CYPRESS BIOSCIENCE INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

(Mark One)

ý Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2005, or

o Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number 0-12943

CYPRESS BIOSCIENCE, INC.

(Exact Name of Registrant as specified in its charter)

DELAWARE		22-2389839
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

4350 Executive Drive, Suite 325, San Diego, California 92121

(Address of principal executive offices) (zip code)

(858) 452-2323

(Registrant’s telephone number including area code)

Indicate by check ý 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.

Yes ý No o

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

Yes ý No o

At May 5, 2005, 30,406,225 shares of Common Stock, par value $.001, of the registrant were issued and outstanding.

ITEM 1 – CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

CYPRESS BIOSCIENCE, INC.

BALANCE SHEETS

	March 31, 2005			December 31, 2004
	(Unaudited)			(Note)
ASSETS
Current assets:
Cash and cash equivalents	$	3,933,286		$	8,303,388
Short-term investments	107,285,968			103,720,610
Receivable from Forest Laboratories	2,562,302			5,656,964
Prepaid expenses and other current assets	681,977			601,721
Total current assets	114,463,533			118,282,683

Property and equipment, net	76,778			75,379
Other assets	31,462			31,462
Total assets	$	114,571,773		$	118,389,524

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	586,557		$	712,843
Accrued compensation	497,686			308,855
Accrued liabilities	222,744			461,582
Payable to Forest Laboratories	793,431			800,000
Capital lease obligations	33,004			36,870
Current portion of deferred revenue	3,125,000			3,125,000
Total current liabilities	5,258,422			5,445,150

Deferred rent	20,630			20,565
Deferred revenue, net of current portion	17,968,750			18,750,000

Stockholders’ equity:
Common stock, $.001 par value; 60,000,000 shares of common stock authorized; 30,404,415 and 30,363,994 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively; 15,000,000 shares of preferred stock authorized; no shares issued and outstanding	30,404			30,364
Additional paid-in capital	230,356,828			231,474,500
Accumulated other comprehensive income	178,401			161,327
Accumulated deficit	(139,241,662		)	(137,492,382		)
Total stockholders’ equity	91,323,971			94,173,809
Total liabilities and stockholders’ equity	$	114,571,773		$	118,389,524

See accompanying notes to financial statements.

Note: The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by accounting principles generally accepted in the United States.

CYPRESS BIOSCIENCE, INC.

STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended March 31,
	2005			2004
Revenue:
Revenues under collaborative agreement	$	3,210,590		$	3,392,618

Costs and expenses:
Research and development	5,392,556			4,572,728
General and administrative	1,369,606			2,167,124
Non-cash compensation charges (A)	141,187			5,448,281
Compensation benefit – variable stock options (B)	(1,392,060		)	(1,442,933		)
Total costs and expenses	5,511,289			10,745,200

Other income (expense):
Interest and other income, net	552,308			71,637
Interest expense	(889		)	(1,902		)
	551,419			69,735

Net loss	$	(1,749,280	)	$	(7,282,847	)

Net loss per share – basic and diluted	$	(0.06	)	$	(0.33	)

Shares used in computing net loss per share –basic and diluted	30,391,504			22,361,079

(A) Non-cash compensation charges include the following related expenses:
Research and development	$	87,729		$	104,552
General and administrative	53,458			5,343,729
	$	141,187		$	5,448,281

(B) Compensation benefit –variable stock options includes the following related expenses:
Research and development	$	—		$	(185,032	)
General and administrative	(1,392,060		)	(1,257,901		)
	$	(1,392,060	)	$	(1,442,933	)

See accompanying notes to financial statements.

CYPRESS BIOSCIENCE, INC.

STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended March 31,
	2005			2004
Operating Activities
Net loss	$	(1,749,280	)	$	(7,282,847	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization	9,155			13,566
Stock options and warrants issued for services	141,187			5,448,281
Stock compensation benefit on variable employee options	(1,392,060		)	(1,442,933		)
Changes in operating assets and liabilities, net	2,050,359			23,079,210
Net cash (used in) provided by operating activities	(940,639		)	19,815,277

Investing Activities
Purchases of short-term investments	(137,263,284		)	(34,814,897		)
Proceeds from sale of short-term investments	133,715,000			17,569,000
Purchases of property and equipment	(10,554		)	(5,134		)
Net cash used in investing activities	(3,558,838		)	(17,251,031		)

Financing Activities
Proceeds from exercise of stock options and warrants	133,241			436,012
Proceeds from payment of shareholder receivable	—			189,973
Payment of capital lease obligations	(3,866		)	(3,489		)
Net cash provided by financing activities	129,375			622,496

Increase (decrease) in cash and cash equivalents	(4,370,102		)	3,186,742
Cash and cash equivalents at beginning of period	8,303,388			859,820
Cash and cash equivalents at end of period	$	3,933,286		$	4,046,562

See accompanying notes to financial statements.

CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)

1. Business

We are committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes, such as Fibromyalgia Syndrome, or FMS, and other central nervous system disorders. We in-licensed our first clinical candidate for clinical development, milnacipran, in August of 2001 from Pierre Fabre Médicament, or Pierre Fabre. We completed our Phase II trial to evaluate milnacipran in the potential treatment of FMS in the fourth quarter of 2002, and the final results were announced in the first quarter of 2003. We initiated our first Phase III clinical trial evaluating the use of milnacipran as a potential treatment for FMS in the fourth quarter of 2003. In January 2004, we entered into an agreement with Forest Laboratories for the development and marketing of milnacipran (Note 10). In October 2004, we and Forest Laboratories initiated the second Phase III clinical trial evaluating milnacipran for the treatment of FMS.

2. Basis of Presentation

The accompanying financial statements have been prepared by our management without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the SEC. In the opinion of our management, all adjustments necessary for a fair presentation of the accompanying unaudited financial statements are reflected herein. All such adjustments are normal and recurring in nature. Interim results are not necessarily indicative of results for the full year. For more complete financial information, these financial statements should be read in conjunction with the audited financial statements and the related disclosures included in our 2004 report on Form 10-K filed with the SEC on March 16, 2005.

3. Short-Term Investments

Our short-term investments consist of securities of the U.S. government or its agencies and certificates of deposit with maturities ranging from one to twelve months. We have classified our short-term investments as “available-for-sale” and carry them at fair value with unrealized gains and losses, if any, reported as a separate component of stockholders’ equity and included in comprehensive loss.

At March 31, 2005 and December 31, 2004, short-term investments consisted of the following:

	March 31, 2005
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value

U.S. government and agency debt	$	100,506,932	$	188,584	$	—		$	100,695,516
Certificates of deposit	6,600,635		—		(10,183		)	6,590,452
	$	107,107,567	$	188,584	$	(10,183	)	$	107,285,968

	December 31, 2004
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value

U.S. government and agency debt	$	95,058,608	$	175,347	$	—		$	95,233,955
Certificates of deposit	8,500,675		—		(14,020		)	8,486,655
	$	103,559,283	$	175,347	$	(14,020	)	$	103,720,610

4. Revenue Recognition

In accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements (as amended by SAB 104), and Emerging Issues Task Force (“EITF”) No. 00-21, Revenue Arrangements with Multiple Deliverables, 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. Amounts received for upfront license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Amounts received for sponsored development activities are recognized as research costs are incurred over the period specified in the related agreement or as the services are performed. Amounts received for milestones are recognized upon achievement of the milestone, which requires substantive effort and was not readily assured at the inception of the agreement. Any amounts received prior to satisfying revenue recognition criteria will be recorded as deferred revenue.

5. Research and Development Expenses

Research and development expenses are expensed as incurred and consist primarily of salaries and related personnel expenses for our research and development personnel, fees paid to external service providers, patient enrollment costs, fees and milestone payments under our license and development agreements and costs for facilities, supplies, materials and equipment. All such costs are charged to research and development expenses as incurred. Such costs also include research and development expenses incurred in connection with our first Phase III program for milnacipran which are reimbursed by Forest Laboratories pursuant to our collaboration agreement.

6. Net Income (Loss) Per Share

Net income (loss) per share is computed using the weighted average number of shares of common stock outstanding and is presented for basic and diluted income (loss) per share. Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares had been issued. The dilutive effect of outstanding stock options and warrants is reflected in diluted income (loss) per share by application of the treasury stock method. We have excluded all outstanding stock options and warrants from the calculation of diluted loss per share for the three months ended March 31, 2005 and 2004 because such securities are antidilutive for these periods. The total number of potential common shares excluded from the calculation of diluted loss per common share was 2,802,749 and 3,770,641 for the three months ended March 31, 2005 and 2004, respectively.

The following table presents the computation of basic and diluted shares outstanding:

	Three Months Ended March 31,
	2005	2004

Weighted average common shares outstanding – shares used in calculating per share amounts – basic	30,391,504	22,361,079
Effect of dilutive common share equivalents – stock options and warrants outstanding	—	—
Shares used in calculating per share amounts – diluted	30,391,504	22,361,079

7. Comprehensive Loss

The components of comprehensive loss are as follows:

	Three Months Ended March 31,
	2005			2004
Net loss	$	(1,749,280	)	$	(7,282,847	)
Unrealized gain on short-term Investments	17,074			11,547
Comprehensive loss	$	(1,732,206	)	$	(7,271,300	)

8. Stock-Based Compensation

We record compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees. Accordingly, no compensation expense is recognized if the exercise price of stock options equals the fair market value of the underlying stock at the date of grant. Options which were granted to employees pursuant to our option cancel and re-grant program are accounted for as variable in accordance with FASB Interpretation No. 44 (“FIN 44”), Accounting for Certain Transactions Involving Stock Compensation – An Interpretation of APB Opinion No. 25, whereby the intrinsic value of the options to purchase common stock are re-measured at the end of each period for the term of the option and amortized over the vesting period.

Compensation expense for options granted to non-employees has been determined at the grant date in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, and Emerging Issues Task Force (“EITF”) No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services, and has been recorded at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. Such compensation is recognized over the related vesting period of the underlying option.

As required under SFAS No. 123, Accounting for Stock-Based Compensation Transition and Disclosure, the pro forma effects of stock-based compensation on net loss and net loss per share have been estimated at the date of grant using the Black-Scholes option-pricing model. Had compensation cost for our stock-based compensation plans been determined based on the fair value at the grant dates for

awards under those plans, our net loss and net loss per share would have been adjusted to the pro forma amounts presented below:

	Three Months Ended March 31
	2005			2004

Net loss, as reported	$	(1,749,280	)	$	(7,282,847	)
Add: Stock-based employee compensation benefit included in reported net loss	(1,392,060		)	(1,442,933		)
Deduct: Total stock-based employee compensation expense determined under fair value based methods	(1,188,251		)	(433,340		)
Pro forma net loss	$	(4,329,591	)	$	(9,159,120	)

	Three Months Ended March 31,
	2005			2004
Net loss per share:
Basic and diluted – as reported	$	(0.06	)	$	(0.33	)
Basic and diluted – pro forma	$	(0.14	)	$	(0.41	)

9. Stockholders’ Equity

Stock Option Cancel and Re-Grant Program

In June 2001, we implemented an option cancel and re-grant program. Pursuant to the program, the exercise price of certain options held by certain of our executive officers and directors were exchanged for options with an exercise price of $2.50 per share, the fair market value of our common stock on June 27, 2001, the date the option cancel and re-grant program was effected. The replacement options expire no later than the earlier of the expiration date of the original option grant or June 27, 2006.

As a result of the program, we granted options to purchase 618,738 shares of our common stock. In accordance with FIN 44, the shares underlying the options are accounted for as variable, and the intrinsic value of the options to purchase common stock are re-measured at the end of each period for the term of the option and amortized over the vesting period. During the three months ended March 31, 2005 and 2004, as the intrinsic value of the common stock underlying the options decreased due to a decrease in our stock price during these periods, we recognized a compensation benefit of $1,392,060 and $1,442,933, respectively.

10. Collaboration Agreement

In January 2004, we entered into a collaboration agreement with Forest Laboratories for the development and marketing of milnacipran. Under our agreement with Forest Laboratories, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals, as well as a certain number of our employees. However, in light of the increased expense and risk associated with running two parallel trials, we have agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to the agreement with Forest Laboratories. In connection with this arrangement, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004, and we will pay for a

majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the New Drug Application (NDA) submission to the FDA and with a premium under certain additional circumstances. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, and we will have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest Laboratories in an amount equal to Forest Laboratories’ cost of providing the equivalent detailing calls.

Under the agreement with Forest Laboratories, we received an upfront, non-refundable payment of $25.0 million, of which $1.25 million, classified as research and development expenses, was paid to Pierre Fabre as a sublicense fee. The total upfront and milestone payments to us under the agreement could total approximately $205.0 million related to the development of milnacipran for the treatment of FMS, a large portion of which will depend upon achieving certain sales of milnacipran and an additional $45.0 million in the event that we and Forest Laboratories develop other indications for milnacipran. In addition, we have the potential to receive royalty payments based on sales of licensed product under this agreement. Forest Laboratories also assumed the future royalty payments due to Pierre Fabre and the transfer price for the active ingredient used in milnacipran.

11. Related Party Transaction

A member of our board of directors accepted the position of CEO of a biotechnology company in April 2005. We entered into an agreement with this company in January 2005 with respect to the in-license of certain patents. Under this agreement, we have paid an aggregate of $1.5 million to such biotechnology company. In the event we move forward with development of a product or products under this agreement, we would be obligated to pay certain milestone and royalty payments.

12. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share Based Payment (“SFAS 123R”), which is a revision of SFAS 123, Accounting for Stock-Based Compensation. This statement supercedes APB Opinion 25, Accounting for Stock Issued to Employees (“APB 25”), and amends SFAS 95, Statement of Cash Flows. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123, however, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

SFAS 123R permits companies to adopt its requirements using either a “modified prospective” method or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements for SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but also permits companies to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. We currently utilize the Black-Scholes model to measure the fair value of stock options granted to employees. While SFAS 123R permits companies to continue to use such model, it also permits the use of a “lattice” model. We have not yet determined which model we will use to measure the fair value of employee stock options under the adoption for SFAS 123R. The new standard was originally to be effective for the first interim reporting period that begins after June 15, 2005; however, a recent action by the Securities and Exchange Commission delayed the effective date until fiscal 2006.

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 of 1933, as amended and Section 21E of the Securities 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-Q and any or all of our forward looking statements may turn out to be wrong. Factors that could cause or contribute to differences include, but are not specifically limited to, our ability to develop milnacipran for Fibromyalgia Syndrome, our ability to develop or acquire any compounds or products to treat any other indications we may pursue in a timely manner, or at all, as well as the other risks detailed in this Form 10-Q and in our other SEC filings.

We undertake no obligation to publicly release revisions in such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events or circumstances, except as required by securities and other applicable laws.

Company Overview

We are committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes and other central nervous system disorders. Functional Somatic Syndromes refer to several related syndromes characterized more by symptoms, suffering and disability than by disease-specific abnormalities that are found upon physical examination and include many overlapping pain and psychiatric conditions such as Fibromyalgia Syndrome, or FMS, irritable bowel syndrome, non-cardiac chest pain and interstitial cystitis, or chronic pelvic pain. Our goal is to be the first to commercialize a product approved in the United States for the treatment of FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes. In January 2004, we entered into a collaboration agreement with Forest Laboratories, Inc., a leading marketer of central nervous system drugs with a strong franchise in the primary care and psychiatric markets, for the development and marketing of milnacipran. We are currently running the first Phase III trial for milnacipran, which was commenced in October 2003. Enrollment in this trial was completed in December 2004, with results expected to be available in the Fall of 2005. In October 2004, Forest Laboratories initiated the second Phase III trial evaluating milnacipran for the treatment of FMS. These two Phase III trials and any additional studies needed for regulatory approval could possibly be completed in 2006 and, if successful, a New Drug Application, or NDA, for FMS could possibly be submitted later in that year at the earliest.

We completed a Phase II trial evaluating milnacipran for the treatment of FMS in the Fall of 2002. The Phase II trial was a three-month, randomized, placebo-controlled study involving 14 sites and 125 FMS patients who were randomized to either milnacipran treatment or placebo. In this clinical trial, milnacipran was shown to provide statistically significant improvement in pain, the primary symptom of FMS. No unexpected safety concerns arose from this trial and there were no serious adverse events.

We obtained an exclusive license for milnacipran from Pierre Fabre Medicament in 2001. Milnacipran has been marketed outside of the United States since 1997 as an antidepressant and has been used by over 3,000,000 patients worldwide. We have paid Pierre Fabre a total of $2.5 million, including upfront payments of $1.5 million in connection with the execution of the original license agreement in 2001 and a $1.0 million milestone payment in September 2003, and issued Pierre Fabre 1,000,000 shares of

common stock and warrants to purchase 300,000 shares of common stock in connection with an amendment to the agreement with Pierre Fabre. Additional payments to Pierre Fabre of up to a total of $4.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones. Under our agreement with Forest Laboratories, we sublicensed our rights to milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. Additionally, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approval, as well as a specified number of our employees. However, in light of the increased expense and risk associated with running two parallel trials, we have agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with this arrangement, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004, and we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA and with a premium under certain additional circumstances. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, while we have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls.

In August 2002, we entered into a reformulation and new product agreement with Collegium Pharmaceutical, Inc. pursuant to which Collegium is attempting to develop new formulations of milnacipran and new products that are analogs of milnacipran. In January 2004, we exercised our option to acquire an exclusive license to technology developed under this agreement. In the event we commercialize any of the reformulations or new products developed under our agreement with Collegium, we will be obligated to pay Collegium milestone payments of up to $5.4 million in the aggregate upon achievement of defined clinical and regulatory objectives, as well as potential royalty payments based on the net sales of reformulated or new products. In October 2002, we also 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.

We are continuing to evaluate other various potential strategic transactions, including the potential acquisitions of products, technologies and companies, and other alternatives that we believe may enhance stockholder value.

Results of Operations

The following discussion should be read in conjunction with the financial statements and the related notes contained elsewhere in this quarterly report.

Comparison of Three Months Ended March 31, 2005 and 2004

Revenue

We recognized revenues under our collaborative agreement of $3.2 million for the three months ended March 31, 2005 compared to $3.4 million for the three months ended March 31, 2004. The decrease in revenues under our collaborative agreement is due to the elimination of funding from Forest Laboratories for certain of our employees devoted to the development of milnacipran as of the fourth quarter in 2004. This decrease was partially offset by an increase in sponsored development reimbursements during the first quarter of 2005, including costs incurred during the first quarter of 2005 in connection with the extension trial to our first Phase III trial, which commenced during the third

quarter of 2004. The revenues recorded during 2005 and 2004 consist solely of amounts earned pursuant to our collaboration agreement with Forest Laboratories for the development and marketing of milnacipran, entered into in January 2004. Such revenues include the recognition of the upfront payment of $25.0 million from Forest Laboratories on a straight-line basis over a period of 8 years, sponsored development reimbursements and funding received from Forest Laboratories during the first quarter of 2004 for certain of our employees devoted to the development of milnacipran.

We currently are not generating any revenues from product sales and we do not expect to generate revenues from product sales for at least the next several years, if at all. Until we generate revenues from product sales, we expect our revenues to consist of the continued recognition on a straight-line basis of the upfront payment of $25.0 million, sponsored development reimbursements and possible future milestone payments under our agreement with Forest Laboratories, which are contingent upon the achievement of agreed upon objectives and which are not guaranteed payments. In connection with our arrangement with Forest Laboratories regarding cost sharing arrangements for the second Phase III trial only, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004. Additionally, the amount of sponsored development reimbursements from Forest Laboratories may change periodically based on the level of development activity. Our collaboration agreement is subject to early termination by Forest Laboratories upon specified events, including breach of the agreement.

Research and Development

Research and development expenses for the three months ended March 31, 2005 were $5.4 million compared to $4.6 million for the three months ended March 31, 2004. The increase in research and development expenses is primarily attributable to costs incurred during the first quarter of 2005 in connection with the extension trial to our first Phase III trial, which commenced during the third quarter of 2004, and our second Phase III trial for milnacipran, which commenced during the fourth quarter of 2004, a license fee of $1.5 million paid during the first quarter of 2005 and costs incurred in connection with various proof of concept studies. This increase in research and development expenses during the first quarter of 2005 was partially offset by a $1.25 million sublicense fee to Pierre Fabre recorded during the first quarter of 2004 in connection with our collaboration agreement with Forest Laboratories and a payment for the exercise of our option in January 2004 to acquire an exclusive license to technology developed under our reformulation and new product agreement with Collegium. During the first quarter of 2005, we incurred total costs of $3.1 million in connection with our Phase III programs compared to a total of $3.5 million (including the $1.25 million sublicense fee to Pierre Fabre) during the first quarter of 2004. The costs for the first Phase III clinical trial and extension trial are being reimbursed by Forest Laboratories as noted below.

Effective January 9, 2004, pursuant to our collaboration agreement with Forest Laboratories, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals. This funding received from Forest Laboratories for sponsored development reimbursements is included as a component of our revenue under collaborative agreement on the statement of operations. However, in light of the increased expense and risk associated with running two parallel trials, we have agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with this arrangement, we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA and with a premium under certain additional circumstances.

In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $88,000 and $105,000 related to research and development expenses for the three months ended March 31, 2005 and 2004, respectively, and as discussed below in “Compensation Benefit — Variable Stock Options,” we recognized a compensation benefit for variable stock options of $0 and $185,000 related to research and development expenses for the three months ended March 31, 2005 and 2004, respectively.

General and Administrative

General and administrative expenses for the three months ended March 31, 2005 were $1.4 million compared to $2.2 million for the three months ended March 31, 2004. The decrease in general and administrative expenses is primarily due to non-recurring costs incurred during the first quarter of 2004, consisting of a success-based fee paid to our investment bankers in connection with the closing of our collaboration agreement with Forest Laboratories in January 2004 and a one-time fee associated with our being listed during the first quarter of 2004 on the Nasdaq National Market. This decrease was partially offset by an increase in consulting costs and travel expenses during the first quarter of 2005 in connection with business development activities.

In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $53,000 and $5.3 million related to general and administrative expenses for the three months ended March 31, 2005 and 2004, respectively, and as discussed below in “Compensation Benefit — Variable Stock Options,” we recognized a compensation benefit for variable stock options of $1.4 million and $1.3 million related to general and administrative expenses for the three months ended March 31, 2005 and 2004, respectively.

Non-Cash Compensation Charges

Non-cash compensation charges for the three months ended March 31, 2005 were $141,000, consisting of approximately $88,000 related to research and development expenses and $53,000 related to general and administrative expenses, compared to $5.4 million, consisting of approximately $105,000 related to research and development expenses and $5.3 million related to general and administrative expenses, for the three months ended March 31, 2004. The decrease in non-cash compensation charges is primarily due to non-recurring, non-cash compensation charges recorded during the first quarter of 2004, consisting of $2.4 million related to stock options previously granted to consultants and two former board members for services that vested upon the completion of the collaboration agreement with Forest Laboratories and $2.8 million in connection with the accounting treatment for stock options related to the resignation of certain board members to roles as consultants during the first quarter of 2004.

Compensation Benefit – 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. During the three months ended March 31, 2005, as the intrinsic value of the common stock underlying the options declined due to a decrease in our stock price during the period, we recognized a compensation benefit of $1.4 million, consisting of $0 related to research and development expenses and $1.4 million related to general and administrative expenses. Similarly, due to a decrease in our stock price during the three months ended March 31, 2004, we recognized a compensation benefit of $1.4 million, consisting of $185,000 related to research and development expenses and $1.3 million related to general and administrative expenses. In the event our stock price is above $9.14 (closing price on March 31,

2005) on June 30, 2005, we will record additional compensation charges (however, we cannot predict what our stock price will be in the future and it may be substantially lower than $9.14).

Interest and Other Income

Interest and other income, net, for the three months ended March 31, 2005 was $552,000 compared to $72,000 for the three months ended March 31, 2004. The increase in interest and other income for the three months ended March 31, 2005 compared to the corresponding period in 2004 is primarily due to higher cash and investment balances during the first quarter of 2005 achieved primarily through the proceeds from our secondary offering completed in April 2004, and a general increase in interest rates and related yields experienced during the first quarter of 2005 compared to the first quarter of 2004.

Liquidity and Capital Resources

At March 31, 2005, we had cash, cash equivalents and short-term investments of $111.2 million compared to cash, cash equivalents and short-term investments of $112.0 million at December 31, 2004. Working capital at March 31, 2005 totaled $109.2 million compared to $112.8 million at December 31, 2004. We have invested a substantial portion of our available cash in high quality marketable debt instruments of governmental agencies and certificates of deposit, which are within federally insured limits. We have established guidelines relating to our investments to preserve principal and maintain liquidity.

Net cash used in operating activities totaled $0.9 million for the three months ended March 31, 2005, compared to net cash provided by operating activities of $19.8 million for the three months ended March 31, 2004. The primary use of cash during the three months ended March 31, 2005 was to fund our operating activities during the period. The primary source of cash from operations during the three months ended March 31, 2004 was the upfront payment of $25.0 million received from Forest Laboratories, offset by cash used in operations of approximately $5.2 million.

Net cash used in investing activities was $3.6 million for the three months ended March 31, 2005, compared to $17.3 million for the three months ended March 31, 2004. The decrease in net cash used in investing activities during the three months ended March 31, 2005 compared to the corresponding prior year period was primarily a result of the purchase of short-term securities with a portion of the proceeds from the upfront payment of $25.0 million received from Forest Laboratories during the first quarter of 2004.

Net cash provided by financing activities was $0.1 million for the three months ended March 31, 2005, compared to $0.6 million for the three months ended March 31, 2004. The decrease in net cash provided by financing activities during the three months ended March 31, 2005 compared to the corresponding prior year period was primarily the result of proceeds of approximately $0.1 million from the exercise of stock options during the first quarter of 2005, compared to proceeds of approximately $0.4 million from the exercise of stock options and warrants and the receipt of the payment of the shareholder receivable in the amount of $0.2 million during the first quarter of 2004.

The following table summaries our long-term contractual obligations as of March 31, 2005:

	Total		Less than 1 year (2005)		1 - 3 years (2006- 2008)		After 4 years (2009 and beyond)
Capital leases, including interest payments	$	36,455.455	$	14,265	$	22,190	$	—
Operating leases	429,080		134,006		295,074		—
Purchase obligations (1)	334,665		297,165		37,500		—
Total	$	800,200	$	445,436	$	354,764	$	—

(1) Purchase obligations include agreements to purchase goods or services, including consulting services, that are enforceable and legally binding on us and that specify all significant terms. This includes contracts that are cancelable with notice and the payment of an early termination penalty. Purchase obligations exclude agreements that are cancelable without penalty and also exclude liabilities to the extent presented on the balance sheet as of March 31, 2005.

Other commercial commitments include certain potential milestone, sublicense and royalty payments to Pierre Fabre and Collegium discussed in the “Overview” section. Contractual obligations for which we will be reimbursed by Forest Laboratories are not included in the table above. In light of the increased expense and risk associated with running two parallel trials, we have agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with this arrangement, we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA and with a premium under certain additional circumstances.

Until we can consistently generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources that were primarily generated from the proceeds of offerings of our equity securities and from revenue from our collaboration agreement and if available to us, cash from financings. Our current expected primary cash needs on both a short term and long-term basis are for the identification, acquisition or license, and development of potential future products, development of current products, working capital and other general corporate purposes. In addition to the amounts required to pay any amounts payable under our agreements with Pierre Fabre and Collegium, costs of in-licensing or acquiring additional compounds or companies, funding external research and funding clinical development for any product that we may in-license or acquire, we estimate that based on our current business plan, we will require approximately $9 million to fund our operations for the remainder of 2005. One of our goals for 2005 is to identify and in-license a new product. In the event we acquire, license or develop any new products, the amount to fund our operations for 2005 would increase, possibly materially. We expect the current trend of net losses to continue for at least the next several years as we seek to acquire, license or develop additional products for the treatment of Functional Somatic Syndromes and other central nervous system disorders. Such losses may fluctuate, and the fluctuations may be substantial.

Based on our current business plan, we believe our cash and cash equivalents and short-term investments balances at March 31, 2005 are sufficient to fund operations for the next several years. However, we are actively continuing to evaluate various potential strategic transactions, including the

potential acquisitions of products and companies, and other alternatives that we believe may enhance stockholder value. In order to acquire or develop additional products, we will require additional capital. The amount of capital we require is dependent upon many forward-looking factors that could significantly increase our capital requirements, including the following:

• the extent to which we acquire or invest in other products and businesses;

• the costs of in-licensing drug candidates;

• the ability of Forest Laboratories and us to reach milestones, and other events or developments under our collaboration agreement;

• the costs and timing of development and regulatory approvals for milnacipran; 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. Until we can generate a sufficient amount of product revenue, if ever, we expect to finance future capital needs through public or private debt or equity offerings or collaboration and licensing arrangements, as well as interest income earned on cash balances. We do not currently have any commitments for future external funding. 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 may be required to delay, scale back or eliminate some or all of our development of future additional product candidates.

To date, we have not had any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies

There were no significant changes in critical accounting policies or estimates from those at December 31, 2004.

Recent Accounting Pronouncements

retrospective” method, the requirements are the same as under the “modified prospective” method, but also permits companies to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. We currently utilize the Black-Scholes model to measure the fair value of stock options granted to employees. While SFAS 123R permits companies to continue to use such model, it also permits the use of a “lattice” model. We have not yet determined which model we will use to measure the fair value of employee stock options under the adoption for SFAS 123R. The new standard was originally to be effective for the first interim reporting period that begins after June 15, 2005; however, a recent action by the Securities and Exchange Commission delayed the effective date until fiscal 2006.

We currently account for share-based payments to employees using APB 25’s intrinsic value method and, as such, recognize no compensation cost for employee stock options granted with exercise prices equal to or greater than the fair value of our common stock on the date of the grant. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on the level of share-based payments granted in the future. However, had we adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share in the notes to the financial statements.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We have invested our excess cash in United States government securities, certificates of deposit and money market funds with strong credit ratings. Our investment policy also allows us to invest in AAA-rated commercial paper. 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 4 – CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the timelines specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the

Risk Factors

There are limited data regarding milnacipran as a treatment of FMS and it may not work for FMS or there may be safety issues with its use in this patient population.

There are limited data supporting the use of milnacipran, our only product candidate, for the treatment of FMS. Although milnacipran is currently being sold by Pierre Fabre outside North America as an antidepressant, it has only been tested as a treatment for FMS in our Phase II trial, during which milnacipran was administered to only 97 individuals with FMS. We must conduct and obtain favorable results in at least two pivotal Phase III trials to support an application for FDA approval of the product candidate. We have two ongoing Phase III clinical trials and cannot predict whether the results of our Phase II trial will be repeated in our Phase III clinical trials which have larger patient populations and are being conducted for longer time periods. As expected, we are experiencing higher patient drop out rates in our Phase III trials than in our Phase II trial for milnacipran. The only data we, or any of our investigators, currently have available to us from these trials is blended and blinded, meaning that the data is pooled from a number of patients and we do not have access to the key to correlate individual patients’ responses to whether they are on placebo or drug. The data are therefore not decipherable and any speculation about outcome from these data is not meaningful for predicting efficacy of milnacipran. Milnacipran may not prove to be effective to treat FMS in either or both of our Phase III trials. The FDA has never approved a drug for the treatment of FMS. In addition, our clinical trials may reveal that milnacipran is not safe. If milnacipran is not demonstrated to be a safe and effective treatment for FMS to the satisfaction of the FDA or other regulatory agencies, we will not receive regulatory approval and our business would be materially harmed.

We are dependent on our collaboration with Forest Laboratories to develop and commercialize milnacipran, our only product candidate, and to obtain regulatory approval. Events or circumstances may occur that delay or prevent the development and commercialization of milnacipran.

Pursuant to the terms of our collaboration agreement with Forest Laboratories, we granted Forest Laboratories an exclusive sublicense for the development and marketing of milnacipran, our only product candidate, for all indications in the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has the option to acquire an exclusive license from us in the United States, and potentially Canada, to any compounds developed under our agreement with Collegium Pharmaceutical. Forest Laboratories is responsible for funding the development of milnacipran, including clinical trials and regulatory approval. In light of the increased expense and risk associated with running two parallel trials, we have agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. If the FDA approves this product candidate, Forest Laboratories will also have primary responsibility for the marketing and sale of the approved product and will share responsibility for compliance with regulatory requirements. We have limited control over the amount and timing of resources that Forest Laboratories will dedicate to the development, approval and marketing of milnacipran. Our ability to generate milestone and royalty payments from Forest Laboratories depends on Forest Laboratories’ ability to establish the safety and efficacy of milnacipran, obtain regulatory approvals and achieve market acceptance of milnacipran for the treatment of FMS.

We are subject to a number of additional risks associated with our dependence on our collaboration with Forest Laboratories, including:

• Forest Laboratories could delay the commencement of any additional clinical trials for milnacipran for the treatment of FMS, extend the timeframe of any clinical trials, including

the second Phase III clinical trial for milnacipran, underfund such clinical trials, stop either phase III trial or any other clinical trials for milnacipran or abandon development of milnacipran, repeat or conduct additional clinical trials or require a new formulation of milnacipran for clinical testing;

• We and Forest Laboratories could disagree as to development plans, including the number and timing of clinical trials or regulatory approval strategy, or as to which additional indications for milnacipran should be pursued, if any, and therefore milnacipran may never be developed for any indications other than FMS;

• Forest Laboratories could independently develop, develop with third parties or acquire products that could compete with milnacipran, including drugs approved for other indications used by physicians off-label for the treatment of FMS;

• Forest Laboratories could fail to devote sufficient resources to the development, approval, commercialization, or marketing and distribution of any products developed under our collaboration agreement, including by failing to develop specialty sales forces if such sales forces are necessary for the most effective distribution of any approved product; and

• Disputes regarding the collaboration agreement that delay or terminate the development, commercialization or receipt of regulatory approvals of milnacipran, may delay or prevent the achievement of clinical or regulatory objectives that would result in the payment of milestone payments or result in significant litigation or arbitration.

Furthermore, Forest Laboratories may terminate our collaboration agreement upon our material breach or our bankruptcy and may also terminate our agreement upon 120 days’ notice in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of a new drug application or to result in labeling or indications that would significantly adversely affect the marketing of any product developed under the agreement. If any of these events occur, we may not be able to find another collaborator for development or commercialization, and if we elected to pursue further development and commercialization of milnacipran, we would experience substantially increased capital requirements that we might not be able to fund.

We rely upon an exclusive license from Pierre Fabre in order to develop and sell our milnacipran product candidate, and our ability to pursue the development and commercialization of milnacipran for the treatment of FMS depends upon the continuation of our license from Pierre Fabre.

Our license agreement with Pierre Fabre provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada, with a right to sublicense certain rights to Forest Laboratories under our collaboration with Forest Laboratories. Either we or Pierre Fabre may terminate the license agreement for cause upon 90 days’ prior written notice to the other party upon the bankruptcy or dissolution of the other party, or upon a breach of any material provision of the agreement if the breach is not cured within 90 days following the written notice. Furthermore, Pierre Fabre has the right to terminate the agreement upon 90 days’ prior notice to us if we and Forest terminate our development and marketing activities with respect to milnacipran, if we challenge certain patent rights of Pierre Fabre and under specified other circumstances. If our license agreement with Pierre Fabre were terminated, we would lose our rights to develop and commercialize products using the compound milnacipran as an active ingredient, as the compound is manufactured under Pierre Fabre patents and using Pierre Fabre know-how and trade secrets, and it would be unlikely that we could obtain the active ingredient in milnacipran from any other source.

We rely upon Pierre Fabre as our exclusive supplier of the compound used as the active ingredient in our milnacipran product candidate and if Pierre Fabre fails to supply us sufficient quantities of the active ingredient it may delay or prevent us from developing and commercializing our only product candidate.

Pursuant to our purchase and supply agreement with Pierre Fabre, Pierre Fabre is the exclusive supplier to us and Forest Laboratories of the compound used as the active pharmaceutical ingredient in our milnacipran product candidate. Neither we nor Forest Laboratories have facilities for the manufacture of the product candidate. Currently, Pierre Fabre manufactures the active ingredient of milnacipran in its facility in Gaillac, France and Pierre Fabre is the only worldwide supplier of the active ingredient of milnacipran that is currently approved for sale as an antidepressant in 32 countries, but is not approved for sale in the United States. If any product is commercialized under the agreement, Pierre Fabre will have the exclusive right to manufacture the active ingredient used in our commercial product. If milnacipran is commercialized in the United States, Pierre Fabre’s facility will need to be inspected by the FDA for compliance with current good manufacturing practices, or cGMP, requirements. Due to the projected commercial quantities of milnacipran that we may require and to provide a second manufacturing site, Pierre Fabre has agreed that within a certain time period after commercial launch of milnacipran, it will qualify an additional manufacturing facility. We do not have control over Pierre Fabre’s compliance with cGMP requirements or Pierre Fabre’s compliance with its obligation to qualify a second manufacturing facility. If Pierre Fabre fails or is unable to provide, in a timely and economic manner, required quantities of the active ingredient that Forest Laboratories or we request for clinical purposes, our development program could be delayed. In addition, if Pierre Fabre fails to timely and economically supply us sufficient quantities for commercial sale, our product sales and market acceptance of the product could be adversely affected.

Furthermore, our purchase and supply agreement may be terminated for cause either by us or by Pierre Fabre upon 90 days’ prior written notice to the other party upon a material breach of the agreement if the breach is not cured within 90 days following the written notice. We have the right to manufacture milnacipran if Pierre Fabre does not have a required buffer stock or in the event that we terminate our license agreement with Pierre Fabre under certain circumstances. If our purchase and supply agreement with Pierre Fabre is terminated, we are unlikely to be able to qualify another supplier of the active ingredient within a reasonable time period, and our ability to develop and commercialize milnacipran will be significantly impaired.

Our agreements with Pierre Fabre and Forest Laboratories restrict our ability to develop specified compounds, which limits how we can expand our product candidates.

Under our agreements with Pierre Fabre and Forest Laboratories, Forest Laboratories has agreed to pay Pierre Fabre and us a royalty, in the event that Forest Laboratories sells a product other than milnacipran for FMS for a specified period of time, which shall not be less than three years. We are, in turn, obligated to pay a portion of the royalty we receive from Forest Laboratories to Pierre Fabre. In addition, each of us is subject to limitations related to each party’s development of any serotonin norephinephrine reuptake inhibitors, or SNRI, products other than milnacipran. These limitations include: (i) a prohibition on developing an SNRI product for specified indications for which milnacipran is being developed; and (ii) a prohibition on developing an SNRI product for any indication for a specified time period, and after such specified time period, a requirement that if one of the parties launches and sells an SNRI product that is prescribed off-label for any indication for which milnacipran is being developed, the selling party must reimburse the other parties for lost sales due to the off-label use.

Provisions in our collaboration agreement with Forest Laboratories and our license agreement with Pierre Fabre may prevent or delay a change in control.

Our collaboration agreement with Forest Laboratories provides that Forest Laboratories may elect to terminate our co-promotion rights for milnacipran or any other product developed under the collaboration agreement and we may lose our decision making authority with respect to the development of milnacipran if

we engage in a merger, consolidation or sale of all or substantially all of our assets, or if another person or entity acquires at least 50% of our voting capital stock. Our license agreement with Pierre Fabre provides that Pierre Fabre may elect to terminate the agreement upon a change in control transaction in which a third party acquiror of us controls an SNRI product, and the acquiror does not take certain actions (e.g., divestiture of such SNRI product) within a specified time period to cure the breach of certain restrictions in the agreement that results from such SNRI product.

If Forest Laboratories and/or Pierre Fabre elected to exercise these termination rights, we or our successor could lose the ability to develop, commercialize and market milnacipran. These provisions may have the effect of delaying or preventing a change in control or a sale of all or substantially all of our assets, or may reduce the number of companies interested in acquiring us.

We have limited experience in identifying, completing and integrating acquisitions, including acquisitions of product candidates, and other targets, and we may incur unexpected costs and disruptions to our businesses if we make mistakes in our selection of future acquisitions or fail to integrate any future acquisitions.

As part of our strategy, we are continuing to evaluate potential strategic transactions, including potential acquisitions of products, technologies and companies, in order to expand our product pipeline. As we did with our in-licensing of milnacipran, we may seek to in-license compounds or acquire products or businesses. Future acquisitions and licensing transactions may expose us to operational and financial risks, including:

• higher development costs than we anticipate;

• higher than expected licensing or acquisition and integration costs;

• exposure to unknown liabilities of licensed or acquired intellectual property, compounds or products;

• disruption of our business and diversion of our management’s time and attention to developing licensed or acquired compounds or products;

• incurrence of dilutive issuances of securities or substantial debt to pay for licensing or acquisitions; and

• impairment of relationships with key collaborators, suppliers or customers of any acquired businesses due to changes in management or ownership.

We also may devote resources to potential strategic transactions that require several agreements and that we never complete or may fail to realize the anticipated benefit of any strategic transaction we do complete. Finally, we may incur unexpected costs in connection with the disposition of products or businesses, including our disposition of our PROSORBA column for which we indemnified Fresenius HemoCare for any losses related to patent or trademark infringement claims.

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 and do not have any commercial products. We have only one product candidate, milnacipran, which we sublicensed to Forest Laboratories in January 2004. Milnacipran, or any future product candidates we may acquire or develop, will require significant additional development, clinical trials, regulatory approvals 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 are not shown to be safe and effective in clinical trials, because we have inadequate financial or other resources to pursue clinical development of the product candidate, or because the FDA does not grant regulatory approval. We do not expect milnacipran to be marketed for a number of years, if at all. If we and Forest Laboratories are unable to develop milnacipran as a commercial drug in the United States, 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.

The FDA approval of milnacipran or any future product candidate is uncertain and will involve the commitment of substantial time and resources.

Even if our Phase III trials or any future clinical trials are successful, we may not receive required regulatory approval from the FDA or any other regulatory body required for the commercial sale of milnacipran in the United States. In addition, even if we do obtain approval to market milnacipran, the approval process by the FDA may take longer than we anticipate. The regulatory approval of a new drug typically takes many years and the outcome is uncertain. Despite the time and resources expended, regulatory approval is never guaranteed. If we fail to obtain regulatory approval for milnacipran or any future product candidates, we will be unable to market and sell any products and therefore may never generate any revenues from product sales or become profitable. In addition, our collaborators, or our third party manufacturers’ failure to comply with the FDA and other applicable United States or foreign regulations may subject us to administrative or judicially imposed sanctions, including warning letters, civil and criminal penalties, injunctions, product seizure or detention, product recalls, total or partial suspension of production and refusal to approve new drug approval applications.

As part of the regulatory approval process, we must conduct, at our own expense, preclinical research and clinical trials for each product candidate sufficient to demonstrate its safety and efficacy to the satisfaction of the FDA and other regulatory agencies in the United States and other countries where the product candidate will be marketed if approved. 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 the regulations applicable to any particular product. The regulatory process typically also includes a review of the manufacturing process to ensure compliance with applicable regulations and standards, including the cGMP requirements. The FDA can delay, limit or decline to grant approval for many reasons, including:

• a product candidate may not be safe or effective;

• we may not achieve statistical significance for the primary endpoint;

• FDA officials may interpret data from preclinical testing and clinical trials in different ways than we interpret such data;

• the FDA might not approve our manufacturing processes or facilities, or the processes or facilities of any future collaborators or contract manufacturers, including Pierre Fabre’s facility for the manufacture of the active ingredient in milnacipran; and

• the FDA may change its approval policies or adopt new regulations.

We have agreed to pay certain external expenses associated with our second Phase III clinical trial evaluating milnacipran for FMS, currently being run by Forest Laboratories, and we may never be reimbursed for these amounts.

The amounts we are funding for external expenses for the second Phase III clinical trial evaluating milnacipran are only reimbursed to us by Forest Laboratories under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the New Drug Application (NDA) submission to the FDA. It is possible that the second Phase III trial may not be utilized as one of the pivotal trials in the NDA submission, and, in such event, we will not be reimbursed by Forest Laboratories for certain costs incurred in connection with the second Phase III clinical trial. It is also possible that in the event the results from the first Phase III clinical trial are not successful, that Forest could alter the development plan for milnacipran or even terminate our collaboration agreement plan, which would prevent us from ever being reimbursed for our funding of the external expenses for the second Phase III trial for milnacipran.

If we receive regulatory approval for milnacipran or any other future product candidate, we will be subject to ongoing FDA obligations and continuing regulatory review.

Any regulatory approvals that we or our collaborators receive for milnacipran or any future product candidates will be limited to the indications, dosages and restrictions on the product label. We currently intend to seek approval for milnacipran in the treatment of FMS. The FDA may not approve milnacipran for this indication at all, may approve milnacipran for a more limited indication, or may impose additional limitations on the indicated uses or contain requirements for post-marketing surveillance or the performance of potentially costly post-marketing studies. Even if we receive FDA and other regulatory approvals, as we have seen with other products on the market for pain, 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 our Phase II trial evaluating milnacipran for the treatment of FMS, the most common dose-related side effects reported by patients were nausea, particularly early in the study, as well as a slight increase in heart rate. Any marketed product and its manufacturer continue to be subject to strict FDA regulation after approval, including regulation of product labeling and packaging, adverse event reporting, manufacture, storage, advertising, promotion and recordkeeping. 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.

We rely on third parties to conduct all of our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain regulatory approval for or commercialize milnacipran or any of our other future product candidates.

As of April 30, 2005, we have only 15 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 and Forest Laboratories are using the services of Scirex, a contract research organization, to conduct the first Phase III trial with respect to milnacipran, and to assist in the conduct of the second Phase III trial with respect to milnacipran. Because we do not conduct our own clinical trials, we must rely on the efforts of others and cannot always control or predict accurately the timing of such trials, the costs associated with such trials or the procedures that are followed for such trials. We do not plan on significantly increasing our personnel in the foreseeable future and therefore, expect to continue to rely on third parties to conduct all of our future clinical trials. If these third parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols or for other reasons, or if they fail to maintain compliance with applicable government regulations and standards, our clinical trials may be extended, delayed or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize milnacipran or any of our other future product candidates.

Even if our product candidates are approved, the market may not accept these products.

Even if our product development efforts are successful and even if the requisite regulatory approvals are obtained, milnacipran or any future product candidates that we may develop may not gain market acceptance among physicians, patients, healthcare payors and the medical community. The FDA has never approved a drug for the treatment of FMS and we cannot predict whether milnacipran, if approved for this indication, will gain market acceptance. A number of additional factors may limit the market acceptance of products including the following:

• timing of market entry relative to competitive products;

• extent of marketing efforts by us and third-party distributors or agents retained by us;

• rate of adoption by healthcare practitioners;

• rate of a product’s acceptance by the target community;

• availability of alternative therapies;

• price of our product relative to alternative therapies;

• availability of third-party reimbursement; and

• the prevalence or severity of side effects or unfavorable publicity concerning our products or similar products.

If milnacipran or any future product candidates that we may develop do not achieve market acceptance, we may lose our investment in that product candidate, which may cause our stock price to decline.

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, or other central nervous system disorders. In particular, Pfizer, Inc. has publicly disclosed that it has conducted a Phase II clinical trial evaluating the efficacy and safety of its compound, pregabalin, as a treatment for FMS. In addition, Eli Lilly and Company has publicly disclosed that it has conducted two Phase II clinical trials evaluating the efficacy and safety of its compound, duloxetine, as a treatment for FMS. Both companies may decide to pursue Phase III programs with their compounds in FMS. Duloxetine is a serotonin norepinephrine reuptake inhibitor, and as a dual reuptake inhibitor is therefore similar in pharmacology to milnacipran, which is a norepinephrine serotonin reuptake inhibitor. Based on the similar pharmacology, it is anticipated that duloxetine, which is currently approved but not yet available for the treatment of depression, will receive some off-label use for the treatment of FMS. Tricyclic antidepressants, or TCAs, which are inexpensive generic formulations, are currently viewed as the drugs of choice in treating FMS.

It is possible that our competitors will develop and market products for FMS prior to us and that are less expensive and more effective than milnacipran or any of our future products or that will render milnacipran or any other of our products obsolete. We also expect that, in the treatment of Functional Somatic Syndromes and other central nervous system disorders, competition from other biopharmaceutical companies, pharmaceutical companies, universities and public 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.

We have the right to co-promote milnacipran, but we do not have the marketing, sales or distribution experience or capabilities.

Our ability to co-promote any product developed under our agreement with Forest Laboratories is subject to our building our own marketing and sales capabilities, and we currently do not have the ability to directly sell, market or distribute any product. In addition, in the event our agreement with Forest Laboratories is terminated or with respect to any other product we may develop that is not covered by our collaboration with Forest Laboratories, we would have to obtain the assistance of a pharmaceutical company or other entity with a large distribution system and a large direct sales force or build a substantial marketing and sales force with appropriate technical expertise and supporting distribution capabilities. We may not be able to enter into such arrangements with third parties in a timely manner or on acceptable terms or establish sales, marketing and distribution capabilities of our own. 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 are subject to uncertainty relating to health care reform measures and reimbursement policies which, if not favorable to our product candidates, could hinder or prevent our product candidate’s commercialization success.

The continuing efforts of the government, insurance and management care organizations and other health care payors to contain or reduce prescription drug costs may adversely affect:

• our ability to set a price we believe is fair for our products;

• our ability to generate revenues and achieve or maintain profitability;

• the future revenues and profitability of our potential customers, suppliers and collaborators; and

• the availability of capital.

Successful commercialization of milnacipran in the United States will depend in part on the extent to which government, insurance and management care organizations and other health care payors establish appropriate coverage and reimbursement levels for the cost of our products and related treatments. Third-party payors are increasingly challenging the prices charged for prescription drugs. Third-party payors are also encouraging the use of generic drugs. These trends could influence health care purchases, as well as legislative proposals to reform health care or reduce government insurance programs and result in the exclusion of our product candidates from coverage and reimbursement programs or lower the prices of our product candidates. Our revenues from the sale of any approved products could be significantly reduced as a result of these cost containment measures and reforms.

We rely on our employees and consultants for their scientific and technical expertise in connection with our business operations.

We rely significantly on the scientific and technical expertise of our employees and consultants to conduct our business. As of April 30, 2005, we have only 15 full time employees and therefore, we rely heavily on our employees. In addition, because we have a small number of employees, we rely more on consultants than do other companies. If any of our relationships with our employees or consultants are terminated, we may lose access to scientific knowledge and expertise necessary for the research, development and commercialization of milnacipran or any further products. We do not anticipate significantly increasing our personnel in the foreseeable future and therefore, we expect to continue to rely on consultants and our current employees for scientific and technical knowledge and expertise essential to our business.

Our employment agreement with our chief executive officer provides for “at will” employment, which means that he may terminate his services to us at any time. In addition, our scientific advisors may terminate their services to us at any time.

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

We plan to continue conducting clinical trials on humans using milnacipran, and the use of milnacipran may 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. We currently maintain $10,000,000 in insurance for product liability claims. We may not have sufficient resources to pay any liability resulting from such a claim beyond our insurance coverage.

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

We have incurred substantial losses during our history. For the three months ended March 31, 2005 and the years ended December 31, 2004, 2003 and 2002, we incurred net losses of $1.7 million, $11.2 million, $21.7 million and $1.0 million, respectively. As of March 31, 2005, we had an accumulated deficit of $139.2 million. Our ability to become profitable will depend upon our and Forest Laboratories’ ability to develop, market and commercialize milnacipran with sufficient sales volumes, and our ability to develop, market and commercialize any other products. We do not expect to generate revenue from the sale of products for the next several years or become profitable in the foreseeable future and may never achieve profitability.

We will need substantial additional funding and may be unable to raise capital when needed, which could force us to scale back or discontinue the completion of any proposed acquisitions or adversely affect our ability to realize the expected benefits of any completed acquisitions.

We agreed to pay certain expenses in connection with the second Phase III clinical trial for milnacipran in FMS. In addition, we will incur certain non-reimbursable expenses in connection with the development of milnacipran. We will incur expenses in connection with the evaluation of potential acquisitions or other strategic transactions and additional expenses in the event we close any such transactions. We do not have any committed external sources of funding and we will likely need to raise additional capital through the sale of equity or debt. The amount of capital we will require will depend upon many factors, including but not limited to, the evaluation and potential closing of any strategic transactions and the development strategy for milnacipran. If we are unable to raise capital when we need it, we may have to scale back or discontinue the evaluation or completion of any proposed acquisitions or strategic transaction(s).

Raising additional funds by issuing securities or through collaboration and licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish propriety rights.

We will likely raise additional funds through public or private equity offerings, debt financings or corporate collaborations and licensing arrangements. To the extent that we raise additional capital by issuing

equity securities, our existing stockholders’ ownership percentage will be diluted. In addition, if we raise additional funds through collaborations and licensing arrangements, it may be necessary to relinquish potential valuable rights to our potential products on terms that are not favorable to us.

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

We have incurred substantial losses during our history and do not expect to become profitable in the foreseeable future and may never achieve profitability. To the extent that we continue to generate taxable losses, unused losses will carry forward to offset future taxable income, if any, until such unused losses expire. All unused federal net operating losses will expire 15 or 20 years after any year in which they were generated. The carryforward period is 15 years for losses incurred prior to 1996 and 20 years for losses incurred subsequent to 1997. Approximately $1.2 million in federal net operating losses expired in 2004. Our California tax loss carryforwards will begin to expire in 2006.

Our stock price will likely be volatile.

The market prices of the stock of technology companies, particularly biotechnology companies, have been highly volatile. For the period from January 1, 2002 through December 31, 2004, the high and low closing sales prices for our common stock ranged from $1.00 to $16.05. For the three months ended March 31, 2005, our high and low closing sales prices were $14.05 and $9.09, respectively. Our stock price has been and will likely 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 results and timing of clinical trials for milnacipran;

• developments in our relationship with Forest Laboratories;

• developments in our relationship with Pierre Fabre;

• our entering into, or failing to enter into, an agreement for the acquisition of any products or companies, or an agreement with any corporate collaborator;

• our available cash;

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

• developments in patent or other proprietary rights;

• fluctuations in our operating results;

• litigation initiated by or against us;

• developments in domestic and international governmental policy or regulation; and

• economic and other external factors or other disaster or crisis.

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

As of April 30, 2005, our executive officers, directors and stockholders who hold at least 5% of our stock beneficially owned and controlled approximately 36% of our outstanding common stock. If these officers, directors and principal stockholders act together, they will be able to help entrench management and 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 any directors up for election, the election of the members of our board of directors, 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.

We expect to continue incurring increased costs as a result of recently enacted and proposed changes in laws and regulations relating to corporate governance matters.

Recently enacted changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted by the Securities and Exchange Commission and by the Nasdaq National Market, have and we expect will continue to result in increased costs to us. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant financial resources and management time related to compliance activities. Additionally, these laws and regulations could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.

Risks Related to Our Intellectual Property

We rely primarily on a method patent to protect our proprietary technology for the development of milnacipran, and our ability to compete may decrease or be eliminated if we are not able to protect our proprietary technology.

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 (U.S. Patent 4,478,836) expired in June 2002. Accordingly, we rely on the patent for the method of synthesis of milnacipran (U.S. Patent 5,034,541), which expires on December 27, 2009 and was assigned to Pierre Fabre and licensed to us and on patents on the method of use of milnacipran to treat symptoms of FMS (U.S. Patent 6,602,911) and the method of use of milnacipran to treat symptoms of chronic fatigue syndrome (U.S. Patent 6,635,675) issued to us, to protect our proprietary technology with respect to the development of milnacipran. We have also filed additional patent applications related to milnacipran and to the use of milnacipran for FMS (and other related pain syndromes and disorders), although no patents have issued on these patent applications. Because there is limited patent protection for the composition of matter of milnacipran, other companies may be able to sell milnacipran in competition with us and Forest Laboratories unless we and Forest Laboratories are able to obtain additional protection through milnacipran-related patents or additional use patents that may issue from our pending patent applications or other regulatory exclusivity. It may be more difficult to establish infringement of methods of synthesis, formulation or use patents as compared to a patent on a compound. If we or Forest Laboratories are not able to obtain and enforce these patents, a competitor could use milnacipran for a treatment or use not covered by any of our patents.

We also expect to rely on the United States Drug Price Competition and Patent Term Restoration Act, commonly known as the Hatch-Waxman Amendments, for protection of milnacipran or our other future products. The Hatch-Waxman Amendments provide data exclusivity for new molecular entities, such as that in milnacipran. Once a drug containing a new molecule is approved by the FDA, the FDA cannot accept an abbreviated NDA for a generic drug containing that molecule for five years, although the FDA may accept and approve a drug containing the molecule pursuant to an NDA supported by independent clinical data. Recent amendments have been proposed that would narrow the scope of Hatch-Waxman exclusivity and permit generic drugs to compete with our drug. After the Hatch-Waxman exclusivity period expires, assuming our patents are valid, we still expect to rely on our method of use patents to protect our proprietary technology with respect to the development of milnacipran. The patent positions of pharmaceutical companies are uncertain and may 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 may file patent applications or obtain patents on similar technology or compounds that compete with milnacipran for the treatment of FMS. We cannot predict the breadth of claims that will be allowed and issued in patent 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 similar knowledge, methods and know-how or gain access to our proprietary information through some other means.

Our ability to compete may decline if we do not adequately protect our proprietary rights.

Our commercial success depends on obtaining and maintaining proprietary rights to our product candidates and technologies and their uses as well as successfully defending these rights against third party challenges. We will only be able to protect our product candidates, proprietary technologies and their uses from unauthorized use by third parties to the extent that valid and enforceable patents or effectively-protected trade secrets cover them.

Our ability to obtain patent protection for our products and technologies is uncertain due to a number of factors, including:

• we may not have been the first to make the inventions covered by our pending patent applications or issued patents;

• we may not have been the first to file patent applications for our product candidates or the technologies we rely upon;

• others may independently develop similar or alternative technologies or duplicate any of our technologies;

• our disclosures in patent applications may not be sufficient to meet the statutory requirements for patentability;

• any or all of our pending patent applications may not result in issued patents;

• we may not seek or obtain patent protection in all countries that will eventually provide a significant business opportunity;

• any patents issued to us or our collaborators may not provide a basis for commercially viable products, may not provide us with any competitive advantages or may be challenged by third parties;

• some of our proprietary technologies may not be patentable;

• others may design around our patent claims to produce competitive products which fall outside of the scope of our patents; or

• others may identify prior art which could invalidate our patents.

Even if we obtain patents covering our product candidates or technologies, we may still be barred from making, using and selling our product candidates or technologies because of the patent rights of others. Others may have filed and in the future are likely to file patent applications covering compounds, assays, genes, gene products or therapeutic products that are similar or identical to ours. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the area of central nervous system disorders and the other fields in which we are developing products. These could materially affect our ability to develop our product candidates or sell our products. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates or technologies may infringe. These patent applications may have priority over patent applications filed by us. Disputes may arise regarding the ownership or inventorship of our inventions. It is difficult to determine how such disputes will be resolved. Others may challenge the validity of our patents. If our patents are found to be invalid we will lose the ability to exclude others from making, using or selling the inventions claimed therein.

Some of our research collaborators and scientific advisors have rights to publish data and information to which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, then our ability to receive patent protection or protect our proprietary information will be impaired. In addition, in-licensed technology is important to our business. We generally will not control the patent prosecution, maintenance or enforcement of in-licensed technology.

A dispute concerning the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be time consuming and costly and an unfavorable outcome could harm our business.

There is significant litigation in the industry regarding patent and other intellectual property rights. We may be exposed to future litigation by third parties based on claims that our product candidates, technologies or activities infringe the intellectual property rights of others. If our drug development activities are found to infringe any such patents, we may have to pay significant damages. There are many patents relating to chemical compounds and the uses thereof. If our compounds are found to infringe any such patents, we may have to pay significant damages. A patentee could prevent us from making, using or selling the patented compounds. We may need to resort to litigation to enforce a patent issued to us, protect our trade secrets or determine the scope and validity of third party proprietary rights. From time to time, we may hire scientific personnel formerly employed by other companies involved in one or more areas similar

to the activities conducted by us. Either we or these individuals may be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. If we become involved in litigation, it could consume a substantial portion of our managerial and financial resources, whether we win or lose. We may not be able to afford the costs of litigation. Any legal action against our company or our collaborators could lead to:

• payment of damages, potentially treble damages, if we are found to have willfully infringed such parties’ patent rights;

• injunctive or other equitable relief that may effectively block our ability to further develop, commercialize and sell products; or

• we or our collaborators having to enter into license arrangements that may not be available on commercially acceptable terms, if at all.

As a result, we could be prevented from commercializing current or future products.

The patent applications of pharmaceutical and biotechnology companies involve highly complex legal and factual questions, which could negatively impact our patent position.

The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. The United States Patent and Trademark Office’s standards are uncertain and could change in the future. Consequently, the issuance and scope of patents cannot be predicted with certainty. Patents, if issued, may be challenged, invalidated or circumvented. United States patents and patent applications may also be subject to interference proceedings and United States patents may be subject to reexamination proceedings in the United States Patent and Trademark Office (and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent office), which proceedings could result in either loss of the patent or denial of the patent application or loss or reduction in the scope of one or more of the claims of the patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Accordingly, rights under any issued patents may not provide us with sufficient protection against competitive products or processes.

In addition, changes in or different interpretations of patent laws in the United States and foreign countries may permit others to use our discoveries or to develop and commercialize our technology and products without providing any compensation to us. The laws of some countries do not protect intellectual property rights to the same extent as United States laws and those countries may lack adequate rules and procedures for defending our intellectual property rights. For example, some countries, including many in Europe, do not grant patent claims directed to methods of treating humans, and in these countries patent protection may not be available at all to protect our product candidates.

If we fail to obtain and maintain patent protection and trade secret protection of our product candidates, proprietary technologies and their uses, we could lose our competitive advantage and competition we face would increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability.

PART II

Item 1 - Legal Proceedings

From time to time 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 2 - Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3 - Defaults Upon Senior Securities

Not applicable

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

Not applicable

Item 5 - Other Information

Not applicable

Item 6 - Exhibits

3.1		Second Amended and Restated Certificate of Incorporation. (1)

3.3		Second Amended and Restated By-Laws. (2)

4.1		Form of Stock Certificate. (3)

31.1		Certification of Chief Executive Officer pursuant to Rule 13a – 14(a) or Rule 15d – 14(a) of the Securities Exchange Act of 1934, as amended.

31.2		Certification of Chief Financial Officer pursuant to to Rule 13a – 14(a) or Rule 15d – 14(a) of the Securities Exchange Act of 1934, as amended.

32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a – 14(b) or Rule 15d – 14(b) of the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to Appendix C of our Definitive Proxy Statement filed with the SEC on August 11, 2003

(2) Incorporated by reference to Appendix D of our Definitive Proxy Statement filed with the SEC on August 11, 2003

(3) Incorporated by reference to Exhibit 4.1 to Form S-1 Registration Statement No. 33-41225

PART I - FINANCIAL INFORMATION

	ITEM 1 –	Condensed Financial Statements (Unaudited)

		Balance Sheets as of March 31, 2005 (unaudited) and December 31, 2004

		Statements of Operations for the three months ended March 31, 2005 and 2004 (unaudited)

		Statements of Cash Flows for the three months ended March 31, 2005 and 2004 (unaudited)

		Notes to Financial Statements (unaudited)

	ITEM 2 –	Management’s Discussion and Analysis of Financial Condition and Results of Operations

	ITEM 3 –	Quantitative and Qualitative Disclosures About Market Risk

	ITEM 4 –	Controls and Procedures

		Risk Factors

PART II - OTHER INFORMATION

	ITEM 1 –	Legal Proceedings

	ITEM 2 –	Unregistered Sales of Equity Securities and Use of Proceeds

	ITEM 3 –	Defaults Upon Senior Securities

	ITEM 4 –	Submission of Matters to a Vote of Security Holders

	ITEM 5 –	Other Information

	ITEM 6 –	Exhibits

	Signatures

		Cypress Bioscience, Inc.


Date: May 10, 2005	By:	/s/ JAY D. KRANZLER
		Chief Executive Officer and Chairman of the Board (Principal Executive Officer)

Date: May 10, 2005	By:	/s/ SABRINA MARTUCCI JOHNSON
		Chief Financial Officer and Vice President (Principal Financial Officer)