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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2004

For the transition period from              to             

Commission File No. 000 – 50564

RENOVIS, INC.

(Exact Name of Registrant as Specified in its Charter)

(650) 266-1400

Registrant’s telephone number, including area code

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 10, 2004, 24,549,108 shares of our Common Stock, $.001 par value, were outstanding.

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Renovis, Inc.

INDEX

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RENOVIS, INC.

CONDENSED BALANCE SHEETS

(in thousands, except share and per share data)

(unaudited)

See accompanying notes.

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RENOVIS, INC.

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(unaudited)

See accompanying notes.

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RENOVIS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes

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RENOVIS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. Summary of Significant Accounting Policies

The Company and Nature of Operations

Renovis, Inc. (the Company or Renovis) was incorporated in the state of Delaware on January 5, 2000. Renovis is a biopharmaceutical company developing drugs to treat neurological diseases and disorders. Its facilities are located in South San Francisco, CA.

From inception through December 31, 2003, Renovis was a development stage enterprise and its financial statements during that period were prepared in conformity with accounting principles generally accepted in the United States of America governing development stage enterprises. Beginning January 1, 2004, the Company exited the development stage after entering into a collaborative research, development and license agreement with Genentech (see note 5).

The Company has sustained operating losses since inception and expects such losses to continue over the next several years. Management plans to continue to finance the operations with a combination of equity issuances, debt arrangements, and revenues from corporate alliances with pharmaceutical companies. If adequate funds are not available, the Company may be required to delay, reduce the scope of, or eliminate one or more of its research or development programs.

Basis of Preparation

The Company has prepared the condensed financial statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America can be condensed or omitted. In the opinion of management, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. The information included in this quarterly report on Form 10-Q should be read in conjunction with the financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2003.

The condensed balance sheet amounts at December 31, 2003, have been derived from audited financial statements.

Restricted Cash

As of June 30, 2004 and December 31, 2003, other assets included restricted cash of $711,000 related to bank certificates of deposit to collateralize the rent deposit on the Company’s facility in South San Francisco, California.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The Company operates in one business segment.

Reverse Stock Split

In January 2004, the Board of Directors approved a 1-for-4.5 reverse stock split of its convertible preferred stock and common stock. The split was effective shortly before the completion of the initial public offering on February 10, 2004. An amended and restated certificate of incorporation was filed immediately prior to the closing of the initial public offering setting the authorized common stock and authorized preferred stock to 100,000,000 and 5,000,000 shares, respectively. All common share, preferred share and per share amounts contained in the financial statements have been retroactively adjusted to reflect the reverse stock split for all periods presented.

2. Stock-Based Compensation

The Company accounts for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”), Financial Accounting Standards Board Interpretation (“FIN”) No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB No. 25, and related interpretations and has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”).

The option valuation models used to value the options under SFAS No. 123 were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected price volatility. Because the employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input can materially affect the fair value estimate, in the Company’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of the Company’s employee stock options.

The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by APB Opinion No. 25. The information regarding net loss as required by SFAS No. 123 has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The resulting effect on net loss pursuant to SFAS No. 123 is not likely to be representative of the effects on net loss pursuant to SFAS No. 123 in future years, since future years are likely to include additional grants and the irregular impact of future years’ vesting.

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RENOVIS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

The following table illustrates the weighted average assumptions for the Black-Scholes model used in determining the fair value of options granted to employees:

During the period from January 1, 2003 through January 31, 2004, certain stock options were granted with exercise prices that were below the estimated fair value of the common stock at the date of grant. The deferred compensation balance at June 30, 2004 of $12,182,000 was recorded in accordance with APB Opinion No. 25, and is being amortized on a straight-line basis over the related vesting terms of the options. The Company recorded amortization of employee stock-based compensation of $1,250,000 and $2,434,000 for the three and six months ended June 30, 2004 and $256,000 and $334,000 for the three and six months ended June 30, 2003, respectively.

For purposes of disclosures pursuant to Statement of Financial Accounting Standards No. 123 “Stock-Based Compensation Expense and Equity Market Values” (SFAS No. 123), as amended by Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS No. 148), the estimated fair value of options is amortized to expense over the options’ vesting period. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS No.123 to stock based employee compensation (in thousands, except per share amounts).

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RENOVIS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

3. Comprehensive Loss

The Company’s total comprehensive net loss was the same as its net loss for the period from inception (January 2000) through March 31, 2004. During the three months ended June 30, 2004, the Company included other comprehensive losses of $436,000, representing unrealized losses on available for sale securities, as part of total comprehensive loss. Comprehensive loss for the three and six-months periods ended June 30, 2004 was $10,269,000 and $18,945,000, respectively.

4. Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, preferred stock, options, and warrants are considered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive.

5. Collaboration Agreements

On December 31, 2003, the Company entered into a collaborative research, development and license agreement with Genentech (Genentech Agreement) under which the Company received an up-front payment of $5,250,000. Additionally, as part of the Genentech Agreement and concurrent with the Company’s initial public offering, Genentech purchased 250,000 shares of common stock for an additional $3,000,000, or $12.00 per share. The Genentech Agreement also provides for future milestones and royalties in connection with the development and commercialization of products that may arise from the collaboration. The Company has deferred the $5,250,000 upfront payment and is recognizing it on a straight-line basis over the two-year estimated research period of the agreement. During the three and six months ended June 30, 2004 the Company recognized $656,000 and $1,313,000 in revenue related to this agreement, respectively.

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RENOVIS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

6. Other Current Accrued Liabilities

Other current accrued liabilities consist of the following (in thousands):

7. Loans Payable

In April 2001 and October 2001, the Company entered into credit facilities that provide up to an aggregate of $5,000,000 to finance the purchase of equipment and tenant improvements. During 2002 and 2001, the Company borrowed approximately $200,000 and $4,800,000 under these credit facilities, payable in monthly installments over a period of 36 months. Interest rates range from 10.96% to 11.97% on the advances, which are secured by the assets financed. In connection with the credit facilities, the Company issued warrants to purchase an aggregate of 43,210 shares of the Company’s common stock.

In April 2002 and July 2002, the Company entered into credit facilities that provide up to an aggregate of $2,000,000 to finance the purchase of equipment and tenant improvements. Interest rates range from 9.12% to 9.75% on the advances, which are secured by the assets financed. In connection with the credit facility, the Company issued warrants to purchase an aggregate of 8,000 shares of the Company’s common stock.

In February 2004, the Company entered into a credit facility with a lender that provides up to an aggregate of $5,000,000 to finance the purchase of laboratory and computer equipment and certain leasehold improvements. Under this agreement the Company borrowed approximately $2,200,000 during the six months ended June 30, 2004. Payments are due in monthly installments over a period ranging from 42 to 48 months at an interest rate of 8.8%.

8. Convertible Preferred Stock

On February 10, 2004, the Company completed its initial public offering in which it sold 6,325,000 shares of common stock at $12.00 per share. Upon the closing of the offering, all 15,344,817 shares of the then outstanding preferred stock automatically converted into 16,208,583 shares of common stock.

9. Stockholders’ Equity (Net Capital Deficiency)

Common Stock

On February 10, 2004, the Company sold 6,325,000 shares of common stock to the public and realized net proceeds of approximately $68,400,000. Additionally, concurrent with the initial public offering the Company completed a private placement with Genentech for 250,000 shares of common stock for proceeds of $3,000,000.

2003 Stock Plan

The Company’s 2003 Stock Plan (2003 Plan) became effective concurrently with the initial public offering. The Board of Directors authorized and reserved 333,333 shares of the Company’s common stock for stock option grants under the 2003 Plan. The 2003 Plan also includes additional shares of common stock that have or will have become available for issuance under the Company’s predecessor stock option plan, the Amended and Restated 2003 Equity Incentive Plan. Additionally, on January 15 of each year during the term of the Plan, commencing in 2005, the number of shares reserved for issuance under the Plan will be increased by the lesser of (i) 3.5% of the Company’s outstanding shares of common stock on that date, (ii) 1,055,555 shares, or (iii) such lesser number determined by our Board of Directors.

The 2003 Plan permits the Company to grant incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock, deferred stock, dividend equivalents, performance share awards, stock payments and other stock related benefits, or any combination thereof to employees or consultants of the Company. The Company’s non-employee Directors are also eligible to receive grants under the 2003 Plan.

Incentive stock options awarded to employees may be granted at an exercise price no less than the fair market value of the common stock on the date of grant. Options become exercisable as determined by the Board of Directors, generally at the rate of 25% at the end of the first year, with the remaining balance vesting ratably over the next three years, or 1/48^th per month such that the options will be fully vested after four years. Options granted under the 2003 Plan expire no more than ten years after the date of grant.

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RENOVIS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

Employee Stock Purchase Plan

On February 4, 2004, the Company’s Employee Stock Purchase Plan (the “Purchase Plan”) became effective. A total of 611,111 shares of Company common stock have been initially reserved for issuance under the Purchase Plan. The plan provides for an annual increase to the shares of common stock reserved under the plan on each January 1 equal to the lesser of 194,444 shares, 0.75% of our outstanding shares on such date, or a lesser amount determined by our board of directors. Employees scheduled to work more than 20 hours per week for more than five calendar months per year are eligible to participate in the Purchase Plan.

The Purchase Plan will be implemented by a series of offerings of approximately 24-months in duration. The initial offering commenced on February 4, 2004. Within the offering, there will be a series of semi-annual “purchase periods” with the first period commencing on February 4, 2004 and will end on the last business day of November 2004. The purchase price for shares of common stock purchased at the end of a purchase period in an offering will be the lesser of 85% of the market price of common stock on a participant’s entry date into the offering period, or 85% of the market price of common stock on the last business day of the purchase period. Participants may contribute up to 20% of their cash earnings through payroll deductions, and the accumulated deductions will be applied to the purchase of shares on each semi-annual purchase date.

10. Subsequent Event

In July and August 2004, Renovis granted employment inducement stock options covering a total of 220,760 shares to certain newly hired executives. These options were granted without stockholder approval pursuant to NASDAQ Marketplace Rule 4350 (i)(1)(A)(iv) with Renovis’ standard stock option terms, including a 10-year term and four year vesting, and were granted at exercise prices equal to the fair market value on the date of grant.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth above under the caption “Business – Risk Factors.” You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements and the related notes appearing at the beginning of this report. The interim financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2003 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2004.

Overview

We are a biopharmaceutical company developing drugs to treat neurological diseases and disorders. We currently focus our research and development efforts in the areas of neuroprotection, pain and neurodegenerative diseases. Our most advanced product candidate is Cerovive^® (NXY-059), a neuroprotectant currently in two Phase III clinical trials to determine its effect on disability and neurological recovery in acute ischemic stroke patients. These trials commenced in May 2003 and are being conducted by our exclusive licensee, AstraZeneca plc. Upon commercialization of Cerovive^® (NXY-059), we will be entitled to receive mid-teen royalties on worldwide net sales. We are independently pursuing Phase II clinical trials with an oral drug candidate REN-1654, to determine its effectiveness as a treatment for neuropathic pain. We hold exclusive worldwide rights to REN-1654. On July 29, 2004 we announced our decision to discontinue efforts to commercialize REN-213, an IV drug candidate that we were developing for the treatment of acute post-operative pain (see “Clinical Update” below). In addition to our clinical programs, we are conducting preclinical research and development activities in the areas of neuroprotection, pain and neurodegenerative diseases to identify future product candidates for clinical development. Since our inception in January 2000, we have generated significant losses and have funded our operations primarily through the sale of equity securities. On February 10, 2004 we completed our initial public offering of common stock and concurrent private placement with Genentech, Inc. in which we raised net proceeds of approximately $71.4 million. As of June 30, 2004, we had an accumulated deficit of $100.6 million.

We expect to incur substantial and increasing losses for the next several years as we:

In addition, we intend to take an opportunistic approach to acquiring or in-licensing technology and products and may also acquire or invest in businesses that are complementary to our own.

Since our inception we have generated all of our revenues from agreements with corporate partners. During 2003, we recorded $4.5 million in contract revenue related to milestone payments that we received from AstraZeneca plc following their receipt of regulatory approval to commence Phase III trials for Cerovive (NXY-059). Upon achievement of certain future milestones involving the filing and approval of marketing applications in the U.S. and E.U. or Japan, AstraZeneca is obligated to make additional payments to us totaling up to $7.5 million. Upon commercialization of Cerovive, we are entitled to receive mid-teen percentage royalties on worldwide net sales from AstraZeneca.

On December 31, 2003 we entered into a collaborative research, development and license agreement with Genentech under which we received an up-front payment of $5.25 million. We have deferred the upfront payment and are recognizing it as contract revenue on a straight-line basis over the estimated research period of two years. Accordingly, we recognized $0.7 million and $1.3 million in revenue related to this agreement during the three and six months ended June 30, 2004, respectively. We expect to recognize revenue of approximately $2.6 million related to this agreement during 2004. The agreement with Genentech also provides for future milestones and royalties in connection with the development and commercialization of products that may arise from the collaboration.

In contrast to Cerovive (NXY-059), which is licensed to AstraZeneca, we hold worldwide rights to commercialize REN-1654 and intend to market this product candidate ourselves or with a co-promotion partner in the United States and through strategic collaborations outside of the United States. Alternatively, we may grant exclusive marketing rights in exchange for up-front fees, milestones and royalties on future sales, if any. We currently contract with outside firms to manufacture REN-1654 and have no plans to establish internal manufacturing capability.

Clinical Update

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As of June 30, 2004, we had $103.1 million in cash, cash equivalents and short-term investments. We anticipate that our current cash, cash equivalents and short-term investments will enable us to maintain our currently planned operations for at least another 24 months. However, changes to our current operating plan may require us to consume our capital resources significantly sooner than we expect.

Revenues

To date, all of our revenue has been earned under agreements with AstraZeneca and Genentech. We do not expect to generate revenue from product sales or royalties until at least 2007, if at all. We seek to generate revenue from a combination of product sales, up-front fees and milestone payments in connection with collaborative or strategic relationships, and royalties resulting from the license of our intellectual property. We expect that any revenue we generate will fluctuate from quarter to quarter as a result of the timing and amount of milestone payments we may receive from our collaborative or strategic relationships, as well as those we may receive upon the sale of our products, to the extent any are successfully commercialized.

Research and Development Expenses

Our research and development (R&D) expenses consist primarily of costs associated with research, preclinical development and clinical trials involving product opportunities we are pursuing internally in the areas of neuroprotection, pain, and neurodegenerative diseases. We do not incur research and development costs for Cerovive (NXY-059), which is licensed to AstraZeneca.

The expenses we incur in connection with our research, preclinical and clinical development consist primarily of:

R&D costs, including some upfront fees and milestones paid to collaborators, are expensed as incurred. The timing of upfront fees and milestone payments in the future may cause variability in our future R&D expenses.

Prior to our acquisition of pharmaceutical assets from Centaur in December 2002, we had incurred research and development expenses of approximately $20.8 million to assemble a team of neurobiologists and establish specialized capabilities in assay development, screening, lead optimization, target identification and target validation, which we used to pursue early stage research in the areas of pain and trauma. We are unable to estimate the portion of costs incurred that are allocable to the individual research activities we have conducted because we do not segregate costs among early-stage research programs for both management and external reporting. Moreover, given the early stage nature of these projects and the subsequent integration of intellectual property and product opportunities that we acquired from Centaur, we are unable to reasonably estimate the cost or timeline required to generate cash inflows from our research efforts.

In the third quarter of 2004 we anticipate completion of the new financial accounting system implementation, which will enable us to segregate pre-clinical development and clinical trial costs on a project-by-project basis from the implementation date forward. However, we do not plan to segregate costs related to early-stage research activities because such costs are not specifically allocable to identifiable drug candidates until the later stages of our research.

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During the three and six months ended June 30, 2004, we incurred research and development expenses of $7.2 million and $13.6 million respectively. Of this amount, approximately $4.1 million and $7.0 million was spent by our preclinical and clinical development functions for the three and six months ended June 30, 2004, respectively. Our preclinical development activities during these periods included toxicology and efficacy studies of various development candidates in preclinical models of pain and neurodegenerative disease as well as formulation and manufacturing of drug supply for these studies. Our clinical development efforts during both periods were focused exclusively on initiating and conducting multiple Phase II clinical trials with REN-1654 and REN-213. The remaining amount of $3.1 million and $6.6 million for the three and six months ended June 30, 2004, respectively, was expended primarily on employee costs, supplies and materials and infrastructure related to neurobiology, chemistry and related functions, which are integral to our preclinical research programs.

Development timelines and costs are difficult to estimate and may vary significantly for each product candidate and from quarter to quarter. The process of seeking regulatory approvals, and the subsequent compliance with applicable regulations, requires the expenditure of substantial resources.

General and Administrative Expenses

General and administrative expenses consist primarily of compensation for employees in executive and operational functions, including finance, human resources and business development. Other significant costs include facilities costs and professional fees for accounting and legal services, including legal services associated with obtaining and maintaining patents. We anticipate incurring increases in general and administrative expenses, such as increased costs for insurance and investor relations associated with operating as a publicly-traded company. These increases will also likely include the hiring of additional personnel.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in the notes to our financial statements included in this report, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Revenue under our collaborative agreements is recognized based on the performance requirements of the agreement. Amounts received under such arrangements consist of up-front license fees and include periodic milestone payments upon the achievement of certain events. Up-front payments which are subject to future performance requirements are recorded as deferred revenue and are amortized over the performance period. The performance period is estimated at the inception of the arrangement and is periodically reevaluated. The reevaluation of the performance period may shorten or lengthen the period during which the deferred revenue is recognized which would result in an acceleration or delay of expected revenue recognition. Payments received related to substantive, at-risk milestones are recognized upon achievement of the scientific or regulatory event specified in the underlying agreement.

Stock Compensation

We account for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB No. 25, and related interpretations and have adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. We have elected to continue to follow the intrinsic value method of accounting as prescribed by APB No. 25. The information regarding net loss as required by SFAS No. 123 has been determined as if we had accounted for our employee stock options under the fair value method of that statement. The resulting effect on net loss pursuant to SFAS No. 123 is not likely to be representative of the effects on net loss pursuant to SFAS No. 123 in future years, since future years are likely to include additional grants and the irregular impact of future years’ vesting.

Stock compensation expense, which is a non-cash charge, results from stock option grants prior to our initial public offering at exercise prices below the deemed fair value of the underlying common stock resulting in our recording stock compensation associated with these grants. Stock compensation expense is amortized over the vesting period of the underlying option, generally four years. From inception through June 30, 2004, we recorded amortization of deferred stock compensation of $4.3 million. At June 30, 2004, we had a total of $12.2 million remaining to be amortized over the vesting period of the stock options.

Acquired In-Process Research and Development

Acquired in-process research and development relates primarily to purchased technology, intellectual property and know-how. We evaluate the stage of development of acquired projects, taking into account the level of effort, time and estimated cost associated with further developing the in-process technology and producing a commercial product. The nature of the remaining efforts for completion of acquired in-process research and development projects generally include completion of clinical trials, completion of manufacturing validation, interpretation of clinical and preclinical data and obtaining marketing approval from the FDA and other regulatory bodies, the cost, length and success of which are extremely difficult to determine. Numerous risks and uncertainties exist with timely completion of development projects, including clinical trial results, manufacturing process development results, and ongoing feedback from regulatory authorities, including obtaining marketing approval. In addition, acquired products under development may never be successfully commercialized due to the uncertainties associated with the pricing of new pharmaceuticals, the cost of sales to produce these products in a commercial setting, changes in the reimbursement environment, or the introduction of new competitive products. As a result of the uncertainties noted above, we expense such acquired in-process research and development projects when incurred.

Clinical Study Activities and Other Expenses from Third-Party Contract Research Organizations

Some of our research and development, including certain clinical study activity, is conducted by various third parties, including contract research organizations, which may also provide contractually defined administration and management services. We recognize expenses for these contracted

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activities based upon a variety of factors, including actual and estimated patient enrollment rates, clinical site initiation activities, labor hours and other activity based factors. On a regular basis, our estimates of these costs are reconciled to actual invoices from the service providers, and adjustments are made accordingly.

Results of Operations

Comparison of the Three and Six Months Ended June 30, 2004 and 2003

Revenue

Revenue for the three and six months ended June 30, 2004 was $0.7 and $1.3 million, respectively, compared with $0 and $4.5 million for the same periods in 2003. Revenue during the 2004 period resulted from a collaborative agreement with Genentech, which was signed at the end of 2003. Under this agreement with Genentech we received an up-front payment of $5.25 million that we are recognizing as revenue on a straight-line basis over the two-year estimated research period of the agreement. Revenue during the first quarter of 2003 resulted from $4.5 million in milestone payments we earned from AstraZeneca upon approval from the FDA to commence Phase III clinical trials with Cerovive (NXY-059).

Research and Development Expenses

Total research and development expenses and dollar and percentage change as compared to the prior period are as follows (dollar amounts are in thousands):

The increase in R&D expense of $3.0 million and $6.3 million in the three and six months ended June 30, 2004, respectively, over the comparable period in 2003 was primarily due to factors related to the advancement of REN-1654 and REN-213 into phase II clinical trials that began during the second half of 2003 and the first quarter of 2004, respectively, and due to the expansion of our preclinical programs.

Specific increases for the three months ended June 30, 2004 over the comparable period in 2003 included the following:

Specific increases for the six months ended June 30, 2004 over the comparable period in 2003 included the following:

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The table below summarizes the current status of our drug candidates:

We estimate that typical Phase I clinical trials generally take 6 to 12 months to complete, Phase II clinical trials are expected to last approximately 12 to 24 months and Phase III clinical trials are expected to last approximately 24 to 48 months. However, the actual length of clinical trials are based upon factors such as the intended use of the clinical product and the ability to enroll appropriate patients. Additionally, clinical trials of our drug candidates may fail to demonstrate safety and clinically significant efficacy which would prevent or significantly delay regulatory approval.

We expect research and development expenses to increase in future periods as we continue to advance existing drug candidates into later stages of clinical trials and move pre-clinical products into clinical trials. However, we currently do not have estimates of total costs to reach regulatory approval for each drug candidate or in the aggregate as our drug candidates are subject to an uncertain and lengthy regulatory process which may not result in obtaining the necessary regulatory approval.

General and Administrative Expenses

Total general and administrative (G&A) expenses and dollar and percentage change as compared to the prior period are as follows (dollar amounts are in thousands):

Overall general and administrative expenses increased by $0.8 million and $1.0 million in the three and six months ended June 30, 2004 from the comparable periods in 2003. The increase in G&A expense in 2004 over 2003 is primarily due to increased personnel costs and outside services costs associated with establishing infrastructure appropriate for a public company. Intellectual property expenses also increased, as we continued to seek patent protection for the discoveries made in our preclinical drug development programs.

Amortization of Employee Stock-Based Compensation. In connection with the grant of stock options to employees and directors, we recorded deferred stock compensation of $12.2 million, net of related amortization for the period beginning January 1, 2003 through June 30, 2004. The $12.2 million represents the difference between the exercise price and the deemed fair value of the underlying common stock on the date the options were granted. We recorded this amount as a component of stockholders’ equity (net capital deficiency) and will amortize the amount, on a straight-line basis, as a non-cash charge to operations over the vesting period of the options. We recorded amortization of employee stock-based compensation of $1.3 million and $2.4 million for the three and six months ended June 30, 2004 and $ 0.3 million for both the three and six months ended June 30, 2003.

Acquired In-Process Research and Development. In connection with the additional shares issued by us to Centaur in the second quarter of 2003 following the commencement of Phase III clinical trials for Cerovive (NXY-059), we recorded an expense of $17.3 million. This additional expense related to the acquisition represented the write-off of the estimated fair value of acquired in-process research and development that had not reached technological feasibility and had no alternative future use.

The principal technology acquired as part of the Centaur acquisition related to Cerovive (NXY-059) and REN-1654 that were in the process of being developed. The fair value of each of the in-process research and development projects was based on an income approach that attempts to estimate the future cash flows from the technology based on its successful development, net of tax.

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Interest Income.

Total interest income and dollar and percentage changes as compared to the prior period are as follows (dollar amounts are in thousands):

The $318,000 and $492,000 increases in interest income from the three and six months ended June, 2003 as compared to the corresponding periods in 2004 were primarily attributable to higher average cash balances due to our initial public offering completed in early February 2004.

Interest Expense.

Total interest expense and dollar and percentage changes as compared to the prior period are as follows (dollar amounts are in thousands):

The decrease in interest expense for 2004 was primarily due to our lower aggregate interest rates on debt balances (related to the purchase of equipment and leasehold improvements) in 2004 as compared to the 2003 period.

2004 Financial Guidance

For the year ending December 31, 2004 we presently anticipate:

Liquidity and Capital Resources

To date, we have funded our operations primarily through the sale of equity securities. As of June 30, 2004, we had received approximately $168.2 million from the sale of equity securities. In February 2004, we received approximately $71.4 million from our initial public offering of common stock and concurrent private placement with Genentech. In addition, as of June 30, 2004, we had financed through loans the purchase of equipment and leasehold improvements totaling approximately $9.0 million, of which $3.2 million was outstanding at that date. These obligations are secured by the purchased equipment and leasehold improvements, bear interest at rates ranging from approximately 8.80% to 11.97% and are due in monthly installments through February 2008.

At June 30, 2004, we had $103.1 million in cash, cash equivalents and short-term investments as compared to $41.4 million as of December 31, 2003, an increase of $61.7 million. This increase resulted primarily from the net proceeds of $71.4 million from the completion of our initial public offering of common stock and concurrent private placement with Genentech, partially offset by cash used in operating activities. Our cash and investments are invested in a diversified portfolio of financial instruments, including money market instruments, corporate notes and bonds, government or governmental agency securities and other debt securities issued by financial institutions and other issuers with strong credit ratings.

Net cash used in operating activities was $9.3 million during the six months ended June 30, 2004, compared to $4.9 million during the same period last year. The increase in net cash used in operating activities in 2004 as compared to 2003 was primarily due to the increase in our operating expenses as we grew our research and development activities.

Net cash used in investing activities was $58.4 million during the six months ended June 30, 2004 as compared to $5.3 million provided by investing activities during the same period in the prior year. The increase in cash used in investing activities in 2004 is primarily due to purchases of short-term investments with the proceeds from our initial public offering, partially offset by sales and maturities of short-term investments.

Net cash provided by financing activities was $72.3 million for the six months ended June 30, 2004, compared to $0.4 million used in financing activities during the same period last year. The increase in cash provided in 2004 is primarily due to the net proceeds received from the completion of the company’s initial public offering and concurrent private placement with Genentech and proceeds from our credit facilities partially offset by principal payments on our credit facilities.

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We have entered into a variety of license agreements relating to our research and development efforts, most of which relate to product candidates in the early stage of preclinical development. We have cancelable license agreements relating to Cerovive (NXY-059) under which we could be required to pay $25,000 annually in minimum royalty payments through NDA approval and $100,000 annually in minimum royalty payments after NDA approval. Additionally, low-single digit royalties are payable on net product sales.

Our future capital uses and requirements depend on numerous forward-looking factors. These factors include but are not limited to the following:

Based upon our current operating plan, we believe that our cash and cash equivalents and short term investments as of June 30, 2004, will be sufficient to meet our projected operating requirements for at least the next 24 months.

Until we can generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources. We may be required to seek additional sources of funding to complete development and commercialization of our products. If we need to raise funds in the future, we may be required to raise those funds through public or private financings, strategic relationships or other arrangements. We cannot assure you that the funding, if needed, will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to pursue our business strategy.

We did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q, including the sections entitled “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements.

Forward-looking statements include, but are not limited to, statements about:

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These statements relate to future events or our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks and other factors include those listed under “Risk Factors” and elsewhere in this prospectus. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential”, “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We do not intend to update any of the forward-looking statements after the date of this report or to conform these statements to actual results.

RISK FACTORS

An investment in our common stock is very risky. You should carefully consider the risks described below, together with all of the other information in this report, our Annual Report on Form 10-K for the year ended December 31, 2003 and our Quarterly Report on Form 10-Q for the period ended March 31, 2004 before making a decision to invest in our common stock. If any of the following risks actually occur, our business, financial condition, results of operations and growth prospects could be adversely affected. In this case, the trading price of our common stock could decline and you may lose all or part of your investment in our common stock. Additional risks and uncertainties, not presently known to us, or that we presently deem as immaterial, may also adversely affect our business. If any of these additional risks and uncertainties occurs, the trading price of our common stock could decline, and you might lose all or part of your investment.

Risks Related to Our Company

Clinical trials may fail to demonstrate the safety and efficacy of our product candidates, which could prevent or significantly delay their regulatory approval.

In July 2004, we announced our decision to discontinue efforts to commercialize REN-213, an IV drug candidate we were developing for the treatment of acute post-operative pain. Any failure or substantial delay in completing clinical trials for our other product candidates, including Cerovive^® (NXY-059) and, REN-1654 may severely harm our business. Before obtaining regulatory approval for the sale of any of our potential products or potential products of our current and future strategic partners and licensees, we and our strategic partners or licensees must subject these product candidates to extensive preclinical and clinical testing to demonstrate their safety and efficacy in humans. The success of this preclinical and clinical testing is critical to achieving our product development goals.

Our licensee, AstraZeneca, is currently conducting Phase III clinical trials to test Cerovive (NXY-059) for efficacy in stroke patients. The Cerovive (NXY-059) Phase III clinical trials were designed to include several interim analyses. At each interim analysis, an independent data and safety monitoring board will review patient data to evaluate the safety or efficacy of Cerovive (NXY-059). At such time, a decision can be made to either stop or continue the Phase III clinical trials. If the Cerovive (NXY-059) trials are significantly delayed or fail to demonstrate that Cerovive (NXY-059) is safe and effective for stroke patients, our business and reputation would be harmed and our stock price would be negatively affected.

Clinical trials are expensive, time-consuming and typically take years to complete. In connection with clinical trials, we face the risks that:

A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late stage clinical trials even after achieving promising results in early stage development. The results from the Phase II clinical trials for Cerovive (NXY-059)may not be predictive of results obtained in the Phase III clinical trials and the results from the Phase I and IIa clinical trials for REN-1654 may not be predictive of results obtained in the Phase IIb clinical trials.

Failure to enroll patients for clinical trials may cause delays in developing our product candidates.

We may encounter delays or rejections if we, our strategic partners or licensees are unable to enroll enough patients to complete clinical trials. Patient enrollment depends on many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the trial. We have experienced delays in enrollment of the ongoing Phase II clinical trials involving REN-1654. These delays have resulted in increased costs. Any such delays in planned patient enrollment in the future may result in further increased costs and delays, which could harm our ability to develop products.

The independent clinical investigators and contract research organizations that we and our strategic partners or licensees rely upon to conduct clinical trials may not be diligent, careful or timely, and may make mistakes in the conduct of our trials.

We depend on independent clinical investigators and contract research organizations (CROs) to conduct our clinical trials under their agreements with us or, in the case of Cerovive (NXY-059), with AstraZeneca. We are not employing these investigators, and we cannot control the amount or timing of resources that they devote to our programs. Our contracts with these investigators involve fixed fees. If the costs of performing the clinical trials exceed estimates, these investigators may fail to devote sufficient time and resources to our drug development programs, fail to enroll patients as rapidly as expected, or otherwise fail to perform in a satisfactory manner, regulatory approval and our introductions of new products will be delayed. We contract with CROs for execution of our clinical trials for our product candidates other than Cerovive (NXY-059). Failure of the CROs to meet their obligations could adversely affect clinical development of our product candidates. Moreover, these independent investigators and CROs may also have relationships with other commercial entities, some of which may compete with us. If independent investigators and CROs assist our competitors, it could harm our competitive position.

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We depend on our licensee, AstraZeneca, for the completion of the Cerovive (NXY-059) clinical program and for the commercialization of Cerovive (NXY-059).

Under our exclusive license agreement with AstraZeneca, AstraZeneca is responsible for all aspects of clinical development of Cerovive. If Cerovive (NXY-059) receives regulatory approval, AstraZeneca will be responsible for marketing and sales of the commercial product. Because AstraZeneca is responsible for these functions, we have no control over the development schedule or, if Cerovive (NXY-059) receives regulatory approval, the marketing plan for Cerovive. If the clinical trials for Cerovive (NXY-059) are not successful, Cerovive (NXY-059) will not be commercialized. Moreover, if AstraZeneca elects to terminate the clinical program for Cerovive, the rights to develop and market Cerovive (NXY-059) will revert to us. If these rights revert to us, we will have to fund the clinical programs for Cerovive (NXY-059) on our own, seek a strategic partner or licensee for clinical development or abandon Cerovive (NXY-059).

Our reliance on AstraZeneca poses a number of risks, including the following:

If any of these risks materialize, it could delay the development schedule for Cerovive (NXY-059) and impair its commercialization.

If we or our strategic partners or licensees fail to obtain U.S. regulatory approvals for product candidates under development, including our lead product candidate, Cerovive (NXY-059), and REN-1654, we will not be able to generate revenue in the U.S. market from the commercialization of product candidates.

We must receive FDA approval for each of our product candidates before we can commercialize or sell that product candidate in the United States, and AstraZeneca, our licensee for Cerovive (NXY-059), must receive regulatory approval for Cerovive (NXY-059) and commercialize or sell Cerovive (NXY-059) before we will receive royalties. The FDA can limit or deny their approval for many reasons, including:

Failure to obtain FDA approval or any delay or setback in obtaining such approval could:

Any such failures or delays in the regulatory approval process for any of our product candidates would delay or diminish our receipt of product revenues, if any, and would materially adversely affect our business, financial condition and results of operations.

Even if we obtain FDA approval, our product candidate may not be approved for all indications that we request, which could limit the uses of our product and adversely impact our potential royalties and product sales. If FDA approval of a product is granted, such approval may be subject to limitations on the indicated uses for which the product may be marketed or require costly, post-marketing follow-up studies. As to any product for which marketing approval is obtained, the labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping related to the product will be subject to extensive regulatory requirements. The subsequent discovery of previously unknown problems with the product may result in restrictions on the product, including withdrawal of the product from the market. We may be slow to adapt, or we may never adapt, to changes in existing requirements or adoption of new requirements or policies.

If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.

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If we or our strategic partners or licensees fail to obtain regulatory approvals in other countries for product candidates under development, we will not be able to generate revenue in such countries from the commercialization of product candidates.

In order to market our products outside of the United States, we and our strategic partners and licensees must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process in other countries may include all of the risks detailed above regarding FDA approval in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailed above regarding FDA approval in the United States, including the risk that our product candidate may not be approved for all indications that we request, which could limit the uses of our product and adversely impact our potential royalties and product sales and that such approval may be subject to limitations on the indicated uses for which the product may be marketed or require costly, post-marketing follow-up studies.

If we fail to comply with applicable foreign regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.

Even if our product candidates are approved and commercialized, competitive products may impede market acceptance of our products.

REN-1654 is intended to compete directly with existing drugs. Hospitals, physicians or patients may conclude that our potential products are less safe or effective or otherwise less attractive than these existing drugs. Even if approved and commercialized, Cerovive (NXY-059) may fail to achieve market acceptance with hospitals, physicians or patients. Similarly, hospitals, physicians or patients may continue to use existing drugs in preference to REN-1654. If REN-1654 is approved and commercialized, it will face significant competition in the market for the treatment of neuropathic pain from gabapentin, a drug which is currently marketed by Pfizer Inc. If our products do not receive market acceptance for any reason, our revenue potential could be diminished which would materially adversely affect our business, financial condition and results of operations.

Further, our competitors may develop new products that could be more effective or less costly, or that may seem more cost-effective, than our products. For example, although we believe that Cerovive (NXY-059)would not face direct competition from products currently available to stroke victims, a number of organizations are conducting clinical trials of neuroprotectant drug candidates which, if approved and commercialized, would compete with Cerovive (NXY-059). Competitors developing such products include Bayer AG, Yamanouchi Pharmaceutical Co. Ltd., Ono Pharmaceutical Co., Ltd., Pharmos Corp., Indevus Pharmaceuticals Inc., Vertex Pharmaceuticals Incorporated and D-Pharm Ltd. In addition, gabapentin will be available in generic form as early as 2004, which we anticipate will cause a decrease in the average selling price from current levels and increase competition for REN-1654 for the treatment of neuropathic pain. In addition, Pfizer filed an NDA with the FDA in October 2003 to obtain approval to market a successor product candidate to gabapentin called pregabalin, which has been shown effective for many neuropathic pain patients with fewer side effects than gabapentin. Other competitors working on other treatments for neuropathic pain include NeurogesX, Inc., Novartis AG, CeNeS Pharmaceuticals plc, Xenoport, Inc. and AstraZeneca. Since REN-1654 is in the early stages of development, we cannot reliably assess its competitive advantages or disadvantages in areas such as efficacy, safety, cost and administration compared to existing products or product candidates being developed by our competitors.

Most of our competitors have substantially greater capital resources, research and development staffs, facilities and experience in conducting clinical trials and obtaining regulatory approvals, as well as in manufacturing and marketing pharmaceutical products. As a result, they may achieve product commercialization or patent protection earlier than we can, if at all. Hospitals, physicians, patients or the medical community in general may not accept and use any products that we may develop.

We have no experience selling, marketing or distributing products and no internal capability to do so.

If we receive regulatory approval to commence commercial sales of any of our product candidates other than Cerovive (NXY-059), we will have to establish a sales and marketing organization with appropriate technical expertise and supporting distribution capability. At present, we have no sales or marketing personnel. Factors that may inhibit our efforts to commercialize our products without strategic partners or licensees include:

As an alternative to establishing our own sales and marketing organization, we may engage a pharmaceutical or other healthcare company with an existing distribution system and direct sales organization to assist us. We may not be able to successfully establish sales and distribution capabilities either on our own or in collaboration with third parties or gain market acceptance for our products. To the extent we enter co-promotion or other licensing arrangements, any revenues we receive will depend on the efforts of third parties and we may not succeed.

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If third-party manufacturers of our products fail to devote sufficient time and resources to our concerns, or if their performance is substandard, our clinical trials and product introductions may be delayed and our costs may rise.

We have no manufacturing facilities, and we have no experience in the commercial manufacturing of drugs and no experience in designing drug manufacturing processes. We have contracted with third-party manufacturers to produce, in collaboration with us, our product candidates for clinical trials. We intend to rely on third-party contract manufacturers to manufacture, supply, store and distribute any resulting products.

While we have not experienced problems with our third party manufacturers to date, our reliance on these third-party manufacturers exposes us to the following risks, any of which could delay or prevent the completion of our clinical trials, the approval of our product candidates by the FDA or other regulatory agencies, or the commercialization of our products, result in higher costs, or deprive us of potential product revenues:

Drug manufacturers are subject to ongoing periodic unannounced inspections by the FDA and corresponding state and foreign agencies to ensure strict compliance with cGMPs, other government regulations and corresponding foreign standards. We are not aware of any violations by our third-party manufacturers of any of these regulations or standards. While we are obligated to audit the performance of third-party contractors, we do not have control over our third-party manufacturers’ compliance with these regulations and standards. Failure by our third-party manufacturers or us to comply with applicable regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of the government to grant premarket approval of drugs, delays, suspension or withdrawal of approvals, seizures or recalls of product, operating restrictions and criminal prosecutions.

We may not be able to manufacture our product candidates in commercial quantities, which would prevent us from commercializing our product candidates.

To date, our product candidates have been manufactured in small quantities for preclinical and clinical trials. If any of these product candidates are approved by the FDA or other regulatory agencies for commercial sale, we will need to manufacture them in larger quantities. We may not be able to successfully increase the manufacturing capacity, whether in collaboration with third party manufacturers or on our own, for any of our product candidates in a timely or economic manner, or at all. Significant scale-up of manufacturing may require additional validation studies, which the FDA must review and approve. If we are unable to successfully increase the manufacturing capacity for a product candidate, the regulatory approval or commercial launch of that product candidate may be delayed or there may be a shortage in supply. Our product candidates require precise, high quality manufacturing. Our failure to achieve and maintain these high manufacturing standards, including the incidence of manufacturing errors, could result in patient injury or death, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously hurt our business.

If we are unable to retain and recruit qualified scientists or if any of our key executives, key employees or key consultants discontinues his or her employment or consulting relationship with us, it may delay our development efforts.

We are highly dependent on the key members of our management and scientific staff, especially our chief executive officer, Corey Goodman, Ph.D. The loss of any of our key employees or key consultants could impede the achievement of our development objectives. Furthermore, recruiting and retaining qualified scientific personnel to perform research and development work in the future is critical to our success. We may be unable to attract and retain personnel on acceptable terms given the competition among biotechnology, pharmaceutical and health care companies, universities and non-profit research institutions for experienced scientists. We maintain “key man” insurance on Dr. Goodman. We do not maintain “key man” insurance policies on any of our other officers or employees. All of our employees are employed “at will” and, therefore, each employee may leave our employment at any time.

We have a history of losses and we may never achieve sustained profitability.

Since our inception, we have incurred significant net losses, including net losses of $9.8 million and $18.5 million for the three months and six months ended June 30, 2004 and $23.4 million and $23.8 million for the three and six months ended June 30, 2003, respectively. As of June 30, 2004, our cumulative net loss was $100.6 million. We have not yet completed the development, including obtaining regulatory approvals, of any of our product candidates and, consequently, have not generated revenues from the sale of products. Even if we succeed in developing and commercializing one or more of our product candidates, we expect to incur substantial losses for the foreseeable future. We also expect to continue to incur significant operating and capital expenditures and anticipate that our expenses will increase substantially in the foreseeable future as we:

We also expect to experience negative cash flow for the foreseeable future as we fund our operating losses and capital expenditures. We will need to generate significant revenues to achieve profitability. We may not be able to generate these revenues, and we may never achieve profitability. Our failure to achieve profitability could negatively impact the market price of our common stock. Even if we do become profitable, we may not be able to sustain or increase profitability on a quarterly or annual basis.

If we cannot raise additional capital on acceptable terms, we may be unable to complete planned clinical trials, obtain regulatory approvals or commercialize our product candidates.

We believe that existing cash reserves will fund our planned activities through at least the next 24 months. However, we will require substantial future capital in order to continue to conduct the research and development, clinical and regulatory activities necessary to bring our product candidates to market and to establish commercial manufacturing, sales and marketing capabilities. During the six months ended June 30, 2004, our

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net cash used in operating activities was $9.3 million and we had capital expenditures of $0.9 million for the same period. Our future capital requirements depend on many factors, including:

We intend to seek additional funding through strategic collaborations and may seek funding through private or public sales of our securities or by licensing all or a portion of our technology. This funding may significantly dilute existing stockholders or may limit our rights to our technology.

We may not be able to obtain additional funding on reasonable terms, or at all. If we cannot obtain adequate funds, we may:

Risks Related to Our Industry

Claims that we infringe a third-party’s intellectual property may give rise to burdensome litigation, result in potential liability for damages or stop our development and commercialization efforts.

Third parties may assert patent or other intellectual property infringement claims against us or our strategic partners or licensees with respect to technologies used in our potential products. While we have conducted patent searches to determine whether the technologies used in our products infringe patents held by third parties, we expect that numerous patent applications are currently pending and may be filed in the future for technologies generally related to our technologies, including many patent applications that remain confidential after filing. Due to these factors and the inherent uncertainty in conducting patent searches, we may violate third-party patent rights that we have not yet identified.

U.S. and foreign patents have been issued to third parties in the same fields as some of our product candidates. There may also be patent applications filed by these or other parties in the United States and various foreign jurisdictions that are in the same fields as some of our product candidates. These patent applications, if issued, could subject us to infringement actions. Although to date we have not been subject to any infringement actions, we have received communications from a third party alleging that we infringed certain patents held by the third party.

The owners or licensees of these and other patents may file one or more infringement actions against us. Patent litigation can involve complex factual and legal questions and its outcome is uncertain. Any claim relating to infringement of patents that is successfully asserted against us may cause us to pay substantial damages. Even if we were to prevail, any litigation could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations. Furthermore, as a result of a patent infringement suit brought against us or our strategic partners or licensees, we or our strategic partners or licensees may be forced to stop or delay developing, manufacturing or selling potential products, including Cerovive (NXY-059) or REN-1654, that are claimed to infringe a third party’s intellectual property unless that party grants us or our strategic partners or licensees rights to use its intellectual property. In such cases, we may be required to obtain licenses to patents or proprietary rights of others in order to continue to commercialize our products. However, we may not be able to obtain any licenses required under

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any patents or proprietary rights of third parties on acceptable terms, or at all. Even if our strategic partners, licensees or we were able to obtain rights to the third party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately, we may be unable to commercialize some of our potential products or may have to discontinue development of a product candidate, such as Cerovive (NXY-059) or REN-1654, or cease some of our business operations as a result of patent infringement claims, which could severely harm our business.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

Many of our employees were previously employed at universities or other biotechnology or pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying money claims, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize certain product candidates, which could severely harm our business.

If we are unable to protect our intellectual property rights, our competitors may develop and market products with similar features that may reduce demand for our potential products.

The following factors are important to our success:

We will be able to protect our intellectual property rights in patents and trade secrets from unauthorized use by third parties only to the extent that such intellectual property rights are covered by valid and enforceable patents or are effectively maintained as trade secrets.

We try to protect our proprietary position by filing U.S. and foreign patent applications related to our proprietary technology, inventions and improvements that are important to the development of our business. Because the patent position of biotechnology and pharmaceutical companies involves complex legal and factual questions, the issuance, scope and enforceability of patents cannot be predicted with certainty. Patents, if issued, may be challenged, invalidated or circumvented. U.S. patents and patent applications may also be subject to interference proceedings and U.S. patents may be subject to reexamination proceedings in the U.S. 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. Thus, any patents that we own or license from others may not provide any protection against competitors. Our pending patent applications, those we may file in the future, or those we may license from third parties, may not result in patents being issued. If issued, they may not provide us with proprietary protection or competitive advantages against competitors with similar technology. Furthermore, others may independently develop similar technologies or duplicate any technology that we have developed. We rely on third-party payment services for the payment of foreign patent annuities and other fees. Non-payment or delay in payment of such fees, whether intentional or unintentional, may result in loss of patents or patent rights important to our business. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties (for example, the patent owner has failed to “work” the invention in that country, or the third party has patented improvements). In addition, many countries limit the enforceability of patents against government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. Compulsory licensing of life saving drugs is also becoming increasingly popular in developing countries either through direct legislation or international initiatives. Such compulsory licenses could be extended to include some of our product candidates, which could limit our potential revenue opportunities. Moreover, the legal systems of certain countries, particularly certain developing countries, do not favor the aggressive enforcement of patent and other intellectual property protection which makes it difficult to stop infringement.

In addition, our ability to enforce our patent rights depends on our ability to detect infringement. It is difficult to detect infringers who do not advertise the compounds that are used in their products. Any litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations.

We also rely on trade secrets, know-how and technology, which are not protected by patents, to maintain our competitive position. We try to protect this information by entering into confidentiality agreements with parties that have access to it, such as our strategic partners, collaborators, employees and consultants. Any of these parties may breach these agreements and disclose our confidential information or our competitors might learn of the information in some other way. If any trade secret, know-how or other technology not protected by a patent were to be disclosed to or independently developed by a competitor, our business, financial condition and results of operations could be materially adversely affected.

Governmental and third-party payors may impose sales and pharmaceutical pricing restrictions or controls on our potential products that could limit our future product revenues and adversely affect profitability.

The commercial success of our potential products is substantially dependent on whether third-party reimbursement is available for the ordering of our products by the medical profession for use by their patients. Medicare, Medicaid, health maintenance organizations and other third-party payors may not cover or provide adequate payment for our potential products. They may not view our potential products as cost-effective and reimbursement may not be available to consumers or may not be sufficient to allow our potential products to be marketed on a competitive basis. Likewise, legislative or regulatory efforts to control or reduce health care costs or reform government health care programs could result in lower prices or rejection of our potential products. Changes in reimbursement policies or health care cost containment initiatives that limit or restrict reimbursement for our products may cause our revenue to decline.

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Competition in the biotechnology and pharmaceutical industries is intense, and if we fail to compete effectively our financial results will suffer.

Our business is characterized by extensive research efforts, rapid developments and intense competition. Our competitors may have or may develop superior technologies or approaches to the development of competing products, which may provide them with competitive advantages. Our potential products may not compete successfully. We believe that successful competition in our industry depends on product efficacy, safety, reliability, availability, timing, scope of regulatory approval, acceptance and price, among other things. Important factors to our success also include speed in developing product candidates, completing clinical development and laboratory testing, obtaining regulatory approvals and manufacturing and selling commercial quantities of potential products to the market.

We expect competition to increase as technological advances are made and commercial applications broaden. In commercializing our initial product candidates and any additional product candidates, we will face substantial competition from pharmaceutical, biotechnology and other companies, universities and research institutions.

Many of our competitors have substantially greater capital resources, research and development staffs, facilities and experience in conducting clinical trials and obtaining regulatory approvals, as well as in manufacturing and marketing pharmaceutical products. Many of our competitors may achieve product commercialization or patent protection earlier than we achieve commercialization or patent protection, if at all. Furthermore, we believe that some of our competitors have used, and may continue to use, litigation to gain a competitive advantage.

Rapid technological change could make our products obsolete.

Biopharmaceutical technologies have undergone rapid and significant change and we expect that they will continue to do so. Any compounds, products or processes that we develop may become obsolete or uneconomical before we recover any expenses incurred in connection with their development. Rapid technological change could make our products obsolete or uneconomical.

We face potential product liability exposure far in excess of our limited insurance coverage.

The use of any of our product candidates in clinical trials, and the sale of any approved products, may expose us to product liability claims. These claims might be made directly by consumers, health care providers, pharmaceutical companies or others selling our products. We have obtained limited product liability insurance coverage for our clinical trials in the amount of $5,000,000 per occurrence and $5,000,000 in the aggregate. However, our insurance may not reimburse us or may not be sufficient to reimburse us for expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. If we obtain marketing approval for any of our product candidates in development, we intend to expand our insurance coverage to include the sale of commercial products, but we may be unable to obtain commercially reasonable product liability insurance for any products approved for marketing. On occasion, juries have awarded large judgments in class action lawsuits based on drugs that had unanticipated side effects. In addition, the pharmaceutical and biotechnology industries, in general, have been subject to significant medical malpractice litigation. A successful product liability claim or series of claims brought against us would decrease our cash reserves and could cause our stock price to fall.

Our activities involve hazardous materials and we may be liable for any resulting contamination or injuries.

Our research activities involve the use of hazardous materials. We cannot eliminate the risk of accidental contamination or injury from these materials. If an accident occurs, we may be liable for any resulting damages, which may decrease our cash reserves and could cause our stock price to fall.

Risks Related to Our Common Stock

We expect that our stock price will fluctuate significantly.

Prior to our initial public offering, you could not buy or sell our common stock publicly. An active public market for our common stock may not develop or be sustained. The stock market, particularly in recent years, has experienced significant volatility particularly with respect to pharmaceutical and biotechnology stocks. The volatility of pharmaceutical and biotechnology stocks often does not relate to the operating performance of the companies represented by the stock. Factors that could cause this volatility in the market price of our common stock include:

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These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.

Future sales of common stock by our existing stockholders may cause our stock price to fall.

The market price of our common stock could decline as a result of sales by our existing stockholders of shares of common stock in the market, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate.

Our directors and management exercise significant control over our company.

As of June 30, 2004 our directors and executive officers and their affiliates collectively control approximately 44% of our outstanding common stock. These stockholders, if they act together, can influence our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control of our company and might affect the market price of our common stock.

Provisions of Delaware law or our charter documents could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our stockholders, and could make it more difficult for you to change management.

Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. This is because these provisions may prevent or frustrate attempts by stockholders to replace or remove our current management.

These provisions include:

As a result, these provisions and others available under Delaware law could limit the price that investors are willing to pay in the future for shares of our common stock.

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We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.

We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our businesses. In addition, the terms of existing debts preclude us from paying these dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable securities. We maintain an investment portfolio of investment grade, liquid debt securities that limit the amount of credit exposure to any one issue, issuer or type of instrument. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

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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 time periods 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 for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is 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 period covered by this Quarterly Report on Form 10-Q. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide a reasonable assurance that material information relating to us is made known to management, including our Chief Executive Officer and Chief Financial Officer.

There has been no change in our internal controls over financial reporting during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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Part II. OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

Our Registration Statement on Form S-1 (Reg. No. 333-109806) in connection with our initial public offerings was declared effective by the SEC on February 4, 2004. We completed our initial public offering on February 10, 2004 for gross proceeds of $75,900,000. The Company paid the underwriters a commission of $5,313,000 and incurred offering expenses of $2,187,000. After deducting the underwriters’ commission and the offering expenses, the Company received net proceeds of $68,400,000.

No payments for such expenses were made directly or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity securities or (iii) any of our affiliates.

The net proceeds have been invested into short-term investment grade securities and money market accounts.

We have begun to use, and intend to continue to use, these proceeds for general corporate purposes, including clinical trials, research and development expenses, general and administrative expenses, manufacturing expenses and potential acquisitions of companies, products and technologies that complement our businesses.

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

On June 16, 2004, we held our annual stockholders’ meeting. Of the 24,546,150 shares of common stock entitled to vote at the meeting a total of 20,769,640 shares were represented at the meeting in person or by proxy, constituting a quorum. The voting results are as follows:

Proposal I- Election of Class I Directors

Proposal II- Ratification of the Selection of Ernst & Young LLP as our Independent Auditors for the Fiscal Year 2004

Item 6. Exhibits and Reports on Form 8-K

On April 27, 2004, we furnished a current report on Form 8-K under Item 12 regarding the announcement of certain financial results for the first quarter of 2004.

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SIGNATURES