10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the Quarterly Period Ended March 31, 2006.
	OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from                       to

Commission File Number:  0-497

Lipid Sciences, Inc.

(Exact name of registrant as specified in its charter)

Delaware	43-0433090
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

7068 Koll Center Parkway, Suite 401, Pleasanton, California 94566

(Address of principal executive offices)                      (Zip Code)

(925) 249-4000

(Registrant’s telephone number, including area code)

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

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

Large accelerated filer o Accelerated filer ý Non - accelerated filer o

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

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

Class	Shares outstanding at April 28, 2006
Common Stock
$0.001 par value	27,372,767

LIPID SCIENCES, INC.

FORM 10-Q

For the Period Ended March 31, 2006

Table of Contents

		Page No.
FORWARD-LOOKING STATEMENTS		i
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005	1
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005, and cumulative period from Inception (May 21, 1999) to March 31, 2006	2
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005, and cumulative period from Inception (May 21, 1999) to March 31, 2006	3
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	14
Item 4.	Controls and Procedures	14
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	15
Item 1A.	Risk Factors	15
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	15
Item 3.	Defaults upon Senior Securities	15
Item 4.	Submission of Matters to a Vote of Security Holders	15
Item 5.	Other Information	15
Item 6.	Exhibits	15
SIGNATURES		16
INDEX TO EXHIBITS FOR FORM 10-Q		17

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will,” “may” and other similar expressions. In addition, any statements that refer to expectations, projections, plans, objectives, goals, strategies or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements speak only as of the date stated and we do not undertake any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these expectations may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control, that could cause actual results to differ materially from those suggested by the forward-looking statements. These risks and uncertainties include, but are not necessarily limited to:

•our inability to obtain adequate funds;

•we have incurred significant losses since our inception and it is our expectation that we will incur substantial losses in the future;

•our technology not proving to be safe or effective;

•our inability to obtain regulatory approval of our technology, which is only in the clinical development stage;

•delay or failure to complete clinical studies;

•our dependence on our license agreement with Aruba International B.V.;

•our reliance on collaborations with strategic partners and consultants;

•competition in our industry, including the development of new products by others that may provide alternative or better therapies;

•failure to secure and enforce our intellectual property rights;

•risks associated with use of biological and hazardous materials;

•acceptance of our potential products by healthcare providers and patients; and

•our dependence on key personnel.

Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in “Item 1A. Risk Factors” in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2006.

i

PART I – FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

Lipid Sciences, Inc.

(A Development Stage Company)

Condensed Consolidated Balance Sheet (Unaudited)

(In thousands, except share amounts)	March 31, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents	$	2,244		$	1,752
Short-term investments	10,389			12,836
Prepaid expenses	239			355
Other current assets	36			18
Total current assets	12,908			14,961
Property and equipment	381			419
Long-term lease deposits	19			19
Total assets	$	13,308		$	15,399
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	1,488		$	1,292
Accrued related party royalties	375			250
Accrued compensation	530			390
Taxes payable	3			—
Total current liabilities	2,396			1,932
Deferred rent	11			9
Total liabilities	2,407			1,941
Stockholders’ equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized and issuable; no shares outstanding	—			—
Common stock, $0.001 par value; 75,000,000 shares authorized; 27,372,767 and 27,359,267 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively	27			27
Additional paid-in capital	77,152			76,712
Deficit accumulated in the development stage	(66,278		)	(63,281		)
Total stockholders’ equity	10,901			13,458
Total liabilities and stockholders’ equity	$	13,308		$	15,399

See accompanying Notes to Condensed Consolidated Financial Statements

1

Lipid Sciences, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Operations (Unaudited)

	Three Months Ended March 31,						Period from Inception (May 21, 1999) to March 31,
(In thousands, except per share amounts)	2006			2005			2006
Grant Revenue	$	22		$	—		$	63
Operating expenses:
Research and development (including non-cash stock option compensation expense of $222 and $41 for the three months ended March 31, 2006 and March 31, 2005, respectively)	1,950			1,624			54,198
Selling, general and administrative (including non-cash stock option compensation expense of $203 and zero for the three months ended March 31, 2006 and March 31, 2005, respectively)	1,209			848			24,273
Total operating expenses	3,159			2,472			78,471
Operating loss	(3,137		)	(2,472		)	(78,408		)
Interest and other income	140			87			3,723
Loss from continuing operations	(2,997		)	(2,385		)	(74,685		)
Income tax benefit	—			—			8,004
Net loss from continuing operations	(2,997		)	(2,385		)	(66,681		)
Discontinued operations:
Income from discontinued operations	—			—			582
Income tax expense	—			—			(179		)
Income from discontinued operations - net	—			—			403
Net loss	$	(2,997	)	$	(2,385	)	$	(66,278	)
Loss per share — basic and diluted:
Net loss per share	$	(0.11	)	$	(0.10	)
Weighted average number of common shares outstanding — basic and diluted	27,361			24,912

See accompanying Notes to Condensed Consolidated Financial Statements

2

Lipid Sciences, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Cash Flows (Unaudited)

	Three Months Ended March 31,						Period from Inception (May 21, 1999) to March 31,
(In thousands)	2006			2005			2006
Cash flows used in operating activities:
Net loss from continuing operations	$	(2,997	)	$	(2,385	)	$	(66,681	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation and amortization	53			61			1,230
Loss on disposal of assets	—			—			206
Accretion of discount on investments	(117		)	(60		)	(735		)
Stock compensation expense for options issued to consultants, employees and advisors	425			41			6,589
Issuance of warrants to consultants	—			—			1,044
Changes in operating assets and liabilities:
Prepaid expenses and other current assets	98			60			(275		)
Notes receivable	—			—			6,569
Other assets	—			—			(19		)
Taxes payable	3			4			3
Accounts payable and other current liabilities	196			198			(555		)
Accrued related party royalties	125			(375		)	375
Accrued compensation	140			9			530
Deferred rent	2			—			11
Net cash used in operating activities of continuing operations	(2,072		)	(2,447		)	(51,708		)
Cash flows provided by/(used in) investing activities:
Capital expenditures	(15		)	(11		)	(1,834		)
Proceeds from disposal of assets	—			—			17
Purchases of investments	(2,436		)	(3,448		)	(89,440		)
Maturities and sales of investments	5,000			4,000			79,786
Net cash provided by/(used in) investing activities of continuing operations	2,549			541			(11,471		)
Cash flows provided by financing activities:
Acquisition of NZ Corporation — cash acquired	—			—			20,666
Payment of acquisition costs	—			—			(1,863		)
Payment to repurchase stock	—			—			(12,513		)
Proceeds from sale of common stock, net of issuance costs	15			—			24,979
Proceeds from issuance of warrants	—			—			40
Net cash provided by financing activities of continuing operations	15			—			31,309
Net increase/(decrease) in cash and cash equivalents from continuing operations	492			(1,906		)	(31,870		)
Cash flows provided by discontinued operations
Operating activities	—			1,167			38,185
Investing activities	—			—			10,837
Financing activities	—			—			(14,908		)
Net cash provided by discontinued operations	—			1,167			34,114
Cash and cash equivalents at beginning of period	1,752			4,640			—
Cash and cash equivalents at end of period	$	2,244		$	3,901		$	2,244

3

Lipid Sciences, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Cash Flows (Unaudited) – (Continued)

	Three Months Ended March 31,				Period from Inception (May 21, 1999) to March 31,
(In thousands)	2006		2005		2006
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest (net of amount capitalized)	$	—	$	—	$	839
Income tax recovered	—		—		(1,473		)
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING TRANSACTIONS
Acquisition of NZ Corporation:
Current assets (other than cash)	$	—	$	—	$	1,040
Property and equipment	—		—		30,193
Commercial real estate loans	—		—		16,335
Notes and receivables	—		—		15,166
Investments in joint ventures	—		—		2,343
Current liabilities assumed	—		—		(1,947		)
Long-term debt assumed	—		—		(14,908		)
Deferred taxes associated with the acquisition	—		—		(7,936		)
Fair value of assets acquired (other than cash)	$	—	$	—	$	40,286

See accompanying Notes to Condensed Consolidated Financial Statements

4

Lipid Sciences, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1:ORGANIZATION AND BASIS OF PRESENTATION

On November 29, 2001, Lipid Sciences, Inc., a privately-held corporation, merged with and into NZ Corporation. NZ Corporation survived the merger and changed its name to Lipid Sciences, Inc. In this report, unless the context otherwise requires, the current company, Lipid Sciences, Inc., is referred to as “we,” “the Company” or “Lipid Sciences” with respect to periods of time from the effective date of the merger to the date of this report; the merged company, Lipid Sciences, Inc., a privately-held corporation, is referred to as “we” or “Pre-Merger Lipid” with respect to periods prior to the effective date of the merger; and NZ Corporation is referred to as “NZ,” with respect to periods prior to the effective date of the merger.

The Company is engaged in the research and development of products and processes intended to treat major medical indications such as cardiovascular disease and viral infections in which lipids, or fat components, play a key role. Our primary activities since incorporation have been conducting research and development (including pre-clinical studies); performing business, strategic and financial planning; and raising capital. Accordingly, the Company is considered to be in the development stage.

Historically, NZ engaged in various real estate and commercial real estate lending activities. On March 22, 2002, the Company formalized a plan to discontinue the operations of its real estate and real estate lending business, including commercial real estate loans, to fund the ongoing operations of Lipid Sciences’ biotechnology business. As a result, we have reclassified the results of operations and the assets and liabilities of the discontinued operations for all periods presented. The last remaining real estate asset was sold in February 2005.

In the course of our research and development activities, the Company has sustained continued operating losses and expects those losses to continue for the foreseeable future as we continue to invest in research and development and begin to allocate significant and increasing resources to clinical testing and other activities related to seeking approval to market our products. As of March 31, 2006, we had cash and cash equivalents and short-term investments equal to approximately $12.6 million. We anticipate that these assets will provide sufficient working capital for our operations, including our current development projects, through the first quarter of 2007. We expect additional capital will be required in the future. We intend to seek capital needed to fund our operations through new collaborations, such as licensing or other arrangements, through pursuit of research and development grants or through public or private financings.

The Condensed Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated upon consolidation.

The accompanying interim unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission, or SEC, and do not contain all of the information and footnotes required by GAAP and the SEC for annual financial statements. The results for interim periods are not necessarily indicative of the results to be expected for the full year. The December 31, 2005 balance sheet, as presented, was derived from the audited Consolidated Financial Statements as of December 31, 2005. These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2006.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates and assumptions.

5

NOTE 2:NET LOSS PER SHARE

The Company computes its net loss per share under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.”  Basic net loss per share is calculated by dividing net loss by the weighted average number of shares of common stock outstanding during the period.

Diluted net loss per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company had securities outstanding, which could potentially dilute basic net earnings per share, but because the Company incurred a net loss for all periods presented, such securities were excluded from the computation of diluted net loss per share as their effect would have been antidilutive. The securities excluded from diluted loss per share consist of the following:

	At March 31,
	2006	2005
Stock options	7,285,837	6,362,245
Warrants to purchase common stock	1,624,469	895,412
	8,910,306	7,257,657

NOTE 3:STOCK-BASED COMPENSATION

Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” “FAS 123(R),” which requires that compensation cost relating to share-based payment transactions be recognized in our financial statements. We have adopted FAS 123(R) on a modified prospective basis, which requires that compensation cost relating to all new awards and to awards modified, repurchased, or cancelled is recognized in our financial statements beginning January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of January 1, 2006 will be recognized as the requisite service is rendered on or after January 1, 2006. The pro forma disclosures previously permitted under SFAS No. 123, “Accounting for Stock-Based Compensation,” (“FAS 123”) are no longer an alternative to financial statement recognition.

Stock Option Plans

Prior to the merger, we maintained stock-based compensation plans for our employees, consultants and Directors. The 2000 Stock Option Plan (the “2000 Plan”), adopted by the Board of Directors in May 2000 and approved by stockholders on March 20, 2001, allows for the granting of options for up to 3,118,040 shares of common stock. Stock options granted under the 2000 Plan may be either incentive stock options or nonstatutory stock options. Options may be granted with exercise prices not less than the fair value of the Company’s common stock at the date of grant, as determined by the Board of Directors. All options granted pursuant to the 2000 Plan are to have a term not greater than 10 years from the date of grant. Options vest as determined by the Board of Directors, generally over four years (but not less than 20% of the total number of shares granted per year).

In October 1997, the Company’s Board of Directors approved the New Mexico and Arizona Land Company 1997 Stock Incentive Plan (the “1997 Plan”). The 1997 Plan provides that the following types of awards may be granted under the 1997 Plan: stock appreciation rights, incentive stock options, non-qualified stock options, restricted stock awards, unrestricted stock awards, and performance share awards which entitle recipients to acquire shares upon the attainment of specified performance goals. Under the 1997 Plan, awards may be granted with respect to a maximum of 900,000 shares of the Company’s common stock, subject to adjustment in connection with certain events such as a stock split, merger or other recapitalization of the Company. We assumed the 1997 Plan as a result of the merger.

In November 2001, the Company’s Board of Directors approved the 2001 Performance Equity Plan (the “2001 Plan”). The stockholders approved the Plan on November 29, 2001. The 2001 Plan allows for the granting of options for up to 5,000,000 shares of common stock to employees, officers, consultants, and Directors. The number of shares authorized automatically increases on January 1, in each of the calendar years 2002, 2003, 2004, 2005 and 2006 by an amount equal to 3% of the shares of common stock outstanding on December 31 of the immediately preceding calendar year, if the 2001 Plan is then in effect, but in no event shall any annual increase exceed 500,000 shares of common stock as reflected on the stock ledger of the Company. Stock options granted under the 2001 Plan may be either incentive stock options or nonstatutory stock options. Options may be granted with exercise prices not less than the fair value of the Company’s common stock at the date of grant, as determined by the Board of Directors. All options granted pursuant to the 2001 Plan are to have a term not greater than 10 years from the date of grant. Options vest as determined by the Board of Directors, generally over four years (but not less than 20% of the total number of shares granted per year).

At March 31, 2006, options to purchase 4,814,431 common shares remain available for grant under all the plans.

6

All options in the 2000 Plan were adjusted to reflect the 1.55902 merger exchange ratio with the number of shares underlying each option multiplied by the ratio and the related exercise prices divided by the ratio. All the above disclosures reflect the share and per share amounts on a post merger equivalent basis. Additionally, all historical stock option information of Pre-Merger Lipid that is provided herein has been similarly restated.

Other Required FAS 123(R) Disclosures in the First Period of Adoption

The following table represents stock option activity for the three months ended March 31, 2006:

	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life	Aggregate Intrinsic Value
Outstanding options at beginning of period	6,058,556		$	3.72
Granted	500,244		2.64
Exercised	(13,500	)	1.00
Forfeited	—		—
Outstanding options at end of period	6,545,300		$	3.64	6.43	$	2,456,491
Exercisable options at end of period	5,156,649		$	3.82	5.83	$	2,109,389

We use the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the following weighted-average assumptions for the indicated periods:

	Three Months Ended March 31,
	2006			2005
Risk-free interest rate	4.67		%	3.71		%
Expected life of options (in years)	4.00			2.19
Expected volatility	97.0		%	65.1		%
Expected dividend yield	—			—
Weighted-average grant-date fair value	$	1.84		$	1.45

The assumptions above are based on multiple factors, including historical exercise patterns of employees and post-vesting employment termination behaviors. We use historical data to estimate the options’ expected term, which represents the period of time that options granted are expected to be outstanding. Due to the relatively low trading volume of options on our common stock, we do not use implied volatility to determine the expected volatility of our common stock. Rather, the historical volatility that is commensurate with the expected life of the option on the date that it is measured is used as our estimate of future expected volatility. Since we have never paid any dividends and do not anticipate paying any dividends at least through the expected life of our stock options outstanding, we use an expected dividend yield of zero when calculating the fair value of stock options. The risk-free interest rate for periods within the contracutal life of the option is based on the U.S. Treasury yield curve in effect at the measurement date of the option.

FAS 123(R) requires that we estimate forfeitures, or the number of shares that are expected to be cancelled prior to vesting, at the time of grant, and adjust for actual forfeitures in subsequent periods if they differ from our original estimates. Based on our historical experience of options cancelled prior to vesting, we have assumed an annualized forfeiture rate of 12% for all new option grants. In the Company’s pro-forma information required under FAS 123 for the periods prior to fiscal 2006, we accounted for forfeitures as they occurred.

Had compensation expense for the Company’s employee stock option awards been determined based on the Black-Scholes fair value at the grant dates for awards under those plans consistent with the fair value method of FAS 123, the Company would have recorded additional compensation expense and its net loss and loss per share would have been reduced to the pro forma amounts presented in the following table:

7

	Three Months Ended March 31, 2005
Reported net loss	$	(2,385	)
Compensation expense for stock options	(248		)
Pro forma net loss	$	(2,633	)
Net loss per share — basic and diluted:
As reported	$	(0.10	)
Pro forma	$	(0.11	)

Total compensation cost for share-based payment arrangements recognized in income for the three months ended March 31, 2006 was approximately $425,000. This included approximately $392,000 and $33,000 for employee and non-employee share-based arrangements, respectively. The total compensation cost related to nonvested awards not yet recognized as of March 31, 2006 was approximately $1,853,000 and the weighted average expected remaining recognition period as of March 31, 2006 was approximately 2 years. We received $13,500 in gross proceeds as a result of 13,500 stock options exercised in the three month period ended March 31, 2006. We did not recognize any tax benefit related to these share-based arrangements as we are in a loss position and have a full valuation allowance against our tax benefits.

NOTE 4:RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” This statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements. The pro forma disclosures previously permitted under FAS 123 are no longer an alternative to financial statement recognition. This statement is effective beginning with our first quarter of fiscal 2006. We have adopted FAS 123(R) on a modified prospective basis and recognized $392,000 in expense related to the adoption of the new accounting standard (See Note 3).

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3.”  This statement changes the requirement for the accounting for and reporting of a change in accounting principle by requiring retroactive application of a voluntary change in accounting principle to prior period financial statements unless it is impracticable. This statement is effective beginning with our first quarter of fiscal 2006. We believe that the adoption of this statement will not have a material impact on our financial position, results of operations or cash flows.

In November 2005, the FASB issued FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“FSP 115-1”), which outlines a three-step model for identifying investment impairments in debt and equity securities within the scope of FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”), and cost-method investments. The three steps involve (1) determining whether the investment is impaired, (2) evaluating whether the impairment is other-than-temporary, and (3) if the impairment is other than temporary, recognizing an impairment loss. FSP 115-1 carries forward the disclosure requirements of Emerging Issues Task Force (“EITF”) Issue 03-1-1, “The Meaning of Other-Than-Temporary Impairment and its Applications to Certain Investments.”  FSP 115-1 is effective for reporting periods beginning after December 15, 2005. We believe that the adoption of FSP 115-1 will not have a material impact on our financial position, results of operations or cash flows.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statement No. 133 and 140.”  This statement clarifies the accounting for and reporting of the servicing of certain financial assets. This statement is effective for fiscal years beginning after September 15, 2006. We believe that the adoption of this statement will not have a material impact on our financial position, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.”  This statement clarifies the conditions that must exist to recognize a servicing asset or liability and permits an entity to choose between an amortization or fair value method for each class of separately recognized servicing assets and servicing liabilities. This statement is effective for fiscal years beginning after September 15, 2006. We believe that the adoption of this statement will not have a material impact on our financial position, results of operations or cash flows.

8

NOTE 5:RELATED PARTY TRANSACTIONS

In December 1999, we entered into an Intellectual Property License Agreement to obtain the exclusive worldwide rights to certain patents, trademarks, and technology with Aruba International Pty. Ltd. (“Aruba”), an Australian company controlled by Bill E. Cham, Ph.D., a founding stockholder of Pre-Merger Lipid and one of our former Directors. As consideration for the license, we issued Aruba 4,677,060 shares of our common stock valued at $250,000. Under this agreement, we are obligated to pay Aruba a continuing royalty on revenue in future years, subject to a minimum annual royalty amount of $500,000, 10% of any External Research Funding initiated by Dr. Cham and received by us to further this technology, as defined in the agreement, and $250,000 upon commencement of our initial human clinical trial utilizing the technology under the patents. The $250,000 related to the commencement of our initial human clinical trial was paid to Aruba in July 2002. In November 2004, all rights, title, interest and obligations covered under the Intellectual Property License Agreement were assigned to Aruba International B.V., a Netherlands company controlled by Dr. Cham. For the three month periods ended March 31, 2006 and 2005, we have expensed $125,000 and $125,000, respectively, related to this agreement. Amounts for 2006 and 2005 were charged to research and development expense. Accrued related party royalties under this agreement were $375,000 and $375,000 at March 31, 2006 and 2005, respectively.

On May 16, 2005 we entered into a consulting agreement with H. Bryan Brewer, Jr., M.D., a Director of the Company, and Washington Cardiovascular Associates, LLC (“WCA”), an entity beneficially owned by Dr. Brewer, pursuant to which WCA will provide the services of Dr. Brewer as the Company’s Chief Scientific Director. Dr. Brewer was also appointed Vice Chairman of the Company’s Board of Directors on May 16, 2005, and serves as Chairman of the Company’s Scientific Advisory Board. The consulting agreement is for a three year term. As consideration for Dr. Brewer’s services as Chief Scientific Director, we are required to pay WCA annual fees of $395,000. For the three months ended March 31, 2006, approximately $98,750 was charged to selling, general and administrative expense for fees related to the consulting agreement. In addition to the annual fee, we have granted Dr. Brewer an option award of 100,000 shares of our common stock to vest in three equal annual installments on the first, second and third anniversaries of the consulting agreement. For the three months ended March 31, 2006, approximately $28,000 was recorded as non-cash compensation charges related to the stock option awarded to Dr. Brewer under the consulting agreement.

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Form 10-Q contains forward-looking statements concerning plans, objectives, goals, strategies, future events or performance as well as all other statements which are not statements of historical fact. These statements contain words such as, but not limited to, “believes,” “anticipates,” “expects,” “estimates,” “projects,” “will,” “may” and “might.”  The forward-looking statements contained in this Form 10-Q reflect our current beliefs and expectations on the date of this Form 10-Q. Actual results, performance or outcomes may differ materially from what is expressed in the forward-looking statements. We have discussed the important factors, which we believe could cause actual results, performance or outcomes to differ materially from what is expressed in the forward-looking statements, in “Item 1A. Risk Factors” in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2006. We are not obligated to publicly announce any revisions to these forward-looking statements to reflect a change in facts or circumstances.

You should read the discussion below in conjunction with Part I, Item 1, “Financial Statements,” of this Form 10-Q and Part II, Items 7, 7A and 8, “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” “Quantitative and Qualitative Disclosures About Market Risk” and “Financial Statements and Supplementary Data,” respectively, of our Annual Report on Form 10-K for the year ended December 31, 2005.

Overview

We are a development-stage biotechnology company engaged in research and development of products and processes intended to treat major medical indications such as cardiovascular disease and viral infections in which lipids, or fat components, play a key role. Our primary activities since incorporation have been conducting research and development (including pre-clinical studies); performing business, strategic and financial planning; and raising capital, including, from the date of the merger, disposing of Company real estate assets. Accordingly, the Company is considered to be in the development stage.

On November 29, 2001, the merger between NZ and Pre-Merger Lipid was completed. The merger with NZ was accounted for under the purchase method of accounting and was treated as a reverse acquisition because the stockholders of Pre-Merger Lipid owned the majority of the Company’s common stock immediately after the merger. Pre-Merger Lipid was considered the acquiror for accounting and financial reporting purposes. Accordingly, all financial information prior to November 29, 2001 included in this report reflects Pre-Merger Lipid results. As a result of the merger, certain real estate assets were acquired, and thus our business was organized into two segments: Biotechnology and Real Estate. On March 22, 2002, we formalized a plan to discontinue the operations of our Real Estate segment, and as of December 31, 2004, we had completed the disposition of substantially all of the real estate assets and our business is no longer organized into two segments. The remaining real estate asset at December 31, 2004 was sold in February 2005 for $1,167,000.

In the course of our research and development activities, we have incurred significant operating losses and we expect these losses to continue for the foreseeable future as we continue to invest in research and development and begin to allocate significant and increasing resources to clinical testing and other activities related to seeking approval to market our products.

We intend to finance our operations through corporate partnerships, technology licensing, the pursuit of research and development grants, public or private financings, and cash on hand. We anticipate that existing cash, cash equivalents and short-term investments will provide sufficient working capital for our operations, which includes our current development projects, through the first quarter of 2007. In the longer term, we expect to additionally finance our operations through revenues from product sales and licenses, including outlicensing opportunities of our proprietary delipidation process for non-human health applications such as the field of animal health, upon receiving all relevant approvals. If adequate funds are not available to satisfy our requirements we may have to substantially reduce, or eliminate, certain areas of our product development activities, significantly limit our operations, or otherwise modify our business strategy.

In December 2005, the Company filed an Investigational Device Exemption (“IDE”) application with the Center for Devices and Radiological Health of the Food and Drug Administration (“FDA”) for their review. In January 2006, the FDA granted conditional approval of the IDE to allow the Company to begin a human clinical trial with the Company’s Plasma Delipidation System-2 (“PDS-2”). The Company was granted this approval subject to the condition that within 45 days it would submit a response to the questions and observations made by the FDA. The Company submitted its response on February 22, 2006, which was within 45 days of receiving conditional approval from the FDA. In addition, the FDA required the Company to obtain approval from the Institutional Review Board (“IRB”) of the MedStar Institute in Washington, D.C. to begin the trial.

On April 20, 2006, we announced that we received approval from the IRB. On April 28, 2006 that approval was submitted to the FDA as required. We are now prepared to begin our human clinical trial. The PDS-2 systems are in place at the trial site, Washington Hospital Center in Washington, D.C., and have been validated. The clinical trial support personnel are in place and have

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been trained. The planned process of validating every step of the human clinical trial protocol in preparation for the recruitment of the trial subjects is nearing completion. We have begun an outreach effort to the regional medical community to identify subjects within that patient population who might be suitable for recruitment into our human clinical trial, “A Randomized Single-Blind Placebo Controlled Study to Evaluate the Safety of the Lipid Sciences PDS-2 in Subjects with Prior Acute Coronary Syndrome.”  We expect to begin the process to recruit 30 patients on May 15, 2006.  The subjects of the trial will be between 18 and 75 years of age with angiographic evidence of Coronary Artery Disease in the target artery as defined by at least one lesion with an occlusion between 20-50%. An intravascular ultrasound assessment will be made before inclusion into the trial and after the conclusion of 7 weekly delipidation/re-infusion treatments. The treatment subjects will receive infusions of plasma that has been delipidated by the PDS-2 system; the control subjects will receive infusions of their own untreated plasma that has not been delipidated. Including the screening, treatment and post treatment analysis, the study duration for each subject will be approximately 10 weeks. It is expected that the total study will conclude by the end of 2006.

Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires that compensation cost relating to share-based payment transactions be recognized in our financial statements. We have adopted FAS 123(R) on a modified prospective basis, which requires that compensation cost relating to all new awards and to awards modified, repurchased, or cancelled is recognized in our financial statements beginning January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of January 1, 2006 will be recognized as the requisite service is rendered on or after January 1, 2006. The pro forma disclosures previously permitted under SFAS No. 123, “Accounting for Stock-Based Compensation,” are no longer an alternative to financial statement recognition.

Results of Continuing Operations – Three Months Ended March 31, 2006 and 2005

Revenue. We recognized $22,000 in grant revenue in the three months ended March 31, 2006. This grant revenue relates to the Small Business Technology Transfer grant awarded in the second quarter of 2004 by the National Institutes of Health, for a Virion Solvent Treatment for Severe Acute Respiratory Syndrome. The term of the grant was extended to March 31, 2007 during the three months ended March 31, 2006.

We have had no product revenues since our Inception (May 21, 1999). Future product revenues will depend on our ability to develop and commercialize our two primary platforms: HDL Therapy and Viral Immunotherapy.

Research and Development Expenses. Research and development expenses include applied and scientific research, regulatory and business development expenses. Research and development expenses increased approximately $326,000, or 20%, to $1,950,000 in the three months ended March 31, 2006 from $1,624,000 for the same period in 2005. The increase was due primarily to an increase in stock compensation expense. This non-cash stock compensation expense included approximately $189,000 related to employee stock option expense. As described above, we have implemented FAS 123(R) this quarter which requires us to recognize the fair value of employee stock options in the income statement, rather than as a pro-forma disclosure, which was allowed in prior periods. Outside research and development costs also increased in preparation of our human clinical trial of our HDL Therapy platform at Washington Hospital Center in Washington D.C. This increase was partially offset by a decrease in costs related to our non-human primate study at Wake Forest University Baptist Medical Center in Winston-Salem, North Carolina, which concluded in the second quarter of 2005.

While we allocate and track resources when required pursuant to the terms of development arrangements, our research team typically works on different platforms concurrently, and our equipment and intellectual property resources often are deployed over a range of products with a view to maximize the benefit of our investment. Accordingly, we have not, and do not intend to, separately track the costs for each of our research projects on a product-by-product basis. For the three months ended March 31, 2006 however, we estimate that the majority of our research and development expense was associated with our two primary platforms, HDL Therapy and Viral Immunotherapy.

Selling, General and Administrative Expenses. General and administrative expenses include costs associated with our business operations, inclusive of management, legal and finance, and accounting expenses. General and administrative expenses increased approximately $361,000, or 43%, to $1,209,000 in the three months ended March 31, 2006 from $848,000 for the same period in 2005. The increase was due primarily to an increase in stock compensation expense. This non-cash stock compensation expense included approximately $203,000 related to employee stock option expense resulting from the implementation of FAS 123(R).

Interest and Other Income. Interest and other income for the three months ended March 31, 2006 increased approximately $53,000, or 61%, to $140,000 from $87,000 for the same period in 2005. The increase was due to higher yields earned on both our cash and short-term investment assets during the three months ended March 31, 2006.

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Liquidity and Capital Resources

The net cash used in operating activities was approximately $2,072,000 for the three months ended March 31, 2006, resulting primarily from operating losses incurred. The net cash used in operating activities for the three months ended March 31, 2005, was approximately $2,447,000, resulting from operating losses incurred, and a $500,000 payment of related party royalties, which reflected the minimum annual royalty due to Bill E. Cham, Ph.D., a founding stockholder of Pre-Merger Lipid and one of our former Directors.

The net cash provided by investing activities was approximately $2,549,000 and $541,000 for the three months ended March 31, 2006 and March 31, 2005, respectively. The net cash provided by investing activities for the periods were primarily attributable to the purchase and subsequent maturities of short-term investments.

The net cash provided by financing activities was approximately $15,000 for the three month periods ended March 31, 2006. The net cash provided by financing activities for the three month period ended March 31, 2006 was attributable to the proceeds received from employee stock option exercises.

Net cash provided by discontinued operations was approximately $1,167,000 for the three month periods ended March 31, 2005 and was primarily attributable to the sale of royalty credits in February 2005, representing the disposition of our last remaining real estate asset.

In September 2005, we completed the private placement of 2,430,198 shares of the Company’s common stock at a price of $2.98 per share, for an aggregate offering price of approximately $7.2 million, to institutional accredited investors (the “Investors”). Pursuant to the terms of the private placement, we issued to the Investors warrants to purchase 729,057 shares of common stock at $4.20 per share and Additional Investment Rights (“AIRs”) in the form of warrants to purchase 1,215,096 shares of common stock at $3.73 per share. The AIRs expired March 29, 2006, and the warrants will expire September 30, 2010. Up to 607,509 additional shares of common stock are issuable as a result of potential future adjustments to the exercise price of the warrants. In connection with the private placement, approximately $490,000 was paid to A.G. Edwards who acted as the placement agent for the transaction.

Our principal uses of funds are expected to be the payment of operating expenses and continued research and development funding to support our HDL Therapy and Viral Immunotherapy platforms. The expected use of funds related to our HDL Therapy platform includes costs associated with conducting our human clinical trial. The expected use of our funds related to our Viral Immunotherapy platform includes costs associated with our non-human primate study. We believe the results of this non-human primate study could lead to the initiation of a human clinical trial for the treatment of HIV-infected patients, with approval from the FDA, or to an offshore human study in collaboration with a partner. We expect our principal sources of funds to be cash on hand. As of March 31, 2006 we had cash and cash equivalents and short-term investments equal to approximately $12,600,000. We anticipate that these assets will provide sufficient working capital for our operations, which include our current development projects and human clinical trial, through the first quarter of 2007. We expect additional capital will be required in the future. Our Board of Directors continues to consider third-party inquiries and explore strategic initiatives, public or private financings, and the formation of strategic development or licensing partnerships. However, there can be no assurance that funds secured from any of these efforts, if obtained, will be sufficient to meet the Company’s future cash requirements.

Contractual Obligations

Future estimated contractual obligations are:

(In thousands)	2006		2007		2008		2009		2010		2011		Total
Operating Leases	$	206	$	211	$	217	$	223	$	56	$	—	$	913
Purchase Obligations	36		—		—		—		—		—		36
Royalty Payments*	500		500		500		500		500		500		3,000
Total	$	742	$	711	$	717	$	723	$	556	$	500	$	3,949

*We have agreed to pay annual royalties in the amount of $500,000 to Aruba International B.V. in exchange for the exclusive worldwide rights to certain patents, trademarks, and technology. Under certain circumstances, additional payments related to this agreement could be required in the future. The amounts presented in the above table reflect the minimum annual royalty amount payable through the next six years.

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Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or Special Purpose Entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies

In December 2001, the Securities and Exchange Commission (“SEC”), required that all registrants disclose and describe their “critical accounting policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results of operations and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. In applying those policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry and information available from other outside sources, as appropriate. We believe that the following accounting policy, which changed during the three month period ended March 31, 2006, as a result of the adoption of FAS 123(R), fits this definition:

Stock-Based Compensation

The Company accounts for all stock options in accordance with the provisions SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires that compensation cost relating to share-based payment transactions be recognized in our financial statements  The Company accounts for stock-based awards to non-employees in accordance with FAS 123(R)and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Significant judgment is required on the part of management in determining the proper assumptions to use in the computation of the amounts to be recorded pursuant to the provisions of FAS 123(R). The fair value of each option granted to an employee is estimated on the date of grant using the Black-Scholes option valuation model.

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 generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. Our significant accounting policies are more fully described in our audited Consolidated Financial Statements and notes thereto for the year ended December 31, 2005, which appear in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2006.

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ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk associated with changes in interest rates relates to our investment portfolio. We maintain an investment portfolio consisting of government issued securities. These investments are classified as held-to-maturity and are accounted for at their amortized cost, as per SFAS No. 115.

As of March 31, 2006, the amortized cost of our investment portfolio, which equaled approximately $10,389,000 exceeded the market value of the investments contained in the portfolio by approximately $11,000. We have both the ability and intent to hold the securities contained in the investment portfolio until their respective maturity dates. Additionally, all securities contained in the investment portfolio have maturity dates of less than one year. Therefore, we have concluded that this unrealized loss is not considered “other than temporary,” as defined by FSP 115-1, and we have not booked any impairment charges related to this unrealized loss. Due to the short duration of our investment portfolio, an immediate 10% change in market interest rates would not have a material impact on the value of our investment portfolio.

ITEM 4.CONTROLS AND PROCEDURES

(a)Evaluation of Disclosure Controls and Procedures. Our President and Chief Executive Officer and our Chief Financial Officer have performed an evaluation, required pursuant to Rule 13a-15(b) or 15d-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them, on a timely basis, to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic filings under the Exchange Act.

(b)Changes in Internal Controls Over Financial Reporting. There have not been any significant changes in our internal controls over financial reporting (as such item is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1.LEGAL PROCEEDINGS

We are from time to time a party to legal proceedings. All of the legal proceedings we are currently involved in are ordinary and routine. The outcomes of the legal proceedings are uncertain until they are completed. We believe that the results of the current proceedings will not have a material adverse effect on our business or financial condition or results of operations.

ITEM 1A.RISK FACTORS

There have been no material changes from the risk factors previously disclosed in our 2005 Form 10-K, filed on March 15, 2006.

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5.OTHER INFORMATION

None.

ITEM 6.EXHIBITS

(a)Exhibits - - See Exhibit Index.

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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.

Date: May 10, 2006	Lipid Sciences, Inc.
	By:	/s/ Sandra Gardiner
	Sandra Gardiner
	Chief Financial Officer*

*Signing on behalf of the Registrant as a duly authorized officer and as the Principal Financial Officer of the Registrant

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EXHIBIT INDEX

Exhibit Number	Description
3.1	Certificate of Incorporation. Previously filed as Exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 13, 2002.
10.1	Employment Agreement with S. Lewis Meyer, effective April 14, 2006.
31.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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EX-10.1

Exhibit 10.1

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT is effective as of this 14th day of April 2006 by and between LIPID SCIENCES, INC., a Delaware corporation (the “Company”), and S. LEWIS MEYER, Ph.D., an individual (the “Employee”).

W I T N E S S E T H:

WHEREAS, the Company desires to continue to employ the Employee in the manner hereinafter specified and to make provision for payment of reasonable compensation to the Employee for such services, and the Employee is willing to be employed by the Company to perform the duties incident to such employment upon the terms and conditions hereinafter set forth; and

WHEREAS, the parties desire to enter into this Agreement as of the Effective Date (as hereinafter defined), setting forth the terms and conditions of the employment relationship of the Employee with the Company during the Term (as hereinafter defined).

NOW, THEREFORE, in consideration of the foregoing premises, the mutual covenants, terms and conditions set forth herein, and other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows:

1.             EMPLOYMENT AND DUTIES

(a)           General.  Effective as of the Effective Date, the Company hereby employs the Employee as Chief Executive Officer and President of the Company and the Employee agrees upon the terms and conditions herein set forth to be employed by the Company.  The Employee shall diligently perform all of the duties normally accorded to such position and shall report directly to the Board of Directors of the Company (the “Board”).

(b)           Services.  During the Term, the Employee shall well and faithfully serve the Company, and shall devote substantially all of his business time and attention to the performance of the duties of such employment and the advancement of the best interests of the Company and shall not, directly or indirectly, render services to any other person or organization for which he receives compensation without the prior written approval of the Board.  No such approval shall be required in connection with services the Employee performs with respect to other persons and entities, including, but not limited, to Lexrite Labs and the Ambient Capital Group, provided that the aggregate amount of time spent on these services does not exceed a maximum of eight hours per week and that such services do not contravene the provisions of Section 5 hereof.  The Employee hereby agrees to refrain from engaging in any activity that does, shall or could reasonably be deemed to conflict with the best interests of the Company.

(c)           Location of Employment.  The Employee’s place of employment shall be at the office of the Company located in Pleasanton, California, but the Employee shall travel to the extent and to the places necessary for the performance of his duties to the Company.

2.             TERM OF EMPLOYMENT

The term of the Employee’s employment under this Agreement shall commence on April 14, 2006 (the “Effective Date”) and continue until the second anniversary thereof (the “Term”).

3.             COMPENSATION AND OTHER BENEFITS

Subject to the provisions of this Agreement including without limitation the termination provisions contained in Section 4, the Company shall pay and provide the following compensation and other benefits to the Employee during the Term as compensation for all services rendered hereunder:

(a)           Salary.  The Company shall pay to the Employee a salary (the “Salary”) at a rate of $290,000 per annum, payable to the Employee in accordance with the normal payroll practices of the Company as are in effect from time to time.  The amount of the Salary shall be reviewed annually by the Compensation Committee of the Board and may be increased on the basis of the review.

(b)           Annual Performance Bonus.  The Employee shall be eligible to earn an annual discretionary cash bonus (the “Annual Bonus”) in an amount and subject to such other terms and conditions, including performance objectives, as are determined, by the Board.

(c)           Expenses.  The Company shall pay or reimburse the Employee for all reasonable out-of-pocket expenses incurred by the Employee in connection with his employment hereunder upon submission of appropriate documentation or receipts in accordance with the policies and procedures of the Company as are in effect from time to time.  No expense payment or reimbursement under this Section 3(d) shall be “grossed up” or increased to take into account any tax liability incurred by the Employee as a result of such payment or reimbursement.

(d)           Retirement, Welfare and Fringe Benefits.  The Employee shall be eligible to participate in the retirement, medical, disability and life insurance plans applicable to senior officers of the Company generally in accordance with the terms of such plans as in effect from time to time.  The foregoing shall not be construed to limit the ability of the Company or any of its affiliates to amend, modify or terminate any such benefit plans, policies or programs at any time and from time to time.

(e)           Vacation.  The Employee shall be entitled to annual vacation in accordance with the Company’s policies applicable to senior officers of the Company generally as are in effect from time to time.

4.             TERMINATION OF EMPLOYMENT

Subject to the notice and other provisions of this Section 4, the Company shall have the right to terminate the Employee’s employment hereunder, and the Employee shall have the right to resign, at any time for any reason or for no stated reason.

(a)           Termination for Cause or Resignation.  (i) If, prior to the expiration of the Term, the Employee’s employment is terminated by the Company for “Cause” (as hereinafter

2

defined) or if the Employee resigns from his employment hereunder, the Employee shall be entitled to payment of (A) his Salary accrued up to and including the date of termination or resignation, and (B) any unreimbursed expenses.  Except to the extent required by the terms of the benefits provided under Section 3(e) or applicable law, the Employee shall have no right under this Agreement or otherwise to receive any other compensation or to participate in any other plan, program or arrangement after such termination or resignation of employment with respect to the year of such termination or resignation and later years.

(ii)           Termination for “Cause” shall mean a termination of the Employee’s employment with the Company because of (A) a plea of guilty or nolo contendere to, or conviction for, the commission of a felony offense by the Employee; (B) the involvement by the Employee as a party to any litigation or regulatory proceeding or in any other circumstance known to the general public that, in the good faith determination of the Board, is reasonably certain to subject the Employee, the Company or its affiliates to disrepute, ridicule, contempt or scandal or that is reasonably certain to reflect unfavorably upon the reputation of the Employee, the Company or its affiliates or the Company’s products or technologies; (C) the willful and continued failure to perform in any material respect the Employee’s duties; (D) an intentional act of fraud, embezzlement, theft or a material and dishonest act against the Company or its affiliates; or (E) a material breach by the Employee of the terms and provisions of the Agreement.

(iii)          Termination of the Employee’s employment for Cause shall be communicated by delivery to the Employee of a written notice from the Company stating that the Employee will be terminated for Cause, specifying the particulars thereof and the effective date of such termination.  In the cases of Sections 4(a)(ii)(B), 4(a)(ii)(C) and 4(a)(ii)(E), the Employee shall have thirty (30) business days from the date of receipt of such notice to effect a cure of the actions constituting Cause, or to effect a cure of the adverse effect such actions.  Upon cure or correction thereof by the Employee to the reasonable satisfaction of the Company, the action shall no longer constitute Cause for purposes of this Agreement.  The date of a resignation by the Employee shall be the date specified in a written notice of resignation from the Employee to the Company.  The Employee shall provide at least 90 days’ advance written notice of his resignation.

(b)           Termination without Cause.

(i)            If, prior to the expiration of the Term, the Company terminates the Employee’s employment for any reason other than Disability or Cause (such termination or resignation being hereinafter referred to as a “Termination without Cause”), the Employee shall be entitled to (A) payment of his Salary accrued up to and including the date of such Termination without Cause, (B) payment of any unreimbursed expenses, and (C) severance, subject to the Employee’s execution and delivery of a release in the form then deemed appropriate by the Company and in exchange for consulting services of the Employee, consisting of (1) continuation of his Salary, at the rate in effect on the date of the Termination without Cause, for the lesser of 12 months commencing on the date next following the date of the Termination without Cause or the remaining term of the this Agreement (the “Severance Period”) and (2) continued participation on the same terms and conditions as are in effect immediately prior to the Termination without Cause in the Company’s health and medical plans

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provided to the Employee pursuant to Section 3(e) above at the time of such Termination without Cause through the expiration of the Severance Period, or until the Employee becomes eligible to participate in a subsequent employer’s benefit plan, whichever occurs first. Anything herein to the contrary notwithstanding, the Company shall have no obligation to continue to maintain during the Severance Period any plan, program or level of benefits solely as a result of the provisions of this Agreement, but this provision shall apply with respect to any substitute or replacement plan.

(ii)           The date of termination of employment without Cause shall be the date specified in a written notice of termination to the Employee.

(c)           Termination Due to Disability.  In the event of the Employee’s Disability, the Company shall be entitled to terminate his employment.  In the case that the Company terminates the Employee’s employment due to Disability, the Employee shall be entitled to his Salary up to and including the date of termination as well as any unpaid expense reimbursements.  As used in this Section 4(c), the term “Disability” shall mean the Company’s determination that due to physical or mental illness or incapacity, whether total or partial, the Employee is substantially unable to perform his duties hereunder for a period of 90 consecutive days or shorter periods aggregating 90 days during any period of 180 consecutive days.

(d)           Death.  Except as provided in this Section 4(d), no Salary or benefits shall be payable under this Agreement following the date of the Employee’s death.  In the event of the Employee’s death, any Salary earned by the Employee up to the date of death, as well as any unreimbursed expenses, shall be paid to the Employee’s estate or Employee’s named beneficiary within a reasonable period following his death.

5.             PROTECTION OF THE COMPANY’S INTEREST

(a)           Employee Confidential Information and Invention Agreement.  The Employee hereby acknowledges that he has previously executed and delivered to the Company the Company’s Employee Confidential Information and Invention Agreement (the “Confidentiality Agreement”), which is attached hereto as Annex A.  The Employee hereby acknowledges and understands that the provisions of the Confidentiality Agreement are incorporated into this Agreement.

(b)           Protection of Trade Secrets; Non-Solicitation.

(i)            The Employee acknowledges that in the course of his employment with the Company, he has and will in the course of his continued employment with the Company become familiar with the trade secrets of the Company and its affiliates and with other Confidential Information (as defined in the Confidentiality Agreement) concerning the business of the Company and its affiliates and that his services have been and will be of special, and unique and extraordinary value to the Company and its affiliates.  Because of the foregoing and in further consideration of the compensation and other benefits to be provided to the Employee hereunder, the Employee hereby agrees that, during the Term, and at any time thereafter, he shall not, directly or indirectly, use trade secrets (as such term is defined in Section 3426(1)(d) of the

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Uniform Trade Secrets Act) of the Company or its affiliates or Confidential Information or otherwise engage in unfair competition against the Company or any of its affiliates.

(ii)           During the Term, and continuing through the first anniversary of the termination date of the Employee’s employment for any reason (the “Restricted Period”), the Employee shall not directly or indirectly through another person or entity induce or attempt to induce any customer, supplier, licensee, licensor, franchisee or other business relation of the Company or any such affiliate that is within any geographical area in which the Company or its affiliates engage or plan to engage in such businesses to cease doing business with the Company or such affiliate or in any way interfere with the relationship between any such customer, supplier, licensee or business relation and the Company or any such affiliate.

(c)           Extension of Time of Restrictions.  The Restricted Period shall be extended by the length of any period during which the Employee is in breach of the restrictions set forth in Section 5(b).

(d)           Non-Disparagement.  The Employee agrees that at any time during his employment with the Company or at any time thereafter, the Employee shall not make, or cause or assist any other person to make, any statement or other communication which impugns or attacks, or is otherwise critical of, the reputation, business or character of the Company, any subsidiary or any of their respective officers, directors, employees, products or services.

(e)           Enforcement.  The Employee hereby acknowledges that he has carefully reviewed the provisions of this Agreement and agrees that the provisions are fair and equitable, and that they are necessary and reasonable in order to protect the Company and its affiliates in the conduct of their business.  However, in light of the possibility of differing interpretations of law and change in circumstances, the parties hereto agree that if any one or more of the provisions of this Section 5 (including any provision contained in the Confidentiality Agreement) is determined by a court or other tribunal of competent jurisdiction to be invalid, void or unenforceable under circumstances then existing, the parties hereto agree that the maximum period, scope or geographical area reasonable or enforceable under such circumstances shall be substituted for the stated period, scope or area.

(f)            Remedies.  The Employee acknowledges that the Company has a compelling business interest in preventing unfair competition stemming from the intentional or inadvertent use or disclosure of the Company’s confidential and proprietary information, including trade secrets of the Company.  The Employee further acknowledges and agrees that damages for a breach or threatened breach of any of the covenants set forth in this Section 5 (including any provision contained in the Confidentiality Agreement) will be difficult to determine and will not afford a full and adequate remedy, and therefore agrees that the Company, in addition to seeking actual damages in connection therewith and the termination of the Company’s obligations in Section 4(b), may seek specific enforcement of any such covenant in any court of competent jurisdiction, including, without limitation, by the issuance of a temporary or permanent injunction without the necessity of showing any actual damages or posting any bond or furnishing any other security, and that the specific enforcement of the provisions of this Agreement will not diminish the Employee’s ability to earn a livelihood or create or impose upon the Employee any undue hardship. The Employee also agrees that any

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request for such relief by the Company shall be in addition to, and without prejudice to, any claim for monetary damages that the Company may elect to assert.

6.             GENERAL PROVISIONS

(a)           No Other Severance Benefits.  Except as specifically set forth in this Agreement, the Employee covenants and agrees that he shall not be entitled to any other form of severance benefits from the Company, including, without limitation, benefits otherwise payable under the Company’s regular severance policies, if any, in the event his employment hereunder ends for any reason and, except with respect to obligations of the Company expressly provided for herein, the Employee unconditionally releases the Company and its subsidiaries and affiliates, and their respective directors, officers, employees and stockholders, or any of them, from any and all claims, liabilities or obligations under any severance arrangements of the Company or any of its subsidiaries or affiliates.

(b)           Tax Withholding.  All amounts paid to Employee hereunder shall be subject to all applicable federal, state and local wage withholding.

(c)           Notices.  Any notice hereunder by either party to the other shall be given in writing by personal delivery, or certified mail, return receipt requested, or (if to the Company) by facsimile, in any case delivered to the applicable address set forth below:

(i)	To the Company:	Lipid Sciences, Inc.
		7068 Koll Center Parkway, Suite 401
		Pleasanton, CA 94566-3111
		Facsimile No.: (925) 249-4000
		Attn: Chairman of the Board of Directors
	With a copy to:	Shearman & Sterling
		1080 Marsh Road
		Menlo Park, CA 94025
		Facsimile No.: (650) 838-3699
		Attn: James B. Bucher, Esq.
(ii)	To the Employee:	S. Lewis Meyer, Ph.D.
		Last known residential address
		and fax number on file with the Company

or to such other persons or other addresses as either party may specify to the other in writing.

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(d)           Representation by the Employee.  The Employee represents and warrants that his entering into this Agreement does not, and that his performance under this Agreement and consummation of the transactions contemplated hereby will not, violate the provisions of any agreement or instrument to which the Employee is a party or any decree, judgment or order to which the Employee is subject, and that this Agreement constitutes a valid and binding obligation of the Employee in accordance with its terms.  Breach of this representation will render all of the Company’s obligations under this Agreement void ab initio.

(e)           Assignment; Assumption of Agreement.  No right, benefit or interest hereunder shall be subject to assignment, encumbrance, charge, pledge, hypothecation or setoff by the Employee in respect of any claim, debt, obligation or similar process.  The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets of the Company to assume expressly and to agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place.

(f)            Amendment.  No provision of this Agreement may be amended, modified, waived or discharged unless such amendment, modification, waiver or discharge is agreed to in writing and signed by the parties.  No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.

(g)           Severability.  If any term or provision hereof is determined to be invalid or unenforceable in a final court or arbitration proceeding, (i) the remaining terms and provisions hereof shall be unimpaired and (ii) the invalid or unenforceable term or provision shall be deemed replaced by a term or provision that is valid and enforceable and that comes closest to expressing the intention of the invalid or unenforceable term or provision.

(h)           Governing Law.  This Agreement shall be governed by and construed in accordance with the laws of the State of California (determined without regard to the choice of law provisions thereof).

(i)            Entire Agreement.  This Agreement and the Confidentiality Agreement contain the entire agreement of the Employee, the Company and any predecessors or affiliates thereof with respect to the subject matter hereof and all prior agreements and negotiations are superceded hereby.

(j)            Counterparts.  This Agreement may be executed by the parties hereto in counterparts, each of which shall be deemed an original, but both such counterparts shall together constitute one and the same document.

(k)           Survival.  The provisions of Section 5 (including the provisions of the Confidentiality Agreement) shall survive the termination of this Agreement.

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IN WITNESS WHEREOF, the parties have executed this Agreement, effective as of the day and year first written above.

LIPID SCIENCES, INC.
By:	/s/ Sandra Gardiner
	Name:	Sandra Gardiner
	Title:	Chief Financial Officer

EMPLOYEE
By:	/s/ S. Lewis Meyer, Ph.D.
	S. LEWIS MEYER, Ph.D.

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EX-31.1

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT

I, S. Lewis Meyer, Ph.D., certify that:

1.I have reviewed this quarterly report on Form 10-Q of Lipid Sciences, Inc.

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report.

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report.

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f) for the registrant and have:

a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a.All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date:  May 10, 2006

/s/ S. Lewis Meyer, Ph.D.

S. Lewis Meyer, Ph.D.

President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT

I, Sandra Gardiner, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Lipid Sciences, Inc.

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report.

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report.

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f) for the registrant and have:

a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of:

a.All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date:  May 10, 2006

/s/ Sandra Gardiner

Sandra Gardiner

Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

This certification is not to be deemed filed pursuant to the Securities Exchange Act of 1934, as amended, and does not constitute a part of the Quarterly Report of Lipid Sciences, Inc. (the “Company”) on Form 10-Q for the period ending March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”).

In connection with this Report, we, S. Lewis Meyer, Ph.D., President and Chief Executive Officer of the Company and Sandra Gardiner, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: May 10, 2006

/s/ S. Lewis Meyer, Ph.D.

S. Lewis Meyer, Ph.D.

President and Chief Executive Officer

/s/ Sandra Gardiner

Sandra Gardiner

Chief Financial Officer