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United States
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-K

CYPRESS BIOSCIENCE, INC.
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (858) 452-2323

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:  NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock $.02 Par Value
(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

The aggregate market value of the voting stock held by nonaffiliates of the Registrant as of June 28, 2002 was $13,626,777*

The number of shares outstanding of the Registrant’s common stock as of March 14, 2003 was 13,197,226.

DOCUMENTS INCORPORATED BY REFERENCE:  None

* Calculated based on 6,988,091 shares of common stock held as of June 28, 2002 by non-affiliates and a per share market price of $1.95.  Excludes 6,193,796 shares of common stock held by directors and executive officers and stockholders whose ownership exceeds five percent of the common stock outstanding at June 28, 2002.  Exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant or that such person is controlled by or under common control with the Registrant.

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CYPRESS BIOSCIENCE, INC.
FORM 10-K
INDEX

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PART I

Item 1.  Business

          Except for the historical information contained herein, the information contained herein contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act of 1934, as amended, including, in particular, statements about our plans, strategies and prospects.  These statements, which may include words such as “may,” “will,” “expect,” “believe,” “intend,” “plan,” “anticipate,” “estimate,” or similar words, are based on our current beliefs, expectations and assumptions and are subject to a number of risks and uncertainties.  Although we believe that our beliefs, expectations and assumptions reflected in these statements are reasonable, our actual results and financial performance may prove to be very different from what we might have predicted on the date of this Form 10-K.  Factors that could cause or contribute to differences include, but are not specifically limited to, our ability to develop milnacipran, our ability to develop or acquire any compounds or products to treat FMS or any other indications we may pursue in a timely manner, or at all, as well as the other risks detailed in this Form 10-K and in our other SEC filings.

Company Overview

          We are committed to being the innovator and commercial leader in providing products for the diagnosis and treatment of patients with Functional Somatic Syndromes, such as Fibromyalgia Syndrome, or FMS, and other related chronic pain and central nervous system disorders.  Our goal is to be the first to market a product approved in the United Stated for the treatment of FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes.  Our business strategy is focused on combining novel technology and clinical development of well-characterized drugs that we believe offer strong potential to help patients with Functional Somatic Syndromes.

          Our near-term marketing strategy focuses on building valuable relationships with FMS patients and physicians with large FMS practices.  Through the use of our physician and patient registries, as well as our FMS website at www.FMSresource.com, we are attempting to gain important market information, enhance participation in our future clinical trials for milnacipran and build relationships with potential customers. 

          We licensed our first clinical candidate for the treatment of FMS, milnacipran, in August of 2001 from Pierre Fabre Médicament, or Pierre Fabre, of Paris, France.  We have in the past evaluated various possible strategic transactions, including seeking a partner to assist us in the development and commercialization of milnacipran, potential acquisitions of products, technologies and companies, private and public financings and other alternatives that we believe may enhance stockholder value.  We expect to continue to do so in the future.

Fibromyalgia Syndrome

          FMS is a chronic and debilitating condition characterized by widespread pain and stiffness throughout the body, accompanied by severe fatigue, headache and insomnia.  Most FMS patients begin to experience symptoms in their 20s and 30s that worsen throughout their lives.  Although FMS has been medically recognized for many years, it was only in 1990 that medical specialists agreed on the signs and symptoms that must be present to make the diagnosis.  Specialists in the field of FMS have concluded that FMS is a generalized and heightened perception of sensory stimuli resulting from abnormal pain processing within the central nervous system, and in most instances, is triggered by physical trauma, emotional stress or infection.

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          Status of Milnacipran Trial

          We licensed our first clinical candidate for the treatment of FMS, milnacipran, from Pierre Fabre in August of 2001.  We completed a Phase II trial clinical trial to evaluate milnacipran in the treatment of FMS in the first quarter of 2003, and we are in the process of completing a report to present the final results of the trial to the Food and Drug Administration, or the FDA.  Milnacipran, the first of a new class of agents known as NSRI’s, or Norepinephrine Serotonin Reuptake Inhibitors, shares a pharmacological profile with the tricyclic antidepressants (TCAs).  Recent published studies have indicated that these TCAs are considered the most effective drugs for treatment of FMS.  However, their usage is limited by side effects.  While milnacipran shares a pharmacologic profile with TCAs, it appears to lack the side effects associated with the latter.

          In our Phase II clinical trial, milnacipran was shown to provide statistically significant improvement in pain, the primary symptom of FMS.  Seventy percent of all milnacipran-treated patients reported overall improvement in pain compared to thirty six percent in the placebo group.  Further, thirty seven percent of milnacipran-treated patients randomized to the twice a day dosing group reported at least a fifty percent reduction in pain intensity compared to fourteen percent of patients in the placebo group.  Additionally, milnacipran-treated patients showed improvements in fatigue and depressed mood on multiple outcome measures.

          Market Opportunity

          FMS affects an estimated 2%-4% of the population worldwide and is the second most common diagnosis by rheumatologists in the United States, after osteoarthritis.  Despite the high prevalence and severity of this syndrome, there are no approved treatments specifically for FMS in the United States or elsewhere.

The PROSORBA Column

          In January 2001, Fresenius purchased most of our assets related to the PROSORBA column and assumed various related liabilities.  In February 2002, we amended certain provisions of our license and distribution agreement with Fresenius.  Under the terms of the amendment, the initial $8 million we payment received in January 2001 was made non-refundable under any circumstances.  The amendment also eliminated the payment from Fresenius to us of royalties on column sales in excess of 10,000 in any of the first five years of the agreement and eliminated all royalties on sales beyond five years.  A contingent payment is due to us in the amount of $1 million if sales during the first seven years exceed 35,000 units, $2 million if they exceed 50,000 units and none if the sales are less than 35,000 units.  Such payment, if any, will be due on June 30, 2008 and is nonrefundable

Cyplex™ , a Platelet Alternative

          We own the rights to Cyplex, an alternative to traditional platelet transfusions.  No further product development activities will be conducted for the Cyplex platelet alternative product.

Licenses and Collaborations

          On August 1, 2001, we entered into a license agreement and a trademark agreement with Pierre Fabre.  The license agreement was amended and restated on November 13, 2001.  The license agreement provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for the treatment of FMS and related chronic pain syndromes in the United States and Canada.  We also have an option to include other indications in these markets.  We paid Pierre Fabre

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upfront payments of $1.5 million and additional payments to Pierre Fabre of up to a total of $5.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones.  If the product is commercialized, Pierre Fabre will manufacture the active ingredients used in the commercial product, and we will pay Pierre Fabre a transfer price and royalties based on net sales.  Pierre Fabre retains the right to sell products developed by us for FMS and related chronic pain syndromes outside the United States and Canada and will pay us a royalty based on net sales for such rights. 

          In August 2002, we entered into a Reformulation and New Product Agreement with Collegium Pharmaceutical, Inc. pursuant to which Collegium will attempt to develop reformulations of milnacipran and new products that are analogs of milnacipran.  We received an option to acquire an exclusive license to technology developed under this agreement for a specified time period.  We paid Collegium an upfront fee and a project management fee.  In addition, we agreed to reimburse Collegium for its out-of-pocket expenses.  In the event we exercise our option under the agreement, we would be obligated to pay Collegium certain milestone payments, as well as potential royalty payments based on the net sales of reformulated or new products.  Additionally, in October 2002, we entered into a Common Stock Issuance Agreement with Collegium, pursuant to which Collegium may elect to be issued shares of our common stock, subject to certain conditions, in lieu of cash, for milestone payments.

Patents, Trademarks and Proprietary Technology

          We believe that patents, trademarks, copyrights and other proprietary rights are important to our business.  We also rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position.  We seek to protect our intellectual property rights by a variety of means, including patents, maintaining trade secrets and proprietary know-how, and technological innovation to develop and maintain our competitive position.  We actively seek patent protection both in the United States and internationally and have filed seven patent applications related to FMS.  It is possible that a patent application will not issue from any of our patent applications and the breadth or scope of protection allowed under any issued patents may not provide adequate protection to protect any of our future products.  We intend to attempt to enforce our patents, trademarks and brand names.  We have also obtained a license from Pierre Fabre to certain patents related to milnacipran, our only product candidate.  The composition of matter patent for milnacipran expired in June 2002.  We may not be able to secure any additional patent protection and, if we do not, we expect we will need to rely on the Hatch-Waxman Act for an exclusivity period during which generic manufacturers would not be able to manufacture milnacipran.  Even so, recent amendments to the Hatch-Waxman Act have been proposed and it, therefore, may not apply to us in the future.   

          Although patents are enforceable from the date of issuance and presumed to be valid, future litigation or reexamination proceedings regarding the enforcement of validity of our existing patents or future patents, if issued, could result in a ruling adverse to us that could invalidate such patents or substantially reduce the scope of protection afforded by such patents.  Our patents may not afford commercially significant protection of our proprietary technology or have commercial application.  There has been no judicial determination of the validity or scope of our proprietary rights.  Moreover, the patent laws in foreign countries may differ from those of the United States, and the degree of protection afforded by foreign patents may be different.

          Others have filed applications for, or have been issued, patents and may obtain additional patents and other proprietary rights relating to products or processes competitive with us.  The scope and validity of such patents is presently unknown.  If existing or future patents are upheld as valid by courts, we may be required to obtain licenses to use technology covered by such patents.

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Government Regulation

          Research, preclinical development, clinical trials, and manufacturing and marketing activities are subject to regulation for safety, efficacy and quality by numerous governmental authorities in the United States and other countries.  In the United States, drugs are subject to rigorous FDA regulation.  The Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations govern, among other things, the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of our products.  Product development and approval within this regulatory framework takes many years and is very expensive.

          The steps required before a pharmaceutical agent may be marketed in the United States include:

          In addition to obtaining FDA approval for each product, each domestic drug manufacturing establishment must be registered with the FDA.  Domestic drug manufacturing establishments are subject to regular inspections by the FDA and must comply with FDA regulations.  To supply products for use in the United States, foreign manufacturing establishments must also comply with FDA regulations and are subject to periodic inspection by the FDA, or by corresponding regulatory agencies in their home countries under reciprocal agreements with the FDA.

          Preclinical studies include the laboratory evaluation of in vitro pharmacology, product chemistry and formulation, as well as animal studies to assess the potential safety and efficacy of a product.  Compounds must be formulated according to the FDA’s regulations on good manufacturing practices and preclinical safety tests must be conducted by laboratories that comply with FDA regulations regarding good laboratory practices.  The results of the preclinical tests are submitted to the FDA as part of an IND application and are reviewed by the FDA before human clinical trials may begin.  The IND must also contain protocols for any clinical trials that will be carried out.  If the FDA objects to an IND application during this 30 day waiting period or at any time thereafter, the FDA may halt proposed or ongoing clinical trials until the agency authorizes trials under specified terms.  Such a halt, called a clinical hold, continues in effect until and unless the FDA’s concerns are adequately addressed.  In some cases, clinical holds are never lifted.  Imposition by the FDA of a clinical hold can delay or preclude further product development.  The IND process may be extremely costly and may substantially delay product development.

          In December 2001 we submitted an IND to the FDA for clinical testing of milnacipran in humans with FMS.  In January of 2002, the 30 day waiting period during which the FDA may review the IND expired and we commenced a Phase II clinical trial in the first quarter of 2002 to evaluate milnacipran in the treatment of FMS.  The Phase II trial was completed in the first quarter of 2003, and we are in the process of completing a report to present the final results of the trial to the FDA. 

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          Clinical trials must be sponsored and conducted in accordance with good clinical practice under protocols and methodologies that:

          Furthermore, each clinical study must be conducted under the supervision of a principal investigator operating under the auspices of an institutional review board, at the institution where the study is conducted.  The institutional review board will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution.  Sponsors, investigators and institutional review board members are obligated to avoid conflicts of interests and ensure compliance with all legal requirements.

          Clinical trials are conducted in accordance with protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated.  Each protocol is submitted to the FDA as part of the IND.  Clinical trials typically are conducted in three sequential phases.  In Phase I, the initial introduction of the drug into a small number of healthy volunteers is undertaken.  The drug is evaluated for safety by assessing the adverse effects, dosage tolerance, metabolism, distribution, excretion and clinical pharmacology.  The Phase I trial must provide pharmacological data that is sufficient to devise the Phase II trials.

          Phase II trials involve a limited patient population in order to:

          When a compound is determined preliminarily to be effective and to have an acceptable safety profile in Phase II evaluation, Phase III trials can be undertaken to evaluate safety and efficacy endpoints further in expanded patient populations at geographically diverse clinical trial sites.  Positive results in Phase II are no guarantee of positive results in Phase III.

          The results of the pharmaceutical development, preclinical studies and clinical trials are submitted to the FDA in the form of a new drug application, which must be complete, accurate and in compliance with FDA regulations.  The approval of a new drug application permits commercial-scale manufacturing, marketing, distribution, exporting from the United States and sale of the drug in the United States.  The testing and approval process typically requires substantial time, effort and expense.  The FDA may deny a new drug application filed by us or our collaborators if the applicable scientific and regulatory criteria are not satisfied and thus, we may not be able to manufacture and sell the product in the United States.  Moreover, the FDA may require additional testing or information, or may require post-approval testing, surveillance and reporting to monitor the products.  Notwithstanding any of the foregoing, the FDA may ultimately decide that a new drug application filed by us or our collaborators does not meet the applicable agency standards, and even if approval is granted, it can be limited or revoked if evidence subsequently emerges casting doubt on the safety or efficacy of a product or if the manufacturing facility, processes or controls do not comply with regulatory standards.  Finally, an approval may entail limitations on the uses, labeling, dosage forms, distribution and packaging of the product.

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          Among the conditions for new drug approval is the requirement that the prospective manufacturer’s quality control, record keeping, notifications and reporting and manufacturing systems conform to the FDA’s regulations on current good manufacturing practices.  In complying with the standards contained in these regulations, manufacturers must continue to expend time, money, resources and effort in order to ensure compliance.

          Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authority.  This foreign regulatory approval process includes many of the same steps associated with FDA approval described above.

          In addition to regulations enforced by the FDA, we are subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and future federal, state or local regulations.  Our research and development activities involve the controlled use of hazardous materials, chemicals and various radioactive compounds.  Although we believe that the safety procedures used by third parties for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated.  In the event of an accident, we could be liable for any damages that result.

          The clearance process for milnacipran or any of our future products is expensive and time consuming and any applicable regulatory agency may not grant clearance.  We may not have sufficient resources to complete the required testing and regulatory review processes.  Furthermore, we are unable to predict the extent of adverse governmental regulation, which might arise from future United States, or foreign legislative or administrative action.

Competition

          We are currently focusing on developing milnacipran to treat patients with FMS.  Currently, there are no approved treatments specifically for FMS in the United States or elsewhere.  As a result, the first option for treatment of FMS is physical therapy, followed by analgesics to attempt to alleviate the pain.  If the analgesics do not alleviate the pain, then muscle relaxants and antidepressants are often prescribed.  We are also focusing on the development of products for the diagnosis and treatment of patients with Functional Somatic Syndromes. 

          Preliminary clinical trials have been conducted by other pharmaceutical companies for the treatment of FMS.  The market potential for Functional Somatic Syndromes, including FMS, is considerable and a number of pharmaceutical companies focused on therapies for alleviating pain or antidepressant therapies could decide to evaluate their current product candidates for the treatment of  Functional Somatic Syndromes, including FMS at any time. Due to the high incidence of Functional Somatic Syndromes, including FMS, we anticipate that most, if not all, of the major pharmaceutical companies will have significant research and product development programs in these areas.  We expect to encounter significant competition both in the United States and in foreign markets for each of the drugs we seek to develop.

          Our competitors include fully-integrated pharmaceutical and biotechnology companies both in the United States and in foreign markets which have expertise in research and development, manufacturing processes, testing, obtaining regulatory clearances and marketing, and may have financial and other resources significantly greater than we do.  Smaller companies may also prove to be significant competitors.  Academic institutions, United States and foreign government agencies and other public and private research organizations conduct research relating to Functional Somatic Syndromes, including FMS, and may develop products for the treatment of these diseases that may compete directly with any

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products we develop.  Our competitors may compete with us for collaborations.  These companies and institutions also compete with us in recruiting and retaining highly qualified scientific personnel. 

          Our competition will be partially determined by the potential indications that are ultimately cleared for marketing by regulatory authorities, by the timing of any clearances and market introductions and by whether any currently available drugs, or drugs under development by others, are effective in the same indications.  Accordingly, the relative speed with which we can develop milnacipran or any of our future product candidates, complete the clinical trials, receive regulatory clearance and supply commercial quantities of the products to the market is expected to be an important competitive factor.  We expect that competition among products approved for sale will be based, among other things, on product efficacy, safety, reliability, availability and patent protection.

Manufacturing and Supply

          Pursuant to the terms of our agreement with Pierre Fabre, they agreed to supply us with the active pharmaceutical ingredient for milnacipran in exchange for a transfer price.  We have contracted with a third party to manufacture the bulk product of milnacipran for our clinical trials.  If we receive FDA clearance for milnacipran in the United States, which is not anticipated for several years, if at all, we intend to seek a partner to manufacture milnacipran for commercial distribution.

Employees

          As of January 31, 2003, we employed ten full-time employees.  None of our employees is covered by a collective bargaining agreement.  We believe that our relationship with our employees is good.

Available Information

          Our website address is www.cypressbio.com.  We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

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Risk Factors

Due to our change of business focus, we are at an early stage of development and we do not have and may never develop any commercial drugs or other products that generate revenues.

          We are at an early stage of development as a biotechnology company due to a change in focus in 2001 and do not have any commercial products. We have only one product candidate, milnacipran, and we have only completed a Phase II clinical trial for the treatment of FMS. In addition, we currently only have ten full-time employees.  Milnacipran, or any of our future product candidates, will require significant additional development, clinical trials, regulatory clearances and additional investment before they can be commercialized.  Our product development and product acquisition efforts may not lead to commercial drugs, either because the product candidates fail to be safe and effective in clinical trials, or because we have inadequate financial or other resources to pursue clinical development of the product candidate.  We do not expect to be able to market milnacipran for a number of years, if at all.  If we are unable to develop any commercial drugs, or if such development is delayed, we will be unable to generate revenues, may be unsuccessful in raising additional capital, and may cease our operations.

Milnacipran has never been tested for the treatment of FMS, and may not be effective for treatment of FMS.

          Milnacipran, our only product candidate, has never been tested for the treatment of FMS.  Although milnacipran is currently being sold by Pierre Fabre outside North America as an antidepressant, it has never been tested as a treatment for FMS or other pain disorders.  Even though patients in our recent Phase II trial appeared to tolerate milnacipran, our future clinical trials may reveal that milnacipran is not a suitable product candidate for the treatment of FMS, either for safety or efficacy reasons.  If milnacipran does not prove to be a safe and effective treatment for FMS, our business would be materially harmed and our stock price would decline.

The FDA approval of milnacipran or any future product candidate is uncertain.

          Milnacipran is in the early stages of development and even if our future clinical trials are successful, we may not receive required regulatory clearance from the FDA, or any other regulatory body to commercially market and sell milnacipran, or the clearance may take longer than we anticipate.  The regulatory clearance process typically takes many years and is extremely expensive and uncertain.  If we fail to obtain regulatory clearance for milnacipran or future product candidates, we will be unable to market and sell any products and therefore may never be profitable.

          As part of the regulatory clearance process, we must conduct, at our own expense, preclinical research and clinical trials for each product candidate to demonstrate safety and efficacy.  The number of preclinical studies and clinical trials that will be required varies depending on the product, the disease or condition that the product is in development for and regulations applicable to any particular product.  The regulatory process typically also includes a review of the manufacturing process to ensure compliance with applicable standards.  The FDA can delay, limit or not grant approval for many reasons, including:

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          The FDA also may approve a product candidate for fewer indications than requested or may condition approval on the performance of post marketing studies for a product candidate.  Even if we receive FDA and other regulatory approvals, milnacipran or any of our other future product candidates may later exhibit adverse effects that limit or prevent their widespread use or that force us to withdraw those product candidates from the market.  In addition, any marketed product and its manufacturer continue to be subject to strict regulation after approval.  Any unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including its withdrawal from the market.  The process of obtaining approvals in foreign countries is subject to delay and failure for the same reasons indicated above. 

If we do not find a collaborator for milnacipran, we have to reduce or delay our clinical development of milnacipran and/or increase our expenditures.

          Our strategy for developing, manufacturing and commercializing milnacipran includes entering into a corporate collaboration with a pharmaceutical company to advance the development of milnacipran and reduce our expenditures.  We may not be able to enter into such a collaboration agreement.  If we are not able to establish a collaboration agreement with respect to milnacipran, we may have to reduce or delay our future development of milnacipran and/or increase our expenditures and undertake the development activities at our own expense.  If we elect to fund our development, we will need to obtain additional capital, which may not be available on acceptable terms or at all.

We need additional capital to commercialize milnacipran.

          We will spend substantial amounts on research, development and commercialization of milnacipran, including amounts spent for clinical supplies and conducting clinical trials and on any of our future product candidates and general operations.  We do not have committed external sources of funding, and we need to raise additional capital through the sale of equity or debt sources or through collaborations in order to commercialize milnacipran. The amount of capital will be dependent upon many factors, including some of those set forth in other sections of this report. The actual costs of development of milnacipran and any of our future products may exceed our expectations.  In addition, it may not be possible to raise additional capital from any source, especially if weak market conditions persist for biotechnology companies.  If we are unable to raise additional capital when we need it or on acceptable terms, we may have to significantly delay, scale back or discontinue the development of milnacipran or any of our future programs, clinical trials or other aspects of our operations.  We may also have to seek corporate collaborators at an earlier stage than would be desirable to maximize the rights to future product candidates or relinquish license rights to technologies or product candidates on terms that are less favorable to us than might otherwise be available.  Our inability to raise additional capital would materially harm our business and stock price.

We rely on third parties to conduct all of our clinical trials.

          We currently have only ten full-time employees.  We have in the past and expect to continue to rely on third parties to conduct all of our clinical trials.  We are using the services of a contract research organization to conduct our clinical trials with respect to milnacipran.  Because we do not conduct these trials, we must rely on the efforts of others and cannot always predict accurately the timing of such trials, the costs associated with such trials or the procedures to be followed for such trials.  We do not anticipate increasing our personnel for the foreseeable future and therefore, expect to continue to rely on third parties to conduct all of our future clinical trials.

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If we are unable to create sales, marketing and distribution capabilities or enter into agreements with third parties to perform these functions, we will not be able to commercialize our products.

          We currently have a staff of ten employees and have virtually no ability to directly sell, market or distribute any product we may develop.  To directly market and distribute any product we may develop, we must build a substantial marketing and sales force with appropriate technical expertise and supporting distribution capabilities.  Alternatively, we may obtain the assistance of a pharmaceutical company or other entity with a large distribution system and a large direct sales force.  We may not be able to establish sales, marketing and distribution capabilities of our own or enter into such arrangements with third parties in a timely manner or on acceptable terms.  To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful.

We have a history of operating losses and we may never be profitable.

          We have incurred substantial losses during our history.  As of December 31, 2002, we had an accumulated deficit of approximately $104.5 million.  Our ability to become profitable will depend upon our ability to develop, market and commercialize milnacipran with sufficient sales volumes to achieve profitability, and our ability to develop, market and commercialize any other products.  We currently do not have any agreements under which we expect to recognize any revenue. Additionally, we do not expect to be profitable in the foreseeable future and may never achieve profitability.

We may engage in strategic transactions that fail to enhance stockholder value.

          From time to time, we consider possible strategic transactions, including the potential acquisitions of products, technologies and companies, and other alternatives with the goal of maximizing stockholder value.  We will continue to evaluate potential strategic transactions and alternatives that we believe may enhance stockholder value.  We may never complete a strategic transaction(s) and in the event that we do complete a strategic transaction(s), it may not be consummated on terms favorable to us.  Further, although our goal is to maximize stockholder value, such transactions may impair stockholder value or otherwise adversely affect our business and the trading price of our stock.  Any such transaction may require us to incur non-recurring or other charges and may pose significant integration challenges and/or management and business disruptions, any of which could harm our results of operation and business prospects.

Our competitors may develop and market products that are less expensive, more effective or safer, which may diminish or eliminate the commercial success of any products we may commercialize.

          The biotechnology market is highly competitive.  Large pharmaceutical and biotechnology companies have developed or are attempting to develop products that will compete with any products we may develop to target Functional Somatic Syndromes, such as FMS.  It is possible that our competitors will develop and market products that are less expensive and more effective than our future products or that will render our products obsolete.  It is also possible that our competitors will commercialize competing products before any of our products are marketed, and that our competitors may market a product for the treatment of FMS before we do.  We expect that, in the treatment of Function Somatic Syndromes, competition from other biopharmaceutical companies, pharmaceutical companies, universities and pubic and private research institutions will increase.  Many of these competitors have substantially greater financial resources, technical expertise, research capabilities and other resources than we do. We may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully. 

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Our ability to compete may decrease or be eliminated if we are not able to protect our proprietary technology.

          The composition of matter patent for milnacipran expired in June 2002.  We may not be able to secure any additional patent protection and, if we do not, we expect we will need to rely on the Hatch-Waxman Act for an exclusivity period during which generic manufacturers would not be able to manufacture milnacipran.  Even so, recent amendments to the Hatch-Waxman Act have been proposed and it, therefore, may not apply to us in the future.  The patent positions of pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and factual questions.  We may incur significant expense in protecting our intellectual property and defending or assessing claims with respect to intellectual property owned by others.  Any patent or other infringement litigation by or against us could result in significant expense to us, including diversion of the resources of management.

          Others have filed applications for, or have been issued, patents and may obtain additional patents and other proprietary rights competing with milnacipran or any processes.  We cannot predict the breadth of claims that will be allowed and issued in patents related to biotechnology or pharmaceutical applications.  Once patents have issued, we cannot predict how the claims will be construed or enforced.  We may infringe on intellectual property rights of others without being aware of the infringement.  If another party claims we are infringing their technology, we could have to defend an expensive and time consuming lawsuit, pay a large sum if we are found to be infringing, or be prohibited from selling or licensing our products unless we obtain a license or redesign our product, which may not be possible.

          We also rely on trade secrets and proprietary know-how to develop and maintain our competitive position.  Some of our current or former employees, consultants or scientific advisors, or current or prospective corporate collaborators, may unintentionally or willfully disclose our confidential information to competitors or use our proprietary technology for their own benefit.  Furthermore, enforcing a claim alleging the infringement of our trade secrets would be expensive and difficult to prove, making the outcome uncertain.  Our competitors may also independently develop equivalent knowledge, methods and know-how or gain access to our proprietary information through some other means.

We may be subject to product liability claims that could cause us to incur liabilities beyond our insurance coverage.

          We are conducting clinical trials on humans using milnacipran, and therefore, we face the risk that the use of milnacipran will result in adverse effects.  We cannot predict all possible harm or side effects that may result from the treatment of patients with milnacipran or any of our future products, and the amount of insurance coverage we currently hold may not be adequate to protect us from any liabilities.  In addition, the use of the PROSORBA column, may result in adverse side effects to the end-users that could expose us to potential product liability claims.  Although Fresenius has assumed all responsibilities associated with the PROSORBA column, including maintaining insurance, we may still be named in any lawsuit.  We may not have sufficient resources to pay any liability resulting from such a claim beyond our insurance coverage.

We may lose our net operating loss carryforwards, which could prevent us from offsetting future taxable income.

          Sales of our common stock in September 1991, October 1997 and March 2002 caused the limitation of Section 382 of the Internal Revenue Code of 1986, as amended, to be applicable.  This limitation will allow us to use only a portion of the net operating loss carryforwards to offset future taxable income, if any, for federal income tax purposes.  Based upon the limitations of Section 382, we may be allowed to use no more than a prescribed amount of such losses each year to reduce taxable

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income, if any.  To the extent not used by us, unused losses will carry forward subject to the limitations to offset future taxable income, if any, until such unused losses expire.  All unused net operating losses will expire 15 years after any year in which they were generated.  Approximately $4.9 million in federal net operating losses expired in 2002 and will continue to expire in 2003.  Our California tax loss carryforwards will begin to expire in 2004.  As a result of the sale of common stock, ownership changes occurred in 1991, 1997 and 2002, and the use of net operating loss carryforwards will be limited to a prescribed amount in each successive year.

Issuance of shares in connection with financing transactions, including collaborations or under stock option plans and outstanding warrants will be dilutive.

          We need additional capital to commercialize milnacipran.  If we issue stock in connection with corporate collaborations or raise funds by issuing stock or warrants to purchase our stock, your ownership in our stock will be diluted.  In addition, future investors may receive rights that are superior or favorable to your rights.  We maintain stock option plans under which employees, directors and consultants may acquire shares of our common stock through the exercise of stock options and other purchase rights.  We also have warrants to purchase 4,358,882 shares of our common stock that are outstanding.  You will incur dilution upon exercise of our outstanding options and warrants.

Our stock price will likely be volatile.

          The market prices of technology companies, particularly biotechnology companies, have been highly volatile.  Our stock price has been and may continue to be affected by this type of market volatility, as well as by our own performance.  The following factors, among other risk factors, may have a significant effect on the market price of our common stock:

The concentration of ownership among our existing officers, directors and principal stockholders may prevent other stockholders from influencing significant corporate decisions and depress our stock price.

As of January 31, 2003, our executive officers, directors and stockholders who hold at least 5% of our stock beneficially owned and controlled approximately 58% of our outstanding common stock.  If these officers, directors and principal stockholders act together, they will be able to influence significantly and possibly control matters requiring approval by our stockholders, including a financing in which we sell more than 20% of our voting stock at a discount to the market price, the removal of our directors, the election of the members of our board of directors, approvals of amendments to our certificate of incorporation or bylaws, mergers, a sale of all or substantially all of our assets, going private transactions and other fundamental transactions.  This concentration of ownership could also depress our stock price.

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Item 2.  Properties

          We currently occupy approximately 5,200 square feet of leased office space in San Diego, California.  The San Diego facility houses our executive and administrative offices.  The lease for this facility expires in July 2007. 

Item 3.  Legal Proceedings

          In the normal course of business, we are involved in certain litigation arising out of our operations.  We are not currently engaged in any legal proceedings that we expect would materially harm our business or financial condition.

Item 4.  Submission of Matters to a Vote of Security Holders

          No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2002.

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PART II

Item 5.  Market for our Common Equity and Related Stockholder Matters

          Our common stock is traded on the over-the-counter market on The Nasdaq SmallCap Market under the symbol “CYPB”.  Set forth below are the high and low closing sales prices for our common stock for the first quarter of 2003 (through February 28, 2003) and each quarter of 2002 and 2001 as reported on The NASDAQ SmallCap Market.

          These prices are based on quotations between dealers, which do not reflect retail mark-up, mark-down or commission and may not necessarily represent actual transactions.  As of February 28, 2003, there were approximately 388 holders of record of our common stock.  We have never paid cash dividends on our common stock and do not anticipate any being paid in the foreseeable future.

¹ We implemented a1 for 8 reverse stock split, effective March 9, 2001 at 5:00 p.m. Eastern time. The high and low closing sales prices for our common stock listed above prior to March 12, 2001 have been adjusted for the reverse stock split.

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Item 6.  Selected Financial Data

          The following table presents our selected financial data.  The statement of operations data for the years ended December 31, 2002, 2001 and 2000 and the balance sheet data at December 31, 2002 and 2001 are derived from our audited financial statements included elsewhere in this report.  The statement of operations data for the years ended December 31, 1999 and 1998 and the balance sheet data at December 31, 2000, 1999 and 1998 are derived from our audited financial statements not included in this report.  The information set forth below is not indicative of the results of future operations since we have changed our business focus, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report and the financial statements and the related notes thereto included in this Form 10-K.

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

          We are committed to being the innovator and commercial leader in providing products for the diagnosis and treatment of patients with Functional Somatic Syndromes, such as Fibromyalgia Syndrome, or FMS, and other related chronic pain and central nervous system disorders.  Our goal is to be the first to market a product approved in the United Stated for the treatment of FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes.  Our business strategy is focused on combining novel technology and clinical development of well-characterized drugs that we believe offer strong potential to help patients with Functional Somatic Syndromes.

          We licensed our first clinical candidate for the treatment of FMS, milnacipran, in August of 2001 from Pierre Fabre.  We commenced a Phase II clinical trial in the first quarter of 2002 to evaluate milnacipran in the treatment of FMS.  The Phase II trial was completed in the first quarter of 2003, and we are in the process of completing a report to present the final results of the trial to the Food and Drug Administration.  We have in the past evaluated various possible strategic transactions, including seeking a partner to assist us in the development and commercialization of milnacipran, potential acquisitions of products, technologies and companies, private and public financings and other alternatives that we believe may enhance stockholder value.  We expect to continue to do so in the future.

          As of December 31, 2002, we had working capital of approximately $11.7 million and an accumulated deficit of approximately $104.5 million.  Our future success depends on our ability to develop and market new products for the treatment of Functional Somatic Syndromes, such as FMS, and other related chronic pain and central nervous system disorders.

          Prior to December 31, 2000, we were engaged in the product development and marketing of the PROSORBA column, a medical device, which was marketed for the treatment of rheumatoid arthritis and idiopathic thrombocytopenia purpura.  On January 19, 2001, we sold to Fresenius HemoCare, or Fresenius, most of our assets related to the PROSORBA column, including the United States Food and Drug Administration Pre-Market Approval and applications for the PROSORBA column.  Fresenius is now solely responsible for all ongoing clinical trials, regulatory support, and the marketing and distribution of the PROSORBA column as discussed below.

          On January 19, 2001, we restructured our agreement with Fresenius, which provided Fresenius with an exclusive license to distribute the PROSORBA column in the United States, Europe and Latin America and, subject to certain conditions, Japan and select Asian countries, referred to as the First Restructured Agreement.  Pursuant to the terms of the First Restructured Agreement, Fresenius assumed all of the sales, marketing and clinical efforts associated with the PROSORBA column worldwide.  We received an upfront payment of $8.0 million, a portion of which reflected prepaid royalties on the sales of 10,000 PROSORBA columns in any year during the initial five years of the agreement.  The First Restructured Agreement eliminated certain profit sharing and expense sharing provisions, and we were entitled to receive additional royalties for any sales in excess of the 10,000 PROSORBA columns.  Pursuant to the First Restructured Agreement, we also transferred to Fresenius most of our assets associated with the PROSORBA column.

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          In light of lower sales than we and Fresenius anticipated, we and Fresenius determined to implement a different set of economic terms.  As a result, the agreement was further restructured on February 1, 2002, referred to as the Second Restructured Agreement.  Under the Second Restructured Agreement, we agreed that the $8.0 million upfront fee would cover all sales of the PROSORBA column in the initial seven-year period commencing January 2001 and that it was nonrefundable under any circumstances.  We are not entitled to any additional royalty payments during the initial seven-year period of the agreement.  In addition, whereas under the First Restructured Agreement, we were entitled to certain royalty payments on sales of the PROSORBA column after January 2006, pursuant to the terms of the Second Restructured Agreement, a contingent payment is due to us in the amount of $1 million if sales during the first seven years exceed 35,000 units, $2 million if they exceed 50,000 units and none if the sales are less than 35,000 units.  Such payment, if any, will be due on January 30, 2008 and is nonrefundable  Prior to these modifications, we had accounted for the initial $8.0 million payment as deferred revenue, and had amortized this amount on a straight-line basis over five years, at the rate of $400,000 per quarter.  As a result of these modifications, we recognized the remaining deferred revenue, which amounted to $6.4 million at December 31, 2001, as revenue in the first quarter of 2002.

Results of Operations

Comparison of Years Ended December 31, 2002 and 2001

Revenues

          Revenues for the year ended December 31, 2002 totaled $6.4 million compared to $1.6 million for the year ended December 31, 2001.  Pursuant to the Second Restructured Agreement with Fresenius, the agreement was modified to clarify that the $8.0 million upfront fee received under the First Restructured Agreement was not refundable under any circumstances and therefore, the entire $6.4 million of remaining deferred revenue as of December 31, 2001 was recognized as revenue in the first quarter of 2002.  Revenues for 2001 consisted of the first year of amortization of the upfront payment.  For the year 2001, this upfront payment was recognized as revenue on a straight-line basis over a five-year term, and we recognized $400,000 of revenue each quarter for a total of $1.6 million in 2001. 

          As a result of the modification to our agreement with Fresenius reflected in the Second Restructured Agreement, the 2002 and 2001 revenues are not comparable.  In addition, as a result of this modification, we will not recognize additional revenue, if any, under our agreement with Fresenius until at the earliest, January 30, 2008, when we may receive a one-time payment of $1.0 million, $2.0 million or no payment at all.  We currently do not have any other agreements pursuant to which we may receive any revenue.

Research and Development

          Research and development expenses were $5.2 million and $3.8 million for the years ended December 31, 2002 and 2001, respectively.  The increase in research and development expenses for the year ended December 31, 2002 compared to the same period in 2001 was due to the costs associated with the commencement of the Phase II clinical trial for milnacipran, including expenses for clinical research organization and trial consultants, pre-clinical research and the costs of clinical supplies for the Phase II trial.  Additionally, we incurred costs related to a reformulation and new product agreement entered into with Collegium Pharmaceutical, Inc. in August 2002, including an upfront payment as well as a project management fee. 

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General and Administrative

          General and administrative expenses were $3.1 million and $4.4 million for the years ended December 31, 2002 and 2001, respectively.  The decrease in general and administrative expenses was primarily due to lower business development costs in 2002 compared to 2001.  In 2001, we experienced significant business development activity related to the execution of our license agreement with Pierre Fabre and our efforts to license other potential drug candidates for FMS.  In 2002, our efforts were primarily focused on our Phase II clinical trial for our licensed compound, milnacipran.

Compensation Expense – Variable Stock Options

          In June 2001, we implemented an option cancel and re-grant program, which resulted in variable accounting for the newly issued options under Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), Accounting for Certain Transaction Involving Stock Compensation – An Interpretation of APB 25.  As a result, we recorded stock compensation expense totaling approximately $785,000 for the year ended December 31, 2001.  During 2002, the intrinsic value of the common stock underlying the options declined, which means that our stock price declined.  In accordance with FIN 44, we reversed approximately $688,000 of the cumulative $785,000 charge.  We will continue to record similar non-cash charges in future quarters to reflect the intrinsic value of the re-granted options to purchase common stock, until each of the options held under the cancel and re-grant program has been exercised or is terminated.   

Interest income

          Interest income was approximately $200,000 and $434,000 for the years ended December 31, 2002 and 2001, respectively.  The decrease in interest income was primarily due to lower rates offered for our cash investments.

Interest expense

          Interest expense was approximately $34,000 and $273,000 for the years ended December 31, 2002 and 2001, respectively.  The decrease in interest expense of approximately $239,000 in 2002 compared to the same period in 2001 was due to lower outstanding debt in 2002.  The remaining balance on a prior outstanding term loan was paid in full in July 2002.

Comparison of Years Ended December 31, 2001 and 2000

Revenues

          Revenues for the year ended December 31, 2001 totaled $1.6 million compared to $3.0 million for the year ended December 31, 2000.  This decrease for 2001 is attributable to the restructuring of the agreement with Fresenius in January 2001 pursuant to the First Restructured Agreement and the resulting change in the method of revenue recognition.  Revenues for 2001 consisted of amortization of the upfront payment of $8.0 million that we received under the First Restructured Amendment in January 2001.  For the fiscal year 2001, this upfront payment was recognized as revenue on a straight-line basis over a five-year term, at the rate of $400,000 per quarter.  The unamortized amount of the upfront payment was recorded as deferred revenue. 

          In contrast, revenue from the Fresenius agreement for the year ended December 31, 2000 consisted of our pro rata share of PROSORBA column sales by Fresenius as determined under the Original Fresenius Agreement.  Our pro rata share of PROSORBA column sales was determined as a total

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of allowable reimbursable expenses incurred by us for royalty, research and development, and sales and marketing expenses plus our share of any remaining net profit generated under the agreement.  Our share of remaining net profit was calculated as the gross profit from PROSORBA column sales less reimbursed expenses incurred by us and Fresenius. 

          As a result of the amendments to our agreement with Fresenius and the related changes in the structure of our PROSORBA business, revenues for the years ended December 31, 2001 and 2000 are not directly comparable.

Production Costs

          Production costs were $0 and $427,000 for the years ended December 31, 2001 and 2000, respectively.  In April 1999, Fresenius purchased our PROSORBA column manufacturing facility and related assets.  However, we remained responsible for paying royalties to certain third parties based on the sales of the PROSORBA column prior to January 2001 when we entered into the First Restructured Agreement.  Therefore, production costs in 2000 represented royalties incurred by us for PROSORBA column sales payable to third parties.  No production costs were incurred in 2001 as we changed our business focus and no longer were engaged in the product development and marketing of the PROSORBA column. 

Sales and Marketing

          Sales and marketing costs were $0 and $5.9 million for the years ended December 31, 2001 and 2000, respectively.  The decrease in sales and marketing costs for the year ended December 31, 2001 compared to the same period in 2000 reflects the transfer of the all sales and marketing responsibilities and costs related to the PROSORBA column to Fresenius in January 2001 pursuant to the First Restructured Agreement.  During 2000, we jointly marketed with Fresenius the PROSORBA column in the United States. 

Research and Development

          Research and development expenses were $3.8 million and $1.9 million for the years ended December 31, 2001 and 2000, respectively.  The increase in research and development costs for the year ended December 31, 2001 compared to the same period in 2000 was primarily due to the following:  (i) a $1.5 million licensing fee to Pierre Fabre for the licensing of milnacipran; (ii) the costs associated with filing the IND application with the FDA (filed in December of 2001); (iii) the costs of launching our FMS genomic research program; and (iv) implementation of a database for our physician and patient registries focused on patients with FMS and physicians that treat patients with FMS.  These cost increases were partially offset by the assumption of the research and development activities related to the PROSORBA column by Fresenius.  All of the costs related to the PROSORBA column after January 1, 2001 are the obligation of Fresenius.  

          The increase in research and development costs from the year 2000 to the year 2001 was due to a shift in our focus from maintenance of the PROSORBA column in the year 2000 to the licensing and development of milnacipran for the treatment of FMS in the year 2001. 

General and Administrative

          General and administrative expenses were $4.4 million and $3.3 million for the years ended December 31, 2001 and 2000, respectively.  The increase in general and administrative expenses of approximately $1.0 million in 2001 from the same period in 2000 was primarily due to business

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development activity associated with the execution of our license agreement with Pierre Fabre and our efforts to license other product candidates for the treatment of the FMS.

Compensation Expense – Variable Stock Options

          In connection with the option cancel and re-grant program implemented in June 2001, which resulted in variable accounting for the newly issued options under FIN 44, we recorded stock compensation expense totaling approximately $785,000 for the year ended December 31, 2001.  No such program existed in 2000.  We will continue to record similar non-cash charges in future quarters to reflect the intrinsic value of the re-granted options to purchase common stock, until each of the options held under the cancel and re-grant program has been exercised or is terminated.

Interest Income

          Interest income was approximately $434,000 and $634,000 for the years ended December 31, 2001 and 2000, respectively.  The decrease in interest income of approximately $200,000 in 2001 from the same period in 2000 was primarily due to lower interest rates offered for our cash investments and lower cash and cash equivalent balances maintained during 2001. 

Interest Expense

          Interest expense was approximately $273,000 and $549,000 for the years ended December 31, 2001 and 2000, respectively.  The decrease in interest expense of approximately $276,000 in 2001 compared to the same period in 2000 was due to a lower outstanding borrowing base in 2001 resulting from the repayment of the convertible debentures and repayment of the maturing portion of the term loan.  The remaining convertible debentures were due and repaid in full in March 2001. 

Liquidity and Capital Resources

          Our cash and cash equivalents and short-term investments balance at December 31, 2002 totaled $12.2 million compared to $5.9 million at December 31, 2001.  The net increase in cash and cash equivalents and short-term investments was due to the net proceeds of approximately $15.3 million from the private placement of our common stock and warrants to purchase our common stock completed in March 2002, offset by cash used in operations of $9.0 million for the year ended December 31, 2002.  Working capital at December 31, 2002 totaled $11.7 million compared to a deficit of $2.1 million at December 31, 2001.

          On August 1, 2001, we entered into a license agreement and a trademark agreement with Pierre Fabre.  The license agreement was amended and restated on November 13, 2001.  The license agreement provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for the treatment of FMS and related chronic pain syndromes in the United States and Canada.  We also have an option to include other indications in these markets.  We paid Pierre Fabre upfront payments of $1.5 million and additional payments to Pierre Fabre of up to a total of $5.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones.  If the product is commercialized, Pierre Fabre will manufacture the active ingredients used in the commercial product, and we will pay Pierre Fabre a transfer price and royalties based on net sales.  Pierre Fabre retains the right to sell products developed by us for FMS and related chronic pain syndromes outside the United States and Canada and will pay us a royalty based on net sales for such rights. 

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          In August 2002, we entered into a Reformulation and New Product Agreement with Collegium Pharmaceutical, Inc. pursuant to which Collegium will attempt to develop reformulations of milnacipran and new products that are analogs of milnacipran.  We paid Collegium an upfront payment, which has been expensed pursuant to SFAS No. 2, Accounting for Research and Development Costs, as the ultimate commercialization of the products is uncertain and the technology has no alternative uses.  Additionally, we paid a project management fee to Collegium, and we agreed to pay their out-of-pocket expenses.  During a specified time period during the agreement, in the event we exercise our option to acquire an exclusive license to technology developed under this agreement, we would be obligated to pay Collegium certain milestone payments, as well as potential royalty payments based on the net sales of reformulated or new products.  Additionally, in October 2002, we entered into a Common Stock Issuance Agreement with Collegium, pursuant to which Collegium may elect to be issued shares of our common stock, subject to certain conditions, in lieu of cash, for milestone payments.

          Based on our current business plan, we believe our cash and cash equivalents and short-term investments balance at December 31, 2002 is sufficient to fund operations through the end of 2003.  Our expected primary cash needs on both a short term and long term basis are for clinical development of milnacipran, working capital and other general corporate purposes.  In order to successfully continue to develop milnacipran and acquire or develop additional products for the diagnosis and treatment of Functional Somatic Syndromes, including FMS, we will be required to raise additional capital. The amount of capital we require is dependent upon many factors, including the following: the costs associated with the research, development and potential commercialization of milnacipran, the costs of in-licensing drug candidates for the treatment of Functional Somatic Syndromes, the costs and results associated with the clinical trials designed for any new developed and/or acquired product, results of our research and development efforts, the FDA regulatory process, and the costs of commercialization of any future products.  Because we are unable to predict the outcome of the foregoing factors, some of which are beyond our control, we are unable to estimate with certainty our mid to long-term capital needs.  Although we will seek to raise additional capital through equity or debt financings or through collaborations, we may not be able to raise additional capital through such sources and the funds we raise, if any, may not allow us to maintain our current and planned operations. If we are unable to obtain additional capital, we will be required to delay, scale back or eliminate some or all of our planned research and development activities related to the development of milnacipran or any future additional product candidates.

Contractual Obligations and Commercial Commitments

          Future minimum payments for all contractual obligations for years subsequent to December 31, 2002 are as follows:

          Other commercial commitments include certain potential milestone and royalty payments to Pierre Fabre and Collegium discussed in the “Liquidity and Capital Resources” section.

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Critical Accounting Policies and Estimates

          Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, technology licenses for research and development, stock-based compensation and income taxes.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors.  Actual results may differ from these estimates under different assumptions or conditions.  We believe the following are some of the more critical accounting policies that affect the significant judgments and estimates used in the preparation of our financial statements (see also the notes to our financial statements).

Revenue Recognition

          In accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements, revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured.  Revenue is deferred for fees received before earned.

          The only agreement pursuant to which we may receive revenue in the future is our agreement with Fresenius.  Under the terms of the First Restructured Agreement, we received $8.0 million in January 2001 in exchange for granting a license to Fresenius, which was royalty-free for the first 10,000 units of sales for each of the first five years, and a royalty of $200 per unit on sales exceeding 10,000 units in any year.  We were entitled to receive royalties on all unit sales after the fifth year.  We originally deferred the recognition of this payment over the initial prepaid period of five years.  In February 2002, we and Fresenius amended certain provisions of the license agreement in the form of the Second Restructured Agreement.  Under the Second Restructured Agreement, the initial $8.0 million payment received in January 2001 was made nonrefundable under any circumstances.  The Second Restructured Agreement also eliminated the payment of royalties on PROSORBA column sales in excess of 10,000 in the first five years of the agreement and eliminated all royalties on PROSORBA column sales beyond five years.  A contingent nonrefundable payment is due to us on January 30, 2008 in the amount of $1 million if sales during the first seven years exceed 35,000 units, and $2.0 million if they exceed 50,000 units.  We will not receive any payment if the sales are less than 35,000 units.  As a result of this amendment, we recognized the remaining deferred revenue, which amounted to $6.4 million as of December 31, 2001, as revenue during the first quarter of 2002.

Technology Licenses for Research and Development

          We expense research and development costs as they are incurred pursuant to SFAS No. 2, Accounting for Research and Development Costs, as the ultimate commercialization of the related products is uncertain and the technology has no alternative uses.  We currently have agreements with Pierre Fabre and Collegium pursuant to which we have made certain payments and are obligated under certain circumstances to make additional payments.  In connection with our agreement with Pierre Fabre, we paid upfront fees of $1.5 million and are also obligated to make additional payments based on meeting certain clinical and regulatory milestones.  The total payments to date of $1.5 million, $750,000 of which was paid as of December 31, 2001 and the remaining $750,000 was accrued as of December 31, 2001 and paid in the first quarter of 2002, have been expensed pursuant to SFAS No. 2.  If the drug is

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commercialized, we will pay Pierre Fabre a transfer price and royalties based on net sales.  Pierre Fabre retains the right to sell products developed by us for FMS and other related chronic pain syndromes outside the United States and Canada and will pay us a royalty based on net sales for such rights.  Additionally, in connection with our agreement with Collegium, the upfront and project management fees paid to Collegium have been expensed pursuant to SFAS No. 2.  Pursuant to the agreement with Collegium, during a specified time period during the agreement, in the event that we exercise our option to acquire an exclusive license to technology developed under the agreement, we would be obligated to pay Collegium certain milestone payments, as well as potential royalty payments based on the net sales of reformulated or new products.

Stock Based Compensation

          We grant stock options for a fixed number of shares to employees in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, as amended by SFAS No. 123 (“FAS 123”), Accounting for Stock Based Compensation.  Accordingly, we ordinarily recognize no compensation expense for stock option grants to employees provided that the option exercise price is not less than the fair market value of the underlying stock on the date of grant.  The value of options or stock awards issued to non-employees have been determined in accordance with FAS 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring or in Conjunction with selling Goods and Services, and are periodically re-measured as the options vest.  For the years ended December 31, 2002 and 2001, we recorded compensation expense of $143,363 and $34,531, respectively, related to options issued to consultants.

          In June 2001, we entered into an option cancel and re-grant program, which resulted in variable accounting for the newly issued options under Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), Accounting for Certain Transaction Involving Stock Compensation – An Interpretation of APB 25.  Pursuant to FIN 44, the intrinsic value of the options to purchase common stock will be re-measured at the end of each period for the term of the option and amortized over the vesting period.  As a result, we recorded stock compensation totaling $784,874 for the year ended December 31, 2001.  During the year ended December 31, 2002, the intrinsic value of the common stock underlying the options declined, which means our stock price declined, resulting in a reversal of $688,376 of the cumulative compensation charge of $784,874.  In the event our stock price is above $2.70 (closing price on December 31, 2002) on March 31, 2003, we will record additional compensation charges.  Pursuant to the option cancel and re-grant program, the exercise price of certain options held by certain of our employees, including executive officers, and directors were exchanged for options with an exercise price of $2.50, the fair market value of our common stock on June 27, 2001, the date the program was effected.

Valuation Allowance for Deferred Tax Assets

          A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before we are able to realize their benefit, or that future deductibility is uncertain.  In general, companies that have a history of operating losses are faced with a difficult burden of proof on their ability to generate sufficient future taxable income within the next two years in order to realize the benefit of the deferred tax assets.  We have recorded a full valuation allowance against our deferred tax assets in the amount of $33.3 million as of December 31, 2002 based on our history of losses.  The deferred tax assets are still available for us to use in the future to offset taxable income, which would result in the recognition of a tax benefit and a reduction to our effective tax rate.

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Recent Accounting Pronouncements

          In April 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections,” which is effective for the Company beginning January 1, 2003.  The adoption of this standard is not expected to have a material effect on the financial position or results of operations of the Company.

          In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment of SFAS No. 123.”  SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  We have accounted for stock-based employee compensation using the intrinsic value method and have adopted the amendments to the disclosure provisions of this statement.

Item 7A.  Quantitative and Qualitative Disclosure about Market Risk

          We invest our excess cash in United States government securities and money market funds with strong credit ratings.  As a result, our interest income is most sensitive to changes in the general level of United States interest rates.  We do not use derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion.  Accordingly, we believe that, while the investment-grade securities we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.  A hypothetical 1% adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our financial instruments that are exposed to changes in interest rates.

Item 8.  Financial Statements and Supplementary Data

          Refer to the Index on Page F-1 of the Financial Report included herein.

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

          None

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PART III

Item 10.  Directors and Executive Officers

          Our directors and executive officers, the positions held by them and their ages as of January 31, 2003 are as follows:

          JAY D. KRANZLER, M.D., PH.D., was appointed as our Chief Executive Officer and Vice-Chairman in December 1995.  In April 1998, Dr. Kranzler was appointed as Chairman of the Board.  From January 1989 until August 1995, Dr. Kranzler served as President, Chief Executive Officer and a director of Cytel Corporation, a publicly held biotechnology company.  Dr. Kranzler has been an adjunct member of the Research Institute of Scripps Clinic since January 1989.  Before joining Cytel, from 1985 to January 1989, Dr. Kranzler was employed by McKinsey & Company, a management-consulting firm, as a consultant specializing in the pharmaceutical industry.

          R. MICHAEL GENDREAU, M.D., PH.D., was appointed as our Vice President of Research and  Development and Chief Medical Officer in December 1996 and is currently serving as the Vice President of Development and Chief Medical Officer.  Dr. Gendreau joined us in 1994 and held various positions from 1994 through 1996, including Executive Director of Scientific Affairs.  From 1991 to 1994, Dr. Gendreau was Vice President of Research and Development and Chief Medical Officer for MicroProbe Corporation, a developer and manufacturer of DNA probe-based diagnostic equipment.

          SABRINA MARTUCCI JOHNSON was appointed as our interim Chief Financial Officer in February 2002 and in April 2002, she was appointed as our Vice President and Chief Financial Officer.  Ms. Johnson served as our Vice President of Marketing from March 2001 to April 2002.  Ms. Johnson joined us in August of 1998 and held various positions from 1998 through 2000, including Product

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Director, Executive Director of Marketing and Sales, and Vice President of Marketing and Sales.  Ms. Johnson previously held marketing and sales positions with Advanced Tissue Sciences and Clonetics.  Ms. Johnson has an MBA from the American Graduate School of International Management (Thunderbird) and a MSc. in Biochemical Engineering from the University of London.  Ms. Johnson began her career in the biotechnology industry as a research scientist with Baxter Healthcare, Hyland Division.

          JACK H. VAUGHN has served as a director since 1991.  Mr. Vaughn is a retired foreign service officer, his last post having been ambassador to Colombia.  Mr. Vaughn has been a director of the Nature Conservancy, Columbia Pictures and Allegheny & Western Energy Corporation.

          SAMUEL D. ANDERSON has served as a director since April 1998.  Currently, Mr. Anderson is an independent consultant.  From 1990 to 1991, he was the President and Chief Executive Officer of Trancel Corporation, a biotechnology company.  From 1984 to 1989 Mr. Anderson was the Chief Executive Officer of Alpha Therapeutics Corporation, a blood plasma fractionator, and between 1989 and 1990 served as its Chairman of the Board.  Mr. Anderson is currently Chairman of the Board of Hycor, a publicly traded company, and is also a Board member of publicly traded SeraCare Life Sciences.

          LAWRENCE J. KESSEL, M.D., FACP has served as a director since October 1999.  Dr. Kessel has been the president of a five physician practice specializing in Internal Medicine and Geriatrics since 1984.  He graduated Magna Cum Laude with a B.S. degree from the University of Pittsburgh as an honors major in Biology and subsequently graduated with an MD degree from Temple Medical School.  He completed a formal residency in Internal Medicine at Abington Memorial Hospital, and is Board Certified in Internal Medicine with added qualification as a diplomat in Geriatric Medicine.  He is an active staff attending and Clinical Instructor at Chestnut Hill Hospital (University of Pennsylvania affiliate) and Roxborough Memorial Hospital in Philadelphia, Pennsylvania.  Dr. Kessel is a Board Reviewer for the American Board of Internal Medicine, as well as a Fellow of the American College of Physicians.  He also serves on the advisory board of Independence Blue Cross.  Dr. Kessel presently serves as a director to Dor BioPharma, Inc. of Lake Forest, Illinois.  He previously served on the Board of Genta, Inc.

          CHARLES B. NEMEROFF, M.D., Ph.D., has served as a director since March 2001.  Currently, Dr. Nemeroff is the Reunette W. Harris Professor and Chairman of the Department of Psychiatry and Behavioral Sciences at the Emory University School of Medicine in Atlanta, Georgia.  He serves on the Mental Health Advisory Council of the National Institute of Mental Health and the biomedical Research Council for NASA.  In addition, Dr. Nemeroff is a consultant to various pharmaceutical companies including Forest Laboratories, GlaxoSmithKline, Janssen Pharmaceutica, Merck, Inc., Otsuka Pharmacia/Upjohn, Somerset Pharmaceuticals and Wyeth-Ayerst Laboratories.  Dr. Nemeroff is the past President of the American College of Psychiatrists and past President of the American College of Neuropsychopharmacology.  He serves as the Editor-in-Chief of Neuropsychopharmacology.  Dr. Nemeroff has received numerous awards for his research including the Bowis Award from the American College of Psychiatrists and the Menninger Prize from the American College of Physicians.  In 2002, he was elected to the Institute of Medicine. 

          MARTIN B. KELLER, M.D., was elected by our board of directors to serve as a director in May 2001.  Dr. Martin Keller has been the Mary E. Zucker Professor and Chairman of the Department of Psychiatry and Human Behavior at the Brown University School of Medicine in Providence, Rhode Island since 1989.  He is also Executive Psychiatrist-in-Chief at the Brown University affiliated hospitals.  Dr. Keller is a consultant to various pharmaceutical companies including Bristol-Myers Squibb, Eli Lilly, Forest Laboratories, Janssen Pharmaceutica, Merck, Inc, Organon, Otsuka Pharmacia/Upjohn, Pharmastar, Pfizer, Inc. and Wyeth-Ayerst Laboratories.  In addition, he serves on the scientific advisory board of numerous pharmaceutical companies including Bristol-Myers Squibb, Cephalon, Cyberonics,

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Inc., Eli Lilly, Forest Laboratories, Merck, Inc, Pfizer, Mitsubishi, Organon, Sepracor, Scirex, Somerset Pharmaceuticals, Vela Pharmaceuticals, SmithKline Beecham and Wyeth-Ayerst Laboratories.  Dr. Keller received his BA from Dartmouth College and his medical training at Cornell University, and completed a medical internship at Bellevue Medical Center in New York City and a psychiatric residency at Massachusetts General Hospital in Boston.

          SHELDON DROBNY, was elected by the Board to serve as a director in June 2001.  Mr. Drobny is a certified public accountant and winner of the Elijah Watts Sells award.  Mr. Drobny has been a partner in the Northbrook, Illinois based accounting firm of Adler Drobny Fischer since 1971 and is admitted to practice before the U.S. Tax Court as a non-attorney.  Mr. Drobny worked for the Internal Revenue Service from 1967 to 1971 as an auditor, supervisor and instructor.  Mr. Drobny currently serves as Chairman and Managing Director of the Paradigm Group, L.L.C., and is on the board of directors of Vertaport, Inc. and Alternative Medicine, Inc.  Mr. Drobny received his BS in accounting from Roosevelt University.  He has been an author and lecturer in the field of accounting and taxation.

          Each officer serves at the discretion of the Board of Directors.  Our Bylaws permit the Board of Directors to establish by resolution the authorized number of directors, and we currently have seven directors authorized.  Our Restated Certificate of Incorporation and Bylaws provide that the Board of Directors shall be divided into three classes, each class consisting, as nearly as possible, of one-third of the total number of directors, with each class having a three-year term.  Each director holds office until the annual meeting of our stockholders which coincides with the end of such director’s three-year term and until such director’s successors have been elected and duly qualified.

Board Committees and Meetings

          During the fiscal year ended December 31, 2002 our board of directors held eight meetings and acted by unanimous written consent one time.  Our board of directors has an Audit Committee, a Compensation Committee, a Stock Option Committee and a Non-Executive Officer Stock Option Committee.

          The Audit Committee of our board of directors oversees our corporate accounting and financial reporting process.  For this purpose, the Audit Committee performs several functions.  The Audit Committee evaluates the performance of and assesses the qualifications of the independent auditors; determines the engagement of the independent auditors; determines whether to retain or terminate the existing independent auditors or to appoint and engage new independent auditors; reviews and approves the retention of the independent auditors to perform any proposed non-permissible audit services; monitors the rotation of partners of the independent auditors on our  engagement team as required by law; reviews the financial statements to be included in our Annual Report on Form 10-K; and discusses with management and the independent auditors the results of the annual audit and the results of our quarterly financial statements.  The Audit Committee is composed of three directors: Mr. Vaughn, Mr. Drobny and Mr. Anderson.  It met five times during fiscal year 2002.  Effective January 23, 2003, Mr. Drobny replaced Mr. Vaughn in the role of Chairman of the Audit Committee.  All members of our Audit Committee are independent (as independence is currently defined in Rule 4200(a)(14) of the NASD listing standards).  In addition, our board of directors believes that Mr. Drobny is an audit committee financial expert.  An audit committee financial expert is a person who has (i) an understanding of generally accepted accounting principles and financial statements, (ii) the ability to assess the general application of said principles in connection with the accounting for estimates, accruals and reserves, (iii) experience preparing, auditing, analyzing or evaluating financial statements of comparable breadth and complexity to the Company’s or experience supervising others who do, and (iv) an understanding of internal controls and procedures.

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          The Compensation Committee reviews and approves our overall compensation strategy and policies.  The Compensation Committee makes recommendations based on management’s input concerning salaries and incentive compensation, awards stock options to executives under our stock option plans and otherwise determines compensation levels and performs such other functions regarding compensation as our board of directors may delegate.  Three non-employee directors comprise the Compensation Committee:  Mr. Anderson (Chairman), Mr. Vaughn and Dr. Kessel.  It met three times during fiscal year 2002 and acted by unanimous written consent one time.

          The Stock Option Committee considers and recommends to our board of directors the amount and terms of stock options to be granted to officers and employees.  The Stock Option Committee is composed of two directors: Mr. Anderson and Dr. Kessel.  It did not meet during fiscal year 2002.  The Non-Executive Officer Stock Option Committee was created by the Stock Option Committee in February 1996.  It has the authority to grant certain numbers of options to employees who are not our executive officers; provided, however, that the number of options granted to employee by the Non-Executive Officer Stock Option Committee is limited to 250,000 each period between board meetings.  The Non-Executive Officer Stock Option Committee is comprised of one director, Dr. Kranzler.

          During the fiscal year ended December 31, 2002, each director attended 75% or more of the aggregate of the meetings of our board of directors and of the committees on which he served.

Scientific Advisory Boards

          We have two scientific advisory boards to provide scientific and clinical support and guidance related to our development of products related to the treatment of Functional Somatic Syndromes, including FMS.  The areas of focus of the scientific advisory boards are fibromyalgia syndrome and psychopharmacology.

          The Fibromyalgia Syndrome Advisory Board, or the FAB, is composed of Daniel J. Clauw, M.D., Director, Center for the Advancement of Clinical Research Professor of Medicine, at The University of Michigan; Robert Bennett, M.D., FRCP, FACP, FACR, Professor of Medicine at Oregon Health and Science University; Laurence Bradley, Ph.D., Professor of Medicine at the University of Alabama, Birmingham; Jacques Caldwell, M.D., FACR, Medical Director for Radiant Research/Daytona Beach and Gainesville; Leslie Crofford, M.D., Associate Professor of Internal Medicine, Division of Rheumatology at University of Michigan; Roy Fleischmann, M.D., Clinical Professor of Medicine at University of Texas Southwestern Medical Center; Don L. Goldenberg, M.D., Chief of Rheumatology at Newton-Wellesley Hospital;  Daniel G. Malone, M.D., Associate Professor of Medicine at the University of Wisconsin; Philip Mease, M.D., FACP, FACR, Clinical Professor at the University of Washington; Allan Metzger, M.D., FACP, FACR, Clinical Professor of Medicine at UCLA; Sanford Roth, M.D., Medical Director, Arizona Research and Education; I. Jon Russell, M.D., Ph.D., Associate Professor of Medicine, University of Texas Clinical Research Center; Stuart Silverman, M.D., FACP, FACR, Clinical Professor of Medicine and Rheumatology at UCLA; Daniel Wallace, M.D., FACP, FACR, Clinical Professor of Medicine at UCLA; Arthur L. Weaver, M.D., FACP, MACR, Director of Clinical Research at the Arthritis Center of Nebraska; and Muhammad B. Yunus, M.D., FACP, Professor of Medicine and Rheumatology at the University of Illinois College of Medicine.  The focus of the FAB is to provide us guidance on evaluation of candidate therapeutic agents for treatment of FMS and the design and conduct of human clinical trials for the therapeutic agents identified to treat FMS.

          The Psychopharmacology Advisory Board, or the PSYAB, is composed of Charles Nemeroff, M.D., Ph.D., the Reunette W. Harris Professor and Chairman of the Department of Psychiatry and Behavioral Sciences at the Emory University School of Medicine in Atlanta, Georgia (also a member of our Board); David Dunner, M.D., Director, Center for Anxiety and Depression, Department of Psychiatry

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and Behavioral Sciences at the University of Washington; Jan Fawcett, M.D., Professor and Chairman, Department of Psychiatry at Rush-Presbyterian-St. Luke’s Medical Center; Martin B. Keller, M.D., Professor and Chairman, Department of Psychiatry and Human Behavior at Brown Medical School (also a member of our Board); Lorrin M. Koran, M.D., Professor (Clinical) Psychiatry and Behavioral Sciences at Stanford University Medical Center; K. Ranga Krishnan, M.B., Ch.B., Department of Psychiatry and Behavioral Sciences at Duke University; Charles F. Reynolds, M.D. University of Pittsburgh, Department of Psychiatry; Stephen Stahl, M.D., Ph.D., UCSD, Department of Psychiatry.  The focus of the PSYAB is to assist us in selecting and evaluating the potential effectiveness of drug candidates and designing clinical trials for these compounds.

Section 16(a) Beneficial Ownership Reporting Compliance

          Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers, and persons who own more than ten percent of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other of our equity securities.  Officers, directors and greater than ten percent stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file.

          To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the fiscal year ended December 31, 2002, all Section 16(a) filing requirements applicable to our offices, directors and greater than ten percent beneficial owners were complied with, except that two reports covering two transactions were filed late by Mr. Anderson and Mr. Drobny.

Item 11.  Executive Compensation

Compensation of Directors

          In the fiscal year ended December 31, 2002, each of our non-employee directors received $24,000 for such person’s service as a director.  Directors who are also our employees do not receive any fee for their service as directors.  None of our directors receive any fees for their service on any committee of the Board.  All of our directors are reimbursed for their out-of-pocket travel and accommodation expenses incurred in connection with their service as our directors.  In addition, Dr. Nemeroff received $24,000 for services as a member of our PSYAB.

          Each of our directors may receive stock option grants under the 1996 Equity Incentive Plan (the “1996 Plan”) and the 2000 Equity Incentive Plan, as amended (the “2000 Plan”).  In April 2001, our board of directors approved automatic yearly option grants for each of its non-employee directors.  Accordingly, on January 1, 2002, each non-employee director was automatically granted under the 2000 Plan, without further action, an option to purchase 5,000 shares of our common stock (the “2002 Automatic Grants”).  The exercise price of the 2002 Automatic Grants was $4.12, which was the fair market value of our common stock on the date the 2002 Automatic Grants were made.  The 2002 Automatic Grants vest on a daily basis over a period of one year.  The term of the 2002 Automatic Grants is ten years.  In addition, on April 29, 2002, we made the following option grants to our directors under the 2000 Plan:

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          In addition, we granted an option to purchase 12,500 shares of our common stock to Dr. Nemeroff on January 27, 2002 in connection with Dr. Nemeroff’s service on our PSYAB. 

          The 1996 Plan and the 2000 Plan (collectively the “Plans”) provide for the grant of incentive stock options, nonstatutory stock options, stock bonuses and restricted stock purchase awards.  Incentive stock options granted under the Plans are intended to qualify as “incentive stock options” within the meaning of Section 422 of the Internal Revenue Code (the “Code”).   Nonstatutory stock options, such as those granted to non-employee directors under the Plans, are not intended to qualify as incentive stock options under the Code.  With the exception of options issued to stockholders holding more than 10% of our stock, the exercise price of incentive stock options issued under the Plans may not be less than 100% of the fair market value on the date of grant, and the exercise price of nonstatutory stock options issued under the Plans may not be less than 85% of fair market value.  The maximum term of options under the Plans is typically ten years, except that the term is five years for options issued under the Plans to stockholders holding more than 10% of our stock.  The 1996 Plan will terminate on January 17, 2006 and the 2000 Plan will terminate on May 3, 2010, unless either of the Plans is earlier terminated by our board of directors.  In the event of a sale of substantially all of our assets, specified types of merger, or other corporate reorganization, any surviving corporation shall assume awards outstanding under the Plans or substitute similar awards for those outstanding under the Plans and in the event the surviving corporation fails to assume such options, the vesting of all outstanding options shall be accelerated and the options will terminate if not exercised immediately prior to the sale or merger.

          In May 2000, our board of directors adopted a resolution providing that the vesting of all existing and future stock options held by non-employee directors will be accelerated upon a change of control in the Company which includes the sale of substantially all of our assets, specified types of merger, or other corporate reorganization.

          We also have consulting arrangements with all of our non employee directors that are described under the caption “Certain Transactions”.

Compensation of Executive Officers

          The following table shows for the fiscal years ended December 31, 2002, 2001 and 2000, compensation awarded or paid to, or earned by, (i) our Chief Executive Officer; (ii) our two other most highly compensated executive officers, for whom salary and bonus for services rendered to us was in excess of $100,000; and (iii) one former executive officer who departed from the Company during fiscal 2002:

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SUMMARY COMPENSATION TABLE

STOCK OPTION GRANTS AND EXERCISES IN LAST FISCAL YEAR

          We grant options to our executive officers under our 1996 Plan and our 2000 Plan.  As of December 31, 2002, options to purchase a total of 765,715 shares were outstanding under the 1996 Plan and options to purchase 9,192 shares remained available for grant under the 1996 Plan.  As of December 31, 2002, options to purchase a total of 922,214 shares were outstanding under the 2000 Plan and options to purchase 1,087,494 shares remained available for grant under the 2000 Plan.  The 2000 Plan contains a provision whereby the total number of shares reserved for issuance under both the 1996 Plan and the 2000 Plan, in the aggregate, is increased quarterly such that the number equals 21.1% of the number of shares of our common stock issued and outstanding.

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Option Grants in Last Fiscal Year

          The following table sets forth certain information regarding options granted during the fiscal year ended December 31, 2002 to our executive officers:

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES

          During the year ended December 31, 2002, no options were exercised by our executive officers.  The following table sets forth certain information as of December 31, 2002 regarding options held by our executive officers.  There were no stock appreciation rights outstanding at December 31, 2002.

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Employment, Severance and Change of Control Agreements

          In January 1996 we entered into an employment agreement with Jay D. Kranzler, M.D., Ph.D., our Chairman of the board of directors and Chief Executive Officer.  In January 2001, we amended our Employment Agreement with Dr. Kranzler.  Pursuant to the amendment, Dr. Kranzler’s base salary was set at $427,000, effective September 1, 2000, subject to adjustment by our Board.  Dr. Kranzler’s current salary is $460,007.  In addition, in the event that Dr. Kranzler is terminated, Dr. Kranzler is entitled to severance payments equal to his base salary for one year after his termination. In the event Dr. Kranzler is replaced as our Chief Executive Officer, Dr. Kranzler may elect to continue in the position of executive Chairman of the board of directors, devoting up to 50% of his time capacity to such position, at a pro-rated base salary until December 31, 2003.  As an alternative, Dr. Kranzler may elect to act solely as a non-executive Chairman of the board of directors, with no time commitment to us beyond acting as Chairman, and if he makes such election, Dr. Kranzler’s base salary shall be reduced to 25% of his base salary then in effect until December 31, 2003.  Dr. Kranzler will receive this reduced compensation, based on which election he makes through December 31, 2003, even if Dr. Kranzler resigns as Chairman or director and no longer devotes any time to us.  In addition, in the event of the termination of Dr. Kranzler without cause, the consummation of a merger, consolidation, corporate reorganization or acquisition of all or substantially all of our assets that does not provide for Dr. Kranzler to assume the duties of the Chief Executive Officer, or any demotion or removal of Dr. Kranzler from the position of Chief Executive Officer, then the vesting of all of Dr. Kranzler’s outstanding options will be accelerated and all his options will be immediately exercisable.

          In December 2001, we entered into an amended employment agreement with Dr. R. Michael Gendreau, our Vice President of Development and Chief Medical Officer, which restated his previous employment agreement entered into in January 1996.  This agreement expired in September 2002. 

          In June 2001, we entered into an employment agreement with Dr. John N. Bonfiglio, our Chief Operating Officer and Executive Vice President.  Pursuant to the employment agreement, Dr. Bonfiglio received a base salary of $260,000 and the possibility, at the discretion of the board of directors, of a cash and/or stock bonus based on individual and Company performance.  In addition, Dr. Bonfiglio received an upfront payment of $5,000 to offset moving expenses and $2,000 per month to be used for living expenses, payable until the first year anniversary of his employment with us.  In August 2002, Dr. Bonfiglio’s employment agreement was amended, whereby his employment with us terminated effective November 18, 2002.

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Equity Compensation Plan Information

          The following table sets forth certain information as of December 31, 2002 regarding our equity compensation plans that were approved by our stockholders.  As of December 31, 2002, we did not have any equity compensation plans that were not approved by our stockholders.

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Security Ownership of Certain Beneficial Owners and Management

          The following table sets forth certain information regarding the ownership of our common stock as of January 31, 2003 by:  (i) all those known by us to be beneficial owners of more than 5% of our common stock; (ii) each of our executive officers named in the Summary Compensation Table; (iii) each of our directors; and (iv) all of our executive officers and directors as a group.

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          We have an employment agreement with our chief executive officer, as described under the caption “Employment, Severance and Change of Control Agreements.”  We have also granted stock options to certain of our directors and executive officers.  See “Executive Compensation.”

          On June 27, 2001, we implemented an option cancel and re-grant program.  As a condition to participating in the option cancel and re-grant program, optionees who elected to surrender their old options for replacement options had to exercise at least 20% of the replacement options on June 27, 2001.  Dr. Kranzler exercised his option to purchase 101,319 shares pursuant to a promissory note that was issued by us and is secured by his stock.  The outstanding principal amount of the promissory note is due on June 27, 2006, and the interest is payable annually.  The principal amount of the loan is $189,973.12 and the interest rate is variable, adjusted monthly and is two points above the federal funds rate.

          Pursuant to consulting agreements with Mr. Anderson, Mr. Drobny, Dr. Keller and Mr. Vaughn, these members of our board of directors have agreed to serve as consultants to us to assist on an as needed basis at the rate of $2,000 per day for any days that exceed their commitment as members of our board of directors.  During 2002, no additional services were provided by these directors.

          Pursuant to our consulting agreement with Dr. Kessel dated October 28, 1999, Dr. Kessel agreed to spend on average three days per month working on our behalf on clinical, sales and marketing issues at $4,000 per month.  During 2002, we paid Dr. Kessel $48,000 under such agreement.

          Pursuant to our consulting agreement with Dr. Nemeroff dated March 1, 2001, as amended and restated on December 21, 2001, Dr. Nemeroff agreed to serve as a member of our Psychopharmacology Advisory Board for a retainer of $24,000 per year.  During 2002, Dr. Nemeroff was paid $24,000 as compensation for his services as a member of our Psychopharmacology Advisory Board.  In addition, pursuant to the terms of the amended agreement, we granted an option to purchase 12,500 shares of our common stock to Dr. Nemeroff in connection with his service on the Psychopharmacology Advisory Board.  Dr. Nemeroff was also paid an additional $12,000 during 2002 in connection with services provided in an advisory capacity during 2001.  Dr. Nemeroff may also receive additional compensation of either $100,000 in cash or shares of our common stock with a value equal to $100,000, if our board of directors determines, in its sole discretion, that he actively and substantially participated and assisted in our achievement of certain milestones, including the following: identification, introduction, negotiation and completion of a significant strategic collaboration or similar transaction with any third party that we are pursuing; completion of a licensing transaction in which we license a pre-clinical or clinical compound or technology related to any indication that we are pursuing; or the completion of any other significant strategic transaction.

          On March 28, 2002, we issued and sold shares of our common stock and warrants to purchase shares of our common stock for an aggregate purchase price of approximately $17 million in a private financing.  Paramount Capital, Inc., one of the placement agents in the financing, is affiliated with Paramount Capital Asset Management, Inc., an 18.6% stockholder of the Company as of January 31, 2003.  In exchange for its services as a placement agent, Paramount received a cash commission of $594,040 and a warrant to purchase 343,573 shares of our common stock.

          Tim McInerney and Scott Katzmann both participated in the financing and are Senior Managing Directors at Paramount.  In addition, Lindsay Rosenwald, the President of Paramount Capital Asset Management, Inc., is the Managing Member of Orion Biomedical Fund, LP and Orion Biomedical Offshore Fund, LP, both of which participated in the financing.

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          Dr. Lawrence Kessel, a member of our board of directors, Daniel Kessel, Dr. Kessel’s brother, and Dr. Jay Kranzler, our Chief Executive Officer and Chairman of our board of directors, also participated in the financing. 

          Our Bylaws provide that we will indemnify our directors and executive officers and may indemnify our other officers, employees and other agents to the fullest extent permitted by Delaware law.  We are also empowered under our bylaws to enter into indemnification contracts with our directors and officers and to purchase insurance on behalf of any person who we are required or permitted to indemnify.  Pursuant to this provision, we have entered into indemnity agreements with each of our directors and officers and currently maintain directors and officers insurance coverage.

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PART IV

(a)     Evaluation of disclosure controls and procedures.  Our Principal Executive Officer and Principal Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act of 1934, as amended, rules 240.13a-14(c) and 15d-14(c)) as of a date within ninety days before the filing date of this annual report.  Based on that evaluation, the Principal Executive Officer and Principal Financial Officer have concluded that our current disclosure controls and procedures are effective.

(b)     Changes in internal controls.  There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of evaluation.

(a)   Financial Statements