**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

 

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

| **ý**                                                                                                                                                                                             |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                   |   |                                                                                               |
| **For the quarterly period ended March 31, 2004**                                                                                                                                                 |
|                                                                                                                                                                                                   |   |                                                                                               |
| **OR**                                                                                                                                                                                                 |
|                                                                                                                                                                                                   |   |                                                                                               |
| **o**                                                                                                                                                                                                  |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                   |   |                                                                                               |
| **For the transition period from                 to               ** |
|                                                                                                                                                                                                   |   |                                                                                               |
| **Commission File 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.) |
|                                                       |   |                |
| **830 Winter 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) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.                                         Yes  ý   No  o

 

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

 

As of April 30, 2004, there were 52,323,252shares of the registrant’s common stock, $.01 par value, outstanding.

 

 

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**PRAECISPHARMACEUTICALS INCORPORATED**

**FORM 10-Q**

**FOR THE QUARTER ENDED MARCH 31,2004**

 

**INDEX**

 
| **PART I.**        |   | **FINANCIAL  INFORMATION**                                                                               |   |   |
|--------------------|--------|----------------------------------------------------------------------------------------------------------|--------|--------|
|               |   |                                                                                                     |   |   |
| Item 1.            |   | Financial Statements  (Unaudited)                                                                        |   |   |
|               |   |                                                                                                     |   |   |
|               |   | Condensed  Consolidated Balance Sheets – December 31, 2003 and March 31, 2004             |   |   |
|               |   |                                                                                                     |   |   |
|               |   | Condensed  Consolidated Statements of Operations – three months ended March 31,  2003 and 2004 |   |   |
|               |   |                                                                                                     |   |   |
|               |   | Condensed  Consolidated Statements of Cash Flows – three months ended March 31,  2003 and 2004 |   |   |
|               |   |                                                                                                     |   |   |
|               |   | Notes  to Condensed Consolidated Financial Statements                                                    |   |   |
|               |   |                                                                                                     |   |   |
| Item  2.           |   | Management’s  Discussion and Analysis of Financial Condition  and Results of Operations        |   |   |
|               |   |                                                                                                     |   |   |
| Item  3.           |   | Quantitative  and Qualitative Disclosures About Market Risk                                              |   |   |
|               |   |                                                                                                     |   |   |
| Item  4.           |   | Controls  and Procedures                                                                                 |   |   |
|               |   |                                                                                                     |   |   |
| **PART II.**       |   | **OTHER  INFORMATION**                                                                                   |   |   |
|               |   |                                                                                                     |   |   |
| Item  6.           |   | Exhibits  and Reports on Form 8-K                                                                        |   |   |
|               |   |                                                                                                     |   |   |
| **SIGNATURE**      |   |                                                                                                     |
|               |   |                                                                                                     |
| **EXHIBIT  INDEX** |   |                                                                                                     |
|                    |        |                                                                                                          |        |        |  |  |

 

2

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**PART I.**** FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

**PRAECIS PHARMACEUTICALS INCORPORATED**

**Condensed Consolidated Balance Sheets**

**(Inthousands, except share data)**

**(Unaudited)**

 
|                                                                                                                                           |   | **December 31,  2003** |    | **March 31,  2004** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|--------------------------|--------|
|                                                                                                                                           |   |                        |    |                     |   |
| **Assets**                                                                                                                                     |   |                        |    |                     |   |
| Current assets:                                                                                                                                |   |                        |    |                     |   |
| Cash and cash equivalents                                                                                                                      |   | $                           | 15,687  |                     | $      | 11,806 |   |
| Marketable securities                                                                                                                          |   | 127,505                     |    | 114,046                  |   |
| Accounts receivable                                                                                                                            |   | —                      |    | 395                      |   |
| Inventory                                                                                                                                      |   | —                      |    | 1,172                    |   |
| Prepaid expenses and other current assets                                                                                                      |   | 726                         |    | 1,291                    |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Total current assets                                                                                                                           |   | 143,918                     |    | 128,710                  |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Property and equipment, net                                                                                                                    |   | 67,713                      |    | 66,734                   |   |
| Due from officer                                                                                                                               |   | 833                         |    | 808                      |   |
| Other assets                                                                                                                                   |   | 14                          |    | 15                       |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Total assets                                                                                                                                   |   | $                           | 212,478 |                     | $      | 196,267 |   |
|                                                                                                                                           |   |                        |    |                     |   |
| **Liabilities and  Stockholders’ Equity**                                                                                                 |   |                        |    |                     |   |
| Current liabilities:                                                                                                                           |   |                        |    |                     |   |
| Accounts payable                                                                                                                               |   | $                           | 2,483   |                     | $      | 1,905 |   |
| Accrued expenses                                                                                                                               |   | 7,707                       |    | 7,377                    |   |
| Current portion of long-term debt                                                                                                              |   | 747                         |    | 747                      |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Total current liabilities                                                                                                                      |   | 10,937                      |    | 10,029                   |   |
| Long-term debt                                                                                                                                 |   | 31,880                      |    | 31,693                   |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Commitments and contingencies                                                                                                                  |   |                        |    |                     |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Stockholders’ equity:                                                                                                                     |   |                        |    |                     |   |
| Common Stock, $0.01 par value; 200,000,000  shares authorized; 52,011,002 shares in 2003 and 52,320,169 shares in 2004  issued and outstanding |   | 520                         |    | 523                      |   |
| Additional paid-in capital                                                                                                                     |   | 355,373                     |    | 355,572                  |   |
| Accumulated other comprehensive income                                                                                                         |   | 73                          |    | 135                      |   |
| Accumulated deficit                                                                                                                            |   | (186,305                    | )       | (201,685                 | )      |
|                                                                                                                                           |   |                        |    |                     |   |
| Total stockholders’ equity                                                                                                                |   | 169,661                     |    | 154,545                  |   |
|                                                                                                                                           |   |                        |    |                     |   |
| Total liabilities and stockholders’ equity                                                                                                |   | $                           | 212,478 |                     | $      | 196,267 |   |

 

*See accompanying notes*.

 

3

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**PRAECIS PHARMACEUTICALS INCORPORATED**

**Condensed Consolidated Statements ofOperations**

**(In thousands, except per share data)**

**(Unaudited)**

 
|                                                             |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------------------|--------|-----------------------------------------|---------|
|                                                             |   | **2003**                                |    | **2004** |   |
|                                                             |   |                                    |    |   |   |
| **Revenues:**                                                    |   |                                    |    |   |   |
| Product sales                                                    |   | $                                       | —  |   | $ | 411 |   |
| Licensing and other revenues                                     |   | —                                  |    | 50 |   |
| Total revenues                                                   |   | —                                  |    | 461 |   |
|                                                             |   |                                    |    |   |   |
| **Costs and expenses:**                                          |   |                                    |    |   |   |
| Cost of goods sold                                               |   | —                                  |    | 1,134 |   |
| Research and development                                         |   | 8,679                                   |    | 7,871 |   |
| Sales and marketing                                              |   | 1,028                                   |    | 4,080 |   |
| General and administrative                                       |   | 2,124                                   |    | 2,984 |   |
| Total costs and expenses                                         |   | 11,831                                  |    | 16,069 |   |
|                                                             |   |                                    |    |   |   |
| Operating loss                                                   |   | (11,831                                 | )       | (15,608 | ) |
|                                                             |   |                                    |    |   |   |
| Interest income, net                                             |   | 416                                     |    | 228 |   |
|                                                             |   |                                    |    |   |   |
| Net loss                                                         |   | $                                       | (11,415 | ) | $ | (15,380 | ) |
|                                                             |   |                                    |    |   |   |
| Basic and diluted net loss per share                             |   | $                                       | (0.22   | ) | $ | (0.29 | ) |
|                                                             |   |                                    |    |   |   |
| Weighted average number of basic and  diluted shares outstanding |   | 51,820                                  |    | 52,147 |   |

 

*Seeaccompanying notes.*

 

4

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**PRAECIS PHARMACEUTICALS INCORPORATED**

**Condensed Consolidated Statements ofCash Flows**

**(In thousands)**

**(Unaudited)**

 
|                                                                     |   | **Three  Months Ended  March 31,** |    |
|--------------------------------------------------------------------------|--------|-----------------------------------------|---------|
|                                                                     |   | **2003**                                |    | **2004** |   |
| **Operating  activities:**                                               |   |                                    |    |   |   |
| Net loss                                                                 |   | $                                       | (11,415 | ) | $ | (15,380 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities: |   |                                    |    |   |   |
| Depreciation and amortization                                            |   | 1,140                                   |    | 1,174 |   |
| Stock compensation                                                       |   | 30                                      |    | 15 |   |
| Changes in operating assets and  liabilities:                            |   |                                    |    |   |   |
| Accounts receivable                                                      |   | —                                  |    | (395 | ) |
| Inventory                                                                |   | —                                  |    | (1,172 | ) |
| Prepaid expenses and other assets                                        |   | 312                                     |    | (566 | ) |
| Due from officer                                                         |   | 25                                      |    | 25 |   |
| Accounts payable                                                         |   | (2,016                                  | )       | (578 | ) |
| Accrued expenses                                                         |   | (1,922                                  | )       | (330 | ) |
|                                                                     |   |                                    |    |   |   |
| Net cash used in operating activities                                    |   | (13,846                                 | )       | (17,207 | ) |
|                                                                     |   |                                    |    |   |   |
| **Investing  activities:**                                               |   |                                    |    |   |   |
| Purchase of available-for-sale securities                                |   | (17,529                                 | )       | (31,614 | ) |
| Sales or maturities of available-for-sale  securities                    |   | 52,576                                  |    | 45,135 |   |
| Purchase of property and equipment                                       |   | (87                                     | )       | (195 | ) |
|                                                                     |   |                                    |    |   |   |
| Net cash provided by investing activities                                |   | 34,960                                  |    | 13,326 |   |
|                                                                     |   |                                    |    |   |   |
| **Financing activities:**                                                |   |                                    |    |   |   |
| Principal payments on debt                                               |   | —                                  |    | (187 | ) |
| Proceeds from exercises of stock options                                 |   | 6                                       |    | 187 |   |
|                                                                     |   |                                    |    |   |   |
| Net cash provided by financing activities                                |   | 6                                       |    | — |   |
|                                                                     |   |                                    |    |   |   |
| Increase (decrease) in cash and cash  equivalents                        |   | 21,120                                  |    | (3,881 | ) |
| Cash and cash equivalents, beginning of  period                          |   | 40,847                                  |    | 15,687 |   |
|                                                                     |   |                                    |    |   |   |
| Cash and cash equivalents, end of period                                 |   | $                                       | 61,967  |   | $ | 11,806 |   |

 

*Seeaccompanying notes.*

 

5

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**PRAECIS PHARMACEUTICALS INCORPORATED**

**Notes to Condensed ConsolidatedFinancial Statements**

(Unaudited)

 

**1.             Basisof Presentation**

 

Theaccompanying condensed consolidated financial statements have been prepared byPRAECIS PHARMACEUTICALS INCORPORATED (the “Company”) in accordance withgenerally accepted accounting principles and pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations.  It is suggestedthat the financial 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, 2003, as amended.

 

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

 

Thepreparation of these financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

**2.             Summary of Significant AccountingPrinciples**

 

***Principles of Consolidation***

 

The accompanying consolidated financial statements include theCompany’s accounts and the accounts of its wholly owned subsidiaries, 830Winter Street LLC and PRAECIS Europe Limited. All significant intercompany account balances and transactions betweenthe companies have been eliminated.

 

***Inventory***

 

Inventory is stated at the lower of cost or market with cost determinedunder the first-in/first-out (“FIFO”) method. The Company writes down obsoleteor otherwise unmarketable inventory to its estimated net realizable value. Ifthe actual realizable value is less than that estimated by the Company,additional inventory write-downs may be required.  The Company did not write down any unmarketable inventory for thethree-month period ended March 31, 2004.

 

The components of inventory are as follows (in thousands):

 
|            |   | **December 31,  2003** |   | **March 31,  2004** |   |
|-----------------|--------|-----------------------------|--------|--------------------------|--------|
| Raw materials   |   | $                           | — |                     | $      | 32 |   |
|            |   |                        |   |                     |   |
| Work-in-process |   | —                      |   | 1,086                    |   |
|            |   |                        |   |                     |   |
| Finished goods  |   | —                      |   | 54                       |   |
|            |   |                        |   |                     |   |
|            |   | $                           | — |                     | $      | 1,172 |   |

 

Work-in-process and finished goods inventories consist of materials,labor and manufacturing overhead.

 

6

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***Stock-BasedCompensation***

 

The Company has elected to follow Accounting Principles Board OpinionNo. 25*, Accounting for Stock Issued toEmployees* (“APB No. 25”), and related interpretations, in accountingfor its stock-based compensation plans. Under APB No. 25, when the exerciseprice of options granted to employees under these plans equals the market priceof the underlying stock on the date of grant, no compensation expense isrequired.  The Company also follows theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 148, *Accounting for Stock-Based Compensation-Transitionand Disclosure, an amendment of Financial Accounting Standards Board (“FASB”)Statement No. 123*(“SFAS No. 148”).

 

Accordingly, had compensation expense for the Company’s stock optionplans been determined based on the fair value at the grant date for awardsunder these plans, consistent with the methodology prescribed under SFAS No.148, the Company’s net loss and net loss per share would have approximated thepro forma amounts indicated below (in thousands, except per share data):

 
|                                                                                                                                                                                |   | **Three  Months Ended  March 31,** |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|---------|
|                                                                                                                                                                                |   | **2003**                                |    | **2004** |   |
| Net loss, as reported                                                                                                                                                               |   | $                                       | (11,415 | ) | $ | (15,380 | ) |
|                                                                                                                                                                                |   |                                    |    |   |   |
| 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 |   | (2,768                                  | )       | (2,958 | ) |
|                                                                                                                                                                                |   |                                    |    |   |   |
| Pro forma net loss                                                                                                                                                                  |   | $                                       | (14,183 | ) | $ | (18,338 | ) |
|                                                                                                                                                                                |   |                                    |    |   |   |
| Diluted net loss per share, as reported                                                                                                                                             |   | $                                       | (0.22   | ) | $ | (0.29 | ) |
|                                                                                                                                                                                |   |                                    |    |   |   |
| Diluted net loss per share, pro forma                                                                                                                                               |   | $                                       | (0.27   | ) | $ | (0.35 | ) |

 

The fair value of the stock options at the date of grant was estimatedusing the Black-Scholes option pricing model with the following weightedaverage assumptions: 

 
|                    |   | **2003** |   | **2004** |   |
|-------------------------|--------|----------|--------|----------|--------|
| Risk-free interest rate |   | 4.0      | %      | 4.0      | %      |
|                    |   |     |   |     |   |
| Expected life (years)   |   | 6        |   | 6        |   |
|                    |   |     |   |     |   |
| Volatility              |   | 103      | %      | 84       | %      |

 

The Company has never declared or paid any cash dividends on any of itscapital stock and does not expect to do so in the foreseeable future.

 

***Revenue Recognition***

 

Revenues from productsales are recognized in the period when the product is delivered provided thatthere is pervasive evidence that an arrangement exists, the price is fixed ordeterminable and collection of the related receivable is probable.  Revenues are recorded net of applicableallowances as provision is made for estimated returns, rebates and otherapplicable discounts and allowances. Shipping and other distribution costs are charged to cost of productsales.

 

The Company prepares its provisions for sales returns and allowances, discounts and rebates based primarily on estimates.  Contractual allowances and rebates primarily result from sales under contracts with healthcare providers, Medicaid programs and other government agencies.  The Company’s policy for returns allows authorized distributors to return the product three months prior to, and six months after, product expiration.  The reserve for product returns is determined by reviewing the history of product returns for products with similar characteristics to Plenaxis and by utilizing data obtained directly from the Company’s authorized distributors.  These data are reviewed to monitor

 

7

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product movement through the supply chain to identify remaining inventory in the supply chain that may result in chargebacks or returns.  The reserves are reviewed at each reporting period and adjusted to reflect data available at that time.  To the extent the Company’s estimates of contractual allowances, rebates and product returns is different from actuals, it will adjust the reserve which will impact the amount of product sales revenue recognized in the period of the adjustment.

 

In November 2003,the Company received regulatory approval to market Plenaxis in the UnitedStates.  There is a launch periodinitiative undertaken in cooperation with substantially all of the Company’sdistributors which provides that the payment terms on purchases of Plenaxisduring the launch will be up to 120 days.

 

***Net Loss Per Share***

 

Basic net loss per share is based on the weighted average number ofcommon shares outstanding.  For thethree months ended March 31, 2003 and 2004, diluted net loss per commonshare is the same as basic net loss per common share as the inclusion of commonstock options would be antidilutive due to the Company’s net losses for allperiods presented.   Diluted net lossper common share excluded 7,594,404 and 8,273,049 common stock options for theperiods ended March 31, 2003 and 2004, respectively.

 

***Comprehensive Income***

 

SFAS No. 130, *Reporting Comprehensive Income*,establishes standards for the reporting and display of comprehensive income(loss) and its components in the consolidated financial statements.  The Company’s accumulated othercomprehensive income is comprised primarily of net unrealized gains or losseson available-for-sale securities.  Forthe three months ended March 31, 2003 and 2004, comprehensive loss was asfollows (in thousands):

 
|                                                 |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------|--------|-----------------------------------------|---------|
|                                                 |   | **2003**                                |    | **2004** |   |
| Net loss                                             |   | $                                       | (11,415 | ) | $ | (15,380 | ) |
|                                                 |   |                                    |    |   |   |
| Changes in comprehensive loss:                       |   |                                    |    |   |   |
|                                                 |   |                                    |    |   |   |
| Net unrealized holding gains (losses)  oninvestments |   | 161                                     |    | (62 | ) |
|                                                 |   |                                    |    |   |   |
| Total comprehensive loss                             |   | $                                       | (11,254 | ) | $ | (15,442 | ) |

 

***Reclassification***

 

Certain prior yearamounts have been reclassified to conform to the current year presentation.

 

***Recent AccountingPronouncements***

 

In January 2003, theFASB issued FASB Interpretation No. 46, *Consolidationof Variable Interest Entities* (“FIN No. 46”). FIN No. 46sets forth the criteria used in determining whether an investment in a variableinterest entity (“VIE”) should be consolidated and is based on the generalpremise that companies that control another entity through interests other thanvoting interests should consolidate the controlled entity. The Company does nothave any VIE’s. Accordingly, the implementation of FIN No. 46 did not haveany impact on the Company’s consolidated financial statements.

 

In May 2003, theFASB issued SFAS No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*(“SFAS No. 150”). SFAS No. 150 establishes how acompany classifies and measures certain financial instruments withcharacteristics of both liabilities and equity, including redeemableconvertible preferred stock. This statement is effective for financialinstruments entered into or modified after May 31, 2003, and is otherwiseeffective at the beginning of the interim period commencing July 1, 2003,except for mandatory redeemable financial instruments of nonpublic companies.The FASB has indefinitely deferred implementation of some provisions of SFASNo. 150. The Company believes that the adoption of SFAS No. 150 willnot have a material impact on its consolidated financial statements.

 

8

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**3.**                                      **MortgageFinancing**

 

On July 30, 2003, the Company exercised the first of two one-yearextension options on its acquisition and construction loan agreement, extendingthe maturity date until July 30, 2004. On August 1, 2003, the Company began to pay approximately $62,000per month in principal in addition to the existing interest payments on the loan.  In connection with this extension, theCompany also entered into an interest rate cap agreement in order to reduce thepotential impact of interest rate increases on future income.

 

In April 2004, the Company signed a non-binding term sheet withits current lender to amend its existing loan agreement.  The term sheet provides for the extension ofthe maturity date through April 2009 at a fixed rate of 5.95%.  The term sheet also provides for certainfinancial operating covenants which would become effective as ofDecember 31, 2006.  The term sheetprovides that, in addition to interest, the Company would continue to repayprincipal on a monthly basis using a 25-year amortization schedule andwould have the option to extend the loan for two additional, one-year extensionperiods, subject to meeting certain qualifications.

 

**4.**                                      **Schering AGAgreement**

 

In April 2004, the Company entered into a license, supply anddistribution agreement (the “Schering License Agreement”) with Schering AG, ofBerlin, Germany (“Schering”).  Under theSchering License Agreement, the Company granted exclusive rights to Schering tocommercialize Plenaxis in the field of prostate cancer in Europe, Russia, theMiddle East, South Africa, Australia and New Zealand (the “LicensedTerritory”).  The Company will receive acombination of upfront, regulatory approval and performance-based milestonepayments, as well as a share of revenue through transfer price payments fordrug product which will be supplied by the Company.  The transfer price will vary based upon net sales of Plenaxis, aswell as pricing and reimbursement levels, in the Licensed Territory.  The milestone payments may total over timeup to approximately $90.0 million, dependent upon Euro/U.S. Dollar conversionrates and the attainment of specified annual sales levels which the majority ofthe milestone payments are conditioned upon.

 

9

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| **ITEM  2.** |   | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.** |
|--------------|--------|--------------------------------------------------------------------------------------------------|

 

*The following discussion of ourfinancial condition and results of operations should be read together with thecondensed consolidated financial statements and accompanying notes to thosestatements included elsewhere in this Form 10-Q.  This Form 10-Q contains forward-looking statements within themeaning of Section 21E of the Securities Exchange Act of 1934, as amended,that involve risks and uncertainties. All statements other than statements of historical information set forthherein are forward-looking and may contain information about financial results,economic conditions, trends and known uncertainties.  Our actual results could differ materially from those discussedin these forward-looking statements as a result of a number of factors, whichinclude those discussed in this section and elsewhere in this report, andthe risks discussed in our other filings with the Securities and ExchangeCommission.  Readers are cautioned notto place undue reliance on these forward-looking statements, which reflectmanagement’s analysis, judgment, belief or expectation only as of the datehereof.  PRAECIS undertakes noobligation to publicly reissue or modify these forward-looking statements toreflect events or circumstances that arise after the date hereof.*

 

**Overview**

 

We are a biopharmaceutical company focused on the discovery anddevelopment of innovative therapies to address unmet medical needs.   In November 2003, we received FDAapproval to market our first product, Plenaxis (abarelix for injectablesuspension), in the United States for the treatment of the symptoms of men withadvanced prostate cancer for whom other hormonal therapies are not appropriateand who have refused surgical castration. For safety reasons, Plenaxis was approved with marketing restrictionswhich include a risk management program - the PLUS (PLenaxis User Safety)Program.  Only physicians enrolled inthe PLUS Program may prescribe Plenaxis. We are promoting Plenaxis in the United States through our own dedicatedmarketing and sales team.  Plenaxis isavailable to authorized physicians and pharmacies through a network ofspecialty distributors with whom we have contracted.

 

In June 2003, we initiated the regulatory submission process inthe European Union seeking approval to market Plenaxis for the treatment of abroad population of hormonally responsive prostate cancer patients.  We submitted a marketing authorizationapplication, or MAA, in Germany and, assuming favorable action in Germany, planto seek additional European Union member state approvals under the MutualRecognition Procedure, or MRP.  Webelieve that the German review process will be completed during 2004.   In April 2004, we signed an agreementwith Schering AG of Berlin, Germany, for the commercialization of Plenaxisacross Europe, Russia, the Middle East, South Africa, Australia and NewZealand.  Under terms of the agreement,we will receive a combination of upfront, regulatory approval andperformance-based milestone payments, as well as a share of revenue throughtransfer price payments for drug product which will be supplied by us.  The transfer price will vary based upon netsales of Plenaxis, as well as pricing and reimbursement levels, in the licensedterritory.  The milestone payments maytotal over time up to approximately $90.0 million, dependent upon Euro/U.S. Dollarconversion rates and the attainment of specified annual sales levels which themajority of the milestone payments are conditioned upon.

 

We also are continuing to evaluate potential licensing opportunitiesfor the development and commercialization of Plenaxis in Japan and otherex-U.S. territories not covered by the Schering AG agreement.

 

We are currently conducting a phase 1b trial of Apan, our proprietaryinvestigational drug candidate for the treatment of Alzheimer’s disease.  During the fourth quarter of 2003, weinitiated a phase 1 clinical trial to study PPI-2458 in patients withnon-Hodgkin’s lymphoma.  PPI-2458 is ourproprietary compound in development for the potential treatment of a range ofcancers, as well as certain autoimmune diseases.  In March 2004, the FDA placed this trial on clinicalhold.  We are currently assembling adetailed plan for submission to the FDA during the second quarter of 2004 in orderto gain FDA approval to restart clinical testing.  We also have developed a proprietary, non-invasiveinvestigational test for the diagnosis of endometriosis in women.  We are currently planning a clinical studyto confirm the accuracy of this diagnostic test and are evaluating partnershipopportunities.  We also have otherprograms in the research or preclinical development stage.

 

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Prior to 2004, a significant portion of our revenues was received undercollaboration agreements through which we converted the potential valueunderlying our Plenaxis program into a stream of upfront, milestone and expensereimbursement payments from corporate collaborators.  Following the approval of Plenaxis in November of 2003, webegan hiring and deploying our sales force and establishing the commercialinfrastructure to support those activities. During the first quarter of 2004, we shipped the first units of Plenaxisto distributors and substantially completed the hiring of our sales force.  Most of our expenditures to date have beenfor drug development and commercialization activities and for general andadministrative expenses.

 

Due primarily to the costs associated with the commercialization ofPlenaxis in the United States, as well as other research and development andgeneral and administrative expenses, we had a net operating loss for the threemonths ended March 31, 2004.  Ouraccumulated deficit as of March 31, 2004 was approximately $201.7million.  We expect to continue to havenet operating losses through 2005. Assuming the successful commercialization of Plenaxis, partnering ofclinical programs at opportune times and continued prudent fiscal management,we believe that our existing cash and investments will be sufficient for us toexecute our current operating plan and attain profitability by 2006.

 

The market for available hormonal therapies to treat prostate cancer isapproximately $1.2 billion in the United States.  We believe that the revenue opportunity for Plenaxis, based uponits approved indication, may represent 15% or more of this market.  However, our actual revenues will dependupon the impact of our risk management program, physician and patientacceptance of Plenaxis and the overall success of our commercializationefforts.

 

At March 31, 2004, we had 190 full-time employees compared to 147full-time employees at March 31, 2003. This increase in headcount was due to the hiring of our sales forcefollowing the approval of Plenaxis in November 2003.

 

**Critical AccountingPolicies**

 

While our significant accounting policies are more fully described inNote 2 to our consolidated financial statements appearing elsewhere inthis report, we believe the following accounting policies to be critical:

 

*Use of 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.  Actual payments, and thus our actualresults, could differ from our estimates.

 

*Revenue Recognition. *Werecognize revenue from product sales in the period when the product isdelivered provided that there is pervasive evidence that an arrangement exists,the price is fixed or determinable and collection of the related receivable isprobable.  Revenues are recorded net ofapplicable allowances as provision is made for estimated returns, rebates andother applicable discounts and allowances. Shipping and other distribution costs are charged to cost of productsales.

 

We prepare our estimates of provisions for sales returns and allowances, discounts and rebates based primarily on estimates.  Contractual allowances and rebates primarily result from sales under contracts with healthcare providers, Medicaid programs and other government agencies.  Our policy for returns allows our authorized distributors to return the product three months prior to and six months after product expiration.  The reserve for product returns is determined by reviewing the history of product returns for products with similar characteristics to Plenaxis and by utilizing data obtained directly from our authorized distributors.  These data are reviewed to monitor product movement through the supply chain to identify remaining inventory in the supply chain that may result in chargebacks or returns. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time.  To the extent our estimate of contractual allowances, rebates and product returns is different than actuals, we will adjust the reserve which will impact the amount of product sales revenue recognized in the period of the adjustment.

 

In November 2003, wereceived regulatory approval to market Plenaxis in the United States.  There is a launch period initiativeundertaken in cooperation with substantially all of our distributors whichprovides that the payment terms on purchases of Plenaxis during the launch willbe up to 120 days.

 

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*Impairment or Disposal of Long-Lived Assets*.  Statement of Financial Accounting StandardsNo. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets,*or SFAS No.144, requires that if the sum of the undiscounted future cash flows expected toresult from a company’s asset, net of interest charges, is less than thereported value of the asset, an asset impairment must be recognized in thefinancial statements.   We evaluate ourproperty, plant and equipment for impairment whenever indicators of impairmentexist.  The amount of the impairment to berecognized is calculated by subtracting the fair value of the asset from the reportedvalue of the asset.

 

We believe that the application of SFAS No. 144 and the method used todetermine the impairment of our property, plant and equipment involve criticalaccounting estimates because they are highly susceptible to change from periodto period and because they require management to make assumptions about futurecash flows, including residual values. In addition, we believe that had alternative assumptions been used theimpact of recognizing an impairment, if any, on the assets reported on ourbalance sheet, as well as our net loss, may have been material.

 

We reviewed our building for impairment as of December 31,2003.  We have determined that theundiscounted sum of the expected future cash flows from the building exceededthe recorded value of the building.  Asa result, no impairment allowance was required in accordance with SFAS No. 144.

 

*Inventory.* We value inventory at cost or, if lower, fairmarket value. We determine cost using the first-in, first-out method. Weanalyze our inventory levels quarterly and write down inventory that has becomeobsolete, inventory that has a cost basis in excess of its expected netrealizable value and inventory in excess of expected requirements, to cost ofproduct revenues. Expired inventory is disposed of and the related costs arewritten off. If actual market conditions are less favorable than thoseprojected by management, additional inventory write-downs may be required.

 

Management has discussedthe development, selection and disclosure of these critical accounting policieswith the audit committee of our board of directors.

 

**Results of Operations**

 

**Three Months Ended March 31, 2004 Compared To Three Months Ended March 31, 2003**

 

Revenues for the three months ended March 31, 2004 were $0.5 millioncompared to zero for the corresponding period in 2003.  Of this amount, approximately $0.4 millionwas related to sales of Plenaxis to our distributors.  In November 2003, the FDA approved Plenaxis for thetreatment of the symptoms of men with advanced prostate cancer for whom otherhormonal therapies are not appropriate and who have refused surgicalcastration.  In January 2004, webegan shipping product to our authorized distributors.  We are promoting Plenaxis in the UnitedStates through our own dedicated marketing and sales team, and as of the end ofthe first quarter of 2004, we had substantially completed the hiring anddeployment of that sales force.

 

Cost of goods sold for the three months ended March 31, 2004 was$1.1 million compared to no cost of goods sold for the corresponding period in2003.  In January of 2004, we beganselling Plenaxis and accordingly, began recognizing costs related to thosesales.  The majority of our cost ofgoods sold in 2004 was related to a $1.0 million milestone payment which becamedue and payable upon the first commercial sale of Plenaxis under our licenseagreement with Indiana University Advanced Research and Technology Institute,Inc., or IUF.  Much of the raw materialused to produce Plenaxis (including the active pharmaceutical ingredient) waspurchased prior to the FDA granting approval for the commercial sale ofPlenaxis.  Accordingly, these purchaseswere treated as research and development costs and expensed as incurred.  Excluding the effect of the $1.0 millionmilestone payment to IUF during the first quarter of 2004, we anticipate thatcost of goods sold will increase as sales volume increases, but may decline asa percentage of revenue as fixed costs are spread over a larger revenue number.  Cost of goods sold will increase as apercentage of revenue as previously expensed materials are exhausted.  We cannot predict when such previouslyexpensed materials will be exhausted, as this will be dependent upon the commercialsuccess of Plenaxis in both the United States and abroad.

 

Research and development expenses for the three months endedMarch 31, 2004 decreased 9.3% to approximately $7.9 million, fromapproximately $8.7 million for the corresponding period in 2003.  The decrease reflects reduced spending inour clinical and preclinical programs. As a result of the approval of Plenaxis in November 2003, spendingon prostate cancer clinical development was

 

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reduced during the first quarter of 2004.  Offsetting this decrease, spending related to our clinicaldevelopment program for PPI-2458 increased from the prior year.  This increase was due to several ongoingpreclinical studies, manufacturing activities and the costs associated with thephase 1 clinical trial initiated late in 2003. As announced in March 2004, this program has been placed onclinical hold by the FDA pending our submission of a detailed plan to address aneuropathological finding in a preclinical study that was completed followinginitiation of the clinical trial. Spending on our Apan program was consistent with the prior year as weprogressed from a phase 1a clinical trial to a phase 1b clinical trial andcontinued to incur costs related to preclinical evaluations of the drugcandidate.  Although we are unable topredict the precise level of spending on individual clinical programs due tothe uncertain nature of clinical development, overall, we expect our researchand development expenses for the remainder of 2004 to increase as we providesupport for certain investigator-sponsored clinical studies of Plenaxis, and,assuming FDA concurrence, initiate a phase 1/2a study in Apan and re-initiateclinical testing in our PPI-2458 clinical development program.

 

We currently have several other ongoing research and developmentprograms.  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, we will assess the possibility of enteringinto corporate collaborations to offset a portion of development costs. Theultimate success of our research and development programs and the impact ofthese programs on our operations and financial results cannot be accuratelypredicted and will depend, in large part, upon the outcome and timing of manyvariables outside of our control.

 

Members of our research and development team typically work on a numberof projects concurrently. In addition, a substantial amount of our fixed costssuch as facility depreciation, utilities and maintenance are shared by ourvarious programs. Accordingly, we have not and do not plan to specificallyidentify all costs related to each of our research and development programs. Weestimate that during the three months ended March 31, 2004 and during2003, the majority of our research and development expenses were related tomanufacturing costs, clinical trial costs, salaries and lab supplies related toour prostate cancer, Alzheimer’s disease and non-Hodgkin’s lymphoma programs.The remaining research and development costs consisted primarily of salariesand lab supplies for our other research programs.

 

We began our clinical program to develop Plenaxis for the treatment ofprostate cancer during 1996.  InNovember 2003, the FDA approved Plenaxis for the palliative treatment ofmen with advanced symptomatic prostate cancer, in whom LHRH agonist therapy isnot appropriate and who refuse surgical castration, and have one or more of thefollowing: (1) risk of neurological compromise due to metastases,(2) ureteral or bladder outlet obstruction due to local encroachment ormetastatic disease, or (3) severe bone pain from skeletal metastasespersisting on narcotic analgesia. Plenaxis is not indicated for use in women orchildren. For safety reasons, Plenaxis was approved with marketingrestrictions. Only physicians enrolled in the PLUS Program may prescribePlenaxis.

 

In June 2003, we also submitted an MAA for Plenaxis in Germany. Webelieve that the German regulatory authorities will complete their review ofour MAA during 2004. Assuming  favorableaction, we plan to subsequently seek further European Union approval forPlenaxis under the MRP to market Plenaxis for the treatment of a broadpopulation of hormonally responsive prostate cancer patients.  As stated above, in April 2004, wesigned an agreement with Schering AG of Berlin, Germany for thecommercialization of Plenaxis across Europe, Russia, the Middle East, SouthAfrica, Australia and New Zealand and we continue to evaluate potentiallicensing opportunities for the development and commercialization of Plenaxisin Japan and other ex-U.S. territories not covered by the Schering AGagreement.  However, we cannot assureinvestors that we will be successful in obtaining approval in any regionoutside of the United States for the commercialization of Plenaxis for thetreatment of any portion of the hormonally responsive prostate cancer patientpopulation or for any other indication, or that we will be able to enter intoadditional collaboration agreements on favorable terms, if at all.

 

In 1998, we began our clinical program to develop Plenaxis for thetreatment of endometriosis. We completed a phase 2 study of Plenaxis for thetreatment of pain associated with endometriosis in March 2002.  During 2002 and 2003, we conducted apharmacokinetic study to determine the appropriate dose and dosingschedule necessary to maximize the benefit of the therapy for patientswhile minimizing attendant bone mineral density loss.  The results of this study will be used as guidance for potentialfuture clinical studies.  We do notcurrently have any additional endometriosis studies planned and do not expectto conduct further studies without a corporate partner. Any additionaldevelopment in endometriosis would also require concurrence by the FDA.

 

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We began our clinical program for Apan in 2000. We have completed anormal volunteer, phase 1a dose escalation study of Apan and have identified amaximum tolerated dose, or MTD, in healthy volunteers. During the secondquarter of 2003, we initiated a phase 1b trial of Apan in Alzheimer’s diseasepatients. In this trial, a single dose of Apan is administered, with the goalof establishing the MTD in patients. We anticipate completing this study duringthe first half of 2004.  Thetolerability of Apan in Alzheimer’s patients has exceeded expectations andadditional dosing cohorts are now expected to enroll in this trial, which willincrease drug exposure in patients to levels higher than the MTD identified inhealthy volunteers in a phase 1a trial. Assuming FDA concurrence on the protocol and on safety demonstrated inchronic toxicology studies, we anticipate initiating during the second half of2004 a phase 1/2a study evaluating the safety and efficacy of multipleadministrations of Apan to Alzheimer’s patients.

 

During the fourth quarter of 2003, we initiated our first clinicalstudy for PPI-2458 in which an oral formulation is being evaluated in non-Hodgkin’slymphoma patients who are no longer benefiting from other therapies. InMarch 2004, the FDA placed this trial on clinical hold until questionsrelating to a neuropathological finding observed in a three-month animal safetystudy have been satisfactorily resolved. The results of this study were notavailable at the time that the clinical study was initiated. The FDA hasindicated that we will need to submit a detailed plan in order to address thisfinding. We have further evaluated this finding and will submit a plan to theFDA addressing it during the second quarter of 2004. While we intend to workdiligently with the FDA to resolve this issue, we cannot currently predict whenthe clinical hold will be released. We intend to continue evaluating the potentialutility of PPI-2458 for treating certain other cancers, as well as certainautoimmune diseases.

 

Sales and marketing expenses for the three months ended March 31,2004 increased $3.1 million to approximately $4.1 million, from approximately$1.0 million for the corresponding period in 2003.  During the first quarter of 2004, we incurred increased sales andmarketing expenses related to the commercial launch of Plenaxis in the UnitedStates.  This increase was principallydue to our hiring of a sales force comprised of 40 field sales representativesand five regional managers, as well as the establishment of the commercialinfrastructure to support our sales force.  We also experienced increased costs related to market research, variousphysician and national meetings, pricing and reimbursement consulting, andother sales force deployment activities. We expect our sales and marketing expenses will increase during 2004 andwill include expenses relating to the continued build-out of a marketing infrastructure,the cost of our sales force, and promotional and marketing programs.

 

General and administrative expenses for the three months endedMarch 31, 2004 increased 40% to approximately $3.0 million fromapproximately $2.1 million for the corresponding period in 2003.  The increase was due primarily to higherexpenses related to business development activities and increased professionalservices expenses.  We expect that generaland administrative expenses will increase slightly during 2004 and thereafterbased on normal hiring of additional administrative personnel to support thecontinued growth of our commercialization initiatives and our research anddevelopment activities.

 

Net interest income for the three months ended March 31, 2004decreased 45% to approximately $0.2 million, from approximately $0.4 millionfor the corresponding period in 2003. The decrease in net interest income wasdue primarily to reduced average interest rates and lower average cashbalances.

 

At December 31, 2003, we had federal net operating losscarryforwards of $170.3 million that will expire in varying amountsthrough 2023, if not utilized. Utilization of net operating loss and tax credit carryforwards will besubject to substantial annual limitations under the Internal Revenue Code of1986, as amended. The annual limitations may result in the expiration of thenet operating loss and tax credit carryforwards before full utilization.

 

**Liquidity and CapitalResources**

 

To date, our operations and capitalrequirements have been financed primarily with the proceeds of public andprivate sales of common stock and preferred stock, payments under research anddevelopment partnerships and collaborative agreements, investment income and,since the first quarter of 2004, revenues from product sales.

 

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At March 31, 2004, we had cash, cashequivalents and marketable securities of approximately $125.9 million andworking capital of approximately $118.7 million, compared to approximately$143.2 million and $133.0 million, respectively, at December 31,2003.  We expect our cash, cash equivalents and marketable securities atDecember 31, 2004 to range from approximately $60.0 million to $70.0million.  We believe that our existingcash and investments will be sufficient to meet the working capital and capitalexpenditure needs under our current operating plan through approximately theend of 2005.  Assuming the successful commercialization of Plenaxis,partnering of clinical programs at opportune times and continued prudent fiscalmanagement, we believe that we should have sufficient financial resources toexecute our operating plan and attain profitability by 2006.

 

For the three months ended March 31,2004, net cash of approximately $17.2 million was used in operating activities,compared to approximately $13.8 million used in operating activities during thethree months ended March 31, 2003. During the three months endedMarch 31, 2004, our use of cash in operations was due principally to ournet loss of approximately $15.4 million, accounts receivable and inventorybuild of approximately $1.6 million and the reduction in accounts payable andaccrued expenses of approximately $0.9 million, partially offset bydepreciation and amortization.  We expect our cash utilization to increaseduring 2004 as a result of an overall increase in operating expenses as wecontinue launch-related activities for Plenaxis, continue with clinical trialsfor Apan, continue preclinical and clinical trials for PPI-2458, and expand ourresearch and development initiatives. We also expect to use a significantamount of cash for the production of inventory and increases in accountsreceivable. We expect that cash used for inventory purchases will increasethrough the end of fiscal year 2005 to support commercial sales of Plenaxis.The actual amount of overall expenditures will depend on numerous factors,including the timing of expenses and the timing and progress of our research,development and commercialization efforts.

 

Net cash provided by investing activities ofapproximately $13.3 million for the three months ended March 31, 2004consisted primarily of net sales or maturities of marketable securities ofapproximately $13.5 million.  This compares to net cash provided byinvesting activities of approximately $35.0 million for the correspondingperiod in 2003.  Net cash provided by investing activities for the threemonths ended March 31, 2003 was also related primarily to net sales ormaturities of marketable securities.

 

In July 2000, in connection with thepurchase, through our wholly owned real estate subsidiary, of our corporateheadquarters and research facility in Waltham, Massachusetts, the subsidiaryentered into an acquisition and construction loan agreement providing for up to$33.0 million in financing for the acquisition of, and improvements to, thefacility. As of March 31, 2004, $31.7 million was outstanding under theloan agreement. Advances bear interest at a rate equal to the 30-day LIBOR plus2.0% (3.09% at March 31, 2004). Principal and interest are payable monthlyin arrears.  In July, we exercised thefirst of two one-year extension options, extending the maturity date of theloan until July 30, 2004. As a result of this extension, inAugust 2003 we started making monthly principal payments on the loan ofapproximately $62,000, in addition to interest payments. In connection withthis extension, we also entered into an interest rate cap agreement in order toreduce the potential impact of interest rate increases on future income.

 

In April 2004, we signed a non-binding term sheet with our currentlender to amend the existing loan agreement. The term sheet provides for the extension of the maturity date throughApril 2009 at a fixed rate of 5.95%. The term sheet also provides for certain financial operating covenantswhich would become effective as of December 31, 2006.  The term sheet provides that, in addition tointerest, we would continue to repay principal on a monthly basis using a25-year amortization schedule and would have the option to extend the loanfor two additional, one-year extension periods, subject to meeting certainqualifications.

 

At December 31, 2003, we had provided avaluation allowance of $86.5 million for our deferred tax assets. Thevaluation allowance represents the value of the deferred tax assets.  Dueto anticipated  future operating losses, we believe that it is more likelythan not that we will not realize the net deferred tax assets in the future andwe have provided an appropriate valuation allowance.

 

**Recent Accounting Pronouncements**

 

In January 2003, the Financial Accounting Standards Board, orFASB, issued FASB Interpretation No. 46, *Consolidation of Variable Interest Entities*,or FIN No. 46.  FIN No. 46 sets forth

 

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the criteria used in determining whether an investment in a variableinterest entity, or VIE, should be consolidated and is based on the generalpremise that companies that control another entity through interests other thanvoting interests should consolidate the controlled entity.  We do not have any VIE’s.  Accordingly, the implementation of FIN No.46 did not have any impact on our consolidated financial statements.

 

In May 2003, theFASB issued Statement of Financial Accounting Standards No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*, or SFASNo. 150. SFAS No. 150 establishes how a company classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity, including redeemable convertible preferred stock. This statement iseffective for financial instruments entered into or modified after May 31,2003, and is otherwise effective at the beginning of the interim periodcommencing July 1, 2003, except for mandatory redeemable financialinstruments of nonpublic companies. The Financial Accounting Standards Boardhas indefinitely deferred implementation of some provisions of SFASNo. 150. We believe that the adoption of SFAS No. 150 will not have amaterial impact on our consolidated financial statements.

 

**Risk Factors that May Affect Future Results**

 

*The risks anduncertainties described below are not the only ones we face.  Additional risks and uncertainties notpresently known to us or that are currently deemed immaterial may also impairour business, financial condition and results of operations.  If any of these risks actually occur, ourbusiness, financial condition and results of operations could be materiallyadversely affected.*

 

**We have a history of losses and anticipatesignificant increases in our operating expenses over the next several years,and we may not be profitable in the future.**

 

We cannot assure you that we will be profitable in the future or, if weattain profitability, that it will be sustainable.  In November 2003, we received FDA approval to marketPlenaxis for the treatment of the symptoms of men with advanced prostate cancerfor whom other hormonal therapies are not appropriate and who have refusedsurgical castration.  All of our otherproduct candidates are in the research or development stage.  Sales of Plenaxis began inJanuary 2004.  Prior to the launchof Plenaxis, we had never marketed or sold any products.  Our marketing and selling efforts withregard to Plenaxis may not be commercially successful, and we may be unable tosuccessfully develop or market any other products in the future. To date, wehave derived substantially all of our revenues from payments under corporatecollaboration and license agreements. We expect to continue to spend significant amounts to further developour commercial sales and marketing capabilities, continue clinical studies andseek regulatory approval for our other product candidates. We also intend to spendsubstantial amounts to fund additional research and development for otherpotential products, enhance our core technologies, and for general andadministrative purposes.  As ofMarch 31, 2004, we had an accumulated deficit of approximately $201.7 million.  We expect that our operating expenses willincrease significantly due primarily to increased expenses related to continuedcommercialization activities for Plenaxis, as well as the initiation andcontinuation of studies as part of our other clinical programs, resulting insignificant operating losses at least through 2005.  We currently do not expect to achieve profitability until 2006 atthe earliest.  Moreover, our ability toattain profitability by 2006 is dependent on numerous factors, including ourability to successfully commercialize Plenaxis, partnering of clinical programsat opportune times and continued prudent fiscal management.  Even if we do become profitable, we cannotassure you that we would be able to sustain or increase profitability on aquarterly or annual basis.

 

**Our business is dependent on the commercialsuccess of Plenaxis.  If Plenaxis failsto achieve market acceptance, it may never be commercially successful and wemay be unable to continue our operations as planned.**

 

The success of our business is dependent on the successfulcommercialization of Plenaxis.  Plenaxisis new to the market in the United States and may be unfamiliar to members ofthe medical community and to patients. Market acceptance will depend largely onour ability to demonstrate, to the oncology and urology communities inparticular, the efficacy and safety of Plenaxis as an alternative to

 

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currently marketed therapies or surgical options. We cannot be certainthat Plenaxis will provide benefits considered adequate by providers ofoncology and urology services or that enough providers will use the product toensure its commercial success.  Manyfactors may affect its market acceptance and commercial success, including:

 

•                                          thescope of the patient population and the indication for which Plenaxis wasapproved in the United States, and if approval is obtained outside of theUnited States, the scope of the patient population and the indication for whichPlenaxis is so approved;

 

•                                          theterms of the risk management program required by the FDA in connection with theapproval of Plenaxis, as well as any marketing restrictions that may be imposedby foreign regulatory authorities in connection with the approval of Plenaxisoutside of the United States;

 

•                                          theproduct labeling and product insert required by the FDA, and, if approval isobtained outside of the United States, by foreign regulatory authorities;

 

•                                          theeffectiveness of Plenaxis and the potential side effects, including the risk ofimmediate-onset systemic allergic reactions, as compared to alternativetreatment methods;

 

•                                          theextent and success of our marketing and sales efforts in the United States, andif approval is obtained outside of the United States, the extent and success ofthe marketing and sales efforts of our corporate collaborator(s);

 

•                                          thecost-effectiveness of Plenaxis and the availability of insurance or otherthird-party reimbursement, in particular Medicare, for patients, and the rateof such reimbursement;

 

•                                          thecompetitive features of Plenaxis as compared to other products or treatmentoptions, including the frequency of administration of Plenaxis as compared toother products, and doctor and patient acceptance of these features; and

 

•                                          unfavorablepublicity concerning Plenaxis or any similar products.

 

In addition, we must continually submit any labeling, advertising andpromotional material to the FDA for review and pre-approval.  There is risk that the FDA will prohibit useof the marketing material in the form we desire. Unfavorable outcomes resultingfrom factors such as those identified above could limit sales of Plenaxis orcause sales of Plenaxis to decline.  Inthose circumstances, we may have to find additional sources of funding or scaleback or cease operations. If Plenaxis is not commercially successful, we may be unable to continue our operationsas planned.

 

**We may be unable to either establishmarketing and sales capabilities or enter into corporate collaborationsnecessary to successfully commercialize Plenaxis or our other potentialproducts.**

 

We have no experience in marketing or selling pharmaceutical productsand have limited marketing and sales resources. To achieve commercial successfor Plenaxis, or any other approved product, we must either develop a marketingand sales force, as well as the infrastructure to support it, or enter intoarrangements with others to market and sell our products.  We are promoting Plenaxis in the UnitedStates through our own dedicated marketing and sales team.  Recruiting and retaining qualified salespersonnel is therefore critical to our success.  Competition for skilled personnel is intense, and we cannot assureyou that we will be able to attract and retain a sufficient number of qualifiedindividuals to successfully launch Plenaxis. Accordingly, we may be unable to establish marketing, sales anddistribution capabilities necessary to commercialize and gain market acceptancefor Plenaxis.

 

In addition, establishing the expertise necessary to successfullymarket and sell Plenaxis, or any other product, will require a substantialcapital investment.  Our ability to makethat investment and also execute our current operating plan and attain profitabilityby 2006 is dependent on numerous factors, including, as described above,partnering of clinical programs at opportune times and continued prudent fiscalmanagement.  Accordingly, we cannotassure investors that we will have the funds to successfully commercializePlenaxis or any other potential product in the United States or elsewhere.

 

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Moreover, Plenaxis competes, and our product candidates in developmentare likely to compete, with products of other companies that currently haveextensive and well-funded marketing and sales operations.  Because these companies are capable ofdevoting significantly greater resources to their marketing and sales efforts,our marketing and sales efforts may not compete successfully against theefforts of these other companies.

 

We have also announced our intention to market and sell Plenaxisoutside of the United States through one or more marketing partners uponreceipt of approval abroad.  We recentlyentered into an agreement with Schering AG for the commercialization ofPlenaxis in the field of prostate cancer across Europe, Russia, the MiddleEast, South Africa, Australia and New Zealand. We have limited influence over the decisions made by Schering AG or theresources they devote to the marketing and distribution of Plenaxis products intheir licensed territory, and we cannot assure you that they will meet theirobligations in this regard.  Moreover,Schering AG may market certain products that compete with our products, whichcould limit potential revenues from product sales.  Our marketing and distribution arrangement with Schering AG maynot be successful, and we may not receive any revenues from it.  Also, we cannot assure you that we will beable to enter into marketing and sales agreements on acceptable terms, if atall, for Plenaxis in territories not covered by the Schering AG agreement, orfor any of our other product candidates.

 

**Alternative treatment options exist and maybe more readily available or acceptable to physicians and patients, which mayimpair our ability to capture or maintain market share for Plenaxis.**

 

Alternative products and medical treatments exist or are underdevelopment to treat advanced symptomatic prostate cancer.  For example, the FDA has approved severaldrugs for the treatment of prostate cancer that respond to changes in hormonelevels, and there are other treatment alternatives available, includingradiation therapy and surgery.  TheFDA’s approval of Plenaxis is limited to use in a subset of advancedsymptomatic prostate cancer patients, and distribution of Plenaxis will only bemade in accordance with our risk management program, which includes physicianenrollment in a prescribing program and a signed patient consent form regardingthe risks and benefits of the therapy. Due to the potential risk of immediate-onset systemic allergicreactions, physicians must also monitor patients for 30 minutes following theinjection of Plenaxis.  Prescribingphysicians and patients may view these requirements as burdensome or may recommendor choose to use alternative treatments that are more acceptable to the doctorand/or the patient.  If, due to thesefactors, Plenaxis does not achieve broad market acceptance as a drug for thetreatment of the symptoms of men with advanced prostate cancer for whom otherhormonal therapies are not appropriate and who have refused surgicalcastration, we may be unable tocontinue our operations as planned.

 

**Our potential revenues will diminish if wefail to obtain adequate reimbursement coverage for Plenaxis or our otherproduct candidates from third-party payors.**

 

The continuing efforts of government and third-party payors to containor reduce the costs of health care may limit our commercial opportunity. Ifgovernment and other third-party payors do not provide appropriate coverage andadequate reimbursement for Plenaxis or our other product candidates, physiciansmay not prescribe them.  Additionally,physicians may not prescribe Plenaxis if we fail to provide adequate educationabout its benefits and uses.  In someforeign markets, pricing and profitability of prescription pharmaceuticals aresubject to government control. In the United States, we expect that there willcontinue to be federal and state proposals for similar controls. In addition, managedcare initiatives in the United States will continue to put pressure on thepricing of pharmaceutical products.

 

Our ability to earn revenues from Plenaxis, or any other potentialproduct, alone or with collaborators, may depend in part on the availabilityand levels of reimbursement from:

 

•                                          governmentand health administration authorities, including Medicare and Medicaid;

 

•                                          privatehealth insurers; and

 

•                                          otherthird-party payors.

 

We cannot predict the availability of coverage or reimbursement fornewly approved drugs such as Plenaxis by Medicare or any other payor.  Third-party payors, including Medicare, are

 

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increasingly challenging the prices charged for medical products andservices. Government and other third-party payors increasingly are limitingboth coverage and the level of reimbursement for new drugs and, in some cases,refusing to provide coverage for a patient’s use of an approved drug forpurposes not approved by the FDA. Third-party insurance coverage may not beavailable to patients for Plenaxis or any of our other products.

 

**We may experiencepressure to lower the price of Plenaxis or our other potential products becauseof new and/or proposed federal legislation.**

 

New federal legislation, enacted in December 2003, has altered theway in which physician-administered drugs covered by Medicare are reimbursed,generally leading to lower reimbursement levels.  The new legislation has also added an outpatient prescriptiondrug benefit to Medicare, effective January 2006.  In the interim, Congress has established adiscount drug card program for Medicare beneficiaries.  Both benefits will be provided primarilythrough private entities, which will attempt to negotiate price concessionsfrom pharmaceutical manufacturers. These negotiations may increase pressures to lower prices.  While the new law specifically prohibits theUnited States government from interfering in price negotiations betweenmanufacturers and Medicare drug plan sponsors, some members of Congress arepursuing legislation that would permit the United States government to use itsenormous purchasing power to demand discounts from pharmaceutical companies,thereby creating de facto price controls on prescription drugs.  In addition, the new law contains triggersfor Congressional consideration of cost containment measures for Medicare inthe event Medicare cost increases exceed a certain level.  These cost containment measures could includesome sorts of limitations on prescription drug prices.

 

**As Plenaxis is used commercially, unintendedside effects or adverse reactions could occur that could result in additionalregulatory controls and reduced sales.**

 

During research and development, the use of pharmaceutical products,such as Plenaxis, is limited principally to clinical trial patients undercontrolled conditions and under the care of expert physicians. The widespreadcommercial use of Plenaxis could produce undesirable or unintended side effectsthat have not been evident in our clinical trials.  In addition, in patients who take multiple medications, druginteractions could occur that can be difficult to predict.  These events, among others, could result inthe imposition of additional regulatory controls that could limit thecircumstances under which Plenaxis is prescribed or even lead to the withdrawalof the product from the market.  Due tothe occurrence of immediate-onset systemic allergic reactions in patientstreated with Plenaxis during clinical trials, Plenaxis has been approved underregulations concerning drugs with certain safety profiles, under which the FDAhas established special restrictions to ensure safe use.  Post-marketing phase 4 studies are alsorequired to evaluate the incidence of and further characterize such allergicreactions to the extent they occur.  Anyviolation of these special restrictions or unfavorable findings in the phase 4studies could lead to the imposition of further restrictions or withdrawal of Plenaxisfrom the market.

 

**If we fail to develop and maintain ourrelationships with third-party manufacturers, or if these manufacturers fail toperform adequately, we may be unable to commercialize Plenaxis or any of ourproduct candidates.**

 

Our ability to conduct, or continue to conduct, clinical trials andcommercialize Plenaxis or other product candidates, will depend in part on ourability to manufacture, or arrange for third-party manufacture of, our productson a large scale, at a competitive cost and in accordance with regulatoryrequirements. We must establish and maintain a commercial scale formulation andmanufacturing process for each of our potential products for which we seekmarketing approval. We or third-party manufacturers may encounter difficultieswith these processes at any time that could result in delays in clinicaltrials, regulatory submissions or in the commercialization of potentialproducts.

 

We have no experience in large-scale product manufacturing, nor do wehave the resources or facilities to manufacture products on a commercial scale.We will continue to rely upon contract manufacturers to produce Plenaxis andother compounds for later-stage preclinical, clinical and commercial purposesfor a significant period of time. Third-party manufacturers may not be able to meetour needs as to timing, quantity or quality of materials. If we are unable tocontract for a sufficient

 

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supply of needed materials on acceptable terms, or if we encounterdelays or difficulties in our relationships with manufacturers, our clinicaltrials may be delayed, thereby preventing or delaying the submission of productcandidates for, or the granting of, regulatory approval and thecommercialization of our potential products. Any such delays may lower ourrevenues and delay or prevent our attaining or maintaining profitability.

 

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

 

In addition, we and the third-party manufacturers that we use mustcontinually adhere to current good manufacturing practice requirements enforcedby the FDA through its facilities inspection program.  Foreign regulatory authorities may also inspect our third-partymanufacturers as a condition of approval. In complying with these regulations and foreign regulatory requirements,we and any of our third-party manufacturers will be obligated to expend time,money and effort in production, record-keeping and quality control to assurethat our potential products meet applicable specifications and otherrequirements.  If we or any of ourthird-party manufacturers fail to comply with these requirements, we may besubject to regulatory sanctions, and the facilities could be shut down.

 

Any of these factors could prevent, or cause delays in, obtainingregulatory approvals for our potential products, and the manufacturing,marketing or selling of Plenaxis, and could also result in significantly higheroperating expenses.

 

**The loss or failure of any of our third-partymanufacturers could substantially delay or impair our sale or continued sale ofPlenaxis.**

 

For each stage of Plenaxis production we have relied, and expect in thenear term to continue to rely, on a single third-party manufacturer, and wecurrently have not contracted, and in the near term do not expect to contract,with a second supplier for any of these production stages. Accordingly, theloss of one or more of these suppliers for any reason, including as a result offire, terrorism, acts of God or insolvency or bankruptcy, could result insubstantial delays in, or substantially impair our ability to complete,clinical trials and regulatory submissions or reviews, and could delay orimpair substantially our sale or continued sale of Plenaxis. Such delays orimpairment, and the associated costs and expenses, may lower our potentialrevenues and delay or prevent our attaining profitability. While we areevaluating the possibility of a second source of supply at certain stages ofPlenaxis production, the number of qualified alternative suppliers is limited,and we cannot assure investors that we will be able to locate alternativesuppliers or negotiate second supply agreements on reasonable terms.Furthermore, the process of engineering a new supplier’s facility for theproduction of Plenaxis and obtaining the necessary FDA and foreign regulatoryapproval of the facility would require substantial lead-time and could beextremely costly. We cannot assure investors that we will not lose one or moreof our suppliers, or that in such event we would be readily able to continuethe commercialization of Plenaxis without substantial and costly delays.

 

**If our corporate collaborator reduces, delays or terminates its support, we may be unable to successfully commercialize Plenaxis outside of the United States.**

 

We will depend upon our corporate collaborator, Schering AG, to help usobtain regulatory approval for Plenaxis and to commercialize Plenaxis inSchering’s licensed territory. Despite our collaborative relationship, we havelimited influence over the amount and timing of resources that Schering AG willdevote to Plenaxis.   In addition,Schering AG may terminate our collaboration agreement in variouscircumstances.  We cannot assure youthat Schering AG or future collaborators will meet their obligations to usunder our collaboration agreements with them. If Schering AG or another collaborator terminates its agreement with usor fails to perform, or delays performance of, its obligations, it could delayor otherwise adversely affect or prevent, the commercialization of Plenaxis incertain regions outside of the United States. As a result, we could be forcedto devote unforeseen additional resources to Plenaxis commercialization outsideof the United States.  We cannot assureyou

 

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that we would be able to raise the necessary funds or negotiateadditional corporate collaborations on acceptable terms, if at all, and in thatevent we could have to curtail planned operations for the commercialization ofPlenaxis outside of the United States.

 

**We are subject to extensive governmentregulation that increases our costs and could prevent us from selling Plenaxisor our other potential products.**

 

The development and sale of Plenaxis, and our product candidates, issubject to extensive regulation by governmental authorities. Obtaining andmaintaining regulatory approval typically is costly and takes many years.Regulatory authorities, most importantly, the FDA, have substantial discretionto place on clinical hold or terminate clinical trials, delay, withhold orwithdraw registration and marketing approval in the United States, andeffectively mandate product recalls. Failure to comply with regulatoryrequirements may result in criminal prosecution, civil penalties, recall orseizure of products, total or partial suspension of production or injunction,as well as other actions as to Plenaxis, our other potential products oragainst us. Outside the United States, we can market a product only if wereceive marketing authorization from the appropriate regulatory authorities. Thisforeign regulatory approval process includes all of the risks associated withthe FDA approval process, and may include additional risks.

 

To gain regulatory approval from the FDA and foreign regulatoryauthorities for the commercial sale of any product, we must demonstrate inclinical trials, and satisfy the FDA and foreign regulatory authorities as to,the safety and efficacy of the product. If we develop a product to treat a long-lasting disease, such as cancer orAlzheimer’s disease, we must gather data over an extended period of time. Thereare many risks associated with our clinical trials. For example, we may beunable to achieve the same level of success in later trials as we did inearlier ones. Additionally, data we obtain from preclinical and clinicalactivities are susceptible to varying interpretations that could impederegulatory approval. Further, some patients in our prostate cancer, Alzheimer’sdisease and non-Hodgkin’s lymphoma programs have a high risk of death,age-related disease or other adverse medical events that may not be related toour products.  These events may affectthe statistical analysis of the safety and efficacy of our products. If weobtain regulatory approval for a product, the approval will be limited to thosediseases for which our clinical trials demonstrate the product is safe andeffective.

 

In addition, many factors could delay or result in termination of ourongoing or future clinical trials. For example, results from ongoingpreclinical studies or analyses could raise concerns over the safety orefficacy of a product candidate.  TheFDA recently placed our phase 1 clinical trial of PPI-2458 on clinical hold dueto a neuropathological abnormality observed in some of the animals tested in ananimal safety study completed following initiation of the clinical trial.  The FDA has indicated that we will need tosubmit a detailed plan in order to address this finding.  We have explored this finding to assess itspotential implications and are preparing a plan for submission to the FDA.  While we intend to work diligently with theFDA to resolve this issue, we cannot currently predict when the clinical holdwill be released.  A clinical trial mayalso experience slow patient enrollment or lack of sufficient drug supplies. Patientsmay experience adverse medical events or side effects, and there may be a realor perceived lack of effectiveness of, or of safety issues associated with, thedrug we are testing. Future governmental action or existing or changes in FDApolicies or precedents, may also result in delays or rejection of anapplication for marketing approval.  TheFDA has considerable discretion in determining whether to grant marketingapproval for a drug, and may delay or deny approval even in circumstances wherethe applicant’s clinical trials have proceeded in compliance with FDAprocedures and regulations and have met the established end-points of thetrials. Challenges to FDA determinations are generally time-consuming andcostly, and rarely, if ever succeed. Although we received FDA approval to market Plenaxis in the UnitedStates in November 2003, we can give no assurance that we will obtainmarketing approval for any of our other product candidates.

 

Any regulatory approval may be conditioned upon significant labelingrequirements and, as in the case of the FDA approval of Plenaxis, marketingrestrictions and post-marketing study commitments.  Such labeling and marketing restrictions could materiallyadversely affect the marketability or value of a product, including Plenaxis,resulting in decreased sales.  In such acase, we may have insufficient funds to continue operations as currentlyplanned.

 

In addition, even after regulatory approval is obtained, our Company,product and the manufacturing facilities for our product will be subject tocontinual review and periodic inspection. Later discovery of previously unknownproblems with a product, manufacturer or facility may result in

 

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restrictions on the product, the manufacturer or us, includingwithdrawal of the product from the market. The FDA stringently appliesregulatory standards. Our manufacturing facilities will also be subject to FDAinspections 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 anymodifications to a product, further regulatory approval will be required.

 

For safety reasons, Plenaxis was approved by the FDA with acomprehensive risk management program. This program includes educational outreach to patients and physiciansregarding the risks and benefits of Plenaxis, restricted distribution of theproduct only to physicians enrolled in a prescribing registry, a system forcollecting and reporting adverse events to the FDA and auditing requirements toevaluate the effectiveness of the program. We are also required to conduct several phase 4 studies to evaluate therisk management program and the appropriate use of the drug in the indicatedpopulation.  Under the regulations underwhich Plenaxis was approved, the FDA has the authority to pre-approve allpromotional materials and has available to it an expedited market withdrawalprocedure if issues arise regarding the safe use of Plenaxis.  If approval for Plenaxis is withdrawn, wewill not be able to sell Plenaxis and may have insufficient funds to continueoperations as currently planned.

 

If we are unable to maintain FDA approval, or to obtain any foreignregulatory approval for Plenaxis, or to obtain or maintain regulatory approvalto market our other potential products, we may exhaust our available resourcessignificantly sooner than we had planned. If this were to happen, we would need to either raise additional fundsor seek partners to continue our currently planned research and developmentprograms. We cannot assure you that we would be able to raise the necessaryfunds or negotiate additional corporate collaborations on acceptable terms, ifat all.

 

**We rely upon alimited number of pharmaceutical specialty distributors that could impact theability to sell Plenaxis.**

 

In the United States, we rely upon a limited number of specialtydistributors to deliver Plenaxis to physicians and hospital pharmacies. Thereare a relatively small number of specialty distributors and wholesalers whoprovide such services. These distributors must also distribute Plenaxis only tophysicians and hospital pharmacists enrolled in our risk managementprogram.  There can be no assurancesthat these distributors will adequately provide their services to either theend users or to the Company.

 

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

 

We have contracts with a limited number of research organizations todesign and conduct our laboratory testing and human clinical studies. If wecannot contract for testing activities on acceptable terms, or at all, we maynot complete our product development efforts in a timely manner. To the extentwe rely on third parties for laboratory testing and human clinical studies, wemay lose some control over these activities. For example, third parties may notcomplete testing activities on schedule or when we request them to do so.In addition, these third parties may conduct our clinical trials in a mannerinconsistent with regulatory requirements or otherwise in a manner that yieldsmisleading or unreliable data. This, or other failures of these third partiesto carry out their duties, could result in significant additional costs andexpenses and could delay or prevent the development and commercialization ofour product candidates.

 

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

 

A biopharmaceutical company such as ours must keep pace with rapidtechnological change and faces intense competition. We compete withbiotechnology and pharmaceutical companies for funding, access to newtechnology, research personnel and in product research and development. Many

 

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of these companies have greater financial resources and more experiencethan we do in developing drugs, obtaining regulatory approvals, manufacturing,marketing and sales. We also face competition from academic and researchinstitutions and government agencies pursuing alternatives to our products andtechnologies. We expect that Plenaxis, and all of our products underdevelopment, will face intense competition from existing or future drugs andother medical treatments. In addition, for each of our product candidates, wemay face increasing competition from generic formulations or existing drugswhose active components are no longer covered by patents.

 

Our competitors may:

 

•                                          successfullyidentify drug candidates or develop products earlier than we do;

 

•                                          obtainapprovals from the FDA or foreign regulatory bodies more rapidly than we do;

 

•                                          developproducts that are more effective, have fewer side effects or cost less than ourproducts; or

 

•                                          successfullymarket and sell products that compete with our products.

 

The success of our competitors in any of these efforts would adverselyaffect our ability to promote Plenaxis and to develop and commercialize ourproduct candidates, and to ultimately attain and maintain profitability.

 

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

 

Our success will depend in part on our ability to obtain patents andmaintain adequate protection of our technologies and potential products. If wedo not adequately protect our intellectual property, competitors may be able touse our technologies and erode any competitive advantage we may have. Forexample, if we lose our patent protection for Plenaxis, another party couldproduce and market the compound in direct competition with us. Some foreigncountries lack rules and methods for defending intellectual property rights anddo not protect proprietary rights to the same extent as the United States. Manycompanies have had difficulty protecting their proprietary rights in foreigncountries.

 

Patent positions are sometimes uncertain and usually involve complexlegal and factual questions. We can protect our proprietary rights fromunauthorized use by third parties only to the extent that our proprietarytechnologies are covered by valid and enforceable patents or are effectivelymaintained as trade secrets. We currently own or have exclusively licensed 27issued United States patents. We have applied, and will continue to apply, forpatents covering both our technologies and products as we deem appropriate.Others may challenge our patent applications or our patent applications may notresult in issued patents. Moreover, any issued patents on our own inventions,or those licensed from third parties, may not provide us with adequateprotection, or others may challenge the validity of, or seek to narrow orcircumvent, these patents. Third-party patents may impair or block our abilityto conduct our business. Additionally, third parties may independently developproducts similar to our products, duplicate our unpatented products, or designaround any patented products we develop.

 

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

 

In addition to patents, we rely on a combination of trade secrets,confidentiality, nondisclosure and other contractual provisions, and securitymeasures to protect our confidential and proprietary information. Thesemeasures may not adequately protect our trade secrets or other proprietaryinformation. If these measures do not adequately protect our rights, third partiescould use our technology, and we could lose any competitive advantage we mayhave. In addition, others may independently develop similar proprietaryinformation or techniques, which could impair any competitive advantage we mayhave.

 

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

 

Our technologies, processes, product or product candidates may giverise to claims that they infringe patents or other intellectual property rightsof third parties.  A third party couldforce us to pay damages, stop our use of these technologies or processes, orstop our manufacturing or marketing of the affected products by bringing alegal action against us for infringement. In addition, we could be required toobtain a license to continue to use the technologies or processes or to manufactureor market the affected products, and we may not be able to do so on acceptableterms or at all. We believe that significant litigation will continue in ourindustry regarding patent and other intellectual property rights. If we becomeinvolved in litigation, it could consume a substantial portion of ourresources. Even if legal actions were meritless, defending a lawsuit could takesignificant time, be expensive and divert management’s attention from otherbusiness concerns.

 

**If third parties terminate our licenses, wecould experience delays or be unable to complete the development andcommercialization of our potential products.**

 

We license some of our technology from third parties. Termination ofour licenses could force us to delay or discontinue some of our development andcommercialization programs. For example, if Advanced Research and TechnologyInstitute, Inc., the assignee of Indiana University Foundation, terminated ourlicense with them, we could have to discontinue the commercialization ofPlenaxis. We cannot assure you that we would be able to license substitutetechnology in the future. Our inability to do so could impair our ability toconduct our business because we may lack the technology, or the necessaryrights to technology, required to develop and commercialize our potentialproducts.

 

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

 

The administration of drugs to humans, whether in clinical trials orcommercially, can result in product liability claims whether or not the drugsare actually at fault for causing an injury. As Plenaxis is used more widely, the likelihood of an adverse drugreaction (both expected or unexpected) or unintended side effect will increase.  Furthermore, Plenaxis or our productcandidates may cause, or may appear to have caused, adverse side effects(including death) or potentially dangerous drug interactions that we may notlearn about or understand fully until the drug has been administered topatients for some time.

 

Product liability claims can be expensive to defend and may result inlarge judgments or settlements against us, which could have a negative effecton our financial performance. The costs of product liability insurance haveincreased dramatically in recent years, and the availability of coverage hasdecreased.  Although the Company carriesinsurance that it regards as reasonably adequate to protect it from potentialclaims, there can be no assurance that the Company will be able to maintain itscurrent product liability insurance at a reasonable cost, or at all.  Our former collaboration agreementsincluded, and the agreements regarding the termination of those collaborationsalso include, an indemnification for liabilities associated with thedevelopment and commercialization of Plenaxis. Our agreement with Schering AG contains similar indemnificationprovisions.  If a third party, includinga former 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 the Company’s insurance coverage.  Further, a successful claim could result inthe recall of Plenaxis, or could reduce revenues from sales of Plenaxis.  Even if a product liability claim is notsuccessful, the adverse publicity and time and expense of defending such aclaim may interfere with our business.

 

**Pharmaceuticalcompanies have been the target of lawsuits and investigations and there is noassurance that if we were to be involved in any such lawsuits or investigation,that our defense would be successful.**

 

Pharmaceutical companies have been the target of lawsuits andinvestigations including, in particular, claims asserting violations of theFederal False Claim Act, Anti-Kickback Act, the Prescription Drug Marketing Actor other violations in connection with Medicare and/or Medicaid

 

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reimbursement, and claims under state laws, including stateanti-kickback and fraud laws. Public companies may also be the subject ofcertain other types of claims, including those asserting violations ofsecurities laws or related to environmental matters. There is no assurance thatif we were to be involved in any such lawsuits or investigation, that we wouldbe successful in defending ourselves or in asserting our rights.

 

**If we lose our key personnel or are unable toattract and retain additional skilled personnel, we may be unable to pursue ourproduct development and commercialization efforts.**

 

We depend substantially on the principal members of our management andscientific staff, including Malcolm L. Gefter, Ph.D., our Chief ExecutiveOfficer and Chairman of the Board, and William K. Heiden, our President andChief Operating Officer. We do not have employment agreements with any of ourexecutive officers. Any officer or employee can terminate his or herrelationship with us at any time and work for one of our competitors. The lossof these key individuals could result in competitive harm because we couldexperience delays in our product research, development and commercializationefforts without their expertise.

 

Recruiting and retaining qualified scientific personnel to performfuture research and development work also will be critical to our success.Competition for skilled personnel is intense and the turnover rate can be high.We compete with numerous companies and academic and other research institutionsfor experienced scientists. This competition may limit our ability to recruitand retain qualified personnel on acceptable terms. Failure to attract andretain qualified personnel would prevent us from continuing to develop ourpotential products, enhancing our technologies and launching our productscommercially. Our planned activities will require the addition of newpersonnel, including management and marketing and sales personnel, and thedevelopment of additional expertise by existing management personnel, inparticular in the area of product marketing and sales. The inability to attractand retain these people or to develop this expertise could prevent, or resultin delays in, the marketing and sale of Plenaxis or the research, developmentand commercialization of our product candidates.

 

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

 

Our research and development processes involve the controlled use ofhazardous materials, including chemicals and radioactive and biologicalmaterials, which may pose health risks. For example, the health risksassociated with accidental exposure to Plenaxis include temporary impotence orinfertility and harmful effects on pregnant women. Our operations also producehazardous waste products. We cannot completely eliminate the risk of accidentalcontamination or discharge from hazardous materials and any resultant injury.Federal, state and local laws and regulations govern the use, manufacture,storage, handling and disposal of hazardous materials. Compliance with healthand safety and environmental laws and regulations is necessary and expensive.Current or future health and safety and environmental regulations may impairour research, development or production efforts. We may be required to payfines, penalties or damages in the event of noncompliance or the exposure ofindividuals to hazardous materials.

 

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

 

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

 

The market price of our common stock may fluctuate substantially due toa variety of factors, including, but not limited to:

 

•                                          ourability to successfully commercialize Plenaxis in the United States;

 

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

 

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•                                          theavailability of reimbursement coverage for Plenaxis and changes in thereimbursement policies of third-party insurance companies or governmentagencies;

 

•                                          thewillingness of our corporate collaborator to commercialize Plenaxis interritories outside of the United States and the timing and success of thatcommercialization;

 

•                                          theloss of our corporate collaborator, Schering AG, failure or delay by ourcorporate collaborator in performing its obligations or disputes with ourcorporate collaborator;

 

•                                          ourability to enter into additional foreign corporate collaborations for Plenaxis,or United States or foreign corporate collaborations for our other productcandidates, and the timing and terms of such collaborations;

 

•                                          thesuccess rate of our discovery efforts and clinical trials;

 

•                                          announcementof FDA or foreign regulatory approval or disapproval of any of our productcandidates, or of associated labeling requirements;

 

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

 

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

 

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

 

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

 

•                                          changesin government regulation of the pharmaceutical or medical industry;

 

•                                          actualor anticipated fluctuations in our operating results;

 

•                                          changesin financial estimates or recommendations by securities analysts;

 

•                                          salesof large blocks of our common stock;

 

•                                          changesin accounting principles; and

 

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

 

In addition, the stock market has experienced extreme price and volumefluctuations. The market prices of the securities of biotechnology companies,particularly companies like ours without current product revenues and earnings,have been highly volatile, and may continue to be highly volatile in thefuture. This volatility has often been unrelated to the operating performanceof particular companies. In the past, securities class action litigation hasoften been brought against companies that experience volatility in the marketprice of their securities. Whether or not meritorious, litigation broughtagainst us could result in substantial costs and a diversion of management’sattention and resources.

 

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

 

Our quarterly operating results have fluctuated in the past and arelikely to do so in the future. These fluctuations could cause our stock priceto decline. Some of the factors that could cause our operating results tofluctuate include:

 

•                                          expectedor unexpected fluctuations in Plenaxis revenues in the United States;

 

•                                          thetiming and level of expenses related to the commercialization of Plenaxis inthe United States;

 

•                                          thetiming and success of the commercialization of Plenaxis outside of the UnitedStates;

 

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

 

•                                          thetiming of our commercialization of other products resulting in revenues.

 

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Due to the possibility of fluctuations in our revenues and expenses, webelieve that quarter-to-quarter comparisons of our operating results are not agood indication of our future performance.

 

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

 

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

 

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

 

Provisions in our certificate of incorporation and by-laws may delay orprevent an acquisition of us or a change in our management. Also, because weare incorporated in Delaware, we are governed by the provisions ofSection 203 of the Delaware General Corporation Law, which may prohibit ordelay large stockholders, in particular those owning 15% or more of ouroutstanding voting stock, from merging or combining with us. In addition, therights issued under our rights agreement may be a substantial deterrent to aperson acquiring 10% or more of our common stock without the approval of ourboard of directors. These provisions in our charter and by-laws, rightsagreement and under Delaware law could reduce the price that investors might bewilling to pay for shares of our common stock in the future and result in themarket price being lower than it would be without these provisions.

 

**ITEM 3****.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK.**

 

The primary objective of our investment activities is to preserveprincipal while at the same time maximizing the income we receive from ourinvestments without significantly increasing risk.  We have not entered into any instruments for tradingpurposes.  Some of the securities thatwe invest in may have market risk. This means that an increase in prevailinginterest rates may cause the principal amount of the investment to decrease. Tominimize this risk in the future, we maintain our portfolio of cash equivalentsand short-term investments in a variety of securities, including commercialpaper, money market funds and government and non-government debt securities. Animmediate hypothetical 100 basis point increase in interest rates would haveresulted in an approximate $0.5 million decrease in the fair value of ourinvestments as of March 31, 2004. The same hypothetical increase in interest rates as of December 31,2003 would have resulted in an approximate $0.8 million decrease in the fairvalue of our investments.  Due to theconservative nature and relatively short duration of our investments, interestrate risk is mitigated. As of March 31, 2004, approximately 85% of ourtotal investments will mature or reset in one year or less, with the remaindermaturing in less than two years.

 

In connection with the purchase of our new facility in July 2000,our wholly owned real estate subsidiary executed an acquisition andconstruction loan agreement that provides for up to $33.0 million inborrowings at a floating interest rate indexed to 30-day LIBOR. InJuly 2003, we exercised the first of two one-year extension optionsextending the maturity date of the loan until July 30, 2004.  In connection with this extension, thesubsidiary entered into an interest rate cap agreement which limits exposure tointerest rate increases above a certain threshold through July 30, 2004.

 

In April 2004, we signed a non-binding term sheet with our currentlender to amend the existing loan agreement. The term sheet provides for the extension of the maturity date throughApril 2009 at a fixed rate of 5.95%. The term sheet also provides for certain financial operating covenantswhich would become effective as of December 31, 2006.  The term sheet provides that, in addition tointerest, we would continue to repay principal

 

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on a monthly basis using a 25-year amortization schedule and wouldhave the option to extend the loan for two additional, one-year extensionperiods subject to meeting certain qualifications.  Because of this amendment to the loan agreement, we do notbelieve that there is material interest rate risk exposure with respect to theloan facility.

 

**ITEM 4****.****     CONTROLSAND PROCEDURES.**

 

*(a)*                               *DisclosureControls and Procedures*.

 

The Company’s management, with the participation of the Company’s chiefexecutive officer and chief financial officer, has evaluated the effectivenessof the Company’s disclosure controls and procedures (as such term is defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended) as of the end of the period covered by this report.  Based on such evaluation, the Company’schief executive officer and chief financial officer have concluded that, as ofthe end of such period, the Company’s disclosure controls and procedures areeffective to provide reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin applicable SEC rules and forms.

 

*(b)**                               InternalControl 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 quarter ended March 31, 2004 that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

28

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**PART II****.  OTHER INFORMATION**

 

**ITEM 6**.  EXHIBITS AND REPORTS ON FORM 8-K.

** **

(a)                                  Exhibits

 
| ***Exhibit  Number*** |   | ***Exhibit***                                                                                                                                                          |
|-----------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                   |   | Amended and Restated Certificate of Incorporation (2)                                                                                                                  |
|                  |   |                                                                                                                                                                   |
| 3.2                   |   | Third Amended and Restated By-Laws (5)                                                                                                                                 |
|                  |   |                                                                                                                                                                   |
| 4.1                   |   | Specimen certificate representing shares of common stock (1)                                                                                                           |
|                  |   |                                                                                                                                                                   |
| 4.2                   |   | Specimen certificate representing shares of common stock (including  Rights Agreement Legend) (3)                                                                      |
|                  |   |                                                                                                                                                                   |
| 4.3                   |   | Rights Agreement between the Registrant and American Stock Transfer  & Trust Company, as Rights Agent (4)                                                          |
|                  |   |                                                                                                                                                                   |
| 4.4                   |   | Form of Certificate of Designations of Series A Junior Participating  Preferred Stock (attached as Exhibit A to the Rights Agreement filed as  Exhibit 4.3 hereto) (4) |
|                  |   |                                                                                                                                                                   |
| 4.5                   |   | Form of Rights Certificate (attached as Exhibit B to the Rights  Agreement filed as Exhibit 4.3 hereto) (4)                                                            |
|                  |   |                                                                                                                                                                   |
| 10.1                  |   | Amendment dated March 29, 2004 to Letter Agreement dated as of  May 9, 2002 between PRAECIS and William K. Heiden                                                 |
|                  |   |                                                                                                                                                                   |
| 31.1                  |   | Certification of Chief Executive Officer                                                                                                                               |
|                  |   |                                                                                                                                                                   |
| 31.2                  |   | Certification of Chief Financial Officer                                                                                                                               |
|                  |   |                                                                                                                                                                   |
| 32.1                  |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002          |
|                  |   |                                                                                                                                                                   |
| 32.2                  |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002          |

 

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

 

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

 

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

 

(4)                                  Incorporated byreference to Registration Statement on Form 8-A filed with the Securities andExchange Commission on January 26, 2001.

 

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

 

29

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(b)                                 ReportsSubmitted on Form 8-K

 

On January 30, 2004, we furnished a Current Report on Form 8-K tofurnish under Item 12 (Results of Operations and Financial Condition) a copy ofour Press Release dated January 30, 2004.

 

On February 23, 2004, we furnished a Current Report on Form 8-K tofurnish under Item 9 (Regulation FD Disclosure) a copy of our Press Releasedated February 23, 2004.

 

On March 12, 2004, we furnished a Current Report on Form 8-K tofurnish under Item 9 (Regulation FD Disclosure) a copy of our Press Releasedated March 12, 2004.

 

On March 31, 2004, we furnished a Current Report on Form 8-K tofurnish under Item 9 (Regulation FD Disclosure) a copy of our Press Releasedated March 31, 2004.

 

30

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**SIGNATURE**

 

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

 
|                     | PRAECIS  PHARMACEUTICALS INCORPORATED |
|--------------------------|---------------------------------------|
|                     |                                  |   |
|                     |                                  |   |
| Date:  May 10, 2004 | By                                    | /s/ Kevin F. McLaughlin |   |
|                     |                                  | Kevin F.  McLaughlin |
|                     |                                  | Chief Financial  Officer, Executive Vice President, |
|                     |                                  | Treasurer and  Secretary *(Duly  Authorized Officer and Principal Financial and Accounting Officer)* |

 

31

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**EXHIBIT INDEX**

 
| ***Exhibit  Number*** |   | ***Exhibit***                                                                                                                                                          |
|-----------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                   |   | Amended and Restated Certificate of Incorporation (2)                                                                                                                  |
|                  |   |                                                                                                                                                                   |
| 3.2                   |   | Third Amended and Restated By-Laws (5)                                                                                                                                 |
|                  |   |                                                                                                                                                                   |
| 4.1                   |   | Specimen certificate representing shares of common stock (1)                                                                                                           |
|                  |   |                                                                                                                                                                   |
| 4.2                   |   | Specimen certificate representing shares of common stock (including  Rights Agreement Legend) (3)                                                                      |
|                  |   |                                                                                                                                                                   |
| 4.3                   |   | Rights Agreement between the Registrant and American Stock Transfer  & Trust Company, as Rights Agent (4)                                                          |
|                  |   |                                                                                                                                                                   |
| 4.4                   |   | Form of Certificate of Designations of Series A Junior Participating  Preferred Stock (attached as Exhibit A to the Rights Agreement filed as  Exhibit 4.3 hereto) (4) |
|                  |   |                                                                                                                                                                   |
| 4.5                   |   | Form of Rights Certificate (attached as Exhibit B to the Rights  Agreement filed as Exhibit 4.3 hereto) (4)                                                            |
|                  |   |                                                                                                                                                                   |
| 10.1                  |   | Amendment dated March 29, 2004 to Letter Agreement dated as of  May 9, 2002 between PRAECIS and William K. Heiden                                                 |
|                  |   |                                                                                                                                                                   |
| 31.1                  |   | Certification of Chief Executive Officer                                                                                                                               |
|                  |   |                                                                                                                                                                   |
| 31.2                  |   | Certification of Chief Financial Officer                                                                                                                               |
|                  |   |                                                                                                                                                                   |
| 32.1                  |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002          |
|                  |   |                                                                                                                                                                   |
| 32.2                  |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002          |

 

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(1)          Incorporated by reference to RegistrationStatement on Form S-1 (Registration No. 333-96351) initially filed with theSecurities and Exchange Commission on February 8, 2000 and declaredeffective on April 26, 2000.

 

(2)          Incorporated by reference to Quarterly Reporton Form 10-Q for the quarter ended March 31, 2000 filed with theSecurities and Exchange Commission on June 7, 2000.

 

(3)          Incorporated by reference to RegistrationStatement on Form S-1 (Registration No. 333-54342) initially filed with theSecurities and Exchange Commission on January 26, 2001 and declaredeffective on February 14, 2001.

 

(4)          Incorporated by reference to RegistrationStatement on Form 8-A filed with the Securities and Exchange Commission onJanuary 26, 2001.

 

(5)          Incorporated by reference to Annual Report onForm 10-K for the year ended December 31, 2002 filed with the Securitiesand Exchange Commission on March 19, 2003.

 

32

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