**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For thequarterly period ended June 30, 2005**

 

**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**

 

**PRAECIS PHARMACEUTICALS INCORPORATED**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                               | ** ** | **04-3200305**       |
|------------------------------------------------------------|------------|----------------------|
| (State or  other jurisdiction of                           |       | (I.R.S.  Employer    |
| incorporation  or organization)                            |       | Identification  No.) |
|                                                       |       |                 |
| **830  Winter Street, Waltham, MA 02451-1420**             |
| (Address of  principal executive offices and zip code)     |
|                                                       |
| **(781) 795-4100**                                         |
| (Registrant’s  telephone number, including area code) |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct).     Yes ý No o

 

As of July 29, 2005, therewere 52,470,951 shares of the registrant’s common stock, $.01 par value,outstanding.

 

 

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**PRAECISPHARMACEUTICALS INCORPORATED**

**FORM 10-Q**

**FOR THEQUARTER ENDED JUNE 30, 2005**

 

**INDEX**

 
| **PART I.**       | ** ** | **FINANCIAL INFORMATION**                                                                                       | ** ** |
|------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **             | ** ** | ** **                                                                                                      | ** ** |
| Item 1.                |       | Financial Statements (Unaudited)                                                                                |       |
|                   |       |                                                                                                            |       |
|                   |       | Condensed  Consolidated Balance Sheets –  December 31, 2004 and June 30, 2005                    |       |
|                   |       |                                                                                                            |       |
|                   |       | Condensed  Consolidated Statements of Operations –  three and six months ended June 30, 2004 and 2005 |       |
|                   |       |                                                                                                            |       |
|                   |       | Condensed  Consolidated Statements of Cash Flows –  six months ended June 30, 2004 and 2005           |       |
|                   |       |                                                                                                            |       |
|                   |       | Notes  to Condensed Consolidated Financial Statements                                                           |       |
|                   |       |                                                                                                            |       |
| Item 2.                |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                     |       |
|                   |       |                                                                                                            |       |
| Item 3.                |       | Quantitative  and Qualitative Disclosures About Market Risk                                                     |       |
|                   |       |                                                                                                            |       |
| Item 4.                |       | Controls and  Procedures                                                                                        |       |
|                   |       |                                                                                                            |       |
| **PART II.**      | ** ** | **OTHER INFORMATION**                                                                                           |       |
| ** **             | ** ** | ** **                                                                                                      | ** ** |
| Item 1.                |       | Legal Proceedings                                                                                               |       |
|                   |       |                                                                                                            |       |
| Item 4.                |       | Submission of  Matters to a Vote of Security Holders                                                            |       |
|                   |       |                                                                                                            |       |
| Item 5.                |       | Other Information                                                                                               |       |
|                   |       |                                                                                                            |       |
| Item 6.                |       | Exhibits                                                                                                        |       |
|                   |       |
| **SIGNATURE**          |       |
| ** **             | ** ** |
| **EXHIBIT INDEX** | ** ** |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

**PRAECISPHARMACEUTICALS INCORPORATEDCondensed Consolidated Balance Sheets(In thousands, except share data)(Unaudited)**

 
| ** **                                                                                                                                      | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                      | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                      | ** ** | ** **            | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                      |       |                  |       |              |       |
| Current  assets:                                                                                                                                |       |                  |       |              |       |
| Cash and  cash equivalents                                                                                                                      |       | $                     | 11,178     |              | $          | 46,841 |   |
| Marketable  securities                                                                                                                          |       | 72,171                |       | 9,498             |       |
| Accounts  receivable                                                                                                                            |       | 1,052                 |       | 680               |       |
| Inventory                                                                                                                                       |       | 93                    |       | 162               |       |
| Prepaid  expenses and other current assets                                                                                                      |       | 952                   |       | 1,251             |       |
|                                                                                                                                            |       |                  |       |              |       |
| Total  current assets                                                                                                                           |       | 85,446                |       | 58,432            |       |
|                                                                                                                                            |       |                  |       |              |       |
| Property and  equipment, net                                                                                                                    |       | 64,538                |       | 43,670            |       |
| Inventory                                                                                                                                       |       | 4,136                 |       | 1,374             |       |
| Other assets                                                                                                                                    |       | 187                   |       | 150               |       |
|                                                                                                                                            |       |                  |       |              |       |
| Total assets                                                                                                                                    |       | $                     | 154,307    |              | $          | 103,626 |   |
|                                                                                                                                            |       |                  |       |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                  |       |                  |       |              |       |
| Current  liabilities:                                                                                                                           |       |                  |       |              |       |
| Accounts  payable                                                                                                                               |       | $                     | 2,191      |              | $          | 1,002 |   |
| Accrued  expenses                                                                                                                               |       | 6,085                 |       | 3,743             |       |
| Accrued  restructuring                                                                                                                          |       | —                |       | 4,643             |       |
| Deferred  revenue                                                                                                                               |       | 167                   |       | 167               |       |
| Current  portion of long-term debt                                                                                                              |       | 596                   |       | 614               |       |
|                                                                                                                                            |       |                  |       |              |       |
| Total  current liabilities                                                                                                                      |       | 9,039                 |       | 10,169            |       |
|                                                                                                                                            |       |                  |       |              |       |
| Long-term  accrued restructuring                                                                                                                |       | —                |       | 3,174             |       |
| Long-term  deferred revenue                                                                                                                     |       | 1,722                 |       | 1,639             |       |
| Long-term  debt                                                                                                                                 |       | 31,373                |       | 31,061            |       |
|                                                                                                                                            |       |                  |       |              |       |
| Commitments  and contingencies                                                                                                                  |       |                  |       |              |       |
|                                                                                                                                            |       |                  |       |              |       |
| Stockholders’  equity:                                                                                                                     |       |                  |       |              |       |
| Common  Stock, $0.01 par value; 200,000,000 shares authorized;  52,378,398 shares in 2004 and 52,470,951 shares in 2005 issued and  outstanding |       | 524                   |       | 525               |       |
| Additional  paid-in capital                                                                                                                     |       | 355,721               |       | 355,815           |       |
| Accumulated  other comprehensive loss                                                                                                           |       | (169                  | )          | (139              | )          |
| Accumulated  deficit                                                                                                                            |       | (243,903              | )          | (298,618          | )          |
|                                                                                                                                            |       |                  |       |              |       |
| Total  stockholders’ equity                                                                                                                |       | 112,173               |       | 57,583            |       |
|                                                                                                                                            |       |                  |       |              |       |
| Total  liabilities and stockholders’ equity                                                                                                |       | $                     | 154,307    |              | $          | 103,626 |   |

 

*See accompanying notes.*

 

3

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**PRAECISPHARMACEUTICALS INCORPORATEDCondensed Consolidated Statements of Operations(In thousands, except per share data)(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                              | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                              | ** ** | **2004**               | ** ** | **2005**             | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| **Revenues:**                                                           |       |                   |       |                 |       |   |   |   |   |
| Product  sales                                                          |       | $                      | 645        |                 | $          | 350 |   | $ | 1,056 |   | $ | 1,154 |   |
| Licensing  and other revenues                                           |       | 28                     |       | 42                   |       | 78 |   | 119 |   |
| Total revenues                                                          |       | 673                    |       | 392                  |       | 1,134 |   | 1,273 |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| **Costs  and expenses:**                                                |       |                   |       |                 |       |   |   |   |   |
| Cost of  goods sold                                                     |       | 146                    |       | 3,611                |       | 1,280 |   | 3,792 |   |
| Research and  development                                               |       | 7,760                  |       | 6,276                |       | 15,675 |   | 13,559 |   |
| Sales and  marketing                                                    |       | 5,181                  |       | 2,128                |       | 9,424 |   | 5,785 |   |
| General and  administrative                                             |       | 2,401                  |       | 1,989                |       | 5,178 |   | 3,967 |   |
| Restructuring  and asset impairment                                     |       | —                 |       | 28,680               |       | — |   | 28,680 |   |
| Total costs  and expenses                                               |       | 15,488                 |       | 42,684               |       | 31,557 |   | 55,783 |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Operating  loss                                                         |       | (14,815                | )          | (42,292              | )          | (30,423 | ) | (54,510 | ) |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Interest  (expense) income, net                                         |       | (27                    | )          | (78                  | )          | 201 |   | (205 | ) |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Net loss                                                                |       | $                      | (14,842    | )                    | $          | (42,370 | ) | $ | (30,222 | ) | $ | (54,715 | ) |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Basic and  diluted net loss per common share                            |       | $                      | (0.28      | )                    | $          | (0.81 | ) | $ | (0.58 | ) | $ | (1.04 | ) |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Weighted  average number of basic and diluted common shares outstanding |       | 52,332                 |       | 52,426               |       | 52,239 |   | 52,424 |   |

 

*See accompanying notes.*

 

4

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**PRAECISPHARMACEUTICALS INCORPORATEDCondensed Consolidated Statements of Cash Flows(In thousands)(Unaudited)**

 
| ** **                                                               | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                               | ** ** | **June 30,**    | ** ** |
| ** **                                                               | ** ** | **2004**             | ** ** | **2005** | ** ** |
| **Operating  activities:**                                               |       |                 |       |   |   |
| Net loss                                                                 |       | $                    | (30,222    | ) | $ | (54,715 | ) |
| Adjustments  to reconcile net loss to cash used in operating activities: |       |                 |       |   |   |
| Non-cash  asset impairment                                               |       | —               |       | 19,676 |   |
| Depreciation                                                             |       | 2,494                |       | 1,747 |   |
| Stock  compensation                                                      |       | 17                   |       | — |   |
| Changes in  operating assets and liabilities:                            |       |                 |       |   |   |
| Accounts  receivable                                                     |       | (818                 | )          | 372 |   |
| Inventory                                                                |       | (1,888               | )          | 2,693 |   |
| Prepaid  expenses and other assets                                       |       | (707                 | )          | (262 | ) |
| Due from  officer                                                        |       | 50                   |       | — |   |
| Accounts  payable                                                        |       | (1,629               | )          | (1,189 | ) |
| Accrued  expenses                                                        |       | (333                 | )          | (2,342 | ) |
| Accrued  restructuring                                                   |       | —               |       | 7,817 |   |
| Deferred  revenue                                                        |       | 1,972                |       | (83 | ) |
|                                                                     |       |                 |       |   |   |
| Net cash  used in operating activities                                   |       | (31,064              | )          | (26,286 | ) |
|                                                                     |       |                 |       |   |   |
| **Investing  activities:**                                               |       |                 |       |   |   |
| Purchase of  available-for-sale securities                               |       | (87,566              | )          | (13,094 | ) |
| Sales or  maturities of available-for-sale securities                    |       | 115,944              |       | 75,797 |   |
| Proceeds  from disposition of property and equipment                     |       | 50                   |       | — |   |
| Purchase of  property and equipment                                      |       | (278                 | )          | (555 | ) |
|                                                                     |       |                 |       |   |   |
| Net cash  provided by investing activities                               |       | 28,150               |       | 62,148 |   |
|                                                                     |       |                 |       |   |   |
| **Financing  activities:**                                               |       |                 |       |   |   |
| Repayments  of long-term debt                                            |       | (374                 | )          | (294 | ) |
| Proceeds  from the issuance of common stock                              |       | 334                  |       | 95 |   |
|                                                                     |       |                 |       |   |   |
| Net cash  used in financing activities                                   |       | (40                  | )          | (199 | ) |
|                                                                     |       |                 |       |   |   |
| (Decrease)  increase in cash and cash equivalents                        |       | (2,954               | )          | 35,663 |   |
| Cash and  cash equivalents, beginning of period                          |       | 15,687               |       | 11,178 |   |
|                                                                     |       |                 |       |   |   |
| Cash and  cash equivalents, end of period                                |       | $                    | 12,733     |   | $ | 46,841 |   |

 

*See accompanying notes.*

 

5

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Notes toCondensed Consolidated Financial Statements**

(Unaudited)

 

# **1.**                                      Basis of Presentation

# ** **

Theaccompanying condensed consolidated financial statements have been prepared byPRAECIS PHARMACEUTICALS INCORPORATED (the “Company”) in accordance withaccounting principles generally accepted in the United States and pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”).Certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States have been condensed or omitted pursuant to such rules andregulations. It is suggested that the financial statements be read inconjunction with the audited financial statements and the accompanying notesincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2004.

 

Theinformation furnished reflects all adjustments which, in the opinion ofmanagement, are considered necessary for a fair presentation of results for theinterim periods. Such adjustments consist only of normal recurring items. Itshould also be noted that results for the interim periods are not necessarilyindicative of the results expected for the full year or any future period.

 

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

 

# **2.             Summaryof Significant Accounting Principles**

# ** **

***Principles of Consolidation***

 

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

 

***Inventory***

 

Inventory is stated at the lower of cost or market with cost determinedunder the first-in/first-out (“FIFO”) method. The Company will write down anyobsolete, excess or otherwise unmarketable inventory to its estimated netrealizable value, as necessary. If the net realizable value is determined to beless than that estimated by the Company, additional inventory write-downs maybe required in future periods. In connection with the Company’s strategicrestructuring announced in May 2005, the Company discontinued promotionalactivities related to Plenaxis® and the sale of Plenaxis®for new patients in the United States. As a result, during the second quarterof 2005, the Company wrote down approximately $3.5 million of inventory that itestimated to be in excess of its expected requirements. This amount isclassified in cost of goods sold in the Statements of Operations. The remaininginventory balance consists of materials that are expected to be used inconnection with the commercialization of Plenaxis® in the EuropeanUnion.

 

The components ofinventory are as follows:

 
| ** **            | ** ** | **December 31,  2004** | ** ** | **June 30,  2005** | ** ** |
|-----------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **            | ** ** | **(in thousands)**          | ** ** |
|                  |       |                        |       |                    |       |
| Raw  materials        |       | $                           | 1,644      |                    | $          | — |   |
| Work-in-process       |       | 2,442                       |       | 1,536                   |       |
| Finished  goods       |       | 143                         |       | —                  |       |
| Total  inventory      |       | 4,229                       |       | 1,536                   |       |
| Less current  portion |       | (93                         | )          | (162                    | )          |
| Long-term  inventory  |       | $                           | 4,136      |                    | $          | 1,374 |   |

 

6

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Rawmaterials, work-in-process and finished goods 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 ofinventory at June 30, 2005 was approximately $162,000. Muchof the raw material used to produce Plenaxis® (including the activepharmaceutical ingredient) was expensed as research and development costs priorto the FDA granting approval for the commercial sale of Plenaxis® inthe United States.

 

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

 

Statement of Financial Accounting Standards (“SFAS”)No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets* (“SFAS No. 144”),requires that if the sum of the undiscounted future cash flows expected toresult from a company’s asset, net of interest charges, is less than thereported value of the asset, an asset impairment may be recognized in thefinancial statements if the reported value of the asset exceeds the fair valuedetermined by either a quoted market price, if any, or a value determined byutilizing a discounted cash flow technique. The Company evaluates its property,plant and equipment for impairment whenever indicators of impairment exist. Theamount of the impairment to be recognized is calculated by subtracting the fairvalue of the asset from the reported value of the asset. In connection with theCompany’s strategic restructuring announced in May 2005, the Companyperformed an assessment and determined that its corporate headquarters andresearch facility was impaired. As a result, the Company recorded a non-cashimpairment charge of approximately $19.7 million related to the facility aspart of restructuring and asset impairment expenses under SFAS No. 144.The Company obtained an independent appraisal that was based upon a fee simpleexpected present value technique in combination with an evaluation ofcomparable assets in the geographic area in order to estimate the fair value ofits corporate headquarters and research facility.

 

***Stock-Based Compensation***

 

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

 

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

 
| ** **                                                                                                                                                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net loss, as  reported                                                                                                                                                               |       | $                                     | (14,842    | )                                   | $          | (42,370 | ) | $ | (30,222 | ) | $ | (54,715 | ) |
| Add: Stock based  compensation cost as computed under APB No. 25, included in the  determination of net loss as reported                                                        |       | 2                                     |       | —                              |       | 17 |   | — |   |
| Deduct:  Stock-based employee compensation cost that would have been included in the  determination of net loss as reported if the fair value method had been  applied to all awards |       | (2,576                                | )          | (2,660                              | )          | (5,549 | ) | (5,470 | ) |
| Pro forma  net loss                                                                                                                                                                  |       | $                                     | (17,416    | )                                   | $          | (45,030 | ) | $ | (35,754 | ) | $ | (60,185 | ) |
| Diluted net  loss per common share, as reported                                                                                                                                      |       | $                                     | (0.28      | )                                   | $          | (0.81 | ) | $ | (0.58 | ) | $ | (1.04 | ) |
| Diluted net loss  per common share, pro forma                                                                                                                                        |       | $                                     | (0.33      | )                                   | $          | (0.86 | ) | $ | (0.68 | ) | $ | (1.15 | ) |

 

7

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

 
| ** **               | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate |       | 4.00     | %          | 3.78     | %          |
| Expected  life (years)   |       | 6.0      |       | 6.2      |       |
| Volatility               |       | 84.0     | %          | 87.1     | %          |

 

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

 

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

 

***Revenue Recognition***

 

The Company follows the provisions of the SEC’sSAB No. 104,*Revenue Recognition*. Revenuesfrom product sales are recognized in the period when the product is delivered,provided there is persuasive evidence that an arrangement exists, the price isfixed or determinable and collection of the related receivable is reasonablyassured. Revenues are recorded net of applicable allowances as provision ismade for estimated sales returns, rebates, distributor fees and otherapplicable discounts and allowances. Shipping and other distribution costs arecharged to cost of product sales.

 

The Company prepares its provisions for salesreturns and allowances, rebates and discounts based primarily on estimates. Contractualallowances and rebates result primarily from sales under contracts withhealthcare providers, Medicaid programs and other government agencies. TheCompany’s policy for sales returns allows authorized distributors to return theproduct three months prior to, and six months after, product expiration. Inconnection with the Company’s strategic restructuring announced in May 2005,the Company modified its policy for sales returns to eliminate theserestrictions in order to accommodate returns resulting from the announcement ofthe discontinuation of promotional activities for Plenaxis® and thesale of Plenaxis® for new patients in the United States. The reservefor sales returns is determined by reviewing the history of returns forproducts with similar characteristics to Plenaxis®. The Company alsoutilizes daily reports itemizing sales to physicians and hospital pharmacies,obtained directly from its authorized distributors, in order to analyzespecific account ordering trends. This data is reviewed to monitor productmovement through the supply chain to identify remaining inventory that mayresult in chargebacks or sales returns. The Company estimates that there wasapproximately $0.2 million of product at distributors at June 30, 2005.The reserves are reviewed at each reporting period and adjusted to reflect dataavailable at that time. The Company had accrued approximately $0.2 million insales return reserves and $0.2 million in other revenue reserves as of June 30,2005. To the extent the Company’s estimates of contractual allowances, rebatesand sales returns are different from actuals, the Company adjusts the reservewhich impacts the amount of product sales revenue recognized in the period ofthe adjustment.

 

8

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

 

In April 2004, the Company entered intoa license, supply and distribution agreement with Schering AG (“Schering AG”),of Berlin, Germany (the “Schering AG Agreement”). The Schering AG Agreementprovides for a combination of upfront, regulatory approval andperformance-based milestone payments, as well as a share of revenue throughtransfer price payments for drug product which will be supplied by the Company.The Company analyzes such multiple element arrangements to determine whetherthe elements can be separated and accounted for individually as separate unitsof accounting in accordance with EITF No. 00-21, *Revenue Arrangements with Multiple Deliverables.*Nonrefundableupfront licensing fees and certain guaranteed, time-based payments that requirecontinuing involvement in the form of development, manufacturing or othercommercialization efforts by the Company are recognized as licensing revenueratably over the period under which the Company is obligated to perform thoseservices.  Milestone payments are recognized as licensing revenue orproduct sales when the performance obligations, as defined in the contract, areachieved, so long as the milestone is deemed to be substantive. Performancemilestones typically consist of milestones in the development and/orcommercialization of a product, such as obtaining approval from regulatoryagencies and the achievement of targeted sales levels. Reimbursements ofdevelopment costs are recognized as licensing revenue as the related costs areincurred.

 

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

 

***Net Loss Per Share***

 

Basic net loss per common share is based onthe weighted average number of shares of common stock, par value $.01 per share(“Common Stock”) outstanding. For all periods presented, diluted net loss percommon share is the same as basic net loss per common share as the inclusion ofCommon Stock equivalents, including the effect of stock options, would beantidilutive due to the Company’s net loss position for all periods presented. Dilutednet loss per common share excluded 7,994,067 and 9,623,837 Common Stock optionsfor the periods ended June 30, 2004 and 2005, respectively.

 

***Comprehensive Loss***

 

SFAS No. 130, *ReportingComprehensive Income*, establishes standards for the reporting anddisplay of comprehensive income (loss) and its components in the condensedconsolidated financial statements. The Company’s accumulated othercomprehensive loss is comprised of net unrealized gains or losses onavailable-for-sale securities. For the three and six months ended June 30,2004 and 2005, comprehensive loss was as follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                              |       | $                                     | (14,842    | )                                   | $          | (42,370 | ) | $ | (30,222 | ) | $ | (54,715 | ) |
| Changes in  comprehensive loss:                       |       |                                  |       |                                |       |   |   |   |   |
| Net  unrealized holding (losses)/gains on investments |       | (464                                  | )          | 21                                  |       | (402 | ) | 30 |   |
| Total  comprehensive loss                             |       | $                                     | (15,306    | )                                   | $          | (42,349 | ) | $ | (30,624 | ) | $ | (54,685 | ) |

 

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***Recent Accounting Pronouncements***

 

In May 2005, the FASB issued SFAS No. 154,*Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and FASB Statement No. 3*(“SFAS No. 154”). Previously, APB No. 20, *Accounting Changes and SFAS No. 3, Reporting AccountingChanges in Interim Financial Statements*, required the inclusion ofthe cumulative effect of changes in accounting principle in net income of theperiod of the change. SFAS No. 154 requires companies to recognize achange in accounting principle, including a change required by a new accountingpronouncement when the pronouncement does not include specific transitionprovisions, retrospectively to prior periods’ financial statements. The Companydoes not believe the adoption of SFAS No. 154 will have a material impacton its condensed consolidated financial statements.

 

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

 

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

 

Duringthe three months ended June 30, 2005, the Company recorded approximately$28.7 million of restructuring and asset impairment expenses under SFAS No. 146,*Accounting for Costs Associated with Exit orDisposal Activities.*The Company also recorded a non-cash impairmentcharge in cost of goods sold of approximately $3.5 million related to inventorydue to the discontinuation of promotional activities relating to Plenaxis®in the United States. Included in restructuring and asset impairment expensesare cash charges of approximately $2.6 million for employee severance, benefitsand related costs, approximately $0.2 million associated with the terminationof various contracts and approximately $0.2 million of other associated costs. Inaddition, a non-cash impairment charge of approximately $19.7 million wasrecorded under SFAS No. 144 relating to the Company’s corporateheadquarters and research facility. The Company also concluded that itscommitments under certain existing Plenaxis® manufacturing andsupply agreements with third parties exceed the Company’s estimated futurePlenaxis® requirements by approximately $7.2 million. During thesecond quarter of 2005, the Company recorded a charge of approximately $6.0million which represents the net present value of these excess commitments. TheCompany expects to expense the remaining $1.2 million of these excess commitmentsover the remaining term of the applicable manufacturing and supply agreements,ranging from two to five years.

 

Thefollowing table outlines the components of the Company’s restructuring andasset impairment expenses for the three months ended June 30, 2005 (inthousands):

 
| ** **                                       | ** ** | **Charges** | ** ** | **Cash Paid** | ** ** | **Non-Cash  Write-off** | ** ** | **Amounts  Accrued as of  June 30, 2005** | ** ** |
|--------------------------------------------------|------------|-------------|------------|---------------|------------|-------------------------|------------|------------------------------------------------|------------|
| Employee  severance, benefits and related costs  |       | $           | 2,555      |          | $          | 983                     |       | $                                              | —     |   | $ | 1,572 |   |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Contract  termination costs                      |       | 168         |       | 44            |       | —                  |       | 124                                            |       |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Other costs                                      |       | 247         |       | 160           |       | —                  |       | 87                                             |       |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Impairment  on building                          |       | 19,676      |       | —        |       | 19,676                  |       | —                                         |       |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Manufacturing  commitments restructuring expense |       | 6,034       |       | —        |       | —                  |       | 6,034                                          |       |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Restructuring  and asset impairment              |       | 28,680      |       |          |       |                    |       |                                           |       |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Impairment  on inventory                         |       | 3,493       | *          | —        |       | 3,493                   |       | —                                         |       |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Total                                            |       | $           | 32,173     |          | $          | 1,187                   |       | $                                              | 23,169     |   | $ | 7,817 |   |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Less current  portion                            |       |        |       |          |       |                    |       | (4,643                                         | )          |
|                                             |       |        |       |          |       |                    |       |                                           |       |
| Long-term  restructuring accrual                 |       |        |       |          |       |                    |       | $                                              | 3,174      |   |

 

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*Amount is recorded in cost of goods sold.

 

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

 

In April 2004, the Company entered intothe Schering AG Agreement, under which the Company granted exclusive rights toSchering AG to commercialize Plenaxis® in the field of prostatecancer in Europe, Russia, the Middle East, South Africa, Australia and NewZealand (the “Licensed Territory”). The Schering AG Agreement provides for acombination of upfront, regulatory approval and performance-based milestone payments,as well as a share of revenue through transfer price payments for drug productwhich will be supplied by the Company. The transfer price will vary based uponnet sales of Plenaxis®, as well as pricing and reimbursement levels,in the Licensed Territory. The Company received a $2.0 million signing paymentfrom Schering AG during the second quarter of 2004, which the Company isrecognizing into revenues through 2016, which represents the remaining patentlife of Plenaxis® in Europe. As of June 30, 2005, the Companyhad recognized approximately $0.2 million in revenues under the Schering AGAgreement.

 

**5.****                                      MortgageFinancing**

 

In June 2004,the Company amended its acquisition and construction loan agreement (the “AmendedLoan Agreement”) to extend the maturity date of the loan and modify certainother terms of the original agreement. Under the Amended Loan Agreement, on July 30,2009 the principal amount then outstanding is due and payable in full, subjectto two one-year extension options which are exercisable at the Company’selection provided the Company is in compliance with certain financial covenants.The outstanding principal bears interest at a fixed rate of 5.95% through April 2009and at a floating rate for the remainder of the term. Principal and interestare payable through a fixed monthly payment of approximately $207,000, with theprincipal portion being calculated using a 25-year amortization schedule. Interestpaid under the Amended Loan Agreement approximated interest expense during boththe three and six months ended June 30, 2004 and 2005. The Amended LoanAgreement also provides for certain additional financial operating covenants,one of which was effective immediately and the remainder of which will becomeeffective as of December 31, 2006. The covenant which was immediatelyeffective is tested on a quarterly basis and requires that the Company maintain$25.0 million in unrestricted cash, cash equivalents and marketable securities.The Company is also subject to other covenants relating to the value of theproperty securing the debt relative to the total debt outstanding under the AmendedLoan Agreement, as well as the lease income threshold required in connectionwith the established debt service coverage ratio.

 

**6****.****                                     ****Litigation**

 

In December 2004 and January 2005,the Company, Chairman and (now former) Chief Executive Officer Malcolm Gefter,President and (now former) Chief Operating Officer Kevin F. McLaughlin, ChiefFinancial Officer and Treasurer Edward C. English, and former President andChief Operating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. The complaints generally allegesecurities fraud during the period from November 25, 2003 through December 6,2004. Each of the complaints 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®.

 

On February 7,2005, a motion was filed to consolidate the three actions and to appoint leadplaintiffs and lead counsel. On February 18, 2005, the Company and theindividual defendants filed a brief response to that motion, reserving theirrights to challenge the adequacy and typicality, among other things, of theproposed lead plaintiffs in connection with class certification proceedings, ifany. On April 13, 2005, the Court entered an Order granting the plaintiffs’motion to consolidate the three actions (as well as each case that relates tothe same subject matter that may be subsequently filed in or transferred to theUnited States District Court for the District of Massachusetts), appoint leadplaintiffs and approve such plaintiffs’ selection of co-lead counsel. On August1, 2005, lead plaintiffs filed a consolidated amended complaint. At this time,plaintiffs have not specified the amount of damages they are seeking in theactions.

 

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TheCompany has not recorded an estimated liability associated with the legalproceedings described above. Due to the uncertainties related to both thelikelihood and the amount of any potential loss, the Company is unable to makea reasonable estimate of the liability that could result from an unfavorableoutcome. Management believes that the allegations against the Company arewithout merit, and the Company intends to vigorously defend against theplaintiffs’ claims. However, if theCompany is not successful in defending these actions, its business andfinancial condition could be adversely affected.

 

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

 

*Thefollowing discussion of our financial condition and results of operationsshould be read together with the condensed consolidated financial statementsand accompanying notes to those statements included elsewhere in this Form 10-Q.This Form 10-Q contains forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, that involve risks anduncertainties. All statements other than statements of historical informationset forth herein are forward-looking and may contain information aboutfinancial results, events, economic conditions, trends and known uncertainties.Actual results and events could differ materially from those discussed in theseforward-looking statements as a result of a number of factors, which includethose discussed in this section and elsewhere in this report, and therisks discussed in our other filings with the Securities and ExchangeCommission. Readers are cautioned not to place undue reliance on theseforward-looking statements, which reflect management’s analysis, judgment,belief or expectation only as of the 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 a biopharmaceutical company focused onthe discovery, development and commercialization of innovative therapies thateither address unmet medical needs or offer improvements over existingtherapies. On May 19, 2005, our Board of Directors approved a strategicrestructuring to focus the Company’s resources on our most promising assets andprograms and significantly reduce our cost structure. Going forward, we willfocus our resources on:

 

•                  Continuingthe clinical development of PPI-2458, our novel, proprietary oral compound forthe treatment of cancer and autoimmune diseases; and

 

•                  Continuingto advance our Direct SelectTM drug discovery technology and seeking researchcollaborations and partnerships with respect to that technology.

 

We are also, in collaboration with ScheringAG, continuing to seek marketing approval of Plenaxis® in Germany,with a view to thereafter gaining approval for Plenaxis® in other EuropeanUnion member states and elsewhere in Schering AG’s other licensed territoriesand successfully commercializing Plenaxis® through our collaborationwith Schering AG.

 

The strategic restructuring included voluntarilydiscontinuing promotional activities related to Plenaxis® and thesale of Plenaxis® for new patients in the United States; voluntarilysuspending the ongoing clinical development of ApanTM, our drug candidate forAlzheimer’s disease; and implementing a reduction of our 182-person headcountby approximately 60% to approximately 75 full-time employees. We are alsoactively pursuing the sale of our corporate headquarters and research facilitylocated in Waltham, Massachusetts. In order to minimize disruption to ourongoing operations, we intend to lease-back a portion of laboratory and officespace within this facility, which would represent a substantial reduction inour current occupancy and related facility costs.

 

We are focusing our research and developmentefforts on PPI-2458, a novel, proprietary oral compound targeted at theinhibition of the enzyme, methionine aminopeptidase type 2, or MetAP-2. Webelieve that, due to its antiproliferative and antiangiogenic activity, PPI-2458has the potential to address multiple therapeutic areas and we are currently inthe process of establishing a long-term clinical development plan for thiscompound. During the fourth quarter of 2003, we initiated our first clinicaltrial for PPI-2458 evaluating an oral formulation in non-Hodgkin’s lymphomapatients who were no longer benefiting from other therapies. In March 2004,the FDA placed this trial on clinical hold. In June 2004, we receivedclearance from the FDA to resume clinical trials and in late 2004, we opened anew phase 1 clinical trial of PPI-2458 in non-Hodgkin’s lymphoma patients. Duringthe second quarter of 2005, we expanded the enrollment criteria of this trialto include patients with solid tumors. While only a small number of patientshave been treated with PPI-2458 thus far, we have observed that, following oraldosing, MetAP-2 is inhibited by this compound. In addition to conducting aclinical study in cancer patients, we have been conducting an extensivepreclinical evaluation of the use of PPI-2458 for treating certain inflammatoryand autoimmune disorders, including rheumatoid arthritis. In light of thesignificant anticipated development costs associated with the PPI-2458 clinicalprogram, we continue to anticipate seeking a partner for this program asclinical development advances.

 

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As part of the ongoing evolution andenhancement of our discovery technologies, we are focusing our early stageresearch efforts on the further development and enhancement of our novel DirectSelectTM drug discovery technology. We continue to make significant progress onthe development of this technology, including solving many of the technicalchallenges associated with creating and screening ultra-large advancedcombinatorial chemistry libraries.  We believe that Direct SelectTMtechnology, through the creation of these vast libraries of drug-likemolecules, will allow us to more rapidly and directly identify orally availablecompounds with high affinity and specificity than has routinely been possibleusing traditional drug discovery methods.  During the third quarter, weplan to expand our library collection to approximately 3.5 billion structures, andto continue to test the ability of the technology to rapidly identify drug-likemolecules.  As previously announced, the continued development andenhancement of Direct SelectTM is a key part of our operating plan and wecontinue to believe that this technology will be an important tool for thefuture of drug discovery and development.  We are in discussions regardingpotential partnership opportunities for Direct SelectTM.  We alsointend to utilize this technology in identifying new compounds for internaldevelopment.

 

As stated above, in May 2005, wevoluntarily discontinued promotional activities related to Plenaxis®and the sale of Plenaxis® for new patients in the United States. Plenaxis®continues to be available to those patients in the United States who werealready receiving the drug at the time we announced our strategic restructuringin May 2005. We are also exploring partnering opportunities regardingPlenaxis® in the United States.

 

In April 2004, we signed an agreementwith Schering AG of Berlin, Germany, for the commercialization of Plenaxis®across Europe, Russia, the Middle East, South Africa, Australia and NewZealand. The Schering AG agreement provides for a combination of upfront,regulatory approval and performance-based milestone payments, as well as ashare of revenue through transfer price payments for drug product which will besupplied by us. The transfer price will vary based upon net sales of Plenaxis®,as well as pricing and reimbursement levels, in the licensed territory. Themilestone payments to us may total over time up to approximately $90.0 million,depending upon Euro/U.S. Dollar conversion rates, and the attainment ofspecified annual sales levels which the majority of the milestone payments areconditioned upon. The overall financial terms were intended, depending uponperformance levels, to approximate an equal sharing of the net present value ofthe product. We received a $2.0 million signing payment from Schering AG duringthe second quarter of 2004, which we are recognizing into revenues through2016, which represents the remaining patent life of Plenaxis® inEurope. As of June 30, 2005, we had recognized approximately $0.2 millionof revenues under this agreement. Schering AG has the right to terminate theagreement at any time in its sole discretion because the product was notapproved in Germany by June 30, 2005. Schering AG may also terminate theagreement if the terms of the approval in Germany do not meet certain criteria in the agreementdefining a commercially acceptable label.

 

In June 2003, we initiated theregulatory submission process in the European Union, submitting a marketingauthorization application, or MAA, in Germany seeking approval to marketPlenaxis® for the hormonal management of prostate cancer whereandrogen suppression is appropriate. Earlier this year we submitted a responseto a communication and requests received from the German Federal Institute for Drugs and Medical Devices, or BfArM,regarding the MAA, and we continue to interact with the BfArM and expect theBfArM to complete its review by the end of the third quarter of 2005. Our goalremains to obtain a commercially acceptable label under the Schering AGagreement. Assuming favorable action by the German regulatoryauthorities granting marketing approval with a commercially acceptable label,we plan to seek, in collaboration with Schering AG, additional European Unionmember state approvals through the Mutual Recognition Procedure. However, wecannot assure investors whether or when such regulatory action on our MAA willoccur, or that any such action will be viewed as a viable commercialopportunity by Schering AG or will otherwise result in the successfulcommercialization of Plenaxis® in Germany or in any other country inthe European Union.

 

We also arecontinuing to evaluate potential licensing opportunities for the developmentand commercialization of Plenaxis® in Japan and other ex-U.S. territories notcovered by the Schering AG agreement. We expect to actively pursue suchopportunities following approval of a commercially acceptable label in Germany.We cannot assure investors that we will be able to enter into additionalcollaboration agreements on favorable terms, or at all.

 

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In connection with our strategicrestructuring, we also voluntarily suspended the clinical development programfor ApanTM. We began this program in 2000 and, prior to its suspension,completed both a phase 1a single dose escalation study, identifying a maximumtolerated dose, or MTD, in healthy volunteers and a phase 1b single doseescalation study, identifying the MTD in Alzheimer’s patients. Enrollment in aphase 1/2a multiple dose study was suspended prior to completion. As previouslystated, the suspension of clinical development for ApanTM was not due to anyunexpected or undesirable event or clinical result, but rather to conservefunds. We anticipate continuing to explore partnering opportunities for thiscompound to enable its further development in the future.

 

Most of our expenditures to date have beenfor drug development, commercialization activities and for general andadministrative expenses.

 

During the three months ended June 30,2005, we recorded approximately $28.7 million of restructuring and assetimpairment expenses under Statement of Financial Accounting Standards No. 146,*Accounting for Costs Associated with Exit orDisposal Activities*, or SFAS No. 146. We also recorded anon-cash impairment charge of approximately $3.5 million related to inventorydue to the discontinuation of promotional activities relating to Plenaxis®in the United States. Included in restructuring and asset impairment expensesare cash charges of approximately $2.6 million for employee severance, benefitsand related costs, approximately $0.2 million associated with the terminationof various contracts and approximately $0.2 million of other associated costs. Inaddition, a non-cash impairment charge of approximately $19.7 million was recordedunder Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,or SFAS No. 144, relating to our corporate headquarters and researchfacility. We also concluded that our commitments under certain existingPlenaxis® manufacturing and supply agreements with third partiesexceed our estimated future Plenaxis® requirements by approximately$7.2 million. During the second quarter of 2005, we recorded a charge ofapproximately $6.0 million which represents the net present value of these excesscommitments. We expect to expense the remaining $1.2 million of these excesscommitments over the remaining term of the applicable manufacturing and supplyagreements, ranging from two to five years.

 

Due primarily to the costs associated withthe commercialization of Plenaxis® in the United States and itscontinued development, as well as other research and development and generaland administrative expenses, we had a net operating loss for the first half of2005. Our accumulated deficit as of June 30, 2005 was approximately $298.6million. We expect to continue to have net operating losses for at least thenext several years.

 

We continue to expect that, as a result ofthe strategic restructuring, our annual cash utilization will decrease fromapproximately $60.0 million per year to less than $30.0 million per year for2006, and that we should have available resources to allow us to pursue ourcurrent operating plan through approximately the second quarter of 2007, andpossibly longer assuming receipt of a marketing approval for Plenaxis®in Germany that is commercially acceptable to Schering AG or the successful partnering of eitherour PPI-2458 program or our Direct SelectTM technology. However, wecannot assure investors that we will be able to gain a commercially acceptableapproval of Plenaxis® outside of the United States, or that we willbe able to enter into appropriate collaborative arrangements relating to ourPPI-2458 program or our Direct SelectTM technology in a timely manner and onfavorable terms, if at all. If we are unable to carry out the key elements ofour operating plan, we may have to obtain additional sources of funding orsignificantly modify our operating plan, including by curtailing certainelements of our operations. We have no committed sources of capital and do notknow whether additional financing will be available when needed, or, ifavailable, that the terms will be favorable to us. If we are required to raisemoney in the future and we experience difficulties or are unable to do so, itcould become necessary for us to cease operations or seek protection understate or federal insolvency or bankruptcy laws.

 

At June 30, 2005, we had 77 full-timeemployees, excluding those employees whose positions were eliminated inconnection with our strategic restructuring, compared to 185 full-timeemployees at June 30, 2004. This decrease is due primarily to theapproximate 60% reduction in headcount effected as part of our strategicrestructuring.

 

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**Critical Accounting Policies**

 

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

 

*Use of Estimates.*Weprepare our financial statements in accordance with accounting principlesgenerally accepted in the United States. These principles require that we makeestimates and use assumptions that affect the reporting of our assets and ourliabilities as well as the disclosures that we make regarding assets andliabilities and revenues and expenses that are contingent upon uncertainfactors as of the reporting date. Actual payments, and thus our actual results,could differ from our estimates.

 

*Revenue Recognition.*Wefollow the provisions of the Securities and Exchange Commission’s StaffAccounting Bulletin No. 104, *Revenue Recognition*.We recognize revenues from product sales in the period when the product isdelivered, provided there is persuasive evidence that an arrangement exists,the price is fixed or determinable and collection of the related receivable isreasonably assured. Revenues are recorded net of applicable allowances asprovision is made for estimated sales returns, rebates, distributor fees andother applicable discounts and allowances. Shipping and other distributioncosts are charged to cost of product sales.

 

We prepare our provisions for sales returnsand allowances, rebates and discounts based primarily on estimates. Contractualallowances and rebates result primarily from sales under contracts withhealthcare providers, Medicaid programs and other government agencies. Ourpolicy for sales returns allows authorized distributors to return the productthree months prior to, and six months after, product expiration. In connectionwith our strategic restructuring announced in May 2005, we modified ourpolicy for sales returns to eliminate these restrictions in order toaccommodate returns resulting from the announcement of the discontinuation ofpromotional activities for Plenaxis® and the sale of Plenaxis®for new patients in the United States. The reserve for sales returns isdetermined by reviewing the history of returns for products with similarcharacteristics to Plenaxis®. We also utilize daily reportsitemizing sales to physicians and hospital pharmacies, obtained directly fromour authorized distributors, in order to analyze specific account orderingtrends. This data is reviewed to monitor product movement through the supplychain to identify remaining inventory that may result in chargebacks or salesreturns. We estimate that there was approximately $0.2 million of product atdistributors at June 30, 2005. The reserves are reviewed at each reportingperiod and adjusted to reflect data available at that time. We had accruedapproximately $0.2 million in sales return reserves and $0.2 million in otherrevenue reserves as of June 30, 2005. To the extent our estimates ofcontractual allowances, rebates and sales returns are different from actuals,we adjust the reserve which impacts the amount of product sales revenuerecognized in the period of the adjustment.

 

We currently provide substantially all of ourdistributors with payment terms of up to 120 days on purchases of Plenaxis®.Through June 30, 2005, payments have generally been made in a timelymanner.

 

We analyze our multiple element arrangementsto determine whether the elements can be separated and accounted forindividually as separate units of accounting in accordance with EITF No. 00-21,*Revenue Arrangements with MultipleDeliverables.*Nonrefundable upfront licensing fees and certainguaranteed, time-based payments that require continuing involvement in the formof development, manufacturing or other commercialization efforts by us arerecognized as licensing revenue ratably over the period under which we areobligated to perform those services.  Milestone payments are recognized aslicensing revenue or product sales when the performance obligations, as definedin 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 over which a fee or paymentwill be recognized as revenue cannot be specifically identified from thecontract, management estimates the deferral period based upon other criticalfactors contained within the contract, including but not limited to patent lifeor contract term. We continually review these estimates which could result in achange in the deferral period and might impact the timing and the amount ofrevenue recognized.

 

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*Restructuring and AssetImpairment Expenses.*OnMay 19, 2005, our Board of Directors approved a strategic restructuring tofocus the Company’s resources on our most promising assets and programs andsignificantly reduce our cost structure. The strategic restructuring includedvoluntarily discontinuing promotional activities related to Plenaxis®and the sale of Plenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM, our drugcandidate for Alzheimer’s disease; and implementing a reduction of our 182-personheadcount by approximately 60%. These restructuring charges were accounted forin accordance with SFAS No. 146. In determining the manufacturingcommitments restructuring expense and inventory impairment, various assumptionswere made with respect to future Plenaxis® sales.****These assumptions will be reviewed periodically and shouldthese estimates change, adjustments to the net present value of remainingcommitments as well as inventory may be necessary in future periods. Pleaserefer to the discussion of *Inventory* and*Impairment or Disposal of Long-Lived Assets*appearing directly**below, as well as Note 3 to our condensed consolidatedfinancial statements included elsewhere in this report, for additional information regarding ourstrategic restructuring.

 

*Inventory.*We valueinventory at the lower of cost or market value. We determine cost using thefirst-in, first-out method. We analyze our inventory levels quarterly and writedown inventory that has become obsolete, inventory that has a cost basis inexcess of its expected net realizable value and inventory in excess of expectedrequirements, to cost of goods sold. Expired inventory is disposed of and therelated costs are written off. Ifactual market conditions are less favorable than that estimated by us,additional write-downs of existing inventory may be required in futureperiods. In connectionwith our strategic restructuring announced in May 2005, we discontinuedpromotional activities related to Plenaxis® and the sale of Plenaxis® for new patients in theUnited States. As a result, during the second quarter of 2005,  we wrote down approximately $3.5 million ofinventory that we estimated to be in excess of our expected requirements. Thisamount is classified as cost of goods sold in the Statements of Operations. Theremaining inventory balance consists of materials that are expected to be usedin connection with the commercialization of Plenaxis® in the EuropeanUnion.

 

Weclassify any inventory that we estimate to be sold in the next twelve months ascurrent with the remaining amount classified as long-term inventory.

 

*Impairment or Disposal of Long-Lived Assets*.SFAS No. 144 requires that if the sum of the undiscounted future cashflows expected to result from a company’s asset, net of interest charges, isless than the reported value of the asset, an asset impairment may berecognized in the financial statements if the reported value of the assetexceeds the fair value determined by either a quoted market price, if any, or avalue determined by utilizing a discounted cash flow technique. We evaluate ourproperty, plant and equipment for impairment whenever indicators of impairmentexist. The amount of the impairment to be recognized is calculated bysubtracting the fair value of the asset from the reported value of the asset.

 

We believe that the application of SFAS No. 144and the method used to determine the impairment of our property, plant andequipment involve critical accounting estimates because they are highlysusceptible to change from period to period and because they require managementto make assumptions about future cash flows, including residual values. 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.

 

In connection with our strategicrestructuring announced in May 2005, we performed an assessment anddetermined that our corporate headquarters and research facility was impaired. Asa result, a non-cash impairment charge of approximately $19.7 million relatedto the facility was recorded as part of restructuring and asset impairmentexpenses under SFAS No. 144. We obtained an independent appraisal that wasbased upon a fee simple expected present value technique in combination with anevaluation of comparable assets in the geographic area in order to estimate thefair value of our corporate headquarters and research facility.

 

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

 

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**Results of Operations**

 

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

 

Revenues for the three months ended June 30,2005 were approximately $0.4 million compared to approximately $0.7 million forthe corresponding period in 2004. Of these amounts, approximately $0.4 millionand $0.6 million, respectively, were related to sales of Plenaxis®. Thedecrease in revenues was due primarily to the voluntary discontinuation ofpromotional activities related to Plenaxis® and the sale of Plenaxis®for new patients in the United States. However, Plenaxis® continuesto be available to those patients in the United States who were alreadyreceiving the drug at the time our strategic restructuring was announced in May 2005.Accordingly, we expect to have a small amount of revenues from Plenaxis®sales during the remainder of 2005. Other sources of revenues during 2005 andthereafter may be from potential payments under our agreement with Schering AG,and potential payments under other future corporate collaborations relating toPPI-2458 and our Direct SelectTM drug discovery technology, if consummated. Theamount and timing of these other development will depend on the timing andscope of regulatory approvals in the European Union, as well as the success ofour PPI-2458 clinical development program and our Direct SelectTM technology,and our ability to enter into partnerships with respect to these programs. Wecannot assure investors as to if or when we will receive any such revenues.

 

Cost of goods sold for the three months endedJune 30, 2005 was $3.6 million compared to approximately $0.1 million forthe three months ended June 30, 2004. During the second quarter of 2005,we recorded a non-cash impairment charge of approximately $3.5 million relatedto inventory due to the discontinuation of promotional activities relating toPlenaxis® in the United States. Much of the raw material used toproduce Plenaxis® (including the active pharmaceutical ingredient)was purchased prior to the FDA granting approval for the commercial sale ofPlenaxis® in the United States. Accordingly, these purchases weretreated as research and development costs and expensed as incurred. We cannotpredict when such previously expensed materials will be exhausted, as this willbe dependent upon the commercial success of Plenaxis® abroad.

 

We currently have several ongoing researchand development programs. Using industry estimates, typical drug developmentprograms may last for ten or more years and may cost hundreds of millions ofdollars to complete. As our programs progress, we assess the possibility ofentering into corporate collaborations to offset a portion or all of ourresearch and development costs. The ultimate success of our research anddevelopment programs and the impact of these programs on our operations andfinancial results cannot be accurately predicted and will depend, in largepart, upon the outcome and timing of many variables outside of our control.

 

Members of our research and development teamtypically work on a number of projects concurrently. In addition, a substantialamount of our fixed costs such as facility depreciation, utilities andmaintenance are shared by our various programs. Accordingly, we have notspecifically identified, and do not plan to specifically identify, all costsrelated to each of our research and development programs. We estimate thatduring the three and six months ended June 30, 2005 and during 2004, themajority of our research and development expenses consisted of salaries,benefits, clinical trial costs, manufacturing costs and lab supplies related toour Plenaxis®, ApanTM and PPI-2458 clinical development programs. Theremaining research and development costs consisted primarily of salaries,benefits and lab supplies related to the development of our Direct SelectTMtechnology and our other research programs.

 

Research and development expenses for thethree months ended June 30, 2005 decreased 19% to approximately $6.3million, from approximately $7.8 million for the corresponding period in 2004. Thedecrease reflects reduced spending in our clinical and preclinical programs. Spendingon the Plenaxis® program decreased by approximately $0.2 million dueprimarily to lower development-related costs. Spending on our ApanTM programduring the three months ended June 30, 2005 decreased compared to thecorresponding period in the prior year due to a decrease in clinical expensesof approximately $0.6 million offset by an increase of approximately $0.2million of preclinical expenses. Spending related to our PPI-2458 programduring the three months ended June 30, 2005 decreased by approximately$0.1 million due primarily to reduced spending on preclinical studies. Theremaining decrease was due to lower personnel-related expenses of approximately$0.8 million during the three months ended June 30, 2005. In May 2005,as part of our strategic restructuring, we voluntarily suspended the clinicaldevelopment of ApanTM, as well as certain investigator-sponsored and phase 4clinical studies of Plenaxis®. Although we are unable to predict theprecise level of spending on individual clinical programs due to the uncertainnature of clinical development, we expect our research

 

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and development expenses for the remainder of 2005 and thereafter toremain lower than 2004 levels, as we continue to advance our clinical trial ofPPI-2458, enhance our Direct SelectTM technology and end ApanTM and Plenaxis®clinical development activities.

 

Sales and marketing expenses for the threemonths ended June 30, 2005 decreased 59% to approximately $2.1 million,from approximately $5.2 million for the corresponding period in 2004. Thedecrease was due primarily to the voluntary discontinuation of promotionalactivities related to Plenaxis® in the United States. We do notexpect to continue to incur significant sales and marketing expenses during theremainder of 2005 or thereafter.

 

General and administrative expenses for thethree months ended June 30, 2005 decreased 17% to approximately $2.0million, from approximately $2.4 million for the corresponding period in 2004. Thedecrease resulted primarily from lower personnel-related expenses during thethree months ended June 30, 2005. We expect that general andadministrative expenses will remain relatively consistent with current levelsfor the remainder of 2005. As describedin detail in this report under Part II, Item 2. “Legal Proceedings,” in December 2004and January 2005, the Company and certain of its current and formerexecutive officers were named as defendants in three purported class actionsecurities lawsuits filed in the United States District Court for the Districtof Massachusetts. Management believes that the allegations against the Companyare without merit, and the Company intends to vigorously defend against theplaintiffs’ claims. As this litigation is in an initial stage, management isunable to predict its outcome or its ultimate effect, if any, on our financialcondition. However, we expect that the costs and expenses related to thislitigation may be significant. Our current director and officer liabilityinsurance policies (which, subject to the terms and conditions thereof, alsoprovide “entity coverage” for the Company for this litigation) provide that theCompany is responsible for the first $2.5 million of such costs and expenses. Ifwe are not successful in defending these actions, our business and financialcondition could be adversely affected.

 

Restructuringand asset impairment expenses for the three months ended June 30, 2005were $28.7 million compared to zero for the corresponding period in 2004. Pleaserefer to the discussion under “Overview” in this Item 2, as well as Note 3 –Restructuring, included in our condensed consolidated financial statementsappearing elsewhere in this report for additional information regarding ourstrategic restructuring.

 

Net interest expense for the three monthsended June 30, 2005 was approximately $0.1 million compared to zero forthe corresponding period in 2004. The increase in net interest expense was dueprimarily to the refinancing of the mortgage on our facility from a lowervariable rate to a higher fixed rate and lower average cash balances.

 

At December 31, 2004, we had federal netoperating loss carryforwards of approximately $226.0 million and researchtax credits of approximately $7.3 million, that will expire in varying amountsthrough 2024, if not utilized. Utilization of net operating loss and tax creditcarryforwards will be subject to substantial annual limitations under theInternal Revenue Code of 1986, as amended. The annual limitations may result inthe expiration of the net operating loss and tax credit carryforwards beforefull utilization.

 

**Six Months Ended June 30, 2005 Compared To Six Months Ended June 30, 2004**

 

Revenues for the six months ended June 30,2005 were approximately $1.3 million compared to approximately $1.1 million forthe corresponding period in 2004. Substantially all of our revenues wererelated to sales of Plenaxis® during the six months ended June 30,2005 and 2004, with the remaining amounts representing licensing and otherrevenues.

 

Cost of goods sold for the six months ended June 30,2005 was approximately $3.8 million compared to approximately $1.3 million forthe corresponding period in 2004. During the second quarter of 2005, werecorded a non-cash impairment charge of approximately $3.5 million related toinventory due to the discontinuation of promotional activities relating toPlenaxis® in the United States. The majority of our cost of goodssold during the first half of 2004 was comprised of a $1.0 million milestonepayment which became due and payable upon the first commercial sale of Plenaxis®under our license agreement with Indiana University Advanced Research andTechnology Institute, Inc.

 

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Research and development expenses for the sixmonths ended June 30, 2005 decreased 13% to approximately $13.6 million,from approximately $15.7 million for the corresponding period in 2004. Thedecrease reflects reduced spending on our clinical and preclinical programs. Spendingon the Plenaxis® program during the first half of 2005 increased by approximately$0.5 million compared to the first half of 2004 due primarily to higherdevelopment-related costs. Spending on our ApanTM program during the six monthsended June 30, 2005 decreased compared to the corresponding period in theprior year due to lower preclinical expenses of approximately $0.3 million andlower clinical expenses of approximately $0.5 million. Spending related to ourPPI-2458 program during the six months ended June 30, 2005 decreased byapproximately $0.8 million due primarily to reduced spending on preclinicalstudies. The remaining decrease was due to lower personnel-related expenses ofapproximately $1.0 million during the six months ended June 30, 2005.

 

Sales and marketing expenses for the six monthsended June 30, 2005 decreased 39% to approximately $5.8 million, fromapproximately $9.4 million for the corresponding period in 2004. The decreaseresulted primarily from the voluntary discontinuation of promotional activitiesrelated to Plenaxis® in the United States, as well as variousone-time costs that occurred in the first half of 2004 in conjunction with thelaunch of Plenaxis® in the United States.

 

General and administrative expenses for thesix months ended June 30, 2005 decreased 23% to approximately $4.0million, from approximately $5.2 million for the corresponding period in 2004. Thedecrease resulted primarily from lower personnel and business developmentexpenses during the six months ended June 30, 2005.

 

Restructuringand asset impairment expenses for the six months ended June 30, 2005 were$28.7 million compared to zero for the corresponding period in 2004. Pleaserefer to the discussion under “Overview” in this Item 2, as well as Note 3 –Restructuring, included in our condensed consolidated financial statementsappearing elsewhere in this report for additional information regarding ourstrategic restructuring.

 

Net interest expense for the six months endedJune 30, 2005 was $0.2 million compared to net interest income ofapproximately $0.2 million for the corresponding period in 2004. The decreasein net interest income (expense) was due primarily to the refinancing of themortgage on our facility from a lower variable rate to a higher fixed rate andlower average cash balances.

 

**Liquidity and Capital Resources**

 

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

 

On May 19, 2005, our Board of Directorsapproved a strategic restructuring to focus the Company’s resources on our mostpromising assets and programs and significantly reduce our cost structure. Thestrategic restructuring included voluntarily discontinuing promotionalactivities related to Plenaxis® and the sale of Plenaxis®for new patients in the United States; voluntarily suspending the ongoingclinical development of ApanTM; and implementing a headcount reduction ofapproximately 60%. We are also actively pursuing the sale of our corporateheadquarters and research facility located in Waltham, Massachusetts. In orderto minimize disruption to our ongoing operations, we intend to lease-back aportion of laboratory and office space within this facility, which would resultin a substantial reduction in our current occupancy and related facility costs.

 

At June 30, 2005, we had cash, cashequivalents and marketable securities of approximately $56.3 million andworking capital of approximately $48.3 million, compared to approximately $83.3million and $76.4 million, respectively, at December 31, 2004. We continueto expect that, as a result of the strategic restructuring, our annual cashutilization will decrease from approximately $60.0 million per year to lessthan $30.0 million per year for 2006, and that we should have availableresources to allow us to pursue our current operating plan throughapproximately the second quarter of 2007, and possibly longer assuming receiptof marketing approval for Plenaxis® in Germany that is commerciallyacceptable to Schering AG or thesuccessful partnering of either our PPI-2458 program or our Direct SelectTMtechnology.

 

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We expect to continue to have net operatinglosses for at least the next several years. We cannot assure investors that wewill be able to gain a commercially acceptable approval of Plenaxis®outside of the United States, or that we will be able to enter into appropriatecollaborative arrangements relating to our PPI-2458 program or our DirectSelectTM technology in a timely manner and on favorable terms, if at all. If weare unable to carry out the key elements of our operating plan, we may have toobtain additional sources of funding or significantly modify our operatingplan, including by curtailing certain elements of our operations. 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. If we are required to raise money in the future and we experiencedifficulties or are unable to do so, it could become necessary for us to ceaseoperations or seek protection under state or federal insolvency or bankruptcylaws.

 

For the six months ended June 30, 2005,net cash of approximately $26.3 million was used in operating activities,compared to approximately $31.1 million used in operating activities during thesix months ended June 30, 2004. During the six months ended June 30,2005, our use of cash in operations was due principally to our net loss ofapproximately $54.7 million and the reduction in accounts payable and accruedexpenses of approximately $3.5 million, offset by non-cash asset impairmentexpenses of approximately $19.7 million, an increase in accrued restructuringcosts of approximately $7.8 million, a reduction in inventory of approximately$2.7 million and depreciation of approximately $1.7 million. Cash utilizationwill continue for 2005 and thereafter as we continue our clinical developmentprogram for PPI-2458 and focus on the refinement of our Direct SelectTM drugdiscovery technology and our other research and development initiatives. Theactual amount of overall expenditures will depend on numerous factors,including the timing of expenses and the timing and progress of our research,development and commercialization efforts.

 

Net cashprovided by investing activities of approximately $62.1 million for the sixmonths ended June 30, 2005 consisted primarily of net sales or maturitiesof marketable securities of approximately $62.7 million.  This compares tonet cash provided by investing activities of approximately $28.2 million forthe corresponding period in 2004, which was also related primarily to net salesor maturities of marketable securities of approximately $28.4 million.

 

In July 2000, in connection with thepurchase, through our wholly owned real estate subsidiary, of our corporateheadquarters and research facility in Waltham, Massachusetts, the subsidiaryentered into an acquisition and construction loan agreement providing for up to$33.0 million in financing for the acquisition of, and improvements to, thefacility. As of June 30, 2005, approximately $31.7 million was outstandingunder the loan agreement, as amended as described below. The loan is secured bythe facility, together with all fixtures, equipment, improvements and otherrelated items, and by all rents, income or profits received by our real estatesubsidiary, and is unconditionally guaranteed by us.

 

In June 2004, the acquisition andconstruction loan agreement was amended to extend the maturity date of the loanand modify certain other terms of the original agreement. Under the amendedloan agreement, on July 30, 2009 the principal amount then outstanding isdue and payable in full, subject to two one-year extension options which areexercisable at our election provided we are in compliance with certainfinancial covenants. The outstanding principal bears interest at a fixed rateof 5.95% through April 2009 and at a floating rate for the remainder ofthe term. Principal and interest are payable through a fixed monthly payment ofapproximately $207,000, with the principal portion being calculated using a 25-yearamortization schedule. The amended loan agreement also provides for certainadditional financial operating covenants, one of which was effectiveimmediately and the remainder of which will become effective as of December 31,2006. The covenant which was immediately effective is tested on a quarterlybasis and requires that we maintain $25.0 million in unrestricted cash, cashequivalents and marketable securities. We are also subject to other covenantsrelating to the value of the property securing the debt relative to the totaldebt outstanding under the amended loan agreement, as well as the lease incomethreshold required in connection with the established debt service coverageratio. As stated above, we are actively pursuing the sale and partial leasebackof our corporate headquarters and research facility. In the event that we areunable to sell the facility in a timely manner and are unable to successfullycarry out the key elements of our operating plan, we are likely to default onone or more of the financial covenants under the loan agreement.

 

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At December 31, 2004 we had provided avaluation allowance of approximately $110.7 million for our deferred taxassets. The valuation allowance represents the value of the deferred tax assets.Due to anticipated future operating losses, we believe that it is more likelythan not that we will not realize the net deferred tax assets in the future andwe have provided an appropriate valuation allowance.

 

**Recent Accounting Pronouncements**

 

In December 2004, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standards No. 123R,*Share-Based Payment – An Amendment of FASBStatements No. 123 and 95*, or SFAS No. 123R, whichrequires all companies to measure compensation cost for all share-basedpayments, including employee stock options, at fair value, and was originallyeffective for public companies for interim or annual periods beginning after June 15,2005.  In April 2005, the Securities and Exchange Commission amendedthe compliance dates for SFAS No. 123R to allow companies to implementSFAS No. 123R at the beginning of their next fiscal year, January 2006for us. Generally, the approach in SFAS No. 123R is similar to theapproach described in Statement of Financial Accounting Standards No. 123,*Accounting for Stock-Based Compensation*. However, SFAS No. 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values.  Pro forma disclosure is no longeran alternative.  The adoption of SFAS No. 123R will have asignificant impact on our results of operations, although it will have noimpact on our overall financial position. In March 2005, the Securitiesand Exchange Commission issued Staff Accounting Bulletin No. 107, orSAB No. 107, which expressed the views of the Commission regarding theinteraction between SFAS No. 123R and certain rules andregulations of the Commission. SAB No. 107 provides guidance relatedto the valuation of share-based payment arrangements for public companies,including assumptions such as expected volatility and expected term. We areevaluating SFAS No. 123R and SAB No. 107 and have not yet determinedthe amount of stock option expense that will be incurred in future periods.

 

In May 2005, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 154,*Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and FASB Statement No. 3*,or SFAS No. 154. Previously, APB No. 20, *Accounting Changes* and SFAS No. 3, *Reporting Accounting Changes in Interim Financial**Statements* required the inclusion of the cumulative effectof changes in accounting principle in net income of the period of the change.SFAS No. 154 requires companies to recognize a change in accountingprinciple, including a change required by a new accounting pronouncement whenthe pronouncement does not include specific transition provisions,retrospectively to prior periods’ financial statements. We do not believe theadoption of SFAS No. 154 will have a material impact on our condensedconsolidated financial statements.

 

**Risk Factors that May Affect FutureResults**

 

*The risks and uncertainties described beloware 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 risksactually occur, our business, financial condition and results of operationscould be materially adversely affected.*

 

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

 

We cannotassure investors that we will be profitable in the future or, if we attainprofitability, that it will be sustainable. In May 2005, ourBoard of Directors approved a strategic restructuring to focus the Company’sresources on our most promising assets and programs and significantly reduceour cost structure. Going forward under our current operating plan, we willfocus our resources on continuing the clinical development of PPI-2458 andcontinuing to advance our Direct SelectTM drug discovery technology and seekingresearch collaborations and partnerships with respect to that technology. Weare also, in collaboration with Schering AG, continuing to seek marketing approvalof Plenaxis® in Germany, with a view to thereafter gaining approvalfor Plenaxis® in other European Union member states and elsewhere inSchering AG’s other licensed territories, and successfully commercializingPlenaxis® abroad through our collaboration with Schering AG.

 

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To date, wehave derived substantially all of our revenues from payments under corporatecollaboration and license agreements, and from product sales. Our marketing andselling efforts with regard to Plenaxis® in the United States were not commerciallysuccessful, and we may be unable to successfully develop or market any otherproducts in the future. Our current operating plan includes significant ongoingexpenditures to support the ongoing pursuit of regulatory approval for Plenaxis® in the European Union, the continuation ofour PPI-2458 clinical development program and the ongoing enhancement of our DirectSelectTM technology, and for general and administrative purposes. As of June 30,2005, we had an accumulated deficit of approximately $298.6 million. We expect that we will continue to incursignificant operating losses for at least the next several years, and we maynever be profitable in the future.

 

**If we are unable to successfully carry outour operating plan, including the sale of our facility, we may have to obtainadditional sources of funding or significantly modify our operating plan.Moreover, in this event, we are likely to default on one or more of thefinancial covenants under our acquisition and construction loan agreement.**

 

If we are unable to successfully carry outthe key elements of our operating plan described in the immediately precedingrisk factor, we believe that our existing cash and investments will besufficient to meet our working capital and capital expenditure needs throughapproximately the second quarter of 2007. If we are able to successfully carryout the key elements of our operating plan, described above, we may be able,without obtaining additional funding, to continue to meet our working capitaland capital expenditure needs beyond that time, although we cannot provide anyassurances as to if or for how long we would be able to do so. If we are unableto successfully carry out the key elements of our operating plan, we may haveto obtain additional sources of funding or significantly modify our operatingplan, including by curtailing or eliminating certain elements of ouroperations. We have no committed sources of capital and do not know whetheradditional financing will be available when needed, or, if available, that theterms will be favorable to us.

 

To date, our operations and capitalrequirements have been financed primarily with the proceeds of public andprivate sales of common stock and preferred stock, payments under research anddevelopment partnerships and collaborative agreements, investment income andrevenues from product sales. There can be no assurance that we will be able tosell any such securities, enter into additional partnerships and collaborativeagreements or borrow funds in the future at favorable terms, or at all. If weraise additional funds by issuing equity securities, further dilution to existingstockholders will result. In addition, as a condition to giving additionalfunds to us, future investors may demand, and may be granted, rights superiorto those of existing stockholders. We may also be required to take otheractions, which may lessen the value of our common stock or dilute our commonstockholders, including borrowing money on terms that are not favorable to us. Ifwe are required to raise money in the future and we experience difficulties orare unable to do so, it could become necessary for us to cease operations orseek protection under state or federal insolvency or bankruptcy laws.

 

In June 2004, we amended the acquisitionand construction loan agreement relating to our corporate headquarters andresearch facility. As of June 30, 2005, approximately $31.7 million wasoutstanding under the amended loan agreement. The amended loan agreementprovides for certain additional financial operating covenants, one of which waseffective immediately and the remainder of which will become effective as of December 31,2006. The covenant which was immediately effective is tested on a quarterlybasis and requires that we maintain $25.0 million in unrestricted cash, cashequivalents and marketable securities. We are also subject to other covenantsrelating to the value of the property securing the debt relative to the totaldebt outstanding under the amended loan agreement, as well as the lease incomethreshold required in connection with the established debt service coverageratio. We are actively pursuing the sale of our facility. In the event that weare unable to sell the facility in a timely manner and are unable tosuccessfully carry out the key elements of our operating plan, we are likely todefault on one or more of the financial covenants under the loan agreement. Tothe extent that we are not able to comply with the financial covenants of ourloan agreement, we may be unable to borrow additional amounts and outstandingamounts may become due on an accelerated basis, which would adversely affectour liquidity.

 

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

 

Thedevelopment and sale of Plenaxis®, and our product candidates, is subject toextensive regulation by governmental authorities. Obtaining regulatory approvaltypically is costly and takes many years; maintaining regulatory approval alsorequires 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, as well as other actions as to Plenaxis®, our other potential products or against us.Outside the United States, we can market a product only if we receive marketingauthorization from the appropriate regulatory authorities. This foreignregulatory approval process includes all of the risks associated with the FDAapproval process, and may include additional risks.

 

To gainregulatory approval from the FDA and foreign regulatory authorities for thecommercial sale of any product, we must demonstrate in clinical trials, andsatisfy the FDA and foreign regulatory authorities as to, the safety andefficacy of the product. If we develop a product to treat a long-lastingdisease, such as cancer, we must gather data over an extended period of time.There are many risks associated with our clinical trials. For example, we maybe unable to achieve the same level of success in later trials as we did inearlier ones. Additionally, data we obtain from preclinical and clinicalactivities are susceptible to varying interpretations that could impederegulatory approval. Further, some patients in our PPI-2458 clinical trial havea high risk of death or other adverse medical events due to their advancedcancer that may not be related to our product. These events may affect thestatistical analysis of the safety and efficacy of our products. If we obtainregulatory approval for a product, the approval will be limited to thosediseases for which our clinical trials demonstrate the product is safe andeffective.

 

In addition,many factors could delay or result in termination of our ongoing or future clinicaltrials. For example, results from ongoing preclinical studies or analyses couldraise concerns over the safety or efficacy of a product candidate. In March 2004,the FDA placed our phase 1 clinical trial of PPI-2458 on clinical hold. Althoughwe subsequently received clearance from the FDA to resume clinical testing ofPPI-2458, we cannot assure investors that the FDA will not place this or otherclinical trials on hold in the future. A clinical trial may also experienceslow patient enrollment. A study could also be delayed due to lack ofsufficient drug supply. Patients may experience adverse medical events or sideeffects, and there may be a real or perceived lack of effectiveness of, or ofsafety issues associated with, the drug we are testing. Future governmentalaction or existing or changes in FDA or foreign regulatory policies orprecedents, may also result in delays or rejection of an application formarketing approval. The FDA, and comparable foreign regulatory authorities,have considerable discretion in determining whether to grant marketing approvalfor a drug, and may delay or deny approval even in circumstances where theapplicant’s clinical trials have proceeded in compliance with establishedprocedures and regulations and have met the established end-points of thetrials. Challenges to regulatory determinations are generally time-consumingand costly, and rarely, if ever, succeed. Although we received FDA approval tomarket Plenaxis® in the United States in November 2003,we can give no assurance that we will obtain marketing approval for any of ourother product candidates.

 

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 and marketing restrictions could, and in thecase of Plenaxis® inthe United States, did, materially adversely affect the marketability and/orvalue of the product.  As part of ourrecent restructuring to focus our resources on our most promising assets andprograms and significantly reduce our cost structure, we have voluntarilydiscontinued promotional activities related to Plenaxis® and the sale of Plenaxis® for new patients in the United States.  Even if Plenaxis® is approved in Germany, such approval maynot be considered commercially acceptable by our partner, Schering AG, or otherpotential collaborators. In such a case, we may not have sufficient funds tocontinue operations as currently planned.

 

In addition,even if regulatory approval is obtained for any of our products, the product(s)and the manufacturing facilities for our product(s) will be subject tocontinual review and periodic inspection by regulatory authorities. Laterdiscovery of previously unknown problems with a product, manufacturer orfacility may result in restrictions on the product, the manufacturer or us,including withdrawal of the product from the market. The FDA and comparableforeign regulatory authorities stringently apply regulatory standards. Ourmanufacturing facilities will also be subject to

 

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FDA and foreign regulatory inspections for adherence to goodmanufacturing practices prior to marketing clearance and periodically duringthe manufacturing process. Failure to comply can, among other things, result infines, denial or withdrawal of regulatory approvals, product recalls orseizures, operating restrictions, injunctions and criminal prosecution. Ifthere are any modifications to a product, further regulatory approval will berequired.

 

Our manufacturing, sales, promotion, andother activities following product approval are subject to regulation bynumerous regulatory authorities in addition to the FDA and comparableregulatory authorities outside the United States, including potentially theFederal Trade Commission, the Department of Justice and individual U.S.Attorney offices within the Department of Justice, CMS, other divisions of theDepartment of Health and Human Services, state and local governments andcomparable governmental authorities outside the United States. Sales, marketingand scientific/educational programs must comply with the anti-kickbackprovisions of the Social Security Act, the False Claims Act, and similar statelaws. Pricing and rebate programs must comply with pricing and reimbursementrules, including the Medicaid rebate requirements of the Omnibus BudgetReconciliation Act of 1990 and the Veteran’s Health Care Act. If products aremade available to authorized users of the Federal Supply Schedule of theGeneral Services Administration, additional laws and requirements apply. All ofour activities are potentially subject to federal and state consumer protectionand unfair competition laws and comparable foreign laws.

 

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

 

If we are unableto obtain foreign regulatory approvals for Plenaxis®, or to successfully carry out the otherelements of our operating plan, which include the continued clinicaldevelopment of PPI-2458, we may need to raise additional capital and, if wewere unable to do so, it could become necessary for us to cease operations orseek protection under state or federal bankruptcy laws.

 

**If our corporate collaborator reduces, delaysor terminates its support, we may be unable to successfully commercializePlenaxis**®**outside of the United States.**

 

We willdepend upon our corporate collaborator, Schering AG, to commercialize Plenaxis® in Schering AG’s licensed territory. Despiteour collaborative relationship, we have limited influence over the amount andtiming of resources that Schering AG will devote to Plenaxis®. Even if marketing approval for Plenaxis®is obtained in Germany, we cannot assure investors that Schering AG will findthat the label included as part of such approval is commercially acceptable forpurposes of our collaboration agreement or that it will proceed tocommercialize Plenaxis® in Germany or elsewhere in its licensedterritory. In addition, Schering AG may terminate our collaboration agreementin various circumstances. For example, Schering AG has the right toterminate the agreement at any time in its sole discretion because the productwas not approved in Germany by June 30, 2005. Schering AG may alsoterminate the agreement if the terms of the German approval do not meet certain criteria in the agreementdefining a commercially acceptable label. We cannot assure investors that Schering AG will not terminate ouragreement. Moreover, we cannot assure investors that Schering AG or futurecollaborators will meet their obligations to us under our collaborationagreements with them. If Schering AG or another collaborator terminates itsagreement with us or fails to perform, or delays performance of, itsobligations, it could delay or otherwise adversely affect or prevent, thecommercialization of Plenaxis® in certain regions outside of the United States. As a result, we couldbe forced to devote unforeseen additional resources to Plenaxis® commercialization outside of the UnitedStates. We cannot assure investors that we would be able to raise the necessaryfunds or negotiate additional corporate collaborations on acceptable terms, ifat all, and in that event we could have to curtail planned operations for thecommercialization of Plenaxis® outside of the United States and would not be able to successfully carryout our current operating plan. As described in the second risk factor in this section andelsewhere in this report, if we are unable to successfully carry out the keyelements of our operating plan we may need to raise additional capital and, ifwe were unable to do so, it could become necessary for us to significantlycurtail or cease operations or seek protection under state or federalinsolvency or bankruptcy laws.

 

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**If Plenaxis**®**fails to achieve market acceptance outside of theUnited States, it may never be commercially successful and we may haveinsufficient funds to continue our operations as currently planned.**

 

The successof our business is dependent in part on the successful commercialization ofPlenaxis®abroad. Sales of Plenaxis®  in theUnited States were significantly lower than expected, leading to our decisionin May 2005 to voluntarily discontinue promotional activities related toPlenaxis® and the sale of Plenaxis® for new patients in theUnited States. We have filed anapplication with the German regulatory authorities seeking approval to marketPlenaxis® for a broadpopulation of advanced prostate cancer patients. Assuming that Plenaxis® is approved in Germany, we intend to seekapproval in other countries in the European Union under the mutual recognitionprocedure. However, even if Plenaxis® is approved for marketing outside of the United States, we cannot becertain that the drug will provide benefits considered adequate by providers ofurology or oncology services or that enough providers will use the product toensure its commercial success. Assuming we obtain a commercially acceptableapproval of Plenaxis®in Germany and other countries abroad, many factors may affect its market acceptanceand commercial success, including:

 

•                                          the scope of the patient population and theindication for which Plenaxis® is approved;

 

•                                          the terms of any marketing restrictions thatmay be imposed by foreign regulatory authorities in connection with the approvalof Plenaxis®;

 

•                                          the product labeling and product insertrequired by foreign regulatory authorities;

 

•                                          the effectiveness of Plenaxis® and the potential side effects, including therisk of immediate-onset systemic allergic reactions, as compared to alternativetreatment methods;

 

•                                          the price of Plenaxis® and the availability of insurance or otherthird-party reimbursement for patients, and the rate of such reimbursement;

 

•                                          the extent and success of the marketing andsales efforts of Schering AG or our other corporate collaborator(s), if any;

 

•                                          the competitive features of Plenaxis® as compared to other products or treatmentoptions, including the frequency of administration of Plenaxis® as compared to other products, and doctorand patient acceptance of these features; and

 

•                                          unfavorable publicity concerning Plenaxis® or any similar products.

 

Any or allof the factors identified above may limit sales of Plenaxis® or cause sales of Plenaxis® to decline. If we or our collaborators areunable to successfully commercialize Plenaxis® outside of the United States, we may haveinsufficient funds to continue our operations as contemplated by our currentoperating plan. In those circumstances, or if we are unsuccessful in carryingout the other key elements of our operating plan, we would have to obtainadditional sources of funding or scale back or cease operations. If we requireadditional funding and were unable to obtain it, it could become necessary forus to seek protection under state or federal insolvency or bankruptcy laws.

 

**We may be unable to establish or maintainmarketing and sales capabilities or enter into and maintain corporatecollaborations necessary to successfully commercialize Plenaxis**®**outside of Schering AG’s licensed territories or to commercializeour other potential products in the United States or abroad in the future.**

 

We havelimited experience in marketing or selling pharmaceutical products and havevery limited marketing and sales resources. To achieve commercial success forany approved product, we must either rely upon our limited experience andinfrastructure, or enter into arrangements with others to market and sell ourproducts. During 2004, we entered into an agreement with Schering AG, ofBerlin, Germany, for the commercialization of Plenaxis® in the field of prostate cancer acrossEurope, Russia, the Middle East, South Africa, Australia and New Zealand. However,as noted in the risk factor above captioned “If our corporate collaboratorreduces, delays or terminates its support, we may be unable to successfullycommercialize Plenaxis® outside of the United States,” our marketing and distribution arrangementwith Schering AG may terminate or may not be successful, and we may not receiveany revenues from it. Also, we cannot assure investors that we will be able toenter into marketing and sales agreements on acceptable terms, if

 

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at all, for Plenaxis® in territories not covered by theSchering AG agreement, or for any of our other product candidates.

 

Until May 2005,we were promoting Plenaxis® in the United States through our own dedicated marketing and sales team.We experienced significant turnover in both our sales management and fieldsales personnel which we believe had an adverse impact on our ability tocommercialize Plenaxis®. In May 2005, in connection with the strategic restructuringof our operations, we voluntarily discontinued promotional activities relatedto Plenaxis® and the sale of Plenaxis® for new patientsin the United States, and accordingly, we terminated all of our sales andmarketing personnel. Competition forexperienced and skilled marketing and sales personnel is intense, and we cannotassure investors that we would be able to attract and retain a sufficientnumber of qualified individuals to successfully promote any other potentialproduct in the future. In addition, establishing the expertise necessary tosuccessfully market and sell any product requires a substantial capitalinvestment. We cannot assure investors that we will have the funds tosuccessfully commercialize any other potential product in the United States orelsewhere. Moreover, our product candidates in development are likely tocompete with products of other companies that currently have extensive andwell-funded marketing and sales operations. Because these companies are capableof devoting significantly greater resources to their marketing and salesefforts, our future marketing and sales efforts may not compete successfullyagainst the efforts of these other companies.

 

**As Plenaxis**®**is used commercially, unanticipated side effects oradverse reactions could occur that could negatively impact the marketopportunity for Plenaxis**®**outside of the United States.**

 

Duringresearch and development, the use of pharmaceutical products, such as Plenaxis®, is limited principally to clinical trialpatients under controlled conditions and under the care of expert physicians. Dueto the occurrence of immediate-onset systemic allergic reactions in patientstreated with Plenaxis®during clinical trials, Plenaxis® was approved in the United States under regulations concerning drugswith certain safety profiles, under which the FDA has established specialrestrictions to ensure safe use. Plenaxis® was launched for commercial use in theUnited States in January 2004, and although we voluntarily discontinuedthe promotion of Plenaxis® and its sale for new patients in May 2005, the product remainsavailable to patients who were on therapy at or prior to such time. Thecontinued commercial use of Plenaxis® could produce unanticipated or undesirable side effects that have notbeen evident in our clinical trials. In addition, in patients who take multiplemedications, drug interactions could occur that can be difficult to predict. Weare seeking approval to market Plenaxis® for a broad population of advanced prostatecancer patients in Germany and, assuming such approval, will seek approval inother countries outside of the United States. If we gain approval for Plenaxis® outside of the United States, the occurrenceof immediate-onset systemic allergic reactions, or unanticipated side effectsor adverse reactions, among other events, could result in the imposition ofregulatory controls that could limit the circumstances under which Plenaxis® is prescribed or otherwise negatively impactthe market opportunity for Plenaxis® outside of the United States.

 

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

 

We are focusing our early stage drugdiscovery efforts on our proprietary Direct SelectTM drug discovery technology,and our future success depends in part on the successful development of thistechnology, as well as our ability to enter into collaborations relating tothis technology. We believe that Direct SelectTM is a novel technology that willallow us to rapidly and directly identify compounds that are orally availableand have high affinity and specificity. However, we cannot assure investorsthat this technology will allow us to offer significant advantages overtraditional drug discovery methods. For example, the feasibility of creatingand screening ultra-large advanced combinatorial chemistry libraries resultingin successful leads is still in the development stage. Moreover, we may not beable to identify novel compounds from the libraries that we create that canaddress a wide spectrum of targets or that can be rapidly taken into clinicaldevelopment and that ultimately lead to marketable products. If we are notsuccessful in continuing to enhance this technology and in identifying productcandidate(s) using this technology for either a partner or for internaldevelopment, we would be required to significantly modify our operating plan.

 

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Given our strategic focus on formingpartnerships with respect to our Direct SelectTM technology, we are alsodependent upon the extent to which pharmaceutical and biotechnology companiescontinue to collaborate with outside companies to obtain drug discoveryexpertise. Our revenue will depend, in part, on research and developmentexpenditures by pharmaceutical and biotechnology companies, particularlycompanies outsourcing research and development projects and adding new andimproved technologies to accelerate their drug discovery and developmentinitiatives. Our capabilities include aspects of the drug discovery processthat pharmaceutical companies have traditionally performed internally. Althoughthere is a history among pharmaceutical and biotechnology companies ofoutsourcing drug research and development functions, this practice may notcontinue. Our ability to convince one or more of these companies to use ourdrug discovery technology and capabilities rather than develop them internallywill depend on many factors, including our ability to:

 

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

 

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

 

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

 

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

 

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

 

We dependsubstantially on the principal members of our management and scientific staff,including Kevin F. McLaughlin, our President and Chief Executive Officer, MarcB. Garnick, M.D., our Executive Vice President and Chief Medical and RegulatoryOfficer, and Richard W. Wagner, Ph.D., our Executive Vice President, DiscoveryResearch. We do not have employment agreements with any of our executiveofficers. Any officer or employee can terminate his or her relationship with usat any time and work for one of our competitors. The loss of these keyindividuals could result in competitive harm because we could experience delaysin the development of our drug discovery technology or our product research,development and commercialization efforts without their expertise.

 

Recruitingand retaining qualified scientific personnel to perform future research anddevelopment work also will be critical to our success. Competition for skilledpersonnel is intense and the turnover rate can be high. We compete withnumerous companies and academic and other research institutions for experiencedscientists. This competition may limit our ability to recruit and retainqualified personnel on acceptable terms. Moreover, due to our recent strategicrestructuring and our limited resources compared to many of our competitors, wemay face additional challenges when recruiting qualified personnel in thefuture. Failure to attract and retain qualified personnel would prevent us fromcontinuing to develop our potential products, enhancing our technologies andlaunching our products commercially.

 

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

 

We havecontracts with a limited number of research organizations to design and conductour laboratory testing and human clinical studies. If we cannot contract fortesting activities on acceptable terms, or at all, we may not complete ourproduct development efforts in a timely manner. To the extent we rely on thirdparties for laboratory testing and human clinical studies, we may lose somecontrol over these activities. For example, third parties may not completetesting activities on schedule or when we request them to do so. Inaddition, these third parties may conduct our clinical trials in a mannerinconsistent with regulatory requirements or otherwise in a manner that yieldsmisleading or unreliable data. This, or other failures of these third partiesto carry out their duties, could result in significant additional costs andexpenses and could delay or prevent the development and commercialization ofour product candidates.

 

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**If we fail to develop and maintain ourrelationships with third-party manufacturers, or if these manufacturers fail toperform adequately, we may be unable to commercialize Plenaxis**®**outside of the United States or to develop andcommercialize any of our product candidates.**

 

Our abilityto conduct, or continue to conduct, large clinical trials, to commercializePlenaxis®outside the United States if we obtain the requisite regulatory approvals or tocommercialize other product candidates, 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 regulatory requirements. Wemust establish and maintain a commercial scale formulation and manufacturingprocess for each of our potential products for which we seek marketing approval.We or third-party manufacturers may encounter difficulties with these processesat any time that could result in delays in clinical trials, regulatorysubmissions or in the commercialization of potential products.

 

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

 

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

 

In addition,we and the third-party manufacturers that we use must continually adhere tocurrent good manufacturing practice requirements enforced by the FDA throughits facilities inspection program. Foreign regulatory authorities may alsoinspect our third-party manufacturers as a condition of obtaining andmaintaining the requisite approvals. In complying with these requirements, weand any of our third-party manufacturers will be obligated to expend time,money and effort in production, record-keeping and quality control to assurethat our potential products meet applicable specifications and otherrequirements. If we or any of our third-party manufacturers fail to comply withthese requirements, we may be subject to regulatory sanctions, manufacturingdelays, or the facilities could be shut down.

 

Any of thesefactors could prevent, or cause delays in, obtaining regulatory approvals forour potential products, and the manufacturing, marketing or selling of Plenaxis®, and could also result in significantlyhigher operating expenses.

 

**The loss or failure of any of our third-partymanufacturers could result in substantial delays in, or substantially impairour ability to complete, foreign regulatory submissions or reviews orsubstantially delay or impair our sale of Plenaxis**®**outside the United States if we obtainthe requisite regulatory approvals.**

 

For eachstage of Plenaxis® production we have relied, and expect in the near term to continue torely, on a single source third-party manufacturer. Accordingly, the loss of oneor more of these third-party suppliers for any reason, including as a result offire, terrorism, acts of God or insolvency or bankruptcy, could result in substantialdelays in, or substantially impair our ability to complete, foreign regulatorysubmissions or reviews for Plenaxis or delay or impair substantially our saleof Plenaxis®****outside the United States if we obtain therequisite regulatory authority. Such delays or impairment, and the associatedcosts and expenses, may lower our potential revenues and delay or prevent ourattaining profitability. While we evaluate from time to time, as part of ourstrategic planning process, the possibility of a second source of supply atcertain stages of Plenaxis® production, the number of qualified alternative

 

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suppliers is limited, and we cannot assure investors that we will beable to locate alternative suppliers or negotiate second supply agreements onreasonable terms. Furthermore, the process of engineering a new supplier’sfacility for the production of Plenaxis® and obtaining the necessaryregulatory approvals of the facility would require substantial lead-time andcould be extremely costly. We cannot assure investors that we will not lose oneor more of our suppliers, or that in such event we would be readily able toobtain regulatory approvals for Plenaxis® and commercialize orcontinue the commercialization of, Plenaxis® without substantial andcostly delays.

 

**Our potential revenues may diminish if we orour corporate collaborator(s) fail to obtain acceptable prices or adequatereimbursement for Plenaxis® or our other product candidates fromthird-party payors.**

 

The continuing efforts of government andthird-party payors to contain or reduce the costs of health care may limit ourcommercial opportunity. In some foreign markets, pricing and profitability ofprescription pharmaceuticals are subject to government control. We cannotassure investors that if Plenaxis® is approved outside of the UnitedStates, that we or our corporate collaborators will be able to obtain adequatereimbursement to support its commercialization. In the United States, we expectthat there will continue to be federal and state proposals for similar controls.In addition, managed care initiatives in the United States will continue to putpressure on the pricing of pharmaceutical products. Cost control initiativescould decrease the price that we receive for any products in the future.Further, cost control initiatives could impair or diminish our ability orincentive, or the ability or incentive of potential partners, to commercializePlenaxis® or any of our other products, and our ability to earnrevenues from this commercialization.

 

Our ability to earn revenues from thecommercialization of pharmaceutical products, alone or with collaborators, maydepend in part on the availability of reimbursement for our products in theUnited States or abroad from:

 

•                                          governmentand health administration authorities;

 

•                                          privatehealth insurers; and

 

•                                          otherthird party payors, including Medicare and Medicaid.

 

We cannot predict the availability ofreimbursement for newly approved drugs. Third-party payors, including Medicare,are increasingly challenging the prices charged for medical products andservices. Government and other third-party payors increasingly are limitingboth coverage and the level of reimbursement for new drugs and, in some cases,refusing to provide coverage for a patient’s use of an approved drug forpurposes not approved by the FDA. Accordingly, third-party insurance coveragemay not be available to patients for Plenaxis®, particularly outsideof the United States, or for any of our other potential products.

 

**If we fail to meet the Nasdaq National Market’sminimum bid price continued listing standard our common stock may be delistedfrom the Nasdaq National Market.**

 

The market price of our common stock hasdeclined substantially. On June 7,2005, we received a letter from The Nasdaq Stock Market notifying us that for30 consecutive trading days the bid price of our common stock closed below theminimum $1.00 per share required for continued inclusion under the Nasdaq Rules.If the bid price of our common stock does not equal or exceed $1.00 fora minimum of 10 consecutive business days during the subsequent 180 calendarday period following the date of the notice (by December 5, 2005), TheNasdaq Stock Market could take action seeking to delist our common stock fromthe Nasdaq National Market. If we met the initial listing requirements of theNasdaq SmallCap Market, other than its minimum bid price requirement, we couldapply to transfer our common stock to the Nasdaq SmallCap Market and, if thatapplication were approved, we would be afforded the remainder of the NasdaqSmallCap Market’s additional 180 calendar day compliance period to meet the$1.00 per share minimum bid price requirement for continued listing on theNasdaq SmallCap Market.

 

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We can not assure investors that we will beable to regain compliance with the minimum bid price rule by December 5,2005, that we will be eligible to transfer to the Nasdaq SmallCap Market orthat, if we are able to transfer to the Nasdaq SmallCap Market, that we will beable to regain compliance with the minimum bid price rule within anyadditional compliance period. Moreover, delisting of our common stock from theNasdaq National Market, even if it were listed and traded on the NasdaqSmallCap Market, would likely result in reduced liquidity, thereby increasingthe volatility of the trading price, of our common stock, a loss of current orfuture coverage by certain analysts and a diminution of institutional investorinterest. It could also potentially cause a loss of confidence of corporatecollaborators, contract manufacturers and our employees, which could adverselyaffect our business.

 

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

 

Theadministration of drugs to humans, whether in clinical trials or commercially,can result in product liability claims whether or not the drugs are actually atfault for causing an injury. As Plenaxis® is used more widely, the likelihood of anadverse drug reaction (both expected or unexpected) or unintended side effectwill increase. Furthermore, Plenaxis® or our product candidates may cause, or may appear to have caused,adverse side effects (including death) or potentially dangerous druginteractions that we may not learn about or understand fully until the drug hasbeen administered to 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 has decreased. Althoughwe carry insurance that we regard as reasonably adequate to protect us frompotential claims, there can be no assurance that we will be able to maintainour current product liability insurance at a reasonable cost, or at all. Ourformer collaboration agreements included, and the agreements regarding thetermination of those collaborations also include, an indemnification forliabilities associated with the development and commercialization of Plenaxis®. Our agreement with Schering AG containssimilar indemnification provisions. If a third party, including a formercollaborator, successfully sues us for any injury, or for indemnification forlosses, there is no guarantee that the amount of the claim would not exceed thelimit of our insurance coverage. Even if a product liability claim is notsuccessful, the adverse publicity and time and expense of defending such aclaim may interfere with our business.

 

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

 

Abiopharmaceutical company such as ours must keep pace with rapid technologicalchange and faces intense competition. We compete with biotechnology and pharmaceuticalcompanies for funding, access to new technology, research, medical and managementpersonnel, and in product research and development. Many of these companieshave greater financial resources and more experience than we do in developingdrugs or drug discovery technologies, obtaining regulatory approvals,manufacturing, marketing and sales. We also face competition from academic andresearch institutions and government agencies pursuing alternatives to ourproducts and technologies. We expect that Plenaxis®, as well as products under development, willface intense competition from existing or future drugs and other medicaltreatments. In addition, for each of our product candidates, we may faceincreasing competition from generic formulations or existing drugs whose activecomponents are no longer covered by patents. We also expect to face competitionfrom other companies that are developing drug discovery technologies that offeradvantages similar to or better than those of our Direct SelectTM technology.

 

Ourcompetitors may:

 

•                                          develop drug discovery technologies that arefaster, more efficient or more advanced than our technology;

 

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

 

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

 

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

 

•                                          successfully market and sell products thatcompete with our products.

 

The success of our competitors in any ofthese efforts would adversely affect our ability to develop and commercializePPI-2458 or other potential product candidates, to further enhance and refineand eventually partner our Direct SelectTM technology, to sell Plenaxis®, particularly outside of the United States,and to ultimately attain and maintain profitability.

 

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

 

Our successwill depend in part on our ability to obtain patents and maintain adequateprotection of our technologies and potential products. If we do not adequatelyprotect our intellectual property, competitors may be able to use ourtechnologies and erode any competitive advantage we may have. For example, ifwe are unable to obtain adequate patent protection for our Direct SelectTMtechnology, another party could offer drug discovery capabilities that directlycompete with our capabilities or could attempt to block our ability to practiceour technology. Additionally, if we lose our patent protection for Plenaxis®, another party could produce and market thecompound in direct competition with us. Some foreign countries lack rules andmethods for defending intellectual property rights and do not protectproprietary rights to the same extent as the United States. Many companies havehad difficulty protecting their proprietary rights in foreign countries.

 

Patentpositions are sometimes uncertain and usually involve complex legal and factualquestions. We can protect our proprietary rights from unauthorized use by thirdparties only to the extent that our proprietary technologies are covered byvalid and enforceable patents or are effectively maintained as trade secrets.We currently own or have exclusively licensed 29 issued United States patents.We have applied, and will continue to apply, for patents covering both ourtechnologies and products as we deem appropriate. Others may challenge ourpatent applications or our patent applications may not result in issuedpatents. Moreover, any issued patents on our own inventions, or those licensedfrom third parties, may not provide us with adequate protection, or others maychallenge the validity of, or seek to narrow or circumvent, these patents. Third-partypatents may impair or block our ability to conduct our business. Additionally,third parties may independently develop products similar to our products,duplicate our unpatented products, or design around any patented products wedevelop.

 

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

 

In additionto patents, we rely on a combination of trade secrets, confidentiality,nondisclosure and other contractual provisions, and security measures toprotect our confidential and proprietary information. These measures may notadequately protect our trade secrets or other proprietary information. If thesemeasures do not adequately protect our rights, third parties could use ourtechnology, and we could lose any competitive advantage we may have. Inaddition, others may independently develop similar proprietary information ortechniques, which could impair any competitive advantage we may have.

 

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

 

Ourtechnologies, processes, product or product candidates may give rise to claimsthat they infringe patents or other intellectual property rights of thirdparties. A third party could force us to pay damages, stop our use of thesetechnologies or processes, or stop our manufacturing or marketing of theaffected products by bringing a legal action against us for infringement. Inaddition, we could be required to obtain a license to continue to use thetechnologies or processes or to manufacture or market the affected products,and we may not be able to do so on acceptable terms or at all. We believe that

 

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significant litigation will continue in our industry regarding patentand other intellectual property rights. If we become involved in litigation, itcould consume a substantial portion of our resources. Even if legal actionswere meritless, defending a lawsuit could take significant time, be expensiveand divert management’s attention from other business concerns.

 

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

 

We licensesome of our technology from third parties. Termination of our licenses couldforce us to delay or discontinue some of our development and commercializationprograms. For example, if Advanced Research and Technology Institute, Inc.,the assignee of Indiana University Foundation, terminated our license with themdue to a breach by us of the terms of that license, we could have todiscontinue the commercialization of Plenaxis®. We cannot assure investors that we would beable to license substitute technology in the future. Our inability to do socould impair our ability to conduct our business because we may lack thetechnology, or the necessary rights to technology, required to develop andcommercialize our potential products.

 

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

 

As describedin detail in this report under Part II, Item 1. “Legal Proceedings,” in December 2004and January 2005, the Company, Chairman and (now former) Chief ExecutiveOfficer Malcolm Gefter, President and (now former) Chief Operating OfficerKevin F. McLaughlin, Chief Financial Officer and Treasurer Edward C. English,and former President and Chief Operating Officer William K. Heiden, were namedas defendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts. The complaintsgenerally allege securities fraud during the period from November 25, 2003through December 6, 2004. Each of the complaints purports to assert claimsunder Sections 10(b) and 20(a) of the Securities and Exchange Act of1934 and Rule 10b-5 promulgated thereunder, and alleges that the Companyand the individually named defendants made materially false and misleadingpublic statements concerning the Company’s business and financial results,particularly statements regarding the commercialization of Plenaxis®. The complaints were consolidated into oneaction in April 2005. In August 2005, lead plaintiffs filed a consolidatedamended complaint.

 

Managementbelieves that the allegations against the Company are without merit, and theCompany intends to vigorously defend against the plaintiffs’ claims. As thislitigation is in an initial stage, management is unable to predict its outcomeor its ultimate effect, 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 and officer liability insurance policies(which, subject to the terms and conditions thereof, also provide “entitycoverage” for the Company for this litigation) provide that the Company isresponsible for the first $2.5 million of such costs and expenses. Also, ajudgment in or settlement of these actions could exceed our insurance coverage.If we are not successful in defending these actions, our business and financialcondition could be adversely affected. In addition, whether or not we aresuccessful, the defense of these actions may divert the attention of ourmanagement and other resources that would otherwise be engaged in running ourbusiness.

 

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

 

Pharmaceuticalcompanies have been the target of lawsuits and investigations including, inparticular, claims asserting violations of the Federal False Claim Act,Anti-Kickback Act, the Prescription Drug Marketing Act or other violations inconnection with Medicare and/or Medicaid reimbursement, and claims under state laws,including state anti-kickback and fraud laws. Similar actions, investigationsand claims may also be brought or arise under comparable foreign laws. Publiccompanies may also be the subject of certain other types of claims, includingthose related to environmental matters. There is no assurance that if we wereto be involved in any such lawsuits or investigation, that we would besuccessful in defending ourselves or in asserting our rights. Governmentinvestigations of these sorts of

 

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issues are typically expensive, disruptive and burdensome, and generatenegative publicity. If our previous promotional activities with respect toPlenaxis® were found to be in violation of the law, we would likelyface significant fines and penalties. In addition, we and our senior officerscould be civilly or criminally prosecuted, potentially resulting in ourexclusion from participation in government healthcare programs such as Medicareand Medicaid.

 

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

 

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

 

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

 

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

 

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

 

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

 

As directedby Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiringpublic companies to include a report of management on the Company’s internalcontrol over financial reporting in their annual reports on Form 10-K thatcontains an assessment by management of the effectiveness of the company’sinternal control over financial reporting. In addition, the independentregistered public accounting firm auditing the Company’s financial statementsmust attest to and report on management’s assessment and on the effectivenessof the Company’s internal control over financial reporting. Our independentregistered public accounting firm provided us with an unqualified report as toour assessment and the effectiveness of our internal control over financialreporting as of December 31, 2004, which report was included in our AnnualReport on Form 10-K for the year ended December 31, 2004. However, wecannot assure investors that management or our independent registered publicaccounting firm will be able to provide such an assessment or unqualifiedreport as of future year-ends as required by Section 404 of theSarbanes-Oxley Act of 2002. In this event, investors could lose confidence

 

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in the reliability of our financial statements, which could result in adecrease in the market value of our common stock.

 

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

 

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

 

•                                          our ability to enter into United States orforeign corporate collaborations for our product candidate, PPI-2458, and ourDirect SelectTM drug discovery technology, and the timing and terms of suchcollaborations;

 

•                                          the success rate of our discovery efforts,particularly utilizing our Direct SelectTM drug discovery technology, and ourclinical trials;

 

•                                          announcement of foreign regulatory approvalor disapproval of Plenaxis® and/or associated labeling requirements;

 

•                                          the willingness of our corporate collaborator,Schering AG, to commercialize Plenaxis® in territories outside of the United Statesand the timing and success of that commercialization;

 

•                                          the loss of our corporate collaborator,Schering AG, failure or delay by our corporate collaborator in performing itsobligations or disputes with our corporate collaborator;

 

•                                          the availability of reimbursement coveragefor Plenaxis® outsideof the United States and changes in the reimbursement policies of third-partyinsurance companies or foreign government agencies;

 

•                                          announcements regarding the possibledelisting of our common stock from the NASDAQ National Market;

 

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

 

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

 

•                                          our ability to enter into additional foreigncorporate collaborations for Plenaxis®;

 

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

 

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

 

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

 

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

 

•                                          changes in government regulation of thepharmaceutical or medical industry;

 

•                                          our ability to sell our corporateheadquarters and research facility and the terms of any such sale;

 

•                                          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.

 

In addition,the stock market has experienced extreme price and volume fluctuations. Themarket prices of the securities of biotechnology companies, particularlycompanies like ours with limited product revenues and without earnings, havebeen highly volatile, and may continue to be highly volatile in the future.This volatility has often been unrelated to the operating performance ofparticular companies. In 

 

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the past, securities class action litigation has often been broughtagainst companies that experience volatility in the market price of theirsecurities. Whether or not meritorious, litigation brought against us couldresult in substantial costs and a diversion of management’s attention andresources.

 

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

 

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

 

•                                          the timing and scope of approvals to marketPlenaxis® outside ofthe United States;

 

•                                          the timing and success of thecommercialization of Plenaxis® outside of the United States;

 

•                                          the timing of corporate collaborationsrelating to our PPI-2458 and our Direct SelectTM drug discovery technology resulting in revenues; and

 

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

 

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

 

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

 

Provisionsin our certificate of incorporation and by-laws may delay or prevent anacquisition of us or a change in our management. Also, because we areincorporated in Delaware, we are governed by 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%or more of our common stock without the approval of our board of directors.These provisions in our charter and by-laws, rights agreement and underDelaware law could reduce the price that investors might be willing to pay forshares of our common stock in the future and result in the market price beinglower than it would be without these provisions.

 

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

 

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

 

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

 

The primary objective of our investmentactivities is to preserve principal while at the same time maximizing theincome we receive from our investments without significantly increasing risk. Wehave not entered into any instruments for trading purposes. Some of thesecurities that we invest in may have market risk. This means that an increasein prevailing interest rates may cause the principal amount of the investmentto decrease. To minimize this risk in the future, we maintain our portfolio ofcash equivalents and short-term investments in a variety of securities,including commercial paper, money market funds and government andnon-government debt securities. An immediate hypothetical 100 basis pointincrease in interest rates would have resulted in an approximate $0.1 milliondecrease in the fair value of our investments as of June 30, 2005. Thesame hypothetical increase in interest rates as of December 31, 2004 wouldhave resulted in an approximate $0.2 million decrease in the fair value of ourinvestments. Due to the conservative nature and relatively short duration ofour investments, interest rate risk is mitigated. As of June 30, 2005,approximately 98% of our total investments will mature or reset in one year orless, with the remainder maturing in less than two years.

 

In connection with the purchase of our newfacility in July 2000, our wholly owned real estate subsidiary executed anacquisition and construction loan agreement that provided for up to$33.0 million in borrowings at a floating interest rate indexed to 30-dayLIBOR. In July 2003, we exercised the first of two one-year extensionoptions extending the maturity date of the loan until July 30, 2004. Inconnection with this extension, the subsidiary entered into an interest ratecap agreement which limited exposure to interest rate increases above a certainthreshold through July 30, 2004.

 

In June 2004, the acquisition andconstruction loan agreement was amended to extend the maturity date of the loanand modify certain other terms of the original agreement. Under the amendedloan agreement, on July 30, 2009 the principal amount then outstanding isdue and payable in full, subject to two one-year extension options which areexercisable at our election provided we are in compliance with certainfinancial covenants. The outstanding principal bears interest at a fixed rateof 5.95% through April 2009 and at a floating rate for the remainder ofthe term. Principal and interest are payable through a fixed monthly payment ofapproximately $207,000, with the principal portion being calculated using a 25-yearamortization schedule. Because of this amendment to the loan agreement, we donot believe that there is material interest rate risk exposure with respect tothe loan facility. The amended loan agreement also provides for certainadditional financial operating covenants, one of which was effectiveimmediately and the remainder of which will become effective as of December 31,2006. The covenant which was immediately effective is tested on a quarterlybasis and requires that we maintain $25.0 million in unrestricted cash, cashequivalents and marketable securities. We are also subject to other covenantsrelating to the value of the property securing the debt relative to the totaldebt outstanding under the amended loan agreement, as well as the lease incomethreshold required in connection with the established debt service coverageratio. In addition, we are actively pursuing the sale of our corporateheadquarters and research facility. In the event that we are unable to sell thefacility in a timely manner and are unable to successfully carry out ouroperating plan, we will likely default on our financial covenants under theloan agreement.

 

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

 

*(a)*                               *DisclosureControls and Procedures*.

 

The Company’s management, with theparticipation of our chief executive officer and chief financial officer, hasevaluated the effectiveness of the Company’s disclosure controls and procedures(as defined in Rules 13a-15(e) or 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2005.Based on such evaluation, our chief executive officer and chief financialofficer have concluded that, as of June 30, 2005, the Company’s disclosurecontrols and procedures were effective in ensuring that information required tobe disclosed by the Company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in applicable rules and forms of the Securities andExchange Commission, and is accumulated and communicated to the Company’smanagement, including the Company’s chief executive officer and chief financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

37

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

 

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

 

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**PART II. OTHER INFORMATION**

 

**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, ChiefFinancial Officer and Treasurer Edward C. English, and former President andChief Operating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. Those purported class actions arecaptioned Katz v. Praecis Pharmaceuticals Inc., Malcolm Gefter, KevinMcLaughlin, Edward English and William K. Heiden, Civil Action No. 04-12581-GAO(filed December 9, 2004), Schwartz v. Praecis Pharmaceuticals Inc.,Malcolm Gefter, Kevin McLaughlin, Edward English and William K. Heiden,Civil Action No. 04-12704-REK (filed December 27, 2004) and Bassinv. Praecis Pharmaceuticals Inc., Malcolm L. Gefter, Ph.D., Kevin F. McLaughlin,Edward C. English and William K. Heiden, Civil Action No. 05-10134-GAO(filed January 21, 2005). The complaints generally allege securities fraudduring the period from November 25, 2003 through December 6, 2004. Eachof the complaints purports to assert claims under Sections 10(b) and 20(a) ofthe Securities and Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder, and alleges that the Company and the individually named defendantsmade materially false and misleading public statements concerning the Company’sbusiness and financial results, particularly relating to statements regardingthe commercialization of Plenaxis®.

 

On February 7, 2005, a motion was filedto consolidate the Katz, Schwartz and Bassin actions andto appoint lead plaintiffs and lead counsel. On February 18, 2005, 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 Ordergranting the plaintiffs’ motion to consolidate the three actions (as well aseach case that relates to the same subject matter that may be subsequentlyfiled in or transferred to the United States District Court for the District ofMassachusetts), appoint lead plaintiffs and approve such plaintiffs’ selectionof co-lead counsel. The consolidated actions are captioned IN RE PRAECISPHARMACEUTICALS, INC. SECURITIES LITIGATION, Civil Action No. 04-12581-GAO.On August 1, 2005, lead plaintiffs filed a consolidated amended complaint. Atthis time, plaintiffs have not specified the amount of damages they are seekingin the actions.

 

Management believes that the allegationsagainst the Company are without merit, and the Company intends to vigorouslydefend against the plaintiffs’ claims. As this litigation is in an initialstage, management is unable to predict its outcome or its ultimate effect, ifany, on the Company’s financial condition. However, we expect that the costs and expenses related to this litigationmay be significant. Our current director and officer liability insurancepolicies (which, subject to the terms and conditions thereof, also provide “entitycoverage” for the Company for this litigation) provide that the Company isresponsible for the first $2.5 million of such costs and expenses. Also, ajudgment in or settlement of these actions could exceed our insurance coverage.If we are not successful in defending these actions, our business and financialcondition could be adversely affected. In addition, whether or not we aresuccessful, the defense of these actions may divert the attention of ourmanagement and other resources that would otherwise be engaged in running ourbusiness.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

 

We held our Annual Meeting of Stockholders onMay 12, 2005 to (i) elect eight directors and (ii) ratify theappointment of Ernst & Young LLP as our independent registered publicaccounting firm for fiscal year 2005.

 

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The following nominees were elected, by thevote set forth below, to hold office until the next annual meeting ofstockholders and until their successors are duly elected and qualified:

 
| **Nominee:**                | ** ** | **Number of Votes For:** | ** ** | **Number of Votes Withheld:** | ** ** |
|-----------------------------|------------|--------------------------|------------|-------------------------------|------------|
|                        |       |                     |       |                          |       |
| Malcolm L.  Gefter, Ph.D.   |       | 42,505,040               |       | 5,230,160                     |       |
|                        |       |                     |       |                          |       |
| Kevin F.  McLaughlin        |       | 42,539,592               |       | 5,195,608                     |       |
|                        |       |                     |       |                          |       |
| G. Leonard  Baker, Jr. |       | 42,582,926               |       | 5,152,274                     |       |
|                        |       |                     |       |                          |       |
| Garen G.  Bohlin            |       | 42,744,771               |       | 4,990,429                     |       |
|                        |       |                     |       |                          |       |
| Henry F.  McCance           |       | 42,584,226               |       | 5,150,974                     |       |
|                        |       |                     |       |                          |       |
| Leonard E.  Post, Ph.D.     |       | 42,326,588               |       | 5,408,612                     |       |
|                        |       |                     |       |                          |       |
| David B.  Sharrock          |       | 41,586,695               |       | 6,148,505                     |       |
|                        |       |                     |       |                          |       |
| Patrick J.  Zenner          |       | 36,331,425               |       | 11,403,775                    |       |

 

The stockholders also ratified theappointment of Ernst & Young LLP as our independent registered publicaccounting firm for fiscal year 2005 by the following vote:

 
| **For:**   | ** ** | **Against:** | ** ** | **Abstain:** | ** ** |
|------------|------------|--------------|------------|--------------|------------|
|       |       |         |       |         |       |
| 47,254,629 |       | 427,687      |       | 52,884       |       |

 

**ITEM 5. OTHERINFORMATION.**

** **

***(a)****                              *On May 11, 2005, our Board of Directors approved the SecondAmended and Restated Employee Stock Purchase Plan, which extends the term ofour existing Amended and Restated Employee Stock Purchase Plan through June 2007and provides for four additional six-month exercise periods. The Second Amendedand Restated Employee Stock Purchase Plan also permits employees to withdrawtheir contributions from the plan during a six-month exercise period. TheSecond Amended and Restated Employee Stock Purchase Plan is included as Exhibit 10.1to this report.

** **

***(b)****                              *Not applicable.

 

**ITEM 6. EXHIBITS.**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                       |
| 3.1                 |       | Amended and Restated Certificate of  Incorporation (2)                                                                                                                                     |
|                |       |                                                                                                                                                                                       |
| 3.2                 |       | Third Amended and Restated By-Laws (5)                                                                                                                                                     |
|                |       |                                                                                                                                                                                       |
| 4.1                 |       | Specimen certificate representing shares of  common stock (1)                                                                                                                              |
|                |       |                                                                                                                                                                                       |
| 4.2                 |       | Specimen certificate representing shares of  common stock (including Rights Agreement Legend) (3)                                                                                          |
|                |       |                                                                                                                                                                                       |
| 4.3                 |       | Rights Agreement between the Registrant and  American Stock Transfer & Trust Company, as Rights Agent (4)                                                                         |
|                |       |                                                                                                                                                                                       |
| 4.4                 |       | Form of Certificate of Designations of  Series A Junior Participating Preferred Stock (attached as Exhibit A  to the Rights Agreement filed as Exhibit 4.3 hereto) (4) |
|                |       |                                                                                                                                                                                       |
| 4.5                 |       | Form of Rights Certificate (attached  as Exhibit B to the Rights Agreement filed as Exhibit 4.3 hereto)  (4)                                                                |
|                |       |                                                                                                                                                                                       |
| 10.1                |       | Second Amended and Restated Employee Stock  Purchase Plan*                                                                                                                                 |
|                |       |                                                                                                                                                                                       |
| 31.1                |       | Certification of Chief Executive Officer                                                                                                                                                   |

 

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| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                   |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                          |
| 31.2                |       | Certification of Chief Financial Officer                                                                                                                      |
|                |       |                                                                                                                                                          |
| 32.1                |       | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
|                |       |                                                                                                                                                          |
| 32.2                |       | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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*                                         Representsa compensatory plan or arrangement.

 

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

 

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

 

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

 

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

 

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

 

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**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:  August 5, 2005 | By                                    |      /s/  Edward C. English |   |
|                       |                                  | Edward  C. English |
|                       |                                  | Chief  Financial Officer, Vice President, |
|                       |                                  | Treasurer  and Assistant Secretary |
|                       |                                  | *(Duly  Authorized Officer and Principal Financial  and Accounting Officer)* |

 

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# **EXHIBIT INDEX**

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

 

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*                                         Representsa compensatory plan or arrangement.

 

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

 

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

 

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

 

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

 

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

 

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