UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ý     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 000-50791

SENOMYX, INC.

(Exact name of registrant as specified in its charter)

(858) 646-8300

Registrant’s telephone number, including area code

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

None

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

Common Stock, par value $.001 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 ý

Indicate by check if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ý          No o

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  ý  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 definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is 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.
Large accelerated filer o          Accelerated filer ý          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  ý

As of June 30, 2005, the aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the last sale price of such stock as of such date on the NASDAQ National Market, was approximately $235,467,000. Excludes an aggregate of 11,208,467 shares of common stock held by officers and directors and by each person known by the registrant to own 5% or more of the outstanding common stock as of June 30, 2005. Exclusion of shares held by any of these persons should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant.

As of February 28, 2006, there were 29,803,263 shares of the registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s definitive Proxy Statement for the 2006 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K, are incorporated by reference in Part III, Items 10-14 of this Form 10-K.

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SENOMYX, INC.

Annual Report on Form 10-K

For the Fiscal Year Ended December 31, 2005

TABLE OF CONTENTS

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included or incorporated by reference in this Annual Report on Form 10-K other than statements of historical fact, are forward-looking statements. You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,” “continue” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to such statements.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the caption “Risk Factors” in Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K and elsewhere in this Annual Report on Form 10-K. Readers are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements speak only as of the date on which they are made and we undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made except as required by law.

PART I

Item 1.    Business

Overview

We are a leading company focused on using proprietary taste receptor-based assays and screening technologies to discover and develop novel flavors, flavor enhancers and taste modulators for the packaged food and beverage industry. We believe our flavor ingredients will enable packaged food and beverage companies to improve the nutritional profile of their products while maintaining or enhancing taste and may generate cost of goods savings. We license our flavor ingredients to our collaborators on an exclusive or co-exclusive basis, which we believe we will provide these companies with the ability to differentiate their products. We have entered into product discovery and development collaborations with five of the world’s leading packaged food and beverage companies: Cadbury Schweppes, Campbell Soup Company, The Coca-Cola Company, Kraft Foods Global, Inc. and Nestlé SA. We currently anticipate that we will derive all of our revenues from existing and future collaborations. Depending upon the collaboration, our existing collaboration agreements provide for upfront fees, research and development funding, reimbursement of certain regulatory costs, milestone payments based upon our achievement of research or development goals and, in the event of commercialization, royalties on future sales of consumer products incorporating our flavors, flavor enhancers or taste modulators. Our current programs focus on the development of savory, sweet and salt flavor enhancers and bitter taste modulators.

Flavors are substances that impart tastes or aromas in foods and beverages. Individuals experience the sensation of taste when flavors in food and beverage products interact with taste receptors in the mouth. A taste receptor functions either by physically binding to a flavor ingredient in a process analogous to the way a key fits into a lock or by acting as a channel to allow ions to flow directly into a taste cell. As a result of these interactions, signals are sent to the brain where a specific taste sensation is registered. There are currently five recognized primary senses of taste: umami, which is the savory taste of glutamate, sweet, salt, bitter and sour.

We are currently pursuing savory, sweet and salt flavor enhancer and bitter taste modulator discovery and development programs. The goals of our savory program are to enhance the taste of naturally occurring glutamate and enable the reduction or elimination of added monosodium glutamate, or MSG. The goals of our sweet program are to enhance the taste of natural and artificial sweeteners and enable a significant reduction in added sweeteners. The goals of our salt program are to enhance the taste of salt and enable a significant reduction in added salt. The goals of our bitter taste modulation program are to reduce or block bitter taste and improve the overall taste characteristics of packaged foods, beverages, over the counter (or OTC) health care products and pharmaceutical products.

Our internet address is www.senomyx.com. We post links on our website to the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and

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Exchange Commission (“SEC”): annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendment to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available through our website free of charge. Our filings may also be read and copied at the SEC’s Public Reference Room at 100 F Street, NE Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is www.sec.gov.

Industry Background

Packaged Food and Beverage Industry

Packaged food and beverage products include carbonated and non-carbonated beverages, frozen foods, snack foods, ice cream, pasta, canned soup and numerous other products. According to recent data from Euromonitor International, an independent research organization, worldwide sales of packaged food and beverage products in 2004 were approximately $1.3 trillion, of which $270 billion was generated in the United States. These figures represent growth rates of approximately 4% and 3%, respectively, over 2003 amounts. Based on these estimates, of the worldwide total, sales of packaged foods were approximately $1.1 trillion and sales of non-alcoholic beverages were approximately $304 billion. Based on recent data from Euromonitor, Information Resources, Inc. and our collaborators’ 2004 annual reports, we estimate that our collaborators’ combined worldwide sales in 2004 of their products that fall within their exclusive product fields were over $45 billion. Our collaboration agreements provide that we will receive royalties of up to 4% on our collaborators’ sales of products containing our flavors, flavor enhancers or taste modulators. However, we do not anticipate that our collaborators will incorporate our flavors, flavor enhancers and taste modulators into all of their products within their exclusive product fields.

Each of our flavors, flavor enhancers and taste modulators addresses large, potentially overlapping markets. The following table sets forth the four primary taste areas on which we are focused and, for each taste area, provides examples of product categories that could incorporate ingredients in those taste areas, estimated worldwide sales and our estimates of the worldwide sales for food and beverage products of our existing collaborators in their exclusive or co-exclusive product fields.

(1)          According to recent Euromonitor data for packaged food and beverages, excluding pharmaceutical and OTC health care applications.

(2)          Based on recent data from Euromonitor, Information Resources, Inc. and our collaborators’ 2004 annual reports.

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Flavor Industry

Flavors, flavor enhancers and taste modulators are used in a variety of packaged food and beverage products throughout the world. Flavors are substances that impart tastes or aromas in foods or beverages. Flavor enhancers and taste modulators are substances that supplement, enhance or modify the original flavor or aroma of foods, without necessarily imparting noticeable flavors or aromas. Flavors, flavor enhancers and taste modulators can originate from either naturally occurring or chemically synthesized compounds.

While some packaged food and beverage companies have their own internal research and development programs, most have traditionally relied on purchases of flavors, flavor enhancers and taste modulators from third parties. Historically, flavors, flavor enhancers and taste modulators have been sold on a commodity basis by independent manufacturers who make their products broadly available to packaged food and beverage companies on a non-exclusive basis. This has limited the ability of packaged food and beverage companies to use flavors, flavor enhancers and taste modulators to differentiate their brands from competitors.

Traditionally, flavor companies have discovered new flavors, flavor enhancers and taste modulators primarily using inefficient, non-automated and labor-intensive trial and error processes involving a limited number of trained taste testers. Using this approach, taste testers must physically taste each potential flavor and flavor enhancer compound to assess the taste characteristics of the compound. Taste testers can assess only a limited number of potential flavors or flavor enhancers at one time due to the sensory fatigue that results from repeated tasting. As a result, only a small fraction of the available universe of compounds can be tested economically.

In the United States, most flavors, flavor enhancers and taste modulators are regulated as Generally Recognized as Safe, or GRAS, substances under the provisions of the Federal Food, Drug and Cosmetic Act, or FD&C Act. GRAS determinations for most new flavors, flavor enhancers and taste modulators are made by an independent panel of scientists administered by the Flavor and Extract Manufacturers Association, or FEMA. Four compounds developed as part of our savory program have received FEMA GRAS determination.  The process from selection for development until receipt of that determination took approximately 12 months.  Costs associated with the FEMA GRAS process, including synthesis of material for regulatory studies, contract safety studies and preparation of the application, were less than $1 million. We expect that future flavors, flavor enhancers and taste modulators we develop will take a similar amount of time and cost a similar amount. However, the length of time may vary depending on the properties of the flavor, flavor enhancer or taste modulator. Once a flavor or flavor enhancer is determined to be FEMA GRAS, it may be immediately incorporated into products for test marketing and commercialization in the United States and in 20 other countries.

Flavors, Flavor Enhancers and Taste Modulators as a Source of Competitive Advantage

The packaged food and beverage industry is comprised of a number of large and highly competitive market segments. Small market share gains in specific large market segments can translate into significant additional revenue for packaged food and beverage companies. For example, according to recent Euromonitor data, estimated 2004 worldwide sales of soft drinks were approximately $260 billion. Thus, an increase of a tenth of a percentage point in overall worldwide market share would result in additional revenue of approximately $260 million.

As a result of these market opportunities, packaged food and beverage companies are constantly seeking ways to differentiate their products, demand for which can be greatly affected by very small actual

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or perceived improvements in flavor or health profiles. Flavors, flavor enhancers and taste modulators can potentially provide an important way to differentiate a particular product through enhanced taste, improvements in nutritional profile or labeling, flavor ingredient exclusivity and cost of goods savings.

•                     Taste. Product taste is a critical competitive factor for packaged food and beverage companies. These companies seek to use flavors, flavor enhancers and taste modulators to improve or maintain taste while improving the nutritional profile of packaged food and beverage products or reducing ingredient costs.

•                  Health Benefits. Packaged food and beverage companies are exploring ways to improve overall nutritional quality of their products. It is widely accepted that poor diet contributes to adverse health conditions such as cardiovascular disease, diabetes and obesity. To address these concerns, many companies have introduced reduced calorie, reduced sodium and reduced fat content products to the market. Flavors, flavor enhancers and taste modulators with specific desired characteristics provide an innovative way to reduce the levels of ingredients that may contribute to these concerns without compromising desirable taste attributes.

•                  Flavor Ingredient Exclusivity. Failure of packaged food and beverage companies to differentiate their brands from their competition, including private label products, may result in significant loss of market share, price pressure and erosion of profit margins. Packaged food and beverage companies spend millions of dollars creating brands and brand images to compete with other products. Many of these competitive products contain the same or similar flavor ingredients. The limited availability of proprietary flavors, flavor enhancers and taste modulators makes it difficult for manufacturers to differentiate their products based on flavor ingredients.

•                  Cost of Goods Savings. The packaged food and beverage industry purchases enormous volumes of raw materials to produce their products. According to the Food and Agriculture Division of the United Nations, estimated worldwide sugar production in 2004 was approximately 141.1 million metric tons, and consumption was over 143.1 million metric tons. Given such high demand for sugar, spot prices for processed sugar rose over 50% from February 2005 to February 2006 such that the market value of processed sugar produced worldwide during that period exceeded $100 billion, based on US spot prices in February 2006. Similarly, according to the 2003 Chemical Economics Handbook, worldwide consumption of MSG was nearly 1.6 million metric tons in 2002 at a cost of $1.4 billion. Flavors, flavor enhancers and taste modulators can potentially facilitate a reduction in the volume of these ingredients used in packaged food and beverage products, which could result in significant decreases in costs and associated increases in profit margins.

Our Solution

We use our proprietary taste receptor-based assays and screening technologies to discover and develop novel flavors, flavor enhancers and taste modulators. We have developed proprietary taste receptor-based assays that incorporate human taste receptors. We use these assays in our high-throughput screening systems to rapidly and efficiently screen our compound libraries and identify large numbers of novel potential flavors, flavor enhancers and taste modulators. We believe our approach improves the likelihood that compounds with the desired characteristics can be discovered and then optimized into novel flavors, flavor enhancers or taste modulators.

We believe our approach will result in the discovery and development of flavors, flavor enhancers and taste modulators that will provide the following valuable solutions to the following key challenges faced by the packaged food and beverage industry:

•                  Maintaining and Improving Taste. We are developing flavors, flavor enhancers and taste modulators to enable our collaborators to improve or maintain taste while improving the nutritional profile of packaged food and beverage products or reducing ingredient costs.

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•                  Reducing Sugar, Salt and MSG in Packaged Food and Beverage Products. We are developing flavors, flavor enhancers and taste modulators to enable our collaborators to significantly reduce the levels of sugar, salt and MSG in packaged food and beverage products while maintaining or improving taste. We believe reducing the levels of such ingredients will improve the nutritional profile of packaged food and beverage products.

•                  Blocking Undesirable Tastes. We are discovering taste modulators that we believe will be useful in blocking bitter and other unwanted tastes associated with certain packaged food, beverage, OTC health care products and pharmaceutical products.

•                  Obtaining Exclusive or Co-Exclusive Use of Proprietary Flavors, Flavor Enhancers and Taste Modulators. We are able to offer our collaborators exclusive or co-exclusive use of our proprietary flavors, flavor enhancers and taste modulators in defined packaged food and beverage product categories. We believe this approach will assist our collaborators in differentiating their products from those of their competitors.

•                  Reducing Cost of Goods. We believe our proprietary flavors, flavor enhancers and taste modulators will enable our collaborators to reduce overall raw material ingredient costs, particularly for those products containing high levels of natural and artificial sweeteners and MSG.

Our Strategy

Our goal is to become the leader in discovering, developing and commercializing new and improved flavors, flavor enhancers and taste modulators. Key elements of our strategy include:

•                  Collaborating With Leading Packaged Food and Beverage Companies. We are collaborating with leading packaged food and beverage companies to develop and commercialize our product candidates. Our collaborators are responsible for marketing, selling and distributing their products incorporating our flavors, flavor enhancers and taste modulators that are incorporated into their products. In addition, our collaborators are responsible for all manufacturing costs of our flavors, flavor enhancers or taste modulators. As a result, we expect to commercialize our flavors, flavor enhancers and taste modulators without incurring significant sales, marketing, manufacturing and distribution costs. We currently have collaborations with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé.

•                  Developing Flavors, Flavor Enhancers and Taste Modulators that are Eligible for FEMA GRAS Determination. Our primary focus is on the development of flavors, flavor enhancers and taste modulators that will qualify for a FEMA GRAS determination. Four compounds developed as part of our savory program have received FEMA GRAS determination.  The process from selection for development until receipt of that determination took approximately 12 months.  Costs associated with the FEMA GRAS process, including synthesis of material for regulatory studies, contract safety studies and preparation of the application, were less than $1 million. We expect that future flavors, flavor enhancers and taste modulators we develop will take a similar amount of time and cost a similar amount. However, the length of time may vary depending on the properties of the flavor, flavor enhancer or taste modulator. Upon the GRAS determination, our collaborators can begin to test market and commercialize products incorporating our flavors, flavor enhancers or taste modulators. In the event that a particular flavor enhancer or taste modulator is not eligible for FEMA GRAS determination, we may dedicate our development efforts to alternative compounds.

•                  Pursuing Additional Collaborations and Market Opportunities. We seek to establish additional collaborations with leading packaged food and beverage companies to use flavors, flavor enhancers or taste modulators developed through our existing programs for exclusive or co-exclusive use within new packaged food and beverage product fields. We intend to receive from

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future collaborators up-front fees, research and development funding, milestone payments and royalties on future sales of products incorporating these flavors, flavor enhancers or taste modulators. In addition, we plan to target fields in which our collaborators can incorporate more than one of our flavors, flavor enhancers or taste modulators into a particular product.

•                  Expanding Our Product Candidate Pipeline. We will continue to focus on the discovery and development of additional flavor ingredients based on additional taste receptors to address new taste areas. We believe potential new taste receptors include the fat taste and cold taste receptors. We also intend to improve the beneficial characteristics of our current product candidates through the development of next-generation flavors, flavor enhancers and taste modulators. We will also continue to consider applications of our current products and technologies outside of the packaged food and beverage industry.

•                  Maintaining and Expanding Our Technology Position. We believe our proprietary taste receptor-based technologies, including our receptor discovery, assay development and high-throughput screening technologies and natural and synthetic compound libraries, provide us and our collaborators with significant competitive advantages. We intend to continue to develop and acquire proprietary technologies and related intellectual property rights to expand and enhance our ability to discover and develop new proprietary flavors, flavor enhancers and taste modulators.

Our Discovery and Development Process

The following diagram summarizes our discovery and development process.

The key elements of our Discovery and Development process are:

•                  Proprietary Taste Receptor-Based Assay Development. The first step in our discovery and development process is to develop proprietary assays based on human taste receptors. Our assays are tests that measure interactions between the taste receptors and potential flavors, flavor enhancers and taste modulators. To date we have developed assays to test for compounds that affect savory, sweet and salt taste. We are in the process of developing an assay for bitter taste receptors.

•                  High-throughput Screening and Identification of Lead Compounds. The next step in our discovery and development process is to use our proprietary taste receptor-based assays to identify compounds that bind to human taste receptors, known as hits. We use automated high-throughput screening to rapidly evaluate our libraries of diverse synthetic and natural compounds. A panel of taste testers then evaluates the taste effect of the most potent hits. Based on this evaluation, we designate hits that exhibit a positive taste effect as proof-of-concept compounds. We then select the most promising of those proof-of-concept compounds, which we call lead compounds, for optimization.

•                  Optimization of Lead Compounds and Selection of Product Candidates. The next step in our discovery and development process is to chemically enhance, or optimize, our lead compounds to allow lower amounts of the compound to be used in the finished product or improve the enhancement effect to meet the taste attribute goals of our collaborators. Optimization may also be required to enhance the safety profile or to improve the physical properties of a compound so that it is stable under manufacturing, storage and food preparation conditions. We refer to optimized compounds that provide desirable taste attributes in packaged food and beverage product

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prototypes as product candidates.

•                  Safety Studies and FEMA GRAS Determination of Product Candidates. The next step in our discovery and development process is to select, in conjunction with our collaborators, one or more product candidates for commercialization. We then evaluate the selected product candidate for safety. Following this evaluation, we submit the safety data along with the physical and chemical properties of the product candidate and a description of manufacturing and conditions of intended use to the FEMA GRAS expert panel for review. Four compounds developed as part of our savory program have received FEMA GRAS determination.  The process from selection for development until receipt of that determination took approximately 12 months.  Costs associated with the FEMA GRAS process, including synthesis of material for regulatory studies, contract safety studies and preparation of the application, were less than $1 million. We expect that future flavors, flavor enhancers and taste modulators we develop will take a similar amount of time and cost a similar amount. However, the length of time may vary depending on the properties of the flavor, flavor enhancer or taste modulator.

Following a FEMA GRAS determination, foods and beverages containing our proprietary flavors, flavor enhancers and taste modulators can be immediately commercialized in the United States and 20 other countries. We intend to use the data from the FEMA GRAS review to facilitate approval of our flavors, flavor enhancers and taste modulators for use in products sold in additional countries. We anticipate, however, that our collaborators will test market their products containing our flavors, flavor enhancers and taste modulators through a series of consumer acceptance tests prior to initiating any wide-scale commercialization.

Our Discovery and Development Programs

We are currently pursuing the discovery and development of flavors, flavor enhancers and taste modulators through programs focused on savory, sweet, salt and bitter.

Savory Enhancer Program

Using SavoryScreenHT, our high-throughput savory receptor-based assay system, we identified two product candidates, S336 and S807, that enhance the savory taste of glutamate. Our collaborator evaluated S336 and S807 for savory taste enhancement in product prototypes. S336 is approximately three times more potent than S807 in taste tests and exhibits greater water solubility compared to S807. Other characteristics, such as heat stability, are similar for the two compounds. Based on the results of such studies, our collaborator formally selected both S336 and S807 for development in May 2004.

We completed the safety assessment studies for S807 and S336 and submitted applications for GRAS determination to the FEMA Expert Panel in December 2004. In March 2005, S807 and S336 were determined to be GRAS. In addition, two other flavor enhancers, S263 and S976, which are related to S336, were also determined by FEMA to be GRAS. A more detailed description of the FEMA GRAS process is provided in Item I, Business – Regulatory Process. With our having achieved FEMA GRAS status for the four savory compounds, our collaborator initiated product development efforts to identify initial applications, optimal concentrations and the development of new recipes. Application work and taste testing is being conducted at multiple product development sites. This work is expected to be completed no later than the end of September 2006. In parallel to this effort, we are conducting additional application and product development work both in-house and in collaboration with a number of consultants and potential partners.

Sweet Enhancer Program

Using SweetScreenHT, our high-throughput sweet receptor-based assay system, we identified S1395 and S888, proof-of-concept compounds. Optimization chemistry led to the identification of S679, which in taste tests was found to be approximately three times more potent than S1395 and S888. We believe that the compounds we are developing in our sweet enhancer program will function with both carbohydrate and

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artificial sweeteners used in a variety of packaged food and beverage products and may provide for a significant reduction in added sweetener in the finished product while maintaining or improving the desired sweet taste.

During 2005, we identified a number of novel compounds using our optimization chemistry process. One compound, S951, demonstrated enhanced potency in the receptor assay and in preliminary taste tests over the previous lead compound S679. At a concentration of approximately 1.5 parts per million in a solution of 6% fructose, S951 tastes as sweet as a 10% fructose solution. This is equivalent to a 40% reduction of the added carbohydrate sweetener. S951 was also effective in more complex product prototypes such as ice cream and cereal, but required approximately 6 parts per million to significantly reduce the carbohydrate sweetener and maintain the sweet taste.

During the fourth quarter of 2005, we created derivatives of S951 and other compounds to reduce the amounts needed in products and to optimize physical properties such as solubility in food and beverages. Recently, we identified S8613, a compound that is approximately as potent as S951 in taste tests, but is significantly more water soluble than S951. We expect such improvements in physical properties to improve functionality in products. It is our goal to identify a sweet product candidate and initiate development and safety studies by the end of the third quarter of 2006, and to achieve the first commercial sale of a product containing an ingredient from the sweet program in 2007.

Salt Enhancer Program

The goal of our salt enhancer program is to identify compounds that enhance the taste of salt and provide a significant reduction in sodium levels in a variety of foods while maintaining or improving the desired salt taste. We are continuing to identify enhancers of the ion channel, ENaC, the most potent of which is S4613. In addition, during the fourth quarter of 2005, we completed characterization of a second form of ENaC in taste cells, termed Delta ENaC, which may also play a role in salt taste but has different properties from Alpha ENaC, the form we had been studying previously. Based on our new findings, we have initiated discovery of Delta ENaC enhancers and have isolated a set of active compounds using our proprietary screening methods. We will continue to identify enhancers of Alpha and Delta ENaC and optimize these compounds to improve potency with the goal of identifying a compound that functions in taste tests by the end of the second quarter of 2006. As with the sweet program, our goal is to identify a product candidate and initiate development and safety studies by the end of the third quarter of 2006 in order to achieve the first commercial sale of a product containing one of our salt enhancers in 2007.

Bitter Taste Modulator Program

The goal of our bitter taste modulator program is to identify compounds that modulate or eliminate the bitter taste associated with certain packaged food and beverage products, OTC health care products and pharmaceutical products. In 2005, we continued to make progress along several lines of research. The first steps of this program involve the identification of taste receptors that respond to bitter ingredients known to be present in a variety of food and beverages, followed by the use of these receptors to discover bitter taste blockers. A key accomplishment during 2005 was our development of methods that allow us to test fluorescent samples, which we previously could not test in our bitter assay. These new methods allow us to test a broader range of bitter compounds in our screening process. Lastly, we continue to develop high-throughput screening assays to identify bitter blockers. We anticipate initiating screening for bitter blockers by the end of 2006.

Product Discovery and Development Collaborations

We pursue collaborations with leaders in the packaged food and beverage market. Under each of our current product discovery and development collaboration agreements, we have agreed to conduct research and develop flavors, flavor enhancers or taste modulators in one or more specified taste areas, such as savory, sweet, salt or bitter. Each of these collaborations is focused on one or more specific product fields, such as non-alcoholic beverages, wet soups, or frozen foods. To date, we have entered into product discovery and development collaborations with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé.

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All of our current collaboration agreements provide for research and development funding, milestone payments upon achievement of pre-defined research or development targets, cost reimbursement and royalty payments based upon future product sales in the event the collaborator commercializes a product incorporating our flavors, flavor enhancers or taste modulators. Certain of our current collaboration agreements also provide for upfront fees. The research and development funding under each of these agreements is paid according to a fixed payment schedule. Each of these collaborations provides us with a portion of the funding we require to pursue the discovery and development of flavors, flavor enhancers and taste modulators for the applicable program. Under each of these agreements, we are primarily responsible for the discovery, development and regulatory approval phases and any associated expenses, while our collaborator is primarily responsible for selecting the consumer products that may incorporate our flavors, flavor enhancers or taste modulators. Our collaborator is also responsible for manufacturing, marketing, selling and distributing any of these consumer products, and any associated expenses. We believe our collaborations will allow us to benefit from our collaborators’ well-established brand recognition, global market presence, established sales and distribution channels and other industry-specific expertise. Each of our collaborations is governed by a joint steering committee, consisting of an equal number of representatives of the collaborator and us. The steering committees provide strategic direction and establish performance criteria for the research, development and commercialization of our flavors, flavor enhancers and taste modulators. All decisions of the steering committees must be unanimous.

Each of our collaboration agreements provides that we will conduct research and development on flavors, flavor enhancers and taste modulators for use within clearly defined packaged food and beverage product fields on an exclusive basis for the collaborator during the collaborative period specified in each of the agreements. Our current product discovery and development collaborators are not prohibited from entering into research and development collaboration agreements with third parties in any product field. Under the terms of each agreement, we will retain rights to flavors, flavor enhancers and taste modulators that we discover during the collaboration for use with the collaborator, or for our use or with other collaborators outside of the defined product field. We will also retain rights to any flavors, flavor enhancers and taste modulators that we discover after the respective collaborative period. In addition, if the collaborator terminates the agreement or, in the case of certain of our agreements, fails after a reasonable time following regulatory approval or GRAS determination to incorporate one or more of our flavors, flavor enhancers or taste modulators into a product, it will no longer be entitled to use, and we will have the right to license, the flavors, flavor enhancers or taste modulators to other packaged food and beverage companies for use in any product field.

Each of our agreements terminates when we are no longer entitled to royalty payments under the agreement. In addition, each agreement may be terminated earlier by mutual agreement or by either party in the event of a breach by the other party of its obligations under the agreement. Our agreement with Kraft Foods and our initial agreement with Nestlé may each be terminated by our collaborator upon 60 days written notice, provided that it pay a specified termination fee if it terminates the agreement prior to the end of the research collaborative period. Campbell Soup may only terminate its agreement without cause upon 60 days written notice, provided that it pay a specified termination fee if it terminates the agreement prior to the end of the collaborative period. Our agreement with Coca-Cola permits Coca-Cola to terminate the agreement upon specified major corporate events. Our most recent agreement with Nestlé gives Nestlé the right to terminate the agreement without cause on or after October 26, 2006 upon 90 days written notice, provided that it pay a specified termination fee if it terminates the agreement after October 26, 2006 but prior to the end of the collaborative period. Cadbury Schweppes may terminate its agreement without cause on or after April 15, 2006 upon 90 days written notice.

Cadbury Schweppes

In July 2005, we entered into a collaborative research and license agreement with Cadbury Adams USA, LLC, a Cadbury Schweppes company, for the discovery and commercialization of new flavor ingredients in the gum confectionary area. Under the terms of the collaboration, Cadbury Schweppes has agreed to pay us research funding for up to two years based on research progress during the collaborative period. We are also eligible to receive milestone payments upon our achievement of specific product discovery and development goals. Through December 31, 2005, we have received $650,000 in research

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funding. If all milestones are achieved, and including the $650,000 in research funding paid through December 31, 2005, we may be entitled to up to $3.1 million in research funding and milestone payments. In addition, in the event of commercialization, we are entitled to receive royalties based on sales of products containing new flavor ingredients developed under the agreement. We cannot assure you that we will receive any future milestone payments or royalties under this collaboration.

Campbell Soup Company

In March 2001, we entered into a collaboration agreement with Campbell Soup, a global manufacturer and marketer of consumer food products, to work for a three-year collaborative period to discover specified flavors and flavor enhancers in the packaged food and beverage product fields of soups, including frozen soups. We later amended the agreement to add the product field of specified savory beverages in consideration for additional research and development payments and potential milestone and royalty payments. In February 2006, we extended the collaborative period until the earlier of March 2009 or submission for a GRAS determination, subject to earlier termination under specified circumstances.

Under the terms of the collaboration, Campbell Soup has agreed to pay to us certain research and development funding. We are also eligible to receive a milestone payment upon our achievement of a specific product development goal. Through December 31, 2005, we have received $9.1 million in research and development funding. If all milestones are achieved, and including the $9.1 million in research and development funding paid through December 31, 2005, we may be entitled to up to $13.1 million in research and development funding and milestone payments. In addition, in the event of commercialization, we are entitled to receive royalties on future net sales of products containing a discovered flavor or flavor enhancer from the date of introduction of each product in each country until 17 years thereafter or until the expiration of relevant patents in such country, whichever is earlier. We cannot assure you that we will receive any future milestone payments or royalties under this collaboration.

The Coca-Cola Company

In April 2002, we entered into a collaboration agreement with Coca-Cola, the world’s largest beverage company, to work for a three-year collaborative period with Coca-Cola for the discovery and development of specified new flavors and flavor enhancers in the product field of soft drinks and other non-alcoholic beverages. In addition, we will work with Coca-Cola on a co-exclusive basis with Kraft Foods for the discovery and development of flavor enhancers in a specified food and beverage product field. In April 2004, we amended the agreement to extend the collaborative period until April 2008.

Under the agreement, Coca-Cola has agreed to pay certain research and development funding over the collaborative period. We are also eligible to receive milestone payments upon our achievement of specific product discovery and development goals. Through December 31, 2005, we have received $7.5 million in research and development funding. If all milestones are achieved, and including all research and development funding paid or payable, we may be entitled to up to $14.8 million. In addition, in the event of commercialization, we are entitled to receive royalties on future sales of products containing a discovered flavor or flavor enhancer until the expiration of relevant patents. We cannot assure you that we will receive any future milestone payments or royalties under this collaboration. The collaborative period is subject to early conclusion by Coca-Cola upon 60 days written notice upon payment of a specified early conclusion fee, provided that Coca-Cola may terminate the collaborative period without payment of an early conclusion fee in the event that we fail to achieve a specified research and development goal by April 22, 2006, subject to payment of research funding through July 22, 2006. In the event of early conclusion, Coca-Cola will no longer be entitled to use, and we will have the right to license, any flavors or flavor enhancers discovered prior to such early conclusion to third parties for use in any product field, provided that Coca-Cola would retain non-exclusive rights in the field of non-alcoholic beverages with the exception of dry powdered beverages.

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Kraft Foods Global, Inc.

In December 2000, we entered into a collaboration agreement with Kraft Foods, a global leader in branded foods and beverages. The collaborative period for the original product discovery and development program expired on its own terms in December 2003. However, prior to December 2003 we amended our collaboration agreement to provide for a new collaborative program through May 2005. In April 2005 and July 2005 we further amended our collaboration agreement to extend the collaborative research phase for three months and an additional two years through July 2007, respectively. Under this program, we will work with Kraft Foods for the discovery and development of flavor enhancers, on a co-exclusive basis with Coca-Cola in a specified food and beverage product field. We will also work with Kraft Foods on the discovery and development of novel flavor modifiers on an exclusive basis in a specified product field in the dessert product category. Under the collaboration agreement, as amended, Kraft Foods has agreed to pay us certain research and development funding over a 6.5-year collaborative period. We are also eligible to receive milestone payments upon our achievement of specific product discovery and development goals. Through December 31, 2005, we have received $8.4 million in research and development funding and one milestone payment of $375,000. If all milestones are achieved, and including all research and development funding paid or payable, we may be entitled to up to $11.7 million. In addition, in the event of commercialization, we are entitled to receive royalties on future net sales of products containing a discovered flavor enhancer from the date of introduction of each product in each country until the earlier of 17 years thereafter or until the expiration of relevant patents in such country. We cannot assure you that we will receive any further milestone payments or royalties under this collaboration.

In December 2005, we further amended the agreement to provide for a new three-year discovery and development collaboration. In this new collaboration, we will work with Kraft Foods on the discovery and development of novel flavor modifiers on a co-exclusive basis in the chilled and processed meat product category within North America. Under the terms of the new collaboration, Kraft Foods has agreed to pay us an initial license fee and incremental discovery and development funding over the three-year period. In addition, we are eligible to receive milestone payments upon achievement of specific product discovery and development goals. Through December 31, 2005, we have not received any payments in license fees or research and development funding. We received the upfront license fee and first discovery and development funding payment for this collaboration in January 2006. If all milestones are achieved, and including all license fees and research and development funding payable, we may be entitled to up to $4.6 million. In addition, in the event of commercialization, we are entitled to receive royalties on future net sales of products containing a discovered flavor enhancer from the date of introduction of each product in each country until the earlier of 17 years thereafter or until the expiration of relevant patents in such country. We cannot assure you that we will receive any further milestone payments or royalties under this collaboration.

Nestlé SA

In April 2002, we entered into an initial collaboration agreement with Nestlé, the world’s largest food company, to work for a three-year collaborative period to discover specified flavors and flavor enhancers in the food and beverage product fields of dehydrated and culinary food, frozen food and wet soup. In April 2005, we amended the agreement to provide for a three-year extension of the collaborative research phase.

Under the terms of the collaboration agreement, Nestlé has agreed to pay to us certain research and development funding over three years. We are also eligible to receive milestone payments upon our achievement by certain dates of specific product discovery and development goals. Through December 31, 2005, we have received $7.9 million in research and development funding, reimbursement of certain regulatory expenses of $339,000 and four milestone payments of $375,000 each. If all milestones are achieved, and including all research and development funding paid or payable, we may be entitled to up to $16.0 million under the initial collaboration. In addition, in the event of commercialization, we are entitled to receive royalties on future net sales of products containing a discovered flavor or flavor enhancer from the date of introduction of each product in each country until the expiration of relevant patents. We cannot assure you that we will receive any further milestone payments or royalties under this collaboration.

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In October 2004, we entered into a second product discovery and development collaboration agreement with Nestlé to work for a five-year collaborative period focusing on the discovery and commercialization of specified novel flavor ingredients in the coffee and coffee whiteners field. Under the terms of the agreement, Nestlé has agreed to pay us certain research and development funding over five years, subject to earlier termination under specified circumstances. We are also eligible to receive milestone payments upon achievement of specific product discovery and development goals. Through December 31, 2005, we have received $2.3 million in research and development funding. If all milestones are achieved, and including all research and development funding paid or payable, we may be entitled to up to $13.1 million under the second collaboration. In addition, in the event of commercialization, we are entitled to receive royalties on future net sales of products containing a discovered flavor ingredient from the date of introduction of each product in each country until the expiration of relevant patents. We cannot assure you that we will receive any milestone payments or royalties under this collaboration.

Our Technology

We have discovered or in-licensed many of the key receptors that mediate taste in mammals. Having isolated human taste receptors, we have created proprietary taste receptor-based assay systems that provide a biochemical or electronic readout when a test compound affects the receptor. To enable faster compound discovery, we integrated our proprietary taste receptor-based screening assays into a robot-controlled automated system that uses plates containing an array of individual wells, each of which can screen a different compound. Our receptor-based discovery and development process has enabled us to improve our ability to find novel flavors, flavor enhancers and taste modulators over the traditional use of simple taste tests.

Receptor Discovery and Assay Development Technology

There are currently five recognized primary senses of taste: umami (which is the savory taste of glutamate), sweet, salt, bitter and sour. Scientists generally believe that each of these taste sensations is recognized by a distinct taste receptor or family of taste receptors in the mouth or on the tongue. A taste receptor functions either by physically binding to a flavor ingredient in a process analogous to the way a key fits into a lock or by acting as a channel to allow ions to flow directly into a taste cell. The brain recognizes tastes by determining which of the numerous receptors in the mouth have been contacted by a given flavor ingredient. Savory, sweet and bitter taste compounds bind to taste receptors specific to each taste on the surface of taste bud cells. In contrast, the taste of salt and the sour taste are thought to be recognized by taste channels that allow the passage of particular ions into the taste bud cells.

The current status in the development of proprietary taste receptor-based assay systems for human taste receptors is as follows:

•                  Savory Receptor. Glutamate is a natural component of foods including tomatoes, mushrooms, parmesan cheese, and meats. It is often added to foods in the form of MSG to provide a savory flavor. The human savory receptor is composed of two proteins called hT1R1 and hT1R3. The T1R proteins are members of the G protein-coupled receptor, or GPCR, family and are expressed on the surface of certain taste bud cells. We created SavoryScreenHT, a proprietary high-throughput savory taste receptor-based assay system and demonstrated that it responded to MSG and inosine monophosphate, or IMP. We have screened over 200,000 compounds in SavoryScreenHT and identified a number of savory enhancers, including S807, S336, S263 and S976, which were determined to be GRAS in March 2005.

•                  Sweet Receptor. The human sweet receptor is composed of two proteins called hT1R2 and hT1R3. The hT1R3 protein is shared in common with the savory receptor. Like the savory receptor, the sweet receptor is also a member of the GPCR family and is expressed on the surface of certain taste bud cells. We created SweetScreenHT, a proprietary high-throughput sweet taste receptor-based assay system, and demonstrated that it responded to many different sweet-tasting compounds including carbohydrate sweeteners and high potency artificial sweeteners. We have

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screened over 200,000 compounds in SweetScreenHT and identified novel compounds that modulate sweet taste.

•                  Bitter Receptors. There are 25 bitter receptors in humans. These are also members of the GPCR protein family. Work from model systems showed that the 25 bitter receptors are likely present together in the same taste cell. The bitter receptors are believed to have evolved as a defense mechanism to warn of and prevent the ingestion of poisonous substances. It is thought that each bitter receptor recognizes a different set of bitter-tasting compounds. We have characterized many of the 25 T2R receptors and we have initiated the development of receptor-based assays.

•                  Salt Receptor. In contrast to the GPCRs that mediate savory, sweet, and bitter tastes, sodium ions and to a lesser extent potassium ions, are thought to produce a salt taste via ion channels present on the surface of taste bud cells. Ion channels are receptors that span the cell membrane and allow a flow of ions into or out of cells. Published work suggests that the Epithelial Sodium Channel, or ENaC, is a mediator of salt taste. We have characterized two forms of ENaC from human taste cells, termed Alpha ENaC and Delta ENaC. For each form of ENaC, we have developed two proprietary ENaC-based assay systems, SaltScreenHT, a high-throughput system capable of screening thousands of compounds per day, and SaltScreenEP, a lower-throughput electrophysiology-based system. We demonstrated each of the SaltScreen systems are responsive to sodium and therefore could be used to identify novel salt flavor enhancers.

Screening Technologies and Compound Libraries

We have developed or acquired access to expansive libraries of potential flavors, flavor enhancers and taste modulators currently comprised of over 250,000 natural and synthetic compounds. We intend to continue to acquire or develop additional compounds to add to our libraries. We have designed and selected our libraries to comprise compounds that we believe are likely to be safe and economical for use in packaged food and beverage products. We are using our SavoryScreenHT, SweetScreenHT, SaltScreenHT, SaltScreenEP and BitterScreen assay systems to screen the compounds in our libraries for their effects on specific taste receptors. These systems use many of the same technologies that pharmaceutical companies use to discover medicines. We also use these systems to assist us in optimizing our lead compounds by rapidly and iteratively testing the potency of the flavors, flavor enhancers and taste modulators generated in the optimization process as the lead compound progresses to become a product candidate.

Regulatory Process

Flavoring substances, including flavors, flavor enhancers and taste modulators, intended for use in foods in the United States are regulated under provisions of the FD&C Act administered by the United States Food and Drug Administration, or FDA. Flavor compounds sold in countries and regions outside of the United States are also subject to regulations imposed by national governments or regional regulatory authorities as is the case in the European Union.

Regulation of Flavors, Flavor Enhancers and Taste Modulators in the United States

In the United States, flavor compounds are regulated by the FDA as approved food additives, or as GRAS ingredients under the FD&C Act. The Food Additive Amendments of 1958 prompted the flavor industry to establish in 1960 the FEMA Expert Panel. FEMA has administered the GRAS program for flavors on behalf of the industry for over 40 years. Other possible routes to approval of a flavor-modifying compound would be a GRAS self-determination (independent of FEMA) with or without FDA notification, or a food additive petition to the FDA; however, few flavors are currently approved via these routes. Our goal is that the flavor compounds, including flavors, flavor enhancers and taste modulators we may discover will be subject to the FEMA GRAS review process as described below.

GRAS Review Process. Flavor compounds that qualify for the GRAS review process are generally intended to be consumed in small quantities and have data supporting their safety under conditions of intended use. An expert panel, convened to undertake a GRAS review, determines whether a compound is

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generally recognized as safe under the conditions of its intended use. These experts are qualified by scientific training and experience to evaluate the safety of chemicals used in food and may declare certain compounds as having been adequately shown through scientific procedures to be generally recognized as safe under the conditions of their intended use. Under the GRAS process, manufacturers are required to obtain safety data from the scientific literature or through the conduct of safety studies, determine the estimated daily intake of the flavor compound per person and submit a report to the GRAS review panel describing the physical, chemical, safety, and metabolic properties of the flavor compound. The entire GRAS determination process, including the safety and metabolic studies, application preparation and GRAS panel review, can take up to two years or longer. However, if there are prior safety data on the compound or a compound with a related structure, then fewer safety studies may be required for the GRAS review and the GRAS review process can be considerably shorter than two years.

The most common types of GRAS review are:

•                  FEMA Expert Panel. The FEMA Expert Panel is an independent panel of experts established by FEMA. The FEMA Expert Panel, which may be used by FEMA members and certain other parties, meets at least three times per year. The conclusions of the Expert Panel regarding a flavor or flavor enhancer are provided directly to the FDA and published in the journal Food Technology. To our knowledge, the FDA has not challenged the FEMA Expert Panel’s conclusion that the use of a flavoring substance is GRAS. In 2005, the FEMA Expert Panel published its findings on 185 new compounds determined to be GRAS for specific flavor applications. We have been an associate member of FEMA since 2003. Four of our savory compounds were determined to be GRAS by the FEMA Expert Panel in 2005.

•                  Specifically Convened Independent Panel. An independent, qualified panel of experts in pertinent scientific disciplines may be formed by the manufacturer to evaluate the safety of a specific compound for GRAS status. This process is known as a “self determination of GRAS status.”  The basis for the GRAS self determination is not required to be submitted to the FDA. However, the FDA may request information on compounds that have been self determined to be GRAS, or the information may be provided voluntarily.

Food Additive Petition Process. Food ingredients for which the GRAS process is not available may be evaluated as food additives. Food additives require FDA approval prior to use in foods. A compound may be ineligible for GRAS determination, and may be considered a food additive, because there is insufficient general knowledge or for a variety of other reasons, including conditions of intended use resulting in high dietary exposure or the compound’s safety profile. If the compound is considered a food additive, a food additive petition must be filed and approved by the FDA. Examples of compounds that have gone through a food additive petition include the artificial sweeteners Aspartame, Acesulfame K, and Sucralose, and the fat substitute Olestra. The food additive petition approval process for such food ingredients can take eight years or more. In the event that a particular flavor or flavor enhancer is not eligible for GRAS determination and therefore requires FDA approval prior to use, we may dedicate our development efforts to alternative compounds that would be eligible for a GRAS determination.

Benefits of the FEMA GRAS Process

There are three key benefits of the FEMA GRAS review process:

•                  Rapid Time for Commercialization. Four compounds developed as part of our savory program have received FEMA GRAS determination.  The process from selection for development until receipt of that determination took approximately 12 months. We expect that future flavors, flavor enhancers and taste modulators we develop will take a similar amount of time. However, the length of time may vary depending on the properties of the flavor, flavor enhancer or taste modulator. This is much shorter than the typical eight years or longer to obtain FDA approval under the food additive petition process applicable to other food ingredients. Once the compound is determined to be FEMA GRAS, it can be immediately commercialized in the United States and 20 other countries that recognize the FEMA GRAS status. As described above, the initial phase of commercialization may include compound manufacturing, incorporation of the flavor enhancer

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into products, and the commercialization of products in consumer test markets.

•                  Low Development Costs. The total costs for the FEMA GRAS process, including synthesis of material for regulatory studies, contract safety studies and preparation of the FEMA GRAS application is generally under $1 million per compound.

•                  Facilitated Approval in Other Countries. Approval of flavors for use outside of the United States varies widely by country. According to FEMA, seven countries, including Brazil, New Zealand and Australia, recognize compounds on the FEMA GRAS list.  An additional set of countries recognize compounds on the FEMA GRAS list “in principle”. These include Canada, China, Philippines and Turkey. Approval in these countries may require specific applications to the food safety authority of the individual countries but usually not additional safety testing.

License Arrangements

We have licensed rights from several companies and academic institutions, including the following:

University of California

In March 2000, we entered into a license agreement with the University of California under which we obtained exclusive rights to certain technologies held by the University of California that are involved in the biology of taste, including specified receptors in two taste receptor families, T1Rs and T2Rs. The license may be converted to a non-exclusive license, or terminated, by the University of California if we fail to meet specified milestones relating to the discovery of specified products and the sale of specified products and services. Our exclusive rights are also subject to rights granted by the University of California to the United States Government and a private medical foundation. The agreement required a license issue fee, payable in installments through 2005, and calls for annual maintenance fees commencing in 2006 and royalties or service revenues on sales of any products developed using technologies licensed under the agreement. Royalties will accrue in each country for as long as there exists a valid patent claim covering a product developed under the agreement. No royalty payments have accrued under the agreement to date. The agreement will remain in effect until the later of the expiration of the last to expire patent licensed under the agreement, or ten years from the date that the last product to be developed under the agreement is introduced to market in the United States. We may terminate the agreement at any time, without cause, upon notice to the University of California. The University of California may terminate the agreement upon a breach of our obligations under the agreement. In addition, we are in discussions with the University of California to amend the license agreement to include additional related technology related to the coexpression of T1R taste receptors.

Aurora Biosciences Corporation

In November 2000, we entered into a technology collaboration and license agreement with Aurora to develop certain assay technologies, which was amended April 2002. Under the collaboration, we developed high-throughput screening assays using Aurora’s proprietary screening technologies. The agreement terminated in October 2002 and Invitrogen Corporation subsequently acquired certain surviving rights and obligations under this agreement. Under the surviving terms of the agreement, we maintain exclusive rights to use certain proprietary screening technologies with our taste receptor targets for the discovery of flavors, flavor enhancers and taste modulators. These exclusive rights are subject to rights granted under other current and future license agreements in connection with the purchase of certain screening systems, as well as Invitrogen’s right to grant licenses under its proprietary technology to academic, government and other non-profit organizations. Our rights with respect to the screening of flavors, flavor enhancers and taste modulators are fully paid-up and will remain in effect, except in the event that we breach any remaining obligations to Invitrogen under the agreement. In November 2000, Aurora purchased 1,000,000 shares of our Series C preferred stock for $4.8 million.

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Competition

Our goal is to be the leader in discovering novel flavors, flavor enhancers and taste modulators for use in a wide range of packaged food and beverage products. Other companies are possibly pursuing similar technologies and the commercialization of products and services relevant to flavors, flavor enhancers and taste modulators. Although we are not aware of any other companies that have the scope of proprietary technologies and processes that we have developed in our field, there are a number of competitors who possess capabilities relevant to the flavor, flavor enhancer or taste modulation fields.

In particular, we face substantial competition from companies pursuing the commercialization of products and services relevant to taste using more traditional methods for the discovery of flavors, flavor enhancers and taste modulators. These competitors include leading flavor companies, such as International Flavors & Fragrances Inc., Givaudan SA, Symrise, Quest International and Firmenich. These companies provide flavors and other products, such as oils, extracts and distillates, to consumer products companies for use in a wide variety of products including foods, beverages, confectionaries, dairy products and pharmaceuticals. We also face indirect competition from other companies such as Newly Weds Foods, Inc., a manufacturer of food coatings and seasonings for restaurants, airlines and the food services industry. We currently compete and will continue to compete in the future with these companies in collaborating with and selling flavor products and technologies to manufacturers of packaged food and beverage products. Many of these companies have substantially greater capital resources, research and development resources and experience, manufacturing capabilities, regulatory expertise, sales and marketing resources, established relationships with consumer products companies and production facilities.

We may in the future face competition from life sciences and other technology companies and other commercial enterprises. These entities engage as we do in biotechnology, biology or chemistry and could apply this technology to the discovery and development of flavors, flavor enhancers and taste modulators. We are aware of another company, Linguagen Corp., a privately-held company, that we believe is involved in research on sweetness potentiators, salt substitutes and bitter blockers, specifically adenosine 5’ monophosphate, or AMP, and has announced research and development collaborations with a number of companies. While we do not believe that either of these collaborations is competitive with our product discovery and development efforts, we cannot guarantee that products developed as a result of our competitors’ existing or future collaborations will not compete with our flavors, flavor enhancers and taste modulators.

Universities and public and private research institutions are also potential competitors. While these organizations primarily have educational objectives, they may develop proprietary technologies related to the sense of taste or secure patent protection that we may need for the development of our technologies and products. We may attempt to license these proprietary technologies, but these licenses may not be available to us on acceptable terms, if at all.

To our knowledge, there are no other entities using a receptor-based approach to develop flavors, flavor enhancers or taste modulators. Methods for reducing sodium include the use of potassium chloride in combination with flavors and masking agents. Although savory flavor enhancers, such as IMP, are commercially available, they are not very potent, are not patent protected and are sold as a commodity. The blocking of bitter taste is typically accomplished by attempting to mask the bitter taste with a sweetener or another flavor ingredient. Although AMP has received GRAS determination, we do not believe this compound has been widely adopted into packaged food and beverage products. However, our competitors, either alone or with their collaborative partners, may succeed in developing technologies or discovering flavors, flavor enhancers or taste modulators that are similar or preferable in the areas of, among others, effectiveness, safety, cost and ease of commercialization, and our competitors may obtain intellectual property protection or commercialize such products sooner than we do. Developments by others may render our product candidates or our technologies obsolete. In addition, our current product discovery and development collaborators are not prohibited from entering into research and development agreements with third parties in any particular field.

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Patents and Proprietary Rights

We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary rights are described by valid and enforceable patents or are effectively maintained as trade secrets. Accordingly, we are pursuing and will continue to pursue patent protection for our proprietary technologies. As of December 31, 2005 we had 3 issued United States patents, 54 pending United States patent applications and 74 pending foreign applications covering various aspects of our proprietary technology. Our issued patents have terms that expire in 2018 through 2021. In addition, we have exclusive license agreements with Johns Hopkins University, The University of California, Incyte Corporation and Aurora covering an additional 41 issued United States patents, 31 pending United States patent applications, 27 issued foreign patents and 53 pending foreign applications.

Our policy is to file patent applications and to protect technologies, inventions and improvements to inventions that are commercially important to the development of our business. For example, we may seek patent protection for receptors and nucleic acid sequences encoding receptors that are involved in taste and the use of such receptors to identify ingredients that modulate taste. We also rely on trademarks to protect our proprietary technology. Generally, United States patents have a term of 17 years from the date of issue or 20 years from the earliest claimed priority date, whichever is later, for patents issued from applications filed with the United States Patent and Trademark Office prior to June 8, 1995 or 20 years from the application filing date or earlier claimed priority date in the case of patents issued from applications filed on or after June 8, 1995. Patents in most other countries have a term of 20 years from the date of filing the patent application. Our success depends significantly upon our ability to develop ingredients and technologies that are protected by our intellectual property and that do not infringe any competitor patents. We intend to continue to file patent applications as we discover and develop new flavors or flavor enhancers and technologies.

Seeking and obtaining patents may provide some degree of protection for our intellectual property. However, our patent positions are highly uncertain and may involve complex legal and factual questions. No consistent standard regarding the allowability and enforceability of claims in many of the pending patent applications has emerged to date. As a result, we cannot predict the breadth of claims that will ultimately be allowed in our patent applications, if any, including those we in-licensed or how we may be able to enforce our patent claims against our competitors. In addition, we may not have been the first to file patent applications for or to invent inventions relating to the technologies upon which we rely, which would preclude us from obtaining issued patents on the relevant inventions. We are aware of other companies and academic institutions which have been performing research and have applied for patents in the area of mammalian taste. In particular, other companies and academic institutions have announced that they have identified taste receptors, published data on taste receptor sequence information or have filed patent applications on receptors and their use, including the University of California, Linguagen, Monell Chemical Senses, Mount Sinai School of Medicine, Scripps Research Institute, Pfizer and the German Institute of Human Nutrition. If any of these companies or academic institutions are successful in obtaining broad patent claims, such patents could potentially block our ability to use various aspects of our discovery and development process and might prevent us from developing or commercializing newly discovered flavors, flavor enhancers or taste modulators or otherwise conducting our business.

We also rely in part on trade secret protection for our confidential and proprietary information and process. Our policy is to execute confidentiality agreements with our employees and consultants upon the commencement of an employment or consulting relationship. These agreements generally require that all confidential information developed by the individual or made known to the individual by us during the course of their employment shall be our exclusive property. However, there can be no assurance that we will be able to effectively enforce these agreements or that the subject proprietary information will not be disclosed.

We are not a party to any litigation, opposition, interference, or other potentially adverse ex parte or inter-party governmental or non-governmental proceeding with regard to our patent and trademark positions. However, if we become involved in litigation, interference proceedings, oppositions or other intellectual property proceedings, for example as a result of an alleged infringement, or a third-party

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alleging an earlier date of invention, we may have to spend significant amounts of money and time and, in the event of an adverse ruling, we could be subject to liability for damages, invalidation of our intellectual property and injunctive relief that could prevent us from using technologies or developing products, any of which could have a significant adverse effect on our business financial condition and results of operation. In addition, any claims relating to the infringement of third-party proprietary rights, or earlier date of invention, even if not meritorious, could result in costly litigation, lengthy governmental proceedings, divert management’s attention and resources and require us to enter royalty or license agreements which are not advantageous if available at all.

Sales and Marketing

While we do not currently intend to establish internal sales and marketing capabilities, we are developing the capability to enable us to work closely with our collaborators and their suppliers in the incorporation of our flavors, flavor enhancers and taste modulators into their products. Under our current collaboration agreements, our collaborators are responsible for sales, marketing, and distribution of any packaged food or beverage product incorporating our flavors, flavor enhancers and taste modulators. As a result, we expect to commercialize our flavors, flavor enhancers and taste modulators without incurring significant sales, marketing and distribution costs. Our five current collaborators, Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé, are recognized leaders in the sales, marketing, and distribution of packaged food and beverage products.

Manufacturing

We intend to utilize third parties to manufacture our flavors, flavor enhancers and taste modulators. Under two of our existing product discovery and development collaborations, our collaborator may, in its sole discretion, manufacture itself or through a third party manufacturer the flavors, flavor enhancers or taste modulators it licenses from us. The remaining four agreements require the collaborator to identify with us a mutually agreed upon third party to manufacture the flavors, flavor enhancers or taste modulators it licenses from us. In some of these agreements, we maintain either the first right of negotiation or an option to manufacture based on provisions within the agreement.

There are a number of reliable third party contract manufacturers available to produce our flavors, flavor enhancers and taste modulators. Our current product candidates are relatively simple structures making them easy and inexpensive to produce. We do not anticipate any capacity issues because of our low volume requirements and the number of reliable and available manufacturers.

Employees

As of December 31, 2005, we had 90 full-time employees, including 23 with Ph.D. degrees. Of our full-time workforce, 65 employees are engaged in research and development and 25 are engaged in business development, finance and administration. We also retain outside consultants. None of our employees are covered by collective bargaining arrangements, and our management considers its relationships with our employees to be good. We have entered into employment letter agreements with Kent Snyder, Mark Zoller, Ph.D., Harry Leonhardt, Esq., John Poyhonen and Nigel R.A. Beeley, Ph.D., the terms of which are described in Item 11 of this Form 10-K.

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Executive Officers

The following table sets forth certain information concerning our executive officers and their ages as of December 31, 2005:

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Kent Snyder, President and Chief Executive Officer, joined us in June 2003 and has served as a member of our board of directors since that time. Prior to joining us, from October 2001 to June 2003, Mr. Snyder was retired. From July 1991 to October 2001, Mr. Snyder held various marketing and sales management positions with Agouron Pharmaceuticals, Inc., a Pfizer company. Mr. Snyder was President of Global Commercial Operations at Agouron. Prior to holding the position of President of Global Commercial operations, Mr. Snyder served as Senior Vice President of Commercial Affairs and Vice President of Business Development. Mr. Snyder received his B.S. from the University of Kansas and his M.B.A. from Rockhurst College.

Mark J. Zoller, Ph.D., joined us in March 2000 as Vice President of Research and was promoted to Executive Vice President of Discovery and Development and Chief Scientific Officer in January 2006, which position he still holds. From May 1992 to December 1999, Dr. Zoller held a number of scientific management positions at ARIAD Pharmaceuticals, most recently as Senior Vice President, Genomics and Scientific Director of the Hoechst-ARIAD Genomics Center, which in December 1999 was acquired by Aventis Pharmaceuticals. Dr. Zoller received his B.A. in Chemistry from Pomona College and his Ph.D. in Chemistry from the University of California, San Diego.

Harry J. Leonhardt, Esq., Senior Vice President, General Counsel and Corporate Secretary, joined us in September 2003 as Vice President, General Counsel and Corporate Secretary and was promoted in January 2006 to Senior Vice President, General Counsel and Corporate Secretary. From February 2001 to February 2003, Mr. Leonhardt served as Executive Vice President of Business Development, General Counsel and Corporate Secretary of Genoptix, Inc. From July 1996 to November 2000, Mr. Leonhardt held senior management positions with Nanogen, Inc. and served most recently as Senior Vice President, General Counsel and Secretary. Mr. Leonhardt received his B.S. degree from the University of the Sciences in Philadelphia and his Juris Doctorate from the University of Southern California Law Center.

John Poyhonen, Senior Vice President and Chief Financial and Business Officer, joined us in October 2003 as Vice President and Chief Business Officer and was promoted in April 2004 to Vice President, Chief Financial and Business Officer. In January 2006, he was promoted to Senior Vice President, Chief Financial and Business Officer. From 1996 until October 2003, Mr. Poyhonen served in various sales and marketing positions for Agouron Pharmaceuticals, a Pfizer company, most recently as Vice President of National Sales. Prior to holding this position, Mr. Poyhonen served as Vice President of Marketing and Vice President of National Accounts. Mr. Poyhonen received his B.A. in Marketing from Michigan State University and his M.B.A. from the University of Kansas.

Nigel R.A. Beeley, Ph.D., joined us in June 2004 as Vice President, Discovery. From March 1999 through June 2004, Dr. Beeley served as Vice President, Chief Chemical Officer of Arena Pharmaceuticals, a biopharmaceutical company. From 1994 to 1998, Dr. Beeley was Senior Director of Chemistry at Amylin Pharmaceuticals, Inc., a biotechnology company, and from 1988 to 1994, he served as Head of Oncology-Chemistry for Celltech, a biotechnology company. From 1980 to 1988, Dr. Beeley held positions of increasing seniority in the cardiovascular group at Synthelabo Research, a pharmaceutical company, and, from 1978 to 1980, he was a CNS medicinal chemist in the pharmaceutical division of Reckitt and Coleman, a conglomerate. From 1976 to 1978, Dr. Beeley held a Royal Society Overseas Research Fellow at ETH, Zurich, Switzerland. Dr. Beeley has a B.Sc. Honours (Class 1) degree in Chemistry from the University of Liverpool, U.K. and a Ph.D. in Chemistry from the University of Manchester, U.K.

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Item 1A. Risk Factors

You should consider carefully the following information about the risks described below, together with the other information contained in this annual report on Form 10-K and in our other public filings, in evaluating our business. If any of the following risks actually occurs, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected.  In these circumstances, the market price of our common stock would likely decline.

Risks Related To Our Business

We are dependent on our product discovery and development collaborators for all of our revenue and we are dependent on our current and any future product discovery and development collaborators to develop and commercialize any flavors, flavor enhancers or taste modulators we may discover.

A key element of our strategy is to commercialize our flavors, flavor enhancers and taste modulators through product discovery and development collaborations. To date, all of our revenue has been derived solely from research and development payments and milestone payments received under collaboration agreements with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé. Substantially all of our revenue in the foreseeable future will result from these types of payments from these collaborations, unless we successfully commercialize a product candidate through these or other collaborators and earn royalties on future sales of consumer products incorporating our flavors, flavor enhancers or taste modulators.

Our agreement, as amended, with Campbell Soup provides for research and development funding until March 2009 and gives Campbell Soup the right to terminate the agreement earlier without cause, provided that it pay a specified termination fee if it terminates the agreement prior to March 28, 2009. Our agreement with Coca-Cola provides for research and development funding until April 2008, and gives Coca-Cola the right to conclude the collaborative program earlier for any reason upon payment to us of a termination fee, provided that Coca-Cola may terminate the collaborative period without payment of an early conclusion fee in the event that we fail to achieve a specified research and development goal by April 22, 2006, subject to payment of research funding through July 22, 2006. Our agreement with Kraft Foods provides for research and development funding until December 2008, and gives Kraft Foods the right to conclude the agreement earlier for any reason upon payment to us of a termination fee. Our initial agreement with Nestlé (as amended in April 2005) provides for research and development funding through April 2008 and gives Nestlé the right to terminate the agreement earlier without cause on or after April 18, 2006, provided that it pay additional specified research funding if it terminates the agreement after April 18, 2006 but prior to April 18, 2008. Our most recent agreement with Nestlé provides for research and development funding through October 2009 and gives Nestlé the right to terminate the agreement earlier without cause on or after October 26, 2006, provided that it pay additional specified research funding if it terminates the agreement after October 26, 2006 but prior to October 26, 2009.  Our agreement with Cadbury Schweppes provides for research and development funding through July 2007, and gives Cadbury Schweppes the right to terminate the agreement earlier without cause on or after April 15, 2006 upon 90 days’ written notice. If any or all of our material agreements with our collaborators expire or are terminated, our revenue would significantly decline and if all of our agreements expire or are terminated, our revenue would be substantially eliminated, which would have a material adverse effect on our business, financial condition and results of operations. Our collaborators may not renew their agreements with us or, if they do, they may not be on terms that are as favorable to us as our current agreements.

Our current collaboration agreements provide that we will receive royalties of up to 4% on our collaborators’ sales of products containing our flavors, flavor enhancers or taste modulators. The actual royalties payable vary by agreement and depend on a number of factors including, for example, the product field, cost of goods savings, degree of flavor enhancement and sales volume of collaborator products incorporating our flavor ingredients. It is possible that our collaborators will not incorporate our flavors, flavor enhancers and taste modulators into any or all of their products within their exclusive product fields.

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We do not currently have a commercialized product and cannot assure you we will have a commercialized product in the foreseeable future, or at all. We will be dependent on our current and any other possible future collaborators to commercialize any flavors, flavor enhancers or taste modulators that we successfully develop and to provide the sales, marketing and distribution capabilities required for the success of our business. We have limited or no control over the amount and timing of resources that our current or any future collaborators may devote to our programs or potential products. Our collaborators may decide not to devote the necessary resources to the commercialization of our flavors, flavor enhancers or taste modulators, or may pursue a competitor’s product if our flavors, flavor enhancers or taste modulators do not have the characteristics desired by the collaborator. These characteristics include, among other things, enhancement properties, temperature stability, solubility, taste and cost. If these collaborators fail to conduct their commercialization, sales and marketing or distribution activities successfully and in a timely manner, we will earn little or no royalty revenues from our flavors, flavor enhancers and taste modulators and we will not be able to achieve our objectives or build a sustainable or profitable business.

Our present and any future product discovery and development collaboration opportunities could be harmed if:

•                  our existing or any future collaborators terminate their collaboration agreements with us prior to the expiration of the agreements;

•                  we do not achieve our research and development objectives under our collaboration agreements prior to the termination of the collaboration periods;

•                  we disagree with our collaborators as to the parties’ respective licensing rights to our flavors, flavor enhancers and taste modulators, methods or other intellectual property we develop;

•                  we are unable to manage multiple simultaneous collaborations;

•                  potential collaborators fail to spend their resources on research and development or commercialization of our flavors, flavor enhancers and taste modulators due to general market conditions or for any other reason; or

•                  consolidation in our target markets limits the number of potential collaborators.

We may not be able to negotiate additional collaboration agreements having terms satisfactory to us or at all.

We may not be able to enter into additional product discovery and development collaborations due to the exclusive nature of our current product discovery and development collaborations. Each of our current collaboration agreements provides that we will conduct research and development on flavors, flavor enhancers and taste modulators for use within one or more defined packaged food and beverage product fields on an exclusive basis for the respective collaborator during the collaborative period specified in the agreement. Because each of these agreements is exclusive or co-exclusive, we will not be able to enter into a collaboration agreement with any other food and beverage company covering the same product field during the applicable collaborative period. In addition, our collaborators’ competitors may not wish to do business with us at all due to our relationship with our collaborators. If we are unable to enter into additional product discovery and development collaborations, our ability to sustain or expand our business will be significantly diminished.

We may not be successful in developing flavors, flavor enhancers or taste modulators useful for formulation into products.

We may not succeed in developing flavors, flavor enhancers or taste modulators with the appropriate attributes required for use in successful commercial products. Successful flavors, flavor enhancers and taste modulators require, among other things, appropriate biological activity, including the correct flavor or flavor enhancer property for the product application, an acceptable safety profile, including lack of toxicity or allergenicity, and appropriate physical or chemical properties, including relative levels of stability, volatility and resistance to heat. Successful flavors, flavor enhancers and taste modulators must also be cost-efficient for our collaborators. We may not be able to develop flavors, flavor enhancers or taste modulators that meet these criteria.

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If we or our collaborators are unable to obtain and maintain the GRAS determination or regulatory approval required before any flavors, flavor enhancers or taste modulators can be incorporated into products that are sold, we would be unable to commercialize our flavors, flavor enhancers and taste modulators and our business would be adversely affected.

In March 2005, we obtained a GRAS determination for four of our savory product candidates. Apart from these product candidates, we do not have GRAS determination or regulatory approval for any other product candidate at this time. In the United States, the development, sale and incorporation of our flavors, flavor enhancers or taste modulators into products are subject to regulation by FDA and in some instances other government bodies. Obtaining and maintaining a GRAS determination or regulatory approval can be costly and take many years.

Depending on the amount or intended use of a particular flavor, flavor enhancer or taste modulator added to a product and the number of product categories in which the flavor, flavor enhancer or taste modulator will be incorporated, specific safety assessment protocols and regulatory processes must be satisfied before we or our collaborators can commercially market and sell products containing any flavors, flavor enhancers or taste modulators that we may discover. A key element of our strategy is to develop flavors, flavor enhancers and taste modulators that will be subject to review under the FEMA GRAS process, which, based on our experience with the savory program, we expect will take approximately 12 months and is less expensive than the alternative of filing a food additive petition with the FDA, approval of which can take eight years or more. The FEMA GRAS review process may take longer than 12 months and cost more than $1 million depending on the properties of the flavor, flavor enhancer or taste modulator, and if additional safety studies are requested by the FEMA Expert Panel or are necessary to explain unexpected safety study findings. There is a risk that one or more of our product candidates may not qualify for a FEMA GRAS determination. This may occur for a variety of reasons, including the flavor, flavor enhancer or taste modulator’s intended use, the amount of the flavor, flavor enhancer or taste modulator intended to be added to packaged foods and beverages, the number of product categories in which the flavor, flavor enhancer or taste modulator will be incorporated, whether the flavor, flavor enhancer or taste modulator imparts sweetness, the safety profile of the flavor, flavor enhancer or taste modulator and the FEMA Expert Panel’s interpretation of the safety data. Even if we obtain a GRAS determination with respect to a flavor, flavor enhancer or taste modulator, the FDA has the ability to challenge such determination, which could materially adversely affect our ability to market products on schedule or at all. In the event that a particular flavor, flavor enhancer or taste modulator does not qualify for FEMA GRAS determination, we will be required to pursue a lengthy FDA approval process or dedicate our development efforts to alternative compounds, which would further delay commercialization. In addition, laws, regulations or FDA practice governing the regulatory approval process, the availability of the GRAS determination process or the manufacture or labeling of such products, may change in a manner that could adversely affect our ability to commercialize products on schedule or at all.

Sales of our flavors, flavor enhancers or taste modulators outside of the United States will be subject to foreign regulatory requirements. In most cases, whether or not a GRAS determination or FDA approval has been obtained, approval of a product by the comparable regulatory authorities of foreign countries must still be obtained prior to manufacturing or marketing the product in those countries. A GRAS determination or FDA approval in the United States or in any other jurisdiction does not ensure approval in other jurisdictions because the requirements from jurisdiction to jurisdiction may vary widely. Obtaining foreign approvals could result in significant delays, difficulties and costs for us and require additional safety studies and additional expenses. If we fail to comply with these regulatory requirements or to obtain and maintain required approvals, our ability to generate revenue will be diminished.

We and our collaborators may not be successful in overcoming these regulatory hurdles, which could result in product launch delays, unanticipated expenses, termination of collaborations, and flavors, flavor enhancers and taste modulators not being approved for incorporation into consumer products. These consequences would have a material adverse effect on our business financial condition and results of operations.

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Even if we or our collaborators receive a GRAS determination or regulatory approval and incorporate our flavors, flavor enhancers or taste modulators into products, those products may never be commercially successful.

Even if we discover and develop flavors, flavor enhancers and taste modulators that obtain the necessary GRAS determination or regulatory approval, our success depends to a significant degree upon the commercial success of packaged food and beverage products incorporating those flavors, flavor enhancers or taste modulators. If these products fail to achieve or subsequently maintain market acceptance or commercial viability, our business would be significantly harmed because our royalty revenue is dependent upon consumer sales of these products. In addition, we could be unable to maintain our existing collaborations or attract new product discovery and development collaborators. Many factors may affect the market acceptance and commercial success of any potential products incorporating flavors, flavor enhancers or taste modulators that we may discover, including:

•                  health concerns, whether actual or perceived, or unfavorable publicity regarding our flavors, flavor enhancers and taste modulators or those of our competitors;

•                  the timing of market entry as compared to competitive products;

•                  the rate of adoption of products by our collaborators and other companies in the flavor industry; and

•                  any product labeling that may be required by the FDA or other United States or foreign regulatory agencies for products incorporating our flavors, flavor enhancers and taste modulators.

We have a history of operating losses and we may not achieve or maintain profitability.

We have not been profitable and have generated substantial operating losses since we were incorporated in September 1998. We incurred net losses of approximately $19.8 million for the year ended December 31, 2005. As of December 31, 2005, we had an accumulated deficit of approximately $104.2 million. We expect to incur additional losses for at least the next two years. The extent of our future losses will depend, in part, on the rate of increase in our operating expenses and the rate of growth, if any, in our revenue from our five existing and any future product discovery and development collaborations as well as from other sources that may become available to us in the future and on the level of our expenses. To date, our revenue has come solely from research and development funding, upfront fees, cost reimbursement and milestone payments under our product discovery and development collaboration agreements with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé. In order for us to generate royalty revenue and become profitable, we must retain our existing product discovery and development collaborations and our collaborators must commercialize products incorporating one or more of our flavors, flavor enhancers or taste modulators, from which we can derive royalty revenues. Our ability to generate royalty revenue is uncertain and will depend upon our ability to meet particular research, development and commercialization objectives.

We expect that our results of operations will fluctuate from period to period, and this fluctuation could cause our stock price to decline, causing investor losses.

Our operating results have fluctuated in the past and are likely to vary significantly in the future based upon a number of factors, many of which we have little or no control over. We operate in a highly dynamic industry and future results could be subject to significant fluctuations. These fluctuations could cause us to fail to meet or exceed financial expectations of securities analysts or investors, which could cause our stock price to decline rapidly and significantly. Revenue and expenses in future periods may be greater or less than revenue and expenses in the immediately preceding period or in the comparable period of the prior year. Therefore, period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. Some of the factors that could cause our operating results to fluctuate include:

•                  termination of any of our product discovery and development collaboration agreements;

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•                  our ability to discover and develop flavors, flavor enhancers and taste modulators or the ability of our product discovery and development collaborators to incorporate them into packaged food and beverage products;

•                  our receipt of milestone payments in any particular period;

•                  the ability and willingness of collaborators to commercialize products incorporating our flavors, flavor enhancers and taste modulators on expected timelines, or at all;

•                  our ability to enter into new product discovery and development collaborations and technology collaborations or to extend the terms of our existing collaboration agreements and our payment obligations, expected revenue and other terms of any other agreements of this type;

•                  our ability, or our collaborators’ ability, to successfully satisfy all pertinent regulatory requirements;

•                  the demand for our collaborators’ products containing our flavors, flavor enhancers and taste modulators; and

•                  general and industry specific economic conditions, which may affect our collaborators’ research and development expenditures.

Changes in financial accounting standards related to stock option expenses are expected to have a significant effect on our reported results.

The FASB recently issued a revised standard that requires that we record compensation expense in the statement of operations for employee stock options using the fair value method. The adoption of the new standard is expected to have a significant effect on our reported earnings, although it will not affect our cash flows, and could adversely impact our ability to provide accurate guidance on our projected future financial results due to the variability of the factors used to establish the value of stock options. As a result, the adoption of the new standard in the first quarter of fiscal 2006 could negatively affect our stock price and our stock price volatility.

Compliance with regulation of corporate governance and public disclosure may result in additional expenses.

Laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, SEC regulations and Nasdaq National Market rules, is costly. Our efforts to comply with these laws, regulations and standards, as they become applicable to us, have resulted in, and are likely to continue to result in, general and administrative expense and management time related to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment requires the commitment of significant financial and managerial resources. If our efforts to comply with laws, regulations and standards differ from the activities intended by regulatory or governing bodies, our reputation may be harmed and we might be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission. Any such action could adversely affect our financial results and the market price of our common stock.

We may need to obtain additional capital to fund our operations.

If we are unable to successfully commercialize our flavors, flavor enhancers and taste modulators, we may need to obtain additional capital or change our strategy to continue our operations. In addition, our business and operations may change in a manner that would consume available resources at a greater rate than anticipated. In such event, we may need to raise substantial additional capital to, among other things:

•                  fund new research, discovery or development programs;

•                  advance additional product candidates into and through the regulatory approval process; and

•                  acquire rights to products or product candidates, technologies or businesses.

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If we require additional capital to continue our operations, we cannot assure you that additional financing will be available on terms acceptable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, take advantage of opportunities, identify and develop flavors, flavor enhancers and taste modulators, develop technologies or otherwise respond to competitive pressures could be significantly limited. In addition, if financing is not available, we may need to alter our strategy or cease operations. In addition, issuances of debt or additional equity could impact the rights of the holders of our common stock, may dilute our stockholders’ ownership and may impose restrictions on our operations. These restrictions could include limitations on additional borrowing, specific restrictions on the use of our assets as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments.

If we lose our key personnel or are unable to attract and retain qualified personnel, it could adversely affect our business.

Our success depends to a significant degree upon the continued contributions of our executive officers, management and scientific staff. If we lose the services of one or more of these people and, in particular, Kent Snyder, our President and Chief Executive Officer, or Mark Zoller, Ph.D., our Executive Vice President of Discovery & Development and Chief Scientific Officer, the relationships we have with our collaborators would likely be negatively impacted and we may be delayed or unable to develop new product candidates, commercialize our existing product candidates or achieve our other business objectives, any of which could cause our stock price to decline. We have entered into employment letter agreements with the following executive officers: Kent Snyder, Mark Zoller, Ph.D., Harry Leonhardt, Esq., our Senior Vice President, General Counsel and Corporate Secretary, John Poyhonen, our Senior Vice President, Chief Financial and Business Officer and Nigel R.A. Beeley, Ph.D., our Vice President, Discovery. All of our employees are at-will employees, which means that either we or the employee may terminate their employment at any time. We currently have no key person insurance.

In addition, our discovery and development programs depend on our ability to attract and retain highly skilled scientists, including molecular biologists, biochemists, chemists and engineers. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among technology-based businesses, particularly in the San Diego area. We also face competition from universities and public and private research institutions in recruiting and retaining highly qualified scientific and management personnel. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to meet the demands of our current or any future product discovery and development collaborators in a timely fashion or to support our independent discovery and development programs.

We may encounter difficulties managing our growth, which could adversely affect our business.

Our strategy includes entering into and working on simultaneous flavor and flavor enhancer discovery and development programs across multiple markets. We increased the number of our full-time employees from seven on December 31, 1999 to 90 on December 31, 2005 and we expect to continue to grow to meet our strategic objectives. If our growth continues, it will continue to place a strain on us, our management and our resources. Our ability to effectively manage our operations, growth and various projects requires us to continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. We may not be able to successfully implement these tasks on a larger scale and, accordingly, we may not achieve our research, development and commercialization goals. If we fail to improve our operational, financial and management information systems, or fail to effectively monitor or manage our new and future employees or our growth, our business would suffer significantly. In addition, no assurance can be made that we will be able to secure adequate facilities to house our staff, conduct our research or achieve our business objectives.

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We will rely on third parties to manufacture our flavors, flavor enhancers and taste modulators on a commercial scale.

We do not have experience in manufacturing, nor do we have the resources or facilities to manufacture, flavors, flavor enhancers and taste modulators on a commercial scale. Therefore, the commercialization of our flavors, flavor enhancers and taste modulators will depend in part on our or our collaborators’ ability to contract with third-party manufacturers of our flavors, flavor enhancers and taste modulators on a large scale, at a competitive cost, with the specified quality and in accordance with relevant food and beverage regulatory requirements. Any such third-party manufacturers may encounter manufacturing difficulties at any time that could result in delays in the commercialization of potential flavors, flavor enhancers and taste modulators. Our inability to find capable third-party manufacturers or to enter into agreements on acceptable terms with third-party manufacturers could delay commercialization of any products we may develop and may harm our relationships with our existing and any future product discovery and development collaborators and our customers. Moreover, if we are required to change from one third-party manufacturer to another for any reason, the commercialization of our products may be delayed further. In addition, if third-party manufacturers fail to comply with the FDA’s good manufacturing practice regulations or similar regulations in other countries, then we may be subject to adverse regulatory action including product recalls, warning letters and withdrawal of our products, or our collaborators’ or customers’ products, from the market.

Further, because our flavors, flavor enhancers and taste modulators are regulated as food products under the Federal Food, Drug and Cosmetic Act, we and the third parties with which we collaborate or contract to manufacture, process, pack, import or otherwise handle our products or our product ingredients, may be required to comply with certain registration, prior notice submission, recordkeeping and other regulatory requirements. Failure of any party in the chain of distribution to comply with any applicable requirements under the Federal Food, Drug and Cosmetic Act or the FDA’s implementing regulations, or similar regulations in other countries, may adversely affect the manufacture and/or distribution of our products in commerce.

If we acquire products, technologies or other businesses, we will incur a variety of costs, may have integration difficulties and may experience numerous other risks that could adversely affect our business.

If appropriate opportunities become available, we may consider acquiring businesses, technologies or products that we believe are a strategic fit with our business. We currently have no commitments or agreements with respect to, and are not actively seeking, any material acquisitions. We have limited experience in identifying acquisition targets, successfully acquiring them and integrating them into our current infrastructure. We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future without a significant expenditure of operating, financial and management resources, if at all. In addition, future acquisitions might be funded by issuances of additional debt or equity, which could impact your rights as a holder of our common stock and may dilute your ownership percentage. Any of the foregoing could have a significant adverse effect on our business, financial condition and results of operations.

Risks Related To Our Industry

Our ability to compete in the flavor and flavor enhancer market may decline if we do not adequately protect our proprietary technologies.

Our success depends in part on our ability to obtain and maintain intellectual property that protects our technologies and flavors, flavor enhancers and taste modulators. Patent positions may be highly uncertain and may involve complex legal and factual questions, including the ability to establish patentability of sequences relating to taste receptors, proteins, chemical synthesis techniques, compounds and methods for using them to modulate taste for which we seek patent protection. No consistent standard regarding the allowability or enforceability of claims in many of our pending patent applications has

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emerged to date. As a result, we cannot predict the breadth of claims that will ultimately be allowed in our patent applications, if any, including those we have in-licensed or the extent to which we may enforce these claims against our competitors. The degree of future protection for our proprietary rights is therefore highly uncertain and we cannot assure you that:

•                  we were the first to file patent applications or to invent the subject matter claimed in patent applications relating to the technologies upon which we rely;

•                  others will not independently develop similar or alternative technologies or duplicate any of our technologies;

•                  others did not publicly disclose our claimed technology before we conceived the subject matter included in any of our patent applications;

•                  any of our patent applications will result in issued patents;

•                  any of our patent applications will not result in interferences or disputes with third parties regarding priority of invention;

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

•                  we will develop additional proprietary technologies that are patentable;

•                  the patents of others will not have an adverse effect on our ability to do business; or

•                  new proprietary technologies from third parties, including existing licensors, will be available for licensing to us on reasonable commercial terms, if at all.

In addition, patent law outside the United States is uncertain and in many countries intellectual property laws are undergoing review and revision. The laws of some countries do not protect intellectual property rights to the same extent as domestic laws. It may be necessary or useful for us to participate in opposition proceedings to determine the validity of our competitors’ patents or to defend the validity of any of our or our licensor’s future patents, which could result in substantial costs and would divert our efforts and attention from other aspects of our business.

Technologies licensed to us by others, or in-licensed technologies, are important to our business. In particular, we depend on high-throughput screening technologies that we licensed from Aurora Biosciences, technology related to certain taste receptor sequences that we license from the University of California and others and technology related to compound libraries that we license from third parties. In addition, we may in the future acquire rights to additional technologies by licensing such rights from existing licensors or from third parties. Such in-licenses may be costly. Also, we generally do not control the patent prosecution, maintenance or enforcement of in-licensed technologies. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we do over our internally developed technologies. Moreover, some of our academic institution licensors, collaborators and scientific advisors have rights to publish data and information to which we have rights. If we cannot maintain the confidentiality of our technologies and other confidential information in connection with our collaborations, our ability to protect our proprietary information or obtain patent protection in the future may be impaired, which could have a significant adverse effect on our business, financial condition and results of operations.

Many of the patent applications we and our licensors have filed have not yet been substantively examined and may not result in patents being issued.

Many of the patent applications filed by us and our licensors were filed recently with the United States Patent and Trademark Office and most have not been substantively examined and may not result in patents being issued. Some of these patent applications claim sequences that were identified from different publicly available sequence information sources such as the High-Throughput Genomic Sequences division of GenBank. It is difficult to predict whether any of our or our licensors’ applications will ultimately be found to be patentable or, if so, to predict the scope of any allowed claims. In addition, the disclosure in our or our licensors’ patent applications, particularly in respect of the utility of our claimed inventions, may not be sufficient to meet the statutory requirements for patentability in all cases. As a result, it is difficult to predict whether any of our or our licensors’ applications will be allowed, or, if so, to predict the scope of

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any allowed claims or the enforceability of the patents. Even if enforceable, others may be able to design around any patents or develop similar technologies that are not within the scope of such patents. Our and our licensors’ patent applications may not issue as patents that will provide us with any protection or competitive advantage.

Disputes concerning the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be time consuming and extremely costly and could delay our research and development efforts.

Our commercial success, if any, will be significantly harmed if we infringe the patent rights of third parties or if we breach any license or other agreements that we have entered into with regard to our technology or business.

We are aware of other companies and academic institutions that have been performing research in the areas of taste modulation and flavors, flavor enhancers and taste modulators. In particular, other companies and academic institutions have announced that they have conducted taste-receptor research and have published data on taste receptor sequence information and taste receptors or filed patent applications or obtained patent protection on taste modulation or taste receptors and their uses, including Linguagen Corp., Mount Sinai School of Medicine, The Scripps Research Institute, the University of California, Monell Chemical Senses Corp., Pfizer, Inc., Virginia Commonwealth University and the German Institute of Human Nutrition. To the extent any of these companies or academic institutions currently have, or obtain in the future, broad patent claims, such patents could block our ability to use various aspects of our discovery and development process and might prevent us from developing or commercializing newly discovered flavors, flavor enhancers and taste modulators or otherwise conducting our business. The University of California, for example, claims certain patent rights relating to the coexpression of T1R receptors that may not have been licensed to us. While our technology is focused on the use of human T1R receptors, we cannot assure you that it does not infringe such patent rights. In such event, if we are not able to amend our license with the University of California to include such patent rights and our technology is found to interfere with or infringe such patent rights, our business, financial condition and results of operations could suffer a significant adverse effect. In addition, it is possible that some of the flavors, flavor enhancers or taste modulators that are discovered using our technology may not be patentable or may be covered by intellectual property of third parties.

We are not currently a party to any litigation, interference, opposition, protest, reexamination, reissue or any other potentially adverse governmental, ex parte or inter-party proceeding with regard to our patent or trademark positions. However, the life sciences and other technology industries are characterized by extensive litigation regarding patents and other intellectual property rights. Many life sciences and other technology companies have employed intellectual property litigation as a way to gain a competitive advantage. If we become involved in litigation, interference proceedings, oppositions, reexamination, protest or other potentially adverse intellectual property proceedings as a result of alleged infringement by us of the rights of others or as a result of priority of invention disputes with third parties, we might have to spend significant amounts of money, time and effort defending our position and we may not be successful. In addition, any claims relating to the infringement of third-party proprietary rights or proprietary determinations, even if not meritorious, could result in costly litigation, lengthy governmental proceedings, divert management’s attention and resources, or require us to enter into royalty or license agreements that are not advantageous to us.

Should any person have filed patent applications or obtained patents that claim inventions also claimed by us, we may have to participate in an interference proceeding declared by the relevant patent regulatory agency to determine priority of invention and, thus, the right to a patent for these inventions in the United States. Such a proceeding could result in substantial cost to us even if the outcome is favorable. Even if successful on priority grounds, an interference action may result in loss of claims based on patentability grounds raised in the interference action. Litigation, interference proceedings or other proceedings could divert management’s time and efforts. Even unsuccessful claims could result in significant legal fees and other expenses, diversion of management’s time and disruption in our business. Uncertainties resulting from initiation and continuation of any patent proceeding or related litigation could

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harm our ability to compete and could have a significant adverse effect on our business, financial condition and results of operations.

An adverse ruling arising out of any intellectual property dispute, including an adverse decision as to the priority of our inventions, could undercut or invalidate our intellectual property position. An adverse ruling could also subject us to significant liability for damages, including possible treble damages, prevent us from using technologies or developing products, or require us to negotiate licenses to disputed rights from third parties. Although patent and intellectual property disputes in the technology area are often settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include license fees and ongoing royalties. Furthermore, necessary licenses may not be available to us on satisfactory terms, if at all. Failure to obtain a license in such a case could have a significant adverse effect on our business, financial condition and results of operations.

If we are unable to protect our trade secrets and other proprietary information, we could lose any competitive advantage we may have, which could adversely affect our business.

We rely in part on trade secret protection for our confidential and proprietary information, know how and processes. Our policy is to execute proprietary information and invention agreements with our employees and consultants upon the commencement of an employment or consulting relationship. These agreements generally require that all confidential information developed by the individual or made known to the individual by us during the course of the individual’s relationship with us be kept confidential and not be disclosed to third parties. These agreements also generally provide that inventions conceived by the individual in the course of their employment shall be our exclusive property. There can be no assurance that we will be able to effectively enforce these agreements or that proprietary information is our exclusive property. There can be no assurance that the subject proprietary information will not be disclosed, that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or that we can meaningfully protect our trade secrets. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Many potential competitors, including those who have greater resources and experience than we do, may develop products or technologies that make ours obsolete or noncompetitive.

The life sciences and other technology industries are characterized by rapid technological change, and the area of sensory or taste receptor research is a rapidly evolving field. Our future success will depend on our ability to maintain a competitive position with respect to technological advances. Technological developments by others may result in our flavors, flavor enhancers or taste modulators and technologies becoming obsolete.

In particular, we face substantial competition from companies pursuing the commercialization of products and services relevant to taste using more traditional methods for the discovery of flavors, flavor enhancers and taste modulators, or for the reduction of salt, sugar, MSG or bitter taste. These competitors include leading flavor companies, such as International Flavors & Fragrances Inc., Givaudan SA, Symrise, Quest International and Firmenich. We currently compete and will continue to compete in the future with these companies in collaborating with and selling flavor products and technologies to manufacturers of packaged food and beverage products. Many of these companies have substantially greater capital resources, research and development resources and experience, manufacturing capabilities, regulatory expertise, sales and marketing resources, established relationships with consumer products companies and production facilities.

Savory flavor enhancers, particularly inosine monophosphate, or IMP, are commercially available, and we will compete with the companies that produce these flavors. IMP is widely available and is a generally accepted food additive by the packaged food and beverage industry. As a result, our existing and future collaborators may choose to incorporate IMP or similar savory flavor enhancers into their packaged food and beverage products instead of our savory flavors, flavor enhancers and taste modulators. In

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addition, we may compete with bitter masking or bitter blocking compounds, such as adenosine 5’ monophosphate, or AMP.

We may in the future face competition from life sciences and other technology companies and other commercial enterprises. These entities engage as we do in biotechnology, biology or chemistry and could apply this technology to the discovery and development of flavors, flavor enhancers and taste modulators. We are aware of one other company, Linguagen Corp., a privately-held company that we believe is involved in research on sweetness potentiators, salt substitutes and bitter blockers, specifically AMP, and has announced research and development collaborations with several companies. We cannot guarantee that products developed as a result of our competitors’ existing or future collaborations will not compete with our flavors, flavor enhancers and taste modulators.

Universities and public and private research institutions are also potential competitors. While these organizations primarily have educational objectives, they may develop proprietary technologies related to the sense of taste or secure patent protection that we may need for the development of our technologies and products. We may attempt to license these proprietary technologies, but these licenses may not be available to us on acceptable terms, if at all.

Our competitors, either alone or with their collaborative partners, may succeed in developing technologies or discovering flavors, flavor enhancers or taste modulators that are more effective, safer, more affordable or more easily commercialized than ours, and our competitors may obtain intellectual property protection or commercialize products sooner than we do. Developments by others may render our product candidates or our technologies obsolete. In addition, our current product discovery and development collaborators are not prohibited from entering into research and development collaboration agreements with third parties in any product field. Our failure to compete effectively would have a significant adverse effect on our business, financial condition and results of operations.

We may be sued for product liability, which could adversely affect our business.

Because our business strategy involves the development and sale by our collaborators of commercial products incorporating our flavors, flavor enhancers and taste modulators, we may be sued for product liability. We may be held liable if any product we develop and commercialize, or any product our collaborators commercialize that incorporates any of our flavors, flavor enhancers or taste modulators, causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing, sale or consumer use. In addition, the safety studies we must perform and the FEMA GRAS determination we must obtain prior to incorporating our flavors, flavor enhancers and taste modulators into a commercial product will not protect us from any such liability.

If we and our collaborators commence sale of commercial products we will need to obtain product liability insurance, and this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products developed by us or our product discovery and development collaborators. We may be obligated to indemnify our product discovery and development collaborators for product liability or other losses they incur as a result of our flavors, flavor enhancers and taste modulators. Any indemnification we receive from such collaborators for product liability that does not arise from our flavors, flavor enhancers and taste modulators may not be sufficient to satisfy our liability to injured parties. If we are sued for any injury caused by our flavors, flavor enhancers and taste modulators or products incorporating our flavors, flavor enhancers and taste modulators, our liability could exceed our total assets.

We use hazardous materials. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our discovery and development process requires our employees to routinely handle hazardous chemical, radioactive and biological materials. Our operations also produce hazardous waste products. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. As a result of the increase in size of our operations, we were recently re-classified from a

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small quantity to a large quantity generator of hazardous waste. This reclassification may result in increased scrutiny of our operations by the Environmental Protection Agency. Compliance with applicable environmental laws and regulations may be expensive, and current or future environmental regulations may impair our discovery and development efforts.

In addition, we cannot entirely eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Our property and casualty policy has very limited coverage for damages or cleanup costs related to radioactive contamination and pollutants and our general liability insurance policy excludes coverage for damages and fines arising from biological or hazardous waste disposal or contamination. We do not carry specific biological or hazardous waste insurance. We may be forced to curtail operations or be sued for any injury or contamination that results from our use or the use by others of these materials, and our liability may exceed our total assets.

Risks Related To Our Common Stock

The price of our common stock is volatile.

The market prices for securities of biotechnology companies historically have been highly volatile, and the market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Since our initial public offering in June 2004, the price of our common stock has ranged from approximately $5 per share to approximately $23 per share. The market price of our common stock may fluctuate in response to many factors, including:

•                  developments related to the FEMA GRAS determination and international regulatory approval of our products;

•                  developments concerning our collaborative agreements;

•                  announcements of technological innovations by us or others;

•                  developments in patent or other proprietary rights;

•                  results of safety evaluation of our flavors, flavor enhancers and taste modulators;

•                  results of consumer acceptance testing of our flavors, flavor enhancers and taste modulators by our collaborators;

•                  delays in commercialization of our flavors, flavor enhancers and taste modulators;

•                  future sales of our common stock by existing stockholders;

•                  comments by securities analysts;

•                  general market conditions;

•                  fluctuations in our operating results;

•                  government regulation;

•                  failure of any of our flavors, flavor enhancers or taste modulators, if approved, to achieve commercial success; and

•                  public concern as to the safety of our flavors, flavor enhancers, and taste modulators.

Anti-takeover provisions in our charter documents and under Delaware law may make an acquisition of us more complicated and the removal and replacement of our directors and management more difficult.

Provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions may also make it difficult for stockholders to remove and replace our board of directors and management. These provisions:

•                  authorize the issuance of “blank check” preferred stock by our board of directors, without stockholder approval, which could increase the number of outstanding shares and prevent or delay a takeover attempt;

•                  limit who may call a special meeting of stockholders;

•                  prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and

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•                  establish advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon at stockholder meetings.

In addition, the requirements of Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a third party from acquiring us.

Our shareholder rights plan may hinder or prevent change of control transactions.

Our shareholder rights plans may discourage transactions involving an actual or potential change in our ownership. In addition, our board of directors may issue shares of preferred stock without any further action by you. Such issuances may have the effect of delaying or preventing a change in our ownership. If changes in our ownership are discouraged, delayed or prevented, it would be more difficult for our current board of directors to be removed and replaced, even if you and other stockholders believe such actions are in the best interests of us and our stockholders.

If our officers, directors and largest stockholders choose to act together, they may be able to control our management and operations, acting in their best interests and not necessarily the interests of other stockholders.

As of February 28, 2006, our executive officers, directors and stockholders with at least 5% of our stock together beneficially owned approximately 27% of our common stock. If these officers, directors and principal stockholders act together, they will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of mergers or other business combination transactions. The interests of this concentration of ownership may not always coincide with our interests or the interests of investors in this offering or other stockholders. For instance, officers, directors and principal stockholders, acting together, could cause us to enter into transactions or agreements that we would not otherwise consider. Similarly, this concentration of ownership may have the effect of delaying or preventing a change in control of our company otherwise favored by our other stockholders. This concentration of ownership could depress our stock price.

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

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

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Item 1B.            Unresolved Staff Comments

None.

Item 2.                     Properties

We currently lease 86,962 square feet of laboratory and office space at 11099 North Torrey Pines Road, La Jolla, California 92037. Of this leased space, as of December 31, 2005 we subleased approximately 26,102 square feet to other companies. Our lease for this facility expires on December 31, 2006. Our current monthly lease obligations for rent are approximately $272,000, which includes space that has been sublet to other companies. In addition, we are responsible for expenses associated with the use and maintenance of the building, such as utilities and common area maintenance. These costs vary each month, and historically have been approximately $134,000 per month.

On January 12, 2006 we entered into a lease agreement with ARE-NEXUS CENTRE II, LLC (“the Nexus Lease”), pursuant to which we will lease up to approximately 64,000 square feet of real estate space in San Diego, California, consisting of laboratory and office space. The lease is targeted to commence on September 1, 2006, with rent targeted to commence April 1, 2007 and ending on February 28, 2017. We have the right to extend the term of the Nexus Lease for an additional five years, and we have the right to terminate the Nexus Lease early effective March 31, 2014 upon payment of an early termination fee.

As both leases described above are with the same landlord, in connection with the execution of the Nexus Lease, on January 12, 2006 we amended our existing lease with ARE-11099 North Torrey Pines, LLC for our current property to provide for the extension of the lease term, subject to certain limitations, until we move all of our operations to the new location, which we expect to occur in the fourth quarter of 2006. As a result of entering into two leases with the same landlord, we anticipate that we will be able to avoid making rent payments on two facilities at the same time. Furthermore, we anticipate a period of three months in early 2007 when we will not be required to make a payment for rent.

We believe that our existing facilities and our new facilities are adequate to meet our business requirements for the near-term and that additional space will be available on commercially reasonable terms, if required.

Item 3.           Legal Proceedings

We are not a party to any material legal proceedings at this time.

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

No matters were submitted to a vote of our security holders during the quarter ended December 31, 2005.

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PART II

Item 5.           Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

Common Stock Market Price

Our common stock commenced trading on the NASDAQ National Market on June 22, 2004 under the symbol “SNMX.” The following table sets forth the high and low sales prices per share of our common stock as traded on the NASDAQ National Market for the periods indicated.

The last sale price for our common stock as reported by the NASDAQ National Market on February 28, 2006 was $16.26 per share. As of February 28, 2006, there were approximately 97 shareholders of record of our common stock.

We have never declared or paid any cash dividends to our shareholders. We do not presently plan to pay cash dividends in the foreseeable future and intend to retain any future earnings for reinvestment in our business.

Information about our equity compensation plans is included in Item 12 of Part III of this Annual Report.

Repurchases of Equity Securities

There were no repurchases of equity securities in the fourth quarter of 2005.

Use of Proceeds

Our initial public offering, referred to as the Offering, of our common stock, par value $0.001, was effected through a Registration Statement on Form S-1 (File No. 333-113998) that was declared effective by the SEC on June 21, 2004. The Registration Statement covered the offer and sale of up to 6,900,000 shares of our common stock for an aggregate offering price of $41.4 million. The Offering commenced on June 22, 2004. On June 25, 2004, 6,000,000 shares of common stock were sold for an aggregate offering price of $36.0 million. On July 23, 2004, 450,000 shares of our common stock were sold for an aggregate offering price of $2.7 million upon the exercise of the underwriters’ over-allotment option. The Offering terminated following the sale of all of the foregoing securities and the expiration of the underwriters’ over-allotment option. The Offering resulted in aggregate proceeds to us of approximately $34.3 million, net of underwriting discounts and commissions of approximately $2.7 million and offering expenses of approximately $1.7 million, through a syndicate of underwriters managed by Citigroup Global Markets Inc., Deutsche Bank Securities Inc., Needham & Company, Inc. and First Albany Capital Inc.

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No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or person owning ten percent or more of any class of our equity securities or to any other affiliates. All offering expenses were paid directly to others.

As of December 31, 2005, we estimate that we had used approximately $2.4 million for the purchase of equipment and approximately $19.7 million for working capital expenditures. The remainder of the proceeds has been invested into short-term securities and cash equivalents.

The foregoing payments were direct payments made to third parties who were not our directors or officers (or their associates), persons owning ten percent or more of any class of our equity securities or any other affiliate, except that the proceeds used for working capital included regular compensation for officers and directors. The use of proceeds does not represent a material change from the use of proceeds described in the prospectus we filed pursuant to Rule 424(b) of the Securities Act with the SEC on June 22, 2004.

On November 9, 2005, we completed a public offering of 4,049,295 shares of common stock for proceeds of $57.3 million, net of underwriting discounts, commissions and offering expenses. The offering was made under a shelf registration statement and included the exercise by the underwriters of an over-allotment option of 528,169 shares of common stock. No proceeds from this offering had been used as of December 31, 2005.

Item 6.           Selected Financial Data

The Statement of Operations Data and Balance Sheet Data presented below should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statement included in this Annual Report on Form 10-K. Amounts are in thousands, except share and per share amounts.

(1)          Please see Note 1 to our financial statements for an explanation of the method used to calculate the historical and pro forma net loss per share and the number of shares used in the computation of the per share amounts.

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

The following discussion of our financial condition and results of operations should be read in conjunction with our Financial Statements and the related Notes to Financial Statements in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

Certain statements contained in this annual report on Form 10-K, including statements regarding the development, growth and expansion of our business, our intent, belief or current expectations, primarily with respect to our future operating performance, and the products we expect to offer and other statements regarding matters that are not historical facts, are “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act, and are subject to the “safe harbor” created by these sections. Future filings with the SEC, future press releases and future oral or written statements made by us or with our approval, which are not statements of historical fact, may also contain forward-looking statements. Because such statements include risks and uncertainties, many of which are beyond our control, actual results may differ materially from those expressed or implied by such forward-looking statements. Some of the factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements can be found under the caption “Risk Factors,” and elsewhere in this annual report on Form 10-K. Readers are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made.

Overview and Recent Developments

We are a leading company focused on using proprietary taste receptor-based assays, screening technologies and optimization chemistry to discover and develop novel flavors, flavor enhancers and taste modulators for the packaged food and beverage industry. We believe our flavor ingredients will enable packaged food and beverage companies to improve the nutritional profile of their products while maintaining or enhancing taste and may generate cost of goods savings. We license our flavor ingredients to our collaborators on an exclusive or co-exclusive basis, which we believe will provide these companies with the ability to differentiate their products. We have entered into product discovery and development collaborations with five of the world’s leading packaged food and beverage companies: Cadbury Schweppes, Campbell Soup Company (or Campbell Soup), The Coca-Cola Company (or Coca-Cola), Kraft Foods Global, Inc. (or Kraft Foods) and Nestlé SA (or Nestlé). We currently anticipate that we will derive all of our revenues from existing and future collaborations. Depending upon the collaboration, our existing collaboration agreements provide for upfront fees, research and development funding, reimbursement of certain regulatory costs, milestone payments based upon our achievement of research or development goals and, in the event of commercialization, royalties on future sales of consumer products incorporating our flavors, flavor enhancers or taste modulators. Our current programs focus on the development of savory, sweet and salt flavor enhancers and bitter taste modulators.

We have incurred significant losses since our inception in 1998 and, as of December 31, 2005 our accumulated deficit was $104.2 million. We expect to incur additional losses over at least the next two

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years as we continue to develop flavors, flavor enhancers and taste modulators. Our results of operations have fluctuated from period to period and likely will continue to fluctuate substantially in the future based upon:

•                  termination of any of our product discovery and development collaboration agreements;

•                  our ability to discover and develop new flavors, flavor enhancers and taste modulators or the ability of our product discovery and development collaborators to incorporate them into their products;

•                  our ability to enter into new, or extend existing, product discovery and development collaborations and technology collaborations;

•                  the demand for our collaborators’ products containing our flavors, flavor enhancers and taste modulators; and

•                  variability of our stock-based compensation expense in conjunction with fluctuations of our stock price.

In March 2005, we were notified by the Flavor and Extract Manufacturers Association (FEMA) that our savory enhancers S807 and S336 have been determined to be Generally Recognized as Safe (GRAS) under the provisions of the Federal Food, Drug and Cosmetic Act, administered by the United States Food and Drug Administration (FDA). In addition, two of our other savory enhancers, S263 and S976, which are related to S336, were also determined to be GRAS.

In April 2005, we announced an agreement for a three-year extension of the collaborative research phase of our initial discovery and development agreement with Nestlé. Under the terms of the extension, based upon research progress, Nestlé has agreed to pay us incremental discovery and development funding of up to $6.6 million over a period of up to an additional three years, subject to certain termination provisions.

In May 2005, we announced an agreement for an expansion and extension of the collaborative research phase under our discovery and development agreement with Kraft Foods. During the extension period, which ran through July 30, 2005, we began working with Kraft Foods on an exclusive basis on the discovery and development of novel flavor modifiers in a new product field in the dessert category. We also agreed to continue to work with Kraft Foods for the discovery and development of novel flavor enhancers on a co-exclusive basis in an existing specified food and beverage product field. Kraft Foods agreed to continue its existing research funding to us during the extension period.

In July 2005, we entered into an agreement for a two-year extension of the collaborative research phase under our discovery and development agreement with Kraft Foods. During the extension period, we will continue working with Kraft Foods on the discovery and development of novel flavor modifiers on an exclusive basis in a specified product field in the dessert product category and on a co-exclusive basis in an existing specified food and beverage product field. Under the terms of the extension, Kraft Foods has agreed to pay us incremental discovery and development funding of over $2.7 million over the two-year extension period, subject to certain termination provisions. Upon commercialization, we will be entitled to royalty payments based on sales of Kraft products containing any flavor enhancers developed under the agreement.

In July 2005, we entered into a Collaborative Research and License Agreement with Cadbury Schweppes for the discovery and commercialization of new flavor ingredients in the gum confectionary area. Under the terms of the agreement, Cadbury Schweppes agreed to pay us research funding for up to two years based on research progress during the collaborative period, subject to certain termination provisions. In addition, we are eligible to receive milestone payments upon achievement of specific

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product discovery and development goals. The combined total of research funding and milestone payments could exceed $3.0 million if all milestones are met. Upon commercialization, we will receive royalty payments based on sales of products containing new flavor ingredients developed under the agreement.

In November 2005, we completed a public offering of 4.0 million shares of common stock for proceeds of $57.3 million, net of underwriting discounts, commissions and offering expenses. The offering was made under a shelf registration statement and included the exercise by the underwriters of an over-allotment option of 528,000 shares of common stock.

In December 2005, we amended our existing agreement with Kraft Foods to provide for a new three-year discovery and development collaboration. In this new collaboration, we will work with Kraft Foods on the discovery and development of novel flavor modifiers on a co-exclusive basis in the chilled and processed meat product category within North America. Under the terms of the new collaboration, Kraft Foods has agreed to pay us an initial license fee and incremental discovery and development funding over the collaborative period, subject to certain termination provisions. In addition, we are eligible to receive milestone payments upon the achievement of specific product discovery and development goals. The combined total of initial license fees, research funding and milestone payments could reach $4.6 million, if all milestones are met. Upon commercialization, we will be entitled to royalty payments based on sales of Kraft products containing any flavor modifiers developed under the agreement.

In February 2006, we amended our existing agreement with Campbell Soup to extend the collaborative research phase for an additional research phase of up to three years, through March 2009. During the extension period, we will continue to work with Campbell on the discovery and commercialization of new ingredients that improve the taste of wet soups and savory beverages. Under the terms of the extension, Campbell Soup has agreed to pay us incremental research funding of up to $3.0 million, assuming we meet specified research goals, over the three-year extension period. The other payment terms of the existing agreement, including milestones and royalties based on net sales of products using the new ingredients, remain unchanged.

Revenue

We derive revenue from our product discovery and development collaborations. To date, our revenue has come solely from upfront fees, research and development funding, reimbursement of certain regulatory costs and milestone payments under our product discovery and development collaboration agreements with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé. As of December 31, 2005, we have recognized cumulative revenue under our collaborations of $37.0 million. If any of these collaborative agreements were to be terminated, this could have a significant effect on future revenues.

From our inception date to the present, research and development payments represented the primary source of our revenue. Based on current collaborations, we anticipate that substantially all of our revenues in the near future will be derived from research and development payments, and we may receive additional milestone payments in the future upon the achievement of certain goals set forth in our collaboration agreements.

In addition, in the event our collaborators launch products incorporating our flavors, flavor enhancers or taste modulators, we will receive royalty payments based upon the future sales of those products, which, if received, could be significantly larger than research and development funding or milestone payments. In order for us to generate royalty revenue and become profitable, we must retain our existing or establish new product discovery and development collaborations and our collaborators must commercialize products incorporating one or more of our flavors, flavor enhancers or taste modulators. Our ability to generate royalty revenue is uncertain and will depend upon our ability to meet particular research, development and commercialization objectives.

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Research and Development

Our research and development expenses consist primarily of costs associated with our discovery and development efforts in connection with our four primary programs: savory, sweet, salt and bitter. We track research and development costs by the type of cost incurred rather than by project. Research and development costs are comprised of salaries and other personnel related expenses, facilities and depreciation, research and development supplies, patent and licensing, and outside services. We charge research and development expenses to operations as incurred.

The research and development payments we have received from our collaboration agreements with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods and Nestlé historically have not covered all of our research and development expenses. We expect that our research and development expenses are likely to increase in the future as a result of our existing product discovery and development collaborations, internal product discovery and development activities and technology development and any expansion of these activities.

At this time, due to the risks inherent in the discovery of flavors, flavor enhancers and taste modulators, we are unable to estimate with any certainty the costs we will incur in the continued development of our flavors, flavor enhancers and taste modulators for commercialization. We anticipate that we will make determinations regarding the research and development projects to pursue and the funding of each project on an ongoing basis in response to the progress of each discovery and development program, as well as an ongoing assessment of its market potential. We cannot be certain when any net cash inflow from the commercialization of our flavors, flavor enhancers and taste modulators will commence.

Our ability to complete the development of our current product candidates is subject to many risks and uncertainties. These risks include the risks, among others, that:

•                  we are substantially dependent upon our collaborators for research and development funding;

•                  our collaborators may terminate their respective collaboration programs early;

•                  we may not be able to discover flavors, flavor enhancers or taste modulators with the desired taste attributes;

•                  we may not be successful in developing flavors, flavor enhancers or taste modulators with attributes required for use in commercial products;

•                  we may be unable to maintain FEMA GRAS determination for our savory product candidates; and

•                  we may be unable to obtain FEMA GRAS determination for candidates in our other programs.

If we do not complete the development of our flavors, flavor enhancers and taste modulators on a timely basis, our collaborators may terminate or not renew our collaboration agreements, we may begin receiving revenue from the commercialization of products incorporating our flavors, flavor enhancers and taste modulators later than anticipated, or not at all, and it may be more difficult to enter into new collaboration agreements. In any of these cases, we may require substantial additional funding in order to continue development of our flavors, flavor enhancers and taste modulators.

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General and Administrative

General and administrative expenses consist primarily of salaries and other personnel-related expenses related to business development, legal, financial and other administrative functions and Sarbanes-Oxley compliance. We expect that our general and administrative expenses will increase in 2006 primarily as a result of the implementation of revised Statement of Financial Accounting Standards (“SFAS”) No. 123 (SFAS No.123(R)), Share-Based Payment.

Stock-Based Compensation

We have recorded deferred compensation for stock options and stock awards granted equal to the difference between the exercise price and the fair value of our common stock on the date of grant as determined for the purpose of recording our initial public offering (IPO) cheap stock calculation. We record options or awards issued to non-employees at their fair value in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, and periodically remeasure them in accordance with Emerging Issues Task Force No. (“EITF”) 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services, and recognize them over the service period. In connection with the grant of stock options to employees, we recorded deferred stock-based compensation of $442,000 and $13.3 million for the years ended December 31, 2004 and 2003, respectively. We recorded these amounts as a component of stockholders’ equity and amortize them, on an accelerated basis, as a non-cash charge to operations over the vesting period of the options. We recorded employee and non-employee stock-based compensation expense of $5.3 million, $6.0 million and $6.3 million for the years ended December 31, 2005, 2004 and 2003, respectively.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued revised statement No. 123 (SFAS No. 123(R)), Share-Based Payment, which requires companies to expense the estimated fair value of employee stock options and similar awards. This statement is a revision to SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. The accounting provisions of SFAS No. 123(R) will be effective for the first quarter of fiscal 2006. In conjunction with the adoption of SFAS No. 123(R), the unamortized balance of deferred compensation recorded for our IPO cheap stock calculation will be written off against stockholders’ equity. As of December 31, 2005, the unamortized balance of deferred compensation was $1.1 million.

SFAS No. 123(R) permits public companies to choose between the following two adoption methods:

1. A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date, or

2. A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method. The impact of the adoption of SFAS No. 123 (R) cannot be predicted at this time because it will be depend on levels of share-based payments granted in the future. However, valuation of employee stock options under SFAS No. 123 (R) is similar to SFAS No. 123, with minor exceptions. For information about what our reported results of operations and earnings per share would have been for the year ended December 31, 2005 had we adopted SFAS No. 123, please see the discussion under the heading “Stock-Based Compensation” in Note 1 to our Financial Statements. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on our results of operations, although it will have no impact on our liquidity or overall financial condition. Use of an option valuation model, as required by SFAS No. 123 and SFAS No. 123(R), includes highly subjective

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assumptions based on long-term predictions, including the expected stock price volatility and average life of each stock option grant. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. This model does not consider the employment, transfer or vesting restrictions that are inherent in our employee stock options or purchase rights granted pursuant to the Employee Stock Purchase Plans. Because our share-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimate of the fair values, in our opinion, existing valuation models may not be reliable single measures of the fair values of our share-based payments. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

Results of Operations

Years Ended December 31, 2005, 2004 and 2003

Revenue Under Collaboration Agreements

We recorded revenue of $9.4 million, $8.3 million and $9.5 million during the years ended December 31, 2005, 2004 and 2003, respectively. Research and development payments, reimbursement of certain regulatory expenses, upfront fees and milestone payments under collaborations with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods, and Nestlé accounted for approximately 100% of total revenue for the year ended December 31, 2005. Research and development payments and milestone payments under collaborations with Campbell Soup, Coca-Cola, Kraft Foods, and Nestlé accounted for 100% of total revenue for the years ended December 31, 2004 and 2003.

Research and Development Expenses

Our research and development expenses (excluding stock-based compensation expenses charged to research and development) were $17.7 million, $16.9 million, and $16.8 million for the years ended December 31, 2005, 2004 and 2003. Stock-based compensation expenses charged to research and development for the years ended December 31, 2005, 2004 and 2003 were $2.6 million, $1.4 million and $1.3 million, respectively. A comparison of research and development expenses exclusive of stock-based compensation expenses by category is as follows (in thousands):

Salaries and Personnel. Our expenses for research and development personnel, including consultants, were $7.7 million, $7.2 million and $5.5 million for the years ended December 31, 2005, 2004 and 2003, respectively. The increase of $474,000 from 2004 to 2005 was primarily due to increases in payroll expenses of approximately $575,000, partially offset by a decrease in consulting expense of approximately $103,000. Our research and development staff increased from an average of 56 for the year ended December 31, 2004 to an average of 61 for the year ended December 31, 2005. The increase in staff was primarily to support continuing optimization of product candidates from our discovery and development programs. The increase of $1.7 million from 2003 to 2004 was primarily due to increases in payroll expenses, recruiting expenses and employee benefits expenses of approximately $1.4 million, $158,000 and $125,000, respectively. Our research and development staff increased from an average of 50 for the year

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ended December 31, 2003 to an average of 56 for the year ended December 31, 2004. The increase in staff was primarily to support continuing optimization of product candidates from our discovery and development programs.

Facilities and Depreciation.   Our facilities and depreciation expenses were $4.6 million, $4.4 million and $4.5 million for the years ended December 31, 2005, 2004 and 2003, respectively. The increase of $119,000 from 2004 to 2005 was primarily attributable to an increase in rent expense and related costs of approximately $349,000, incurred as a result of reduced sublease rental income and increased rent expense due to inflation adjustments. This increase was partially offset by a reduction in our depreciation expense of approximately $230,000. The decrease of $49,000 from 2003 to 2004 was primarily attributable to a reduction of depreciation expense of approximately $506,000, offset by an increase in rent expense and other related costs of approximately $436,000 incurred as a result of occupying additional space within our facility for the full year, as opposed to part of the year in 2003.

Research and Development Supplies. Our expenses for supplies used in research and development were $2.7 million, $2.0 million and $2.3 million for the years ended December 31, 2005, 2004 and 2003, respectively. The increase of $753,000 from 2004 to 2005 was primarily attributable to increased purchases of scientific supplies and compound acquisition expenses associated with increased screening activity in 2005. The decrease of $310,000 from 2003 to 2004 was primarily attributable to reduced screening activities as our research and development activities were focused on certain less expensive optimization activities during 2004.

Patent and Licensing. Our patent and licensing expenses were $1.4 million, $1.6 million and $3.7 million for the years ended December 31, 2005, 2004 and 2003, respectively. The decrease of $182,000 from 2004 to 2005 was primarily attributable to reduced licensing fees in 2005 compared to 2004. The decrease of $2.2 million from 2003 to 2004 was primarily attributable to reduced licensing fees in 2004 compared to 2003. Included in licensing fees was the amortization of certain licenses totaling $2.9 million for the year ended December 31, 2003. The related licenses were fully amortized at December 31, 2003, thus we did not have any costs relating to the amortization of these licenses for the year ended December 31, 2004. This decrease was partially offset by an increase of approximately $656,000 incurred for outside patent legal fees associated with developing our intellectual property portfolio.

Outside Services. Our outside services expenses were $806,000, $1.4 million and $479,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The decrease of $551,000 from 2004 to 2005 was primarily attributable to a reduction of costs incurred for outsourced development activities related to the development of our savory compounds, which were determined to be FEMA GRAS in March 2005. The increase of $878,000 from 2003 to 2004 was primarily attributable to costs incurred for outsourced development activities, including regulatory studies and product candidate synthesis scale-up.

General and Administrative Expenses

Our general and administrative expenses (excluding stock-based compensation expenses charged to general and administrative) were $7.5 million, $5.6 million and $4.1 million for the years ended December 31, 2005, 2004 and 2003, respectively. Stock-based compensation expenses charged to general and administrative for the years ended December 31, 2005, 2004 and 2003 were $2.7 million, $4.6 million and $5.0 million, respectively. The $2.0 million increase in expenses (other than stock-based compensation expense) from 2004 to 2005 was primarily attributable to an increase in expenses for personnel and related expenses of approximately $1.0 million due to increased headcount reflecting our increased business development activities, reporting activities and Sarbanes-Oxley compliance activities. Additionally, the increase in expense was due to increases in audit, legal and consulting fees of approximately, $358,000, $178,000 and $53,000, respectively, due to Sarbanes-Oxley compliance requirements and increased reporting obligations as a result of being a public company for a full year, as opposed to part of the year in 2004. The $1.5 million increase in expenses (other than stock-based compensation expense) from 2003 to 2004 was primarily attributable to an increase in expenses for personnel and related expenses of approximately $849,000, an increase in facilities expense of approximately $319,000, and an increase in public relations and marketing costs of approximately $263,000.

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Stock-based Compensation

Our aggregate stock-based compensation expenses charged to both research and development and general and administrative expenses decreased to $5.3 million for the year ended December 31, 2005 from $6.0 million for the year ended December 31, 2004. The decrease in overall stock-based compensation expense is primarily due to a decrease in stock-based compensation expense in 2005 compared to 2004 for stock options granted to employees, as the amortization of deferred compensation related to these stock options is recognized on an accelerated basis, partially offset by an increase in compensation expense in 2005 compared to 2004 for stock options granted to non-employees, as the fair value of these options at December 31, 2005 was revalued in accordance with EITF Issue No. 96-18. Our aggregate stock-based compensation expenses charged to both research and development and general and administrative expenses decreased to $6.0 million for the year ended December 31, 2004 from $6.3 million for the year ended December 31, 2003. The decrease in overall stock-based compensation expense is primarily due to a decrease in compensation expense in 2004 compared to 2003 for stock options granted to employees, partially offset by an increase in compensation expense in 2004 compared to 2003 for stock options granted to non-employees, as the fair value of these options at December 31, 2004 was revalued in accordance with EITF Issue No. 96-18. In connection with the grant of stock options to employees, we recorded deferred stock-based compensation of $442,000 and $13.3 million for the years ended December 31, 2004 and 2003, respectively. We recorded these amounts as a component of stockholders’ equity and amortize them, on an accelerated basis, as a non-cash charge to operations over the vesting period of the options. Commencing in the first quarter of 2006, we will adopt SFAS No. 123(R), which requires companies to expense the estimated fair value of employee stock options and similar awards. In conjunction with the adoption of SFAS No. 123(R), the unamortized balance of deferred compensation will be written off against stockholders’ equity. As of December 31, 2005, the unamortized balance of deferred compensation was $1.1 million.

Interest Income, net

Interest income was $1.3 million, $435,000 and $268,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The increase of $909,000 from 2004 to 2005 was primarily attributable to our higher average cash balances for the year ended December 31, 2005 as a result of our initial public offering in June 2004 and our November 2005 public offering of common stock, which generated higher interest earnings on those balances. The increase of $167,000 from 2003 to 2004 was primarily attributable to our higher average cash balances for the year ended December 31, 2004 as a result of our initial public offering in June 2004, which generated higher interest earnings on those balances. Interest expense was $0, $0 and $70,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Interest expense decreased $70,000 from 2004 to 2003 due to the payment in full of equipment financing debt in July 2003.

Liquidity and Capital Resources

Since our inception, we have financed our business primarily through private and public placements of stock, research and development payments under our product discovery and development collaborations with Cadbury Schweppes, Campbell Soup, Coca-Cola, Kraft Foods, and Nestlé, and interest income. As of December 31, 2005 we had received in excess of $164.9 million in proceeds from the sales of common and preferred stock. In addition, we had received $38.0 million in non-refundable license fees, research and development payments, cost reimbursements and milestone payments from our collaboration agreements, and $3.6 million in interest income. As of December 31, 2005, over the remaining life of our current collaboration agreements, we expect to receive an additional $27.7 million in non-refundable research and development payments from our collaborators. In addition, we may receive payments in the event we achieve research or development milestones and royalty payments in the event our collaborators commercialize products incorporating our flavors, flavor enhancers and taste modulators.

At December 31, 2005, we had $83.8 million in cash, cash equivalents and investments available-for-sale as compared to $40.8 million at December 31, 2004, an increase of $43.0 million. This overall increase resulted primarily from the sale of common stock for net proceeds of $58.7 million.

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Operating Activities

Operating activities used cash of $13.9 million for the year ended December 31, 2005 compared to $10.1 million for the year ended December 31, 2004. Operating cash flow in 2005 compared to the prior year period reflects an increase in our net loss of $116,000. Non-cash expenses for the year ended December 31, 2005 decreased $1.2 million to $6.3 million for the year ended December 31, 2005 from $7.5 million for the year ended December 31, 2004. This decrease was primarily due to a relative decrease in the amortization of employee deferred compensation of approximately $2.6 million for the year ended December 31, 2005, partially offset by an increase in stock-based compensation expense for non-employees of $1.9 million for the year ended December 31, 2005. Additionally, net increases in operating assets and liabilities over the year ended December 31, 2005 used cash of $456,000, while net increases in operating assets and liabilities over the year ended December 31, 2004 provided cash of $2.1 million.

Operating activities used cash of $10.1 million for the year ended December 31, 2004 compared to $8.3 million for the year ended December 31, 2003. Operating cash flow in 2004 compared to the prior year period reflects an increase in our net loss of $2.3 million. Non-cash expenses for the year ended December 31, 2004 decreased $3.7 million to $7.5 million for the year ended December 31, 2004 from $11.2 million for the year ended December 31, 2003. This decrease was primarily due to relative decreases in depreciation and license amortization expense of approximately $3.6 million, specifically the amortization of certain licenses totaling $2.9 million for the year ended December 31, 2003. The related licenses were fully amortized at December 31, 2003, thus we did not have any non-cash amortization expense relating to the amortization of these licenses for the year ended December 31, 2004. Additionally, net increases in operating assets and liabilities over the year ended December 31, 2004 provided cash of $2.1 million, while net decreases in operating assets and liabilities over the year ended December 31, 2003 used cash of $2.0 million.

Investing Activities

Investing activities provided cash of $12.1 million for the year ended December 31, 2005, and used cash of $21.3 million for the year ended December 31, 2004. Cash provided in 2005 reflects the maturities of available-for-sale securities of $45.8 million, offset by purchases of available-for-sale securities of $31.8 million with the proceeds from our public offering in November 2005 to obtain higher rates of interest income.   Cash used in 2004 reflects the purchases of available-for-sale securities with the proceeds from our initial public offering in June 2004 to obtain higher rates of interest income.

Investing activities used cash of $21.3 million for the year ended December 31, 2004, and provided cash of $1.7 million for the year ended December 31, 2003. Cash used in 2004 reflects the purchases of available-for-sale securities with the proceeds from our initial public offering in June 2004 to obtain higher rates of interest income.   Cash provided in 2003 reflects the maturities of available-for-sale securities, partially offset by purchases of available-for-sale securities.

Financing Activities

Financing activities provided cash of $58.7 million for the year ended December 31, 2005, provided cash of $35.0 million for the year ended December 31, 2004 and used cash of $1.7 million for the year ended December 31, 2003. Cash provided by financing activities in 2005 reflects the net proceeds from the sale of common stock of $58.7 million, primarily from the sale of common stock during our November 2005 public offering of common stock. Cash provided by financing activities in 2004 reflects the net proceeds from the sale of common stock of $35.0 million, primarily from the sale of common stock during our initial public offering. Cash used by financing activities in 2003 reflects the repayment of equipment financing arrangements of $1.8 million, offset by the net proceeds of $53,000 from the issuance of common stock.

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As of December 31, 2005 future minimum payments due under our contractual obligations are as follows (in thousands):

In January 2006, we entered into a lease agreement with ARE-NEXUS CENTRE II, LLC (the “Nexus Lease”) to lease approximately 64,000 square feet of office, research and development space for a term targeted to commence on September 1, 2006, with rent payments targeted to commence April 1, 2007 and ending on February 28, 2017. Annual rent payments are expected to be approximately $2.3 million, subject to annual rent increases of 3%. In connection with the execution of the Nexus Lease, we amended our existing lease with ARE-11099 North Torrey Pines, LLC for our current property to provide for the extension of the lease term, subject to certain limitations, until we move all of our operations to the new location, which we expect to occur in the fourth quarter of 2006.

As of December 31, 2005, we had no long-term debt obligations.

As of December 31, 2005, we have net open purchase orders (defined as total open purchase orders at year end less any accruals or invoices charged to or amounts paid against such purchase orders) totaling approximately $88,000. In the next twelve months, we also plan to spend approximately $4.0 to $4.5 million on capital expenditures.

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

•                  the rate of progress and cost of research and development activities;

•                  the number and scope of our research activities;

•                  the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;

•                  our ability to establish and maintain product discovery and development collaborations;

•                  the effect of competing technological and market developments;

•                  the terms and timing of any collaborative, licensing and other arrangements that we may establish; and

•                  the extent to which we acquire or in-license new products, technologies or businesses.

We believe our available cash, cash equivalents, investments and existing sources of funding will be sufficient to satisfy our anticipated operating and capital requirements through at least the next 12 months.

Until we can generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources that were primarily generated from the proceeds of offerings of our equity securities and research and development payments and milestone payments under our product discovery and development collaborations. As of December 31, 2005, under our existing collaboration agreements, assuming all milestones are achieved and we receive all research and development funding, we may be entitled to up to $38.3 million. In 2006, we anticipate receiving $10.2 million in non-refundable research and development funding. This does not include any additional payments we may receive related to the achievement of additional milestones, or to new collaborations or extensions of existing collaborations. We may not receive the payments if the collaborations are terminated or not renewed, or if we do not achieve the milestones set forth in the collaboration agreements. In addition, the timing of the receipt of milestone payments in particular is uncertain, as we may achieve milestones significantly earlier or later than we currently expect. We continue to pursue additional collaborations, which could result in additional revenue. We may not recognize revenues for research and development funding or milestones if

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the collaborations are terminated, or if we do not achieve the milestones set forth in the collaboration agreements. Our expenses will vary based upon (but not limited to) the forward-looking factors listed above. Upon the implementation of SFAS No. 123(R) or other similar accounting changes, our non-cash stock-based compensation expense will vary upon the volatility of our stock price, the risk-free interest rate, the expected life of our stock options, the closing price of our stock, the strike price at which stock options are granted and the number of options granted.

As of December 31, 2005 and 2004, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose or structured finance entities, which would have been established for the purposes of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, long-lived assets, accrued liabilities, and income taxes. These estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in Note 1 to our financial statements, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements:

Revenue Recognition

Our revenue recognition policies are in compliance with the Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition in Financial Statements and EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenue is deferred for fees received before earned. Some of our agreements contain multiple elements, including upfront fees, research funding, reimbursement of certain regulatory costs, milestones, and royalties.

Revenue from milestones is recognized when earned, as evidenced by written acknowledgement from the collaborator or other persuasive evidence that the milestone has been achieved, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, and (ii) our performance obligations after the milestone achievement will continue to be funded by the collaborator at a level comparable to before the milestone achievement. If both of these criteria are not met, the milestone payment is recognized over the remaining minimum period of our performance obligations under the agreement. Non-refundable upfront fees, if not associated with our future performance, are recognized when received. Non-refundable license fees, if associated with our future performance, are recognized over the related service period. Amounts received for research funding are recognized as revenues as the services are performed. Royalties to be received based on product sales made by our collaborators incorporating our product, if any, will be recognized as earned. To date, we have not earned any royalties.

Stock-based Compensation

As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, we account for stock options granted to employees using the intrinsic value method in accordance with Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, and the Financial Accounting Standards Board, or FASB, Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation – An Interpretation of APB 25. Pursuant to these guidelines, we measure the intrinsic value of the option or restricted stock award on its grant date as the difference between the purchase price of the restricted stock or the exercise price of employee stock options and the fair market value of our stock on the

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date of issuance or grant, and expense the difference, if any, over the vesting period of the option or restricted stock award.

SFAS No. 123 required stock-based compensation to be accounted for under the fair value method. If we adopted SFAS No. 123 to account for options granted to employees under our stock-based compensation plans, our loss would have been materially impacted. The impact of this method is disclosed in the notes to the financial statements.

Options or stock awards are issued to non-employees are recorded at their fair value in accordance with SFAS No. 123, and periodically remeasured in accordance with EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services, and recognized over the related service period.

New Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, which requires companies to expense the estimated fair value of employee stock options and similar awards. This statement is a revision to SFAS No. 123 and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. The accounting provisions of SFAS No. 123(R) will be effective for the first quarter of fiscal 2006.

SFAS No. 123(R) permits public companies to choose between the following two adoption methods:

1. A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date, or

2. A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method. The impact of the adoption of SFAS No. 123(R) cannot be predicted at this time because it will be depend on levels of share-based payments granted in the future. However, valuation of employee stock options under SFAS No. 123(R) is similar to SFAS No. 123, with minor exceptions. For information about what our reported results of operations and earnings per share would have been had we adopted SFAS No. 123, please see the discussion under the heading “Stock-based Compensation” in Note 1 to our Financial Statements. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. Use of an option valuation model, as required by SFAS No. 123 and SFAS No. 123(R), includes highly subjective assumptions based on long-term predictions, including the expected stock price volatility and average life of each stock option grant. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. This model does not consider the employment, transfer or vesting restrictions that are inherent in our employee stock options or purchase rights granted pursuant to the Employee Stock Purchase Plans. Because our share-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimate of the fair values, in our opinion, existing valuation models may not be reliable single measures of the fair values of our share-based payments. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. In conjunction with the adoption of SFAS No. 123(R), the unamortized balance of deferred compensation on our balance sheet at December 31, 2005 will be written off against stockholders’

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equity. As of December 31, 2005, the unamortized balance of deferred compensation was $1.1 million.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of United States interest rates. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

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Item 8.           Financial Statements and Supplementary Data

Index to Financial Statements

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Senomyx, Inc.

 We have audited the accompanying balance sheets of Senomyx, Inc. as of December 31, 2005 and 2004, and the related statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Senomyx, Inc. at December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

 We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Senomyx, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2006 expressed an unqualified opinion thereon.

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Senomyx, Inc.

Balance Sheets

(In thousands, except share and per share data)

See accompanying notes to financial statements.

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Senomyx, Inc.

Statements of Operations

(In thousands, except share and per share data)

See accompanying notes to financial statements.

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Senomyx, Inc.

Statements of Stockholders’ Equity

(In thousands, except for share data)