**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

| ** **                                             | **(Mark One)** |
|--------------------------------------------------------|----------------|
| ** **                                             | **ý**     | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                             | ** **     | ** ** |
| **For the quarterly period ended  June 30, 2004** |
| ** **                                             | ** **     | ** ** |
| **OR**                                                 |
| ** **                                             | ** **     | ** ** |
| ** **                                             | **o**          | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from         to        **

 

**Commission File Number: 000-30289**

 

**PRAECIS PHARMACEUTICALS INCORPORATED**

(Exact name of registrant as specified in itscharter)

 

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

 

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

(Address of principal executive offices andzip code)

 

**(781) 795-4100**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90days.         Yes ý No o

 

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

 

As of July 31, 2004, there were 52,377,773 sharesof the registrant’s common stock, $.01 par value, outstanding.

 

 

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**PRAECIS PHARMACEUTICALS INCORPORATED**

**FORM 10-Q**

**FOR THEQUARTER ENDED JUNE 30, 2004**

 

**INDEX**

 
| **PART I.**       | **FINANCIAL  INFORMATION**                                                                                      | ** ** |
|-------------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **        | ** **                                                                                                      | ** ** |
| Item  1.          | Financial  Statements (Unaudited)                                                                               |       |
|              |                                                                                                            |       |
|              | Condensed Consolidated Balance Sheets –  December 31, 2003 and June 30, 2004                     |       |
|              |                                                                                                            |       |
|              | Condensed  Consolidated Statements of Operations –  three and six months ended June 30, 2003 and 2004 |       |
|              |                                                                                                            |       |
|              | Condensed  Consolidated Statements of Cash Flows –  six months ended June 30, 2003 and 2004           |       |
|              |                                                                                                            |       |
|              | Notes  to Condensed Consolidated Financial Statements                                                           |       |
|              |                                                                                                            |       |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |       |
|              |                                                                                                            |       |
| Item 3.           | Quantitative  and Qualitative Disclosures About Market Risk                                                     |       |
|              |                                                                                                            |       |
| Item 4.           | Controls and Procedures                                                                                         |       |
|              |                                                                                                            |       |
| **PART II.**      | **OTHER INFORMATION**                                                                                           | ** ** |
| ** **        | ** **                                                                                                      | ** ** |
| Item 4.           | Submission  of Matters to a Vote of Security Holders                                                            |       |
|              |                                                                                                            |       |
| Item 6.           | Exhibits and Reports  on Form 8-K                                                                               |       |
|              |                                                                                                            |       |
| **SIGNATURE**     | ** **                                                                                                      |
| ** **        | ** **                                                                                                      |
| **EXHIBIT INDEX** | ** **                                                                                                      |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1****.****  FINANCIAL STATEMENTS.**

 

**PRAECISPHARMACEUTICALS INCORPORATED**

**Condensed Consolidated BalanceSheets**

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

**(Unaudited)**

 
| ** **                                                                                                                                     | ** ** | **December 31,  2003** | ** ** | **June 30,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **Assets**                                                                                                                                     |       |                        |       |                    |       |
| Current assets:                                                                                                                                |       |                        |       |                    |       |
| Cash and cash equivalents                                                                                                                      |       | $                           | 15,687     |                    | $          | 12,733 |   |
| Marketable securities                                                                                                                          |       | 127,505                     |       | 98,725                  |       |
| Accounts receivable                                                                                                                            |       | —                      |       | 818                     |       |
| Inventory                                                                                                                                      |       | —                      |       | 1,888                   |       |
| Prepaid expenses and other assets                                                                                                              |       | 726                         |       | 1,232                   |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Total current assets                                                                                                                           |       | 143,918                     |       | 115,396                 |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Property and equipment, net                                                                                                                    |       | 67,713                      |       | 65,447                  |       |
| Due from officer                                                                                                                               |       | 833                         |       | 783                     |       |
| Other assets                                                                                                                                   |       | 14                          |       | 215                     |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Total assets                                                                                                                                   |       | $                           | 212,478    |                    | $          | 181,841 |   |
|                                                                                                                                           |       |                        |       |                    |       |
| **Liabilities and  Stockholders’ Equity**                                                                                                 |       |                        |       |                    |       |
| Current liabilities:                                                                                                                           |       |                        |       |                    |       |
| Accounts payable                                                                                                                               |       | $                           | 2,483      |                    | $          | 854 |   |
| Accrued expenses                                                                                                                               |       | 7,707                       |       | 7,374                   |       |
| Deferred revenue                                                                                                                               |       | —                      |       | 167                     |       |
| Current portion of long-term debt                                                                                                              |       | 747                         |       | 578                     |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Total current liabilities                                                                                                                      |       | 10,937                      |       | 8,973                   |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Deferred revenue                                                                                                                               |       | —                      |       | 1,805                   |       |
| Long-term debt                                                                                                                                 |       | 31,880                      |       | 31,675                  |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Commitments and contingencies                                                                                                                  |       |                        |       |                    |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Stockholders’ equity:                                                                                                                     |       |                        |       |                    |       |
| Common Stock, $0.01 par value; 200,000,000  shares authorized; 52,011,002 shares in 2003 and 52,377,773 shares in 2004  issued and outstanding |       | 520                         |       | 524                     |       |
| Accumulated other comprehensive income                                                                                                         |       | 73                          |       | (329                    | )          |
| Additional paid-in capital                                                                                                                     |       | 355,373                     |       | 355,720                 |       |
| Accumulated deficit                                                                                                                            |       | (186,305                    | )          | (216,527                | )          |
|                                                                                                                                           |       |                        |       |                    |       |
| Total stockholders’ equity                                                                                                                |       | 169,661                     |       | 139,388                 |       |
|                                                                                                                                           |       |                        |       |                    |       |
| Total liabilities and stockholders’ equity                                                                                                |       | $                           | 212,478    |                    | $          | 181,841 |   |

 

*See accompanying notes.*

 

3

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**PRAECISPHARMACEUTICALS INCORPORATED**

** Condensed Consolidated Statementsof Operations**

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

 
| ** **                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2003**                              | ** ** | **2004**                            | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| **Revenues:**                                                    |       |                                  |       |                                |       |   |   |   |   |
| Product sales                                                    |       | $                                     | —     |                                | $          | 645 |   | $ | — |   | $ | 1,056 |   |
| Licensing and other revenues                                     |       | —                                |       | 28                                  |       | — |   | 78 |   |
| Total revenues                                                   |       | —                                |       | 673                                 |       | — |   | 1,134 |   |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| **Costs and expenses:**                                          |       |                                  |       |                                |       |   |   |   |   |
| Cost of goods sold                                               |       | —                                |       | 146                                 |       | — |   | 1,280 |   |
| Research and development                                         |       | 12,343                                |       | 7,760                               |       | 21,100 |   | 15,675 |   |
| Sales and marketing                                              |       | 1,066                                 |       | 5,181                               |       | 2,090 |   | 9,424 |   |
| General and administrative                                       |       | 2,519                                 |       | 2,401                               |       | 4,569 |   | 5,178 |   |
| Total costs and expenses                                         |       | 15,928                                |       | 15,488                              |       | 27,759 |   | 31,557 |   |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| Operating loss                                                   |       | (15,928                               | )          | (14,815                             | )          | (27,759 | ) | (30,423 | ) |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| Interest income (expense), net                                   |       | 378                                   |       | (27                                 | )          | 794 |   | 201 |   |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                                         |       | $                                     | (15,550    | )                                   | $          | (14,842 | ) | $ | (26,965 | ) | $ | (30,222 | ) |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted net loss per share                             |       | $                                     | (0.30      | )                                   | $          | (0.28 | ) | $ | (0.52 | ) | $ | (0.58 | ) |
|                                                             |       |                                  |       |                                |       |   |   |   |   |
| Weighted average number of basic and  diluted shares outstanding |       | 51,842                                |       | 52,332                              |       | 51,831 |   | 52,239 |   |

 

 

*See accompanying notes.*

 

4

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Condensed Consolidated Statementsof Cas****h Flows**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                               | ** ** | **2003**                            | ** ** | **2004** | ** ** |
| **Operating  activities:**                                               |       |                                |       |   |   |
| Net loss                                                                 |       | $                                   | (26,965    | ) | $ | (30,222 | ) |
| Adjustments to reconcile net loss to cash used  in operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                            |       | 2,285                               |       | 2,494 |   |
| Stock compensation                                                       |       | 68                                  |       | 17 |   |
| Changes in operating assets and  liabilities:                            |       |                                |       |   |   |
| Accounts receivable                                                      |       | —                              |       | (818 | ) |
| Inventory                                                                |       | —                              |       | (1,888 | ) |
| Prepaid expenses and other assets                                        |       | (442                                | )          | (707 | ) |
| Due from officer                                                         |       | 50                                  |       | 50 |   |
| Accounts payable                                                         |       | (2,542                              | )          | (1,629 | ) |
| Accrued expenses                                                         |       | (616                                | )          | (333 | ) |
| Deferred revenue                                                         |       | —                              |       | 1,972 |   |
|                                                                     |       |                                |       |   |   |
| Net cash used in operating activities                                    |       | (28,162                             | )          | (31,064 | ) |
|                                                                     |       |                                |       |   |   |
| **Investing  activities:**                                               |       |                                |       |   |   |
| Purchase of available-for-sale securities                                |       | (42,236                             | )          | (87,566 | ) |
| Sales or maturities of available-for-sale  securities                    |       | 79,228                              |       | 115,944 |   |
| Proceeds from disposition of property and  equipment                     |       | —                              |       | 50 |   |
| Purchase of property and equipment                                       |       | (317                                | )          | (278 | ) |
|                                                                     |       |                                |       |   |   |
| Net cash provided by investing activities                                |       | 36,675                              |       | 28,150 |   |
|                                                                     |       |                                |       |   |   |
| **Financing  activities:**                                               |       |                                |       |   |   |
| Principal payments on debt                                               |       | —                              |       | (374 | ) |
| Proceeds from exercises of stock options                                 |       | 130                                 |       | 334 |   |
|                                                                     |       |                                |       |   |   |
| Net cash provided by (used in) financing activities                      |       | 130                                 |       | (40 | ) |
|                                                                     |       |                                |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                    |       | 8,643                               |       | (2,954 | ) |
| Cash and cash equivalents, beginning of  period                          |       | 40,847                              |       | 15,687 |   |
|                                                                     |       |                                |       |   |   |
| Cash and cash equivalents, end of period                                 |       | $                                   | 49,490     |   | $ | 12,733 |   |

 

*See accompanying notes.*

 

5

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Notes to Condensed ConsolidatedFinancia****l Statements**

**(Unaudited)**

 

# **1.**             Basis of Presentation

# ** **

Theaccompanying condensed consolidated financial statements have been prepared byPRAECIS PHARMACEUTICALS INCORPORATED (the “Company”) in accordance withgenerally accepted accounting principles and pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations.  It is suggestedthat the financial statements be read in conjunction with the audited financialstatements and the accompanying notes included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2003, as amended. 

 

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

 

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

 

# **2.**             Summary of Significant Accounting Principles

 

***Principlesof Consolidation***

 

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

 

***Inventory***

 

Inventory is stated at the lower of cost ormarket with cost determined under the first-in/first-out (“FIFO”) method. TheCompany will write down any obsolete or otherwise unmarketable inventory to itsestimated net realizable value, as necessary. If the actual realizable value is less than that estimated by theCompany, additional inventory write-downs may be required.  The Company did not write down anyunmarketable inventory for the six months ended June 30, 2004.

 

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

 
| ** **      | ** ** | **December 31,  2003** | ** ** | **June 30,  2004** | ** ** |
|-----------------|------------|-----------------------------|------------|-------------------------|------------|
| Raw materials   |       | $                           | —     |                    | $          | 42 |   |
| Work-in-process |       | —                      |       | 1,779                   |       |
| Finished goods  |       | —                      |       | 67                      |       |
|            |       | $                           | —     |                    | $          | 1,888 |   |

 

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

 

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

 

Statement of Financial Accounting Standards (“SFAS”) No. 144, *Accounting for the Impairment or Disposal of Long-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 must be recognized in thefinancial statements.  The Companyevaluates its property, plant and equipment for impairment whenever indicatorsof impairment exist.  The amount of theimpairment to be recognized is calculated by subtracting the fair value of theasset from the reported value of the asset. Through June 30, 2004, no revision to the estimated useful life orrecorded amount of property and equipment was required.

 

6

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***Stock-BasedCompensation***

 

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

 

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

 

| ** **                                                                                                                                                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2003**                              | ** ** | **2004**                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                                                                                               |       | $                                     | (15,550    | )                                   | $          | (14,842 | ) | $ | (26,965 | ) | $ | (30,222 | ) |
| 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 |       | (2,696                                | )          | (2,574                              | )          | (5,457 | ) | (5,532 | ) |
| Pro forma net loss                                                                                                                                                                  |       | $                                     | (18,246    | )                                   | $          | (17,416 | ) | $ | (32,422 | ) | $ | (35,754 | ) |
| Diluted net loss per share, as reported                                                                                                                                             |       | $                                     | (0.30      | )                                   | $          | (0.28 | ) | $ | (0.52 | ) | $ | (0.58 | ) |
| Diluted net loss per share, pro forma                                                                                                                                               |       | $                                     | (0.35      | )                                   | $          | (0.33 | ) | $ | (0.63 | ) | $ | (0.68 | ) |

 

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: 

 

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

 

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

 

In March 2004, the FASB issued an Exposure Draft of a proposedstandard, *Share-Based Payment – An Amendment of FASBStatements No. 123 and 95*, which, if adopted, will significantlychange the accounting for employee stock options and other equity-based compensation.  The proposed standard would require companiesto expense the fair value of stock options on the grant date and would beeffective at the beginning of the Company’s 2005 fiscal year. The Company willevaluate the requirements of the standard, which is expected to be finalized inlate 2004, to determine its impact on the Company’s results of operations. 

 

***Revenue Recognition***

 

Revenues from productsales are recognized in the period when the product is delivered, providedthere is pervasive evidence that an arrangement exists, the price is fixed ordeterminable and collection of the related receivable is probable.  Revenues are recorded net of applicableallowances as 

 

7

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provision is made for estimated sales returns,rebates and other applicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales.

 

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

 

In November 2003, the Company received regulatory approval tomarket Plenaxis® in the United States.  There is a launch period initiativeundertaken in cooperation with substantially all of the Company’s distributorswhich currently provides that the payment terms on purchases of Plenaxis®will be up to 120 days.  Through June 30,2004, payments under the Company’s launch period initiative have been made in atimely manner.

 

In April 2004, the Company entered into a license, supply anddistribution agreement with Schering AG (“Schering AG”), of Berlin, Germany(the “Schering AG Agreement”).  TheSchering AG Agreement provides for a combination of upfront, regulatoryapproval and performance-based milestone payments, as well as a share ofrevenue through transfer price payments for drug product which will be suppliedby the Company.  The Company analyzes itsmultiple element arrangements to determine whether the elements can beseparated and accounted for individually as separate units of accounting inaccordance with EITF No. 00-21, *“RevenueArrangements with Multiple Deliverables.”*  Nonrefundable upfront licensing fees andcertain guaranteed, time-based payments that require continuing involvement inthe form of development, manufacturing or other commercialization efforts bythe Company are recognized as licensing revenue ratably over the period underwhich the Company is obligated to perform those services.  Milestonepayments are recognized as licensing revenue or product sales when theperformance obligations, as defined in the contract, are achieved, so long asthe milestone is deemed to be substantive. Performance milestones typically consist of milestones in thedevelopment and/or commercialization of a product, such as obtaining approvalfrom regulatory agencies and the achievement of targeted sales levels.  Reimbursements of development costs arerecognized as licensing revenue as the related costs are incurred. 

 

When the period over which a fee or payment will be recognized asrevenue cannot be specifically identified from the contract, managementestimates the deferral period based upon other critical factors containedwithin the contract, including but not limited to patent life or contractterm.  The Company continually reviewsthese estimates which could result in a change in the deferral period and mightimpact the timing and the amount of revenue recognized. 

 

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

 

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

 

***Net Loss Per Share***

 

Basic net loss per share is based on the weighted average number ofcommon shares outstanding.  For the threeand six months ended June 30, 2003 and 2004, diluted net loss per commonshare is the same as basic net loss per common share as the inclusion of commonstock options would be antidilutive due to the Company’s net loss for allperiods presented.  Diluted net loss percommon share excluded 7,591,612 and 7,994,067 common stock options for theperiods ended June 30, 2003 and 2004, respectively.

 

8

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***Comprehensive Income***

 

SFAS No. 130, *Reporting ComprehensiveIncome*, establishes standards for the reporting and display ofcomprehensive income (loss) and its components in the consolidated financialstatements.  The Company’s accumulatedother comprehensive income is comprised of net unrealized gains or losses onavailable-for-sale securities.  For thethree and six months ended June 30, 2003 and 2004, comprehensive loss wasas follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **2003**                              | ** ** | **2004**                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net loss                                              |       | $                                     | (15,550    | )                                   | $          | (14,842 | ) | $ | (26,965 | ) | $ | (30,222 | ) |
| Changes in comprehensive loss:                        |       |                                  |       |                                |       |   |   |   |   |
| Net unrealized holding (losses) gains on  investments |       | (68                                   | )          | (464                                | )          | 93 |   | (402 | ) |
| Total comprehensive loss                              |       | $                                     | (15,618    | )                                   | $          | (15,306 | ) | $ | (26,872 | ) | $ | (30,624 | ) |

 

***Reclassification*** 

 

Certain amounts reported in previous periods have been reclassified toconform to the current period presentation.

 

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

 

In April 2004, the Company entered into the Schering AG Agreement,under which the Company granted exclusive rights to Schering AG tocommercialize Plenaxis® in the field of prostate cancer in Europe,Russia, the Middle East, South Africa, Australia and New Zealand (the “LicensedTerritory”).  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 theCompany.  The transfer price will varybased upon net sales of Plenaxis®, as well as pricing andreimbursement levels, in the Licensed Territory.  The milestone payments to the Company maytotal over time up to approximately $90.0 million, depending upon Euro/U.S.Dollar conversion rates, and the attainment of specified annual sales levelswhich the majority of the milestone payments are conditioned upon.  The Company received a $2.0 million signingpayment from Schering AG during the second quarter of 2004, which it isrecognizing into revenues over the remaining patent life of Plenaxis®in Europe of approximately twelve years. As of June 30, 2004, the Company has recognized approximately$28,000 in revenues under the Schering AG Agreement.

 

**4.****             MortgageFinancing**

 

In June 2004, the Company amended its acquisition and constructionloan agreement (the “Amended Loan Agreement”) to extend the maturity date ofthe loan and modify certain other terms of the original agreement.  Under the Amended Loan Agreement, principalis due and payable in full on July 30, 2009, subject to two one-yearextension options which are exercisable at the Company’s option provided theCompany is in compliance with certain financial covenants.** **The outstanding principal bearsinterest at a fixed rate of 5.95% through April 2009.  Principal and interest are payable through afixed monthly payment of approximately $207,000, with the principal portionbeing calculated using a 25-year amortization schedule.  The Amended Loan Agreement also provides forcertain additional financial operating covenants, one of which is effectiveimmediately and the remainder of which will become effective as ofDecember 31, 2006.  

 

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**5.****             CambrexCharles City, Inc. (“Cambrex”)**

 

InJuly 2004, the Company amended its supply agreement with Cambrex (formerlySalsbury Chemicals, Inc.) for the manufacture of the commercial depotformulation of Plenaxis®. Under the amendment, the term of the original agreement has beenextended for an additional five years (through July 2010) with an optionfor the Company to further extend the term for up to an additional five years,subject to an agreed upon increase in price and in the minimum annual purchasecommitment.**** As part of the amendment, the Company hasagreed to a minimum purchase commitment of $900,000 per year for the next fiveyears.

 

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

 

*Thefollowing discussion of our financial condition and results of operationsshould be read together with the condensed consolidated financial statementsand accompanying notes to those statements included elsewhere in this Form10-Q.  This Form 10-Q containsforward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended, thatinvolve risks and uncertainties.  Allstatements other than statements of historical information set forth herein areforward-looking and may contain information about financial results, events,economic conditions, trends and known uncertainties.  Our actual results and actual events coulddiffer materially from those discussed in these forward-looking statements as aresult of a number of factors, which include those discussed in thissection and elsewhere in this report, and the risks discussed in our otherfilings with the Securities and Exchange Commission.  Readers are cautioned not to place unduereliance on these forward-looking statements, which reflect management’sanalysis, judgment, belief or expectation only as of the date hereof.  PRAECIS undertakes no obligation to publiclyreissue or modify these forward-looking statements to reflect events orcircumstances that arise after the date hereof.*

 

**Overview**

 

We are a biopharmaceutical company focused on the discovery anddevelopment of innovative therapies to address unmet medical needs.  In November 2003, we received FDAapproval to market our first product, Plenaxis® (abarelix forinjectable suspension), in the United States for the treatment of the symptomsof men with advanced prostate cancer for whom other hormonal therapies are notappropriate and who have refused surgical castration.  For safety reasons, Plenaxis® wasapproved with marketing restrictions which include a risk management program -the Plenaxis® User Safety (PLUS) Program.  Only physicians enrolled in the PLUS Programmay prescribe Plenaxis®.  Weare promoting Plenaxis® in the United States through our owndedicated marketing and sales team. Plenaxis® is available to authorized physicians andpharmacies through a network of specialty distributors with whom we havecontracted.  

 

In June 2003, we initiated the regulatory submission process inthe European Union seeking approval to market Plenaxis® for thetreatment of a broad population of hormonally responsive prostate cancerpatients.  We submitted a marketingauthorization application, or MAA, in Germany and, assuming favorable action inGermany, plan to seek additional European Union member state approvals underthe Mutual Recognition Procedure, or MRP. We believe that the German review process will be completed by late2004/early 2005.  In April 2004, wesigned an agreement with Schering AG of Berlin, Germany, for the commercializationof Plenaxis® across Europe, Russia, the Middle East, South Africa,Australia and New Zealand.  The ScheringAG agreement provides for a combination of upfront, regulatory approval andperformance-based milestone payments, as well as a share of revenue throughtransfer price payments for drug product which will be supplied by us.  The transfer price will vary based upon netsales of Plenaxis®, as well as pricing and reimbursement levels, inthe licensed territory.  The milestonepayments to us may total over time up to approximately $90.0 million, dependingupon Euro/U.S. Dollar conversion rates, and the attainment of specified annualsales levels which the majority of the milestone payments are conditionedupon.  The overall financial terms areintended, depending upon performance levels, to approximate an equal sharing ofthe value of the product.  We received a$2.0 million signing payment from Schering AG during the second quarter of2004, which we are recognizing into revenues over the remaining patent life ofPlenaxis® in Europe of approximately twelve years.

 

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

 

We are currently conducting a phase 1b trial of Apan, our proprietaryinvestigational drug candidate for the treatment of Alzheimer’s disease.  We are also developing PPI-2458, ourproprietary compound for the potential treatment of a range of cancers, as wellas certain autoimmune diseases.  Duringthe second half of 2004, we expect to begin a new clinical trial of PPI-2458 inpatients with non-Hodgkin’s lymphoma.  Inaddition, we have developed a simple, non-invasive investigational diagnostictest for endometriosis based on the presence of unique molecules in the serumof disease sufferers.  We 

 

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believe that additional validation isrequired in a clinical setting in order to assess the test’sapplicability.  We do not intend tocommercialize this test independently, but will continue to evaluate potentialpartners for this program.****We also haveother programs in the research or preclinical development stage.

 

Prior to 2004, a significant portion of our revenues was received undercollaboration agreements through which we converted the potential valueunderlying our Plenaxis® program into a stream of upfront, milestoneand expense reimbursement payments from corporate collaborators.  Following the approval of Plenaxis®in November of 2003, we began hiring and deploying our sales force andestablishing the commercial infrastructure to support the marketing and sale ofPlenaxis® in the United States. During the first quarter of 2004, we shipped the first units of Plenaxis®to distributors and substantially completed the hiring of our salesforce.  Most of our expenditures to datehave been for drug development, commercialization activities and for generaland administrative expenses.

 

Due primarily to the costs associated with the commercialization ofPlenaxis® in the United States, as well as other research anddevelopment and general and administrative expenses, we had a net operatingloss for the first half of 2004.  Ouraccumulated deficit as of June 30, 2004 was approximately $216.5million.  We expect to continue to havenet operating losses through at least 2005. 

 

We believe that our existing cash and investments will be sufficient tomeet the working capital and capital expenditure needs under our currentoperating plan through approximately the end of 2005.  Assuming the successful commercialization ofPlenaxis®, partnering of clinical programs at opportune times andcontinued prudent fiscal management, we believe that our existing cash andinvestments will be sufficient for us to execute our current operating plan andattain profitability by 2006.  However,the uptake of Plenaxis® since its initial launch in lateJanuary 2004 has been slower than expected.  We cannot predict at this time the length orextent of this trend and what effect, if any, this could have on longer-termsales assumptions and our ability to attain profitability by 2006.  Moreover, we cannot assure investors that wewill be able to partner our clinical programs at opportune times and onfavorable terms, if at all.

 

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

 

At June 30, 2004, we had 185 full-time employees compared to 148full-time employees at June 30, 2003. This increase in headcount is due primarily to the hiring of our salesforce following FDA approval in November 2003 to market Plenaxis® inthe United States.

 

**Critical Accounting Policies**

 

While our significant accounting policies are more fully described inNote 2 to our condensed consolidated financial statements appearingelsewhere in this report, we believe the following accounting policies to becritical: 

 

*Use of Estimates.*  We prepare our financial statements inaccordance with accounting principles generally accepted in the United States.These principles require that we make estimates and use assumptions that affectthe reporting of our assets and our liabilities as well as the disclosures thatwe make regarding assets and liabilities and revenues and expenses that are contingentupon uncertain factors as of the reporting date.  Actual payments, and thus our actual results,could differ from our estimates. 

 

*RevenueRecognition.** *We recognize revenue from product sales in the periodwhen the product is delivered, provided there is pervasive evidence that anarrangement exists, the price is fixed or determinable and collection of therelated receivable is probable.  Revenuesare recorded net of applicable allowances as provision is made for estimatedsales returns, rebates and other applicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales.

 

We prepare our estimates of provisions for sales returns and allowances, rebates and discounts based primarily on estimates.  Contractual allowances and rebates result primarily from sales under contracts with healthcare providers, Medicaid programs and other government agencies.  Our policy for sales returns allows our authorized distributors to return the product three months prior to and six months after product expiration.  The reserve for sales returns is determined by reviewing the history of 

 

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returns for products with similar characteristics to Plenaxis® and by utilizing data obtained directly from our authorized distributors.  These data are reviewed to monitor product movement through the supply chain to identify remaining inventory in the supply chain that may result in chargebacks or sales returns. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time.  To the extent our estimate of contractual allowances, rebates and sales returns is different than actuals, we will adjust the reserve which will impact the amount of product sales revenue recognized in the period of the adjustment. 

 

In November 2003, wereceived regulatory approval to market Plenaxis® in the United States.  There is a launch period initiativeundertaken in cooperation with substantially all of our distributors whichcurrently provides that the payment terms on purchases of Plenaxis® will be up to 120 days.  Through June 30, 2004,payments under our launch period initiative have been made in a timely manner.

 

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

 

When the period over which a fee or payment will be recognized asrevenue cannot be specifically identified from the contract, managementestimates the deferral period based upon other critical factors containedwithin the contract, including but not limited to patent life or contract term.  We continually review these estimates whichcould result in a change in the deferral period and might impact the timing andthe amount of revenue recognized. 

 

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

 

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

 

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

 

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

 

Management has discussedthe development, 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, 2004 Compared To Three Months Ended June 30, 2003**

 

Revenues for the three months ended June 30, 2004 wereapproximately $0.7 million, compared to zero for the corresponding period in2003.  Of this amount, approximately $0.6million was related to sales of Plenaxis®, with the remaining amountbeing comprised of revenue amortization with respect to a $2.0 million signingpayment from Schering AG.  InNovember 2003, the FDA approved Plenaxis® for the treatment ofthe symptoms of men with advanced prostate cancer for whom other hormonal therapiesare not appropriate and who have refused surgical castration.  In January 2004, we began shippingproduct to our authorized distributors. We are promoting Plenaxis® in the United States through ourown dedicated marketing and sales team, of which substantially all were hired,trained and deployed as of the end of the first quarter of 2004. Since Plenaxis®was not launched until late January, sales during thesecond quarter represent the first full quarter of product sales where initialdistributor stocking of inventory was not a significant factor. 

 

Cost of goods sold for the three months ended June 30, 2004 wasapproximately $0.1 million compared to no cost of goods sold for thecorresponding period in 2003.  InJanuary of 2004, we began selling Plenaxis® and accordingly,began recognizing costs related to those sales. Much of the raw material used to produce Plenaxis® (includingthe active pharmaceutical ingredient) was purchased prior to the FDA grantingapproval for the commercial sale of Plenaxis®.  Accordingly, these purchases were treated asresearch and development costs and expensed as incurred.  We anticipate that cost of goods sold willincrease as sales volume increases, but may decline as a percentage of revenueas fixed costs are spread over a larger revenue number.  Cost of goods sold will increase as apercentage of revenue as previously expensed materials are exhausted.  We cannot predict when such previouslyexpensed materials will be exhausted, as this will be dependent upon the commercialsuccess of Plenaxis® in both the United States and abroad.  

 

Research and development expenses for the three months endedJune 30, 2004 decreased 37% to approximately $7.8 million, fromapproximately $12.3 million for the corresponding period in 2003.  The decrease reflects reduced spending in ourclinical development programs.  As aresult of the approval of Plenaxis® in November 2003, spendingon prostate cancer clinical development was reduced during 2004, specificallymanufacturing related costs.  Spending onour Apan program was lower than the prior year due to lower preclinicalexpenses as we focus our efforts on our phase 1b clinical trial. Spendingrelated to our PPI-2458 program was consistent with the prior year.  This was due to an increase in preclinicalspending resulting from several ongoing studies necessary to resume clinicaltrials, offset by a reduction in manufacturing activities for PPI-2458.  In March 2004, the FDA placed on holdour phase 1 clinical study of PPI-2458 in patients with non-Hodgkin’slymphoma.  In June 2004, the FDAnotified us that clinical trials of PPI-2458 could resume.  We expect to resume clinical testing ofPPI-2458 during the second half of 2004. Although we are unable to predict the precise level of spending onindividual clinical programs due to the uncertain nature of clinicaldevelopment, overall, we expect our research and development expenses for theremainder of 2004 to increase as we provide support for certaininvestigator-sponsored clinical studies of Plenaxis®, initiate,assuming FDA concurrence, a phase 1/2a study in Apan, and begin a new clinicaltrial of PPI-2458 in non-Hodgkin’s lymphoma patients.

 

We currently have several ongoing research and developmentprograms.  Using industry estimates,typical drug development programs may last for ten or more years and may costhundreds of millions of dollars to complete. As our programs progress, we continue to assess the possibility ofentering into corporate collaborations to offset a portion of developmentcosts. The ultimate success of our research and development programs and theimpact of these programs on our operations and financial results cannot beaccurately predicted and will depend, in large part, upon the outcome andtiming of many variables outside of our control. 

 

Members of our research and development team typically work on a numberof projects concurrently. In addition, a substantial amount of our fixed costssuch as facility depreciation, utilities and maintenance are shared by ourvarious programs. Accordingly, we have not and do not plan to specificallyidentify all costs related to each of our research and development programs. Weestimate that during the first half of 2004 and during 2003, the majority ofour research and development expenses were related to manufacturing costs,clinical trial costs, salaries and lab supplies, related to our prostatecancer, Alzheimer’s disease and non-Hodgkin’s lymphoma programs. The remaining 

 

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research and development costs consistedprimarily of salaries and lab supplies for our other research programs. 

 

We began our clinical program to develop Plenaxis® for thetreatment of prostate cancer during 1996. In November 2003, the FDA approved Plenaxis® for thepalliative treatment of men with advanced symptomatic prostate cancer, in whomLHRH agonist therapy is not appropriate and who refuse surgical castration, andhave one or more of the following: (1) risk of neurological compromise dueto metastases, (2) ureteral or bladder outlet obstruction due to localencroachment or metastatic disease, or (3) severe bone pain from skeletalmetastases persisting on narcotic analgesia. Plenaxis® is notindicated for use in women or children. For safety reasons, Plenaxis® wasapproved with marketing restrictions. Only physicians enrolled in the PLUSProgram may prescribe Plenaxis®.

 

In June 2003, we also submitted an MAA for Plenaxis® inGermany. We believe that the German regulatory authorities will complete theirreview of our MAA by late 2004/early 2005. Assuming favorable action, we planto subsequently seek further European Union approval for Plenaxis®under the MRP to market Plenaxis® for the treatment of a broadpopulation of hormonally responsive prostate cancer patients.  As described above, in April 2004, wesigned an agreement with Schering AG of Berlin, Germany for thecommercialization of Plenaxis® across Europe, Russia, the MiddleEast, South Africa, Australia and New Zealand, and we continue to evaluatepotential licensing opportunities for the development and commercialization ofPlenaxis® in Japan and other ex-U.S. territories not covered by theSchering AG agreement.  However, wecannot assure investors that we will be successful in obtaining approval in anyregion outside of the United States for the commercialization of Plenaxis®for the treatment of any portion of the hormonally responsive prostatecancer patient population or for any other indication, or that we will be ableto enter into additional collaboration agreements on favorable terms, if atall. 

 

In 1998, we began our clinical program to develop Plenaxis®for the treatment of endometriosis.  InMarch 2002, we completed a phase 2 study ofPlenaxis® for the treatment of pain associated withendometriosis.  During 2002 and 2003, weconducted a pharmacokinetic study to determine the appropriate dose and dosingschedule necessary to maximize the benefit of the therapy forendometriosis patients while minimizing attendant bone mineral densityloss.  The results of this study will beused as guidance for potential future clinical studies.  We do not currently have any additionalendometriosis studies planned and do not expect to conduct further studieswithout a corporate partner. Any additional development in endometriosis wouldalso require concurrence by the FDA. 

 

We began our clinical program for Apan in 2000. We have completed anormal volunteer, phase 1a dose escalation study of Apan and have identified amaximum tolerated dose, or MTD, in healthy volunteers. During the secondquarter of 2003, we initiated a phase 1b trial of Apan in Alzheimer’s diseasepatients.  In this trial, a single doseof Apan is administered, with the goal of establishing the MTD in patients. Weanticipate completing this study during the second half of 2004.  During the second half of 2004, we alsoanticipate initiating a phase 1/2a study that will evaluate the safety andefficacy of a multiple dose regimen of Apan administered to Alzheimer’spatients, assuming FDA concurrence on the protocol and on safety based upon itsreview of chronic toxicology studies. 

 

During the fourth quarter of 2003, we initiated our first clinicalstudy for PPI-2458 in which an oral formulation was to be evaluated innon-Hodgkin’s lymphoma patients who are no longer benefiting from othertherapies. In March 2004, the FDA placed this trial on clinical hold untilquestions relating to a neuropathological finding observed in a three-monthanimal safety study were satisfactorily resolved.  The results of this study were not availableat the time that the clinical study was initiated.  In June 2004, we received clearance fromthe FDA, following its review of our revised clinical plan, to resume clinicaltrials.  We expect to begin a new clinicaltrial of PPI-2458 in non-Hodgkin’s lymphoma patients during the second half of2004.  In December 2003, we enteredinto a collaboration with the NCI’s Division of CancerTreatment and Diagnosis for the expansion of clinical development of PPI-2458for the treatment of various forms of cancer. Under the collaboration, we will work with the NCI to optimize aclinical development path for PPI-2458 in cancers other than non-Hodgkin’slymphoma.** **Wealso intend to continue evaluating the potential utility of PPI-2458 fortreating certain autoimmune diseases, including rheumatoid arthritis.

 

Sales and marketing expenses for the three months ended June 30,2004 increased to approximately $5.2 million, from approximately $1.1 millionfor the corresponding period in 2003. The increase resulted mainly from increased expenses related to thecommercial launch of Plenaxis® in 

 

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the United States, principally the hiringof our sales force during the first quarter of 2004, as well as theestablishment of the commercial infrastructure to support the sales force.  We also experienced increased costs relatedto market research, various physician and national meetings, advertising,pricing and reimbursement consulting, and other sales force deploymentactivities.  We expect our sales andmarketing expenses will remain at these levels for the remainder of 2004 andwill consist primarily of the cost of our sales force and various promotionaland marketing programs.

 

General and administrative expenses for the three months endedJune 30, 2004 decreased 5% to approximately $2.4 million, fromapproximately $2.5 million for the corresponding period in 2003. We expect thatgeneral and administrative expenses will increase slightly during 2004 andthereafter based on normal hiring of additional administrative personnel tosupport the continued growth of our commercialization initiatives and ourresearch and development activities

 

Net interest income for the three months ended June 30, 2004decreased to approximately zero, from approximately $0.4 million for thecorresponding period in 2003. The decrease in net interest income was dueprimarily to the refinancing of the mortgage on our facility to a fixed rateand lower average cash balances.

 

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

 

**Six Months Ended June 30, 2004 Compared To Six Months EndedJune 30, 2003**

 

Revenues for the six months ended June 30, 2004 were approximately$1.1 million, compared to zero for the corresponding period in 2003.  Substantially all of our revenues wererelated to sales of Plenaxis® during the six months endedJune 30, 2004, with the remaining amount representing licensing and otherrevenues. 

 

Cost of goods sold for the six months ended June 30, 2004 wasapproximately $1.3 million, compared to no cost of goods sold for thecorresponding period in 2003.  InJanuary of 2004, we began selling Plenaxis® and accordingly,began recognizing costs related to those sales. The majority of our cost of goods sold during the first half of 2004 wasrelated to a $1.0 million milestone payment which became due and payable uponthe first commercial sale of Plenaxis® under our license agreementwith Indiana University Advanced Research and Technology Institute, Inc., orIUF.  Much of the raw material used toproduce Plenaxis® (including the active pharmaceutical ingredient)was purchased prior to the FDA granting approval for the commercial sale ofPlenaxis®.  Accordingly, thesepurchases were treated as research and development costs and expensed asincurred.  Excluding the effect of the$1.0 million milestone payment to IUF during the first quarter of 2004, weanticipate that cost of goods sold will increase as sales volume increases, butmay decline as a percentage of revenue as fixed costs are spread over a largerrevenue number.  Cost of goods sold willincrease as a percentage of revenue as previously expensed materials areexhausted.  We cannot predict when suchpreviously expensed materials will be exhausted, as this will be dependent uponthe commercial success of Plenaxis® in both the United States andabroad.  

 

Research and development expenses for the six months endedJune 30, 2004 decreased 26% to approximately $15.7 million, fromapproximately $21.1 million for the corresponding period in 2003.  The decrease reflects reduced spending in ourclinical development programs.  As aresult of the approval of Plenaxis® in November 2003, spendingon prostate cancer clinical development was reduced during 2004, specificallymanufacturing related costs.  Spending onour Apan program during the six months ended June 30, 2004 decreasedcompared to the corresponding period in 2003 due to lower preclinical expensesas we focus our efforts on our phase 1b clinical trial.  Spending related to our PPI-2458 programduring the six months ended June 30, 2004 was consistent with thecorresponding period in 2003.  This wasdue to an increase in preclinical spending resulting from several ongoingstudies necessary to resume clinical trials, offset by a reduction inmanufacturing activities for PPI-2458.  

 

Sales and marketing expenses for the six months ended June 30,2004 increased to approximately $9.4 million, from approximately $2.1 millionfor the corresponding period in 2003. The increase resulted mainly from increased expenses related to thecommercial launch of Plenaxis® in 

 

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the United States, principally the hiringof our sales force, as well as the establishment of the commercialinfrastructure to support the sales force. We also experienced increased costs related to market research, variousphysician and national meetings, advertising, pricing and reimbursementconsulting, and other sales force deployment activities.  We expect our sales and marketing expenseswill remain at these levels for the remainder of 2004 and will consistprimarily of the cost of our sales force and various promotional and marketingprograms.

 

General and administrative expenses for the six months endedJune 30, 2004 increased 13% to approximately $5.2 million, fromapproximately $4.6 million for the corresponding period in 2003. The increasewas due primarily to higher expenses related to business development activitiesand increased professional services expenses. We expect that general and administrative expenses will increaseslightly during 2004 and thereafter based on normal hiring of additionaladministrative personnel to support the continued growth of ourcommercialization initiatives and our research and development activities

 

Net interest income for the six months ended June 30, 2004 decreased75% to approximately $0.2 million, from approximately $0.8 million for thecorresponding period in 2003. The decrease in net interest income was dueprimarily to the refinancing of the mortgage on our facility to a fixed rateand lower 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 under research anddevelopment partnerships and collaborative agreements, investment income andrevenues from product sales.  IfPlenaxis® is not commercially successful, we would have to modify our operatingplan and potentially seek additional sources of funding.  We cannot assure investors that we couldobtain additional funding on attractive terms, if at all.

 

At June 30, 2004, we had cash, cash equivalents and marketablesecurities of approximately $111.5 million and working capital of approximately$106.4 million, compared to approximately $143.2 million and $133.0 million,respectively, at December 31, 2003. We continue to believe that through management of our operatingexpenses, our cash, cash equivalents and marketable securities at December 31,2004 will range from approximately $60.0 million to $70.0 million.  We believe that our existing cash andinvestments will be sufficient to meet the working capital and capitalexpenditure needs under our current operating plan through approximately theend of 2005.  Assuming the successfulcommercialization of Plenaxis®, partnering of clinical programs atopportune times and continued prudent fiscal management, we believe that ourexisting cash and investments will be sufficient for us to execute our currentoperating plan and attain profitability by 2006.  However, the uptake of Plenaxis®since its initial launch in late January 2004 has been slower thanexpected.  We cannot predict at this timethe length or extent of this trend and what effect, if any, this could have onlonger-term sales assumptions and our ability to attain profitability by2006.  Moreover, we cannot assureinvestors that we will be able to partner our clinical programs at opportunetimes and on favorable terms, if at all.

 

For the six months ended June 30, 2004,net cash of approximately $31.1 million was used in operating activities,compared to approximately $28.2 million used in operating activities during thesix months ended June 30, 2003. During the six months ended June 30, 2004, our use of cash inoperations was due principally to our net loss of approximately $30.2 million,accounts receivable and inventory build of approximately $2.7 million and thereduction in accounts payable and accrued expenses of approximately $2.0million, offset by approximately $2.0 million of deferred revenue in additionto approximately $2.5 million of depreciation and amortization.  We expect our cash utilization to continueduring 2004 as a result of an overall increase in operating expenses as we continuelaunch-related activities for Plenaxis®, continue with clinicaltrials for Apan, resume clinical trials for PPI-2458, and expand our researchand development initiatives.  We expectthat cash used for inventory purchases and accounts receivable build willincrease through the end of fiscal year 2005 to support commercial sales ofPlenaxis®.  The actual amountof overall expenditures will depend on numerous factors, including the timingof expenses and the timing and progress of our research, development andcommercialization efforts.

 

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Net cash provided by investing activities of approximately $28.2million for the six months ended June 30, 2004 consisted primarily of netsales or maturities of marketable securities of approximately $28.4 million.  This compares to net cash provided byinvesting activities of approximately $36.7 million for the correspondingperiod in 2003, which was also related primarily to net sales or maturities ofmarketable securities. 

 

In July 2000, in connection with the purchase, through our whollyowned real estate subsidiary, of our corporate headquarters and researchfacility in Waltham, Massachusetts, the subsidiary entered into an acquisitionand construction loan agreement providing for up to $33.0 million in financingfor the acquisition of, and improvements to, the facility.  As of June 30, 2004, approximately $32.3million was outstanding under the loan agreement.  In June 2004, the acquisition andconstruction loan agreement was amended to extend the maturity date of the loanand modify certain other terms of the original agreement.  Under the amended loan agreement, principalis due and payable in full on July 30, 2009, subject to two one-yearextension options which are exercisable at our option provided we are incompliance with certain financial covenants. The outstanding principal bears interest at a fixed rate of 5.95%through April 2009.  Principal andinterest are payable through a fixed monthly payment of approximately $207,000,with the principal portion being calculated using a 25-year amortizationschedule.  The amended loan agreementalso provides for certain additional financial operating covenants, one ofwhich is effective immediately and the remainder of which will become effectiveas of December 31, 2006.  The loanis secured by the facility, together with all fixtures, equipment, improvementsand other related items, and by all rents, income or profitsreceived by our real estate subsidiary, and is unconditionallyguaranteed by us. 

 

In July 2004, we amended our supply agreement with Cambrex CharlesCity, Inc. (formerly Salsbury Chemicals, Inc.) for the manufacture of thecommercial depot formulation of Plenaxis®.  Under the amendment, the term of the originalagreement has been extended for an additional five years (throughJuly 2010) with an option for us to further extend the term for up to anadditional five years, subject to an agreed upon increase in price and in theminimum annual purchase commitment.**** As part of the amendment, we have agreed to aminimum purchase commitment of $900,000 per year for the next five years.  This represents a slight increase from ourprevious commitment of approximately $800,000 for 2004.

 

At December 31, 2003, we had provided a valuation allowance of$86.5 million for our deferred tax assets. The valuation allowancerepresents the value of the deferred tax assets.  Due to anticipated future operating losses,we believe that it is more likely than not that we will not realize the netdeferred tax assets in the future and we have provided an appropriate valuationallowance. 

 

**Risk Factors That May Affect Future Results**

 

*The risks and uncertainties described below are not the only ones weface.  Additional risks and uncertaintiesnot presently known to us or that are currently deemed immaterial may alsoimpair our business, financial condition and results of operations.  If any of these risks actually occur, ourbusiness, financial condition and results of operations could be materiallyadversely affected.*

 

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

 

We cannot assure you that we will be profitable in the future or, if weattain profitability, that it will be sustainable.  In November 2003, we received FDAapproval to market Plenaxis® for the treatment of the symptoms ofmen with advanced prostate cancer for whom other hormonal therapies are notappropriate and who have refused surgical castration.  All of our other product candidates are inthe research or development stage.  Salesof Plenaxis® began in January 2004.  Prior to the launch of Plenaxis®,we had never marketed or sold any products. Our marketing and selling efforts with regard to Plenaxis®may not be commercially successful, and we may be unable to successfullydevelop or market any other products in the future. To date, we have derivedsubstantially all of our revenues from payments under corporate collaborationand license agreements.  We expect tocontinue to spend significant amounts to further develop our commercial salesand marketing capabilities, continue clinical studies and seek regulatoryapproval for our other product candidates. We also intend to spend substantialamounts to fund additional research and development for other potentialproducts, enhance our core technologies, and for general and administrativepurposes.  As of June 30, 2004, wehad an accumulated deficit of approximately $216.5 million.  We expect that our operating expenses willcontinue at current levels or increase due primarily to expenses related tocontinued commercialization activities for Plenaxis®, as well as theinitiation and continuation of studies as part of our other clinical 

 

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programs, resulting in significantoperating losses at least through 2005. We currently do not expect to achieve profitability until 2006 at theearliest.  The uptake of Plenaxis®since its initial launch in late January 2004 has been slower thanexpected.  We cannot predict at this timethe length or extent of this trend and what effect, if any, this could have onlonger-term sales assumptions and our ability to attain profitability in thistime frame.  Moreover, our ability toattain profitability by 2006 is dependent on numerous factors, including ourability to successfully commercialize Plenaxis®, partnering ofclinical programs at opportune times and continued prudent fiscalmanagement.  Even if we do become profitable,we cannot assure you that we would be able to sustain or increase profitabilityon a quarterly or annual basis. 

 

**Our business is dependent on the commercialsuccess of****Plenaxis®.  If Plenaxis® fails to achieve market acceptance, it maynever be commercially successful and we would likely not have sufficient fundsto continue our operations as currently planned.**

 

The success of our business is dependent on the successfulcommercialization of Plenaxis®. Plenaxis® is new to the market in the United States and maybe unfamiliar to members of the medical community and to patients. Marketacceptance will depend largely on our ability to demonstrate, to the oncologyand urology communities in particular, the efficacy and safety of Plenaxis®as an alternative to currently marketed therapies or surgical options. Wecannot be certain that Plenaxis® will provide benefits consideredadequate by providers of oncology and urology services or that enough providerswill use the product to ensure its commercial success.  Many factors may affect its market acceptanceand commercial success, including: 

 

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

 

•                                          theterms of the risk management program required by the FDA in connection with theapproval of Plenaxis®, as well as any marketing restrictions thatmay be imposed by foreign regulatory authorities in connection with theapproval of Plenaxis® outside of the United States; 

 

•                                          the product labeling and product insert required by the FDA,and, if approval is obtained outside of the United States, by foreign regulatoryauthorities; 

 

•                                          theeffectiveness of Plenaxis® and the potential side effects, includingthe risk of immediate-onset systemic allergic reactions, as compared toalternative treatment methods; 

 

•                                          the ability to hire, train and retain qualified sales personnelto promote Plenaxis® in the United States;

 

•                                          the extent and success of our marketing and sales efforts inthe United States, and if approval is obtained outside of the United States,the extent and success of the marketing and sales efforts of our corporatecollaborator(s); 

 

•                                          the cost-effectiveness of Plenaxis® and theavailability of insurance or other third-party reimbursement, in particularMedicare, for patients, and the rate of such reimbursement; 

 

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

 

•                                          unfavorable publicity concerning Plenaxis® or anysimilar products. 

 

In addition, we must continually submit any labeling, advertising andpromotional material to the FDA for review and pre-approval.  There is risk that the FDA will prohibit useof the marketing material in the form we desire. Unfavorable outcomes resultingfrom factors such as those identified above could limit sales of Plenaxis®or cause sales of Plenaxis® to decline.  In those circumstances, we may have to findadditional sources of funding or scale back or cease operations. If Plenaxis®is not commercially successful, we would likely not have sufficient funds tocontinue our operations as currently planned.

 

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**We may be unable to either establishmarketing and sales capabilities or enter into corporate collaborationsnecessary to successfully commercialize****Plenaxis® orour other potential products.**

 

We have limited experience in marketing or selling pharmaceuticalproducts and have limited marketing and sales resources. To achieve commercialsuccess for Plenaxis®, or any other approved product, we must eitherrely upon our limited marketing and sales force and related infrastructure, orenter into arrangements with others to market and sell our products.  We are promoting Plenaxis® in theUnited States through our own dedicated marketing and sales team.  Recruiting, training and retaining qualifiedsales personnel is therefore critical to oursuccess.  Competition for skilledpersonnel is intense, and we cannot assure you that we will be able to attractand retain a sufficient number of qualified individuals to successfully launchPlenaxis®.  Accordingly, wemay be unable to establish marketing, sales and distribution capabilitiesnecessary to commercialize and gain market acceptance for Plenaxis®.  

 

In addition, establishing the expertise necessary to successfullymarket and sell Plenaxis®, or any other product, will require asubstantial capital investment.  Ourability to make that investment and also execute our current operating plan andattain profitability by 2006 is dependent on numerous factors, including, asdescribed above, partnering of clinical programs at opportune times andcontinued prudent fiscal management. Accordingly, we cannot assure investors that we will have the funds tosuccessfully commercialize Plenaxis® or any other potential productin the United States or elsewhere.

 

Moreover, Plenaxis® competes, and our product candidates indevelopment are likely to compete, with products of other companies thatcurrently have extensive and well-funded marketing and sales operations.  Because these companies are capable ofdevoting significantly greater resources to their marketing and sales efforts,our marketing and sales efforts may not compete successfully against theefforts of these other companies.

 

We have also announced our intention to market and sell Plenaxis®outside of the United States through one or more marketing partners uponreceipt of approval abroad.  We recentlyentered into an agreement with Schering AG of Berlin, Germany, for thecommercialization of Plenaxis® in the field of prostate canceracross Europe, Russia, the Middle East, South Africa, Australia and NewZealand.  We have limited influence overthe decisions made by Schering AG or the resources they devote to the marketingand distribution of Plenaxis® products in their licensed territory,and we cannot assure you that they will meet their obligations in thisregard.  Moreover, Schering AG may marketcertain products that compete with our products, which could limit potentialrevenues from product sales.  Ourmarketing and distribution arrangement with Schering AG may not be successful,and we may not receive any revenues from it. Also, we cannot assure you that we will be able to enter into marketingand sales agreements on acceptable terms, if at all, for Plenaxis®in territories not covered by the Schering AG agreement, or for any of ourother product candidates.

 

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

 

Alternative products and medical treatments exist or are underdevelopment to treat advanced symptomatic prostate cancer.  For example, the FDA has approved severaldrugs for the treatment of prostate cancer that respond to changes in hormonelevels, and there are other treatment alternatives available, includingradiation therapy and surgery.  The FDA’sapproval of Plenaxis® is limited to use in a subset of advancedsymptomatic prostate cancer patients, and distribution of Plenaxis®will only be made in accordance with our risk management program, whichincludes physician enrollment in a prescribing program and a signed patientconsent form regarding the risks and benefits of the therapy.  Due to the potential risk of immediate-onsetsystemic allergic reactions, physicians must also monitor patients for 30minutes following the injection of Plenaxis®.  Prescribing physicians and patients may viewthese requirements as burdensome or may recommend or choose alternativetreatments that are more acceptable to the doctor and/or the patient.  Additionally, physicians may not prescribePlenaxis® if we fail to provide adequate education about itsbenefits and uses.  If, due to thesefactors, Plenaxis® does not achieve broad market acceptance as adrug for the treatment of the symptoms of men with advanced prostate cancer forwhom other hormonal therapies are not appropriate and who have refused surgicalcastration, we would likely not havesufficient funds to continue our operations as currently planned.

 

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**Our potential revenues will diminish if wefail to obtain adequate reimbursement coverage for****Plenaxis® orour other product candidates from third-party payors.**

 

The continuing efforts of government and third-party payors to containor reduce the costs of health care may limit our commercial opportunity. Ifgovernment and other third-party payors do not provide appropriate coverage andadequate reimbursement for Plenaxis® or our other productcandidates, physicians may not prescribe them. In some foreign markets, pricing and profitability of prescriptionpharmaceuticals are subject to government control. In the United States, weexpect that there will continue to be federal and state proposals for similarcontrols. In addition, managed care initiatives in the United States willcontinue to put pressure on the pricing of pharmaceutical products. 

 

Our ability to earn revenues from Plenaxis®, or any otherpotential product, alone or with collaborators, may depend in part on theavailability and levels of reimbursement from: 

 

•                                          government and health administration authorities, includingMedicare and Medicaid; 

 

•                                          private health insurers; and 

 

•                                          other third-party payors. 

 

We cannot predict the availability of coverage or reimbursement fornewly approved drugs such as Plenaxis® by Medicare or any otherpayor.  Third-party payors, includingMedicare, are increasingly challenging the prices charged for medical productsand services. Government and other third-party payors increasingly are limitingboth coverage and the level of reimbursement for new drugs and, in some cases,refusing to provide coverage for a patient’s use of an approved drug forpurposes not approved by the FDA. Third-party insurance coverage may not beavailable to patients for Plenaxis® or any of our other products. 

 

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

 

New federal legislation, enacted in December 2003, has altered theway in which physician-administered drugs covered by Medicare are reimbursed,generally leading to lower reimbursement levels.  As a new drug, Plenaxis® wasunaffected by the first stage of Medicare reimbursement cuts implementedJanuary 2004.  However, Medicarereimbursement for Plenaxis® will likely be reduced by the next roundof cuts to be implemented January 2005 (which entail a new reimbursementmethodology based on a product’s “average sales price” rather than the current“average wholesale price” methodology). It is possible that some physicians may alter practice patterns and/orrefer Medicare patients to hospital outpatient settings rather than continue totreat patients in-office and it is unclear at thistime how such a shift in the marketplace dynamic might affect sales forPlenaxis®.  It is alsopossible that payors other than Medicare may adopt an average sales pricereimbursement over time, and the effect of this on Plenaxis® salesis also unclear.

 

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

 

While the new lawspecifically prohibits the United States government from interfering in pricenegotiations between manufacturers and Medicare drug plan sponsors, somemembers of Congress are pursuing legislation that would permit the UnitedStates government to use its enormous purchasing power to demand discounts frompharmaceutical companies, thereby creating de facto price controls onprescription drugs.  In addition, the newlaw contains triggers for Congressional consideration of cost containmentmeasures for Medicare in the event Medicare cost increases exceed a certainlevel.  These cost containment measurescould include some sorts of limitations on prescription drug prices.  Additionally, the expanded Medicare coveragefor prescription drugs beginning in 2006 

 

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may impact physician decision-making withrespect to self-administered drugs that were not covered previously and maycompete directly or indirectly with Plenaxis. 

 

Any or all of theseissues may create pressure to lower the price of Plenaxis in order to be orremain competitive in the changing marketplace. It is unclear to what extent, if any, Plenaxis sales would increase or decrease in response to price changes.

 

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

 

During research and development, the use of pharmaceutical products,such as Plenaxis®, is limited principally to clinical trial patientsunder controlled conditions and under the care of expert physicians. Thewidespread commercial use of Plenaxis® could produce undesirable orunintended side effects that have not been evident in our clinical trials.  In addition, in patients who take multiplemedications, drug interactions could occur that can be difficult topredict.  These events, among others,could result in the imposition of additional regulatory controls that couldlimit the circumstances under which Plenaxis® is prescribed or evenlead to the withdrawal of the product from the market.  Due to the occurrence of immediate-onsetsystemic allergic reactions in patients treated with Plenaxis®during clinical trials, Plenaxis® has been approved underregulations concerning drugs with certain safety profiles, under which the FDAhas established special restrictions to ensure safe use.  Post-marketing phase 4 studies are alsorequired to evaluate the incidence of and further characterize such allergicreactions to the extent they occur.  Anyviolation of these special restrictions or unfavorable findings in the phase 4studies could lead to the imposition of further restrictions or withdrawal ofPlenaxis® from the market. 

 

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

 

Our ability to conduct, or continue to conduct, clinical trials andcommercialize Plenaxis® or other product candidates, will depend inpart on our ability to manufacture, or arrange for third-party manufacture of,our products on a large scale, at a competitive cost and in accordance withregulatory requirements. We must establish and maintain a commercial scaleformulation and manufacturing process for each of our potential products forwhich we seek marketing approval. We or third-party manufacturers may encounterdifficulties with these processes at any time that could result in delays in clinicaltrials, regulatory submissions or in the commercialization of potentialproducts. 

 

We have no experience in large-scale product manufacturing, nor do wehave the resources or facilities to manufacture products on a commercial scale.We will continue to rely upon contract manufacturers to produce Plenaxis®and other compounds for later-stage preclinical, clinical and commercialpurposes for a significant period of time. Third-party manufacturers may not beable to meet our needs as to timing, quantity or quality of materials. If weare unable to contract for a sufficient supply of needed materials onacceptable terms, or if we encounter delays or difficulties in ourrelationships with manufacturers, our clinical trials may be delayed, therebypreventing or delaying the submission of product candidates for, or thegranting of, regulatory approval and the commercialization of our potentialproducts. Any such delays may lower our revenues and delay or prevent ourattaining or maintaining profitability. 

 

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

 

In addition, we and the third-party manufacturers that we use mustcontinually adhere to current good manufacturing practice requirements enforcedby the FDA through its facilities inspection program.  Foreign regulatory authorities may alsoinspect our third-party manufacturers as a condition of approval.  In complying with these regulations andforeign regulatory requirements, we and any of our third-party manufacturerswill be obligated to expend time, money and effort in production,record-keeping and quality control to assure that our potential products meetapplicable specifications and 

 

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other requirements.  If we or any of our third-party manufacturersfail to comply with these requirements, we may be subject to regulatorysanctions, and the facilities could be shut down. 

 

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

 

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

 

For each stage of Plenaxis® production we have relied, andexpect in the near term to continue to rely, on a single third-partymanufacturer, and we currently have not contracted with a second supplier forany of these production stages. Accordingly, the loss of one or more of thesesuppliers for any reason, including as a result of fire, terrorism, acts of Godor insolvency or bankruptcy, could result in substantial delays in, orsubstantially impair our ability to complete, clinical trials and regulatory submissionsor reviews, and could delay or impair substantially our sale or continued saleof Plenaxis®. Such delays or impairment, and the associated costsand expenses, may lower our potential revenues and delay or prevent ourattaining profitability. While we are evaluating the possibility of a secondsource of supply at certain stages of Plenaxis® production, thenumber of qualified alternative suppliers is limited, and we cannot assureinvestors that we will be able to locate alternative suppliers or negotiatesecond supply agreements on reasonable terms. Furthermore, the process ofengineering a new supplier’s facility for the production of Plenaxis®and obtaining the necessary FDA and foreign regulatory approval of the facilitywould require substantial lead-time and could be extremely costly. We cannotassure investors that we will not lose one or more of our suppliers, or that insuch event we would be readily able to continue the commercialization ofPlenaxis® without substantial and costly delays. 

 

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

 

We will depend upon our corporate collaborator, Schering AG, to help usobtain regulatory approval for Plenaxis® and to commercializePlenaxis® in Schering AG’s licensed territory. Despite ourcollaborative relationship, we have limited influence over the amount andtiming of resources that Schering AG will devote to Plenaxis®.  In addition, Schering AG may terminate ourcollaboration agreement in various circumstances.  We cannot assure you that Schering AG orfuture collaborators will meet their obligations to us under our collaborationagreements with them.  If Schering AG oranother collaborator terminates its agreement with us or fails to perform, ordelays performance of, its obligations, it could delay or otherwise adverselyaffect or prevent, the commercialization of Plenaxis® in certainregions outside of the United States. As a result, we could be forced to devoteunforeseen additional resources to Plenaxis® commercializationoutside of the United States.  We cannotassure you that we would be able to raise the necessary funds or negotiateadditional corporate collaborations on acceptable terms, if at all, and in that event we could have to curtail plannedoperations for the commercialization of Plenaxis® outside of theUnited States.

 

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

 

The development and sale of Plenaxis®, and our productcandidates, is subject to extensive regulation by governmental authorities.Obtaining and maintaining regulatory approval typically is costly and takesmany years. Regulatory authorities, most importantly, the FDA, have substantialdiscretion to place on clinical hold or terminate clinical trials, delay,withhold or withdraw registration and marketing approval in the United States,and effectively mandate product recalls. Failure to comply with regulatoryrequirements may result in criminal prosecution, civil penalties, recall orseizure of products, total or partial suspension of production or injunction,as well as other actions as to Plenaxis®, our other potentialproducts or against us. Outside the United States, we can market a product onlyif we receive marketing authorization from the appropriate regulatoryauthorities. This foreign regulatory approval process includes all of the risksassociated with the FDA approval process, and may include additional risks. 

 

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To gain regulatory approval from the FDA and foreign regulatoryauthorities for the commercial sale of any product, we must demonstrate inclinical trials, and satisfy the FDA and foreign regulatory authorities as to,the safety and efficacy of the product. If we develop a product to treat a long-lasting disease, such as canceror Alzheimer’s disease, 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 prostate cancer, Alzheimer’sdisease and non-Hodgkin’s lymphoma programs have a high risk of death,age-related disease or other adverse medical events that may not be related toour products.  These events may affectthe statistical analysis of the safety and efficacy of our products. If weobtain regulatory approval for a product, the approval will be limited to thosediseases for which our clinical trials demonstrate the product is safe andeffective. 

 

In addition, many factors could delay or result in termination of ourongoing or future clinical trials. For example, results from ongoingpreclinical studies or analyses could raise concerns over the safety orefficacy of a product candidate.  InMarch 2004, the FDA placed our phase 1 clinical trial of PPI-2458 onclinical hold due to a neuropathological abnormality observed in some of theanimals tested in an animal safety study completed following initiation of theclinical trial.  In June 2004,following review by the FDA of our revised clinical plan addressing thisfinding, we received clearance from the FDA to resume clinical testing ofPPI-2458.  We cannot assure investorsthat the FDA will not place this or other clinical trials on hold in thefuture.  A clinical trial may alsoexperience slow patient enrollment or lack of sufficient drug supplies.Patients may experience adverse medical events or side effects, and there maybe a real or perceived lack of effectiveness of, or of safety issues associatedwith, the drug we are testing. Future governmental action or existing orchanges in FDA policies or precedents, may also result in delays or rejectionof an application for marketing approval. The FDA has considerable discretion in determining whether to grantmarketing approval for a drug, and may delay or deny approval even incircumstances where the applicant’s clinical trials have proceeded incompliance with FDA procedures and regulations and have met the establishedend-points of the trials. Challenges to FDA determinations are generallytime-consuming and costly, and rarely, if ever succeed.  Although we received FDA approval to marketPlenaxis® in the United States in November 2003, we can give noassurance that we will obtain marketing approval for any of our other productcandidates.  

 

Any regulatory approval may be conditioned upon significant labelingrequirements and, as in the case of the FDA approval of Plenaxis®,marketing restrictions and post-marketing study commitments.  Such labeling and marketing restrictionscould materially adversely affect the marketability or value of a product,including Plenaxis®, resulting in decreased sales.  In such a case, we would likely not havesufficient funds to continue operations as currently planned.

 

In addition, even after regulatory approval is obtained, our Company,product(s) and the manufacturing facilities for our product(s) will be subjectto continual review and periodic inspection. Later discovery of previouslyunknown problems with a product, manufacturer or facility may result inrestrictions on the product, the manufacturer or us, including withdrawal ofthe product from the market. The FDA stringently applies regulatory standards.Our manufacturing facilities will also be subject to FDA inspections foradherence to good manufacturing practices prior to marketing clearance andperiodically during the manufacturing process. Failure to comply can, amongother things, result in fines, denial or withdrawal of regulatory approvals,product recalls or seizures, operating restrictions, injunctions and criminalprosecution.  If there are anymodifications to a product, further regulatory approval will be required. 

 

For safety reasons, Plenaxis® was approved by the FDA with acomprehensive risk management program. This program includes educational outreach to patients and physiciansregarding the risks and benefits of Plenaxis®, restricteddistribution of the product only to physicians enrolled in a prescribingregistry, a system for collecting and reporting adverse events to the FDA andauditing requirements to evaluate the effectiveness of the program.  We are also required to conduct several phase4 studies to evaluate the risk management program and the appropriate use ofthe drug in the indicated population. Under the regulations under which Plenaxis® was approved, theFDA has the authority to pre-approve all promotional materials and hasavailable to it an expedited market withdrawal procedure if issues ariseregarding the safe use of Plenaxis®. If approval for Plenaxis® is withdrawn, we will not be ableto sell Plenaxis® and would likely not have sufficient funds tocontinue operations as currently planned.

 

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If we are unable to maintain FDA approval, or to obtain any foreignregulatory approval for Plenaxis®, or to obtain or maintainregulatory approval to market our other potential products, we are likely toexhaust our available resources significantly sooner than we had planned.  If this were to happen, we would need toeither raise additional funds or seek partners to continue our currentlyplanned research and development programs. We cannot assure you that we wouldbe able to raise the necessary funds or negotiate additional corporatecollaborations on acceptable terms, if at all. 

 

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

 

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

 

Product liability claims can be expensive to defend and may result inlarge judgments or settlements against us, which could have a negative effecton our financial performance. The costs of product liability insurance haveincreased dramatically in recent years, and the availability of coverage hasdecreased.  Although the Company carriesinsurance that it regards as reasonably adequate to protect it from potentialclaims, there can be no assurance that the Company will be able to maintain itscurrent product liability insurance at a reasonable cost, or at all.  Our former collaboration agreements included,and the agreements regarding the termination of those collaborations alsoinclude, an indemnification for liabilities associated with the development andcommercialization of Plenaxis®. Our agreement with Schering AG contains similar indemnificationprovisions.  If a third party, includinga former collaborator, successfully sues us for any injury, or forindemnification for losses, there is no guarantee that the amount of the claimwould not exceed the limit of the Company’s insurance coverage.  Further, a successful claim could result inthe recall of Plenaxis®, or could reduce revenues from sales ofPlenaxis®.  Even if a productliability claim is not successful, the adverse publicity and time and expenseof defending such a claim may interfere with our business.

 

**We rely upon a limited number of pharmaceutical specialty distributorsand pharmacies that could impact the ability to sell Plenaxis®.**

 

In the United States, we rely upon a limited number of specialtydistributors and pharmacies to deliver Plenaxis® to physicians andhospital pharmacies. There are a relatively small number of specialtydistributors and wholesalers who provide such services. These distributors mustalso distribute Plenaxis® only to physicians and hospitalpharmacists enrolled in our risk management program.  There can be no assurances that these distributorsand pharmacies will adequately provide their services to either the end usersor to the Company or that we could find additional outlets to distributePlenaxis®.  

 

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

 

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

 

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

 

A biopharmaceutical company such as ours must keep pace with rapidtechnological change and faces intense competition. We compete withbiotechnology and pharmaceutical companies for funding, access to new technology,research personnel and in product research and development. Many of thesecompanies have greater financial resources and more experience than we do indeveloping drugs, obtaining regulatory approvals, manufacturing, marketing andsales. We also face competition from academic and research institutions andgovernment agencies pursuing alternatives to our products and technologies. Weexpect that Plenaxis®, and all of our products under development,will face 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. 

 

Our competitors may: 

 

•                                          successfully identify drug candidates or develop productsearlier than we do; 

 

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

 

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

 

•                                          successfully market and sell products that compete with ourproducts. 

 

The success of our competitors in any of these efforts would adverselyaffect our ability to promote Plenaxis® and to develop andcommercialize our product candidates, and to ultimately attain and maintainprofitability. 

 

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

 

Our success will depend in part on our ability to obtain patents andmaintain adequate protection of our technologies and potential products. If wedo not adequately protect our intellectual property, competitors may be able touse our technologies and erode any competitive advantage we may have. Forexample, if we lose our patent protection for Plenaxis®, anotherparty could produce and market the compound in direct competition with us. Someforeign countries lack rules and methods for defending intellectual propertyrights and do not protect proprietary rights to the same extent as the UnitedStates. Many companies have had difficulty protecting their proprietary rightsin foreign countries. 

 

Patent positions are sometimes uncertain and usually involve complexlegal and factual questions. We can protect our proprietary rights fromunauthorized use by third parties only to the extent that our proprietarytechnologies are covered by valid and enforceable patents or are effectivelymaintained as trade secrets. We currently own or have exclusively licensed 28issued United States patents. We have applied, and will continue to apply, forpatents covering both our technologies and products as we deem appropriate.Others may challenge our patent applications or our patent applications may notresult in issued patents. Moreover, any issued patents on our own inventions,or those licensed from third parties, may not provide us with adequateprotection, or others may challenge the validity of, or seek to narrow orcircumvent, these patents. Third-party patents may impair or block our abilityto conduct our business. Additionally, third parties may independently developproducts similar to our products, duplicate our unpatented products, or designaround any patented products we develop. 

 

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

 

In addition to patents, we rely on a combination of trade secrets,confidentiality, nondisclosure and other contractual provisions, and securitymeasures to protect our confidential and proprietary information. Thesemeasures may not adequately protect our trade secrets or other proprietary 

 

26

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information. If these measures do notadequately protect our rights, third parties could use our technology, and wecould lose any competitive advantage we may have. In addition, others mayindependently develop similar proprietary information or techniques, whichcould impair any competitive advantage we may have. 

 

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

 

Our technologies, processes, product or product candidates may giverise to claims that they infringe patents or other intellectual property rightsof third parties.  A third party couldforce us to pay damages, stop our use of these technologies or processes, orstop our manufacturing or marketing of the affected products by bringing alegal action against us for infringement. In addition, we could be required toobtain a license to continue to use the technologies or processes or tomanufacture or market the affected products, and we may not be able to do so onacceptable terms or at all. We believe that significant litigation willcontinue in our industry regarding patent and other intellectual propertyrights. If we become involved in litigation, it could consume a substantialportion of our resources. Even if legal actions were meritless, defending alawsuit could take significant time, be expensive and divert management’sattention 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 license some of our technology from third parties. Termination ofour licenses could force us to delay or discontinue some of our development andcommercialization programs. For example, if Advanced Research and TechnologyInstitute, Inc., the assignee of Indiana University Foundation, terminated ourlicense with them, we could have to discontinue the commercialization ofPlenaxis®. We cannot assure you that we would be able to licensesubstitute technology in the future. Our inability to do so could impair ourability to conduct our business because we may lack the technology, or thenecessary rights to technology, required to develop and commercialize ourpotential products. 

 

**Pharmaceutical companies have been the target of lawsuits andinvestigations and there is no assurance that if we were to be involved in anysuch lawsuits or investigation, that our defense would be successful.**

 

Pharmaceutical companies have been the target of lawsuits and investigationsincluding, in particular, claims asserting violations of the Federal FalseClaim Act, Anti-Kickback Act, the Prescription Drug Marketing Act or otherviolations in connection with Medicare and/or Medicaid reimbursement, andclaims under state laws, including state anti-kickback and fraud laws. Publiccompanies may also be the subject of certain other types of claims, includingthose asserting violations of securities laws or related to environmentalmatters. There is no assurance that if we were to be involved in any suchlawsuits or investigation, that we would be successful in defending ourselvesor in asserting our rights. 

 

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

 

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

 

Recruiting and retaining qualified scientific personnel to performfuture research and development work also will be critical to our success.Competition for skilled personnel is intense and the turnover rate can be high.We compete with numerous companies and academic and other research 

 

27

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institutions for experienced scientists.This competition may limit our ability to recruit and retain qualifiedpersonnel on acceptable terms. Failure to attract and retain qualifiedpersonnel would prevent us from continuing to develop our potential products,enhancing our technologies and launching our products commercially. Our plannedactivities will require the addition of new personnel, including management andmarketing and sales personnel, and the development of additional expertise byexisting management personnel, in particular in the area of product marketingand sales. The inability to attract and retain these people or to develop thisexpertise could prevent, or result in delays in, the marketing and sale ofPlenaxis® or the research, development and commercialization of ourproduct candidates. 

 

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

 

Our research and development processes involve the controlled use ofhazardous materials, including chemicals and radioactive and biologicalmaterials, which may pose health risks. For example, the health risksassociated with accidental exposure to Plenaxis® include temporaryimpotence or infertility and harmful effects on pregnant women. Our operationsalso produce hazardous waste products. We cannot completely eliminate the riskof accidental contamination or discharge from hazardous materials and anyresultant injury. Federal, state and local laws and regulations govern the use,manufacture, storage, handling and disposal of hazardous materials. Compliancewith health and safety and environmental laws and regulations is necessary andexpensive. Current or future health and safety and environmental regulationsmay impair our research, development or production efforts. We may be requiredto pay fines, penalties or damages in the event of noncompliance or theexposure of individuals to hazardous materials. 

 

From time to time, third-parties have also worked with hazardousmaterials in connection with our agreements with them. We haveagreed to indemnify our present and former collaborators in some circumstancesagainst damages and other liabilities arising out of development activities orproducts produced in connection with these collaborations. 

 

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

 

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

 

•                                          our ability to successfully commercialize Plenaxis®in the United States;

 

•                                          failure or delay by third-party manufacturers in performingtheir supply obligations or disputes or litigation regarding those obligations;

 

•                                          the availability of reimbursement coverage for Plenaxis®and changes in the reimbursement policies of third-party insurance companies orgovernment agencies; 

 

•                                          announcement of foreign regulatory approval or disapprovalof Plenaxis® and/or associated labeling requirements;

 

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

 

•                                          the loss of our corporate collaborator, Schering AG, failureor delay by our corporate collaborator in performing its obligations ordisputes with our corporate collaborator;

 

•                                          our ability to enter into additional foreign corporatecollaborations for Plenaxis®, or United States or foreign corporatecollaborations for our other product candidates, and the timing and terms ofsuch collaborations;

 

•                                          the success rate of our discovery efforts and clinicaltrials; 

 

•                                          announcement of FDA or foreign regulatory approval ordisapproval of any of our other product candidates and/or associated labelingrequirements; 

 

•                                          announcements of technological innovations or new productsby us or our competitors; 

 

28

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•                                          developments or disputes concerning patents or proprietaryrights, including claims of infringement, interference or litigation against usor our licensors; 

 

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

 

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

 

•                                          changes in government regulation of the pharmaceutical ormedical industry; 

 

•                                          actual or anticipated fluctuations in our operating results;

 

•                                          changesin financial estimates or recommendations by securities analysts; 

 

•                                          sales of large blocks of our common stock; 

 

•                                          changes in accounting principles; and 

 

•                                          the loss of any of our key scientific or managementpersonnel. 

 

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

 

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

 

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

 

•                                          expected or unexpected fluctuations in Plenaxis®revenues in the United States;

 

•                                          the timing and level of expenses related to thecommercialization of Plenaxis® in the United States; 

 

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

 

•                                          the timing and level of expenses related to our otherresearch and clinical development programs; and 

 

•                                          the timing of our commercialization of other productsresulting in revenues. 

 

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

 

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

 

If appropriate opportunities become available, we may attempt toacquire businesses, or acquire or in-license products or technologies,that we believe are a strategic fit with our business. We currently haveno commitments or agreements for any acquisitions.  If we do undertake any transaction of thissort, the process of integrating an acquired business, or an acquired orin-licensed product or technology, may result in unforeseen operatingdifficulties and expenditures and may absorb significant management attentionthat would otherwise be available for the ongoing development of our business.Moreover, we may fail to realize the anticipated benefits of any transaction ofthis sort. To the extent we issue stock in a transaction, the ownershipinterest of our stockholders will be diluted. Transactions of this kind couldalso cause us to incur debt, expose us to future liabilities and result inexpenses related to goodwill and other intangible assets. 

 

29

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

 

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

 

30

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

 

The primary objective of our investment activities is to preserveprincipal while at the same time maximizing the income we receive from ourinvestments without significantly increasing risk.  We have not entered into any instruments fortrading purposes.  Some of the securitiesthat we invest in may have market risk. This means that an increase inprevailing interest rates may cause the principal amount of the investment todecrease. 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 $0.5 milliondecrease in the fair value of our investments as of June 30, 2004.  The same hypothetical increase in interestrates as of December 31, 2003 would have resulted in an approximate $0.8million decrease in the fair value of our investments.  Due to the conservative nature and relativelyshort duration of our investments, interest rate risk is mitigated.  As of June 30, 2004, approximately 82%of our total investments will mature or reset in one year or less, with theremainder maturing in less than three years. 

 

In connection with the purchase of our new facility in July 2000,our wholly owned real estate subsidiary executed an acquisition andconstruction loan agreement that provided for up to $33.0 million inborrowings at a floating interest rate indexed to 30-day LIBOR.  In July 2003, we exercised the first oftwo one-year extension options extending the maturity date of the loan untilJuly 30, 2004.  In connection withthis extension, the subsidiary entered into an interest rate cap agreementwhich limited exposure to interest rate increases above a certain thresholdthrough July 30, 2004.  

 

In June 2004, the acquisition and construction loan agreement wasamended to extend the maturity date of the loan and modify certain other termsof the original agreement.  Under theamended loan agreement, principal is now due and payable in full onJuly 30, 2009, subject to two one-year extension options which areexercisable at our option provided we are in compliance with certain financialcovenants.  The outstanding principalbears interest at a fixed rate of 5.95% through April 2009.  Principal and interest are payable through afixed monthly payment of approximately $207,000, with the principal portionbeing calculated using a 25-year amortization schedule.  The amended loan agreement also provides forcertain additional financial operating covenants, one of which is effectiveimmediately and the remainder of which will become effective as ofDecember 31, 2006.  Because of thisamendment to the loan agreement, we do not believe that there is materialinterest rate risk exposure with respect to the loan facility. 

 

**ITEM 4.****  CONTROLS AND PROCEDURES.**

 

*(a)*          *Disclosure Controls and Procedures*. 

 

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

 

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

 

There have notbeen any changes in the Company’s internal control over financial reporting (assuch term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)during the quarter ended June 30, 2004 that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

31

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**PART II.****  OTHERINFORMATION**

 

**ITEM 4.****  SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS.**

 

We held our Annual Meeting of Stockholders on May 13, 2004 to (i) electeight directors, (ii) approve our Third Amended and Restated 1995 Stock Plan,and (iii) ratify the appointment of Ernst & Young LLP as our independent auditorsfor fiscal year 2004.

 

The following nominees were elected, by the vote set forth below, tohold office until the next annual meeting of stockholders and until theirsuccessors are duly elected and qualified:

 
| **Nominee:**             | ** ** | **Number of Votes For:** | ** ** | **Number of Votes Withheld:** | ** ** |
|--------------------------|------------|--------------------------|------------|-------------------------------|------------|
| ** **               | ** ** | ** **               | ** ** | ** **                    | ** ** |
| Malcolm L. Gefter, Ph.D. |       | 45,379,309               |       | 3,157,485                     |       |
| G. Leonard Baker, Jr.    |       | 45,874,309               |       | 2,662,485                     |       |
| Garen G. Bohlin          |       | 45,874,309               |       | 2,662,485                     |       |
| Henry F. McCance         |       | 45,789,156               |       | 2,747,638                     |       |
| Leonard E. Post, Ph.D.   |       | 45,874,309               |       | 2,662,485                     |       |
| William R. Ringo         |       | 43,275,475               |       | 5,261,319                     |       |
| David B. Sharrock        |       | 43,247,775               |       | 5,289,019                     |       |
| Patrick J. Zenner        |       | 39,590,878               |       | 8,945,916                     |       |

 

In addition, the stockholders approved the Third Amended and Restated1995 Stock Plan, which amends and restates our Second Amended and Restated 1995Stock Plan, as amended, to increase by 1,500,000 the number of shares of commonstock, par value $.01 per share, authorized for issuance under the plan andextend the term of the plan until January 5, 2015, by the following vote: 

 
| **For:**   | ** ** | **Against:** | ** ** | **Abstain:** | ** ** |
|------------|------------|--------------|------------|--------------|------------|
| ** ** | ** ** | ** **   | ** ** | ** **   | ** ** |
| 24,607,877 |       | 10,207,690   |       | 1,310,079    |       |

 

The stockholders also ratified the appointment of Ernst & Young LLPas our independent auditors for fiscal year 2004 by the following vote:

 
| **For:**   | ** ** | **Against:** | ** ** | **Abstain:** | ** ** |
|------------|------------|--------------|------------|--------------|------------|
| ** ** | ** ** | ** **   | ** ** | ** **   | ** ** |
| 47,789,879 |       | 709,687      |       | 37,228       |       |

 

**ITEM 6.**  EXHIBITSAND REPORTS ON FORM 8-K.

** **

(a)           Exhibits

 
| ***Exhibit  Number*** | *** *** | ***Exhibit***                                                                                     |
|-----------------------|--------------|---------------------------------------------------------------------------------------------------|
| *** ***          | *** *** | *** ***                                                                                      |
| 3.1                   |         | Amended and Restated Certificate of Incorporation (2)                                             |
|                  |         |                                                                                              |
| 3.2                   |         | Third Amended and Restated By-Laws (5)                                                            |
|                  |         |                                                                                              |
| 4.1                   |         | Specimen certificate representing shares of common stock (1)                                      |
|                  |         |                                                                                              |
| 4.2                   |         | Specimen certificate representing shares of common stock (including  Rights Agreement Legend) (3) |

 

32

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| ***Exhibit  Number*** | *** *** | ***Exhibit***                                                                                                                                                                                                                                                                             |
|-----------------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *** ***          | *** *** | *** ***                                                                                                                                                                                                                                                                              |
| 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                  |         | Third Amended and Restated 1995 Stock Plan (6)                                                                                                                                                                                                                                            |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.2†            |         | License, Supply and Distribution Agreement dated April 27, 2004  by and between the Registrant and Schering AG                                                                                                                                                                       |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.3†            |         | Amendment No. 2 dated as of July 1, 2004 by and between the  Registrant and Cambrex Charles City, Inc. (formerly Salsbury Chemicals, Inc.)  to the Supply Agreement dated as of July 23, 1998 by and between the  Registrant and Salsbury Chemicals, Inc., as amended           |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.4                  |         | First Amendment to Acquisition and Construction Loan Agreement dated  as of June 28, 2004 by and between 830 Winter Street LLC and Anglo  Irish Bank Corporation plc, together with related Loan, Security and  Assignment Agreements, each as amended as of June 28, 2004 |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.5                  |         | First Amendment to and Reaffirmation of Guaranty of Non-Recourse  Exceptions dated as of June 28, 2004 by and between the Registrant and  Anglo Irish Bank Corporation plc                                                                                                           |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.6                  |         | First Amendment to and Reaffirmation of Environmental Compliance and  Indemnity Agreement dated as of June 28, 2004 by and between 830 Winter  Street LLC, the Registrant and Anglo Irish Bank Corporation plc                                                                       |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 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                                                                                                                             |

 

----

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

 

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

 

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

 

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

 

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

 

(6)           Incorporated by reference to RegistrationStatement on Form S-8 (333-116188) filed with the Securities and ExchangeCommission on June 4, 2004.

 

†              Confidential treatment has been requestedfor certain portions of this exhibit. Omitted portions have been filedseparately with the Securities and Exchange Commission. 

 

33

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(b)           Reports Submitted onForm 8-K

 

On April 28, 2004, we filed a Current Report on Form 8-K to reportunder Item 5 (Other Events) a collaboration with Schering AG and file as anexhibit under Item 7 a copy of our Press Release dated April 28, 2004.

 

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

 

On May 24, 2004, we furnished a Current Report on Form 8-K to furnishunder Item 9 (Regulation FD Disclosure) a copy of our Press Release dated May24, 2004.

 

On June 21, 2004, we furnished a Current Report on Form 8-K tofurnish under Item 9 (Regulation FD Disclosure) a copy of our Press Releasedated June 21, 2004.

 

On June 22, 2004, we furnished a Current Report on Form 8-K tofurnish under Item 9 (Regulation FD Disclosure) a copy of our Press Releasedated June 22, 2004.

 

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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 9, 2004 | By                                    |  /s/ Kevin F. McLaughlin |
|                            |                                  | Kevin F.  McLaughlin |
|                            |                                  | Chief Financial  Officer, Executive Vice President, |
|                            | * *                              | Treasurer and  Secretary *(Duly Authorized Officer* |
| * *                        |                                  | *and  Principal Financial and Accounting Officer)* |

 

35

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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                  |         | Third Amended and Restated 1995 Stock Plan (6)                                                                                                                                                                                                                                            |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.2†            |         | License, Supply and Distribution Agreement dated April 27, 2004  by and between the Registrant and Schering AG                                                                                                                                                                       |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.3†            |         | Amendment No. 2 dated as of July 1, 2004 by and between the  Registrant and Cambrex Charles City, Inc. (formerly Salsbury Chemicals, Inc.)  to the Supply Agreement dated as of July 23, 1998 by and between the  Registrant and Salsbury Chemicals, Inc., as amended           |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.4                  |         | First Amendment to Acquisition and Construction Loan Agreement dated  as of June 28, 2004 by and between 830 Winter Street LLC and Anglo  Irish Bank Corporation plc, together with related Loan, Security and Assignment  Agreements, each as amended as of June 28, 2004 |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.5                  |         | First Amendment to and Reaffirmation of Guaranty of Non-Recourse  Exceptions dated as of June 28, 2004 by and between the Registrant and  Anglo Irish Bank Corporation plc                                                                                                           |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 10.6                  |         | First Amendment to and Reaffirmation of Environmental Compliance and  Indemnity Agreement dated as of June 28, 2004 by and between 830 Winter  Street LLC, the Registrant and Anglo Irish Bank Corporation plc                                                                       |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 31.1                  |         | Certification of Chief Executive Officer                                                                                                                                                                                                                                                  |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 31.2                  |         | Certification of Chief Financial Officer                                                                                                                                                                                                                                                  |
|                  |         |                                                                                                                                                                                                                                                                                      |
| 32.1                  |         | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                             |
| 32.2                  |         | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                             |

 

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(1)   Incorporated by reference to Registration Statementon Form S-1 (Registration No. 333-96351) initially filed with the Securitiesand Exchange Commission on February 8, 2000 and declared effective onApril 26, 2000.

 

(2)   Incorporated by reference to Quarterly Report onForm 10-Q for the quarter ended March 31, 2000 filed with the Securitiesand Exchange Commission on June 7, 2000.

 

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(3)   Incorporated by reference to Registration Statementon Form S-1 (Registration No. 333-54342) initially filed with the Securitiesand Exchange Commission on January 26, 2001 and declared effective onFebruary 14, 2001.

 

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

 

(5)   Incorporated by reference to Annual Report on Form10-K for the year ended December 31, 2002 filed with the Securities andExchange Commission on March 19, 2003.

 

(6)   Incorporated by reference to Registration Statementon Form S-8 (333-116188) filed with the Securities and Exchange Commission onJune 4, 2004.

 

†              Confidential treatment has been requestedfor certain portions of this exhibit. Omitted portions have been filedseparately with the Securities and Exchange Commission. 

 

37

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