**UNITED STATESSECURITIES AND 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 September 30, 2004** |
| ** **                                                  | ** **      | ** ** |
| **OR**                                                      |
| ** **                                                  | ** **      | ** ** |
| ** **                                                  | **o**           | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**For thetransition period from          to        **

 

**CommissionFile Number: 000-30289**

 

**PRAECIS PHARMACEUTICALS INCORPORATED**

(Exact name of registrant asspecified 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 whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.          Yes ý No o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).Yes ý No o

 

As of October 31, 2004,there were 52,378,398 shares of the registrant’s common stock, $.01 par valueper share, outstanding.

 

 

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**PRAECISPHARMACEUTICALS INCORPORATED**

**FORM 10-Q**

**FOR THEQUARTER ENDED SEPTEMBER 30, 2004**

 

**INDEX**

 
| **PART I.**        | **FINANCIAL INFORMATION**                                                                                              | ** ** |
|--------------------|------------------------------------------------------------------------------------------------------------------------|------------|
| ** **         | ** **                                                                                                             | ** ** |
| Item 1.            | Financial Statements  (Unaudited)                                                                                      |       |
|               |                                                                                                                   |       |
|               | Condensed  Consolidated Balance Sheets –   December 31, 2003 and September 30, 2004                     |       |
|               |                                                                                                                   |       |
|               | Condensed  Consolidated Statements of Operations –   three and nine months ended September 30, 2003 and 2004 |       |
|               |                                                                                                                   |       |
|               | Condensed  Consolidated Statements of Cash Flows – nine months ended September 30,  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.**

 

**PRAECISPHARMACEUTICALS INCORPORATED**

**Condensed ConsolidatedBalance Sheets**

**(Inthousands, except share data)**

**(Unaudited)**

 
| ** **                                                                                                                                     | ** ** | **December 31,  2003** | ** ** | **September 30,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| **Assets**                                                                                                                                     |       |                        |       |                         |       |
| Current  assets:                                                                                                                               |       |                        |       |                         |       |
| Cash and  cash equivalents                                                                                                                     |       | $                           | 15,687     |                         | $          | 9,489 |   |
| Marketable  securities                                                                                                                         |       | 127,505                     |       | 86,799                       |       |
| Accounts  receivable                                                                                                                           |       | —                      |       | 1,715                        |       |
| Inventory                                                                                                                                      |       | —                      |       | 2,513                        |       |
| Prepaid  expenses and other current assets                                                                                                     |       | 726                         |       | 1,502                        |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  current assets                                                                                                                          |       | 143,918                     |       | 102,018                      |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Property and  equipment, net                                                                                                                   |       | 67,713                      |       | 65,146                       |       |
| Due from  officer                                                                                                                              |       | 833                         |       | —                       |       |
| Other assets                                                                                                                                   |       | 14                          |       | 214                          |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total assets                                                                                                                                   |       | $                           | 212,478    |                         | $          | 167,378 |   |
|                                                                                                                                           |       |                        |       |                         |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                 |       |                        |       |                         |       |
| Current  liabilities:                                                                                                                          |       |                        |       |                         |       |
| Accounts  payable                                                                                                                              |       | $                           | 2,483      |                         | $          | 465 |   |
| Accrued  expenses                                                                                                                              |       | 7,707                       |       | 7,242                        |       |
| Deferred  revenue                                                                                                                              |       | —                      |       | 167                          |       |
| Current  portion of long-term debt                                                                                                             |       | 747                         |       | 587                          |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  current liabilities                                                                                                                     |       | 10,937                      |       | 8,461                        |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Deferred  revenue                                                                                                                              |       | —                      |       | 1,764                        |       |
| Long-term  debt                                                                                                                                |       | 31,880                      |       | 31,525                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Commitments  and contingencies                                                                                                                 |       |                        |       |                         |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Stockholders’  equity:                                                                                                                    |       |                        |       |                         |       |
| Common  Stock, $0.01 par value; 200,000,000 shares authorized; 52,011,002 shares in  2003 and 52,378,398 shares in 2004 issued and outstanding |       | 520                         |       | 524                          |       |
| Accumulated  other comprehensive income                                                                                                        |       | 73                          |       | (136                         | )          |
| Additional  paid-in capital                                                                                                                    |       | 355,373                     |       | 355,721                      |       |
| Accumulated  deficit                                                                                                                           |       | (186,305                    | )          | (230,481                     | )          |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  stockholders’ equity                                                                                                               |       | 169,661                     |       | 125,628                      |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  liabilities and stockholders’ equity                                                                                               |       | $                           | 212,478    |                         | $          | 167,378 |   |

 

*See accompanying notes.*

 

3

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Condensed ConsolidatedStatements of Operations**

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

**(Unaudited)**

 
| ** **                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                       | ** ** | **2003**                                   | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues:**                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Product  sales                                                   |       | $                                          | —     |                                      | $          | 1,032 |   | $ | — |   | $ | 2,088 |   |
| Licensing  and other revenues                                    |       | —                                     |       | 42                                        |       | — |   | 120 |   |
| Total  revenues                                                  |       | —                                     |       | 1,074                                     |       | — |   | 2,208 |   |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| **Costs  and expenses:**                                         |       |                                       |       |                                      |       |   |   |   |   |
| Cost of  goods sold                                              |       | —                                     |       | 181                                       |       | — |   | 1,461 |   |
| Research and  development                                        |       | 9,989                                      |       | 7,369                                     |       | 31,089 |   | 23,044 |   |
| Sales and  marketing                                             |       | 751                                        |       | 5,559                                     |       | 2,841 |   | 14,983 |   |
| General and  administrative                                      |       | 2,353                                      |       | 1,885                                     |       | 6,922 |   | 7,063 |   |
| Total costs  and expenses                                        |       | 13,093                                     |       | 14,994                                    |       | 40,852 |   | 46,551 |   |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Operating  loss                                                  |       | (13,093                                    | )          | (13,920                                   | )          | (40,852 | ) | (44,343 | ) |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Interest  income (expense), net                                  |       | 308                                        |       | (34                                       | )          | 1,102 |   | 167 |   |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Net loss                                                         |       | $                                          | (12,785    | )                                         | $          | (13,954 | ) | $ | (39,750 | ) | $ | (44,176 | ) |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Basic and  diluted net loss per share                            |       | $                                          | (0.25      | )                                         | $          | (0.27 | ) | $ | (0.77 | ) | $ | (0.84 | ) |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average number of basic and diluted shares outstanding |       | 51,883                                     |       | 52,378                                    |       | 51,838 |   | 52,286 |   |

 

*See accompanying notes.*

 

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**PRAECIS PHARMACEUTICALSINCORPORATED**

**Condensed ConsolidatedStatements of Cash Flows**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                               | ** ** | **2003**                                  | ** ** | **2004** | ** ** |
| **Operating  activities:**                                               |       |                                      |       |   |   |
| Net loss                                                                 |       | $                                         | (39,750    | ) | $ | (44,176 | ) |
| Adjustments  to reconcile net loss to cash used in operating activities: |       |                                      |       |   |   |
| Depreciation  and amortization                                           |       | 3,416                                     |       | 3,484 |   |
| Stock  compensation                                                      |       | 114                                       |       | 18 |   |
| Changes in  operating assets and liabilities:                            |       |                                      |       |   |   |
| Accounts  receivable                                                     |       | —                                    |       | (1,715 | ) |
| Inventory                                                                |       | —                                    |       | (2,513 | ) |
| Prepaid  expenses and other assets                                       |       | (120                                      | )          | (976 | ) |
| Due from  officer                                                        |       | 75                                        |       | 833 |   |
| Accounts  payable                                                        |       | (2,161                                    | )          | (2,018 | ) |
| Accrued  expenses                                                        |       | 485                                       |       | (465 | ) |
| Deferred  revenue                                                        |       | —                                    |       | 1,931 |   |
|                                                                     |       |                                      |       |   |   |
| Net cash  used in operating activities                                   |       | (37,941                                   | )          | (45,597 | ) |
|                                                                     |       |                                      |       |   |   |
| **Investing  activities:**                                               | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Purchase of  available-for-sale securities                               |       | (96,363                                   | )          | (112,003 | ) |
| Sales or  maturities of available-for-sale securities                    |       | 98,780                                    |       | 152,500 |   |
| Proceeds  from disposition of property and equipment                     |       | —                                    |       | 50 |   |
| Purchase of  property and equipment                                      |       | (414                                      | )          | (967 | ) |
|                                                                     |       |                                      |       |   |   |
| Net cash  provided by investing activities                               |       | 2,003                                     |       | 39,580 |   |
|                                                                     |       |                                      |       |   |   |
| **Financing  activities:**                                               | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Principal  payments on debt                                              |       | (186                                      | )          | (515 | ) |
| Proceeds  from exercises of stock options                                |       | 230                                       |       | 334 |   |
|                                                                     |       |                                      |       |   |   |
| Net cash  provided by (used in) financing activities                     |       | 44                                        |       | (181 | ) |
|                                                                     |       |                                      |       |   |   |
| Net decrease  in cash and cash equivalents                               |       | (35,894                                   | )          | (6,198 | ) |
| Cash and  cash equivalents, beginning of period                          |       | 64,913                                    |       | 15,687 |   |
|                                                                     |       |                                      |       |   |   |
| Cash and  cash equivalents, end of period                                |       | $                                         | 29,019     |   | $ | 9,489 |   |

 

*See accompanying notes.*

 

5

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Notes to CondensedConsolidated Financial Statements**

**(Unaudited)**

# ** **

# **1. **                                Basis of 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 Accounting Principles

 

***Principles of Consolidation***

 

The accompanying consolidated financialstatements include the Company’s accounts and the accounts of its wholly ownedsubsidiaries, 830 Winter Street LLC and PRAECIS Europe Limited.  All significant intercompany account balancesand transactions between the companies have been eliminated.

 

***Inventory***

 

Inventoryis stated at the lower of cost or market with cost determined under the first-in/first-out(“FIFO”) method. The Company will write down any obsolete or otherwiseunmarketable inventory to its estimated net realizable value, asnecessary.  If the actual realizablevalue is less than that estimated by the Company, additional inventory write-downsmay be required.

 

The components ofinventory are as follows (in thousands): 

 
| ** **      | ** ** | **December 31,  2003** | ** ** | **September 30,  2004** | ** ** |
|-----------------|------------|-----------------------------|------------|------------------------------|------------|
| Raw materials   |       | $                           | —     |                         | $          | 52 | ** ** |
| Work-in-process |       | —                      |       | 2,369                        |       |
| Finished  goods |       | —                      |       | 92                           |       |
|            |       | $                           | —     |                         | $          | 2,513 |   |

 

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

 

6

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***Impairment or Disposal ofLong-Lived Assets*.**

 

Statement ofFinancial Accounting Standards (“SFAS”) No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets* (“SFAS No. 144”), requires that if the sum ofthe undiscounted future cash flows expected to result from a company’s asset,net of interest charges, is less than the reported value of the asset, an assetimpairment must be recognized in the financial statements.   The Company evaluates its property, plantand equipment for impairment whenever indicators of impairment exist.  The amount of the impairment to be recognizedis calculated by subtracting the fair value of the asset from the reportedvalue of the asset.  Through September 30,2004, no revision to the estimated useful life or recorded amount of propertyand equipment was required.

 

***Stock-BasedCompensation***

 

The Company has elected to follow AccountingPrinciples Board Opinion No. 25*, Accountingfor Stock Issued to Employees* (“APB No. 25”) and relatedinterpretations, in accounting for its stock-based compensation plans. UnderAPB No. 25, when the exercise price of options granted to employees under theseplans equals the market price of the underlying stock on the date of grant, nocompensation expense is required.  TheCompany also follows the provisions of SFAS No. 148, *Accounting for Stock-Based Compensation-Transition and Disclosure, anamendment of Financial Accounting Standards Board (“FASB”) Statement No. 123*(“SFASNo. 148”).

 

Accordingly, had compensation expense for theCompany’s stock option plans been determined based on the fair value at thegrant date for awards under these plans, consistent with the methodologyprescribed under SFAS No. 148, the Company’s net loss and net loss per sharewould have approximated the pro forma amounts indicated below (in thousands,except per share data):

 
| ** **                                                                                                                                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2003**                                   | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net loss, as  reported                                                                                                                                                               |       | $                                          | (12,785    | )                                         | $          | (13,954 | ) | $ | (39,750 | ) | $ | (44,176 | ) |
| 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 |       | (2,917                                     | )          | (3,274                                    | )          | (8,417 | ) | (8,806 | ) |
| Pro forma  net loss                                                                                                                                                                  |       | $                                          | (15,702    | )                                         | $          | (17,228 | ) | $ | (48,167 | ) | $ | (52,982 | ) |
| Diluted net  loss per share, as reported                                                                                                                                             |       | $                                          | (0.25      | )                                         | $          | (0.27 | ) | $ | (0.77 | ) | $ | (0.84 | ) |
| Diluted net  loss per share, pro forma                                                                                                                                               |       | $                                          | (0.30      | )                                         | $          | (0.33 | ) | $ | (0.93 | ) | $ | (1.01 | ) |

 

The fair valueof the stock options at the date of grant was estimated using the Black-Scholesoption pricing model with the following weighted average assumptions: 

 
| ** **               | ** ** | **2003** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate |       | 4.0      | %          | 4.0      | %          |
| Expected  life (years)   |       | 6        |       | 6        |       |
| Volatility               |       | 103      | %          | 89       | %          |

 

The Companyhas never declared or paid any cash dividends on any of its capital stock anddoes not expect to do so in the foreseeable future.

 

7

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In October2004, the FASB concluded that the proposed standard, FASB 123R, *Share-Based Payment – An Amendment of FASB Statements No. 123 and 95*(“FASB123R”), which would require all companies to measure compensation cost for allshare-based payments, including employee stock options, at fair value, would beeffective for public companies for interim or annual periods beginning afterJune 15, 2005.  Retroactive applicationof the requirements of SFAS No. 123, *Accounting for Stock-BasedCompensation*, not FASB 123R, to the beginning of the fiscal yearthat includes the effective date would be permitted, but not required and earlyadoption of FASB 123R is encouraged.  TheFASB is planning on issuing the final statement in December 2004.  The Company is in the process of determiningthe impact of this standard on its results of operations.

 

***Revenue Recognition***

 

Revenues from product salesare recognized in the period when the product is delivered, provided there ispervasive 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 sales returns, rebates and otherapplicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales.

 

The Company prepares its provisions for sales returns and allowances, rebates and discounts based primarily on estimates.  Contractual allowances and rebates result primarily from sales under contracts with healthcare providers, Medicaid programs and other government agencies.  The Company’s policy for sales returns allows authorized distributors to return the product three months prior to, and six months after, product expiration.  Plenaxis® currently has an approved shelf life of 24 months.  As of September 30, 2004, the Company has shipped product with expiration dates of February 2005 and June 2006. The reserve for sales returns is determined by reviewing the history of returns for products with similar characteristics to Plenaxis®. The Company also utilizes daily reports itemizing sales to physicians and hospital pharmacies, obtained directly from its authorized distributors, in order to analyze specific account ordering trends.  These data are reviewed to monitor product movement through the supply chain to identify remaining inventory that may result in chargebacks or sales returns.  There was approximately $0.4 million of product at distributors at September 30, 2004. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time.  The Company accrued approximately $0.5 million in revenue reserves as of September 30, 2004.  Reserve activity for the three months ended September 30, 2004 included a $0.2 million reduction related to the termination of the Company’s rebate program, offset by a $0.2 million increase adjustment related to potential specific account product returns.  To the extent the Company’s estimates of contractual allowances, rebates and sales returns is different from actuals, the Company adjusts the reserve which impacts the amount of product sales revenue recognized in the period of the adjustment.

 

The Company currently provides substantiallyall of its distributors with payment terms of up to 120 days on purchases ofPlenaxis®.  Through September 30,2004, payments have generally been made in a timely manner.

 

In April 2004, the Company entered intoa license, supply and distribution agreement with Schering AG (“Schering AG”),of Berlin, Germany (the “Schering AG Agreement”).  The Schering AG Agreement provides for 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 Company analyzes such multiple elementarrangements to determine whether the elements can be separated and accountedfor individually as separate units of accounting in accordance with EITFNo. 00-21, *Revenue Arrangements withMultiple Deliverables.* Nonrefundable upfront licensing fees and certain guaranteed, time-basedpayments that require continuing involvement in the form of development,manufacturing or other commercialization efforts by the Company are recognizedas licensing revenue ratably over the period under which the Company isobligated to perform those services.  Milestone payments are recognized aslicensing revenue or product sales when the performance obligations, as definedin the contract, are achieved, so long as the milestone is deemed to besubstantive.  Performance milestonestypically consist of milestones in the development and/or commercialization ofa product, such as obtaining approval from regulatory agencies and theachievement of targeted sales levels. Reimbursements of development costs are recognized as licensing revenueas the related costs are incurred.

 

When the period over which a fee or paymentwill be recognized as revenue cannot be specifically identified from the contract,management estimates the deferral period based upon other critical factorscontained within the contract, including but not limited to patent life orcontract term.

 

8

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The Company continually reviews these estimates which could result in achange in the deferral period and might impact the timing and the amount ofrevenue recognized.

 

***Net Loss Per Share***

 

Basic net loss per share is based on theweighted average number of common shares outstanding.  For the three and nine months ended September 30,2003 and 2004, diluted net loss per common share is the same as basic net lossper common share as the inclusion of common stock options would be antidilutivedue to the Company’s net loss for all periods presented.  Diluted net loss per common share excluded7,967,327 and 7,934,048 common stock options for the periods ended September 30,2003 and 2004, respectively.

 

***Comprehensive Income***

 

SFAS No. 130, *ReportingComprehensive Income*, establishes standards for the reporting anddisplay of comprehensive income (loss) and its components in the consolidatedfinancial statements.  The Company’saccumulated other comprehensive income is comprised of net unrealized gains orlosses on available-for-sale securities. For the three and nine months ended September 30, 2003 and 2004,comprehensive loss was as follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2003**                                   | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net loss                                              |       | $                                          | (12,785    | )                                         | $          | (13,954 | ) | $ | (39,750 | ) | $ | (44,176 | ) |
| Changes in  comprehensive loss:                       |       |                                       |       |                                      |       |   |   |   |   |
| Net  unrealized holding (losses) gains on investments |       | (131                                       | )          | 193                                       |       | (38 | ) | (209 | ) |
| Total  comprehensive loss                             |       | $                                          | (12,916    | )                                         | $          | (13,761 | ) | $ | (39,788 | ) | $ | (44,385 | ) |

 

***Reclassification***

 

Certain amounts reported in previous periodshave been reclassified to conform to the current period presentation.

 

**3.**                                      **Schering AG Agreement**

 

In April 2004, the Company entered intothe Schering AG Agreement, under which the Company granted exclusive rights toSchering AG to commercialize Plenaxis® in the field of prostatecancer in Europe, Russia, the Middle East, South Africa, Australia and NewZealand (the “Licensed Territory”).  TheSchering AG Agreement provides for a combination of upfront, regulatoryapproval and performance-based milestone payments, as well as a share ofrevenue through transfer price payments for drug product which will be suppliedby the Company.  The transfer price willvary based upon net sales of Plenaxis®, as well as pricing andreimbursement levels, in the Licensed Territory.  The milestone payments to the Company maytotal over time up to approximately $90.0 million, depending upon Euro/U.S.Dollar conversion rates, and the attainment of specified annual sales levelswhich the majority of the milestone payments are conditioned upon.  The Company received a $2.0 million signingpayment from Schering AG during the second quarter of 2004, which it isrecognizing into revenues over the remaining patent life of Plenaxis®in Europe of approximately twelve years. As of September 30, 2004, the Company has recognized approximately$69,000 in revenues under the Schering Agreement.

 

9

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**4.****                                      MortgageFinancing**

 

In June 2004, the Company amended itsacquisition and construction loan agreement (the “Amended Loan Agreement”) toextend the maturity date of the loan and modify certain other terms of theoriginal agreement.  Under the AmendedLoan Agreement, on July 30, 2009 the principal amount then outstanding isdue and payable in full, subject to two one-year extension options which areexercisable at the Company’s election provided the Company is in compliancewith certain financial covenants.** **The outstanding principal bearsinterest at a fixed rate of 5.95% through April 2009.  Principal and interest are payable through afixed monthly payment of approximately $207,000, with the principal portionbeing calculated using a 25-year amortization schedule.  The Amended Loan Agreement also provides forcertain additional financial operating covenants, one of which was effectiveimmediately and the remainder of which will become effective as of December 31,2006.

 

**5.****                                     ****UCB S.A. (“UCB”)**

 

In August 2004,the Company amended its Development andSupply Agreement dated as of June 21, 2000 with UCB (the “UCB Agreement”).  The UCB Agreement was assigned to the Companyby Amgen Inc. effective as of December 17, 2001.  The UCB Agreement provides for the supply byUCB of commercial volumes of the active pharmaceutical ingredient for Plenaxis®(“API”).  Under the amendment, theCompany has committed to purchase a specified quantity of API for delivery in2005 (at a price reduced from the price that would otherwise be applicableunder the UCB Agreement), for an aggregate purchase price of $3.9 million, $1.8million of which is payable prior to December 31, 2004, with the remainderdue upon the later of the delivery of the API and December 31, 2005.  Such API will be produced using quantities ofmaterials in UCB’s inventory purchased by UCB pursuant to forecasts submittedto UCB prior to 2001 under the terms of the UCB Agreement (the “Materials”).

 

Inaddition, the Company has committed to purchase the remaining Materials for anaggregate purchase price of approximately $3.4 million.  The Company is required to purchase aspecified quantity of such Materials each year beginning in 2006 and ending in2009.  UCB has granted the Company theoption, in lieu of purchasing the remaining Materials, to purchase each year,at the same reduced price as noted above, specified quantities of API producedusing such Materials.  The option can beexercised in whole or in part.  Materialspurchased in one year can be utilized at a later date for the manufacture ofAPI, and the Company will be credited the cost of such previously purchasedMaterials.

 

**6.****                                     ****Due from Officer**

 

InMay 2002, the Company extended a $1.0 million loan to an officer in connectionwith the officer’s acceptance of employment with the Company. Under the termsof the promissory note (the “Note”) executed in connection with the loan, 10%of the original loan principal was forgiven annually on each anniversary dateof the Note, provided that the officer remained an employee of the Company. In September 2004,the officer left the Company and paid $0.8 million to the Company, representingthe remaining balance due under the Note.

 

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

 

*Thefollowing discussion of our financial condition and results of operationsshould be read together with the condensed consolidated financial statementsand accompanying notes to those statements included elsewhere in this Form10-Q.  This Form 10-Q containsforward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended, that involve risks anduncertainties.  All statements other thanstatements of historical information set forth herein are forward-looking andmay contain information about financial results, events, economic conditions,trends and known uncertainties.  Ouractual results and actual events 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 not toplace undue reliance on these forward-looking statements, which reflectmanagement’s analysis, judgment, belief or expectation only as of the datehereof.  PRAECIS undertakes no obligationto publicly reissue or modify these forward-looking statements to reflectevents or circumstances that arise after the date hereof.*

 

**Overview**

 

We are abiopharmaceutical company focused on the discovery, development andcommercialization of innovative therapies to address unmet medical needs.   In November 2003, we received FDAapproval to market our first product, Plenaxis® (abarelix forinjectable suspension), in the United States. Plenaxis® is indicated for the palliative treatment of menwith advanced symptomatic prostate cancer, in whom LHRH agonist therapy is notappropriate 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.  For safetyreasons, Plenaxis® was approved with marketing restrictions whichinclude a risk management program - the Plenaxis® User Safety (PLUS)Program.  Only physicians enrolled in thePLUS Program may prescribe Plenaxis®.  We are promoting Plenaxis® in theUnited States through our own dedicated marketing and sales team.  Plenaxis® is available toauthorized physicians and pharmacies through a network of specialtydistributors with whom we have contracted.

 

In June 2003, we initiated theregulatory submission process in the European Union seeking approval to marketPlenaxis® for the treatment of a broad population of prostate cancerpatients.  We submitted a marketingauthorization application, or MAA, in Germany and, assuming favorable action inGermany, plan to seek additional European Union member state approvals underthe Mutual Recognition Procedure, or MRP. We believe that the German review process will be completed early in2005.  However, we do not have anycontrol over the timing of the German regulatory authority’s review of our MAAand we cannot assure investors that we will be successful in obtaining approvalin Germany in this timeframe, or at all.

 

In April 2004, we signed an agreementwith Schering AG of Berlin, Germany, for the commercialization of Plenaxis®across Europe, Russia, the Middle East, South Africa, Australia and NewZealand.  The Schering AG agreementprovides for 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, inthe licensed territory.  The milestonepayments to us may total over time up to approximately $90.0 million, dependingupon Euro/U.S. Dollar conversion rates, and the attainment of specified annualsales levels which the majority of the milestone payments are conditionedupon.  The overall financial terms areintended, depending upon performance levels, to approximate an equal sharing ofthe value of the product.  We received a$2.0 million signing payment from Schering AG during the second quarter of2004, which we are recognizing into revenues over the remaining patent life ofPlenaxis® in Europe of approximately twelve years.

 

We also arecontinuing to evaluate potential licensing opportunities for the developmentand commercialization of Plenaxis® in Japan and other ex-U.S.territories not covered by the Schering AG agreement.

 

We arecurrently conducting a phase 1b trial of Apan, our proprietary investigationaldrug candidate for the treatment of Alzheimer’s disease.  We expect to begin a phase 1/2a multiple dosetrial following the successful qualification of a clinical site. We are alsodeveloping PPI-2458, our proprietary compound for the potential treatment of arange of cancers, as well as certain autoimmune diseases.  During the fourth quarter of 2004, we expectto begin a new clinical trial of PPI-2458 in patients with non-Hodgkin’slymphoma.  In addition, we continue todedicate resources to developing and expanding

 

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our Direct Select technology platform.  We intend to use this technology inidentifying new compounds for internal development and also intend to seekpartnering opportunities with other companies to leverage this discoveryplatform.  We also have other programs inthe research or preclinical development stage.

 

Following FDA approval of Plenaxis®in November of 2003, we began hiring and deploying our sales force andestablishing the commercial infrastructure to support the marketing and sale ofPlenaxis® in the United States. During the first quarter of 2004, we shipped the first units of Plenaxis®to distributors and substantially completed the hiring of our salesforce.  Most of our expenditures to datehave been for drug development, commercialization activities and for generaland administrative expenses.

 

Due primarily to the costs associated withthe commercialization of Plenaxis® in the United States, as well asother research and development and general and administrative expenses, we hada net operating loss for the first nine months of 2004.  Our accumulated deficit as of September 30,2004 was approximately $230.5 million. We expect to continue to have net operating losses through at least2005.

 

Assuming the successful commercialization ofPlenaxis®, the reduction, through collaboration arrangements orotherwise, of our net expenses related to our clinical programs and the receiptof revenues through research collaborations involving our Direct Selecttechnology platform, and continued prudent fiscal management, we believe thatour existing cash and investments and anticipated Plenaxis®-relatedrevenues will be sufficient for us to execute our current operating plan andattain profitability during 2006. However, the uptake of Plenaxis® since its initial launch inlate January 2004 has been slower than expected.   We cannot predict at this time the length orextent of this trend and what effect, if any, this could have on longer-termsales assumptions and our ability to attain profitability during 2006.  Moreover, we cannot assure investors that wewill be able to enter into appropriate collaborative arrangements relating toour clinical programs and technology platform in a timely manner and onfavorable terms, if at all.

 

The market for available hormonal therapiesto treat prostate cancer is approximately $1.2 billion in the United States annually.  We continue to believe that the revenueopportunity for Plenaxis®, based upon its approved indication, mayrepresent 15% or more of this market.  Our actual revenues from sales of Plenaxis® in the UnitedStates will depend upon numerous factors, including the impact of our riskmanagement program, physician and patient acceptance of Plenaxis®,the impact of Medicare reform initiatives and the overall success of ourcommercialization efforts.

 

At September 30, 2004, we had 180full-time employees compared to 139 full-time employees at September 30,2003.  This increase in headcount is dueprimarily to the hiring of our sales force following FDA approval in November 2003to market Plenaxis® in the United States.

 

**Critical Accounting Policies**

 

While oursignificant accounting policies are more fully described in Note 2 to ourcondensed consolidated financial statements appearing elsewhere in this 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 actual results,could differ from our estimates.

 

*Revenue Recognition. *We recognize revenues from product sales in the period when the productis delivered, provided 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 sales returns, rebatesand other applicable discounts and allowances. Shipping and other distribution costs are charged to cost of productsales.

 

We prepare our provisions for sales returns and allowances, rebates and discounts based primarily on estimates.  Contractual allowances and rebates result primarily from sales under contracts with healthcare providers, Medicaid programs and other government agencies.  Our policy for sales returns allows authorized distributors to return the product three months prior to, and six months after, product expiration.  Plenaxis® currently has an approved shelf life of 24 months.  As of September 30,

 

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2004, we had shipped product with expiration dates of February 2005 and June 2006. The reserve for sales returns is determined by reviewing the history of returns for products with similar characteristics to Plenaxis®.  We also utilize daily reports itemizing sales to physicians and hospital pharmacies, obtained directly from our authorized distributors, in order to analyze specific account ordering trends.  These data are reviewed to monitor product movement through the supply chain to identify remaining inventory that may result in chargebacks or sales returns.  There was approximately $0.4 million of product at distributors at September 30, 2004.  The reserves are reviewed at each reporting period and adjusted to reflect data available at that time.   We accrued approximately $0.5 million in revenue reserves as of September 30, 2004.  Reserve activity for the three months ended September 30, 2004 included a $0.2 million reduction related to the termination of our rebate program, offset by a $0.2 million increase adjustment related to potential specific account product returns.  To the extent our estimates of contractual allowances, rebates and sales returns is different from actuals, we adjust the reserve which impacts the amount of product sales revenue recognized in the period of the adjustment.

 

We currently provide substantially all of ourdistributors with payment terms of up to 120 days on purchases of Plenaxis®.  Through September 30, 2004, paymentshave generally been made in a timely manner.

 

We analyze our multipleelement arrangements to determine whether the elements can be separated andaccounted for individually as separate units of accounting in accordance withEITF No. 00-21, *Revenue Arrangementswith Multiple Deliverables.* Nonrefundable upfront licensing fees and certain guaranteed, time-basedpayments that require continuing involvement in the form of development,manufacturing or other commercialization efforts by us are recognized aslicensing revenue ratably over the period under which we are obligated toperform those services.  Milestone payments are recognized as licensingrevenue or product sales when the performance obligations, as defined in thecontract, are achieved.  Performancemilestones typically consist of significant milestones in the developmentand/or commercialization of a product such as obtaining approval fromregulatory agencies and the achievement of targeted sales levels.Reimbursements of development costs are recognized as licensing revenue as therelated costs are incurred.

 

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

 

*Inventory.* We value inventory at cost or, iflower, fair market value. We determine cost using the first-in, first-outmethod. We analyze our inventory levels quarterly and write down inventory thathas become obsolete, inventory that has a cost basis in excess of its expectednet realizable value and inventory in excess of expected requirements, to costof goods sold. 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.

 

*Impairmentor Disposal of Long-Lived Assets*.  Statement of Financial Accounting StandardsNo. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets,*or SFAS No. 144, requires that if the sum of theundiscounted future cash flows expected to result from a company’s asset, netof interest charges, is less than the reported value of the asset, an assetimpairment must be recognized in the financial statements.   We evaluate our property, plant andequipment for impairment whenever indicators of impairment exist.  The amount of the impairment to be recognizedis calculated by subtracting the fair value of the asset from the reportedvalue of the asset.

 

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

 

We reviewedour building for impairment as of December 31, 2003.  We have determined that the undiscounted sumof the expected future cash flows from the building exceeded the recorded valueof the building.  As a result, noimpairment allowance was required in accordance with SFAS No. 144.

 

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

 

**Results of Operations**

 

**Three Months Ended September 30, 2004 Compared To Three Months Ended September 30, 2003**

 

Revenues forthe three months ended September 30, 2004 were approximately $1.1 million,compared to zero for the corresponding period in 2003.  Of this amount, approximately $1.0 millionwas related to sales of Plenaxis®, with the remaining amount beingcomprised of revenue amortization with respect to a $2.0 million signingpayment from Schering AG received during the second quarter of 2004. In January 2004,we began shipping Plenaxis® to our authorized distributors.

 

Cost of goods sold for the three months endedSeptember 30, 2004 was approximately $0.2 million compared to no cost ofgoods sold for the corresponding period in 2003.  In January 2004, we began sellingPlenaxis® and accordingly, began recognizing costs related to thosesales.  Much of the raw material used toproduce Plenaxis® (including the active pharmaceutical ingredient)was purchased prior to the FDA granting approval for the commercial sale ofPlenaxis®.  Accordingly, thesepurchases were treated as research and development costs and expensed asincurred.  We anticipate that cost ofgoods sold will decline as a percentage of revenue as fixed costs are spreadover a larger revenue number.  Cost ofgoods sold will increase as a percentage of revenue as previously expensedmaterials are exhausted.  We cannotpredict when such previously expensed materials will be exhausted, as this willbe dependent upon the commercial success of Plenaxis® in both theUnited States and abroad.

 

Research and development expenses for thethree months ended September 30, 2004 decreased 26% to approximately $7.4million, from approximately $10.0 million for the corresponding period in2003.  The decrease reflects reducedspending in our clinical development programs. As a result of FDA approval of Plenaxis® in November 2003,spending on prostate cancer clinical development was reduced during 2004,specifically manufacturing related costs. Spending on our Apan program during the three months ended September 30,2004 was lower than in the corresponding period in 2003 due to reducedpreclinical and clinical expenses. Spending related to our PPI-2458 programduring the three months ended September 30, 2004 increased slightlycompared to the corresponding period in the prior year.  This was due to an increase in preclinicaland clinical spending resulting from several ongoing activities necessary toresume clinical trials. Although we are unable to predict the precise level ofspending on individual clinical programs due to the uncertain nature ofclinical development, overall, we expect our research and development expensesfor the remainder of 2004 and into 2005 to remain consistent as we providesupport for certain investigator-sponsored clinical studies of Plenaxis®,begin a new clinical trial of PPI-2458 in non-Hodgkin’s lymphoma patients andinitiate a phase 1/2a study in Apan.

 

We currently have several ongoing researchand development programs.  Using industryestimates, typical drug development programs may last for ten or more years andmay cost hundreds of millions of dollars to complete.  As our programs progress, we continue toassess the possibility of entering into corporate collaborations to offset aportion of development costs. The ultimate success of our research anddevelopment programs and the impact of these programs on our operations andfinancial results cannot be accurately predicted and will depend, in largepart, upon the outcome and timing of many variables outside of our control.

 

Members of our research and development teamtypically work on a number of projects concurrently. In addition, a substantialamount of our fixed costs such as facility depreciation, utilities andmaintenance are shared by our various programs. Accordingly, we have not and donot plan to specifically identify all costs related to each of our research anddevelopment programs. We estimate that during the first nine months of 2004 andduring 2003, the majority of our research and development expenses were relatedto manufacturing costs, clinical trial costs, salaries and lab supplies,related to our prostate cancer, Alzheimer’s disease and non-Hodgkin’s lymphomaprograms. The remaining research and development costs consisted primarily ofsalaries and lab supplies for our other research programs.

 

We began our clinical program to developPlenaxis® for the treatment of prostate cancer during 1996.  In November 2003, the FDA approvedPlenaxis® for the palliative treatment of men with advancedsymptomatic prostate cancer, in whom LHRH agonist therapy is not appropriateand who

 

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refuse surgical castration, and have one or more of the following:(1) risk of neurological compromise due to metastases, (2) ureteralor bladder outlet obstruction due to local encroachment or metastatic disease,or (3) severe bone pain from skeletal metastases persisting on narcoticanalgesia. Plenaxis® is not indicated for use in women or children.For safety reasons, Plenaxis® was approved with marketingrestrictions. Only physicians enrolled in the PLUS Program may prescribePlenaxis®.

 

In June 2003, we also submitted an MAAfor Plenaxis® in Germany. We believe that the German regulatoryauthorities will complete their review of our MAA early in 2005.  However, we do not have any control over thetiming of the German regulatory authority’s review of our MAA and we cannotassure investors that we will be successful in obtaining a decision fromGermany in this timeframe.  Assuming favorableaction, we plan to subsequently seek further European Union approval forPlenaxis® under the MRP to market Plenaxis® for thetreatment of a broad population of prostate cancer patients.  As described above, in April 2004, wesigned an agreement with Schering AG of Berlin, Germany for thecommercialization of Plenaxis® across Europe, Russia, the MiddleEast, South Africa, Australia and New Zealand, and we continue to evaluatepotential licensing opportunities for the development and commercialization ofPlenaxis® in Japan and other ex-U.S. territories not covered by theSchering AG agreement.  However, wecannot assure investors that we will be successful in obtaining approval in anyregion outside of the United States for the commercialization of Plenaxis®for the treatment of any portion of the 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 todevelop Plenaxis® for the treatment of endometriosis.  In March 2002, we completed a phase 2study of Plenaxis® for the treatment of pain associated withendometriosis.  During 2002 and 2003, weconducted a pharmacokinetic study to determine the appropriate dose and dosing schedule necessaryto maximize the benefit of the therapy for endometriosis patients whileminimizing attendant bone mineral density loss. The results of this study will be used as guidance for potential futureclinical studies.  We do not currentlyhave any additional endometriosis studies planned and do not expect to conductfurther studies without a corporate partner. Any additional clinical trials ofPlenaxis® for the treatment of endometriosis would also requireconcurrence by the FDA.

 

We began our clinical program for Apan in2000. We have completed a normal volunteer, phase 1a dose escalation study ofApan and have identified a maximum tolerated dose, or MTD, in healthyvolunteers. During the second quarter of 2003, we initiated a phase 1b trial ofApan in Alzheimer’s disease patients.  Inthis trial, a single dose of Apan is administered, with the goal ofestablishing the MTD in patients. The study has taken longer than originallyanticipated due to the enrollment of cohorts beyond the expected MTD, which wasbased upon an earlier phase 1a study, as well as slower than expected patientaccrual.  We anticipate completing thisstudy during the first half of 2005.  Wealso anticipate initiating, following the successful qualification of a clinicalsite, a phase 1/2a study that will evaluate the safety and efficacy of amultiple dose regimen of Apan administered to Alzheimer’s patients.  Patients will receive daily doses of Apan fortwo weeks, followed by semi-weekly dosing for ten weeks.  Samples of the patients’ cerebrospinal fluid,or CSF will be obtained prior to and after dosing, to measure drug and beta-amyloidlevels.  We also plan to conductpreliminary evaluations of memory and functional brain imaging as part of thisstudy.** **Inlight of the anticipated development costs estimated for phase 2 and phase 3studies in Alzheimer’s disease, we will seek a partner to offset the costsassociated with the Apan clinical program beyond the phase 1/2a study.

 

During the fourth quarter of 2003, weinitiated our first clinical trial for PPI-2458 to evaluate an oral formulationin non-Hodgkin’s lymphoma patients who were no longer benefiting from othertherapies. In March 2004, the FDA placed this trial on clinical hold untilquestions relating to a neuropathological finding observed in a three-monthanimal safety study were satisfactorily resolved.  The results of this animal safety study werenot available at the time that the clinical trial was initiated.  In June 2004, we received clearance fromthe FDA, following its review of our revised clinical plan, to resume clinicaltrials.  We expect to begin a newclinical trial of PPI-2458 in non-Hodgkin’s lymphoma patients during the fourthquarter of 2004.  In this trial, patientswill undergo two-months of treatment, with dosing every other day.  The trial is designed to determine theoptimal pharmacological dose and/or the MTD of PPI-2458.  In December 2003, we entered into acollaboration with the NCI’s Division of Cancer Treatment and Diagnosis for theexpansion of clinical development of PPI-2458 for the treatment of variousforms of cancer.  Under thecollaboration, we will work with the NCI to optimize a clinical developmentpath for PPI-2458 in cancers other than non-Hodgkin’s lymphoma.** **We also intend tocontinue evaluating the potential utility of PPI-2458 for treating certainautoimmune diseases, including rheumatoid arthritis.  In light of the anticipated development costsassociated with the PPI-2458 clinical program, we will seek a partner for thisprogram.

 

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Sales and marketing expenses for the threemonths ended September 30, 2004 increased to approximately $5.6 million,from approximately $0.8 million for the corresponding period in 2003.  The increase resulted mainly from increasedexpenses related to the commercial launch of Plenaxis® in the UnitedStates, principally the hiring of our sales force during the first quarter of2004, as well as the establishment of the commercial infrastructure to supportthe sales force.  We also experiencedincreased costs related to market research, various physician and nationalmeetings, advertising, pricing and reimbursement consulting, and other salesforce deployment activities.  We expectour sales and marketing expenses will remain at these levels for the remainderof 2004 and into 2005, and will consist primarily of the cost of our salesforce and various promotional and marketing programs.

 

General andadministrative expenses for the three months ended September 30, 2004decreased 20% to approximately $1.9 million, from approximately $2.4 millionfor the corresponding period in 2003. The decrease was a result of lower expenses related to businessdevelopment activities and professional services.

 

Net interestincome for the three months ended September 30, 2004 decreased toapproximately zero, from approximately $0.3 million for the correspondingperiod in 2003. The decrease in net interest income was due primarily to therefinancing of the mortgage on our facility from a lower variable rate to a higherfixed rate and lower average cash balances.

 

At December 31,2003, we had federal net operating loss carryforwards of $170.3 millionthat will expire in varying amounts through 2023, if not utilized.  Utilization of net operating loss and taxcredit carryforwards will be subject to substantial annual limitations underthe Internal Revenue Code of 1986, as amended. The annual limitations mayresult in the expiration of the net operating loss and tax credit carryforwardsbefore full utilization.

 

**Nine Months Ended September 30, 2004Compared To Nine Months Ended September 30, 2003**

 

Revenues forthe nine months ended September 30, 2004 were approximately $2.2 million,compared to zero for the corresponding period in 2003.  Substantially all of our revenues wererelated to sales of Plenaxis® during the nine months ended September 30,2004, with the remaining amount representing licensing and other revenues.

 

Cost of goods sold for the nine months ended September 30,2004 was approximately $1.5 million, compared to no cost of goods sold for thecorresponding period in 2003.  In January 2004,we began selling Plenaxis® and accordingly, began recognizing costsrelated to those sales.  The majority ofour cost of goods sold during the first half of 2004 was related to a $1.0million milestone payment which became due and payable upon the firstcommercial sale of Plenaxis® under our license agreement withIndiana University Advanced Research and Technology Institute, Inc., orIUF.  Much of the raw material used toproduce Plenaxis® (including the active pharmaceutical ingredient)was purchased prior to the FDA granting approval for the commercial sale ofPlenaxis®.  Accordingly, thesepurchases were treated as research and development costs and expensed asincurred.  Excluding the effect of the$1.0 million milestone payment to IUF during the first quarter of 2004, weanticipate that cost of goods sold will increase as sales volume increases, butmay decline as a percentage of revenue as fixed costs are spread over a largerrevenue number.  Cost of goods sold willincrease as a percentage of revenue as previously expensed materials areexhausted.  We cannot predict when suchpreviously expensed materials will be exhausted, as this will be dependent uponthe commercial success of Plenaxis® in both the United States andabroad.

 

Research and development expenses for thenine months ended September 30, 2004 decreased 26% to approximately $23.0million, from approximately $31.1 million for the corresponding period in2003.   The decrease reflects reducedspending in our clinical development programs. As a result of FDA approval of Plenaxis® in November 2003,spending on prostate cancer clinical development was reduced during 2004,specifically manufacturing related costs. Spending on our Apan program during the nine months ended September 30,2004 decreased compared to the corresponding period in 2003 due to lowerpreclinical and clinical expenses. Spending related to our PPI-2458 program during the nine months ended September 30,2004 was higher than the corresponding period in 2003.  This was due to an increase in preclinicalspending resulting from several ongoing studies necessary to resume clinicaltrials, offset by a reduction in manufacturing activities for PPI-2458.

 

Sales and marketing expenses for the ninemonths ended September 30, 2004 increased to approximately $15.0 million,from approximately $2.8 million for the corresponding period in 2003.

 

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The increase resulted mainly from increased expenses related to thecommercial launch of Plenaxis® in the United States, principally thehiring of our sales force, as well as the establishment of the commercialinfrastructure to support the sales force.  We also experienced increased costs related to market research, variousphysician and national meetings, advertising, pricing and reimbursementconsulting, and other sales force deployment activities.

 

General andadministrative expenses for the nine months ended September 30, 2004increased 2% to approximately $7.1 million, from approximately $6.9 million forthe corresponding period in 2003.

 

Net interestincome for the nine months ended September 30, 2004 decreased to approximately$0.2 million, from approximately $1.1 million for the corresponding period in2003. The decrease in net interest income was due primarily to the refinancingof the mortgage on our facility from a lower variable rate to a higher fixedrate and lower average cash balances.

 

**Liquidity and Capital Resources**

 

To date, ouroperations and capital requirements have been financed primarily with theproceeds of public and private sales of common stock and preferred stock,payments under research and development partnerships and collaborativeagreements, investment income and revenues from product sales.  If Plenaxis® is not commercially successful,we would have to modify our operating plan and potentially seek additionalsources of funding.  We cannot assureinvestors that we could obtain additional funding on attractive terms, if atall.

 

At September 30, 2004, we had cash, cashequivalents and marketable securities of approximately $96.3 million andworking capital of approximately $93.6 million, compared to approximately$143.2 million and $133.0 million, respectively, at December 31,2003.  We continue to closely manage our operating expenses, and expect to end2004 with cash, cash equivalents and marketable securities of at least $75.0million.

 

Assuming the successful commercialization ofPlenaxis®, the reduction, through collaboration arrangements orotherwise, of our net expenses related to our clinical programs and the receiptof revenues through research collaborations involving our Direct Selecttechnology platform, and continued prudent fiscal management, we believe thatour existing cash and investments and anticipated Plenaxis®-relatedrevenues will be sufficient for us to execute our current operating plan andattain profitability during 2006. However, the uptake of Plenaxis® since its initial launch inlate January 2004 has been slower than expected.   We cannot predict at this time the length orextent of this trend and what effect, if any, this could have on longer-termsales assumptions and our ability to attain profitability during 2006.  Moreover, we cannot assure investors that wewill be able to enter into appropriate collaborative arrangements relating toour clinical programs and technology platform in a timely manner and onfavorable terms, if at all.

 

For the ninemonths ended September 30, 2004, net cash of approximately $45.6 millionwas used in operating activities, compared to approximately $37.9 million usedin operating activities during the nine months ended September 30, 2003.  During the nine months ended September 30,2004, our use of cash in operations was due principally to our net loss ofapproximately $44.2 million, accounts receivable and inventory build ofapproximately $4.2 million and the reduction in accounts payable and accruedexpenses of approximately $2.5 million, offset by approximately $1.9 million ofdeferred revenue and approximately $3.5 million of depreciation andamortization.  We expect our cashutilization to continue for the remainder 2004 and into 2005 as we continuecommercial activities for Plenaxis®, continue with clinical trialsfor Apan, resume clinical trials for PPI-2458, and expand our research anddevelopment initiatives.  We expect thatcash used for inventory purchases and accounts receivable build will increasethrough the end of fiscal year 2005 to support commercial sales of Plenaxis®.  The actual amount of overall expenditureswill depend on numerous factors, including the timing of expenses and thetiming and progress of our research, development and commercialization efforts.

 

Net cash provided by investing activities ofapproximately $39.6 million for the nine months ended September 30, 2004consisted primarily of net sales or maturities of marketable securities ofapproximately $40.5 million.  Thiscompares to net cash provided by investing activities of

 

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approximately $2.0 million for the corresponding period in 2003, whichwas also related primarily to net sales or maturities of marketable securitiesof approximately $2.4 million.

 

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 September 30, 2004,approximately $32.1 million was outstanding under the loan agreement, as amendedas described below.  In June 2004,the acquisition and construction loan agreement was amended to extend thematurity date of the loan and modify certain other terms of the originalagreement.  Under the amended loanagreement, on July 30, 2009 the principal amount then outstanding is dueand payable in full, subject to two one-year extension options which areexercisable at our election provided we are in compliance with certainfinancial covenants.  The outstandingprincipal bears interest at a fixed rate of 5.95% through April 2009.  Principal and interest are payable through afixed monthly payment of approximately $207,000, with the principal portionbeing calculated using a 25-year amortization schedule.  The amended loan agreement also provides for certainadditional financial operating covenants, one of which was effectiveimmediately and the remainder of which will become effective as of December 31,2006.  The loan is secured by thefacility, together with all fixtures, equipment, improvements and other relateditems, and by all rents, income or profits received by our real estatesubsidiary, and is unconditionally guaranteed by us.

 

In July 2004, we amended our supplyagreement with Cambrex Charles City, Inc. (formerly Salsbury Chemicals, Inc.)for the manufacture of the commercial depot formulation of Plenaxis®.  Under the amendment, the term of the originalagreement has been extended for an additional five years (through July 2010),with an option for us to further extend the term for up to an additional fiveyears, subject to an agreed upon increase in price and in the minimum annualpurchase commitment.**** As part of the amendment, we agreed to aminimum purchase commitment of $900,000 per year for 2004 and each of thesubsequent four years.

 

In August 2004,we amended our Development and Supply Agreement with UCBS.A.  The UCB agreement was assigned tous by Amgen Inc. effective as of December 17, 2001.  This agreement provides for the supply by UCBof commercial volumes of the active pharmaceutical ingredient, or API, forPlenaxis®.  Under theamendment, we have committed to purchase a specified quantity of API fordelivery in 2005 (at a price reduced from the price that would otherwise beapplicable under the agreement), for an aggregate purchase price of $3.9million, $1.8 million of which is due prior to December 31, 2004, with theremainder due upon the later of the delivery of the API and December 31,2005.  This API will be produced usingquantities of materials in UCB’s inventory purchased by UCB pursuant toforecasts submitted to UCB prior to 2001 under the terms of the UCB agreement.

 

Inaddition, we have committed to purchase the remaining materials referencedabove for an aggregate purchase price of approximately $3.4 million.  We are required to purchase a specifiedquantity of such materials each year beginning in 2006 and ending in 2009.  UCB has granted us the option, in lieu ofpurchasing the remaining materials, to purchase each year, at the same reducedprice as noted above, specified quantities of API produced using suchmaterials.  The option can be exercisedin whole or in part.  Materials purchasedin one year can be utilized at a later date for the manufacture of API, and wewill be credited the cost of such previously purchased materials.

 

At December 31,2003, we had provided a valuation allowance of $86.5 million for ourdeferred tax assets. The valuation allowance represents the value of thedeferred tax assets.  Due to anticipated  future operating losses, we believe that itis more likely than not that we will not realize the net deferred tax assets inthe future and we have provided an appropriate valuation allowance.

 

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**Risk Factors That May AffectFuture Results**

 

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

 

**We have a history oflosses and anticipate significant increases in our operating expenses over thenext several years, and we may not be profitable in the future.**

 

We cannot assure you that we will beprofitable in the future or, if we attain profitability, that it will besustainable.  In November 2003, wereceived FDA approval to market Plenaxis® for the treatment of thesymptoms of men with advanced prostate cancer for whom other hormonal therapiesare not appropriate and who have refused surgical castration.  All of our other product candidates are inthe research or development stage.  Salesof Plenaxis® began in January 2004.  Prior to the launch of Plenaxis®,we had never marketed or sold any products. Our marketing and selling efforts with regard to Plenaxis®may not be commercially successful, and we may be unable to successfullydevelop or market any other products in the future. To date, we have derivedsubstantially all of our revenues from payments under corporate collaborationand license agreements.  We expect tocontinue to spend significant amounts to further develop our commercial salesand marketing capabilities, continue clinical studies and seek regulatoryapproval for our other product candidates. We also intend to spend substantialamounts to fund additional research and development for other potential products,enhance our core technologies, and for general and administrativepurposes.  As of September 30, 2004,we had an accumulated deficit of approximately $230.5 million.  We expect that our operating expenses willcontinue at current levels due primarily to expenses related to continuedcommercialization activities for Plenaxis®, as well as theinitiation and continuation of studies as part of our other clinical programs,resulting in significant operating losses at least through 2005.  We currently do not expect to achieveprofitability until 2006 at the earliest. The uptake of Plenaxis® since its initial launch in late January 2004has been slower than expected.  We cannotpredict at this time the length or extent of this trend and what effect, ifany, this could have on longer-term sales assumptions and our ability to attainprofitability in this timeframe. Moreover, our ability to attain profitability during 2006 is dependenton numerous factors, including our ability to successfully commercialize Plenaxis®,the reduction, through collaboration arrangements or otherwise, of our netexpenses related to our clinical programs and the receipt of revenues throughresearch collaborations involving our Direct Select technology platform, andcontinued prudent fiscal management. Even if we do become profitable, we cannot assure you that we would beable to sustain or increase profitability on a quarterly or annual basis.

 

**Our business isdependent on the commercial success of****Plenaxis®.  If Plenaxis® fails to achieve market acceptance, it maynever be commercially successful and we would likely have insufficient funds tocontinue our operations as currently planned.**

 

The success of our business is dependent onthe successful commercialization of Plenaxis®.  Plenaxis® is new to the market inthe United States and may be unfamiliar to members of the medical community andto patients. Market acceptance will depend largely on our ability todemonstrate, to the oncology and urology communities in particular, the efficacyand safety of Plenaxis® as an alternative to current therapies orsurgical options. We cannot be certain that Plenaxis® will providebenefits considered adequate by providers of oncology and urology services orthat enough providers will use the product to ensure its commercialsuccess.  To date, the uptake of Plenaxis®since its initial launch in the United States in late January 2004has been slower than expected.  Manyfactors may affect its market acceptance and commercial success, including:

 

•                                          thescope of the patient population and the indication for which Plenaxis®was approved 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 thatmay be imposed by foreign regulatory authorities in connection with theapproval of Plenaxis® outside of the United States;

 

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•                                          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, includingthe risk of immediate-onset systemic allergic reactions, as compared toalternative treatment methods;

 

•                                          ourability to continue to hire, train and retain qualified sales personnel topromote Plenaxis® in the United States;

 

•                                          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 orother third-party reimbursement, in particular Medicare, for patients, and therate of such reimbursement;

 

•                                          thecompetitive features of Plenaxis® as compared to other products ortreatment options, including the frequency of administration of Plenaxis®as compared to other products, and doctor and patient acceptance of thesefeatures; and

 

•                                          unfavorablepublicity concerning Plenaxis® or any similar products.

 

In addition, we must continually submit anylabeling, advertising and promotional material to the FDA for review andpre-approval.  There is risk that the FDAwill prohibit use of marketing materials in the form we desire. Unfavorable outcomesresulting from factors such as those identified above could limit sales ofPlenaxis® or cause sales of Plenaxis® to decline.  In those circumstances, we may have to findadditional sources of funding or scale back or cease operations. If Plenaxis®is not commercially successful, we wouldlikely have insufficient funds to continue our operations as currently planned.

 

**We may be unable toeither establish and maintain marketing and sales capabilities or enter intocorporate collaborations necessary to successfully commercialize****Plenaxis® orour other potential products.**

 

We have limited experience in marketing orselling pharmaceutical products and have limited marketing and sales resources.To achieve commercial success for Plenaxis®, or any other approvedproduct, we must either rely upon our limited marketing and sales force andrelated infrastructure, or enter into arrangements with others to market andsell our products.  We are promotingPlenaxis® in the United States through our own dedicated marketingand sales team.  Recruiting, training andretaining qualified sales personnel is therefore critical to our success.  To date, we have experienced turnover in bothour sales management and field sales personnel. Competition for skilled personnel is intense, and we cannot assure youthat we will be able to continue to attract and retain a sufficient number ofqualified individuals to successfully promote Plenaxis®.  Accordingly, we may be unable to establishand maintain marketing, sales and distribution capabilities necessary tosuccessfully commercialize and gain market acceptance for Plenaxis®.

 

In addition, establishing the expertisenecessary to successfully market and sell Plenaxis®, or any otherproduct, requires a substantial capital investment.  Our ability to make that investment and alsoexecute our current operating plan and attain profitability during 2006 isdependent on numerous factors, including, as described above, the reduction,through collaboration arrangements or otherwise, of our net expenses related toour clinical programs and the receipt of revenues through researchcollaborations involving our Direct Select technology platform, and continuedprudent fiscal management.  Accordingly,we cannot assure investors that we will have the funds to successfullycommercialize Plenaxis® or any other potential product in the UnitedStates or elsewhere.

 

Moreover, Plenaxis® competes, andour product candidates in development are likely to compete, with products ofother companies that currently have extensive and well-funded marketing andsales operations.  Because thesecompanies are capable of devoting significantly greater resources to theirmarketing and sales efforts, our marketing and sales efforts may not competesuccessfully against the efforts of these other companies.

 

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We have also announced our intention tomarket and sell Plenaxis® outside of the United States through oneor more marketing partners upon receipt of approval abroad.  We recently entered into an agreement withSchering AG, of Berlin, Germany, for the commercialization of Plenaxis®in the field of prostate cancer across Europe, Russia, the Middle East, SouthAfrica, Australia and New Zealand.  Wehave limited influence over the decisions made by Schering AG or the resourcesthey devote to the marketing and distribution of Plenaxis® productsin their 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 arrangementwith Schering AG may not be successful, and we may not receive any revenuesfrom it.  Also, we cannot assure you thatwe will be able to enter into marketing and sales agreements on acceptableterms, if at all, for Plenaxis® in territories not covered by theSchering AG agreement, or for any of our other product candidates.

 

**Alternative treatmentoptions exist and may be more readily available or acceptable to physicians andpatients, which may impair our ability to capture or maintain market share for****Plenaxis®.**

 

Alternative products and medical treatmentsexist or are under development to treat advanced symptomatic prostatecancer.  For example, the FDA hasapproved several drugs for the treatment of prostate cancer that respond tochanges in hormone levels, and there are other treatment alternativesavailable, including radiation therapy and surgery.  The FDA’s approval of Plenaxis® islimited to use in a subset of advanced symptomatic prostate cancer patients,and distribution of Plenaxis® will only be made in accordance withour risk management program, which includes physician enrollment in aprescribing program and a signed patient consent form regarding the risks andbenefits of the therapy.  Due to thepotential risk of immediate-onset systemic allergic reactions, physicians mustalso monitor patients for 30 minutes following the injection of Plenaxis®.  Prescribing physicians and patients may viewthese requirements as burdensome or may recommend or choose alternativetreatments that are more acceptable to the doctor and/or the patient.  Additionally, physicians may not prescribePlenaxis® if we fail to provide adequate education about itsbenefits and uses.  If, due to thesefactors, Plenaxis® does not achieve broad market acceptance as adrug for the treatment of the symptoms of men with advanced prostate cancer forwhom other hormonal therapies are not appropriate and who have refused surgicalcastration, we would likely not havesufficient funds to continue our operations as currently planned.

 

**Our potentialrevenues will diminish if we fail to obtain adequate reimbursement coverage for****Plenaxis® or our other product candidates from third-partypayors.**

 

The continuing efforts of government andthird-party payors to contain or reduce the costs of health care may limit ourcommercial opportunity.  In some foreignmarkets, pricing and profitability of prescription pharmaceuticals are subjectto government control. In the United States, we expect that there will continueto 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. If government and other third-party payorsdo not provide appropriate coverage and adequate reimbursement for Plenaxis®or our other product candidates, physicians may not prescribe them and/orpatients may be unwilling to have them administered.

 

Our ability toearn revenues from Plenaxis®, or any other potential product, aloneor with collaborators, may depend in part on the availability and levels ofreimbursement from:

 

•                                          governmentand health administration authorities, including Medicare and Medicaid;

 

•                                          privatehealth insurers; and

 

•                                          otherthird-party payors.

 

We cannot predict the availability ofcoverage or reimbursement for newly approved drugs such as Plenaxis®by Medicare or any other payor. Third-party payors, including Medicare, are increasingly challenging theprices charged for medical products and services. Government and otherthird-party payors increasingly are limiting both coverage and the level ofreimbursement for new drugs and, in some cases, refusing to provide coveragefor a patient’s use of an approved drug for purposes not approved by the FDA.Third-party insurance coverage may not be available to patients for Plenaxis®or any of our other products.

 

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**We may experience pressure to lower the priceof Plenaxis® or our other potential products to remain competitivein light of new and/or proposed federal legislation.**

 

New federal legislation, enacted in December 2003,has altered the way in which physician-administered drugs covered by Medicareare reimbursed, generally leading to lower reimbursement levels.  As a new drug, Plenaxis® wasunaffected by the first stage of Medicare reimbursement cuts implemented January 2004.  However, Medicare reimbursement for Plenaxis®will likely be reduced by the next round of cuts to be implemented January 2005(which entail a new reimbursement methodology based on a product’s “averagesales price” rather than the current “average wholesale price”methodology).  It is possible that somephysicians may alter practice patterns and/or refer Medicare patients tohospital outpatient settings rather than continue to treat patients in-officeand it is unclear at this time how such a shift in the marketplace dynamicmight affect sales for Plenaxis®. It is also possible that payors other than Medicare may adopt an averagesales price reimbursement over time, and the effect of this on Plenaxis® salesis also unclear.

 

The new legislation createsvarious opportunities for private entities to become involved in theadministration of the Medicare drug benefit. Among other things, the new legislation added an outpatient prescriptiondrug benefit to Medicare, effective January 2006, to be administeredprimarily through private entities. Increased privatization of the Medicare drug benefit under the newlegislation may increase the number and leverage of private entities attemptingto negotiate price concessions from pharmaceutical manufacturers and may lowerparticipating provider reimbursement levels, and the effect that this may haveon Plenaxis® salesis unclear.

 

While the new lawspecifically prohibits the United States government from interfering in pricenegotiations between manufacturers and Medicare drug plan sponsors, somemembers of Congress are pursuing legislation that would permit the UnitedStates government to use its enormous purchasing power to demand discounts frompharmaceutical companies, thereby creating de facto price controls onprescription drugs.  In addition, the newlaw contains triggers for Congressional consideration of cost containmentmeasures for Medicare in the event Medicare cost increases exceed a certainlevel.  These cost containment measurescould include some sorts of limitations on prescription drug prices.  Additionally, the expanded Medicare coveragefor prescription drugs beginning in 2006 may impact physician decision-makingwith respect to self-administered drugs that were not covered previously andmay compete directly or indirectly with Plenaxis®.

 

Any or all of these issuesmay create pressure to lower the price of Plenaxis® in order to be or remain competitive in thechanging marketplace.  It is unclear towhat extent, if any, Plenaxis® sales would increase or decrease in response to price changes.

 

**As****Plenaxis® isused commercially, unintended side effects or adverse reactions could occurthat could result in additional regulatory controls and reduced sales.**

 

During research and development, the use ofpharmaceutical products, such as Plenaxis®, is limited principallyto clinical trial patients under controlled conditions and under the care ofexpert physicians. The widespread commercial use of Plenaxis® couldproduce undesirable or unintended side effects that have not been evident inour clinical trials.  In addition, inpatients who take multiple medications, drug interactions could occur that canbe difficult to predict.  These events,among others, could result in the imposition of additional regulatory controlsthat could limit the circumstances under which Plenaxis® isprescribed or even lead to the withdrawal of the product from the market.  Due to the occurrence of immediate-onsetsystemic allergic reactions in patients treated 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 or from the overall commercial experience with the drug could lead tothe imposition of further restrictions or withdrawal of Plenaxis®from the market.

 

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**If we fail to developand maintain our relationships with third-party manufacturers, or if thesemanufacturers fail to perform adequately, we may be unable to commercialize****Plenaxis® orany of our product candidates.**

 

Our ability to conduct, or continue toconduct, clinical trials and commercialize Plenaxis® or otherproduct candidates, will depend in part on our ability to manufacture, orarrange for third-party manufacture of, our products on a large scale, at acompetitive cost and in accordance with regulatory requirements. We mustestablish and maintain a commercial scale formulation and manufacturing processfor each of our potential products for which we seek marketing approval. We orthird-party manufacturers may encounter difficulties with these processes atany time that could result in delays in clinical trials, regulatory submissionsor in the commercialization of potential products.

 

We have no experience in large-scale productmanufacturing, nor do we have the resources or facilities to manufactureproducts on a commercial scale. We will continue to rely upon contractmanufacturers to produce Plenaxis® and other compounds forlater-stage preclinical, clinical and commercial purposes for a significantperiod of time. Third-party manufacturers may not be able to meet our needs asto timing, quantity or quality of materials. If we are unable to contract for asufficient 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 whichwe rely fail to meet our needs for clinical or commercial supply, we may berequired to supplement our manufacturing capacity by building our ownmanufacturing facilities. This would require substantial expenditures.  Also, we would need to hire and trainsignificant numbers of employees to staff a new facility. If we are required tobuild our own facility, we may not be able to develop sufficient manufacturingcapacity to produce drug materials for clinical trials or commercial use in atimely manner, if at all.

 

In addition, we and the third-partymanufacturers that we use must continually adhere to current good manufacturingpractice requirements enforced by the FDA through its facilities inspectionprogram.  Foreign regulatory authoritiesmay also inspect our third-party manufacturers as a condition of approval.  In complying with these regulations andforeign regulatory requirements, we and any of our third-party manufacturerswill be obligated to expend time, money and effort in production,record-keeping and quality control to assure that our potential products meetapplicable specifications and other requirements.  If we or any of our third-party manufacturersfail to comply with these requirements, we may be subject to regulatorysanctions, and the facilities could be shut down.

 

Any of these factors could prevent, or causedelays in, obtaining regulatory approvals for our potential products, and themanufacturing, marketing or selling of Plenaxis®, and could alsoresult in significantly higher operating expenses.

 

**The loss or failureof any of our third-party manufacturers could substantially delay or impair oursale or continued sale of****Plenaxis®.**

 

For each stage of Plenaxis®production we have relied, and expect in the near term to continue to rely, ona single third-party manufacturer.  Wehave only recently contracted with a second supplier for one of theseproduction stages, and that supplier will not be prepared to manufacturePlenaxis® on a commercial scale for the foreseeable future.  Accordingly, the loss of one or more of ourprimary suppliers for any reason, including as a result of fire, terrorism,acts of God or insolvency or bankruptcy, could delay or impair substantiallyour sale or continued sale of Plenaxis® or result in substantialdelays in, or substantially impair our ability to complete, foreign regulatorysubmissions or reviews. Such delays or impairment, and the associated costs andexpenses, may lower our potential revenues and delay or prevent our attainingprofitability. While we are evaluating the possibility of a second source ofsupply at certain other stages of Plenaxis® production, the numberof qualified alternative suppliers is limited, and we cannot assure investorsthat we will be able to locate alternative suppliers or negotiate second supplyagreements on reasonable terms. Furthermore, the process of engineering a newsupplier’s facility for the production of Plenaxis® and obtainingthe necessary FDA and foreign regulatory approval of the facility would requiresubstantial lead-time and could be extremely costly. We cannot assure investorsthat we will not lose one or more of our suppliers, or that

 

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in such event we would be readily able to continue thecommercialization of Plenaxis® without substantial and costlydelays.

 

**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 dependupon our corporate collaborator, Schering AG, to help us obtain regulatoryapproval for Plenaxis® and to commercialize Plenaxis® inSchering AG’s licensed territory. Despite our collaborative relationship, wehave limited influence over the amount and timing of resources that Schering AGwill devote to Plenaxis®.   Inaddition, Schering AG may terminate our collaboration agreement in variouscircumstances.  We cannot assure you thatSchering AG or future collaborators will meet their obligations to us under ourcollaboration agreements with them.  IfSchering AG or another collaborator terminates its agreement with us or failsto perform, or delays performance of, its obligations, it could delay orotherwise adversely affect or prevent, the commercialization of Plenaxis®in certain regions outside of the United States. As a result, we could beforced to devote unforeseen additional resources to Plenaxis®commercialization outside of the United States. We cannot assure you that we would be able to raise the necessary fundsor negotiate additional corporate collaborations on acceptable terms, if atall, and in that event we could have to curtail planned operations for thecommercialization of Plenaxis® outside of the United States.

 

**We are subject toextensive government regulation that increases our costs and could prevent usfrom selling****Plenaxis® or our other potential products.**

 

The development and sale of Plenaxis®,and our product candidates, is subject to extensive regulation by governmentalauthorities. Obtaining and maintaining regulatory approval typically is costlyand takes many years. Regulatory authorities, most importantly, the FDA, havesubstantial discretion to place on clinical hold or terminate clinical trials,delay, withhold or withdraw registration and marketing approval in the UnitedStates, and effectively mandate product recalls. Failure to comply withregulatory requirements may result in criminal prosecution, civil penalties,recall or seizure of products, total or partial suspension of production orinjunction, as well as other actions as to Plenaxis®, our otherpotential products or against us. Outside the United States, we can market aproduct only if we receive marketing authorization from the appropriateregulatory authorities. This foreign regulatory approval process includes allof the risks associated with the FDA approval process, and may includeadditional risks.

 

To gain regulatory approval from the FDA andforeign regulatory authorities for the commercial sale of any product, we mustdemonstrate in clinical trials, and satisfy the FDA and foreign regulatoryauthorities as to, the safety and efficacy of the product.  If we develop a product to treat along-lasting disease, such as cancer or Alzheimer’s disease, we must gatherdata over an extended period of time. There are many risks associated with ourclinical trials. For example, we may be unable to achieve the same level ofsuccess in later trials as we did in earlier ones. Additionally, data we obtainfrom preclinical and clinical activities are susceptible to varyinginterpretations that could impede regulatory approval. Further, some patientsin our prostate cancer, Alzheimer’s disease and non-Hodgkin’s lymphoma programshave a high risk of death, age-related disease or other adverse medical eventsthat may not be related to our products. These events may affect the statistical analysis of the safety andefficacy of our products. If we obtain regulatory approval for a product, theapproval will be limited to those diseases for which our clinical trialsdemonstrate the product is safe and effective.

 

In addition, many factors could delay orresult in termination of our ongoing or future clinical trials. For example,results from ongoing preclinical studies or analyses could raise concerns overthe safety or efficacy of a product candidate. In March 2004, the FDA placed our phase 1 clinical trial ofPPI-2458 on clinical hold due to a neuropathological abnormality observed insome of the animals tested in an animal safety study completed followinginitiation of the clinical trial.  In June 2004,following review by the FDA of our revised clinical plan addressing thisfinding, we received clearance from the FDA to resume clinical testing ofPPI-2458.  We cannot assure investorsthat the FDA will not place this or other clinical trials on hold in thefuture.  A clinical trial may also experienceslow patient enrollment or lack of sufficient drug supplies. Patients mayexperience adverse medical events or side effects, and there may be a real orperceived lack of effectiveness of, or of safety issues associated with, thedrug we are testing. Future governmental action or existing or changes in FDApolicies or

 

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precedents, may also result in delays or rejection of an applicationfor marketing approval.  The FDA hasconsiderable discretion in determining whether to grant marketing approval fora drug, and may delay or deny approval even in circumstances where theapplicant’s clinical trials have proceeded in compliance with FDA proceduresand regulations and have met the established end-points of the trials.Challenges to FDA determinations are generally time-consuming and costly, andrarely, if ever, succeed.  Although wereceived FDA approval to market Plenaxis® in the United States in November 2003,we can give no assurance that we will obtain marketing approval for any of ourother product candidates.

 

Any regulatory approval may be conditionedupon significant labeling requirements and, as in the case of the FDA approvalof Plenaxis®, marketing restrictions and post-marketing studycommitments.  Such labeling and marketingrestrictions could materially adversely affect the marketability or value of aproduct, including Plenaxis®, resulting in decreased sales.  In such a case, we would likely not havesufficient funds to continue operations as currently planned.

 

In addition, even after regulatory approvalis obtained, our Company, product(s) and the manufacturing facilities for ourproduct(s) will be subject to continual review and periodic inspection. Laterdiscovery of previously unknown problems with a product, manufacturer orfacility may result in restrictions on the product, the manufacturer or us,including withdrawal of the product from the market. The FDA stringentlyapplies regulatory standards. Our manufacturing facilities will also be subjectto FDA inspections for adherence to good manufacturing practices prior tomarketing clearance and periodically during the manufacturing process. Failureto comply can, among other things, result in fines, denial or withdrawal ofregulatory approvals, product recalls or seizures, operating restrictions,injunctions and criminal prosecution.  Ifthere are any modifications to a product, further regulatory approval will berequired.

 

For safety reasons, Plenaxis® wasapproved by the FDA with a comprehensive risk management program.  This program includes educational outreach topatients and physicians regarding the risks and benefits of Plenaxis®,restricted distribution of the product only to physicians enrolled in aprescribing registry, a system for collecting and reporting adverse events tothe FDA and auditing requirements to evaluate the effectiveness of theprogram.  We are also required to conductseveral phase 4 studies to evaluate the risk management program and theappropriate use of the drug in the indicated population.  Under the regulations under which Plenaxis®was approved, the FDA has the authority to pre-approve all promotionalmaterials and has available to it an expedited market withdrawal procedure ifissues arise regarding the safe use of Plenaxis®.  If approval for Plenaxis® iswithdrawn, we will not be able to sell Plenaxis® and would likelynot have sufficient funds to continue operations as currently planned.

 

If we areunable to maintain FDA approval, or to obtain any foreign regulatory approvalfor Plenaxis®, or to obtain or maintain regulatory approval tomarket our other potential products, we are likely to exhaust our availableresources significantly sooner than we had planned.  If this were to happen, we would need to eitherraise additional funds or seek partners to continue our currently plannedresearch and development programs. We cannot assure you that we would be ableto raise the necessary funds or negotiate additional corporate collaborationson acceptable terms, if at all.

 

**We may havesubstantial exposure to product liability claims and may not have adequateinsurance to cover those claims.**

 

The administration of drugs to humans,whether in clinical trials or commercially, can result in product liabilityclaims whether or not the drugs are actually at fault for causing aninjury.  As Plenaxis® is usedmore widely, the likelihood of an adverse drug reaction (both expected orunexpected) or unintended side effect will increase.  Furthermore, Plenaxis® or ourproduct candidates may cause, or may appear to have caused, adverse sideeffects (including death) or potentially dangerous drug interactions that wemay not learn about or understand fully until the drug has been administered topatients for some time.

 

Product liability claims can be expensive todefend and may result in large judgments or settlements against us, which couldhave a negative effect on our financial performance. The costs of productliability insurance have increased dramatically in recent years, and theavailability of coverage has decreased. Although the Company carries insurance that it regards as reasonablyadequate to protect it from potential claims, there can be no assurance thatthe Company will be able to maintain its current product liability insurance ata reasonable cost, or at all.  Our formercollaboration agreements included, and the agreements regarding the terminationof those collaborations also include, an

 

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indemnification for liabilities associated with the development andcommercialization of Plenaxis®. Our agreement with Schering AG contains similar indemnificationprovisions.  If a third party, includinga former collaborator, successfully sues us for any injury, or for indemnificationfor losses, there is no guarantee that the amount of the claim would not exceedthe limit of the Company’s insurance coverage. Further, a successful claim could result in the 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.

 

**We rely upon a limited number of specialtypharmaceutical distributors and specialty pharmacies for the distribution ofPlenaxis® in the United States. The loss of one of them, or changes in their purchasing patterns, couldimpact sales of Plenaxis®, and potentially adversely affect ouroperating results.**

 

In the United States, we sell to a limited numberof specialty distributors and pharmacies that we rely upon for the delivery ofPlenaxis® to physicians and hospital pharmacies.  There are a relatively small number ofspecialty distributors and wholesalers who provide such services.  For the nine months ended September 30,2004, sales to our three largest distributors represented approximately 78% ofour aggregate net product sales. Consolidation or financial difficulties among our specialty pharmaceuticaldistributors and pharmacies could result in situations which could temporarilyincrease returns of Plenaxis® from such entities and/or cause theseentities to reduce their respective inventory levels by delaying purchases ofPlenaxis®.  In addition, thesespecialty distributors and pharmacies may increase or decrease purchase levelsin anticipation of future price changes which may also cause an unexpectedchange in the level of trade inventories that they would normallymaintain.   Although we have developed aplan to manage trade inventory levels of Plenaxis®, this plan maynot be effective.  If trade inventorylevels of Plenaxis® become too high, or if prescription growth ofPlenaxis® is lower than expected by the trade, specialtydistributors and pharmacies could reduce their orders for Plenaxis®,which could adversely affect our operating results.

 

These specialty distributors and pharmaciesmust also distribute Plenaxis® only to physicians and hospitalpharmacists enrolled in our risk management program.  There can be no assurance that these specialtydistributors and pharmacies will adequately provide their services to eitherthe end users or to the Company or that we could find additional outlets todistribute Plenaxis®.

 

**Because we depend onthird parties to conduct laboratory testing and human clinical studies andassist us with regulatory compliance, we may encounter delays in productdevelopment and commercialization.**

 

We have contracts with a limited number ofresearch organizations to design and conduct our laboratory testing and humanclinical studies. If we cannot contract for testing activities on acceptableterms, or at all, we may not complete our product development efforts in atimely manner. To the extent we rely on third parties for laboratory testingand human clinical studies, we may lose some control over these activities. Forexample, third parties may not complete testing activities on schedule orwhen we request them to do so. In addition, these third parties may conduct ourclinical trials in a manner inconsistent with regulatory requirements orotherwise in a manner that yields misleading or unreliable data. This, or otherfailures of these third parties to carry out their duties, could result insignificant additional costs and expenses and could delay or prevent the developmentand commercialization of our product candidates.

 

**Many of ourcompetitors have substantially greater resources than we do and may be able todevelop and commercialize products that make our potential products andtechnologies obsolete or non-competitive.**

 

A biopharmaceutical company such as ours mustkeep pace with rapid technological change and faces intense competition. Wecompete with biotechnology and pharmaceutical companies for funding, access tonew technology, 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 productsunder development, will face intense competition from existing or future drugsand other medical treatments. In addition, for each of our product candidates,we may face increasing competition from generic formulations or existing drugswhose active components are no longer covered by patents.

 

Ourcompetitors 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 ofthese efforts would adversely affect our ability to promote Plenaxis®and to develop and commercialize our product candidates, and to ultimatelyattain and maintain profitability.

 

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

 

Our success will depend in part on ourability to obtain patents and maintain adequate protection of our technologiesand potential products. If we do not adequately protect our intellectualproperty, competitors may be able to use our technologies and erode anycompetitive advantage we may have. For example, if we lose our patentprotection for Plenaxis®, another party could produce and market thecompound in direct competition with us. Some foreign countries lack rules andmethods for defending intellectual property rights and do not protectproprietary rights to the same extent as the United States. Many companies havehad difficulty protecting their proprietary rights in foreign countries.

 

Patent positions are sometimes uncertain andusually involve complex legal and factual questions. We can protect ourproprietary rights from unauthorized use by third parties only to the extentthat our proprietary technologies are covered by valid and enforceable patentsor are effectively maintained as trade secrets. We currently own or haveexclusively licensed 28 issued United States patents. We have applied, and willcontinue to apply, for patents covering both our technologies and products aswe deem appropriate. Others may challenge our patent applications or our patentapplications may not result in issued patents. Moreover, any issued patents onour own inventions, or those licensed from third parties, may not provide uswith adequate protection, or others may challenge the validity of, or seek tonarrow or circumvent, these patents. Third-party patents may impair or blockour ability to conduct our business. Additionally, third parties mayindependently develop products similar to our products, duplicate ourunpatented products, or design around any patented products we develop.

 

**If we are unable toprotect our trade secrets and proprietary information, we could lose anycompetitive advantage we may have.**

 

In addition to patents, we rely on acombination of trade secrets, confidentiality, nondisclosure and othercontractual provisions, and security measures to protect our confidential andproprietary information. These measures may not adequately protect our tradesecrets or other proprietary information. If these measures do not adequatelyprotect our rights, third parties could use our technology, and we could loseany competitive advantage we may have. In addition, others may independentlydevelop similar proprietary information or techniques, which could impair anycompetitive advantage we may have.

 

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**If our technologies,processes or products conflict with the patents or other intellectual propertyrights of competitors, universities or others, we could have to engage incostly litigation and be unable to commercialize those products.**

 

Our technologies, processes, product orproduct candidates may give rise to claims that they infringe patents or otherintellectual property rights of third parties. A third party could force us to pay damages, stop our use of thesetechnologies or processes, or stop our manufacturing or marketing of theaffected products by bringing a legal action against us for infringement. Inaddition, we could be required to obtain a license to continue to use thetechnologies or processes or to manufacture or market the affected products,and we may not be able to do so on acceptable terms or at all. We believe thatsignificant litigation will continue in our industry regarding patent and otherintellectual property rights. If we become involved in litigation, it couldconsume a substantial portion of our resources. Even if legal actions weremeritless, defending a lawsuit could take significant time, be expensive anddivert management’s attention from other business concerns.

 

**If third partiesterminate our licenses, we could experience delays or be unable to complete thedevelopment and commercialization of our potential products.**

 

We license some of our technology from thirdparties. Termination of our licenses could force us to delay or discontinuesome of our development and commercialization programs. For example, ifAdvanced Research and Technology Institute, Inc., the assignee of IndianaUniversity Foundation, terminated our license with them due to a breach by usof the terms of that license, we could have to discontinue thecommercialization of Plenaxis®. We cannot assure you that we wouldbe able to license substitute technology in the future. Our inability to do socould impair our ability to conduct our business because we may lack thetechnology, or the necessary rights to technology, required to develop andcommercialize our potential products.

 

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

 

Pharmaceutical companies have been the targetof lawsuits and investigations including, in particular, claims assertingviolations of the Federal False Claim Act, Anti-Kickback Act, the PrescriptionDrug Marketing Act or other violations in connection with Medicare and/or Medicaidreimbursement, and claims under state laws, including state anti-kickback andfraud laws. Public companies may also be the subject of certain other types ofclaims, including those asserting violations of securities laws or related toenvironmental matters. There is no assurance that if we were to be involved inany such lawsuits or investigation, that we would be successful in defendingourselves or in asserting our rights.

 

**If we lose our keypersonnel or are unable to attract and retain additional skilled personnel, wemay be unable to pursue our product development and commercialization efforts.**

 

We depend substantially on the principalmembers of our management and scientific staff, including Malcolm L. Gefter,Ph.D., our Chief Executive Officer and Chairman of the Board, and Kevin F.McLaughlin, our President and Chief Operating Officer. We do not haveemployment agreements with any of our executive officers. Any officer oremployee can terminate his or her relationship with us at any time and work forone of our competitors. The loss of these key individuals could result incompetitive harm because we could experience delays in our product research,development and commercialization efforts without their expertise.  For example, one of our former officers, whowas primarily responsible for commercial operations, recently resigned as ourPresident and Chief Operating Officer. As a result, we were required to appoint a new head of commercializationin an expedited fashion.  We cannotassure investors that this management transition will go smoothly or that ourcommercial operations will not be adversely affected.

 

Recruiting and retaining qualified scientificpersonnel to perform future research and development work also will be criticalto our success. Competition for skilled personnel is intense and the turnoverrate can be high. We compete with numerous companies and academic and otherresearch institutions for experienced scientists. This competition may limitour ability to recruit and retain qualified personnel on acceptable terms.Failure to attract and retain qualified personnel would prevent

 

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us from continuing to develop our potential products, enhancing ourtechnologies and launching our products commercially. Our planned activitieswill require the addition of new personnel, including management and marketingand sales personnel, and the development of additional expertise by existingmanagement personnel, in particular in the area of product marketing and sales.The inability to attract and retain these people or to develop this expertisecould prevent, or result in delays in, the marketing and sale of Plenaxis®or the research, development and commercialization of our product candidates.

 

**We use hazardouschemicals and radioactive and biological materials in our business and anyclaims relating to the handling, storage or disposal of these materials couldbe time consuming and costly.**

 

Our research and development processesinvolve the controlled use of hazardous materials, including chemicals andradioactive and biological materials, which may pose health risks. For example,the health risks associated with accidental exposure to Plenaxis®include temporary impotence or infertility and harmful effects on pregnantwomen. Our operations also produce hazardous waste products. We cannotcompletely eliminate the risk of accidental contamination or discharge fromhazardous materials and any resultant injury. Federal, state and local laws andregulations govern the use, manufacture, storage, handling and disposal ofhazardous materials. Compliance with health and safety and environmental lawsand regulations is necessary and expensive. Current or future health and safetyand environmental regulations may impair our research, development orproduction efforts. We may be required to pay fines, penalties or damages inthe event of noncompliance or the exposure of individuals to hazardousmaterials.

 

From time to time, third-parties have alsoworked with hazardous materials in connection with our agreements with them. Wehave agreed to indemnify our present and former collaborators in somecircumstances against damages and other liabilities arising out of developmentactivities or products produced in connection with these collaborations.

 

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

 

The Sarbanes-Oxley Act of 2002, which becamelaw in July 2002, has required changes in some of our corporategovernance, securities disclosure and compliance practices. In response to therequirements of that Act, the SEC and the Nasdaq have promulgated new rules andlisting standards covering a variety of subjects. Compliance with these newrules and listing standards has increased our legal costs, and significantlyincreased our financial and accounting costs, and we expect these increasedcosts to continue. These developments may make it more difficult and moreexpensive for us to obtain director and officer liability insurance. Likewise,these developments may make it more difficult for us to attract and retainqualified members of our board of directors, particularly independentdirectors, or qualified executive officers.

 

As directed by Section 404 of theSarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies toinclude a report of management on the Company’s internal controls overfinancial reporting in their annual reports on Form 10-K that contains anassessment by management of the effectiveness of the company’s internalcontrols over financial reporting. In addition, the public accounting firmauditing the Company’s financial statements must attest to and report onmanagement’s assessment of the effectiveness of the Company’s internal controlsover financial reporting. This requirement will apply to our annual report onForm 10-K for our fiscal year ending December 31, 2004. If our independentauditors are unable to provide us with an unqualified report as to theeffectiveness of our internal controls over financial reporting as of December 31,2004 and future year-ends as required by Section 404 of the Sarbanes-OxleyAct of 2002, investors could lose confidence in the reliability of ourfinancial statements, which could result in a decrease in the value of yoursecurities.

 

**The market price ofour common stock may experience extreme price and volume fluctuations.**

 

The market price of our common stock mayfluctuate substantially due to a variety of factors, including, but not limitedto:

 

•                                          ourability to successfully commercialize Plenaxis® in the UnitedStates;

 

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

 

•                                          announcementof foreign regulatory approval or disapproval of Plenaxis® and/orassociated labeling requirements;

 

**•**                                          thewillingness of our corporate collaborator, Schering AG, to commercializePlenaxis® in territories outside of the United States and the timingand success of that commercialization;

 

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

 

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

 

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

 

•                                          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 otherproduct candidates and/or 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;

 

•                                          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 experiencedextreme price and volume fluctuations. The market prices of the securities ofbiotechnology companies, particularly companies like ours with limited productrevenues and without earnings, have been highly volatile, and may continue tobe highly volatile in the future. This volatility has often been unrelated tothe operating performance of particular companies. In the past, securitiesclass action litigation has often been brought against companies thatexperience volatility in the market price of their securities. Whether or notmeritorious, litigation brought against us could result in substantial costsand a diversion of management’s attention and resources.

 

**We expect that ourquarterly results of operations will fluctuate, and this fluctuation couldcause our stock price to decline.**

 

Our quarterly operating results havefluctuated in the past and are likely to do so in the future. Thesefluctuations could cause our stock price to decline. Some of the factors thatcould cause our operating results to fluctuate include:

 

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

 

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

 

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•                                          thetiming and success of the commercialization of Plenaxis® outside ofthe United States;

 

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

 

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

 

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

 

**If we engage in anacquisition, we will incur a variety of costs and may never realize theanticipated benefits of the acquisition.**

 

If appropriate opportunities becomeavailable, we may attempt to acquire businesses, or acquire or in-licenseproducts or technologies, that we believe are a strategic fit with ourbusiness. We currently have no commitments or agreements for any acquisitions.  If we do undertake any transaction of thissort, the process of integrating an acquired business, or an acquired orin-licensed product or technology, may result in unforeseen operatingdifficulties and expenditures and may absorb significant management attentionthat would otherwise be available for the ongoing development of our business.Moreover, we may fail to realize the anticipated benefits of any transaction ofthis sort. To the extent we issue stock in a transaction, the ownership interestof our stockholders will be diluted. Transactions of this kind could also causeus to incur debt, expose us to future liabilities and result in expensesrelated to goodwill and other intangible assets.

 

**Anti-takeoverprovisions in our charter and by-laws, our rights agreement and certainprovisions of Delaware law may make an acquisition of us more difficult, evenif an acquisition would be beneficial to our stockholders.**

 

Provisions in our certificate ofincorporation and by-laws may delay or prevent an acquisition of us or a changein our management. Also, because we are incorporated in Delaware, we aregoverned by the provisions of Section 203 of the Delaware GeneralCorporation Law, which may prohibit or delay large stockholders, in particularthose owning 15% or more of our outstanding voting stock, from merging orcombining with us. In addition, the rights issued under our rights agreementmay be a substantial deterrent to a person acquiring 10% or more of our commonstock without the approval of our board of directors. These provisions in ourcharter and by-laws, rights agreement and under Delaware law could reduce theprice that investors might be willing to pay for shares of our common stock inthe future and result in the market price being lower than it would be withoutthese provisions.

 

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

 

The primaryobjective of our investment activities is to preserve principal while at thesame time maximizing the income we receive from our investments withoutsignificantly increasing risk.  We havenot entered into any instruments for trading purposes.  Some of the securities that we invest in mayhave market risk. This means that an increase in prevailing interest rates maycause the principal amount of the investment to decrease. To minimize this riskin the future, we maintain our portfolio of cash equivalents and short-terminvestments in a variety of securities, including commercial paper, moneymarket funds and government and non-government debt securities. An immediatehypothetical 100 basis point increase in interest rates would have resulted inan approximate $0.4 million decrease in the fair value of our investments as ofSeptember 30, 2004.  The samehypothetical increase in interest rates as of December 31, 2003 would haveresulted in an approximate $0.8 million decrease in the fair value of ourinvestments.  Due to the conservativenature and relatively short duration of our investments, interest rate risk ismitigated.  As of September 30,2004, approximately 76.1% of our total investments will mature or reset in oneyear or less, with the remainder maturing in less than three years.

 

In connectionwith the purchase of our new facility in July 2000, our wholly owned realestate subsidiary executed an acquisition and construction loan agreement thatprovided for up to $33.0 million in borrowings at a floating interest rateindexed to 30-day LIBOR.  In July 2003,we exercised the first of two one-year extension options extending the maturitydate of the loan until July 30, 2004. In connection with this extension, the subsidiary entered into aninterest rate cap agreement which limited exposure to interest rate increasesabove a certain threshold through July 30, 2004.

 

In June 2004, the acquisition andconstruction loan agreement was amended to extend the maturity date of the loanand modify certain other terms of the original agreement.  Under the amended loan agreement, on July 30,2009 the principal amount then outstanding is due and payable in full, subjectto two one-year extension options which are exercisable at our electionprovided we are in compliance with certain financial covenants.  The outstanding principal bears interest at afixed rate of 5.95% through April 2009. Principal and interest are payable through a fixed monthly payment ofapproximately $207,000, with the principal portion being calculated using a25-year amortization schedule.  Theamended loan agreement also provides for certain additional financial operatingcovenants, one of which was effective immediately and the remainder of whichwill become effective as of December 31, 2006.  Because of this amendment to the loanagreement, we do not believe that there is material interest rate risk exposurewith respect to the loan facility.

 

**ITEM 4.****       CONTROLS AND 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’s chiefexecutive officer and chief financial officer have concluded that, as of theend 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 we file or submit under the Exchange Act arerecorded, processed, summarized and reported within the time periods specifiedin applicable SEC rules and forms.

 

*(b)**                               InternalControl Over Financial Reporting*.

 

There have not been any changes in the Company’s internal control overfinancial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)under the Exchange Act) during the quarter ended September 30, 2004 thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

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

** **
| ***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                  | *            |          | Form of Incentive Stock Option Agreement |
| 10.2                  | *            |          | Form of Non-Qualified Stock Option Agreement |
| 10.3                  | *            |          | Letter Agreement dated as of September 16,  2004 between the Registrant and Edward C. English (6) |
| 10.4                  | *            |          | Letter Agreement dated as of September 16,  2004 between the Registrant and Richard W. Wagner, Ph.D. (6) |
| 10.5                  | †       |          | Amendment No. 2 dated as of August 30,  2004 to the Development and Supply Agreement effective as of June 21,  2000 by and between the Registrant and UCB S.A. |
| 31.1                  |         |          | Certification of Chief Executive Officer |
| 31.2                  |         |          | Certification of Chief Financial Officer |
| 32.1                  |         |          | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.2                  |         |          | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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*                                         Represents amanagement contract or compensatory plan or arrangement.

 

(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.

 

(6)                                  Incorporated byreference to Current Report on Form 8-K filed with the Securities and ExchangeCommission on September 21, 2004.

 

†                                          Confidentialtreatment has been requested for certain portions of this exhibit. Omittedportions have been filed separately with the Securities and ExchangeCommission.

 

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**SIGNATURE**

 

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

 
|                         | PRAECIS  PHARMACEUTICALS INCORPORATED |
|------------------------------|---------------------------------------|
|                         |                                  |   |
|                         |                                  |   |
| Date:  November 9, 2004 |  By                              |   | /s/  Edward C. English |   |
|                         |                                  | Edward  C. English |
|                         |                                  | Vice  President, Chief Financial Officer and |
|                         |                                  | Treasurer  *(Duly Authorized Officer and Principal* |
|                         |                                  | *Financial  and Accounting Officer)* |

 

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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                  | *            |          | Form of Incentive Stock Option Agreement |
| 10.2                  | *            |          | Form of Non-Qualified Stock Option  Agreement |
| 10.3                  | *            |          | Letter Agreement dated as of September 16,  2004 between the Registrant and Edward C. English (6) |
| 10.4                  | *            |          | Letter Agreement dated as of September 16,  2004 between the Registrant and Richard W. Wagner, Ph.D. (6) |
| 10.5                  | †       |          | Amendment No. 2 dated as of August 30,  2004 to the Development and Supply Agreement effective as of June 21,  2000 by and between the Registrant and UCB S.A. |
| 31.1                  |         |          | Certification of Chief Executive Officer |
| 31.2                  |         |          | Certification of Chief Financial Officer |
| 32.1                  |         |          | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.2                  |         |          | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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*                                         Represents amanagement contract or compensatory plan or arrangement.

 

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

 

(4)                                  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.

 

(6)                                  Incorporated byreference to Current Report on Form 8-K filed with the Securities and ExchangeCommission on September 21, 2004.

 

†                                          Confidentialtreatment has been requested for certain portions of this exhibit. Omittedportions have been filed separately with the Securities and ExchangeCommission.

 

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