RespireRx Pharmaceuticals Inc. - Quarter Report: 2007 September (Form 10-Q)

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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED September 30, 2007

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission file number 1-16467

Cortex Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

15241 Barranca Parkway, Irvine, California 92618

(Address of principal executive offices, including zip code)

(949) 727-3157

(Registrant’s telephone number, including area code)

NOT APPLICABLE

(Former name, former address and former fiscal year,

if changed since last report)

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

Indicate by check mark whether the registrant is 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  ¨                    Accelerated filer  x                    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

47,518,426 shares of Common Stock as of November 5, 2007

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CORTEX PHARMACEUTICALS, INC.

INDEX

Items 1 and 2 through 5 of Part II have been omitted because they are not applicable with respect to the current reporting period.

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PART I. FINANCIAL INFORMATION

Cortex Pharmaceuticals, Inc.

Condensed Balance Sheets

See accompanying notes.

Note: The balance sheet as of December 31, 2006 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

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Cortex Pharmaceuticals, Inc.

Condensed Statements of Operations

(Unaudited)

See accompanying notes.

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Cortex Pharmaceuticals, Inc.

Condensed Statements of Cash Flows

(Unaudited)

See accompanying notes.

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Cortex Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(Unaudited)

Note 1 — Basis of Presentation

The accompanying unaudited interim condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2007 are not necessarily indicative of the results that may be expected for the full fiscal year. For further information, refer to the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

In January 1999, Cortex Pharmaceuticals, Inc. (“Cortex” or the “Company”) entered into a research collaboration and exclusive worldwide license agreement with NV Organon (“Organon”). The agreement will enable Organon to develop and commercialize the Company’s AMPAKINE^® technology for the treatment of schizophrenia and depression.

In October 2000, the Company entered into a research collaboration agreement and a license agreement with Les Laboratoires Servier (“Servier”), covering defined territories. The agreements, as amended to date, will enable Servier to develop and commercialize up to three AMPAKINE compounds developed during the research collaboration period for the treatment of (i) declines in cognitive performance associated with aging, (ii) neurodegenerative diseases and (iii) anxiety disorders. The indications covered include, but are not limited to, Alzheimer’s disease, mild cognitive impairment, sexual dysfunction, and the dementia associated with multiple sclerosis and Amyotrophic Lateral Sclerosis. At the request of Cortex, the research collaboration with Servier ended in early December 2006 (Note 2) and, as a result, other than with respect to the compounds selected by Servier, the Company has recovered the rights to use such other AMPAKINE compounds for the treatment of the above indications for worldwide markets.

The Company is seeking collaborative arrangements with other pharmaceutical companies for other applications of the AMPAKINE compounds, under which such companies would provide additional capital to the Company in exchange for exclusive or non-exclusive license or other rights to the technologies and products that the Company is developing. Competition for corporate partnering with major pharmaceutical companies is intense, with a large number of biopharmaceutical companies attempting to arrive at such arrangements. Accordingly, although the Company is in discussions with candidate companies, there is no assurance that an agreement will arise from these discussions in a timely manner, or at all, or that an agreement that may arise from these discussions will successfully reduce the Company’s short or longer-term funding requirements.

To supplement its existing resources, in addition to seeking licensing arrangements with other pharmaceutical companies, the Company may seek to raise additional capital through the sale of debt or equity. There can be no assurance that such capital will be available on favorable terms, or at all. If additional funds are raised by issuing equity securities, dilution to existing stockholders is likely to result.

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Revenue Recognition

The Company recognizes revenue when all four of the following criteria are met: (i) pervasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the fees earned can be readily determined; and (iv) collectibility of the fees is reasonably assured.

During 2006, the Company recognized research revenue from its collaboration with Servier (Note 2) as services were performed under the collaboration agreement. The Company recorded grant revenues as the expenses related to the grant projects were incurred. All amounts received under collaborative research agreements or research grants are nonrefundable, regardless of the success of the underlying research.

Revenues from milestone payments are recognized when earned, as evidenced by written acknowledgement from the collaborator, provided that (i) the milestone event is substantive and its achievement was not reasonably assured at the inception of the agreement, and (ii) the Company’s performance obligations after the milestone achievement will continue to be funded by the collaborator at a comparable level to that before the milestone achievement. If both of these criteria are not met, the milestone payment is recognized over the remaining period of the Company’s performance obligations under the arrangement.

If a collaborator develops and markets a product that utilizes the Company’s technology, the Company will be eligible to receive royalties on net sales of the product, as defined by the relative agreement. The Company will recognize such royalties, if any, at the time that the royalties become payable to the Company from the collaborator.

In November 2002, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (the “FASB”) reached consensus on Issue 00-21. EITF Issue 00-21 addresses the accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. As required, the Company applies the principles of Issue 00-21 to multiple element research and licensing agreements that it enters into after July 1, 2003.

In accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104 (“SAB 104”), amounts received for upfront technology license fees under multiple-element arrangements are deferred and recognized over the period of committed services or performance, if such arrangements require the Company’s on-going services or performance.

Employee Stock Options and Stock-based Compensation

The Company’s 2006 Stock Incentive Plan (the “2006 Plan”) provides for a variety of equity vehicles to allow flexibility in implementing equity awards, including incentive stock options, nonqualified stock options, restricted stock grants, stock appreciation rights, stock payment awards, restricted stock units and dividend equivalents to qualified employees, officers, directors, consultants and other service providers. The exercise price of stock options offered under the 2006 Plan must be at least 100% of the fair market value of the common stock on the date of grant. If the person to whom an incentive stock option is granted is a 10% stockholder of the Company on the date of grant, the exercise price per share shall not be less than 110% of the fair market value on the date of grant. Options granted generally vest over a three-year period, although options granted to officers may include more accelerated vesting. Options generally expire ten years from the date of grant, but options granted to consultants may expire five years from the date of grant.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share Based Payment,” using a modified prospective application. SFAS No. 123(R) is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting

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Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.

For options granted during the three months and nine months ended September 30, 2007 and 2006, the fair value of each option award was estimated using the Black-Scholes option pricing model and the following assumptions:

Expected volatility is based on the historical volatility of the Company’s stock. The Company also uses historical data to estimate the expected term of options granted and employee termination rates. The risk-free rate for periods within the contractual life of the options is based on the U.S. Treasury yield curve in effect at the time of grant.

The weighted-average grant-date fair value of options granted during the three months ended September 30, 2007 and 2006 was $2.08 and $1.87, respectively. The weighted-average grant-date fair value of options granted during the nine months ended September 30, 2007 and 2006 was $1.10 and $1.80, respectively.

A summary of option activity for the nine months ended September 30, 2007 is as follows:

As of September 30, 2007, there was approximately $1,549,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That non-cash cost is expected to be recognized over a weighted-average period of one year.

The Company continues to follow EITF Issue 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services,” for stock options and warrants issued to consultants and other non-employees. In accordance with EITF Issue 96-18, these stock options and warrants issued as compensation for services to be provided to the Company are accounted for based upon the fair value of the services provided or the estimated fair market value of the option or warrant, whichever can be more clearly determined. The Company recognizes this expense over

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the period in which the services are provided. The Company’s net loss for the three months ended September 30, 2007 and 2006 includes a credit of approximately $10,000 and expense of approximately $57,000, respectively for non-cash stock based compensation for options issued to consultants and other non-employees. For the nine months ended September 30, 2007 and 2006, the Company’s net loss includes approximately $118,000 and $235,000, respectively, of non-cash stock-based compensation charges for options and warrants issued to consultants and other non-employees. These expenses are non-cash charges and have no impact on the Company’s available cash or working capital.

Cash received from stock option exercises for the nine months ended September 30, 2007 and 2006 was approximately $220,000 and $9,000, respectively. The Company issues new shares to satisfy stock option exercises.

A summary of warrant activity for the nine months ended September 30, 2007 is as follows:

The effect of potentially issuable shares of common stock was not included in the calculation of diluted loss per share given that the effect would be anti-dilutive.

Registration Payment Arrangements

On August 21, 2003, the Company issued 3,333,334 shares of common stock to accredited investors in a private placement transaction for $1.50 per share, providing gross proceeds of $5,000,000. Net proceeds from the transaction, after issuance costs and placement fees, were approximately $4,500,000. In connection with the transaction, the Company also issued five-year warrants to the investors to purchase up to an additional 3,333,334 shares of the Company’s common stock at an exercise price of $2.55 per share. As of September 30, 2007, related warrants to purchase 1,816,668 shares of common stock remained outstanding.

On January 7, 2004, the Company issued 6,909,091 shares of common stock to accredited investors in a private placement transaction for $2.75 per share, resulting in gross proceeds of $19,000,000. Net proceeds from the transaction, after issuance costs and placement fees, were approximately $17,500,000. In connection with the January 2004 transaction, the Company issued five-year warrants to the investors to purchase up to 4,490,910 shares of the Company’s common stock at an exercise price of $3.25 per share. As of September 30, 2007, related warrants to purchase 3,969,137 shares of common stock remained outstanding.

On December 14, 2004, the Company issued 4,233,333 shares of common stock to accredited investors in a private placement transaction for $2.66 per share, resulting in gross proceeds of $11,260,663. Net proceeds from the transaction, after issuance costs and placement fees, were approximately $10,400,000. In connection with the December 2004 transaction, the Company issued five-year warrants to the investors to purchase up to 2,116,666 shares of the Company’ common stock at an exercise price of $3.00 per share. As of September 30, 2007, related warrants to purchase 1,775,689 shares of common stock remained outstanding.

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Pursuant to the terms of the registration rights agreements entered into in connection with each of the above transactions, within defined timelines the Company was required to file, and did file, with the Securities and Exchange Commission (the “SEC”) a registration statement under the Securities Act of 1933, as amended, covering the resale of all of the common stock purchased and the common stock underlying the issued warrants.

The registration rights agreement for each transaction further provides that if a registration statement is not filed or does not become effective within the defined time period, or if after its initial effectiveness the registration statement ceases to remain continuously effective for all securities for which it is required to be effective, then in addition to any other rights the holders may have, the Company would be required to pay each holder an amount in cash, as liquidated damages, equal to 2% per month of the aggregate purchase price paid by such holder in the private placements for the common stock and warrants then held, prorated daily.

The registration statement for each transaction was filed and declared effective by the SEC within the allowed timeframe. As a result, the Company was not required to pay any liquidated damages in connection with the initial registration for any of the foregoing transactions.

In accordance with EITF 00-19, “Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In a Company’s Own Stock,” (“EITF 00-19”) and the terms of the warrants and the transaction documents, for each of the above transactions the Company recorded the estimated fair value of the warrants as a liability, with an offsetting reduction to additional paid-in capital received from the private placement. The fair value of the warrants was estimated using the Black-Scholes option pricing model.

The estimated fair value of the warrants was re-measured at each reporting date and on the date of effectiveness of the related registration statement, with the increase in fair value recorded as other expense in the Company’s Statement of Operations. As of date of the effectiveness of the registration statement, the warrant liability was reclassified to additional paid-in capital, evidencing the non-impact of these adjustments on the Company’s financial position and business operations.

In December 2006, the FASB issued FASB Staff Position (“FSP”) EITF No. 00-19-2, “Accounting for Registration Payment Arrangements.” This FSP specifies that companies that enter into agreements to register securities will be required to recognize a liability if a payment to investors for failing to fulfill the agreement is probable and can be reasonably estimated. This accounting differs from the guidance in EITF 00-19, which required a liability to be recognized and measured at fair value, regardless of probability.

EITF No. 00-19-2 is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified after the date of issuance of this FSP. For the Company’s registration payment arrangements and financial instruments subject to those arrangements that were entered into prior to the issuance of this FSP, the guidance was effective beginning January 1, 2007.

Transition to EITF 00-19-2 was to be achieved by reporting a change in accounting principle through a cumulative-effect adjustment to the opening balance of retained earnings. For purposes of measuring the cumulative-effect adjustment related to the recognition of a contingent liability, the Company evaluated whether the transfer of consideration under its registration payment arrangements was probable and could be reasonably estimated as of the January 1, 2007 adoption date. Given that the Company did not deem the transfer of consideration under its existing registration payments arrangements as probable as of January 1, 2007, the Company did not record a cumulative-effect adjustment in connection with the adoption of this FSP.

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In connection with the obligation to maintain effectiveness of the registration statements filed with each of the August 2003, January 2004 and December 2004 transactions, the Company has estimated the maximum potential amount of undiscounted payments that it could be required to make under the registration arrangements as approximately $391,000, $3,966,000 and $4,409,000, respectively. Given that the Company did not deem the transfer of consideration under its existing registration payment arrangements as probable as of September 30, 2007, no related expense or liability has been recorded during the nine-month period ended September 30, 2007.

Income Taxes

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109.” Interpretation No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with Interpretation No. 48 involves determining whether it is more likely than not that a tax position will be sustained upon examination, based upon the technical merits of the position. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. If a tax position does not meet the more-likely-than-not recognition threshold, the financial statements do not recognize a benefit for that position.

As required, the Company adopted Interpretation No. 48 during the quarter ended March 31, 2007. The adoption did not result in a material impact to the Company’s results of operations or its financial condition.

The Company is subject to taxation in the U.S. and a small number of state jurisdictions. The material jurisdictions subject to potential examination by taxing authorities for tax years after 2002 primarily include the U.S. and California.

From time to time, the Company may be assessed interest or penalties by its tax jurisdictions, although any such assessments historically have been minimal and immaterial to the Company’s financial results. In the event the Company has received an assessment for interest and/or penalties, it has been classified in the financial statements as general and administrative expense.

Comprehensive Loss

The Company presents unrealized gains and losses on its marketable securities, classified as “available for sale,” in its statement of stockholders’ equity and comprehensive income or loss on an annual basis and in a footnote in its quarterly reports. During the three months ended September 30, 2007 and 2006, total comprehensive loss was $2,948,543 and $3,606,413, respectively. During the nine months ended September 30, 2007 and 2006, total comprehensive loss was $9,674,160 and $12,554,526. Other comprehensive income or loss consists of unrealized gains or losses on the Company’s marketable securities, which are comprised of securities of the U.S. government or its agencies, preferred securities and other asset and mortgage backed securities. Unrealized gains on the Company’s marketable securities for the three months ended September 30, 2007 and 2006 amounted to $13,668 and $28,310, respectively. For the nine months ended September 30, 2007 and 2006, unrealized gains on the Company’s marketable securities amounted to $22,308 and $37,834, respectively.

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New Accounting Standards

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, provides a framework for measuring fair value and expands the disclosures required for fair value measurements. The standard applies to other accounting pronouncements, but does not require any new fair value measurements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). The guidance within SFAS 159 allows reporting entities to choose to measure many financial instruments and certain other items at fair value.

Both SFAS 157 and SFAS 159 are effective for the Company’s fiscal year beginning January 1, 2008. The Company does not anticipate that adoption of SFAS 157 or SFAS 159 will materially impact its financial position or results of operations.

Note 2 — Research and License Agreement with Les Laboratoires Servier

In October 2000, the Company entered into a research collaboration agreement and a license agreement with Servier. The agreements, as amended to date, will enable Servier, at its election prior to early December 2007, to develop and commercialize up to three of Cortex’s proprietary AMPAKINE compounds developed during the research and collaboration period for the treatment of (i) declines in cognitive performance associated with aging, (ii) neurodegenerative diseases and (iii) anxiety disorders. The indications covered include, but are not limited to, Alzheimer’s disease, mild cognitive impairment, sexual dysfunction, and the dementia associated with multiple sclerosis and Amyotrophic Lateral Sclerosis. In early December 2006, the Company terminated the research collaboration with Servier and, as a result, other than with respect to the compounds selected by Servier, the Company recovered the worldwide rights for the development and use of such other AMPAKINE compounds for the indications referenced above.

In connection with the agreements, Servier paid Cortex a nonrefundable, up-front payment of $5,000,000. The upfront payment was amortized as revenue over the research support period, as extended by the amendments entered into in October 2002 and December 2003. The agreements, as amended, included research support of $2,025,000 per year through early December 2006 (subject to Cortex providing agreed-upon levels of research). The amount of support was subject to annual adjustment based upon the increase in the U.S. Department of Labor’s Consumer Price Index. During the year ended December 31, 2006, research revenues from the agreements with Servier were approximately $1,025,000. During the three and nine month periods ended September 30, 2007, the Company had no revenues from the agreements with Servier. The agreements also include milestone payments based upon clinical development and royalty payments on any sales that might result in licensed territories if any of the three compounds chosen by Servier are successfully developed and marketed.

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Note 3 — Offerings of Common Stock and Warrants

On January 22, 2007, the Company completed a registered direct offering with several institutional investors for shares of its common stock and warrants to purchase common stock for an aggregate purchase price of approximately $5,624,000. Net proceeds from the offering were approximately $5,100,000. Under the terms of the transaction, the Company sold an aggregate of 5,021,427 shares of its common stock and warrants to purchase 3,263,927 shares of its common stock. The warrants have an exercise price of $1.66 per share and are exercisable on or before January 21, 2012. The warrants are subject to a call provision in favor of the Company to the extent that the closing price of the Company’s common stock exceeds $3.35 for any 13 consecutive trading-day period.

During the nine months ended September 30, 2007, the Company received approximately $443,000 from the exercise of related warrants. If the remaining warrants are fully exercised, of which there can be no assurance, these warrants would provide approximately $4,975,000 of additional capital.

On August 29, 2007, the Company completed a registered direct offering with several institutional investors for shares of its common stock and warrants to purchase common stock for an aggregate purchase price of $14,150,000. Net proceeds from the offering were approximately $13,135,000. Under the terms of the transaction, the Company sold an aggregate of 7,075,000 shares of its common stock and warrants to purchase 2,830,000 shares of its common stock to the investors. The investors’ warrants have an exercise price of $2.64 per share and are exercisable on or after February 29, 2008 and on or before August 28, 2012. In addition, the Company issued warrants to purchase up to an aggregate of 176,875 shares of its common stock to the placement agents in the offering. The placement agents’ warrants have an exercise price of $3.96 per share and are exercisable on or after February 29, 2008 and on or before August 28, 2012. If the warrants are fully exercised, of which there can be no assurance, these warrants would provide approximately $8,172,000 of additional capital.

Given the terms of the related agreements for the January 2007 and August 2007 registered direct offerings, including the registration of the issued shares and shares underlying the issued warrants on the Company’s Form S-3 No. 333-138844 filed on November 20, 2006 and declared effective by the SEC on November 30, 2006 (before the completion of the transactions), the securities issued in these offerings were not subject to the requirements of EITF 00-19 or EITF 00-19-2 (see Note 1).

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The following discussion and analysis should be read in conjunction with the Financial Statements and Notes relating thereto appearing elsewhere in this report and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

Introductory Note

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and we intend that such forward looking statements be subject to the safe harbors created thereby. These forward-looking statements relate to, among other things, (i) future research plans, expenditures and results, (ii) potential collaborative arrangements, (iii) the potential utility of our proposed products and (iv) the need for, and availability of, additional financing.

The forward-looking statements included herein are based on current expectations, which involve a number of risks and uncertainties and assumptions regarding our business and technology. These assumptions involve judgments with respect to, among other things, future scientific, economic and competitive conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in forward-looking statements will be realized and actual results may differ materially. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events. Readers should carefully review the risk factors described in this and other documents that we file from time to time with the Securities and Exchange Commission, or the SEC, including, without limitation, Quarterly Reports on Form 10-Q, Annual Reports on Form 10-K and subsequent Current Reports on Form 8-K.

About Cortex Pharmaceuticals

We are engaged in the discovery and development of innovative pharmaceuticals for the treatment of neurodegenerative diseases and other neurological and psychiatric disorders. Our primary focus is to develop a novel pharmacology that positively modulates AMPA-type glutamate receptors, a complex of proteins that is involved in communication between nerve cells in the human brain. We are developing a family of proprietary pharmaceuticals, known as AMPAKINE^® compounds, which enhance the activity of this receptor. We believe that AMPAKINE compounds hold promise for correcting neurological and psychiatric diseases and disorders that are known, or thought, to involve depressed functioning of pathways in the brain that use glutamate as a neurotransmitter.

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The AMPAKINE program addresses large potential markets. Our business plan involves partnering with larger pharmaceutical companies for research, development, clinical testing, manufacturing and global marketing of AMPAKINE products for those indications that require sizable, expensive Phase III clinical trials and very large sales forces to achieve significant market penetration. At the same time, we plan to develop internally a selected set of indications, eligible for orphan drug status. Medications for these indications typically require smaller clinical trials and as a result, smaller overall investment in the development stages then the typical chronic medication. Treatments for orphan indications frequently also have shorter review times at the U.S. Food and Drug Administration, or FDA, and if approved for marketing, involve a more concentrated and smaller sales force targeted at selected medical centers and a limited number of medical specialists in the United States. In our licensing discussions, we seek to reserve rights that may be viewed as a natural expansion beyond some of the orphan drug uses to selected larger areas of therapy to thereby allow us to potentially further develop our compounds for such larger non-orphan drug indications. If we are successful in the pursuit of this operating strategy, we may consequently be in a position to contain our costs over the next few years, to maintain our focus on the research and early development of novel pharmaceuticals (where we believe that we have the ability to compete) and eventually to participate more fully in the commercial development of AMPAKINE products in the United States.

Critical Accounting Policies and Management Estimates

The SEC defines critical accounting policies as those that are, in management’s view, most important to the portrayal of our financial condition and results of operations and most demanding of our judgment. Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities.

We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. This process forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition

Our revenue recognition policies are in accordance with the SEC’s Staff Accounting Bulletin No. 104, “Revenue Recognition,” or SAB 104. SAB 104 provides guidance in applying accounting principles generally accepted in the United States to revenue recognition issues, and specifically addresses revenue recognition for up-front, nonrefundable fees received in connection with research collaboration arrangements.

In accordance with SAB 104, revenues from up-front fees from our collaborators are deferred and recorded over the term that we provide ongoing services. Similarly, research support payments are recorded as revenue as we perform the research under the related agreements. We record grant revenues as we incur expenses related to the grant projects. All amounts received under collaborative

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research agreements or research grants are nonrefundable, regardless of the success of the underlying research.

Revenues from milestone payments are recognized when earned, as evidenced by written acknowledgment from our collaborator, provided that (i) the milestone event is substantive and its achievement 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 its collaborator at a comparable level to that 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.

In November 2002, the Emerging Issues Task Force, or EITF, of the Financial Accounting Standards Board, or the FASB, reached consensus on Issue 00-21. EITF Issue 00-21 addresses the accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. As required, we apply the principles of Issue 00-21 to multiple element agreements that we enter into after July 1, 2003.

In accordance with SAB 104, amounts received for upfront technology license fees under multiple-element arrangements are deferred and recognized over the period of committed services or performance, if such arrangements require our on-going service or performance.

Employee Stock Options and Stock-Based Compensation

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share Based Payment,” or SFAS 123(R), using a modified prospective application. SFAS 123(R) is a revision of SFAS 123, and supersedes APB 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.

As of September 30, 2007, there was approximately $1,549,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. These non-cash costs are expected to be recognized over a weighted-average period of one year.

Under the fair value recognition provisions of SFAS 123(R), share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

In accordance with EITF Issue 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services,” stock options and warrants issued to our consultants and other non-employees as compensation for services to be provided to us are accounted for based upon the fair value of the services provided or the estimated fair market value of the option or warrant, whichever can be more clearly determined. We recognize this expense over the period the services are provided.

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Registration Payment Arrangements

In connection with prior private placements of our common stock and warrants to purchase shares of our common stock, we entered into agreements that committed us to timely register the shares of common stock purchased as well as the shares underlying the issued warrants. Those registration agreements specified potential cash penalties if we did not timely register the related shares with the SEC.

In accordance with EITF 00-19, “Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In a Company’s Own Stock,” when the potential cash penalties were included in registration payment arrangements, we recorded the estimated fair value of the warrants as a liability, with an offsetting reduction to additional paid-in capital received from the private placement. The fair value of the warrants was estimated using the Black-Scholes option pricing model.

The estimated fair value of the warrants was re-measured at each reporting date and on the date of effectiveness of the related registration statement, with the increase in fair value recorded as other expense in our Statement of Operations. As of the date of effectiveness of the registration statement, the warrant liability was reclassified to additional paid-in capital, evidencing the non-impact of these adjustments on our financial position and business operations.

In December 2006, the FASB issued FASB Staff Position, or FSP, EITF No. 00-19-2, “Accounting for Registration Payment Arrangements.” This FSP specifies that companies that enter into agreements to register securities will be required to recognize a liability if a payment to investors for failing to fulfill the agreement is probable and can be reasonably estimated. This accounting differs from the guidance in EITF 00-19, which required a liability to be recognized and measured at fair value, regardless of probability.

EITF 00-19-2 is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that we enter into or modify after the date of issuance of this FSP. For our registration payment arrangements and financial instruments subject to those arrangements that were entered prior to the issuance of this FSP, the guidance was effective beginning January 1, 2007.

Transition to EITF 00-19-2 was to be achieved by reporting a change in accounting principle through a cumulative-effect adjustment to the opening balance of retained earnings. For purposes of measuring the cumulative-effect adjustment related to the recognition of a contingent liability, we evaluated whether the transfer of consideration under our registration payment arrangements was probable and could be reasonably estimated as of the January 1, 2007 adoption date. Given that we did not deem the transfer of consideration under our existing registration payment arrangements as probable as of the adoption date, we did not record a cumulative-effect adjustment in connection with the adoption of this FSP.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for our judgment in their application. There are also areas in which our judgment in selecting any available alternative would not produce a materially different result.

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Results of Operations

General

In January 1999, we entered into a research collaboration and exclusive worldwide license agreement with NV Organon, or Organon. The agreement will allow Organon to develop and commercialize our proprietary AMPAKINE technology for the treatment of schizophrenia and depression. In connection with the agreement, we received $2,000,000 up-front and research support payments of approximately $3,000,000 per year for two years. The agreement with Organon also includes milestone payments based upon clinical development, plus royalty payments on worldwide sales. To date, we have received milestone payments from Organon totaling $6,000,000. For each milestone payment, we recorded the related revenue upon achievement of the milestone.

In October 2000, we entered into a research collaboration agreement and a license agreement with Les Laboratoires Servier, or Servier. The agreements will allow Servier to develop and commercialize up to three select AMPAKINE compounds for the treatment of (i) declines in cognitive performance associated with aging, (ii) neurodegenerative diseases and (iii) anxiety disorders. The research collaboration agreement, as amended, included an up-front payment by Servier of $5,000,000 and research support payments of approximately $2,025,000 per year through early December 2006 (subject to us providing agreed-upon levels of research personnel). The amount of research support was subject to annual adjustment based upon the increase in the U.S. Department of Labor’s Consumer Price Index. For the year ended December 31, 2006, our research revenues from the Servier agreements were approximately $1,025,000. In early December 2006, we terminated the research collaboration with Servier and, as a result, the worldwide rights for the AMPAKINE compounds for the treatment of the above indications were returned to us, other than for up to three compounds that may be selected by Servier prior to early December 2007 for commercialization in its territory. Should any of these compounds be successfully commercialized by Servier, we would receive payments based upon key clinical development milestones and royalty payments on sales in licensed territories.

From inception (February 10, 1987) through September 30, 2007, we have sustained losses aggregating approximately $89,454,000. Continuing losses are anticipated over the next several years. During that time, our ongoing operating expenses will only be offset, if at all, by proceeds from Small Business Innovative Research grants and by possible milestone payments from Organon and Servier. Ongoing operating expenses may also be funded by payments under planned strategic alliances that we are seeking with other pharmaceutical companies for the clinical development, manufacturing and marketing of our products. The nature and timing of payments to us under the Organon and Servier agreements or other planned strategic alliances, if and when entered into, are likely to significantly affect our operations and financing activities and to produce substantial period-to-period fluctuations in reported financial results. Over the longer term, we will be dependent upon the successful introduction of a new product into the North American market from our internal development, as well as the successful commercial development of our products by Organon, Servier or our other prospective partners to attain profitable operations from royalties or other product-based revenues.

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Comparison of the Three Months and Nine Months ended September 30, 2007 and 2006

For the three months ended September 30, 2007, our net loss of approximately $2,962,000 compares with a net loss of approximately $3,635,000 for the corresponding prior year period, a decrease of 19%. For the nine months ended September 30, 2007, the net loss of approximately $9,696,000 compares with a net loss of approximately $12,592,000 for the corresponding prior year period, a decrease of 23%. The decreased losses primarily reflect decreased operating expenses, as explained more fully below.

Our revenues for the three months ended September 30, 2007 decreased to $0 from approximately $402,000 for the three months ended September 30, 2006. For the nine months ended September 30, 2007, our revenues decreased to $0 from approximately $864,000 for the corresponding prior year period. Results for both periods primarily reflect decreased research revenues from the agreement with Servier. As reported earlier, we terminated the research collaboration with Servier effective early December 2006.

Our research and development expenses for the three-month period ended September 30, 2007 decreased from approximately $3,192,000 to approximately $1,941,000, or by 39%, from the corresponding prior year period. The decrease in our non-cash stock compensation charges represents approximately $174,000, or 14%, of this decrease. Most of the remaining decrease reflects expenses incurred in the prior year period to address the earlier clinical hold on AMPAKINE CX717 by the FDA.

As reported earlier, the FDA placed a clinical hold on CX717 in late March 2006 due to concerns over some preclinical animal data and not as a result of data from any human clinical trials. After we provided additional toxicological data, the FDA released the clinical hold in October 2006, but imposed a limited dose range for further clinical testing of the compound.

While we could have continued with our Alzheimer’s disease study at low doses, we chose not to given that the original intent of the Alzheimer’s study was to look at a range of doses up to 1200mg. Without the ability to test several different doses, we felt the study could result in a clinical failure for the drug without ever having tested it at higher dose levels. The risks associated with proceeding on that basis were deemed unacceptable and instead we chose to delay the study until we could provide the FDA with sufficient information that would allow us to proceed at all dose levels originally desired for this study.

In April 2007, we submitted further data to the FDA that demonstrates that the cellular effects that originally concerned the Division of Neurology Products were postmortem, fixative induced effects. In July 2007, the FDA indicated that we may resume our previously approved clinical trials with CX717 in Alzheimer’s disease at all requested dose levels.

In September 2007, we filed an Investigational New Drug Application, or IND, for CX717 with the Division of Psychiatry Products of the FDA to potentially initiate a Phase IIb study evaluating CX717 for the treatment of Attention Deficit Hyperactivity Disorder, or ADHD. Prior to the FDA clinical hold, we announced positive statistical and clinical results with CX717 in a Phase IIa pilot clinical trial in adults with that indication.

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In October 2007, the FDA rejected our application to study CX717 in ADHD based upon the results of animal toxicology studies that we filed with the agency. At this time, we do not anticipate re-submitting further data to the FDA for CX717 for the ADHD indication. We are evaluating our options to have this decision reviewed further within the FDA, but at this point we do not believe that the decision by the Division of Psychiatry Products will be changed.

Also, we believe that by developing an acute use for CX717, such as treatment of respiratory depression, we may mitigate the risks perceived with higher chronic doses. The risk/benefit ratio for the treatment of patients with life-threatening disorders, such as respiratory depression, is significantly different than that for the treatment of ADHD. In addition, our preclinical data for improvement of memory and cognition in animals consistently indicates required dose levels of CX717 that represent a 5 to 10-fold level less than the dose required in animal models of ADHD. Either lower dosage levels for chronic administration and/or acute uses are thus possible options for the continued development of CX717.

For the nine-month period ended September 30, 2007, our research and development expenses decreased from approximately $10,363,000 to approximately $6,943,000, or by 33%, from the corresponding prior year period. Non-cash stock compensation charges accounted for approximately $535,000, or 16%, of the decrease due to a decrease in stock options granted during the current year period. Most of the remaining decreased expenses reflect prior year period clinical expenses incurred before the FDA clinical hold on CX717, and preclinical expenses to address the clinical hold.

Our general and administrative expenses for the three-month period ended September 30, 2007 increased from approximately $1,014,000 to approximately $1,182,000, or by 17%, compared to the corresponding prior year period. Non-cash stock compensation charges accounted for approximately $78,000, or nearly one-half of the increase, due to a decrease in the estimated forfeiture rate utilized to compute the related expense. Increased legal, consulting and audit fees also contributed to the current year period expense increase.

For the nine-month period ended September 30, 2007, our general and administrative expenses decreased from approximately $3,604,000 to approximately $3,179,000, or by 12% compared to the prior year period. Non-cash stock compensation charges accounted for approximately $367,000, or 86% of the decrease, with the decreased charges reflecting the vesting schedules of earlier issued stock options. Decreased legal fees also contributed to the current year period expense decrease.

Liquidity and Capital Resources

Sources and Uses of Cash

From inception (February 10, 1987) through September 30, 2007, we have funded our organizational and research and development activities primarily through the issuance of equity securities, funding related to collaborative agreements, various research grants and net interest income.

Under the agreements signed with Servier in October 2000, as amended to date, the collaborative research phase of the agreement ended in early December 2006, but Servier has the right through early December 2007 to select up to three compounds developed during the collaboration for further

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development. If they choose to select any of these compounds for commercialization, we may receive milestone payments based upon successful clinical development of the licensed compounds and royalties on sales in licensed territories. Under the terms of the agreement with Organon, we may receive additional milestone payments based on clinical development of the licensed technology and ultimately, royalties on worldwide sales.

In August 2003, we completed a private placement of an aggregate of 3,333,334 shares of our common stock at $1.50 per share and five-year warrants to purchase up to an additional aggregate of 3,333,334 shares at an exercise price of $2.55 per share. We received approximately $4,500,000 in net proceeds from the private placement. During the year ended December 31, 2006, we received approximately $2,830,000 of proceeds from the exercise of related warrants. During the nine months ended September 30, 2007, we received another $170,000 from the exercise of related warrants, leaving warrants to purchase up to 1,816,668 shares outstanding. If the remaining warrants are fully exercised, of which there can be no assurance, such exercise would provide us approximately $4,633,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $6.00 per share for any 13 consecutive trading days.

In January 2004, we completed a private placement of an aggregate of 6,909,091 shares of our common stock at $2.75 per share and five-year warrants to purchase up to an additional aggregate of 4,490,910 shares at an exercise price of $3.25 per share. We received approximately $17,500,000 in net proceeds from the private placement. During the year ended December 31, 2006, we received approximately $1,696,000 from the exercise of related warrants. As of September 30, 2007, warrants to purchase up to 3,969,137 shares remained outstanding. If the remaining warrants are fully exercised, of which there can be no assurance, these warrants would provide us approximately $12,900,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $7.50 per share for any 13 consecutive trading days.

In December 2004, we completed a private placement of an aggregate of 4,233,333 shares of our common stock at $2.66 per share and five-year warrants to purchase up to an additional aggregate of 2,116,666 shares at an exercise price of $3.00 per share. We received approximately $10,400,000 in net proceeds from the private placement. During the year ended December 31, 2006, we received approximately $1,023,000 from the exercise of related warrants. As of September 30, 2007, warrants to purchase up to 1,775,689 shares remained outstanding. If the remaining warrants are fully exercised, of which there can be no assurance, these warrants would provide us approximately $5,327,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $7.50 per share for any 13 consecutive trading days.

In January 2007, we completed a registered direct offering with several institutional investors for 5,021,427 shares of our common stock and warrants to purchase 3,263,927 shares of our common stock for an aggregate purchase price of approximately $5,624,000. Net proceeds from the offering were approximately $5,100,000. The warrants have an exercise price of $1.66 per share and, subject to the terms therein, are exercisable at any time on or before January 21, 2012. During the nine months ended September 30, 2007, we received approximately $443,000 from the exercise of related

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warrants, leaving warrants to purchase up to 2,996,927 shares outstanding. If the remaining warrants are fully exercised, of which there can be no assurance, these warrants would provide us approximately $4,975,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $3.35 per share for any 13 consecutive trading days.

In August 2007, we completed a registered direct offering with several institutional investors for 7,075,000 shares of our common stock and warrants to purchase 2,830,000 shares of our common stock for an aggregate purchase price of $14,150,000. Net proceeds from the offering were approximately $13,135,000. The investors’ warrants have an exercise price of $2.64 per share and, subject to the terms therein, are exercisable on or after February 29, 2008 and on or before August 28, 2012. In addition, we issued warrants to purchase up to an aggregate of 176,875 shares of our common stock to the placement agents in the offering. The placement agents’ warrants have an exercise price of $3.96 per share and, subject to the terms therein, are exercisable on or after February 29, 2008 and on or before August 28, 2012. If the related warrants are fully exercised, of which there can be no assurance, these warrants would provide us approximately $8,172,000 of additional capital.

As of September 30, 2007, we had cash, cash equivalents and marketable securities totaling approximately $20,233,000 and working capital of approximately $18,580,000. In comparison, as of December 31, 2006, we had cash, cash equivalents and marketable securities of approximately $9,449,000 and working capital of approximately $7,917,000. The increases in cash and working capital reflect the proceeds from the offerings of our common stock and warrants to purchase shares of our common stock in January 2007 and August 2007, partially offset by amounts required to fund our operations.

Net cash used in operating activities was approximately $7,815,000 during the nine months ended September 30, 2007, and included our net loss for the period of approximately $9,696,000, adjusted for non-cash expenses for depreciation and stock compensation approximating $1,794,000, and changes in operating assets and liabilities. Net cash used in operating activities was approximately $10,548,000 during the nine months ended September 30, 2006, and included our net loss for the period of approximately $12,592,000, adjusted for non-cash expenses for depreciation, amortization and stock compensation approximating $2,689,000, and changes in operating assets and liabilities.

Net cash used in investing activities approximated $5,451,000 during the nine months ended September 30, 2007, and primarily resulted from the purchases of marketable securities of approximately $12,820,000, partially offset by the sales and maturities of marketable securities of approximately $7,858,000. Fixed asset purchases for the current year period approximated $489,000. Net cash provided by investing activities approximated $5,006,000 during the nine months ended September 30, 2006, and primarily resulted from the sales and maturities of marketable securities of approximately $13,024,000, partially offset by the purchase of marketable securities of $7,926,000. Fixed asset purchases for the prior year period approximated $92,000.

Net cash provided by financing activities amounted to approximately $19,049,000 for the nine months ended September 30, 2007 and resulted primarily from the net proceeds from our offerings of our common stock and warrants to purchase shares of our common stock in January and August 2007.

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Net cash provided by financing activities amounted to approximately $5,951,000 for the nine months ended September 30, 2006, and resulted primarily from the exercise of warrants to purchase shares of our common stock issued to investors in connection with our prior financings as well as the exercise of other outstanding warrants and options to purchase shares of our common stock.

Commitments

We lease approximately 32,000 square feet of research laboratory, office and expansion space under an operating lease that expires May 31, 2009. The commitments under the lease agreement for the remaining three months of the year ending December 31, 2007, the year ending December 31, 2008 and the five months ending May 31, 2009 are approximately $135,000, $556,000 and $237,000, respectively.

Remaining commitments for preclinical and clinical studies amount to approximately $1,156,000. Separately, we are committed to approximately $633,000 for sponsored research at academic institutions, of which $490,000 is payable over the next twelve months.

In June 2000, we received approximately $247,000 from the Institute for the Study of Aging, or the Institute, a non-profit foundation supported by the Estee Lauder Trust. The advance partially offset our limited costs for our testing in patients with mild cognitive impairment that we conducted with our partner, Servier. Provided that we comply with the conditions of the funding agreement, including the restricted use of the amounts received, repayment of the advance will not be required unless we enter an AMPAKINE compound into Phase III clinical trials for Alzheimer’s disease. Upon such potential clinical trials, repayment would include interest computed at a rate equal to one-half of the prime lending rate. In lieu of cash, in the event of repayment the Institute may elect to receive the balance of outstanding principal and accrued interest as shares of our common stock. The conversion price for such form of repayment shall initially equal $4.50 per share, subject to adjustment under certain circumstances.

Staffing

As of September 30, 2007, we had a total of 26 full-time research and administrative employees. We anticipate modest increases in staffing and investments in equipment through the next twelve months.

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Outlook

We anticipate that our cash, cash equivalents and marketable securities will be sufficient to satisfy our capital requirements into 2009. Additional funds will be required to continue operations beyond that time. We may receive additional milestone payments from the Organon and Servier agreements. However, there is no assurance that we will receive such milestone payments from Organon or Servier. We may also receive funds from the exercise of warrants to purchase shares of our common stock. As of September 30, 2007, warrants to purchase approximately 14 million shares of our common stock were outstanding with a weighted average exercise price of $2.66 per share. If all remaining warrants are fully exercised, of which there can be no assurance, such exercise would provide approximately $37,000,000 of additional capital.

In order to provide for our longer-term capital requirements, we are presently seeking additional collaborative or other arrangements with larger pharmaceutical companies. Under these agreements, it is intended that such companies would provide capital to us in exchange for an exclusive or non-exclusive license or other rights to certain of the technologies and products that we are developing. Competition for such arrangements is intense with a large number of biopharmaceutical companies attempting to secure alliances with more established pharmaceutical companies. Although we have been engaged in discussions with candidate companies, there is no assurance that an agreement or agreements will arise from these discussions in a timely manner, or at all, or that revenues that may be generated thereby will offset operating expenses sufficiently to reduce our longer-term funding requirements.

Because there is no assurance that we will secure additional corporate partnerships, we may seek to raise additional capital through the sale of debt or equity securities. There is no assurance that funds will be available on favorable terms, or at all. If equity securities are issued to raise additional funds, dilution to existing stockholders is likely to result. Such additional capital would, more importantly, enhance the ability of us to achieve significant milestones in our efforts to develop the AMPAKINE technology.

Additional Risks and Uncertainties

Our proposed products are in the preclinical or early clinical stage of development and will require significant further research, development, clinical testing and regulatory clearances. They are subject to the risks of failure inherent in the development of products based on innovative technologies. These risks include, but are not limited to, the possibilities that any or all of the proposed products will be found to be ineffective or unsafe, or otherwise fail to receive necessary regulatory clearances; that the proposed products, although effective, will be uneconomical to market; that third parties may now or in the future hold proprietary rights that preclude us from marketing them; or that third parties will market superior or equivalent products. Accordingly, we are unable to predict whether our research and development activities will result in any commercially viable products or applications. Further, due to the extended testing and regulatory review process required before marketing clearance can be obtained, we do not expect to be able to commercialize any therapeutic drug for at least four years, either directly or through our current or prospective partners or licensees. There can

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be no assurance that our proposed products will prove to be safe or effective or receive regulatory approvals that are required for commercial sale.

Off-Balance Sheet Arrangements

We have not engaged in any “off-balance sheet arrangements” within the meaning of Item 303(a)(4)(ii) of Regulation S-K.

We are exposed to certain market risks associated with interest rate fluctuations on our marketable securities and borrowing arrangement. All investments in marketable securities are entered into for purposes other than trading. We are not subject to significant risks from currency rate fluctuations as we do not typically conduct transactions in foreign currencies. In addition, we do not utilize hedging contracts or similar instruments.

Our exposure to interest rate risk arises from financial instruments entered into in the normal course of business. Certain of our financial instruments are fixed rate, short-term investments in government and corporate notes and bonds. Changes in interest rates generally affect the fair value of the investments, however, because these financial instruments are considered “available for sale,” all such changes are reflected in the financial statements in the period affected. We manage interest rate risk on our investment portfolio by matching scheduled investment maturities with our cash requirements. As of September 30, 2007, our investment portfolio had a fair value and carrying amount of approximately $12,801,000. If market interest rates were to increase immediately and uniformly by 10% from levels as of September 30, 2007, the resulting decline in the fair value of fixed rate bonds held within the portfolio would not be material to our financial position, results of operations and cash flows.

Our borrowing consists of our advance from the Institute for the Study of Aging, which is subject to potential repayment in the event that we enter an AMPAKINE compound into Phase III clinical testing as a potential treatment for Alzheimer’s disease. Potential repayment would include interest accruing at a rate equal to one-half of the prime lending rate. Changes in interest rates generally affect the fair value of such debt, but, based upon historical activity, such changes are not expected to have a material impact on earnings or cash flows. As of September 30, 2007, the principal and accrued interest of the advance amounted to approximately $303,000.

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, or the CEO, and Chief Financial Officer, or the CFO, as appropriate, to allow timely decisions regarding required disclosure.

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We performed an evaluation, under the supervision and with the participation of our management, including the CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, pursuant to Rules 13a-15(b) and 15d-15(b) under the Exchange Act. Based upon that evaluation, the CEO and CFO have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were effective in timely alerting them to material information required to be included in our periodic filings under the Exchange Act.

There has been no change in our internal control over financial reporting (as defined in Rules 13(a)-15(f) and 15(d)-15(f) under the Exchange Act) during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Other than the matter described below, there have been no material changes from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.

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If we are unable to progress in our clinical development of AMPAKINE CX717 for an acute indication in a timely manner, or at all, there could be a significant negative impact on our business operations and the market price of our common stock.

On October 10, 2007, the Division of Psychiatry Products, or DPP, of the FDA notified us that it rejected our IND to study the AMPAKINE CX717 in ADHD. The denial was based upon results of animal toxicology studies that we filed with the agency. At this time, we do not anticipate re-submitting further data to the FDA for CX717 in the ADHD indication.

Our objective is to continue our plans to develop CX717 for the acute treatment of respiratory depression and to continue our study of CX717 in our Alzheimer’s disease PET scan study. We believe that the IND previously filed with the Division of Neurology Products of the FDA for the treatment of Alzheimer’s disease will not be affected by the actions of the DPP. However, there can be no assurance that we will receive final FDA approval for any eventual New Drug Application submission.

We also believe that by developing an acute use for CX717, such as treatment of respiratory depression, the risks perceived to be associated with higher chronic doses required for ADHD may be mitigated. Additionally, the risk/benefit ratio for the treatment of patients with life-threatening respiratory depression is substantially different than for the treatment of ADHD. Also, our preclinical data for animal models of improvement of memory and cognition consistently shows that the dose level of CX717 required is 5-10 fold less than the dose required in animal models of ADHD. We believe that either lower dosage levels for chronic administration and/or acute uses are possible options for the continued development of CX717.

If we are unable to progress in our clinical development of AMPAKINE CX717 for an acute indication in a timely manner, or at all, there could be a significant negative impact on our business operations and the market price of our common stock.

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Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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