured. Revenuesare recorded net of applicable allowances as provision is made for estimatedsales returns, rebates, distributor fees and other applicable discounts andallowances. Shipping and other distribution costs are charged to cost ofproduct sales. Product revenues are related solely to Plenaxis® for all periods presented in this report. Inconnection with the Company’s strategic restructuring announced in May 2005,the Company voluntarily discontinued promotional activities related to Plenaxis® and the sale of Plenaxis® fornew patients in the United States. In June 2006, the Company announced that itwould voluntarily discontinue the limited sale and distribution of Plenaxis® to all patients. The Company expects that theproduct will continue to be available in the United States through August 31,2006.

The Company currently provides substantially all ofits distributors with payment terms of up to 120 days on purchases of Plenaxis®. Through June 30, 2006,payments have generally been made in a timely manner.

The Company analyzes its multipleelement arrangements to determine whether the elements can be separated andaccounted for individually as separate units of accounting in accordance withEITF No. 00-21, *Revenue Arrangements with MultipleDeliverables*. Nonrefundable upfront licensing fees and certain guaranteed,time-based payments that require continuing involvement in the form ofdevelopment, manufacturing or other commercialization efforts by the Companyare recognized as licensing revenue ratably over the period during which theCompany is obligated to perform those services. Milestone payments arerecognized as licensing revenue or product sales when the performanceobligations, as defined in the contract, are achieved. Performance milestonestypically consist of significant milestones in the development and/orcommercialization of a product 

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such as obtaining approval from regulatory agencies andthe achievement of targeted sales levels. Reimbursements of development costsare recognized as licensing revenue as the related costs are incurred.

When the period over which a feeor payment will be recognized as revenue cannot be specifically identified fromthe contract, management estimates the deferral period based upon othercritical factors contained within the contract, including but not limited to patentlife or 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.

***NetLoss Per Share***

Basic net loss per share is basedon the weighted average number of shares of Common Stock outstanding. For allperiods presented, diluted net loss per share of Common Stock is the same asbasic net loss per share of Common Stock as the inclusion of Common Stockequivalents, including the effect of stock options, would be antidilutive dueto the Company’s net loss position for all periods presented. Diluted net lossper share of Common Stock excluded 1,924,767 and 1,677,151 Common Stock optionsfor the periods ended June 30, 2005 and 2006, respectively, as their impactwould have been antidilutive.

***ComprehensiveLoss***

SFAS No. 130, *Reporting ComprehensiveIncome*, establishes standards for the reporting and display ofcomprehensive income or loss and its components in the condensed consolidatedfinancial statements. The Company’s accumulated other comprehensive loss iscomprised of net unrealized gains or losses on available-for-sale securities. Forthe three and six months ended June 30, 2005 and 2006, comprehensive loss wasas follows (in thousands):
| ** **                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net loss                                   |       | $                                               | (42,370    | )                                             | $          | (15,073 | ) | $ | (54,715 | ) | $ | (22,125 | ) |
| Changes in  comprehensive loss:            |       |                                            |       |                                          |       |   |   |   |   |
| Net unrealized holding gain on investments |       | 21                                              |       | 9                                             |       | 30 |   | 90 |   |
| Total  comprehensive loss                  |       | $                                               | (42,349    | )                                             | $          | (15,064 | ) | $ | (54,685 | ) | $ | (22,035 | ) |

 

**3.**                 Restructuring andAsset Impairment

On May 19, 2005, the Company’s Board of Directorsapproved a strategic restructuring to focus the Company’s resources on its mostpromising assets and programs and significantly reduce its cost structure. Thestrategic restructuring included voluntarily discontinuing promotionalactivities related to Plenaxis® andthe sale of Plenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM, the Company’sdrug candidate for Alzheimer’s disease; and implementing a reduction of theCompany’s 182-person headcount by approximately 60%.

During the year ended December 31, 2005, the Companyrecorded approximately $28.7 million of restructuring and asset impairmentexpenses under SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities* (“SFAS No. 146”). Includedin these restructuring and asset impairment expenses were cash charges ofapproximately $2.6 million for employee severance, benefits and related costs,approximately $0.2 million associated with the termination of various contractsand approximately $0.2 million of other associated costs. The Company alsorecorded a non-cash impairment charge in cost of goods sold of approximately$3.5 million related to inventory due to the discontinuation of promotional activitiesrelating to Plenaxis® and the sale of Plenaxis® fornew patients in the United States. At December 31, 2005, the Company’scondensed consolidated balance sheet included approximately $1.9 million ofPlenaxis®-relatedequipment and approximately $1.7 million of Plenaxis®-related inventory.

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In connection with the restructuring, the Company alsodetermined that its commitments under certain manufacturing and supplyagreements with third parties exceeded the Company’s estimated future Plenaxis® requirements by approximately $7.2 million. Duringthe year ended December 31, 2005, the Company recorded a charge ofapproximately $6.0 million which represented the net present value of suchexcess future commitments at that time. Under SFAS No. 146, the remaining $1.2million of these excess commitments was required to be expensed over theremaining respective terms of the applicable manufacturing and supplyagreements, which ranged from two to five years.

In addition, the Company performed an assessment anddetermined that its corporate headquarters and research facility (the“Facility”) was impaired. As a result, a non-cash impairment charge ofapproximately $19.7 million related to the Facility was recorded as partof restructuring and asset impairment expenses under SFAS No. 144 duringthe year ended December 31, 2005. 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.

The followingtable sets forth the components of the Company’s restructuring and assetimpairment expenses for the year ended December 31, 2005 (in thousands):
| ****                                             | ** ** | **Original  Charges** | ** ** | **Non-Cash  Write-off** | ** ** | **Amounts  Paid  Through  December 31,  2005** | ** ** | **Amounts  Accrued as of  December 31,  2005** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Employee  severance, benefits and related costs  |       | $                     | 2,555      |                    | $          | —                                              |       | $                                                             | 2,437      |   | $ | 118 |   |
| Contract  termination costs                      |       | 168                   |       | —                  |       | 168                                                 |       | —                                                        |       |
| Other costs                                      |       | 247                   |       | —                  |       | 197                                                 |       | 50                                                            |       |
| Impairment on  building                          |       | 19,676                |       | 19,676                  |       | —                                              |       | —                                                        |       |
| Manufacturing  commitments restructuring expense |       | 6,034                 |       | —                  |       | 760                                                 |       | 5,274                                                         |       |
| Total restructuring and asset impairment         |       | 28,680                |       | 19,676                  |       | 3,562                                               |       | 5,442                                                         |       |
| Impairment on  inventory                         |       | 3,493                 | *          | 3,493                   | *          | —                                              |       | —                                                        |       |
| Total                                            |       | $                     | 32,173     |                    | $          | 23,169                                              |       | $                                                             | 3,562      |   | 5,442 |   |
| Less current  portion                            |       |                  |       |                    |       |                                                |       | (3,608                                                        | )          |
| Long-term  restructuring accrual                 |       |                  |       |                    |       |                                                |       | $                                                             | 1,873      |   |

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*******                   **Amountwas recorded in cost of goods sold.

On June 19, 2006, the Company’s Board of Directorsdetermined to cease the Company’s previously announced process of activelyseeking to dispose of the Company’s Plenaxis® assets through a license or sale transaction.The Company currently intends to voluntarily discontinue the limited sale anddistribution of the product in the United States as of August 31, 2006 and willnot pursue further the commercialization of Plenaxis® outside the United States. The Company willalso discontinue any remaining Plenaxis®-related activities, except as necessary to support thewind-down of product distribution in the United States. During this wind-down,the Company will continue to evaluate potential opportunities for this asset tothe extent such opportunities arise.

Due to the cessation of its active efforts to licenseor sell its Plenaxis® assets, the Company recorded charges ofapproximately $7.5 million during the three months ended June 30,2006. Of this amount, non-cash charges of approximately $1.9 million and$1.7 million were incurred with respect to Plenaxis®-related equipment and Plenaxis® inventory, respectively, to write down theseassets to their net realizable or salvage value. At June 30, 2006, theestimated net realizable value of Plenaxis® inventory was zeroand the estimated salvage value of Plenaxis®-related equipment was $45,000. The Company hadanticipated that these assets would be used in connection with thecommercialization of Plenaxis® outside of the United States by a third partyfollowing a license or sale transaction. During the three months ended June 30,2006, the Company also recorded a charge of approximately $3.8 millionrelated to commitments under certain Plenaxis® manufacturing and supply agreements, which theCompany concluded will provide no future economic benefit to the Company, and otherassociated costs of approximately $0.1 million. The $3.8 millioncharge represents the net present value of approximately $4.9 million ofthe aggregate future cash commitments under these agreements. The Companyexpects to expense the balance of $1.1 million over the remainingrespective terms of the applicable manufacturing and supply agreements, whichrange from one to four years. The Company currently has an aggregate ofapproximately $9.2 million in minimum annual obligations under third-partymanufacturing 

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and supply agreementswhich become payable in varying annual amounts through 2010.

During the sixmonths ended June 30, 2006, the Company also recorded additional restructuringexpenses of approximately $0.2 million related to the amortization of the netpresent value of excess future manufacturing commitments. In addition, inJanuary 2006, the Company amended a manufacturing and supply agreement toprovide for the suspension of certain manufacturing activities in exchange fora reduced payment by the Company of $1.5 million of a $2.1 million excessfuture commitment. Accordingly, during the six months ended June 30, 2006, theCompany reduced the excess accrued restructuring liability by $0.6 millionthrough a reduction to restructuring expense. Cash disbursements ofapproximately $1.6 million were made during the six months ended June 30,2006 related to restructuring charges.

The followingtable sets forth the activity and components of the Company’s restructuring andasset impairment expenses for the six months ended June 30, 2006 (inthousands):

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| ** **                                      | ** ** | ** **                                                        | ** ** | **Activity During the Six Months Ended June 30, 2006** | ** ** | ** **                    | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                      | ** ** | **Amounts  Accrued as of  December 31, 2005** | ** ** | **Additional  Charges**                                                                        | ** ** | **Reversal of  Charges** | ** ** | **Non-Cash  Write-off** | ** ** | **Amounts  Paid** | ** ** | **Amounts  Accrued as of  June 30, 2006** | ** ** |
| Employee severance, benefits and related costs  |       | $                                                                 | 118        |                                                                                           | $          | —                        |       | $ | — |   | $ | — |   | $ | 118 |   | $ | — |   |
| Other costs                                     |       | 50                                                                |       | 90                                                                                             |       | —                        |       | 50 |   | — |   | 90 |   |
| Impairment on fixed assets                      |       | —                                                            |       | 1,878                                                                                          |       | —                        |       | 1,878 |   | — |   | — |   |
| Manufacturing commitments restructuring expense |       | 5,274                                                             |       | 210                                                                                            |       | (600                          | )          | — |   | 1,500 |   | 3,384 |   |
| Total restructuring and asset impairment        |       | 5,442                                                             |       | 2,178                                                                                          |       | (600                          | )          | 1,928 |   | 1,618 |   | 3,474 |   |
| Manufacturing commitments                       |       | —                                                            |       | 3,785                                                                                          | *          | —                        |       | — |   | — |   | 3,785 | * |
| Impairment on inventory                         |       | —                                                            |       | 1,686                                                                                          | *          | —                        |       | 1,686 | * | — |   | — |   |
| Total                                           |       | $                                                                 | 5,442      |                                                                                           | $          | 7,649                         |       | $ | (600 | ) | $ | 3,614 |   | $ | 1,618 |   | 7,259 |   |
| Less current portion                            |       |                                                              |       |                                                                                           |       |                          |       |   |   |   |   | (4,154 | ) |
| Long-term  restructuring accrual                |       |                                                              |       |                                                                                           |       |                          |       |   |   |   |   | $ | 3,105 |   |

 

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*******                    **Amounts were recorded in cost of goodssold.

**4.**                 Litigation

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, Chief FinancialOfficer and Treasurer Edward C. English, and former President and ChiefOperating 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. On February 7, 2005, a motion wasfiled to consolidate the three actions and to appoint lead plaintiffs and leadcounsel. On February 18, 2005, the Company and the individual defendants fileda 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, theCourt entered an Order granting the plaintiffs’ motion to consolidate the threeactions (as well as each case that relates to the same subject matter that maybe subsequently filed in or transferred to the United States District Court forthe District of Massachusetts), appoint lead plaintiffs and approve suchplaintiffs’ selection of co-lead counsel.

On August 1, 2005, lead plaintiffs filed aconsolidated amended complaint. Lead plaintiffs generally allegesecurities fraud during the period from November 25, 2003 through December 6,2004. The consolidated amended complaint purports to assert claims underSections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder, and alleges that the Company and the individually named

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defendants madematerially false and misleading public statements concerning the Company’sbusiness and financial results, particularly relating to statements regardingthe commercialization of Plenaxis®, thereby allegedly causing plaintiffs topurchase the Company’s securities at artificially inflated prices. At thistime, plaintiffs have not specified the amount of damages they are seeking inthe actions. On September 12, 2005, theCompany and the individual defendants filed a Motion to Dismiss the consolidated amended complaint in itsentirety. On October 24, 2005, lead plaintiffs filed an Opposition to theCompany’s Motion to Dismiss and the defendants filed a reply on November 14,2005. On January 17, 2006, the Court heard oral argument on the Motion toDismiss and took the matter under advisement.

The Company has notrecorded an estimated liability associated with the legal proceedings describedabove. Due to the uncertainties related to both the likelihood and the amountof any potential loss, the Company is unable to make a reasonable estimate ofthe liability that could result from an unfavorable outcome. Managementbelieves that the allegations against the Company are without merit, and theCompany intends to vigorously defend against the plaintiffs’ claims. However,if the Company is not successful in defending these actions, its business andfinancial condition could be adversely affected.

**5.**                 Stock PurchaseAgreement

On April 7, 2006,the Company entered into a pilot study and option agreement with SmithKlineBeecham Corporation (“SBC”) and Glaxo Group Limited (“GGL”), relating to theCompany’s DirectSelectTM drug discovery technology (the “Pilot Study Agreement”).In connection with the execution of the Pilot Study Agreement, the Companyconcurrently entered into a stock purchase agreement (the “Stock PurchaseAgreement”) with SBC and GGL (SBC and GGL together, the “Investor”). Under theStock Purchase Agreement, on April 28, 2006 the Investor purchased 102,538unregistered shares of Common Stock at $4.88 per share, for an aggregatepurchase price of $500,000. Under the terms of the Stock Purchase Agreement, the per shareprice was determined based upon the average of the daily closing prices pershare of the Common Stock on The NASDAQ Global Market, as reported in the WallStreet Journal, over the trading days during the period beginning on, andincluding, March 11, 2006, and ending on, and including, April 25, 2006.

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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 Form10-Q. This Form 10-Q contains forward-looking statements within the meaning ofSection 21E of the Securities Exchange Act of 1934, as amended, that involverisks and uncertainties. All statements other than statements of historicalinformation set forth herein are forward-looking and may contain informationabout financial results, expected or anticipated events, economic conditions,trends and known uncertainties. Actual results and events could differmaterially from those discussed in these forward-looking statements as a resultof a number of factors, which include those discussed in this section andelsewhere in this report under Part II, Item 1A — Risk Factors, and the risksdiscussed in our other filings with the Securities and Exchange Commission. Readersare cautioned not to place undue reliance on these forward-looking statements,which reflect management’s analysis, judgment, belief or expectation only as ofthe date hereof. PRAECIS undertakes no obligation to publicly reissue or modifythese forward-looking statements to reflect events or circumstances that ariseafter the date hereof.*

**Overview**

We are abiopharmaceutical company focused on utilizing our DirectSelectTM and otherproprietary technologies to discover, in a rapid and efficient manner, novel,orally-available compounds with the potential to address unmet medical needs orimprove existing therapies. We are seeking to collaborate with pharmaceuticaland biotechnology companies on the discovery and development of these compoundsacross a broad range of therapeutic areas, and we entered into two pilotagreements during the first half of 2006. We also intend to select promisingcompounds that we discover for internal development and will partner thesecompounds at various stages of development to optimize their value to theCompany. We have a novel methionine aminopeptidase type 2, or MetAP-2,inhibitor, PPI-2458, in clinical development for cancer indications, includingnon-Hodgkin’s lymphoma and solid tumors. Preclinical data also supports the use of this compound in inflammatoryand autoimmune disorders. We currently do not intend to independently marketthe products that may ultimately result from our discovery and developmentefforts. The key elements of our strategy include:

·                                          Continuingto develop and enhance our DirectSelectTM technology, entering intopharmaceutical partnerships for drug discovery and development utilizing thistechnology that will provide significant cash to us, and expanding our ownproprietary development pipeline; and

·                                          AdvancingPPI-2458 through a phase 1 trial in cancer patients and continuing preclinicalevaluation of the compound in inflammatory and autoimmune disorders, includingrheumatoid arthritis, with a goal of partnering this program in one or moreindications as clinical development advances.

In addition to ourdiscovery efforts utilizing our DirectSelectTM technology, we are alsoconducting preclinical research, using conventional medicinal chemistry leadoptimization, aimed at the identification of a selective S1P1(sphingosine-1-phosphate) receptor agonist. S1P1 receptor agonists are ligands for a specific G-protein coupledreceptor which mediates immunomodulatory effects, potentially making themcandidates for treating autoimmune disorders such as multiple sclerosis and inconnection with improved outcome of solid organ transplant.  We are currently evaluating multiplepreclinical candidates with a goal of identifying one or more lead candidatesto take forward into clinical testing.

In June 2006, wereported that we were ceasing our active efforts to license or sell ourPlenaxis® assets. We currently intend to voluntarilydiscontinue the limited sale and distribution of the product in the UnitedStates as of August 31, 2006 and will not pursue further the commercializationof Plenaxis® outside the United States. Due to thecessation of our license or sale process, we recorded charges of approximately$7.5 million during the three months ended June 30, 2006.

As previouslyannounced, we are actively exploring strategic options which may be availableto the Company. These options include principally a financing transaction or abusiness combination with a public or private company. We have engaged aninvestment banking firm to advise and assist us in these efforts. No decisionhas been made as to whether we will engage in a financing, a businesscombination or any other transaction. There can be no assurance that theseefforts will result in a successful financing, a business combination or in anyother transaction. We do not currently intend to disclose developments oranticipated timing regarding these efforts unless and until our board ofdirectors has approved a specific transaction.

*DirectSelectTM*

We are focusingour research efforts on developing and enhancing a novel drug discoverytechnology, DirectSelectTM, which we believe may be an important tool for thefuture of drug discovery and development. We believe that DirectSelectTM, whichenables the generation and practical use of ultra-large libraries for thediscovery of orally active compounds for drug development, will allow us tomore rapidly and directly identify orally available compounds with highaffinity and specificity than has routinely been possible using traditional 

16

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drug discovery methods. During the first half of 2006,we continued to expand our library collection to greater than 5.5 billioncompounds and we are focusing on the creation of novel drug-like molecules inunpatented chemical space. We continue to incorporate multiple new chemistriesand scaffolds into these libraries. We are applying DirectSelectTM to a numberof therapeutic targets of interest to us and in connection with these efforts,we have identified inhibitors to four targets: one protease and three separatekinase targets. We intend to use this technology to expand our own proprietarydevelopment pipeline.

In addition to ourinternal efforts to develop and enhance DirectSelectTM, our strategic operatingplan includes entering into drug discovery and development partnershipsutilizing DirectSelectTM. In March 2006, we entered into a technology transferand option agreement with Gilead Sciences, Inc. Under the agreement, we areutilizing DirectSelectTM to identify lead drug candidates for an antiviraltarget supplied by Gilead. We will collaborate with Gilead to identify leadmolecules that have defined activities against the antiviral target. Eachcompany is funding its own efforts during the course of the researchcollaboration. We will own any lead molecules identified during the course ofthe research collaboration. Gilead has an exclusive option to enter into alicense agreement for any lead molecules so identified.

In addition, inApril 2006, we entered into a two year pilot study and option agreement with SmithKlineBeecham Corporation and Glaxo Group Limited, which we refer to together as GSK,through GSK’s recently established Center of Excellence for External DrugDiscovery, or CEEDD. The goal of this pilot study is to apply DirectSelectTM toidentify small molecule lead drug candidates against a diverse set of fourtargets selected by GSK. Under the terms of the agreement, following ouridentification of lead compounds meeting pre-established success criteriaagainst at least one of the specified targets, GSK will have the exclusiveoption to enter into a broader strategic alliance for further discovery anddevelopment of such lead compounds. The pilot agreement contemplates that anybroader strategic alliance could cover one or more of the targets included inthe pilot study, as well as additional targets as may be agreed upon by theparties. During the pilot study, we will be entitled to receive a $500,000milestone payment with respect to each of the first two targets for which leadcompounds are identified meeting the pre-established success criteria.

In connection withthe execution of the pilot study agreement, we concurrently entered into astock purchase agreement with GSK, pursuant to which we sold, on April 28,2006, 102,538 unregistered shares of our common stock at $4.88 per share, foran aggregate purchase price of $500,000.

We are continuingto initiate and advance research collaboration discussions with other majorpharmaceutical companies with respect to DirectSelectTM.

*PPI-2458*

We are alsofocusing our research and development efforts on PPI-2458, a novel, proprietaryoral compound targeted at the inhibition of the enzyme MetAP-2. We believethat, due to its antiproliferative and antiangiogenic activity, PPI-2458 hasthe potential to address broad therapeutic areas, and we are currently in theprocess of establishing a plan for additional clinical studies for thiscompound. In late 2004, we opened a phase 1 clinical trial of PPI-2458 innon-Hodgkin’s lymphoma patients. During the first quarter of 2005, we expandedthe enrollment criteria of this trial to include patients with solid tumors. Whilethe clinical trial is still in its early stages, thus far oral dosing ofPPI-2458 has been well tolerated and has produced substantial inhibition ofmolecular targeted MetAP-2 activity in most subjects evaluated. Our goal is topresent interim data from our phase 1 trial during the fourth quarter of 2006. Inaddition, based on preclinical data we have generated, we believe PPI-2458could be a potential treatment with disease modifying activity for rheumatoidarthritis and other inflammatory and autoimmune disorders, and we are activelyinvestigating various strategic partnering and clinical development alternativesfor PPI-2458 in these indications. In light of the anticipated developmentcosts associated with the PPI-2458 clinical program, we anticipate seeking apartner for this program in one or more indications as clinical developmentadvances.

*2005 Strategic Restructuring*

During 2005, we fundamentally altered our strategicoperating plan to focus our efforts on early stage research and developmentactivities. On May 19, 2005, our board of directors approved a strategicrestructuring to focus the Company’s resources on our most promising assets andprograms and significantly reduce our cost structure. The strategicrestructuring included voluntarily discontinuing promotional activities relatedto Plenaxis® and the sale of Plenaxis® fornew patients in the United States; voluntarily suspending the ongoing clinicaldevelopment of ApanTM, our drug candidate for Alzheimer’s disease; andimplementing a reduction of 

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our 182-person headcount by approximately 60% toapproximately 75 full-time employees. As of June 30, 2006, we had 76 full-timeemployees, 60 of whom were research and development personnel and 16 of whomwere general and administrative personnel. This compares to 77 full-timeemployees as of June 30, 2005.

We currentlyintend to voluntarily discontinue the limited sale and distribution of Plenaxis® in the United States as of August 31, 2006. Plenaxis® was approved by the FDA in November 2003. Welaunched the product in the United States using our own dedicated marketing andsales team in early 2004, but product sales were significantly lower thanexpected. In September 2005, we received marketing authorization for Plenaxis® from German regulatory authorities.

During 2005, werecorded approximately $28.7 million of restructuring and asset impairmentexpenses under Statement of Financial Accounting Standards No. 146, *Accounting for Costs Associated with Exit or Disposal Activities,*or SFAS No. 146. Included in these restructuring and asset impairment expenseswere cash charges of approximately $2.6 million for employee severance,benefits and related costs, approximately $0.2 million associated with thetermination of various contracts and approximately $0.2 million of otherassociated costs. We also recorded a non-cash impairment charge ofapproximately $3.5 million related to inventory due to the discontinuation ofpromotional activities relating to Plenaxis® inthe United States and the sale of Plenaxis® for new patients. 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 the impairment of our corporate headquarters andresearch facility.

We also determinedthat our commitments under certain manufacturing and supply agreements withthird parties exceeded our estimated future Plenaxis® requirements by approximately $7.2 million. Accordingly,during 2005, we recorded a charge of approximately $6.0 million whichrepresented the net present value of these excess commitments at that time. UnderSFAS No. 146, the remaining $1.2 million of these excess commitments wasrequired to be expensed over the remaining respective terms of the applicablemanufacturing and supply agreements, which ranged from two to five years. Werecorded restructuring expenses of $0.2 million related to the amortization ofthe net present value for these excess commitments during the six months endedJune 30, 2006. In addition, in January 2006, we amended a manufacturing andsupply agreement to provide for the suspension of certain manufacturingactivities in exchange for a reduced payment of $1.5 million of a$2.1 million excess future commitment. Accordingly, during the six monthsended June 30, 2006, we reduced the excess accrued restructuring liability by$0.6 million through a reduction to restructuring expense.

In October 2005,we sold our corporate headquarters and research facility for $51.25 million. Werealized proceeds, net of fees and expenses, of approximately $50.4 millionfrom this sale, and used approximately $31.6 million of the proceeds to retirethe outstanding debt obligation related to the facility. In connection with thesale of the facility, we executed a lease for approximately 65,000 square feetof office and laboratory space in this facility. As a result of the sale andpartial leaseback of the facility, we realized a total gain of approximately$10.5 million, of which we recognized approximately $1.4 million as a gainduring 2005. The remaining amount of approximately $9.1 million will berecorded as a reduction of rent expense over the initial term of the lease.During the six months ended June 30, 2006, we recorded a reduction ofapproximately $0.9 million to rent expense related to this deferred gain.

*Plenaxis*®* Disposition*

As noted above, onJune 19, 2006, our board of directors determined to cease our previouslyannounced process of actively seeking to dispose of our Plenaxis® assets through a license or sale transaction.We currently intend to voluntarily discontinue the limited sale anddistribution of the product in the United States as of August 31, 2006 and willnot pursue further the commercialization of Plenaxis® outside the United States. We will alsodiscontinue any remaining Plenaxis®-relatedactivities, except as necessary to support the wind-down of productdistribution in the United States. During this wind-down, we will continue toevaluate potential opportunities for this asset to the extent suchopportunities arise.

Due to thetermination of our active efforts to license or sell our Plenaxis® assets, we recorded charges of approximately$7.5 million during the three months ended June 30, 2006. Of this amount,non-cash charges of approximately $1.9 million and $1.7 million were incurredwith respect to Plenaxis®-relatedequipment and Plenaxis® inventory, respectively, to write down theseassets to their net realizable or salvage value. We had anticipated that theseassets would be used in connection with the commercialization of Plenaxis® outside of the United States by a third partyfollowing a license or sale transaction. At June 30, 2006, the estimated netrealizable value of Plenaxis® inventorywas zero and the estimated salvage value of Plenaxis®-related equipment was $45,000.

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During the threemonths ended June 30, 2006, we also recorded a charge of approximately $3.8million related to commitments under certain Plenaxis® manufacturing and supply agreements, which weconcluded will provide no future economic benefit to us, and other associatedcosts of approximately $0.1 million. The $3.8 million charge represents the netpresent value of approximately $4.9 million of the aggregate future cashcommitments under these agreements. We expect to expense the balance of $1.1million over the remaining respective terms of the applicable manufacturing andsupply agreements, which range from one to four years. We currently have anaggregate of approximately $9.2 million in outstanding cash obligations underthird-party manufacturing and supply agreements which are due in varying annualamounts through 2010.

*Accumulated Deficit*

Most of ourexpenditures to date have been for drug development, the development of ourdrug discovery technologies, commercialization activities related to Plenaxis® and for general and administrative expenses.Our accumulated deficit as of June 30, 2006 was approximately $327.2 million. Wehave incurred net operating losses since fiscal 2000 and expect to continue toincur such losses for at least the next several years.

**Critical Accounting Policies**

While our significantaccounting policies are more fully described in Note 2 to our condensedconsolidated financial statements appearing elsewhere in this report, webelieve the following accounting policies to be critical:

*Useof Estimates.* We prepare our financial statements inaccordance with accounting principles generally accepted in the United States.These principles require that we make estimates and use assumptions that affectthe reporting of our assets and our liabilities as well as the disclosures thatwe make regarding assets and liabilities and revenues and expenses that arecontingent upon uncertain factors as of the reporting date. Such estimatesrelate to the useful lives of fixed assets, the net realizable value ofinventory, accrued restructuring expenses, other accrued expenses, otherreserves, and assumptions used in valuing stock-based compensation awards. Actualpayments, and thus our actual results, could differ from our estimates and such differences may be material to ourcondensed consolidated financial statements.

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*Restructuringand Asset Impairment Expenses.* On May 19, 2005, our board ofdirectors approved a strategic restructuring to focus the Company’s resourceson our most promising assets and programs and significantly reduce our coststructure. The strategic restructuring included voluntarily discontinuingpromotional activities related to Plenaxis® and the sale ofPlenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM; andimplementing a reduction of our 182-person headcount by approximately 60%. Therestructuring charges were accounted for in accordance with SFAS No. 146.In determining the manufacturing commitments restructuring expense andinventory impairment, various assumptions were made with respect to futurePlenaxis® sales. These assumptions will be reviewedperiodically and should these estimates change, adjustments to the net presentvalue of remaining commitments as well as inventory may be necessary in futureperiods.

On June 19, 2006,our board of directors determined to cease our previously announced process ofactively seeking to dispose of our Plenaxis® assets through a license or sale transaction.We currently intend to voluntarily discontinue the limited sale anddistribution of the product in the United States as of August 31, 2006 and willnot pursue further the commercialization of Plenaxis® outside the United States. We will alsopromptly discontinue any remaining Plenaxis®-related activities, except as necessary to support thewind-down of product distribution in the United States. During this wind-down,we will continue to evaluate potential opportunities for this asset to theextent such opportunities arise. Please refer to the discussion of *Impairment or Disposal of Long-Lived Assets*and *Inventory* appearing directly below, as well as Note 3 —Restructuring and Asset Impairment, included in our condensed consolidatedfinancial statements appearing elsewhere in this report, for additionalinformation regarding our strategic restructuring and the cessation of ouractive efforts to dispose of our Plenaxis® assets.

*Impairmentor Disposal of Long-Lived Assets*. SFAS No. 144 requires thatif the sum of the undiscounted future cash flows expected to result from acompany’s asset, net of interest charges, is less than the reported value ofthe asset, an asset impairment may be recognized in the financial statements ifthe reported value of the asset exceeds the fair value determined by either aquoted market price, if any, or a value determined by utilizing a discountedcash flow technique. We evaluate our property, plant and equipment forimpairment whenever indicators of impairment exist. The amount of theimpairment to be recognized is calculated by subtracting the fair value of theasset from the reported value of the asset.

We believe thatthe application of SFAS No. 144 and the method used to determine the impairmentof our property, plant and equipment involve critical accounting estimatesbecause they are highly susceptible to change from period to period and becausethey require management to make assumptions about future cash flows, includingresidual values. In addition, we believe that had alternative assumptions beenused, the impact on the assets reported on our balance sheet, as well as ournet loss, may have been material.

*Inventory.*We value inventory atcost or, if lower, market value. We determine cost using the first-in,first-out method. We analyze our inventory levels quarterly and write downinventory that has become obsolete, inventory that has a cost basis in excessof its expected net realizable value and inventory in excess of expected requirements,to cost of goods sold. Expired inventory is disposed of and the related costsare written off. If actual market conditions are less favorable than asestimated by us, additional write-downs of existing inventory may be requiredin future periods. We classify any inventory that we estimate to be sold in thenext twelve months as current with the remaining amount classified as long-terminventory. In connection with our strategic restructuring announced in May2005, we discontinued promotional activities related to Plenaxis® andthe sale of Plenaxis® for new patients in the United States. Asa result, we wrote down approximately $3.5 million of inventory during thethree months ended June 30, 2005 that we estimated to be in excess of expectedrequirements. The remaining inventory balance consisted of materialsthat were expected to be used in connection with the commercialization ofPlenaxis® in Europe and other territories by a thirdparty following a license or sale transaction relating to the product. Due tothe cessation in June 2006 of our active efforts to license or sell ourPlenaxis® assets, we wrote down the remaininginventory of approximately $1.7 million to zero during the three months endedJune 30, 2006. This amount was classified in cost of goods sold in thecondensed consolidated statement of operations for that period.

*RevenueRecognition.*We follow the provisions of the Securities andExchange Commission’s Staff Accounting Bulletin No. 104, *RevenueRecognition*. We recognize revenues from product sales in the periodwhen the product is delivered, provided there is persuasive evidence that anarrangement exists, the price is fixed or determinable and collection of therelated receivable is reasonably assured. Revenues are recorded net 

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of applicable allowances as provision is made forestimated sales returns, rebates, distributor fees and other applicablediscounts and allowances. Shipping and other distribution costs are charged tocost of product sales. Product revenues are related solely to Plenaxis® for all periods presented in this report. Inconnection with our strategic restructuring announced in May 2005, wevoluntarily discontinued promotional activities related to Plenaxis® and the sale of Plenaxis® fornew patients in the United States. In June 2006, we announced that we wereceasing our previously announced process of actively seeking to dispose of ourPlenaxis® assets, and that we intended to voluntarilydiscontinue the sale and distribution of Plenaxis® to all patients. We expect that the productwill continue to be available in the United States through August 31, 2006.

We currentlyprovide substantially all of our distributors with payment terms of up to 120days on purchases of Plenaxis®. Through June 30, 2006, payments have generally beenmade in a timely manner.

We analyze ourmultiple element arrangements to determine whether the elements can beseparated and accounted for individually as separate units of accounting inaccordance with EITF No. 00-21, *RevenueArrangements with Multiple Deliverables.* Nonrefundable upfrontlicensing 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 during which we are obligated to perform those services.Milestone payments are recognized as licensing revenue or product sales whenthe performance obligations, as defined in the contract, are achieved. Performancemilestones typically consist of significant milestones in the developmentand/or commercialization of a product such as obtaining approval fromregulatory agencies and the achievement of targeted sales levels.Reimbursements of development costs are recognized as licensing revenue as therelated costs are incurred.

When the periodover which a fee or payment will be recognized as revenue cannot bespecifically identified from the contract, management estimates the deferralperiod based upon other critical factors contained within the contract,including but not limited to patent life or contract term. We continuallyreview these estimates which could result in a change in the deferral periodand might impact the timing and the amount of revenue recognized.

*Stock-basedCompensation.*Effective January 1, 2006, we adopted the fairvalue recognition provisions of Statement of Financial Accounting Standards No.123R, *Share-Based Payment — An Amendment of FASBStatements No. 123 and 95,*or SFAS No. 123R. SFAS No. 123R requirescompanies to measure compensation cost for all share-based awards at fair valueon the date of grant and recognize it as expense ratably over the requisiteservice period of the award. We use the Black-Scholes option pricing model tocalculate the fair value of share-based awards on the grant date. This optionpricing model requires the input of highly subjective assumptions, includingthe term during which the awards are expected to be outstanding and the pricevolatility of the underlying stock. In addition, SFAS No. 123R requiresforfeitures, which represent only the unvested portion of a surrendered award,to be estimated at the time of the grant and revised, if necessary, insubsequent periods. Please refer to Note 2 — Summary of Significant AccountingPrinciples — Stock-Based Compensation, included in the condensed consolidatedfinancial statements appearing elsewhere in this report, for additionalinformation regarding our adoption of SFAS No. 123R.

Management hasdiscussed the development, selection and disclosure of these criticalaccounting policies with the audit committee of our board of directors.

**Results of Operations**

**Three Months Ended June 30, 2006 Compared To Three Months Ended June 30, 2005**

Revenues fromsales of Plenaxis® for the three months ended June 30, 2006 wereapproximately $73,000 compared to approximately $0.4 million for thecorresponding period in 2005. Thedecrease in revenues was due to the voluntary discontinuation of promotionalactivities related to Plenaxis® and the sale of Plenaxis® fornew patients in the United States in May 2005. We expect to have aninsignificant amount of revenues from Plenaxis® sales through August 2006. Other sources ofrevenues during 2006 and thereafter may include potential payments under ourcurrent or future partnerships relating to our DirectSelectTM drug discoverytechnology, or future partnerships relating to PPI-2458 or our other researchprograms or technologies, in each case if consummated. The amount and timing ofthese other potential sources of revenues will depend on the success of ourDirectSelectTM technology and our PPI-2458 clinical development program, and ourability to enter into partnerships with respect to these and other programswhich provide cash to us. We cannot assure investors as to if or when we willreceive any such revenues.

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Cost of goods sold for the three months ended June 30,2006 was approximately $5.5 million compared to approximately $3.6 million forthe corresponding period in 2005. During the three months ended June 30, 2006,we recorded a charge of $3.8 million related to excess Plenaxis®-related manufacturing andsupply commitments and a non-cash impairment charge of approximately $1.7million related to inventory due to the cessation of our active efforts tolicense or sell our Plenaxis® assets, which charges were recorded in cost ofgoods sold. During the three months ended June 30, 2005, we recorded a non-cashimpairment charge of approximately $3.5 million related to inventory due to thediscontinuation of promotional activities relating to Plenaxis® inthe United States. We expect cost of goods sold to be substantially lower forthe remainder of 2006.

We currently haveseveral ongoing research and development programs. Using industry estimates,typical drug development programs may last for ten or more years and may costhundreds of millions of dollars to complete. As our programs progress, weassess the possibility of entering into partnerships or other arrangements tooffset a portion or all of our research and development costs. The ultimatesuccess of our research and development programs and the impact of theseprograms on our operations and financial results cannot be accurately predictedand will depend, in large part, upon the outcome and timing of many variablesoutside of our control.

Members of ourresearch and development team typically work on a number of projectsconcurrently. In addition, a substantial amount of our fixed costs such asfacility and equipment depreciation, utilities and maintenance are shared byour various programs. Accordingly, we have not specifically identified, and donot plan to specifically identify, all costs related to each of our researchand development programs. During the three months ended June 30, 2006 and 2005,the majority of our research and development expenses consisted of salaries,benefits, clinical trial costs, manufacturing costs and lab supplies related tothe development of our DirectSelectTM technology, as well as our PPI-2458,Plenaxis® and ApanTM clinical development programs andother research programs. In addition, research and development expenses for thethree months ended June 30, 2006 include stock-based compensation expense dueto our adoption of SFAS No. 123R effective January 1, 2006.

Research anddevelopment expenses for the three months ended June 30, 2006 decreased 2% toapproximately $6.1 million, from approximately $6.3 million for thecorresponding period in 2005. Total personnel-related research and developmentexpenses for the three months ended June 30, 2006 increased approximately $0.2million due to our adoption of SFAS No. 123R effective January 1, 2006.Stock-based compensation expense of approximately $0.7 million for the threemonths ended June 30, 2006 more than offset lower personnel-related expensesresulting from our strategic restructuring announced in May 2005. The decreasein research and development expenses reflects reduced spending in our clinicaland preclinical development programs. Due to our strategic restructuring,spending on the Plenaxis® and ApanTM programs during the three monthsended June 30, 2006 decreased by approximately $78,000 and $36,000,respectively, and spending on the PPI-2458 program increased by approximately$16,000. The remaining decrease in research and development expenses during thethree months ended June 30, 2006 reflects lower depreciation and equipmentmaintenance expense of approximately $0.6 million, which was due primarily tothe sale of our corporate headquarters and research facility in October 2005,offset by a net increase in third-party laboratory services and supply expensesof approximately $0.4 million. Although we are unable to predict the preciselevel of spending on individual research and development or clinical programsdue to the uncertain nature of these activities, we expect our research anddevelopment expenses to increase slightly during 2006 and thereafter, as wecontinue to develop and enhance our DirectSelectTM technology and utilize thistechnology to support partnerships and internal programs, continue our clinicaltrial of PPI-2458 and advance our other research programs.

There were nosales and marketing expenses for the three months ended June 30, 2006, comparedto sales and marketing expenses of approximately $2.1 million for the correspondingperiod in 2005. The decrease resulted from the voluntary discontinuation ofpromotional activities related to Plenaxis® inthe United States. Beginning in 2004 through May 2005, we promoted Plenaxis® in the United States through our own marketingand sales team. In the future, we intend to partner products that mayultimately result from our discovery and development efforts at the appropriatetime in an effort to maximize the value of the product to the Company. Accordingly,we currently do not intend to independently market future products and do notexpect to incur significant sales and marketing expenses during 2006 orthereafter.

General andadministrative expenses were approximately $2.0 million for the three monthsended June 30, 2006 and 2005. Increases in total personnel-related general andadministrative expenses for the three 

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months ended June 30, 2006 were offset by decreasedprofessional service expenses and lower occupancy costs due to the sale of ourcorporate headquarters and research facility in October 2005. Totalpersonnel-related general and administrative expenses increased $0.4 millioncompared to the corresponding period in 2005 due primarily to our adoption ofSFAS No. 123R effective January 1, 2006. Stock-based compensation expensewas approximately $0.3 million for the three months ended June 30, 2006. We expect that general and administrativeexpenses will remain consistent with current levels for the remainder of 2006.

As described inmore detail in Note 4—Litigation, included in our condensed consolidatedfinancial statements appearing elsewhere in this report, in December 2004 andJanuary 2005, the Company and certain of its current and former executiveofficers were named as defendants in three purported class action securitieslawsuits filed in the United States District Court for the District ofMassachusetts. The complaints were consolidated into one action in April 2005. Managementbelieves that the allegations against the Company are without merit, and theCompany intends to vigorously defend against the plaintiffs’ claims. As thislitigation is in an early stage, management is unable to predict its outcome orits ultimate effect, if any, on our financial condition. However, we expectthat the costs and expenses related to this litigation may be significant. Ourcurrent director and officer liability insurance policies (which, subject tothe terms and conditions thereof, also provide “entity coverage” for theCompany for this litigation) provide that the Company is responsible for thefirst $2.5 million of such costs and expenses. Also, a judgment in orsettlement of these actions could exceed our insurance coverage. Accordingly,if we are not successful in defending these actions, our business and financialcondition could be adversely affected.

Restructuring and asset impairment expensesfor the three months ended June 30, 2006 and 2005 were $2.1 million and $28.7million, respectively. Please refer to the discussion under “Overview — 2005Strategic Restructuring” and “Critical Accounting Policies” in this Item 2, aswell as Note 3 — Restructuring and Asset Impairment, included in our condensedconsolidated financial statements appearing elsewhere in this report, foradditional information regarding these expenses.

Net interest income for the three months ended June 30,2006 was approximately $0.6 million compared to net interest expense ofapproximately $78,000 for the corresponding period in 2005. This change was dueprimarily to the retirement of theoutstanding debt related to our corporate headquarters and research facility,which we sold in October 2005.

The provision for income taxes for the three months ended June 30, 2006and 2005 was zero. We anticipate that we will continue to be in a net operatingloss carryforward position for the next several years. Therefore, no taxbenefit from our operating losses was recognized.

For the three months ended June 30, 2006, net loss was approximately$15.1 million, or $1.42 per share, compared to a net loss of approximately$42.4 million, or $4.04 per share, for the three months ended June 30, 2005.

**Six Months Ended June 30, 2006 Compared To Six Months Ended June 30, 2005**

Revenues for thesix months ended June 30, 2006 were approximately $0.2 million compared toapproximately $1.3 million for the corresponding period in 2005. Revenues inboth periods were related primarily to sales of Plenaxis®. The decrease in revenues was due to the voluntary discontinuation ofpromotional activities related to Plenaxis® andthe sale of Plenaxis® for new patients in the UnitedStates in May 2005.

Cost of goods sold for the six months ended June 30,2006 was approximately $5.6 million compared to approximately $3.8 millionfor the corresponding period in 2005. During the six months ended June 30, 2006,we recorded a charge of $3.8 million related to excess Plenaxis®-related manufacturing andsupply commitments and a non-cash impairment charge of approximately $1.7million related to inventory due to the termination of our active efforts tolicense or sell our Plenaxis® assets, which charges were recorded in cost ofgoods sold. During the six months ended June 30, 2005, we recorded a non-cashimpairment charge of approximately $3.5 million related to inventory due to thediscontinuation of promotional activities relating to Plenaxis® inthe United States.

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Research and development expenses for the six monthsended June 30, 2006 decreased 7% to approximately $12.5 million, fromapproximately $13.6 million for the corresponding period in 2005. Totalpersonnel-related research and development expenses for the six months endedJune 30, 2006 increased approximately $0.3 million due to our adoption of SFASNo. 123R effective January 1, 2006. Stock-based compensation expense of approximately$1.4 million for the six months ended June 30, 2006 more than offset lowerpersonnel-related expenses resulting from our strategic restructuring announcedin May 2005. The decrease in research and development expenses reflects reducedspending in our clinical and preclinical development programs. Due to ourstrategic restructuring, spending on the Plenaxis® andApanTM programs during the six months ended June 30, 2006 decreased byapproximately $0.7 million and $0.2 million, respectively, and spending on thePPI-2458 program increased by approximately $0.5 million. The remainingdecrease in research and development expenses during the six months ended June30, 2006 reflects lower depreciation and equipment maintenance expense ofapproximately $1.2 million, which was due primarily to the sale of ourcorporate headquarters and research facility in October 2005, and lowerallocation of both corporate personnel and related expenses of approximately$0.2 million, offset by a net increase in third-party laboratory services andsupply expenses of approximately $0.7 million.

There were nosales and marketing expenses for the six months ended June 30, 2006, comparedto sales and marketing expenses of approximately $5.8 million for thecorresponding period in 2005. The decrease resulted from the voluntarydiscontinuation of promotional activities related to Plenaxis® in the United States.

General andadministrative expenses were approximately $3.9 million for the six monthsended June 30, 2006 compared to approximately $4.0 million for thecorresponding period in 2005. Total personnel-related general andadministrative expenses for the six months ended June 30, 2006 increasedapproximately $0.4 million due to our adoption of SFAS No. 123R effectiveJanuary 1, 2006. Stock-based compensation expense of approximately $0.5 millionfor the six months ended June 30, 2006 more than offset lower personnel-relatedexpenses resulting from our strategic restructuring announced in May 2005. Thedecrease in general and administrative expenses reflects reduced spending ofapproximately $0.3 million for professional services and lower occupancy costsof approximately $0.2 million due to the sale of our corporate headquarters andresearch facility in October 2005.

Restructuring and asset impairment expensesfor the six months ended June 30, 2006 and 2005 were $1.6 million and $28.7million, respectively. Please refer to the discussion under “Overview — 2005Strategic Restructuring” and “Critical Accounting Policies” in this Item 2, aswell as Note 3 — Restructuring and Asset Impairment, included in our condensedconsolidated financial statements appearing elsewhere in this report, foradditional information regarding these expenses.

Net interest income for the six months ended June 30,2006 was approximately $1.2 million compared to net interest expense ofapproximately $0.2 million for the corresponding period in 2005. This changewas due primarily to the retirement of theoutstanding debt related to our corporate headquarters and research facility,which we sold in October 2005.

The provision for income taxes for the six months ended June 30, 2006and 2005 was zero. We anticipate that we will continue to be in a net operatingloss carryforward position for the next several years. Therefore, no taxbenefit from our operating losses was recognized.

For the six months ended June 30, 2006, net loss was approximately $22.1million, or $2.10 per share, compared to a net loss of approximately $54.7million, or $5.22 per share, for the six months ended June 30, 2005.

**Liquidity and Capital Resources**

To date, ouroperations and capital requirements have been financed primarily with theproceeds of public and private sales of common stock and preferred stock,payments received under research and development partnerships and collaborativeagreements, investment income, revenues from product sales and proceeds fromthe October 2005 sale of our corporate headquarters and research facility. 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.

At June 30, 2006,we had cash and cash equivalents of approximately $46.2 million and workingcapital of approximately $38.1 million, compared to cash, cash equivalents andmarketable securities of approximately $62.6 million and working capital ofapproximately $54.1 million at December 31, 2005.

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In May 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. The strategic restructuring included voluntarilydiscontinuing promotional activities related to Plenaxis® and the sale of Plenaxis® fornew patients in the United States; voluntarily suspending the ongoing clinicaldevelopment of ApanTM; and implementing a headcount reduction of approximately60%.

We expect tocontinue to have net operating losses for the next several years as we investin developing and enhancing our DirectSelectTM technology, and advancingPPI-2458 and potentially other proprietary compounds through clinical andpreclinical development. In order to achieve our business objective, we mustsuccessfully carry out the following key elements of our operating plan:continue development and enhancement of our DirectSelectTM technology and usethis technology to support pharmaceutical partnerships in drug discovery anddevelopment that will provide significant cash to us, as well as to expand ourown proprietary development pipeline; and advance PPI-2458 through a phase 1trial in cancer patients and continue preclinical evaluation of the compound ininflammatory and autoimmune disorders, including rheumatoid arthritis, with thegoal of partnering this program in one or more indications as clinicaldevelopment advances. Given the uncertainty of timing related to the keyelements of our strategy, we are not providing earnings or cash guidance forquarterly or annual periods.

We believe that our existing cash and investments ofapproximately $46.2 million at June 30, 2006 will be sufficient to meet ourworking capital and capital expenditure needs, at current levels, throughapproximately the end of 2007. If we are able to successfully carry out keyelements of our strategic operating plan by establishing partnerships relatingto our DirectSelectTM technology or our PPI-2458 program that providesignificant cash to us, we may have available resources to allow us to pursueour strategic operating plan beyond the end of 2007. However, we cannot assureinvestors that we will be able to enter into appropriate collaborativearrangements relating to our DirectSelectTM technology or our PPI-2458 programthat will provide significant cash to us. If we are unable to successfully andin a timely manner carry out key elements of our strategic operating plan, wewill have to obtain additional funding in 2007 or significantly modify ourstrategic operating plan, including by curtailing, eliminating or disposing ofcertain elements of our operations. We have no committed sources of capital anddo not know whether additional financing will be available when needed, or, ifavailable, that the terms will be acceptable to us. If we are required to raisemoney in the future and we experience difficulties or are unable to do so, itcould become necessary for us to cease operations or seek protection understate or federal insolvency or bankruptcy laws.

In June 2006, weannounced that we are actively exploring strategic options which may beavailable to the Company. These options include principally a financingtransaction or a business combination with a public or private company. We haveengaged an investment banking firm to advise and assist us in these efforts. Nodecision has been made as to whether we will engage in a financing, a businesscombination or any other transaction. There can be no assurance that theseefforts will result in a successful financing, a business combination or in anyother transaction.

For the six months ended June 30, 2006, net cash ofapproximately $16.4 million was used in operating activities, compared toapproximately $26.3 million used in operating activities during the six monthsended June 30, 2005. During the six months ended June 30, 2006, our use of cashin operations was due principally to our net loss of approximately $22.1million and the impact of non-cash charges such as restructuring and assetimpairment charges of approximately $7.0 million, depreciation of approximately$0.6 million and stock-based compensation of approximately $1.8 million, offsetby non-cash gains of approximately $0.9 million related to the amortization ofthe deferred gain on the sale of our facility. Our use of cash in operationsfor the six months ended June 30, 2006 also includes a reduction ofapproximately $0.9 million in accounts payable and accrued expenses. Inaddition, we made cash payments of approximately $1.6 million associated withaccrued restructuring charges during the six months ended June 30, 2006. Duringthe six months ended June 30, 2005, our use of cash in operations was dueprincipally to our net loss of approximately $54.7 million and the reduction inaccounts payable and accrued expenses of approximately $3.5 million, offset bynon-cash asset impairment expenses of approximately $19.7 million, anincrease in accrued restructuring costs of approximately $7.8 million, areduction in inventory of approximately $2.7 million and depreciation ofapproximately $1.7 million.

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Our cash utilization will continue for 2006 andthereafter as we continue to develop and advance our research and developmentinitiatives. The actual amount of overall expenditures will depend on numerousfactors, including the timing of expenses, the timing and terms ofcollaboration agreements or other strategic transactions, if any, the timingand progress of our research and development efforts, and the timing ofpotential costsand expenses associated with the defense of the pending purported classaction securities lawsuit.

Netcash provided by investing activities of approximately $4.9 million for the sixmonths ended June 30, 2006 consisted primarily of maturities of marketablesecurities of approximately $5.6 million offset by purchases of property andequipment of approximately $0.7 million. This compares to net cash provided byinvesting activities of approximately $62.1 million for the correspondingperiod in 2005, which was related primarily to net sales and maturities ofmarketable securities of approximately $62.7 million.

Our financingactivities for the six months ended June 30, 2006 consisted of approximately$0.6 million in proceeds from the issuance of common stock. Our financingactivities for the six months ended June 30, 2005 consisted of $0.3 million indebt principal repayments offset by approximately $95,000 in proceeds from theissuance of common stock.

At December 31, 2005, we hadprovided a valuation allowance of approximately $133.5 million for our deferredtax assets. The valuation allowance represents the value of the deferred taxassets. Due to anticipated operating losses in the future, we believe that itis more likely than not that we will not realize the net deferred tax assets inthe future and we have provided an appropriate valuation allowance.

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

The primary objective ofour investment activities is to preserve principal while at the same timemaximizing the income we receive from our investments without significantlyincreasing risk. We have not entered into any instruments for trading purposes.Some of the securities that we invest in may have market risk. This means thatan increase 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. As of June 30, 2006, we did not own anymarketable securities. As of December 31, 2005, we owned approximately $5.5million of marketable securities with a weighted-average maturity ofapproximately four months. An immediate hypothetical 100 basis point increasein interest rates would have resulted in an approximate $5,000 decrease in thefair value of our marketable securities as of December 31, 2005. Due to theconservative nature of our investments and relatively short duration, interestrate risk is mitigated.

**ITEM 4.**                    CONTROLS ANDPROCEDURES.

*(a)*          *Disclosure Controls andProcedures*.

The Company’smanagement, with the participation of our chief executive officer and chieffinancial officer, has evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June30, 2006. Based on such evaluation, our chief executive officer and chieffinancial officer have concluded that, as of June 30, 2006, the Company’sdisclosure controls and procedures were effective in ensuring that informationrequired to be disclosed by the Company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in applicable rules and forms of the Securities andExchange Commission, and is accumulated and communicated to the Company’smanagement, including the Company’s chief executive officer and chief financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.

*(b)          Changes in Internal Control Over Financial Reporting*.

There have notbeen any changes in the Company’s internal control over financial reporting (assuch term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)during the three months ended June 30, 2006 that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

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**PART II. OTHER INFORMATION**

**ITEM 1.   LEGALPROCEEDINGS.**

As previously disclosed, in December 2004 and January2005, the Company, Chairman and (now former) Chief Executive Officer MalcolmGefter, President and (now former) Chief Operating Officer Kevin F. McLaughlin,Chief Financial Officer and Treasurer Edward C. English, and former Presidentand Chief Operating Officer William K. Heiden, were named as defendants inthree purported class action securities lawsuits filed in the United StatesDistrict Court for the District of Massachusetts.  In April 2005, these actions wereconsolidated, and the Court appointed lead plaintiffs and approved suchplaintiffs' selection of co-lead counsel. The consolidated actions are captioned IN RE PRAECIS PHARMACEUTICALS,INC. SECURITIES LITIGATION, Civil Action No. 04-12581-GAO.  In August 2005, lead plaintiffs filed aconsolidated amended complaint.  The leadplaintiffs generally allege securities fraud during the period from November25, 2003 through December 6, 2004.  In September2005, the Company and the individual defendants moved to dismiss theconsolidated amended complaint in its entirety. In January 2006, the Court heard oral argument on this motion and tookthe matter under advisement.

There have been no material developments with respectto this litigation since the filing of our Quarterly Report on Form 10-Q forthe three months ended March 31, 2006, which was filed with the Securities andExchange Commission on May 5, 2006.

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**ITEM 1A.**   RISKFACTORS.

*The risks and uncertainties described below are notthe only ones we face. Additional risks and uncertainties not presently knownto us or that are currently deemed immaterial may also impair our business,financial condition and results of operations. If any of these risks actuallyoccur, our business, financial condition and results of operations could bematerially adversely affected.*

**We have a historyof losses and we may not be profitable in the future.**

We cannot assure investors that we will be profitablein the future or, if we attain profitability, that it will be sustainable. InMay 2005, our board of directors approved a strategic restructuring to focusthe Company’s resources on our most promising assets and programs andsignificantly reduce our cost structure. Under our current strategic operatingplan, we are focusing our resources on continuing to develop and enhance ourDirectSelectTM technology and seeking to enter into pharmaceutical partnershipsfor drug discovery and development utilizing this technology that will providesignificant cash to us, as well as to expand our own proprietary developmentpipeline; and advancing the clinical development of PPI-2458, with a goal ofpartnering this program in one or more indications as clinical developmentadvances.

To date, we have derived substantially all of ourrevenues from payments under corporate collaboration and license agreements,and from product sales. Our marketing and selling efforts with regard toPlenaxis® in the United States were not commerciallysuccessful and we currently intend to voluntarily discontinue the limited saleand distribution of the product in the United States in August 2006. Moreover,in June 2006, we announced the termination of our active efforts to license orsell our Plenaxis® assets. We may be unable to successfullydiscover, develop or market any other products in the future. In addition, we maybe unable to enter into research collaborations or partnerships with respect toDirectSelectTM or PPI-2458 that provide significant cash to us. Our currentstrategic operating plan includes significant ongoing expenditures to supportthe continued enhancement of our DirectSelectTM technology and the continuationof our PPI-2458 clinical development program, and for general andadministrative purposes. As of June 30, 2006, we had an accumulated deficit ofapproximately $327.2 million. We expect that we will continue to incursignificant operating losses for at least the next several years, and we maynot be profitable in the future.

**If we are unable to successfully and in a timelymanner carry out key elements of our strategic operating plan, we will have to obtain additionalfunding in 2007 or significantly modify our strategic operating plan.**

If we are unable to successfully carry out keyelements of our strategic operating plan described in the immediately precedingrisk factor, we believe that our existing cash and investments of approximately$46.2 million at June 30, 2006 will be sufficient to meet our working capitaland capital expenditure needs, at current levels, through approximately the endof 2007. If we are able to successfully carry out key elements of our strategicoperating plan by establishing partnerships relating to our DirectSelectTMtechnology or our PPI-2458 program that provide significant cash to us, we mayhave available resources to allow us to pursue our strategic operating planbeyond the end of 2007, although we cannot provide any assurances as to if orfor how long we would be able to do so. If we are unable to successfully and ina timely manner carry out key elements of our strategic operating plan, we willhave to obtain additional funding in 2007 or significantly modify our strategicoperating plan, including by curtailing, eliminating or disposing of certainelements of our operations. We have no committed sources of capital and do notknow whether additional financing will be available when needed, or, ifavailable, that the terms will be acceptable to us.

To date, our operations and capital requirements havebeen financed primarily with the proceeds of public and private sales of commonstock and preferred stock, payments under research and development partnershipsand collaborative agreements, investment income, revenues from product salesand the net proceeds from the sale of our facility. However, there can be noassurance that we will be able to sell any securities, enter into additionalpartnerships and collaborative agreements or borrow funds in the future on favorableterms, or at all. If we raise additional funds by issuing equity securities,further dilution to existing stockholders will result, which could besubstantial. In addition, as a condition to investing in us, future investorsmay demand, and may be granted, rights superior to those of existingstockholders. We may also be required to take other actions, which may lessenthe value of our common stock or dilute our common stockholders, includingborrowing money on terms that are not favorable 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.

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**The outcome of ourexploration of strategic options is uncertain and this process entails numerousrisks and uncertainties.**

In June 2006, we announced that we are activelyexploring strategic options which may be available to the Company. These optionsinclude principally a financing transaction or a business combination with apublic or private company. We have engaged an investment banking firm to adviseand assist us in these efforts. No decision has been made as to whether we willengage in a financing, a business combination or other transaction as a resultof our exploration of available alternatives, and there can be no assurancethat any transaction will occur or, if a transaction does occur, the terms ortiming thereof or the impact thereof on our operating results or stock price. Theprocess of exploring strategic options entails numerous risks anduncertainties, including the following:

·                    the processwill likely be time-consuming and may disrupt our operations and divertmanagement’s attention;

·                    perceiveduncertainties as to our future direction may result in the loss of, or ourinability to attract, key employees or business partners;

·                    the processwill likely increase expenditures for professional advisors to assist inreviewing and evaluating possible strategic alternatives which may bepresented; and

·                    we may not beable to identify a financing, a business combination or other transaction thatwe determine is appropriate to pursue or that would achieve and enhanceshareholder value.

If we are unable to identify and conclude in a timelymanner a financing, a business combination or other transaction, we will needto consider other alternatives for the Company. Such alternatives would likelyinclude significantly modifying our strategic operating plan, including bycurtailing, eliminating or disposing of certain elements of our operations.

**If we engage in a strategic transaction, we will incura variety of costs and may never realize the anticipated benefits of such a transaction.**

We have announced that we are actively exploringstrategic options which may be available to the Company. If we proceed with astrategic transaction other than a financing transaction, the process ofintegrating our business with another business or consummating some otherstrategic transaction may result in unforeseen operating difficulties andexpenditures and may absorb significant management attention that wouldotherwise be available for the ongoing development of our business, which coulddiminish the value of any interest that our stockholders may have in a combinedor continuing company resulting from such a transaction. In addition to therisks associated with our business as it is currently constituted, reasons forthe failure of any strategic transaction could include risks associated withthe other party’s business, including all the risks associated with adevelopment-stage biotechnology or biopharmaceutical company. Moreover, we mayfail to realize the anticipated benefits of any transaction of this sort. Tothe extent we issue stock in a transaction, the ownership interest of ourstockholders will be diluted and such dilution could be substantial. Transactionsof this kind could also cause us to incur debt, expose us to future liabilitiesand result in expenses related to goodwill and other intangible assets.

**If we lose our key personnel or are unable to attractand retain additional skilled personnel, we may be unable to pursue the development of our drugdiscovery technology or our product research and development efforts, and ourongoing process of exploring strategic options could be adversely affected.**

We depend substantially on the principal members ofour management and scientific staff, including Kevin F. McLaughlin, ourPresident and Chief Executive Officer, and Richard W. Wagner, Ph.D., ourExecutive Vice President, Discovery Research. We do not have employmentagreements with any of our executive officers. Any officer or employee canterminate his or her relationship with us at any time and work for one of ourcompetitors. The loss of these key individuals could result in competitive harmbecause we could spend a significant amount of time and resources to replacethem and could experience delays in the development of our drug discoverytechnology or our product research and development efforts without theirexpertise.

Retaining our current employees and recruiting andretaining qualified personnel to perform future research and development workalso will be critical to our success. Competition for skilled personnel isintense and 

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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 strategicrestructuring in May 2005, our recent announcement of our exploration ofstrategic options for the Company and our limited resources compared to many ofour competitors, we may face additional challenges retaining our currentemployees, including, possibly, key members of our management and scientificstaff, and recruiting qualified personnel in the future. The failure of any keyemployee to perform in his or her current position, or our inability to attractand retain qualified personnel, as needed, would prevent us from continuing todevelop and enhance our DirectSelectTM technology and using this technology tosupport pharmaceutical partnerships that will provide significant cash to us,as well as expanding our own proprietary development pipeline and advancing ourPPI-2458 clinical development program. Such a failure or inability could alsohinder or delay, or adversely affect the outcome of, our ongoing process ofexploring strategic options. Depending on the outcome of this process, we mayalso incur significant costs relating to retention or severance of employees.

**Our DirectSelectTM drug discovery technology is stillunder development, and we may not be able to enter into pharmaceutical partnershipswith respect to this technology and/or discover compounds that will providesignificant cash to us.**

We are focusing our early stage drug discovery effortson our proprietary DirectSelectTM drug discovery technology, and our futuresuccess depends in large part on the successful development of this technology,as well as our ability to enter into collaborations relating to this technologythat will provide significant cash to us. If we are unable to obtain andmaintain adequate patent protection for our DirectSelectTM technology, anotherparty could offer drug discovery capabilities that directly compete with ourcapabilities or could attempt to block our ability to practice our technology. For example, there are published U.S. patentapplications that disclose variations of certain aspects of our DirectSelectTMtechnology. Furthermore, we cannot assure investors that this technologywill allow us to offer significant advantages over traditional drug discoverymethods or competing technologies. For example, the feasibility of creating andscreening ultra-large advanced combinatorial chemistry libraries resulting insuccessful leads is still in the development stage. Moreover, we may not beable to identify novel compounds from the libraries that we create that canaddress a broad spectrum of targets or that can be rapidly taken into clinicaldevelopment and that ultimately lead to marketable products. If we are not successfulin continuing to enhance this technology and in identifying productcandidate(s) using this technology for either a partner or for internaldevelopment, and in realizing significant proceeds through partnerships withrespect to, or capital infusions facilitated by, our DirectSelectTM technologyor such product candidate(s), we would need to significantly modify ouroperating plan.

Given our strategic focus on forming partnerships withrespect to our DirectSelectTM technology, we are also dependent upon the extentto which pharmaceutical and biotechnology companies continue to collaboratewith outside companies to obtain drug discovery expertise. Our revenue willdepend, in part, 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 includeaspects of the drug discovery process that pharmaceutical companies havetraditionally performed internally. Although there is a history amongpharmaceutical and biotechnology companies of outsourcing drug research anddevelopment functions, this practice may not continue. Our ability to convinceone or more of these companies to use and pay for our drug discovery technologyand capabilities rather than develop them internally will depend on manyfactors, including our ability to:

·                    continue toenhance and refine our DirectSelectTM technology resulting in the identificationof high-quality drug candidates under our current pilot study agreements,potentially leading to broader collaborations with the counter-parties to theseagreements or with other parties, and in connection with our internal drugdiscovery programs;

·                    identify andretain scientists and discover and utilize technology that are of the highestcaliber; and

·                    achieveintended results in a timely fashion, with acceptable quality and cost.

We also face and will continue to face intensecompetition from other companies for such collaborative arrangements, andtechnological and other developments by our competitors may make it moredifficult for us to establish such relationships. In addition, perceiveduncertainties as to our future direction following our recent announcementregarding the exploration of financing alternatives and other strategic optionsmay make it more 

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difficult for us to attract collaborators. If we areunable to continue to attract collaborators, we may never generate revenuesfrom our DirectSelectTM technology and would be forced to significantly modifyour operating plan.

**We may be unable to enter into and maintain corporatecollaborations necessary to support the discovery and development of productsusing our DirectSelectTM technology or the further development and potentialcommercialization of PPI-2458 or other potential products in the future.**

One of our key business objectives is to utilize ourDirectSelectTM and other proprietary technologies to discover, in a rapid andefficient manner, novel, orally-available compounds with the potential toaddress unmet medical needs or improve existing therapies. We intend tocollaborate with pharmaceutical and biotechnology companies on the discoveryand development stages for these compounds across a broad range of therapeuticareas. We also intend to select promising compounds that we discover to retainfor internal development and will seek to partner these compounds at variousstages of development in an effort to optimize their value to the Company. In addition,we have announced our intention to partner our PPI-2458 program in one or moreindications as development advances. We do not currently intend toindependently market the products that may ultimately result from our discoveryand development efforts. We cannotassure investors that we will be able to enter into and maintainpartnerships and corporate collaborations in a timely manner and on favorableterms, if at all. Moreover, perceiveduncertainties as to our future direction following our recent announcementregarding our exploration of financing alternatives and other strategic optionsmay make it more difficult for us to attract collaborators. Even if we are ableto enter into such arrangements, we cannot assure our investors that our futurecollaborators will meet their obligations to us under our collaborationagreements. If a partner terminates its agreement with us or fails to performits obligations, it may delay the discovery and development of productcandidates. As a result, we could have to devote unforeseen additionalresources to drug discovery and development or be forced to significantlymodify our operating plan.

**We are subject to extensive government regulation thatincreases our costs and could prevent us from developing, and ultimately commercializing,potential products.**

The development and sale of pharmaceutical products,including Plenaxis®,PPI-2458 or other product candidates we may discover, is subject to extensiveregulation by governmental authorities. Obtaining regulatory approval typicallyis costly and takes many years; maintaining regulatory approval also requiressubstantial resources. Regulatory authorities, most importantly, the FDA, havesubstantial discretion to place on clinical hold or terminate clinical trials,delay, withhold or withdraw registration and marketing approval in the UnitedStates, and effectively mandate product recalls. Failure to comply withregulatory requirements may result in criminal prosecution, civil penalties,recall or seizure of products, total or partial suspension of production orinjunction. Outside the United States, we can market a product only if wereceive marketing authorization from the appropriate regulatory authorities.This foreign regulatory approval process includes all of the risks associatedwith the FDA approval process, and may include additional risks.

To gain regulatory approval from the FDA and foreignregulatory authorities for the commercial sale of any product, we mustdemonstrate in clinical trials, and satisfy the FDA and foreign regulatoryauthorities as to, the safety and efficacy of the product. If we develop aproduct to treat a long-term, recurrent or terminal disease, such as cancer, wemust gather data over an extended period of time. There are many risks associatedwith our clinical trials. For example, we may discover that the product we aretesting is not effective, despite positive results in preclinical studies. Whileour compound, PPI-2458, has been shown to inhibit its target enzyme, MetAP-2,in preclinical and early clinical testing, we do not know if this willultimately result in an effective treatment for cancer or any other disease. Wealso may be unable to achieve the same level of success in later trials as wedid in earlier ones. Additionally, data we obtain from preclinical and clinicalactivities are susceptible to varying interpretations that could impederegulatory approval. Furthermore, patients may experience adverse events whileparticipating in a clinical trial that are unrelated to our product, but thatnevertheless may affect the statistical analysis of the safety and efficacy ofPPI-2458, potentially slow the rate of subject accrual in this trial orotherwise adversely affect the clinical trial. If we obtain regulatory approvalfor a product, the approval will be limited to those diseases for which ourclinical trials demonstrate the product is safe and effective.

In addition, many factors could delay or result intermination of our ongoing or future clinical trials. For example, results fromongoing preclinical studies or analyses could raise concerns over the safety orefficacy of a product candidate. In March 2004, the FDA placed our phase 1clinical trial of PPI-2458 on clinical hold due to non-clinical study findingswith PPI-2458. Although we subsequently received clearance from the FDA toresume 

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clinical testing of PPI-2458 in June 2004, we cannotassure investors that the FDA will not place this or other clinical trials onhold in the future or that we will be able to resolve any such clinical hold ina timely manner, or at all. A clinical trial may also experience slow patientenrollment. A study could also be delayed due to lack of sufficient drugsupply. Patients may experience adverse medical events or side effects, andthere may be a real or perceived lack of effectiveness of, or of safety issuesassociated with, the drug we are testing. 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, and comparable foreign regulatory authorities,have considerable discretion in determining whether to grant marketing approvalfor a drug, and may delay or deny approval even in circumstances where theapplicant’s clinical trials have proceeded in compliance with establishedprocedures and regulations and have met the established end-points of thetrials. Challenges to regulatory determinations are generally time-consumingand costly, and rarely, if ever, succeed. Although we received FDA approval tomarket Plenaxis® inthe United States in November 2003 and in Germany in September 2005, we cangive no assurance that we will obtain marketing approval for PPI-2458 or anyother potential product candidate.

Any regulatory approval may be conditioned uponsignificant labeling requirements and, as in the case of the FDA approval ofPlenaxis®,marketing restrictions and post-marketing study commitments. Such labeling andmarketing restrictions could, and in the case of Plenaxis® inthe United States, did, materially adversely affect the marketability and/orvalue of the product. As part of our strategic restructuring announced in May2005, we voluntarily discontinued promotional activities related to Plenaxis® and the sale of Plenaxis® fornew patients in the United States. In addition, although Plenaxis® wasapproved in Germany, our former partner elected to terminate its agreement withus. In June 2006, we announced that we will cease the limited sale anddistribution of Plenaxis in the United States and will not pursue further thecommercialization of Plenaxis® outside the United States.

Even if regulatory approval is obtained for a product,the product and the manufacturing facilities for the product will be subject tocontinual review and periodic inspection by regulatory authorities. Laterdiscovery of previously unknown problems with a product, manufacturer orfacility may result in restrictions on the product, the manufacturer or us,including withdrawal of the product from the market. The FDA and comparableforeign regulatory authorities stringently apply 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 complycan, among other things, result in fines, denial or withdrawal of regulatoryapprovals, product recalls or seizures, operating restrictions, injunctions andcriminal prosecution. If there are any modifications to a product, furtherregulatory approval will be required.

In addition, manufacturing, sales, promotion, andother 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, marketingand scientific/educational programs must comply with the anti-kickbackprovisions of the Social Security Act, the False Claims Act, and similar statelaws. Pricing and rebate programs must comply with pricing and reimbursementrules, including the Medicaid rebate requirements of the Omnibus BudgetReconciliation Act of 1990 and the Veteran’s Health Care Act. If products aremade available to authorized users of the Federal Supply Schedule of theGeneral Services Administration, additional laws and requirements apply. All ofour activities are potentially subject to federal and state consumer protectionand unfair competition laws and comparable foreign laws.

Depending on the circumstances, failure to meet theseapplicable 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.

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**Because we depend on third parties to conductlaboratory testing and human clinical studies and assist us with regulatory compliance, wemay encounter delays in our drug discovery and development efforts.**

We currently have contracts with a limited number ofresearch organizations to design and conduct our laboratory testing,preclinical evaluations and human clinical studies. If we cannot contract fordata analysis and  testing activities onacceptable terms, or at all, we may not complete our drug discovery anddevelopment efforts in a timely manner. To the extent we rely on third partiesfor these activities, we may lose some control over these activities. Forexample, third parties may not complete data analysis and testing activities onschedule or when we request them to do so. In addition, these third parties mayconduct these contracted tasks in a manner inconsistent with regulatoryrequirements or otherwise in a manner that yields misleading or unreliabledata. This, or other failures of these third parties to carry out their duties,could result in significant additional costs and expenses and could delay orprevent our ability to effectively perform our responsibilities under existingor future third-party agreements or utilize our DirectSelectTM technology forinternal programs, or further develop PPI-2458 or other future productcandidates.

**If we fail to develop and maintain our relationshipswith third-party manufacturers, or if these manufacturers fail to perform adequately, we maybe unable to develop and commercialize PPI-2458 or any other future productcandidate.**

Our ability to conduct large clinical trials for, orto commercialize, PPI-2458 or any future product candidate, will depend in parton our ability to manufacture, or arrange for third-party manufacture of,PPI-2458 or any such future product on a large scale, at a competitive cost andin accordance with regulatory requirements. We must establish and maintain acommercial scale formulation and manufacturing process for each of ourpotential products for which we seek marketing approval. We or third-partymanufacturers may encounter difficulties with these processes at any time thatcould result in delays in clinical trials, regulatory submissions or in thecommercialization of potential products.

We have no direct experience in large-scale productmanufacturing, nor do we have the resources or facilities to manufacture on ourown products for use in humans. We currently rely on contract manufacturers forthe manufacture of PPI-2458 and 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 future revenues and delay orprevent our attaining or maintaining profitability.

In addition, we and the third-party manufacturers thatwe use must continually adhere to current good manufacturing practicerequirements enforced by the FDA through its facilities quality programs. Foreignregulatory authorities may also inspect our third-party manufacturers as acondition of obtaining and maintaining the requisite approvals. In complyingwith these requirements, we and any of our third-party manufacturers will be obligatedto expend time, money and effort in production, record-keeping and qualitycontrol to assure that our potential products meet applicable specificationsand other requirements. If we or any of our third-party manufacturers fail tocomply with these requirements, we may be subject to regulatory sanctions,manufacturing delays, or the facilities could be shut down.

Any of these factors could prevent, or cause delaysin, obtaining regulatory approvals for PPI-2458 or any other potential product,and the manufacturing, marketing or selling of PPI-2458 or any such otherproduct, and could also result in significantly higher operating expenses.

**We may have substantialexposure to product liability claims and may not have adequate insurance tocover those claims.**

The administration of drugs to humans, whether inclinical trials or commercially, can result in product liability claims whetheror not the drugs are actually at fault for causing an injury. Plenaxis®, PPI-2458, ApanTM or futureproduct candidates may cause, or may appear to have caused, adverse sideeffects (including death) or potentially dangerous drug interactions that wemay not learn about or understand fully until the drug has been administered topatients for some time.

Product liability claims can be expensive to defendand may result in large judgments or settlements against us, which could have anegative effect on our financial performance. The costs of product liabilityinsurance have increased dramatically in recent years, and the availability ofcoverage 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 agreementsincluded, and some of the agreements regarding the termination of certain ofthose 

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collaborations also include, an indemnification forliabilities associated with the development and commercialization 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 productliability claim is not successful, the adverse publicity and time and expenseof defending such a claim may interfere with our business.

**Many of our competitors have substantially greaterresources than we do and may be able to discover and develop product candidates ortechnologies that make our potential products and technologies obsolete ornon-competitive.**

A biopharmaceutical company such as ours faces intensecompetition. We face competition from companies that are pursuing the same orsimilar technologies for drug discovery. We also face significant competitionfrom organizations that are pursuing drugs that would compete with the productcandidates we are now developing or may pursue in the future. We may not beable to compete successfully against these organizations, which include manylarge and well-financed and experienced pharmaceutical and biotechnologycompanies, as well as academic institutions and government-based agencies. Theseentities may have greater financial resources and more experience than we do indeveloping and improving drug discovery technologies and identifying andcompleting collaborations with respect thereto with interested parties, and indiscovering and developing drugs, obtaining regulatory approvals, manufacturingand marketing. In addition, academic, government and industry-basedresearch is intense, resulting in considerable competition in obtainingqualified research personnel, submitting patent filings for protection ofintellectual property rights and establishing strategic corporate alliances.

Our investigational compound, PPI-2458, and any otherpotential products in research or development, will face competition from otherproducts. Many companies are developing or market products for the treatment ofcancer, inflammation and autoimmune disorders. We are currently enrollingpatients with non-Hodgkin’s lymphoma and solid tumors in our phase 1 trial forPPI-2458. We are competing with many other companies that are conductingclinical trials in these indications. We may not be able to accrue patients toour trial at the same pace as our competitors. Even if we are able tosuccessfully complete our clinical trials of PPI-2458 and gain regulatoryapproval to market the product, we will face competition from a broad range oftherapeutics available for the treatment of cancer.

We also expect to encounter competition from othercompanies with drug discovery technologies similar to our technologies. Forexample, we are aware of competitors or potential competitors that may be ableto offer technologies that would compete with our DirectSelectTM technology and there may also be other competitors of whichwe are not aware. Moreover, if weare unable to obtain adequate patent protection for our DirectSelectTMtechnology, another company could offer drug discovery capabilities thatdirectly compete with our capabilities or could attempt to block our ability topractice our technology. Given our strategic focus on forming partnerships withrespect to our DirectSelectTM technology, we are also dependent upon the extentto which pharmaceutical and biotechnology companies continue to collaboratewith outside companies to obtain drug discovery expertise and our ability toestablish and maintain partnerships with such companies. We also face and willcontinue to face intense competition from other companies for suchcollaborative arrangements, and technological and other developments by ourcompetitors may make it more difficult for us to establish such relationships.

The success or continued success of our competitors inany of these efforts may adversely affect our ability to further enhance andrefine and partner on favorable terms our DirectSelectTM technology, to develop,partner on favorable terms and commercialize PPI-2458 or other future productcandidates, and to ultimately attain and maintain profitability.

**If we are unableto obtain and enforce valid patents, we could lose any competitive advantage wemay have.**

Our success will depend in part on our ability toobtain patents and maintain adequate protection of our technologies andpotential products. If we do not adequately protect our intellectual property,competitors may be able to use our technologies and erode any competitiveadvantage we may have. If we are unable to obtain adequate patent protectionfor our DirectSelectTM technology, another party could offer drug discoverycapabilities that directly compete with our capabilities or 

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could attempt to block our ability to practice ourtechnology. For example, there are publishedU.S. patent applications that disclose variations of certain aspects of ourDirectSelectTM technology. Some foreign countries lack rules and methodsfor defending intellectual property rights and do not protect proprietaryrights to the same extent as the United States. Many companies have haddifficulty protecting their proprietary rights in certain foreign countries.

Patent positions are sometimes uncertain and usuallyinvolve complex legal and factual questions. We can protect our proprietaryrights from unauthorized use by third parties only to the extent that ourproprietary technologies are covered by valid and enforceable patents or areeffectively maintained as trade secrets. We currently own or have exclusivelylicensed 33 issued United States patents and 116 granted foreign patents. Wehave 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 may challengethe validity of, or seek to narrow or circumvent, these patents. Third-partypatents may impair or block our ability to conduct our business. Additionally,third parties may independently develop products similar to our products,duplicate our unpatented products, or design around any patented products wedevelop.

**If we are unable to protect our trade secrets andproprietary information, we could lose any competitive advantage we may have.**

In addition to patents, we rely on a combination oftrade secrets, confidentiality, nondisclosure and other contractual provisions,and security measures to protect our confidential and proprietary information.These measures may not adequately protect our trade secrets or otherproprietary information. If these measures do not adequately protect ourrights, 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 products conflictwith the patents or other intellectual property rights of competitors, universities or others, wecould have to engage in costly litigation and be unable to commercialize thoseproducts.**

Our technologies, processes, product or productcandidates may give rise to claims that they infringe patents or otherintellectual property rights of third parties. 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.

**We are a defendant in purported class actionsecurities lawsuits regarding the adequacy of our public disclosure which could have a materialadverse affect on our financial condition.**

As described in more detail in Note 4—Litigation,included in our condensed consolidated financial statements appearing elsewherein this report, 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, Chief Financial Officer andTreasurer Edward C. English, and former President and Chief Operating OfficerWilliam K. Heiden, were named as defendants in three purported class actionsecurities lawsuits filed in the United States District Court for the Districtof Massachusetts. The complaints were consolidated into one action in April2005. In August 2005, lead plaintiffs filed a consolidated amended complaint. Thelead plaintiffs generally allege securities fraud during the period fromNovember 25, 2003 through December 6, 2004. 

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Management believes that the allegations against theCompany are without merit, and the Company intends to vigorously defend againstthe plaintiffs’ claims. As this litigation is in an early stage, management isunable to predict its outcome or its ultimate effect, if any, on the Company’sfinancial condition. However, we expect that the costs and expenses related tothis 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 and expenses. Also,a judgment in or settlement of these actions could exceed our insurancecoverage. Accordingly, if we are not successful in defending these actions, ourbusiness and financial condition could be adversely affected. In addition,whether or not we are successful, the defense of these actions may divert theattention of our management and other resources that would otherwise be engagedin running our business.

**We use hazardous chemicals and radioactive andbiological materials in our business and any claims relating to the handling, storage ordisposal of these materials could be time consuming and costly.**

Our research and development processes involve thecontrolled use of hazardous materials, including chemicals and radioactive andbiological materials, which may pose health risks. In addition, the healthrisks associated with accidental exposure to Plenaxis® include temporary impotence or infertility andharmful effects on pregnant women. Our operations also produce hazardous wasteproducts. We cannot completely eliminate the risk of accidental contaminationor discharge from hazardous materials and any resultant injury. Federal, stateand local laws and regulations govern the use, manufacture, storage, handling anddisposal of hazardous materials. Compliance with health and safety andenvironmental laws and regulations is necessary and expensive. Current orfuture health and safety and environmental regulations may impair our research,development or production efforts. We may be required to pay fines, penaltiesor damages in the event of noncompliance or the exposure of individuals tohazardous materials.

From time to time, third-parties have also worked withhazardous materials in connection with our agreements with them. We have agreedto indemnify our present and former collaborators in some circumstances againstdamages and other liabilities arising out of development activities or productsproduced in connection with these collaborations.

**Changes in thesecurities laws and regulations have increased, and are likely to continue toincrease, our costs.**

The Sarbanes-Oxley Act of 2002, which became law inJuly 2002, has required changes in some of our corporate governance,securities disclosure and compliance practices. In response to the requirementsof that Act, the Securities and Exchange Commission and the NASDAQ Stock Markethave promulgated rules and listing standards covering a variety of subjects.Compliance with these rules and listing standards has increased our legalcosts, and significantly increased our financial and accounting costs, and weexpect these increased costs to continue. These developments may make it moredifficult and more expensive for us to obtain director and officer liabilityinsurance. Likewise, these developments may make it more difficult for us toattract and retain qualified members of our board of directors, particularlyindependent directors, or qualified executive officers.

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**Themarket price of our common stock may experience extreme price and volumefluctuations.**

The market price of our common stock may fluctuatesubstantially due to a variety of factors, including, but not limited to:

·                     ourannouncement of a financing, a business combination or other transaction, theterms of such a transaction and its implications for our existing stockholders,or other announcement regarding the outcome of our ongoing exploration ofstrategic options;

·                     our abilityto enter into partnerships for our DirectSelectTM drug discovery technology andour product candidate, PPI-2458, and the timing and terms of such partnerships;

·                     the successrate of our discovery efforts, particularly utilizing our DirectSelectTM drugdiscovery technology for both external and internal programs, and progress orsetbacks in our clinical trials;

·                     our abilityto identify and complete, and our announcement of, the disposition of ourPlenaxis® assets;

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

·                     failure ordelay by third-party manufacturers in performing their supply obligationsor disputes or litigation regarding those obligations;

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

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

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

·                     changes ingovernment regulation of the pharmaceutical or medical industry;

·                     actual oranticipated fluctuations in our operating results;

·                     changes infinancial estimates or recommendations by securities analysts;

·                     sales oflarge blocks of our common stock;

·                     changes inaccounting principles; and

·                     the loss ofany of our key scientific or management personnel.

In addition, the stock market has experienced extremeprice and volume fluctuations. The market prices of the securities ofbiotechnology companies, particularly companies like ours with limited productrevenues and without earnings, have been highly volatile, and may continue tobe highly volatile in the future. This volatility has often been unrelated tothe operating performance of particular companies. In the past, securitiesclass action litigation has often been brought against companies thatexperience volatility in the market price of their securities. We are currentlya defendant in a purported class action lawsuit. Whether or not meritorious,this or other litigation brought against us could result in substantial costsand a diversion of management’s attention and resources.

**We expect that our quarterly results of operationswill fluctuate, and this fluctuation could cause our stock price to decline.**

Our quarterly operating results have fluctuated in thepast and are likely to do so in the future. These fluctuations could cause ourstock price to decline. Some of the factors that could cause our operatingresults to fluctuate include:

·                     the timing ofpartnerships relating to our DirectSelectTM drug discovery technology and ourPPI-2458 program resulting in revenues; and

·                     the timingand level of expenses related to our other research and clinical developmentprograms.

Due to the possibility of fluctuations in our revenuesand expenses, we believe that quarter-to-quarter comparisons of our operatingresults are not a good indication of our future performance.

 

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**If we or our independentregistered public accounting firm are unable to affirm the effectiveness of ourinternal control over financial reporting in future years, the market value ofour common stock could be adversely affected.**

As directed by Section 404 of the Sarbanes-OxleyAct of 2002, the Securities and Exchange Commission adopted rules requiringmany public companies, including the Company, to include in their annualreports on Form 10-K a report of management, based on its assessment of thecompany’s internal control over financial reporting, as to the effectiveness ofsuch internal control as of the end of the most recent fiscal year. Inaddition, under these rules, the independent registered public accounting firmauditing the company’s financial statements must audit and report on management’sassessment and on the effectiveness of the company’s internal control overfinancial reporting as of such fiscal year end. Our management reported, basedon its assessment, that as of December 31, 2004 our internal control overfinancial reporting was effective, and our independent registered publicaccounting firm provided us with an unqualified report as to management’sassessment and the effectiveness of our internal control over financialreporting as of December 31, 2004. These reports were included in our AnnualReport on Form 10-K for the year ended December 31, 2004. Since we are nolonger an “accelerated filer” under rules recently promulgated by theSecurities and Exchange Commission, we were not required to include in ourAnnual Report on Form 10-K for the year ended December 31, 2005 such a reportof management based on its assessment, or a report by our independentregistered public accounting firm on management’s assessment and theeffectiveness, of our internal control over financial reporting as of December31, 2005. However, under the current transition rules we will be required toinclude such reports in our Annual Report for the year ended December 31, 2007and for subsequent years, and we cannot assure investors that management or ourindependent registered public accounting firm will be able to provide suchreports, or that such reports will be unqualified, as of December 31, 2007 orsubsequent year-ends. In this event, investors could lose confidence in thereliability of our financial statements, which could result in a decrease inthe market value of our common stock.

**Anti-takeover provisions in our charter and by-laws,our rights agreement and certain provisions of Delaware law may make an acquisition of usmore difficult, even if an acquisition would be beneficial to our stockholders.**

Provisions in our certificate of incorporation andby-laws may delay or prevent an acquisition of us or a change in ourmanagement. Also, because we are incorporated in Delaware, we are governed bythe provisions of Section 203 of the Delaware General Corporation Law, whichmay prohibit or delay large stockholders, in particular those owning 15% ormore of our outstanding voting stock, from merging or combining with us. Inaddition, the rights issued under our rights agreement may be a substantialdeterrent to a person acquiring 10% or more of our common stock without theapproval of our board of directors. These provisions in our charter andby-laws, rights agreement and under Delaware law could reduce the price thatinvestors might be willing to pay for shares of our common stock in the futureand result in the market price being lower than it would be without theseprovisions.

**ITEM 2.   UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

(a)           OnApril 7, 2006, we entered into a pilot study and option agreement withSmithKline Beecham Corporation, or SBC, and Glaxo Group Limited, or GGL,relating to our DirectSelectTM drug discovery technology. In connection with theexecution of the pilot study agreement, we concurrently entered into a stockpurchase agreement with SBC and GGL, which we refer to together as theInvestor. Under the stock purchase agreement, on April 28, 2006 the Investorpurchased 102,538 unregistered shares of our common stock at $4.88 per share,for an aggregate purchase price of $500,000. Under the terms of the stock purchaseagreement, the per share price was determined based upon the average of thedaily closing prices per share of our common stock on The NASDAQ Global Market,as reported in the Wall Street Journal, over the trading days during the periodbeginning on, and including, March 11, 2006, and ending on, and including,April 25, 2006.

The shares of common stock issued to the Investorunder the stock purchase agreement were not registered under the Securities Actof 1933, as amended, as such shares were issued in a transaction not involvinga public offering under Section 4(2) of the Securities Act of 1933.

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

We held our Annual Meeting of Stockholders onMay 11, 2006 to (i) elect eight directors; (ii) approve our FourthAmended and Restated 1995 Stock Plan, which amends and restates the ThirdAmended and Restated 1995 Stock Plan, to increase by 500,000 the number ofshares of Common Stock authorized for issuance under the plan, permit the grantof restricted stock awards and include certain performance goals for purposesof Section 162(m) of the Internal Revenue Code of 1986, as amended; (iii)approve an amendment to our Second Amended and Restated Employee Stock PurchasePlan to increase by 80,000 the number of shares of Common Stock authorized forissuance under the Plan; and (iv) ratify the appointment of Ernst &Young LLP as our independent registered public accounting firm for fiscal year2006.

The following nominees for director were elected, bythe vote set forth below, to hold office until the 2007 annual meeting ofstockholders and until their successors are duly elected and qualified:
| **Nominee:**                | ** ** | **Number of Votes For:** | ** ** | **Number of Votes Withheld:** |
|-----------------------------|------------|--------------------------|------------|-------------------------------|
| Malcolm L.  Gefter, Ph.D.   |       | 7,374,540                |       | 2,065,452                     |
| Kevin F.  McLaughlin        |       | 7,381,683                |       | 2,058,309                     |
| G. Leonard  Baker, Jr. |       | 7,388,484                |       | 2,051,508                     |
| Garen G. Bohlin             |       | 7,797,307                |       | 1,642,685                     |
| Henry F. McCance            |       | 7,387,984                |       | 2,052,008                     |
| Leonard E. Post,  Ph.D.     |       | 7,799,207                |       | 1,640,785                     |
| David B.  Sharrock          |       | 7,388,764                |       | 2,051,228                     |
| Patrick J.  Zenner          |       | 7,000,670                |       | 2,439,322                     |

 

The stockholders approved our Fourth Amended andRestated 1995 Stock Plan by the following vote:

| For:      | ** ** | **Against:** | ** ** | **Abstain:** | ** ** | **Broker-  Non-Votes:** | ** ** |
|-----------|------------|--------------|------------|--------------|------------|-------------------------|------------|
| 3,190,885 |       | 2,618,144    |       | 12,697       |       | 3,618,266               |       |

 

The stockholders approved an amendment to our SecondAmended and Restated Employee Stock Purchase Plan by the following vote:

| For:      | ** ** | **Against:** | ** ** | **Abstain:** | ** ** | **Broker-  Non-Votes:** | ** ** |
|-----------|------------|--------------|------------|--------------|------------|-------------------------|------------|
| 4,866,672 |       | 946,718      |       | 8,337        |       | 3,618,265               |       |

 

The stockholders also ratified the appointment ofErnst & Young LLP as our independent registered public accounting firmfor fiscal year 2006 by the following vote:

| For:      | ** ** | **Against:** | ** ** | **Abstain:** | ** ** | **Broker-  Non-Votes:** | ** ** |
|-----------|------------|--------------|------------|--------------|------------|-------------------------|------------|
| 8,863,317 |       | 564,483      |       | 12,191       |       | —                  |       |

 

**ITEM 6.   EXHIBITS.**
| Exhibit  Number | *** *** | **Exhibit**                                                                                                                                                                 |
|-----------------|--------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |         | Amended and Restated Certificate of Incorporation  (1)                                                                                                                      |
| 3.2             |         | Certificate of Amendment of the Amended and Restated  Certificate of Incorporation (effecting reverse stock split) (4)                                                      |
| 3.3             |         | Third Amended and Restated By-Laws (3)                                                                                                                                      |
| 4.1             |         | Specimen certificate representing shares of common  stock (post-reverse stock split) (4)                                                                                    |
| 4.2             |         | Rights Agreement between the Registrant and American  Stock Transfer & Trust Company, as Rights Agent (2)                                                               |
| 4.3             |         | Form of Certificate of Designations of Series A  Junior Participating Preferred Stock (attached as Exhibit A to the Rights  Agreement identified as Exhibit 4.2 hereto) (2) |
| 4.4             |         | Form of Rights Certificate (attached as Exhibit B to  the Rights Agreement identified as Exhibit 4.2 hereto) (2)                                                            |
| 10.1*           |         | Fourth Amended and Restated 1995 Stock Plan (5)                                                                                                                             |
| 10.2*           |         | Amendment to Second Amended and Restated Employee  Stock Purchase Plan (5)                                                                                                  |
| 10.3*           |         | Consulting and Termination Agreement and General  Release dated June 19, 2006 between PRAECIS and Marc B. Garnick, M.D. (6)                                                 |
| 10.4            |         | Stock Purchase Agreement dated as of April 7, 2006  by and between PRAECIS, SmithKline Beecham Corporation and Glaxo Group  Limited                                         |
| 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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*                    Representsa management contract or compensatory plan or arrangement.

(1)    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.

(2)             Incorporatedby reference to Registration Statement on Form 8-A filed with the Securitiesand Exchange Commission on January 26, 2001.

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

(4)             Incorporatedby reference to Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2005 filed with the Securities and Exchange Commission onNovember 4, 2005.

(5)             Incorporatedby reference to Registration Statement on Form S-8 (Registration No. 333-134397) filed with the Securities andExchange Commission on May 23, 2006.

(6)             Incorporatedby reference to Current Report on Form 8-K filed with the Securities andExchange Commission on June 20, 2006.

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** **

**SIGNATURE**

Pursuant to the requirements ofthe Securities Exchange Act of 1934, as amended, the Registrant has duly causedthis report to be signed on its behalf by the undersigned hereunto dulyauthorized.
|                      |   | PRAECIS PHARMACEUTICALS INCORPORATED |
|----------------------|--------|--------------------------------------|
|                 |   |                                 |
| Date: August 4, 2006 |   | 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)* |

#  

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#  

# **EXHIBITINDEX**

| Exhibit  Number | *** *** | **Exhibit**                                                                                                                                                                 |
|-----------------|--------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |         | Amended and Restated Certificate of Incorporation  (1)                                                                                                                      |
| 3.2             |         | Certificate of Amendment of the Amended and Restated  Certificate of Incorporation (effecting reverse stock split) (4)                                                      |
| 3.3             |         | Third Amended and Restated By-Laws (3)                                                                                                                                      |
| 4.1             |         | Specimen certificate representing shares of common  stock (post-reverse stock split) (4)                                                                                    |
| 4.2             |         | Rights Agreement between the Registrant and American  Stock Transfer & Trust Company, as Rights Agent (2)                                                               |
| 4.3             |         | Form of Certificate of Designations of Series A  Junior Participating Preferred Stock (attached as Exhibit A to the Rights  Agreement identified as Exhibit 4.2 hereto) (2) |
| 4.4             |         | Form of Rights Certificate (attached as Exhibit B to  the Rights Agreement identified as Exhibit 4.2 hereto) (2)                                                            |
| 10.1*           |         | Fourth Amended and Restated 1995 Stock Plan (5)                                                                                                                             |
| 10.2*           |         | Amendment to Second Amended and Restated Employee  Stock Purchase Plan (5)                                                                                                  |
| 10.3*           |         | Consulting and Termination Agreement and General  Release dated June 19, 2006 between PRAECIS and Marc B. Garnick, M.D. (6)                                                 |
| 10.4            |         | Stock Purchase Agreement dated as of April 7, 2006  by and between PRAECIS, SmithKline Beecham Corporation and Glaxo Group  Limited                                         |
| 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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*                                         Represents a management contract or compensatoryplan or arrangement.

(1)   Incorporated by reference to Quarterly Reporton Form 10-Q for the quarter ended March 31, 2000 filed with the Securities andExchange Commission on June 7, 2000.

(2)          Incorporated by referenceto Registration Statement on Form 8-A filed with the Securities and ExchangeCommission on January 26, 2001.

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

(4)          Incorporated by reference to Quarterly Report on Form 10-Q for thequarter ended September 30, 2005 filed with the Securities and ExchangeCommission on November 4, 2005.

(5)          Incorporated byreference to Registration Statement on Form S-8 (Registration No. 333-134397) filed with the Securities andExchange Commission on May 23, 2006.

(6)          Incorporated by reference to Current Report on Form 8-K filed with theSecurities and Exchange Commission on June 20, 2006.

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