10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 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 x    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 x                                             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 x

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 July 31, 2006
Common Stock
$0.001 par value		27,372,767

LIPID SCIENCES, INC.

FORM 10-Q

For the Period Ended June 30, 2006

Table of Contents

		Page No.
PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005	1
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005, and cumulative period from Inception (May 21, 1999) to June 30, 2006	2
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005, and cumulative period from Inception (May 21, 1999) to June 30, 2006	3
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	16
Item 4.	Controls and Procedures	16
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		17
Item 1A.	Risk Factors		17
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		17
Item 3.	Defaults upon Senior Securities		17
Item 4.	Submission of Matters to a Vote of Security Holders		17
Item 5.	Other Information		17
Item 6.	Exhibits		17
SIGNATURES		18
INDEX TO EXHIBITS FOR FORM 10-Q		19

PART I — FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

Lipid Sciences, Inc.
(A Development Stage Company)
Condensed Consolidated Balance Sheets (Unaudited)

(In thousands, except share amounts)	June 30, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents	$	3,459		$	1,752
Short-term investments	6,437			12,836
Prepaid expenses	150			355
Other current assets	14			18
Total current assets	10,060			14,961
Property and equipment	434			419
Long-term lease deposits	19			19
Total assets	$	10,513		$	15,399
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	1,129		$	1,292
Accrued related party royalties	500			250
Accrued compensation	410			390
Taxes payable	6			—
Other current liabilities	43			—
Total current liabilities	2,088			1,932
Deferred rent	13			9
Total liabilities	2,101			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 June 30, 2006 and December 31, 2005, respectively	27			27
Additional paid-in capital	77,247			76,712
Deficit accumulated in the development stage	(68,862		)	(63,281		)
Total stockholders’ equity	8,412			13,458
Total liabilities and stockholders’ equity	$	10,513		$	15,399

See accompanying Notes to Condensed Consolidated Financial Statements

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Lipid Sciences, Inc.
(A Development Stage Company)

Condensed Consolidated Statements of Operations (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,						Period from Inception (May 21, 1999) to June 30,
(In thousands, except per share amounts)	2006			2005			2006			2005			2006
Grant revenue	$	6		$	1		$	27		$	1		$	69
Operating expenses:
Research and development(1)	1,749			1,872			3,698			3,495			55,947
Selling, general and administrative(2)	965			861			2,174			1,709			25,238
Total operating expenses	2,714			2,733			5,872			5,204			81,185
Operating loss	(2,708		)	(2,732		)	(5,845		)	(5,203		)	(81,116		)
Interest and other income	124			102			264			189			3,847
Loss from continuing operations	(2,584		)	(2,630		)	(5,581		)	(5,014		)	(77,269		)
Income tax benefit	—			—			—			—			8,004
Net loss from continuing operations	(2,584		)	(2,630		)	(5,581		)	(5,014		)	(69,265		)
Discontinued operations:
Income from discontinued operations	—			—			—			—			582
Income tax expense	—			—			—			—			(179		)
Income from discontinued operations — net	—			—			—			—			403
Net loss	$	(2,584	)	$	(2,630	)	$	(5,581	)	$	(5,014	)	$	(68,862	)
Loss per share — basic and diluted:
Net loss per share	$	(0.09	)	$	(0.11	)	$	(0.20	)	$	(0.20	)
Weighted average number of common shares outstanding — basic and diluted	27,373			24,920			27,367			24,916
Non-cash stock option compensation expense included in operating expenses:
(1)Research and development	(21		)	101			201			142
(2)Selling, general and administrative	136			21			339			21

See accompanying Notes to Condensed Consolidated Financial Statements

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Lipid Sciences, Inc.
(A Development Stage Company)
Condensed Consolidated Statements of Cash Flows (Unaudited)

	Six Months Ended  June 30,						Period from Inception  (May 21, 1999) to June 30,
(In thousands)	2006			2005			2006
Cash flows used in operating activities:
Net loss from continuing operations	$	(5,581	)	$	(5,014	)	$	(69,265	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation and amortization	110			114			1,287
Loss on disposal of assets	—			—			206
Accretion of discount on investments	(210		)	(136		)	(828		)
Stock compensation expense for options issued to consultants, employees and advisors	540			162			6,705
Issuance of warrants to consultants	—			—			1,044
Changes in operating assets and liabilities:
Prepaid expenses and other current assets	209			137			(164		)
Notes receivable	—			—			6,569
Other assets	—			(19		)	(19		)
Taxes payable	6			4			6
Accounts payable and other current liabilities	(140		)	537			(892		)
Accrued related party royalties	250			(250		)	500
Accrued compensation	20			(170		)	410
Deferred rent	4			3			13
Net cash used in operating activities of continuing operations	(4,792		)	(4,632		)	(54,428		)
Cash flows provided by/(used in) investing activities:
Capital expenditures	(125		)	(41		)	(1,944		)
Proceeds from disposal of assets	—			—			17
Restricted cash	—			105			—
Purchases of investments	(4,391		)	(7,368		)	(91,395		)
Maturities and sales of investments	11,000			10,000			85,786
Net cash provided by/(used in) investing activities of continuing operations	6,484			2,696			(7,536		)
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			10			24,979
Proceeds from issuance of warrants	—			—			40
Net cash provided by financing activities of continuing operations	15			10			31,309
Net increase/(decrease) in cash and cash equivalents from continuing operations	1,707			(1,926		)	(30,655		)
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	$	3,459		$	3,881		$	3,459

3

Lipid Sciences, Inc.
(A Development Stage Company)
Condensed Consolidated Statements of Cash Flows (Unaudited) — (Continued)

	Six Months Ended				Period from Inception (May 21, 1999) to
	June 30,				June 30,
(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
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING TRANSACTIONS
Accrued financing costs	$	20	$	—-	$	20

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, clinical and 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 June 30, 2006, we had cash and cash equivalents and short-term investments equal to approximately $9.9 million.  We anticipate that these assets, in addition to the $6.3 million in gross proceeds received from the recently completed financing involving the sale of 4,993,781 shares of our common stock and warrants exercisable for an additional 1,498,127 shares of common stock completed on August 8, 2006, will provide sufficient working capital for our operations, including our current development projects, into the fourth 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.  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.

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.

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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 June 30,
	2006	2005
Stock options	7,378,337	6,846,183
Warrants to purchase common stock	1,468,567	895,412
	8,846,904	7,741,595

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, but 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, but generally over four years (but not less than 20% of the total number of shares granted per year).

6

At June 30, 2006, options to purchase an aggregate of 4,721,931 shares of common stock remain available for grant under all the plans.

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

The following table represents stock option activity for the three months ended June 30, 2006:

	Number of Shares	Weighted-Average Exercise Price		Weighted-Average Remaining  Contract Life	Aggregate Intrinsic Value
Outstanding options at beginning of period	6,545,300	$	3.64
Granted	92,500	1.61
Exercised	—	—
Forfeited	—	—
Outstanding options at end of period	6,637,800	$	3.61	6.23	$	95,521
Exercisable options at end of period	5,566,097	$	3.70	5.74	$	95,396

The following table represents stock option activity for the six months ended June 30, 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	592,744		2.48
Exercised	(13,500	)	1.00
Forfeited	—		—
Outstanding options at end of period	6,637,800		$	3.61	6.23	$	95,521
Exercisable options at end of period	5,566,097		$	3.70	5.74	$	95,396

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 June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Risk-free interest rate	5.01		%	3.63		%	4.73		%	3.65		%
Expected life of options (in years)	3.27			3.31			3.88			2.99
Expected volatility	85.5		%	87.6		%	95.2		%	81.2		%
Expected dividend yield	—			—			—			—
Weighted-average grant-date fair value	$	0.95		$	2.33		$	1.70		$	2.08

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

7

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 that have been 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:

	Three Months Ended			Six Months Ended
	June 30, 2005			June 30, 2005
Reported net loss	$	(2,630	)	$	(5,014	)
Add stock-based compensation included in net loss	21			21
Compensation expense for stock options	(514		)	(762		)
Pro forma net loss	$	(3,123	)	$	(5,755	)
Net loss per share — basic and diluted:
As reported	$	(0.11	)	$	(0.20	)
Pro forma	$	(0.13	)	$	(0.23	)

Total compensation cost for share-based payment arrangements recognized in income for the three and six month periods ended June 30, 2006 was approximately $115,000 and $540,000, respectively.  The compensation cost for share-based payment arrangements for the three month period ended June 30, 2006 was comprised of approximately $175,000 in employee related compensation expense and approximately $60,000 in non-employee related compensation income.  The compensation cost for share-based payment arrangements for the six month period ended June 30, 2006 was comprised of approximately $567,000 in employee related compensation expense and approximately $27,000 in non-employee related compensation income.  The total compensation cost related to nonvested awards not yet recognized as of June 30, 2006 was approximately $1,631,000 and the weighted average expected remaining recognition period as of June 30, 2006 was approximately 2.2 years.  We received $13,500 in gross proceeds as a result of the 13,500 stock options that were exercised in the six month period ended June 30, 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 approximately $115,000 and $540,000 in compensation cost for our share-based payment arrangements, for the three and six month periods ended June 30, 2006, respectively (See Note 3).

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” This interpretation prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.  This interpretation is effective for fiscal years beginning after December 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.

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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 June 30, 2006 and 2005, we have expensed $125,000 and $125,000, respectively, and for the six month periods ended June 30, 2006 and 2005 we have expensed $250,000 and $250,000, 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 $500,000 and $250,000 at June 30, 2006 and December 31, 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 periods ended June 30, 2006 and 2005, approximately $99,000 and $49,000 was charged to selling, general and administrative expense for fees related to the consulting agreement.  For the six month periods ended June 30, 2006 and 2005, approximately $198,000 and $49,000 was charged to selling, general and administrative expense for fee 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 and six month periods ended June 30, 2006, approximately $37,000 and $8,000, respectively, was recorded as non-cash compensation income related to the stock option awarded to Dr. Brewer under the consulting agreement.  For the three and six month periods ended June 30, 2005, approximately $32,000 was recorded as non-cash compensation expense related to the stock option awarded to Dr. Brewer under the consulting agreement.

In connection with the Company’s August 8, 2006 private placement, the Company sold 2,714,817 shares of common stock and warrants exercisable for an additional 814,445 shares to Sterling Pacific Assets, Inc. in exchange for an investment of $3,421,000.  The shares and warrants held by Sterling Pacific Assets, Inc. are deemed beneficially owned by Mr. William Pope, an existing substantial shareholder of the Company and former Director of the Company.  The shares of common stock and warrants were issued to Sterling Pacific Assets, Inc. on the same terms as those offered to the other participating investors (See Note 6).

In addition, in the private placement the Company sold 257,933 shares of common stock for an aggregate investment of approximately $325,000 and warrants exercisable for an additional 77,376 shares to five members of our Board of Directors: Frank M. Placenti, Bosko Djordjevic, Gary S. Roubin, M.D., Ph.D.,  S. Lewis Meyer, Ph.D. and H. Bryan Brewer, Jr., M.D.   The individual investments made by each Director are listed in the table below.  The shares of common stock and warrants were issued on the same terms as those offered to the other participating investors (See Note 6).

Investor	Investment		Common Stock Issued	Warrants Issued
Directorship Services, Inc. Profit Sharing Trust(1)	$	14,999	11,904	3,571
Placenti Revocable Trust(2)	9,999		7,936	2,380
Bosko Djordjevic	100,000		79,365	23,809
Gary S. Roubin, M.D., Ph.D.	74,999		59,523	17,856
The Meyer Family Revocable Trust(3)	49,999		39,682	11,904
Washington Cardiovascular Associates, LLC(4)	74,999		59,523	17,856
	$	324,995	257,933	77,376

(1)    Frank M. Placenti serves as a Director pursuant to an arrangement between the Company and Directorship Services, Inc. (“DSI”). Directorship Services, Inc. Profit Sharing Trust was established by DSI as a retirement planning vehicle for DSI’s employees. Mr. Placenti is the sole trustee of the trust and, in such capacity, has sole beneficial ownership of all Company shares owned by the Trust.

(2)    The Placenti Revocable Trust is an estate planning trust of which Mr. Placenti is a trustee. In his capacity as a trustee of such trust, Mr. Placenti is deemed to have beneficial ownership of all Company shares held by the Placenti Revocable Trust.

(3)    The Meyer Family Revocable Trust is an estate planning trust of which S. Lewis Meyer, Ph.D. is a trustee. In his capacity as a trustee of such trust, Mr. Meyer is deemed to have beneficial ownership of all Company shares held by The Meyer Family Revocable Trust.

(4)    H. Bryan Brewer, Jr., M.D. serves as a Director pursuant to an arrangement between the Company and Washington Cardiovascular Associates, LLC, an entity owned by Dr. Brewer. Dr. Brewer is deemed a 100% beneficial owner of Washington Cardiovascular Associates, LLC.

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NOTE 6:  SUBSEQUENT EVENTS

On August 8, 2006, we completed the sale of  4,993,781 shares of common stock at $1.26 per share and warrants to purchase an additional 1,498,127 shares of common stock at $1.51 per share in a private placement to institutional and accredited investors which included several directors of the Company, for gross proceeds of approximately $6,300,000.  The purchase price for the shares was equal to the average of the volume weighted closing prices of the Company’s common stock over the ten trading days preceding the closing of the transaction.  The warrants are exercisable for a period of five years commencing on February 9, 2007 and terminating on February 9, 2012.  The exercise price of the warrants was equal to 120% of the average of the volume weighted closing prices of the Company’s common stock over the ten trading days preceding the closing of the transaction.  The warrants contain a full ratchet anti-dilution mechanism that switches to a weighted average anti-dilution mechanism after the effective date of a registration statement filed under the Securities Act of 1933 with respect to the shares issuable thereunder.  However, the exercise price may never adjust to less than $1.20 per share.  We have agreed to register the shares of common stock issued to the investors, including the shares issuable upon exercise of the warrants, for resale by the investors through the filing of a registration statement with the Securities and Exchange Commission.

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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, clinical and 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 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, in addition to the $6.3 million in gross proceeds received from the recently completed financing involving the sale of 4,993,781 shares of our common stock and warrants exercisable for an additional 1,498,127 shares of common stock completed on August 8, 2006, will provide sufficient working capital for our operations, including our current development projects, into the fourth 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.

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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.  On June 1, 2006, we announced that the first patient procedure had been completed in the Company’s 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”.  The subjects of the trial will be 30 male and female patients 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 (“IVUS”) 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.  Dr. Ron Waksman, Principal Investigator for the trial and Associate Director, Division of Cardiology, at Washington Hospital Center, expects to be able to present the complete safety and indication of effectiveness results from this trial at CRT (Cardiovascular Revascularization Therapies) 2007 to be held in Washington, D.C., March 7- 9, 2007.  As of the date of this filing, we have completed all 7 procedures for our first patient, all of which were well tolerated by the patient, recruited and initiated procedures in additional patients and are actively recruiting additional patients to enroll in the trial.

Effective January 1, 2006, we adopted Statement 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.

Upon expiration of his previous employment agreement, we entered into a two year employment agreement with S. Lewis Meyer, Ph.D., effective April 14, 2006, by which Dr. Meyer will continue as President and Chief Executive Officer, and Director of the Company.

Results of Continuing Operations — Three Months Ended June 30, 2006 and 2005

Revenue.  We recognized $6,000 in grant revenue in the three months ended June 30, 2006.  This grant revenue relates to the Small Business Technology Transfer (“STTR”) grant awarded in the second quarter of 2004 by the National Institutes of Health (“NIH”), for a Virion Solvent Treatment for Severe Acute Respiratory Syndrome.

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 decreased approximately $123,000, or 7%, to $1,749,000 in the three months ended June 30, 2006 from $1,872,000 for the same period in 2005.  The decrease was due primarily to a decrease in stock compensation expense.  This non-cash stock compensation expense includes approximately $39,000 related to employee stock option expense and $60,000 in non-employee stock option income.  As described above, we have implemented FAS 123(R) in the first quarter of 2006 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 decreased due to the completion of our non-human primate study at Wake Forest University Baptist Medical Center in Winston-Salem, North Carolina in the second quarter of 2005.  Offsetting this decrease was an increase in costs related to the preparation and commencement of a human clinical trial of our HDL Therapy platform at the Washington Hospital Center in Washington, D.C.

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.  However, for the three months ended June 30, 2006, 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 $104,000, or 12%, to $965,000 in the three months ended June 30, 2006 from $861,000 for the same period in 2005.  The increase was due primarily to an increase in stock compensation expense.  This non-cash stock compensation expense includes approximately $136,000 related to employee stock option expense resulting from the implementation of FAS 123(R).

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Interest and Other Income.  Interest and other income for the three months ended June 30, 2006 increased approximately $22,000 or 22%, to $124,000 from $102,000  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 June 30, 2006.

Results of Continuing Operations — Six Months Ended June 30, 2006 and 2005

Revenue.  We recognized $27,000 in grant revenue in the six months ended June 30, 2006.  This grant revenue relates to the STTR grant awarded in the second quarter of 2004 by the NIH, for a Virion Solvent Treatment for Severe Acute Respiratory Syndrome.  The term of the grant expires March 31, 2007.

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 $203,000, or 6%, to $3,698,000 in the six months ended June 30, 2006 from $3,495,000 for the same period in 2005.  The increase was due primarily to an increase in outside research and development costs related to the preparation and commencement of a human clinical trial of our HDL Therapy platform at the Washington Hospital Center in Washington, D.C.  Contributing to the increase was an increase in stock compensation expense.  This non-cash stock compensation expense includes approximately $228,000 related to employee stock option expense and $27,000 in non-employee stock option income.  As described above, we have implemented FAS 123(R) in the first quarter of 2006 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.  This increase was partially offset by a decrease in outside research and development 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.  Research and development expense accounted for approximately 63% of total operating expenses for the six months ended June 30, 2006.

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.  However, for the six months ended June 30, 2006, 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 $465,000, or 27%, to $2,174,000 in the six months ended June 30, 2006 from $1,709,000 for the same period in 2005.  The increase was due primarily to an increase in stock compensation expense, employee related expenses and consulting expenses related to a consulting agreement with WCA, which was entered into on May 16, 2005.  The non-cash stock compensation expense includes approximately $339,000 related to employee stock option expense resulting from the implementation of FAS 123(R).  Partially offsetting this increase was a decrease in facility related expenses as a result of the renegotiation and extension of our facility lease in Pleasanton, CA in April 2005.

Interest and Other Income.  Interest and other income for the six months ended June 30, 2006 increased approximately $75,000, or 40%, to $264,000 from $189,000 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 six months ended June 30, 2006.

Liquidity and Capital Resources

The net cash used in operating activities was approximately $4,792,000 for the six months ended June 30, 2006, resulting primarily from operating losses incurred as adjusted for non-cash compensation charges.  The net cash used in operating activities for the six months ended June 30, 2005, was approximately $4,632,000 resulting primarily from operating losses incurred as adjusted for non-cash compensation charges and partially offset by an increase in accounts payable primarily related to accrued costs and invoices received for various pre-clinical studies.

The net cash provided by investing activities was approximately $6,484,000 and $2,696,000 for the six months ended June 30, 2006 and June 30, 2005, respectively. The net cash provided by investing activities for these periods was primarily attributable to the purchase and subsequent maturities of short-term investments.

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The net cash provided by financing activities was approximately $15,000 and $10,000 for the six month periods ended June 30, 2006 and June 30, 2005, respectively.  The net cash provided by financing activities for these periods was attributable to the proceeds received from employee stock option exercises.

Net cash provided by discontinued operations was approximately $1,167,000 for the six month period ended June 30, 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.  The results of this 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 June 30, 2006 we had cash and cash equivalents and short-term investments equal to approximately $9,900,000.  We anticipate that these assets, in addition to the $6.3 million in gross proceeds received in our recently completed private placement, will provide sufficient working capital for our operations, including our current development projects, into the fourth quarter of 2007.  We expect additional capital will be required in the future.  The Company continues to consider public or private financings, the formation of strategic development or licensing partnerships, and explore strategic initiatives.  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.

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

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experience, terms of existing contracts, our observance of trends in the industry and information available from other outside sources, as appropriate.  Except for the following accounting policy which changed during the six month period ended June 30, 2006, our critical accounting policies as described in our annual report on our most recent form 10-K remain unchanged:

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 assumptions used in the Black-Scholes option valuation model include the risk free interest rate, expected life, volatility and dividend yield of the option.  Management bases its assumptions on historical data where available.  However, these assumptions consist of estimates of future market conditions, which are inherently uncertain, and therefore are subject to management’s judgment.

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 of June 30, 2006, the amortized cost of our investment portfolio, which equaled approximately $6,437,000 exceeded the market value of the investments contained in the portfolio by approximately $6,000.  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 FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”, 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.

Our management, including our President and Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls or our internal controls over financial reporting 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 due to numerous factors, ranging from errors to conscious acts of an individual, or individuals acting together.  In addition, 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 the inherent limitations in a cost-effective control system, misstatements due to error and/or fraud may occur and not be detected.

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PART II — OTHER INFORMATION

ITEM 1.      LEGAL PROCEEDINGS

On June 14, 2006, we received a subpoena from the Office of Inspector General (“OIG”) of the United States Department of Health and Human Services, requesting that we produce certain documents related to H. Bryan Brewer, Jr., M.D., the Vice-Chairman of our Board of Directors and our Chief Scientific Director.

We understand that the inquiry by the OIG relates to limitations on outside activities by National Institutes of Health (“NIH”) personnel, including Dr. Brewer’s work for the Company during and after his employment by the NIH.

To date, we have produced the requested documents and we will continue to cooperate fully with the investigation.  We do not believe that Dr. Brewer’s work on our behalf violated any of the conflict of interest laws applicable to NIH personnel.  As the investigation is ongoing, we can not predict its outcome or its effect on our business or operations.

We are also, from time to time, a party to legal proceedings.  Any legal proceeding we may be currently involved in is ordinary and routine.  Outcomes of the legal proceedings are uncertain until they are completed.  We believe that the results of any current proceedings will not have a material adverse effect on our business or financial condition or results of operations.

ITEM 1A. RISK FACTORS

Our 2005 Form 10-K, filed on March 15, 2006, includes a detailed discussion of our risk factors.  The information presented below updates, and should be read in conjunction with, the risk factors and information disclosed in that Form 10-K.

Our business exposes us to product liability claims.

Our design, testing, development, manufacture and marketing of products involve an inherent risk of exposure to product liability claims and related adverse publicity.  Insurance coverage is expensive and difficult to obtain, and we may be unable to obtain coverage in the future on acceptable terms, if at all.  Although we currently maintain product liability insurance for our products in the amounts we believe to be commercially reasonable, we cannot be certain that the coverage limits of our insurance policies or those of our strategic partners will be adequate.  If we are unable to obtain sufficient insurance at an acceptable cost or if a successful product liability claim is made against us, whether fully covered by insurance or not, our business could be harmed.

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

On June 1, 2006, the Company held its annual meeting of stockholders.  As of April 3, 2006, the record date for the annual meeting, there were 27,372,767 shares of common stock of the Company issued and outstanding and entitled to vote at the annual meeting.  The following item was submitted to a vote of the stockholders:

To elect one Class I member currently serving on the Board of Directors to a three-year term.

Election of Director	Votes for	Votes Withheld
S. Lewis Meyer, Ph.D.	20,178,162	70,585

As a result, S. Lewis Meyer, Ph.D. was elected as a Director of the Company.  The following incumbent members continue to serve on the Board of Directors: H. Bryan Brewer Jr., M.D., Bosko Djordjevic, Frank M. Placenti and Gary S. Roubin, M.D., Ph.D.

John E. Crawford was elected to the Board of Directors on May 15, 2006 and will serve as an independent director with an initial term of one year.  Mr. Crawford will be eligible for re-election at the 2007 Annual Meeting of Stockholders.

William A. Pope did not stand for re-election and as a result, his term expired at the 2006 Annual Meeting of Stockholders.

ITEM 5.      OTHER INFORMATION

None.

ITEM 6.      EXHIBITS

(a)Exhibits - See Exhibit Index.

17

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: August 9, 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

18

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 and incorporated herein by reference.
3.2	Bylaws, as amended. Previously filed as Exhibit 3.2 to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 10, 2005 and incorporated herein by reference.
10.1	Employment Agreement with S. Lewis Meyer, effective April 14, 2006. Previously filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 10, 2006 and incorporated herein by reference.
10.2	Clinical Study Agreement (Lipid Sciences Protocol LS-001) with MedStar Research Institute dated May 15, 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.

*Confidential Treatment Requested

19

EX-10.2

Exhibit 10.2

Portions of this agreement, marked by asterisks (***), have been omitted pursuant to a request for confidential treatment.  The omitted information has been filed separately with the Securities and Exchange Commission.

CLINICAL STUDY AGREEMENT
LIPID SCIENCES PROTOCOL LS-081

This agreement is made effective as of the 15th day of May, 2006 (“Effective Date”), between MedStar Research Institute, with its principal offices located at 6495 New Hampshire Avenue, Suite 201, Hyattsville, MD 20783, USA, Washington Hospital Center located at 110 Irving St, NW, Washington, DC 20010 both affiliates of Medstar Health hereinafter referred to as (“Medstar”) and Lipid Sciences, Inc. (“Sponsor”), with its principal offices located at 7068 Koll Center Parkway, Suite 401, Pleasanton, CA 94566.

Whereas, Sponsor desires for Medstar to assist it in conducting clinical research pursuant to the LS-011 Study designated below (“Study”); and

Whereas, Medstar has the facilities and the personnel with the required skills, experience and knowledge to undertake the Study;

Therefore, in consideration of the foregoing and the covenants contained herein, the receipt and adequacy of which is hereby acknowledged, the parties hereto agree as follows:

1.Scope of Work and Principal Investigator,

1.1The Study shall be performed in accordance with the Protocol entitled “A Randomized, Single-Blind, Placebo-Controlled Study to Evaluate the Safety of the Lipid Sciences PDS-2 in Subjects with Prior Acute Coronary Syndrome (LS-001)” (“Protocol”, Exhibit A) and this Clinical Study Agreement (“Agreement”), copies of which have been provided to Medstar.. Any changes, amendments or modifications to the Protocol or, the Agreement must be authorized in writing by all parties. The Study will be conducted in full compliance with this Agreement, and in accordance with the Protocol, any Agreement or Protocol amendments, any conditions set forth by the reviewing Institutional Review Board, Ethics Committee, or equivalent, and all applicable laws and regulations, including but not limited to, the requirements of 21 C.F.R Part 312.

1.2Medstar agrees to appoint Ron Waksman, M.D., as Principal Investigator under this Agreement. In the event the Principal Investigator shall be unable to complete this clinical Study and Medstar and Sponsor shall be unable to mutually agree to a substitute investigator within a period of fifteen (15) days, this Agreement shall be immediately terminated at the discretion of Sponsor.

1.3Medstar certifies that neither Principal Investigator, nor any of Medstar’s officers, employees or affiliated companies providing services to Sponsor under this Agreement, have been debarred, nor have they been engaged in any acts which may result in debarment as specified by the Genetic Drug Enforcement Act, codified at 21 U.S.C. 306.

1.4Medstar shall contract with Kristen Alcorn, MD, Medical Director Transfusion Services, Washington Hospital Center, to oversee the plasma pheresis portion of the delipidation procedures as outlined in the Protocol.

2.Consideration.  Sponsor will provide Study Device, support by Sponsor’s personnel, materials and supplies required to carry out the Study to Medstar at no charge to Medstar. Medstar shall provide access to Medstar’s facilities to Sponsor’s personnel as required to carry out the Study at no charge to Sponsor. Sponsor will compensate Medstar per Exhibit B and B I attached. Medstar shall invoice Sponsor on a monthly basis for any billable activity incurred in the previous month no later than twenty (20) days following the end of each calendar month to the attention of Sandra Gardiner at the address, or facsimile number, indicated in Section 13.1.

3.Term and Termination.

3.1Term of Agreement. The term of this Agreement shall commence on the Effective Date and, unless terminated sooner pursuant to the provisions of Section 3.2, will expire upon completion of the Study.

3.2Termination of Agreement. This Agreement may be terminated as follows:

3.2.1Sponsor may terminate this Agreement by providing at least thirty (30) days prior written notice to Medstar thereof; or

3.2.2If one of the parties believes that another party has breached a material term of this Agreement, that party may provide written notice to the breaching party, with a copy to all other parties, describing the alleged Breach in reasonable detail and containing a reference to this section. If the breaching party does not cure the breach within thirty (30) days after receiving the notice of breach, the party who gave the notice may immediately terminate this Agreement for cause by providing written notice to the other parties.

3.3Survival.  Any provision of this Agreement that imposes or contemplates continuing obligations on a party will survive the expiration or termination of this Agreement, including but not limited to sections 2, 4, 5, 6, 7, 8, 9 and 12.3.

4.Independent Contractor Status.  The relationships of Medstar and Sponsor shall be solely that of independent contractors. Medstar and Sponsor agree that neither Medstar nor Sponsor is an employee, employer, agent, partner or joint venture of another party. Neither Medstar nor Sponsor shall have or hold itself out as having the right or authority to assume or create any obligations or responsibility, whether express or implied, an behalf of or in the name of another party, except with the express written authority of that party.

5.Employees.  All employees of the Medstar or any other person or organization appointed by Medstar in the performance of this Agreement shall be considered employees of Medstar or such other person or organization, as the case may be, and not employees of

Sponsor.  Medstar shall be responsible for paying their employees any and all wages and other compensation and for all employment taxes and other employment related obligations arising in connection with those employees.

6.Usage, and Ownership of Property.

6.1Data and Research Results Produced Under the Study.  The data and research results produced as a result of the Study are the sole property of Sponsor.

6.2Patents and Inventions.  Sponsor shall own all right, title and interest in and to any and all inventions, discoveries, or innovations, whether or not patentable, arising directly or indirectly in the performance of the Protocol (collectively “Inventions”). Medstar shall promptly notify Sponsor in writing of any Inventions, and at Sponsor’s request and expense, Medstar will cause to be assigned to Sponsor all right, title, and interest in and to any Inventions and shall provide reasonable assistance to obtain patents including causing the execution of any invention assignment or other documents.

7.Trademarks. Logos, Etc.  Neither party shall, without the prior written consent of the other party in each instance, use in any manner whatsoever, including, without limitations, in any advertisement, the name, trademarks, logos, symbols, or other images of the other party or of any party affiliated therewith.

8.Confidentiality.

8.1Confidential Information.  During the course of the performance of this Agreement, it is anticipated that the parties will exchange Confidential Information. “Confidential Information” means confidential or proprietary information that is in tangible form and marked or designated in writing to indicate its confidential or proprietary nature, or, if disclosed orally, is confirmed as confidential in writing within thirty (30) days of such disclosure. Each party receiving Confidential Information agrees to limit disclosure of the furnishing party’s Confidential Information to personnel having a need to know the information for the purposes of this Agreement, and not to disclose any such Confidential Information to any third party unless such third party is under a confidentiality agreement with the receiving party or unless such disclosure is required by law. These obligations will continue for five (5) years after the expiration or termination of this Agreement. For the avoidance of doubt, as between the parties to this Agreement all patient medical records are Medstar’s Confidential Information regardless of whether or how they are marked.

8.2Information Not Deemed Confidential Information.  Confidential Information received from the other party shall not be deemed Confidential Information, and the receiving party will have no obligation with respect to such Confidential Information if:

8.2.1the Confidential Information is part of the public domain as of the Effective Date, or subsequently becomes part of the public domain through no fault of the receiving party;

8.2.2the receiving party can show that the Confidential Information was rightfully in its possession without obligation of confidentiality, as evidenced by written records or by the proof of actual use at the time of executing this Agreement;

8.2.3the Confidential Information is subsequently disclosed to the receiving party without obligation of confidentiality by a third party not in violation of any right of, or obligation to, the other party to this Agreement;

8.2.4the Confidential Information is developed independently by any recipients without reference to the Confidential Information; or

8.2.5the receiving party is obligated to produce the Confidential Information pursuant to an order of a court of competent jurisdiction or a facially valid administrative, Congressional or other subpoena, provided that the recipient is subject to the order of the subpoena.

8.3Patient Confidentiality.  Patient information, including identity, shall be treated confidentially by all parties in accordance with all applicable federal, state, and local laws including, but not limited to, the Standards for Individually Identifiable Health Information, 45 C.F.R. Parts 160 and 164 (the “HIPAA Privacy Regulation”).

9.Publication and Data.

9.1Publication; Presentation and Use of Material.  Medstar has the right to publish and make public presentations regarding the results of the research, and other information from the Study or otherwise make results of the research available to the public in furtherance of its charitable and educational purposes in accordance with this Agreement. Publication will occur as promptly as reasonably possible and not less than twenty-four (24) months after the conclusion of the Study. If Medstar desires to present or publish materials relating to the Study, Medstar will provide Sponsor with two (2) copies of any such publications or presentation materials at least sixty (60) calendar days prior to the submission of manuscripts. Sponsor will have sixty (60) calendar days from the receipt of such materials to object in writing to publication or presentation of any materials that Sponsor believes to contain Confidential Information. If Medstar receives no response from Sponsor within such sixty (60) day period, Medstar will be free to proceed with publication or presentation of the data, results, or information from the Study. If the Sponsor raises an objection that the materials disclose Confidential Information, Medstar shall refrain from the disclosure of the Confidential Information identified by Sponsor in the materials unless the parties agree on a mutually acceptable format for publishing or presenting such Confidential

Information. Sponsor agrees that it may only object to such publication or dissemination by Medstar on the basis of potential disclosure of Sponsor’s Confidential Information.

9.2Publishing Rights.  Medstar retains all rights to the publications and other copyrightable material that it produces pursuant to Paragraph 9.1. Sponsor agrees that said copyrightable material is the sole property of Medstar and hereby assigns and agrees to assign to Medstar, its successors, and assigns any right, title and interest in and to said copyrightable material Sponsor may have.

9.3Continuing Copyright Requirement.  This Article shall survive termination or expiration of this Agreement.

10.Indemnification

10.1Indemnification of Sponsor.  Medstar agrees to indemnify, defend and hold harmless Sponsor, its directors, officers, employees, representatives and agents from and against any and all third party claims, suits, losses, damages, costs, fees and expenses (including reasonable attorney’s fees), and other liabilities asserted by third parties arising out of or related to this Agreement to the extent based upon: (i) any material misrepresentation contained in or breach of any warranty made by Medstar under this Agreement or (ii) any material breach, violations or nonperformance of any covenant, condition or agreement in this Agreement by Medstar.

10.2Indemnification of Medstar.  Sponsor shall, at its own expense, indemnify, defend and hold harmless Medstar and their investigators, directors, officers, employees, representatives, agents and affiliates, including without limitation any employee conducting the Study, from and against any and all third party claims, suits, losses, damages, costs, fines, fees and expenses (including reasonable attorneys’ fees) arising out of or related to this Agreement (except to the extent covered by this Section 10.2) including without limitation, for injury to persons, damage to property, or non-compliance with applicable laws and regulations whether litigated or not, arising from the negligent or wrongful acts or omissions of Sponsor, its agents or employees in the design, development, marketing, distribution, use or sale of any product or services derived from or embodying the Study (including the Protocol) or which is otherwise the subject of this Agreement. Sponsor shall also, at its own expense, indemnify, defend and hold harmless Medstar and their investigators, directors, officers, employees, representatives, agents and affiliates including any employee conducting the Study from any and all third party claims, suits, losses, damages, costs, fines, fees and expenses (including reasonable attorney’s fees) arising out of the acts of the sponsor’s employees participating in the Study at Medstar.

10.3Sponsor will be responsible for reasonable patient medical care costs that are a direct result of a patient’s participation in this Study but are not covered by third party payors and are not the result of negligence, failure to follow the Protocol or

IRB requirements or applicable laws or regulations, or any reckless or willful malfeasance by Medstar or its employees, agents, officers, or assignees.

10.4Insurance Requirements. Sponsor shall, at its own expense, carry and maintain professional and general liability insurance from a carrier acceptable to Medstar in amounts consistent with industry standards and adequate to protect the Medstar, and the Sponsor from any and all claims of any nature for damage to property or for personal injury, including death, which may arise from performance of this Agreement and from claims which may arise pursuant to Section 10.2 above. Sponsor shall provide evidence of insurance to Medstar promptly upon execution of this Agreement.

11.Inspections.

11.1Inspections by Sponsor.  Sponsor, its agents or representatives, shall provide, during Medstar’s regular hours of business and after reasonable prior notice to Medstar, reasonable scheduled access to Medstar’s facility to perform quality assurance inspections at mutually convenient times. Medstar shall cooperate with Sponsor’s inspectors and shall provide Sponsor with copies of all documents reasonably required by Sponsor to properly perform such inspections so long as Sponsor can assure patient confidentiality.

11.2Inspections by Regulatory Authorities.  Medstar shall notify Sponsor, as soon as reasonably practicable, of all inspections or anticipated inspections of its facility conducted by any regulatory authority, including, without limitation, the Food and Drug Administration, that in any way directly relates to the Study. Medstar shall promptly provide copies of all reports, emotions, violations, warnings, and notices of deficiency received by Medstar with such inspections.

12.Record Keeping and Reporting

12.1Medstar shall report to Sponsor any Serious or Unexpected Adverse Event, as those terms are defined at 21 C.F.R. 312.32(a), as required by the Protocol, by using the appropriate Case Report Form within twenty-four (24) hours after Medstar or Principal Investigator receives information about the event. All other Adverse Events shall be timely reported to Sponsor as required by Protocol.

12.2Medstar shall maintain all records required to be maintained under federal, state or local laws, including, but not limited to, case report forms, informed consent forms, drug accountability records, source documents, data correction forms, monitoring logs, correspondence, clinical supplies receipts, dispensing and final disposition records, Medstar Review Board/Ethics Review Committee correspondence and appropriate, and all other Study documents. Medstar shall ensure that Principal Investigator signs a statement in each subject’s case report form attesting to Principal Investigator’s review of the data, and attesting that the data are an accurate accounting of the treatment, care, and events surrounding the subject’s involvement in the Study.

Sections of this agreement marked by asterisks (***) have been omitted pursuant to a request for confidential treatment.  The omitted information has been filed separately with the Securities and Exchange Commission.

12.3Medstar shall retain records for the Study produced pursuant to the Agreement for a minimum of five (5) years following completion of the Study. To avoid any possible errors, Medstar agrees to obtain the approval of Sponsor prior to the destruction of any Study-related records. If Sponsor wishes to receive all Study records in lieu of their destruction, Medstar shall, at the expense of the Sponsor, ship all Study records to Sponsor within (30) days of Sponsor request. In the event of accidental loss or destruction of any Study record, to promptly notify Sponsor. This provision shall survive the expiration or termination of this Agreement.

13.Miscellaneous.

13.1Notices.  All notices, requests, demands, and other communications required or permitted to be given hereunder shall be in writing, shall be deemed to have been duly given when delivered in person, or when sent by telex, or telecopy, or other facsimile transmission (with the receipt confirmed), or on the third business day after posting thereof by registered or certified mail, return receipt requested, prepaid and addressed as follows (or other such address site the parties may designate by written notice in the manner aforesaid):

In the case of Medstar:		In the case of Sponsor:
MedStar Research Institute 6495 New Hampshire Avenue, Suite 201 Hyattsville, MD 20783		Lipid Sciences, Inc. 7068 Koll Center Parkway, Suite 401 Pleasanton, CA 94566 Attn: Lew Meyer
Attn:	***	Fax:  (925) 249-4040
Fax:	***
with a copy to:		with a copy to:
Cardiovascular Research Institute 110 Irving Street, NW, Suite 4B1 Washington, D.C. 20010 Attn: Ron Waksman, M.D.		Lipid Sciences, Inc. 7068 Koll Center Parkway, Suite 401 Pleasanton, CA 94566 Attn: Sandra Gardiner
Fax:	***	Fax:  (925) 249-4080

13.2Governing Law. This Agreement shall be construed and enforced in all respects in accordance with the laws of the District of Columbia, without regard to any provision of District of Columbia law that would require or permit the application of the substantive law of any other jurisdiction.

13.3Non-Assignment. This Agreement may not be assigned by either party without the prior written consent of the other party, except in the case of an acquisition of at least fifty one percent (51%) outstanding shares of either party (“Acquisition”). In the case of an Acquisition, the party being acquired may assign this Agreement without the prior written consent of the other party, provided the party being acquired notifies the other party in writing.

13.4Entire Agreement.  This Agreement sets forth the entire understanding of the parties with respect to the subject matter of this Agreement. This Agreement supersedes all prior representations, agreements, and understanding among the parties with respect to such subject matter. In the event of any conflict between the Protocol and the other provisions of this Agreement, the other provisions of this Agreement shall govern.

The Exhibits referred to in and attached to this Agreement are made a part of it as if fully included in the text.

13.5Amendment.  No changes or amendments or alterations shall be effective unless in writing and signed by both parties.

13.6Waiver.  No waiver of any default in the performance of any of the duties or obligations arising out of this Agreement shall be valid unless in writing and signed by the waiving party. Waiver of any one default does not waive any successive or other default. No course of dealing between the parties shall operate as a waiver or preclude the exercise of any rights or remedies under this Agreement. Failure on the part of either party to object to any act or failure to act by or on the part of the other party, or declare the other party in default, regardless of the extent of such default, shall not constitute a waiver by the party of its rights hereunder.

13.7Severability.  The provisions of this Agreement will be deemed severable, and the enforceability of any one or more provisions will not affect the enforceability of any other provisions. In addition, if any provision of this Agreement, for any reason, is declared to be unenforceable, the parties will substitute an enforceable provision that, to the maximum extent possible in accordance with applicable law, preserves the original intentions and economic positions of the parties.

13.8Construction.  This Agreement shall be interpreted without any regard to any presumption or rule requiring construction against the party causing this Agreement to be drafted.

13.9Counterparts.  This Agreement may be executed in one or more counterparts, including facsimile counterparts, each of which shall be deemed an original and all of which together shall constitute one and the same agreement.

13.10Captions.  The captions contained in this Agreement are inserted only as a matter of convenience and in no way define, limit, or extend the scope or intent of this Agreement or any provision hereof.

THIS SPACE INTENTIONALLY LEFT BLANK

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first written above.

MedStar Research Institute		Lipid Sciences, Inc.
By:	***	By:	/s/ S. Lewis Meyer
Name:	***	Name:	S. Lewis Meyer
Title:	Sr. VP, Administration	Title:	President and CEO
Date:	May 24, 2006	Date:	May 16, 2006
Read and Understood
By:	/s/ Ron Waksman, MD
Name:	Ron Waksman, MD
Title:	Principal Investigator
Date:	May 22, 2006

EXHIBIT A
PROTOCOL

***  This Exhibit has been omitted pursuant to a request for confidential treatment.  The omitted information has been filed separately with the Securities and Exchange Commission.

Portions of this agreement, marked by asterisks (***), have been omitted pursuant to a request for confidential treatment.  The omitted information has been filed separately with the Securities and Exchange Commission.

EXHIBIT B
BUDGET

1.The anticipated budget worksheet is attached as Exhibit B1.

2.Shipping:

Sponsor authorizes the use of Sponsor’s Federal Express Number for returning to Sponsor and sites those materials, products, documentation, etc. as commonly occurs during the conduct of a Study of this nature.

3.Payment Information:

All payments shall be made by Sponsor in US Dollars to the following fund:

Fund Name:	MedStar Research Institute
Tax ID#:	***
Mailing Address:	P.O. Box 632010
	Baltimore, MD 21263
Attention:	CFO

4.Upon written agreement by both parties, additional items may be added to the budget.

5.MedStar shall invoice Sponsor on a monthly basis for any billable patient related charges incurred in the previous month no later than twenty (20) days following the end of each calendar month to the attention to Sandra Gardiner at the address, or facsimile number, indicated in Section 13.1.  Reimbursement for data management and project management shall be invoiced as follows:  50% at completion of first patient enrolled and 50% at completion of last patient enrolled.

6.***

EXHIBIT B1
BUDGET WORKHEET

***  This Exhibit has been omitted pursuant to a request for confidential treatment.  The omitted information has been filed separately with the Securities and Exchange Commission.

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: August 9, 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:  August 9, 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 June 30, 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:  August 9, 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