**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

** **
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|----------------------------------------------------------------------------------------------|

 

**For TheQuarterly Period Ended June 30, 2005**

 

**or**

 
| **o** | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|-----------------------------------------------------------------------------------------------|

 

**For theTransition Period from                to                **

 

**CommissionFile Number 000-50439**

** **

**NitroMed, Inc.**

(Exact Name ofRegistrant as Specified in Its Charter)

 
| **Delaware**                                    | ** ** | **22-3159793**      |
|-------------------------------------------------|------------|---------------------|
| (State or Other Jurisdiction of                 |       | (I.R.S. Employer    |
| Incorporation or Organization)                  |       | Identification No.) |
|                                            |       |                |
| **125 Spring Street, Lexington, Massachusetts** | ** ** | **02421**           |
| (Address of Principal Executive Offices)        |       | (Zip Code)          |

 

Registrant’stelephone number, including area code: **(781) 266-4000**

 

Former Name, Former Address and Formal Fiscal Year, ifChanged Since Last Report

 

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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days.    Yes ý  No o

 

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

As of July 31, 2005, the registrant had 30,373,036 sharesof Common Stock, $0.01 par value per share, outstanding.

 

 

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NITROMED, INC.

 

FORM 10-Q

 

FOR THE QUARTERLY PERIODENDED JUNE 30, 2005

 

**TABLEOF CONTENTS**
| ** **     | ** ** | ** **                                                                                      | ** ** |
|----------------|------------|-------------------------------------------------------------------------------------------------|------------|
| PART I.        |       | FINANCIAL  INFORMATION                                                                          |       |
| Item  1.       |       | Financial  Statements (unaudited)                                                               |       |
|           |       | Balance Sheets as of June  30, 2005 and December 31, 2004 (unaudited)                           |       |
|           |       | Statements of Operations for  the three and six months ended June 30, 2005 and 2004 (unaudited) |       |
|           |       | Statements of Cash Flows for  the six months ended June 30, 2005 and 2004 (unaudited)           |       |
|           |       | Notes To Unaudited Financial  Statements                                                        |       |
| Item  2.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations     |       |
| Item 3.        |       | Quantitative  and Qualitative Disclosures About Market Risk                                     |       |
| Item 4.        |       | Controls and  Procedures                                                                        |       |
| PART II.       |       | OTHER INFORMATION                                                                               |       |
| Item  5.       |       | Submission  of Matters to a Vote of Security Holders                                            |       |
| Item  6.       |       | Exhibits                                                                                        |       |
| Signatures     |       |
| Exhibit  Index |       |

 

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.****    Financial Statements(unaudited)**

** **

**NITROMED, INC.**

**BALANCESHEETS(in thousands, except par value amounts)**

 
| ** **                                                                                                                                                      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
|                                                                                                                                                            | ** ** | ** **         | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                      |       |               |       |                   |       |
| Current assets:                                                                                                                                                 |       |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                       |       | $                  | 29,667     |                   | $          | 35,882 |   |
| Marketable securities                                                                                                                                           |       | 90,856             |       | 106,485                |       |
| Inventories                                                                                                                                                     |       | 6,071              |       | —                 |       |
| Prepaid expenses and other current assets                                                                                                                       |       | 1,565              |       | 3,216                  |       |
| Total current assets                                                                                                                                            |       | 128,159            |       | 145,583                |       |
| Property and equipment, net                                                                                                                                     |       | 3,341              |       | 2,963                  |       |
| Other assets                                                                                                                                                    |       | 802                |       | 811                    |       |
|                                                                                                                                                            |       |               |       |                   |       |
| Total assets                                                                                                                                                    |       | $                  | 132,302    |                   | $          | 149,357 |   |
|                                                                                                                                                            |       |               |       |                   |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                   |       |               |       |                   |       |
| Current liabilities:                                                                                                                                            |       |               |       |                   |       |
| Accounts payable                                                                                                                                                |       | $                  | 6,354      |                   | $          | 2,662 |   |
| Accrued expenses                                                                                                                                                |       | 9,408              |       | 8,091                  |       |
| Deferred revenue                                                                                                                                                |       | 796                |       | 1,592                  |       |
| Current portion of long –term debt                                                                                                                         |       | 6,667              |       | —                 |       |
|                                                                                                                                                            |       |               |       |                   |       |
| Total current liabilities                                                                                                                                       |       | 23,225             |       | 12,345                 |       |
|                                                                                                                                                            |       |               |       |                   |       |
| Long-term debt                                                                                                                                                  |       | 13,333             |       | —                 |       |
|                                                                                                                                                            |       |               |       |                   |       |
| Stockholders’ equity:                                                                                                                                      |       |               |       |                   |       |
| Preferred stock, $0.01 par value; 5,000  shares authorized; no shares issued or outstanding                                                                     |       | —             |       | —                 |       |
| Common stock, $0.01 par value; 65,000  shares authorized; 30,288 and 30,124 shares issued and outstanding at June  30, 2005 and December 31, 2004, respectively |       | 303                |       | 301                    |       |
| Additional paid-in capital                                                                                                                                      |       | 276,147            |       | 275,727                |       |
| Deferred stock-based compensation                                                                                                                               |       | (1,651             | )          | (2,095                 | )          |
| Accumulated deficit                                                                                                                                             |       | (178,832           | )          | (136,619               | )          |
| Accumulated other comprehensive loss                                                                                                                            |       | (223               | )          | (302                   | )          |
| Total stockholders’ equity                                                                                                                                 |       | 95,744             |       | 137,012                |       |
|                                                                                                                                                            |       |               |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                                 |       | $                  | 132,302    |                   | $          | 149,357 |   |

 

Seeaccompanying notes.

 

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**NITROMED, INC.**

**STATEMENTS OF OPERATIONS(in thousands, except per share amounts) (unaudited)**

** **
| ** **                                                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                                                 |       |                             |       |                           |       |   |   |   |   |
| Research and development                                                                                  |       | $                                | 398        |                           | $          | 2,331 |   | $ | 796 |   | $ | 4,662 |   |
| Operating expenses:                                                                                       |       |                             |       |                           |       |   |   |   |   |
| Research and development                                                                                  |       | 8,302                            |       | 5,085                          |       | 15,998 |   | 10,713 |   |
| Sales, general and administrative                                                                         |       | 15,484                           |       | 2,261                          |       | 28,547 |   | 3,797 |   |
| Total operating expenses                                                                                  |       | 23,786                           |       | 7,346                          |       | 44,545 |   | 14,510 |   |
| Loss from operations                                                                                      |       | (23,388                          | )          | (5,015                         | )          | (43,749 | ) | (9,848 | ) |
| Non-operating income:                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                                           |       | 764                              |       | 315                            |       | 1,536 |   | 592 |   |
|                                                                                                      |       | 764                              |       | 315                            |       | 1,536 |   | 592 |   |
|                                                                                                      |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Net loss                                                                                                  |       | $                                | (22,624    | )                              | $          | (4,700 | ) | $ | (42,213 | ) | $ | (9,256 | ) |
|                                                                                                      |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Basic and diluted net loss per common share  attributable to common stockholders                          |       | $                                | (0.75      | )                              | $          | (0.18 | ) | $ | (1.40 | ) | $ | (0.36 | ) |
| Shares used in computing basic and diluted  net loss per common share attributable to common stockholders |       | 30,275                           |       | 25,696                         |       | 30,255 |   | 25,648 |   |

 

See accompanyingnotes.

 

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**NITROMED, INC.**

**STATEMENTS OF CASH FLOWS(in thousands) (unaudited)**

 
| ** **                                                                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| **Operating activities**                                                     |       |                           |       |   |   |
| Net loss                                                                     |       | $                              | (42,213    | ) | $ | (9,256 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                |       | 434                            |       | 162 |   |
| Stock-based compensation expense                                             |       | 224                            |       | 521 |   |
| Changes in operating assets and liabilities:                                 |       |                           |       |   |   |
| Inventories                                                                  |       | (6,071                         | )          | — |   |
| Prepaid expenses and other current assets                                    |       | 1,651                          |       | (91 | ) |
| Deferred revenue                                                             |       | (796                           | )          | (3,463 | ) |
| Accounts payable and accrued expenses                                        |       | 5,009                          |       | (345 | ) |
| Net cash used in operating activities                                        |       | (41,762                        | )          | (12,472 | ) |
| **Investing activities**                                                     |       |                           |       |   |   |
| Purchases of property and equipment                                          |       | (812                           | )          | (1,080 | ) |
| Purchases of marketable securities                                           |       | (57,428                        | )          | (44,255 | ) |
| Sales of marketable securities                                               |       | 73,136                         |       | 11,838 |   |
| Other assets                                                                 |       | 9                              |       | (807 | ) |
| Net cash provided by (used in) investing activities                          |       | 14,905                         |       | (34,304 | ) |
| **Financing activities**                                                     |       |                           |       |   |   |
| Proceeds from long-term debt                                                 |       | 20,000                         |       | — |   |
| Proceeds from employee stock plans                                           |       | 642                            |       | 225 |   |
| Principal payments on notes payable                                          |       | —                         |       | (22 | ) |
| Net cash provided by (used in) financing  activities                         |       | 20,642                         |       | (203 | ) |
| Net decrease in cash and cash equivalents                                    |       | (6,215                         | )          | (46,573 | ) |
| Cash and cash equivalents at beginning of  period                            |       | 35,882                         |       | 67,614 |   |
| Cash and cash equivalents at end of period                                   |       | $                              | 29,667     |   | $ | 21,041 |   |

 

Seeaccompanying notes.

 

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**NITROMED, INC.**

**NOTES TO UNAUDITED FINANCIAL STATEMENTSJUNE 30, 2005**

 

### **(1)**           Basisof Presentation

 

The accompanying unaudited financial statements ofNitroMed, Inc. (“NitroMed” or the “Company”) have been prepared in accordancewith accounting principles generally accepted in the United States (“GAAP”) forinterim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by GAAP for complete financialstatements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for the fair presentation of theresults for the interim periods have been included. The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Interim results are not necessarilyindicative of results to be expected for the entire fiscal year endingDecember 31, 2005. These unaudited financial statements should be read inconjunction with the Company’s latest annual audited financial statements andrelated notes thereto included in the Company’s annual report on Form 10-K, which was filed with the Securities and Exchange Commission (“SEC”)on March 10, 2005.

 

### **(2)**           Inventories

 

Inventoriesare stated at the lower of cost or market, with cost determined on a first-in,first-out basis.  Inventories consisted of the following:

 
| ** **         | ** ** | **June 30,** | ** ** |
|--------------------|------------|--------------|------------|
| **(in thousands)** | ** ** | **2005**     | ** ** |
| Raw materials      |       | $            | 2,026      |   |
| Finished goods     |       | 4,045        |       |
|               |       | $            | 6,071      |   |

 

### **Duringthe six month period ending June 30, 2005, the Company purchased andcapitalized inventories to be used for samples and commercial sales related tothe then-anticipated July 2005 product launch of BiDil, the Company’s productfor the treatment of heart failure in self-identified black patients. BiDilcurrently has a twelve month shelf life. On a quarterly basis, the Companyanalyzes its inventory levels, and writes down inventory that has becomeun-saleable, inventory that has a cost basis in excess of its expected netrealizable value and inventory that is in excess of expected requirements ofproduct revenues. Expired inventory will be disposed of, and the related costswill be written off.  As of June 30,2005, there has been no impairment of inventory.**

### ** **

### **(3)**           Stock-BasedCompensation

 

The Company has elected to account for its stock-basedcompensation plans under the intrinsic value method pursuant to AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations, ratherthan the alternative fair value accounting provided under Statement ofFinancial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation* (“SFAS 123”). In accordance withEmerging Issues Task Force (“EITF”) 96-18, *Accountingfor Equity Instruments that are Issued to Other than Employees for Acquiring,or in Connection with Selling, Goods or Services*, the Companyrecords stock-based compensation expense equal to the fair value of the optiongranted to non-employees over the vesting period, which is generally the periodof service.

 

For the years ended December 31, 2003 andDecember 31, 2002, the Company granted 431,250 and 241,000 options,respectively, to employees at exercise prices below the fair value of theCompany’s common stock. The Company recorded deferred stock-based compensationrelated to these grants of $3,317,000 and $566,000 in 2003 and 2002, respectively.These amounts are being recognized ratably over the vesting period of fouryears. Included in the results of operations for the three-month periods endedJune 30, 2005 and 2004 is stock-based

 

4

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compensation expense of $221,000 and $287,000,respectively. Included in the results of operations for the six-month periodsended June 30, 2005 and 2004 is stock-based compensation expense of $444,000and $516,000, respectively.

 

TheCompany also has additional stock-based awards that are accounted for asvariable awards and are re-measured at each reporting period Included in theresults of operations for the three-month periods ended June 30, 2005 and 2004is stock-based compensation expense of $210,000 and a reduction in the expenseof ($69,000), respectively. Included in the results of operations for thesix-month periods ended June 30, 2005 and 2004 is a reduction in stock-basedcompensation expense of ($220,000) and an expense of $5,000, respectively.

 

Forpurposes of pro forma disclosures, the estimated fair value of the stock optionis amortized over the stock option’s vesting period. Had compensation expensefor the Company’s stock-based compensation plans been determined based on thefair value at the grant dates for awards under those plans consistent with themethod of SFAS 123, the Company’s net loss and net loss per share wouldhave been as follows:

 
| ** **                                                                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in thousands, except per share  amounts)**                                               | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss as reported                                                                        |       | $                                | (22,624    | )                              | $          | (4,700 | ) | $ | (42,213 | ) | $ | (9,256 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss               |       | 282                              |       | 255                            |       | 301 |   | 560 |   |
| Deduct: Stock-based employee compensation  expense determined under fair value based method |       | (1,478                           | )          | (1,341                         | )          | (2,560 | ) | (1,661 | ) |
| Pro forma net loss                                                                          |       | $                                | (23,820    | )                              | $          | (5,786 | ) | $ | (44,472 | ) | $ | (10,357 | ) |
|                                                                                        |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Basic and diluted net loss per share                                                        |       |                             |       |                           |       |   |   |   |   |
| As reported                                                                                 |       | $                                | (0.75      | )                              | $          | (0.18 | ) | $ | (1.40 | ) | $ | (0.36 | ) |
| Pro forma                                                                                   |       | $                                | (0.79      | )                              | $          | (0.23 | ) | $ | (1.47 | ) | $ | (0.40 | ) |

 

### **(4)**           ComprehensiveIncome (Loss)

### ** **

Components of comprehensive income (loss) include netloss and certain transactions that have generally been reported in thestatement of stockholders’ equity. Comprehensive loss is comprised solely ofnet loss and unrealized gains and losses from marketable securities.Comprehensive loss for the three months ended June 30, 2005 and June 30, 2004was $22,514,000 and $5,105,000, respectively. Comprehensive loss for the sixmonths ended June 30, 2005 and June 30, 2004 was $42,134,000 and $9,645,000,respectively.

 

### **(5)**           NetLoss Per Share

### ** **

Basic net loss per share is computed by dividing netloss available to common stockholders by the weighted average number of sharesof common stock outstanding during the period. Diluted net loss per share iscomputed by dividing net loss available to common stockholders by the weightedaverage number of shares of common stock and the dilutive potential commonstock equivalents then outstanding. Potential common stock equivalents consistof stock options and warrants. Since the Company has a net loss for all periodspresented, the effect of all potentially dilutive securities is antidilutive.Accordingly, basic and diluted net loss per share is the same.

 

The following table sets forth the computation ofbasic and diluted net loss per share for the respective periods. 

 
| ** **                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in thousands, except per share  amounts)**                      | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| *Basic and Diluted:*                                               |       |                             |       |                           |       |   |   |   |   |
| Net loss                                                           |       | $                                | (22,624    | )                              | $          | (4,700 | ) | $ | (42,213 | ) | $ | (9,256 | ) |
|                                                               |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Weighted average common shares used to  compute net loss per share |       | 30,275                           |       | 25,696                         |       | 30,255 |   | 25,648 |   |
| Basic and diluted net loss per share                               |       | $                                | (0.75      | )                              | $          | (0.18 | ) | $ | (1.40 | ) | $ | (0.36 | ) |

 

5

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### **Asof June 30, 2005 and 2004, options to purchase 3,869,249 and 3,073,084 sharesof common stock, respectively, and warrants to purchase 13,023 and 150,778shares of common stock, respectively, were not included in the computation ofdiluted net loss per share since their inclusion would be antidilutive.**

### ** **

### **(6)**           LongTerm Debt

### ** **

### **OnJune 28, 2005, the Company borrowed (i) $10.0 million from Oxford FinanceCorporation (“Oxford”), and (ii) $10.0 million from General Electric CapitalCorporation (“GECC”) pursuant to the terms of Promissory Notes (“the Notes”).The Notes bear interest at a fixed rate of 9.95% per annum and are payable in36 consecutive monthly installments of principal and accrued interest, with thefirst installment due and payable on July 1, 2005.  Also onJune 28, 2005, the Company entered into Master Security Agreements withboth Oxford and GECC (“the Agreements”).  Under terms of these Agreements,the Company granted to both Oxford and GECC a security interest in and againstall of the property of the Company and in and against all additions,attachments, accessories and accessions to such property, all substitutions,replacements or exchanges , and all insurance and/or other proceeds (“theCollateral”).  The Collateral comprises all of the Company’s personalproperty and fixtures including, but not limited to, all inventory, equipment,fixtures, accounts, deposit accounts, documents, investment property, instruments,general intangibles, chattel paper and any and all proceeds (but excludingintellectual property).  The Collateral does not include any intellectualproperty or products (or interests in any intellectual property or products(including any royalties)) acquired, whether by purchase, license or otherwise,on or after the execution of the Agreements (collectively, “New Property”), nordo the Agreements limit any indebtedness secured by any New Property providedthat debt or non-cash equity(e.g., stock) is used to acquire New Property.  In the eventthat the Company uses cash to purchase New Property, Oxford’s and GECC’sexisting liens will extend to such New Property.  The Agreements also contain a MaterialAdverse Change clause with both Oxford and GECC. Under this clause, if Oxfordor GECC reasonably determine that the Company’s ability to repay the Notes hasbeen materially impaired, the Company would be considered in default. As ofJune 30, 2005 the Company was in compliance with this clause.**

### ** **

### **(7)**           Commitmentsand Contingencies

### ** **

Inconnection with seeking to obtain the approval of BiDil from the U.S. Food andDrug Administration (“FDA”), the Company contracted with a consulting firm forservices related to the regulatory approval process for BiDil. The agreementprovides for payment of legal consulting fees when the Company receives writtenFDA approval of BiDil and also provides for the Company to pay costs andexpenses incurred in performing services under the agreement within 30 daysafter receipt of a statement with respect to such expenses. In addition, theagreement requires the Company to pay royalties to such consulting firm onsales of the BiDil product. The royalty term ends six months after the date ofmarket introduction of an FDA approved generic version of the BiDil product.During the year ended December 31, 2004, the Company recorded charges ofapproximately $1.9 million pertaining to the legal consulting fees relatedto this agreement. Such charges included only the legal consulting feeobligations and not the royalty or expense obligations. For the three monthsended June 30, 2005 and June 30, 2004, the Company recorded $266,000 and $0,respectively, pertaining to fees and expenses related to this agreement. Forthe six months ended June 30, 2005 and June 30, 2004, the Company recorded$532,000 and $0, respectively, pertaining to fees and expenses related to thisagreement. On June 23, 2005, the Company received written FDA approval ofBiDil. The Company estimates that approximately $2.5 million in legalconsulting fees will be paid out under this agreement within forty-five daysafter the approval date as required by the agreement.

 

Anacademic institution has asserted that patents and patent applications whichrelate to the nitric oxide stent program may require a license from suchinstitution. It is the opinion of the Company’s management and outside legalcounsel that the disputed intellectual property has been validly licensed to,or is validly owned by, the Company. Accordingly, the accompanying financialstatements do not include any provision related to this claim.

 

On July 20,2004, the Market Regulation Department of the National Association ofSecurities Dealers, Inc. (“NASD”) advised the Company that it initiated areview of trading activity in the Company’s common stock

 

6

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surrounding the Company’sJuly 19, 2004 announcement that it had halted its phase III clinical trialof BiDil due to the significant survival benefit seen with BiDil. The NASD isreviewing, among other things, information on relationships between the Company’sofficers, directors and service providers and individuals and institutions thatmay have traded in the Company’s common stock prior to the July 19, 2004announcement. The Company has cooperated with this review and has identifiedcertain persons on the list provided to the Company by the NASD as having arelationship with the Company’s chief executive officer and others at theCompany. The Company has established a special committee of its board ofdirectors to oversee the Company’s response to this review. The Company ispresently unable to predict the outcome of this matter or the timing of itsresolution.

 

OnOctober 3, 2004, the Company entered into an agreement with Publicis SellingSolutions, Inc. (“Publicis”), a contract sales organization, pursuant to which,on the Company’s behalf, Publicis has employed and trained a specializedcardiovascular sales force of approximately 195 sales representatives to sellBiDil to the Company’s target prescriber markets.  The agreement is for a term of 24 monthsbeginning January 31, 2005, with the Company having the option to continue theagreement beyond this term. Estimated year one costs are $30,964,000, excludingone-time start-up costs of $3,108,000, and year two costs are projected at$32,494,000. The Company has the right to terminate this agreement upon 90 dayswritten notice to Publicis.  If theCompany terminates this agreement during months one through twelve of the termof the agreement, the Company is required to pay a termination fee in theamount of $1.0 million. If the Company terminates this agreement during monthsthirteen through eighteen, the termination fee will be $750,000. If the Companyterminates the agreement after month eighteen, no termination fee will beassessed. For the three months ended June 30, 2005, $6.4 million has been paidand $7.9 million has been expensed related to this agreement. For the sixmonths ended June 30, 2005, $12.5 million has been paid and $13.3 million hasbeen expensed related to this agreement.

 

OnFebruary 16, 2005, the Company engaged Schwarz Pharma Manufacturing, Inc. (“SchwarzPharma”) under a five-year exclusive manufacturing and supply agreement solelyfor the three times daily immediate release dosage formulation of  BiDil. Under the supply agreement, theCompany has the right to engage a backup manufacturer. In connection with thissupply agreement, the Company placed a binding purchase order in the amount of $2,994,000for production of BiDil finished goods during the third quarter of 2005. OnJune 29, 2005, the Company and Schwarz Pharma executed a Quality Agreement thatdelineated cGMP responsibilities between the two parties. The Company ordersbulk materials from the same suppliers that were used for the clinical trialbatches of BiDil: hydralazine from Flavine, the U.S. representative ofSumitomo, and isosorbide dinitrate from Dottikon, and has them delivereddirectly to Schwarz Pharma for manufacturing. In connection with the Company’sprocurement of hydralazine from Flavine, the Company placed an irrevocablepurchase order for $3,150,000 in November 2004, $787,500 of which was paidprior to December 31, 2004, $616,000 of which was paid during the first quarterof 2005, and $928,000 of which was paid during the second quarter of 2005. Theremaining $818,500 is due upon the receipt of the final shipment of hydralazineunder this purchase order.

 

OnJune 23, 2005 the Company engaged Cardinal Health PTS, LLC (“Cardinal Health”),under a three-year exclusive agreement for the commercial distribution ofBiDil. Estimated year one costs are $290,000, excluding one-time programimplementation fees of $40,000, and year two costs are projected at $450,000.The Company has the right to terminate this agreement upon 120 days writtennotice to Cardinal Health and would be required to pay Cardinal Health thelesser of (1) the fixed fees for the remainder of the initial term of theagreement, or (2) the fixed fees for a period of twelve months, upontermination.

 

### **(8)**           NewAccounting Pronouncements

 

OnDecember 16, 2004, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) (“SFAS123R”), *Share-Based Payment*,which is a revision of SFAS No. 123, *Accountingfor Stock-Based Compensation*. SFAS 123R supersedes AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees*(“APB25”), and amends SFAS No. 95, *Statementof Cash Flows*. Generally, the approach in SFAS 123R is similar tothe approach described in SFAS 123, detailed below. However, SFAS 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the statement of operations based on their fairvalues at the date of grant. Pro forma disclosure is no longer an alternative.In April 2005, the Securities and Exchange Commission (“SEC”) delayed theeffective date for adoption to no later than the beginning of the first fiscalyear beginning after December 15, 2005.

 

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Early adoption will be permitted in periods in whichfinancial statements have not yet been issued. The Company expects to adoptSFAS 123R on January 1, 2006, the commencement of its first quarter offiscal 2006.

 

SFAS123R permits public companies to adopt its requirements using one of twomethods. The “modified prospective” is a method in which compensation cost isrecognized beginning with the effective date (a) based on the requirementsof SFAS 123R for all share-based payments granted after the effective date and(b) based on the requirements of SFAS 123 for all awards granted toemployees prior to the effective date of SFAS 123R that remain unvested on theeffective date. The “modified retrospective” is a method which includes therequirements of the modified prospective method described above, but alsopermits entities to restate based on the amounts previously recognized underSFAS 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption.The Company has yet to determine which method to use in adopting SFAS 123R.

 

Aspermitted by SFAS 123, the Company currently accounts for share-based paymentsto employees using APB 25’s intrinsic value method. The adoption of SFAS 123R’sfair value method may have a significant impact on the Company’s result ofoperations, although it will have no impact on the Company’s overall financialposition. The impact of adoption of SFAS 123R cannot be predicted at this timebecause it will depend on levels of share-based payments granted in the future.However, had the Company adopted SFAS 123R in prior periods, the impact of thatstandard would have approximated the impact of SFAS 123 as described in thedisclosure of pro forma net loss and net loss per share in Note 3 to thesefinancial statements. The Company is currently evaluating the impact of theadoption of SFAS 123R on its financial position and results of operations,including the valuation methods and support for the assumptions that underliethe valuation of the awards.

 

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

 

**Overview**

 

We are a pharmaceutical company that discovers,develops and seeks to commercialize proprietary pharmaceuticals. We havedevoted substantially all of our efforts towards the research and developmentof our product candidates. Since our inception, we have had no revenue fromproduct sales and have funded our operations through the sale of equitysecurities, debt financings, license fees, research and development funding andmilestone payments from our collaborative partners.  We have never been profitable and haveincurred an accumulated deficit of $178.8 million as of June 30, 2005.

 

Research, development andcommercialization expenses relating to our product candidates and to enhancingour core technologies will continue to increase in the near term and may varysignificantly from our current estimates. On June 23, 2005, the U.S. Food andDrug Administration, or FDA, approved our product, BiDil, for the treatment ofheart failure in self identified black patients. BiDil is an orally administeredfixed dose combination of isosorbide dinitrate and hydralazine. BiDil isindicated to improve survival, prolong time to first hospitalization for heartfailure and improve patient-reported functional status, as an adjunct tocurrent standard heart failure therapy in self-identified black patients. Thereis little experience in patients with New York Heart Association class IV heartfailure. Most patients in the clinical trial supporting effectiveness, referredto as the African American Heart Failure Trial, received, in addition to BiDilor placebo, a loop diuretic, an angiotensin converting enzyme inhibitor or anangiotensin receptor blocker, and a beta blocker, and many also received acardiac glycoside or an aldosterone antagonist.

 

Wecurrently estimate that our operating expenses for the year ended December 31,2005, comprised primarily of expenses relating to the development of our salesand marketing capabilities and the BiDil launch, will be in the range of $100.0million to $115.0 million.  We alsoestimate that sales, general and administrative costs will increasesignificantly as we launch BiDil in the third quarter of 2005. We currentlyestimate that our existing cash, cash equivalents and marketable securitieswill be sufficient to fund our operating plan, including increased operatingexpenses in support of the launch of BiDil, for at least the next fifteenmonths.

 

Inthe near-term, a key driver of our success will be our ability to successfullylaunch BiDil and achieve market penetration of BiDil. We will need to generatesignificant revenues to achieve profitability. At the present time we areunable to estimate the level of revenues that we will realize from the sales ofBiDil or the commercialization of other product candidates that we maysuccessfully commercialize. We are therefore unable to estimate when we willachieve profitability, if at all.

 

OnJuly 20, 2004, the Market Regulation Department of the NationalAssociation of Securities Dealers, Inc., or NASD, advised us that itinitiated a review of trading activity in our common stock surrounding ourJuly 19, 2004 announcement that we had halted our phase III clinical trialof BiDil due to the significant survival benefit seen with BiDil. The NASD isreviewing, among other things, information on relationships between ourofficers, directors and service providers and individuals and institutions thatmay have traded in our common stock prior to the July 19, 2004announcement. We have cooperated with this review and have identified certainpersons on the list provided to us by the NASD as having a relationship withour chief executive officer and others at NitroMed. We have established aspecial committee of our board of directors to oversee our response to thisreview.

 

**Financial Operations Overview**

 

*Revenue.*  We have not generated anyrevenue from product sales since our inception. We expect to begin to generaterevenue from the sale of BiDil in the third quarter of 2005. All of our revenueto date has been derived from license fees, research and development paymentsand milestone payments that we have received from our corporate collaborators.In future years, we will seek to generate revenue from a combination of productsales, up-front fees, milestone and royalty payments in connection withcollaborative or strategic relationships, as well as royalties resulting fromthe license of our intellectual property. We expect that any revenue wegenerate will fluctuate from quarter to quarter as a result of the timing andamount of research and development, milestone and other payments received under

 

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our collaborative orstrategic relationships and related continuing obligations, as well as thetiming and amount of payments we receive upon the sale of our products, to theextent any are successfully commercialized.

 

*Research and Development.* Research and development expense consists of expenses incurred inidentifying, developing and testing product candidates. These expenses consistprimarily of salaries and related expenses for personnel, fees paid toprofessional service providers for independent monitoring and analysis of ourclinical trials, costs of contract research and manufacturing, and costs offacilities.

 

Thefollowing summarizes our primary research and development programs. We have notprovided program costs because prior to 2000 we did not track and accumulatecost information by research program.

 

•*  BiDil.* From May 2001 to July 2004, we enrolled 1,050 patients at169 clinical sites in the United States in our phase III clinical trial forBiDil. We halted the trial in July 2004 due to a significant survivalbenefit in the preliminary data for patients taking BiDil. The FDA approvedBiDil on June 23, 2005. We estimate that the total direct cost for the BiDiltrial will be at least $42.0 million. We anticipate that we will begin toreceive revenue from BiDil in the third quarter of 2005.

 

•  *Nitric Oxide-Enhancing Cardiovascular Compounds.* We are using our know-how and expertise innitric oxide to develop new chemical entities (drugs) that are nitricoxide-enhanced versions of existing cardiovascular medicines. These studies areat a pre-clinical stage of testing, and it remains speculative whether theaddition of nitric oxide will result in an improved clinical profile of thesecardiovascular medicines. The many uncertainties involved with the developmentof successful new products will exist until a new product candidatesuccessfully passes all preclinical safety testing as well as the early phasesof clinical evaluation. A new and novel nitric oxide-enhanced cardiovascularmedicine will take several years and involve a significant and largely unknownsum of expenditures. The success of achieving a new nitric oxide-enhancedcardiovascular medicine is important as it is needed to fill our pipeline.Failure to produce and successfully commercialize a new product in a timelyfashion may have a material adverse effect on our business, financial positionand results of operations.

 

•  *Nitric Oxide Stents.* We are currentlyworking with Boston Scientific Corporation, or (“Boston Scientific”), todevelop stents enhanced with a bio-compatible polymer that is capable ofreleasing nitric oxide. This program is in pre-clinical development. We expectthat additional expenditures will be required to conduct pre-clinical testingand, if such pre-clinical testing is successful, to apply for and conductclinical trials. Because this program is in pre-clinical development, thesuccessful development of products based upon this program is highly uncertain.As such, we are unable to estimate the cost to complete the research anddevelopment phase, nor are we able to estimate the timing of bringing productcandidates to market and, therefore, when material cash inflows from milestonesand royalties could commence. Our failure, or our partner’s failure, tocommercialize products based upon this program on a timely basis could have amaterial adverse effect on our business, financial position and results ofoperations.

 

•  *Nitric Oxide-Enhancing COX-2 Inhibitors.*From December 2002 until November 2004,we had a collaboration with Merck FrosstCanada & Co., a wholly-owned subsidiary of Merck & Co., orMerck, to screen proprietary nitric oxide-enhanced COX-2 inhibitors in advanceof clinical testing as analgesic and anti-inflammatory agents and in otherspecified disease areas. These agents are intended to be second-generationCOX-2 inhibitors. On September 30, 2004, Merck halted the phase II trialof our lead candidate in nitric oxide-enhancing COX-2 inhibitors. In November2004, we agreed with Merck to terminate the collaboration agreement. We retainall rights to our technology in the field of nitric oxide-enhancing COX-2 inhibitors and may seek collaborations with other potential partners toutilize the full value, if any, of this technology in the development of newanalgesic and anti-inflammatory agents. Significant additional expenditureswill be required to conduct pre-clinical testing and to apply for, and conduct,clinical trials. Because these agents are in pre-clinical development, theirsuccessful development is highly uncertain. As such, we are not able toestimate the cost to complete the research and development phase, nor are weable to estimate the timing of bringing potential candidates to market and,therefore, when material cash inflows from milestones and royalties couldcommence. Our failure, or any future partner’s failure, to commercialize theseproduct candidates under development on a timely basis could have a materialadverse effect on our business, financial condition and results of operations.

 

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•  *Other Discovery Research.* We are alsocurrently utilizing our nitric oxide expertise to develop products foradditional medical conditions and we are also currently working on thedevelopment of a sustained release (“SR”) version of BiDil. Our efforts inthese areas consist primarily of discovery-stage research primarily directed toestablishing our intellectual property position. We expect that additionalexpenditures will be required to conduct pre-clinical testing and, if suchpre-clinical testing is successful, to apply for, and conduct, clinical trialsfor any such programs. Because these programs are in pre-clinical development,the successful development of products based upon these programs is highlyuncertain. As such, we are not able to estimate the cost to complete researchand development, nor are we able to estimate the timing of bringing productcandidates to market and, therefore, when material cash inflows from productsales, milestones and royalties could commence.

 

*Sales,**General and Administrative.* Sales, general and administrative expense consists primarily of salariesand other related costs for personnel in sales and marketing, executive,finance, investor relations, accounting, business development, and humanresource functions. Other costs include facility costs not otherwise includedin research and development expense; costs for public relations, advertisingand promotion services; professional fees for legal and accounting services;and costs related to our third party contract sales agreement with PublicisSelling Solutions, Inc., or Publicis.

 

Wehave incurred, and will continue to incur, increased sales, general andadministrative expense for investor relations and other activities associatedwith operating as a public company. These increases will include the hiring ofadditional personnel. We expect to continue to incur increased internal andexternal business development costs to support our various product developmentefforts, which can vary from period to period. During the remainder of 2005, wealso anticipate incurring significant increased expenses in connection with thecommercial launch of BiDil.

 

*Non-Operating Income.* Interest income includes interest earned on our cash, cash equivalentsand marketable securities.

 

*Boston Scientific Collaboration.*  InNovember 2001, we entered into a development and license agreement withBoston Scientific to develop cardiovascular stents enhanced with nitric oxide-releasingcompounds. We granted Boston Scientific an exclusive worldwide license todevelop and commercialize products for restenosis incorporating two nitricoxide-releasing compounds. In consideration of this license, Boston Scientificmade an upfront non-refundable license payment of $1.5 million, which isbeing recognized over the estimated time period of our contractual obligationto provide research and development services. In the event that specifiedresearch, development and commercialization milestones are achieved, BostonScientific is obligated to make milestone payments to us. Boston Scientific isalso obligated to pay royalties to us on the sale of any products resultingfrom the collaboration. In December 2003, we agreed to extend the researchand development collaboration through December 2005 and received anadditional $3.0 million, which is being recognized ratably over theresearch and development collaboration term. Boston Scientific made a$3.5 million equity investment in our stock in 2001 and made an additional$500,000 equity investment in our stock in August 2003.

 

*Merck Collaboration.*  FromDecember 2002 until November 2004, we were party to an exclusive,worldwide research, collaboration and licensing agreement that granted Merckmarketing and sales rights for nitric oxide-enhancing COX-2 inhibitors. Theresearch portion of the agreement was for three years. In 2003, we received anupfront non-refundable license payment of $10.0 million and two payments,each of $5.0 million, for achieving the first two milestones. The licensefee revenue and the revenue from the first $5.0 million milestone paymentwere being recognized over the contractual term of the research and developmentprogram, which was expected to end on December 31, 2005. The revenue fromthe second $5.0 million payment was recognized in the fourth quarter of2003, the period in which Merck achieved the milestone. On September 30,2004, Merck halted the phase II trial of our lead candidate in nitric oxide-enhancingCOX-2 inhibitors. This lead nitric oxide candidate is composed of a derivativeof rofecoxib. Rofecoxib is the active ingredient in Vioxx, a COX-2 inhibitorwhich Merck voluntarily withdrew from worldwide markets on September 30,2004. In November 2004, we agreed with Merck to terminate the collaborationagreement. Merck paid us a lump sum of $1.8 million, representing the fullamount of the research funding owed to us for 2005, however, we will notreceive any commercialization milestones or royalty payments from Merck. As aresult of the termination of this agreement, we accelerated the recognition ofdeferred license revenue of $5.3 million in the fourth quarter of 2004, andwe recognized the lump sum payment of $1.8 million as revenue in thefourth quarter of

 

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2004. No research anddevelopment fees were recognized as revenue during the three and six monthperiods ended June 30, 2005. During the three and six month periods ended June30, 2004, we received $0.6 million and $1.2 million, respectively, in researchand development fees from Merck, all of which has been recognized as revenuefor the three and six months, respectively.

 

**Results of Operations**

 

***Three Months Ended June 30, 2005 and2004***

** **

*Revenue.*  Total revenue for the three months ended June30, 2005 was $0.4 million compared to $2.3 million for the three monthsended June 30, 2004. The $1.9 million, or 83% decrease in revenue in the 2005period is primarily attributable to the termination of the Merck agreement inNovember 2004.

 

*Researchand Development.* Research and development expense for the three months ended June 30,2005 was $8.3 million compared to $5.1 million for the three months endedJune 30, 2004. The $3.2 million, or 63% increase in research and developmentexpenses was primarily due to increased medical support costs associated withobtaining regulatory approval of BiDil, offset partially by decreases in clinicaltrial expense as a result of the early halting of the African American HeartFailure Trial.

 

The following table summarizes the primary componentsof our research and development expense for our principal research anddevelopment programs for the three month periods ended June 30, 2005 and2004.  

 
| ** **                                       | ** ** | **Three Months Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| **Research and Development Program**             |       |                             |       |   |   |
| ** **                                       |       |                             |       |   |   |
| BiDil                                            |       | $                                | 4.9        |   | $ | 3.8 |   |
| Nitric oxide-enhancing cardiovascular  compounds |       | 1.5                              |       | — |   |
| Nitric oxide enhanced stents                     |       | 0.6                              |       | 0.4 |   |
| Nitric oxide-enhancing COX-2 inhibitors          |       | —                           |       | 0.5 |   |
| Other discovery research                         |       | 1.3                              |       | 0.4 |   |
| Total research and development expense           |       | $                                | 8.3        |   | $ | 5.1 |   |

 

*Sales,General and Administrative.* Sales, general and administrative expense for the three months endedJune 30, 2005 was $15.5 million compared to $2.3 million for the three monthsended June 30, 2004.  The $13.2 million,or 574% increase in sales, general and administrative expense was primarily dueto $12.0 million for the preparation for the launch of BiDil, including costsrelated to the contract sales force agreement with Publicis, hiring of salesand marketing management personnel, public relations services; and advertisingand promotion services. We also incurred higher sales, general andadministrative expense in the three months ended June 30, 2005 due to increasedcosts of $716,000 associated with professional fees in preparation of the launch of BiDil, $215,000 in increasedinfrastructure costs due to the occupation of a new facility, $102,000 relatedto increased management and administrative personnel costs, and $124,000in increased insurance costsassociated with operating as a public company.

 

*Non-OperatingIncome.*  Non-operatingincome for the three months ended June 30, 2005 was $764,000 compared to$315,000 for the three months ended June 30, 2004. The $449,000, or 143%increase was due to higher fund balances available for investment as a resultof the closing of our follow-on offering of common stock in December 2004.

 

***Six Months Ended June 30, 2005 and2004***

** **

*Revenue.*  Total revenue for the six months ended June30, 2005 was $0.8 million compared to $4.7 million for the six monthsended June 30, 2004. The $3.9 million, or 83% decrease in revenue in the 2005period is primarily attributable to the termination of the Merck agreement inNovember 2004.

 

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*Researchand Development.* Research and development expense for the six months ended June 30, 2005was $16.0 million compared to $10.7 million for the six months ended June30, 2004. The $5.3 million, or 50% increase in research and development expensewas primarily due to increased medical support costs associated with obtainingregulatory approval of BiDil, offset partially by decreases in clinical trialexpense as a result of the early halting of the African American Heart FailureTrial.

 

The following table summarizes the primary componentsof our research and development expense for our principal research anddevelopment programs for the six month periods ended June 30, 2005 and 2004.

 
| ** **                                       | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| **Research and Development Program**             |       |                           |       |   |   |
|                                             |       |                           |       |   |   |
| BiDil                                            |       | $                              | 10.4       |   | $ | 7.7 |   |
| Nitric oxide-enhancing cardiovascular  compounds |       | 2.7                            |       | — |   |
| Nitric oxide enhanced stents                     |       | 1.0                            |       | 0.9 |   |
| Nitric oxide-enhancing COX-2 inhibitors          |       | —                         |       | 1.3 |   |
| Other discovery research                         |       | 1.9                            |       | 0.8 |   |
| Total research and development expense           |       | $                              | 16.0       |   | $ | 10.7 |   |

* *

*Sales,General and Administrative.* Sales, general and administrative expense for the six months ended June30, 2005 was $28.5 million compared to $3.8 million for the six months endedJune 30, 2004.  The $24.7 million, or650% increase in sales, general and administrative expenses was primarily dueto $22.3 million for the preparation for the launch of BiDil, including costsrelated to the contract sales force agreement with Publicis, hiring of salesand marketing management personnel, public relations services, and advertisingand promotion services. We also incurred higher sales, general andadministrative expense in the six months ended June 30, 2005 due to increasedcosts of $1.3 million associated with professional fees in preparation of the launch of BiDil, $517,000 in increasedinfrastructure costs due to the occupation of a new facility, $289,000 relatedto increased management and administrative personnel costs, and $240,000 in increased insurance costs associated withoperating as a public company.

 

*Non-OperatingIncome.*  Non-operatingincome for the six months ended June 30, 2005 was $1.5 million compared to $0.6million for the six months ended June 30, 2004. The $0.9 million, or 150%increase was due to higher fund balances available for investment as a resultof the closing of our follow-on offering of common stock in December 2004.

 

**Liquidity andCapital Resources**

** **

We have financed our operations since inceptionthrough the sale of equity, debt and payments from collaborative partners forlicenses, research and development and achievement of milestones. As of June30, 2005, we have received net proceeds of $242.8 million from the issuance ofequity securities, primarily as the result of the sale of $99.1 million of ourredeemable convertible preferred stock, net proceeds of $60.1 million fromour initial public offering in November 2003 and net proceeds of $81.8million from our follow-on public offering in December 2004. At June 30, 2005,we had $120.5 million in cash, cash equivalents and marketable securities.

 

On June 28, 2005, we borrowed (i) $10.0 millionfrom Oxford Finance Corporation or Oxford, and (ii) $10.0 million from GeneralElectric Capital Corporation or GECC pursuant to the terms of promissory notesmade by us with both Oxford and GECC, respectively.  The notes bearinterest at a fixed rate of 9.95% per annum and are payable in 36 consecutivemonthly installments of principal and accrued interest, with the firstinstallment due and payable on July 1, 2005. The notes are secured by asecurity interest in all our personal property and fixtures with the exceptionof any intellectual property or products acquired, whether by purchase, licenseor otherwise, on or after the execution of the notes. The Agreements also contain a Material Adverse Change clause with bothOxford and GECC. Under this clause, if Oxford or GECC reasonably determine thatthe Company’s ability to repay the

 

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Notes has been materiallyimpaired, the Company would be considered in default. As of June 30, 2005 theCompany was in compliance with this clause.

 

During the six months ended June 30, 2005, operatingactivities used cash of $41.8 million, driven by a net loss of $42.2 million,an increase in inventory of $6.1 million, and a decrease in deferred revenue of$0.8 million, offset by an increase in accounts payable and accrued expenses of$5.0 million, and a decrease in prepaid expenses and other current assets of$1.7 million.

 

During the six months ended June 30, 2005, investingactivities provided cash of $14.9 million due to net sales of marketablesecurities of $15.7 million, offset by purchases of property and equipment of$0.8 million due to the purchases of computers and lab equipment. We expect toinvest approximately $2.0 to $2.5 million in capital expenditures for2005, principally related to the purchase of laboratory equipment and computerequipment to support headcount growth.

 

During the six months ended June 30, 2005, financingactivities provided cash of $20.6 million due to proceeds from $20.0 million inlong term debt and $0.6 million in proceeds from stock plans.

 

*ContractualObligations*

 

Thefollowing table summarizes our contractual obligations at June 30, 2005 and theeffects such obligations are expected to have on our liquidity and cash flowsin future periods. 

 
| **Contractual Obligations**                | ** ** | **Total**  | ** ** | **Less than  one year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  five years** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------------------|------------|---------------|------------|---------------|------------|---------------------------|------------|
|                                       |       |       |       |                    |       |          |       |          |       |                      |       |
| Operating lease obligation                 |       | $          | 14,497,000 |                    | $          | 1,310,000     |       | $             | 2,990,000  |                      | $          | 3,163,000 |   | $ | 7,034,000 |   |
| Purchase obligations (1)                   |       | 50,933,000 |       | 31,978,000              |       | 18,955,000    |       | —        |       | —                    |       |
| Long term debt                             |       | 23,047,000 |       | 7,675,000               |       | 15,372,000    |       | —        |       | —                    |       |
| Consulting and license payment obligations |       | 3,476,000  |       | 3,476,000               |       | —        |       | —        |       | —                    |       |
| Total contractual cash obligations         |       | $          | 91,953,000 |                    | $          | 44,439,000    |       | $             | 37,317,000 |                      | $          | 3,163,000 |   | $ | 7,034,000 |   |

 

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(1) On October 3, 2004, we entered into an agreement with Publicis, acontract sales organization, pursuant to which, on our behalf, Publicis hasemployed and is training a specialized cardiovascular sales force ofapproximately 195 sales representatives to sell BiDil to our target prescribermarkets. The agreement is for a term of 24 months, with our option to continuethe agreement beyond this term. We have the right to terminate this agreementupon 90 days written notice to Publicis. If we terminate this agreement duringmonths one through eighteen of the term of the agreement, we will be requiredto pay a termination fee. If we terminate the agreement after month eighteen,no termination fee will be assessed. Also, on November 3, 2004, we entered intoa purchase order for hydralazine with Flavine, the U.S. representative ofSumitomo. On July 7, 2005 and July 14, 2005, we placed binding purchase ordersin the approximate amount of $2.9 million with Schwarz Pharma Manufacturing,Inc. for production of BiDil finished goods during the third and fourthquarters of 2005. These orders are not included in the table above.

 

Webelieve that our existing cash, cash equivalents and marketable securities willbe sufficient to fund our operating plan, including increased operatingexpenses in support of the launch of BiDil, for at least the next fifteenmonths. However, we may require significant additional funds earlier than wecurrently expect.

 

Wemay seek additional funding through collaborative arrangements and public orprivate financings. Additional funding may not be available to us on acceptableterms or at all. In addition, the terms of any financing may adversely affectthe holdings or the rights of our stockholders. For example, if we raiseadditional funds by issuing equity securities or convertible debt securities,further dilution to our existing stockholders may result. If we are unable toobtain funding on a timely basis, we may be required to significantly curtailone or more of our research or development programs. We also could be requiredto seek funds through arrangements with collaborators or others that

 

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may require us to relinquishrights to some of our technologies, product candidates or products which wewould otherwise pursue on our own.

 

Evenif we are able to raise additional funds in a timely manner, our future capitalrequirements may vary from what we expect and will depend on many factors,including the following:

 

•              the costs of launching BiDil;

 

•              the revenues generated from the sales ofBiDil;

 

•              the timing, receipt, and amount of royalties,milestone and other payments, if any, from collaborators;

 

•              the timing, receipt, and amount of sales androyalties, if any, from our product candidates;

 

•              the resources required to successfullycomplete our clinical trials;

 

•              the time and costs involved in obtainingregulatory approvals;

 

•              continued progress in our research anddevelopment programs, as well as the magnitude of these programs;

 

•              the cost of manufacturing, marketing andsales activities;

 

•              the costs involved in preparing, filing,prosecuting, maintaining, and enforcing patent claims;

 

•              the cost of obtaining and maintaininglicenses to use patented technologies; and

 

•              our ability to establish and maintainadditional collaborative arrangements.

 

**Critical Accounting Policies and Estimates**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based on our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. On an on-going basis, we evaluate our estimates andjudgments, including those related to revenue, inventories, accrued expensesand the factors used to determine the fair value assigned to our stock options.We base our estimates on historical experience, known trends and events andvarious other factors that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

Webelieve the following critical accounting policies affect our more significantjudgments and estimates used in the preparation of our financial statements.

 

 *Revenue.*  We have not generated any revenue fromproduct sales since our inception. We expect to begin to generate revenue fromthe sale of BiDil in the third quarter of 2005. All of our revenue to date hasbeen derived from license fees, research and development payments and milestonepayments that we have received from our corporate collaborators. We recordrevenue on an accrual basis as it is earned and when amounts are consideredcollectible. Revenues received in advance of performance obligations or incases where we have a continuing obligation to perform services, are deferredand recognized over the contractual or estimated performance period. Revenuesfrom milestone payments that represent the culmination of a separate earningsprocess are recorded when the milestone is achieved. Contract revenues arerecorded as the services are performed. When we are required to defer revenue,the period over

 

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whichsuch revenue should be recognized is subject to estimates by management and maychange over the course of the collaborative agreement.

 

*Inventories*.  Wereview our estimates of the net realizable value of our inventories at eachreporting period. Our estimate of the net realizable value of ourinventories is subject to judgment and estimation. The actual netrealizable value of our inventories could vary significantly from our estimatesand could have a material effect on our financial condition and results ofoperations in any reporting period.  During the six month period endingJune 30, 2005, we purchased and capitalized $6.1 million in inventories to beused for samples and commercial sales related to BiDil, our product for thetreatment of heart failure in self-identified black patients. BiDil currentlyhas a twelve month shelf life.****On a quarterlybasis, we analyze our inventory levels and write down inventory that has becomeun-saleable, inventory that has a cost basis in excess of its expected netrealizable value and inventory that is in excess of expected requirements ofproduct revenues. Expired inventory will be disposed of and the related costswill be written off.  As of June 30,2005, there has been no impairment of inventory.

 

 *AccruedExpenses.*  As part of theprocess of preparing financial statements, we are required to estimate accruedexpenses. This process involves identifying services which have been performedon our behalf, and estimating the level of service performed and the associatedcost incurred for such service as of each balance sheet date in our financialstatements. Examples of estimated expenses we accrue include contract servicefees such as amounts paid to our third party contract sales organization,Publicis, clinical monitors, data management organizations and investigators inconjunction with clinical trials, fees paid to contract manufacturers inconjunction with the production of clinical materials, marketing, advertising,consulting fees and professional service fees, such as lawyers and accountants.In connection with such service fees, our estimates are most affected by ourunderstanding of the status and timing of services provided relative to theactual levels of services incurred by such service providers. The majority ofour service providers invoice us monthly in arrears for services performed. Inthe event that we do not identify certain costs which have begun to beincurred, or we over or under estimate the level of services performed or thecosts of such services, our reported expenses for such period would be too lowor too high. The date on which certain services commence, the level of servicesperformed on or before a given date and the cost of such services are oftendetermined based on subjective judgments. We make these judgments based uponthe facts and circumstances known to us in accordance with generally acceptedaccounting principles.

 

 *Stock-BasedCompensation.*  We have electedto follow Accounting Principles Board, or APB, Opinion No. 25, “Accountingfor Stock Issued to Employees,” or APB 25, and related interpretations, inaccounting for our stock-based compensation plans, rather than the alternativefair value method provided for under Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation,” orSFAS 123. In 2003 and 2002, certain grants of stock options were made atexercise prices less than the fair value of our common stock and, as a result,we recorded deferred stock compensation expense. In the notes to our financialstatements, we provide pro forma disclosures in accordance with SFAS 123.We account for transactions in which services are received from non-employeesin exchange for equity instruments based on the fair value of such servicesreceived or of the equity instruments issued, whichever is more reliablymeasured, in accordance with SFAS 123 and the Emerging Issues Task Force,or EITF, Issue 96-18, “Accounting for Equity Instruments that Are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods orServices,” or EITF 96-18.

 

Accountingfor equity instruments granted or sold by us under APB 25, SFAS 123 andEITF 96-18 requires fair value estimates of the equity instrument granted orsold. If our estimates of the fair value of these equity instruments are toohigh or too low, our expenses may be over or under stated. For equityinstruments granted or sold in exchange for the receipt of goods or services,we estimate the fair value of the equity instruments based upon considerationof factors which we deem to be relevant at that time. Because shares of ourcommon stock were not publicly traded prior to the commencement of our publicoffering on November 5, 2003, market factors historically considered invaluing stock and stock option grants include comparative values of publiccompanies discounted for the risk and limited liquidity provided for in the shareswe had issued, pricing of private sales of our redeemable convertible preferredstock, prior valuations of stock grants and the effect of events that occurredbetween the time of such grants, economic trends, and the comparative rightsand preferences of the security being granted compared to the rights andpreferences of our other outstanding equity.

 

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Priorto our initial public offering, the fair value of our common stock wasdetermined by our board of directors contemporaneously with the grant. In theabsence of a public trading market for our common stock, our board of directorsconsidered numerous objective and subjective factors in determining the fairvalue of our common stock. At the time of option grants and other stockissuances, our board of directors considered the liquidation preferences,dividend rights, voting control and anti-dilution protection attributable toour then-outstanding redeemable convertible preferred stock, the status ofprivate and public financial markets, valuations of comparable private andpublic companies, the likelihood of achieving a liquidity event such as aninitial public offering, our existing financial resources, our anticipatedcontinuing operating losses and increased spending levels required to completeour clinical trials, dilution to common stockholders from anticipated futurefinancings and a general assessment of future business risks.

 

**Inflation**

 

Webelieve the effects of inflation generally do not have a material adverseimpact on our operations or financial condition.

 

**Off-Balance Sheet Arrangements**

 

Wedo not have any material off-balance sheet arrangements.

 

**Recently Issued Accounting Pronouncement**

 

OnDecember 16, 2004, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards, or SFAS, No. 123 (revised 2004),referred to as SFAS 123R, *Share-BasedPayment*, which is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*.SFAS 123R supersedes Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees, or APB 25,*andamends SFAS No. 95, *Statement of CashFlows*. Generally, the approach in SFAS 123R is similar to theapproach described in SFAS 123, detailed below. However, SFAS 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the statement of operations based on their fair values atthe date of grant. Pro forma disclosure is no longer an alternative. In April2005, the Securities and Exchange Commission (“SEC”) delayed the effective datefor adoption to no later than the beginning of the first fiscal year beginningafter December 15, 2005. Early adoption will be permitted in periods in whichfinancial statements have not yet been issued. We expect to adopt SFAS 123R onJanuary 1, 2006, the commencement of our first quarter of fiscal 2006.

 

SFAS123R permits public companies to adopt its requirements using one of twomethods. The “modified prospective” requires compensation cost to be recognizedbeginning with the effective date (a) based on the requirements of SFAS123R for all share-based payments granted after the effective date and(b) based on the requirements of SFAS 123 for all awards granted toemployees prior to the effective date of SFAS 123R that remain unvested on theeffective date. The “modified retrospective” includes the requirements of themodified prospective method described above, but also permits entities torestate their financial statements based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption. Wehave yet to determine which method to use in adopting SFAS 123R.

 

Aspermitted by SFAS 123, we currently account for share-based payments toemployees using APB 25’s intrinsic value method. The adoption of SFAS 123R’sfair value method may have a significant impact on our result of operations,although it will have no impact on our overall financial position. The impactof adoption of SFAS 123R cannot be predicted at this time because it willdepend on levels of share-based payments granted in the future. However, had weadopted SFAS 123R in prior periods, the impact of the standard would haveapproximated the impact of SFAS 123 as described in the disclosure of pro formanet loss and net loss per share in Note 3 to our financial statements. We arecurrently evaluating the impact of the adoption of SFAS 123R on our financialposition and results of operations, including the valuation methods and supportfor the assumptions that underlie the valuation of the awards.

 

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**Forward-Looking Statements**

 

Thisquarterly report on Form 10-Q includes forward-looking statements withinthe meaning of Section 21E of the Securities Exchange Act of 1934, asamended, which we refer to as the Exchange Act. For this purpose, anystatements contained herein regarding our strategy, future operations,financial position, future revenues, projected costs, prospects, plans andobjectives of management, other than statements of historical facts, areforward-looking statements. The words “anticipates,” “believes,” “estimates,”“expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similarexpressions are intended to identify forward-looking statements, although notall forward-looking statements contain these identifying words. We cannotguarantee that we actually will achieve the plans, intentions or expectationsdisclosed in our forward-looking statements. There are a number of importantfactors that could cause actual results or events to differ materially fromthose disclosed in the forward-looking statements we make. These importantfactors include the risk factors set forth below under the caption “FactorsThat May Affect Future Results.” Although we may elect to update forward-lookingstatements in the future, we specifically disclaim any obligation to do so,even if our estimates change, and readers should not rely on those forward-lookingstatements as representing our views as of any date subsequent to the date ofthis quarterly report.

 

**Factors That MayAffect Future Results**

** **

**Risks Relating toour Business**

 

**Because we have ahistory of losses and our future profitability is uncertain, our common stockis a highly speculative investment.**

 

Wehave experienced significant operating losses since our inception in 1992. Forthe three months and six months ended June 30, 2005, we had a net loss of$22.6 million and $42.2 million, respectively. As of June 30, 2005, we hadan accumulated deficit of approximately $178.8 million. We expect that wewill continue to incur substantial losses and that our cumulative losses willincrease as our research, development and commercialization efforts expand. Weexpect that the losses that we incur will fluctuate from quarter to quarter andthat these fluctuations may be substantial. To date, we have not recorded anyrevenue from the sale of products. We received approval for BiDil from the FDAon June 23, 2005, and we do not anticipate receiving revenues from BiDil untilthe third quarter of 2005. All of our other product candidates are in researchor pre-clinical development, will require significant additional testing priorto submission of any regulatory applications and, as such, are not expected tobe commercially available for many years, if at all.

 

Alarge portion of our expenses is fixed, including expenses related tofacilities, equipment and personnel. In addition, we expect to spendsignificant amounts to launch BiDil in July 2005, fund research, developmentand commercialization of our product candidates and to enhance our coretechnologies. As a result, we expect that our operating expenses will continueto increase significantly in the near term and, consequently, we will need togenerate significant revenue to achieve profitability. At the present time weare unable to estimate the level of revenues that we will realize from thecommercialization of BiDil or any of our other product candidates. We aretherefore unable to estimate when we will achieve profitability, if at all.Even if we do achieve profitability, we may not be able to sustain or increaseprofitability on a quarterly or annual basis. Our failure to become and remainprofitable could depress the market price of our common stock and could impairour ability to raise capital, expand our business, diversify our productofferings or continue our operations.

 

**Our business is substantiallydependent on the commercial success of BiDil.**

 

On June 23, 2005 the FDA approved BiDil for the treatment ofheart failure in self-identified black patients. We launched BiDil in July2005. BiDil is currently our only commercial product, and we expect it willaccount for substantially all of our revenues for the next several years. Weface a number of significant risks relating to our ability to successfully commercializeBiDil, including the various factors discussed throughout this section titled“-Factors That May Affect Future Results.” If we fail to successfullycommercialize BiDil, our near-term ability to generate product revenue, ourreputation and our ability to raise additional capital will be materiallyimpaired, and the value of an investment in our stock will decline.

 

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**We will require substantialadditional funds and, if additional capital is not available, we may need tolimit, scale back or cease our operations.**

 

Wehave used and will continue to require substantial funds to conduct researchand development, including pre-clinical testing and clinical trials of ourproduct candidates, and to market and manufacture any products that areapproved for commercial sale including our lead product, BiDil, which the FDAapproved in June 2005.  We expect that wewill incur significant expenses during 2005 and beyond relating tomanufacturing, sales and marketing of BiDil. Moreover, we may incur significantadditional expenditures to conduct pre-clinical testing of our early-stagedevelopment programs. Because the successful development of these programs isuncertain, we are unable to estimate the actual funds we will require tocomplete research and development of our product candidates andcommercialization of our products. We believe that our existing cash, cashequivalents and marketable securities will be sufficient to fund our currentoperating plan including increased operating expenses in support of the launchof BiDil for at least the next fifteen months.

 

However,our future capital requirements, and the period in which we expect our currentcash to support our operations, may vary from what we expect due to a number offactors, including the following:

 

•  thecost of launching and successfully commercializing BiDil;

 

•  thetime and costs involved in obtaining regulatory approvals for our other productcandidates;

 

•  thetiming, receipt and amount of milestone and other payments, if any, fromcollaborators;

 

•  thetiming, receipt and amount of sales and royalties, if any, from our productcandidates;

 

•  theresources required to successfully complete our clinical trials;

 

•  continuedprogress in our research and development programs, as well as the magnitude ofthese programs;

 

•  thecosts involved in preparing, filing, prosecuting, maintaining and enforcingpatent claims;

 

•  thecosts related to acquiring and/or in-licensing new technologies; and

 

•  ourability to establish and maintain additional collaborative arrangements.

 

Wemay be required to seek additional funding in the future and may do so throughcollaborative arrangements and public or private financings. Additionalfinancing may not be available to us on acceptable terms, or at all. Inaddition, the terms of the financing may adversely affect the holdings or therights of our stockholders. For example, if we raise additional funds byissuing equity securities, further dilution to our then-existing stockholderswill result. If we are unable to obtain funding on a timely basis, we may berequired to significantly curtail one or more of our research or developmentprograms. We also could be required to seek funds through arrangements with collaboratorsor others that may require us to relinquish rights to some of our technologies,product candidates or products which we would otherwise pursue on our own.

 

**If we do not successfullymarket and sell BiDil or our other product candidates, either directly orthrough third parties, our future revenue will be limited.**

 

Wecurrently have limited sales, marketing and distribution experience. We willlaunch and market BiDil in North America ourselves, using a contract salesforce, and, in the future, we may also seek to market other products ourselveswhich are not already subject to marketing agreements where we believe thetarget physician market can be effectively reached by the sales force we intendto establish directly or by contract. In order to develop or contract for salesand marketing capabilities, we will have to invest significant amounts of moneyand management resources. For BiDil and any other product candidates for whichwe decide to perform the sales, marketing and distribution functions ourselvesor through a third party, we could face a number of additional risks,including:

 

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•  we may not be able to attract, build andretain or contract for a significant and qualified marketing or sales force;

 

•  the cost of establishing or contracting for amarketing and sales force may not be justifiable in light of the revenuesgenerated by any particular product or combination of products; and

 

•  our direct sales and marketing efforts maynot be successful.

 

Forpotential future products with larger target physician markets, we plan to relysignificantly on sales, marketing and distribution arrangements with thirdparties. For example, we plan to rely on our existing collaborator for thecommercialization of stents enhanced with nitric oxide-releasing compounds ifdevelopment is successful and such products are approved by the FDA. We mayhave to enter into additional marketing arrangements in the future. We may notbe able to successfully enter into sales, marketing and/or distributionagreements with any other third parties in the future, on terms which arefavorable to us, if at all. In addition, we may have limited or no control overthe sales, marketing and distribution activities of these third parties. Ourfuture revenues for any products for which we rely on third-party sales,marketing and distribution support will depend heavily on the success of theefforts of these third parties.

 

**If our third-party contractsales organization does not devote sufficient resources to our BiDil project,our ability to achieve near-term revenue could be harmed.**

 

Wehave entered into an agreement with Publicis, a contract sales organization,pursuant to which, on our behalf, Publicis has employed and trained a specialtysales force of approximately 195 sales representatives to sell BiDil to ourtarget prescriber markets. Under separate agreements, Publicis has recruited,hired and trained eight account executives that will assist us in gainingformulary access for BiDil, and have hired ten medical science liaisons toreport into our Medical Affairs group. Our near-term revenue for BiDil willdepend heavily upon the success and efforts of Publicis. If Publicis does notdevote the resources, time and training required to establish an effective andqualified sales force, our ability to achieve revenue from sales of BiDil willbe harmed.

 

**Physicians, payors andpatients may not be receptive to BiDil or our other product candidates, ifapproved, which could prevent us from achieving and maintaining profitability.**

 

BiDiland the other product candidates that we are currently developing are basedupon technologies or therapeutic approaches that are not currently in themarketplace. We plan to market BiDil only in the U.S. Key participants in theU.S. pharmaceutical marketplace, such as physicians, payors and patients, maynot accept a product intended to improve therapeutic results based onethnicity. As a result, it may be more difficult for us to convince the medicalcommunity, third-party payors and patients to accept and use our products. Ourbusiness is substantially dependent on market acceptance of BiDil. If we areunable to successfully commercialize BiDil, we will not generate revenue fromBiDil, and our stock price may decline.

 

Otherfactors that we believe will materially affect market acceptance of BiDil andour other product candidates under development include:

 

•  thetiming of our receipt of any marketing approvals outside the U.S., the terms ofany non-U.S. approval (including labeling requirements and/or limitations), andthe countries in which approvals are obtained, if any;

 

•  thesafety, efficacy and ease of administration of BiDil;

 

•  thesuccess of our promotional physician programs; and

 

•  theavailability of government and third-party payor reimbursement.

 

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**If BiDil is not commercially successful, the value of significantinventory we have purchased during the pre-launch period may be materially adverselyaffected.**

 

Weare currently purchasing raw materials and commercial quantities of BiDilfinished product to sell starting in the second half of 2005.  If we fail to successfully commercializeBiDil, our inventories could be materially impaired and their value diminished,and we could forfeit significant expenditures incurred in advance.  Moreover, our business and operating resultscould be materially and adversely affected as a result of inaccurate forecastingof inventory levels because our current forecasting is based upon our estimateof expected customer orders following BiDil’s July 2005 product launch, ratherthan actual customer orders.

 

**The application of ournitric oxide technology is unproven in humans and, as a result, we may not beable to successfully develop and commercialize any products based upon thistechnology.**

 

Acomponent of our strategy is to seek to improve existing medicines with ourproprietary nitric oxide technology. Our product candidates include nitricoxide enhancements of existing drugs. Thus, we are modifying compounds whosechemical and pharmacological profiles are well-documented and understood.However, many of our potential product candidates are new molecules withchemical and pharmacological profiles that differ from that of the existingdrugs. These compounds may not demonstrate in patients the chemical andpharmacological properties ascribed to them in laboratory studies, and they mayinteract with human biological systems in unforeseen, ineffective or harmful ways.In addition, it is possible that existing drugs or newly-discovered drugs maynot benefit from the application of our nitric oxide technology. If we are notable to successfully develop and commercialize drugs based upon ourtechnological approaches, we will not generate revenue based on these drugs,and the value of our stock will decline.

 

**If our clinical trials forany product candidates we advance into clinical testing are not successful, wemay not be able to successfully develop and commercialize our products.**

 

Inorder to obtain regulatory approvals for the commercial sale of our productcandidates, we or our collaborators will be required to complete extensiveclinical trials in humans to demonstrate the safety and efficacy of our productcandidates. We may not be able to obtain authority from the FDA or otherregulatory agencies to commence or complete these clinical trials. Ifpermitted, such clinical testing may not prove that our drug candidates aresafe and effective to the extent necessary to permit us to obtain marketingapprovals from regulatory authorities. Moreover, positive results demonstratedin pre-clinical studies and clinical trials that we complete may not beindicative of results obtained in future clinical trials. Furthermore, we, oneof our collaborators, institutional review boards or regulatory agencies maysuspend clinical trials at any time if it is believed that the subjects orpatients participating in such trials are being exposed to unacceptable healthrisks. Adverse or inconclusive clinical trial results concerning any of ourdrug candidates could require us to conduct additional clinical trials, resultin increased costs and significantly delay the filing for marketing approvalfor those drug candidates with the FDA or result in a filing for a narrowerindication than was originally sought or result in a decision to discontinuedevelopment of those drug candidates.

 

Thesuccessful completion of our clinical trials will depend on, among otherthings, the rate of patient enrollment. Patient enrollment is a function ofmany factors, including the size of the patient population, the nature of theclinical protocol, the availability of alternative treatments, the proximity ofpatients to clinical sites and the eligibility criteria for the study. We maybe unable to enroll the number of patients we need to complete a trial on atimely basis. Moreover, delays in planned patient enrollment for clinicaltrials may cause us to incur increased costs and delay commercialization.

 

Wehave relied on academic institutions or clinical research organizations tosupervise or monitor some or all aspects of our African American Heart FailureTrial, and we expect to rely on academic institutions and clinical researchorganizations for other product candidates we advance into clinical testing.Accordingly, we have less control over the timing and other aspects of theseclinical trials than if we conducted them entirely on our own.

 

Asa result of these factors, we or third parties on whom we rely may notsuccessfully begin or complete our clinical trials in the time periods we haveforecasted, if at all. Moreover, if we incur costs and delays in our programsor if we do not successfully develop and commercialize our products, our stockprice could decline.

 

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**If we and our partners donot obtain and maintain the regulatory approvals required to market and sellour product candidates, then our business will be unsuccessful, and the marketprice of our stock will substantially decline.**

 

Weand our partners will not be able to market any of our product candidates inthe United States, Europe or in any other country without marketing approvalfrom the FDA or equivalent foreign regulatory agency. The regulatory process toobtain market approval for a new drug or medical device takes many years andrequires expenditures of substantial resources. We have had only limitedexperience in preparing applications and obtaining regulatory approvals.

 

Ifwe do not receive required regulatory approval or clearance to market any ofour product candidates, we will not be able to develop and commercialize theseproducts, which will affect our ability to achieve profitability and cause thevalue of our common stock to substantially decline.

 

**Even if we obtainregulatory approvals, our marketed drugs, including BiDil, will be subject toongoing regulatory review. If we fail to comply with continuing United Statesand foreign regulations, we could lose our approvals to market drug and ourbusiness would be seriously harmed.**

 

Even after approval, any drugs we develop will besubject to ongoing regulatory review and restrictions, including the review ofclinical results which are reported after our drug products are made commerciallyavailable and restrictions on the indications for which we can market the drug.The marketing claims we are permitted to make in labeling or advertisingregarding our marketed drugs are limited to those specified in any FDAapproval. For example, because BiDil is specifically approved for labeling forself-identified black patients, we may not promote BiDil for use in otherpatient populations. In addition, the manufacturer and manufacturing facilitieswe use to produce any of our drug candidates will be subject to periodic reviewand inspection by the FDA. We will be required to report any serious andunexpected adverse experiences and certain quality problems with our productsand make other periodic reports to the FDA. The discovery of any previouslyunknown problems with the product, manufacturer or facility may result inrestrictions on the drug or manufacturer or facility, including withdrawal ofthe drug from the market. Certain changes to an approved product, including theway it is manufactured or promoted, often require prior FDA approval before theproduct as modified may be marketed. If we fail to comply with applicablecontinuing regulatory requirements, we may be subject to recalls, warningletters, civil penalties, suspension or withdrawal of regulatory approvals,product recalls, and seizures, injunctions, operating restrictions and/orcriminal prosecutions and penalties.

 

**If we, our third-partymanufacturers or our service providers fail to comply with applicable laws andregulations, we or they could be subject to enforcement actions, which couldaffect our ability to market and sell our products and harm our reputation.**

 

Ifwe or our third-party manufacturers or service providers fail to comply withapplicable federal, state or foreign laws or regulations, we could be subjectto enforcement actions which could affect our ability to develop, market andsell our products successfully and could harm our reputation and lead to feweracceptances of our products by the market. These enforcement actions include:

 

•  product seizures;

 

•  voluntary or mandatory recalls;

 

•  voluntary or mandatory patient or physiciannotifications;

 

•  withdrawal of product approvals;

 

•  restrictions on, or prohibitions against,marketing our products;

 

•  fines;

 

•  restrictions on importation of our products;

 

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•  injunctions;

 

•  debarments;

 

•  civil and criminal penalties; and

 

•  suspension of review of, or refusal toapprove, pending applications.

 

**If the third-partymanufacturer of BiDil encounters delays or difficulties in production, we maynot be able to meet demand for the product, and we may lose potential revenue.**

 

We do notmanufacture BiDil and have no plans to do so. We have engaged Schwarz PharmaManufacturing (“Schwarz Pharma”), under a five-year exclusive manufacture andsupply agreement solely for the three times daily immediate release dosageformulation of BiDil. Under the supply agreement, we have the right to engage abackup manufacturer. The terms of the supply agreement provide that it may beterminated by either us or Schwarz Pharma under specified circumstances,including a material breach of the supply agreement by either party, theoccurrence of a payment default by us, our material impairment of themanufacturing licenses we have granted to Schwarz Pharma or a failure ofSchwarz Pharma to supply conforming products. In addition, either party mayterminate the supply agreement in the event the FDA takes any action, theresult of which is to permanently prohibit the manufacture, sale or use of theproduct. If we are unable to maintain a commercially reasonable manufacturingagreement for the production of BiDil with Schwarz Pharma, we may not be ableto successfully commercialize BiDil and our stock price will decline.

 

Furthermore,Schwarz Pharma may encounter difficulties in production. These problems mayinclude:

 

•  difficulties with production costs andyields;

 

•  quality control and assurance;

 

•  shortages of qualified personnel;

 

•  compliance with strictly enforced federal,state and foreign regulations; and

 

•  lack of capital funding.

 

Thenumber of third-party manufacturers with the manufacturing and regulatoryexpertise and facilities necessary to manufacture finished drug products for uson a commercial scale is limited, and it would take a significant amount oftime to arrange, qualify, and receive necessary regulatory approval foralternative arrangements. We may not be able to contract for manufacturing onacceptable terms, if at all.

 

Anyof these factors could increase our costs and result in our being unable toeffectively commercialize BiDil. Furthermore, if Schwarz Pharma or any otherthird-party manufacturer of BiDil fails to deliver the required commercialquantities of finished product on a timely basis and at commercially reasonableprices, we may be unable to meet the demand for our product, and we may losepotential revenues.

 

**The development andcommercialization of our product candidates may be terminated or delayed, andthe cost of development and commercialization may increase, if third parties onwhom we rely to manufacture our products do not fulfill their obligations.**

 

Wedo not manufacture any of our other product candidates and have no currentplans to develop any capacity to do so in the future. In order to continue todevelop products, apply for regulatory approvals and commercialize ourproducts, we plan to rely on third parties for the production of clinical andcommercial quantities of our product candidates. We will depend upon thesethird parties to perform their obligations in a timely manner and in accordancewith applicable laws and regulations. To the extent that third-partymanufacturers with whom we contract fail to perform their obligations in accordancewith applicable laws and regulations, we may be adversely affected in a numberof ways, including:

 

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•  we may not be able to initiate or continueclinical trials of our product candidates;

 

•  we may be delayed in submitting applicationsfor regulatory approvals for our product candidates;

 

•  we may be required to cease distributionand/or recall some or all batches of our products; and

 

•  we may not be able to meet commercial demandsfor our products or achieve profitability.

 

**We rely on a single sourcesupplier for one of the two active ingredients in BiDil, and the loss of thissupplier could prevent us from selling BiDil, which would materially harm ourbusiness.**

 

Werely on Sumitomo for our supply of hydralazine, one of the two activeingredients in BiDil. Sumitomo is currently the only supplier of hydralazineworldwide. We do not have any agreement with Sumitomo regarding the supply ofhydralazine. If Sumitomo stops manufacturing or is unable to manufacturehydralazine, or if we are unable to procure hydralazine from Sumitomo oncommercially favorable terms, we may be unable to continue to sell BiDil oncommercially viable terms, if at all. Furthermore, because Sumitomo iscurrently the sole supplier of hydralazine, Sumitomo has unilateral controlover the price of hydralazine. Any increase in the price for hydralazine mayreduce our gross margins.

 

**The termination of ourcollaboration agreement with Merck, resulting from Merck’s recent decision towithdraw its COX-2 inhibitor, Vioxx, from worldwide markets, has resulted in the lossof potential milestone and royalty-based revenue from the collaboration and mayindicate that the development of nitric oxide-enhancing COX-2 inhibitors is notviable.**

 

InDecember 2002, we entered into an exclusive, worldwide research,collaboration and licensing agreement with Merck pursuant to which we grantedMerck marketing and sales rights to our technology for nitric oxide-enhancingCOX-2 inhibitors. On September 30, 2004, Merck halted the phase II trialof our lead candidate in nitric oxide-enhancing COX-2 inhibitors. We and Merckterminated our collaboration agreement during November 2004, which will resultin the loss of any potential milestone or royalty revenue from the sale ofproducts that may have resulted from the collaboration as well as any researchand development funding that we may have received beyond the end of the initialresearch term in December 2005. If the FDA imposes additional regulatoryburdens for the approval of new COX-2 inhibitors, if COX-2 inhibitors continueto pose safety concerns, or if the market for COX-2 inhibitors contracts, thenwe may lose any investment made in the development of, and any potentialrevenue that may have resulted from, the development, sale or licensing ofnitric oxide-enhancing COX-2 inhibitors.

 

**We currently depend on acollaborative partner for a portion of our revenues and to develop andcommercialize nitric oxide enhancing stents based upon our technologies and wemay enter into additional collaborations with third parties to develop andcommercialize other product candidates based upon our technologies. Thesecollaborations may not be successful.**

 

Weare relying on Boston Scientific to fund the development of and tocommercialize nitric oxide-enhancing stents using our technology to prevent there-closure of arteries, or restenosis, following balloon angioplasty, atreatment to widen blocked arteries. All of our $16.5 million of revenuesfor 2004 and our $796,000 of revenues for the six months ended June 30, 2005were derived from licensing, research and development and milestone paymentspaid to us by Boston Scientific and from a collaboration with Merck which weand Merck terminated in November 2004.

 

Ouragreement with Boston Scientific provides us research and development fundingfor our nitric oxide-enhancing stent program through December 2005, andadditional payments due to us under the collaboration agreement are generallybased on the achievement of specific development and commercializationmilestones that may not be met. The agreement with Boston Scientific can beterminated at any time upon 30 days’ prior written notice. We are alsoentitled to royalty payments that are based on the sales of products developedand marketed through the collaboration. These future royalty payments may notmaterialize or may be less than expected if the related product candidates arenot successfully developed or marketed, or if we or our collaborator is forcedto license intellectual property from third parties. The loss of the BostonScientific collaboration could decrease our revenues. We intend to

 

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enter into collaborativeagreements with other parties in the future relating to other productcandidates, and we are likely to have similar risks with regard to any suchfuture collaboration.

 

Inaddition, our existing collaboration and any future collaborative arrangementsthat we seek to enter into with third parties may not be scientifically orcommercially successful. Factors that may affect the success of ourcollaborations include the following:

 

•  ourcollaborators may be pursuing alternative technologies or developingalternative product candidates, either on their own or in collaboration withothers, that may be competitive with the product candidate on which they arecollaborating with us and which could affect their commitment to ourcollaboration;

 

•  reductionsin marketing or sales efforts or a discontinuation of marketing or sales of ourproducts by our collaborators would reduce our revenues which would be based ona percentage of net sales by the collaborator;

 

•  ourcollaborators may terminate their collaborations with us, which could make itdifficult for us to attract new collaborators or adversely affect how we areperceived in the business and financial communities; and

 

•  ourcollaborators may pursue higher-priority programs or change the focus of theirdevelopment programs, which could affect the collaborators’ commitment to us.

 

**Our failure to successfullyacquire, develop and market additional drug candidates or approved drugs wouldimpair our ability to grow.**

 

Aspart of our strategy, we intend to acquire, develop and market additional drugsand drug candidates for cardiovascular diseases. The success of this strategydepends upon our ability to identify, select and acquire appropriatepharmaceutical drug candidates and drugs.

 

Anydrug candidate we license or acquire may require additional development effortsprior to commercial sale, including extensive clinical testing and approval bythe FDA and applicable foreign regulatory authorities. All drug candidates areprone to the risks of failure inherent in pharmaceutical product development, includingthe possibility that the drug candidate will not be shown to be sufficientlysafe and effective for approval by regulatory authorities. In addition, wecannot guarantee that any drugs that we develop or acquire that are approvedwill be manufactured or produced economically, successfully commercialized orwidely accepted in the marketplace.

 

Proposing,negotiating and implementing an economically viable acquisition of a drug ordrug candidate is a lengthy and complex process. Other companies, includingthose with substantially greater financial, marketing and sales resources, maycompete with us for the acquisition of product candidates and approvedproducts. We may not be able to acquire the rights to additional drugcandidates and approved drugs on terms that we find acceptable, if at all.

 

**If the estimates we make and the assumptions onwhich we rely in preparing our financial statements prove inaccurate, ouractual results may vary significantly.**

 

Our financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of our assets,liabilities, revenues and expenses, the amounts of charges taken by us andrelated disclosure. Such estimates and judgments include revenue recognition,the carrying value of our inventory and assets, our estimates of accruedexpenses and our estimates of the fair value of equity instruments granted orsold by us. We base our estimates and judgments on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances. However, these estimates and judgments, or the assumptionsunderlying them, may prove to be incorrect. Accordingly, our actual financialresults may vary significantly from the estimates contained in our financialstatements.  For a further discussion ofthe estimates and judgments that we make and the critical accounting policiesthat affect these estimates and judgments, see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations —Critical AccountingPolicies and Estimates” above.

 

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**Weface costs and risks associated with compliance with Section 404 of theSarbanes-Oxley Act***.*

 

Weare evaluating our internal control systems in order to allow our management toreport on, and our independent registered public accounting firm to attest to,our internal controls over financial reporting, as required by Section 404 ofthe Sarbanes-Oxley Act. As a result, we are incurring additional expenses and adiversion of management’s time. While we currently anticipate completion oftesting and evaluation of our internal controls over financial reporting withrespect to the requirements of Section 404 of the Sarbanes-Oxley Act in atimely fashion, there can be no assurance that we will be able to accomplishthis. If we are not able to implement the requirements of Section 404 in atimely manner or with adequate compliance, we might be subject to investigationby regulatory authorities. Any such action could adversely affect our financialresults and/or the market price of our common stock.

 

**Risks Relating to our Intellectual Property Rights**

 

**Our patent protection forBiDil, which is a combination of two generic drugs, is limited, and we may besubject to generic substitution or competition and resulting pricing pressure.**

 

Wehave no composition of matter patent covering BiDil, which we launched in theU.S. in July 2005 for the treatment of heart failure in self-identified blackpatients as an adjunct to standard therapy. BiDil is a fixed-dose combinationof two generic drugs, isosorbide dinitrate and hydralazine, which are approved andseparately marketed, in dosages similar to those we include in BiDil, forindications other than heart failure, at prices below the prices we arecharging for BiDil. We have three issued method-of-use patents, one of whichcovers the use of the combination of isosorbide dinitrate and hydralazine toreduce the incidence of mortality associated with chronic congestive heartfailure, expiring in 2007, and the others covering the treatment of heartfailure in black patients, expiring in 2020. As a practical matter, we may notbe able to enforce these method-of-use patents to prevent physicians fromprescribing isosorbide dinitrate and hydralazine separately for the treatmentof heart failure in black patients, even though neither drug is approved forsuch use.  We also may not be ableto enforce these method-of-use patents to prevent hospitals and pharmacies fromsupplying such patients with these generic drugs separately in lieu of BiDil. Forexample, we are aware of a hospital pharmacy and therapeutics formularycommittee that has recently recommended that, in lieu of adding BiDil to itsformulary, its patients taking BiDil should be given these generic ingredientsrather than BiDil. We are currently evaluating this matter and we are unable topredict whether we can successfully enforce our method-of-use patents to barthis or other similar cases of infringement.

 

Otherfactors may also adversely affect our patent protection for BiDil. Thecombination therapy of isosorbide dinitrate and hydralazine for use in heartfailure was developed through lengthy, publicly-sponsored clinical trialsconducted during the 1980s, prior to the filing of the patent application thatresulted in the 2007 patent. The U.S. Patent and Trademark Office, or U.S.patent office, considered published reports on these clinical trials andconcluded that they did not constitute prior art that would prevent theissuance of the 2007 patent. The U.S. patent office also considered thequestion of whether the 2007 patent constituted prior art with respect to the2020 patents, and determined that the claims of the 2020 patents were non-obviousand patentable. A court considering the validity of the 2007 or 2020 patentswith respect to questions of prior art might be presented with other alleged priorart or might reach conclusions different from those reached by the U.S. patentoffice. If the 2007 or 2020 patents were to be invalidated or if physicianswere to prescribe isosorbide dinitrate and hydralazine separately for heartfailure in black patients, our BiDil revenue could be significantly reduced, wecould fail to recover the cost of developing BiDil and BiDil might not be aviable product.

 

**If we are not able toobtain and enforce patent protection for our discoveries, our ability todevelop and commercialize our product candidates will be harmed, and we may notbe able to operate our business profitably.**

 

Oursuccess depends, in part, on our ability to protect proprietary methods andtechnologies that we develop under the patent and other intellectual propertylaws of the United States and other countries, in order to prevent others fromusing our inventions and proprietary information. Because certain United Statespatent applications are confidential until patents issue, such as applications filedprior to November 29, 2000 or applications filed after such date whichwill not be filed in foreign countries, third parties may have filed patentapplications for technology covered by our pending patent applications withoutour being aware of those applications, and our patent applications may not havepriority over any patent applications of others.

 

Ourstrategy depends on our ability to rapidly identify and seek patent protectionfor our discoveries. This process is expensive and time consuming, and we maynot be able to file and prosecute all necessary or desirable patentapplications at a reasonable cost or in a timely manner. Despite our efforts toprotect our proprietary rights,

 

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unauthorized parties may beable to obtain and use information that we regard as proprietary. The mereissuance of a patent does not guarantee that it is valid or enforceable, soeven if we obtain patents, they may not be valid or enforceable against thirdparties.

 

Theissued patents and patent applications for our product candidates and nitricoxide technology include claims with respect to both the composition ofspecific drugs or compounds and specific methods of using these drugs orcompounds in therapeutic areas. In some cases, like BiDil, our only patentprotection is with respect to the method of using a drug or compound, and we donot have patent claims covering the underlying composition of the drug orcompound. Method-of-use patents may provide less protection for our productcandidates because it may be more difficult to prove direct infringementagainst a pharmaceutical manufacturer or distributor once they have gainedapproval for an alternative indication. In addition, if any other company gainsFDA approval for an indication separate from the one we are pursuing andmarkets a drug that we expect to market under the protection of a method-of-usepatent, physicians will be able to prescribe that drug for use in theindication for which we have obtained approval, even though the drug is notapproved for such indication. As a practical matter, we may not be able toenforce our method-of-use patents against physicians prescribing drugs for suchoff-label use. Off-label use and any resulting off-label sales could make itmore difficult to obtain the price we would otherwise wish to achieve for, orto successfully commercialize, our product. In addition, in those situationswhere we have only method-of-use patent coverage for a product candidate, itmay be more difficult to find a pharmaceutical company partner to license orsupport development of our product candidate.

 

Ourpending patent applications may not result in issued patents. The patentposition of pharmaceutical or biotechnology companies, including ours, isgenerally uncertain and involves complex legal and factual considerations. Thestandards which the U.S. patent office and its foreign counterparts use togrant patents are not always applied predictably or uniformly and can change.There is also no uniform, worldwide policy regarding the subject matter andscope of claims granted or allowable in pharmaceutical or biotechnologypatents. Accordingly, we do not know the degree of future protection for ourproprietary rights or the breadth of claims allowed in any patents issued to usor to others.

 

Wealso rely on trade secrets, know-how and technology, which are not protected bypatents, to maintain our competitive position. If any trade secret, know-how orother technology not protected by a patent were to be disclosed to orindependently developed by a competitor, our business and financial conditioncould be materially adversely affected.

 

**If we become involved inpatent litigation or other proceedings to enforce our patent rights, we wouldincur substantial costs and expenses, substantial liability for damages and/orbe required to stop our product development and commercialization efforts.**

 

Athird party may sue us for infringing on its patent rights. Likewise, we mayneed to resort to litigation to enforce a patent issued to us or to determinethe scope and validity of third-party proprietary rights. The cost to us of anylitigation or other proceeding relating to intellectual property rights, evenif resolved in our favor, could be substantial, and the litigation would divertour management’s efforts. Some of our competitors may be able to sustain thecosts of complex patent litigation more effectively than we can because theyhave substantially greater resources. In addition, our strategy of providing nitricoxide-enhancing versions of existing medicines could lead to more patentlitigation as the markets for these existing medicines are very large andcompetitive. Uncertainties resulting from the initiation and continuation ofany litigation could limit our ability to continue our operations.

 

Forexample, we have filed an opposition in the European Patent Office, or EPO, torevoke NicOx S.A.’s European Patent No. 904 110, which we refer to as EP‘110. This patent is directed to the use of organic compounds containing anitrate group or inorganic compounds containing a nitric oxide group to reducethe toxicity caused by certain drugs, including non-steroidal anti-inflammatorydrugs, or NSAID’s. The basis for our opposition, in part, is that the claims inEP ‘110 are anticipated and therefore invalid if they are construed to cover asingle compound chemically linked to a nitrate moiety. While we believe thatthe claims in EP ‘110 will be invalidated, or be narrowed, we cannot predictwith certainty the outcome of the opposition. If the EPO finds that there arevalid claims in EP ‘110 that cover compounds chemically linked to nitrates, wemay be adversely affected in our ability to market our product candidates forreducing gastrointestinal toxicity without first obtaining a license fromNicOx, which may not be available on favorable terms, if at all.

 

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Ifany parties are able to successfully claim that our creation or use ofproprietary technologies infringes upon their intellectual property rights, wemight be forced to pay damages, potentially including treble damages, if we arefound to have willfully infringed on such parties’ patent rights. In additionto any damages we might have to pay, a court could require us to stop theinfringing activity or obtain a license on unfavorable terms. Moreover, anylegal action against us or our partners claiming damages and seeking to enjoincommercial activities relating to the affected products and processes could, inaddition to subjecting us to potential liability for damages, require us or ourpartners to obtain a license in order to continue to manufacture or market theaffected products and processes. Any license required under any patent may notbe made available on commercially-acceptable terms, if at all. In addition,some licenses may be non-exclusive, and therefore our competitors may haveaccess to the same technology licensed to us. If we fail to obtain a requiredlicense or are unable to design around a patent, we may be unable toeffectively market some of our technology and product candidates, which couldlimit our ability to generate revenues or achieve profitability and possiblyprevent us from generating revenue sufficient to sustain our operations. In addition,a number of our collaborations provide that royalties payable to us forlicenses to our intellectual property may be offset by amounts paid by ourcollaboration partners to third parties who have competing or superiorintellectual property positions in the relevant fields, which could result insignificant reductions in our revenues from products developed throughcollaborations.

 

**We in-license a significantportion of our principal proprietary technologies, and if we fail to complywith our obligations under any of the related agreements, we could lose licenserights that are necessary to developing BiDil and our other product candidates.**

 

Weare a party to a number of licenses that give us rights to third-partyintellectual property that is necessary for our business. In particular, wehave obtained the exclusive right to develop and commercialize BiDil pursuantto a license agreement with Dr. Jay N. Cohn and some of our intellectualproperty rights relating to nitric oxide compounds have been obtained pursuantto license agreements with the Brigham and Women’s Hospital and BostonUniversity. We expect to enter into additional licenses in the future. Theselicenses impose various development, commercialization, funding, royalty,diligence, and other obligations on us. If we breach these obligations, thelicensor may have the right to terminate the license or render the license non-exclusive,which would result in us being unable to develop, manufacture and sell productsthat are covered by the licensed technology.

 

**Risks Relating to our Industry**

 

**We face significantcompetition, which may result in others discovering, developing orcommercializing products before or more successfully than we do.**

 

Thepharmaceutical and medical device industries are highly competitive andcharacterized by rapid and significant technological change. Our principalcompetitors in the markets we have targeted, including cardiovascular disease,are large, multinational pharmaceutical and medical device companies that havesubstantially greater financial and other resources than we do and areconducting extensive research and development activities on technologies andproduct candidates similar to or competitive with ours.

 

Thereare a number of companies currently marketing and selling products to treatheart failure in the general population that will compete with BiDil. Theseinclude GlaxoSmithKline, plc, which currently markets Coreg, Merck &Co., Inc., which currently markets Vasotec, Pfizer, Inc., whichcurrently markets Inspra, and Astra Zeneca, plc, which currently markets ToprolXL.

 

Wealso face competition from other pharmaceutical companies seeking to developdrugs using nitric oxide technology. For example, we are aware of at leastseven companies working in the area of nitric oxide based therapeutics. Thesecompanies are: Angiogenix Inc., GB Therapeutics, NicOx S.A., OxoN Medica,RenoPharm, Vasopharm BIOTECH GmbH, and Nitrox LLC.

 

Manyof our competitors are more experienced than we are in drug development andcommercialization, obtaining regulatory approvals and product marketing andmanufacturing. As a result, our competitors may develop and

 

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commercialize pharmaceuticalproducts before we do. In addition, our competitors may develop andcommercialize products that render our products obsolete or non-competitive orthat block or delay approval of our products as a result of patent or non-patentexclusivity.

 

**We may be exposed toproduct liability claims and may not be able to obtain or maintain adequateproduct liability insurance.**

 

Ourbusiness exposes us to the risk of product liability claims that is inherent inthe manufacturing, testing, and marketing of human therapeutic products. Ourclinical trial liability and commercial product liability insurance is subjectto deductibles and coverage limitations. We may not be able to obtain ormaintain insurance on acceptable terms, or at all. Moreover, any insurance thatwe do obtain may not provide adequate protection against potential liabilities.

 

**If third-party payors donot reimburse customers for BiDil or any of our product candidates that areapproved for marketing, they might not be used or purchased, and our revenuesand profits might be adversely affected.**

 

Ourrevenues and profits depend heavily upon the availability of coverage andreimbursement for the use of BiDil and any of our other product candidates thatmaybe approved for marketing, from third-party healthcare and state and federalgovernment payors, both in the United States and in foreign markets.Reimbursement by a third-party payor may depend upon a number of factors,including the third-party payor’s determination that use of a product is:

 

•  safe, effective and medically necessary;

 

•  appropriate for the specific patient;

 

•  cost-effective; and

 

•  neither experimental nor investigational.

 

Sincereimbursement approval for a product is required from third-party andgovernment payors, seeking this approval, particularly when seeking approvalfor a preferred form of reimbursement over other competitive products, is atime-consuming and costly process. Third-party payors may require cost-benefitanalysis data from us in order to demonstrate the cost-effectiveness of anyproduct we might bring to market. For any individual third-party payor, we maynot be able to provide data sufficient to gain reimbursement on a similar orpreferred basis to competitive products or at all. Once reimbursement at anagreed level is approved by a third-party payor, we may lose thatreimbursement, entirely or we may lose the similar or better reimbursement wereceive compared to competitive products. As reimbursement is often approvedfor a period of time, this risk is greater at the end of the time period, ifany, for which the reimbursement was approved.

 

**Wecould be negatively impacted by the application or enforcement of federal andstate fraud and abuse laws, including anti-kickback laws and other federal andstate anti-referral laws.**

 

We are subject tovarious federal and state laws pertaining to healthcare fraud and abuse,including anti-kickback laws and physician self-referral laws. Violations ofthese laws are punishable by criminal and civil sanctions, including, in someinstances, imprisonment and exclusion from participation in federal and statehealthcare programs, including the Medicare, Medicaid and VeteransAdministration health programs. Because of the far-reaching nature of theselaws, we may be required to alter or discontinue one or more of our practicesto be in compliance with these laws. Healthcare fraud and abuse regulations arecomplex, and even minor irregularities can potentially give rise to claims thata statute or prohibition has been violated. Any violations of these laws, orany action against us for violation of these laws, even if we successfullydefend against it, could result in a material adverse effect on our business,financial condition and results of operations. If there is a change in law,regulation or administrative or judicial interpretations, we may have to changeor discontinue our business practices or our existing business practices couldbe challenged as unlawful, which could have a material adverse effect on ourbusiness, financial condition and results of operations. In addition, we couldbecome subject to false claims litigation under federal statutes, which canlead to treble damages based on the reimbursements by federal health careprograms, civil money penalties (including penalties levied on a per falseclaim basis), restitution, criminal fines and imprisonment, and exclusion fromparticipation in Medicare, Medicaid and other federal and state healthcare

 

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programs. These false claims statutes include the False Claims Act,which allows any person to bring suit on behalf of the federal governmentalleging the submission of false or fraudulent claims, or causing to presentsuch false or fraudulent claims, under federal programs or contracts claims orother violations of the statute and to share in any amounts paid by the entityto the government in fines or settlement. These suits against biotechnologycompanies have increased significantly in recent years and have increased therisk that a healthcare company will have to defend a false claim action, payfines or restitution, or be excluded from the Medicare, Medicaid or otherfederal and state healthcare programs as a result of an investigation arisingout of such action. We cannot assure you that we will not become subject tosuch litigation or, if we are not successful in defending against such actions,that such actions will not have a material adverse effect on our business,financial condition and results of operations. In addition, we cannot assureyou that the costs of defending claims or allegations under the False ClaimsAct will not have a material adverse effect on our business, financialcondition and results of operations.

 

**Risks Relating to our Common Stock**

 

**Our stock price is subjectto fluctuation, which may cause an investment in our stock to suffer a declinein value.**

 

Themarket price of our common stock may fluctuate significantly in response tofactors that are beyond our control. The stock market in general has recentlyexperienced extreme price and volume fluctuations. The market prices ofsecurities of pharmaceutical, biotechnology and other life sciences companieshave been extremely volatile, and have experienced fluctuations that often havebeen unrelated or disproportionate to the operating performance of thesecompanies. For example, our stock price could be adversely affected if productcandidates by others that utilize nitric oxide technology are not successful inclinical testing, fail to achieve regulatory approval or are not accepted inthe marketplace, even though these failures may not be related to BiDil, ourproduct candidates or technology. These broad market fluctuations could resultin extreme fluctuations in the price of our common stock, which could cause adecline in the value of our common stock.

 

**We may incur significantcosts and suffer management distraction and reputational damage from classaction litigation and regulatory or government investigations and actions dueto trading in our common stock.**

 

Ourstock price has been, and is likely to continue to be, volatile. Our stockprice may fluctuate for many reasons, including as a result of publicannouncements regarding the commercialization of BiDil, the progress of ourdevelopment and marketing efforts, the addition or departure of key personnel,variations in our quarterly operating results and changes in market valuationsof pharmaceutical, biotechnology or other life sciences companies. When themarket price of a company’s stock is volatile, holders of that company’s stockmay bring securities class action litigation against the company that issuedthe stock. If any of our stockholders were to bring a lawsuit of this typeagainst us, even if the lawsuit was without merit, we could incur substantialcosts defending the lawsuit.

 

OnJuly 20, 2004, the Market Regulation Department of the NASD advised usthat it initiated a review of trading activity in our common stock surroundingour July 19, 2004 announcement that we had halted our phase III clinicaltrial of BiDil due to the significant survival benefit seen with BiDil. TheNASD is reviewing, among other things, information on relationships between ourofficers, directors and service providers and individuals and institutions thatmay have traded in our common stock prior to the July 19, 2004announcement. We have cooperated with this review and have identified certainpersons on the list provided to us by the NASD as having a relationship withour chief executive officer and others at NitroMed. We have established aspecial committee of our board of directors to oversee our response to thisreview.

 

TheSEC or other securities regulators may investigate trading activity of insidersand others around events that result in stock price volatility, such as ourJuly 19, 2004 announcement, and we may incur substantial costs inconnection with any such government investigation or related action. Astockholder lawsuit, SEC or other investigation or action could also damage ourreputation or that of our officers or directors and divert their time andattention away from our management.

 

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**Substantially all of ouroutstanding common stock may be sold into the market at any time. This couldcause the market price of our common stock to drop significantly.**

 

Salesof a substantial number of shares of our common stock in the public marketcould occur at any time. These sales, or the perception in the market that theholders of a large number of shares intend to sell shares, could reduce themarket price of our common stock. As of June 30, 2005, we had outstanding30,288,187 shares of common stock. Substantially all of these shares may alsobe resold in the public market at any time. In addition, we have a significantnumber of shares that are subject to outstanding options. The exercise of theseoptions and the subsequent sale of the underlying common stock could cause afurther decline in our stock price. These sales also might make it difficultfor us to sell equity securities in the future at a time and at a price that wedeem appropriate.

 

**Insiders have substantialcontrol over us and could delay or prevent a change in corporate control.**

 

Asof June 30, 2005, our directors, executive officers and principal stockholders,together with their affiliates, own, in the aggregate, approximately 48% of ouroutstanding common stock. As a result, these stockholders, if acting together,may have the ability to determine the outcome of matters submitted to ourstockholders for approval, including the election and removal of directors andany merger, consolidation or sale of all or substantially all of our assets. Inaddition, these persons, if acting together, will have the ability to controlthe management and affairs of our Company. Accordingly, this concentration ofownership may harm the market price of our common stock by:

 

•  delaying, deferring or preventing a change incontrol of our Company;

 

•  impeding a merger, consolidation, takeover orother business combination involving our Company; or

 

• discouraging a potential acquirer from making a tender offer orotherwise attempting to obtain control of our Company.

 

**Provisions in our charterdocuments and under Delaware law may prevent or frustrate attempts bystockholders to change current management and hinder efforts to acquire acontrolling interest in our Company.**

 

Provisionsof our restated certificate of incorporation and bylaws may discourage, delayor prevent a merger, acquisition or other change in control that stockholdersmay consider favorable, including transactions in which stockholders mightotherwise receive a premium for their shares. These provisions may prevent orfrustrate attempts by stockholders to replace or remove our current management.These provisions include:

 

•  aprohibition on stockholder action through written consent;

 

•  arequirement that special meetings of stockholders be called only by a majorityof the board of directors, the chairman of the board or the chief executiveofficer;

 

• advance notice requirements for stockholder proposals and nominations;

 

• limitations on the ability of stockholders to amend, alter or repeal ourcertificate of incorporation or bylaws; and

 

•  theauthority of the board of directors to issue preferred stock with such terms asthe board of directors may determine.

 

Inaddition, Section 203 of the Delaware General Corporation Law prohibits apublicly-held Delaware corporation from engaging in a business combination withan interested stockholder, generally defined as a person or entity which togetherwith its affiliates owns or within the last three years has owned 15% of ourvoting stock, for a period of three years after the date of the transaction inwhich the person became an interested stockholder, unless the businesscombination is approved in a prescribed manner. Accordingly, Section 203may discourage, delay or prevent a change in control of our Company.

 

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**Item 3.****           Quantitativeand Qualitative Disclosures About Market Risk**

 

Weare exposed to market risk related to changes in interest rates. Our currentinvestment policy is to maintain an investment portfolio consisting mainly ofU.S. money market and high-grade corporate and U.S. government-relatedsecurities, directly or through managed funds, with average contractualmaturities of less than two years. Our cash is deposited in and investedthrough highly rated financial institutions in North America. Our marketablesecurities are subject to interest rate risk and will fall in value if market interestrates increase. If market interest rates were to increase immediately anduniformly by 10% from levels at June 30, 2005, we estimate that the fair valueof our investment portfolio would decline by an immaterial amount. We have theability to hold our fixed income investments until maturity, and therefore wedo not expect our operating results or cash flows to be affected to anysignificant degree by the effect of a change in market interest rates on ourinvestments.

 

**Item 4.****           Controlsand Procedures**

 

Ourmanagement, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of June 30, 2005. The term “disclosure controls andprocedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by a company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms. Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. Management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving their objectives, and management necessarily applies its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Based on the evaluation of our disclosure controls and procedures as of June30, 2005, our chief executive officer and chief financial officer concludedthat, as of such date, our disclosure controls and procedures were effective atthe reasonable assurance level.

 

Nochange in our internal control over financial reporting occurred during thefiscal quarter ended June 30, 2005 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 5.    Submission ofMatters to a Vote of Security Holders.**

 

OurAnnual Meeting of Stockholders was held on May 16, 2005. At the Annual Meeting,the following matters were voted upon by holders of 90.7% of the totaloutstanding shares:

 

1.             To elect the following ninedirectors:

 
| ** **                    | ** ** | **VOTES  FOR** | ** ** | **VOTES  WITHHELD** | ** ** |
|-------------------------------|------------|----------------|------------|---------------------|------------|
| Argeris Karabelas, Ph.D.      |       | 26,942,761     |       | 535,537             |       |
| Michael D.  Loberg, Ph.D.     |       | 27,325,400     |       | 152,898             |       |
| Robert S. Cohen               |       | 27,081,826     |       | 396,472             |       |
| Frank L. Douglas, M.D., Ph.D. |       | 27,322,210     |       | 156,088             |       |
| Zola Horovitz, Ph.D.          |       | 25,316,037     |       | 2,162,261           |       |
| Mark Leschly                  |       | 27,085,016     |       | 393,282             |       |
| John W. Littlechild           |       | 26,798,407     |       | 679,891             |       |
| Joseph Loscalzo, M.D., Ph.D.  |       | 27,150,079     |       | 328,219             |       |
| Davey Scoon                   |       | 27,322,505     |       | 155,793             |       |

 

Each of the above named individuals was elected as adirector.

 

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| 2. | To  adopt the amendment to, and approve the continuance of, our amended and  restated 2003 stock incentive plan: |
|----|------------------------------------------------------------------------------------------------------------------|

 
| **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **VOTES WITHHELD** | ** ** |
|---------------|------------|-------------------|------------|--------------------|------------|
| 15,384,500    |       | 5,736,120         |       | 6,357,678          |       |

 
|   | The proposal was approved. |
|--------|----------------------------|

 
| 3.                  | To  ratify the selection of Ernst & Young LLP as our independent registered  public accounting firm for the fiscal year ending |
|---------------------|------------------------------------------------------------------------------------------------------------------------------------|
| December  31, 2005: |

 
| **VOTES FOR** | ** ** | **VOTES AGAINST** | ** ** | **VOTES WITHHELD** | ** ** |
|---------------|------------|-------------------|------------|--------------------|------------|
| 27,418,407    |       | 56,215            |       | 3,676              |       |

 
|   | The proposal was approved. |
|--------|----------------------------|

 
| **Item  6.** | **Exhibits** |                                                                                                             |
|--------------|--------------|------------------------------------------------------------------------------------------------------------------|
|         |         |                                                                                                             |
|         | (a)          | The exhibits  listed in the accompanying exhibit index are filed as part of this Quarterly  Report on Form 10-Q. |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                  | NITROMED, INC. |
|-----------------------|----------------|
|                  |           |
|                  |           |
|                  | By:            | /s/ LAWRENCE E.  BLOCH, M.D., J.D. |
|                  |           | Lawrence E.  Bloch, M.D., J.D. |
|                  |           | Chief Financial  Officer, Chief Business Officer, Treasurer |
|                  |           | and Secretary *(Principal Financial Officer)* |
| Date: August 3,  2005 |           |   |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                     |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                          |
| 10.1(1)             |       | Scientific  Advisory Board Agreement, dated May 16, 2005, between NitroMed, Inc. and  Frank L. Douglas, Ph.D., M.D.                                                                                                                                                                                                                                                                 |
| 10.2(2)             |       | Master  Security Agreement (including Collateral Schedule No. 001) and  Financial Covenants Addendum No. 001, each dated as of June 28,  2005, between NitroMed, Inc. and Oxford Finance Corporation and  Promissory Note, dated as of June 28, 2005, made by NitroMed, Inc.  for the benefit of Oxford Finance Corporation                      |
| 10.3(2)             |       | Master  Security Agreement (including Collateral Schedule No. 001) and  Financial Covenants Addendum No. 001, each dated as of June 28,  2005, between NitroMed, Inc. and General Electric Capital Corporation  and Promissory Note, dated as of June 28, 2005, made by  NitroMed, Inc. for the benefit of General Electric Capital Corporation. |
| 31.1                |       | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a)  of the Securities Exchange Act of 1934, as amended                                                                                                                                                                                                                                     |
| 31.2                |       | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a)  of the Securities Exchange Act of 1934, as amended                                                                                                                                                                                                                                     |
| 32.1                |       | Certification  of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                        |
| 32.2                |       | Certification  of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                        |

 

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(1) Incorporatedby reference to the exhibits to NitroMed, Inc.’s Current Report on Form 8-Kfiled on May 20, 2005 (File No. 000-50439).

 

(2) Incorporatedby reference to the exhibits to NitroMed, Inc.’s Current Report on Form 8-Kfiled on July 5, 2005 (File No. 000-50439).

 

35

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