**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

| (Mark One) | ** ** | ** **                                                                                           |
|-----------------|------------|------------------------------------------------------------------------------------------------------|
| x               | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

**For the fiscal year endedDecember 31, 2005**

**or**

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

**Forthe transition period from ***          * to *          *

**Commissionfile number 000-30289**

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**PRAECIS PHARMACEUTICALS INCORPORATED**

(Exact name of registrantas specified in its charter)

| **Delaware******(State or other  jurisdiction of  incorporation or organization)         | ** ** | **04-3200305**(I.R.S. Employer  Identification No.) |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|
| **830 Winter Street****Waltham, Massachusetts**(Address of  principal executive offices) | ** ** | **02451-1420******(Zip code)                        |

 

**(781) 795-4100**

(Registrant’s telephone number, including area code)

**Securities registered pursuant to Section 12(b) ofthe Act:**

      None      

(Title of Class)

**Securities registered pursuant to Section 12(g) ofthe Act:**

Common Stock, parvalue $.01 per share

(Title of Class)

Preferred StockPurchase Rights

(Title of Class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Actof 1933. Yes o No x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934. Yes o No x

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 forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§ 229.405 of thischapter) is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

Large acceleratedfiler o                    Acceleratedfiler o                   Non-acceleratedfiler x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act). Yes o No x

The aggregate market valueof voting and non-voting stock held by non-affiliates of the registrant, basedupon the last sale price of the common stock, par value $.01 per share,reported on The Nasdaq National Market on June 30, 2005, was $25,570,563.

The number of shares of common stock, par value $.01per share, outstanding as of February 28, 2006 was 10,503,555.

All share and per share amounts, including all commonstock equivalents (stock options and the exercise prices thereof), reported inthis Annual Report on Form 10-K have been have adjusted for allperiods presented to reflect a 1-for-5 reverse split of theregistrant’s common stock effected on November 1, 2005.

**Documents Incorporated By Reference**

Specified portions of thedefinitive Proxy Statement with respect to the registrant’s 2006 Annual Meetingof Stockholders to be filed by the registrant with the Securities and ExchangeCommission are incorporated by reference into Part III of this AnnualReport on Form 10-K.

 

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**Factors That May Affect Future Results**

The Company’s prospects are subject to certainuncertainties and risks. This Annual Report on Form 10-K alsocontains certain forward-looking statements within the meaning of thefederal securities laws. The Company’s future results may differ materiallyfrom its current results and actual events and results could differ materiallyfrom those described in the forward-looking statements as a result ofvarious risks and uncertainties, including the risk factors described in thisreport. READERS SHOULD PAY PARTICULAR ATTENTION TO THE CONSIDERATIONS DESCRIBEDIN THE SECTION OF THIS REPORT ENTITLED “RISK FACTORS.” Readers should alsocarefully review the risk factors described in the other documents the Companyfiles from time to time with the Securities and Exchange Commission.

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**PRAECISPHARMACEUTICALS INCORPORATEDANNUAL REPORT ON FORM 10-KTABLE OF CONTENTS**

|                   | ** ** | ** **                                                                                                         | ** ** | **Page** |
|-------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|
| **Part I**   |       |                                                                                                               |
| Item 1.           |       | Business                                                                                                           |       | 1        |
| Item 1A.          |       | Risk Factors                                                                                                       |       | 14       |
| Item 1B.          |       | Unresolved Staff Comments                                                                                          |       | 27       |
| Item 2.           |       | Properties                                                                                                         |       | 27       |
| Item  3.          |       | Legal  Proceedings                                                                                                 |       | 27       |
| Item 4.           |       | Submission of Matters to a Vote of Security Holders                                                                |       | 28       |
| **Part II**  |       |                                                                                                               |
| Item 5.           |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       | 29       |
| Item 6.           |       | Selected Financial Data                                                                                            |       | 30       |
| Item 7.           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       | 31       |
| Item 7A.          |       | Quantitative and Qualitative Disclosures About Market  Risk                                                        |       | 44       |
| Item 8.           |       | Financial Statements and Supplementary Data                                                                        |       | 44       |
| Item 9.           |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       | 45       |
| Item 9A.          |       | Controls and Procedures                                                                                            |       | 45       |
| Item  9B.         |       | Other  Information                                                                                                 |       | 45       |
| **Part III** |       |                                                                                                               |
| Item 10.          |       | Directors and Executive Officers of the Registrant                                                                 |       | 46       |
| Item 11.          |       | Executive Compensation                                                                                             |       | 46       |
| Item 12.          |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       | 46       |
| Item 13.          |       | Certain Relationships and Related Transactions                                                                     |       | 46       |
| Item 14.          |       | Principal Accountant Fees and Services                                                                             |       | 46       |
| **Part IV**  |       |                                                                                                               |
| Item 15.          |       | Exhibits, Financial Statement Schedules                                                                            |       | 47       |
|              |       | Signatures                                                                                                         |       | 50       |
|              |       | Index to Financial Statements                                                                                      |       | F-1      |

 

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**PART I**

**ITEM 1.**                BUSINESS.

**Overview**

We are a biopharmaceuticalcompany focused on the discovery and development of novel compounds with thepotential to address unmet medical needs or improve existing therapies. During 2005, we fundamentally altered our strategicoperating plan to focus our efforts on early stage research and developmentactivities. We are focusing our resources on an innovative drugdiscovery technology, DirectSelect, which enables the generation and practicaluse of ultra-large libraries for the discovery of orally active compoundsfor drug development. We believe that this technology will be an important toolfor the future of drug discovery and development, and we intend to leverage itspotential both through partnerships and the identification of new compounds forinternal development. In addition, we have a novel methionine aminopeptidasetype 2, or MetAP-2, inhibitor, PPI-2458, in clinical developmentfor cancer indications, including non-Hodgkin’s lymphoma and solid tumors. Preclinicaldata also supports the use of this compound in inflammatory and autoimmunedisorders, including rheumatoid arthritis. We have received approval to marketPlenaxis, our drug for advanced prostate cancer, in the United States andGermany. As part of our strategy to focus our resources and attention onadvancing our DirectSelect and PPI-2458 programs, we are activelypursuing, with the assistance of an investment banking firm, the disposition ofour Plenaxis assets through a license or sale transaction, and such a possibletransaction is currently being evaluated by several interested parties.

***Significant 2005 Events***

*StrategicRestructuring.**  *On May 19,2005, our board of directors approved a strategic restructuring to focus theCompany’s resources on our most promising assets and programs and significantlyreduce our cost structure. The strategic restructuring was intended to reduceour annual cash utilization and allow us to focus our resources on thecontinued advancement of our DirectSelect drug discovery technology and on ourPPI-2458 clinical development program.

The strategic restructuring included voluntarilydiscontinuing promotional activities related to Plenaxis and the sale of Plenaxisfor new patients in the United States; voluntarily suspending the ongoingclinical development of Apan, our drug candidate for Alzheimer’s disease; andimplementing a reduction of our 182-person headcount by approximately 60%to approximately 75 full-time employees. Plenaxis continues to be available tothose patients in the United States who had already received the drug at thetime we announced our strategic restructuring. We plan to explore potentialpartnering opportunities for Apan to enable its further development.

In connection with thestrategic restructuring, we recorded approximately $28.7 million ofrestructuring and asset impairment expenses. We also recorded a non-cashimpairment charge of approximately $3.5 million related to inventory due to thediscontinuation of promotional activities relating to Plenaxis in the UnitedStates. This inventory impairment charge is classified in cost of goods sold inour consolidated statements of operations. Included in restructuring and assetimpairment expenses are cash charges of approximately $2.6 million for employeeseverance, benefits and related costs, approximately $0.2 million associatedwith the termination of various contracts and approximately $0.2 millionof other associated costs.

*German RegulatoryApproval*

In September 2005, we received marketingauthorization for Plenaxis from the German regulatory authorities. Shortlyafter our receipt of the German approval, we received notice from Schering AG,of Berlin, Germany, that it was exercising its right to terminate its license,supply and distribution agreement with us due to our not having received marketing authorization for Plenaxis inGermany with a requisite label by June 30, 2005. Under the Schering AGagreement, we received a $2.0 million signing payment during the second quarterof 2004, which we were recognizing as revenue ratably over a period through 

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2016based on the remaining patent life of Plenaxis in Europe. Due to thetermination of the Schering AG agreement in September 2005, we recognizedapproximately $1.9 million in revenues for the year ended December 31,2005, representing the remaining deferred revenue from the $2.0 million signingpayment. In October 2005, in connection with the termination of theSchering AG agreement, the parties entered into a settlement agreement underwhich Schering AG paid us $4.0 million, representing full and completesatisfaction of its obligations under the agreement arising prior to itstermination. We recognized this $4.0 million payment as revenues in 2005. Dueto our discontinuation of promotional activities related to Plenaxis in theUnited States and the termination of the Schering AG agreement, we arecurrently seeking to dispose of our Plenaxis assets through a license or saletransaction.

*FacilitySale.**  *In October 2005,we sold our corporate headquarters and research facility for $51.25 million.We realized proceeds, net of fees and expenses, of approximately $50.4 millionfrom this sale, and used approximately $31.6 million of the proceeds to retirethe outstanding debt obligation related to the facility. The remaining netproceeds of approximately $18.8 million will be used to further our researchand development efforts. In connection with the sale of the facility, weexecuted a lease for approximately 65,000 square feet of office and laboratoryspace in the facility. The lease has an initial term of five years. We haveoptions to extend the lease for up to three additional five-year terms at thencurrent market rates.

*Reverse Stock Split.**  *On November 1, 2005, we implemented aone-for-five reverse split of our common stock. As a result, the number ofshares of our issued and outstanding common stock was reduced fromapproximately 52.5 million shares to approximately 10.5 million shares. All pershare amounts and outstanding shares, including all common stock equivalents(stock options and the exercise prices thereof), have been retroactivelyrestated for all periods presented in this report to reflect the reverse stocksplit.

**Additional Information**

We were incorporated in Delaware in July 1993under the name Pharmaceutical Peptides, Inc. In June 1997, we changedour name to PRAECIS PHARMACEUTICALS INCORPORATED.  Our corporate headquarters and researchfacility is located in Waltham, Massachusetts. We conduct our business in onebusiness segment. For the year ended December 31, 2005, a majority of ourrevenue was generated through payments made by Schering AG, of Berlin, Germany,under or in connection with the Schering AG agreement, with the remainder ofour revenue being generated in the United States through sales of Plenaxis. Forthe year ended December 31, 2004, substantially all of our revenue wasgenerated in the United States. We did not have any revenue for the year ended December 31,2003. Long-lived assets consist primarily of property and equipment and arelocated solely in the United States for all periods presented.

Plenaxis® and PRAECIS® areregistered trademarks of our company. ApanTM, DirectSelectTM, Rel-EaseTM and thePLUSTM Program are trademarks or trade names of our Company.

**Our Strategy**

Our businessobjective is to utilize our DirectSelect and other proprietary technologies todiscover, in a rapid and efficient manner, novel, orally-available compoundswith the potential to address unmet medical needs or improve existing therapies.We intend to collaborate with pharmaceutical and biotechnology companies on thediscovery and development of these compounds across a broad range oftherapeutic areas. We also intend to select promising compounds to retain forinternal development and will partner these compounds at various stages ofdevelopment to optimize their value to the Company. We currently do not intendto independently market the products that may ultimately result from our discoveryand development efforts. The key elements of our strategy include:

·       Continuing to develop and enhance our DirectSelect technology, enteringinto pharmaceutical partnerships for drug discovery and developmentutilizing this technology that will provide revenues to us, and expanding ourown proprietary development pipeline; and

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·       Advancing PPI-2458 through a phase 1 trialin cancer patients and continuing preclinical evaluation of this compound ininflammatory and autoimmune disorders, including rheumatoid arthritis, with agoal of partnering this program in one or more indications as clinicaldevelopment advances.

Additionally, as part ofour strategy to focus our resources and attention on advancing our DirectSelectand PPI-2458 programs, we are actively pursuing, with the assistance ofan investment banking firm, the disposition of our Plenaxis assets through alicense or sale transaction.

**DrugDiscovery and Development Programs**

We utilize a number of drug discovery methodologies toidentify novel candidates for drug development, including DirectSelect andtraditional medicinal chemistry lead optimization. We are currently conductingpreclinical evaluations of various compounds discovered using thesemethodologies. Our most advanced internal product candidate, PPI-2458, isderived from traditional medicinal chemistry lead optimization and is currentlyin clinical testing.

Weare focusing our drug discovery and development efforts on the programsoutlined below.

***DirectSelect Drug Discovery Technology***

We are focusing our research efforts on developing andenhancing a novel drug discovery technology which we call DirectSelect. We havemade significant progress on the development of DirectSelect, including solving many of the technical challengesassociated with creating and screening ultra-large advanced combinatorialchemistry libraries. The enhanced capabilities of these libraries stemfrom their sheer size, up to 10,000 times the size of compound librariestypically used in the pharmaceutical industry. We believe that our DirectSelecttechnology, through thecreation of these vast libraries of drug-like molecules, will allow us to morerapidly and directly identify orally available compounds with high affinity andspecificity than has routinely been possible using traditional drug discoverymethods. Traditional drug discovery methods often utilized by largepharmaceutical companies typically start with up to one million molecules tofind a promising molecule. Subsequent optimization of that molecule to developa lead compound may take four to five years. Our vision for DirectSelect is tocreate libraries with such high diversity—tens’ of billions of compounds—thatthe normal time frame for drug discovery can be dramatically shortened byrapidly identifying lead molecules without a significant investment inmedicinal chemistry optimization. In addition, we believe libraries of thisscale will yield multiple series of lead molecules, thereby providing theopportunity to select the least toxic molecules for advancement into theclinic.

During 2005, we expanded our DirectSelect librarycollection to greater than five billion compounds. The design of the librarieshas been focused on creating novel, drug-like structures in accordance withvarious rules and guidelines used in the industry, such as the Lipinski “Rule ofFive” and Veber’s rules for drug-like properties. The design of thelibraries also emphasizes occupying unpatented chemical space so that thecompounds that result from the screening of the library have apparentfreedom-to-operate. This issue is increasingly challenging in the industry, butone which we believe can be addressed in advance with the initial design of ourlibraries. In addition, we have developed a range of new chemical reactionsthat will allow for continued synthesis of diversified libraries.

One of the challenges that we faced during 2005 wasdemonstrating our ability to routinely screen libraries of millions or billionsof compounds and identify novel compounds. During the fourth quarter of 2005,as a proof-of-concept, three targets—three kinase and one protease—werescreened to identify hit molecules. In each case, novel advanced “hit”molecules were identified. A “hit” is a molecule that was re-synthesizedwithout accompanying tags used in the library version of the molecule,confirmed structurally, and shown to inhibit the biochemical activity of thetarget. An “advanced hit” is an identified group or family of relatedstructures that share a relationship between structure and activity. Theprocess of performing the screen, analyzing the output data, re-synthesizingthe compounds and testing them in enzyme inhibition and cell assays tookapproximately one month per target. Several of the advanced hits 

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are currently beingoptimized to identify “lead” molecules through the creation and screening offocused libraries using DirectSelect. “Lead” molecules are compounds that haveimproved potency at inhibiting the target of interest with defined selectivityfor the target. Given our internal validation of DirectSelect’s utility inidentifying hit molecules, we have initiated activities to screen for newcompounds against therapeutic targets of interest. The continued developmentand enhancement of DirectSelect is a key component of our strategic operatingplan, and we believe that this technology may be an important tool for thefuture of drug discovery and development. We have filed United States andforeign patent applications covering the DirectSelect process and librariesgenerated under this process.

In addition to ourinternal efforts to develop and enhance DirectSelect, our strategic operatingplan includes entering into drug discovery and development partnershipsutilizing DirectSelect, and we are continuing to initiate and advance researchcollaboration discussions with major pharmaceutical companies with respect tothis technology. We also intend to use this technology to expand our ownproprietary development pipeline.

***PPI-2458***

We are also focusing our research and developmentefforts on PPI-2458, a novel, proprietary oral compound targeted at theinhibition of the enzyme methionine aminopeptidase type 2, or MetAP-2. PPI-2458is based on the fumagillin class ofcompounds. This class of compounds has been shown to prevent the formation ofnew blood vessels (known as angiogenesis) as well as abnormal cell growth; bothevents are known contributors to the growth of aberrant tissues in diseasessuch as cancer and rheumatoid arthritis. Clinical development with previousfumagillin derivatives has been limited by their pharmacokinetic and toxicityprofiles. In preclinical studies to date, PPI-2458 has demonstrated thepotent activity of this class of compounds, while displaying an improved pharmacokineticand toxicity profile. The improved pharmacokinetic profile enables oraladministration of PPI-2458, which we believe represents an additionalimprovement over its predecessors. We believe that, due to itsantiproliferative and antiangiogenic activity, PPI-2458 has the potentialto address broad therapeutic areas, and we are currently in the process ofestablishing a plan for additional clinical studies for this compound. In light of the anticipated development costsassociated with the PPI-2458 clinical program, we anticipate seeking apartner for this program as clinical development advances.

*CancerIndications.*   Inpreclinical studies conducted independently by us and the National CancerInstitute, or NCI, in both cellular and animal models, PPI-2458demonstrated significant anti-tumor activity against several varied cancer celllines. The NCI has presented its data on the anti-angiogenic activity of PPI-2458and its preclinical efficacy in a variety of xenograft animal models of humancancer, which indicates that the activity of PPI-2458 compares favorablyto that of TNP-470, another compound of this class that was previouslystudied by TAP Pharmaceutical Products Inc. To evaluate the activity of PPI-2458on a molecular level, we have developed a proprietary pharmacodynamic assay toassess the level of inhibition achieved by PPI-2458 of its target enzyme,MetAP-2. Preclinical research has demonstrated that inhibition of MetAP-2by PPI-2458 directly correlates with biological anti-cancer activity incell lines and tumors grown in animal models. During 2005, we presented preclinicaldata demonstrating that due to its potent inhibition of MetAP-2, PPI-2458has potential for use as a new therapy for non-Hodgkin’s lymphoma, or NHL. MetAP-2is highly expressed in human germinal center B cells and some of the neoplasticcounterparts of these cells, which are NHL subtypes, such as diffuse large Bcell lymphoma and follicular lymphoma. PPI-2458 has been shown to reducethe formation of germinal centers in lymphoid tissues in animal models*,* to have direct anti-proliferative activity on several NHLcell lines *in vivo* and to inhibit the growth of NHLtumor xenografts in a preclinical animal model. Other studies have demonstratedthat PPI-2458 significantly inhibited the growth of certain tumors in adose-dependent manner, and that the degree of growth inhibition was correlatedto the level of MetAP-2 inhibition achieved by PPI-2458. Additionally,in preclinical animal models, the activity of PPI-2458 is synergisticwith several chemotherapeutic agents that are routinely used in combination inNHL patients. There is also published evidence that MetAP-2 is highlyexpressed in some other human cancer cell lines and, 

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accordingly, we believethat PPI-2458 may have much broader therapeutic application in oncologyand that these results provide the scientific rationale for clinicalinvestigation of PPI-2458 in cancer patients.

During the fourth quarter of 2003, we initiated ourfirst clinical trial for PPI-2458 evaluating an oral formulation innon-Hodgkin’s lymphoma patients who were no longer responding to othertherapies. In March 2004, the FDA placed this trial on clinical hold dueto a non-clinical safety concern. In June 2004, we received clearance fromthe FDA to resume clinical trials, and in late 2004, we opened a phase 1clinical trial of PPI-2458 in non-Hodgkin’s lymphoma patients. During thefirst quarter of 2005, we expanded the enrollment criteria of this trial toinclude patients with solid tumors. This trial is designed to assess the safetyand tolerability of orally administered PPI-2458 and to identify themaximum tolerated dose. As a secondary endpoint, the study will assess thepharmacokinetics and the pharmacodynamic activity of PPI-2458. While theclinical trial is still in its early stages, thus far oral dosing of PPI-2458has been well tolerated and has produced substantial inhibition of moleculartargeted MetAP-2 activity in most subjects evaluated.

*Inflammatory andAutoimmune Indications.*   We continue to evaluatethe therapeutic potential of PPI-2458 in inflammatory and autoimmunedisorders, including rheumatoid arthritis. A hallmark of rheumatoid arthritisis the progressive destructionofarticular joints and joint surfaces, characterized by the rapid, uncontrolledgrowth of the cells that line the joints, called synoviocytes. Thesynoviocytes, in turn, secrete a variety of chemicals that contribute toinflammation, tissue degradation and harmful new blood vessel formation. Previouslypublished data from our preclinical studies demonstrate that PPI-2458inhibits thegrowth ofboth human endothelial cells and human fibroblast-like synoviocytesderived from rheumatoidarthritis patients. Both cell types are thought to be important in theprogression of joint destruction in rheumatoid arthritis patients. In addition,growth inhibitionofthese PPI-2458-sensitive cell types in rheumatoid arthritis hasbeen shown in preclinical studies to be linked to MetAP-2enzyme inhibition in a dose-dependentfashion. In a rodent model of rheumatoid arthritis, PPI-2458 inwell-tolerated doses also significantly lessened joint swelling whenadministered therapeuticallyafter the onset of chronic disease. Based on preclinical data we have generated,we believe that PPI-2458 could be a potential treatment withdisease-modifying activity for rheumatoid arthritis and other inflammatory andautoimmune disorders.

**Other Programs**

***Plenaxis***

As part of our strategy to focus our resources andattention on advancing our DirectSelect and PPI-2458 programs, we areactively pursuing, with the assistance of an investment banking firm, thedisposition of our Plenaxis assets through a license or sale transaction, andsuch a possible transaction is currently being evaluated by several interestedparties. However, we cannot assure investors that we will be able to concludesuch a transaction in a timely manner and on acceptable terms, or at all. If weare unable to do so, we do not intend to pursue further the commercializationof Plenaxis outside the United States and will seek to discontinue alldistribution of Plenaxis in the United States.

*ClinicalStudies.*   We have conducted extensive clinical studies of Plenaxis (abarelixfor injectable suspension), a gonadotropin releasing hormone (GnRH) antagonist, in patientswith hormonally responsive advanced prostate cancer. We have also previouslyconducted clinical studies of this compound for the treatment of endometriosisand androgen independent prostate cancer. We are currently in the process ofwinding down our phase 4 Plenaxis experience study and are no longer enrollingpatients in this study. We do not intend to conduct any further clinicalstudies of Plenaxis in any indication.

*RegulatoryApprovals.**  *In November 2003, wereceived FDA approval to market Plenaxis in the United States. In the UnitedStates, Plenaxis is indicated for the palliative treatment of men with advancedsymptomatic prostate cancer, in whom LHRH agonist therapy is not appropriate andwho refuse surgical castration, and have 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. For safety reasons, Plenaxis is 

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approved with marketingrestrictions under 21 CFR 314, Subpart H, and is available only to physicianswho enroll in the PLUS (PLenaxis User Safety) Program.  Full prescribing information for Plenaxis isavailable at www.plenaxis.com.

In January 2004, we began commercial distributionof Plenaxis. As noted above, as part of our strategic restructuring announcedin May 2005, we voluntarily discontinued promotional activities related toPlenaxis and the sale of Plenaxis for new patients in the United States. Thedecision to discontinue promotion of Plenaxis in the United States was promptedsolely by commercial considerations, and was not prompted in any way by safety,efficacy or other regulatory issues. The product has exhibited the same safetyprofile in commercial use as was demonstrated in the clinical studies leadingto its approval, and the risk/benefit profile of the drug has not changed. Plenaxiscontinues to be available to those patients in the United States who hadalready received the drug at the time we announced our strategic restructuring.

In June 2003, we submitted a marketingauthorization application in Germany. In late September 2005, we receivedmarketing authorization for Plenaxis from the German regulatory authorities. InGermany, Plenaxis is indicated to initiate hormonal castration in patients withadvanced or metastatic, hormone-dependent prostate cancer, if androgensuppression is appropriate. Shortly after our receipt of the German approval,we received notice from Schering AG, of Berlin, Germany, that it was exercisingits right to terminate its license, supply and distribution agreement with usdue to our not having received marketing authorization for Plenaxis in Germanywith a requisite label by June 30, 2005. Due to our discontinuation ofpromotional activities related to Plenaxis in the United States and thetermination of the Schering AG agreement, we are actively seeking to license orsell Plenaxis.

*ManufacturingAgreements.**  *Wehave long-term agreements for each stage of the Plenaxis manufacturing process.We have a development and supply agreement with Lonza Ltd., which acquiredUCB-Bioproducts, the manufacturing division of UCB S.A., and assumed all of UCB’srights and obligations under its agreement with us, in February 2006. Underthis agreement, Lonza supplies us with commercial volumes of the activepharmaceutical ingredient, or API, for Plenaxis. In January 2006, weamended our existing agreement with UCB. Under the amendment, UCB agreed tosuspend certain in-process manufacturing and process development work in returnfor a payment covering the estimated value of the work carried out to date. Thefull value of these manufacturing and process development activities under theagreement was approximately $2.2 million. Pursuant to the amendment, inconsideration for the suspension of these activities, UCB agreed to a partialpayment of approximately $1.6 million. This payment was made upon signing ofthe amendment in January 2006. In addition, under the UCB agreement, wehave committed to purchase certain quantities of raw materials in UCB’sinventory for an aggregate purchase price of approximately $3.4 million. We arerequired to purchase a specified quantity of these materials each yearbeginning in 2006 and ending in 2009. Our minimum purchase commitment relatedto these raw materials for 2006 is $0.6 million. Including both the $1.6million partial payment and our minimum purchase commitment, as of December 31,2005, our total commitments under this development and supply agreement were $5.0million, of which $1.6 million was paid in January 2006 as noted above. Wemade payments under this agreement of approximately $1.8 million during 2005.

We also have a supply agreement with Cambrex CharlesCity, Inc., formerly Salsbury Chemicals, Inc. Under this supplyagreement, Cambrex has agreed to manufacture commercial depot formulations ofPlenaxis. We retain all rights in manufacturing technology developed in connectionwith this agreement. Under the Cambrex agreement, we are obligated to a minimumannual purchase commitment of $900,000 per year through the term(July 2010). As a result of the timing of receipt of invoices, we madepayments related to minimum purchase commitments and other services providedunder the Cambrex agreement of approximately $0.7 million during 2005.

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In addition, we have a commercial supply agreementwith Baxter Pharmaceutical Solutions LLC to supply Plenaxis in finished vials. Ourminimum annual purchase commitment for the remainder of the term of the Baxteragreement (through June 2007) is $650,000. As a result of the timing ofinvoices and credits, we made payments related to minimum purchase commitmentsand other services provided under the Baxter agreement of approximately $0.3million during 2005.

*Marketingand Sales.**  *Inconnection with the approval and commercial launch of Plenaxis, we establishedan internal infrastructure to support the marketing and sale of the product inthe United States. We also established a nationwide sales force, as well as astaff of medical science liaisons. In May 2005, in connection with thestrategic restructuring, we voluntarily discontinued promotional activitiesrelated to Plenaxis and the sale of Plenaxis for new patients in the UnitedStates, and accordingly, we terminated all of our sales and marketingpersonnel.

*Distribution/Customers.**  *Although we voluntarily discontinued promotionalactivities related to Plenaxis and the sale of Plenaxis for new patients in theUnited States in May 2005, the product continues to be available to thosepatients in the United States who had already received the drug at the time weannounced our strategic restructuring. We sell Plenaxis directly to a limitednumber of authorized specialty pharmaceutical distributors and pharmacies. Ourpolicy for sales returns has historically allowed authorized distributors toreturn the product three months prior to, and six months after, productexpiration. In connection with our strategic restructuring announced in May 2005,we modified our policy for sales returns to eliminate these restrictions inorder to accommodate subsequent product returns. We currently providesubstantially all of our distributors with payment terms of up to 120 days onpurchases of Plenaxis. Through December 31, 2005, payments have generallybeen made in a timely manner.

***Apan***

In connection with ourstrategic restructuring announced in May 2005, we voluntarily suspendedour clinical development program for Apan, our proprietary investigationalcompound for Alzheimer’s disease. We began this program in 2000 and, prior toits suspension, completed both a phase 1a single dose escalation study,identifying a maximum tolerated dose in healthy volunteers, and a phase 1bsingle dose escalation study, identifying the maximum tolerated dose inAlzheimer’s patients. Enrollment in a phase 1/2a multiple dose study wassuspended prior to completion. The suspension of clinical development for Apanwas not due to any unexpected or undesirable event or clinical result, butrather to redirect our resources. We plan to explore potential partneringopportunities for this compound to enable its further development.

**Other Technology Assets**

***Rel-Ease Drug Delivery Technology***

We have developed Rel-Ease, our proprietary sustainedrelease drug delivery technology, to allow for the delivery of drugs in aninjectable long-acting depot and potentially in oral formulations. For example,using Rel-Ease technology, we are able to formulate Plenaxis in such a way thata physician needs to administer it to prostate cancer patients only once everyfour weeks (following the first month, in which an additional dose is given onday 15). In addition to the obvious benefit of reducing the frequency of dosingfor injectable drugs, less frequent injections of a drug in a sustained releaseformulation may also be more advantageous and desirable than oraladministration, leading to improved patient compliance, added convenienceand/or simplified reimbursement.

Rel-Ease differs from manyother sustained release formulations in that it allows high drug loads withminimal initial “burst” and uses aqueous processes which are compatible withbiomolecules. Moreover, Rel-Ease uses readily available pharmaceutical gradepolymers, has a robust manufacturing process that readily scales to commercialquantities and has demonstrated its acceptability to both United States andGerman regulatory authorities with the Plenaxis marketing approvals. We have formulated a variety of other moleculeswith Rel-Ease technology, including other peptides, proteins and low molecularweight 

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pharmaceuticals, and believe that Rel-Ease may be usefulfor formulating drugs in clinical development, as well as creating improvedinjectable depot or oral sustained release formulations of approved drugs. Wehold patents that cover the general application of this technology for a broadrange of peptides, peptidomimetics and proteins. We have also filed patentapplications covering the general application of this technology for a broadrange of non-peptidic molecules, such as low molecular weight drugs. We currentlyintend to retain the rights to Rel-Ease for the potential use with compoundsother than Plenaxis and may seek partnering opportunities for our Rel-Easetechnology during 2006.

**Research and Development Spending**

Successful research and development in thebiopharmaceutical industry is highly uncertain, and very few research anddevelopment programs yield a commercial product. Product candidates and drugdiscovery technologies that appear promising in various phases of research anddevelopment may ultimately not be commercially successful for a number ofreasons. We evaluate on a regular basis the progress of our research anddevelopment programs to determine if our resources and personnel are allocatedappropriately and our programs are progressing on a reasonable timeline anddemonstrating favorable results.

We have spent substantialfunds over the past three years to develop Plenaxis, PPI-2458 and Apan,and to develop and enhance our drug discovery technologies. We spentapproximately $41.8 million in 2003, $31.5 million in 2004 and $24.5 million in2005 on research and development activities. We expect to continue to investsignificantly in research and development activities in the future, inparticular to support the ongoingenhancement of our DirectSelect technology and the continuation of our PPI-2458clinical development program.

**License Agreements**

***Indiana University Foundation***

In October 1996, we entered into a licenseagreement with Indiana University Foundation. The license agreement was amendedin June 1998, and Indiana University Foundation assigned it to IndianaUniversity’s Advanced Research and Technology Institute, Inc. Under theagreement, we have an exclusive worldwide license under patent applications,future patents and technology of Indiana University Foundation relating to GnRHantagonist compounds, including abarelix, which is the active ingredient ofPlenaxis, and methods of use for abarelix. The agreement includes an obligationto pay royalties on net sales of products covered by the license, includingPlenaxis, and provides for performance-based payments of up to anadditional $1.5 million in connection with regulatory approvals inadditional therapeutic indications. We have announced our intention to licenseor sell Plenaxis and will not seek regulatory approval for Plenaxis in anotherindication or for any other product covered under this license agreement.

During the year ended December 31, 2005, we hadpaid non-refundable fees, performance-based payments and royalties of approximately$48,000 under this agreement. These amounts were recorded as expenses duringthe periods amounts were paid. The license agreement remains in effect untilthe last licensed patent expires, currently 2015. Expiration of the licensewill not preclude us from continuing to develop and market the licensedproducts and use the licensed technology, provided we obtain the consent ofAdvanced Research and Technology Institute to extend the license term past theexpiration date. Advanced Research and Technology Institute may notunreasonably withhold its consent to our request for such an extension. We canterminate the agreement at any time upon 90 days notice. Advanced Researchand Technology Institute may terminate upon 90 days notice if wematerially breach the agreement or fail to make required payments.

***Schering AG***

In April 2004, we entered into a license, supplyand distribution agreement with Schering AG, of Berlin, Germany, under which wegranted exclusive rights to Schering AG to commercialize Plenaxis in the 

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field of prostate cancerin Europe, Russia, the Middle East, South Africa, Australia and New Zealand. Shortlyafter our receipt of marketing approval for Plenaxis in Germany in September 2005,we received notice from Schering AG that it was exercising its right toterminate its agreement with us due to our not having received marketingauthorization for Plenaxis in Germany with a requisite label by June 30,2005. Under the agreement, as a result of the termination, all of Schering AG’srights and licenses with respect to Plenaxis have ceased.

Under the agreement, wereceived a $2.0 million signing payment from Schering AG during the secondquarter of 2004, which we were recognizing into revenues ratably over a periodthrough 2016 based on the remaining patent life of Plenaxis in Europe. Due tothe termination of the Schering AG agreement in September 2005, werecognized approximately $1.9 million in revenues for the year ended December 31,2005, representing the remaining deferred revenue from the $2.0 million signingpayment. In October 2005,in connection with the termination of the Schering AG agreement, the partiesentered into a settlement agreement under which Schering AG paid us $4.0million, representing full and complete satisfaction of its obligations underthe agreement arising prior to its termination. We recognized this$4.0 million payment as revenues in 2005. The settlement agreement alsoincluded mutual releases of any and all claims under or relating to theSchering AG agreement.

**Manufacturing**

We generally manufacturein-house the drug supply required to support our early preclinicalstudies. External contractors provide all of our later-stage preclinical,clinical and commercial supplies. We have long-term contracts for each stage ofthe commercial manufacturing process for Plenaxis which are described above inthe section captioned “Plenaxis—Manufacturing Agreements.”

**Patents and Proprietary Rights**

Proprietary protection for our products, technologiesand processes is essential to our business. We seek proprietary protectionpredominantly in the form of patents on our products and the processes we useto discover them. With respect to a particular product, we generally seekpatent protection on the compound itself, its commercial formulation, its rangeof applications and its production. Where possible, we also seek patentcoverage that could prevent the marketing of, or restrict the commercial threatof, competitive products.

We currently hold 27 United States patents andexclusive licenses to 3 United States patents. These patents have expirationdates ranging from 2015 through 2022. We also hold or have exclusive licensesto 98 granted foreign patents. In addition, we have filed or hold exclusivelicenses to 140 United States utility and provisional patent applications, aswell as 301 related foreign patent applications, including both PatentCooperation Treaty filings and national filings.

In particular, we have various pending United Statesand foreign patent applications directed to the DirectSelect drug discoverytechnology, including claims directed to the libraries of compounds containingan encoding oligonucleotide tag and methods for generating and screeninglibraries of these compounds. We also have issued United States and foreignpatents and pending United States and foreign patent applications covering abroad family of MetAP-2 inhibitors, including PPI-2458,pharmaceutical compositions containing these compounds, uses of these compoundsin treating disease (*e.g.*,angiogenic diseases, including cancer and autoimmune diseases, and parasiticinfections), and methods for assessing the ability of a MetAP-2 inhibitorto inhibit the enzyme*in vivo*. Theissued patents covering PPI-2458 and its uses expire in 2020 and 2022.

We also have issued United States and foreignpatents and pending United States and foreign patent applications covering****Apan, pharmaceutical compositions containing Apan andmethods of using Apan, *e.g.*, methodsfor inhibiting aggregation of natural ß-amyloid peptides and methods for treating a diseaseassociated with ß-amyloidosis(*e.g.*, Alzheimer’s disease) in a subject.The issued patents covering Apan and its uses expire in 2020.

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In addition, we have or hold exclusive licenses toUnited States patents that cover both the active ingredient of Plenaxis, knownas abarelix, as well as methods of use for abarelix for treating a variety ofconditions, including prostate cancer, and the sustained release formulationenabling its once-per-month administration. These patents expire in 2015 and2016. We also have patents covering the use of abarelix and certain specificuses of any other GnRH antagonist in various therapeutic settings, including incombination with surgery or radiation therapy.

We also have issued United States and foreign patentsand pending United States and foreign patent applications covering ourproprietary Rel-Ease drug delivery technology. The issued patents covering theRel-Ease technology and its uses expire in 2016.

We intend to file additional United States and foreignpatent applications, where appropriate, relating to new product discoveries,technologies or improvements.

We also rely on tradesecrets, know-how and continuing technological advances to protect variousaspects of our core technology. We require our employees, consultants andscientific collaborators to execute confidentiality and invention assignmentagreements with us to maintain the confidentiality, and our ownership, of ourtrade secrets and proprietary information. These agreements generally providethat the employee, consultant or scientific collaborator will not disclose ourconfidential information to third parties, compete with us nor solicit our employeesduring the course of their employment, consultancy or collaboration with us. Theseagreements also provide that inventions conceived by the employee, consultantor scientific collaborator in the course of working for us will be ourexclusive property. Additionally, our employees agree, for one year followingtermination of their employment with us, not to solicit our other employees.

**Competition**

A biopharmaceutical company such as ours faces intensecompetition. We face competition from companies that are pursuing the same orsimilar technologies for drug discovery. We also face significant competitionfrom organizations that are pursuing drugs that would compete with the productcandidates we are now developing or may pursue in the future. These organizationsinclude many large and well-financed and experienced pharmaceutical andbiotechnology companies, as well as academic institutions and government-basedagencies. These entities may have greater financial resources and moreexperience than we do in discovering and developing drugs, obtaining regulatoryapprovals, manufacturing and marketing. In addition, academic, government andindustry-based research is intense, resulting in considerable competitionin obtaining qualified research personnel, submitting patent filings forprotection of intellectual property rights and establishing strategic corporatealliances.

Our investigational compound, PPI-2458, and anyother potential products in research or development, will face competition fromother products. Many companies are developing or marketing products for thetreatment of cancer, inflammation and autoimmune disorders. We are currentlyenrolling patients with non-Hodgkin’s lymphoma and solid tumors in our phase 1trial for PPI-2458. We are competing with many other companies that areconducting clinical trials in these indications. We may not be able to accruepatients to our trial at the same pace as our competitors. Even if we are ableto successfully complete our clinical trials of PPI-2458 and gainregulatory approval to market the product, we will face competition from abroad range of therapeutics available for the treatment of cancer.

We also expect toencounter competition from other companies with technologies similar to ourtechnologies. For example, if we are unable to obtain adequate patentprotection for our DirectSelect technology, another company could offer drugdiscovery capabilities that directly compete with our capabilities or couldattempt to block our ability to practice our technology. Given our strategicfocus on forming partnerships with respect to our DirectSelect technology, weare also dependent upon the extent to which pharmaceutical and biotechnologycompanies continue to collaborate with outside companies to obtain drugdiscovery expertise and our ability to establish and maintain partnerships withsuch companies. We also face and will continue to face intense competition fromother companies for such collaborative 

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arrangements,and technological and other developments by our competitors may make it moredifficult for us to establish such relationships.

**Government Regulation**

The manufacture and marketing of pharmaceuticalproducts and our ongoing research and development activities in the UnitedStates require the approval of numerous governmental authorities, including theFDA. We also must obtain similar approvals from comparable agencies in mostforeign countries. The FDA has established mandatory procedures and safetystandards which apply to preclinical testing and clinical trials, as well as tothe manufacture, storage, distribution, marketing, sales, import and export ofpharmaceutical products. State, local and other authorities also regulatepharmaceutical manufacturing and distribution facilities, among other things.

The pharmaceutical research, development and approvalprocess in the United States is typically intensive, uncertain, lengthy andrigorous and can take many years, depending on the product under consideration.As an initial step in the FDA regulatory approvalprocess, an applicant typically conducts preclinical studies in animals toassess a drug’s pharmacological profile and to identify potential safetyissues. An applicant must conduct specified preclinical laboratory and animalstudies in compliance with the FDA’s good laboratory practice regulations. Failureto follow these requirements can invalidate the data, among other things. An applicant must submit the results of thesestudies to the FDA as part of an investigational new drug application, or IND,before initiating testing in humans. Proposed clinical testing can only beginif the FDA raises no objections to the IND. We can give no assurance that anysubmission of an IND to the FDA relating to our product candidates will resultin the commencement of a clinical trial. The FDA may prevent studies from moving forward by imposing a clinicalhold, and may suspend or terminate studies once initiated.

Clinical testing must meet requirements forinstitutional review board, or IRB, oversight and study subject informedconsent, as well as FDA prior review, oversight and good clinical practicerequirements. Independent IRBs areresponsible for overseeing studies at particular sites and protecting humanresearch study subjects. An IRB may prevent a study from beginning or suspendor terminate a study once initiated. Typically, clinical testinginvolves a three-phase process. Phase 1 clinical trials generally involvea small number of subjects and are designed to provide information about bothproduct safety and the expected dose of the drug. Phase 2 clinical trialsgenerally provide additional information on dosing and safety in a limitedpatient population. Generally, phase 2 trials may also provide preliminaryevidence of product efficacy. Phase 3 clinical trials are large-scale,well-controlled studies. The goal of phase 3 clinical trials generally is toprovide statistically valid proof of efficacy, as well as safety, in the targetpatient population to support marketing authorization. In order to seek approvalto commence commercial sales, the company performing the preclinical testingand clinical trials of a pharmaceutical product then submits the results to theFDA in the form of a new drug application, or NDA, along with proposed labeling for the product and information about themanufacturing processes and facilities that will be used to ensure productquality. Each NDA submission requires a substantial user fee payment for whichthe FDA has committed generally to review and make a decision concerning approvalwithin 10 months, and of a new “priority” drug within 6 months. However finalFDA action on the NDA can take substantially longer and also may involve reviewand recommendations by an independent FDA advisory committee. PreparingNDA applications involves considerable data collection, verification, analysisand expense. In responding to an NDA, theFDA may conduct a pre-approval inspection of the relevant manufacturingfacility or facilities to assess conformance to the current good manufacturingpractice requirements and may also inspect sites of clinical investigatorsinvolved in the clinical development program to ensure their conformance togood clinical practices.

The FDA must grant approval of our products, whichincludes a review of the manufacturing processes and facilities used to producethese products, before we can market these products in the United States. Theprocess of obtaining approvals from the FDA can be costly, time consuming andsubject to unanticipated delays. The FDAmay not approve an NDA, or may require revisions to the product 

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labeling,require that additional studies be conducted prior to or as a condition ofapproval, or impose other limitations or conditions on product distribution,including, for example, adoption of a special risk management plan. Ifthe FDA grants approval of a drug product, the approval will be limited tospecific indications. Approval may also be withdrawn if new issues ariseconcerning a drug’s safety or effectiveness.

The FDA has considerable discretion in determiningwhether to grant marketing approval for a drug, and may delay or deny approvaleven in circumstances where the applicant’s clinical trials have proceeded incompliance with FDA procedures and regulations and have met the established end-pointsof the trials. Challenges to FDA determinations are generally time-consumingand costly, and rarely if ever succeed. In November 2003, we received FDAapproval to market Plenaxis for the palliative treatment of men with advancedsymptomatic prostate cancer for whom other hormonal therapies are notappropriate, who have refused surgical castration and who are experiencing oneor more of a specific set of symptoms. We can give no assurance that we willobtain marketing approval for any of our other product candidates.

Once a company receives a marketing approval for aproduct, it must comply with FDA requirements for manufacturing, labeling,advertising, record keeping and reporting of adverse experiences and otherinformation. In addition, FDA approval must be obtained for any significantchanges to the product, the manufacturing of the product, or the labeling. Drugadvertising and promotion are subject to federal and state regulations. In theUnited States, the FDA regulates all company and product promotion, includingdirect-to-consumer advertising. The manufacture of a product after approval isalso subject to comprehensive and continuing regulation. These regulationsrequire the manufacture of products in specific approved facilities and inaccordance with current good manufacturing practices, and the listing ofproducts and registration of manufacturing establishments with the FDA. Theseregulations also impose certain organizational, procedural and documentationrequirements with respect to manufacturing and quality assurance activities.All manufacturing facilities are subject to comprehensive, periodic inspectionsby the FDA.

Our manufacturing, sales,promotion, and other activities following product approval are subject toregulation by numerous regulatory authorities in addition to the FDA, includingpotentially the Federal Trade Commission, the Department of Justice andindividual U.S. Attorney offices within the Department of Justice, CMS, otherdivisions of the Department of Health and Human Services, and state and localgovernments.

Depending on the circumstances,failure to meet these applicable legal and regulatory requirements can resultin criminal prosecution, fines or other penalties, injunctions, recall orseizure of products, total or partial suspension of production, denial orwithdrawal of pre-marketing product approvals, private “qui tam” actionsbrought by individual whistleblowers in the name of the government, or refusalto allow us to enter into supply contracts, including government contracts. Inaddition, even if we comply with FDA and other requirements, new informationregarding the safety or effectiveness of a product could lead FDA to modify orwithdraw a product approval.

We also are subject to various laws and regulationsrelating to safe working conditions, laboratory and manufacturing practices,the experimental use of animals and the use and disposal of hazardous orpotentially hazardous substances, including chemicals, micro-organismsand various radioactive compounds used in connection with our research anddevelopment activities. Although we believe that our safety procedures forhandling and disposing of these materials comply with the standards prescribedby state and federal regulations, we cannot assure you that accidentalcontamination or injury from these materials will not occur. Compliance withlaws and regulations relating to the protection of the environment has not hada material effect on our capital expenditures or our competitive position.However, we cannot accurately predict the extent of government regulation, andthe cost and effect thereof on our competitive position, which might resultfrom any legislative or administrative action.

Additionally, we willlikely need to obtain approval of a product from comparable regulatoryauthorities in foreign countries prior to the commencement of marketing of theproduct in those countries. The approval procedure varies among countries, mayinvolve additional testing and the time required may 

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differfrom that required for FDA approval.  Under the current regulatory system in theEuropean Union, marketing authorization applications may be submitted pursuantto a centralized, a decentralized or a national level process. The centralizedprocedure is mandatory for the approval of biotechnology products and hightechnology products and available at the applicant’s option for other products.The centralized procedure provides for the grant of a single marketingauthorization that is valid in all European Union member states. Thedecentralized procedure is available for all medicinal products that are notsubject to the centralized procedure. The decentralized procedure provides formutual recognition of national approval decisions, changes existing proceduresfor national approvals and establishes procedures for coordinated EuropeanUnion actions on products, suspensions and withdrawals. Under this procedure,the holder of a national marketing authorization for which mutual recognitionis sought may submit an application to one or more European Union memberstates, certify that the dossier is identical to that on which the firstapproval was based or explain any differences and certify that identicaldossiers are being submitted to all member states for which recognition is sought.Within 90 days of receiving the application and assessment report, eachEuropean Union member state must decide whether to recognize approval. Theprocedure encourages member states to work with applicants and other regulatoryauthorities to resolve disputes concerning mutual recognition. Lack ofobjection of a given country within 90 days automatically results inapproval of the European Union country. Following receipt of marketingauthorization in a member state, we would then be required to engage in pricingdiscussions and negotiations with a separate prescription pricing authority inthat country. In September 2005, wereceived approval from the German regulatory authorities to market Plenaxis to initiate hormonal castration in patientswith advanced or metastatic, hormone-dependent prostate cancer, if androgensuppression is appropriate. We do not intend to independently seekadditional marketing approvals for Plenaxis in the European Union and can giveno assurance that we will obtain marketing approval for any of our otherproduct candidates outside of the United States.

**Product Liability Insurance**

*We maintain product liability insurance for themanufacture and commercial sale of Plenaxis, as well as for*clinical trials, in theamount of $15.0 million per occurrence and $15.0 million in the aggregate.Although we maintain product liability insurance, we cannot be sure that thiscoverage is adequate or that it will continue to be available to us onacceptable terms. Insurance coverage is becoming increasingly expensive,and we may be unable to maintain insurance coverage at a reasonable cost or insufficient amounts to protect us against losses due to liability. We may incursignificant liability and our business would be harmed if product liabilitylawsuits are initiated against us and are successful. Furthermore, productliability claims, regardless of their merits or outcome, could be costly anddivert management’s attention from other business concerns or adversely affectour reputation.

**Human Resources**

As of February 28,2006, we had 78 full-time employees, 63 of whom were research and developmentpersonnel and 15 of whom were general and administrative personnel. All of ouremployees are located at our corporate headquarters in Waltham, Massachusetts.We also utilize consultants and independent contractors on a regular basis toassist in the research, development and potential partnering of our productsand technologies. None of our employees are party to a collective bargainingagreement and we have never experienced a work stoppage. We consider ouremployee relations to be good. We believe that our future success is dependentin part on our ability to attract and retain skilled scientific and otherprofessional and senior management personnel. Competition in our industry isintense and we cannot assure you that we will be able to attract, integrate andretain these personnel.

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**Available Information**

We file annual, quarterly, and current reports, proxystatements and other documents with the Securities and Exchange Commission underthe Securities Exchange Act of 1934, as amended. The public may read and copyany materials that we file with the Securities and Exchange Commission at theCommission’s Public Reference Room at 450 Fifth Street, NW, Washington, DC20549. The public may obtain information on the operation of the PublicReference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330.Also, the Securities and Exchange Commission maintains an Internet website thatcontains reports, proxy and information statements, and other informationregarding issuers, including us, that file electronically with the Commission.The public can obtain any documents that we file with the Securities andExchange Commission at http://www.sec.gov.

We maintain a website withthe address *www.praecis.com*. We are not includingthe information contained on our website as a part of, or incorporating it byreference into, this Annual Report on Form 10–K. We make available free ofcharge through our website our Annual Reports on Form 10–K,  Quarterly Reports on Form 10–Q andCurrent Reports on Form 8–K, and amendments to these reports, as soon asreasonably practicable after we electronically file such material with, orfurnish such material to, the Securities and Exchange Commission.

**ITEM 1A.**        RISKFACTORS.

*The risksand uncertainties described below are not the only ones we face. Additionalrisks and uncertainties not presently known to us or that are currently deemedimmaterial may also impair our business, financial condition and results ofoperations. If any of these risks actually occur, our business, financialcondition and results of operations could be materially adversely affected.*

**We have a historyof losses and we may not be profitable in the future.**

We cannot assure investors that we will be profitablein the future or, if we attain profitability, that it will be sustainable. In May 2005,our board of directors approved a strategic restructuring to focus the Company’sresources on our most promising assets and programs and significantly reduceour cost structure. Under our current strategic operating plan, we are focusingour resources on continuing to develop and enhance our DirectSelect technologyand seeking to enter into pharmaceutical partnerships for drug discovery anddevelopment utilizing this technology that will provide revenues to ourCompany, as well as to expand our own proprietary development pipeline; andadvancing the clinical development of PPI-2458, with a goal of partneringthis program in one or more indications as clinical development advances. Weare also actively pursuing the disposition of our Plenaxis assets.  If we are unable to do so in a timely mannerand on acceptable terms, we intend to cease distribution of the product in theUnited States.

To date, we have derivedsubstantially all of our revenues from payments under corporate collaborationand license agreements, and from product sales. Our marketing and sellingefforts with regard to Plenaxis in the United States were not commerciallysuccessful, and we may be unable to successfully discover, develop or marketany other products in the future. Moreover, we may be unable to enter intoresearch collaborations or partnerships with respect to DirectSelect or PPI-2458,or dispose of our Plenaxis assets in a timely manner and on acceptable terms, orat all. Our current strategic operating plan includes significant ongoingexpenditures to support the continued enhancement of our DirectSelecttechnology and the continuation of our PPI-2458 clinical developmentprogram, and for general and administrative purposes. As of December 31,2005, we had an accumulated deficit of approximately $305.1 million. We expectthat we will continue to incur significant operating losses for at least thenext several years, and we may not be profitable in the future.

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**If we are unable tosuccessfully carry out our strategic operating plan, we may have to obtainadditional sources of funding or significantly modify our strategic operatingplan.**

If we are unable to successfully carry out one or moreof the key elements of our strategic operating plan described in theimmediately preceding risk factor, we believe that our existing cash andinvestments of approximately $62.6 million at December 31, 2005 will besufficient to meet our working capital and capital expenditure needs throughapproximately the end of 2007. If we are able to successfully carry out one ormore of the key elements of our strategic operating plan described above, or ifwe are able to realize significant value from the disposition of our Plenaxisassets, we may be able, without obtaining additional funding, to continue tomeet our working capital and capital expenditure needs beyond that time,although we cannot provide any assurances as to if or for how long we would beable to do so. If we are unable to successfully carry out one or more of thekey elements of our strategic operating plan, and/or realize significant valuefrom the disposition of our Plenaxis assets, we may have to obtain additionalsources of funding or significantly modify our strategic operating plan,including by curtailing or eliminating certain elements of our operations. Moreover,if we are unable to dispose of our Plenaxis assets in a timely manner and onacceptable terms, we intend to cease distribution of Plenaxis in the UnitedStates, in which event, we would incur a yet undetermined amount of shut-downcosts and expenses and would need to devote funds and other resources thatwould otherwise be available to carry out our current strategic operating plan.We have no committed sources of capital and do not know whether additionalfinancing will be available when needed, or, if available, that the terms willbe acceptable to us.

To date, our operationsand capital requirements have been financed primarily with the proceeds ofpublic and private sales of common stock and preferred stock, payments underresearch and development partnerships and collaborative agreements, investmentincome and revenues from product sales. In addition, in October 2005 wesold our facility and intend to use the net proceeds from that sale to fund ourongoing operations. However, there can be no assurance that we will be able tosell any securities, enter into additional partnerships and collaborativeagreements or borrow funds in the future at favorable terms, or at all. If weraise additional funds by issuing equity securities, further dilution toexisting stockholders will result. In addition, as a condition to givingadditional funds to us, future investors may demand, and may be granted, rightssuperior to those of existing stockholders. We may also be required to takeother actions, which may lessen the value of our common stock or dilute ourcommon stockholders, including borrowing money on terms that are not favorableto us. If we are required to raise money in the future and we experiencedifficulties or are unable to do so, it could become necessary for us to ceaseoperations or seek protection under state or federal insolvency or bankruptcylaws.

**Our DirectSelect drugdiscovery technology is still under development, and we may not be able toenter into pharmaceutical partnerships with respect to this technology and/ordiscover compounds that will provide significant revenues for our Company andlead to marketable products.**

We are focusing our early stage drug discovery effortson our proprietary DirectSelect drug discovery technology, and our futuresuccess depends in large part on the successful development of this technology,as well as our ability to enter into collaborations relating to this technology.We believe that DirectSelect is a novel technology that will allow us torapidly and directly identify compounds that are orally available and have highaffinity and specificity. However, if we are unable to obtain adequate patentprotection for our DirectSelect technology, another party could offer drugdiscovery capabilities that directly compete with our capabilities or couldattempt to block our ability to practice our technology. Furthermore, we cannotassure investors that this technology will allow us to offer significantadvantages over traditional drug discovery methods. For example, thefeasibility of creating and screening ultra-large advanced combinatorialchemistry libraries resulting in successful leads is still in the developmentstage. Moreover, we may not be able to identify novel compounds from thelibraries that we create that can address a broad spectrum of targets or thatcan be rapidly taken into clinical development and that ultimately lead to marketableproducts. If we are not successful in continuing to enhance this technology andin identifying 

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product candidate(s) usingthis technology for either a partner or for internal development, we may nevergenerate revenues from this technology and would be required to significantlymodify our operating plan.

Given our strategicfocus on forming partnerships with respect to our DirectSelect technology, weare also dependent upon the extent to which pharmaceutical and biotechnologycompanies continue to collaborate with outside companies to obtain drugdiscovery expertise. Our revenue will depend, in part, on research anddevelopment expenditures by pharmaceutical and biotechnology companies,particularly companies outsourcing research and development projects and addingnew and improved technologies to accelerate their drug discovery anddevelopment initiatives. Our capabilities include aspects of the drug discoveryprocess that pharmaceutical companies have traditionally performed internally. Althoughthere is a history among pharmaceutical and biotechnology companies ofoutsourcing drug research and development functions, this practice may notcontinue. Our ability to convince one or more of these companies to use ourdrug discovery technology and capabilities rather than develop them internallywill depend on many factors, including our ability to:

·       continueto enhance and refine our DirectSelect technology resulting in theidentification of high-quality drug candidates;

·       identifyand retain scientists and discover and utilize technology that are of thehighest caliber; and

·       achieveintended results in a timely fashion, with acceptable quality and cost.

We also face and willcontinue to face intense competition from other companies for such collaborativearrangements, and technological and other developments by our competitors maymake it more difficult for us to establish such relationships. If we are unableto attract collaborators, we may never generate revenues from this technologyand would be forced to significantly modify our operating plan.

**We are subject toextensive government regulation that increases our costs and could prevent usfrom developing, and ultimately commercializing, potential products.**

The development and sale of pharmaceutical products,including Plenaxis, PPI-2458 or other product candidates we may discover,is subject to extensive regulation by governmental authorities. Obtainingregulatory approval typically is costly and takes many years; maintainingregulatory approval also requires substantial resources. Regulatoryauthorities, most importantly, the FDA, have substantial discretion to place onclinical hold or terminate clinical trials, delay, withhold or withdrawregistration and marketing approval in the United States, and effectivelymandate product recalls. Failure to comply with regulatory requirements mayresult in criminal prosecution, civil penalties, recall or seizure of products,total or partial suspension of production or injunction. Outside the UnitedStates, we can market a product only if we receive marketing authorization fromthe appropriate regulatory authorities. This foreign regulatory approvalprocess includes all of the risks associated with the FDA approval process, andmay include additional risks.

To gain regulatory approval from the FDA and foreignregulatory authorities for the commercial sale of any product, we mustdemonstrate in clinical trials, and satisfy the FDA and foreign regulatoryauthorities as to, the safety and efficacy of the product. If we develop aproduct to treat a long-term, recurrent or terminal disease, such as cancer, wemust gather data over an extended period of time. There are many risksassociated with our clinical trials. For example, we may discover that theproduct we are testing is not effective, despite positive results inpreclinical studies. While our compound, PPI-2458, has been shown toinhibit its target enzyme, MetAP-2, in preclinical and early clinicaltesting, we do not know if this will ultimately result in an effectivetreatment for cancer or any other disease. We also may be unable to achieve thesame level of success in later trials as we did in earlier ones. Additionally,data we obtain from preclinical and clinical activities are susceptible tovarying interpretations that could impede regulatory approval. Furthermore,patients may experience adverse events while participating in a clinical trialthat are unrelated to our product, but that nevertheless may affect thestatistical analysis of the safety and efficacy of PPI-2458, potentiallyslow the rate of subject accrual in this trial or otherwise adversely 

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affect the clinical trial.If we obtain regulatory approval for a product, the approval will be limited tothose diseases for which our clinical trials demonstrate the product is safeand effective.

In addition, many factors could delay or result intermination of our ongoing or future clinical trials. For example, results fromongoing preclinical studies or analyses could raise concerns over the safety orefficacy of a product candidate. For example, in March 2004, the FDAplaced our phase 1 clinical trial of PPI-2458 on clinical hold due tonon-clinical study findings with PPI-2458. Although we subsequentlyreceived clearance from the FDA to resume clinical testing of PPI-2458,we cannot assure investors that the FDA will not place this or other clinicaltrials on hold in the future. A clinical trial may also experience slow patientenrollment. A study could also be delayed due to lack of sufficient drug supply.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 or foreign regulatory authority policies or precedents, may alsoresult in delays or rejection of an application for marketing approval. TheFDA, and comparable foreign regulatory authorities, have considerablediscretion in determining whether to grant marketing approval for a drug, andmay delay or deny approval even in circumstances where the applicant’s clinicaltrials have proceeded in compliance with established procedures and regulationsand have met the established end-points of the trials. Challenges to regulatorydeterminations are generally time-consuming and costly, and rarely, ifever, succeed. Although we received FDA approval to market Plenaxisin the United States in November 2003and in Germany in September 2005, we can give no assurance that we willobtain marketing approval for PPI-2458 or any other potential productcandidate.

Any regulatory approval may be conditioned uponsignificant labeling requirements and, as in the case of the FDA approval ofPlenaxis, marketing restrictions and post-marketing study commitments. Suchlabeling and marketing restrictions could, and in the case of Plenaxis in theUnited States, did, materially adversely affect the marketability and/or valueof the product. As part of our recent restructuring to focus our resources onour most promising assets and programs and significantly reduce our coststructure, we have voluntarily discontinued promotional activities related toPlenaxis and the sale of Plenaxis for new patients in the United States. Inaddition, although Plenaxis was approved in Germany, our former partner electedto terminate its agreement with us, and we may not be able to license or sellthe product to a third party to enable its commercialization in Germany or topursue additional regulatory approvals in other countries.

Even if regulatory approval is obtained for a product,the product and the manufacturing facilities for the product will be subject tocontinual review and periodic inspection by regulatory authorities. Laterdiscovery of previously unknown problems with a product, manufacturer orfacility may result in restrictions on the product, the manufacturer or us,including withdrawal of the product from the market. The FDA and comparableforeign regulatory authorities stringently apply regulatory standards. Ourmanufacturing facilities will also be subject to FDA or foreign regulatoryinspections for adherence to good manufacturing practices prior to marketingclearance and periodically during the manufacturing process. Failure to complycan, among other things, result in fines, denial or withdrawal of regulatoryapprovals, product recalls or seizures, operating restrictions, injunctions andcriminal prosecution. If there are any modifications to a product, furtherregulatory approval will be required.

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

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General ServicesAdministration, additional laws and requirements apply. All of our activitiesare potentially subject to federal and state consumer protection and unfaircompetition laws and comparable foreign laws.

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

If we are unable tosuccessfully carry out one or more of the key elements of our operating plan,which include the continued clinical development of PPI-2458 andpotentially other product candidates discovered using our DirectSelecttechnology, we may need to raise additional capital and, if we were unable todo so, it could become necessary for us to cease operations or seek protectionunder state or federal bankruptcy laws.

**We may be unable toenter into and maintain corporate collaborations necessary to support thediscovery and development of products using our DirectSelect technology or thefurther development and potential commercialize of PPI-2458 or otherpotential products in the future.**

Our business objective isto utilize our DirectSelect and other proprietary technologies to discover, ina rapid and efficient manner, novel, orally-available compounds with thepotential to address unmet medical needs or improve existing therapies. Weintend to collaborate with pharmaceutical and biotechnology companies on thediscovery and development stages for these compounds across a broad range oftherapeutic areas. We also intend to select promising compounds to retain forinternal development and will partner these compounds at various stages ofdevelopment to optimize their value to the Company. In addition, we have announcedour intention to partner our PPI-2458 program in one or more indicationsas clinical development advances. We currently do not intend to independentlymarket the products that may ultimately result from our discovery anddevelopment efforts. We cannot assureinvestors that we will be able to enter into and maintain partnershipsand corporate collaborations in a timely manner and on favorable terms. if at all. Even if we are able to enter intosuch arrangements, we cannot assure our investors that our future collaboratorswill meet their obligations to us under our collaboration agreements. If apartner terminates its agreement with us or fails to perform its obligations,it may delay the discovery and development of product candidates. As a result, wecould have to devote unforeseen additional resources to drug discovery anddevelopment or be forced to significantly modify our operating plan.

**If we lose our keypersonnel or are unable to attract and retain additional skilled personnel, wemay be unable to pursue the development of our drug discovery technology or ourproduct development and commercialization efforts.**

We depend substantially on the principal members ofour management and scientific staff, including Kevin F. McLaughlin, ourPresident and Chief Executive Officer, and Richard W. Wagner, Ph.D., ourExecutive Vice President, Discovery Research. We do not have employmentagreements with any of our executive officers. Any officer or employee canterminate his or her relationship with us at any time and work for one of ourcompetitors. The loss of these key individuals could result in competitive harmbecause we could experience delays in the development of our drug discoverytechnology or our product research and development efforts without theirexpertise.

Recruiting and retainingqualified scientific personnel to perform future research and development workalso will be critical to our success. Competition for skilled personnel isintense and the turnover rate can be high. We compete with numerous companiesand academic and other research institutions for experienced scientists. Thiscompetition may limit our ability to recruit and retain qualified personnel onacceptable terms. Moreover, due to our strategic restructuring in May 2005 andour limited resources 

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comparedto many of our competitors, we may face additional challenges when recruitingqualified personnel in the future. Failure to attract and retain qualifiedpersonnel would prevent us from continuing to develop and enhance ourDirectSelect technology and use this technology to support pharmaceuticalpartnerships in drug discovery and development that will provide significantrevenues to our Company, as well as to expand our own proprietary developmentpipeline and advance our PPI-2458 clinical development program.

**Due to thetermination by Schering AG of our collaboration agreement, absent a third partysale or license agreement, we do not expect that Plenaxis will becommercialized outside of the United States or continue to be available forpatients in the United States.**

We depended upon our corporate collaborator, ScheringAG, to commercialize Plenaxis in Schering AG’s licensed territory, includingGermany, where we received marketing authorization in September 2005. Wealso relied on Schering AG to some extent in seeking regulatory approval forPlenaxis in various other countries in the European Union and European EconomicArea which participate in the Mutual Recognition Procedure, or MRP, andelsewhere in Schering AG’s licensed territory under local regulatory procedures.Although we have received marketing authorization for Plenaxis in Germany, wedo not have the financial resources or expertise to market the product inGermany or in any other territories outside of the United States. For thisreason, we do not intend to independently seek additional approvals forPlenaxis in the European Union under the MRP or in any other territory outsidethe United States. Accordingly, the termination of our agreement with ScheringAG may delay or prevent additional regulatory approvals for Plenaxis, and theultimate commercialization of Plenaxis, outside of the United States.

Moreover, due to thetermination of the Schering AG agreement, we would need to devote funds andother resources to the Plenaxis program that we had planned would be availablefrom Schering AG, in particular to support the continuing costly manufacture ofthe product for limited distribution in the United States and to meet ourminimum purchase commitments under our Plenaxismanufacturing agreements. We haveannounced our intention to dispose of our Plenaxis assets through a license orsale transaction and have engaged an investment banking firm to assist us withthis effort. However, we cannot assure investors that we will be able toconclude such a transaction in a timely manner and on acceptable terms, or atall. In that event we do not intend to pursue further the commercialization ofPlenaxis outside of the United States and will seek to discontinue alldistribution of Plenaxis in the United States. If we so terminate Plenaxisdistribution, we would incur a yet undetermined amount of shut-down costs andexpenses and would need to devote funds and other resources that wouldotherwise be available to support our current operating plan. We have nocommitted sources of capital and do not know whether additional financing willbe available when needed, or, if available, that the terms will be favorable tous.

**Because we dependon third parties to rapidly analyze data generated by our DirectSelecttechnology and to conduct laboratory testing and human clinical studies andassist us with regulatory compliance, we may encounter delays in our drugdiscovery and development efforts.**

We currently rely on asingle vendor to rapidly analyze data generated by our DirectSelect technology.In addition, we have contracts with a limited number of research organizationsto design and conduct our laboratory testing and human clinical studies. If wecannot contract for data analysis and testing activities on acceptable terms,or at all, we may not complete our drug discovery and development efforts in atimely manner. To the extent we rely on third parties for these activities, wemay lose some control over these activities. For example, third parties may notcomplete data analysis and testing activities on schedule or when we requestthem to do so. In addition, these third parties may conduct our clinical trialsin a manner inconsistent with regulatory requirements or otherwise in a mannerthat yields misleading or unreliable data. This, or other failures of thesethird parties to carry out their duties, could result in significant additionalcosts and expenses and could delay or prevent our ability to effectivelyutilize our DirectSelect 

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technologyfor internal programs or in connection with partnerships or further develop PPI-2458or other future product candidates.

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

Our ability to conduct large clinical trials for, orto commercialize, PPI-2458 or any future product candidate, will dependin part on our ability to manufacture, or arrange for third-party manufactureof, 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 inclinical trials, regulatory submissions or in the commercialization ofpotential products.

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

If the third-party manufacturers upon which we relyfail to meet our needs for clinical or commercial supply, we may be required tosupplement our manufacturing capacity by building our own manufacturingfacilities. This would require substantial expenditures. Also, we would need tohire and train significant numbers of employees to staff a new facility. If weare required to build our own facility, we may not be able to developsufficient manufacturing capacity to produce drug materials for clinical trialsor commercial use in a timely manner, if at all.

In addition, we and the third-party manufacturers thatwe use must continually adhere to current good manufacturing practicerequirements enforced by the FDA through its facilities quality programs. Foreignregulatory authorities may also inspect our third-party manufacturers as acondition of obtaining and maintaining the requisite approvals. In complyingwith these requirements, we and any of our third-party manufacturers will beobligated to expend time, money and effort in production, record-keeping andquality control to assure that our potential products meet applicablespecifications and other requirements. If we or any of our third-partymanufacturers fail to comply with these requirements, we may be subject toregulatory sanctions, manufacturing delays, or the facilities could be shutdown.

Any of these factors couldprevent, or cause delays in, obtaining regulatory approvals for PPI-2458or any other potential product, and the manufacturing, marketing or selling ofPPI-2458 or any such other product, and could also result insignificantly higher operating expenses. Any of these factors, insofar as theyaffect the manufacture of Plenaxis, could also adversely affect our ability toenter into a license or sale transaction with respect to Plenaxis in a timelymanner and on acceptable terms, or at all.

**Our one-for-fivereverse stock split could have various negative effects on our common stock andour stockholders.**

Our one-for-five reversestock split effected in November 2005 resulted in an immediate increase inthe market price of our common stock. However, this increase in the marketprice of our common stock may not be in proportion to the reduction in thenumber of shares of our common stock outstanding or result in a permanentincrease in the market price (which depends on many factors, including our 

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performance,prospects and other factors that may be unrelated to the number of sharesoutstanding). If the market price of our common stock declines, the percentagedecline as an absolute number and as a percentage of our overall marketcapitalization may be greater than would occur in the absence of the reversestock split. Furthermore, the liquidity of our common stock may be adverselyaffected by the reduced number of shares that are now outstanding following thereverse stock split. In addition, the reverse split has likely increased thenumber of our stockholders who own odd lots (less than 100 shares). Stockholderswho hold odd lots typically will experience an increase in the cost of sellingtheir shares, as well as possibly greater difficulty in effecting such sales.

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

The administration of drugs to humans, whether inclinical trials or commercially, can result in product liability claims whetheror not the drugs are actually at fault for causing an injury. Plenaxis, PPI-2458,Apan or future product candidates may cause, or may appear to have caused,adverse side effects (including death) or potentially dangerous druginteractions that we may not learn about or understand fully until the drug hasbeen administered to patients for some time.

Product liability claimscan be expensive to defend and may result in large judgments or settlementsagainst us, which could have a negative effect on our financial performance.The costs of product liability insurance have increased dramatically in recentyears, and the availability of coverage has decreased. Although we carryinsurance that we regard as reasonably adequate to protect us from potentialclaims, there can be no assurance that we will be able to maintain our currentproduct liability insurance at a reasonable cost, or at all. Our formercollaboration agreements included, and some of the agreements regarding thetermination of certain of those collaborations also include, an indemnificationfor liabilities associated with the development and commercialization ofPlenaxis. If a third party, including a former collaborator, successfully suesus for any injury, or for indemnification for losses, there is no guaranteethat the amount of the claim would not exceed the limit of our insurancecoverage. Even if a product liability claim is not successful, the adversepublicity and time and expense of defending such a claim may interfere with ourbusiness.

**Many of ourcompetitors have substantially greater resources than we do and may be able todiscover and develop product candidates or technologies that make our potentialproducts and technologies obsolete or non-competitive.**

A biopharmaceutical company such as ours faces intensecompetition. We face competition from companies that are pursuing the same orsimilar technologies for drug discovery. We also face significant competitionfrom organizations that are pursuing drugs that would compete with the productcandidates we are now developing or may pursue in the future. We may not beable to compete successfully against these organizations, which include manylarge and well-financed and experienced pharmaceutical and biotechnologycompanies, as well as academic institutions and government-based agencies. Theseentities may have greater financial resources and more experience than we do indiscovering and developing drugs, obtaining regulatory approvals, manufacturingand marketing. In addition, academic, government and industry-basedresearch is intense, resulting in considerable competition in obtainingqualified research personnel, submitting patent filings for protection ofintellectual property rights and establishing strategic corporate alliances.

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Our investigational compound, PPI-2458, and anyother potential products in research or development, will face competition fromother products. Many companies are developing or market products for thetreatment of cancer, inflammation and autoimmune disorders. We are currentlyenrolling patients with non-Hodgkin’s lymphoma and solid tumors in our phase 1trial for PPI-2458. We are competing with many other companies that areconducting clinical trials in these indications. We may not be able to accruepatients to our trial at the same pace as our competitors. Even if we are ableto successfully complete our clinical trials of PPI-2458 and gainregulatory approval to market the product, we will face competition from abroad range of therapeutics available for the treatment of cancer.

We also expect to encounter competition from othercompanies with technologies similar to our technologies. For example, if we areunable to obtain adequate patent protection for our DirectSelect technology,another company could offer drug discovery capabilities that directly competewith our capabilities or could attempt to block our ability to practice ourtechnology. Given our strategic focus on forming partnerships with respect toour DirectSelect technology, we are also dependent upon the extent to whichpharmaceutical and biotechnology companies continue to collaborate with outsidecompanies to obtain drug discovery expertise and our ability to establish andmaintain partnerships with such companies. We also face and will continue toface intense competition from other companies for such collaborativearrangements, and technological and other developments by our competitors maymake it more difficult for us to establish such relationships.

The success or continuedsuccess of our competitors in any of these efforts may adversely affect ourability to further enhance and refine and partner on favorable terms ourDirectSelect technology, to develop, partner on favorable terms andcommercialize PPI-2458 or other future product candidates, to license orsell Plenaxis in a timely manner and on acceptable terms, and to ultimatelyattain and maintain profitability.

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

Our success will depend in part on our ability toobtain patents and maintain adequate protection of our technologies andpotential products. If we do not adequately protect our intellectual property,competitors may be able to use our technologies and erode any competitiveadvantage we may have. For example, if we are unable to obtain adequate patentprotection for our DirectSelect technology, another party could offer drugdiscovery capabilities that directly compete with our capabilities or couldattempt to block our ability to practice our technology. Additionally, if welose our patent protection for Plenaxis, another party could produce and marketthe compound in direct competition with a potential licensor or purchaser ofour Plenaxis assets, which would adversely affect our ability to dispose of ourPlenaxis assets in a timely manner and on acceptable terms, or at all. Someforeign countries lack rules and methods for defending intellectualproperty rights and do not protect proprietary rights to the same extent as theUnited States. Many companies have had difficulty protecting their proprietaryrights in certain foreign countries.

Patent positions aresometimes uncertain and usually involve complex legal and factual questions. Wecan protect our proprietary rights from unauthorized use by third parties onlyto the extent that our proprietary technologies are covered by valid andenforceable patents or are effectively maintained as trade secrets. Wecurrently own or have exclusively licensed 30 issued United States patents and 98granted foreign 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.

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

In addition to patents, werely on a combination of trade secrets, confidentiality, nondisclosure andother contractual provisions, and security measures to protect our confidentialand proprietary information. These measures may not adequately protect ourtrade secrets or other proprietary 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 ourtechnologies, processes or products conflict with the patents or otherintellectual property rights of competitors, universities or others, we couldhave to engage in costly litigation and be unable to commercialize thoseproducts.**

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

**If third partiesterminate our licenses, our efforts to license or sell Plenaxis to a thirdparty could be adversely affected.**

We license some of ourtechnology from third parties. Termination of our licenses could require us todelay or discontinue our plan to license or sell Plenaxis to a third party. IfAdvanced Research and Technology Institute, Inc., the assignee of IndianaUniversity Foundation, terminated our license with them due to a breach by usof the terms of that license, the likelihood of our licensing or sellingPlenaxis to a third party on acceptable terms, or at all, would be materiallydiminished. We cannot assure investors 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.

**We are a defendantin purported class action securities lawsuits regarding the adequacy of ourpublic disclosure which could have a material adverse affect on our financialcondition.**

As described in detail in this report under Part I,Item 3. “Legal Proceedings,” in December 2004 and January 2005, theCompany, Chairman and (now former) Chief Executive Officer Malcolm Gefter,President and (now former) Chief Operating Officer Kevin F. McLaughlin, ChiefFinancial Officer and Treasurer Edward C. English, and former President andChief Operating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. The complaints were consolidated intoone action in April 2005. In August 2005, lead plaintiffs filed aconsolidated amended complaint. The lead plaintiffs generally allege securitiesfraud during the period from November 25, 2003 through December 6,2004. The consolidated amended complaint purports to assert claims underSections 10(b) and 20(a) of the Securities and Exchange Act of 1934and Rule 10b-5 promulgated thereunder, and alleges that the Companyand the individually named defendants made materially false and misleadingpublic statements concerning the Company’s business and financial results,particularly relating to statements regarding the commercialization of Plenaxis,thereby allegedly causing plaintiffs to purchase the Company’s securities atartificially inflated prices. In September 2005, we filed a motion todismiss plaintiffs’ consolidated amended 

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complaint. In October 2005,lead plaintiffs filed an opposition to our motion to dismiss and the defendantsfiled a reply on November 14, 2005. In January 2006, the Court heardoral argument on the motion to dismiss and took the matter under advisement.

Management believes thatthe allegations against the Company are without merit, and the Company intendsto vigorously defend against the plaintiffs’ claims. As this litigation is inan early stage, management is unable to predict its outcome or its ultimateeffect, if any, on the Company’s financial condition. However, we expect thatthe costs and expenses related to this litigation may be significant. Ourcurrent director and officer liability insurance policies (which, subject tothe terms and conditions thereof, also provide “entity coverage” for theCompany for this litigation) provide that the Company is responsible for thefirst $2.5 million of such costs and expenses. Also, a judgment in orsettlement of these actions could exceed our insurance coverage. Accordingly,if we are not successful in defending these actions, our business and financialcondition could be adversely affected. In addition, whether or not we aresuccessful, the defense of these actions may divert the attention of ourmanagement and other resources that would otherwise be engaged in running ourbusiness.

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

Pharmaceutical companieshave been the target of lawsuits and investigations including, in particular,claims asserting violations of the Federal False Claim Act, Anti-Kickback Act,the Prescription Drug Marketing Act or other violations in connection withMedicare and/or Medicaid reimbursement, and claims under state laws, includingstate anti-kickback and fraud laws. Similar actions, investigations and claimsmay also be brought or arise under comparable foreign laws. Public companiesmay also be the subject of certain other types of claims, including thoserelated to environmental matters. There is no assurance that if we were to beinvolved in any such lawsuits or investigation, that we would be successful indefending ourselves or in asserting our rights. Government investigations ofthese sorts of issues are typically expensive, disruptive and burdensome, andgenerate negative publicity. If our previous promotional activities withrespect to Plenaxis were found to be in violation of the law, we could possiblyface significant fines and penalties. In addition, we and our senior officerscould be civilly or criminally prosecuted, potentially resulting in ourexclusion from participation in government healthcare programs such as Medicareand Medicaid.

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

Our research and development processes involve thecontrolled use of hazardous materials, including chemicals and radioactive andbiological materials, which may pose health risks. In addition, the healthrisks associated 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 hazardous materials in connection with ouragreements with them. We have agreed to indemnify our present and formercollaborators in some circumstances against damages and other liabilitiesarising out of development activities or products produced in connection withthese collaborations.

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**Changes in thesecurities laws and regulations have increased, and are likely to continue toincrease, our costs.**

The Sarbanes-Oxley Act of2002, which became law in July 2002, has required changes in some of ourcorporate governance, securities disclosure and compliance practices. Inresponse to the requirements of that Act, the Securities and ExchangeCommission and the Nasdaq Stock Market have promulgated rules and listingstandards covering a variety of subjects. Compliance with these rules andlisting standards has increased our legal costs, and significantly increasedour financial and accounting costs, and we expect these increased costs tocontinue. These developments may make it more difficult and more expensive forus to obtain director and officer liability insurance. Likewise, these developmentsmay make it more difficult for us to attract and retain qualified members ofour board of directors, particularly independent directors, or qualifiedexecutive officers.

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

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

·       ourability to enter into partnerships for our DirectSelect drug discoverytechnology and our product candidate, PPI-2458, and the timing and termsof such partnerships;

·       thesuccess rate of our discovery efforts, particularly utilizing our DirectSelectdrug discovery technology, and progress or set backs in our clinical trials;

·       ourability to identify and complete, and our announcement of, the disposition ofour Plenaxis assets;

·       failureor delay by third-party manufacturers in performing their supplyobligations or disputes or litigation regarding those obligations;

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

·       adverseoutcomes with respect to the pending purported shareholder class action againstus;

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

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

·       changesin government regulation of the pharmaceutical or medical industry;

·       actualor anticipated fluctuations in our operating results;

·       changesin financial estimates or recommendations by securities analysts;

·       salesof large blocks of our common stock;

·       changesin accounting principles; and

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

In addition, the stockmarket has experienced extreme price and volume fluctuations. The market pricesof the securities of biotechnology companies, particularly companies like ourswith limited product revenues and without earnings, have been highly volatile,and may continue to be highly volatile in the future. This volatility has oftenbeen unrelated to the operating performance of particular companies. In thepast, securities class action litigation has often been brought againstcompanies that experience volatility in the market price of their securities.Whether or not meritorious, litigation brought against us could result insubstantial costs and a diversion of management’s attention and resources.

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

Our quarterlyoperating results have fluctuated in the past and are likely to do so in thefuture. These fluctuations could cause our stock price to decline. Some of thefactors that could cause our operating results to fluctuate include:

·       thetiming of partnerships relating to our DirectSelect drug discovery technologyand our PPI-2458 program resulting in revenues;

·       thetiming of a license or sale transaction relating to Plenaxis resulting in thecommercialization of the product in Europe and other territories and inrevenues to us; and

·       thetiming and level of expenses related to our other research and clinicaldevelopment programs.

Due to the possibility offluctuations in our revenues and expenses, we believe that quarter-to-quartercomparisons of our operating results are not a good indication of our futureperformance.

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

As directed by Section 404of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commissionadopted rules requiring many public companies, including the Company, toinclude in their annual reports on Form 10-K a report of management,based on its assessment of the company’s internal control over financialreporting, as to the effectiveness of such internal control as of the end ofthe most recent fiscal year. In addition, under these rules, the independentregistered public accounting firm auditing the company’s financial statementsmust audit and report on management’s assessment and on the effectiveness ofthe company’s internal control over financial reporting as of such fiscal yearend. Our management reported, based on its assessment, that as of December 31,2004 our internal control over financial reporting was effective, and ourindependent registered public accounting firm provided us with an unqualifiedreport as to management’s assessment and the effectiveness of our internalcontrol over financial reporting as of December 31, 2004. These reportswere included in our Annual Report on Form 10-K for the year ended December 31,2004. Since we are no longer an “accelerated filer” under rules recentlypromulgated by the Securities and Exchange Commission, we are not required toinclude in this Annual Report on Form 10-K for the year ended December 31,2005 such a report of management based on its assessment, or a report by ourindependent registered public accounting firm on management’s assessment andthe effectiveness, of our internal control over financial reporting as of December 31,2005. However, under current transition rules we will be required to includesuch reports in our Annual Report for the year ending December 31, 2007and for subsequent years, and we cannot assure investors that management or ourindependent registered public accounting firm will be able to provide suchreports, or that such reports will be unqualified, as of December 31, 2007or subsequent year-ends. In this event, investors could lose confidence in thereliability of our financial statements, which could result in a decrease inthe market value of our common stock.

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

Provisions in ourcertificate of incorporation and by-laws may delay or prevent an acquisition ofus or a change in our management. Also, because we are incorporated inDelaware, we are governed by the provisions of Section 203 of the DelawareGeneral Corporation Law, which may prohibit or delay large stockholders, inparticular those owning 15% or more of our outstanding voting stock, frommerging or combining with us. In addition, the rights issued under our rightsagreement may be a substantial deterrent to a person acquiring 10% or more ofour common stock without the approval of our board of directors. 

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Theseprovisions in our charter and by-laws, rights agreement and under Delaware lawcould reduce the price that investors might be willing to pay for shares of ourcommon stock in the future and result in the market price being lower than itwould be without these provisions.

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

If appropriateopportunities become available, we may attempt to acquire businesses, oracquire or in-license products or technologies, that we believe are a strategicfit with our business. We currently have no commitments or agreements for anyacquisitions. If we do undertake any transaction of this sort, the process ofintegrating an acquired business, or an acquired or in-licensed product ortechnology, may result in unforeseen operating difficulties and expendituresand may absorb significant management attention that would otherwise beavailable for the ongoing development of our business. Moreover, we may fail torealize the anticipated benefits of any transaction of this sort. To the extentwe issue stock in a transaction, the ownership interest of our stockholderswill be diluted. Transactions of this kind could also cause us to incur debt,expose us to future liabilities and result in expenses related to goodwill andother intangible assets.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS.

Not applicable.

**ITEM 2.**                PROPERTIES.

Our corporate headquarters and principal researchfacility is located in Waltham, Massachusetts, where we lease and occupyapproximately 65,000 square feet of office and laboratory space. The lease forour facility has an initial term of five years and expires in October of2010. We have options to extend the lease for up to three additional five-yearterms at then current market rates.

We believe that ourfacility will be adequate for our operations for at least the next eighteenmonths and that we would be able to obtain additional space as needed oncommercially reasonable terms.

**ITEM 3.**                LEGALPROCEEDINGS.

In December 2004 and January 2005, theCompany, Chairman and (now former) Chief Executive Officer Malcolm Gefter, Presidentand (now former) Chief Operating Officer Kevin F. McLaughlin, Chief FinancialOfficer and Treasurer Edward C. English, and former President and ChiefOperating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. Those purported class actions arecaptioned *Katz v. Praecis Pharmaceuticals Inc., MalcolmGefter, Kevin McLaughlin, Edward English and William K. Heiden*,Civil Action No. 04-12581-GAO (filed December 9, 2004), *Schwartz v. Praecis Pharmaceuticals Inc., Malcolm Gefter, KevinMcLaughlin, Edward English and William K. Heiden*, Civil Action No. 04-12704-REK(filed December 27, 2004) and *Bassin v. PraecisPharmaceuticals Inc., Malcolm L. Gefter, Ph.D., Kevin F. McLaughlin, Edward C.English and William K. Heiden*, Civil Action No. 05-10134-GAO(filed January 21, 2005).  On February 7,2005, a motion was filed to consolidate the *Katz*, *Schwartz* and *Bassin* actionsand to appoint lead plaintiffs and lead counsel. On February 18, 2005, theCompany and the individual defendants filed a brief response to that motion,reserving their rights to challenge the adequacy and typicality, among otherthings, of the proposed lead plaintiffs in connection with class certificationproceedings, if any. On April 13, 2005, the Court entered an Ordergranting the plaintiffs’ motion to consolidate the three actions (as well aseach case that relates to the same subject matter that may be subsequentlyfiled in or transferred to the United States District Court for the District ofMassachusetts), appoint lead plaintiffs and approve such plaintiffs’ selectionof co-lead counsel. The consolidated actions are captioned *IN REPRAECIS PHARMACEUTICALS, INC. SECURITIES LITIGATION*, Civil Action No. 04-12581-GAO.

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On August 1,2005, lead plaintiffs filed a consolidated amended complaint. Lead plaintiffs generallyallege securities fraud during the period from November 25, 2003 through December 6,2004. The consolidated amended complaint purports to assert claims underSections 10(b) and 20(a) of the Securities and Exchange Act of 1934and Rule 10b-5 promulgated thereunder, and alleges that the Companyand the individually named defendants made materially false and misleadingpublic statements concerning the Company’s business and financial results,particularly relating to statements regarding the commercialization of Plenaxis®, thereby allegedly causingplaintiffs to purchase the Company’s securities at artificially inflated prices.At this time, plaintiffs have not specified the amount of damages they areseeking in the actions. On September 12,2005, the Company and the individual defendants filed a Motion to Dismiss the consolidated amended complaint in its entirety.On October 24, 2005, lead plaintiffs filed an Opposition to the Company’sMotion to Dismiss and the defendants filed a reply on November 14, 2005. OnJanuary 17, 2006, the Court heard oral argument on the Motion to Dismissand took the matter under advisement

Management believes thatthe allegations against the Company are without merit, and the Company intendsto vigorously defend against the plaintiffs’ claims. As this litigation is inan early stage, management is unable to predict its outcome or its ultimateeffect, if any, on the Company’s financial condition. However, we expect that the costs and expenses related to this litigationmay be significant. Our current director and officer liability insurancepolicies (which, subject to the terms and conditions thereof, also provide “entitycoverage” for the Company for this litigation) provide that the Company isresponsible for the first $2.5 million of such costs and expenses. Also, ajudgment in or settlement of these actions could exceed our insurance coverage.Accordingly, if we are not successful in defending these actions, our businessand financial condition could be adversely affected. In addition, whether ornot we are successful, the defense of these actions may divert the attention ofour management and other resources that would otherwise be engaged in runningour business.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.

We held a Special Meeting of Stockholders on October 27,2005 seeking approval for a series of amendments to our Amended and RestatedCertificate of Incorporation to effect a reverse stock split of our commonstock whereby each outstanding five (5), seven and one-half (7.5) or ten (10) sharesof common stock would be combined into and become one (1) share of common stock,with the effectiveness of one of such amendments and the abandonment of theother amendments, or the abandonment of all amendments, as permitted under Section 242(C) ofthe Delaware General Corporation Law, to be determined by the Board in itsdiscretion.

Thestockholders approved the proposed amendments to our Amended and RestatedCertificate of Incorporation described above by the following vote:

| **For:**   | ** ** | **Against:** | ** ** | **Abstain:** | ** ** |
|------------|------------|--------------|------------|--------------|------------|
| 41,868,311 |       | 5,463,376    |       | 72,007       |       |

 

Following the special meeting, our board of directorsauthorized implementation of a reverse stock split at a ratio of 1-for-5,which was effected after the close of trading on November 1, 2005.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES.

Ourcommon stock is traded on The Nasdaq National Market under the symbol “PRCS.”  The following table shows the range of highand low per share sale prices of our common stock as reported on The NasdaqNational Market for the periods indicated (adjusted for all periods to reflectthe 1-for-5 reverse stock split of our common stock effected on November 1,2005).

| ** **                          | ** ** | **Common Stock  Price** | ** ** |
|-------------------------------------|------------|------------------------------|------------|
| ** **                          | ** ** | **High**                     | ** ** | **Low** | ** ** |
| Year Ended  December 31, 2005: |       |                         |       |   |   |
| First Quarter                       |       | $                            | 10.50      |   | $ | 4.85 |   |
| Second Quarter                      |       | 5.75                         |       | 2.50 |   |
| Third Quarter                       |       | 3.65                         |       | 1.85 |   |
| Fourth Quarter                      |       | 4.39                         |       | 2.30 |   |
| Year Ended December 31, 2004:  |       |                         |       |   |   |
| First Quarter                       |       | $                            | 37.90      |   | $ | 25.60 |   |
| Second Quarter                      |       | 32.80                        |       | 16.80 |   |
| Third Quarter                       |       | 19.95                        |       | 9.80 |   |
| Fourth Quarter                      |       | 12.30                        |       | 8.00 |   |

 

As of February 28, 2006, there were approximately62 holders of record of our common stock registered with our transfer agent,American Stock Transfer & Trust Company. Because many of these sharesare held by brokers and other institutions on behalf of stockholders, we areunable to estimate the total number of stockholders represented by the recordholders.

We have never declared or paid any cash dividends onour capital stock, and we do not currently intend to pay any cash dividends onour common stock in the foreseeable future. We expect to retain futureearnings, if any, to fund the development and growth of our business. Therefore,you should not expect to receive any funds in respect of shares of our commonstock without selling your shares.

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**ITEM 6.**                SELECTEDFINANCIAL DATA.

Youshould read the following selected financial data in conjunction with ourconsolidated financial statements and the related notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”appearing elsewhere in this report. We have derived our statement of operationsdata for each of the three years in the period ended December 31, 2005,and our balance sheet data at December 31, 2004 and 2005, from our auditedconsolidated financial statements, which we include elsewhere in this report.We have derived the statement of operations data for the years ended December 31,2001 and 2002 and the balance sheet data at December 31, 2001, 2002 and2003 from our audited consolidated financial statements, which we do notinclude in this report.

| ** **                                                              | ** ** | **Year Ended December 31,**                         | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2001**                                                           | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                              | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statement of Operations Data:**                                       |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Revenues:**                                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Product sales                                                           |       | $                                                                  | —     |   | $ | — |   | $ | — |   | $ | 2,817 |   | $ | 1,679 |   |
| Licensing and other revenues                                            |       | 9,907                                                              |       | 1,029 |   | — |   | 171 |   | 5,924 |   |
| Total revenues                                                          |       | 9,907                                                              |       | 1,029 |   | — |   | 2,988 |   | 7,603 |   |
| **Costs  and expenses:**                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cost of goods sold                                                      |       | —                                                             |       | — |   | — |   | 1,703 |   | 4,019 |   |
| Research and development                                                |       | 59,416                                                             |       | 56,383 |   | 41,847 |   | 31,455 |   | 24,502 |   |
| Sales and marketing                                                     |       | 8,737                                                              |       | 1,837 |   | 5,596 |   | 18,880 |   | 5,988 |   |
| General and administrative                                              |       | 6,961                                                              |       | 9,676 |   | 9,704 |   | 8,653 |   | 6,994 |   |
| Restructuring and asset impairment                                      |       | —                                                             |       | — |   | — |   | — |   | 28,680 |   |
| Total costs and expenses                                                |       | 75,114                                                             |       | 67,896 |   | 57,147 |   | 60,691 |   | 70,183 |   |
| Operating loss                                                          |       | (65,207                                                            | )          | (66,867 | ) | (57,147 | ) | (57,703 | ) | (62,580 | ) |
| Gain on sale of  property and equipment                                 |       | —                                                             |       | — |   | — |   | — |   | 1,419 |   |
| Gain on  assignment of leasehold improvements                      |       | 1,499                                                              |       | — |   | — |   | — |   | — |   |
| Gain on  termination of collaboration agreement                    |       | —                                                             |       | 16,020 |   | — |   | — |   | — |   |
| Interest income  (expense), net                                         |       | 9,105                                                              |       | 4,772 |   | 1,349 |   | 105 |   | (22 | ) |
| Net loss                                                                |       | $                                                                  | (54,603    | ) | $ | (46,075 | ) | $ | (55,798 | ) | $ | (57,598 | ) | $ | (61,183 | ) |
| Basic and diluted net loss per common   share                           |       | $                                                                  | (5.48      | ) | $ | (4.46 | ) | $ | (5.38 | ) | $ | (5.51 | ) | $ | (5.83 | ) |
| Weighted average number of basic and diluted common  shares outstanding |       | 9,955                                                              |       | 10,336 |   | 10,374 |   | 10,462 |   | 10,490 |   |

 

| ** **                                              | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|
| ** **                                              | ** ** | **2001**                | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                              | ** ** | **(in thousands)** | ** ** |
| **Balance Sheet Data:**                                 |       |                    |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and marketable securities  |       | $                       | 266,216    |   | $ | 195,035 |   | $ | 143,192 |   | $ | 83,349 |   | $ | 62,580 |   |
| Working capital                                         |       | 229,028                 |       | 185,523 |   | 132,981 |   | 76,407 |   | 54,081 |   |
| Total assets                                            |       | 342,125                 |       | 268,250 |   | 212,478 |   | 154,307 |   | 69,544 |   |
| Long-term  debt (including current portion)             |       | 33,000                  |       | 33,000 |   | 32,627 |   | 31,969 |   | — |   |
| Total stockholders’  equity                        |       | 270,696                 |       | 224,890 |   | 169,661 |   | 112,173 |   | 51,163 |   |
|                                                         |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSON AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

**General**

The following discussionand analysis of our financial condition and results of operations should beread in conjunction with “Selected Financial Data” and our consolidatedfinancial statements and notes thereto, as well as “Business,” each appearingelsewhere in this report. This discussion and analysis contains forward-lookingstatements that involve risks, uncertainties and assumptions. All statements otherthan statements of historical information set forth herein are forward-lookingand may contain information about financial results, events, economicconditions, trends and known uncertainties. Actual results and events coulddiffer materially from those discussed in these forward-looking statements as aresult of a number of factors, which include those discussed in this sectionand in the “Risk Factors” appearing elsewhere in this report, and the risksdiscussed in our other filings with the Securities and Exchange Commission. Readersare cautioned not to place undue reliance on these forward-looking statements,which reflect management’s analysis, judgment, belief or expectation only as ofthe date hereof. We undertake no obligation to publicly reissue or modify theseforward-looking statements to reflect events or circumstances that arise afterthe date hereof.

**Overview**

We are abiopharmaceutical company focused on utilizing our DirectSelect and otherproprietary technologies to discover, in a rapid and efficient manner, novel,orally-available compounds with the potential to address unmet medical needs orimprove existing therapies. We intend to collaborate with pharmaceutical andbiotechnology companies on the discovery and development of these compoundsacross a broad range of therapeutic areas. We also intend to select promisingcompounds to retain for internal development and will partner these compoundsat various stages of development to optimize their value to the Company. We currentlydo not intend to independently market the products that may ultimately resultfrom our discovery and development efforts. The key elements of our strategyinclude:

·       Continuingto develop and enhance our DirectSelect technology, entering intopharmaceutical partnerships for drug discovery and development utilizing thistechnology that will provide revenues to us, and expanding our own proprietarydevelopment pipeline; and

·       AdvancingPPI-2458 through a phase 1 trial in cancer patients and continuingpreclinical evaluation of the compound in inflammatory and autoimmunedisorders, including rheumatoid arthritis, with a goal of partnering thisprogram in one or more indications as clinical development advances.

Additionally, as part of our strategy to focus ourresources and attention on advancing our DirectSelect and PPI-2458programs, we are actively pursuing, with the assistance of an investmentbanking firm, the disposition of our Plenaxis assets through a license or saletransaction.

We are focusing our research efforts on developing andenhancing a novel drug discovery technology which we call DirectSelect. Webelieve that DirectSelect, which enables the generation and practical use ofultra-large libraries for the discovery of orally active compounds fordrug development, will allow us to more rapidly and directly identify orallyavailable compounds with high affinity and specificity than has routinely beenpossible using traditional drug discovery methods. During 2005, we continued toexpand our library collection to greater than five billion molecules throughthe generation of additional sub-libraries that comprised new chemicalscaffolds and an expanded building block set. The continued development andenhancement of DirectSelect is a key component of our strategic operating plan,and we believe that this technology may be an important tool for the future ofdrug discovery and development. In addition to our internal efforts to develop and enhance DirectSelect,our strategic operating plan includes entering into drug discovery anddevelopmentpartnerships utilizing DirectSelect, and we are continuing to initiate andadvance research collaboration discussions with major pharmaceutical companies with respect to this technology. We alsointend to use this technology to expand our own proprietary developmentpipeline.

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We are also focusing our research and developmentefforts on PPI-2458, a novel, proprietary oral compound targeted at theinhibition of the enzyme methionine aminopeptidase type 2, or MetAP-2. Webelieve that, due to its antiproliferative and antiangiogenic activity, PPI-2458has the potential to address broad therapeutic areas, and we are currently inthe process of establishing a plan for additional clinical studies for thiscompound. During the fourth quarter of 2003, we initiated our first clinicaltrial for PPI-2458 evaluating an oral formulation in non-Hodgkin’slymphoma patients who were no longer responding to other therapies. In March 2004,the FDA placed this trial on clinical hold due to a non-clinical safety concern.In June 2004, we received clearance from the FDA to resume clinical trialsand in late 2004, we opened a phase 1 clinical trial of PPI-2458 innon-Hodgkin’s lymphoma patients. During the first quarter of 2005, we expandedthe enrollment criteria of this trial to include patients with solid tumors. Whilethe clinical trial is still in its early stages, thus far oral dosing of PPI-2458has been well tolerated and has produced substantial inhibition of moleculartargeted MetAP-2 activity in most subjects evaluated. In addition to theongoing clinical program in cancer patients, based on preclinical data we havegenerated, we believe PPI-2458 could be a potential treatment withdisease modifying activity for rheumatoid arthritis and other inflammatory andautoimmune disorders. In light of the anticipated development costs associatedwith the PPI-2458 clinical program, we anticipate seeking a partner forthis program as clinical development advances.

During 2005, we fundamentally altered our strategicoperating plan to focus our efforts on early stage research and developmentactivities. On May 19, 2005, our board of directors approved a strategicrestructuring to focus the Company’s resources on our most promising assets andprograms and significantly reduce our cost structure. The strategicrestructuring included voluntarily discontinuing promotional activities relatedto Plenaxis and the sale of Plenaxis for new patients in the United States;voluntarily suspending the ongoing clinical development of Apan, our drugcandidate for Alzheimer’s disease; and implementing a reduction of our 182-personheadcount by approximately 60% to approximately 75 full-time employees. As of February 28,2006, we had 78 full-time employees, 63 of whom were research and developmentpersonnel and 15 of whom were general and administrative personnel.

Plenaxis continues to be available to those patientsin the United States who had already received the drug at the time we announcedour strategic restructuring. Plenaxis was approved by the FDA with certainprescribing and marketing restrictions in November 2003 for the palliativetreatment of certain men with advanced symptomatic prostate cancer. We launchedPlenaxis in the United States using our own dedicated marketing and sales teamin early 2004. Sales of Plenaxis during 2004 were significantly lower thanexpected. In addition, in September 2005, we received marketingauthorization for Plenaxis from the German regulatory authorities. Shortlyafter our receipt of the German approval, we received notice from Schering AG,of Berlin, Germany, that it was exercising its right to terminate its license,supply and distribution agreement with us due to our not having receivedmarketing authorization for Plenaxis in Germany with a requisite label by June 30,2005. Under the agreement, as a result of the termination, all of Schering AG’srights and licenses with respect to Plenaxis ceased. We received a $2.0 millionsigning payment from Schering AG during the second quarter of 2004, which wewere recognizing as revenue ratably over a period through 2016 based on theremaining patent life of Plenaxis in Europe. Due to the termination of theSchering AG agreement in September 2005, we recognized approximately $1.9million in revenues for the year ended December 31, 2005, representing theremaining deferred revenue from the $2.0 million signing payment. In October 2005,in connection with the termination of the Schering AG agreement, the partiesentered into a settlement agreement under which Schering AG paid us $4.0million, representing full and complete satisfaction of its obligations underthe agreement arising prior to its termination. We recognized this$4.0 million payment as revenues in 2005.

Due to our discontinuation of promotional activitiesrelated to Plenaxis in the United States, the termination of the Schering AGagreement and our strategy to focus our resources and attention on advancing ourDirectSelect and PPI-2458 programs, we are actively pursuing, with theassistance of an investment banking firm, the disposition of our Plenaxisassets through a license or sale transaction, and such a possible transactionis currently being evaluated by several interested parties. However, we cannot 

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assure investors that wewill be able to conclude such a transaction in a timely manner and onacceptable terms, or at all. If we are unable to do so, we do not intend topursue further the commercialization of Plenaxis outside the United States andwill seek to discontinue all distribution of Plenaxis in the United States. Inthat event, we would incur a yet undetermined amount of shut-down costs andexpenses and would need to devote funds and other resources that wouldotherwise be available to support our current strategic operating plan.

In connection with our strategic restructuring, wealso voluntarily suspended the clinical development program for Apan. We beganthis program in 2000 and, prior to its suspension, completed both a phase 1asingle dose escalation study, identifying a maximum tolerated dose in healthyvolunteers, and a phase 1b single dose escalation study, identifying themaximum tolerated dose in Alzheimer’s patients. Enrollment in a phase 1/2amultiple dose study was suspended prior to completion. As previously stated,the suspension of clinical development for Apan was not due to any unexpectedor undesirable event or clinical result, but rather to redirect our resources. Weplan to explore potential partnering opportunities for this compound to enableits further development.

In October 2005, we sold our corporateheadquarters and research facility for $51.25 million. We realized proceeds,net of fees and expenses, of approximately $50.4 million from this sale, andused approximately $31.6 million of the proceeds to retire the outstanding debtobligation related to the facility. The remaining net proceeds of approximately$18.8 million will be used to further our research and development efforts. Inconnection with the sale of the facility, we executed a lease for approximately65,000 square feet of office and laboratory space in this facility. The leasehas an initial term of five years at an annual base rent of approximately $2.1million for the first two years, increasing to approximately $2.3 millionper year for the remaining three years. We have options to extend the lease forup to three additional five-year terms at then current market rates. As aresult of the sale and partial leaseback of the facility, we realized a totalgain of approximately $10.5 million, of which we recognized approximately$1.4 million as a gain during 2005. The remaining amount of approximately$9.1 million will be recorded as a reduction of rent expense over theinitial term of the lease.

During 2005, we recorded approximately $28.7 millionof restructuring and asset impairment expenses under Statement of FinancialAccounting Standards No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*, or SFAS No. 146. Wealso recorded a non-cash impairment charge of approximately $3.5 millionrelated to inventory due to the discontinuation of promotional activitiesrelating to Plenaxis in the United States and the sale of Plenaxis for newpatients. Included in restructuring and asset impairment expenses are cashcharges of approximately $2.6 million for employee severance, benefits andrelated costs, approximately $0.2 million associated with the termination ofvarious contracts and approximately $0.2 million of other associated costs.In addition, a non-cash impairment charge of approximately $19.7 millionwas recorded under Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,or SFAS No. 144, relating to the impairment of our corporate headquartersand research facility. We also determined that our commitments under certainexisting Plenaxis manufacturing and supply agreements with third partiesexceeded our estimated future Plenaxis requirements by approximately $7.2million. During 2005, we recorded a charge of approximately $6.0 millionwhich represents the net present value of these excess commitments. Under SFAS No. 146,we are required to expense the remaining $1.2 million of these excesscommitments over the remaining term of the applicable manufacturing and supplyagreements, which currently range from two to five years.

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

Most of our expenditures to date have been for drugdevelopment, the development of our drug discovery technologies,commercialization activities related to Plenaxis and for general andadministrative 

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expenses. Our accumulateddeficit as of December 31, 2005 was approximately $305.1 million. We haveincurred net operating losses since fiscal 2000 and expect to continue to incursuch losses for at least the next several years.

We believe that ourexisting cash and investments of approximately $62.6 million at December 31,2005 will be sufficient to meet our working capital and capital expenditureneeds through approximately the end of 2007. Given the uncertainty of timingrelated to the key partnering elements of our strategy, we are not providingearnings or cash guidance for quarterly or annual periods during 2006. If weare able to successfully carry out one or more of the key elements of ourstrategic operating plan by establishing partnerships relating to ourDirectSelect technology or our PPI-2458 program, or if we are able torealize significant value from the disposition of our Plenaxis assets, we mayhave available resources to allow us to pursue our strategic operating planbeyond the end of 2007. However, we cannot assure investors that we will beable to enter into appropriate collaborative arrangements relating to ourDirectSelect technology or our PPI-2458 program, or realize significant valuefrom the disposition of our Plenaxis assets. If we are unable to successfullycarry out one or more of the key elements of our strategic operating planand/or realize significant value from the disposition of our Plenaxis assets,we may have to obtain additional sources of funding or significantly modify ourstrategic operating plan, including by curtailing or eliminating certainelements of our operations. We have no committed sources of capital and do notknow whether additional financing will be available when needed, or, ifavailable, that the terms will be acceptable to us. If we are required to raisemoney in the future and we experience difficulties or are unable to do so, itcould become necessary for us to cease operations or seek protection understate or federal insolvency or bankruptcy laws.

**Critical Accounting Policies**

While our significant accounting policies are morefully described in Note 2 to our consolidated financial statementsappearing elsewhere in this report, we believe the following accountingpolicies to be critical:

*Useof Estimates.**  *Weprepare our financial statements in accordance with U.S. generally acceptedaccounting principles. These principles require that we make estimates and useassumptions that affect the reporting of our assets and our liabilities as wellas the disclosures that we make regarding assets and liabilities and revenuesand expenses that are contingent upon uncertain factors as of the reportingdate. Actual payments, and thus our actual results, could differ from ourestimates and such differences may bematerial to our consolidated financial statements.

*Restructuringand Asset Impairment Expenses.**  *OnMay 19, 2005, our board of directors approved a strategic restructuring tofocus the Company’s resources on our most promising assets and programs andsignificantly reduce our cost structure. The strategic restructuring includedvoluntarily discontinuing promotional activities related to Plenaxis and thesale of Plenaxis for new patients in the United States; voluntarily suspendingthe ongoing clinical development of Apan, our drug candidate for Alzheimer’sdisease; and implementing a reduction of our 182-person headcount byapproximately 60%. These restructuring charges were accounted for in accordancewith SFAS No. 146. In determining the manufacturing commitmentsrestructuring expense and inventory impairment, various assumptions were madewith respect to future Plenaxis sales. These assumptions will be reviewedperiodically and should these estimates change, adjustments to the net presentvalue of remaining commitments as well as inventory may be necessary in futureperiods. Please refer to the discussion of *Inventory* and *Impairment or Disposal of Long-Lived Assets*appearingdirectly below, as well as Note 8—Restructuring included in our consolidatedfinancial statements appearing elsewhere in this report, for additionalinformation regarding our strategic restructuring. Our balance sheet at December 31,2005 includes approximately $1.9 million of Plenaxis-related equipment andapproximately $1.7 million of Plenaxis-related inventory. We cannot assureinvestors that we will be able to conclude the disposition of our Plenaxisassets in a timely manner and on acceptable terms, or at all, and depending onthe outcome of our efforts to do so, and the timing of that outcome, we may berequired to record a non-cash write-down related to these assets.

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*Impairmentor 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 may be recognized in thefinancial statements if the reported value of the asset exceeds the fair valuedetermined by either a quoted market price, if any, or a value determined byutilizing a discounted cash flow technique. We evaluate our property, plant andequipment for impairment whenever indicators of impairment exist. The amount ofthe impairment to be recognized is calculated by subtracting the fair value ofthe asset from the reported value of the asset.

We believe that the application of SFAS No. 144and the method used to determine the impairment of our property, plant andequipment involve critical accounting estimates because they are highlysusceptible to change from period to period and because they require managementto make assumptions about future cash flows, including residual values. Inaddition, we believe that had alternative assumptions been used, the impact ofrecognizing an impairment, if any, on the assets reported on our balance sheet,as well as our net loss, may have been material.

In connection with our strategic restructuringannounced in May 2005, we performed an assessment and determined that ourcorporate headquarters and research facility was impaired. As a result, anon-cash impairment charge of approximately $19.7 million related to thefacility was recorded as part of restructuring and asset impairment expensesunder SFAS No. 144. We obtained an independent appraisal that was basedupon a fee simple expected present value technique in combination with anevaluation of comparable assets in the geographic area in order to estimate thefair value of our corporate headquarters and research facility.

*Inventory.**  *We value inventory at cost or, if lower, marketvalue. We determine cost using the first-in, first-out method. We analyze ourinventory levels quarterly and write down inventory that has become obsolete,inventory that has a cost basis in excess of its expected net realizable valueand inventory in excess of expected requirements, to cost of goods sold. Expiredinventory is disposed of and the related costs are written off. If actualmarket conditions are less favorable than that estimated by us, additionalwrite-downs of existing inventory may be required in future periods. Weclassify any inventory that we estimate to be sold in the next twelve months ascurrent with the remaining amount classified as long-term inventory.   In connection with our strategicrestructuring announced in May 2005, we discontinued promotionalactivities related to Plenaxis and the sale of Plenaxis for new patients in theUnited States. As a result, during 2005, we wrote down approximately $3.5million of inventory that we estimated to be in excess of our expectedrequirements. This amount is classified as cost of goods sold in theconsolidated statement of operations for the year ended December 31, 2005appearing elsewhere in this report. The remaining inventory balance consists ofmaterials that are expected to be used in connection with the commercializationof Plenaxis in Europe and other territories by a third party following alicense or sale transaction relating to the product. We have engaged aninvestment banking firm to explore the disposition of our Plenaxis assetsthrough a license or sale transaction, and such a possible transaction iscurrently being evaluated by several interested parties. Our balance sheet at December 31,2005 includes approximately $1.7 million of Plenaxis-related inventory. Asnoted above, if we are unable to conclude the disposition of our Plenaxisassets, we may be required to record a non-cash write-down related to thisinventory.

*RevenueRecognition.**  *Wefollow the provisions of the Securities and Exchange Commission’s StaffAccounting Bulletin No. 104, *Revenue Recognition*.We recognize revenues from product sales in the period when the product isdelivered, provided there is persuasive evidence that an arrangement exists,the price is fixed or determinable and collection of the related receivable isreasonably assured. Revenues are recorded net of applicable allowances asprovision is made for estimated sales returns, rebates, distributor fees andother applicable discounts and allowances. Shipping and other distributioncosts are charged to cost of product sales. Product revenues are related solelyto Plenaxis for all periods presented in this report. In connection with ourstrategic restructuring announced in May 2005, we voluntarily discontinuedpromotional activities related to Plenaxis and the sale of Plenaxis for newpatients in the United States.

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We prepare our provisions for Plenaxis sales returnsand allowances, rebates and discounts based primarily on estimates. Contractualallowances and rebates result primarily from sales under contracts withhealthcare providers, Medicaid programs and other government agencies. Ourpolicy for sales returns has historically authorized distributors to return theproduct three months prior to, and six months after, product expiration. Inconnection with our strategic restructuring announced in May 2005, wemodified our policy for sales returns to eliminate these restrictions in orderto accommodate returns resulting from the announcement of the discontinuationof promotional activities for Plenaxis and the sale of Plenaxis for newpatients in the United States. Historically, the reserve for sales returns wasdetermined by reviewing the history of returns for products with similarcharacteristics to Plenaxis. We also utilize daily reports itemizing sales tophysicians and hospital pharmacies, obtained directly from our authorizeddistributors, in order to analyze specific account ordering trends. This datais reviewed to monitor product movement through the supply chain to identifyremaining inventory that may result in chargebacks or sales returns. Thereserves are reviewed at each reporting period and adjusted to reflect dataavailable at that time. As of December 31, 2005, we had accruedapproximately $0.1 million in sales return and other revenue reserves. To theextent our estimates of contractual allowances, rebates and sales returns aredifferent from actuals, we adjust the reserve which impacts the amount ofproduct sales revenue recognized in the period of the adjustment.

We currently provide substantially all of ourdistributors with payment terms of up to 120 days on purchases of Plenaxis. ThroughDecember 31, 2005, payments have generally been made in a timely manner.

We analyze our multiple element arrangements todetermine whether the elements can be separated and accounted for individuallyas separate units of accounting in accordance with EITF No. 00-21, *Revenue Arrangements with Multiple Deliverables.*Nonrefundableupfront licensing fees and certain guaranteed, time-based payments that requirecontinuing involvement in the form of development, manufacturing or othercommercialization efforts by us are recognized as licensing revenue ratablyover the period under which we are obligated to perform those services. Milestonepayments are recognized as licensing revenue or product sales when theperformance obligations, as defined in the contract, 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 berecognized as revenue 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 estimateswhich could result in a change in the deferral period and might impact thetiming and the amount of revenue recognized.

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

**Results of Operations**

***Years Ended December 31, 2005 and 2004***

Total revenues for the year ended December 31,2005 were approximately $7.6 million compared to approximately $3.0 million forthe year ended December 31, 2004. Licensing and other revenues increasedto approximately $5.9 million for the year ended December 31, 2005 fromapproximately $0.2 million for the year ended December 31, 2004. Due tothe termination of the Schering AG agreement in September 2005, werecognized approximately $1.9 million in licensing and other revenues for theyear ended December 31, 2005, representing the remaining deferred revenuerelated to a $2.0 million signing payment that we received in April 2004. Duringthe year ended December 31, 2004, we recognized licensing and otherrevenues of approximately $0.1 million related to this agreement. During theyear 

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ended December 31,2005, we also recognized $4.0 million in licensing and other revenuesconsisting of a one-time payment that we received from Schering AG in October 2005under a settlement agreement.

For the year ended December 31, 2005, productrevenues, which relate solely to Plenaxis, decreased to approximately $1.7million from approximately $2.8 million for the year ended December 31,2004. The decrease in product revenues was due primarily to the voluntarydiscontinuation of promotional activities related to Plenaxis and the sale ofPlenaxis for new patients in the United States as part of our strategicrestructuring announced in May 2005. We expect to continue to have a smallamount of revenues from Plenaxis sales during 2006. Other sources of revenuesduring 2006 and thereafter may include potential payments under future partnershipsrelating to our DirectSelect drug discovery technology or relating to PPI-2458or from a disposition of our Plenaxis assets through a license or saletransaction, in each case if consummated. The amount and timing of these otherpotential sources of revenues will depend on the success of our DirectSelecttechnology and our PPI-2458 clinical development program, and our abilityto enter into partnerships with respect to these programs, and the interest ofthird parties, if any, to enter into a license or sale transaction relating toPlenaxis. We cannot assure investors as to if or when we will receive any suchrevenues.

Cost of goods sold for the year ended December 31,2005 was approximately $4.0 million compared to approximately $1.7 million forthe year ended December 31, 2004. During the year ended December 31,2005, we recorded a non-cash impairment charge of approximately $3.5 millionrelated to Plenaxis inventory due to the voluntary discontinuation ofpromotional activities relating to Plenaxis and the sale of Plenaxis for newpatients in the United States. The majority of our cost of goods sold for theyear ended December 31, 2004 was comprised of a $1.0 million milestonepayment which became due and payable upon the first commercial sale of Plenaxisunder our license agreement with Indiana University Advanced Research andTechnology Institute, Inc.

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

Members of our research and development team typicallywork on a number of projects concurrently. In addition, a substantial amount ofour fixed costs such as facility and equipment depreciation, utilities andmaintenance are shared by our various programs. Accordingly, we have notspecifically identified, and do not plan to specifically identify, all costsrelated to each of our research and development programs. We estimate thatduring 2005 and 2004, the majority of our research and development expensesconsisted of salaries, benefits, clinical trial costs, manufacturing costs andlab supplies related to our Plenaxis, Apan and PPI-2458 clinicaldevelopment programs and the development of our DirectSelect technology.

Research and development expenses for the year ended December 31,2005 decreased approximately 22%, or $7.0 million, to approximately $24.5million from approximately $31.5 million for the year ended December 31,2004. Due primarily to the strategic restructuring announced in May 2005,personnel-related research and development expenses for the year ended December 31,2005 decreased approximately $2.4 million compared to 2004. In addition,we reduced spending on our clinical and preclinical programs during 2005. Spendingon the Plenaxis and Apan programs decreased by approximately $1.0 million and$1.1 million, respectively, during the year ended December 31, 2005compared to the prior year. Spending related to our PPI-2458 programduring the year ended December 31, 2005 decreased by approximately $0.8million compared to the prior year due primarily to reduced spending onpreclinical studies. The remaining decrease in research and developmentexpenses in 2005 compared to 2004 reflects lower depreciation expense ofapproximately $1.4 million, which was due primarily to the sale of ourcorporate headquarters and research facility, and lower allocation of bothcorporate personnel and related expenses 

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of approximately $0.3million. Although we are unable to predict the precise level of spending onindividual clinical programs due to the uncertain nature of clinicaldevelopment, we expect our research and development expenses to increaseslightly during 2006 and thereafter, as we continue to develop and enhance ourDirectSelect technology and utilize this technology to support partnerships andinternal programs, and continue our clinical trials of PPI-2458.

Sales and marketing expenses for the year ended December 31,2005 decreased to approximately $6.0 million, from approximately $18.9million for the year ended December 31, 2004. The decrease resulted primarilyfrom the voluntary discontinuation of promotional activities related toPlenaxis in the United States and the absence in 2005 of significant one-timecosts that were incurred during 2004 in connection with the initial launch ofPlenaxis in the United States. Beginning in 2004 through May 2005, wepromoted Plenaxis in the United States through our own marketing and sales team. In the future, we intend to partnerproducts that may ultimately result from our discovery and development effortsat the appropriate time to maximize the value of the product to the Company. Accordingly,we currently do not intend to independently market future products and we donot expect to incur significant sales and marketing expenses during 2006 orthereafter.

General and administrative expenses for the year endedDecember 31, 2005 decreased approximately 19% to approximately $7.0million, from approximately $8.7 million for the year ended December 31,2004. The decrease resulted primarily from lower personnel-related expenses ofapproximately $1.1 million, lower legal expenses of approximately $0.3 millionand lower depreciation expense of approximately $0.2 million during theyear ended December 31, 2005. As described in detail in this report underItem 3. “Legal Proceedings,” in December 2004 and January 2005, theCompany and certain of its current and former executive officers were named asdefendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts. The complaintswere consolidated into one action in April 2005. In August 2005, leadplaintiffs filed a consolidated amended complaint. In September 2005, wefiled a motion to dismiss plaintiffs’ consolidated amended complaint. In October 2005,lead plaintiffs filed an opposition to our motion to dismiss and the defendantsfiled a reply in November 2005. In January 2006, the Court heard oralargument on the motion to dismiss and took the matter under advisement.Management believes that the allegations against the Company are without merit,and the Company intends to vigorously defend against the plaintiffs’ claims. Asthis litigation is in an early stage, management is unable to predict itsoutcome or its ultimate effect, if any, on our financial condition. However, weexpect that the costs and expenses related to this litigation may besignificant. Our current director and officer liability insurance policies(which, subject to the terms and conditions thereof, also provide “entitycoverage” for the Company for this litigation) provide that the Company isresponsible for the first $2.5 million of such costs and expenses. Also, ajudgment in or settlement of these actions could exceed our insurance coverage.Accordingly, if we are not successful in defending these actions, our businessand financial condition could be adversely affected.

Restructuring and asset impairment expenses for theyear ended December 31, 2005 were approximately $28.7 million compared tozero in 2004. Please refer to the discussion under “Overview” and “CriticalAccounting Policies” in this Item 7, as well as Note 8—Restructuring includedin our consolidated financial statements appearing elsewhere in this report,for additional information regarding our strategic restructuring.

Net interest expense for the year ended December 31,2005 was approximately $22,000 compared to net interest income of approximately$105,000 for the year ended December 31, 2004. Interest expense was higherthan interest income during 2005 due to higher interest rates being paid on themortgage on our facility and lower average cash balances earning interest. Weexpect to have net interest income in 2006 due to the retirement in October 2005of the outstanding loan under our acquisition and construction loan agreementand termination of the mortgage on our facility.

During the year ended December 31, 2005, werecognized a gain of approximately $1.4 million on the sale of property andequipment. This gain was attributable primarily to the sale of our corporate 

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headquarters and researchfacility in October 2005. Please refer to the discussion under “Overview”in this Item 7, as well as Note 13—Sale of Facility and Partial Leasebackincluded in our consolidated financial statements appearing elsewhere in thisreport, for additional information regarding this transaction.

The provision for income taxes for the years ended December 31,2005 and 2004 was zero. We anticipate that we will continue to be in a netoperating loss carryforward position for the next several years. Therefore, asin 2004, no benefit from our operating losses has been recognized. We accountfor income taxes under Statement of Financial Accounting Standards No. 109,*Accounting for Income Taxes*. Realizationof deferred tax assets is dependent on future earnings, if any, the timing andamount of which are uncertain. Accordingly, valuation allowances, in amountsequal to the net deferred tax assets have been established in each period toreflect these uncertainties.

At December 31, 2005, we had federal netoperating loss carryforwards of approximately $273.5 million that willexpire in varying amounts through 2025, if not utilized. Utilization of netoperating loss carryforwards will be subject to substantial annual limitations underthe Internal Revenue Code of 1986, as amended. The annual limitations mayresult in the expiration of the net operating loss carryforwards before fullutilization.

For the year ended December 31,2005, net loss was approximately $61.2 million, or $5.83 per share, compared toa net loss of approximately $57.6 million, or $5.51 per share, for the yearended December 31, 2004.

***Years Ended December 31, 2004 and 2003***

Revenues for the year ended December 31, 2004were approximately $3.0 million, compared to zero in 2003. Of this amount,approximately $2.8 million was related to sales of Plenaxis, with the majorityof the remaining amount being comprised of revenue amortization with respect toa $2.0 million signing payment from Schering AG received during the secondquarter of 2004. We recognized revenues of approximately $0.1 million underthis agreement during 2004. In January 2004, we began shipping Plenaxis toour authorized distributors. Since the initial launch of Plenaxis, we faced many challenges that had an adverseimpact on the uptake of the product in the market and as a result, salesof Plenaxis during 2004 were significantly lower than expected. These challenges included the need toestablish more effective messaging to educate physicians about the product’sindication and to differentiate the appropriate patient population, overcome physician uncertainty and concernsover reimbursement, reposition our marketing campaign, strengthen and focus our salesforce, and hire representatives for open territories**.**

Cost of goods sold for the year ended December 31,2004 was approximately $1.7 million, compared to zero cost of goods sold in2003. In January 2004, we began selling Plenaxis and accordingly, beganrecognizing costs related to those sales. The majority of our cost of goodssold during 2004 was related to a $1.0 million milestone payment which becamedue and payable upon the first commercial sale of Plenaxis under our licenseagreement with Indiana University Advanced Research and Technology Institute, Inc.Much of the raw material used to produce Plenaxis (including the activepharmaceutical ingredient) was purchased prior to the FDA granting approval forthe commercial sale of Plenaxis in the United States. Accordingly, thesepurchases were treated as research and development costs and expensed asincurred.

Research and development expenses for the year ended December 31,2004 decreased 25% to approximately $31.5 million, from approximately$41.8 million in 2003. The decrease reflects reduced spending in ourclinical development programs and management of internal resources during 2004.As a result of FDA approval of Plenaxis in November 2003, spending onprostate cancer clinical development was reduced during 2004 by approximately$6.2 million, specifically manufacturing-related costs which were previouslyexpensed to research and development but, beginning in January 2004, werecapitalized to inventory. Spending on our Apan program during the year ended December 31,2004 decreased compared to the prior year due to lower preclinical expenses ofapproximately $1.9 million and lower manufacturing-related activities ofapproximately $0.4 million. Spending related to our PPI-2458 programduring the year ended December 31, 2004 was higher than in the prior year.This was due to an increase in preclinical 

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spending of approximately$0.7 million resulting from several ongoing studies necessary to resumeclinical trials of PPI-2458 and higher clinical spending of approximately$0.4 million in preparation for our phase 1 trial, offset by a reduction inmanufacturing activities of approximately $0.5 million. The remaining decreasewas due to lower research and development personnel-related expenses ofapproximately $2.4 million during the year ended December 31, 2004compared to the prior year.

Sales and marketing expenses for the year ended December 31,2004 increased by approximately $13.3 million to approximately$18.9 million, from approximately $5.6 million in 2003. The increaseresulted primarily from increased sales expenses of approximately $10.2 millionrelated to the commercial launch of Plenaxis in the United States, principallythe hiring of our sales force, as well as the establishment of the commercialinfrastructure to support the sales force. We also experienced increasedmarketing expenses of approximately $3.1 million related to market research,various physician and national meetings, advertising, pricing and reimbursementconsulting, and other marketing activities. We promoted Plenaxis in the UnitedStates through our own marketing and sales team.

General and administrative expenses for the year endedDecember 31, 2004 decreased 11% to approximately $8.7 million, fromapproximately $9.7 million in 2003. The decrease resulted primarily fromlower expenses related to business development activities and professionalservices.

Net interest income for the year ended December 31,2004 decreased to approximately $0.1 million, from approximately$1.3 million in 2003. The decrease in net interest income was dueprimarily to the refinancing of the mortgage on our facility from a lowervariable rate to a higher fixed rate and lower average cash balances.

The provision for income taxes for the years ended December 31,2004 and 2003 was zero. We anticipate that we will continue to be in a netoperating loss carryforward position for the next several years. Therefore, asin 2003, no benefit from our operating losses was recognized.

For the year ended December 31,2004, net loss was approximately $57.6 million, or $5.51 per share, compared toa net loss of approximately $55.8 million, or $5.38 per share, for the yearended December 31, 2003.

**SelectedQuarterly Operating Results**

Thefollowing table sets forth our unaudited statement of operations data for eachof the eight quarters ended December 31, 2005. This information has beenderived from our unaudited financial statements. The unaudited financialstatements have been prepared on the same basis as the audited financialstatements appearing in this report and include all adjustments, consistingonly of normal recurring adjustments, that we consider necessary for a fairpresentation of such information when read in conjunction with our annualaudited financial statements and notes thereto appearing elsewhere in thisreport. You should not draw any conclusions from the operating results for anyquarter.

| ** **                                   | ** ** | **Quarter Ended**                                             | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Mar. 31,  2004**                                            | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **Mar. 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** |
| ** **                                   | ** ** | **(in thousands, except per share data)** | ** ** |
| Total revenues                               |       | $                                                                  | 461        |   | $ | 673 |   | $ | 1,074 |   | $ | 780 |   | $ | 881 |   | $ | 392 |   | $ | 2,088 |   | $ | 4,242 |   |
| Restructuring and asset   impairment         |       | —                                                             |       | — |   | — |   | — |   | — |   | 28,680 |   | — |   | — |   |
| Operating loss                               |       | (15,608                                                            | )          | (14,815 | ) | (13,920 | ) | (13,360 | ) | (12,218 | ) | (42,292 | ) | (5,034 | ) | (3,036 | ) |
| Net loss                                     |       | (15,380                                                            | )          | (14,842 | ) | (13,954 | ) | (13,422 | ) | (12,345 | ) | (42,370 | ) | (5,168 | ) | (1,300 | ) |
| Basic and diluted  net loss per common share |       | $                                                                  | (1.47      | ) | $ | (1.42 | ) | $ | (1.33 | ) | $ | (1.28 | ) | $ | (1.18 | ) | $ | (4.04 | ) | $ | (0.49 | ) | $ | (0.12 | ) |

 

We expect to experiencesignificant fluctuations in our quarterly operating results in the future. Webelieve that period-to-period comparisons of our operating results may not bemeaningful, and you should not rely upon them as any indication of future performance.Operating results in one or more future 

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quartersmay be different from the expectations of securities analysts and investors. Inthe event that our operating results are lower than expectations, the tradingprice of our common stock would likely decline.

**Liquidity and Capital Resources**

To date, our operations and capital requirements havebeen financed primarily with the proceeds of public and private sales of commonstock and preferred stock, payments received under research and development partnershipsand collaborative agreements, investment income, revenues from product salesand proceeds from the October 2005 sale of our corporate headquarters andresearch facility. We have no committed sources of capital and do not knowwhether additional financing will be available when needed, or, if available,that the terms will be favorable to us.

In May 2005, our Board of Directors approved astrategic restructuring to focus the Company’s resources on our most promisingassets and programs and significantly reduce our cost structure. The strategicrestructuring included voluntarily discontinuing promotional activities relatedto Plenaxis and the sale of Plenaxis for new patients in the United States;voluntarily suspending the ongoing clinical development of Apan; andimplementing a headcount reduction of approximately 60%.

At December 31, 2005, we had cash, cashequivalents and marketable securities of approximately $62.6 million andworking capital of approximately $54.1 million, compared to approximately $83.3million and $76.4 million, respectively, at December 31, 2004.

We expect to continue to have net operating losses forthe next several years as we invest in developing and enhancing ourDirectSelect technology and advancing PPI-2458, and potentially otherproprietary compounds, through clinical and preclinical development. In orderto achieve our business objective, we must successfully carry out the followingkey elements of our operating plan: continue development and enhancement of ourDirectSelect technology and use this technology to support pharmaceuticalpartnerships in drug discovery and development that will provide revenues toour Company, as well as to expand our own proprietary development pipeline; andadvance PPI-2458 through a phase 1 trial in cancer patients and continuepreclinical evaluation of the compound in inflammatory and autoimmunedisorders, including rheumatoid arthritis. Additionally, as part of ourstrategy to focus our resources and attention on advancing our DirectSelect andPPI-2458 programs, we are actively pursuing, with the assistance of aninvestment banking firm, the disposition of our Plenaxis assets through alicense or sale transaction.

Given the uncertainty of timing related to the keypartnering elements of our strategy, we are not providing earnings or cashguidance for quarterly or annual periods during 2006. However, we believe thatour existing cash and investments of approximately $62.6 million at December 31,2005 will be sufficient to meet our working capital and capital expenditureneeds through approximately the end of 2007. If we are able to successfullycarry out one or more of the key elements of our strategic operating plan, orif we are able to realize significant value from the disposition of ourPlenaxis assets, we may have available resources to allow us to pursue ourstrategic operating plan beyond the end of 2007. However, we cannot assureinvestors that we will be able to enter into appropriate collaborative arrangementsrelating to our DirectSelect technology or our PPI-2458 program, orrealize significant value from the disposition of our Plenaxis assets. If weare unable to successfully carry out one or more of the key elements of ourstrategic operating plan and/or realize significant value from the dispositionof our Plenaxis assets, we may have to obtain additional sources of funding orsignificantly modify our strategic operating plan, including by curtailing oreliminating certain elements of our operations. We have no committed sources ofcapital and do not know whether additional financing will be available whenneeded, or, if available, that the terms will be acceptable to us. If we arerequired to raise money in the future and we experience difficulties or areunable to do so, it could become necessary for us to cease operations or seekprotection under state or federal insolvency or bankruptcy laws.

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For the year ended December 31, 2005, net cash ofapproximately $37.5 million was used in operating activities, compared toapproximately $58.0 million used in operating activities during 2004. Duringthe year ended December 31, 2005, our use of cash for operating activitiesprimarily reflects our net loss of approximately $61.2 million excludingnon-cash asset impairment expenses of approximately $23.2 million. During theyear ended December 31, 2004, our use of cash in operations was dueprincipally to our net loss of approximately $57.6 million, stemming from ourinvestment in research and development, as well as sales and marketing expensesrelated to the Plenaxis launch, and our purchases of inventory of approximately$4.2 million, partially offset by approximately $4.4 million of depreciation. Ourcash utilization will continue for 2006 and thereafter as we continue todevelop and advance our research and development initiatives. The actual amountof overall expenditures will depend on numerous factors, including the timingof expenses, the timing and terms of collaboration agreements or otherstrategic transactions, if any, and the timing and progress of our research anddevelopment efforts.

For the year ended December 31, 2005, net cashprovided by investing activities of approximately $115.2 million resulted fromnet sales and maturities of marketable securities of approximately $66.8million and proceeds of approximately $50.7 million from the sale of propertyand equipment, partially offset by purchases of property and equipment ofapproximately $1.4 million and an increase in restricted cash of approximately$0.8 million. For the year ended December 31, 2004, net cash provided byinvesting activities of approximately $53.8 million resulted from net sales andmaturities of marketable securities of approximately $55.1 million, partiallyoffset by purchases of property and equipment of approximately $1.3 million.

Our financing activities for the year ended December 31,2005 primarily consisted of approximately $32.0 million in principal repaymentsunder our acquisition and construction loan agreement described below. Ourfinancing activities for the year ended December 31, 2004 consisted ofapproximately $0.3 million of proceeds received from the exercise ofcommon stock options and approximately $0.7 million in principalrepayments under our acquisition and construction loan agreement.

In July 2000, in connection with the purchase ofour corporate headquarters and research facility in Waltham, Massachusetts, weentered into an acquisition and construction loan agreement providing for up to$33.0 million in financing for the acquisition of, and improvements to, thefacility. In October 2005, we sold this facility for gross proceeds of$51.25 million, and realized proceeds, net of fees and expenses, ofapproximately $50.4 million. A portion of the proceeds from the sale was usedto retire the loan of approximately $31.6 million and accordingly, there was nooutstanding balance under the acquisition and construction loan agreement at December 31,2005. As of December 31, 2004, approximately $32.0 million was outstandingunder the loan agreement. In connection with the sale of the facility, weexecuted a lease for approximately 65,000 square feet of office and laboratoryspace in this facility. The lease has an initial term of five years at anannual base rent of approximately $2.1 million for the first two years,increasing to approximately $2.3 million per year for the remaining three years.We have options to extend the lease for up to three additional five-year termsat then current market.

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Inaddition to our operating lease obligation, we have significant contractualobligations under various agreements. As of December 31, 2005, ouroperating lease and estimated significant contractual obligations were asfollows:

| ** **                                  | ** ** | ** ** | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**            | ** ** | ** ** | ** ** | **Total**                                 | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **After 5 Years** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | **(in thousands)**                   | ** ** |
| Lease commitments  (1)                      |       | $          | 10,774     |                                      |       | $ | 2,128 | ** ** |   | $ | 6,737 |   | $ | 1,909 |   |   | $ | — | ** ** |   |
| Unconditional  purchase obligations (2)     |       | 10,830     |       |                                      | 3,780      | ** ** |   | 6,150 |   | 900 |   |   | — | ** ** |   |
| Estimate of  clinical trial commitments (3) |       | 2,397      |       |                                      | 1,920      | ** ** |   | 477 |   |    — |   |   | — | ** ** |   |
| Total                                       |       | $          | 24,001     |                                      |       | $ | 7,828 | ** ** |   | $ | 13,364 |   | $ | 2,809 |   |   | $ | — | ** ** |   |
|                                             |            |            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The amounts representthe minimum rental commitments under the lease for our facility.

(2)          These amounts representminimum commitments due under our third-party manufacturing and supplyagreements which are described more fully elsewhere in this report under thecaption “Business—Plenaxis—Manufacturing Agreements.” In connection with thestrategic restructuring announced in May 2005, we recorded a charge ofapproximately $6.0 million representing commitments under these agreements inexcess of our estimated future requirements. At December 31, 2005,approximately $5.3 million was included in accrued restructuring.

(3)          These amounts representcommitments to various contract vendors for administering and carrying out ourclinical trials. The timing and amount of payments is uncertain as payments aredependent upon actual services performed by the organizations as determined bypatient enrollment levels and related activities. However, we currently expectto pay for these commitments through 2008 as ongoing clinical trials arecompleted.

At December 31, 2005,we had provided a valuation allowance of approximately $133.5 million forour deferred tax assets. The valuation allowance represents the value of thedeferred tax assets. Due to anticipated operating losses in the future, webelieve 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.

**Recent Accounting Pronouncements**

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 123R,*Share-Based Payment—An Amendment of FASB StatementsNo. 123 and 95*, or SFAS No. 123R, which requires allcompanies to measure compensation cost for all share-based payments, includingemployee stock options, at fair value, and was originally effective for publiccompanies for interim or annual periods beginning after June 15, 2005. In April 2005,the Securities and Exchange Commission amended the compliance dates for SFAS No. 123Rto allow companies to implement SFAS No. 123R at the beginning of their first fiscal year beginning after June 15,2005. As a result, we adopted SFAS No. 123Reffective January 1, 2006. We will use the modified prospective transitionmethod, which requires that compensation cost be recognized for all awardsgranted, modified or settled after the effective date as well as for all awardsgranted to employees prior to the effective date that remain unvested as of theeffective date. Generally, the approach in SFAS No. 123R is similarto the approach described in Statement of Financial Accounting Standards No. 123,*Accounting for Stock-Based Compensation*.However, SFAS No. 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values. Pro forma disclosure is no longer analternative.

The adoption of SFAS No. 123R may have asignificant impact on our reported results of operations, although it will haveno impact on our overall financial position. In March 2005, the Securitiesand Exchange Commission issued Staff Accounting Bulletin No. 107, or SAB No. 107,which expressed the views of the Commission regarding the interaction betweenSFAS No. 123R and certain rules and 

43

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regulations of theCommission. SAB No. 107 provides guidance related to the valuation ofshare-based payment arrangements for public companies, including assumptionssuch as expected volatility and expected term. We are evaluatingSFAS No. 123R and SAB No. 107 and have not yet determinedthe amount of stock option expense that will be incurred in future periods.

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 151, *Inventory Costs*,or SFAS No. 151. SFAS No. 151 requires abnormal amounts of inventorycosts related to idle facility, freight handling and wasted material expensesto be recognized as current period charges. Additionally, SFAS No. 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. Thestandard is effective for fiscal years beginning after June 15, 2005. Wedo not believe that the adoption of SFAS No. 151 will have a materialimpact on our consolidated financial statements.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The primary objective of our investment activities isto preserve principal while at the same time maximizing the income we receivefrom our investments without significantly increasing risk. We have not enteredinto any instruments for trading purposes. Some of the securities that weinvest in may have market risk. This means that an increase in prevailinginterest rates may cause the principal amount of the investment to decrease. Tominimize this risk in the future, we maintain our portfolio of cash equivalentsand short-term investments in a variety of securities, including commercialpaper, money market funds and government and non-government debt securities. Animmediate hypothetical 100 basis point increase in interest rates would haveresulted in an approximate $5,000 decrease in the fair value of our investmentsas of December 31, 2005. The same hypothetical increase in interest ratesas of December 31, 2004 would have resulted in an approximate $0.2 milliondecrease in the fair value of our investments. As of December 31, 2005, weowned approximately $5.5 million of marketable securities with aweighted-average maturity of approximately four months. Due to the conservativenature of our investments and relatively short duration, interest rate risk ismitigated.

In July 2000, inconnection with the purchase of our corporate headquarters and researchfacility in Waltham, Massachusetts, we entered into an acquisition andconstruction loan agreement providing for up to $33.0 million in financing at afloating interest rate indexed to 30-day LIBOR. In July 2003, weexercised the first of two one-year extension options extending the maturitydate of the loan until July 30, 2004. In connection with this extension,we entered into an interest rate cap agreement which limited exposure tointerest rate increases above a certain threshold through July 30, 2004. InJune 2004, the acquisition and construction loan agreement was amended toextend the maturity date of the loan and modify certain other terms of theoriginal agreement. The interest rate was fixed at 5.95% through April 2009and at a floating rate for the remainder of the term. Principal and interestwere payable through a fixed monthly payment of approximately $207,000, withthe principal portion being calculated using a 25-year amortizationschedule. Because of this amendment to the loan agreement, we do not believethat there was a material interest rate risk exposure with respect to the loanfacility through October 18, 2005. On October 18, 2005, we completedthe sale of our facility for approximately $51.25 million. We realized proceeds,net of fees and expenses, of approximately $50.4 million from this sale, andused approximately $31.6 million of the proceeds to retire the outstanding loanunder the acquisition and construction loan agreement and terminate themortgage on the facility.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

The financial statementsrequired by this Item are included on pages F-1 through F-23of this report. The supplementary financial information required by this Itemis included in the section of this report captioned “Management’s Discussionand Analysis of Financial Condition and Results of Operations,” under theheading “Selected Quarterly Operating Results.”

44

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES.

*(a)**          DisclosureControls and Procedures.*

The Company’smanagement, with the participation of our chief executive officer and chieffinancial officer, has evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on such evaluation, our chiefexecutive officer and chief financial officer have concluded that, as of theend of such period, the Company’s disclosure controls and procedures wereeffective in ensuring that information required to be disclosed by the Companyin the reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and is accumulatedand communicated to the Company’s management, including the Company’s chiefexecutive officer and chief financial officer, as appropriate to allow timelydecisions regarding required disclosure.

*(b)**          Management’sAnnual Report on Internal Control Over Financial Reporting.*

Not applicable.

*(c)**           AttestationReport of the Independent Registered Public Accounting Firm.*

Not applicable.

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

There have not been anychanges in the Company’s internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during the quarter ended December 31, 2005 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

**ITEM 9B.**       OTHERINFORMATION.

Not applicable.

 

45

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT.

We have adopted a code of ethics and conduct thatapplies to all of our directors, officers and employees. We have made a copy ofour code of ethics and conduct available on our website under “InvestorRelations—Corporate Governance.”  We maysatisfy the disclosure requirement under Item 5.05 of Form 8-Kregarding an amendment to, or a waiver from, a provision of our code of ethicsand conduct that applies to our principal executive officer or our principalfinancial and accounting officer by posting such information on our website, *www.praecis.com*.

Information required bythis Item with respect to directors, executive officers, the Company’s auditcommittee and compliance with Section 16(a) of the Securities Act of1934, as amended, may be found in the sections captioned “Nominees for Electionto the Board of Directors,” “Executive Officers Who Are Not Directors,” “BoardActions; Committees of the Board of Directors—Audit Committee” and “Section 16(a) BeneficialOwnership Reporting Compliance,” appearing in our definitive Proxy Statement tobe delivered to stockholders in connection with the Annual Meeting ofStockholders expected to be held on May 11, 2006. Such information isincorporated herein by reference.

**ITEM 11.**         EXECUTIVECOMPENSATION.

Information required bythis Item may be found in the sections captioned “Director Compensation,” “ExecutiveCompensation and Other Information,” and “Compensation Committee Interlocks andInsider Participation,” appearing in our definitive Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersexpected to be held on May 11, 2006. Such information is incorporatedherein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

Information required bythis Item may be found in the sections captioned “Stock Ownership of CertainBeneficial Owners and Management” and “Equity Compensation Plan Information,”appearing in our definitive Proxy Statement to be delivered to stockholders inconnection with the Annual Meeting of Stockholders expected to be held on May 11,2006. Such information is incorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.

Information required bythis Item may be found in the section captioned “Certain Relationships andRelated Transactions,” appearing in our definitive Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersexpected to be held on May 11, 2006. Such information is incorporatedherein by reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES.

Information required bythis Item may be found in the section captioned “Independent Registered Public Accounting Firm Fees,” appearing inour definitive Proxy Statement to be delivered to stockholders in connectionwith the Annual Meeting of Stockholders expected to be held on May 11,2006. Such information is incorporated herein by reference.

46

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**PART IV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENT SCHEDULES.

*(a)**          1.      Financial Statements*

The financial statements filed as part of this reportare listed on the Index to Consolidated Financial Statements located on page F-1,which immediately follows the signature page of this report.

*2.**                 FinancialStatement Schedules*

All schedules for which provision is made in theapplicable accounting regulations of the Securities and Exchange Commission arenot required under the related instructions or are inapplicable and thereforehave been omitted.

*3.**                 Exhibits*

| Exhibit No. | ** ** | **Exhibit** |
|------------------|------------|-------------|
|             | 3.1        |        |   | Amended and Restated Certificate of Incorporation  (2) |
|             | 3.2        |        |   | Certificate of Amendment (effecting reverse stock  split) (14) |
|             | 3.3        |        |   | Third Amended and Restated By-Laws (7) |
|             | 4.1        |        |   | Specimen certificate representing shares of common  stock (post-reverse stock split) (14) |
|             | 4.2        |        |   | Rights Agreement between PRAECIS and American Stock  Transfer & Trust Company, as Rights Agent (3) |
|             | 4.3        |        |   | Form of Certificate of Designations of  Series A Junior Participating Preferred Stock (attached as  Exhibit A to the Rights Agreement filed as Exhibit 4.2) (3) |
|             | 4.4        |        |   | Form of Rights Certificate (attached as  Exhibit B to the Rights Agreement filed as Exhibit 4.2) (3) |
|             | 10.1       | *           |   | Third Amended and Restated 1995 Stock Plan (9) |
|             | 10.2       | *           |   | Form of Incentive Stock Option Agreement (12) |
|             | 10.3       | *           |   | Form of Non-Qualified Stock Option Agreement  (12) |
|             | 10.4       | *           |   | Executive Management Bonus Plan, as amended and  restated as of September 12, 2002 (6) |
|             | 10.5       | *           |   | Second Amended and Restated Employee Stock Purchase  Plan (13) |
|             | 10.6       | *           |   | Management Incentive Program (7) |
|             | 10.7       | *           |   | Letter Agreement dated as of May 9, 2002  between PRAECIS and Malcolm L. Gefter, Ph.D. (5) |
|             | 10.8       | *           |   | Letter Agreement dated as of May 9, 2002 between  PRAECIS and Kevin F. McLaughlin (5) |
|             | 10.9       | *           |   | Letter Agreement dated as of May 9, 2002  between PRAECIS and Marc B. Garnick, M.D. (5) |
|             | 10.10      | *           |   | Letter Agreement dated as of September 16, 2004  between PRAECIS and Edward C. English (11) |
|             | 10.11      | *           |   | Letter Agreement dated as of September 16, 2004  between PRAECIS and Richard W. Wagner, Ph.D. (11) |
|             | 10.12      | *           |   | Summary of Executive Officer, Non-Executive Chairman  and Non-Employee Director Compensation Arrangements for 2006 |
|             | 10.13      | †      |   | License Agreement effective as of October 17,  1996 by and between PRAECIS and Indiana University Foundation, as amended as  of June 3, 1998 (1) |
|             | 10.14      | †      |   | Supply Agreement dated as of July 23, 1998 by  and between PRAECIS and Salsbury Chemicals, Inc. (1) |
|             | 10.15      | †      |   | Amendment No. 2 dated as of July 1, 2004  by and between PRAECIS and Cambrex Charles City, Inc. (formerly Salsbury  Chemicals, Inc.) to the Supply Agreement dated as of July 23, 1998  by and between PRAECIS and Salsbury Chemicals, Inc., as amended (10) |

47

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|        | 10.16 | †       |   | Development and Supply Agreement effective as of  June 21, 2000 by and between UCB S.A. and Amgen Inc., as amended by  Amendment No. 1 thereto dated as of March 26, 2002 (together with  the Assignment of Development and Supply Agreement entered into January 18,  2002 and effective as of December 17, 2001 by and between Amgen Inc. and  PRAECIS) (4) |
|--------|-------|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10.17 | †       |   | Amendment No. 2 dated as of August 30,  2004 to the Development and Supply Agreement effective as of June 21,  2000 by and between PRAECIS and UCB S.A. (12)                                                                                                                                                                                                            |
|   | 10.18 | †† |   | Letter Agreement dated as of January 6, 2006 by  and between PRAECIS and UCB S.A.                                                                                                                                                                                                                                                                                                 |
|   | 10.19 | †       |   | Commercial Supply Agreement dated December 4,  2002 and effective as of June 1, 2002 by and between Baxter  Pharmaceutical Solutions LLC and PRAECIS (7)                                                                                                                                                                                                                     |
|   | 10.20 |         |   | Settlement Agreement and Release dated as  October 19, 2005 by and between the PRAECIS and Schering AG                                                                                                                                                                                                                                                                            |
|   | 10.21 |         |   | Real Estate Purchase Agreement dated as of  October 11, 2005 between 830 Winter Street LLC and Intercontinental Real  Estate Investment Fund III, LLC (14)                                                                                                                                                                                                                        |
|   | 10.22 |         |   | Lease by and between Intercontinental Fund III 830  Winter Street LLC and PRAECIS dated October 18, 2005 (14)                                                                                                                                                                                                                                                                     |
|   | 21.1  |         |   | List of Subsidiaries of PRAECIS (8)                                                                                                                                                                                                                                                                                                                                                    |
|   | 23.1  |         |   | Consent of Ernst & Young LLP, Independent  Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                  |
|   | 24.1  |         |   | Power of Attorney (included on the signature  page of this Report on Form 10-K)                                                                                                                                                                                                                                                                                              |
|   | 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                                                                                                                                                                                                                          |

----

*                    Represents amanagement contract or compensatory plan or arrangement.

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

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

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

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

(3)          Incorporated byreference to Registration Statement on Form 8-A filed with theSecurities and Exchange Commission on January 26, 2001.

(4)          Incorporated byreference to Annual Report on Form 10-K for the year ended December 31,2001 filed with the Securities and Exchange Commission on April 1, 2002.

(5)          Incorporated byreference to Quarterly Report on Form 10-Q for the quarter ended June 30,2002 filed with the Securities and Exchange Commission on August 12, 2002.

(6)          Incorporated by referenceto Quarterly Report on Form 10-Q for the quarter ended September 30,2002 filed with the Securities and Exchange Commission on November 14,2002.

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

48

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(8)          Incorporated byreference to Annual Report on Form 10-K for the year ended December 31,2003 filed with the Securities and Exchange Commission on March 15, 2004.

(9)          Incorporated by referenceto Registration Statement on Form S-8 (Registration No. 333-116188)filed with the Securities and Exchange Commission on June 4, 2004.

(10)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended June 30,2004 filed with the Securities and Exchange Commission on August 9, 2004.

(11)   Incorporated by reference toCurrent Report on Form 8-K filed with the Securities and ExchangeCommission on September 21, 2004.

(12)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended September 30,2004 filed with the Securities and Exchange Commission on November 9,2004.

(13)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended June 30,2005 filed with the Securities and Exchange Commission on August 5, 2005.

(14)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended September 30,2005 filed with the Securities and Exchange Commission on November 4,2005.

49

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**SIGNATURE**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this Report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                           |   |     | PRAECIS PHARMACEUTICALS  INCORPORATED                                                            |
|---------------------------|--------|----------|--------------------------------------------------------------------------------------------------|
|                      |   | By:      | /s/  EDWARD C. ENGLISH                                                                           |
| Date: March 17, 2006 |   | * * | Edward C. English  *Chief Financial Officer, Vice President,  Treasurer and Assistant Secretary* |

 

**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below constitutes and appoints Kevin F. McLaughlin andEdward C. English and each of them, as such person’s true and lawfulattorney-in-fact and agent with full power of substitution and revocation forsuch person and in such person’s name, place and stead, in any and allcapacities, to execute any and all amendments to this Annual Report on Form 10-K,and to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, grantingunto said attorney-in-fact and agent full power and authority to do and performeach and every act and thing requisite and necessary to be done, as fully toall intents and purposes as such person might or could do in person, herebyratifying and confirming all that said attorney-in-fact and agent or hissubstitute or substitutes, may lawfully do or cause to be done by virtuehereof.

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned below by the following persons on behalf of the registrant and in thecapacities indicated on March 17, 2006.

| ** **                      | **Signature** | ** **                                                        | ** ** |  | **Title** | ** ** |
|---------------------------------|---------------|-------------------------------------------------------------------|------------|--|-----------|------------|
| /s/ KEVIN F.  MCLAUGHLIN        |          | President, Chief  Executive Officer and Director                  |
| Kevin  F. McLaughlin            | * *      | *(Principal Executive Officer)*                                   |
| /s/ EDWARD C.  ENGLISH          |          | Chief Financial  Officer, Vice President, Treasurer and Assistant |
| Edward  C. English              |          | Secretary                                                         |
|                            | * *      | *(Principal Financial and  Accounting Officer)*                   |
| /s/ MALCOLM L.  GEFTER, PH.D.   |          | Chairman of the  Board and Chief Scientific Officer               |
| Malcolm  L. Gefter, Ph.D.       |          |                                                              |
| /s/ G. LEONARD  BAKER, JR. |          | Director                                                          |
| G.  Leonard Baker, Jr.     |          |                                                              |
| /s/ GAREN G.  BOHLIN            |          | Director                                                          |
| Garen  G. Bohlin                |          |                                                              |
| /s/ HENRY F.  MCCANCE           |          | Director                                                          |
| Henry  F. McCance               |          |                                                              |
| /s/ LEONARD E.  POST, PH.D.     |          | Director                                                          |
| Leonard  E. Post, Ph.D.         |          |                                                              |
| /s/ DAVID B.  SHARROCK          |          | Director                                                          |
| David  B. Sharrock              |          |                                                              |
| /s/ PATRICK J.  ZENNER          |          | Director                                                          |
| Patrick J. Zenner               |          |                                                              |

 

50

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**PRAECISPHARMACEUTICALS INCORPORATEDINDEX TO CONSOLIDATEDFINANCIAL STATEMENTS**

|                                                          | ** ** | **Page** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm |       |     | F-2        |   |   |
| Consolidated Balance Sheets                              |       |     | F-3        |   |   |
| Consolidated Statements of Operations                    |       |     | F-4        |   |   |
| Consolidated Statements of Stockholders’ Equity     |       |     | F-5        |   |   |
| Consolidated Statements of Cash Flows                    |       |     | F-6        |   |   |
| Notes  to Consolidated Financial Statements              |       |     | F-7        |   |   |

 

F-1

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**Reportof Independent Registered Public Accounting Firm**

Board of Directors and StockholdersPRAECIS PHARMACEUTICALS INCORPORATED

We have audited the accompanying consolidated balancesheets of PRAECIS PHARMACEUTICALS INCORPORATED as of December 31, 2005 and2004, and the related consolidated statements of operations, stockholders’equity and cash flows for each of the three years in the period ended December 31,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. We were not engaged to perform an audit of the Company’sinternal control over financial reporting. Our audit included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company's internal controlover financial reporting. Accordingly, we express no such opinion. An audit alsoincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of PRAECIS PHARMACEUTICALS INCORPORATED at December 31, 2005 and2004, and the consolidated results of its operations and its cash flows foreach of the three years in the period ended December 31, 2005, in conformitywith U.S. generally accepted accounting principles.

/s/ Ernst &Young LLP

Boston, MassachusettsJanuary 20, 2006

F-2

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**PRAECISPHARMACEUTICALS INCORPORATEDConsolidated Balance Sheets(In thousands, except share data)**

| ** **                                                                                                                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                     | ** ** | **2004**              | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                                     |       |                  |       |   |   |
| Current assets:                                                                                                                                |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                      |       | $                     | 11,178     |   | $ | 57,088 |   |
| Marketable securities                                                                                                                          |       | 72,171                |       | 5,492 |   |
| Accounts receivable                                                                                                                            |       | 1,052                 |       | 184 |   |
| Inventory                                                                                                                                      |       | 93                    |       | 154 |   |
| Prepaid expenses and other current assets                                                                                                      |       | 952                   |       | 742 |   |
| Total current assets                                                                                                                           |       | 85,446                |       | 63,660 |   |
| Property and  equipment, net                                                                                                                   |       | 64,538                |       | 3,559 |   |
| Inventory                                                                                                                                      |       | 4,136                 |       | 1,532 |   |
| Restricted cash                                                                                                                                |       | —                |       | 793 |   |
| Other assets                                                                                                                                   |       | 187                   |       | — |   |
| Total assets                                                                                                                                   |       | $                     | 154,307    |   | $ | 69,544 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                 |       |                  |       |   |   |
| Current liabilities:                                                                                                                           |       |                  |       |   |   |
| Accounts payable                                                                                                                               |       | $                     | 2,191      |   | $ | 780 |   |
| Accrued expenses                                                                                                                               |       | 6,085                 |       | 3,373 |   |
| Accrued restructuring                                                                                                                          |       | —                |       | 3,608 |   |
| Deferred revenue                                                                                                                               |       | 167                   |       | — |   |
| Deferred gain on sale-leaseback of building                                                                                                    |       | —                |       | 1,818 |   |
| Current portion of long-term debt                                                                                                              |       | 596                   |       | — |   |
| Total current liabilities                                                                                                                      |       | 9,039                 |       | 9,579 |   |
| Long-term accrued restructuring                                                                                                                |       | —                |       | 1,834 |   |
| Long-term  deferred revenue                                                                                                                    |       | 1,722                 |       | — |   |
| Long-term  deferred gain on sale-leaseback of building                                                                                         |       | —                |       | 6,968 |   |
| Long-term  debt                                                                                                                                |       | 31,373                |       | — |   |
| Commitments and  contingencies (Note 14)                                                                                                       |       |                  |       |   |   |
| Stockholders’  equity:                                                                                                                    |       |                  |       |   |   |
| Common Stock, $0.01 par value; 200,000,000 shares  authorized; 10,475,664 shares in 2004 and 10,494,174 shares in 2005 issued  and outstanding |       | 105                   |       | 105 |   |
| Additional paid-in capital                                                                                                                     |       | 356,140               |       | 356,234 |   |
| Accumulated other comprehensive loss                                                                                                           |       | (169                  | )          | (90 | ) |
| Accumulated deficit                                                                                                                            |       | (243,903              | )          | (305,086 | ) |
| Total stockholders’ equity                                                                                                                |       | 112,173               |       | 51,163 |   |
| Total liabilities  and stockholders’ equity                                                                                               |       | $                     | 154,307    |   | $ | 69,544 |   |

 

*See accompanying notes.*

F-3

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**PRAECISPHARMACEUTICALS INCORPORATEDConsolidated Statements of Operations(In thousands, except per share data)**

| ** **                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Revenues:**                                                           |       |                                       |       |   |   |   |   |
| Product sales                                                           |       | $                                          | —     |   | $ | 2,817 |   | $ | 1,679 |   |
| Licensing and other revenues                                            |       | —                                     |       | 171 |   | 5,924 |   |
| Total revenues..                                                        |       | —                                     |       | 2,988 |   | 7,603 |   |
| **Costs and expenses:**                                                 |       |                                       |       |   |   |   |   |
| Cost of goods sold                                                      |       | —                                     |       | 1,703 |   | 4,019 |   |
| Research and development                                                |       | 41,847                                     |       | 31,455 |   | 24,502 |   |
| Sales and marketing                                                     |       | 5,596                                      |       | 18,880 |   | 5,988 |   |
| General and administrative                                              |       | 9,704                                      |       | 8,653 |   | 6,994 |   |
| Restructuring and asset impairment                                      |       | —                                     |       | — |   | 28,680 |   |
| Total costs and expenses                                                |       | 57,147                                     |       | 60,691 |   | 70,183 |   |
| Operating loss                                                          |       | (57,147                                    | )          | (57,703 | ) | (62,580 | ) |
| Interest income                                                         |       | 2,508                                      |       | 1,771 |   | 1,747 |   |
| Interest expense                                                        |       | (1,159                                     | )          | (1,666 | ) | (1,769 | ) |
| Gain on sale of  property and equipment                                 |       | —                                     |       | — |   | 1,419 |   |
| Net loss                                                                |       | $                                          | (55,798    | ) | $ | (57,598 | ) | $ | (61,183 | ) |
| Basic and diluted net loss per common share                             |       | $                                          | (5.38      | ) | $ | (5.51 | ) | $ | (5.83 | ) |
| Weighted average  number of basic and diluted common shares outstanding |       | 10,374                                     |       | 10,462 |   | 10,490 |   |

 

*See accompanying notes.*

F-4

----

**PRAECISPHARMACEUTICALS INCORPORATEDConsolidated Statements of Stockholders’ Equity (In thousands, except share data)**

| ** **                                | ** ** | ** **            | ** ** | **Additional** | ** ** | **Accumulated  Other** | ** ** | ** **             | ** ** | **Total**              | ** ** |
|-------------------------------------------|------------|-----------------------|------------|----------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **Common Stock** | ** ** | **Paid-in**    | ** ** | **Comprehensive**      | ** ** | **Accumulated**        | ** ** | **Stockholders’** | ** ** |
| ** **                                | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**            | ** ** | **Income (Loss)** | ** ** | **Deficit**            | ** ** | **Equity** | ** ** |
| Balance at  December 31, 2002        |       | 10,360,269            |       |           | $          | 104                    |       |                   | $          | 355,090                |       |   | $ | 203 |   |   |   | $ | (130,507 | ) |   |   | $ | 224,890 |   |   |
| Net loss                                  |       |                  |       |           |       |                   |       |                   |       |                   |       |   |   |   | (55,798 | ) |   |   | (55,798 | ) |   |
| Unrealized loss  on marketable securities |       |                  |       |           |       |                   |       |                   |       |                   | (130       | ) |   |   |   |   |   |   | (130 | ) |   |
| Total  comprehensive loss                 |       |                  |       |           |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   | (55,928 | ) |   |
| Stock  compensation                       |       |                  |       |           |       |                   |       | 148                    |       |                   |       |   |   |   |   |   |   |   | 148 |   |   |
| Issuance of  Common Stock                 |       | 41,916                |       |           |       |                   |       | 551                    |       |                   |       |   |   |   |   |   |   |   | 551 |   |   |
| Balance at  December 31, 2003        |       | 10,402,185            |       |           | 104        |                   |       | 355,789                |       |                   | 73         |   |   |   | (186,305 | ) |   |   | 169,661 |   |   |
| Net loss                                  |       |                  |       |           |       |                   |       |                   |       |                   |       |   |   |   | (57,598 | ) |   |   | (57,598 | ) |   |
| Unrealized loss  on marketable securities |       |                  |       |           |       |                   |       |                   |       |                   | (242       | ) |   |   |   |   |   |   | (242 | ) |   |
| Total  comprehensive loss                 |       |                  |       |           |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   | (57,840 | ) |   |
| Stock  compensation                       |       |                  |       |           |       |                   |       | 18                     |       |                   |       |   |   |   |   |   |   |   | 18 |   |   |
| Issuance of  Common Stock                 |       | 73,479                |       |           | 1          |                   |       | 333                    |       |                   |       |   |   |   |   |   |   |   | 334 |   |   |
| Balance at  December 31, 2004        |       | 10,475,664            |       |           | 105        |                   |       | 356,140                |       |                   | (169       | ) |   |   | (243,903 | ) |   |   | 112,173 |   |   |
| Net loss                                  |       |                  |       |           |       |                   |       |                   |       |                   |       |   |   |   | (61,183 | ) |   |   | (61,183 | ) |   |
| Unrealized gain  on marketable securities |       |                  |       |           |       |                   |       |                   |       |                   | 79         |   |   |   |   |   |   |   | 79 |   |   |
| Total comprehensive  loss                 |       |                  |       |           |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   | (61,104 | ) |   |
| Issuance of  Common Stock                 |       | 18,510                |       |           |       |                   |       | 94                     |       |                   |       |   |   |   |   |   |   |   | 94 |   |   |
| Balance at  December 31, 2005        |       | 10,494,174            |       |           | $          | 105                    |       |                   | $          | 356,234                |       |   | $ | (90 | ) |   |   | $ | (305,086 | ) |   |   | $ | 51,163 |   |   |

 

*See accompanying notes.*

F-5

----

**PRAECISPHARMACEUTICALS INCORPORATEDConsolidated Statements of Cash Flows(In thousands)**

| ** **                                                               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                               | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Operating activities:**                                                |       |                                       |       |   |   |   |   |
| Net loss                                                                 |       | $                                          | (55,798    | ) | $ | (57,598 | ) | $ | (61,183 | ) |
| Adjustments to reconcile  net loss to cash used in operating activities: |       |                                       |       |   |   |   |   |
| Non-cash asset impairment                                                |       | —                                     |       | — |   | 23,169 |   |
| Amortization of deferred gain on sale-leaseback of  building             |       | —                                     |       | — |   | (303 | ) |
| Gain on sale of property and equipment                                   |       | —                                     |       | — |   | (1,419 | ) |
| Depreciation                                                             |       | 4,551                                      |       | 4,434 |   | 2,533 |   |
| Stock compensation                                                       |       | 148                                        |       | 18 |   | — |   |
| Changes in  operating assets and liabilities:                            |       |                                       |       |   |   |   |   |
| Accounts receivable                                                      |       | —                                     |       | (1,052 | ) | 868 |   |
| Inventory                                                                |       | —                                     |       | (4,229 | ) | (950 | ) |
| Prepaid expenses, other current assets and other  assets                 |       | 290                                        |       | (399 | ) | 397 |   |
| Due from officer                                                         |       | 100                                        |       | 833 |   | — |   |
| Accounts payable                                                         |       | (802                                       | )          | (292 | ) | (1,411 | ) |
| Accrued expenses                                                         |       | 632                                        |       | (1,622 | ) | (2,712 | ) |
| Accrued restructuring                                                    |       | —                                     |       | — |   | 5,442 |   |
| Deferred revenue                                                         |       | —                                     |       | 1,889 |   | (1,889 | ) |
| Net cash used in  operating activities                                   |       | (50,879                                    | )          | (58,018 | ) | (37,458 | ) |
| **Investing  activities:**                                               |       |                                       |       |   |   |   |   |
| Purchase of  available-for-sale securities                               |       | (88,786                                    | )          | (126,622 | ) | (13,094 | ) |
| Sales and  maturities of available-for-sale securities                   |       | 115,339                                    |       | 181,714 |   | 79,852 |   |
| Proceeds from  disposition of property and equipment                     |       | —                                     |       | 50 |   | 50,673 |   |
| Purchase of  property and equipment                                      |       | (1,012                                     | )          | (1,309 | ) | (1,395 | ) |
| Increase in  restricted cash                                             |       | —                                     |       | — |   | (793 | ) |
| Net cash provided  by investing activities                               |       | 25,541                                     |       | 53,833 |   | 115,243 |   |
| **Financing  activities:**                                               |       |                                       |       |   |   |   |   |
| Repayments of  long-term debt                                            |       | (373                                       | )          | (658 | ) | (31,969 | ) |
| Proceeds from the  issuance of Common Stock                              |       | 551                                        |       | 334 |   | 94 |   |
| Net cash provided  by (used in) financing activities                     |       | 178                                        |       | (324 | ) | (31,875 | ) |
| (Decrease) increase in cash and cash equivalents                         |       | (25,160                                    | )          | (4,509 | ) | 45,910 |   |
| Cash and cash  equivalents at beginning of year                          |       | 40,847                                     |       | 15,687 |   | 11,178 |   |
| Cash and cash  equivalents at end of year                                |       | $                                          | 15,687     |   | $ | 11,178 |   | $ | 57,088 |   |
| **Supplemental  disclosure of non-cash investing activities:**           |       |                                       |       |   |   |   |   |
| Deferred gain on  sale-leaseback of building                             |       | $                                          | —     |   | $ | — |   | $ | 9,089 |   |

 

*See accompanying notes.*

F-6

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements**

**1. Basis ofPresentation**

***The Company***

PRAECIS PHARMACEUTICALSINCORPORATED (the “Company”) was incorporated in July 1993 under the lawsof the State of Delaware. The Company is engaged in the discovery anddevelopment of novel compounds with the potential to address unmet medicalneeds or improve existing therapies. The Company is focusing its resources onan innovative drug discovery technology, DirectSelect. In addition, the Companyhas a novel proprietary compound, PPI-2458, in clinical development forcancer indications. Preclinical data also supports the use of this compound ininflammatory and autoimmune disorders, including rheumatoid arthritis. TheCompany has received approval to market Plenaxis in the United States andGermany and is actively pursuing the disposition of its Plenaxis assets througha license or sale transaction.

***Reverse Stock Split***

On November 1, 2005,the Company effected a one-for-five reverse stock split of its outstandingcommon stock, par value $.01 per share (“Common Stock”). The reverse stocksplit was approved by the Company’s stockholders at a special meeting held on October 27,2005. As a result of the reverse stock split, each five outstanding shares ofcommon stock automatically converted into one share of Common Stock, with cashbeing paid in lieu of fractional shares. The number of authorized shares ofCommon Stock was not changed by the reverse stock split and remains at200,000,000. The par value of the Common Stock was also not affected by thereverse stock split. All per share amounts and outstanding shares, includingall Common Stock equivalents (stock options and the exercise prices thereof),have been retroactively restated for all periods presented to reflect thereverse stock split.

***Use of Estimates***

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Such estimates relate to the useful lives of fixed assets,the net realizable value of inventory, accrued restructuring expenses and otherreserves. Actual results could differ from those estimates and such differencesmay be material to the Company’s consolidated financial statements.

***Principles of Consolidation***

The accompanyingconsolidated financial statements include the Company’s accounts and theaccounts of its wholly owned subsidiaries, 830 Winter Street LLC and PRAECISEurope Limited. All significant intercompany account balances and transactionsbetween the companies have been eliminated.

**2. Significant AccountingPolicies**

***Cash Equivalents***

Cash equivalents consistprincipally of money market funds and other investments with originalmaturities of three months or less at the date of purchase.

F-7

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**2. SignificantAccounting Policies (Continued)**

***Marketable Securities***

The Company invests inmarketable securities of highly rated financial institutions and investment-gradedebt instruments and limits the amount of credit exposure with any one entity.The Company has classified its marketable securities as “available-for-sale”and, accordingly, carries such securities at aggregate fair value. Unrealizedgains and losses, if any, are reported as other comprehensive income withinstockholders’ equity. The amortized cost of debt securities in this category isadjusted for amortization of premiums and accretion of discounts to maturity.Such amortization is included in interest income. Realized gains and losses onavailable-for-sale securities are included in interest income andexpense. The cost of securities sold is based on the specific identificationmethod. Interest and dividends are included in interest income. At December 31,2005, the Company’s marketable securities had a maximum estimated life of lessthan three years with a weighted average maturity of approximatelyfour months.

***Concentrations of Credit Risk***

Financial instruments that potentially subject theCompany to concentration of credit risk consist principally of cash, cashequivalents and marketable securities. The Company maintains its cash, cashequivalents and marketable securities with high credit quality financialinstitutions and, by policy, limits its credit exposure to any one financialinstrument, sovereignty or issuer.

Product sales for theyears ended December 31, 2005 and 2004 relate solely to Plenaxis. TheCompany had no product sales during 2003. As discussed in Note 8, in connectionwith the Company’s strategic restructuring announced in May 2005, theCompany voluntarily discontinued promotional activities related to Plenaxis andthe sale of Plenaxis for new patients in the United States. The Company sellsPlenaxis directly to a limited number of authorized specialty pharmaceuticaldistributors and pharmacies which, in turn, sell the product to physicians andhospital pharmacists. The Company had five significant customers whichaccounted for 29%, 22%, 20%, 16% and 13% of the Company’s product sales in2005, and 39%, 18%, 16%, 16% and 10% of the Company’s product sales in 2004. Inorder to control credit risk,****the Companyperforms regular credit evaluations of its customers’ financial condition.****The Company has not realized any credit losses or recordedan allowance for doubtful accounts to date.

***Property and Equipment***

Propertyand equipment are recorded at cost. Depreciation is calculated using thestraight-line method over the estimated useful life of the asset as follows:

| Building                                  |   | 30 years                                                              |
|-------------------------------------------|--------|-----------------------------------------------------------------------|
| Building improvements                     |   | 30 years or the  remaining life of the building, whichever is shorter |
| Leasehold improvements                    |   | 5-7 years or  remaining term of lease, whichever is shorter           |
| Laboratory, computer and office equipment |   | 3-7 years                                                             |

 

In accordance with Statementof Financial Accounting Standards (“SFAS”) No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets* (“SFASNo. 144”), the Company reviews property, plant and equipment andlong-term inventory for impairment whenever events or changes in circumstancesindicate that the carrying amount of such an asset may not be recoverable. 

F-8

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**2. SignificantAccounting Policies (Continued)**

Recoverabilityof these assets is measured by comparing the carrying amount to the futureundiscounted cash flows the assets are expected to generate over their remainingeconomic life.

***Revenue Recognition***

The Company follows the provisions of the Securitiesand Exchange Commission’s (the “SEC”) Staff Accounting Bulletin (“SAB”) No. 104,*Revenue Recognition*. The Companyrecognizes revenues from product sales in the period when the product isdelivered, provided there is persuasive evidence that an arrangement exists,the price is fixed or determinable and collection of the related receivable isreasonably assured. Revenues are recorded net of applicable allowances asprovision is made for estimated sales returns, rebates, distributor fees andother applicable discounts and allowances. Shipping and other distributioncosts are charged to cost of product sales. Product revenues are related solelyto Plenaxis for all periods presented in this report. In connection with theCompany’s strategic restructuring announced in May 2005, the Companyvoluntarily discontinued promotional activities related to Plenaxis and thesale of Plenaxis for new patients in the United States.

The Company prepares its provisions for Plenaxis salesreturns and allowances, rebates and discounts based primarily on estimates. Contractualallowances and rebates result primarily from sales under contracts withhealthcare providers, Medicaid programs and other government agencies. TheCompany’s policy for sales returns has historically authorized distributors toreturn the product three months prior to, and six months after, productexpiration. In connection with the Company’s strategic restructuring announcedin May 2005, the Company modified its policy for sales returns toeliminate these restrictions in order to accommodate returns resulting from theannouncement of the discontinuation of promotional activities for Plenaxis andthe sale of Plenaxis for new patients in the United States. Historically, thereserve for sales returns was determined by reviewing the history of returnsfor products with similar characteristics to Plenaxis. The Company alsoutilizes daily reports itemizing sales to physicians and hospital pharmacies,obtained directly from its authorized distributors, in order to analyzespecific account ordering trends. This data is reviewed to monitor productmovement through the supply chain to identify remaining inventory that mayresult in chargebacks or sales returns. The reserves are reviewed at eachreporting period and adjusted to reflect data available at that time. As of December 31,2005 and 2004, the accrual for sales return and other revenue reserves wasapproximately $0.1 million and $0.5 million, respectively. To the extentestimates of contractual allowances, rebates and sales returns are differentfrom actuals, the Company adjusts the reserve which impacts the amount ofproduct sales revenue recognized in the period of the adjustment

The Company currently provides substantially all ofits distributors with payment terms of up to 120 days on purchases of Plenaxis.Through December 31, 2005, payments have generally been made in a timelymanner.

The Company analyzes its multiple element arrangementsto determine whether the elements can be separated and accounted forindividually as separate units of accounting in accordance with EITF No. 00-21,*Revenue Arrangements with 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 the Company are recognizedas licensing revenue ratably over the period under which the Company isobligated to perform those services. Milestone payments are recognized aslicensing revenue or product sales when the performance obligations, as definedin the contract, are achieved. Performance milestones typically consist ofsignificant milestones in the development and/or commercialization of a productsuch as obtaining approval from regulatory 

F-9

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**2. SignificantAccounting Policies (Continued)**

agencies and theachievement of targeted sales levels. Reimbursements of development costs arerecognized as licensing revenue as the related costs are incurred.

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

***Income Taxes***

The Company accounts forincome taxes in accordance with the provisions of SFAS No. 109, *Accounting for Income Taxes* (“SFAS No. 109”)*.*SFAS No. 109 requires thatdeferred taxes are recognized using the liability method, whereby tax rates areapplied to cumulative temporary differences between carrying amounts of assetsand liabilities for financial reporting purposes and the amounts used forincome tax purposes based on when and how they are expected to affect the taxreturn. A valuation allowance is provided on deferred tax assets if, based uponavailable information, it is determined that it is more likely than not thatthe asset will not be realized.

***Segment Information***

SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information* (“SFAS No. 131”), established standards forreporting information on operating segments in interim and annual financialstatements. Under SFAS No. 131, the Company operates in one segment, the discovery and development of drugs for thetreatment of human diseases. The Company does not operate any materialseparate lines of business with respect to its products or product candidates.Accordingly, the Company does not accumulate discrete financial informationwith respect to separate product areas and does not have separately reportablesegments. For the year ended December 31, 2005, a majority of the Company’srevenue was generated through payments made by Schering AG, of Berlin, Germany(“Schering AG”), under or in connection with a license, supply anddistribution agreement (the “Schering AG Agreement”), with the remainder beinggenerated in the United States through sales of Plenaxis. For the year ended December 31,2004, substantially all of the Company’s revenue was generated in the UnitedStates. The Company did not have any revenue for the year ended December 31,2003.

***Research and Development***

Research and developmentcosts, including those associated with technology, licenses and patents, areexpensed as incurred. Research and development costs include costs primarilyrelated to ongoing clinical programs, manufacturing and materials inventorycosts for use in clinical trials, salaries, lab supplies and other fixedfacility costs used in the Company’s research and development efforts.

***Advertising Costs***

All advertising costs areexpensed as incurred. Advertising expenses were approximately $0.2 million in2003, $2.0 million in 2004, and $0.5 million in 2005.

F-10

----

**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**2. SignificantAccounting Policies (Continued)**

***Stock-Based Compensation***

The Company has elected to follow AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees* (“APB No. 25”) and relatedinterpretations, in accounting for its stock-based employee compensationplans using the intrinsic value method, rather than the alternative fair valueaccounting method provided for under SFAS No. 123, *Accounting for Stock-Based Compensation*(“SFAS No. 123”), as SFAS No. 123 requires the use of optionvaluation models that were not developed for use in valuing employee stockoptions. Under APB No. 25, when the exercise price of options granted toemployees under these plans equals the market price of the underlying stock onthe date of grant, no compensation expense is required. The Company alsofollows the provisions of SFAS No. 148, *Accountingfor Stock-Based Compensation-Transition and Disclosure, an amendment of FASBStatement No. 123*.

Hadcompensation expense for the Company’s stock option plans been determined basedon the fair value at the grant date for awards under these plans, consistentwith the methodology prescribed under SFAS No. 123, the Company’s net lossand net loss per share would have approximated the pro forma amounts indicatedbelow (in thousands, except per share data):

| ** **                                                                                                                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net loss, as  reported                                                                                                                                                      |       | $                                          | (55,798    | ) | $ | (57,598 | ) | $ | (61,183 | ) |
| Add: Stock  compensation cost as computed under APB No. 25, included in the  determination of net loss as reported.                                                    |       | 148                                        |       | 18 |   | — |   |
| Deduct:  Stock-based 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 |       | (7,387                                     | )          | (7,108 | ) | (5,313 | ) |
| Pro forma net  loss                                                                                                                                                         |       | $                                          | (63,037    | ) | $ | (64,688 | ) | $ | (66,496 | ) |
| Basic and diluted  net loss per common share, as reported.                                                                                                                  |       | $                                          | (5.38      | ) | $ | (5.51 | ) | $ | (5.83 | ) |
| Basic and diluted net  loss per common share, pro forma(1)                                                                                                                  |       | $                                          | (6.08      | ) | $ | (6.18 | ) | $ | (6.34 | ) |

----

(1)          Amounts for the yearsended December 31, 2003 and 2004 were originally reported as $(6.35) and$(6.60), respectively, and have been adjusted due to an error in thecalculation.

The pro-forma calculations set forth above reflectrecognition of compensation cost for the total fair value of option grants on astraight-line basis over the options’ vesting periods.

Thefair value of the stock options at the date of grant was estimated using theBlack-Scholes option pricing model with the following weighted averageassumptions:

| ** **               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Risk-free  interest rate |       |     | 4.0        | %        |       |     | 4.0        | % |   |   | 4.3 | % |   |
| Expected life  (years)   |       |     | 6          |     |       |     | 6          |   |   |   | 6 |   |   |
| Volatility               |       |     | 84         | %        |       |     | 82         | % |   |   | 80 | % |   |

 

The Company has neverdeclared or paid any cash dividends on any of its capital stock and does notexpect to do so in the foreseeable future.

F-11

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**2. SignificantAccounting Policies (Continued)**

***Accounting Pronouncements***

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123R, *Share-BasedPayment—An Amendment of FASB Statements No. 123 and 95* (“SFAS No. 123R”),which requires all companies to measure compensation cost for all share-basedpayments, including employee stock options, at fair value. SFAS No. 123Rwas originally effective for public companies for interim or annual periodsbeginning after June 15, 2005. In April 2005, the SEC amended thecompliance dates for SFAS No. 123R to allow companies to implement SFAS No. 123Rat the beginning of their first fiscal year beginning after June 15, 2005.As a result, the Company adopted SFAS No. 123R effective January 1,2006. The Company will use the modified prospective transition method, whichrequires that compensation cost be recognized for all awards granted, modifiedor settled after the effective date as well as for all awards granted toemployees prior to the effective date that remain unvested as of the effectivedate. Generally, the approach in SFAS No. 123R is similar to the approachdescribed in SFAS No. 123. However, SFAS No. 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative. The adoption of SFAS No. 123R may havea significant impact on the Company’s reported results of operations, althoughit will have no impact on the Company’s overall financial position. In March 2005,the SEC issued SAB No. 107, which expressed the views of the SECregarding the interaction between SFAS No. 123R and certain SEC rules andregulations. SAB No. 107 provides guidance related to the valuationof share-based payment arrangements for public companies, including assumptionssuch as expected volatility and expected term. The Company is evaluatingSFAS No. 123R and SAB No. 107 and has not yet determinedthe amount of stock option expense that will be incurred in future periods.

In December 2004, theFASB issued SFAS No. 151, *Inventory Costs*(“SFAS No. 151”). SFAS No. 151 requires abnormal amounts ofinventory costs related to idle facility, freight handling and wasted materialexpenses to be recognized as current period charges. Additionally, SFAS No. 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. Thestandard is effective for fiscal years beginning after June 15, 2005. TheCompany does not believe that the adoption of SFAS No. 151 will havea material impact on its consolidated financial statements.

***Comprehensive Loss***

SFAS No. 130,*Reporting Comprehensive Income*,establishes standards for the reporting and display of comprehensive loss andits components in the consolidated financial statements. The Company’saccumulated other comprehensive loss is comprised of net unrealized gains orlosses on available-for-sale securities. The Company’s comprehensive loss is asfollows:

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | **(in thousands)**                    | ** ** |
| Net loss                                                                          |       | $                                          | (55,798    | ) | $ | (57,598 | ) | $ | (61,183 | ) |
| Changes in  comprehensive loss: Net unrealized holding (loss) gain on investments |       | (130                                       | )          | (242 | ) | 79 |   |
| Total comprehensive loss                                                          |       | $                                          | (55,928    | ) | $ | (57,840 | ) | $ | (61,104 | ) |

 

F-12

----

**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**2.**   SignificantAccounting Policies (Continued)

***Net Loss Per Share***

Basic net loss per shareis based on the weighted average number of shares of Common Stock outstanding.For all years presented, diluted net loss per share of Common Stock is the sameas basic net loss per share of Common Stock as the inclusion of Common Stockequivalents, including the effect of stock options and warrants, would beantidilutive due to the Company’s net loss position for all periods presented.Diluted net loss per share of Common Stock excluded 1,672,094, 1,564,146 and1,681,629 Common Stock options for the years ended 2003, 2004 and 2005,respectively, as their impact would have been antidilutive.

**3.**   MarketableSecurities

TheCompany’s marketable securities, which are classified as available-for-sale,are as follows:

| ** **                           | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| ** **                           | ** ** | **(in thousands)**         | ** ** |
| U.S. government  agencies:           |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Estimated life of one to three years |       |                            | $          | 5,582 |   |   |   | $ | — |   |   |   | $ | (90 | ) |   |   | $ | 5,492 |   |   |
| Total marketable  securities         |       |                            | $          | 5,582 |   |   |   | $ | — |   |   |   | $ | (90 | ) |   |   | $ | 5,492 |   |   |

 

| ** **                           | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| ** **                           | ** ** | **(in thousands)**         | ** ** |
| U.S. government  agencies:           |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Estimated life of one year or less   |       |                            | $          | 9,974 |   |   |   | $ | — |   |   |   | $ | (32 | ) |   |   | $ | 9,942 |   |   |
| Estimated life of one to three years |       |                            | 13,081     |   |   |   | — |   |   |   | (123 | ) |   |   | 12,958 |   |   |
| U.S. auction rate debt  securities:  |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Estimated life of one to three years |       |                            | 40,902     |   |   |   | — |   |   |   | — |   |   |   | 40,902 |   |   |
| U.S. corporate  securities:          |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Estimated life of one year or less   |       |                            | 5,236      |   |   |   | — |   |   |   | (1 | ) |   |   | 5,235 |   |   |
| Estimated life of one to three years |       |                            | 3,147      |   |   |   | — |   |   |   | (13 | ) |   |   | 3,134 |   |   |
| Total marketable  securities         |       |                            | $          | 72,340 |   |   |   | $ | — |   |   |   | $ | (169 | ) |   |   | $ | 72,171 |   |   |

 

**4.**   Inventory

Inventory is stated at the lower of cost or marketwith cost determined under the first-in/first-out (“FIFO”) method. The Companywill write down any obsolete, excess or otherwise unmarketable inventory to itsestimated net realizable value, as necessary. If the net realizable value isdetermined to be less than that estimated by the Company, additional inventorywrite-downs may be required in future periods.

F-13

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**4. Inventory (Continued)**

The components ofinventory are as follows: 

| ** **            | ** ** | **December 31,**   | ** ** |
|-----------------------|------------|-------------------------|------------|
| ** **            | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **            | ** ** | **(in thousands)** | ** ** |
| Raw materials         |       | $                       | 1,644      |   | $ | — |   |
| Work-in-process       |       | 2,442                   |       | 1,532 |   |
| Finished goods        |       | 143                     |       | 154 |   |
| Total inventory       |       | 4,229                   |       | 1,686 |   |
| Less current  portion |       | (93                     | )          | (154 | ) |
| Long-term inventory   |       | $                       | 4,136      |   | $ | 1,532 |   |

 

Raw materials, work-in-process and finished goodsinventories consist of materials, labor and manufacturing overhead. The Companyclassifies any inventory that is estimated to be sold in the next twelve monthsas current inventory, with the remaining amount classified as long-terminventory. The current portion of inventory at December 31, 2005 wasapproximately $154,000. Much of the raw material used to produce Plenaxis(including the active pharmaceutical ingredient) was expensed as research anddevelopment costs prior to the FDA granting approval in November 2003 forthe commercial sale of Plenaxis in the United States.

In connection with theCompany’s strategic restructuring announced in May 2005, the Companydiscontinued promotional activities related to Plenaxis and the sale ofPlenaxis for new patients in the United States. As a result, the Company wrotedown approximately $3.5 million of inventory during 2005 that it estimated tobe in excess of its expected requirements. This amount is classified in cost ofgoods sold in the consolidated statement of operations for the year ended December 31,2005. The remaining inventory balance of approximately $1.7 million at December 31,2005 consists of materials that are expected to be used in connection with thecommercialization of Plenaxis by a third party in Europe and other territoriesfollowing a license or sale transaction relating to the product. In September 2005,the Company received marketing authorization for Plenaxis in Germany. TheCompany is actively pursuing, with the assistance of an investment bankingfirm, the disposition of its Plenaxis assets through a license or saletransaction, and such a possible transaction is currently being evaluated by severalinterested parties.

**5.**   Duefrom Officer

In May 2002, theCompany extended a $1.0 million loan to an officer in connection with theofficer’s acceptance of employment with the Company. Under the terms of thepromissory note (the “Note”) executed in connection with the loan, 10% of theoriginal loan principal was forgiven annually on each anniversary date of theNote, provided that the officer remained an employee of the Company. In September 2004,the officer left the Company and paid $0.8 million to the Company, representingthe remaining balance due under the Note.

F-14

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**6.**   Propertyand Equipment

Propertyand equipment consist of the following:

| ** **                                 | ** ** | **December 31,**   | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in thousands)** | ** ** |
| Building                                   |       | $                       | 56,675     |   | $ | — |   |
| Land                                       |       | 10,500                  |       | — |   |
| Laboratory,  computer and office equipment |       | 16,808                  |       | 15,252 |   |
| Construction in  progress                  |       | 768                     |       | 1,923 |   |
|                                       |       | 84,751                  |       | 17,175 |   |
| Less: accumulated  depreciation            |       | 20,213                  |       | 13,616 |   |
|                                       |       | $                       | 64,538     |   | $ | 3,559 |   |

 

In connection with theCompany’s strategic restructuring announced in May 2005, the Companyperformed an assessment and determined that its approximately 180,000 squarefoot corporate headquarters and research facility (the “Facility”) was impaired.As a result, during 2005, the Company recorded a non-cash impairment charge ofapproximately $19.7 million. As described in Note 13, the Company sold theFacility in October 2005 and executed a lease for approximately 65,000square feet of space within the Facility.

**7.**   AccruedExpenses

Accruedexpenses consist of the following:

| ** **             | ** ** | **December 31,**   | ** ** |
|------------------------|------------|-------------------------|------------|
| ** **             | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **             | ** ** | **(in thousands)** | ** ** |
| Clinical trial costs   |       | $                       | 1,913      |   | $ | 701 |   |
| Accrued  compensation  |       | 1,831                   |       | 1,222 |   |
| Unvouchered  invoices  |       | 144                     |       | 559 |   |
| Professional  services |       | 671                     |       | 519 |   |
| Other                  |       | 1,526                   |       | 372 |   |
|                   |       | $                       | 6,085      |   | $ | 3,373 |   |

 

**8.**   Restructuring

On May 19, 2005, the Company’s Board of Directorsapproved a strategic restructuring to focus the Company’s resources on its mostpromising assets and programs and significantly reduce its cost structure. Thestrategic restructuring included voluntarily discontinuing promotionalactivities related to Plenaxis and the sale of Plenaxis for new patients in theUnited States; voluntarily suspending the ongoing clinical development of Apan,the Company’s drug candidate for Alzheimer’s disease; and implementing areduction of the Company’s 182-person headcount by approximately 60%.

During the year ended December 31, 2005, theCompany recorded approximately $28.7 million of restructuring and assetimpairment expenses under SFAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*(“SFASNo. 146”)*.*The Company also recorded anon-cash impairment charge in cost of goods sold of approximately $3.5 millionrelated to inventory due to the discontinuation of promotional activitiesrelating to Plenaxis and the sale of Plenaxis for new patients in the UnitedStates. Included in restructuring and asset impairment expenses are cashcharges of approximately $2.6 million for 

F-15

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**8. Restructuring (Continued)**

employee severance,benefits and related costs, approximately $0.2 million associated with thetermination of various contracts and approximately $0.2 million of otherassociated costs. In addition, a non-cash charge of approximately $19.7 millionwas recorded under SFAS No. 144 relating to the impairment of the Facility.The Company also determined that its commitments under certain existingPlenaxis manufacturing and supply agreements with third parties exceeded theCompany’s estimated future Plenaxis requirements by approximately $7.2 million.During 2005, the Company recorded a charge of approximately $6.0 million whichrepresents the net present value of such excess future commitments. Under SFAS No. 146,the Company is required to expense the remaining $1.2 million of these excesscommitments over the remaining term of the applicable manufacturing and supplyagreements, which currently range from two to five years.

**Thefollowing table sets forth the components of the Company’s restructuring andasset impairment expenses for the year ended December 31, 2005 (inthousands):**

| ** **                                       | ** ** | **Original  Charges** | ** ** | **Non-Cash  Write-off** | ** ** | **Amounts  Paid  Through  December 31,  2005** | ** ** | **Amounts  Accrued  as of  December 31,  2005** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Employee  severance, benefits and related costs  |       | $                     | 2,555      |                    |       | $                                                   | —     |                                                      |       |   | $ | 2,437 |   |   |   | $ | 118 |   |   |
| Contract  termination costs                      |       | 168                   |       |                    | —     |                                                |       |                                                      | 168        |   |   |   | — |   |   |
| Other costs                                      |       | 247                   |       |                    | —     |                                                |       |                                                      | 197        |   |   |   | 50 |   |   |
| Impairment on  building                          |       | 19,676                |       |                    | 19,676     |                                                |       |                                                      | —     |   |   |   | — |   |   |
| Manufacturing  commitments restructuring expense |       | 6,034                 |       |                    | —     |                                                |       |                                                      | 760        |   |   |   | 5,274 |   |   |
| Total restructuring and asset impairment         |       | 28,680                |       |                    | 19,676     |                                                |       |                                                      | 3,562      |   |   |   | 5,442 |   |   |
| Impairment on inventory                          |       | 3,493                 |       |                    | 3,493      |                                                |       |                                                      | —     |   |   |   | — |   |   |
| Total                                            |       | $                     | 32,173     |                    |       | $                                                   | 23,169     |                                                      |       |   | $ | 3,562 |   |   |   | $ | 5,442 |   |   |
| Less current  portion                            |       |                  |       |                    |       |                                                |       |                                                      |       |   |   |   | (3,608 | ) |   |
| Long-term restructuring  accrual                 |       |                  |       |                    |       |                                                |       |                                                      |       |   |   |   | $ | 1,834 |   |   |

 

**9.**   Stockholders’Equity

***Convertible Preferred Stock***

Under the Company’samended and restated certificate of incorporation, as amended, the Company isauthorized to issue 200,000,000 shares of Common Stock and 10,000,000 shares ofpreferred stock, par value $.01 per share (“Preferred Stock”). The PreferredStock is issuable in one or more classes or series, each of such classes orseries to have such rights and preferences, including voting rights, dividendrights, conversion rights, redemption privileges and liquidation preferences,as may be determined by the Board of Directors. No shares of Preferred Stockhave been issued.

***Rights Plan***

In January 2001, theCompany adopted a Rights Agreement (the “Rights Agreement”), commonly known asa “poison pill.” Under the Rights Agreement, the Company distributed certainrights to acquire shares of the Company’s Series A junior participatingpreferred stock (the “Rights”) as a dividend at the rate of one Right for eachoutstanding share of Common Stock held of record as of February 5, 2001.As a result of the 1-for-5 reverse stock split of the Common Stockwhich became effective at 5:00 p.m. Eastern Standard Time on November 1,2005 (the “Reverse Stock Split Effective Time”), the number of Rights 

F-16

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**9. Stockholders’ Equity (Continued)**

associatedwith each share of Common Stock was automatically proportionally adjusted sothat, at the Reverse Stock Split Effective Time, five (5) Rights were thenassociated with each share of Common Stock then outstanding. Each share ofCommon Stock issued after the February 5, 2001 record date and before theReverse Stock Split Effective Time had an attached Right, and so long as theRights are attached to the Common Stock and as a result of 1-for-5reverse stock split, from and after the Reverse Stock Split Effective Time,five (5) Rights (subject to further adjustment pursuant to the provisionsof the Rights Agreement) shall be deemed to be delivered for and attached toeach share of Common Stock issued by the Company. Under certain conditionsinvolving an acquisition by any person or group of 10% or more of the CommonStock, each Right permits the holder (other than the 10% holder) to purchaseCommon Stock having a value equal to twice the exercise price of the Right,upon payment of the exercise price of the Right. In addition, in the event ofcertain business combinations after an acquisition by a person or group of 10%or more of the Common Stock, each Right entitles the holder (other than the 10%holder) to receive, upon payment of the exercise price, Common Stock having avalue equal to twice the exercise price of the Right. The Rights have no votingprivileges and, unless and until they become exercisable, are attached to, andautomatically trade with, the Common Stock. The Rights will terminate upon theearlier of the date of their redemption or ten years from the date of issuance.

***Employee Stock Purchase Plan***

Under the Company’s SecondAmended and Restated Employee Stock Purchase Plan (the “ESPP”), eligibleemployees may purchase shares of Common Stock at a price per share equal to 85%of the lower of the fair market value per share of Common Stock at thebeginning or the end of each six-month period during the term of the ESPP. Participationis limited to the lesser of 10% of the employee’s compensation or $25,000 inany calendar year. In May 2005, the Company’s Board of Directors approvedan amendment and restatement of the ESPP to extend its term through June 25,2007 and provide for withdrawal from the ESPP by employees during a six-monthexercise period. During 2003, 2004 and 2005, the Company issued 11,173, 7,414and 18,361 shares of Common Stock, respectively, under the ESPP.

***Stock Option Plan***

The Company’s Third Amended and Restated 1995 StockPlan (the “Plan”) allows for the granting of incentive and nonqualified optionsand awards to purchase shares of Common Stock. Historically, incentive optionsgranted to employees under the Plan generally vested over a five-year period,with 20% vesting on the first anniversary of the date of grant and theremainder vesting in equal monthly installments thereafter. During 2005, theCompany began granting options to employees which vest over a four-year period,with 25% vesting on the first anniversary of the date of grant and theremainder vesting in equal monthly installments thereafter. Nonqualifiedoptions issued to non-employee directors and consultants under the Plangenerally vest during their period of service with the Company. Options grantedunder the Plan have a maximum term of ten years from the date of grant. At December 31,2005, a total of 3,175,000 shares of Common Stock were approved for issuanceunder the Plan.

F-17

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**9. Stockholders’ Equity (Continued)**

Information regardingoptions under the Plan is summarized below (in thousands, except price pershare data):

| ** **                                | ** ** | **2003**   | ** ** | **2004**                               | ** ** | **2005**   | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                                | ** ** | **Number** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Options  outstanding at January 1,   |       |       | 1,412      |                                   |       |       | $          | 39.10 |   |   |   | 1,671 |   |   |   | $ | 36.65 |   |   |   | 1,564 |   |   |   | $ | 33.43 |   |   |
| Granted                                   |       |       | 319        |                                   |       |       | 25.75      |   |   |   | 409 |   |   |   | 16.20 |   |   |   | 469 |   |   |   | 3.91 |   |   |
| Exercised                                 |       |       | (31        | )                                      |       |       | 11.95      |   |   |   | (66 | ) |   |   | 3.35 |   |   |   | — |   |   |   | — |   |   |
| Cancelled                                 |       |       | (29        | )                                      |       |       | 45.70      |   |   |   | (450 | ) |   |   | 34.15 |   |   |   | (351 | ) |   |   | 26.62 |   |   |
| Options  outstanding at December 31, |       |       | 1,671      |                                   |       |       | $          | 36.65 |   |   |   | 1,564 |   |   |   | $ | 33.45 |   |   |   | 1,682 |   |   |   | 26.62 |   |   |
| Options  exercisable at December 31, |       |       | 926        |                                   |       |       | $          | 34.10 |   |   |   | 913 |   |   |   | $ | 35.80 |   |   |   | 996 |   |   |   | $ | 34.43 |   |   |

 

The weighted average per share fair value of optionsgranted was $18.52 in 2003, $11.91 in 2004, and $2.67 in 2005. At December 31,2005, there were 2,226,119 shares of Common Stock reserved for the exercise ofstock options and for issuances under the ESPP, including 521,454 and23,332 shares underlying options available for future grant under the Planand the ESPP, respectively.

Thefollowing table presents weighted average exercise price and weighted averageremaining contractual life information about significant option groupsoutstanding at December 31, 2005 (option amounts in thousands):

| ** **              | ** ** | **Outstanding as of  December 31, 2005** | ** ** | **Exercisable as of  December 31, 2005** | ** ** |
|-------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Exercise Price** | ** ** | ** **                                                   | ** ** | **Number**                                                   | ** ** | **Weighted-  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $1.33–$4.08        |       |                                                         | 518        |                                                         |       |   | 7.2 |   |   |   | $ | 2.89 |   |   |   | 128 |   |   |   | $ | 1.37 |   |   |
| $7.30–$11.10       |       |                                                         | 217        |                                                         |       |   | 7.4 |   |   |   | $ | 9.21 |   |   |   | 97 |   |   |   | $ | 9.05 |   |   |
| $12.25–$18.55      |       |                                                         | 360        |                                                         |       |   | 5.4 |   |   |   | $ | 16.32 |   |   |   | 291 |   |   |   | $ | 16.45 |   |   |
| $20.00–$29.90      |       |                                                         | 92         |                                                         |       |   | 4.4 |   |   |   | $ | 23.78 |   |   |   | 71 |   |   |   | $ | 23.39 |   |   |
| $31.87–$35.00      |       |                                                         | 264        |                                                         |       |   | 4.9 |   |   |   | $ | 32.64 |   |   |   | 222 |   |   |   | $ | 32.60 |   |   |
| $52.24–$81.25      |       |                                                         | 79         |                                                         |       |   | 5.1 |   |   |   | $ | 61.75 |   |   |   | 72 |   |   |   | $ | 62.24 |   |   |
| $115.62–$210.00    |       |                                                         | 152        |                                                         |       |   | 4.9 |   |   |   | $ | 129.83 |   |   |   | 115 |   |   |   | $ | 130.84 |   |   |
| $1.33–$210.00      |       |                                                         | 1,682      |                                                         |       |   | 6.0 |   |   |   | $ | 26.62 |   |   |   | 996 |   |   |   | $ | 34.43 |   |   |
|                         |            |                                                              |            |                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

F-18

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**10. Income Taxes**

The Company has reported no income tax provision orbenefit in 2003, 2004 or 2005 due to the significant net operating losses inthese years as well as limitations on the recognition of deferred tax assetsfor financial reporting purposes.

Areconciliation of the Company’s income tax provision to the statutory federalprovision is as follows:

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(in thousands)**                    | ** ** |
| Statutory federal income tax benefit |       | $                                          | (18,971    | ) | $ | (19,583 | ) | $ | (20,802 | ) |
| Increase in  valuation allowance     |       | 18,921                                     |       | 19,435 |   | 20,709 |   |
| Other                                |       | 50                                         |       | 148 |   | 93 |   |
| Income tax provision                 |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

Significantcomponents of the Company’s deferred tax assets are as follows:

| ** **                           | ** ** | **December 31,**   | ** ** |
|--------------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(in thousands)** | ** ** |
| Deferred tax assets:                 |       |                    |       |   |   |
| Net operating losses                 |       | $                       | 91,961     |   | $ | 109,009 |   |
| Deferred revenue                     |       | 761                     |       | — |   |
| Property and equipment               |       | 10,321                  |       | 14,421 |   |
| Accrued expenses                     |       | 286                     |       | 2,414 |   |
| Research and development tax credits |       | 7,259                   |       | 7,535 |   |
| Other                                |       | 111                     |       | 114 |   |
| Total deferred  tax assets           |       | 110,699                 |       | 133,493 |   |
| Valuation  allowance                 |       | (110,699                | )          | (133,493 | ) |
|                                 |       | $                       | —     |   | $ | — |   |

 

At December 31, 2004 and 2005, the Company hasprovided a valuation allowance for the value of the deferred tax assets. Thevaluation allowance increased by approximately $24.2 million in 2004 andapproximately $22.8 million in 2005 due primarily to the increase in netoperating losses and tax credit carryforwards. The Company has federal netoperating loss carryforwards in the amount of approximately $273.5 million,which expire through 2025. Due to anticipated operating losses in the future,the Company believes that it is more likely than not that it will not realizethe net deferred tax assets in the future and has provided an appropriatevaluation allowance.

Anysubsequent recognized tax benefits relating to a reduction in the valuationallowance for deferred tax assets as of December 31, 2005 would beallocated as follows (in thousands):

| Reported in the  statement of operations. |   | $     | 128,804 |   |
|-------------------------------------------|--------|-------|---------|--------|
| Reported in  additional paid-in capital   |   | 4,689 |    |
|                                      |   | $     | 133,493 |   |

 

F-19

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**11. CorporateCollaborations**

***Schering AG Agreement***

In April 2004, the Company entered into the ScheringAG Agreement, whereby the Company granted exclusive rights to Schering AG tocommercialize Plenaxis in the field of prostate cancer in Europe, Russia, theMiddle East, South Africa, Australia and New Zealand. On September 27,2005, the Company received marketing authorization for Plenaxis in Germany. On September 28,2005, the Company received written notice from Schering AG that it wasexercising its right to terminate the Schering AG Agreement due to the Companynot having received marketing authorization for Plenaxis in Germany with arequisite label by June 30, 2005. Under the Schering AG Agreement, as aresult of the termination, all of Schering AG’s rights and licenses withrespect to Plenaxis have ceased.

The Schering AG Agreementprovided for a combination of upfront, regulatory approval andperformance-based milestone payments, as well as a share of revenue throughtransfer price payments. The Company received a $2.0 million signing paymentfrom Schering AG in 2004, which the Company was recognizing as revenue ratably overa period through 2016 based on the remaining patent life of Plenaxis in Europe.Due to the termination of the Schering AG Agreement in September 2005, theCompany recognized approximately $1.9 million in revenues for the year ended December 31,2005, representing the remaining deferred revenue from the $2.0 million signingpayment. In October 2005, in connection with the termination of theSchering AG Agreement, the parties entered into a settlement agreement wherebySchering AG paid the Company $4.0 million, representing full and completesatisfaction of Schering AG’s obligations under the Schering AG Agreementarising prior to its termination. The Company recognized the $4.0 millionpayment as license revenues during the fourth quarter of 2005. The settlementagreement also included mutual releases of any and all claims under or relatingto the Schering AG Agreement.

**12. MortgageFinancing**

In July 2000, in connection with the purchase ofthe Facility, the Company entered into an acquisition and construction loanagreement providing for up to $33.0 million in financing for the acquisitionof, and improvements to, the Facility. In June 2004, the acquisition andconstruction loan agreement was amended (the “Amended Loan Agreement”) to extendthe maturity date of the loan and modify certain other terms of the originalagreement. The interest rate was fixed at 5.95% through April 2009 and ata floating rate for the remainder of the term. Principal and interest werepayable through a fixed monthly payment of approximately $207,000, with theprincipal portion being calculated using a 25-year amortization schedule.

In October 2005, theCompany completed the sale of its Facility to an independent third party. Inconnection with the sale of the Facility, the Company retired the outstandingloan under the Amended Loan Agreement by paying the remaining principal balanceof approximately $32.0 million and terminated the mortgage on the Facility. Interestpaid under the Amended Loan Agreement approximated interest expense in 2003,2004 and 2005.

**13.** Sale of Facility andPartial Leaseback

In connection with the Company’s strategicrestructuring in May 2005, the Company recorded a non-cash impairmentcharge of approximately $19.7 million related to the Facility as part ofrestructuring and asset impairment expenses under SFAS No. 144. In July 2005,the Company determined that the “held-for-sale” criteria had been met underSFAS No. 144 and accordingly, the Facility was no longer depreciated. Asset forth in Note 12 above, in October 2005 the Company sold the Facilityfor gross proceeds of $51.25 million and realized proceeds, net of feesand expenses, of approximately $50.4 million. The 

F-20

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**13.  Sale of Facility and Partial Leaseback(Continued)**

Company used a portion ofthe proceeds from the sale to retire the loan under the Amended Loan Agreementof approximately $31.6 million and terminate the mortgage on the Facility.

In connection with the sale of the Facility, theCompany executed a lease (the “Lease Agreement”) for approximately 65,000 squarefeet of office and laboratory space in the Facility for an initial term of fiveyears at an initial annual rent of approximately $2.1 million, subject toan increase in years three through five of the initial term. Under the LeaseAgreement, the Company is required to pay all real estate taxes and otheroperating expenses for the leased premises and has options to extend the leasefor up to three additional five-year terms.

In connection with the Lease Agreement, the Company isrequired to maintain, on behalf of the landlord, an irrevocable letter ofcredit with a bank in the amount of $710,000 during the first three years ofthe lease term and $382,000 for the remainder of the lease term. This letter ofcredit is guaranteed by a restricted cash deposit held by the bank as securityfor the letter of credit.

In connection with the sale of the Facility, theCompany realized a total gain of approximately $10.5 million representingthe difference between the purchase price, net of broker commissions andclosing costs, and the net book value of the Facility. The difference betweenthe total gain on the sale of the Facility and the net present value of thefuture minimum lease payments under the Lease Agreement is approximately $1.4 million,which the Company recognized as a gain during 2005, while the remaining amountof the gain of approximately $9.1 million will be recorded as a reduction ofrent expense over the initial term of the Lease Agreement. The amortization ofthe deferred gain will be approximately $1.8 million in each of the yearsended December 31, 2006 through December 31, 2009, and approximately$1.5 million in the year ended December 31, 2010. Facility rentexpense, net of amortization of the deferred gain, from the inception of thelease through December 31, 2005, was approximately $0.2 million.

Theminimum rental commitments under the Lease Agreement are as follows (inthousands):

| 2006                          |   | $     | 2,128  |   |
|-------------------------------|--------|-------|--------|--------|
| 2007                          |   | 2,155 |   |
| 2008                          |   | 2,291 |   |
| 2009                          |   | 2,291 |   |
| 2010                          |   | 1,909 |   |
| Total minimum lease  payments |   | $     | 10,774 |   |

 

**14. Commitments andContingencies**

***Indiana University Foundation (“IUF”) LicenseAgreement***

The Company has a licenseagreement with IUF, which was assigned by IUF to IUF’s Advanced Research andTechnology Institute, Inc., with respect to rights to Plenaxis and certainrelated technology. Under the license agreement, the Company has agreed to pay (a) feesof $0.3 million, (b) up to an additional $4.3 million uponachievement of specific milestones and (c) a royalty percentage of netsales of licensed products. The Company made milestone payments of $1.0 millionin 2003, milestone and royalty payments of approximately $1.0 million in 2004and royalty payments of approximately $48,000 in 2005 under the IUF agreement. Theseamounts have been recorded as expenses during the periods amounts were paid. Asof December 31, 2005, $1.5 million in milestones remain subject to futureachievement.

F-21

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**14. Commitmentsand Contingencies (Continued)**

***Baxter Pharmaceutical Solutions LLC (“Baxter”)***

On December 4, 2002,the Company signed a five-year commercial supply agreement (the “BaxterAgreement”) with Baxter related to the fill and finish steps of themanufacturing process for Plenaxis. In January 2005, the first anniversaryof the first commercial shipment of Plenaxis, the minimum annual purchasecommitment increased to $650,000 through 2007. The Company made payments underthe Baxter Agreement of approximately $1.8 million, $1.0 million and $0.3million during 2003, 2004 and 2005, respectively.

***Cambrex Charles City, Inc. (“Cambrex”)***

In July 1998, theCompany entered into a seven-year supply agreement with Cambrex (formerlySalsbury Chemicals, Inc.) for the manufacture of the commercial depotformulation of Plenaxis. The Company retains all rights in manufacturingtechnology developed in connection with this agreement. In July 2004, thesupply agreement was amended. Under the amendment, the term of the originalagreement was extended for an additional five years (through July 2010)and the minimum annual purchase commitment through 2010 was increased to$900,000. The Company made payments to Cambrex of approximately $0.6 million,$1.1 million and $0.7 million during 2003, 2004 and 2005, respectively.

***UCB S.A. (“UCB”)***

In July 2000, the Company entered into adevelopment and supply agreement with UCB under which UCB supplies the Companywith commercial volumes of the active pharmaceutical ingredient, or API, forPlenaxis (the “UCB Agreement”). In connection with an amendment to the UCBAgreement executed in August 2004, the Company committed to purchase aspecified quantity of API for delivery in 2005, for an aggregate purchase priceof $3.9 million. In addition, theCompany committed to purchase additional raw materials used in the manufactureof API for an aggregate purchase price of approximately $3.4 million, to bepaid through specified annual commitments through 2009. UCB has granted theCompany the option, in lieu of purchasing the additional raw materials, topurchase each year quantities of API produced using such materials. The optioncan be exercised in whole or in part. Raw materials purchased in one year canbe utilized at a later date for the manufacture of API, and the Company will becredited the cost of such previously purchased materials. The minimum purchasecommitment for raw materials for 2006 is $600,000. The Company made payments under the UCB Agreement of approximately $4.3million, $1.1 million and $1.8 million during 2003, 2004 and 2005,respectively

In January 2006, the Company further amended itsexisting agreement with UCB. Under the amendment, UCB agreed to suspend certainin-process manufacturing and process development work in return for a paymentcovering the estimated value of the work carried out to date. As of December 31,2005, the full value of these manufacturing and process development activitiesunder the agreement was approximately $2.2 million. During 2005, the Companyincluded this amount as part of its accrued restructuring expense for theexcess future commitments related to this agreement. Pursuant to the amendment,in consideration for the suspension of these activities, UCB agreed to apartial payment of approximately $1.6 million. This payment was made uponsigning of the amendment in January 2006. The Company will reduce theexcess liability by approximately $0.6 million through a reduction torestructuring expense in the first quarter of 2006.

The UCB Agreement wasassigned to the Company by Amgen Inc. effective as of December 17, 2001. InFebruary 2006, Lonza Ltd. acquired UCB-Bioproducts, the manufacturingdivision of UCB, and assumed all of UCB’s rights and obligations under the UCBAgreement in connection with the acquisition.

F-22

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**PRAECIS PHARMACEUTICALS INCORPORATED Notes to Consolidated Financial Statements (Continued)**

**14. Commitmentsand Contingencies (Continued)**

***Litigation***

In December 2004 and January 2005, theCompany, Chairman and (now former) Chief Executive Officer Malcolm Gefter, Presidentand (now former) Chief Operating Officer Kevin F. McLaughlin, Chief FinancialOfficer and Treasurer Edward C. English, and former President and ChiefOperating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. On February 7, 2005, a motion wasfiled to consolidate the three actions and to appoint lead plaintiffs and leadcounsel. On February 18, 2005, the Company and the individual defendantsfiled a brief response to that motion, reserving their rights to challenge theadequacy and typicality, among other things, of the proposed lead plaintiffs inconnection with class certification proceedings, if any. On April 13, 2005,the Court entered an Order granting the plaintiffs’ motion to consolidate thethree actions (as well as each case that relates to the same subject matterthat may be subsequently filed in or transferred to the United States DistrictCourt for the District of Massachusetts), appoint lead plaintiffs and approvesuch plaintiffs’ selection of co-lead counsel.

On August 1,2005, lead plaintiffs filed a consolidated amended complaint. Lead plaintiffs generallyallege securities fraud during the period from November 25, 2003 through December 6,2004. The consolidated amended complaint purports to assert claims underSections 10(b) and 20(a) of the Securities and Exchange Act of 1934and Rule 10b-5 promulgated thereunder, and alleges that the Companyand the individually named defendants made materially false and misleadingpublic statements concerning the Company’s business and financial results,particularly relating to statements regarding the commercialization ofPlenaxis, thereby allegedly causing plaintiffs to purchase the Company’ssecurities at artificially inflated prices. At this time, plaintiffs have notspecified the amount of damages they are seeking in the actions. On September 12, 2005, the Company andthe individual defendants filed aMotion to Dismiss the consolidated amended complaint in its entirety. On October 24,2005, lead plaintiffs filed an Opposition to the Company’s Motion to Dismissand the defendants filed a reply on November 14, 2005. On January 17,2006, the Court heard oral argument on the Motion to Dismiss and took thematter under advisement.

The Company has not recorded an estimated liabilityassociated with the legal proceedings described above. Due to the uncertaintiesrelated to both the likelihood and the amount of any potential loss, theCompany is unable to make a reasonable estimate of the liability that couldresult from an unfavorable outcome. Management believes that the allegationsagainst the Company are without merit, and the Company intends to vigorouslydefend against the plaintiffs’ claims. However, if the Company is notsuccessful in defending these actions, its business and financial conditioncould be adversely affected.

F-23

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**Exhibit Index**

| Exhibit No. | ** ** | **Exhibit**  |
|------------------|------------|--------------|
|             | 3.1        |         |   | Amended and Restated Certificate of Incorporation  (2) |
|             | 3.2        |         |   | Certificate of Amendment (effecting reverse stock  split) (14) |
|             | 3.3        |         |   | Third Amended and Restated By-Laws (7) |
|             | 4.1        |         |   | Specimen certificate representing shares of common  stock (post-reverse stock split) (14) |
|             | 4.2        |         |   | Rights Agreement between PRAECIS and American Stock  Transfer & Trust Company, as Rights Agent (3) |
|             | 4.3        |         |   | Form of Certificate of Designations of  Series A Junior Participating Preferred Stock (attached as  Exhibit A to the Rights Agreement filed as Exhibit 4.2) (3) |
|             | 4.4        |         |   | Form of Rights Certificate (attached as  Exhibit B to the Rights Agreement filed as Exhibit 4.2) (3) |
|             | 10.1       | *            |   | Third Amended and Restated 1995 Stock Plan (9) |
|             | 10.2       | *            |   | Form of Incentive Stock Option Agreement (12) |
|             | 10.3       | *            |   | Form of Non-Qualified Stock Option Agreement  (12) |
|             | 10.4       | *            |   | Executive Management Bonus Plan, as amended and  restated as of September 12, 2002 (6) |
|             | 10.5       | *            |   | Second Amended and Restated Employee Stock Purchase  Plan (13) |
|             | 10.6       | *            |   | Management Incentive Program (7) |
|             | 10.7       | *            |   | Letter Agreement dated as of May 9, 2002  between PRAECIS and Malcolm L. Gefter, Ph.D. (5) |
|             | 10.8       | *            |   | Letter Agreement dated as of May 9, 2002  between PRAECIS and Kevin F. McLaughlin (5) |
|             | 10.9       | *            |   | Letter Agreement dated as of May 9, 2002  between PRAECIS and Marc B. Garnick, M.D. (5) |
|             | 10.10      | *            |   | Letter Agreement dated as of September 16, 2004  between PRAECIS and Edward C. English (11) |
|             | 10.11      | *            |   | Letter Agreement dated as of September 16, 2004  between PRAECIS and Richard W. Wagner, Ph.D. (11) |
|             | 10.12      | *            |   | Summary of Executive Officer, Non-Executive Chairman  and Non-Employee Director Compensation Arrangements for 2006 |
|             | 10.13      | †       |   | License Agreement effective as of October 17,  1996 by and between PRAECIS and Indiana University Foundation, as amended as  of June 3, 1998 (1) |
|             | 10.14      | †       |   | Supply Agreement dated as of July 23, 1998 by  and between PRAECIS and Salsbury Chemicals, Inc. (1) |
|             | 10.15      | †       |   | Amendment No. 2 dated as of July 1, 2004  by and between PRAECIS and Cambrex Charles City, Inc. (formerly Salsbury  Chemicals, Inc.) to the Supply Agreement dated as of July 23, 1998  by and between PRAECIS and Salsbury Chemicals, Inc., as amended (10) |
|             | 10.16      | †       |   | Development and Supply Agreement effective as of  June 21, 2000 by and between UCB S.A. and Amgen Inc., as amended by  Amendment No. 1 thereto dated as of March 26, 2002 (together with  the Assignment of Development and Supply Agreement entered into  January 18, 2002 and effective as of December 17, 2001 by and  between Amgen Inc. and PRAECIS) (4) |
|             | 10.17      | †       |   | Amendment No. 2 dated as of August 30,  2004 to the Development and Supply Agreement effective as of June 21,  2000 by and between PRAECIS and UCB S.A. (12) |
|             | 10.18      | †† |   | Letter Agreement dated as of January 6, 2006 by  and between PRAECIS and UCB S.A. |
|             | 10.19      | †       |   | Commercial Supply Agreement dated December 4,  2002 and effective as of June 1, 2002 by and between Baxter  Pharmaceutical Solutions LLC and PRAECIS (7) |
|             | 10.20      |         |   | Settlement Agreement and Release dated as  October 19, 2005 by and between the PRAECIS and Schering AG |
|             | 10.21      |         |   | Real Estate Purchase Agreement dated as of  October 11, 2005 between 830 Winter Street LLC and Intercontinental Real  Estate Investment Fund III, LLC (14) |
|             | 10.22      |         |   | Lease by and between Intercontinental Fund III 830  Winter Street LLC and PRAECIS dated October 18, 2005 (14) |
|             | 21.1       |         |   | List of Subsidiaries of PRAECIS (8) |
|             | 23.1       |         |   | Consent of Ernst & Young LLP, Independent  Registered Public Accounting Firm |

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|        | 24.1 |   |   | Power of Attorney (included on the signature  page of this Report on Form 10-K)                                                                     |
|--------|------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 31.1 |   |   | Certification of Chief Executive Officer                                                                                                                      |
|   | 31.2 |   |   | Certification of Chief Financial Officer                                                                                                                      |
|   | 32.1 |   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|   | 32.2 |   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

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*                    Represents amanagement contract or compensatory plan or arrangement.

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

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

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

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

(3)          Incorporated byreference to Registration Statement on Form 8-A filed with theSecurities and Exchange Commission on January 26, 2001.

(4)          Incorporated byreference to Annual Report on Form 10-K for the year ended December 31,2001 filed with the Securities and Exchange Commission on April 1, 2002.

(5)          Incorporated byreference to Quarterly Report on Form 10-Q for the quarter ended June 30,2002 filed with the Securities and Exchange Commission on August 12, 2002.

(6)          Incorporated byreference to Quarterly Report on Form 10-Q for the quarter ended September 30,2002 filed with the Securities and Exchange Commission on November 14,2002.

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

(8)          Incorporated byreference to Annual Report on Form 10-K for the year ended December 31,2003 filed with the Securities and Exchange Commission on March 15, 2004.

(9)          Incorporated byreference to Registration Statement on Form S-8 (Registration No. 333-116188)filed with the Securities and Exchange Commission on June 4, 2004.

(10)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended June 30,2004 filed with the Securities and Exchange Commission on August 9, 2004.

(11)   Incorporated by reference toCurrent Report on Form 8-K filed with the Securities and ExchangeCommission on September 21, 2004.

(12)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended September 30,2004 filed with the Securities and Exchange Commission on November 9,2004.

(13)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended June 30,2005 filed with the Securities and Exchange Commission on August 5, 2005.

(14)   Incorporated by reference toQuarterly Report on Form 10-Q for the quarter ended September 30,2005 filed with the Securities and Exchange Commission on November 4,2005.

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