UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2005 or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

for the transition period from ___to ___

Commission File Number 0-27718

NEOSE TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

Delaware		13-3549286
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

102 Witmer Road
Horsham, Pennsylvania		19044
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code : (215) 315-9000

Securities registered pursuant to Section 12(b) of the Act:

None		None
(Title of each class)		(Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act :

Preferred Share Purchase Rights

(Title of class)

Common Stock, par value $0.01 per share

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o      No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o      No þ

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 þ       No o

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

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

Large accelerated filer o           Accelerated filer þ            Non-accelerated filer o

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

As of June 30, 2005, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant was approximately $68,770,104 based on the last sale price of the Common Stock on such date as reported by The NASDAQ National Market. This calculation excludes 10,950,593 shares held on June 30, 2005 by directors, executive officers, and two holders of more than 10% of the registrant’s Common Stock.

As of March 3, 2006, there were 32,782,372 shares of the registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The registrant’s definitive proxy statement to be filed in connection with solicitation of proxies for its Annual Meeting of Stockholders to be held on May 4, 2006, is incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS

PART I			1
ITEM 1. BUSINESS			1
ITEM 1A. RISK FACTORS			11
ITEM 1B. UNRESOLVED STAFF COMMENTS			22
ITEM 2. PROPERTIES			22
ITEM 3. LEGAL PROCEEDINGS			22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			22
PART II			23
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS			23
ITEM 6. SELECTED FINANCIAL DATA			24
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK			39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMTARY DATA			40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			40
ITEM 9A. CONTROLS AND PROCEDURES			41
ITEM 9B. OTHER INFORMATION			43
PART III			44
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT			44
ITEM 11. EXECUTIVE COMPENSATION			44
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT			44
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS			44
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES			44
PART IV			45
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES			45
SIGNATURES			49

NEOSE, GlycoAdvance, GlycoPEGylation and GlycoConjugation are trademarks of Neose Technologies, Inc. This Annual Report on Form 10-K also includes trademarks and trade names of other companies.

PART I

ITEM 1. BUSINESS.

Overview

     We are a biopharmaceutical company using our enzymatic technologies to develop proprietary drugs, focusing primarily on therapeutic proteins. We believe that our core enzymatic technologies, GlycoAdvance^® and GlycoPEGylation™, improve the drug properties of therapeutic proteins by building out, and attaching polyethylene glycol (PEG) to, carbohydrate structures on the proteins. We are using our technologies to develop proprietary versions of protein drugs with proven safety and efficacy and to improve the therapeutic profiles of proteins being developed by our partners. We expect these modified proteins to offer significant advantages, including less frequent dosing and possibly improved efficacy, over the original versions of the drugs now on the market, as well as to meet or exceed the pharmacokinetic profile of next-generation versions of the drugs now on the market. We believe this strategy of targeting drugs with proven safety and efficacy allows us to lower the risk profile of our proprietary development portfolio as compared to de novo protein drug development.

     Our proprietary drug development portfolio currently consists of two therapeutic protein candidates. GlycoPEG-EPO (NE-180) is a long-acting version of erythropoietin (EPO) produced in insect cells. EPO is prescribed to stimulate production of red blood cells, and is approved for sale in major markets around the world for treatment of chemotherapy-induced anemia and anemia associated with chronic renal failure. In February 2006, we initiated a Phase I clinical trial for NE-180 in a Western European country. We expect this clinical trial to conclude by mid-2006. In the U.S., our Investigational New Drug application (IND) for NE-180 is currently on clinical hold with the U.S. Food and Drug Administration (FDA). We anticipate finalizing our “Complete Response” to the FDA in early 2006. The timing of submission of this response to the FDA will depend upon the evolution of our regulatory and clinical strategy. The early clinical development of NE-180 could be carried out entirely in Europe. Our second proprietary protein, GlycoPEG-GCSF, is a long-acting version of granulocyte colony stimulating factor (G-CSF) that we are co-developing with BioGeneriX AG, a company of the ratiopharm Group. G-CSF is prescribed to stimulate production of neutrophils (a type of white blood cell) and is approved for sale in major markets around the world for treatment of neutropenia associated with myelosuppressive chemotherapy. We expect that by the end of the first quarter of 2006, in collaboration with our partner, BioGeneriX, we will commence the regulatory process in a European country. In 2004, the EPO and G-CSF drug categories had aggregate worldwide sales of approximately $10.6 billion and $3.3 billion, respectively.

Opportunities in the Therapeutic Protein Market

     Worldwide sales of protein drugs in 2003 have been reported at over $39 billion, and by some estimates are expected to grow to over $70 billion by 2008. We believe that many of the proteins now on the market will lose the protection of certain patent claims over the next 15 years. In addition, many marketed proteins are facing increased competition from next-generation versions or from other drugs approved for the same disease indications. Although not every protein drug is a candidate for the use of our technologies, we believe our technologies can be applied to many of these marketed drugs to create products with improved clinical profiles. We are pursuing opportunities in this field through our own proprietary drug development portfolio, our exploratory research program and our partnering and licensing program.

Our Technology

     Our GlycoAdvance and GlycoPEGylation technologies involve the use of enzymes to modify or initiate, and attach PEG to, carbohydrate structures on glycoproteins (proteins with carbohydrate structures attached). We have developed a special expertise and extensive intellectual property position in this area. Our technologies may permit the development of therapeutic proteins with improved clinical profiles. In some cases, these improvements to therapeutic proteins may also allow us to create new intellectual property relating to our core technologies as well as new compositions of matter. We continue to make significant investments in research and development and legal services to protect and expand our intellectual property position. We believe our core technologies have broad application to protein drug development and can be extended to provide an opportunity for sustainable growth. We

are using our GlycoAdvance and GlycoPEGylation technologies in our proprietary drug development portfolio, in our exploratory research program and in our partnering and licensing program.

     GlycoAdvance. Our GlycoAdvance technology employs enzymes to modify or initiate carbohydrate structures on proteins. Currently, recombinant glycoprotein drugs are often produced in mammalian cell culture expression systems, primarily Chinese hamster ovary (CHO) cells. Generally, carbohydrates are added to proteins during the process of expression. CHO cells, and many other expression systems used for commercial manufacturing of proteins, tend to produce protein molecules with incomplete or inconsistent carbohydrate structures. In the human body, these incompletely glycosylated proteins may be cleared too rapidly, thus compromising the half-life and effectiveness of these proteins. Conventional approaches to improving the glycosylation of recombinant protein drugs, such as changing the cell line used for expression, re-engineering the protein, and modifying cell culture conditions or media, are time consuming and frequently provide only partial solutions. In addition, when a protein is inconsistently glycosylated, additional purification may be required to remove incompletely glycosylated drug molecules from the desired drug product, resulting in lower manufacturing yields and increased expense.

     Our GlycoAdvance technology addresses these problems by employing enzymes to modify the carbohydrate structures on proteins that have inadequate carbohydrate structures and to initiate carbohydrate structures on proteins that have none. Proteins may have inadequate carbohydrate structures as a result of the cell expression systems used, or may have no carbohydrate structures in their native state or as a result of the cell expression system used. Our GlycoAdvance technology enables the use of alternate expression systems to produce protein drugs, including not only CHO and E. coli, but also insect cells. By modifying or initiating carbohydrate structures on proteins, GlycoAdvance also enables the application of our GlycoPEGylation technology to these proteins.

     GlycoPEGylation. Our GlycoPEGylation technology employs enzymes to attach PEG selectively to the carbohydrate structures on glycoprotein drugs, rather than attaching PEG directly to the protein backbone.

     Common protein drug delivery problems include poor solubility and stability, proteolysis (rapid degradation), rapid clearance, and immunogenicity. For some proteins, one approach to these problems has been conventional chemical pegylation — the attachment of the large, water-soluble polymer, PEG, directly to the amino acid backbone of the protein. Pegylation has been used in marketed drugs, such as PEG-INTRON^®, PEGASYS^® and Neulasta^®. Pegylation increases the effective size of the drug and in some cases improves its solubility, stability, half-life and immunogenicity profile.

     For some protein drugs, it has been difficult to achieve the benefits of pegylation by the conventional approach of attaching PEG directly to the protein backbone. A possible explanation is that the sites for the attachment of PEG occur at positions where the bulky PEG molecules block access to the active site on the protein or alter the conformation of the protein. This may diminish or eliminate drug activity.

     By employing GlycoAdvance and GlycoPEGylation, we are able to attach PEG efficiently and selectively. By linking PEG to carbohydrate structures that are remote from the protein’s active site, GlycoPEGylation may preserve the bioactivity of the drug and extend its half-life. We believe that significant clinical benefits may be achieved through the application of our GlycoPEGylation technology to proteins. By using our GlycoPEGylation technology, we have been able to demonstrate with several drug candidates a prolonged drug effect in animals.

Proprietary Drug Development Portfolio

     Our proprietary drug development portfolio currently consists of two next-generation therapeutic protein candidates: a long-acting version of EPO (NE-180) and a long-acting version of G-CSF (GlycoPEG-GCSF).

     NE-180. We are developing NE-180, a long-acting version of EPO that is produced in insect cells. We filed for authorization to commence a Phase I clinical trial in a Western European country during the later part of 2005. On January 3, 2006, NE-180 was cleared to proceed into a Phase I clinical trial in this European country, which was initiated in February, 2006. We expect to conclude this Phase I clinical trial for NE-180 by mid-2006.

     In the U.S., we submitted an IND for NE-180 to the FDA during the second quarter of 2005. In August 2005, the FDA advised us that it requires additional manufacturing and preclinical information in order to complete its review of the IND and that our proposed Phase I clinical trial of NE-180 in the U.S. had been placed on hold. We anticipate finalizing our “Complete Response” to the FDA in early 2006. The timing of submission of this response to the FDA will depend upon the evolution of our regulatory and clinical strategy. The early clinical development of NE-180 may be carried out entirely in Europe.

     EPO is prescribed to stimulate production of red blood cells, and is approved for sale in major markets around the world for the treatment of chemotherapy-induced anemia and anemia associated with chronic renal failure. EPO accounts for more sales worldwide than any other glycoprotein drug. Worldwide sales in the EPO category in 2004 were approximately $10.6 billion. Of these sales, approximately $7.5 billion were in the U.S., approximately $1.7 billion were in Europe, and approximately $1 billion were in Japan.

     Based on preclinical studies, we believe it is feasible to develop a long-acting EPO through GlycoPEGylation. These studies suggest that the pharmacokinetic profile of EPO can be adjusted by manipulating the number of carbohydrate attachment sites and the molecular weight of the PEG that we attach to the compound. In these early animal studies, multiple constructs of GlycoPEGylated EPO, including NE-180, had improved pharmacokinetic and pharmacodynamic profiles as compared with unmodified EPO, and pharmacokinetic and pharmacodynamic profiles comparable to those of Aranesp^®, Amgen’s long-acting EPO analog. Based on our preliminary market research, we believe that clinicians, particularly oncologists, would respond favorably to a long-acting EPO. This is supported by reported sales data for Aranesp, indicating cumulative sales of approximately $7.7 billion during the period from its launch in 2001 through the fourth quarter of 2005.

     We believe that the expiration of key patents covering EPO will provide commercial opportunities in time frames consistent with our development timeline. While we expect to pursue early entry opportunities in the U.S., we plan to pursue regulatory and marketing approval first in Europe, where, the key patents, along with those in Japan, expired in 2005.

     In the U.S., we believe that the key patents surrounding EPO expressed in non-vertebrate systems will expire by the end of 2013, and that the remaining key patents will expire by the end of 2015. Accordingly, we believe that our use of an insect cell expression system will allow NE-180 to enter the U.S. market sooner than EPO products expressed in vertebrate or mammalian cells. In addition, we believe that the use of an insect cell expression system may allow us to enter the U.S. market before even the non-vertebrate patents expire. Some of the issues relevant to the analysis of our freedom to operate in the U.S. are the subject of ongoing litigation between other parties. We continue to monitor these matters, as well as evaluate whether the applicable patent claims would block our entry into the U.S. market prior to expiration. In the meantime, we expect to continue development in the U.S. of NE-180 under the protection of a statutory safe harbor.

     GlycoPEG-GCSF. We are developing GlycoPEG-GCSF, a long-acting version of G-CSF, in collaboration with our partner BioGeneriX. We expect that by the end of the first quarter of 2006 we and BioGeneriX will commence the regulatory process in a European country. G-CSF is prescribed to stimulate production of neutrophils (a type of white blood cell), and is approved for sale in major markets around the world for treatment of neutropenia associated with myelosuppressive chemotherapy. Worldwide sales in the G-CSF category in 2004 were approximately $3.3 billion. Of these sales, approximately $2.2 billion were in the U.S., approximately $0.7 billion were in Europe, and approximately $0.4 billion were in Japan.

     Based on proof-of-concept data and preclinical development activities, we believe it is feasible to develop a long-acting G-CSF through GlycoPEGylation. These studies suggest that the pharmacokinetic profile of G-CSF can be adjusted by manipulating the number of carbohydrate attachment sites and the molecular weight of the PEG that we attach to the compound. In these early animal studies, multiple constructs of GlycoPEGylated G-CSF, including GlycoPEG-GCSF, had improved pharmacokinetic and pharmacodynamic profiles as compared with unmodified G-CSF (Neupogen^®), and pharmacokinetic and pharmacodynamic profiles comparable to those of Neulasta^®, Amgen’s long-acting G-CSF analog. We believe that clinicians would respond favorably to a long-acting G-CSF as supported by reported sales data for Neulasta, indicating cumulative sales of approximately $5.7 billion during the period from its launch in 2002 through the fourth quarter of 2005.

     We believe that the expiration of key patents covering G-CSF will provide commercial opportunities in a time frame consistent with our development timeline. We expect that regulatory approval for GlycoPEG-GCSF will be sought both in and outside the U.S. We believe that key patents covering G-CSF will expire in Europe in 2006, in the U.S. in late 2013 and in other jurisdictions between these times. We expect to pursue regulatory and marketing approval for GlycoPEG-GCSF first in Europe.

Exploratory Research Program

     We conduct exploratory research, both independently and with collaborators, on therapeutic candidates, primarily proteins, using our enzymatic technologies. Successful therapeutic candidates may be advanced for development through our own proprietary drug development program, our partnering and licensing program, or a combination of the two. Although our primary focus is the development of long-acting proteins, we are also conducting research to assess opportunities to use our enzymatic technologies in other areas, such as glycopeptides and glycolipids.

Partnering And Licensing Program

     Currently we have the following collaborations:

     BioGeneriX — GlycoPEG-GCSF. In April 2004, we entered into an agreement with BioGeneriX to use our proprietary GlycoAdvance and GlycoPEGylation technologies to develop a long-acting version of G-CSF. Under the agreement, we and BioGeneriX share the expenses of preclinical development, BioGeneriX is responsible for supplying the protein and funding the entire clinical development program and we will be responsible for supplying enzyme reagents and sugar nucleotides. If we and BioGeneriX proceed to commercialization, we will have commercial rights in the U.S., Canada, Mexico and Japan, and BioGeneriX will have commercial rights in Europe and the rest of the world. Each company has the ability to search for its own marketing partner for its territories and will receive significant royalties on product sales in the other company’s territory. In connection with the agreement, we received an upfront fee from BioGeneriX. BioGeneriX has the right to terminate the agreement without cause following the completion of preclinical development, in which case we will have all rights to the product candidate, including supply of protein from BioGeneriX or its contract manufacturer. Each party has the right, in various circumstances, to terminate the agreement by giving the required notice to the other party, subject to the other party’s right to continue working on the development and commercialization of a long-acting version of G-CSF, as provided in the agreement.

     BioGeneriX — Additional GlycoPEGylated Protein. On April 28, 2005, we entered into a research, co-development and commercialization agreement with BioGeneriX. We received a non-refundable payment in connection with the execution of this agreement. In addition, under the agreement we are entitled to receive research payments and could receive milestone payments totaling up to $61.5 million, as well as significant royalties on product sales. The agreement provides for us to conduct research on behalf of BioGeneriX for up to 12 months and grant BioGeneriX the right to obtain an exclusive, worldwide license to use our enzymatic technologies to develop and commercialize a long-acting version of the target protein. If BioGeneriX exercises its right to obtain the license, they will be responsible for the further development and commercialization of the target protein. If requested by BioGeneriX, we will provide, and be fully reimbursed for, any required technical assistance. BioGeneriX has the right to terminate the agreement any time after the research period. We have the right to terminate the agreement if specific development milestones are not met within certain periods of time.

     Novo Nordisk. In 2003, we entered into agreements with Novo Nordisk A/S to use our GlycoAdvance and GlycoPEGylation technologies to develop and commercialize three next-generation versions of currently-marketed proteins, one of which is marketed by Novo Nordisk. Under these agreements, we received a $4.3 million upfront fee, and Novo Nordisk funds our research and development activities for these three proteins. We may also receive up to $52.2 million in development milestones under these agreements, as amended, as well as significant royalties on sales of the licensed products. Under these agreements, Novo Nordisk’s license with respect to each protein continues until the expiration of the last Neose patent covering a licensed product, or until the earlier termination of the applicable agreement. Novo Nordisk has the right to terminate each of the agreements without cause. We have the right to terminate the agreement with respect to two of the proteins if there are no commercial sales of licensed products within a specified period, subject to Novo Nordisk’s ability to extend by paying minimum royalties.

     MacroGenics. In 2004, we entered into a research collaboration agreement with MacroGenics, Inc. to use our GlycoAdvance and GlycoPEGylation technologies on multiple monoclonal antibodies of MacroGenics, with the goal of improving the therapeutic profiles of these proteins. Under this agreement, MacroGenics has the right to take a limited number of modified compounds into development. During the research phase, we and MacroGenics each fund our own expenses. If MacroGenics decides to proceed with any of the modified compounds beyond the initial research phase, MacroGenics will be responsible for all further development of the licensed compounds and we will receive royalties on any product sales.

Business Strategy

     Our primary focus is to develop proprietary protein drugs with proven safety and efficacy, and to improve the therapeutic profiles of glycoproteins being developed by our partners. We may also develop other therapeutic drugs by applying our enzymatic technologies in other areas, such as glycopeptides and glycolipids. Key elements of our strategy are to:

	•		Continue to develop our two long-acting therapeutic protein candidates. We continue to develop our two long-acting proprietary therapeutic protein candidates: NE-180 and GlycoPEG-GCSF. With regard to NE-180, we expect to complete a Phase I clinical trial in a Western European country in mid-2006, and assuming the successful outcome of our Phase I clinical trial in Europe, we may seek to conduct our Phase II clinical trials in Europe in the latter half of 2006. In the U.S., we anticipate finalizing our “Complete Response” to the FDA in early 2006. The timing of submission of this response to the FDA will depend upon the evolution of our regulatory and clinical strategy. With regard to GlycoPEG-GCSF, we expect that by the end of the first quarter of 2006, in collaboration with our partner, BioGeneriX, we will commence the regulatory process in a European country.
	•		Target drugs with proven safety and efficacy. We are developing improved therapeutics with a current focus on therapeutic proteins using our proprietary enzymatic technologies, GlycoAdvance and GlycoPEGylation. We expect these modified proteins to offer significant advantages, including less frequent dosing and possibly improved efficacy, over the original versions of the drugs now on the market, as well as to meet or exceed the pharmacokinetic and pharmacodynamic profiles of next-generation versions of the drugs now on the market. We believe this strategy of targeting the many commercially attractive protein drugs with proven safety and efficacy allows us to lower the risk profile of our proprietary drug development portfolio as compared to de novo protein drug development. We intend to continue to focus our research and development resources on therapeutic proteins that we believe have the highest probability of clinically meaningful therapeutic profile improvements from our technology and are in commercially attractive categories.
	•		Leverage our core competencies. We believe that our core enzymatic technologies improve the drug properties of therapeutic proteins. We will continue to use our technologies to research and develop improved versions of protein drugs with proven safety and efficacy and to improve the therapeutic profiles of glycoproteins being developed by our partners. We will also continue to conduct exploratory drug development research in novel therapeutic categories, such as glycolipids, where our proprietary enzymatic technology, intellectual property and internal expertise provide us with opportunities.
	•		Continue to seek attractive partnership opportunities. We will continue our efforts to build a portfolio of commercially attractive partnerships in a blend of co-developments and licenses. Where possible, we will seek partnerships that allow us to participate significantly in the commercial success of each of the compounds.

Intellectual Property

     Our success depends on our ability to protect and use our intellectual property rights in the continued development and application of our technologies, to operate without infringing the proprietary rights of others, and to prevent others from infringing on our proprietary rights. In connection with our proprietary protein drug program,

we have devoted significant resources to investigating the patent protection for currently marketed proteins. We also devote significant resources to obtaining and maintaining patents, and we expect to aggressively enforce our rights if necessary, although we recognize that the scope and validity of patents is never certain.

     Our patent strategy has two main components, the pursuit of a patent portfolio protecting our technologies and their anticipated applications, and the evaluation of patent protection for proteins we may target for development.

     Patents and Proprietary Rights. We have continued to file patent applications covering new developments in our technologies, including compositions and methods for enzymatically adding and modifying sugar chains on a multitude of proteins to form stable linkages between a sugar attached to a polypeptide and a water soluble polymer, therapeutic compound, targeting agent, or other biologically active molecule.

     In addition to developing our own intellectual property, we have obtained and continue to seek complementary intellectual property from others. We have entered into license agreements with various institutions and individuals for certain patent rights, as well as sponsored research and option agreements for the creation and possible license to us of additional intellectual property rights. We are obligated to pay royalties at varying rates based upon, among other things, levels of revenues from the sale of licensed products under our existing license agreements, and we expect to pay royalties under new license agreements for intellectual property. Generally, these agreements continue for a specified number of years or as long as any licensed patents remain in force, unless the agreements are terminated earlier.

     We own 25 issued U.S. patents, and have licensed 63 issued U.S. patents from 12 institutions. In addition, we own or have licensed over 131 patent applications pending in the U.S. There are also 520 foreign patent applications pending or granted related to our owned and licensed patents. In addition, we have assigned four issued U.S. patents and seven granted or pending foreign counterparts to Magnolia Nutritionals, our joint venture with McNeil Nutritionals (a subsidiary of Johnson & Johnson).

     We recently received a Notice of Allowance from the U.S. Patent and Trademark Office for a pending patent application related to our GlycoPEGylation technology. The allowed U.S. claims contained in the application broadly cover glycosyl-linked poly(ethylene glycol) conjugates of therapeutic peptides. This was the first allowed patent application in a series of pending patent applications directed toward our broad GlycoConjugation technology platform.

     Proprietary Protein Drugs. To pursue our strategy of developing proprietary protein drugs, we must ascertain the nature, scope and expiration of existing patent claims covering the proteins we may target for development. The patent coverage on these proteins and methods of making them is complex. These patents must be analyzed on a claim-by-claim basis, and we must make decisions based on our analysis of these varied claims. The patents and their expiration dates often vary from the U.S. to Europe to Japan. It is possible that we are unaware of issued patents or pending patent applications that are relevant to our product candidates, either because our search did not find them or because they are not yet publicly available.

     In order to market proprietary versions of currently marketed proteins, it is necessary to determine the expiration dates of existing patent claims that could cover a product candidate by analyzing numerous, complex patent claims and, in some cases, judicial opinions. The analysis of patents is subject to different interpretations. Our analysis of the patent coverage surrounding both EPO in the U.S. and Europe has encouraged us that there may be opportunities to enter the U.S. market sooner than our competitors whose products would have different characteristics or manufacturing processes. If we pursue a strategy of early entry in the U.S., litigation could result, and would be costly regardless of whether we were successful. Litigation could also result in delays in the launch of a product, even if we ultimately prevailed in the litigation.

     Nature of Protection. The nature of patent protection in the pharmaceutical and biotechnology industry is complex, uncertain and unpredictable. The patents we seek may not issue, or may issue with a narrower scope than originally sought, and may not be valid or effectively enforceable. Even if our patents are enforceable, enforcement of our patents could be time consuming and expensive. If the claims in our pending patent applications are narrowed prior to issuance, others will have greater opportunity to circumvent or design around our patent protection.

     We also have proprietary trade secrets and know-how that are not patentable or which we have chosen to maintain as secret rather than filing for patent protection. We seek to protect our secret information by entering into confidentiality agreements with employees, consultants, licensees, and potential collaboration partners. These agreements generally provide that all confidential information developed by us, or made known by us to the other party, during the relationship shall be kept confidential and may not be disclosed to third parties, except in specific circumstances. Our agreements with employees also provide that inventions made by the employee during the period of employment will be solely owned by us if they are the result of tasks assigned by us or the use of property (including intellectual property) owned or used by us. Our agreements with consultants generally provide that inventions conceived by the consultant while rendering consulting services to us will be our exclusive property.

     We are aware of numerous pending and issued U.S. and foreign patent rights and other proprietary rights owned by third parties in fields related to our technologies. We will continue to expend resources to protect our own technology and seek to avoid infringing the technology of others. Patent protection obtained by others may interfere with our ability to obtain patents, or our ability to effectively employ our technologies.

     Others may claim that our technology infringes on their patents. Even if successful, the process of defending against such claims could result in substantial costs and delay our ability to commercialize our product candidates that utilize the challenged technology.

Government Regulation

     Our research and development activities, the future manufacture of reagents and products incorporating our technologies, and the marketing of these products are subject to regulation for safety and efficacy by numerous governmental authorities in the U.S. and other countries.

     Regulation of Pharmaceutical Product Candidates. The research and development, clinical testing, manufacture and marketing of products using our technologies are subject to regulation by the FDA and by comparable regulatory agencies in other countries. Product development and approval within this regulatory framework take a number of years and involve the expenditure of substantial resources. We anticipate that the development of our next-generation proprietary proteins will involve a traditional development program, including clinical trials.

     After laboratory analysis and preclinical testing in animals, a regulatory filing is required to be submitted to the appropriate authorities before human testing may begin. In the U.S., an IND filing is made to the FDA. In Europe, an Investigational Medicinal Product Dossier (IMPD) or equivalent filing is submitted to the national health authority (Competent Authority) in each country in which a clinical trial is planned. Typically, a sequential three-phase human clinical testing program is then undertaken, but the phases may overlap or be combined. Certain phases may not be necessary for a particular product. Each clinical study is conducted according to an approved protocol after written approval is obtained from an independent Institutional Review Board (IRB) in the U.S, or Independent Ethics Committee (IEC) in Europe. During Phase I, small clinical trials are conducted to determine the safety of the product in healthy volunteers. During Phase II, clinical trials are expanded in size and are conducted to assess safety, establish an acceptable dose, and gain preliminary evidence of the efficacy of the product in a subset of the target population. During Phase III, clinical trials are further expanded in size and conducted to obtain sufficient data to establish statistically significant proof of safety and efficacy in the target population. The time and expense required to perform this clinical testing vary and can be substantial. The results of the preclinical and clinical testing of a biological pharmaceutical product are then submitted to the appropriate authority in the form of a Biologics License Application (BLA), or New Drug Application (NDA), both in the U.S., or a Marketing Authorization Application (MAA) or equivalent, in Europe. If the application contains all pertinent information and data, the appropriate regulatory authority will formally accept the file for review. In responding to this filing, the regulatory authority may grant marketing approval, request additional information, or deny the application.

     No action may be taken to market any new drug or biologic product in either the U.S. or Europe until an appropriate marketing application has been approved by the responsible regulatory authority(ies). Even after initial regulatory approval is obtained, further clinical trials may be required to provide additional data on safety and effectiveness or to gain clearance for the use of a product as a treatment for indications other than those initially approved. Side effects or adverse events that are reported during clinical trials may delay, impede, or prevent marketing approval. Similarly, adverse events that are reported after obtaining marketing approval may result in

additional limitations being placed on the use of a product and, potentially, withdrawal of the product from the market.

     The regulatory requirements and approval processes of countries in Europe (including the European country in which we are conducting a Phase I clinical trial for NE-180) are similar to those in the U.S. The European clinical trials are being performed in a manner consistent with FDA requirements, which would potentially allow the data generated from the European trials to be used to support a U.S. IND application.

     In addition to regulating and auditing human clinical trials, the FDA regulates and inspects equipment, facilities, and processes used in the manufacture and control of products prior to providing approval to market a product. Among other conditions for marketing approval in the U.S., the prospective manufacturer’s quality control and manufacturing procedures must conform on an ongoing basis with current Good Manufacturing Practices (cGMP). Before granting marketing approval, the FDA will perform a prelicensing inspection of the facility to determine its compliance with cGMP and other rules and regulations. In complying with cGMP, manufacturers must continue to expend time, money and effort in the area of production, training and quality control to ensure full compliance. After approval of a BLA or NDA, manufacturers are subject to periodic inspections by the FDA. If, as a result of FDA inspections relating to our products or reagents, the FDA determines that our equipment, facilities, or processes do not comply with applicable FDA regulations or conditions of product approval, the FDA may seek civil, criminal, or administrative sanctions and remedies against us, such as the suspension of our manufacturing operations, the seizure of products we produce, and the suspension of sales of our products.

     Products manufactured in the U.S. for distribution abroad are subject to FDA regulations regarding export, as well as to the requirements of the country to which they are shipped. Products distributed to European countries that are members of the EU are also subject to EU regulations. The requirements of the EU and foreign countries generally cover the conduct of clinical trials, the submission, review and approval of marketing applications, and all aspects of product manufacture and marketing. These requirements may vary significantly from country to country.

     We expect to enter into agreements with third parties for the manufacture of enzymes, sugar nucleotides and other reagents that are used in the production of next-generation glycoPEGylated protein therapeutics using our technology. Any third parties we contract with will be subject to substantially the same regulatory requirements as we are with regard to the items they manufacture for us.

     Other Regulations Affecting our Business. We are subject to various other laws and regulations, such as those relating to safe working conditions, employee relations, employee benefits, the environment (including the use and disposal of hazardous or potentially hazardous substances), antitrust and international trade, public securities and taxation. We endeavor to comply with applicable laws and regulations. However, we recognize that this is a complex and expensive process, and that we cannot predict when changes will occur or whether they would have a material adverse effect on our operations.

     We contract with third parties for supplies and services that are critical to our business. These third parties are also subject to government regulation. The failure of any of these third parties to comply with applicable laws and regulations could cause substantial delays to our drug development timelines and have a material adverse effect on our operations.

     Third-Party Reimbursement. Our ability and each of our collaborator’s ability to successfully commercialize drug products may depend in part on the extent to which coverage and reimbursement for the cost of such products will be available from government health administration authorities, private health insurers, and other organizations. Uncertainty continues within the pharmaceutical and biotechnology industries as to the reimbursement status of new therapeutic products, and we cannot be sure that third-party reimbursement would be available for any therapeutic products that we or our collaborators might develop. Healthcare reform, especially as it relates to prescription drugs, is an area of increasing attention and a priority of many governmental officials.

Competition

     The biotechnology and pharmaceutical industries are characterized by rapidly evolving technology and significant competition. Our competitors include pharmaceutical and biotechnology companies. In addition, many specialized biotechnology companies have formed collaborations with large, established companies to support

research, development and commercialization of products that may be competitive with our current and future product candidates and technologies. Academic institutions, governmental agencies and other public and private research organizations are also conducting research activities and seeking patent protection and may commercialize competitive products or technologies on their own or through collaborations with pharmaceutical and biotechnology companies.

     Next-Generation Protein Development. We are aware that other companies are working on the development of next-generation protein therapeutics in anticipation of the expiration of certain patent claims covering marketed proteins. A number of these competitors are working on the development of next-generation protein therapeutics. Some of these competitors include Maxygen, Nektar Therapeutics, BioRexis, Human Genome Sciences and Alkermes. Other companies have programs focused on developing next-generation or improved versions of EPO and G-CSF, and some are already marketing improved versions of these products. These companies include Amgen, Roche, Shire, Maxygen, Fibrogen, Affymax and Syntonix. Other companies are active in this area, and we expect that competition will increase. We are also aware that there are several companies engaged in glycobiology research. Our product candidates will face competition from products already established in the marketplace and new therapies that may be developed by our competitors or may result from advances in biotechnology or other fields.

     Competitive Next-Generation EPO and G-CSF Products. Other companies have programs focused on developing next-generation or improved versions of EPO and G-CSF, and some are already marketing improved versions of these products.

     Amgen currently markets Aranesp^®, its improved version of EPO, which has a longer circulating half-life than EPO. Amgen launched Aranesp in the last quarter of 2001 and has reported that global sales of Aranesp were approximately $3.3 billion during 2005. Roche is developing an improved EPO known as CERA (Continuous Erythropoiesis Receptor Activator). In December 2005, Roche announced that Phase III clinical trials for CERA had been completed and that in 2006 it intends to seek regulatory approval for the limited commercialization of CERA worldwide for certain renal indications. Roche has indicated that it may delay seeking regulatory approval for other indications for up to two years. In addition, in late 2005 Amgen filed a lawsuit against Roche alleging that CERA infringes on Amgen’s patents. Besides Amgen and Roche, non-originator companies are applying their technologies to develop improved EPO compounds, such as: Syntonix, with its EPO-Fc fusion protein (which we believe is currently in preclinical development); Fibrogen, with its small molecule promoter of endogenous EPO (which we believe is currently in Phase II); and Affymax, with its synthetic EPO-like peptides (which we believe is currently in Phase II).

     Amgen currently markets Neulasta^®, which is a modified version of its original G-CSF product, Neupogen^®. Neulasta is a chemically pegylated compound, with a longer circulating half-life than Neupogen. Amgen launched Neulasta in the first quarter of 2002 and has reported that global sales of Neulasta were approximately $2.3 billion for the year ended December 31, 2005. Other companies, such as Maxygen and Affymax, are also applying their technologies to develop long acting competitors to G-CSF (we believe that both of these products are in preclinical development).

     Follow-on Biologics (Biogenerics). Several companies are pursuing the opportunity to develop and commercialize follow-on versions of currently marketed biologic products, including EPO, G-CSF and others. These companies include Novartis (Sandoz), BioGeneriX, Stada (Bioceuticals), BioPartners and SICOR (a subsidiary of Teva Pharmaceutical USA). In the U.S. and Japan, a clear development and regulatory path does not currently exist for biologic products that are, or soon will be, off-patent. In Europe, the first guidelines regarding the quality, preclinical and clinical development of follow-on biologics was adopted in September 2005, with additional guidelines expected to be adopted in 2006.

     Research and Development Services. Although we are focused on the development of proprietary protein drugs, we also use our GlycoAdvance and GlycoPEGylation technologies to provide collaborative research services and product improvement opportunities to other pharmaceutical and biotechnology companies. These services may compete with efforts within these companies to improve therapeutic protein profiles and expression, and with services provided by other companies to improve proteins, such as chemical pegylation technology.

     There are several companies engaged in glycobiology research. Their work includes efforts to develop better-glycosylating cell lines, optimize cell culture conditions to improve glycosylation, and generate carbohydrate therapeutics. Companies working in this area include Crucell, GlycoFi and Momenta. Crucell has developed human cell lines for glycoprotein production. GlycoFi is focused on expressing glycoproteins in yeast systems and Momenta is utilizing sophisticated analysis and design for carbohydrate-based therapeutics.

Manufacturing

     We have used our pilot facility to develop manufacturing processes for NE-180, enzyme reagents and key sugar nucleotides (including our sugar-PEG nucleotides). We manufactured NE-180 in sufficient quantities to meet the needs of our expected preclinical and early clinical studies. We plan to transfer the manufacturing process for NE-180 to a third-party contract manufacturer or partner outside of the US for Phase III and commercial supplies.

     Our partners currently manufacture the native proteins that are subsequently remodeled using GlycoAdvance and GlycoPEGylation and will incorporate the remodeling processes at their facilities. Our supply chain obligations, outside of NE-180, are therefore confined to the supply of enzyme reagents and sugar nucleotides. We intend to use contract manufacturing organizations (CMOs) for the supply of our enzyme reagents and sugar nucleotides, except those that are available commercially.

     Since we now have excess manufacturing capacity, we continue to evaluate alternatives for the disposition of the facility that contains our pilot manufacturing plant.

Marketing, Distribution, and Sales of Proprietary Protein Products

     We intend to capitalize on the significant experience and resources of our collaborative partners to commercialize proprietary products made using our technologies. These partners generally would be responsible for much of the development, regulatory approval, sales, marketing, and distribution activities for products incorporating our technologies. However, we intend to retain some commercial rights to some proteins in select territories. If we commercialize any products on our own, we will have to establish or contract for regulatory, sales, marketing, and distribution capabilities, and we may have to supplement our development capabilities. The marketing, advertising, and promotion of any product manufactured using our technology would be subject to regulation by the FDA or other governmental agencies.

Employees

     As of December 31, 2005, we employed 109 individuals, consisting of 83 employees engaged in research, development and manufacturing activities, and 26 employees devoted to corporate and administrative activities. Our scientific staff includes carbohydrate biochemists as well as scientists with expertise in organic chemistry, analytical chemistry, molecular biology, microbiology, cell biology, scale-up manufacture, and regulatory affairs. A significant number of our employees have prior experience with pharmaceutical or biotechnology companies, and many have specialized training in carbohydrate technology. None of our employees is covered by collective bargaining agreements. We believe we have good relations with our employees.

     Upon the completion of the restructuring announced in August 2005, we reduced the size of our workforce by approximately 25% compared to the end of the first quarter of 2005.

Restructuring

     In August 2005, we implemented a restructuring of operations to enable an enhanced focus on next-generation proteins, to allow for the anticipated transfer of production of proteins and reagents to our collaborative partners and contract manufacturers now that our programs are more mature, and to reduce cash burn. Upon completion of the restructuring, we reduced the size of our workforce by approximately 25% compared to the end of the first quarter of 2005. Our net loss for 2005 included $14.2 million of charges related to this restructuring, including $13.2 million of non-cash property and equipment impairment charges, most of which related to our Witmer Road facility and related equipment, and $1.0 million of payments for employee severance and facility closure costs.

Internet Address and Securities Exchange Act Filings

          Our internet address is www.neose.com. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make these reports and amendments available on our website as soon as practicable after filing them electronically with, or furnishing them to, the Securities and Exchange Commission.

ITEM 1A. RISK FACTORS.

Financial Risks

          To date, we have funded our operations primarily through proceeds from the public and private placements of equity securities. We have also funded our operations to a lesser extent from proceeds from property and equipment financing, interest earned on investments, revenues from corporate collaborations and gains from the sale of investments. We believe that our existing cash and cash equivalents, expected revenue from collaborations and license arrangements, and interest income should be sufficient to meet our operating and capital requirements at least through 2006, although changes in our collaborative relationships or our business, whether or not initiated by us, may affect the rate at which we deplete our cash and cash equivalents. Our present and future capital requirements depend on many factors, including:

	•		level of research and development investment required to develop our therapeutic proteins, and maintain and improve our technology position;
	•		the costs of procuring proteins and reagents for research and development and at commercial scale;
	•		the results of preclinical and clinical testing, which can be unpredictable in drug development;
	•		changes in product candidate development plans needed to address any difficulties that may arise in manufacturing, preclinical activities, clinical studies or commercialization;
	•		our ability and willingness to enter into new agreements with collaborators and to extend or maintain our existing collaborations, and the terms of these agreements;
	•		our success rate and that of our collaborators in preclinical and clinical efforts associated with milestones and royalties;
	•		the costs of investigating patents that might block us from developing potential drug candidates;
	•		the costs of recruiting and retaining qualified personnel;
	•		the time and costs involved in obtaining regulatory approvals;
	•		the timing, willingness, and ability of our collaborators to commercialize products incorporating our technologies;
	•		the costs of filing, prosecuting, defending, and enforcing patent claims and other intellectual property rights;
	•		our need or decision to acquire or license complementary technologies or new drug targets; and
	•		the evolution of the competitive landscape.

          We will require significant amounts of additional capital in the future, and we do not have any assurance that funding will be available when we need it on terms that we find favorable, if at all. We may seek to raise these funds through public or private equity offerings, debt financings, credit facilities, or corporate collaborations and licensing arrangements.

          If we raise additional capital by issuing equity securities, our existing stockholders’ percentage ownership will be reduced and they may experience substantial dilution. We may also issue equity securities that provide for rights, preference and privileges senior to those of our common stock. If we raise additional funds by issuing debt securities, these debt securities would have rights, preferences, and privileges senior to those of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we may be required to relinquish some rights to our technologies or drug candidates, or to grant licenses on terms that are not favorable to us. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, take advantage of opportunities, develop products and technologies, and otherwise respond to competitive pressures could be significantly delayed or limited, and we may need to downsize or halt our operations.

          We have a credit facility, which was amended in February 2006, with a bank consisting of a credit agreement and a financing agreement. As of December 31, 2005, the outstanding balance under the credit facility was $8.1 million. Pursuant to the agreements comprising the credit facility, we agreed to limit our total outstanding debt to $22.0 million; therefore, we cannot exceed this limit without the bank’s consent. As of December 31, 2005, our total outstanding debt was $14.5 million. The limit on our total debt under the credit agreement could adversely affect us by reducing our flexibility in planning for, or reacting to, changes in our business and our industry.

          If the bank determines a material adverse change has occurred in our business, financial condition, results of operations, or business prospects, the bank, in its sole discretion, may declare at any time an event of default, of which one potential outcome could be the accelerated repayment of the then outstanding loan balance under the facility. If we fail at any time to maintain a minimum required cash and short-term investments balance of at least $12.0 million, the bank has the option to require us to make a payment to reduce the outstanding balance under the credit facility to $6.0 million. If we fail at any time to maintain a minimum required cash and short-term investments balance of at least $10.0 million, the bank has the option to require us to make a payment to reduce the outstanding balance under the credit facility to $5.0 million. Finally, if we fail at any time to maintain a minimum required cash and short-term investments balance of at least $5.0 million we will be considered to be in default of the credit facility and the bank may take certain actions in relation to that default, including, but not limited to, requiring us to repay the entire outstanding balance under the credit facility.

          As of December 31, 2005, we maintained a cash and cash equivalents balance of $37.7 million. During 2006, we anticipate average quarterly spending of approximately $8.0 million to $8.5 million to fund our operating activities, capital expenditures, and debt repayments, without giving effect to the impact of entering into any new collaborative agreements or disposing of our current headquarters and manufacturing facility. We believe that our existing cash and cash equivalents, expected revenue from collaborations and license arrangements, and interest income should be sufficient to meet our operating and capital requirements at least through 2006. Accordingly, we will need to raise substantial additional funds to avoid violating the debt covenant described above (See “Overview” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this Form 10-K) and fund our operations until we are generating sufficient cash flow from operations.

          The agreements comprising the credit facility also contain covenants that, among other things, require us to obtain consent from the bank prior to paying dividends, making certain investments, changing the nature of our business, assuming or guaranteeing the indebtedness of another entity or individual, selling or otherwise disposing of a substantial portion of our assets, or merging or consolidating with another entity.

          A breach of any of the financial tests or other covenants in the agreements comprising the credit facility could result in a default under those agreements. Upon the occurrence of an event of default, the bank could elect to declare all amounts outstanding under the credit facility to be immediately due and payable, and terminate all commitments to extend further credit.

          We have incurred losses each year of our existence, including net losses of $51.8 million for the year ended December 31, 2005, $41.6 million for the year ended December 31, 2004, and $37.7 million for the year ended December 31, 2003. Given our planned level of operating expenses, we expect to continue incurring losses for some time. As of December 31, 2005, we had an accumulated deficit of $239.2 million. To date, we have derived substantially all of our revenue from corporate collaborations, license agreements, and investments. We expect that substantially all of our revenue for the foreseeable future will result from these sources and from the licensing of our technologies. We also expect to spend significant amounts to expand our research and development on our proprietary drug candidates and technologies, maintain and expand our intellectual property position, and expand our business development and commercialization efforts. Our level of operating expenditures will vary depending upon the stage of development of our proprietary proteins and the number and nature of our collaborations. We may continue to incur substantial losses even if our revenues increase.

          We have not yet commercialized any products or technologies, and we may never be able to do so. Since we began operations in 1990, we have not generated any revenues, except from corporate collaborations, license agreements, and investments. We do not know when or if we will complete any of our product development efforts, obtain regulatory approval for any product candidates incorporating our technologies, or successfully commercialize any approved products. Even if we are successful in developing products that are approved for marketing, we will not be successful unless these products gain market acceptance. The degree of market acceptance of these products will depend on a number of factors, including:

	•		the timing of regulatory approvals in the countries, and for the uses, we seek;
	•		the competitive environment;
	•		the establishment and demonstration in the medical community of the safety and clinical efficacy of our products and their potential advantages over existing therapeutic products;
	•		the adequacy and success of distribution, sales and marketing efforts; and
	•		the pricing and reimbursement policies of government and third-party payors, such as insurance companies, health maintenance organizations and other plan administrators.

          Physicians, patients, payors or the medical community in general may be unwilling to accept, utilize or recommend any of our products or products incorporating our technologies. As a result, we are unable to predict the extent of future losses or the time required to achieve profitability, if at all. Even if we or our collaborators successfully develop one or more products that incorporate our technologies, we may not become profitable.

Risks Related to Development of Products and Technologies

          We are seeking to use our enzymatic technologies to develop proprietary next-generation proteins, generally in collaboration with a partner. The development of protein drugs involves a range of special challenges at various stages of the process.

          In the preclinical phase of product development, we and our partners will face several potential problems, including producing or obtaining supplies of the protein on commercially reasonable terms, successfully modifying the protein using our enzymatic technologies, and achieving adequate yields of the next-generation protein. Even if a protein development program appears to be proceeding well in the early phases, a product candidate may fail in clinical trials for several reasons, such as results indicating that the product candidate is less effective than desired (e.g., the trial failed to meet its primary objectives) or that it has harmful or problematic side effects. If clinical trials are successful, it is possible that problems may arise later during commercialization. For example, we are aware that

with our first product, NE-180, an EPO protein. Our success with this program will depend on our ability to have this protein manufactured, at commercial scale, in the insect cell expression system (the production source of NE-180), by a collaborator or supplier. We do not know if we will be able to locate a contract manufacturer outside of the U.S. that will be able to manufacture this protein at commercial scale and on economically feasible terms. To our knowledge, no therapeutic protein produced in this expression system has yet received marketing authorization in the U.S. or Europe, which means that we may face previously unidentified problems resulting from the use of this expression system and related regulatory challenges.

          We will be relying on third parties to manufacture the proteins, enzymes, sugar nucleotides and other reagents we need to apply and commercialize our technologies. We may not be able to find parties willing and able to manufacture these compounds at acceptable prices, and we may become dependent on suppliers that could discontinue our supply arrangements or change supply terms to our disadvantage. Our success depends on our ability to have these compounds manufactured on a commercial scale or to obtain commercial quantities, in either case, at reasonable cost. We may not be able to procure sufficient quantities of the products we develop to meet our needs for preclinical or clinical development.

          Any manufacturing facility and manufacturing process must adhere to the FDA‘s and/or other regulatory agencies’ evolving regulations on cGMP, which are enforced by the FDA and others through facilities inspection programs. The manufacture of products and key reagents at any facility will be subject to strict quality control, testing, and record keeping requirements, and continuing obligations regarding the submission of safety reports and other post-market information. Ultimately, we, our contract manufacturers, or other suppliers may not meet these requirements.

          If we encounter delays or difficulties in connection with manufacturing, commercialization of our products and technologies could be delayed, we could breach our obligations under our collaborative agreements and we could have difficulty obtaining necessary financing.

          We plan to rely to a large extent on collaborative partners to co-develop our products and to commercialize products made using our technologies. We currently have collaborative agreements with Novo Nordisk, BioGeneriX and MacroGenics. We anticipate that substantially all of our revenues during the next several years will continue to be generated from collaboration or license agreements. Our partnering strategy entails many risks, including:

	•		we may be unsuccessful in entering into or maintaining collaborative agreements for the co-development of our products or the commercialization of products incorporating our technologies;
	•		we may not be successful in applying our technologies to the needs of our collaborative partners;
	•		our collaborators may not be successful in, or may not remain committed to, co-developing our products or commercializing products incorporating our technologies;
	•		our collaborators may seek to develop other proprietary alternatives to our products or technologies;
	•		our collaborators may not commit sufficient resources to incorporating our technologies into their products;
	•		our collaborators are not obligated to market or commercialize our products or products incorporating our technologies, and they are not required to achieve any specific commercialization schedule;
	•		our collaborative agreements may be terminated by our partners on short notice; and
	•		continued consolidation in our target markets may limit our ability to enter into collaboration agreements, or may result in terminations of existing collaborations.

          Given these risks, there is a great deal of uncertainty regarding the success of our current and future collaborative efforts.

          The use in humans of compounds developed by us or incorporating our technologies may result in product liability claims. Product liability claims can be expensive to defend, and may result in large settlements of claims or judgments against us. Even if a product liability claim is not successful, the adverse publicity, time, and expense involved in defending such a claim may interfere with our business. We may not be able to obtain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses.

Risks Related to Intellectual Property

          Our commercial success depends in part on avoiding claims of infringement of the patents or proprietary rights of third parties. We have devoted significant resources to investigating the patent protection surrounding the proteins that are the subject of our development programs. The numerous patents, each with multiple claims, may be difficult to uncover and interpret, leading to uncertainty about our freedom to operate. It is possible that we will not be aware of issued patents or pending patent applications that are relevant to our product candidates because our searches do not find them, or pending patent applications because they are not yet publicly available. Our interpretation of patents could be challenged, leading to litigation, and we could face claims of infringement of rights of which we are unaware.

          There have been significant litigation and interference proceedings regarding patent rights, and the patent situation regarding particular products is often complex and uncertain. For example, with respect to EPO, the target of our first development program, the status of issued patents is currently being litigated by others and these patents could delay our ability to market a long-acting EPO in the U.S. As we proceed with this program and other targets, we may face uncertainty and litigation could result, which could lead to liability for damages, prevent our development and commercialization efforts, and divert resources from our business strategy.

          The cost of any litigation challenging our right to pursue our target proteins or technologies could be substantial. Others seeking to develop next-generation versions of proteins, or the holders of patents on our target proteins, may have greater financial resources, making them better able to bear the cost of litigation. In particular, one company that produces products that will likely be in direct competition with our current product candidates has aggressively defended the patents related to its products and this could increase the likelihood of litigation or the cost of litigation. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to develop, manufacture, and market products, form strategic alliances, and compete in the marketplace.

          Third parties from time to time may assert that we are infringing their patents, trade secrets or know-how, although we believe our product candidates do not infringe the products, trade secrets or know-how of third parties. In addition, patents may issue in the future to third parties that our technology may infringe. We could incur substantial costs in defending ourselves and our partners against any such claims. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief, which could effectively block our ability or our partners’ ability to further develop or commercialize some or all of our products or technologies in the U.S. and abroad, and could result in the award of substantial damages. If we are found to infringe, we may be required to obtain one or more licenses from third parties or be unable to proceed. There can be no assurance that we will be able to obtain such licenses at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such required license could have a material adverse effect on us.

          To compete effectively, we need to develop and maintain a proprietary position with regard to our own technologies, products and business. We are seeking to develop patent protection for therapeutic proteins that

include numerous claims for composition of matter, methods of use, and methods of making. Legal standards relating to the validity and scope of claims in our technology field are still evolving. Therefore, the degree of future protection in the U.S. and other countries for our proprietary rights in our core technologies and products made using these technologies is also uncertain. The risks and uncertainties that we face with respect to our patents and other proprietary rights include the following:

	•		the pending patent applications we have filed, or to which we have exclusive rights, may not result in issued patents, or may take longer than we expect to result in issued patents;
	•		we may be subject to interference proceedings;
	•		we may be subject to opposition proceedings in foreign countries;
	•		the claims of any patents that are issued may not provide meaningful protection;
	•		we may not be able to develop additional proprietary technologies that are patentable;
	•		the patents licensed or issued to us or our customers may not provide a competitive advantage;
	•		other companies may challenge patents licensed or issued to us or our customers;
	•		other companies may independently develop similar or alternative technologies, or duplicate our technologies;
	•		other companies may design around technologies we have licensed or developed; and
	•		enforcement of patents is complex, uncertain and expensive.

          We cannot be certain that patents will be issued as a result of any of our pending applications, and we cannot be certain that any of our issued patents will give us adequate protection from competing products. For example, issued patents may be circumvented or challenged, declared invalid or unenforceable, or narrowed in scope. In addition, since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first to make our inventions or to file patent applications covering those inventions. In the event that another party has also filed a patent application relating to an invention claimed by us, we may be required to participate in an interference proceeding declared by the U.S. Patent and Trademark Office to determine priority of invention, which could result in substantial uncertainties and costs for us, even if the eventual outcome were favorable to us. It is also possible that others may obtain issued patents that could prevent us from commercializing our products or require us to obtain licenses requiring the payment of significant fees or royalties in order to enable us to conduct our business. As to those patents that we have licensed, our rights depend on maintaining our obligations to the licensor under the applicable license agreement, and we may be unable to do so. Furthermore, patent protection available to us may vary in different jurisdictions. In particular, the laws in some countries provide little patent protection.

          The cost to us of any patent litigation or other proceeding relating to our patents or applications, even if resolved in our favor, could be substantial. Our ability to enforce our patent protection could be limited by our financial resources, and may be subject to lengthy delays. If we are unable to effectively enforce our proprietary rights, or if we are found to infringe the rights of others, we may be in breach of our license agreements with our partners.

          In addition to patents and patent applications, we depend upon trade secrets and proprietary know-how to protect our proprietary technology. We require our employees, consultants, advisors, and collaborators to enter into confidentiality agreements that prohibit the disclosure of confidential information to any other parties. We require our employees and consultants to disclose and assign to us their ideas, developments, discoveries, and inventions. These agreements may not, however, provide adequate protection for our trade secrets, know-how, or other proprietary information in the event of any unauthorized use or disclosure.

          We have licensed patents and patent applications from a number of institutions. Some of our proprietary rights have been licensed to us under agreements that have performance requirements or other contingencies. The failure to comply with these provisions could lead to termination or modifications of our rights to these licenses. Additionally, we may need to obtain additional licenses to patents or other proprietary rights from other parties to facilitate development of our proprietary technology base. The ownership of patents exclusively licensed to us may be subject to challenge if inventorship was not adequately investigated and represented. If our existing licenses are terminated or if we are unable to obtain such additional licenses on acceptable terms, our ability to perform our own research and development and to comply with our obligations under our collaborative agreements may be delayed while we seek to develop or license alternative technologies.

Risks Related to Competition

          Our business is characterized by extensive research efforts and rapid technological progress. New developments in molecular biology, medicinal chemistry and other fields of biology and chemistry are expected to continue at a rapid pace in both industry and academia. Our potential competitors include both public and private pharmaceutical and biotechnology companies, as well as academic institutions, governmental agencies and other public and private research organizations that are also conducting research activities and seeking patent protection.

          A number of these competitors are working on the development of next-generation protein therapeutics. Some of these competitors include Maxygen, Nektar Therapeutics, BioRexis, Human Genome Sciences and Alkermes. Other companies have programs focused on developing next-generation or improved versions of EPO and G-CSF, and some are already marketing improved versions of these products. These companies include Amgen, Roche, Shire, Maxygen, Fibrogen, Affymax and Syntonix. Other companies are active in this area, and we expect that competition will increase. We are also aware that there are several companies engaged in glycobiology research.

          In addition, we may compete with companies commercializing first-generation protein therapeutics, as a result of pricing practices or reimbursement limitations. Even if we succeed in developing and marketing products that have significant advantages over first-generation products, if first-generation products are available at a lower out-of-pocket cost to the consumer, health-care providers and consumers may choose first-generation products instead of next-generation versions.

          Compared to us, many of our likely and potential competitors have more:

	•		financial, scientific and technical resources;
	•		product development, manufacturing and marketing capabilities;
	•		experience conducting preclinical studies and clinical trials of new products; and
	•		experience in obtaining regulatory approvals for products.

          Competitors may succeed in developing products and technologies that are more effective or less costly than ours and that would render our products or technologies, or both, obsolete or noncompetitive. We know that other companies with substantial resources are working on the development of next-generation proteins, and they may achieve better results in enzymatically modifying our target proteins or the target proteins of our potential collaborators.

          Competitors also may prove to be more successful in designing, manufacturing and marketing products. If we are successful in developing our own drug candidates or versions of drugs that are no longer patented, we will compete with other drug manufacturers for market share. If we are unable to compete successfully, our commercial opportunities will be diminished.

          In addition, while there is no proven abbreviated regulatory pathway for follow-on biologics, this possibility is under discussion in the U.S. and other jurisdictions and has been adopted in part in Europe. If an abbreviated regulatory process is adopted for the approval of follow-on biologics in any major market, competition could increase in related segments of the therapeutic protein market.

          Because of the specialized scientific nature of our business, we are highly dependent upon qualified scientific, technical and managerial personnel, including our research and development team. The advancement of our business is dependent upon our management team‘s ability to evaluate collaboration opportunities and on their ability to focus our company’s efforts. Our anticipated research and development efforts will require additional expertise and the addition of new qualified personnel.

          There is intense competition for qualified management and research and development personnel in the pharmaceutical field. Therefore, we may not be able to attract and retain the qualified personnel necessary for our business. The loss of the services of existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner, could harm our research and development programs and our ability to manage day-to-day operations, attract collaboration partners, attract and retain other employees, and generate revenues. We do not maintain “key person” life insurance on any of our employees.

Risks Related to Government Regulation

          The research, development, manufacture and control, marketing, and sale of our reagents and product candidates manufactured using our technologies are subject to significant, but varying, degrees of regulation by a number of government authorities in the U.S. and other countries.

          Pharmaceutical product candidates manufactured using our technologies must undergo an extensive regulatory approval process before commercialization. This process is regulated by the FDA and by comparable agencies in Europe and in other countries. The U.S. and foreign regulatory agencies have substantial discretion to terminate clinical trials, require additional testing, delay or withhold registration and marketing approval, and mandate product withdrawals.

          In addition, the U.S. or other regulatory agencies could, at any time in the regulatory approval process, place the regulatory submission for a product candidate on “hold” pending the receipt, review and approval of additional information. The IND for our first product candidate, NE-180, is currently on hold in the U.S. There is the risk that we will not be taken off hold and will therefore be unable to proceed with clinical trials of NE-180 in the U.S.

          We and our collaborators intend to base our submissions for regulatory approval and the information contained in such submissions on our understanding of the requirements of the FDA and its foreign counterparts. If additional information is required, we may face delays and additional costs.

          The specific risks of protein drugs may result in the application of more stringent regulatory requirements prior to approval of our product candidates. We face special challenges in connection with the development of proteins produced in the insect cell expression system. To our knowledge, no therapeutic protein for human use produced in this expression system has been submitted for marketing authorization in the U.S. or Europe, and we may encounter long delays and large expenditures or other regulatory hurdles in connection with the approval process for a product produced in this expression system.

          Neither we nor our collaborators have submitted any product candidates incorporating our technologies for approval to the FDA or any other regulatory authority. If any product candidate manufactured using our technology is submitted for regulatory approval, it may not receive the approvals necessary for commercialization, the desired labeling claims, or adequate levels of reimbursement. Any delay in receiving, or failure to receive, these approvals

would adversely affect our ability to generate product revenues or royalties, and we will have already spent significant sums in pursuing approval.

          We anticipate that the development of our next-generation proprietary proteins will involve a traditional development program, including clinical trials. Any new governmental regulations may delay or alter regulatory approval of any product candidate manufactured using our technology. If an abbreviated regulatory process is adopted for the approval of follow-on biologics in any major market, competition could increase in related segments of the therapeutic protein market. We cannot predict the impact of adverse governmental action that might arise from future legislative and administrative action.

          Even if we or our collaborators are successful in obtaining regulatory approvals for any of our products, our or their manufacturing processes will be subject to continued review by the FDA and other regulatory authorities. Any later discovery of unknown problems with our products, products incorporating our technologies, or manufacturing processes could result in restrictions on such products or manufacturing processes, including potential withdrawal of the products from the market. In addition, if regulatory authorities determine that we or our collaborators have not complied with regulations in the research and development of a product candidate or the manufacture and control of our reagents, then we or our collaborators may not obtain necessary approvals to market and sell the product candidate.

          Even if regulatory approval is obtained to sell any product candidates incorporating our technologies, our future revenues, profitability, and access to capital will be determined in part by the price at which we or our collaborators can sell such products. There are continuing efforts by governmental and private third-party payors to contain or reduce the costs of health care through various means. We expect a number of federal, state, and foreign proposals to control the cost of drugs through governmental regulation. We are unsure of the form that any health care reform legislation may take or what actions federal, state, foreign, and private payors may take in response to the proposed reforms. Therefore, we cannot predict the effect of any implemented reform on our business.

          Our and our collaborators’ ability to commercialize our products successfully will depend, in part, on the extent to which reimbursement for the cost of such products and related treatments will be available from government health administration authorities, such as Medicare and Medicaid in the U.S., private health insurers, and other organizations. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products. Adequate third-party coverage may not be available to enable us to maintain price levels sufficient to realize an appropriate return on investment in product research and development. Inadequate coverage and reimbursement levels provided by government and third-party payors for use of our or our collaborators’ products may cause these products to fail to achieve market acceptance and would cause us to lose anticipated revenues and delay achievement of profitability. It is possible that reimbursement may be limited to that which is available for first-generation versions of one or more of our or our collaborator’s products, making it harder for us and our collaborators to realize an appropriate return.

Risks Related to Facilities, Business Interruption, and the Environment

          Our research and development processes involve the controlled use of hazardous materials, chemicals, and radioactive compounds. We conduct experiments that are quite common in the biotechnology industry, in which we use small quantities of corrosive, toxic and flammable chemicals, and trace amounts of radioactive materials. The risk of accidental injury or contamination from these materials cannot be entirely eliminated. We do not maintain a separate insurance policy for these types of risks. In the event of an accident or environmental discharge, we may be held liable for any resulting damages, and any liability could exceed our resources. We are subject to federal, state, and local laws and regulations governing the use, storage, handling, and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

          Our common stock is listed on The NASDAQ National Market under the symbol NTEC. We commenced trading on The NASDAQ National Market on February 15, 1996. The following table sets forth the high and low sale prices of our common stock for the periods indicated.

		Common Stock
		Price
		High				Low
Year Ended December 31, 2004
First Quarter		$	13.80			$	8.73
Second Quarter			10.62				6.50
Third Quarter			8.78				6.45
Fourth Quarter			8.19				6.10
Year Ended December 31, 2005
First Quarter			7.25				2.49
Second Quarter			3.23				1.95
Third Quarter			4.49				2.15
Fourth Quarter			2.85				1.70
Year Ended December 31, 2006
First Quarter (through March 3, 2006)			3.95				1.85

     As of March 3, 2006, there were approximately 200 record holders and 4,400 beneficial holders of our common stock. We have not paid any cash dividends on our common stock and we do not anticipate paying any in the foreseeable future. Moreover, under the terms of our credit agreement with our bank, we are not permitted to pay any dividends without its written consent.

     ITEM 6. SELECTED FINANCIAL DATA.

          The following Statements of Operations and Balance Sheet Data for each of the years in the five-year period ended December 31, 2005 are derived from our audited financial statements. The financial data set forth below should be read in conjunction with the sections of this Annual Report on Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the financial statements and notes included elsewhere in this Form 10-K.

		Year Ended December 31,
		2005				2004				2003				2002				2001
						(in thousands, except per share data)
Statements of Operations Data:
Revenue from collaborative agreements		$	6,137			$	5,070			$	1,435			$	4,813			$	1,266
Operating expenses:
Research and development			33,136				34,672				26,821				21,481				14,857
General and administrative			10,878				11,711				11,148				12,510				9,374
Restructuring charges			14,206				—				—				—				—
Total operating expenses			58,220				46,383				37,969				33,991				24,231
Operating loss			(52,083	)			(41,313	)			(36,534	)			(29,178	)			(22,965	)
Other income			22				—				—				1,653				6,120
Impairment of equity securities			—				—				(1,250	)			—				—
Interest income (expense), net			222				(329	)			103				1,108				3,516
Net loss		$	(51,839	)		$	(41,642	)		$	(37,681	)		$	(26,417	)		$	(13,329	)
Basic and diluted net loss per share		$	(1.64	)		$	(1.82	)		$	(2.14	)		$	(1.85	)		$	(0.95	)
Weighted-average shares outstanding used in computing basic and diluted net loss per share			31,590				22,898				17,611				14,259				14,032
Balance Sheet Data:
Cash, cash equivalents and marketable securities		$	37,738			$	45,048			$	53,060			$	41,040			$	76,245
Total assets			65,363				90,731				94,845				83,092				105,786
Total debt and capital lease obligations			14,454				18,345				10,601				7,411				6,200
Accumulated deficit			(239,220	)			(187,381	)			(145,739	)			(108,058	)			(81,641	)
Total stockholders’ equity			40,117				60,854				72,213				70,685				93,946

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

          This report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations and contentions and are not historical facts that typically may be identified by use of terms such as “anticipate,” “believe,” “estimate,” “plan,” “may,” “expect,” “intend,” “could,” “potential,” and similar expressions, although some forward-looking statements are expressed differently. These forward-looking statements include, among others, the statements about our:

	•		estimate that our existing cash and cash equivalents, expected revenue from collaborations and license agreements, and interest income should be sufficient to meet our operating and capital requirements at least through 2006;
	•		expected losses;
	•		expectations for future capital requirements;
	•		expectations for increases in operating expenses;
	•		expectations for increases in research and development, and marketing, general and administrative expenses in order to develop products, procure commercial quantities of reagents and products, and commercialize our technology;
	•		expectations regarding the scope and expiration of patents;
	•		expectations regarding the timing of preclinical activities, regulatory meetings and submissions, as well as the progression of clinical trials, for NE-180 and preclinical activities and the initiation of clinical trials for GlycoPEG-GCSF;
	•		expectations for the development of long-acting versions of EPO and G-CSF, and subsequent proprietary drug candidates;
	•		expectations as to the costs and benefits of our plans to dispose of our Witmer Road facility;
	•		expectations regarding net cash utilization;
	•		expectations for generating revenue; and
	•		expectations regarding the timing and character of new or expanded collaborations and for the performance of our existing collaboration partners in connection with the development and commercialization of products incorporating our technologies.

          You should be aware that the forward-looking statements included in this report represent management’s current judgment and expectations, but our actual results, events and performance could differ materially from those in the forward-looking statements. Potential risks and uncertainties that could affect our actual results include the following:

	•		our ability to obtain the funds necessary for our operations;
	•		our ability to meet forecasted timelines due to internal or external causes;
	•		our ability to satisfy the FDA’s request for additional information and to obtain clearance from the FDA to commence a Phase I clinical trial for NE-180 in the U.S.;
	•		our preclinical and clinical results for our products may not be favorable;

	•		our ability to develop commercial-scale manufacturing processes for our products and reagents, either independently or in collaboration with others;
	•		our ability to enter into and maintain collaborative arrangements;
	•		our ability to obtain adequate sources of proteins and reagents either manufactured internally or sourced externally;
	•		our ability to develop and commercialize products without infringing the patent or intellectual property rights of others;
	•		our ability to expand and protect our intellectual property and to operate without infringing the rights of others;
	•		our ability and our collaborators’ ability to develop and commercialize therapeutic proteins and our ability to commercialize our technologies;
	•		our ability to attract and retain key personnel;
	•		our ability to compete successfully in an intensely competitive field;
	•		our ability to renovate our facilities as required for our operations; and
	•		general economic conditions.

          These and other risks and uncertainties that could affect our actual results are discussed in this report, particularly in Item 1A of Part I of this Form 10-K in the section entitled “Risk Factors.”

          Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance, or achievements. We do not assume responsibility for the accuracy and completeness of the forward-looking statements other than as required by applicable law. We do not undertake any duty to update any of the forward-looking statements after the date of this report to conform them to actual results, except as required by the federal securities laws.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

          The following discussion should be read in conjunction with our financial statements and related notes included in this Form 10-K.

Overview

          We are a biopharmaceutical company using our enzymatic technologies to develop proprietary drugs, focusing primarily on therapeutic proteins. We believe that our core enzymatic technologies, GlycoAdvance and GlycoPEGylation, improve the drug properties of therapeutic proteins by building out, and attaching polyethylene glycol (PEG) to, carbohydrate structures on the proteins. We are using our technologies to develop proprietary versions of protein drugs with proven safety and efficacy and to improve the therapeutic profiles of proteins being developed by our partners. We expect these modified proteins to offer significant advantages, including less frequent dosing and possibly improved efficacy, over the original versions of the drugs now on the market, as well as to meet or exceed the pharmacokinetic profile of next-generation versions of the drugs now on the market. We believe this strategy of targeting drugs with proven safety and efficacy allows us to lower the risk profile of our proprietary development portfolio as compared to de novo protein drug development.

          We have incurred operating losses each year since our inception. As of December 31, 2005, we had an accumulated deficit of $239,220,000. We expect additional losses in 2006 and over the next several years as we continue product research and development efforts and expand our intellectual property portfolio. We have financed our operations through private and public offerings of equity securities, proceeds from debt financings, and revenues from our collaborative agreements.

          We believe that our existing cash and cash equivalents, expected revenue from collaborations and license arrangements, and interest income should be sufficient to meet our operating and capital requirements at least through 2006, although changes in our collaborative relationships or our business, whether or not initiated by us, may cause us to deplete our cash and cash equivalents sooner than the above estimate. Under agreements we entered into with a bank during the first quarter of 2004, we have agreed to limit our total outstanding debt to $22,000,000. As of December 31, 2005, our total outstanding debt was $14,454,000. In March 2006, we entered into amendments of our agreements with the bank. These amendments, effective March 1, 2006, revised the minimum liquidity requirements, increased the interest rate applicable to the outstanding balance and added a prepayment premium to be paid in the event we repay the loan earlier than as set forth in the agreements. Pursuant to the amendments, if we fail at any time to maintain a minimum required cash and short-term investments balance of at least $12.0 million, the bank has the option to require us to make a payment to reduce the outstanding balance under the credit facility to $6.0 million. If we fail at any time to maintain a minimum required cash and short-term investments balance of at least $10.0 million, the bank has the option to require us to make a payment to reduce the outstanding balance under the credit facility to $5.0 million. Finally, if we fail at any time to maintain a minimum required cash and short-term investments balance of at least $5.0 million we will be considered to be in default of the credit facility and the bank may take certain actions in relation to that default, including, but not limited to, requiring us to repay the entire outstanding balance under the credit facility. See “Financing Activities – Debt Financing Activities – Term Loan from Bank and Industrial Development Authority Bond” in the Liquidity and Capital Resources section of this Form 10-K for a description of the material features of this borrowing.

Liquidity and Capital Resources

     Overview

          We had $37,738,000 in cash and cash equivalents as of December 31, 2005, compared to $45,048,000 in cash and cash equivalents as of December 31, 2004. The decrease for 2005 was primarily attributable to the use of cash to fund our operating activities, capital expenditures, and debt repayments, which were partly offset by proceeds of equity and debt financings. During 2006, we anticipate our average quarterly spending of approximately $8.0 million to $8.5 million to fund our operating activities, capital expenditures, and debt repayments, without giving effect to the impact of entering into any new collaborative agreements or disposing of our current headquarters and manufacturing facility. We believe that our existing cash and cash equivalents, expected revenue from collaborations and license arrangements, and interest income should be sufficient to meet our operating and capital requirements at least through 2006. Accordingly, we will need to raise substantial additional funds to avoid violating the debt covenant described above and to fund our operations until we are generating sufficient cash flow from operations. If we are unable to raise additional capital when required, we may need to delay, scale back, or eliminate some of our research and development programs.

          The development of next-generation proprietary protein therapeutics, which we are pursuing both independently and in collaboration with selected partners, will require substantial expenditures by us and our collaborators. We plan to continue financing our operations through private and public offerings of equity securities, proceeds from debt financings, and revenues from existing and future collaborative agreements. Because our 2006 revenues could be substantially affected by entering into new collaborations and on the financial terms of any new collaborations, we cannot estimate our 2006 revenues. Other than revenues from our collaborations with Novo Nordisk and BioGeneriX, and any future collaborations with others, we do not expect to generate significant revenues until such time as products using our technologies are commercialized, which is not expected during the next several years. We expect an additional several years to elapse before we can expect to generate sufficient cash flow from operations to fund our operating and investing requirements. Accordingly, we will need to raise substantial additional funds to continue our business activities and fund our operations until we are generating sufficient cash flow from operations.

     2005 Restructuring

          In August 2005, we implemented a restructuring of operations to enable an enhanced focus on next-generation proteins, to allow for the anticipated transfer of production of proteins and reagents to our collaborative partners and contract manufacturers now that our programs are more mature, and to reduce cash burn. Our future requirements for internally manufactured products will be substantially lower than the capacity of our 24,000 square-foot pilot manufacturing facility. Therefore, we commenced efforts to dispose of our current headquarters and pilot manufacturing facility (Witmer Road facility), which we own subject to mortgages supporting our term loan and industrial development authority bond (both are more fully described in the Liquidity and Capital Resources section of this Form 10-K under the heading “Financing Activities – Debt Financing Activities – Term Loan from Bank and Industrial Development Authority Bond”). Upon completion of the restructuring, we had reduced the size of our workforce by approximately 25% since the end of the first quarter of 2005. Our net loss for 2005 included $14,206,000 of charges related to this restructuring, including $13,187,000 of non-cash property and equipment impairment charges and $1,019,000 of payments for employee severance and facility closure costs. We expect to realize annualized savings from the restructuring of between $6,000,000 and $8,000,000.

          Property and Equipment Impairment Charges

          As a result of our decision to dispose of the Witmer Road facility, we concluded that identifiable cash flows could be assigned to the Witmer Road facility and related equipment. To determine the appropriate carrying value of these assets, we used a probability-weighted approach of estimated cash flows to be received upon a range of possible disposition outcomes. We based our estimates of potential cash flows related to possible disposition outcomes on conversations with commercial real estate firms that have both knowledge of recent history of sales and expertise in marketing and selling similar facilities. Based on those estimates, we recorded a non-cash impairment charge of $13,000,000, which was included in restructuring charges on our statements of operations, on our Witmer Road facility and related equipment. Also as part of the restructuring, we centralized research activities in Horsham, Pennsylvania by ending operations in our leased facility in San Diego, California. We recorded a non-cash impairment charge of $187,000, which was also included in restructuring charges on our statements of operations, related to property and equipment located in the San Diego facility.

          Employee Severance and Facility Closure Costs

          During 2005, we recorded $867,000, which was also included in restructuring charges on our statements of operations, of employee severance costs related to the restructuring. We also recorded a facility closure charge of $152,000 in restructuring charges on our statements of operations for the operating lease related to the San Diego facility. This charge was based on an estimate of the present value of the loss we would incur over the remaining term of the lease. Because the remaining lease term extended for only five months beyond our cease-use date of the facility, we assumed no sublease income in our calculation.

     Operating Activities

          During 2005, our operating activities consumed cash of $33,069,000, compared to $36,744,000 in 2004. The decrease of $3,675,000 in net cash consumed for 2005 operating activities is substantially the result of $637,000 of cash provided during 2005 compared to $1,470,000 of cash used during 2004 to fund changes in operating assets and liabilities, primarily due to a decrease of $1,809,000 in accounts receivable during 2005. Also contributing to a decrease in net cash consumed by operating activities was an increase in net interest income of $551,000 during 2005 compared to 2004. Fluctuations in operating items vary period-to-period due to, among other factors, the timing of research and development activities, such as the preparation and initiation of preclinical trials.

     Investing Activities

          During 2005 and 2004, cash expenditures for property, plant, and equipment were $792,000 and $9,844,000, respectively. The facility improvement project described below contributed significantly to our capital expenditures during 2004.

          We entered into a lease agreement in 2002 for a 40,000 square foot building, which we intended to convert into laboratory and office space. Later in 2002, we suspended plans to complete these renovations. In November 2003, we reinitiated renovation activities on approximately 25,000 square feet of the facility, leaving approximately 15,000 square feet available for future expansion. In April 2004, we occupied the facility and began amortizing the cost of $10,175,000 of the improvements. During 2004, we entered into agreements with a bank for the purpose of funding these improvements. See “Financing Activities – Debt Financing Activities – Term Loan from Bank and Industrial Development Authority Bond” below for a description of the material features of this borrowing.

          In 2006, we expect our investment in capital expenditures to be approximately $1,000,000 to $1,500,000, excluding the cost of any leasehold improvements we need in order to accomplish a consolidation of our research, development and administrative operations upon the disposition of our current headquarters and pilot manufacturing facility (Witmer Road facility). See “2005 Restructuring” above for a discussion of our efforts to dispose of the Witmer Road facility. We may finance some or all of these capital expenditures through capital leases or the issuance of new debt or equity. We may finance capital expenditures through the issuance of new debt, to the extent that we are allowed to do so under our existing bank covenants. The terms of new debt could require us to maintain a minimum cash and investments balance, or to transfer cash into an escrow account to collateralize some portion of the debt, or both.

     Financing Activities

          Equity Financing Activities

          In February 2005, we offered and sold 8,050,000 shares of our common stock at a public offering price of $4.00 per share, generating net proceeds of $30,006,000. In May 2004, we sold 4,733,476 shares of common stock in a registered direct offering to a number of institutional and individual investors, including 812,408 shares sold to officers and an investment fund affiliated with a director, at a price of $6.77 per share, generating net proceeds of $29,928,000.

          Debt Financing Activities

          Our total debt decreased by $3,891,000 to $14,454,000 at December 31, 2005, compared to $18,345,000 at December 31, 2004. This decrease primarily resulted from $5,365,000 of debt principal repayments during 2005. Partially offsetting the debt repayments were $1,484,000 in proceeds from the issuance of debt during 2005.

               Note Payable Secured by Insurance Policies

          In March 2005, we borrowed $701,000 to finance the insurance policy premiums due on certain insurance policies. We made the last payment in December 2005 and, therefore, there was no outstanding principal balance under this agreement as of December 31, 2005. The interest was calculated based on an annual percentage rate of 3.91%. To secure payment of the amounts financed, we granted the lender a security interest in all of our right, title and interest to the insurance policies.

               Term Loan from Bank and Industrial Development Authority Bond

          During the first quarter of 2004, we and a bank entered into agreements under which the bank acquired and reissued the $1,000,000 outstanding of our tax-exempt Industrial Development Authority bond. In addition, we borrowed $8,000,000 from the bank, of which $6,200,000 funded improvements to our leased facility, which we occupied in April 2004, in Horsham, PA. As of December 31, 2005, we owed the bank $8,111,000. As discussed in “2005 Restructuring” above, we have commenced efforts to dispose of our current headquarters and pilot manufacturing facility (Witmer Road facility). If we dispose of the Witmer Road facility, we will be required to repay the outstanding balance to the bank, whether or not the proceeds from the disposition of the facility exceed the outstanding loan balance.

          During 2006, we will be required to make principal payments totaling $889,000 under these agreements. The interest rate on the bond and bank debt varies quarterly, depending on 90-day LIBOR rates. At December 31,

2005, the 90-day LIBOR was 4.54%. We have the option each quarter to incur interest on the outstanding principal at the LIBOR-based variable interest rate or a fixed rate offered by our bank.

          For the $8,000,000 term loan, interest accrues at an interest rate equal to the 90-day LIBOR plus 3.0%. During 2005, the weighted-average annual interest rate for the term loan was 6.5%. We made quarterly, interest-only payments prior to March 31, 2005. Commencing on March 31, 2005, we began to make quarterly principal payments of $222,000 plus interest. We are required to make these payments over the remaining term of the ten-year loan period. Pursuant to the amendments to our agreements with the bank discussed below, after March 1, 2006, interest on the term loan began to accrue at an interest rate equal to the 90-day LIBOR plus 5.0%.

          For the $1,000,000 Industrial Development Authority bond, we are making quarterly, interest-only payments for ten years at an interest rate equal to the 90-day LIBOR plus 1.5%, followed by a single repayment of principal at the end of the ten-year loan period. If the 90-day LIBOR at the beginning of any calendar quarter is between 4.0% and 6.0%, the bond will bear interest at the 90-day LIBOR plus 1.25%. If the 90-day LIBOR at the beginning of any calendar quarter exceeds 6.0%, the bond will bear interest at the 90-day LIBOR plus 1.0%. During 2005, the weighted-average annual interest rate for the bond was 4.8%. Pursuant to the amendments to our agreements with the bank discussed below, after March 1, 2006, interest on the Industrial Development Authority bond began to accrue at an interest rate equal to the 90-day LIBOR plus 3.5%.

          To provide security for these borrowings, we granted a first mortgage to our bank on the land and building where our present headquarters are located, as well as a security interest of first priority on certain improvements, certain equipment, and other tangible personal property. Under our agreements with the bank, if the bank determines a material adverse change has occurred in our business, financial condition, results of operations, or business prospects, the bank in its sole discretion may declare at any time an event of default, of which one potential outcome could be the accelerated repayment of the loan balance, which was $8,111,000 as of December 31, 2005. Under our agreements with the bank, we agreed to limit our total outstanding debt to $22,000,000. As of December 31, 2005, our total outstanding debt was $14,454,000. Prior to the execution of the amendments discussed below, at any time after January 30, 2008, or if we failed to maintain a minimum required cash and short-term investments balance of at least $22,000,000, our bank would have had the option to require additional collateral from us in the form of a security interest in certain cash and short-term investments, or in the form of a letter of credit. The agreements with our bank also contain covenants that, among other things, require us to obtain consent from the bank prior to paying dividends, making certain investments, changing the nature of our business, assuming or guaranteeing the indebtedness of another entity or individual, selling or otherwise disposing of a substantial portion of our assets, and merging or consolidating with another entity.

          In March 2006, we entered into amendments of our agreements with the bank. These amendments, effective March 1, 2006, revised the minimum liquidity requirements, increased the interest rate applicable to the outstanding balance and added a prepayment premium to be paid in the event we repay the loan earlier than as set forth in the agreements. Pursuant to the amendments, if we fail at any time to maintain a minimum required cash and short-term investments balance of at least $12.0 million, the bank has the option to require us to make a payment to reduce the outstanding balance under the credit facility to $6.0 million. If we fail at any time to maintain a minimum required cash and short-term investments balance of at least $10.0 million, the bank has the option to require us to make a payment to reduce the outstanding balance under the credit facility to $5.0 million. Finally, if we fail at any time to maintain a minimum required cash and short-term investments balance of at least $5.0 million we will be considered to be in default of the credit facility and the bank may take certain actions in relation to that default, including, but not limited to, requiring us to repay the entire outstanding balance under the credit facility.

               Term Loan from Landlord

          In May 2004, we borrowed $1,500,000 from the landlord of our leased facilities in Horsham, Pennsylvania. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 13%. As of December 31, 2005, we owed the landlord $997,000. During 2006, we expect to make principal and interest payments totaling $483,000 under this agreement.

               Equipment Loans

          We borrowed $783,000, $3,612,000, and $4,986,000 during 2005, 2004, and 2003, respectively, from an equipment lender to finance the purchase of equipment and facility improvements, which collateralize the amounts borrowed. The terms of the financings require us to make monthly principal and interest payments through January 2009 at interest rates ranging from 8.00% to 9.44%. As of December 31, 2005, we owed the equipment lender $5,075,000. During 2006, we will be required to make principal and interest payments totaling $2,939,000 under these agreements. As discussed in “2005 Restructuring” above, we have commenced efforts to dispose of our current headquarters and pilot manufacturing facility (Witmer Road facility). If we dispose of the Witmer Road facility, we will be required to repay some of the outstanding balance to the equipment lender.

               Capital Lease Obligations

          We did not enter into any agreements with capital lease obligations during 2005. We entered into agreements with capital lease obligations during 2004 and 2003 for equipment with a value of $184,000 and $787,000, respectively. The terms of existing leases require us to make monthly payments through August 2009. As of December 31, 2005, the present value of aggregate minimum lease payments under these agreements was $271,000. Under these agreements, we will be required to make principal and interest payments totaling $179,000 during 2006.

     Operating Leases

          We lease laboratory, office, warehouse facilities, and equipment under operating lease agreements. In April 2001, we entered into a lease agreement for approximately 10,000 square feet of laboratory and office space in San Diego, California. As part of the restructuring announced in August 2005 and described in the Liquidity and Capital Resources section of this Form 10-K, we centralized research activities in Horsham, Pennsylvania by ending operations in our leased facility in San Diego, California. As of October 31, 2005, we ceased operations at our San Diego facility. The initial term of the San Diego lease ends on March  31, 2006, at which time we intend to terminate the lease.

          We lease approximately 5,000 square feet of office and warehouse space in Horsham, Pennsylvania under a lease agreement that expires April 2007. In February 2002, we entered into a lease agreement for approximately 40,000 square feet of laboratory and office space in another nearby building in Horsham, Pennsylvania. The initial term of the lease ends in July 2022, at which time we have an option to extend the lease for an additional five years, followed by another option to extend the lease for an additional four and one-half years. Our laboratory, office, and warehouse facility leases contain escalation clauses, under which the base rent increases annually by 2%. Our rental expense for the years ended December 31, 2005, 2004, and 2003 was $951,000, $981,000, and $923,000, respectively.

     Summary of Contractual Obligations

          The following table summarizes our obligations to make future payments under current contracts as of December 31, 2005:

		Payments due by period
						Less than
		Total				1 Year				1 - 3 Years				4 - 5 Years				After 5 Years
Long-term debt obligations1
Debt maturities		$	14,183,000			$	3,868,000			$	4,766,000			$	1,882,000			$	3,667,000
Contractual interest			5,012,000				980,000				1,327,000				1,079,000				1,626,000
Capital lease obligations2
Debt maturities			271,000				163,000				101,000				7,000				¾
Contractual interest			27,000				16,000				11,000				¾				¾
Operating leases3			8,818,000				708,000				962,000				936,000				6,212,000
Purchase obligations4			1,022,000				982,000				40,000				¾				¾
Other liabilities reflected on our balance sheet under GAAP5			351,000				351,000				¾				¾				¾
Total contractual obligations		$	29,684,000			$	7,068,000			$	7,207,000			$	3,904,000			$	11,505,000

Off-Balance Sheet Arrangements

          We are not involved in any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies and Estimates

          Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) focuses on our liquidity, capital resources, and financial statements. The financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of financial statements requires management to make estimates and assumptions that affect the carrying amounts of assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are developed and adjusted periodically by management based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

          Our summary of significant accounting policies is described in Note 2 to our financial statements included in Item 8 of this Form 10-K. Management considers the following policies and estimates to be the most critical in understanding the more complex judgments that are involved in preparing our financial statements and the uncertainties that could impact our results of operations, financial position, and cash flows. Management has discussed the development and selection of these critical accounting policies and estimates with the audit committee of our board of directors, and the audit committee has reviewed the company’s disclosure relating to it in this MD&A.

     Accounting for Restructuring Costs

          To account for exit or disposal activities, such as the restructuring described in “Overview” in the Liquidity and Capital Resources section of this Form 10-K, we apply Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146), which requires a liability for a cost associated with an exit or disposal activity to be recognized and measured initially at fair value only when the liability is incurred. It does not apply to costs associated with a disposal activity covered by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). The restructuring charges recorded by us during the six months ended December 31, 2005 were comprised primarily of costs to reduce property and equipment to fair value and to reduce our workforce. Our net loss for the year ended December 31, 2005 included $14,206,000 of charges related to this restructuring, including $13,187,000 of non-cash property and equipment impairment charges and $1,019,000 of payments for employee severance and facility closure costs.

          Under SFAS No. 144, any impairment of property and equipment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. To determine the fair value of assets that are not likely to be used over their remaining useful economic life, we use a probability-weighted approach of estimated cash flows to be received upon a range of possible disposition outcomes. In August 2005, we announced we would evaluate alternatives for our current headquarters and pilot manufacturing facility (Witmer Road facility), which we own subject to a mortgage, including the potential disposition of the facility and further consolidation of our research, development and administrative operations into a currently leased facility that is also located in Horsham, Pennsylvania. Following the announcement, we concluded that identifiable cash flows could be assigned to the Witmer Road facility and related equipment. We based our estimates of potential cash flows related to possible disposition outcomes on conversations with commercial real estate firms that have both knowledge of recent history of sales and expertise in marketing and selling similar facilities. These estimates may turn out to be incorrect and our actual cash flows may be materially different from our estimates.

          Our estimates of future liabilities may change, requiring us to record additional restructuring charges or reduce the amount of liabilities recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure their adequacy, that no excess accruals are retained and the utilization of the provisions are for their intended purposes in accordance with developed exit plans. We periodically evaluate current available information and adjust our restructuring reserve as necessary.

     Revenue Recognition

          Our revenue from collaborative agreements consists of upfront fees, research and development funding, and milestone payments. We recognize revenues consistent with Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104). SAB 104 was issued by the Securities and Exchange Commission in December 2003. Upfront fees and payments received from non-substantive milestones, such as the passage of time, are deferred and

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amortized to revenue over the related performance period. We estimate our performance period based on the specific terms of each collaborative agreement, but the actual performance period may vary. We adjust the performance periods based on available facts and circumstances.

          Periodic payments received for research and development activities are recognized over the period that we perform those activities under the terms of each agreement. Revenue resulting from the achievement of substantive milestone events stipulated in the agreements is recognized when the milestone is achieved. Milestones are based on the occurrence of a substantive element specified in the contract or as a measure of substantive progress towards completion under the contract.

     Stock-based Employee Compensation

          We apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for all stock-based employee compensation. We record deferred compensation for option grants to employees for the amount, if any, by which the market price per share exceeds the exercise price per share. We amortize deferred compensation over the vesting periods of each option.

          We have elected to adopt only the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. The stock-based employee compensation expense determined under the fair value-based method was calculated as of the date of grant of individual awards using the Black-Scholes option-pricing model. The volatility and expected term assumptions have the most significant effect on the results obtained from the Black-Scholes option-pricing model. The volatility assumption for each year has been estimated with reference to our historical volatility. The expected term assumption for each award has been estimated with reference to prior option exercise history, as well as the “simplified” method outlined by the SEC in Staff Accounting Bulletin No. 107, Share-based Payment. The following table contains the assumptions used in the Black-Scholes option-pricing model in each year to value stock-based compensation:

		Year ended December 31,
		2005				2004				2003
Expected life (years):
Stock options			6.7				6.6				5.5
Employee stock purchase plan			N/A				1.3				1.8
Risk-free interest rate:
Stock options			4.1	%			3.5	%			3.0	%
Employee stock purchase plan			N/A				1.6	%			2.9	%
Volatility			75	%			80	%			80	%
Dividend yield			0	%			0	%			0	%

     Impairment of Long-Lived Assets

          We evaluate our long-lived assets for impairment at least annually and whenever indicators of impairment exist, such as our August 2005 restructuring described in “Overview” in the Liquidity and Capital Resources section of this Form 10-K. Because our history of negative operating cash flows is an indicator of impairment, we annually compare the market value of our equity and debt to the carrying value of our net assets. The market value of our equity and debt exceeded the carrying value of our net assets as of December 31, 2005 and, therefore, we did not record any impairment of long-lived assets beyond the impairment recorded in connection with our August 2005 restructuring.

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