**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

**(MarkOne)**

 

**ý****          ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2006**

 

**OR**

 

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

 

**For thetransition period from          to         **

 

**CommissionFile Number: 000-30289**

 

**PRAECISPHARMACEUTICALS INCORPORATED**

(Exact name ofregistrant as specified in its charter)

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

 

**830Winter Street, Waltham, MA 02451-1420**

(Address ofprincipal executive offices and zip code)

 

**(781) 795-4100**

(Registrant’s telephonenumber, including area code)

 

Indicate by check markwhether the 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 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.              Yes ý  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act.  (Check one):

 

Large acceleratedfiler  o                   Acceleratedfiler  o             Non-acceleratedfiler  ý

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct).

 

Yes o  No ý

 

As of April 28, 2006,there were 10,615,593 shares of the registrant’s common stock, $.01 par value,outstanding.

 

All share and per shareamounts, including all common stock equivalents (stock options and the exerciseprices thereof), reported in this Quarterly Report on Form 10-Q have beenhave adjusted for all periods presented to reflect a 1-for-5 reverse split ofthe registrant’s common stock effected on November 1, 2005.

 

 

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**PRAECISPHARMACEUTICALS INCORPORATED**

 

**FORM 10-Q**

 

**FOR THEQUARTER ENDED MARCH 31, 2006**

 

**INDEX**

 
| ** **             | ** **                                                                                               | **PAGE  NUMBER** |
|------------------------|----------------------------------------------------------------------------------------------------------|------------------|
| **PART I.**       | **FINANCIAL INFORMATION**                                                                                | 3                |
|                   |                                                                                                     |             |
| Item 1.                | Financial Statements (Unaudited)                                                                         | 3                |
|                   |                                                                                                     |             |
|                   | Condensed Consolidated  Balance Sheets –  December 31, 2005 and March 31, 2006            | 3                |
|                   |                                                                                                     |             |
|                   | Condensed Consolidated  Statements of Operations –  three months ended March 31, 2005 and 2006 | 4                |
|                   |                                                                                                     |             |
|                   | Condensed Consolidated  Statements of Cash Flows –  three months ended March 31, 2005 and 2006 | 5                |
|                   |                                                                                                     |             |
|                   | Notes to Condensed  Consolidated Financial Statements                                                    | 6                |
|                   |                                                                                                     |             |
| Item  2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations              | 15               |
|                   |                                                                                                     |             |
| Item 3.                | Quantitative  and Qualitative Disclosures About Market Risk                                              | 25               |
|                   |                                                                                                     |             |
| Item 4.                | Controls and  Procedures                                                                                 | 25               |
|                   |                                                                                                     |             |
| **PART II.**      | **OTHER INFORMATION**                                                                                    | 26               |
| ** **             | ** **                                                                                               |             |
| Item 1.                | Legal Proceedings                                                                                        | 26               |
|                   |                                                                                                     |             |
| Item 1A.               | Risk Factors                                                                                             | 27               |
|                   |                                                                                                     |             |
| Item 6.                | Exhibits                                                                                                 | 39               |
|                   |                                                                                                     |             |
| **SIGNATURE**          | 40                                                                                                       |
| ** **             |                                                                                                     |
| **EXHIBIT INDEX** | * *                                                                                                 |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS.**

 

**PRAECISPHARMACEUTICALS INCORPORATED**

**Condensed Consolidated Balance Sheets**

**(Inthousands, except share data)**

**(Unaudited)**

 
| ** **                                                                                                                                     | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| **Assets**                                                                                                                                     |       |                        |       |                     |       |
| Current  assets:                                                                                                                               |       |                        |       |                     |       |
| Cash  and cash equivalents                                                                                                                     |       | $                           | 57,088     |                     | $          | 49,206 |   |
| Marketable  securities                                                                                                                         |       | 5,492                       |       | 3,512                    |       |
| Accounts  receivable                                                                                                                           |       | 184                         |       | 162                      |       |
| Inventory                                                                                                                                      |       | 154                         |       | 154                      |       |
| Prepaid  expenses and other current assets                                                                                                     |       | 742                         |       | 689                      |       |
| Total  current assets                                                                                                                          |       | 63,660                      |       | 53,723                   |       |
| Property  and equipment, net                                                                                                                   |       | 3,559                       |       | 3,895                    |       |
| Inventory                                                                                                                                      |       | 1,532                       |       | 1,532                    |       |
| Restricted  cash                                                                                                                               |       | 793                         |       | 793                      |       |
| Total  assets                                                                                                                                  |       | $                           | 69,544     |                     | $          | 59,943 |   |
|                                                                                                                                           |       |                        |       |                     |       |
| **Liabilities and Stockholders’ Equity**                                                                                                  |       |                        |       |                     |       |
| Current  liabilities:                                                                                                                          |       |                        |       |                     |       |
| Accounts  payable                                                                                                                              |       | $                           | 780        |                     | $          | 1,043 |   |
| Accrued  expenses                                                                                                                              |       | 3,373                       |       | 2,102                    |       |
| Accrued  restructuring                                                                                                                         |       | 3,608                       |       | 2,096                    |       |
| Deferred  gain on sale-leaseback of building                                                                                                   |       | 1,818                       |       | 1,818                    |       |
| Total  current liabilities                                                                                                                     |       | 9,579                       |       | 7,059                    |       |
|                                                                                                                                           |       |                        |       |                     |       |
| Long-term  accrued restructuring                                                                                                               |       | 1,834                       |       | 1,273                    |       |
| Long-term  deferred gain on sale-leaseback of building                                                                                         |       | 6,968                       |       | 6,513                    |       |
|                                                                                                                                           |       |                        |       |                     |       |
| Commitments  and contingencies                                                                                                                 |       |                        |       |                     |       |
|                                                                                                                                           |       |                        |       |                     |       |
| Stockholders’  equity:                                                                                                                    |       |                        |       |                     |       |
| Common  Stock, $0.01 par value; 200,000,000 shares authorized; 10,494,174 shares in  2005 and 10,513,055 shares in 2006 issued and outstanding |       | 105                         |       | 105                      |       |
| Additional  paid-in capital                                                                                                                    |       | 356,234                     |       | 357,140                  |       |
| Accumulated  other comprehensive loss                                                                                                          |       | (90                         | )          | (9                       | )          |
| Accumulated  deficit                                                                                                                           |       | (305,086                    | )          | (312,138                 | )          |
| Total  stockholders’ equity                                                                                                               |       | 51,163                      |       | 45,098                   |       |
| Total  liabilities and stockholders’ equity                                                                                               |       | $                           | 69,544     |                     | $          | 59,943 |   |

 

*Seeaccompanying notes.*

 

3

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Condensed Consolidated Statements of Operations**

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

**(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                               | ** ** | **2006** | ** ** |
|                                                                    |       |                                   |       |   |   |
| **Revenues:**                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Product  sales                                                          |       | $                                      | 804        |   | $ | 136 |   |
| Licensing  and other revenues                                           |       | 77                                     |       | 35 |   |
| Total  revenues                                                         |       | 881                                    |       | 171 |   |
| **Costs and expenses:**                                                 | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Cost  of goods sold                                                     |       | 181                                    |       | 57 |   |
| Research  and development                                               |       | 7,283                                  |       | 6,417 |   |
| Sales  and marketing                                                    |       | 3,657                                  |       | — |   |
| General  and administrative                                             |       | 1,978                                  |       | 1,845 |   |
| Restructuring  and asset impairment                                     |       | —                                 |       | (497 | ) |
| Total  costs and expenses                                               |       | 13,099                                 |       | 7,822 |   |
|                                                                    |       |                                   |       |   |   |
| Operating loss                                                          |       | (12,218                                | )          | (7,651 | ) |
| Interest income                                                         |       | 360                                    |       | 599 |   |
| Interest expense                                                        |       | (487                                   | )          | — |   |
| Net loss                                                                |       | $                                      | (12,345    | ) | $ | (7,052 | ) |
|                                                                    |       |                                   |       |   |   |
| Basic and diluted net  loss per common share                            |       | $                                      | (1.18      | ) | $ | (0.67 | ) |
|                                                                    |       |                                   |       |   |   |
| Weighted average number  of basic and diluted common shares outstanding |       | 10,485                                 |       | 10,505 |   |

 

*Seeaccompanying notes.*

 

4

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**PRAECIS PHARMACEUTICALSINCORPORATED**

**Condensed ConsolidatedStatements of Cash Flows**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                               | ** ** | **2006** | ** ** |
|                                                                     |       |                                   |       |   |   |
| **Operating activities:**                                                |       |                                   |       |   |   |
| Net loss                                                                 |       | $                                      | (12,345    | ) | $ | (7,052 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities: |       |                                   |       |   |   |
| Non-cash  restructuring                                                  |       | —                                 |       | (497 | ) |
| Amortization  of deferred gain on sale-leaseback of building             |       | —                                 |       | (455 | ) |
| Depreciation                                                             |       | 962                                    |       | 336 |   |
| Stock-based  compensation                                                |       | —                                 |       | 872 |   |
| Changes  in operating assets and liabilities:                            |       |                                   |       |   |   |
| Accounts  receivable                                                     |       | 98                                     |       | 22 |   |
| Inventory                                                                |       | (791                                   | )          | — |   |
| Prepaid  expenses, other current assets and other assets                 |       | 217                                    |       | 53 |   |
| Accounts  payable                                                        |       | (1,647                                 | )          | 263 |   |
| Accrued  expenses                                                        |       | (1,008                                 | )          | (1,271 | ) |
| Accrued  restructuring                                                   |       | —                                 |       | (1,576 | ) |
| Deferred  revenue                                                        |       | (41                                    | )          | — |   |
| Net cash used in  operating activities                                   |       | (14,555                                | )          | (9,305 | ) |
| ** **                                                               | ** ** | ** **                             | ** ** | ** ** | ** ** |
| **Investing activities:**                                                |       |                                   |       |   |   |
| Purchase of  available-for-sale securities                               |       | (13,094                                | )          | — |   |
| Sales and maturities of  available-for-sale securities                   |       | 60,251                                 |       | 2,061 |   |
| Purchase of property  and equipment                                      |       | (160                                   | )          | (672 | ) |
| Net cash provided by  investing activities                               |       | 46,997                                 |       | 1,389 |   |
| ** **                                                               | ** ** | ** **                             | ** ** | ** ** | ** ** |
| **Financing activities:**                                                |       |                                   |       |   |   |
| Repayments of long-term  debt                                            |       | (146                                   | )          | — |   |
| Proceeds from the  issuance of Common Stock                              |       | 73                                     |       | 34 |   |
| Net cash (used in)  provided by financing activities                     |       | (73                                    | )          | 34 |   |
|                                                                     |       |                                   |       |   |   |
| Increase (decrease) in  cash and cash equivalents                        |       | 32,369                                 |       | (7,882 | ) |
| Cash and cash  equivalents at beginning of period                        |       | 11,178                                 |       | 57,088 |   |
| Cash and cash  equivalents at end of period                              |       | $                                      | 43,547     |   | $ | 49,206 |   |

 

*Seeaccompanying notes.*

 

5

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Notes to Condensed Consolidated Financial Statements**

**(Unaudited)**

 

# **1.**             Basis of Presentation

 

Theaccompanying condensed consolidated financial statements have been prepared byPRAECIS PHARMACEUTICALS INCORPORATED (the “Company”) in accordance withaccounting principles generally accepted in the United States and pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  It is suggested that the financial statementsbe read in conjunction with the audited financial statements and theaccompanying notes included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005.

 

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.

 

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

 

2.             **Summary of Significant Accounting Principles**

 

***Use of Estimates***

 

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Such estimates relateto the useful lives of fixed assets, the net realizable value of inventory,accrued restructuring expenses, other accrued expenses, other reserves, andassumptions used in valuing stock-based compensation awards.  Actual results could differ from thoseestimates and such differences may be material to the Company’s condensed consolidatedfinancial statements.

 

***Principlesof Consolidation***

 

The accompanyingcondensed consolidated financial statements include the Company’s accounts andthe accounts of its wholly owned subsidiaries, 830 Winter Street LLC andPRAECIS Europe Limited. All significant intercompany account balances andtransactions between the companies have been eliminated.

 

***Inventory***

 

Inventoryis stated at the lower of cost or market with cost determined under thefirst-in/first-out (“FIFO”) method. The Company will write down any obsolete,excess or otherwise unmarketable inventory to its estimated net realizablevalue, as necessary.  If the netrealizable value is determined to be less than that estimated by the Company,additional inventory write-downs may be required in future periods.

 

6

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Thecomponents of inventory are as follows:

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

 

Raw materials, work-in-process and finishedgoods inventories consist of materials, labor and manufacturing overhead.  The Company classifies any inventory that isestimated to be sold in the next twelve months as current inventory, with theremaining amount classified as long-term inventory.  The current portion of inventory at March 31,2006 was approximately $154,000.  Muchof the raw material used to produce Plenaxis® (including the active pharmaceuticalingredient) was expensed as research and development costs prior to the FDAgranting approval for the commercial sale of Plenaxis® inthe United States.

 

In connection with the Company’s strategic restructuringannounced in May 2005, the Company voluntarily discontinued promotionalactivities related to Plenaxis® and the sale of Plenaxis® for new patients in the United States.  As a result, the Company wrote downapproximately $3.5 million of inventory during the three months ended June 30,2005 that it estimated to be in excess of its expected requirements.  This amount was classified in cost of goodssold in the consolidated statement of operations for that period.  The remaining inventory balance of approximately$1.7 million at March 31, 2006 consists of materials that are expected tobe used in connection with the commercialization of Plenaxis® by a third party in Europe andother territories following a license or sale transaction relating to the product.  In September 2005, the Company receivedmarketing authorization for Plenaxis® in Germany. The Company is actively pursuing, with the assistance of an investmentbanking firm, the disposition of its Plenaxis® assets through a license or sale transaction,and to date, a number of parties have evaluated the opportunity.  The Company’s goal is to announce theconclusion of this process by the end of the second quarter of 2006.

 

***Impairmentor Disposal of Long-Lived Assets*.**

 

Statement of FinancialAccounting Standards (“SFAS”) No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets* (“SFAS No. 144”), requires that if thesum of the undiscounted future cash flows expected to result from a company’sasset, net of interest charges, is less than the reported value of the asset,an asset impairment may be recognized in the financial statements if thereported value of the asset exceeds the fair value determined by either aquoted market price, if any, or a value determined by utilizing a discountedcash flow technique.  The Companyevaluates its property, plant and equipment for impairment whenever indicatorsof impairment exist.  The amount of theimpairment to be recognized is calculated by subtracting the fair value of theasset from the reported value of the asset.

 

***Stock-Based Compensation***

 

In December 2004,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, *Share-Based Payment—An Amendment of FASB Statements No. 123 and 95*(“SFAS No. 123R”), which requires all companies to measure compensationcost for all share-based payments, including employee stock options, at fairvalue. Generally, the approach in SFAS No. 123R is similar to the approachdescribed in SFAS No. 123, *Accounting for Stock-BasedCompensation* (“SFAS No.123”). However, SFAS No. 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fair valueover the requisite service period. Pro forma disclosure is no longer analternative.   In March 2005, the SECissued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB No. 107”),which expressed the views of the SEC regarding the interaction between SFAS No. 123Rand certain rules and regulations of the SEC. SAB No. 107 providesguidance related to the valuation of share-based payment arrangements forpublic companies, including assumptions such as expected volatility andexpected term.

 

7

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Effective January 1,2006, the Company adopted the fair value recognition provisions of SFAS No. 123R,using the modified prospective transition method.  Under this transition method, compensationcost recognized in the statement of operations for the three months ended March 31,2006 includes: (a) compensation cost for all share-based payments grantedprior to, but not yet vested as of January 1, 2006, based on the grant-datefair value estimated in accordance with the original provisions of SFAS No. 123;and (b) compensation cost for all share-based payments granted, modifiedor settled subsequent to January 1, 2006, based on the grant-date fairvalue estimated in accordance with the provisions of SFAS No. 123R.  In accordance with the modified prospectivetransition method, results for prior periods have not been restated.

 

For the three monthsended March 31, 2006, the Company recorded stock-based compensationexpense of approximately $864,000 for stock options granted under the Company’sThird Amended and Restated 1995 Stock Plan (the “Plan”) and approximately$8,000 related to the Company’s Second Amended and Restated Employee Stock PurchasePlan (the “ESPP”), of which $647,000 was included in research and developmentexpenses and $225,000 was included in general and administrative expenses.  No amounts relating to stock-basedcompensation have been capitalized.

 

The Company currently hasthe following stock-based employee compensation plans which are subject to theprovisions of SFAS No. 123R:

 

*StockOption Plan* - The Plan allows for the granting of incentiveand nonqualified options and awards to purchase shares of Common Stock.Historically, incentive options granted to employees under the Plan generallyvested over a five-year period, with 20% vesting on the first anniversary ofthe date of grant and the remainder vesting in equal monthly installmentsthereafter. During 2005 and thereafter, the Company began granting options toemployees which generally vest over a four-year period, with 25% vesting on thefirst anniversary of the date of grant and the remainder vesting in equalmonthly installments thereafter. Nonqualified options issued to non-employeedirectors and consultants under the Plan generally vest during their period ofservice with the Company. Options granted under the Plan have a maximum term often years from the date of grant. At March 31, 2006, a total of 3,175,000shares of Common Stock were approved for issuance under the Plan and 542,229shares underlying options were available for future grant under the Plan.  On March 15, 2006, the Company’s Boardof Directors approved, subject to stockholder approval at the Company’s annualmeeting scheduled for May 11, 2006, the Fourth Amended and Restated 1995 StockPlan, which amends and restates the Plan to increase by 500,000, for a total of3,675,000, the number of shares of Common Stock authorized for issuance underthe Plan, permit the grant of restricted stock awards and include certainperformance goals for purposes of Section 162(m) of the Internal RevenueCode of 1986, as amended.

 

*EmployeeStock Purchase Plan* - Under the ESPP, eligible employees maypurchase shares of Common Stock at a price per share equal to 85% of the lowerof the fair market value per share of Common Stock at the beginning or the endof each six-month period during the term of the ESPP. Participation is limitedto the lesser of 10% of the employee’s compensation or $25,000 in any calendaryear. In May 2005, the Company’s Board of Directors approved an amendmentand restatement of the ESPP to extend its term through June 25, 2007 andprovide for withdrawal from the ESPP by employees during a six-month exerciseperiod.   At March 31, 2006, a totalof 66,049 shares of Common Stock had been issued under the ESPP and 13,951shares remained available for issuance. On March 15, 2006, the Company’s Board of Directors approved,subject to stockholder approval at the Company’s annual meeting scheduled for May 11,2006, an amendment to the ESPP to increase by 80,000 shares the number ofshares of Common Stock reserved for issuance thereunder.

 

The Company uses theBlack-Scholes option pricing model to calculate the fair value on the grantdate of stock-based compensation for both stock options granted under the Planand options to purchase shares granted under the ESPP.  The fair value of stock options grantedduring the three months ended March 31, 2005 and 2006 was calculated usingthe following estimated weighted- average assumptions:

 

8

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| ** **              | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Expected term (years)   |       | 6.1      |       | 4.5      |       |
| Volatility              |       | 80.8%    |       | 68.6%    |       |
| Risk-free interest rate |       | 4.2%     |       | 4.7%     |       |

 

Expected term- The expected term of options granted represents the period of time for whichthe options are expected to be outstanding and is derived from the Company’s historicalstock option exercise experience and option expiration data.  To estimate the expected term, the Companyexcluded options granted to employees who were terminated in connection withthe Company’s strategic restructuring announced in May 2005, which includeda reduction of the Company’s 182-person headcount by approximately 60%.  The Company believes that this adjustedhistorical data is currently the best estimate of the expected term of a newoption.  In addition, for purposes ofestimating the expected term, the Company has aggregated all individual optionawards into one group as the Company does not expect substantial differences inexercise behavior among its employees.

 

Expected volatility— The expected volatility is a measure of the amount by which the Company’sstock price is expected to fluctuate during the expected term of optionsgranted. The Company determines the expected volatility solely based upon thehistorical volatility of the Company’s Common Stock over a period commensuratewith the option’s expected term.  TheCompany does not believe that the future volatility of its Common Stock over anoption’s expected term is likely to differ significantly from the past.

 

Risk-free interest rate— The risk-free interest rate is the implied yield available on U.S. Treasuryzero-coupon issues with a remaining term equal to the option’s expected term onthe grant date.

 

Expected dividend yield- The Company has never declared or paid any cash dividends on any of itscapital stock and does not expect to do so in the foreseeable future.  Accordingly, the Company uses an expecteddividend yield of zero to calculate the grant-date fair value of a stockoption.

 

The assumptions used tocalculate the grant-date fair value for options to purchase shares grantedunder the ESPP for the three months ended March 31, 2006 include thefollowing: an expected term of six months, representing the current exerciseperiod for purchases under the ESPP, which began on January 2, 2006 andends on June 25, 2006; an expected annual volatility of 64.5%; anannualized risk-free interest rate of 4.4%; and a zero expected dividendyield.  The weighted-average per sharefair value of options to purchase shares granted under the ESPP during thethree months ended March 31, 2006 was $1.30.

 

The Company recognizescompensation expense on a straight-line basis over the requisite service periodbased upon options that are ultimately expected to vest, and accordingly, suchcompensation expense has been adjusted by an amount of estimatedforfeitures.  Forfeitures represent onlythe unvested portion of a surrendered option. SFAS No. 123R requires forfeitures to be estimated at the time ofgrant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates. Prior to the adoption of SFAS No. 123R, theCompany accounted for forfeitures upon occurrence as permitted under SFAS No. 123.  Based on an analysis of historical data,excluding the impact of options granted to employees who were terminated in connectionwith the Company’s strategic restructuring announced in May 2005, theCompany has calculated a 6.0% annual forfeiture rate, which it believes is areasonable assumption to estimate forfeitures. However, the estimation offorfeitures requires significant judgment, and to the extent actual results orupdated estimates differ from the Company’s current estimates, such amountswill be recorded as a cumulative adjustment in the period estimates arerevised.

 

The weighted average pershare fair value of stock options granted under the Plan during the threemonths ended March 31, 2005 and 2006 was $5.57 and $3.50, respectively.

 

Prior to January 1,2006, the Company applied the pro forma disclosure requirements under SFAS No. 123and accounted for its stock-based employee compensation plans using theintrinsic value method under the recognition and measurement provisions ofAccounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees* and related interpretations.

 

9

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Accordingly, nostock-based employee compensation cost was recognized in the statement ofoperations for the three months ended March 31, 2005, as all stock optionsgranted under the Plan had an exercise price equal to the market value of theunderlying Common Stock on the date of grant.

 

The following tableillustrates the effect on net loss and net loss per share if the Company hadapplied the fair value recognition provisions of SFAS No. 123 to optionsgranted under the Plan for the three months ended March 31, 2005.  Since stock-based compensation expense forthe three months ended March 31, 2006 was calculated under the provisions ofSFAS No. 123R, there is no disclosure of pro forma net loss and net lossper share for that period.  For purposesof the pro forma disclosure for the three months ended March 31, 2005 set forthin the table below, the value of the options is estimated using a Black-Scholesoption pricing model and amortized on a straight-line basis to expense over theoptions’ vesting periods.

 
| ** **                                                                                                                                                                           | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **(in thousands, except per  share data)**  | ** ** |
| Net loss, as reported                                                                                                                                                                |       | $                                           | (12,345    | ) |
| Deduct:  Stock-based employee compensation cost that would have been included in the  determination of net loss as reported if the fair value method had been  applied to all awards |       | (1,544                                      | )          |
| Pro forma net loss                                                                                                                                                                   |       | $                                           | (13,889    | ) |
|                                                                                                                                                                                 |       |                                        |       |
| Basic and diluted net  loss per common share, as reported                                                                                                                            |       | $                                           | (1.18      | ) |
| Basic and diluted net  loss per common share, pro forma (1)                                                                                                                          |       | $                                           | (1.32      | ) |

 

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(1)  The amount for the three months ended March 31,2005 was originally reported as $(1.45) and has been adjusted due to an errorin the calculation.

 

Information regardingoption activity for the three months ended March 31, 2006 under the Planis summarized below (in thousands, except price per share data):

 
| ** **                                                 | ** ** | **Options  Outstanding** | ** ** | **Weighted-  Average  Exercise  Price Per  Share** | ** ** | **Weighted-  Average  Remaining  Contractual  Term in Years** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------------------------|------------|--------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------|------------|
|                                                       |       |                     |       |                                               |       |                                                          |       |                            |       |
| Options  outstanding at January 1, 2006               |       | 1,682                    |       | $                                                  | 26.62      |                                                          |       |                            |       |   |
| Granted                                                    |       | 13                       |       | 5.72                                               |       |                                                          |       |                            |       |
| Exercised                                                  |       | (10                      | )          | 1.33                                               |       |                                                          |       |                            |       |
| Forfeited                                                  |       | (12                      | )          | 7.20                                               |       |                                                          |       |                            |       |
| Expired                                                    |       | (22                      | )          | 24.69                                              |       |                                                          |       |                            |       |
| Options  outstanding at March 31, 2006                |       | 1,651                    |       | $                                                  | 26.77      |                                                          | 5.9        |                            | $          | 1,215 |   |
|                                                       |       |                     |       |                                               |       |                                                          |       |                            |       |
| Options  exercisable at March 31, 2006                |       | 1,012                    |       | $                                                  | 34.55      |                                                          | 4.3        |                            | $          | 478 |   |
|                                                       |       |                     |       |                                               |       |                                                          |       |                            |       |
| Options  vested or expected to vest at March 31, 2006 |       | 1,564                    |       | $                                                  | 27.89      |                                                          | 5.8        |                            | $          | 1,063 |   |

 

The aggregate intrinsicvalue in the table above represents the total pre-tax intrinsic value (thedifference between the closing price of the Common Stock on March 31, 2006of $5.33 and the exercise price of each in-the-money option) that would havebeen received by the option holders had all option holders exercised theiroptions on March 31, 2006.  Totalintrinsic value of stock options exercised under the Plan for the three monthsended March 31, 2006 was $43,000.

 

10

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As of March 31,2006, there was $6,043,000 of total unrecognized compensation cost related tounvested share-based awards.  That costis expected to be recognized over a period of 4.3 years with a weighted-averageof 1.2 years.

 

***RevenueRecognition***

 

The Company follows theprovisions of the SEC’s SAB No. 104, *Revenue Recognition*.  The Company recognizes revenues from productsales in the period when the product is delivered, provided there is persuasiveevidence that an arrangement exists, the price is fixed or determinable andcollection of the related receivable is reasonably assured.  Revenues are recorded net of applicableallowances as provision is made for estimated sales returns, rebates,distributor fees and other applicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales. Product revenues are related solely toPlenaxis® for all periods presented in this report.  In connection with the Company’s strategicrestructuring announced in May 2005, the Company voluntarily discontinuedpromotional activities related to Plenaxis® and the sale of Plenaxis® for new patients in the United States.

 

The Company currentlyprovides substantially all of its distributors with payment terms of up to 120days on purchases of Plenaxis®.  Through March 31, 2006, payments havegenerally been made in a timely manner.

 

The Company analyzes itsmultiple element arrangements to determine whether the elements can beseparated and accounted for individually as separate units of accounting inaccordance with EITF No. 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 during which the Company isobligated to perform those services. Milestone payments are recognized as licensing revenue or product saleswhen the performance obligations, as defined in the contract, are achieved.  Performance milestones typically consist ofsignificant milestones in the development and/or commercialization of a productsuch as obtaining approval from regulatory agencies and the achievement oftargeted sales levels. Reimbursements of development costs are recognized aslicensing revenue as the related costs are incurred.

 

When the period overwhich a fee or payment will be recognized as revenue cannot be specificallyidentified from the contract, management estimates the deferral period basedupon other critical factors contained within the contract, including but notlimited to patent life or contract term.  The Company continually reviews these estimates which could result in achange in the deferral period and might impact the timing and the amount of revenuerecognized.

 

***NetLoss Per Share***

 

Basic net loss per shareis based on the weighted average number of shares of Common Stockoutstanding.  For all periods presented,diluted net loss per share of Common Stock is the same as basic net loss pershare of Common Stock as the inclusion of Common Stock equivalents, includingthe effect of stock options, would be antidilutive due to the Company’s netloss position for all periods presented. Diluted net loss per share of Common Stock excluded 1,561,696 and 1,651,354Common Stock options for the periods ended March 31, 2005 and 2006,respectively, as their impact would have been antidilutive.

 

***ComprehensiveLoss***

 

SFAS No. 130, *Reporting Comprehensive Income*, establishes standards forthe reporting and display of comprehensive income or loss and its components inthe condensed consolidated financial statements.  The Company’s accumulated other comprehensiveloss is comprised of net unrealized gains or losses on available-for-salesecurities.  For the three months ended March 31,2005 and 2006, comprehensive loss was as follows:

 

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| ** **                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|
| ** **                                  | ** ** | **2005**                               | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | **(in thousands)**                     | ** ** |
| Net loss                                    |       | $                                      | (12,345    | ) | $ | (7,052 | ) |
| Changes  in comprehensive loss:             |       |                                   |       |   |   |
| Net  unrealized holding gain on investments |       | 9                                      |       | 81 |   |
| Total comprehensive  loss                   |       | $                                      | (12,336    | ) | $ | (6,971 | ) |

 

**3.****             Restructuring**

 

On May 19, 2005, theCompany’s Board of Directors approved a strategic restructuring to focus theCompany’s resources on its most promising assets and programs and significantlyreduce its cost structure.  The strategicrestructuring included voluntarily discontinuing promotional activities relatedto Plenaxis® and the sale of Plenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM, the Company’sdrug candidate for Alzheimer’s disease; and implementing a reduction of theCompany’s 182-person headcount by approximately 60%.

 

During the year ended December 31,2005, the Company recorded approximately $28.7 million of restructuring andasset impairment expenses under SFAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities* (“SFAS No. 146”)*. *Included in these restructuringand asset impairment expenses are cash charges of approximately $2.6 millionfor employee severance, benefits and related costs, approximately $0.2 millionassociated with the termination of various contracts and approximately $0.2million of other associated costs.  TheCompany also recorded a non-cash impairment charge in cost of goods sold of approximately$3.5 million related to inventory due to the discontinuation of promotionalactivities relating to Plenaxis® and the sale of Plenaxis® for new patients in the United States.  At March 31, 2006, the Company’scondensed consolidated balance sheet includes approximately $1.9 million ofPlenaxis®-related equipment and approximately $1.7million of Plenaxis®-related inventory.

 

In connection with therestructuring, the Company performed an assessment and determined that itscorporate headquarters and research facility (the “Facility”) wasimpaired.  As a result, a non-cashimpairment charge of approximately $19.7 million related to the Facility wasrecorded as part of restructuring and asset impairment expenses under SFAS No. 144during the year ended December 31, 2005. The Company obtained anindependent appraisal that was based upon a fee simple expected present valuetechnique in combination with an evaluation of comparable assets in thegeographic area in order to estimate the fair value of its Facility.

 

In connection with therestructuring, the Company also determined that its commitments under certainexisting manufacturing and supply agreements with third parties exceeded theCompany’s estimated future Plenaxis® requirements by approximately $7.2million.  During the year ended December 31,2005, the Company recorded a charge of approximately $6.0 million whichrepresents the net present value of such excess future commitments.  Under SFAS No. 146, the Company isrequired to expense the remaining $1.2 million of these excess commitments overthe remaining term of the applicable manufacturing and supply agreements, whichcurrently range from two to five years.

 

12

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The following table setsforth the components of the Company’s restructuring and asset impairmentexpenses for the year ended December 31, 2005 (in thousands):

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

 

----

*****Amount wasrecorded in cost of goods sold.

 

During the three monthsended March 31, 2006, the Company recorded additional restructuringexpenses of approximately $0.1 million for excess future manufacturing commitments.  In addition, in January 2006, theCompany amended a manufacturing and supply agreement to provide for thesuspension of certain manufacturing activities in exchange for a reduced paymentby the Company of $1.5 million of a $2.1 million excess future commitment.  Accordingly, during the three months ended March 31,2006, the Company reduced the excess accrued restructuring liability by $0.6million through a reduction to restructuring expense.  Cash disbursements of approximately $1.6million were made during the three months ended March 31, 2006 related torestructuring charges.

 

The following table setsforth the activity and components of the Company’s restructuring and assetimpairment expenses for the three months ended March 31, 2006 (in thousands):

 
| ** **                                       | ** ** | **Amounts Accrued  as of  December 31, 2005** | ** ** | **Activity during the three months ended March 31, 2006** | ** ** | **Amounts Accrued  as of  March 31, 2006** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| **Additional  Charges**                          | ** ** | **Reversal of  Charges**                           | ** ** | **Amounts Paid**                                               |
| Employee  severance, benefits and related costs  |       | $                                                  | 118        |                                                           | $          | —                                          |       | $ | — |   | $ | 76 |   | $ | 42 |   |
| Other  costs                                     |       | 50                                                 |       | —                                                         |       | —                                          |       | — |   | 50 |   |
| Manufacturing  commitments restructuring expense |       | 5,274                                              |       | 103                                                            |       | (600                                            | )          | 1,500 |   | 3,277 |   |
| Total  restructuring and asset impairment.       |       | 5,442                                              |       | 103                                                            |       | (600                                            | )          | 1,576 |   | 3,369 |   |
| Impairment  on inventory                         |       | —                                             |       | —                                                         |       | —                                          |       | — |   | — |   |
| Total                                            |       | $                                                  | 5,442      |                                                           | $          | 103                                             |       | $ | (600 | ) | $ | 1,576 |   | 3,369 |   |
| Less  current portion.                           |       |                                               |       |                                                           |       |                                            |       |   |   | (2,096 | ) |
| Long-term  restructuring accrual                 |       |                                               |       |                                                           |       |                                            |       |   |   | $ | 1,273 |   |

 

13

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**4.****             Litigation**

 

In December 2004and January 2005, the Company, Chairman and (now former) Chief ExecutiveOfficer Malcolm Gefter, President and (now former) Chief Operating OfficerKevin F. McLaughlin, Chief Financial Officer and Treasurer Edward C. English,and former President and Chief Operating Officer William K. Heiden, were namedas defendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts.  On February 7, 2005, a motion was filedto consolidate the three actions and to appoint lead plaintiffs and leadcounsel.  On February 18, 2005, theCompany and the individual defendants filed a brief response to that motion,reserving their rights to challenge the adequacy and typicality, among otherthings, of the proposed lead plaintiffs in connection with class certificationproceedings, if any.  On April 13,2005, the Court entered an Order granting the plaintiffs’ motion to consolidatethe three actions (as well as each case that relates to the same subject matterthat may be subsequently filed in or transferred to the United States DistrictCourt for the District of Massachusetts), appoint lead plaintiffs and approvesuch plaintiffs’ selection of co-lead counsel.

 

On August 1, 2005, lead plaintiffs filed a consolidated amendedcomplaint.  Lead plaintiffs generallyallege securities fraud during the period from November 25, 2003 through December 6,2004.  The consolidated amended complaintpurports to assert claims under Sections 10(b) and 20(a) of the Securitiesand Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, andalleges that the Company and the individually named defendants made materiallyfalse and misleading public statements concerning the Company’s business andfinancial results, particularly relating to statements regarding thecommercialization of Plenaxis®,thereby allegedly causing plaintiffs to purchase the Company’s securities atartificially inflated prices.  At thistime, plaintiffs have not specified the amount of damages they are seeking inthe actions.  On September 12, 2005, the Company and the individualdefendants filed a Motion to Dismissthe consolidated amended complaint in its entirety.  On October 24, 2005, lead plaintiffsfiled an Opposition to the Company’s Motion to Dismiss and the defendants fileda reply on November 14, 2005.  On January 17,2006, the Court heard oral argument on the Motion to Dismiss and took thematter under advisement.

 

The Company has notrecorded an estimated liability associated with the legal proceedings describedabove.  Due to the uncertainties relatedto both the likelihood and the amount of any potential loss, the Company isunable to make a reasonable estimate of the liability that could result from anunfavorable outcome.  Management believesthat the allegations against the Company are without merit, and the Companyintends to vigorously defend against the plaintiffs’ claims.  However, if the Company is not successful indefending these actions, its business and financial condition could beadversely affected.

 

5.             **Subsequent Event**

 

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

 

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

 

*The following discussion of ourfinancial condition and results of operations should be read together with thecondensed consolidated financial statements and accompanying notes to thosestatements included elsewhere in this Form 10-Q.  This Form 10-Q contains forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, that involve risks and uncertainties.  All statements other than statements ofhistorical information set forth herein are forward-looking and may containinformation about financial results, events, economic conditions, trends andknown uncertainties.  Actual results andevents could differ materially from those discussed in these forward-lookingstatements as a result of a number of factors, which include those discussed inthis section and elsewhere in this report under Part II, Item 1A —Risk Factors, and the risks discussed in our other filings with the Securitiesand Exchange Commission.  Readers arecautioned not to place undue reliance on these forward-looking statements,which reflect management’s analysis, judgment, belief or expectation only as ofthe date hereof.  PRAECIS undertakes noobligation to publicly reissue or modify these forward-looking statements toreflect events or circumstances that arise after the date hereof.*

 

**Overview**

 

We are abiopharmaceutical company focused on utilizing our DirectSelectTM and otherproprietary technologies to discover, in a rapid and efficient manner, novel,orally-available compounds with the potential to address unmet medical needs orimprove existing therapies.  We intend tocollaborate with pharmaceutical and biotechnology companies on the discoveryand development of these compounds across a broad range of therapeutic areas,and recently entered into two pilot agreements. We also intend to selectpromising compounds for internal development and will partner these compoundsat various stages of development to optimize their value to the Company.  We currently do not intend to independentlymarket the products that may ultimately result from our discovery anddevelopment efforts. The key elements of our strategy include:

 

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

 

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

 

Additionally, as part ofour strategy to focus our resources and attention on advancing our DirectSelectTMand PPI-2458 programs, we are actively pursuing, with the assistance of aninvestment banking firm, the disposition of our Plenaxis® assets through alicense or sale transaction.  To date, a numberof parties have evaluated the opportunity and our goal is to announce theconclusion of this process by the end of the second quarter of 2006.

 

We are focusing ourresearch efforts on developing and enhancing a novel drug discovery technology,DirectSelectTM, which we believe may be an important tool for the future of drugdiscovery and development.  We believethat DirectSelectTM, which enables the generation and practical use of ultra-largelibraries for the discovery of orally active compounds for drug development,will allow us to more rapidly and directly identify orally available compoundswith high affinity and specificity than has routinely been possible usingtraditional drug discovery methods. During 2005 and the first quarter of 2006, we continued to expand ourlibrary collection to greater than five billion compounds and we are focusingon the creation of novel drug-like molecules in unpatented chemical space.  We continue to incorporate multiple newchemistries and scaffolds into these libraries. We are applying DirectSelectTM to a number of therapeutic targets ofinterest to us and in connection with these efforts, we have identifiedinhibitors to four targets: three kinase and one protease.  We intend to use this technology to expandour own proprietary development pipeline.

 

15

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Inaddition to our internal efforts to develop and enhance DirectSelectTM, ourstrategic operating plan includes entering into drug discovery anddevelopment partnerships utilizingDirectSelectTM.  In March 2006, weentered into a technology transfer and option agreement with Gilead Sciences, Inc.  Under the agreement, we will utilizeDirectSelectTM to identify lead drug candidates for an antiviral target suppliedby Gilead.  The companies willcollaborate to identify lead molecules that have defined activities against theantiviral target.  Each company will fundits own efforts during the course of the research collaboration.  We will own any lead molecules identifiedduring the course of the research collaboration.  Gilead has an exclusive option to enter intoa license agreement for any lead molecules so identified.

 

Inaddition, in April 2006, we entered into a two year pilot study and optionagreement with GlaxoSmithKline, through its recently established Center ofExcellence for External Drug Discovery, or CEEDD.  The goal of this pilot study is to applyDirectSelectTM to identify small molecule lead drug candidates against a diverseset of four targets selected by GlaxoSmithKline.  Under the terms of the agreement, followingour identification of lead compounds meeting pre-established success criteriaagainst at least one of the specified targets, GlaxoSmithKline will have theexclusive option to enter into a broader strategic alliance for furtherdiscovery and development of such lead compounds.  The pilot agreement contemplates that anybroader strategic alliance could cover one or more of the targets included inthe pilot study, as well as additional targets as may be agreed upon by theparties.  During the pilot study, we willbe entitled to receive a $500,000 milestone payment with respect to each of thefirst two targets for which lead compounds are identified meeting the pre-establishedsuccess criteria.

 

Inconnection with the execution of the pilot study agreement, we concurrentlyentered into a stock purchase agreement with GlaxoSmithKline, pursuant to whichwe sold, on April 28, 2006, 102,538 unregistered shares of our commonstock at $4.88 per share, for an aggregate purchase price of $500,000.

 

Weare continuing to initiate and advance research collaboration discussions with othermajor pharmaceutical companies with respect to DirectSelectTM.

 

We are also focusing ourresearch and development efforts on PPI-2458, a novel, proprietary oralcompound targeted at the inhibition of the enzyme methionine aminopeptidasetype 2, or MetAP-2.  We believe that, dueto its antiproliferative and antiangiogenic activity, PPI-2458 has thepotential to address broad therapeutic areas, and we are currently in theprocess of establishing a plan for additional clinical studies for thiscompound.  In late 2004, we opened aphase 1 clinical trial of PPI-2458 in non-Hodgkin’s lymphoma patients.  During the first quarter of 2005, we expandedthe enrollment criteria of this trial to include patients with solidtumors.  While the clinical trial isstill in its early stages, thus far oral dosing of PPI-2458 has been welltolerated and has produced substantial inhibition of molecular targeted MetAP-2activity in most subjects evaluated.  Ourgoal is to present preliminary data from our phase 1 trial during the fourthquarter of 2006*. *Inaddition to the ongoing clinical program in cancer patients, based onpreclinical data we have generated, we believe PPI-2458 could be a potentialtreatment with disease modifying activity for rheumatoid arthritis and otherinflammatory and autoimmune disorders, and we are actively investigatingvarious strategic partnering and clinical development alternatives for PPI-2458in these indications.  In light of theanticipated development costs associated with the PPI-2458 clinical program, weanticipate seeking a partner for this program in one or more indications asclinical development advances.

 

During 2005, we fundamentallyaltered our strategic operating plan to focus our efforts on early stageresearch and development activities.  On May 19,2005, our board of directors approved a strategic restructuring to focus theCompany’s resources on our most promising assets and programs and significantlyreduce our cost structure.  The strategicrestructuring included voluntarily discontinuing promotional activities relatedto Plenaxis® and the sale of Plenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM, our drugcandidate for Alzheimer’s disease; and implementing a reduction of our 182-personheadcount by approximately 60% to approximately 75 full-time employees.  As of March 31, 2006, we had 79full-time employees, 65 of whom were research and development personnel and 14of whom were general and administrative personnel.  This compares to 176 full-time employees asof March 31, 2005.

 

16

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Plenaxis® continues to be availableto those patients in the United States who had already received the drug at thetime we announced our strategic restructuring. Plenaxis® was approved by the FDA in November 2003.  We launched the product in the United Statesusing our own dedicated marketing and sales team in early 2004, but productsales were significantly lower than expected. In September 2005, we received marketing authorization for Plenaxis® from Germanregulatory authorities.  Shortly afterour receipt of the German approval, we received notice from Schering AG, ofBerlin, Germany, that it was exercising its right to terminate its license,supply and distribution agreement with us due to our not having receivedmarketing authorization for Plenaxis® in Germany with a requisite label by June 30,2005.  Under the agreement, as a resultof the termination, all of Schering AG’s rights and licenses with respect toPlenaxis® ceased. We received a $2.0 million signing payment from Schering AG during thesecond quarter of 2004, which we were recognizing as revenue ratably over aperiod through 2016 based on the remaining patent life of Plenaxis® in Europe. Due to the termination of the Schering AG agreement in September 2005,we recognized approximately $1.9 million in revenues for the year ended December 31,2005, representing the remaining deferred revenue from the $2.0 million signingpayment.  In October 2005, inconnection with the termination of the Schering AG agreement, the partiesentered into a settlement agreement under which Schering AG paid us $4.0million, representing full and complete satisfaction of its obligations underthe agreement arising prior to its termination. We recognized this $4.0 million payment as revenues in 2005.

 

Due to ourdiscontinuation of promotional activities related to Plenaxis® in the UnitedStates, the termination of the Schering AG agreement and our strategy to focusour resources and attention on advancing our DirectSelectTM and PPI-2458programs, we are actively pursuing, with the assistance of an investmentbanking firm, the disposition of our Plenaxis® assets through a license or sale transaction, and to date, anumber of parties have evaluated the opportunity.  Our goal is to announce the conclusion ofthis process by the end of the second quarter of 2006.  However, we cannot assure investorsthat we will be able to conclude such a transaction in a timely manner and onacceptable terms, or at all.  If we areunable to do so, we do not intend to pursue further the commercialization ofPlenaxis® outside the United States and will seek todiscontinue all distribution of the product in the United States.  In that event, we would incur a yetundetermined amount of shut-down costs and expenses and would need to devotefunds and other resources that would otherwise be available to support ourcurrent strategic operating plan.

 

In connection with ourstrategic restructuring, we also voluntarily suspended the clinical developmentprogram for ApanTM.  We began this programin 2000 and, prior to its suspension, completed both a phase 1a single doseescalation study, identifying a maximum tolerated dose in healthy volunteers,and a phase 1b single dose escalation study, identifying the maximum tolerateddose in Alzheimer’s patients.  Enrollmentin a phase 1/2a multiple dose study was suspended prior to completion.  The suspension of clinical development forApanTM was not due to any unexpected or undesirable event or clinical result,but rather to redirect our resources.  Weplan to explore potential partnering opportunities for this compound to enableits further development.

 

In October 2005, wesold our corporate headquarters and research facility for $51.25 million.  We realized proceeds, net of fees andexpenses, of approximately $50.4 million from this sale, and used approximately$31.6 million of the proceeds to retire the outstanding debt obligation relatedto the facility. The remaining net proceeds of approximately $18.8 million willbe used to further our research and development efforts.  In connection with the sale of the facility,we executed a lease for approximately 65,000 square feet of office andlaboratory space in this facility.  Thelease has an initial term of five years at an annual base rent of approximately$2.1 million for the first two years, increasing to approximately $2.3 millionper year for the remaining three years. We have options to extend the lease for up to three additional five-yearterms at then current market rates.  As aresult of the sale and partial leaseback of the facility, we realized a totalgain of approximately $10.5 million, of which we recognized approximately $1.4million as a gain during 2005.  Theremaining amount of approximately $9.1 million will be recorded as a reductionof rent expense over the initial term of the lease.  During the three months ended March 31,2006, we recorded a reduction of approximately $0.5 million to rent expenserelated to this deferred gain.

 

17

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During 2005, we recordedapproximately $28.7 million of restructuring and asset impairment expensesunder Statement of Financial Accounting Standards No. 146, *Accounting for Costs Associated with Exit or Disposal Activities*,or SFAS No. 146.  Included in these restructuringand asset impairment expenses are cash charges of approximately $2.6 millionfor employee severance, benefits and related costs, approximately $0.2 millionassociated with the termination of various contracts and approximately $0.2million of other associated costs.  Wealso recorded a non-cash impairment charge of approximately $3.5 millionrelated to inventory due to the discontinuation of promotional activitiesrelating to Plenaxis® in the United States and the sale of Plenaxis® for newpatients.  In addition, a non-cashimpairment charge of approximately $19.7 million was recorded under Statementof Financial Accounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*, or SFAS No. 144,relating to the impairment of our corporate headquarters and research facility.

 

We also determined thatour commitments under certain existing manufacturing and supply agreements withthird parties exceeded our estimated future Plenaxis® requirements by approximately $7.2million.  During 2005, we recorded acharge of approximately $6.0 million which represents the net present value ofthese excess commitments.  Under SFAS No. 146,we are required to expense the remaining $1.2 million of these excesscommitments over the remaining term of the applicable manufacturing and supplyagreements, which currently range from two to five years.  We recorded restructuring expenses of $0.1million for these excess commitments during the three months ended March 31,2006.  In addition, in January 2006,we amended a manufacturing and supply agreement to provide for the suspensionof certain manufacturing activities in exchange for a reduced payment of $1.5million of a $2.1 million excess future commitment.  Accordingly, during the three months ended March 31,2006, we reduced the excess accrued restructuring liability by $0.6 millionthrough a reduction to restructuring expense.

 

On November 1, 2005,we implemented a one-for-five reverse split of our common stock.  As a result, the number of shares of ourissued and outstanding common stock was reduced from approximately 52.5 millionshares to approximately 10.5 million shares. All per share amounts and outstanding shares, including all common stockequivalents (stock options and the exercise prices thereof), have beenretroactively restated for all periods presented in this report to reflect thereverse stock split.

 

Most of our expendituresto date have been for drug development, the development of our drug discoverytechnologies, commercialization activities related to Plenaxis® and for generaland administrative expenses.  Ouraccumulated deficit as of March 31, 2006 was approximately $312.1 million.  We have incurred net operating losses sincefiscal 2000 and expect to continue to incur such losses for at least the nextseveral years.

 

We believe that ourexisting cash and investments of approximately $52.7 million at March 31,2006 will be sufficient to meet our working capital and capital expenditureneeds, at current levels, through approximately the end of 2007.  Given the uncertainty of timing related tothe key elements of our strategy, we are not providing earnings or cashguidance for quarterly or annual periods. If we are able to successfully carry out key elements of our strategicoperating plan by establishing partnerships relating to our DirectSelectTMtechnology or our PPI-2458 program that provide significant cash to us, or ifwe are able to realize significant value from the disposition of our Plenaxis® assets, we mayhave available resources to allow us to pursue our strategic operating planbeyond the end of 2007.  However, wecannot assure investors that we will be able to enter into appropriatecollaborative arrangements relating to our DirectSelectTM technology or our PPI-2458program that will provide significant cash to us, or realize significant valuefrom the disposition of our Plenaxis® assets. If we are unable to successfully and in a timely manner carry out keyelements of our strategic operating plan and realize significant value from thedisposition of our Plenaxis® assets, we will have to obtain additionalfunding in 2007 or significantly modify our strategic operating plan, includingby curtailing or eliminating certain elements of our operations.  We have no committed sources of capital anddo not know whether additional financing will be available when needed, or, ifavailable, that the terms will be acceptable to us.  If we are required to raise money in thefuture and we experience difficulties or are unable to do so, it could becomenecessary for us to cease operations or seek protection under state or federalinsolvency or bankruptcy laws.

 

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**Critical Accounting Policies**

 

While our significantaccounting policies are more fully described in Note 2 to our condensed consolidatedfinancial statements appearing elsewhere in this report, we believe thefollowing accounting policies to be critical:

 

*Use ofEstimates.*  We prepareour financial statements in accordance with accounting principles generallyaccepted in the United States. These principles require that we make estimatesand use assumptions that affect the reporting of our assets and our liabilitiesas well as the disclosures that we make regarding assets and liabilities andrevenues and expenses that are contingent upon uncertain factors as of thereporting date.  Such estimates relate tothe useful lives of fixed assets, the net realizable value of inventory,accrued restructuring expenses, other accrued expenses, other reserves, andassumptions used in valuing stock-based compensation awards.  Actual payments, and thus our actual results,could differ from our estimates and such differences may be material to our condensedconsolidated financial statements.

 

*Restructuringand Asset Impairment Expenses.*  On May 19, 2005, our board of directorsapproved a strategic restructuring to focus the Company’s resources on our mostpromising assets and programs and significantly reduce our cost structure.  The strategic restructuring includedvoluntarily discontinuing promotional activities related to Plenaxis® and the sale ofPlenaxis® fornew patients in the United States; voluntarily suspending the ongoing clinicaldevelopment of ApanTM; and implementing a reduction of our 182-person headcountby approximately 60%. These restructuring charges were accounted for inaccordance with SFAS No. 146.  Indetermining the manufacturing commitments restructuring expense and inventoryimpairment, various assumptions were made with respect to future Plenaxis® sales. Theseassumptions will be reviewed periodically and should these estimates change,adjustments to the net present value of remaining commitments as well asinventory may be necessary in future periods. Please refer to the discussion of*Impairment or Disposal of Long-Lived Assets*and*Inventory* appearing directly below, aswell as Note 3 — Restructuring, included in our condensed consolidatedfinancial statements appearing elsewhere in this report, for additionalinformation regarding our strategic restructuring. Our balance sheet at March 31,2006 includes approximately $1.9 million of Plenaxis®-relatedequipment and approximately $1.7 million of Plenaxis®-relatedinventory.  We cannot assure investorsthat we will be able to conclude the disposition of our Plenaxis® assets in a timely manner and on acceptableterms, or at all, and depending on the outcome of our efforts to do so, and thetiming of that outcome, we may be required to record a non-cash write-downrelated to these assets.

 

*Impairmentor Disposal of Long-Lived Assets*.  SFAS No. 144 requires that if the sum ofthe undiscounted future cash flows expected to result from a company’s asset,net of interest charges, is less than the reported value of the asset, an assetimpairment may be recognized in the financial statements if the reported valueof the asset exceeds the fair value determined by either a quoted market price,if any, or a value determined by utilizing a discounted cash flow technique.  We evaluate our property, plant and equipmentfor 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 believe that theapplication of SFAS No. 144 and the method used to determine theimpairment of our property, plant and equipment involve critical accountingestimates because they are highly susceptible to change from period to periodand because they require management to make assumptions about future cashflows, including residual values.  Inaddition, we believe that had alternative assumptions been used, the impact ofrecognizing an impairment, if any, on the assets reported on our balance sheet,as well as our net loss, may have been material.

 

*Inventory.* We value inventory at cost or, if lower, market value.We determine cost using the first-in, first-out method.  We analyze our inventory levels quarterly andwrite down inventory that has become obsolete, inventory that has a cost basisin excess of its expected net realizable value and inventory in excess ofexpected requirements, to cost of goods sold. Expired inventory is disposed of and the related costs are writtenoff.  If actual market conditions areless favorable than as estimated by us, additional write-downs of existinginventory may be required in future periods. We classify any inventory that weestimate to be sold in the next twelve months as current with the remainingamount classified as long-term inventory. In connection with our strategic restructuring announced in May

 

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2005, we discontinuedpromotional activities related to Plenaxis® and the sale of Plenaxis® for new patients in the United States.  As a result, we wrote down approximately $3.5million of inventory during the three months ended June 30, 2005 that weestimated to be in excess of expected requirements.  This amount was classified in cost of goodssold in the consolidated statement of operations for that period.  The remaining inventory balanceconsists of materials that are expected to be used in connection with thecommercialization of Plenaxis® in Europe and other territories by a thirdparty following a license or sale transaction relating to the product.  We have engaged an investment banking firm toexplore the disposition of our Plenaxis® assets through a license or sale transaction, , and to date, anumber of parties have evaluated the opportunity.  Our goal is to announce the conclusion ofthis process by the end of the second quarter of 2006.  Our balance sheet at March 31, 2006includes approximately $1.7 million of Plenaxis®-relatedinventory.  As noted above, if we areunable to conclude the disposition of our Plenaxis® assets in a timely manner, we may be requiredto record a non-cash write-down related to this inventory.

 

*RevenueRecognition. *We followthe provisions of the Securities and Exchange Commission’s Staff AccountingBulletin No. 104, *Revenue Recognition*.  We recognize revenues from product sales inthe period when the product is delivered, provided there is persuasive evidencethat an arrangement exists, the price is fixed or determinable and collectionof the related receivable is reasonably assured.  Revenues are recorded net of applicableallowances as provision is made for estimated sales returns, rebates,distributor fees and other applicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales. Product revenues are related solely toPlenaxis® forall periods presented in this report.  Inconnection with our strategic restructuring announced in May 2005, wevoluntarily discontinued promotional activities related to Plenaxis® and the sale ofPlenaxis® fornew patients in the United States.

 

We currently providesubstantially all of our distributors with payment terms of up to 120 days onpurchases of Plenaxis®.  Through March 31, 2006, payments havegenerally 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 during 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 overwhich a fee or payment will be recognized as revenue cannot be specificallyidentified from the contract, management estimates the deferral period basedupon other critical factors contained within the contract, including but notlimited to patent life or contract term.  We continually review these estimates which could result in a change inthe deferral period and might impact the timing and the amount of revenuerecognized.

 

*Stock-basedCompensation. *EffectiveJanuary 1, 2006, we adopted the fair value recognition provisions ofStatement of Financial Accounting Standards No. 123R, *Share-BasedPayment — An Amendment of FASB Statements No. 123 and 95,*or SFASNo. 123R.  SFAS No. 123Rrequires companies to measure compensation cost for all share-based awards atfair value on grant date and recognize it as expense ratably over the requisiteservice period of the award.  We use theBlack-Scholes option pricing model to calculate the fair value of share-basedawards on the grant date.  This optionpricing model requires the input of highly subjective assumptions, includingthe term during which the awards are expected to be outstanding and the pricevolatility of the underlying stock.  Inaddition, SFAS No. 123R requires forfeitures, which represent only theunvested portion of a surrendered award, to be estimated at the time of thegrant and revised, if necessary, in subsequent periods.  Please refer to Note 2 — Summary ofSignificant Accounting Principles, included in the condensed consolidatedfinancial statements appearing elsewhere in this report, for additionalinformation regarding our adoption of SFAS No. 123R.

 

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

 

**Results of Operations**

 

**Three Months Ended March 31, 2006 Compared To Three Months Ended March 31, 2005**

 

Revenues for the threemonths ended March 31, 2006 were approximately $0.2 million compared toapproximately $0.9 million for the corresponding period in 2005.  Of these amounts, approximately $0.1 millionand $0.8 million, respectively, were related to sales of Plenaxis®.  The decrease in revenues was due to thevoluntary discontinuation of promotional activities related to Plenaxis® and the sale of Plenaxis® fornew patients in the United States in May 2005.  We expect to continue to have a smallamount of revenues from Plenaxis® sales during 2006.  Other sources of revenues during 2006 andthereafter may include potential payments under our pilot study and optionagreement with GlaxoSmithKline, or potential payments under future partnershipsrelating to our DirectSelectTM drug discovery technology or PPI-2458 or from adisposition of our Plenaxis® assets through a license or sale transaction,in each case if consummated.  The amountand timing of these other potential sources of revenues will depend on thesuccess of our DirectSelectTM technology and our PPI-2458 clinical developmentprogram, and our ability to enter into partnerships with respect to theseprograms which provide cash to us, and the interest of third parties, if any, inentering into a license or sale transaction relating to Plenaxis®.  We cannot assure investors as to if or whenwe will receive any such revenues.

 

Cost of goods sold forthe three months ended March 31, 2006 was approximately $57,000 comparedto approximately $0.2 million for the corresponding period in 2005.  We expect cost of goods sold to continue todecline for the remainder of 2006, but this will be dependent upon the outcomeof the license or sale of Plenaxis®.

 

We currently have severalongoing research and development programs. Using industry estimates, typical drug development programs may last forten or more years and may cost hundreds of millions of dollars to complete. Asour programs progress, we assess the possibility of entering into partnershipsor other arrangements to offset a portion or all of our research anddevelopment costs. The ultimate success of our research and developmentprograms and the impact of these programs on our operations and financialresults cannot be accurately predicted and will depend, in large part, upon theoutcome and timing of many variables outside of our control.

 

Members of our researchand development team typically work on a number of projects concurrently. Inaddition, a substantial amount of our fixed costs such as facility andequipment depreciation, utilities and maintenance are shared by our variousprograms. Accordingly, we have not specifically identified, and do not plan tospecifically identify, all costs related to each of our research anddevelopment programs.  We estimate thatduring the three months ended March 31, 2006 and 2005, the majority of ourresearch and development expenses consisted of salaries, benefits, clinicaltrial costs, manufacturing costs and lab supplies related to the development ofour DirectSelectTM technology, as well as our PPI-2458, Plenaxis® and ApanTM clinicaldevelopment programs.  In addition,research and development expenses for the three months ended March 31,2006 include stock-based compensation expense due to our adoption of SFAS No. 123Reffective January 1, 2006.

 

Research and developmentexpenses for the three months ended March 31, 2006 decreased 12% toapproximately $6.4 million, from approximately $7.3 million for thecorresponding period in 2005.  Totalpersonnel-related research and development expenses for the three months ended March 31,2006 increased approximately $0.1 million due to our adoption of SFAS No. 123Reffective January 1, 2006. Stock-based compensation expense ofapproximately $0.7 million for the three months ended March 31, 2006 morethan offset lower personnel-related expenses resulting from our strategicrestructuring announced in May 2005. The decrease in research and development expenses reflects reducedspending in our clinical and preclinical development programs.  Due to our strategic restructuring, spendingon the Plenaxis® and ApanTM programs during the three monthsended March 31, 2006 decreased by approximately $0.7 million and $0.3million, respectively, and spending on the PPI-2458 program increased byapproximately $0.5 million.  Although weare unable to predict the precise level of spending on individual clinicalprograms due to the uncertain nature of clinical

 

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development, we expectour research and development expenses to increase slightly during 2006 andthereafter, as we continue to develop and enhance our DirectSelectTM technologyand utilize this technology to support partnerships and internal programs, andcontinue our clinical trial of PPI-2458. The remaining decrease in research and development expenses during the threemonths ended March 31, 2006 reflects lower depreciation expense ofapproximately $0.6 million, which was primarily due to the sale of ourcorporate headquarters and research facility in October 2005, offset by anet increase in third-party laboratory services and supply expenses ofapproximately $0.2 million.

 

There were no sales andmarketing expenses for the three months ended March 31, 2006, compared tosales and marketing expenses of approximately $3.7 million for thecorresponding period in 2005.  Thedecrease resulted from the voluntary discontinuation of promotional activitiesrelated to Plenaxis® in the United States.  Beginning in 2004 through May 2005, wepromoted Plenaxis® in the United States through our own marketingand sales team.  In the future, we intendto partner products that may ultimately result from our discovery anddevelopment efforts at the appropriate time to maximize the value of theproduct to the Company.  Accordingly, wecurrently do not intend to independently market future products and do notexpect to incur significant sales and marketing expenses during 2006 orthereafter.

 

General andadministrative expenses for the three months ended March 31, 2006decreased 7% to approximately $1.8 million from approximately $2.0 million forthe corresponding period in 2005.  Totalpersonnel-related general and administrative expenses for the three monthsended March 31, 2006 and 2005 were comparable due to our adoption of SFAS No. 123Reffective January 1, 2006. Stock-based compensation expense ofapproximately $0.2 million for the three months ended March 31, 2006offset lower personnel-related expenses resulting from our strategicrestructuring.  The decrease in generaland administrative expenses resulted primarily from lower occupancy costs dueto the sale of our corporate headquarters and research facility in October 2005.  We expect that general and administrativeexpenses will increase slightly over current levels for the remainder of 2006.

 

Asdescribed in detail in this report under Part II, Item 1. “LegalProceedings,” in December 2004 and January 2005, the Companyand certain of its current and former executive officers were named asdefendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts.  The complaints were consolidated into oneaction in April 2005.  In August 2005,lead plaintiffs filed a consolidated amended complaint.  In September 2005, we filed a motion todismiss plaintiffs’ consolidated amended complaint.  In October 2005, lead plaintiffs filedan opposition to our motion to dismiss and the defendants filed a reply in November 2005.  In January 2006, the Court heard oralargument on the motion to dismiss and took the matter under advisement.Management believes that the allegations against the Company are without merit,and the Company intends to vigorously defend against the plaintiffs’claims.  As this litigation is in anearly stage, management is unable to predict its outcome or its ultimateeffect, if any, on our financial condition. However, we expect that the costs and expenses related to thislitigation may be significant.  Ourcurrent director and officer liability insurance policies (which, subject tothe terms and conditions thereof, also provide “entity coverage” for theCompany for this litigation) provide that the Company is responsible for thefirst $2.5 million of such costs and expenses. Also, a judgment in or settlement of these actions could exceed ourinsurance coverage.  Accordingly, if weare not successful in defending these actions, our business and financialcondition could be adversely affected.

 

Restructuring and assetimpairment expenses for the three months ended March 31, 2006 reflect areversal of approximately $0.6 million of restructuring expenses previouslyrecorded in the three months ended June 30, 2005, offset by approximately $0.1million of additional restructuring expenses. There were no restructuring and asset impairment expenses for the threemonths ended March 31, 2005.  Pleaserefer to the discussion under “Overview” and “Critical Accounting Policies” inthis Item 2, as well as Note 3 – Restructuring, included in our condensedconsolidated financial statements appearing elsewhere in this report, foradditional information regarding our strategic restructuring.

 

Net interest income forthe three months ended March 31, 2006 was approximately $0.6 million comparedto net interest expense of approximately $0.1 million for the correspondingperiod in 2005. This change was primarily due to the retirement of theoutstanding debt related to our corporate headquarters and research facility,which we sold in October 2005.

 

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The provision for incometaxes for the three months ended March 31, 2006 and March 31, 2005was zero.  We anticipate that we willcontinue to be in a net operating loss carryforward position for the nextseveral years.  Therefore, no tax benefitfrom our operating losses was recognized.

 

For the three monthsended March 31, 2006, net loss was approximately $7.1 million, or $0.67per share, compared to a net loss of approximately $12.3 million, or $1.18 pershare, for the three months ended March 31, 2005.

 

**Liquidity and Capital Resources**

 

To date, our operationsand capital requirements have been financed primarily with the proceeds ofpublic and private sales of common stock and preferred stock, payments receivedunder research and development partnerships and collaborative agreements, investmentincome, revenues from product sales and proceeds from the October 2005sale of our corporate headquarters and research facility.  We have no committed sources of capital anddo not know whether additional financing will be available when needed, or, ifavailable, that the terms will be favorable to us.

 

In May 2005, our boardof directors approved a strategic restructuring to focus the Company’sresources on our most promising assets and programs and significantly reduceour cost structure.  The strategicrestructuring included voluntarily discontinuing promotional activities relatedto Plenaxis® and the sale of Plenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM; andimplementing a headcount reduction of approximately 60%.

 

At March 31, 2006,we had cash, cash equivalents and marketable securities of approximately $52.7million and working capital of approximately $46.7 million, compared toapproximately $62.6 million and $54.1 million, respectively, at December 31,2005.

 

We expect to continue tohave net operating losses for the next several years as we invest in developingand enhancing our DirectSelectTM technology and advancing PPI-2458, andpotentially other proprietary compounds, through clinical and preclinicaldevelopment.  In order to achieve ourbusiness objective, we must successfully carry out the following key elementsof our operating plan: continue development and enhancement of ourDirectSelectTM technology and use this technology to support pharmaceuticalpartnerships in drug discovery and development that will provide significantcash to us, as well as to expand our own proprietary development pipeline; andadvance PPI-2458 through a phase 1 trial in cancer patients and continuepreclinical evaluation of the compound in inflammatory and autoimmunedisorders, including rheumatoid arthritis, with a goal of partnering thisprogram in one or more indications as clinical development advances.  Additionally, as part of our strategy tofocus our resources and attention on advancing our DirectSelectTM and PPI-2458programs, we are actively pursuing, with the assistance of an investmentbanking firm, the disposition of our Plenaxis® assets through a license or sale transaction.

 

Given the uncertainty oftiming related to the key elements of our strategy, we are not providingearnings or cash guidance for quarterly or annual periods.  However, we believe that our existing cashand investments of approximately $52.7 million at March 31, 2006 will besufficient to meet our working capital and capital expenditure needs, atcurrent levels, through approximately the end of 2007.  If we are able to successfully carry out keyelements of our strategic operating plan by establishing partnerships relatingto our DirectSelectTM technology or our PPI-2458 program that providesignificant cash to us, or if we are able to realize significant value from thedisposition of our Plenaxis® assets, we may have available resources toallow us to pursue our strategic operating plan beyond the end of 2007.  However, we cannot assure investors that wewill be able to enter into appropriate collaborative arrangements relating toour DirectSelectTM technology or our PPI-2458 program that will providesignificant cash to us, or realize significant value from the disposition ofour Plenaxis® assets. If we are unable to successfully and in a timely manner carry out keyelements of our strategic operating plan and realize significant value from thedisposition of our Plenaxis® assets, we will have to obtain additionalfunding in 2007 or significantly modify our strategic operating plan, includingby curtailing or eliminating certain elements of our operations.  We have no committed sources of capital anddo not know whether additional financing will be available when needed, or, ifavailable, that the terms will be acceptable to us.  If we are required to raise money in thefuture and we experience difficulties or are unable to do so, it could becomenecessary for us to cease operations or seek protection under state or federalinsolvency or bankruptcy laws.

 

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For the three monthsended March 31, 2006, net cash of approximately $9.3 million was used inoperating activities, compared to approximately $14.6 million used in operatingactivities during the three months ended March 31, 2005. During the threemonths ended March 31, 2006, our use of cash in operations was dueprincipally to our net loss of approximately $7.1 million and the impact ofnon-cash charges such as depreciation of approximately $0.3 million andstock-based compensation of approximately $0.9 million offset by non-cash gains,which include the reversal of approximately $0.5 million in accruedrestructuring charges and approximately $0.5 million related to theamortization of the deferred gain on the sale of our facility.  Our use of cash in operations for the threemonths ended March 31, 2006 also includes a reduction of approximately$1.0 million in accounts payable and accrued expenses.  In addition, we made cash payments ofapproximately $1.6 million associated with accrued restructuring charges duringthe three months ended March 31, 2006. During the three months ended March 31, 2005, our use of cash inoperations was due principally to our net loss of approximately $12.3 million,inventory build of approximately $0.8 million and the reduction in accountspayable and accrued expenses of approximately $2.7 million, partially offset bydepreciation of approximately $1.0 million, with the remainder of approximately$0.2 million due to other working capital changes.

 

Our cash utilization willcontinue for 2006 and thereafter as we continue to develop and advance ourresearch and development initiatives. The actual amount of overall expenditures will depend on numerousfactors, including the timing of expenses, the timing and terms ofcollaboration agreements or other strategic transactions, if any, and thetiming and progress of our research and development efforts.

 

Netcash provided by investing activities of approximately $1.4 million for thethree months ended March 31, 2006 consisted primarily of maturities ofmarketable securities of approximately $2.1 million offset by purchases ofproperty and equipment of approximately $0.7 million.  This compares tonet cash provided by investing activities of approximately $47.0 million forthe corresponding period in 2005, which was related primarily to net sales andmaturities of marketable securities of approximately $47.2 million.

 

Our financing activitiesfor the three months ended March 31, 2006 consisted of approximately$34,000 in proceeds from the issuance of common stock.  Our financing activities for the three monthsended March 31, 2005 consisted of $0.1 million in debt principalrepayments offset by approximately $73,000 in proceeds from the issuance ofcommon stock.

 

At December 31,2005, we had provided a valuation allowance of approximately $133.5 million forour deferred tax assets. The valuation allowance represents the value of thedeferred tax assets.  Due to anticipatedoperating losses in the future, we believe that it is more likely than not thatwe will not realize the net deferred tax assets in the future and we haveprovided an appropriate valuation allowance.

 

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**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

Theprimary objective of our investment activities is to preserve principal whileat the same 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 $3,000 decrease in the fair value of our investments as of March 31,2006. The same hypothetical increase in interest rates as of December 31,2005 would have resulted in an approximate $5,000 decrease in the fair value ofour investments.  As of March 31,2006 and December 31, 2005, we owned approximately $3.5 million and $5.5million, respectively, of marketable securities with a weighted-averagematurity of approximately one month and four months, respectively.  Due to the conservative nature of ourinvestments and relatively short duration, interest rate risk is mitigated.

 

**ITEM 4.  CONTROLS AND PROCEDURES.**

 

*(a)*          *Disclosure Controls andProcedures*.

 

The Company’s management,with the participation of our chief executive officer and chief financialofficer, has evaluated the effectiveness of the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of March 31,2006.  Based on such evaluation, ourchief executive officer and chief financial officer have concluded that, as of March 31,2006, the Company’s disclosure controls and procedures were effective inensuring that information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in applicable rules andforms of the Securities and Exchange Commission, and is accumulated andcommunicated to the Company’s management, including the Company’s chiefexecutive officer and chief financial officer, as appropriate to allow timelydecisions regarding required disclosure.

 

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

 

There have not been anychanges in the Company’s internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) during the three months ended March 31, 2006 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS.**

** **

In December 2004 andJanuary 2005, the Company, Chairman and (now former) Chief ExecutiveOfficer Malcolm Gefter, President and (now former) Chief Operating OfficerKevin F. McLaughlin, Chief Financial Officer and Treasurer Edward C. English,and former President and Chief Operating Officer William K. Heiden, were namedas defendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts.  Those purported class actions are captioned Katzv. Praecis Pharmaceuticals Inc., Malcolm Gefter, Kevin McLaughlin, EdwardEnglish and William K. Heiden, Civil Action No. 04-12581-GAO (filed December 9,2004), Schwartz v. Praecis Pharmaceuticals Inc., Malcolm Gefter, KevinMcLaughlin, Edward English and William K. Heiden, Civil Action No. 04-12704-REK(filed December 27, 2004) and Bassin v. Praecis Pharmaceuticals Inc.,Malcolm L. Gefter, Ph.D., Kevin F. McLaughlin, Edward C. English and William K.Heiden, Civil Action No. 05-10134-GAO (filed January 21,2005).   On February 7, 2005, amotion was filed to consolidate the Katz, Schwartz and Bassinactions and to appoint lead plaintiffs and lead counsel.  On February 18, 2005, the Company andthe individual defendants filed a brief response to that motion, reservingtheir rights to challenge the adequacy and typicality, among other things, ofthe proposed lead plaintiffs in connection with class certification proceedings,if any.  On April 13, 2005, theCourt entered an Order granting the plaintiffs’ motion to consolidate the threeactions (as well as each case that relates to the same subject matter that maybe subsequently filed in or transferred to the United States District Court forthe District of Massachusetts), appoint lead plaintiffs and approve suchplaintiffs’ selection of co-lead counsel. The consolidated actions are captioned IN RE PRAECIS PHARMACEUTICALS,INC. SECURITIES LITIGATION, Civil Action No. 04-12581-GAO.

 

On August 1, 2005, lead plaintiffs filed a consolidated amendedcomplaint.  Lead plaintiffs generallyallege securities fraud during the period from November 25, 2003 through December 6,2004.  The consolidated amended complaintpurports to assert claims under Sections 10(b) and 20(a) of theSecurities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder,and alleges that the Company and the individually named defendants madematerially false and misleading public statements concerning the Company’sbusiness and financial results, particularly relating to statements regardingthe commercialization of Plenaxis®,thereby allegedly causing plaintiffs to purchase the Company’s securities atartificially inflated prices.  At thistime, plaintiffs have not specified the amount of damages they are seeking inthe actions.  On September 12, 2005, the Company and the individualdefendants filed a Motion to Dismissthe consolidated amended complaint in its entirety.  On October 24, 2005, lead plaintiffsfiled an Opposition to the Company’s Motion to Dismiss and the defendants fileda reply on November 14, 2005.  On January 17,2006, the Court heard oral argument on the Motion to Dismiss and took thematter under advisement.

 

Management believes thatthe allegations against the Company are without merit, and the Company intendsto vigorously defend against the plaintiffs’ claims. As this litigation is inan early stage, management is unable to predict its outcome or its ultimateeffect, if any, on the Company’s financial condition.  However,we expect that the costs and expenses related to this litigation may besignificant.  Our current director andofficer liability insurance policies (which, subject to the terms andconditions thereof, also provide “entity coverage” for the Company for thislitigation) provide that the Company is responsible for the first $2.5 millionof such costs and expenses.  Also, ajudgment in or settlement of these actions could exceed our insurance coverage.  Accordingly, if we are not successful indefending these actions, our business and financial condition could beadversely affected.  In addition, whetheror not we are successful, the defense of these actions may divert the attentionof our management and other resources that would otherwise be engaged inrunning our business.

 

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**ITEM 1A.               RISK FACTORS.**

 

*Therisks and uncertainties described below are not the only ones we face.  Additional risks and uncertainties not presentlyknown to us or that are currently deemed immaterial may also impair ourbusiness, financial condition and results of operations.  If any of these risks actually occur, ourbusiness, financial condition and results of operations could be materially adverselyaffected.*

 

**We havea history of losses and we may not be profitable in the future.**

 

Wecannot assure investors that we will be profitable in the future or, if weattain profitability, that it will be sustainable.  In May 2005, our board of directorsapproved a strategic restructuring to focus the Company’s resources on our mostpromising assets and programs and significantly reduce our cost structure.  Under our current strategic operating plan,we are focusing our resources on continuing to develop and enhance ourDirectSelectTM technology and seeking to enter into pharmaceutical partnershipsfor drug discovery and development utilizing this technology that will provide significantcash to us, as well as to expand our own proprietary development pipeline; andadvancing the clinical development of PPI-2458, with a goal of partnering thisprogram in one or more indications as clinical development advances.  We are also actively pursuing the dispositionof our Plenaxis® assets.  If we are unable to do so in a timely manner and on acceptable terms, weintend to cease distribution of the product in the United States.

 

Todate, we have derived substantially all of our revenues from payments undercorporate collaboration and license agreements, and from product sales.  Our marketing and selling efforts with regardto Plenaxis® in theUnited States were not commercially successful, and we may be unable tosuccessfully discover, develop or market any other products in the future.  Moreover, we may be unable to enter intoresearch collaborations or partnerships with respect to DirectSelectTM or PPI-2458that provide significant cash to us, or dispose of our Plenaxis® assets in a timely manner and on acceptableterms, or at all.  Our current strategicoperating plan includes significant ongoing expenditures to support thecontinued enhancement of our DirectSelectTM technology and the continuation ofour PPI-2458 clinical development program, and for general and administrativepurposes.  As of March 31, 2006, wehad an accumulated deficit of approximately $312.1 million.  We expect that we will continue to incursignificant operating losses for at least the next several years, and we maynot be profitable in the future.

 

**If weare unable to successfully and in a timely manner carry out key elements of ourstrategic operating plan, we will have to obtain additional funding in 2007 orsignificantly modify our strategic operating plan.**

 

Ifwe are unable to successfully carry out key elements of our strategic operatingplan described in the immediately preceding risk factor, we believe that ourexisting cash and investments of approximately $52.7 million at March 31,2006 will be sufficient to meet ourworking capital and capital expenditure needs, at current levels, throughapproximately the end of 2007.  If we areable to successfully carry out key elements of our strategic operating plandescribed above, or if we are able to realize significant value from thedisposition of our Plenaxis® assets, we may be able, without obtaining additional funding, to continue to meetour working capital and capital expenditure needs beyond that time, although wecannot provide any assurances as to if or for how long we would be able to doso.  If we are unable to successfully andin a timely manner carry out key elements of our strategic operating plan andrealize significant value from the disposition of our Plenaxis® assets, we will have to obtain additional funding in 2007 or significantly modifyour strategic operating plan, including by curtailing or eliminating certainelements of our operations.  Moreover, ifwe are unable to dispose of our Plenaxis® assetsin a timely manner and on acceptable terms, we intend to cease distribution ofPlenaxis® in the United States, in whichevent, we would incur a yet undetermined amount of shut-down costs and expenses and would needto devote funds and other resources that would otherwise be available to carryout our current strategic operating plan. We have no committed sources of capital and do not know whetheradditional financing will be available when needed, or, if available, that theterms will be acceptable to us.

 

Todate, our operations and capital requirements have been financed primarily withthe proceeds of public and private sales of common stock and preferred stock,payments under research and development partnerships and collaborativeagreements, investment income, revenues from product sales

 

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andthe net proceeds from the sale of our facility. However, there can be no assurance that we will be able to sell anysecurities, enter into additional partnerships and collaborative agreements orborrow funds in the future at favorable terms, or at all.  If we raise additional funds by issuingequity securities, further dilution to existing stockholders will result.  In addition, as a condition to investing inus, future investors may demand, and may be granted, rights superior to thoseof existing stockholders.  We may also berequired to take other actions, which may lessen the value of our common stockor dilute our common stockholders, including borrowing money on terms that arenot favorable to us.  If we are requiredto raise money in the future and we experience difficulties or are unable to doso, it could become necessary for us to cease operations or seek protectionunder state or federal insolvency or bankruptcy laws.

 

**OurDirectSelectTM drug discovery technology is still under development, and we maynot be able to enter into pharmaceutical partnerships with respect to thistechnology and/or discover compounds that will provide significant cash to us.**

 

Weare focusing our early stage drug discovery efforts on our proprietaryDirectSelectTM drug discovery technology, and our future success depends inlarge part on the successful development of this technology, as well as ourability to enter into collaborations relating to this technology that willprovide significant cash to us.  Webelieve that DirectSelectTM is a novel technology that will allow us to rapidlyand directly identify compounds that are orally available and have highaffinity and specificity.  However, if weare unable to obtain adequate patent protection for our DirectSelectTMtechnology, another party could offer drug discovery capabilities that directlycompete with our capabilities or could attempt to block our ability to practiceour technology.  Furthermore, we cannotassure investors that this technology will allow us to offer significantadvantages over traditional drug discovery methods or competingtechnologies.  For example, thefeasibility of creating and screening ultra-large advanced combinatorialchemistry libraries resulting in successful leads is still in the developmentstage.  Moreover, we may not be able toidentify novel compounds from the libraries that we create that can address abroad spectrum of targets or that can be rapidly taken into clinical developmentand that ultimately lead to marketable products.  If we are not successful in continuing toenhance this technology and in identifying product candidate(s) using thistechnology for either a partner or for internal development, and in realizingsignificant proceeds through partnerships with respect to, or capital infusionsfacilitated by, our DirectSelectTM technology or such product candidate(s), wewould need to significantly modify our operating plan.

 

Givenour strategic focus on forming partnerships with respect to our DirectSelectTMtechnology, we are also dependent upon the extent to which pharmaceutical andbiotechnology companies continue to collaborate with outside companies toobtain drug discovery expertise.  Ourrevenue will depend, in part, on research and development expenditures bypharmaceutical and biotechnology companies, particularly companies outsourcingresearch and development projects and adding new and improved technologies toaccelerate their drug discovery and development initiatives.  Our capabilities include aspects of the drugdiscovery process that pharmaceutical companies have traditionally performedinternally.  Although there is a historyamong pharmaceutical and biotechnology companies of outsourcing drug researchand development functions, this practice may not continue.  Our ability to convince one or more of thesecompanies to use and pay for our drug discovery technology and capabilitiesrather than develop them internally will depend on many factors, including ourability to:

 

•                                          continue to enhance and refine ourDirectSelectTM technology resulting in the identification of high-quality drugcandidates;

•                                          identify and retain scientists and discoverand utilize technology that are of the highest caliber; and

•                                          achieve intended results in a timely fashion,with acceptable quality and cost.

 

Wealso face and will continue to face intense competition from other companiesfor such collaborative arrangements, and technological and other developmentsby our competitors may make it more difficult for us to establish suchrelationships.  If we are unable to continueto attract collaborators, we may never generate revenues from this technologyand would be forced to significantly modify our operating plan.

 

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**We aresubject to extensive government regulation that increases our costs and couldprevent us from developing, and ultimately commercializing, potential products.**

 

Thedevelopment and sale of pharmaceutical products, including Plenaxis®, PPI-2458 orother product candidates we may discover, is subject to extensive regulation bygovernmental authorities.  Obtainingregulatory approval typically is costly and takes many years; maintainingregulatory approval also requires substantial resources.  Regulatory authorities, most importantly, theFDA, have substantial discretion to place on clinical hold or terminateclinical trials, delay, withhold or withdraw registration and marketingapproval in the United States, and effectively mandate product recalls. Failureto comply with regulatory requirements may result in criminal prosecution,civil penalties, recall or seizure of products, total or partial suspension ofproduction or injunction. Outside the United States, we can market a productonly if we receive marketing authorization from the appropriate regulatoryauthorities. This foreign regulatory approval process includes all of the risksassociated with the FDA approval process, and may include additional risks.

 

Togain regulatory approval from the FDA and foreign regulatory authorities forthe commercial sale of any product, we must demonstrate in clinical trials, andsatisfy the FDA and foreign regulatory authorities as to, the safety andefficacy of the product.  If we develop aproduct to treat a long-term, recurrent or terminal disease, such as cancer, wemust gather data over an extended period of time. There are many risksassociated with our clinical trials. For example, we may discover that theproduct we are testing is not effective, despite positive results inpreclinical studies.  While our compound,PPI-2458, has been shown to inhibit its target enzyme, MetAP-2, in preclinicaland early clinical testing, we do not know if this will ultimately result in aneffective treatment for cancer or any other disease.  We also may be unable to achieve the samelevel of success in later trials as we did in earlier ones. Additionally, datawe obtain from preclinical and clinical activities are susceptible to varyinginterpretations that could impede regulatory approval.  Furthermore, patients may experience adverseevents while participating in a clinical trial that are unrelated to ourproduct, but that nevertheless may affect the statistical analysis of thesafety and efficacy of PPI-2458, potentially slow the rate of subject accrualin this trial or otherwise adversely affect the clinical trial.  If we obtain regulatory approval for aproduct, the approval will be limited to those diseases for which our clinicaltrials demonstrate the product is safe and effective.

 

Inaddition, many factors could delay or result in termination of our ongoing orfuture clinical trials. For example, results from ongoing preclinical studiesor analyses could raise concerns over the safety or efficacy of a productcandidate.  For example, in March 2004,the FDA placed our phase 1 clinical trial of PPI-2458 on clinical hold due tonon-clinical study findings with PPI-2458. Although we subsequently received clearance from the FDA to resumeclinical testing of PPI-2458, we cannot assure investors that the FDA will notplace this or other clinical trials on hold in the future.  A clinical trial may also experience slowpatient enrollment.  A study could alsobe delayed due to lack of sufficient drug supply.  Patients may experience adverse medicalevents or side effects, and there may be a real or perceived lack ofeffectiveness of, or of safety issues associated with, the drug we aretesting.  Future governmental action orexisting or changes in FDA or foreign regulatory authority policies orprecedents, may also result in delays or rejection of an application formarketing approval.  The FDA, andcomparable foreign regulatory authorities, have considerable discretion indetermining whether to grant marketing approval for a drug, and may delay ordeny approval even in circumstances where the applicant’s clinical trials haveproceeded in compliance with established procedures and regulations and havemet the established end-points of the trials. Challenges to regulatorydeterminations are generally time-consuming and costly, and rarely, if ever,succeed.  Although we received FDAapproval to market Plenaxis® in the United States in November 2003and in Germany in September 2005, we can give no assurance that we willobtain marketing approval for PPI-2458 or any other potential productcandidate.

 

Anyregulatory approval may be conditioned upon significant labeling requirementsand, as in the case of the FDA approval of Plenaxis®, marketing restrictions and post-marketingstudy commitments.  Such labeling andmarketing restrictions could, and in the case of Plenaxis® in theUnited States, did, materially adversely affect the marketability and/or valueof the product.  As part of our strategicrestructuring announced in May 2005, we voluntarily discontinuedpromotional activities related to Plenaxis® andthe sale of Plenaxis® fornew patients in the United States.  Inaddition, although Plenaxis® wasapproved in Germany, our former partner elected to terminate its agreement withus, and we may not be able to license or sell the product to a third party to enableits commercialization in

 

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Germanyor to pursue additional regulatory approvals in other countries.

 

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

 

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

 

Dependingon the circumstances, failure to meet these applicable legal and regulatoryrequirements can result in criminal prosecution, fines or other penalties,injunctions, recall or seizure of products, total or partial suspension ofproduction, denial or withdrawal of pre-marketing product approvals, private “quitam” actions brought by individual whistleblowers in the name of thegovernment, or refusal to allow us to enter into supply contracts, includinggovernment contracts.

 

Ifwe are unable to successfully carry out key elements of our operating plan,which include the continued clinical development of PPI-2458 and potentiallyother product candidates discovered using our DirectSelectTM technology, we willneed to raise additional capital in 2007 and, if we were unable to do so, itcould become necessary for us to cease operations or seek protection understate or federal bankruptcy laws.

 

**We maybe unable to enter into and maintain corporate collaborations necessary tosupport the discovery and development of products using our DirectSelectTMtechnology or the further development and potential commercialize of PPI-2458or other potential products in the future.**

 

Our business objective isto utilize our DirectSelectTM and other proprietary technologies to discover, ina rapid and efficient manner, novel, orally-available compounds with thepotential to address unmet medical needs or improve existing therapies.  We intend to collaborate with pharmaceuticaland biotechnology companies on the discovery and development stages for thesecompounds across a broad range of therapeutic areas.  We also intend to select promising compoundsto retain for internal development and will partner these compounds at variousstages of development to optimize their value to the Company.  In addition, we have announced our intentionto partner our PPI-2458 program in one or more indications as developmentadvances.  We do not currently intend toindependently market the products that may ultimately result from our discoveryand development efforts. We cannotassure investors that we will be able to enter into and maintainpartnerships and corporate collaborations in a timely manner and on favorableterms, if at all.  Even if we are able to enter into sucharrangements, we cannot assure our investors that our future collaborators willmeet their obligations to us under our collaboration agreements.  If a partner terminates its agreement with usor fails to perform its obligations, it may delay the discovery and developmentof product candidates.  As a result, wecould have to devote unforeseen additional resources to drug discovery anddevelopment or be forced to significantly modify

 

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ouroperating plan.

 

**If welose our key personnel or are unable to attract and retain additional skilledpersonnel, we may be unable to pursue the development of our drug discoverytechnology or our product development and commercialization efforts.**

 

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

 

Recruitingand retaining qualified scientific personnel to perform future research and developmentwork also will be critical to our success. Competition for skilled personnel isintense and the turnover rate can be high. We compete with numerous companiesand academic and other research institutions for experienced scientists. Thiscompetition may limit our ability to recruit and retain qualified personnel onacceptable terms.  Moreover, due to ourstrategic restructuring in May 2005 and our limited resources compared tomany of our competitors, we may face additional challenges when recruitingqualified personnel in the future. Failure to attract and retain qualified personnel would prevent us fromcontinuing to develop and enhance our DirectSelectTM technology and use thistechnology to support pharmaceutical partnerships in drug discovery anddevelopment that will provide revenues to our Company, as well as to expand ourown proprietary development pipeline and advance our PPI-2458 clinical developmentprogram.

 

**If weare unsuccessful in entering into a third party sale or license agreement, wedo not expect that Plenaxis**® **will be commercialized outside of the United States orcontinue to be available for patients in the United States.**

 

Althoughwe have received marketing authorization for Plenaxis® in Germany, we do not have the financialresources or expertise to market the product in Germany or in any otherterritories outside of the United States. For this reason, we do not intend toseek additional approvals for Plenaxis® in theEuropean Union under the MRP or in any other territory outside the UnitedStates.  Moreover, we have announced ourintention to dispose of our Plenaxis® assetsthrough a license or sale transaction and have engaged an investment bankingfirm to assist us with this effort.  Ifwe are unable to license or sell Plenaxis®, in order to continue even the limitedongoing distribution of the product in the United States, we would need to continueto devote funds and other resources to support the costly manufacture of theproduct and to meet our minimum purchase commitments under our manufacturingagreements.  We cannot assure investorsthat we will be able to conclude a license or sale transaction in a timelymanner and on acceptable terms, or at all. In that event we do not intend to pursue further the commercializationof Plenaxis® outside of the United States andwill seek to discontinue all distribution of Plenaxis® in theUnited States.  If we so terminatePlenaxis® distribution, we would incur ayet undetermined amount of shut-downcosts and expenses and would need to devote funds and other resources thatwould otherwise be available to support our current operating plan. We have nocommitted sources of capital and do not know whether additional financing willbe available when needed, or, if available, that the terms will be favorable tous.

 

**Becausewe depend on third parties to rapidly analyze data generated by ourDirectSelectTM technology and to conduct laboratory testing and human clinicalstudies and assist us with regulatory compliance, we may encounter delays inour drug discovery and development efforts.**

 

Wecurrently rely to a large extent on a single vendor to rapidly analyze datagenerated by our DirectSelectTM technology. In addition, we have contracts with a limited number of researchorganizations to design and conduct our laboratory testing, preclinicalevaluations and human clinical studies. If we cannot contract for data analysis and testing activities onacceptable terms, or at all, we may not complete our drug discovery anddevelopment efforts in a timely manner. To the extent we rely on third parties for these activities, we may losesome control over these activities.  Forexample, third

 

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partiesmay not complete data analysis and testing activities on schedule or whenwe request them to do so.  In addition,these third parties may conduct these contracted tasks in a manner inconsistentwith regulatory requirements or otherwise in a manner that yields misleading orunreliable data.  This, or other failuresof these third parties to carry out their duties, could result in significantadditional costs and expenses and could delay or prevent our ability toeffectively perform our responsibilities under existing or future third-partyagreements or utilize our DirectSelectTM technology for internal programs, orfurther develop PPI-2458 or other future product candidates.

 

**If wefail to develop and maintain our relationships with third-party manufacturers,or if these manufacturers fail to perform adequately, we may be unable todevelop and commercialize PPI-2458 or any other future product candidate or tocontinue to support the commercialization of Plenaxis**®**.**

 

Ourability to conduct large clinical trials for, or to commercialize, PPI-2458 orany future product candidate, will depend in part on our ability tomanufacture, or arrange for third-party manufacture of, our products on a largescale, at a competitive cost and in accordance with regulatoryrequirements.  We must establish and maintaina commercial scale formulation and manufacturing process for each of ourpotential products for which we seek marketing approval.  We or third-party manufacturers may encounterdifficulties with these processes at any time that could result in delays inclinical trials, regulatory submissions or in the commercialization ofpotential products.

 

Wehave no direct experience in large-scale product manufacturing, nor do we havethe resources or facilities to manufacture on our own products for use inhumans. We currently rely on contract manufacturers for the manufacture of PPI-2458and Plenaxis®, and expect to rely on contractmanufacturers for the foreseeable future for the manufacture of any othercompounds for later-stage preclinical, clinical and commercial purposes.Third-party manufacturers may not be able to meet our needs as to timing,quantity or quality of materials. If we are unable to contract for a sufficientsupply of needed materials on acceptable terms, or if we encounter delays ordifficulties in our relationships with manufacturers, our clinical trials maybe delayed, thereby preventing or delaying the submission of product candidatesfor, or the granting of, regulatory approval and the commercialization of ourpotential products.  Any such delays maylower our future revenues and delay or prevent our attaining or maintainingprofitability.

 

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

 

Inaddition, we and the third-party manufacturers that we use must continuallyadhere to current good manufacturing practice requirements enforced by the FDAthrough its facilities quality programs. Foreign regulatory authorities may also inspect our third-partymanufacturers as a condition of obtaining and maintaining the requisiteapprovals.  In complying with theserequirements, we and any of our third-party manufacturers will be obligated toexpend time, money and effort in production, record-keeping and quality controlto assure that our potential products meet applicable specifications and otherrequirements.  If we or any of our third-partymanufacturers fail to comply with these requirements, we may be subject toregulatory sanctions, manufacturing delays, or the facilities could be shutdown.

 

Anyof these factors could prevent, or cause delays in, obtaining regulatoryapprovals for PPI-2458 or any other potential product, and the manufacturing,marketing or selling of PPI-2458 or any such other product, and could alsoresult in significantly higher operating expenses.  Any of these factors, insofar as they affectthe manufacture of Plenaxis®, could also adversely affect our ability toenter into a license or sale transaction with respect to Plenaxis® in a timely manner and on acceptable terms, orat all.

 

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**Ourone-for-five reverse stock split could have various negative effects on ourcommon stock and our stockholders.**

 

Ourone-for-five reverse stock split effected in November 2005 resulted in animmediate increase in the market price of our common stock.  However, this increase in the market price ofour common stock may not be in proportion to the reduction in the number ofshares of our common stock outstanding or result in a permanent increase in themarket price (which depends on many factors, including our performance,prospects and other factors that may be unrelated to the number of sharesoutstanding).  If the market price of ourcommon stock declines, the percentage decline as an absolute number and as apercentage of our overall market capitalization may be greater than would occurin the absence of the reverse stock split. Furthermore, the liquidity of our common stock may be adversely affectedby the reduced number of shares that are now outstanding following the reversestock split.  In addition, the reversesplit has likely increased the number of our stockholders who own odd lots(less than 100 shares).  Stockholders whohold odd lots typically will experience an increase in the cost of sellingtheir shares, as well as possibly greater difficulty in effecting such sales.

 

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

 

Theadministration of drugs to humans, whether in clinical trials or commercially,can result in product liability claims whether or not the drugs are actually atfault for causing an injury.  Plenaxis®, PPI-2458, ApanTMor future product candidates may cause, or may appear to have caused, adverseside effects (including death) or potentially dangerous drug interactions thatwe may not learn about or understand fully until the drug has been administeredto patients for some time.

 

Productliability claims can be expensive to defend and may result in large judgmentsor settlements against us, which could have a negative effect on our financialperformance. The costs of product liability insurance have increaseddramatically in recent years, and the availability of coverage hasdecreased.  Although we carry insurancethat we regard as reasonably adequate to protect us from potential claims,there can be no assurance that we will be able to maintain our current productliability insurance at a reasonable cost, or at all.  Our former collaboration agreements included,and some of the agreements regarding the termination of certain of thosecollaborations also include, an indemnification for liabilities associated withthe development and commercialization of Plenaxis®.  If athird party, including a former collaborator, successfully sues us for anyinjury, or for indemnification for losses, there is no guarantee that theamount of the claim would not exceed the limit of our insurance coverage.  Even if a product liability claim is notsuccessful, the adverse publicity and time and expense of defending such aclaim may interfere with our business.

 

**Many ofour competitors have substantially greater resources than we do and may be ableto discover and develop product candidates or technologies that make ourpotential products and technologies obsolete or non-competitive.**

 

A biopharmaceuticalcompany such as ours faces intense competition. We face competition from companies that are pursuing the same or similartechnologies for drug discovery.  We alsoface significant competition from organizations that are pursuing drugs thatwould compete with the product candidates we are now developing or may pursuein the future.  We may not be able tocompete successfully against these organizations, which include many large andwell-financed and experienced pharmaceutical and biotechnology companies, aswell as academic institutions and government-based agencies.  These entities may have greater financialresources and more experience than we do in discovering and developing drugs,obtaining regulatory approvals, manufacturing and marketing.  In addition, academic, government andindustry-based research is intense, resulting in considerable competition inobtaining qualified research personnel, submitting patent filings forprotection of intellectual property rights and establishing strategic corporatealliances.

 

Our investigationalcompound, PPI-2458, and any other potential products in research ordevelopment, will face competition from other products.  Many companies are developing or marketproducts for the treatment of cancer, inflammation and autoimmunedisorders.  We are currently enrollingpatients with non-Hodgkin’s lymphoma and solid tumors in our phase 1 trial forPPI-2458.  We are

 

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competing with many othercompanies that are conducting clinical trials in these indications.  We may not be able to accrue patients to ourtrial at the same pace as our competitors. Even if we are able to successfully complete our clinical trials of PPI-2458and gain regulatory approval to market the product, we will face competitionfrom a broad range of therapeutics available for the treatment of cancer.

 

We also expect toencounter competition from other companies with technologies similar to ourtechnologies.  For example, if we are unable to obtain adequate patentprotection for our DirectSelectTM technology, another company could offer drugdiscovery capabilities that directly compete with our capabilities or couldattempt to block our ability to practice our technology.  Given our strategic focus on formingpartnerships with respect to our DirectSelectTM technology, we are alsodependent upon the extent to which pharmaceutical and biotechnology companiescontinue to collaborate with outside companies to obtain drug discoveryexpertise and our ability to establish and maintain partnerships with suchcompanies.  We also face and willcontinue to face intense competition from other companies for suchcollaborative arrangements, and technological and other developments by ourcompetitors may make it more difficult for us to establish such relationships.

 

Thesuccess or continued success of our competitors in any of these efforts mayadversely affect our ability to further enhance and refine and partner onfavorable terms our DirectSelectTM technology, to develop, partner on favorableterms and commercialize PPI-2458 or other future product candidates, to licenseor sell Plenaxis® in atimely manner and on acceptable terms, and to ultimately attain and maintainprofitability.

 

**If weare unable to obtain and enforce valid patents, we could lose any competitiveadvantage we may have.**

 

Oursuccess will depend in part on our ability to obtain patents and maintainadequate protection of our technologies and potential products. If we do notadequately protect our intellectual property, competitors may be able to useour technologies and erode any competitive advantage we may have. For example,if we are unable to obtain adequate patent protection for our DirectSelectTMtechnology, another party could offer drug discovery capabilities that directlycompete with our capabilities or could attempt to block our ability to practiceour technology.  Additionally, if we loseour patent protection for Plenaxis®, another party could produce and market thecompound in direct competition with a potential licensor or purchaser of ourPlenaxis® assets, which would adverselyaffect our ability to dispose of our Plenaxis® assetsin a timely manner and on acceptable terms, or at all. Some foreign countrieslack rules and methods for defending intellectual property rights and donot protect proprietary rights to the same extent as the United States. Manycompanies have had difficulty protecting their proprietary rights in certainforeign countries.

 

Patentpositions are sometimes uncertain and usually involve complex legal and factualquestions. We can protect our proprietary rights from unauthorized use by thirdparties only to the extent that our proprietary technologies are covered by validand enforceable patents or are effectively maintained as trade secrets.  We currently own or have exclusively licensed32 issued United States patents and 116 granted foreign patents.  We have applied, and will continue to apply,for patents covering both our technologies and products as we deem appropriate.Others may challenge our patent applications or our patent applications may notresult in issued patents. Moreover, any issued patents on our own inventions,or those licensed from third parties, may not provide us with adequateprotection, or others may challenge the validity of, or seek to narrow orcircumvent, these patents.  Third-partypatents may impair or block our ability to conduct our business.  Additionally, third parties may independentlydevelop products similar to our products, duplicate our unpatented products, ordesign around any patented products we develop.

 

**If weare unable to protect our trade secrets and proprietary information, we couldlose any competitive advantage we may have.**

 

Inaddition to patents, we rely on a combination of trade secrets,confidentiality, nondisclosure and other contractual provisions, and securitymeasures to protect our confidential and proprietary information. Thesemeasures may not adequately protect our trade secrets or other proprietaryinformation.  If these measures do notadequately protect our rights, third parties could use our

 

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technology,and we could lose any competitive advantage we may have. In addition, othersmay independently develop similar proprietary information or techniques, whichcould impair any competitive advantage we may have.

 

**If ourtechnologies, processes or products conflict with the patents or otherintellectual property rights of competitors, universities or others, we couldhave to engage in costly litigation and be unable to commercialize thoseproducts.**

 

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

 

**If thirdparties terminate our licenses, our efforts to license or sell Plenaxis**®** to a third party could be adversely affected.**

 

Welicense some of our technology from third parties. Termination of our licensescould require us to delay or discontinue our plan to license or sell Plenaxis® to a third party.  If Indiana University Research &Technology Corporation (formerly known as Advanced Research and TechnologyInstitute, Inc., the assignee of Indiana University Foundation),terminated our license with them due to a breach by us of the terms of thatlicense, the likelihood of our licensing or selling Plenaxis® to a third party on acceptable terms, or atall, would be materially diminished.  Wecannot assure investors that we would be able to license substitute technologyin the future. Our inability to do so could impair our ability to conduct ourbusiness because we may lack the technology, or the necessary rights totechnology, required to develop and commercialize our potential products.

 

**We are adefendant in purported class action securities lawsuits regarding the adequacyof our public disclosure which could have a material adverse affect on ourfinancial condition.**

 

Asdescribed in detail in this report under Part II, Item 1. “LegalProceedings,” in December 2004 and January 2005, the Company,Chairman and (now former) Chief Executive Officer Malcolm Gefter, President and(now former) Chief Operating Officer Kevin F. McLaughlin, Chief FinancialOfficer and Treasurer Edward C. English, and former President and ChiefOperating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. The complaints were consolidated into one action in April 2005.  In August 2005, lead plaintiffs filed aconsolidated amended complaint.  The leadplaintiffs generally allege securities fraud during the period from November 25,2003 through December 6, 2004.  Theconsolidated amended complaint purports to assert claims under Sections 10(b) and20(a) of the Securities and Exchange Act of 1934 and Rule 10b-5promulgated thereunder, and alleges that the Company and the individually nameddefendants made materially false and misleading public statements concerningthe Company’s business and financial results, particularly relating tostatements regarding the commercialization of Plenaxis®,thereby allegedly causing plaintiffs to purchase the Company’s securities atartificially inflated prices.  In September 2005, we filed a motion todismiss plaintiffs’ consolidated amended complaint.  In October 2005, lead plaintiffs filedan opposition to our motion to dismiss and the defendants filed a reply on November 14,2005.  In January 2006, the Courtheard oral argument on the motion to dismiss and took the matter underadvisement.

 

Managementbelieves that the allegations against the Company are without merit, and the Companyintends to vigorously defend against the plaintiffs’ claims.  As this litigation is in an early stage,management is unable to predict its outcome or its ultimate effect, if any, onthe Company’s financial condition. However, we expect that the costs and expenses related to thislitigation may be significant.  Ourcurrent director and officer liability insurance policies (which, subject tothe terms and conditions thereof, also provide “entity coverage” for theCompany for this litigation) provide that the Company is

 

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responsiblefor the first $2.5 million of such costs and expenses.  Also, a judgment in or settlement of theseactions could exceed our insurance coverage. Accordingly, if we are not successful in defending these actions, ourbusiness and financial condition could be adversely affected.  In addition, whether or not we aresuccessful, the defense of these actions may divert the attention of our managementand other resources that would otherwise be engaged in running our business.

 

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

 

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

 

**We usehazardous chemicals and radioactive and biological materials in our businessand any claims relating to the handling, storage or disposal of these materialscould be time consuming and costly.**

 

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

 

Fromtime to time, third-parties have also worked with hazardous materials inconnection with our agreements with them. We have agreed to indemnify ourpresent and former collaborators in some circumstances against damages andother liabilities arising out of development activities or products produced inconnection with these collaborations.

 

**Changesin the securities laws and regulations have increased, and are likely tocontinue to increase, our costs.**

 

TheSarbanes-Oxley Act of 2002, which became law in July 2002, has requiredchanges in some of our corporate governance, securities disclosure andcompliance practices. In response to the requirements of that Act, theSecurities and Exchange Commission and the Nasdaq Stock Market have promulgatedrules and listing standards covering a variety of subjects. Compliancewith these rules and listing standards has increased our legal costs, andsignificantly increased our financial and accounting costs, and we expect theseincreased costs to continue. These developments may make it more difficult andmore expensive for us to obtain director and officer liability insurance.Likewise, these developments may make it more difficult for us to attract andretain qualified members of our board of directors, particularly independentdirectors, or qualified executive officers.

 

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

 

Themarket price of our common stock may fluctuate substantially due to a varietyof factors, including, but not limited to:

 

•                                          our ability to enter into partnerships forour DirectSelectTM drug discovery technology and our product candidate, PPI-2458,and the timing and terms of such partnerships;

•                                          the success rate of our discovery efforts,particularly utilizing our DirectSelectTM drug discovery technology for bothexternal and internal programs, and progress or setbacks in our clinicaltrials;

•                                          our ability to complete, and our announcementof, the disposition of our Plenaxis® assets;

•                                          developments or disputes concerning patentsor proprietary rights, including claims of infringement, interference orlitigation against us, our licensors or potential licensees;

•                                          failure or delay by third-party manufacturersin performing their supply obligations or disputes or litigation regardingthose obligations;

•                                          announcements of technological innovations ornew products by us or our competitors;

•                                          adverse outcomes with respect to the pendingpurported shareholder class action against us;

•                                          announcements concerning our competitors, orthe biotechnology or pharmaceutical industry in general;

•                                          changes in government regulation of thepharmaceutical or medical industry;

•                                          actual or anticipated fluctuations in ouroperating results;

•                                          changes in financial estimates orrecommendations by securities analysts;

•                                          sales of large blocks of our common stock;

•                                          changes in accounting principles; and

•                                          the loss of any of our key scientific ormanagement personnel.

 

Inaddition, the stock market has experienced extreme price and volumefluctuations. The market prices of the securities of biotechnology companies,particularly companies like ours with limited product revenues and withoutearnings, have been highly volatile, and may continue to be highly volatile inthe future. This volatility has often been unrelated to the operatingperformance of particular companies. In the past, securities class actionlitigation has often been brought against companies that experience volatilityin the market price of their securities.  Whether or not meritorious, litigation broughtagainst us could result in substantial costs and a diversion of management’sattention and resources.

 

**Weexpect that our quarterly results of operations will fluctuate, and thisfluctuation could cause our stock price to decline.**

 

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

 

•                                          the timing of partnerships relating to ourDirectSelectTM drug discovery technology and our PPI-2458 program resulting inrevenues;

•                                          our ability to license or dispose of, and thetiming of any announcement of, the license or disposition of, our Plenaxis® assets resulting in the commercialization ofthe product in Europe and other territories and in revenues to us; and

•                                          the timing and level of expenses related toour other research and clinical development programs.

 

Dueto the possibility of fluctuations in our revenues and expenses, we believethat quarter-to-quarter comparisons of our operating results are not a goodindication of our future performance.

 

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**If we orour independent registered public accounting firm are unable to affirm theeffectiveness of our internal control over financial reporting in future years,the market value of our common stock could be adversely affected.**

 

Asdirected by Section 404 of the Sarbanes-Oxley Act of 2002, the Securitiesand Exchange Commission adopted rules requiring many public companies,including the Company, to include in their annual reports on Form 10-K areport of management, based on its assessment of the company’s internal controlover financial reporting, as to the effectiveness of such internal control asof the end of the most recent fiscal year. In addition, under these rules, the independent registered publicaccounting firm auditing the company’s financial statements must audit andreport on management’s assessment and on the effectiveness of the company’sinternal control over financial reporting as of such fiscal year end.  Our management reported, based on itsassessment, that as of December 31, 2004 our internal control overfinancial reporting was effective, and our independent registered publicaccounting firm provided us with an unqualified report as to management’sassessment and the effectiveness of our internal control over financialreporting as of December 31, 2004. These reports were included in our Annual Report on Form 10-K forthe year ended December 31, 2004. Since we are no longer an “accelerated filer” under rules recentlypromulgated by the Securities and Exchange Commission, we were not required toinclude in our Annual Report on Form 10-K for the year ended December 31,2005 such a report of management basedon its assessment, or a report by our independent registered public accountingfirm on management’s assessment and the effectiveness, of our internal controlover financial reporting as of December 31, 2005.  However, under the current transition rules wewill be required to include such reports in our Annual Report for the yearended December 31, 2007 and for subsequent years, and we cannot assureinvestors that management or our independent registered public accounting firmwill be able to provide such reports, or that such reports will be unqualified,as of December 31, 2007 or subsequent year-ends.  In this event, investors could loseconfidence in the reliability of our financial statements, which could resultin a decrease in the market value of our common stock.

 

**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.**

 

Provisionsin our certificate of incorporation and by-laws may delay or prevent anacquisition of us or a change in our management. Also, because we areincorporated in Delaware, we are governed by the provisions of Section 203of the Delaware General Corporation Law, which may prohibit or delay largestockholders, in particular those owning 15% or more of our outstanding votingstock, from merging or combining with us. In addition, the rights issued underour rights agreement may be a substantial deterrent to a person acquiring 10% ormore of our common stock without the approval of our board of directors. Theseprovisions in our charter and by-laws, rights agreement and under Delaware lawcould reduce the price that investors might be willing to pay for shares of ourcommon stock in the future and result in the market price being lower than itwould be without these provisions.

 

**If weengage in an acquisition, we will incur a variety of costs and may neverrealize the anticipated benefits of the acquisition.**

 

Ifappropriate opportunities become available, we may attempt to acquirebusinesses, or acquire or in-license products or technologies, that we believeare a strategic fit with our business. We currently have no commitments or agreements for anyacquisitions.  If we do undertake anytransaction of this sort, the process of integrating an acquired business, oran acquired or in-licensed product or technology, may result in unforeseenoperating difficulties and expenditures and may absorb significant managementattention that would otherwise be available for the ongoing development of ourbusiness. Moreover, we may fail to realize the anticipated benefits of anytransaction of this sort. To the extent we issue stock in a transaction, theownership interest of our stockholders will be diluted.  Transactions of this kind could also cause usto incur debt, expose us to future liabilities and result in expenses relatedto goodwill and other intangible assets.

 

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**ITEM 6.  EXHIBITS.**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                 |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                  |
| 3.1                 |       | Amended and Restated  Certificate of Incorporation (1)                                                                                                                                      |
| 3.2                 |       | Certificate of  Amendment (effecting reverse stock split) (4)                                                                                                                               |
| 3.3                 |       | Third Amended and  Restated By-Laws (3)                                                                                                                                                     |
| 4.1                 |       | Specimen certificate  representing shares of common stock (post-reverse stock split) (4)                                                                                                    |
| 4.2                 |       | Rights Agreement  between the Registrant and American Stock Transfer & Trust Company,  as Rights Agent (2)                                                                         |
| 4.3                 |       | Form of  Certificate of Designations of Series A Junior Participating Preferred  Stock (attached as Exhibit A to the Rights Agreement filed as Exhibit 4.2  hereto) (2) |
| 4.4                 |       | Form of Rights  Certificate (attached as Exhibit B to the Rights Agreement filed as Exhibit 4.2  hereto) (2)                                                                 |
| 10.1††    |       | Letter Agreement dated  as of January 6, 2006 by and between PRAECIS and UCB S.A. (5)                                                                                                  |
| 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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††                                    Confidentialtreatment has been requested for certain portions of this exhibit.  Omitted portions have been filed separatelywith the Securities and Exchange Commission.

 

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

 

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

 

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

 

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

 

(5)                                  Incorporatedby reference to Annual Report on Form 10-K for the year ended December 31,2005 filed with the Securities and Exchange Commission on March 17, 2006.

 

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**SIGNATURE**

 

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

 
|                    | PRAECIS  PHARMACEUTICALS INCORPORATED |
|-------------------------|---------------------------------------|
|                    |                                  |
|                    |                                  |   |
| Date:  May 5, 2006 | By                                    | /s/  Edward C. English |   |
|                    |                                  | Edward  C. English |
|                    |                                  | Chief  Financial Officer, Vice President, |
|                    |                                  | Treasurer  and Assistant Secretary |
|                    |                                  | *(Duly  Authorized Officer and Principal Financial  and Accounting Officer)* |

 

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**EXHIBIT INDEX**

 
| ***Exhibit  Number*** | *** *** | ***Exhibit***                                                                                                                                                                               |
|-----------------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *** ***          | *** *** | *** ***                                                                                                                                                                                |
| 3.1                   |         | Amended and Restated  Certificate of Incorporation (1)                                                                                                                                      |
| 3.2                   |         | Certificate of  Amendment (effecting reverse stock split) (4)                                                                                                                               |
| 3.3                   |         | Third Amended and  Restated By-Laws (3)                                                                                                                                                     |
| 4.1                   |         | Specimen certificate  representing shares of common stock (post-reverse stock split) (4)                                                                                                    |
| 4.2                   |         | Rights Agreement  between the Registrant and American Stock Transfer & Trust Company,  as Rights Agent (2)                                                                         |
| 4.3                   |         | Form of  Certificate of Designations of Series A Junior Participating Preferred  Stock (attached as Exhibit A to the Rights Agreement filed as Exhibit 4.2  hereto) (2) |
| 4.4                   |         | Form of Rights  Certificate (attached as Exhibit B to the Rights Agreement filed as Exhibit 4.2  hereto) (2)                                                                 |
| 10.1††      |         | Letter Agreement dated  as of January 6, 2006 by and between PRAECIS and UCB S.A. (5)                                                                                                  |
| 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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††                                    Confidentialtreatment has been requested for certain portions of this exhibit.  Omitted portions have been filed separatelywith the Securities and Exchange Commission.

 

(1)          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.

 

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

 

(3)          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.

 

(4)          Incorporated byreference to Quarterly Report on Form 10-Q for the quarter ended September 30,2005 filed with the Securities and Exchange Commission on November 4,2005.

 

(5)          Incorporated byreference to Annual Report on Form 10-K for the year ended December 31,2005 filed with the Securities and Exchange Commission on March 17, 2006.

 

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