Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the Financial Statements and Notes relating thereto appearing elsewhere in this report and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Introductory Note

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

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

About Cortex Pharmaceuticals

We are engaged in the discovery and development of innovative pharmaceuticals for the treatment of neurodegenerative diseases and other neurological and psychiatric disorders. Since 1993, our primary efforts have been to develop products that affect the AMPA-type glutamate receptor, a complex of proteins that is involved in communication between nerve cells in the human brain. We are developing a family of chemical compounds, known as A MPAKINE ^® compounds, which enhance the activity of this receptor. We believe that A MPAKINE compounds hold promise for correcting deficits brought on by a variety of diseases and disorders that are known, or thought, to involve depressed functioning of pathways in the brain that use glutamate as a neurotransmitter.

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The A MPAKINE program addresses large potential markets. Our commercial development plan involves partnering with larger pharmaceutical companies for research, development, clinical testing, manufacturing and global marketing of A MPAKINE products for those indications that require sizable, expensive clinical trials and very large sales forces to achieve significant market penetration. At the same time, we plan to develop internally a selected set of indications, eligible for orphan drug status. These indications typically require more modest investment in the development stages, and involve a more concentrated sales force to reach selected medical centers and a limited number of medical specialists in the United States. If we are successful in the pursuit of this operating strategy, we may be in a position to contain our costs over the next few years, to maintain our focus on the research and early development of novel pharmaceuticals (where we believe that we have the ability to compete) and eventually to participate more fully in the commercial development of A MPAKINE products in the United States.

Critical Accounting Policies and Management Estimates

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

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

Revenue Recognition

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

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

Revenues from milestone payments are recognized when earned, as evidenced by written acknowledgment from our collaborator, provided that (i) the milestone event is substantive and its achievement was not reasonably assured at the inception of the agreement, and (ii) our performance obligations after the milestone achievement will continue to be funded by its collaborator at a

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comparable level to that before the milestone achievement. If both of these criteria are not met, the milestone payment is recognized over the remaining minimum period of our performance obligations under the agreement.

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

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

Employee Stock Options and Stock-Based Compensation

Prior to January 1, 2006, we accounted for stock-based employee compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). According to APB 25, no compensation expense is recognized since the exercise price of our stock options generally equals the market price of the underlying stock on the date of grant. We transitioned to Statement of Financial Accounting Standards No. 123, “Accounting For Stock-Based Compensation” (“SFAS 123”), by utilizing Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS 148”). In accordance with SFAS 148, we disclosed the effects of stock-based employee compensation on reported net income or loss and earnings or loss per share in the footnotes to our annual and interim financial statements.

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share Based Payment” (“SFAS 123(R)”) using a modified prospective application. Earlier periods were not restated. SFAS 123(R) is a revision of SFAS 123, and supersedes APB 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.

Given that we previously followed APB 25 and SFAS 148 in accounting for our employee stock options, the impact of adopting the expense recognition requirements of SFAS 123(R) was significant to our results of operations, but not our financial position. Our net loss for the three months ended June 30, 2006 includes approximately $654,000 of non-cash stock-based employee compensation costs. For the three months ended June 30, 2005, our net loss includes approximately $13,000 for non-cash stock-based employee compensation costs.

For the six months ended June 30, 2006, our net loss includes approximately $1,697,000 of non-cash stock-based employee compensation costs. For the six months ended June 30, 2005, our net loss includes a credit of approximately $13,000 of non-cash stock-based employee compensation costs.

As of June 30, 2006, there was approximately $2,643,000 of total unrecognized compensation cost related to non-vested share-based employee compensation arrangements. These non-cash costs are expected to be recognized over a weighted-average period of 1.2 years.

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

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

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

Results of Operations

General

In January 1999, we entered into a research collaboration and exclusive worldwide license agreement with NV Organon (“Organon”). The agreement will allow Organon to develop and commercialize our proprietary A MPAKINE technology for the treatment of schizophrenia and depression. In connection with the agreement, we received approximately $8,000,000 in up-front and research support payments. The agreement with Organon also includes milestone payments based upon clinical development, plus royalty payments on worldwide sales. To date, we have received milestone payments from Organon totaling $6,000,000. For each milestone payment, we recorded the related revenue upon achievement of the milestone.

In October 2000, we entered into a research collaboration agreement and a license agreement with Les Laboratoires Servier (“Servier”). The agreements will allow Servier to develop and commercialize select A MPAKINE compounds for the treatment of (i) declines in cognitive performance associated with aging, (ii) neurodegenerative diseases and (iii) anxiety disorders. The license agreement includes milestone payments based upon successful clinical development and royalty payments on sales in licensed territories. The research collaboration agreement, as amended, includes an up-front payment by Servier of $5,000,000 and research support payments of up to approximately $2,298,000 per year through early December 2006 (subject to us providing agreed-upon levels of research personnel). For the three months and six months ended June 30, 2006, we recognized research revenues of approximately $189,000 and $369,000, respectively, from the Servier collaboration. We have notified Servier of our intent to terminate the research collaboration in early December 2006. The license agreement with Servier, as amended to date, will continue in accordance with its terms.

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From inception (February 10, 1987) through June 30, 2006, we have sustained losses aggregating approximately $72,661,000. Continuing losses are anticipated over the next several years. During that time, our ongoing operating expenses will only be offset, if at all, by proceeds from Small Business Innovative Research (“SBIR”) grants, research support payments from the collaboration with Servier and by possible milestone payments from Organon and Servier. Ongoing operating expenses may also be funded by payments under planned strategic alliances that we are seeking with other pharmaceutical companies for the clinical development, manufacturing and marketing of our products. The nature and timing of payments to us under the Organon and Servier agreements or other planned strategic alliances, if and when entered into, are likely to significantly affect our operations and financing activities and to produce substantial period-to-period fluctuations in reported financial results. Over the longer term, we will be dependent upon the successful introduction of a new product into the North American market from our internal development, as well as the successful commercial development of our products by Organon, Servier or our other prospective partners to attain profitable operations from royalties or other product-based revenues.

Comparison of the Three Months and Six Months ended June 30, 2006 and 2005

For the three months ended June 30, 2006, the net loss of approximately $4,398,000 compared with a net loss of approximately $2,689,000 for the corresponding prior year period. For the six months ended June 30, 2006, the net loss of approximately $8,958,000 compared to a net loss of approximately $5,337,000 for the corresponding prior year period. For both periods, the increased losses primarily resulted from increased non-cash stock compensation charges and expenses related to addressing the clinical hold on our A MPAKINE CX717 by the U.S. Food and Drug Administration (“FDA”). The increased non-cash stock compensation charges include amounts related to our required adoption of SFAS 123(R) as of January 1, 2006 and the recording of expense for all share-based payments to employees, including grants of employee stock options, based on their fair values.

Our revenues for the three months ended June 30, 2006 decreased from approximately $647,000 to approximately $232,000, or by 64% compared to the three months ended June 30, 2005. For the six months ended June 30, 2006, revenues decreased from approximately $1,346,000 to approximately $463,000, or by 66% compared to the six months ended June 30, 2005. The decreases in the current year periods mostly were due to decreased research revenues from our agreement with Servier. As discussed above, we are in the process of winding down the Servier research collaboration effective December 2006.

Our research and development expenses for the three-month period ended June 30, 2006 increased from approximately $2,793,000 to approximately $3,706,000, or by 33% from the corresponding prior year period. For the six-month period ended June 30, 2006, our research and development expenses increased from approximately $5,450,000 to approximately $7,171,000, or by 32% from the corresponding prior year period. Non-cash stock compensation charges accounted for approximately $288,000, or 32% of the increase in expenses for the three months ended June 30, 2006. For the six months ended June 30, 2006, non-cash stock compensation charges accounted for approximately $1,010,000, or 59% of the increase in research and development expenses. Most of the remaining increases in the current year periods represented expenses related to addressing the FDA clinical hold on CX717, along with increased sponsored research supporting the A MPAKINE program and costs related to expanding our research staff.

Our general and administrative expenses for the three-month period ended June 30, 2006 increased from approximately $696,000 to approximately $1,114,000, or by 60% compared to the corresponding prior year period. For the six-month period ended June 30, 2006, our general and

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administrative expenses increased from approximately $1,464,000 to approximately $2,590,000, or by 77% compared to the corresponding prior year period. Non-cash stock compensation charges accounted for approximately $238,000 and $805,000 of the expense increases for the three months and six months ended June 30, 2006, respectively.

Increased general and administrative expenses for the current year periods also reflect legal fees in connection with our corporate partnering discussions and costs resulting from the change in the timing of our 2006 Annual Meeting of Stockholders to May as compared to December in the prior year. Audit fees also increased for the six months ended June 30, 2006 with the completion of procedures related to Section 404 of the Sarbanes-Oxley Act of 2002, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005 that we filed in March 2006.

Other expenses for the six months ended June 30, 2005 include non-cash charges for the change in estimated value of warrants issued in connection with our private equity financing in December 2004. The charges represent the change in estimated value of the warrants from December 31, 2004 to January 26, 2005, when the related registration statement for the underlying shares was declared effective by the Securities and Exchange Commission.

Liquidity and Capital Resources

Sources and Uses of Cash

From inception (February 10, 1987) through June 30, 2006, we have funded our organizational and research and development activities primarily through the issuance of equity securities, funding related to collaborative agreements and net interest income.

Under the research collaboration agreement with Servier dated October 2000, as amended to date, we receive research support payments of up to approximately $2,298,000 per year through early December 2006, subject to the amount of research personnel that we provide. During the six months ended June 30, 2006, we received research support of approximately $574,000 from the agreement with Servier, including $205,000 that we recorded as unearned revenue at June 30, 2006. As reported on our Current Report on Form 8-K dated March 27, 2006, we have elected to terminate the research collaboration effective December 7, 2006. The license agreement with Servier dated October 2000, as amended to date, will continue in accordance with its terms and includes milestone payments based upon successful clinical development and royalties on sales in licensed territories.

In August 2003, we completed a private placement of an aggregate of 3,333,334 shares of our common stock at $1.50 per share and five-year warrants to purchase up to an additional aggregate of 3,333,334 shares at an exercise price of $2.55 per share. Our gross and net proceeds from this private placement were $5,000,000 and approximately $4,500,000, respectively. During the six months ended June 30, 2006, we received approximately $2,830,000 from the exercise of warrants issued with this private placement. As of June 30, 2006, warrants to purchase up to 1,883,335 shares remained outstanding. If these remaining warrants are fully exercised, of which there can be no assurance, such exercise would provide us approximately $4,803,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $6.00 per share for any 13 consecutive trading days.

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In January 2004, we completed a private placement of an aggregate of 6,909,091 shares of our common stock at $2.75 per share and five-year warrants to purchase up to an additional aggregate of 4,490,910 shares at an exercise price of $3.25 per share. We received gross and net proceeds from this private placement of $19,000,000 and approximately $17,500,000, respectively. During the six months ended June 30, 2006, we received approximately $1,696,000 from the exercise of warrants issued with this private placement. As of June 30, 2006, warrants to purchase up to 3,969,137 shares remained outstanding. If the remaining warrants are fully exercised, of which there can be no assurance, these warrants would provide us approximately $12,900,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $7.50 per share for any 13 consecutive trading days.

In December 2004, we completed a private placement of an aggregate of 4,233,333 shares of our common stock at $2.66 per share and five-year warrants to purchase up to an additional aggregate of 2,116,666 shares at an exercise price of $3.00 per share. We received gross and net proceeds from this private placement of approximately $11,260,000 and approximately $10,400,000, respectively. During the six months ended June 30, 2006, we received approximately $1,023,000 from the exercise of warrants issued with this private placement. As of June 30, 2006, warrants to purchase up to 1,775,689 shares remained outstanding. If the remaining warrants are fully exercised, of which there can be no assurance, these warrants would provide us approximately $5,327,000 of additional capital. The warrants are subject to a call right in our favor to the extent that the closing price of our common stock exceeds $7.50 per share for any 13 consecutive trading days.

As of June 30, 2006, we had cash, cash equivalents and marketable securities totaling approximately $15,538,000 and working capital of approximately $13,368,000. In comparison, as of December 31, 2005, we had cash, cash equivalents and marketable securities of approximately $17,261,000 and working capital of approximately $14,710,000. The decreases in cash and working capital reflect amounts required to fund operations, partially offset by proceeds from the exercise of warrants to purchase shares of our common stock.

Net cash used in operating activities was approximately $7,391,000 during the six months ended June 30, 2006, and included our net loss for the period of approximately $8,958,000, adjusted for non-cash expenses for depreciation, amortization and stock compensation approximating $1,930,000, and changes in operating assets and liabilities. Net cash used in operating activities was approximately $5,209,000 during the six months ended June 30, 2005, and included our net loss for the period of approximately $5,337,000, adjusted for non-cash expenses for depreciation, amortization and stock compensation (including the change in fair value of common stock warrants) approximating $195,000, and changes in operating assets and liabilities.

Net cash provided by investing activities approximated $1,366,000 during the six months ended June 30, 2006, and primarily resulted from the sales and maturities of marketable securities of approximately $9,048,000, partially offset by the purchase of marketable securities of $7,626,000. Fixed asset purchases for the current year period approximated $56,000. Net cash used in investing activities approximated $3,072,000 during the six months ended June 30, 2005, and primarily resulted from the purchase of marketable securities of approximately $13,151,000, partially offset by the sale and maturity of marketable securities of $10,215,000. Fixed asset purchases for the six months ended June 20, 2005 approximated $136,000.

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Net cash provided by financing activities amounted to approximately $5,724,000 for the six months ended June 30, 2006, and resulted primarily from the exercise of warrants to purchase shares of our common stock issued to investors in connection with our prior financings as well as the exercise of other outstanding warrants. Net cash provided by financing activities were minimal for the six months ended June 30, 2005 and resulted from the exercise of options to purchase shares of our common stock.

Commitments

We lease approximately 32,000 square feet of research laboratory, office and expansion space under an operating lease that expires May 31, 2009. The commitments under the lease agreement for the years ending December 31, 2006, 2007, 2008 and 2009 are $258,000, $532,000, $556,000 and $298,000, respectively.

Remaining commitments for clinical studies of CX717 and other preclinical expenses amount to approximately $3,375,000. This amount includes an estimated $820,000 for studies contingent upon the removal of the FDA’s clinical hold on CX717. Separately, we are committed to approximately $273,000 for sponsored research at academic and other institutions, all of which is payable over the next twelve months.

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

Staffing

As of June 30, 2006, we had a total of 26 full-time research and administrative employees. We anticipate modest increases in staffing and investments in plant or equipment through the next twelve months.

Outlook

We anticipate that our cash, cash equivalents and marketable securities will be sufficient to satisfy our capital requirements into 2007. Additional funds will be required to continue operations beyond that time. We may receive additional milestone payments from the Organon and Servier agreements. However, there is no assurance that we will receive such milestone payments from Organon or Servier. Additionally, on March 31, 2006, the FDA notified us that it had placed a clinical hold on our lead compound, A MPAKINE CX717. At present, we are on schedule for meeting our target date for submission of our complete response to the FDA by early September 2006. However, there can be no assurance that we will meet that timeline. Our future capital requirements will be impacted by our ability to successfully address the FDA’s concerns and to effect the removal of the clinical hold.

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

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

Additional Risks and Uncertainties

Our proposed products are in the preclinical or early clinical stage of development and will require significant further research, development, clinical testing and regulatory clearances. They are subject to the risks of failure inherent in the development of products based on innovative technologies. These risks include, but are not limited to, the possibilities that any or all of the proposed products will be found to be ineffective or unsafe, or otherwise fail to receive necessary regulatory clearances; that the proposed products, although effective, will be uneconomical to market; that third parties may now or in the future hold proprietary rights that preclude us from marketing them; or that third parties will market superior or equivalent products. Accordingly, we are unable to predict whether our research and development activities will result in any commercially viable products or applications. Further, due to the extended testing and regulatory review process required before marketing clearance can be obtained, we do not expect to be able to commercialize any therapeutic drug for at least five years, either directly or through our current or prospective partners or licensees. There can be no assurance that our proposed products will prove to be safe or effective or receive regulatory approvals that are required for commercial sale.

Off-Balance Sheet Arrangements

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