The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and related notes included in this quarterly report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended December 31, 2006 included with our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC. Operating results are not necessarily indicative of results that may occur in future periods.

Certain statements contained in this quarterly report on Form 10-Q, including statements regarding the development, growth and expansion of our business, our intent, belief or current expectations, primarily with respect to our future operating performance, and the products we expect to offer and other statements regarding matters that are not historical facts, are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act, and are subject to the "safe harbor" created by these sections. Future filings with the SEC, future press releases and future oral or written statements made by us or with our approval, which are not statements of historical fact, may also contain forward-looking statements. Because such statements include risks and uncertainties, many of which are beyond our control, actual results may differ materially from those expressed or implied by such forward-looking statements. Some of the factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements can be found under the caption "Risk Factors," and elsewhere in this quarterly report on Form 10-Q. Readers are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made.

Overview and Recent Developments

We are a leading company focused on using proprietary taste receptor-based assays, screening technologies and optimization chemistry to discover and develop novel flavor ingredients for the packaged food and beverage industry. We believe our flavor ingredients will enable packaged food and beverage companies to improve the nutritional profile of their products while maintaining or enhancing taste and may generate cost of goods savings. We license our flavor ingredients to our collaborators on an exclusive or co-exclusive basis, which we believe will provide these companies with the ability to differentiate their products. We have entered into product discovery and development collaborations with seven of the world's leading packaged food and beverage companies: Ajinomoto, Cadbury, Campbell, Coca-Cola, Kraft Foods, Nestlé and Solae, LLC. We currently anticipate that we will derive all of our revenues from existing and future collaborations. Depending upon the collaboration, our existing collaboration agreements provide for upfront fees, research and development funding, reimbursement of certain regulatory costs, milestone payments based upon our achievement of research or development goals and, in the event of commercialization, royalties on future sales of consumer products incorporating our flavor ingredients. Our current programs focus on the development of savory, sweet and salt flavor enhancers, high potency sweeteners and bitter taste modulators.

We have incurred significant losses since our inception in 1998 and, as of June 30, 2007 our accumulated deficit was $139.7 million. We expect to incur additional losses over at least the next two years as we continue to develop flavor ingredients. Our results of operations have fluctuated from period to period and likely will continue to fluctuate substantially in the future based upon:

† termination of any of our product discovery and development collaboration agreements;

† our ability to discover and develop new flavor ingredients or the ability of our product discovery and development collaborators to incorporate them into their products;

† our ability to enter into new, or extend existing, product discovery and development collaborations and technology collaborations;

† the demand for our collaborators' products containing our flavor ingredients; and

† variability of our stock-based compensation expense in conjunction with fluctuations of our stock price.

In March 2006, the Company entered into a Collaborative Research, Development, Commercialization and License Agreement with Ajinomoto Co., Inc. for the discovery and commercialization of novel flavor ingredients in select product categories within Japan and other Asian markets. In April 2007, we amended the agreement to expand Ajinomoto's rights into North America. The expanded license provided Ajinomoto with exclusive rights on the development and commercialization of certain existing flavor ingredients for the soup and bouillon, sauce and culinary aids, noodles, snack food and frozen foods product categories within the new territory. The license covers retail, food service and ingredient supply applications for the flavor ingredients. Under the terms of the April 2007 amendment, Ajinomoto agreed to pay us an upfront license fee and we are eligible to receive a new milestone payment upon achievement of a specific goal. The combined total of the upfront license fee and new milestone payment could exceed $1.7 million if the milestone is met. In August 2007, we further amended the agreement to expand Ajinomoto's rights into in additional product categories and geographies not previously licensed by us. The expanded license will provide Ajinomoto with exclusive rights on the development and commercialization of certain existing flavor ingredients in a wide variety of product categories that were not previously licensed within a respective territory including soups, sauces, instant noodles, snack foods, frozen foods and processed meats. The new territories for these product categories include Africa, the Caribbean, Europe, Latin America, the Middle East and Oceania. Under the terms of the new amendment, Ajinomoto has agreed to pay us a license fee of $8.0 million. Upon commercialization, we will receive royalty payments based on sales of products containing flavor ingredients developed under the agreement. In addition, the royalty obligation for both amendments includes predetermined minimum royalties.

In April 2007, we entered into a Collaborative Research, Development, Commercialization and License Agreement with Solae for the discovery and exclusive worldwide commercialization of novel flavor ingredients for soy proteins. Under the terms of the new collaboration, Solae has agreed to pay us research fees for up to three years. In addition, we are eligible to receive milestone payments upon achievement of specific product discovery and development goals. The combined total of research funding and milestone payments could exceed $5.2 million if all milestones are met. Upon commercialization, we will receive royalty payments based on sales of products containing flavor ingredients developed under the agreement.

In June 2007, we announced that Nestlé SA, the world's largest food company, has begun the initial commercial introduction of the first food products that contain our savory flavor ingredients. Under the terms of our agreement with Nestlé, we will receive royalty payments based on sales of products containing our flavor ingredients.

In July 2007, we amended our Collaborative Research and License Agreement with Cadbury Adams USA, LLC, dated July 15, 2005, to extend the collaborative period for an additional twelve months, through July 15, 2008. During the extension period, we will continue to work with Cadbury on the discovery and commercialization of new flavor ingredients in the gum confectionary area. Under the terms of the extension, Cadbury has agreed to pay us incremental research funding of up to $600,000 based on research progress during the extension period. The other payment terms, including milestones and royalties based on sales of products containing new flavor ingredients developed under the agreement, remain unchanged.

In July 2007, we amended our collaboration agreement, dated December 6, 2000, as amended, with Kraft Foods Global, Inc., a global leader in branded foods and beverages, to extend until December 9, 2008 Kraft Foods' ability to evaluate novel flavor modifiers under development by us for potential use by Kraft Foods on an exclusive basis in a specified product field in the dessert product category and on a co-exclusive basis in the powdered beverage product field.

Results of Operations

Three Months Ended June 30, 2007 and 2006

Revenue Under Collaboration Agreements

We recorded revenue of $3.7 million and $3.2 million during the three months ended June 30, 2007 and 2006, respectively. The increase of $522,000 was primarily due to the earnings of a milestone and the commencement of revenue recognition of a new collaboration in the second quarter of 2007. Research and development payments under collaborations with Ajinomoto, Cadbury, Campbell, Coca-Cola, Kraft Foods, Nestlé and Solae accounted for 100% of total revenue for the three months ended June 30, 2007. Research and development payments under collaborations with Ajinomoto, Cadbury, Campbell, Coca-Cola, Kraft Foods and Nestlé accounted for 100% of total revenue for the three months ended June 30, 2006.

Research and Development Expenses

Our research and development expenses (including stock-based compensation
expenses charged to research and development) were $7.0 million and $6.3 million
for the three months ended June 30, 2007 and 2006, respectively.  A comparison
of research and development expenses by category is as follows (in thousands):

                                                                 Three months ended
                                                                      June 30,
                                                                  2007         2006
Salaries and personnel                                         $    2,813    $  2,339
Facilities and depreciation                                         1,315       1,157
Research and development supplies                                     929       1,000
Patent and licensing                                                  721         375
Outside services                                                      277         461
Miscellaneous                                                         252         196
Total research and development expenses (excluding non-cash
stock based compensation)                                           6,307       5,528

Non-cash stock-based compensation                                     653         811
Total research and development expenses                        $    6,960    $  6,339

Salaries and Personnel. Our expenses for research and development personnel, including consultants, were $2.8 million and $2.3 million for the three months ended June 30, 2007 and 2006, respectively. The increase of $474,000 was primarily due to increases in payroll expense of approximately $443,000. Our research and development staff increased from an average of 76 for the three months ended June 30, 2006 to an average of 88 for the three months ended June 30, 2007. The increase in payroll expense reflects the addition of employees to support discovery and development operations and the impact of annual salary adjustments.

Facilities and Depreciation. Our facilities and depreciation expenses were $1.3 million and $1.2 million for the three months ended June 30, 2007 and 2006, respectively. The increase of $158,000 was primarily attributable to an increase in depreciation expense of $265,000 primarily due to tenant improvements in our current facility being placed in service during the fourth quarter of 2006. The increase was partially offset by a decrease in rent expense of $107,000 primarily due to a decrease in rent expense for our current facility compared to our former facility.

Research and Development Supplies. Our expenses for supplies used in research and development were $929,000 and $1.0 million for the three months ended June 30, 2007 and 2006, respectively. The decrease of $71,000 was primarily attributable to lower compound acquisition expenses partially offset by higher discovery and development screening and other lab supplies expenses.

Patent and Licensing. Our patent and licensing expenses were $721,000 and $375,000 for the three months ended June 30, 2007 and 2006, respectively. The increase of $346,000 was primarily attributable to outsourced patent filing related activities associated with our expanding intellectual property portfolio.

Outside Services. Our outside services expenses were $277,000 and $461,000 for the three months ended June 30, 2007 and 2006, respectively. The decrease of $184,000 was primarily attributable to a decrease in costs for chemistry outsourcing, as we redeployed these resources to internal activities.

Non-cash Stock-based Compensation. Our non-cash stock-based compensation expenses were $653,000 and $811,000 for the three months ended June 30, 2007 and 2006, respectively. The decrease of $158,000 was primarily attributable to decreases in compensation expense in 2007 compared to 2006 for stock options granted to both employees prior to 2006 and to non-employees, as the expense for these options is accounted for on an accelerated basis, which results in more expense being recognized for the options earlier in the options' vesting period. This decrease was partially offset by increases in expense related to stock options granted to employees during 2006 and the first and second quarters of 2007. Options granted to employees after 2005 are accounted for on a straight-line basis.

General and Administrative Expenses

Our general and administrative expenses (including stock-based compensation expenses charged to general and administrative) were $3.5 million and $4.0 million for the three months ended June 30, 2007 and 2006, respectively. The $515,000 decrease in expenses from the three months ended June 30, 2006 to 2007 was primarily attributable to decreases in non-cash stock-based compensation expense, recruiting and relocation expenses and management consulting. The decrease of non-cash stock-based compensation expense of approximately $307,000 is primarily due to decreases in compensation expense in 2007 compared to 2006 for stock options granted to employees prior to 2006 as the expense for these options is accounted for on an accelerated basis, which results in more expense being recognized for the options earlier in the options' vesting period. The decrease in expenses for recruiting of approximately $134,000 was due to the addition of key general and administrative personnel in the second quarter of 2006. The decrease in consulting expenses of approximately $132,000 from 2006 to 2007 was due to the one-time use of strategic planning consultants in the second quarter of 2006.

Interest Income (Expense)

Interest income was $855,000 and $947,000 for the three months ended June 30, 2007 and 2006, respectively. The decrease of $92,000 was primarily attributable to lower invested balances for the three months ended June 30, 2007 compared to the same period in 2006. The effect of these lower balances was partially offset by higher average rates of return on those invested balances for the three months ended June 30, 2007 compared to the three months ended June 30, 2006.

Six Months Ended June 30, 2007 and 2006

Revenue Under Collaboration Agreements

We recorded revenue of $6.8 million and $5.6 million during the six months ended June 30, 2007 and 2006, respectively. The increase of $1.2 million was primarily due to recognition of two quarters' of revenue for the Ajinomoto collaboration in 2007, compared to only one quarter for 2006. In addition, the increase was due to the earnings of a milestone and the commencement of revenue recognition in the second quarter of 2007 of a new collaboration. Research and development payments under collaborations with Ajinomoto, Cadbury, Campbell, Coca-Cola, Kraft Foods, Nestlé and Solae accounted for 100% of total revenue for the six months ended June 30, 2007. Research and development payments under collaborations with Ajinomoto, Cadbury, Campbell, Coca-Cola, Kraft Foods and Nestlé accounted for approximately 99% of total revenue for the six months ended June 30, 2006.

Research and Development Expenses

Our research and development expenses (including stock-based compensation
expenses charged to research and development) were $13.8 million and $12.8
million for the six months ended June 30, 2007 and 2006, respectively.  A
comparison of research and development expenses by category is as follows (in
thousands):

                                                                   Six months ended
                                                                       June 30,
                                                                   2007        2006
Salaries and personnel                                           $   5,601   $  4,568
Facilities and depreciation                                          2,900      2,266
Research and development supplies                                    1,823      1,841
Patent and licensing                                                 1,045      1,346
Outside services                                                       637        827
Miscellaneous                                                          605        440
Total research and development expenses (excluding non-cash
stock based compensation)                                           12,611     11,288

Non-cash stock-based compensation                                    1,201      1,547
Total research and development expenses                          $  13,812   $ 12,835

Salaries and Personnel. Our expenses for research and development personnel, including consultants, were $5.6 million and $4.6 million for the six months ended June 30, 2007 and 2006, respectively. The increase of $1.0 million was primarily due to increases in payroll expenses of approximately $1.0 million. Our research and development staff increased from an average of 73 for the six months ended June 30, 2006 to an average of 86 for the six months ended June 30, 2007.

The increase in payroll expense reflects the addition of employees to support discovery and development operations and the impact of annual salary adjustments.

Facilities and Depreciation. Our facilities and depreciation expenses were $2.9 million and $2.3 million for the six months ended June 30, 2007 and 2006, respectively. The increase of $634,000 was primarily attributable to an increase in depreciation expense of $537,000 primarily due to tenant improvements in our current facility being placed in service during 2006.

Research and Development Supplies. Our expenses for supplies used in research and development were $1.8 million for both of the six months ended June 30, 2007 and 2006. The decrease of $18,000 was primarily attributable to lower compound acquisition expenses partially offset by higher discovery and development screening and other lab supplies expenses.

Patent and Licensing. Our patent and licensing expenses were $1.0 million and $1.3 million for the six months ended June 30, 2007 and 2006, respectively. The decrease of $301,000 was primarily attributable to certain outsourced foreign patent filing activities commencing late in the fourth quarter of 2005 and completed early in the second quarter 2006 which were not replicated in 2007.

Outside Services. Our outside services expenses were $637,000 and $827,000 for the six months ended June 30, 2007 and 2006, respectively. The decrease of $190,000 was primarily attributable to a decrease in costs for chemistry outsourcing, as we redeployed these resources to internal activities.

Non-cash Stock-based Compensation. Our non-cash stock-based compensation expenses were $1.2 million and $1.5 million for the six months ended June 30, 2007 and 2006, respectively. The decrease of $346,000 was primarily attributable to decreases in compensation expense in 2007 compared to 2006 for stock options granted to both employees prior to 2006 and to non-employees, as the expense for these options is accounted for on an accelerated basis, which results in more expense being recognized for the options earlier in the options' vesting period. This decrease was partially offset by increases in expense related to stock options granted to employees during 2006 and the first two quarters of 2007. Options granted to employees after 2005 are accounted for on a straight-line basis.

General and Administrative Expenses

Our general and administrative expenses (including stock-based compensation expenses charged to general and administrative) were $7.2 million and $7.4 million for the six months ended June 30, 2007 and 2006, respectively. The $221,000 decrease in expenses from the six months ended June 30, 2006 to 2007 was primarily attributable to decreases in consulting expenses, recruiting expenses and non-cash stock-based compensation expense, partially offset by increases in salaries and personnel costs and depreciation expenses. The decrease in consulting expenses of approximately $321,000 from 2006 to 2007 was due to the one-time use of strategic planning consultants in the first quarter of 2006. The decrease in recruiting and relocation expenses of approximately $194,000 was due to the addition of key general and administrative personnel in the second quarter of 2006. The decrease in non-cash stock-based compensation expense of approximately $192,000 is primarily due to decreases in compensation expense in 2007 compared to 2006 for stock options granted to employees prior to 2006 as the expense for these options is accounted for on an accelerated basis, which results in more expense being recognized for the options earlier in the options' vesting period. Additional expense was incurred in 2006 for modifications made to stock options granted to members leaving our Board of Directors. No such modifications were made in 2007. These decreases were partially offset by increases in expense related to stock options granted to employees and members of our Board of Directors during 2006 and the first two quarters of 2007. The increase in expenses for salaries and personnel of approximately $345,000 was due to the impact of salary adjustments and to increased headcount. The increase in depreciation expense of $164,000 was primarily due to tenant improvements in our current facility being placed in service during the fourth quarter of 2006.

Interest Income (Expense)

Interest income was $1.8 million for both of the six months ended June 30, 2007 and 2006. The decrease of $66,000 was primarily attributable to lower invested balances for the six months ended June 30, 2007 compared to the same period in 2006. The effect of these lower balances was partially offset by higher average rates of return on those invested balances for the six months ended June 30, 2007 compared to the six months ended June 30, 2006.

Liquidity and Capital Resources

Since our inception, we have financed our business primarily through private and public placements of stock, research and development payments under our product discovery and development collaborations with Ajinomoto, Cadbury, Campbell, Coca-Cola, Kraft Foods, Nestlé and Solae and interest income. As of June 30, 2007, we had received in excess of $169.7 million in proceeds from the sales of common and preferred stock. In addition, we had received $60.7 million in non-refundable license fees, research and development payments, cost reimbursements and milestone payments from our collaboration agreements and $9.2 million in interest income. Over the remaining life of our current collaboration agreements, we may receive up to an additional $30.4 million in license fees and non-refundable research and development payments from our collaborators. We expect to receive royalty payments from one collaborator that has commercialized products incorporating our flavor ingredients. We may receive payments in the event we achieve research or development milestones and royalty payments in the event our collaborators commercialize additional products incorporating our flavor ingredients. We may not recognize revenues for research and development funding or milestones if the collaborations are terminated, or if we do not achieve the milestones set forth in the collaboration agreements.

At June 30, 2007, we had $65.0 million in cash, cash equivalents and investments available-for-sale as compared to $74.1 million at December 31, 2006, a decrease of $9.1 million. This overall decrease resulted primarily from the use of cash to fund our operations and to purchase capital equipment, partially offset by the receipt of proceeds of $1.7 million from the issuance of common stock through the exercise of employee and non-employee stock options and from purchases of stock from the employee stock purchase plan.

Operating Activities

Operating activities used cash of $10.6 million for the six months ended June 30, 2007 compared to $4.6 million for the six months ended June 30, 2006. Non-cash income from the accretion of discount on available-for-sale securities increased $857,000 to $1.2 million for the six months ended June 30, 2007 from $327,000 for the six months ended June 30, 2006. Non-cash expenses for the six months ended June 30, 2007 decreased $282,000 to $4.4 million for the six months ended June 30, 2007 from $4.7 million for the six months ended June 30, 2006. This decrease was primarily due to an increase in the amortization of leasehold obligation of $454,000 (a contra-expense) and relative decreases in both employee and non-employee stock-based compensation expense for $298,000 and $240,000, respectively. These reductions in non-cash expenses were partially offset by a relative increase in depreciation expense of $710,000. Net increases in other assets used cash of $1.7 million and $354,000 during the six months ended June 30, 2007 and 2006, respectively. Additionally, net increases in operating liabilities over the six months ended June 30, 2007 and 2006 provided cash of $313,000 and $4.1 million, respectively.

Investing Activities

Investing activities provided cash of $4.7 million and used cash of $429,000 for the six months ended June 30, 2007 and 2006, respectively. Cash provided in the six months ended June 30, 2007 reflects the maturities of available-for-sale securities purchased to obtain higher rates of interest income, partially offset by purchases of available-for-sale securities and purchases of fixed assets. Cash used in the six months ended June 30, 2006 reflects the purchases of available-for-sale securities to obtain higher rates of interest income, partially offset by the maturities of available-for-sale securities.

Financing Activities

Financing activities provided cash of $1.7 million and $989,000 for the six months ended June 30, 2007 and 2006, respectively. Cash provided by financing activities in the six months ended June 30, 2007 and 2006 reflects the net proceeds from the issuance or sale of common stock of $1.7 million and $989,000, respectively, pursuant to the exercise of employee and non-employee stock options and from purchases of stock from the employee stock purchase program. . . .