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, 2007.

¨ 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 ¨

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 ¨ Accelerated filer ¨ Non-accelerated filer x

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

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

Class		Shares outstanding at July 31, 2007
Common Stock
$0.001 par value		37,124,169

LIPID SCIENCES, INC.

FORM 10-Q

For the Period Ended June 30, 2007

TABLE OF CONTENTS

		Page No.
PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006	1
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2007 and 2006, and Cumulative period from Inception (May 21, 1999) to June 30, 2007	2
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and 2006, and Cumulative period from Inception (May 21, 1999) to June 30, 2007	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	14
Item 4.	Controls and Procedures	14
Item 4T.	Controls and Procedures	14
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	15
Item 1A.	Risk Factors	15
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	15
Item 3.	Defaults Upon Senior Securities	15
Item 4.	Submission of Matters to a Vote of Security Holders	16
Item 5.	Other Information	16
Item 6.	Exhibits	16
SIGNATURES		17
INDEX TO EXHIBITS FOR FORM 10-Q		18

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, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	12,133		$	16,691
Accounts receivable	127			—
Prepaid expenses	210			273
Other current assets	52			79
Total current assets	12,522			17,043
Property and equipment	321			374
Long-term lease deposits	19			19
Total assets	$	12,862		$	17,436
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	1,509		$	1,511
Accrued related party royalties	500			250
Accrued compensation	543			680
Taxes payable	1			—
Deferred revenue	23			—
Total current liabilities	2,576			2,441
Deferred rent	17			16
Total liabilities	2,593			2,457

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; 37,124,169 and 37,120,139 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively	37			37
Additional paid-in capital	89,893			89,400
Deficit accumulated in the development stage	(79,661		)	(74,458		)
Total stockholders’ equity	10,269			14,979
Total liabilities and stockholders’ equity	$	12,862		$	17,436

See accompanying Notes to Condensed Consolidated Financial Statements

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,
	2007			2006			2007			2006			2007
	(In thousands, except per share amounts)
Revenue:
Collaboration agreement revenue	$	137		$	—		$	196		$	—		$	196
Grant revenue	—			6			—			27			100
Total revenue	137			6			196			27			296
Operating expenses:
Research and development(1)	2,063			1,749			3,876			3,698			63,683
Selling, general and administrative(2)	992			965			1,898			2,174			29,216
Total operating expenses	3,055			2,714			5,774			5,872			92,899
Operating loss	(2,918		)	(2,708		)	(5,578		)	(5,845		)	(92,603		)
Interest and other income	171			124			375			264			4,535
Loss from continuing operations	(2,747		)	(2,584		)	(5,203		)	(5,581		)	(88,068		)
Income tax benefit	—			—			—			—			8,004
Net loss from continuing operations	(2,747		)	(2,584		)	(5,203		)	(5,581		)	(80,064		)
Discontinued operations:
Income from discontinued operations	—			—			—			—			582
Income tax expense	—			—			—			—			(179		)
Income from discontinued operations - net	—			—			—			—			403
Net loss	$	(2,747	)	$	(2,584	)	$	(5,203	)	$	(5,581	)	$	(79,661	)

Loss per share—basic and diluted:
Net loss per share	$	(0.07	)	$	(0.09	)	$	(0.14	)	$	(0.20	)

Weighted average number of common shares outstanding—basic and diluted	37,120			27,373			37,120			27,367

Non-cash option compensation expense included in operating expenses:
(1)Research and development	103			(21		)	181			201
(2)Selling, general and administrative	167			136			287			339

See accompanying Notes to Condensed Consolidated Financial Statements

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,
	2007			2006			2007
	(In thousands)
Cash flows used in operating activities:
Net loss from continuing operations	$	(5,203	)	$	(5,581	)	$	(80,064	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation and amortization	90			110			1,474
Loss on disposal of assets	3			—			209
Accretion of discount on investments	—			(210		)	(891		)
Stock compensation expense for options issued to consultants, employees and advisors	468			540			7,494
Issuance of warrants to consultants	—			—			1,282
Changes in operating assets and liabilities:
Accounts receivable	(127		)	—			(127		)
Prepaid expenses and other current assets	90			209			(262		)
Notes receivable	—			—			6,569
Other assets	—			—			(19		)
Taxes payable	1			6			1
Accounts payable and other current liabilities	23			(140		)	(535		)
Accrued related party royalties	250			250			500
Accrued compensation	(137		)	20			543
Deferred revenue	23			—			23
Deferred rent	1			4			17
Net cash used in operating activities of continuing operations	(4,518		)	(4,792		)	(63,786		)

Cash flows (used in)/provided by investing activities:
Capital expenditures	(65		)	(125		)	(2,019		)
Proceeds from disposal of assets	—			—			17
Purchases of investments	—			(4,391		)	(91,395		)
Maturities and sales of investments	—			11,000			92,286
Net cash (used in)/provided by investing activities of continuing operations	(65		)	6,484			(1,111		)

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	25			15			36,586
Proceeds from issuance of warrants	—			—			40
Net cash provided by financing activities of continuing operations	25			15			42,916
Net (decrease)/increase in cash and cash equivalents from continuing operations	(4,558		)	1,707			(21,981		)
Cash flows provided by discontinued operations:
Operating activities	—			—			38,185
Investing activities	—			—			10,837
Financing activities	—			—			(14,908		)
Net cash provided by discontinued operations	—			—			34,114
Cash and cash equivalents at beginning of period	16,691			1,752			—
Cash and cash equivalents at end of period	$	12,133		$	3,459		$	12,133

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

See accompanying Notes to Condensed Consolidated Financial Statements

Lipid Sciences, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1: ORGANIZATION AND BASIS OF PRESENTATION

In this Quarterly Report on Form 10-Q, unless the context otherwise requires, Lipid Sciences, Inc., a Delaware corporation, is referred to as “we,” “the Company” or “Lipid Sciences.”

On November 29, 2001, Lipid Sciences, Inc., a privately-held corporation, merged with and into NZ Corporation, an Arizona corporation. Immediately after the completion of the merger, NZ Corporation changed its name to Lipid Sciences, Inc. On June 26, 2002, Lipid Sciences changed its state of incorporation from Arizona to Delaware. In this Quarterly Report on Form 10-Q, we refer to our former name, NZ Corporation, as “NZ,” and we refer to the merged corporation, Lipid Sciences, Inc., as “Pre-Merger Lipid.”

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

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. As of June 30, 2007, we had cash and cash equivalents equal to approximately $12.1 million. We anticipate that existing cash and cash equivalents, in addition to any proceeds received from current or future licensing partnerships, will provide sufficient working capital for our operations, including our current development projects and clinical trial, into the third quarter of 2008. We expect additional capital will be required in the future. 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. However, there can be no assurance that funds secured from any of these efforts, if obtained, will be sufficient to meet our 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, 2006 balance sheet, as presented, was derived from the audited Consolidated Financial Statements as of December 31, 2006. 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 14, 2007.

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.

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,
	2007	2006
Stock options	7,317,006	7,378,337
Warrants to purchase common stock	3,365,749	1,468,567
	10,682,755	8,846,904

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 we recognize compensation cost relating to share-based payment transactions in our financial statements. We have adopted FAS 123(R) on a modified prospective basis, which requires that we recognize compensation cost relating to all new awards and to awards modified, repurchased, or cancelled in our financial statements beginning January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered and were 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. To calculate the excess tax benefits available for use in offsetting potential future tax shortfalls, the Company follows the alternative method discussed in FASB staff Position No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.”

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 market 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, NZ’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 increased on January 1, in each of the calendar years 2002 through 2006 by 500,000 shares of common stock, which was the maximum amount allowable in each year, under the terms of the 2001 Plan. 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 market value of the Company’s common stock at the date of grant, as determined by the Board of Directors. All options granted pursuant to the 2001 Plan are to have a term not greater than 10 years from the date of grant. Options vest as determined by the Board of Directors, generally over four years (but not less than 20% of the total number of shares granted per year).

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 provided herein has been similarly restated.

At June 30, 2007, options to purchase an aggregate of 4,618,232 shares of common stock remain available for grant under all the plans.

Other Required FAS 123(R) Disclosures

The following table represents stock option activity for the three months ended June 30, 2007:

	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life	Aggregate Intrinsic Value
Outstanding options at beginning of period	6,463,398		$	3.45
Granted	145,000		1.27
Exercised	(4,030	)	0.89
Forfeited	(27,899	)	2.15
Expired	—		—
Outstanding options at end of period	6,576,469		$	3.40	5.75	$	1,099,119
Options expected to vest at end of period	6,344,146		$	3.46	5.75	$	1,061,071
Exercisable options at end of period	5,194,071		$	3.75	4.91	$	914,431

The following table represents stock option activity for the six months ended June 30, 2007:

	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life	Aggregate Intrinsic Value
Outstanding options at beginning of period	5,799,398		$	3.68
Granted	809,000		1.36
Exercised	(4,030	)	0.89
Forfeited	(27,899	)	2.15
Expired	—		—
Outstanding options at end of period	6,576,469		$	3.40	5.75	$	1,099,119
Options expected to vest at end of period	6,344,146		$	3.46	5.75	$	1,061,071
Exercisable options at end of period	5,194,071		$	3.75	4.91	$	914,431

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,
	2007			2006			2007			2006
Risk-free interest rate	4.92		%	5.01		%	4.86		%	4.73		%
Expected life of options (in years)	3.90			3.27			4.74			3.88
Expected volatility	76.97		%	85.53		%	89.89		%	95.17		%
Expected dividend yield	—			—			—			—
Weighted-average grant-date fair value	$	0.75		$	0.95		$	0.96		$	1.70

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

FAS 123(R) requires that we estimate forfeitures, or the number of shares that are expected to be cancelled prior to vesting, at the time of grant, and adjust for actual forfeitures in subsequent periods if they differ from our original estimates. Based on our historical experience of options that have been cancelled prior to vesting, we have assumed an annualized forfeiture rate of 12% for all new option grants.

Total compensation cost for share-based payment arrangements recognized in income for the three and six month periods ended June 30, 2007 and 2006 is presented in the following table:

	Three Months Ended June 30,					Six Months Ended June 30,
	2007		2006			2007		2006
	(In thousands)
Employee related compensation cost	$	217	$	175		$	383	$	567
Non-employee related compensation cost	53		(60		)	85		(27		)
Total compensation cost recognized in income	$	270	$	115		$	468	$	540

The total compensation cost related to non-vested awards not yet recognized as of June 30, 2007 was approximately $1,663,000 and the weighted average expected remaining recognition period as of June 30, 2007 was approximately 2.4 years.

We received $3,587 in gross proceeds as a result of 4,030 stock options that were exercised in the six month period ending June 30, 2007. The intrinsic value of options exercised in the six month periods ended June 30, 2006 and June 30, 2007 was approximately $18,000 and $3,000, respectively. 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 September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, established a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We believe that the adoption of this statement will not have a material impact on our financial position, results of operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This statement establishes a fair value option in which entities can elect to report certain financial assets and liabilities at fair value, with changes in fair value recognized in earnings. The statement is effective for fiscal years beginning after November 15, 2007. We believe that the adoption of this statement will not have a material impact on our financial position, results of operations or cash flows.

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., 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 and 10% of any External Research Funding initiated by Dr. Cham and received by us to further this technology, as defined in the agreement. 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. We have expensed to research and development approximately $125,000 in both three month periods ended June 30, 2007 and 2006 related to this agreement. Accrued related party royalties under this agreement were $500,000 and $250,000 at June 30, 2007 and December 31, 2006, 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. As consideration for Dr. Brewer’s services as Chief Scientific Director, we are required to pay WCA annual fees of $395,000. For both six month periods ended June 30, 2007 and 2006, approximately $198,000 was charged to selling, general and administrative expense for fees related to the consulting agreement. In addition to the annual fee, we 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 month and six month periods ended June 30, 2007, approximately $5,000 and $14,000, 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, 2006, approximately $37,000 and $8,000, respectively, was recorded as non-cash compensation expense related to the stock option awarded to Dr. Brewer pursuant to his consulting agreement. On July 31, 2007 the consulting agreement was amended to extend the term of the consulting agreement until May 16, 2011.

NOTE 6: INCOME TAXES

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). 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 de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 on January 1, 2007, and have not recorded any adjustments as a result of our adoption of the new interpretation.

We have elected to record any potential interest or penalties related to uncertain tax positions as income tax expense. For the three and six month periods ended June 30, 2007, we did not record any interest or penalties related to uncertain tax positions. As of June 30, 2007, we did not have any amounts accrued for interest or penalties related to uncertain tax positions.

We are subject to U.S. federal income tax and California state income tax. For the tax years 2000 through 2006, we are subject to examination at the U.S. federal level and multiple state jurisdiction levels.

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 14, 2007. 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, 2006.

Overview

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

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 and cash equivalents, in addition to any proceeds received from current or future licensing partnerships, will provide sufficient working capital for our operations, including our current development projects and clinical trial, into the third quarter of 2008. In the longer term, we expect to additionally finance our operations through revenues from product sales and licenses. 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, we 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 us to begin a clinical trial with the Company’s Plasma Delipidation System-2 (“PDS-2”). We were granted this approval subject to the condition that within 45 days we would submit a response to the questions and observations made by the FDA. We submitted a response on February 22, 2006, which was within 45 days of receiving conditional approval from the FDA. In addition, the FDA required us to obtain approval from the Institutional Review Board (“IRB”) of the MedStar Research Institute in Washington, D.C. to begin the trial.

On April 20, 2006, we announced that we received approval from the IRB. On April 28, 2006 we submitted that approval to the FDA as required. On June 1, 2006, we announced that the first patient procedure had been completed in the Company’s clinical trial: “A Randomized Single-Blind Placebo Controlled Study to Evaluate the Safety of the Lipid Sciences’ PDS-2 in Subjects with Prior Acute Coronary Syndrome.” We are recruiting thirty subjects between the ages of 18 and 85 with angiographic evidence of Coronary Artery Disease in the target artery, as defined by at least one lesion with an occlusion between 20-50%. Each potential participant undergoes an initial screening, which includes a blood panel and intravascular ultrasound (“IVUS”) assessment to determine eligibility for enrollment and randomization into the study. The trial consists of a total of seven weekly delipidation/re-infusion procedures. The treatment subjects receive infusions of their own plasma that has been delipidated by the PDS-2 system; the control subjects receive infusions of their own untreated plasma that has not been delipidated. An IVUS assessment of the participants will also be made at the conclusion of the trial. The study duration for each participant is approximately ten weeks. In addition to our primary clinical trial site, the Washington Hospital Center, on July 19, 2007 the FDA, approved our request to add three clinical trial sites in the Washington D.C. area to increase the pool of eligible participants. We expect to complete the safety/feasibility trial by the end of 2007 and begin the effectiveness trial in 2008.

On November 8, 2006, we announced that we entered into a collaborative research and license agreement with Elanco Animal Health (“Elanco”), a division of Eli Lilly and Company, to develop one or more immunological products for animal health applications beginning with a vaccine directed against certain lipid-enveloped organisms. Under the agreement, the Company granted to Elanco a worldwide exclusive license to research, develop, manufacture, and sell certain immunological products for animal health, which will be developed using its delipidation immunological technology. Pursuant to the terms of the agreement, Elanco will pay for all the associated research and development expenses for each targeted product. In exchange for the license, subject to completion of Elanco’s due diligence and sales of products meeting various thresholds, we may receive a technology access fee, milestone payments and royalties.

On June 7, 2007, we announced that we have developed a synthetic form of HDL that mimics key functions of naturally-occurring human HDL. Our lead HDL Mimetic Peptide compound, LSI 518P, and a back-up compound have been identified and validated with an extensive battery of in vitro assays. The lead compound was selected as a result of screenings at multiple external research sites. In these in vitro tests, the selected mimetic peptide candidates effluxed cholesterol via the ABCA1 transporter metabolic pathway—known to be optimal for removing cholesterol from arterial plaque via the reverse cholesterol transport mechanism—at a rate similar to naturally-occurring HDL.

Results of Continuing Operations—Three Months Ended June 30, 2007 and 2006

Revenue. We recognized $137,000 in collaboration agreement revenue in the three months ended June 30, 2007. This collaboration agreement revenue relates to our collaborative research agreement entered into with Elanco in November 2006 and is composed of reimbursable expenses.

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 HDL Therapy platform, currently consisting of our PDS-2 system and our HDL Mimetic Peptide program, and Viral Immunotherapy platform which focuses on the removal of the lipid coatings from lipid-enveloped viruses and other lipid-containing infectious agents.

Research and Development Expenses. Research and development expenses include applied and scientific research, regulatory and business development expenses. In the three months ended June 30, 2007, research and development expenses increased approximately $314,000 or 18% to $2,063,000, compared with $1,749,000 in the same three month period in 2006. This increase was primarily the result of greater stock compensation expense, and an increase in outside R&D expenses related to the enhancement of our PDS-2 system in preparation for our follow-on clinical trial to demonstrate effectiveness, increased effort associated with our HDL Mimetic Peptide program, inclusive of pre-clinical testing, and reimbursable expenses pertaining to our collaborative research agreement with Elanco. The offsetting revenue received from Elanco is discussed above.

While we allocate and track resources when required pursuant to the terms of development arrangements, our research team typically works on different platforms concurrently, and our equipment and intellectual property resources often are deployed over a range of products with a view to maximize the benefit of our investment. Accordingly, we have not, and do not intend to, separately track the costs for each of our research projects on a product-by-product basis. For the six months ended June 30, 2007, 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 $27,000, or 3%, to $992,000 in the three months ended June 30, 2007 from $965,000 for the same period in 2006. This increase was related primarily to an increase in employee-related expenses, stock compensation expense and consulting expenses, partially offset by a decrease in public company expenses.

Interest and Other Income. Interest and other income for the three months ended June 30, 2007 increased approximately $47,000 or 38%, to $171,000 from $124,000 for the same period in 2006. The increase was due to higher average cash and investment balances coupled with higher investment yields during the three months ended June 30, 2007.

Results of Continuing Operations—Six Months Ended June 30, 2007 and 2006

Revenue. We recognized $196,000 in collaboration agreement revenue in the six months ended June 30, 2007. This collaborative research agreement revenue relates to our collaborative research agreement entered into with Elanco in November 2006 and is composed of reimbursable expenses.

Research and Development Expenses. Research and development expenses include applied and scientific research, regulatory and business development expenses. In the six months ended June 30, 2007, research and development expenses increased approximately $178,000 or 5% to $3,876,000, compared with $3,698,000 in the same six month period in 2006. This increase was primarily the result of an increase in costs related to our Viral Immunotherapy platform pertaining to the progression of our non-human primate study being conducted at Yerkes National Primate Research Center at Emory University and reimbursable costs related to the initiation of our animal health research in collaboration with Elanco. Additional increases in expenses are attributable to costs associated with our HDL Mimetic Peptide program. Partially offsetting these increases was a decrease in costs related to the clinical trial of our PDS-2 system at the Washington Hospital Center in Washington, D.C. The decrease in our clinical trial expenses was attributed to the fact that the set-up costs incurred in the first half of 2006 exceeded the ongoing recruitment and implementation costs incurred through the first half of 2007.

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 decreased approximately $276,000, or 13%, to $1,898,000 in the six months ended June 30, 2007 from $2,174,000 in the same period in 2006. This decrease was primarily related to a decrease in employee-related expenses, stock compensation expense and legal expenses.

Interest and Other Income. Interest and other income for the six months ended June 30, 2007 increased approximately $111,000 or 42%, to $375,000 from $264,000 for the same period in 2006. The increase was due to higher average cash and investment balances coupled with higher investment yields during the six months ended June 30, 2007.

Liquidity and Capital Resources

Net cash used in operating activities was approximately $4,518,000 and $4,792,000 for the six months ended June 30, 2007 and June 30, 2006, respectively, resulting primarily from operating losses incurred as adjusted for non-cash compensation charges and partially offset by the accrual of related party royalties.

Net cash used in investing activities was approximately $65,000 for the six months ended June 30, 2007 and was related to purchase of capital equipment. The net cash provided by investing activities for the six months ended June 30, 2006 was approximately $6,484,000 and was primarily attributable to the purchase and subsequent maturities of short-term investments.

Net cash provided by financing activities was approximately $25,000 and $15,000 for the six months ended June 30, 2007 and June 30, 2006, respectively. The net cash provided by financing activities for these periods was primarily attributable to the proceeds received from the exercise of employee stock options.

On August 8, 2006, we completed the private placement of 4,993,781 shares of the Company’s common stock at a price of $1.26 per share, for an aggregate offering price of approximately $6.3 million, to institutional and accredited investors, which included several Directors of the Company. In connection with the private placement, we also issued warrants to the investors. The warrants became exercisable on February 9, 2007 and expire on February 9, 2012. The warrants contain a redemption feature where the Company has the option to repurchase the warrants for $0.01 per share if our common stock trades at $2.52 for a period of 30 consecutive trading days. The issuance of the shares of common stock and warrants was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof, since the issuance constituted a sale not involving a public offering. Following the offering, we filed a Registration Statement on Form S-3 with the SEC on August 23, 2006 to register for resale by the investors the shares of common stock issued in the offering and issuable upon exercise of the warrants. The registration statement became effective on September 8, 2006.

On December 19, 2006, we completed the private placement of 4,592,591 shares of the Company’s common stock at a price of $1.35 per share, for an aggregate offering price of approximately $6.2 million, to institutional investors. In connection with the private placement, we also issued warrants to Oppenheimer & Co. Inc., the placement agent in the transaction. The issuance of the shares of common stock and warrants was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section4(2) thereof, since the issuance constituted a sale not involving a public offering. Following the offering, we filed a Registration Statement on Form S-3 with the SEC on January 5, 2007 to register for resale by the investors and the placement agent the shares of common stock issued in the offering and issuable upon exercise of the warrants. The registration statement became effective on January 19, 2007.

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 current clinical trial of our PDS-2 system and preparing for future clinical trials of our PDS-2 system, and further development of our HDL Mimetic Peptide program, inclusive of pre-clinical testing. 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 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, proceeds received from public or private financings and any proceeds received from current or future licensing partnerships. As of June 30, 2007, we had cash and cash equivalents equal to approximately $12.1 million. We anticipate that these assets will provide sufficient working capital for our operations, including our current development projects and clinical trial, into the third quarter of 2008. We expect additional capital will be required in the future. The Company continues to consider public or private financings, to plan the formation of strategic development or licensing partnerships, and to 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:

	2007		2008		2009		2010		2011		Total
	(In thousands)
Operating Leases	$	211	$	217	$	223	$	56	$	—	$	707
Royalty Payments*	500		500		500		500		500		2,500
Total	$	711	$	717	$	723	$	556	$	500	$	3,207

*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 five 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

The SEC has 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. We consider the accounting policies described below to be our most critical accounting policies because they are impacted significantly by estimates we make. Those estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry and information available from other outside sources, as appropriate. Our critical accounting policies are described in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2007.

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 typically of government issued securities, although at June 30, 2007, we do not have any investments on our balance sheet. When we carry an investment balance, these investments are generally classified as held-to-maturity and are accounted for at their amortized cost, as per Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

As of June 30, 2007, we did not have any investments on our balance sheet. Every quarter we evaluate our investment portfolio and follow the guidance of FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” to determine if any of our investments are impaired. We have not booked any impairment charges during 2007 and have concluded that an impairment analysis was not necessary. Since we held no investments at June 30, 2007, a sensitivity analysis of a 10% change in market interest rates was not performed.

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, does 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.

ITEM 4T. CONTROLS AND PROCEDURES

Not applicable.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are 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.

Please refer to our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2007, which discloses legal proceedings involving the Company.

ITEM 1A. RISK FACTORS

Our 2006 Form 10-K, filed on March 14, 2007, 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 future pre-clinical animal studies and clinical trials may be delayed or unsuccessful.

Our future success depends in large part upon the results of pre-clinical animal studies and clinical trials designed to assess the safety and effectiveness of our potential product indications. The ultimate results of pre-clinical animal studies or clinical trials cannot be predicted with accuracy and can be impacted by many variables. We cannot be sure whether planned pre-clinical animal studies or clinical trials will begin on time or will be completed on schedule or at all. Delay or failure to complete pre-clinical animal studies or clinical trials may delay or prevent us from bringing products to market, which would materially harm our business, financial condition and results of operations. For example, any of our future pre-clinical animal studies or clinical trials might be delayed in their initiation or performance, or even halted after initiation because:

· additional extensive pre-clinical animal studies are required by the regulatory authorities to demonstrate the safety of the product or process technology;

· the data generated by the pre-clinical animal studies do not indicate to the regulatory authorities that there is a sufficient margin of safety;

· the potential clinical benefit from the product or process cannot be effectively demonstrated through the pre-clinical animal studies;

· the relevant regulatory requirements for initiating and maintaining an application for a clinical trial cannot be met;

· the product or process is not effective, or physicians perceive that the product or process is not effective;

· patients experience severe side effects during treatment or possibly even death as a result of the treatment;

· patients die during a clinical trial because their disease is too advanced or because they experience medical problems that are not related to the product or process being studied;

· patients do not enroll in the clinical trials at the rate we expect; or

· the discovery by us, during the course of the clinical trial, of deficiencies in the way the clinical trial is being conducted by the clinical trial investigators that raise questions as to whether the clinical trial is being conducted in conformity with the relevant regulatory authorities’ regulations or Good Clinical Practice.

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 7, 2007, the Company held its annual meeting of stockholders. As of April 9, 2007, the record date for the annual meeting, there were 37,120,139 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 two year term:

		Votes for		Votes Withheld
John E. Crawford		27,204,303		83,800

To elect three Class II members currently serving on the Board of Directors to a three year term:

	Votes for	Votes Withheld
H. Bryan Brewer, Jr., M.D.	27,205,703	82,400
Frank M. Placenti	27,209,739	78,364
Bosko Djordjevic	27,199,039	89,064

To elect one Class III member to a one year term:

		Votes for		Votes Withheld
Stephen E. Renneckar		27,208,087		80,016

As a result, John E. Crawford, H. Bryan Brewer, Jr., M.D., Frank M. Placenti, Bosko Djordjevic, and Stephen E. Renneckar were elected as Directors of the Company. The following incumbent members continue to serve on the Board of Directors: Gary S. Roubin, M.D., Ph.D. (Class III) and S. Lewis Meyer, Ph.D. (Class I).

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

(a) Exhibits - See Exhibit Index, which is incorporated by reference.

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 6, 2007	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

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.

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.