Item 1. Business.

Overview

We are a biopharmaceutical company focused on the discovery, development, and commercialization of small molecule drugs for the treatment of central nervous system disorders. We currently have five programs in clinical development and several additional programs in preclinical development and discovery stages. In our most advanced proprietary program, we are entering Phase III development with ACP-103 for the treatment of Parkinson’s disease psychosis. We also have three proprietary Phase II-stage clinical programs, including ACP-103 as a co-therapy for schizophrenia, ACP-103 for the treatment of sleep maintenance insomnia, and ACP-104 for the treatment of schizophrenia. We have retained worldwide commercialization rights for all four of these proprietary programs. In addition, we have a neuropathic pain program in Phase II clinical trials in collaboration with Allergan, Inc. All of the drug candidates in our product pipeline emanate from discoveries made using our proprietary drug discovery platform.

Our pipeline addresses diseases that are not well served by currently available therapies and represent large potential commercial opportunities. We believe that our drug candidates offer innovative therapeutic approaches and may provide significant advantages relative to current therapies. Our clinical programs consist of the following:

ACP-103 for the treatment of Parkinson’s disease psychosis . Parkinson’s disease psychosis is a debilitating psychiatric disorder that occurs in up to 40 percent of patients with Parkinson’s disease and is the most common factor leading to nursing home placements of these patients. Currently, there are no therapies approved to treat Parkinson’s disease psychosis in the United States. We believe that ACP-103 may effectively treat psychosis in patients with Parkinson’s disease without impairing motor function, thereby significantly improving the quality

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of life for these patients. We have completed a multi-center Phase II clinical trial in which ACP-103 demonstrated antipsychotic effects, was safe and well tolerated, and did not impair disease-related motor function in patients with Parkinson’s disease psychosis. We are preparing to initiate the first pivotal trial in our Phase III program with ACP-103 for Parkinson’s disease psychosis during the first half of 2007.

ACP-103 as a co-therapy for schizophrenia. Current drugs used to treat schizophrenia have substantial limitations, including severe side effects and lack of effect on most of the negative symptoms of the disease. We believe that co-therapy with ACP-103 may result in enhanced efficacy and fewer side effects relative to existing treatments, thereby providing an improved therapy for patients with schizophrenia. We have completed two clinical trials that showed that ACP-103 reduced motor disturbances associated with treatment with haloperidol, a typical antipsychotic drug. We have also completed enrollment in a large multi-center Phase II clinical trial designed to evaluate the ability of ACP-103 when used as a co-therapy with each of risperidone, an atypical antipsychotic drug, and haloperidol to provide an improved treatment for patients with schizophrenia. We expect to report top-line results from this trial during March 2007.

ACP-103 for the treatment of sleep maintenance insomnia. In contrast to most currently available insomnia drugs, ACP-103 provides the opportunity to treat the symptoms of sleep maintenance insomnia without inducing sleep or impairing daytime functioning. If approved as a treatment for sleep maintenance insomnia, ACP-103 is not expected to be designated as a controlled substance, as is the case with most existing sleep agents due to their potential for abuse. We have completed a proof-of-concept clinical study that demonstrated that ACP-103 induced a statistically significant and dose-related increase in deep, or slow wave, sleep in healthy older adults. We are planning to initiate a Phase II clinical trial with ACP-103 in patients with sleep maintenance insomnia during the first half of 2007.

ACP-104 for the treatment of schizophrenia. We believe that ACP-104 represents a new approach to schizophrenia therapy that combines an atypical antipsychotic efficacy profile with the added potential benefit of enhanced cognition. Currently prescribed treatments do not effectively address or may exacerbate cognitive disturbances associated with schizophrenia. We have completed three initial studies in our Phase II clinical program with ACP-104 in patients with schizophrenia. The results of these studies demonstrated that initial signals of antipsychotic effects were observed within the tolerated dose range of ACP-104. We are planning to initiate a multi-center Phase IIb clinical trial with ACP-104 in patients with schizophrenia during the first half of 2007.

Neuropathic pain. We have discovered a new class of compounds in collaboration with Allergan that we believe may represent a significant breakthrough in the treatment of neuropathic pain. Allergan has completed Phase I clinical trials and is currently conducting Phase II clinical trials in this program.

We have built a proprietary drug discovery platform that we use to rapidly discover new compounds that may serve as potential treatments for significant unmet medical needs. Our technology platform encompasses proprietary target-based and chemistry-based technologies that we integrate with our discovery and development capabilities. We believe that the breadth of our discovery and development programs and the rapid pace at which we have discovered drug candidates provide strong validation of our proprietary platform and a basis for expanding our pipeline.

We leverage our proprietary drug discovery platform and expertise through collaborations with pharmaceutical and biotechnology companies. We have three separate collaborations with Allergan and one with Sepracor Inc. for the discovery and development of small molecule drug candidates.

We have assembled a management team with significant industry experience to lead the discovery, development, and commercialization of our drug candidates. Members of our management team have contributed to the discovery, development, and approval of multiple drug candidates. We complement our management team with a network of scientific and clinical advisors that includes recognized experts in the fields of schizophrenia, Parkinson’s disease, and other central nervous system disorders.

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We were originally incorporated in Vermont in 1993 as Receptor Technologies, Inc. In 1997, we reincorporated in Delaware. “ACADIA” and “R-SAT” are our registered trademarks. Our logos and trademarks are the property of ACADIA Pharmaceuticals Inc. All other brand names or trademarks appearing in this report are the property of their respective holders. Use or display by us of other parties’ trademarks, trade dress, or products in this report is not intended to, and does not, imply a relationship with, or endorsements or sponsorship of, us by the trademark or trade dress owners.

We maintain a website at www.acadia-pharm.com . We make available free of charge on our website our periodic and current reports as soon as reasonably practicable after such reports are filed with the Securities and Exchange Commission, or SEC. Information contained on, or accessible through, our website is not part of this report or our other filings with the SEC.

Our Strategy

Our goal is to become a leader in the discovery, development, and commercialization of novel small molecule drugs for the treatment of central nervous system disorders and other areas of unmet medical need. Key elements of our strategy are to:

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Our Programs

Our programs include five programs in clinical development, three programs in IND-track development, where we or a collaborator have selected a drug candidate for development and are seeking to complete toxicology and other development testing in preparation for future clinical trials, and four programs in preclinical testing, where we have not yet selected a drug candidate for development. Our programs address diseases that are not well served by currently available therapies and represent large potential commercial market opportunities. We believe that our drug candidates offer innovative therapeutic approaches and may provide significant advantages relative to current therapies. The following table summarizes our programs:

Parkinson’s Disease Psychosis

Disease and Market Overview

Parkinson’s disease is a chronic, progressive, neurological disorder that results from the degeneration of neurons in a region of the brain that controls movement. This degeneration creates a shortage of an important

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brain signaling chemical, or neurotransmitter, known as dopamine, rendering patients unable to initiate their movements in a normal manner. Parkinson’s disease is characterized by a number of symptoms including tremors, limb stiffness, slowness of movements, and difficulties with posture and balance. The severity of Parkinson’s disease symptoms tends to worsen over time.

According to the American Parkinson’s Disease Association, over 1.5 million people in the United States suffer from this disease. Parkinson’s disease is more prevalent in people over 60 years of age, and the incidence and prevalence of this disease is expected to increase as the average age of the population increases. In 2005, approximately $2.8 billion was spent on drug therapy worldwide to treat Parkinson’s disease. Parkinson’s disease patients are currently treated with dopamine replacement therapies such as levodopa, commonly referred to as L-dopa, which is metabolized to dopamine, and dopamine agonists, which are molecules that mimic the action of dopamine. These therapies are relatively effective in controlling the symptoms of the disease in most patients and the use of these agents normally is required throughout the course of the disease.

Studies have suggested that up to 40 percent of patients with Parkinson’s disease will develop psychotic symptoms, commonly consisting of visual hallucinations and delusions. The development of psychosis in patients with Parkinson’s disease often disrupts their ability to perform many of the activities of daily living that keeps them independent and active. As a result, Parkinson’s disease psychosis is the most common factor leading to nursing home placements of patients with Parkinson’s disease.

The U.S. Food and Drug Administration, or FDA, has not approved any therapy for Parkinson’s disease psychosis. Physicians may attempt to address Parkinson’s disease psychosis initially by decreasing the dose of the dopamine replacement drugs, which are administered to patients to manage the motoric aspects of Parkinson’s disease. However, this approach is generally not effective in alleviating psychotic symptoms in most patients and is often associated with the significant worsening of motor function in these patients. There have also been numerous attempts to use existing antipsychotic drugs off-label to treat patients with Parkinson’s disease psychosis. Because antipsychotic agents worsen the preexisting brain dopamine deficit, these drugs are generally not well tolerated by patients with Parkinson’s disease at doses required to achieve antipsychotic effects.

One antipsychotic drug therapy that has demonstrated efficacy in reducing psychosis in patients with Parkinson’s disease without further impairing motor function is low-dose treatment with the generic drug clozapine. Our studies suggest that this unique clinical utility of clozapine arises from its potent blocking of a key serotonin receptor, a protein that responds to the neurotransmitter serotonin, known as the 5-HT2A receptor. The use of low-dose clozapine has been approved in Europe for the treatment of psychotic disorders in Parkinson’s disease. However, patients being treated with clozapine require frequent blood monitoring because clozapine is associated with the occurrence of a rare blood disorder leading to the complete loss of blood cells, known as agranulocytosis. Despite substantial limitations, other currently marketed antipsychotic drugs, including Seroquel, are also used off-label for this indication in both the United States and in Europe. Currently, there is a large unmet medical need for new therapies that will effectively treat psychosis in patients with Parkinson’s disease without impairing motor function.

ACP-103 for the Treatment of Parkinson’s Disease Psychosis

Overview

ACP-103 is a small molecule drug candidate that we discovered and are developing to treat patients with Parkinson’s disease psychosis. ACP-103 can be taken orally and is a novel, potent, and selective 5-HT2A inverse agonist, meaning that it blocks the activity of the 5-HT2A receptor. We believe that ACP-103 may effectively treat Parkinson’s disease psychosis without impairing motor function, thereby significantly improving the quality of life for patients with Parkinson’s disease.

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Development Status

We are preparing to initiate the first pivotal trial in our Phase III development program with ACP-103 for Parkinson’s disease psychosis during the first half of 2007. We have designed this trial following an end of Phase II meeting, which we held with the FDA in September 2006. We expect to enroll about 240 patients with Parkinson’s disease psychosis in this multi-center, double-blind, placebo-controlled Phase III trial. Patients in the trial will be randomized to three different study arms, which will include two different doses of ACP-103 and one placebo arm. Patients will receive oral doses of either ACP-103 or placebo once daily for six weeks in addition to stable doses of their existing dopamine replacement therapy. The primary endpoint of the trial is antipsychotic efficacy as measured using the Scale for the Assessment of Positive Symptoms, or SAPS. Motoric tolerability will be an important secondary endpoint in the trial and will be measured using the Uniform Parkinson’s Disease Rating Scale, or UPDRS.

In March 2006, we announced top-line results from a multi-center, double-blind, placebo-controlled Phase II clinical trial designed to evaluate the efficacy, safety, and tolerability of ACP-103 in 60 patients with Parkinson’s disease psychosis. The trial involved once daily oral administration of either ACP-103 or placebo for a 28-day period to patients who also received stable doses of their existing dopamine replacement therapy. The trial met the primary endpoint, which was to demonstrate that administration of ACP-103 did not result in deterioration of the motoric function of these patients as measured by the UPDRS. The trial also evaluated secondary endpoints of antipsychotic efficacy using three different rating scales, and ACP-103 showed antipsychotic effects on two of these rating scales, one of which was SAPS. ACP-103 was safe and well tolerated in the study. In connection with this Phase II trial, we are conducting an open-label extension study, pursuant to which 24 patients with Parkinson’s disease psychosis have been treated with ACP-103 for at least one year, eight of whom have been treated for over 18 months.

In June 2004, we reported results from a double-blind, placebo-controlled Phase Ib/IIa clinical trial, which evaluated the safety and tolerability of ACP-103 in 12 patients with Parkinson’s disease who also received stable doses of their existing dopamine replacement therapy. ACP-103 was well tolerated and the motor skills of these patients did not deteriorate. Patients who entered this trial with treatment-induced dyskinesias exhibited indications of antidyskinetic activity after ACP-103 administration.

In 2003, we completed two Phase I clinical trials that assessed the safety, tolerability, and blood levels of ACP-103 following oral administration in a total of 57 healthy volunteers. These randomized, double-blind, placebo-controlled, dose-escalation trials encompassed both single-dose and multiple-dose studies. In both studies, ACP-103 exhibited consistent drug levels in the blood and a long half-life that we believe make our drug candidate ideal for once-daily dosing. ACP-103 was well tolerated at plasma levels of 229 nanograms per milliliter and below with no changes in cardiovascular or neurological function and no serious adverse events at any plasma level of ACP-103. In addition to our Phase I clinical trials of ACP-103, we conducted drug receptor occupancy studies in healthy volunteers using positron emission tomography, or PET, which demonstrated that even low acute oral doses of this drug candidate produce significant occupancy of 5-HT2A receptors in the human brain.

Schizophrenia

Disease and Market Overview

Schizophrenia is a chronic, debilitating mental illness characterized by disturbances in thinking, emotional reaction, and behavior. These disturbances may include positive symptoms, such as hallucinations and delusions, and a range of negative symptoms, including loss of interest, emotional withdrawal, and cognitive disturbances. Schizophrenia is associated with persistent impairment of a patient’s social functioning and productivity. It is believed that cognitive disturbances prevent patients with schizophrenia from readjusting to society. As a result, patients with schizophrenia are normally required to be under medical care for their entire lives.

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According to the National Institute of Mental Health, or NIMH, approximately one percent of the population develops schizophrenia during their lifetime and more than two million people in the United States suffer from this disease. Worldwide sales of drugs used to treat schizophrenia and other psychoses exceeded $15 billion in 2005. Despite their commercial success, current drugs used to treat schizophrenia have substantial limitations, including severe side effects and lack of effect on most of the negative symptoms of the disease.

The first-generation, or typical, antipsychotics that were introduced in the late-1950s block dopamine receptors. While these drugs are effective against positive symptoms of schizophrenia in many patients, they also induce disabling motor disturbances, including akathisia, an extremely distressful motor disturbance characterized by feelings of inner restlessness and an urge to move. Typical antipsychotics fail to address or worsen most of the negative symptoms of schizophrenia and their use has decreased in the United States and Europe.

Most schizophrenia patients in the United States today are treated with second-generation, or atypical, antipsychotics, which induce fewer motor disturbances than typical antipsychotic agents, but still fail to address most of the negative symptoms of schizophrenia. In particular, currently prescribed treatments do not effectively address or may exacerbate cognitive disturbances associated with schizophrenia. Clozapine, more so than other atypical antipsychotics, appears to have the ability to partially address cognitive disturbances. It is believed that the efficacy of atypical antipsychotics is due to their interactions with dopamine and 5-HT2A receptors. The side effects induced by the atypical agents may include severe obesity, type II diabetes, cardiovascular side effects, and motor disturbances, including akathisia. We believe that these side effects arise either from non-essential receptor interactions that are unrelated to their efficacy or from excessive dopamine blockade.

The limitations of currently available antipsychotics result in poor patient compliance. A study conducted by the NIMH, which was published in The New England Journal of Medicine in September 2006, found that 74 percent of patients taking typical or atypical antipsychotics discontinued treatment within 18 months because of side effects or lack of efficacy. We believe there is a large unmet medical need for new therapies that can effectively treat both the positive and negative symptoms of schizophrenia and induce fewer side effects.

We have two development programs that we believe offer innovative therapeutic solutions to major unmet medical needs in schizophrenia.

ACP-103 as a Co-Therapy for Schizophrenia

Overview

We are developing ACP-103 as a co-therapy to be used together with other antipsychotic drugs to treat schizophrenia. We believe that co-therapy with ACP-103 may result in enhanced efficacy and fewer side effects relative to existing treatments, thereby providing an improved therapy for patients with schizophrenia and related psychiatric disorders. ACP-103 can be taken orally and is a novel, potent, and selective 5-HT2A inverse agonist. By identifying and correlating the biological target interactions of marketed antipsychotic drugs with their clinical actions, we have identified inverse agonism at 5-HT2A receptors as essential to the improved clinical profile of atypical antipsychotic drugs. By adding ACP-103 to existing treatment regimens, we believe that the optimal combination of 5-HT2A inverse agonism and dopamine receptor blockade can be achieved with a range of both atypical and typical antipsychotic drugs.

Development Status

We have completed enrollment in a multi-center, double-blind, placebo-controlled Phase II clinical trial designed to evaluate the ability of ACP-103 when used as a co-therapy with other antipsychotic drugs to provide an improved treatment for patients with schizophrenia. This trial is exploring the ability of ACP-103 when used together with low doses of each of risperidone, an atypical antipsychotic drug, and haloperidol, a typical

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antipsychotic drug, to treat patients with schizophrenia. We enrolled a total of 423 patients with schizophrenia, who were randomized to five different study arms. These study arms included: ACP-103 plus low-dose risperidone; ACP-103 plus low-dose haloperidol; low-dose risperidone plus placebo; low-dose haloperidol plus placebo; and high-dose risperidone plus placebo. The primary endpoint of the trial is antipsychotic efficacy as measured using the Positive and Negative Syndrome Scale, referred to as PANSS, an industry standard rating scale commonly used in schizophrenia trials. We expect to report top-line results from this trial during March 2007.

In December 2005, we reported top-line results of a multi-center, double-blind, placebo-controlled Phase II clinical trial designed to evaluate the ability of ACP-103 to treat haloperidol-induced akathisia in patients with schizophrenia. Results from this clinical study were based on 30 patients who completed the study protocol. Fourteen of these 30 patients received once-daily oral administration of ACP-103 and 16 were administered placebo over a five-day period. Subjects were also maintained on their pre-study dose of haloperidol during the course of the study. Patients were evaluated using the Barnes Akathisia Scale, or BAS, a four-item rating scale. Overall, the results of the study indicated that ACP-103 reduced akathisia. There were no statistically significant differences on day five between ACP-103-treated and placebo-treated subjects for BAS Item 4, global clinical assessment of akathisia, a priori defined as the primary outcome measure of the study, due to a large placebo response. However, ACP-103 significantly reduced BAS Item 1 on day five, and there were statistically significant improvements or statistical trends on day three for each of Items 1, 2, and 3, and the BAS total, Items 1-4. ACP-103 was safe and well tolerated and no serious adverse events were reported in the study.

In September 2004, we reported results of a clinical study designed to assess the ability of ACP-103 to reduce side effects associated with drug treatment with haloperidol. This double-blind, placebo-controlled study involved 18 healthy volunteers. All subjects were administered a single dose of haloperidol and the majority of these subjects developed measurable akathisia. In addition, the haloperidol treatment induced approximately a three-fold increase in prolactin secretion. This condition of elevated prolactin secretion may adversely affect menstrual and sexual function and bone formation. The results of the study indicated that a single dose of ACP-103 reduced akathisia symptoms in most subjects. In addition, ACP-103 reduced haloperidol-induced increases in prolactin secretion by 33 percent.

ACP-104 as a Treatment for Schizophrenia Providing Potential Cognitive Benefits

Overview

ACP-104 is a small molecule drug candidate that we are developing as a stand-alone treatment for patients with schizophrenia. We believe that ACP-104 may provide an effective antipsychotic therapy with the added advantage of improving cognitive function in patients with schizophrenia. It is known that large amounts of ACP-104, or N-desmethylclozapine, are formed in the body after administration of clozapine. That is, clozapine is metabolized to ACP-104. We discovered that ACP-104 has a unique ability to stimulate m1 muscarinic receptors, which are widely known to play an important role in cognition. Since clozapine itself blocks the m1 muscarinic receptor, patients need to extensively metabolize clozapine into ACP-104 to stimulate this receptor and thereby overcome the blocking action of clozapine. Administration of ACP-104 rather than clozapine will avoid the variability of this metabolic process and the competing action of clozapine. Like clozapine, ACP-104 also interacts with 5-HT2A and dopamine receptors. Our research indicates that ACP-104 is a partial agonist that causes weak activation of dopamine D2 and D3 receptors, whereas clozapine and most other antipsychotic drugs block these dopamine receptors. These partial agonist properties of ACP-104 may lead to less motoric side effects than seen with most other antipsychotic drugs. We believe that ACP-104 represents a new approach to schizophrenia therapy that combines an atypical antipsychotic efficacy profile with the added potential benefit of enhanced cognition.

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Development Status

We are planning to initiate a multi-center, double-blind, placebo-controlled Phase IIb clinical trial with ACP-104 in patients with schizophrenia during the first half of 2007. We anticipate that patients in this trial will be randomized to three different study arms, which will include two different doses of ACP-104 and one placebo arm. Patients will receive oral doses of either ACP-104 or placebo once daily for six weeks. The primary endpoint of the trial will be antipsychotic efficacy as measured using PANSS.

In July 2006, we reported top-line results from three initial studies of ACP-104 in patients with schizophrenia. The first clinical trial was a double-blind, placebo-controlled, single ascending-dose study designed primarily to evaluate the safety, tolerability and blood levels of ACP-104 in patients. The second clinical trial was a 14-day, steady-state, double-blind, placebo-controlled multiple ascending-dose study designed to evaluate the safety, tolerability and blood levels of ACP-104, as well as to provide preliminary indications of antipsychotic efficacy. The third study was an open label single-dose PET study designed to determine the relationship between brain receptor occupancy and plasma levels of ACP-104. The three studies enrolled an aggregate of 74 patients with schizophrenia. The results of these studies demonstrated that ACP-104 was well tolerated after repeated dosing of up to 600 mg per day, and that initial signals of antipsychotic effects, as indicated by clinically meaningful reductions in PANSS scores, were observed within the tolerated dose range of ACP-104. In addition, the analysis of plasma levels of ACP-104 and brain receptor occupancies indicated good penetration of ACP-104 into the brain.

We have also analyzed data on clozapine and ACP-104 plasma levels relative to clinical response from two clinical trials that included 92 patients with schizophrenia treated with clozapine for up to six months. We demonstrated in this analysis that the plasma drug ratio of ACP-104 to clozapine positively predicts improvement in cognitive functioning and quality-of-life parameters in these patients. This analysis indicated that a higher ratio of ACP-104 relative to clozapine resulted in a better response by these patients in a wide range of standard cognitive functioning and quality of life clinical measures. The results of this analysis and our preclinical tests suggest that due to its ability to stimulate m1 muscarinic receptors, ACP-104 is responsible for the cognitive benefits of clozapine.

Sleep Maintenance Insomnia

Disease and Market Overview

Chronic insomnia, a sleep disorder lasting a month or more, is estimated to affect about 10 percent of the U.S. adult population. A significant portion of insomnia patients complain of frequent awakenings during the night and difficulty returning to sleep, which may be referred to as sleep maintenance insomnia. Patients with sleep maintenance insomnia may experience a number of problems, including a lack of energy, difficulty concentrating, irritability, and impairment of daytime functioning. The prevalence of sleep disorders appears to increase with advancing age. In particular, slow wave sleep, which is the deepest and most restorative sleep, normally decreases with age, and this may contribute to an increase in sleep maintenance insomnia. There is also an increased incidence of sleep maintenance insomnia in patients with medical, neurological and psychiatric disorders.

Worldwide sales of drugs used to treat insomnia were estimated at approximately $3.7 billion in 2005. Most of the currently marketed therapies for insomnia are sedatives that are designed primarily to address sleep onset and have limitations in treating the symptoms of sleep maintenance insomnia. Most of these therapies work by interacting with gamma-aminobutyric acid, or GABA, receptors in the brain and may be associated with side effects including the risk of developing tolerance to the drug and the potential for causing lethargy upon awakening, referred to as a hangover effect. In addition, drugs that work by activating the GABA receptors are designated by the Drug Enforcement Administration as controlled substances due to their potential for abuse. We believe that there is a large unmet medical need for new therapies that can treat the symptoms of sleep maintenance insomnia without impairing daytime functioning.

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ACP-103 for Sleep Maintenance Insomnia

Overview

We are developing ACP-103 as a novel treatment for sleep maintenance insomnia. ACP-103 can be taken orally and is a novel, potent, and selective 5-HT2A inverse agonist. In contrast to most currently available insomnia drugs, ACP-103 provides the opportunity to treat the symptoms of sleep maintenance insomnia without inducing sleep or impairing daytime functioning. If approved as a treatment for sleep maintenance insomnia, ACP-103 is not expected to be designated as a controlled substance, as is the case with most existing sleep agents due to their potential for abuse. We believe that ACP-103 and other 5-HT2A inverse agonists generated in our serotonin program may provide sleep maintenance insomnia patients with a novel type of sleep therapy without the limitations of most of the current sleep-inducing agents.

Development Status

We are planning to initiate a Phase II clinical trial with ACP-103 in patients with sleep maintenance insomnia during the first half of 2007. In April 2006, we announced positive top-line results from a proof-of-concept clinical study designed to assess the effect of ACP-103 on slow wave sleep in 45 healthy volunteers ranging in age from 40 to 64. Subjects in the study were randomized to one of five study arms, which included four different doses of ACP-103 and a placebo arm. The results of the study demonstrated that ACP-103 induced a statistically significant increase in slow wave sleep that was dose-related. In addition, ACP-103 had a positive impact on measures for sleep maintenance, including decreases in the number of awakenings after sleep onset and in the time awake after sleep onset, referred to as WASO. ACP-103 also did not alter latency to sleep onset and did not impair daytime functioning. ACP-103 was safe and well tolerated in the study.

Neuropathic Pain

Disease and Market Overview

Neuropathic pain is a common form of pain that is thought to involve an alteration in nervous system function or a reorganization of nervous system structure. Neuropathic pain can be associated with nerve damage caused by trauma, diseases such as diabetes, shingles, irritable bowel syndrome, late-stage cancer or the toxic effects of chemotherapy. In many patients, damage to sensory nerves is accompanied by varying degrees of pain. The experience can range from mildly increased sensitivity to touch or temperature to excruciating pain. This kind of pain is extremely difficult to manage clinically because it fails to respond to most medications currently used to treat other forms of pain. According to Pharmaprojects, a healthcare publication, each year approximately 26 million people worldwide suffer from some form of neuropathic pain.

Drugs such as opioid painkillers and non-steroidal anti-inflammatory agents that are effective in treating inflammatory and acute pain usually are not effective in treating neuropathic pain. Opioid painkillers also have significant adverse side effects that limit their usefulness, including respiratory depression, nausea, vomiting, dizziness, sedation, mental clouding, constipation, urinary retention, and severe itching. In addition, prolonged chronic use of opioid painkillers can lead to the need for increasing dosage and potentially to addiction. Neurontin, previously the market leading treatment for neuropathic pain with sales of $2.7 billion in 2004, is now generic. Currently, the leading drugs approved for neuropathic pain indications include Lyrica, the successor to Neurontin, and Cymbalta. Lyrica had worldwide sales of $291 million in 2005. Cymbalta, indicated for treatment of diabetic peripheral neuropathic pain as well as treatment of major depressive disorder, had worldwide sales of $680 million in 2005. We believe that there is a large unmet medical need for new therapies with improved efficacy and side effect profiles.

Our Drug Candidates for Neuropathic Pain

In collaboration with Allergan, we have discovered and are developing a new class of small molecule drug candidates that we believe provide the potential for a significant breakthrough in the treatment of neuropathic

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pain. Using our proprietary drug discovery platform, we identified a previously unappreciated target for neuropathic pain, which is an alpha adrenergic receptor. We have discovered and are developing orally active, small molecule drug candidates that selectively activate this target. Our novel alpha adrenergic agonists provide highly effective pain relief in a wide range of preclinical models, without the side effects of current pain therapies, including sedation and cardiovascular and respiratory effects. Allergan has demonstrated that these drug candidates are highly potent and efficacious when administered orally in relevant animal models and are more efficacious than Neurontin in preclinical models at approximately 300-fold lower doses.

Allergan has completed Phase I clinical trials for two orally active, small molecule drug candidates and is currently conducting Phase II clinical trials in this program.

Our IND-Track Development and Preclinical Programs

In addition to our clinical programs, we have three programs in IND-track development, where we or a collaborator have selected a drug candidate for development and are seeking to complete toxicology and other development testing in preparation for future clinical trials. We also have four programs that are in preclinical testing where we have not yet selected a drug candidate for development. The following summarizes our IND-track development and preclinical programs.

AC-262271 for Treatment of Glaucoma

We have discovered and, in collaboration with Allergan, are developing AC-262271, a small molecule drug candidate for the treatment of glaucoma. Glaucoma is an eye disease that, if left untreated, can lead to degeneration of the optic nerve and blindness. Glaucoma is a leading cause of blindness in the United States. A prevalent symptom of glaucoma is increased fluid pressure within the eye, or intraocular pressure. Currently, physicians treat glaucoma with multiple classes of therapeutics to optimize therapy and minimize side effects.

Using our proprietary drug discovery platform, we identified a subtype of the muscarinic receptors that controls intraocular pressure and discovered lead compounds that selectively activate this target. In a primate model of glaucoma, AC-262271 demonstrated efficacy and a long duration of action. Preclinical data for AC-262271 suggests that this drug candidate has the potential to be a promising new therapy for glaucoma. Allergan is currently conducting studies with AC-262271 in preparation for possible clinical trials.

ACP-105 for Treatment of Endocrine Indications

We have discovered and are developing ACP-105, a non-steroidal and selective androgen receptor agonist. ACP-105 is part of a class of molecules referred to as selective androgen receptor modulators, or SARMs. SARMs may advance the standard of treatment for a variety of disorders including muscle-wasting conditions and osteoporosis, with fewer side effects as compared to current treatments based on testosterone replacement. ACP-105 has exhibited promising pharmacological properties and a favorable safety profile in preclinical testing. In addition, ACP-105 has reversed endocrine and bone-related markers of testosterone deficiency in preclinical animal testing. Unlike testosterone, ACP-105 had little effect on the prostate, thereby demonstrating tissue specificity in its actions. We have initiated development of ACP-105 and we intend to seek a partner to advance the further development of this program.

ACP-106 for Neuropsychiatry and Sleep Indications and Our Serotonin Preclinical Program

We have used our serotonin program to generate new drug candidates to treat neuropsychiatric and related central nervous system disturbances as well as sleep maintenance insomnia. We discovered ACP-103, a potent and selective 5-HT2A inverse agonist, in this program. In addition to ACP-103, we have discovered a large number of compounds having diverse pharmacological, chemical and pharmaceutical properties that interact selectively with the 5-HT2A receptor. These novel 5-HT2A inverse agonists may serve as back-up or follow-on molecules for ACP-103.

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We have recently nominated ACP-106, a potent and selective 5-HT2A inverse agonist, as a clinical candidate. ACP-106 belongs to a class of molecules that is structurally different than ACP-103. We have initiated development of ACP-106 and intend to complete toxicology and other testing in preparation for potential clinical trials. We believe that ACP-106 and other compounds in our serotonin preclinical program provide us with a strong foundation, which expands our base of available assets for potential partnering, and may enable us to more broadly pursue a range of potential therapeutic indications suitable with this mechanism of action, including Parkinson’s disease psychosis, schizophrenia, sleep maintenance insomnia and other central nervous system disturbances.

PCAP Preclinical Program

We have discovered a series of novel lead compounds that provide the potential for a new class of pro-cognitive antipsychotic drugs. These compounds differ structurally from ACP-104, but like ACP-104, they combine muscarinic m1 agonism with actions on both dopamine and serotonin receptors. These novel compounds demonstrate robust effects in animal models of psychosis and pro-cognitive effects in preclinical models of cognition. We are currently in late stages of lead optimization in this program and are seeking to identify a clinical candidate for further development.

Muscarinic Preclinical Program

Our muscarinic program is designed to deliver new drug candidates to treat psychosis, cognitive disturbances in patients with schizophrenia and dementia, neuropathic pain, and other indications. We have identified novel sites for muscarinic receptor/drug interactions that yield selective muscarinic agonists. Such compounds have not shown the side effects typical of non-selective muscarinic agents, but show robust effects in animal models of psychosis, cognition, and neuropathic pain. The promising preclinical profile of our selective muscarinic compounds suggests significant therapeutic potential.

In January 2005, we formed a collaboration with Sepracor that is focused on further developing drug candidates resulting from our muscarinic program. This program includes our muscarinic agonists that selectively target the m1 muscarinic receptor and may represent a novel approach to the treatment of cognition in patients with schizophrenia. We have discovered over 300 potent muscarinic agonists that selectively target the m1 muscarinic receptor. These muscarinic agonist compounds inhibit behaviors associated with psychotic states and enhance cognitive function in preclinical models. We have also identified the muscarinic receptor subtype that we believe alleviates neuropathic pain.

Cannabinoid CB1 Preclinical Program

We have discovered structurally novel lead compounds that potently and selectively block the cannabinoid CB1 receptor. The CB1 receptor is predominantly expressed in the central nervous system and has a key role in regulating appetite and other reward-based behaviors. Blockade of CB1 receptors may lead to novel treatments for obesity and substance abuse. CB1 receptor antagonists may also be useful in the treatment of disorders associated with cognitive deficits. We are currently conducting lead optimization with proprietary compounds that are potent and selective for the CB1 receptor, are active following oral dosing in preclinical animal models, and are well tolerated at high doses.

Our Drug Discovery Platform and Capabilities

Overview

We have established drug discovery and technical expertise in the areas of molecular biology, ultra-high throughput screening, molecular and behavioral pharmacology, and combinatorial, medicinal and analytical chemistry. We have integrated our discovery and development capabilities with our proprietary technologies in a

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seamless fashion. In addition, we collaborate with world-renowned scientists, clinicians, and academic institutions. We believe that our expertise combined with our proprietary drug discovery platform has allowed us to discover drug candidates more efficiently than traditional approaches.

All of our drug candidates that are currently in clinical trials and earlier stages of discovery and development emanate from discoveries made using our proprietary drug discovery platform. We have demonstrated that our platform can be used to rapidly identify drug-like, small molecule chemistries for a wide range of drug targets. We believe that the breadth of our discovery and development programs and the rapid pace at which we have discovered drug candidates provide strong validation of our proprietary platform and a basis for expanding our pipeline.

Our Drug Discovery Approach

Our drug discovery approach is designed to introduce chemistry at an early stage in the drug discovery process and enable selection of the most attractive, drug-like chemistries for desired targets that we validate with past clinical experience. A key to our discovery approach is our comprehensive set of proprietary functional test systems, or assays, that we are developing for members of three important gene families, G-protein coupled receptors, or GPCRs, nuclear receptors, or NRs, and tyrosine kinase linked receptors, or RTKs. We believe that these gene families represent the most relevant and feasible targets for small molecule drug discovery. We use our proprietary assays to validate drug targets and to discover novel small molecule drug candidates that are specific for these targets using two complementary approaches.

Our first approach is to validate potential drug targets. We profile our collection of reference drugs, primarily consisting of currently and formerly marketed central nervous system drugs, over a range of targets in our functional assays to link clinical and physiological effects of drugs with specific drug targets. Using our reference-drug approach, we are able to identify key drug targets that are validated with past clinical experience as well as the targets that we believe are responsible for various side effects of these drugs. Our discoveries of ACP-103 and ACP-104 resulted from the successful application of our reference-drug approach.

Our second approach is to broadly screen large numbers of targets for the most attractive small molecule chemistries. These chemistries may be prioritized and used as starting points for our drug discovery programs. Using this approach, we discovered that one of our target-specific chemistries demonstrated activity in preclinical models of neuropathic pain, providing the starting point for our collaborative neuropathic pain clinical program. Similarly, one of our selective muscarinic agonists was active in a glaucoma model without showing classical side effects, providing the starting point for our collaborative glaucoma development program.

Key Components of Our Drug Discovery Platform

Key components of our drug discovery platform are discussed below:

Our Target-Based Discovery Technologies

Overview

The human genome project has provided information about the genetic structure of essentially all of the potential drug targets in the human genome. This knowledge, when combined with our proprietary technologies, allows for the efficient testing of the effects of chemical compounds on a wide range of potential drug targets. Within the human genome there are families of genes that include the most frequent targets of drugs. We focus our drug discovery efforts on those families of targets that are most likely to be affected by small molecule drugs.

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R-SAT and Other Functional Assay Technologies

Our proprietary receptor selection and amplification technology, which we refer to as R-SAT, is a valuable component of our drug discovery platform. R-SAT is a cell-based assay system where genes are transferred to cultured cells. The functional activity of the gene products, or potential drug targets, are then evaluated through signal transduction pathways that lead to cellular growth. The growth signals are reported using marker gene technologies. Thus, effects of drugs on potential drug targets can be efficiently detected as changes in color or fluorescence. R-SAT enables the efficient screening of large compound libraries for identification of new chemistries at given targets, as well as detailed pharmacological testing of compounds at a wide range of targets. In addition to R-SAT, we have developed other proprietary tools that evaluate compound interaction with these targets. One of these technologies measures the physical interaction of GPCRs and RTKs with signaling proteins.

Proprietary Receptor Assay Platforms

Our scientists have cloned the genes for the majority of the targets in the G-protein coupled receptor, nuclear receptor and tyrosine kinsase gene families. These represent some of the largest families of genes targeted by known drugs. Our R-SAT assay system has enabled the building of functional assays for a large number of these genes yielding assay platforms, which we refer to as GPCR-SAT, NR-SAT and RTK-SAT. We also have developed assays for several additional targets in other relevant gene families.

Our Chemistry-Based Discovery Technologies

Our drug discovery approach aims to identify small molecules that can serve as chemical starting points, or leads, for optimization efforts providing novel, potent and selective drug candidates for targets that are most likely to be affected by small molecule drugs. To enable our screening operation to identify high quality leads, we have assembled a large proprietary chemical library of diverse compounds. This diverse compound library consists of about 800,000 small organic molecules. We have also developed proprietary synthetic methods for library construction and lead optimization. In addition, our reference drug library provides us with the opportunity to validate targets and is another key component of our drug discovery platform. This reference drug library includes a wide range of the known central nervous system active drugs.

Drug Discovery Opportunities

Our proprietary drug discovery platform has generated a wide range of novel chemistries that we believe will continue to provide us with starting points for additional programs. Using these target-specific chemistries, we have established a portfolio of proprietary drug discovery assets and projects in multiple therapeutic areas. In each of these areas, we have identified novel chemistries for different drug targets that we believe play an important role in these major diseases. Our discovery projects aim to answer specific scientific questions using relatively limited synthetic chemistry and biological efforts. When all key criteria have been fulfilled, these earlier-stage discovery projects may be advanced into preclinical programs.

Collaboration Agreements

We have established three separate collaboration agreements with Allergan, a collaboration agreement with Sepracor, a development agreement with the Stanley Medical Research Institute, and a technology license agreement with Aventis to leverage our drug discovery platform and related assets and to commercialize selected drug candidates. Our collaborations have included upfront payments at initiation of the collaboration, which may be in the form of an equity investment, research support during the term, milestone payments upon successful completion of specified development objectives, and royalties based upon sales, if any, of drugs developed under the collaboration. Our current agreements are as follows:

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Sepracor

In January 2005, we entered into a collaboration agreement with Sepracor for the development of new drug candidates targeted toward the treatment of central nervous system disorders. Under the agreement, the parties are investigating potential clinical candidates resulting from our muscarinic preclinical program. In connection with the collaboration, Sepracor has purchased 1,890,422 shares of our common stock for an aggregate of $20 million in two $10 million tranches. On January 13, 2005, Sepracor purchased 1,077,029 shares of our common stock at a price per share of approximately $9.28, which represented a 40 percent premium to the 30-day trailing average closing price. On January 13, 2006, Sepracor purchased an additional 813,393 shares of our common stock at a price per share of approximately $12.29, which represented a 25 percent premium to the 30-day trailing average closing price on the one-year anniversary of the agreement. Under the collaboration, we are also entitled to receive research funding over a three-year term and, if certain conditions are met, we are eligible to receive milestone payments as well as applicable royalties on worldwide product sales, if any. As of December 31, 2006, we had received $4.6 million in funding pursuant to this agreement. Assuming the successful development of a single product in the muscarinic program, we may receive up to $40 million in aggregate payments, plus applicable royalties.

The general terms of this agreement continue until the later of the expiration of the last to expire patent covering a drug candidate licensed under the collaboration and the earlier of the date a generic version of the product is launched or a specified number of years from the date of the first commercial sale of the product. In addition, this agreement may terminate at the end of the research term.

Allergan

In March 2003, we entered into a collaboration agreement with Allergan to discover, develop, and commercialize new therapeutics for ophthalmic and other indications. The agreement originally provided for a three-year research term ending in late-March 2006, which was extended by the parties for two additional years through March 2008. During the extended research term, the parties will focus joint research efforts in the area of pain. As of December 31, 2006, we had received an aggregate of $13.2 million under the agreement, consisting of an upfront payment, and research funding and related fees. While we will receive additional research funding during the extended research term, we currently anticipate lower revenues and related research activities under this collaboration during the extension. During the extended research term, Allergan could exclusively license chemistry and related assets for up to three drug targets for development and commercialization. If we grant Allergan such an exclusive license, we would be eligible to receive license fees and milestone payments upon the successful achievement of agreed upon clinical and regulatory objectives. Allergan would retain the commercialization rights to the drug candidates in the target areas they exclusively license from us, and we would be eligible to receive royalties on future product sales, if any, worldwide. Assuming the license and successful development of a product for each of the three target areas, we could receive up to approximately $47.5 million in aggregate license fees and milestone payments under the agreement, excluding product royalties.

In July 1999, we entered into a collaboration agreement with Allergan to discover, develop and commercialize selective muscarinic drugs for the treatment of glaucoma based on our compounds. Under this agreement, we provided our chemistry and discovery expertise to enable Allergan to select a compound for development. We granted Allergan exclusive worldwide rights to commercialize products based on this compound for the treatment of ocular disease. As of December 31, 2006, we had received an aggregate of $8.8 million in payments under the agreement, consisting of upfront fees, research funding and milestone payments. We are eligible to receive additional milestone payments of up to approximately $15 million, and would receive royalties on future product sales worldwide, if any. Allergan may terminate this agreement upon 90 days’ notice. However, if terminated, Allergan’s rights to the selected compound would revert to us.

In September 1997, we entered into a collaboration agreement with Allergan focused primarily on the discovery and development of new therapeutics for neuropathic pain and ophthalmic indications. This agreement

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was amended in conjunction with the execution and subsequent amendment of the March 2003 collaboration agreement, and provides for the continued development of drug candidates for one target area. We are restricted from conducting competing research in that target area. Pursuant to the agreement, we granted Allergan exclusive worldwide rights to commercialize products resulting from the collaboration. In exchange, we had received an aggregate of $10.5 million in research funding and milestone payments through December 31, 2006. We are eligible to receive additional milestone payments of up to $10.0 million as well as royalties on future worldwide sales of products, if any, resulting from this collaboration. In connection with the execution of the collaboration agreement in 1997, Allergan made a $6.0 million equity investment in us.

The general terms of our collaboration agreements with Allergan continue until the later of the expiration of the last to expire patent covering a drug candidate licensed under the collaboration and at least 10 years from the date of first commercial sale of a drug candidate. In addition, each of our Allergan collaboration agreements includes a research term that is shorter but may be renewed by the parties.

The Stanley Medical Research Institute

In May 2004, we entered into a development agreement with The Stanley Medical Research Institute, or SMRI, a leading nonprofit organization that supports research on the treatment of schizophrenia. The development term is for three years and may be extended for additional consecutive one-year periods by written agreement of the parties. As of December 31, 2006, we had received $5 million of funding under the agreement to support the development of ACP-104. Assuming the successful development and commercialization of ACP-104, we are required to pay to SMRI royalties on product sales of ACP-104 up to a specified level. SMRI may terminate this agreement in selected instances, including if we enter into a strategic alliance covering ACP-104 or do not reasonably progress its development. In connection with this agreement, we also issued a $1 million convertible promissory note to SMRI. Upon the closing of our initial public offering on June 2, 2004, the principal and accrued interest under this note automatically converted into 143,914 shares of our common stock at a conversion price equal to the initial public offering price of $7.00 per share.

Aventis

In July 2002, we entered into an agreement with Aventis under which we have licensed a portion of our technology for their use in a specified area that we are not pursuing presently.

Intellectual Property