**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

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**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**ForThe Quarterly Period Ended September 30, 2006**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Transition Period from            to**

**CommissionFile Number 000-50439**

**NitroMed, Inc.**

(Exact Name of Registrantas 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, if Changed Since Last Report

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

| Large Accelerated  Filer o   Accelerated  Filer x   Non-Accelerated  Filer  o |
|------------------------------------------------------------------------------------------------------------------|

 

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

Asof October 30, 2006, the registrant had  37,145,372 shares of CommonStock, $0.01 par value per share, outstanding.

 

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NITROMED, INC.

FORM 10-Q

FOR THE QUARTERLY PERIODENDED SEPTEMBER 30, 2006

**TABLE OFCONTENTS**
| PART I.       |   | FINANCIAL  INFORMATION                                                                                               |   |   |
|--------------------|--------|----------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.            |   | Financial Statements                                                                                                 |   |   |
|               |   | Condensed  Balance Sheets as of September 30, 2006 and December 31, 2005  (unaudited)                      |   |   |
|               |   | Condensed Statements of Operations for the three and  nine months ended September 30, 2006 and 2005 (unaudited) |   |   |
|               |   | Condensed Statements of Cash Flows for the nine months  ended September 30, 2006 and 2005 (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 1A.           |   | Risk Factors                                                                                                         |   |   |
| Item 6.            |   | Exhibits                                                                                                             |   |   |
| SIGNATURES         |   |                                                                                                                 |   |   |
| EXHIBIT INDEX |   |                                                                                                                 |   |   |

 

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** **

**PART I.FINANCIAL INFORMATION**

**Item 1.****           FinancialStatements (unaudited)**

**NITROMED, INC.CONDENSED BALANCE SHEETS(in thousands, except par value amounts)**
| ** **                                                                                                                                                                      | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                      | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                 |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                      |       | $                            | 24,168     |                        | $          | 11,091 |   |
| Marketable  securities                                                                                                                                                          |       | 30,427                       |       | 50,450                      |       |
| Accounts  receivable                                                                                                                                                            |       | 1,578                        |       | 4,078                       |       |
| Inventories                                                                                                                                                                     |       | 3,053                        |       | 3,247                       |       |
| Prepaid expenses  and other current assets                                                                                                                                      |       | 1,000                        |       | 3,860                       |       |
| Total current assets                                                                                                                                                            |       | 60,226                       |       | 72,726                      |       |
| Property and equipment,  net                                                                                                                                                    |       | 1,881                        |       | 2,992                       |       |
| Restricted cash                                                                                                                                                                 |       | 803                          |       | 803                         |       |
| Total assets                                                                                                                                                                    |       | $                            | 62,910     |                        | $          | 76,521 |   |
|                                                                                                                                                                            |       |                         |       |                        |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                  | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                            |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                |       | $                            | 2,536      |                        | $          | 11,810 |   |
| Accrued expenses                                                                                                                                                                |       | 9,491                        |       | 11,269                      |       |
| Accrued  restructuring                                                                                                                                                          |       | 350                          |       | —                      |       |
| Deferred revenue                                                                                                                                                                |       | —                       |       | 3,451                       |       |
| Current portion  of long-term debt                                                                                                                                              |       | 6,756                        |       | 6,272                       |       |
| Total current  liabilities                                                                                                                                                      |       | 19,133                       |       | 32,802                      |       |
| Long-term debt                                                                                                                                                                  |       | 5,525                        |       | 10,653                      |       |
|                                                                                                                                                                            |       |                         |       |                        |       |
| Commitments and  contingencies (Note 13)                                                                                                                                        |       |                         |       |                        |       |
| 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; 37,145 and 30,512 shares issued  and outstanding at September 30, 2006 and December 31, 2005,  respectively |       | 371                          |       | 305                         |       |
| Additional  paid-in capital                                                                                                                                                     |       | 341,093                      |       | 276,510                     |       |
| Deferred  stock-based compensation                                                                                                                                              |       | —                       |       | (1,208                      | )          |
| Accumulated  deficit                                                                                                                                                            |       | (303,195                     | )          | (242,471                    | )          |
| Accumulated  other comprehensive loss                                                                                                                                           |       | (17                          | )          | (70                         | )          |
| Total stockholders’  equity                                                                                                                                                |       | 38,252                       |       | 33,066                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                 |       | $                            | 62,910     |                        | $          | 76,521 |   |

 

See accompanyingnotes.

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**NITROMED, INC.CONDENSED STATEMENTS OF OPERATIONS(in thousands, except per share amounts) (unaudited)**

 
| ** **                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Product sales                                                         |       | $                                                    | 3,427      |                                                | $          | 1,117 |   | $ | 8,598 |   | $ | 1,117 |   |
| Research and  development                                             |       | —                                               |       | 398                                                 |       | — |   | 1,194 |   |
| Total revenues                                                        |       | 3,427                                                |       | 1,515                                               |       | 8,598 |   | 2,311 |   |
|                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Cost and operating  expenses:                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of product  sales                                                |       | 1,310                                                |       | 2,877                                               |       | 2,827 |   | 2,877 |   |
| Research and  development (1)                                         |       | 4,400                                                |       | 7,393                                               |       | 15,215 |   | 23,391 |   |
| Sales, general  and administrative (1)                                |       | 14,696                                               |       | 23,614                                              |       | 50,761 |   | 52,161 |   |
| Restructuring  charge                                                 |       | —                                               |       | —                                              |       | 2,038 |   | — |   |
| Total cost and  operating expenses                                    |       | 20,406                                               |       | 33,884                                              |       | 70,841 |   | 78,429 |   |
| Loss from operations                                                  |       | (16,979                                              | )          | (32,369                                             | )          | (62,243 | ) | (76,118 | ) |
| Non-operating income:                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Interest expense                                                      |       | (319                                                 | )          | (479                                                | )          | (1,073 | ) | (495 | ) |
| Interest income                                                       |       | 778                                                  |       | 776                                                 |       | 2,592 |   | 2,328 |   |
|                                                                  |       | 459                                                  |       | 297                                                 |       | 1,519 |   | 1,833 |   |
| Net loss                                                              |       | $                                                    | (16,520    | )                                                   | $          | (32,072 | ) | $ | (60,724 | ) | $ | (74,285 | ) |
| Basic and diluted net  loss per common share                          |       | $                                                    | (0.45      | )                                                   | $          | (1.05 | ) | $ | (1.68 | ) | $ | (2.45 | ) |
| Shares used in  computing basic and diluted net loss per common share |       | 37,090                                               |       | 30,421                                              |       | 36,146 |   | 30,311 |   |

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(1)             Includes stock-basedcompensation expense as follows:
| Research and  development              |   | $     | 714    |   | $      | 202   |   | $   | 2,313  |   | $ | 303 |   |
|----------------------------------------|--------|-------|--------|--------|--------|-------|--------|-----|--------|--------|---|-----|--------|
| Sales, general and  administrative     |   | 1,154 |   | 14     |   | 4,128 |   | 137 |   |
| Total stock-based compensation expense |   | $     | 1,868  |   | $      | 216   |   | $   | 6,441  |   | $ | 440 |   |

 

See accompanyingnotes.

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**NITROMED, INC.CONDENSED STATEMENTS OF CASH FLOWS(in thousands) (unaudited)**
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Operating activities**                                                     | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                                                   | (60,724    | ) | $ | (74,285 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                                |       |   |   |
| Depreciation and  amortization                                               |       | 617                                                 |       | 663 |   |
| Non-cash  restructuring charge                                               |       | 597                                                 |       | — |   |
| Stock-based  compensation expense                                            |       | 6,441                                               |       | 440 |   |
| Changes in  operating assets and liabilities:                                |       |                                                |       |   |   |
| Accounts  receivable                                                         |       | 1,028                                               |       | (12,854 | ) |
| Inventories                                                                  |       | 194                                                 |       | (5,137 | ) |
| Prepaid expenses  and other current assets                                   |       | 2,860                                               |       | 1,842 |   |
| Deferred revenue                                                             |       | (1,979                                              | )          | 11,190 |   |
| Accounts payable  and accrued expenses                                       |       | (11,052                                             | )          | 5,223 |   |
| Accrued  restructuring charge                                                |       | 350                                                 |       | — |   |
| Net cash used in  operating activities                                       |       | (61,668                                             | )          | (72,918 | ) |
| **Investing activities**                                                     | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Purchases of property  and equipment                                         |       | (104                                                | )          | (893 | ) |
| Purchases of marketable  securities                                          |       | (122,349                                            | )          | (97,531 | ) |
| Sales of marketable  securities                                              |       | 142,425                                             |       | 128,399 |   |
| Restricted cash                                                              |       | —                                              |       | 10 |   |
| Net cash provided by  investing activities                                   |       | 19,972                                              |       | 29,985 |   |
| **Financing activities**                                                     | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from sale of  common stock                                          |       | 58,505                                              |       | — |   |
| Proceeds from long-term  debt                                                |       | —                                              |       | 20,000 |   |
| Principal payments on  long-term debt                                        |       | (4,644                                              | )          | (1,601 | ) |
| Proceeds from employee  stock plans                                          |       | 912                                                 |       | 893 |   |
| Net cash provided by  financing activities                                   |       | 54,773                                              |       | 19,292 |   |
| Net change in cash and  cash equivalents                                     |       | 13,077                                              |       | (23,641 | ) |
| Cash and cash  equivalents at beginning of period                            |       | 11,091                                              |       | 35,882 |   |
| Cash and cash equivalents at end of period                                   |       | $                                                   | 24,168     |   | $ | 12,241 |   |

 

 

 

 

 

 

See accompanyingnotes.

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**NITROMED, INC.NOTES TO UNAUDITED FINANCIAL STATEMENTSSEPTEMBER 30, 2006**

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

The accompanying unaudited financial statements ofNitroMed, Inc. (“NitroMed” or the “Company”) have been prepared inaccordance with accounting principles generally accepted in the United States(“GAAP”) for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X. Accordingly, they donot include all of the 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, 2006. 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 onForm 10-K, which was filed with the Securities and Exchange Commission(“SEC”) on March 2, 2006.

### **(2)           RevenueRecognition**

The Company’s principal source of revenue is from the saleof BiDil® (isosorbide dinitrate/hydralazinehydrochloride), the Company’s product for the treatment of heart failure inself-identified black patients as an adjunct to current standard therapies.BiDil was launched and began shipping in the third quarter of 2005. Othersources of revenue historically included collaboration revenue, which hasgenerally been recognized ratably over the research and developmentcollaboration term.

*Product Sales/Deferred Revenue.  *TheCompany follows the provisions of Staff Accounting Bulletin No. 104, *Revenue Recognition,* and recognizes revenue from productsales upon delivery of product to wholesalers or pharmacies, when persuasiveevidence of an arrangement exists, the fee is fixed or determinable, title toproduct and associated risk of loss has passed to the wholesalers andpharmacies, and collectibility of the related receivable is reasonably assured.All revenues from product sales are recorded net of applicable allowances forsales returns, rebates, and discounts. For arrangements where the risk of losshas not passed to wholesalers or pharmacies, the Company defers the recognitionof revenue until such time that risk of loss has passed. In addition, theCompany evaluates the level of shipments to wholesalers and pharmacies on aquarterly basis compared to the estimated level of inventory in the channel,remaining shelf-life of the product shipped and quarterly forecasted sales. Asa result of this evaluation, the Company deferred $2.1 million of revenue fromDecember 2005 shipments and recorded this amount in deferred revenueas of December 31, 2005. In the first nine months of 2006, the Companyreversed $1.8 million of this deferred revenue and recognized the remainder asrevenue. The cost of BiDil associated with amounts recorded as deferred revenueis recorded in inventory until such time as risk of loss has passed.

*Sales Returns, Allowances, Rebates and Discounts.  *TheCompany’s product sales are subject to returns, wholesaler allowances, rebates,and cash and contract discounts that are customary in the pharmaceuticalindustry. A large portion of the Company’s product sales are made topharmaceutical wholesalers for further distribution through pharmacies topatients, who are consumers of the product. All revenues from product sales arerecorded net of applicable allowances for sales returns, wholesaler allowances,rebates and cash and contract discounts. The Company determines provisions forsales returns, allowances, rebates and discounts based primarily on estimatesand contractual terms. In developing a reasonable estimate for the reserve forproduct returns, the Company considers the factors in paragraph 8 of Statementof Financial Accounting Standards No. 48, *Revenue RecognitionWhen a Right of Return Exists*. Although the Company has not yetdeveloped a significant history of product returns because of the recent launchof BiDil, the Company believes it has developed a reasonable estimate ofreturns. BiDil has characteristics that are similar to drugs for the broaderheart failure market, such as similar channels of distribution, similar shelflives and similar return rights. The Company has been able to verify throughdiscussions with other pharmaceutical firms that promote and sell other heartfailure drugs that the Company’s initial estimate of returns is reasonable inrelation to product launch and ongoing sales. The Company will continue tomonitor actual returns as the Company gains more sales experience with BiDil.

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*Product Returns*.   Consistentwith industry practice, the Company offers contractual return rights that allowcustomers to return product only during the period that is three months priorto, and twelve months after, product expiration. Commercial product shippedduring 2005 and the first half of 2006 had a shelf-life of twelve months fromdate of manufacture with expiration dates ranging from April 2006 to April2007. During the third quarter of 2006, the Company  began shipping commercial product with anexpiration date of 18 months. Factors that are considered in the Company’sestimate of future product returns include an analysis of the amount of productin the wholesaler and pharmacy channels, discussions with key wholesalers andother customers regarding inventory levels and shipment trends, review ofconsumer consumption data based on aggregate weekly prescription data derivedfrom Source Projected Launchtrac provided by Wolters Kluwer Health, returnrates for similar pharmaceutical products that are sold in the samedistribution channel, the remaining time to expiration of the Company’s productand the Company’s forecast of future sales of the product. At September 30,2006 and December 31, 2005, the Company’s product return reserve was $1,473,000and $98,000, respectively. This reserve is evaluated on a quarterly basis,assessing each of the factors described above, and adjusted accordingly. Basedon the factors noted above, among others, the Company believes its estimate ofproduct returns is reasonable, and changes, if any, from this estimate wouldnot have a material impact to the Company’s financial statements.

*Initial Trade Shipments Incentive*.   DuringJuly 2005, the Company offered certain product stocking incentives to anumber of wholesalers and pharmacy customers. These incentives included productwith guaranteed sales provisions and extended payment terms. As a result ofthese provisions, the Company concluded that these sales were essentiallyconsignment sales as the risk of loss of this product has not passed to thecustomer. Accordingly, the Company deferred all revenue related to this productuntil such time as the product is provided to a patient with a prescription andrecorded $1.2 million as deferred revenue at December 31, 2005. Through September 30,2006, the Company had either recognized the revenue related to this product, orthe product had been returned or estimated to be returned.

*Cash Incentives*.   During thethird quarter of 2005, the Company offered certain additional incentives to anumber of pharmacy customers. These cash incentives included placement andadvertising assistance in the amount of $328,000. The Company recorded thisamount as a reduction to revenue during the year ended December 31, 2005.No cash incentives were offered during the nine month period ended September 30,2006.

*Sample Voucher and Co-Pay Card Programs*.   Beginning inthe third quarter of 2005, the Company initiated a sample voucher programwhereby the Company offers an incentive to patients in the form of a free30-day trial, or approximately 100 tablets, of BiDil. The Company accounts forthis program in accordance with Emerging Issues Task Force Issue No. 01-09,*Accounting for Consideration Given by a Vendor to aCustomer*. These sample programs have historically had quarterlyexpiration dates such that each sample voucher program is only active for onequarter at a time. As a result, at the end of each quarter the Company candetermine the actual amount of reimbursement claims received for the vouchersdistributed during the quarter. The amount of reimbursement is recorded as areduction to revenue. During the third quarter 2006, the Company initiated a sixmonth sample program. As a result of these programs, the Company recorded areduction to revenue of $111,000 for the three month period ended September 30,2006 and $467,000 for the nine month period ended September 30, 2006. TheCompany expects to continue to offer sample voucher and co-pay incentives infuture periods.

*Sales Discounts, Rebates and Allowances*.   Salesdiscounts, rebates and contractual allowances result primarily from sales undercontract with healthcare providers, wholesalers, Medicare and Medicaid programsand other governmental agencies. The Company estimates rebates and contractualallowances, cash and contract discounts and other rebates by considering thefollowing factors: current contract prices, terms, sales volume, estimated customerand wholesaler inventory levels and current average rebate rates. For the threemonth period ended September 30, 2006, the Company recorded salesdiscounts, rebates and other allowances of $218,000. For the nine month periodended September 30, 2006, the Company recorded sales discounts, rebatesand other allowances of $774,000.

*Collaboration Revenue*.   The Companyrecords collaboration revenue on an accrual basis as it is earned and whenamounts are considered collectible. Revenues received in advance of performanceobligations, or in cases where the Company has a continuing obligation toperform services, are deferred and recognized over the contractual orestimated performance period. Revenues from milestone payments that representthe culmination of a separate earnings process are recorded when the milestoneis achieved. Contract revenues are recorded as the

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services are performed. When the Company is requiredto defer revenue, the period over which such revenue should be recognized issubject to estimates by management and may change over the course of thecollaborative agreement. The Company had no collaboration revenue for the threeand nine month periods ended September 30, 2006.

**(3)           AccountsReceivable**

Accounts receivable consists of amounts due fromwholesalers and pharmacies for the purchase of BiDil. Ongoing evaluations ofcustomers’ credit worthiness are performed and collateral is generally notrequired. As of September 30, 2006, the Company has not reserved anyamount for bad debts related to the sale of BiDil. The Company continuouslyreviews all customer accounts to determine if an allowance for uncollectibleaccounts is necessary. The Company currently provides substantially all of itscustomers with payment terms of up to 30 days on purchases of BiDil. Amountspast due from customers are determined based on contractual payment terms.Through September 30, 2006, payments have generally been made in a timelymanner.

**(4)           Inventories**

### Inventories are stated at thelower of cost or market, with cost determined on a first-in, first-out basis.Inventories consisted of the following (in thousands):

|                      | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials        |       | $                            | 2,150      |                        | $          | 2,599 |   |
| Finished goods       |       | 903                          |       | 481                         |       |
| Consigned  inventory |       | —                       |       | 167                         |       |
| Total                |       | $                            | 3,053      |                        | $          | 3,247 |   |

 

On a quarterly basis, theCompany analyzes its current inventory levels and future irrevocable inventorypurchase commitments and writes down inventory that has become un-saleable,inventory that has a cost basis in excess of its expected net realizable valueand future irrevocable inventory purchase commitments that are in excess ofexpected future product sales. Expired inventory is disposed of, and therelated costs are written off. For the three and nine  month periods ended September 30, 2006,the Company recorded inventory impairment charges of $0.8 million and $1.4million, respectively, to cost of product sales related to commercial trade andpatient sample inventory product in excess of expected future inventory requirementsbased on the Company’s current sales forecast. For the three and nine month periods ended September 30, 2005, theCompany recorded inventory impairment charges of $2.6 million.

 

###  **(5)****                              Stock-BasedCompensation**

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of Statement of Financial AccountingStandards No. 123(R),*Share-BasedPayment* (“SFAS 123R”),using the modified-prospective-transition method. Under this transition method,compensation cost recognized in 2006 includes (a) compensation cost forall stock-based payments granted, but not yet vested as of January 1,2006, based on the grant-date fair value estimated in accordance with theoriginal provisions of Statement of Financial Accounting Standards No. 123,*Accounting for Stock Based Compensation*(“SFAS 123”)*,* and (b) compensation cost for allstock-based payments granted subsequent to January 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of SFAS123R. Such amounts have been reduced by the Company’s estimate offorfeitures of all unvested awards. Results for prior periods have not beenrestated. For stock options granted to non-employees, the Company recognizescompensation expense in accordance with the requirements of Emerging IssuesTask Force No. 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services* (“EITF 96-18”). EITF96-18 requires that companies recognize compensation expense based on theestimated fair value of options granted to non-employees over their vestingperiod, which is generally the period during which services are rendered bysuch non-employees. The fair value of unvested non-employee stock awards isre-measured at each reporting period.

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*Stock Option Plans.*   The Company’sRestated 1993 Equity Incentive Plan (the “1993 Plan”), which expired inaccordance with its terms in 2003, provided for the grant of incentive stockoptions, nonstatutory stock options and restricted stock awards to purchase upto 2,288,200 shares of the Company’s common stock. Officers, employees,directors, consultants and advisors of the Company were eligible to receivegrants of options under the 1993 Plan at a price not less than 100% (or 110% inthe case of incentive stock options granted to 10% or greater stockholders) ofthe fair market value of the Company’s common stock, as determined by theCompany’s Board of Directors, at the time the option was granted. InMay 2003, the Company’s stockholders approved the 2003 Stock IncentivePlan (the “2003 Plan”), under which 800,000 shares of common stock wereauthorized for issuance. In October 2003, the stockholders of the Companyapproved an amended and restated 2003 Plan which provided, among other things,for an increase of shares authorized for issuance under the 2003 Plan to2,500,000. In May 2005, the stockholders of the Company approved anamendment to the 2003 Plan which provided for an increase of shares authorizedfor issuance under the 2003 Plan to 3,600,000, and the adoption of an “evergreen”provision that allows for an annual increase in the number of shares of theCompany’s common stock available for issuance under the 2003 Plan. Theevergreen provision provides for an annual increase to be added on the firstday of each fiscal year of the Company during the period beginning in fiscalyear 2006 and ending on the second day of fiscal year 2013, such increase to beequal to the lesser of (i) 1,400,000 shares of the Company’s common stock,(ii) 4% of the outstanding shares on that date or (iii) an amountdetermined by the Company’s Board of Directors. Pursuant to the evergreen provision, in January 2006 the shares ofcommon stock authorized for issuance under the 2003 Plan were increased by1,219,679 shares.

While the Company may grant options to employeesthat become exercisable at different times or within different periods, theCompany generally has granted options to employees that are exercisable inequal annual installments of 25% on each of the first four anniversary dates ofthe grant.

*Employee Stock Purchase Plan*   The Companyalso has an employee stock purchase plan (the “ESPP”) that allows eligibleemployees to purchase common stock at a price per share equal to 85% of thelower of the fair market value of the common stock at the beginning or end ofeach six month period during the term of the ESPP. In May 2006, thestockholders of the Company approved an amendment to the ESPP which providedfor an increase of shares available for issuance under the ESPP to 150,000, andthe adoption of an “evergreen” provision that allows for an annual increase inthe number of shares of the Company’s common stock available for issuance underthe ESPP.  The evergreen provisionprovides for an annual increase to be added on the first day of each fiscalyear of the Company during the period beginning in fiscal year 2007 and endingon the last day of fiscal year 2010, such increase to be equal to the lesser of(i) 150,000 shares of the Company’s common stock or (ii) a lesseramount determined by the Company’s Board of Directors.  Under Accounting Principles Board OpinionNo. 25, *Accounting for Stock Issued to Employees*(“APB25”)*,* which the Company applied to awardsunder the ESPP prior to January 1, 2006, the Company was not required torecognize stock-based compensation expense for the cost of stock options orshares issued under the ESPP. Upon adoption of SFAS 123R, the Company beganrecording stock-based compensation expense related to the ESPP. For the threeand nine month periods ended September 30, 2006, the Company recorded areversal of $17,000 and an expense of $78,000, respectively, in stock-basedcompensation expense related to the ESPP. At September 30, 2006, there were 144,875 shares available for grantunder the ESPP.

In connection with recording stock-based compensationrelated to non-employees, the Company recorded a reversal of $29,000 and $205,000for the three and nine months ended September 30, 2006, respectively.

As a result of adopting SFAS 123R on January 1, 2006,the Company’s net loss for the three and nine months ended September 30, 2006 was$1.9 million and $6.6 million, respectively, which is higher than if it hadcontinued to account for stock-based compensation under APB 25.  Basic and diluted loss per share for the threeand nine months ended September 30, 2006 was $0.05 and $0.18, respectively, whichis lower than if the Company had continued to account for stock-basedcompensation under APB 25.

The following table illustrates the effect on net lossand net loss per share had the Company applied the fair value recognitionprovisions of SFAS 123 for the three and nine month periods ended September 30,2005. For purposes of this pro-forma disclosure, the value of the options isestimated using the Black-Scholes option-pricing model and amortized toexpense over the options’ vesting periods.

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| **(in thousands, except per share amounts)**                        | ** ** | **Three Months  Ended  September 30, 2005** | ** ** | **Nine Months  Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net loss as  reported                                                                        |       | $                                                          | (32,072    | )                                                         | $          | (74,285 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                |       | 197                                                        |       | 498                                                       |       |
| Deduct:  Stock-based employee compensation expense determined under fair value based  method |       | (1,729                                                     | )          | (4,359                                                    | )          |
| Pro forma net loss                                                                           |       | $                                                          | (33,604    | )                                                         | $          | (78,146 | ) |
|                                                                                         |       |                                                       |       |                                                      |       |
| Basic and  diluted net loss per share                                                        |       |                                                       |       |                                                      |       |
| As reported                                                                                  |       | $                                                          | (1.05      | )                                                         | $          | (2.45 | ) |
| Pro forma                                                                                    |       | $                                                          | (1.10      | )                                                         | $          | (2.58 | ) |

 

Thefair value of each stock award is estimated on the grant date using theBlack-Scholes option-pricing model based on the assumptions noted in thefollowing table:

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Volatility               |       | 76                                                   | %          | 73                                                  | %          | 76 | % | 73 | % |
| Risk-free  interest rate |       | 4.8                                                  | %          | 4.0                                                 | %          | 4.7 | % | 3.9 | % |
| Expected life  (years)   |       | 5.0                                                  |       | 6.0                                                 |       | 5.8 |   | 6.0 |   |
| Dividend                 |       | None                                                 |       | None                                                |       | None |   | None |   |

 

Volatility is determined exclusively using historicalvolatility data of the Company’s common stock based on the period of time sincethe Company’s common stock has been publicly traded. The risk-free interestrate is based on the U.S. Treasury yield curve in effect at the time ofgrant commensurate with the expected life assumption. The expected life ofstock options granted is based exclusively on historical data and representsthe weighted average period of time that stock options granted are expected tobe outstanding. The expected life is applied to the stock option grant group asa whole, as the Company does not expect substantially different exercise orpost-vesting termination behavior amongst its employee population.

The Company is using the straight-line attributionmethod to recognize stock-based compensation expense. The amount of stock-basedcompensation expense recognized during a period is based on the value of theportion of the awards that are ultimately expected to vest. SFAS 123R requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. The term“forfeitures” is distinct from “cancellations” or “expirations” and representsonly the unvested portion of the surrendered option. The Company has applied anannual forfeiture rate of 5.5% to all unvested options as of September 30,2006. This analysis will be re-evaluated quarterly and the forfeiture rate willbe adjusted as necessary. Ultimately, the actual expense recognized over thevesting period will only be for those options that vest.

Using the Black-Scholes option-pricing model, theweighted average grant date fair values of options granted during the threemonths ended September 30, 2006 and 2005 were $1.85 and $13.39,respectively, and $4.83 and $10.99 for options granted during the nine monthsended September 30, 2006 and 2005, respectively. For the three months ended September30, 2005, the Company granted options to purchase 110,000 shares of theCompany’s common stock with a weighted average exercise price of $19.96. Forthe nine months ended September 30, 2005, the Company granted options topurchase 914,525 shares of the Company’s common stock with a weighted averageexercise price of $16.32.

A summary of option activity under the Company’s 2003Plan as of September 30, 2006, and changes during the nine month periodthen ended is presented below (in thousands, except weighted average data):

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| ** **                              | ** ** | **Options  Outstanding** | ** ** | **Weighted   Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contracted Term  in Years** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------|------------|
|                                    |       |                     |       |                                             |       |                                                                 |       |                            |       |
| Outstanding at  December 31, 2005  |       | 3,820                    |       | $                                                | 9.39       |                                                                 |       |                            |       |   |
| Granted                                 |       | 3,019                    |       | $                                                | 7.86       |                                                                 |       |                            |       |   |
| Exercised                               |       | (445                     | )          | $                                                | 1.49       |                                                                 |       |                            |       |   |
| Forfeited/Cancelled                     |       | (1,643                   | )          | $                                                | 12.61      |                                                                 |       |                            |       |   |
| Outstanding at  September 30, 2006 |       | 4,751                    |       | $                                                | 8.04       |                                                                 | 7.05       |                            | $          | 1,551 |   |
| Exercisable at  September 30, 2006 |       | 1,938                    |       | $                                                | 6.49       |                                                                 | 6.02       |                            | $          | 1,280 |   |

 

During the three and nine months ended September 30,2006, the total intrinsic value of options exercised (i.e., the differencebetween the market price at exercise and the price paid by the employee toexercise the options) was $40,500 and $1.9 million, respectively, and the totalamount of cash received from exercise of these options was $56,000 and $661,000,respectively. The total grant-date fair value of stock options that vestedduring the three and nine months ended September 30, 2006 wasapproximately $1.3 million and $2.4 million, respectively.

As of September 30, 2006, there was $13.8 millionof total unrecognized compensation cost related to unvested share based awards.This cost is expected to be recognized over a weighted average period of 1.4years. The Company expects approximately 3,794,000 in unvested options to vestat some point in the future. Options expected to vest are calculated byapplying an estimated forfeiture rate to the unvested options.

**(6)**                                 Restructuring

On March 31, 2006, the Company recorded chargesof $2.0 million related to a restructuring of its discovery research operationsthat was intended to better align costs with revenue and operatingexpectations. The restructuring charges pertained to employee severance andimpairment of assets and were recorded in accordance with Statement ofFinancial Accounting Standards No. 146,*Accounting for Costs Associated with Exit or Disposal Activities,*and Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets.*

In connection with the restructuring plan, the Companyterminated 30 employees in its discovery research group, or approximately 30%of the Company’s workforce, resulting in a charge of $1.4 million, which wasaccrued as of March 31, 2006. None of these employees remained employed asof March 31, 2006.

As a result of terminating these employees, theCompany recorded an impairment charge for certain research laboratoryequipment, computer equipment, and furniture and fixtures aggregating $597,000,for which the future use is currently uncertain. These assets were written downto their fair value utilizing a third party appraiser to estimate the fairvalue of the assets based on current market quotes and the current condition ofthe equipment, furniture and fixtures.

The following tablesummarizes the restructuring activity as of September 30, 2006 as part of therestructuring plan:
| ** **         | ** ** | **Balance at   March 31, 2006** | ** ** | **Cash  Payments** | ** ** | **Balance at  September 30, 2006** | ** ** |
|--------------------|------------|-----------------------------------------------------|------------|--------------------|------------|---------------------------------------------------|------------|
|               |       |                                                |       |               |       |                                              |       |
| Severance payments |       | $                                                   | 1,441,000  |               | $          | (1,091,000                                        | )          | $ | 350,000 |   |
|                    |            |                                                     |            |                    |            |                                                   |            |  |  |  |

 

**(7)**                                 Accumulated OtherComprehensive Loss

The Company presentscomprehensive loss in accordance with Statement ofFinancial Accounting Standards No. 130, *Reporting Comprehensive Income*. Accumulated other comprehensive income iscomprised entirely of unrealized gains and losses on available-for-salemarketable securities. For the three months ended September 30, 2006 and2005, total comprehensive loss equaled $16,514,000 and $31,999,000respectively.  For the nine months endedSeptember 30, 2006 and 2005, total comprehensive loss equaled $60,671,000and $74,133,000 respectively.

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**(8)****           Sale of CommonStock**

On January 25, 2006, the Company completed adirect offering of shares of the Company’s common stock previously registeredunder an effective shelf registration statement. Pursuant to this offering, theCompany sold approximately 6.1 million shares of the Company’s common stock toselected institutional investors at a price of $10.25 per share. Proceeds tothe Company from this registered direct offering, net of offering expenses andplacement agency fees, totaled $58.5 million.

### ** (9)****                              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 are the same.

### As of September 30, 2006and 2005, options to purchase 4,751,368 and 3,811,615 shares of common stock,respectively, and warrants to purchase -0- and 1,319 shares of common stock,respectively, were not included in the computation of diluted net loss pershare since their inclusion would be antidilutive.

### **(10)****                          SingleSource Suppliers**

### The Company currently obtainsone of the key active pharmaceutical ingredients for its commercialrequirements for BiDil from a single source. The Company also relies on theservices of one manufacturing source to produce BiDil. The disruption ortermination of the supply of the commercial requirement for BiDil or asignificant increase in the cost of the key active pharmaceutical ingredientfrom this single source, or the disruption or termination of the manufacturingsource, could have a material adverse effect on the Company’s business,financial position and results of operations.

### **(11)****                          Concentrationof Credit Risk**

Statement of Financial Accounting StandardsNo. 105, *Disclosure of Information about FinancialInstruments with Off-Balance-Sheet Risk and Financial Instruments withConcentrations of Credit Risk*, requires disclosure of anysignificant off-balance-sheet and credit risk concentrations. The Company hasno off-balance-sheet or concentrations of credit risk such as foreign exchangecontracts, options contracts or other foreign hedging arrangements. The Companymaintains its cash and cash equivalents and investment balances with severalnonaffiliated institutions.

Thefollowing table summarizes the number of trade customers that individuallycomprise greater than 10% of total revenues and their respective percentage ofthe Company’s total revenues:

 
| ** **                             | ** ** | **Number of  Significant** | ** ** | **Percentage of Total Revenues by Customer** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Customers**                   | ** ** | **A**                                                                 | ** ** | **B** | ** ** | **C** | ** ** |
|                                   |       |                            |       |                                                                  |       |   |   |   |   |
| Three months  ended September 30, 2006 |       | 3                               |       | 39                                                                    | %          | 33 | % | 16 | % |
| Three months  ended September 30, 2005 |       | 2                               |       | 16                                                                    | %          | 26 | % | — | % |
| Nine months  ended September 30, 2006  |       | 3                               |       | 35                                                                    | %          | 33 | % | 18 | % |
| Nine months ended  September 30, 2005  |       | 2                               |       | 11                                                                    | %          | 52 | % | — | % |

 

Thefollowing table summarizes the number of customers that individually comprisegreater than 10% of total accounts receivable and their respective percentageof the Company’s total accounts receivable:

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|                          | ** ** | **Number of  Significant** | ** ** | **Percentage of Total Accounts Receivable  by Customer** | ** ** |
|--------------------------|------------|---------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **Customers**                   | ** ** | **A**                                                                             | ** ** | **B** | ** ** | **C** | ** ** |
| As of:                   |       |                            |       |                                                                              |       |   |   |   |   |
| September 30,  2006 |       | 3                               |       | 36                                                                                | %          | 39 | % | 15 | % |
| December 31, 2005   |       | 2                               |       | 59                                                                                | %          | 21 | % | — | % |

 

Todate, the Company has not written off any significant accounts receivable.

 

### **(12)****                          LongTerm Debt**

OnJune 28, 2005, the Company borrowed (i) $10.0 million from Oxford FinanceCorporation (“Oxford”), and (ii) $10.0 million from General ElectricCapital Corporation (“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,beginning on July 1, 2005. Also on June 28, 2005, the Companyentered into Master Security Agreements with both Oxford and GECC (the “Agreements”). Underthe terms of these Agreements, the Company granted to both Oxford and GECC asecurity interest in and against all of the property of the Company and in andagainst all additions, attachments, accessories and accessions to suchproperty, all substitutions, replacements or exchanges, and all insurance and/orother proceeds (the “Collateral”). The Collateral comprises all of theCompany’s personal property and fixtures including, but not limited to, allinventory, equipment, fixtures, accounts, deposit accounts, documents,investment property, instruments, general intangibles, chattel paper and anyand all proceeds (but excluding intellectual property). The Collateraldoes not include any intellectual property or products (or interests in anyintellectual property or products (including any royalties)) acquired, whetherby purchase, license or otherwise, on or after the execution of the Agreements(collectively, “New Property”), nor do the Agreements limit any indebtednesssecured by any New Property provided that debt or non-cash equity (e.g.,stock) is used to acquire New Property. In the event that theCompany uses cash to purchase New Property, Oxford’s and GECC’s existingliens will extend to such New Property. The Agreements also contain amaterial adverse change clause with both Oxford and GECC. Under this clause, ifOxford or GECC reasonably determines that the Company’s ability to repay theNotes has been materially impaired, the Company would be considered in default.As of September 30, 2006, theCompany was in compliance with this clause.

### **(13)****                          Commitmentsand Contingencies**

In connection with the Company’s efforts to obtain theapproval of BiDil from the FDA, the Company contracted with the law firm ofFoxKiser LLC (“FoxKiser”) for services related to the regulatory approvalprocess for BiDil. The agreement provided for payment of legal consulting feesupon receipt of written FDA approval of BiDil. On June 23, 2005, theCompany received written FDA approval of BiDil, and in July 2005 theCompany paid FoxKiser $2.4 million pursuant to the terms of this agreement. Inaddition, the agreement requires the Company to pay royalties to FoxKiser oncommercial sales of BiDil. The royalty term ends six months after the date ofmarket introduction of an FDA-approved generic version of BiDil. During thethird quarter of 2005, the Company entered into a separate consulting agreementwith FoxKiser following the approval by the FDA of BiDil, which ceased to beeffective in the third quarter of 2006. During the three month periods endedSeptember 30, 2006 and 2005, the Company recorded charges of $0.2 and $0.3million, respectively, pertaining to the legal consulting fees related to theseagreements. During the three month periods ended September 30, 2006 and2005, the Company also paid royalties to FoxKiser in the amounts of $0.1 millionand $-0-, respectively. During the nine month periods ended September 30,2006 and 2005, the Company recorded charges of $0.9 million and $0.9 million,respectively, pertaining to the legal consulting fees related to theseagreements.  During the nine monthperiods ended September 30, 2006 and 2005, the Company also paid royaltiesto FoxKiser in the amounts of $0.3 million and $-0-, respectively.  

In November 2004, as amended in May 2005,the Company executed an agreement with Publicis Selling Solutions, Inc.(“Publicis”), a contract sales organization, pursuant to which, on theCompany’s behalf, Publicis employed and trained a specialty sales forceconsisting of approximately 142 sales representatives to sell BiDil to theCompany’s target prescriber markets. The Company recorded costs in 2005 of$29.8 million, excluding one-time start-up costs, and project costs.  The Company transitioned the Publicis salesforce internally to NitroMed in May 2006 and paid a liquidated damages fee of$500,000 and a sales force transition fee of $348,000 in the second quarter of2006. As a result of the sales force transition, the Company no longer has asignificant contractual 

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commitment with Publicis.

In February 2005, the Company engaged Schwarz PharmaManufacturing, Inc. under a five-year exclusive manufacturing and supplyagreement solely for the three times daily immediate release dosage formulationof BiDil. Under the supply agreement, the Company has the right to engage abackup manufacturer, but to date has not elected to use this right. Inconnection with this supply agreement, the Company placed a binding purchaseorder of $648,000 for production of BiDil finished goods to occur during thefourth quarter of 2006. 

### **(14)****                          SubsequentEvent**

On October 10, 2006, the Company initiated arestructuring program that included the elimination and replacement of theCompany’s existing sales force with a small team of highly experienced seniorcardiovascular specialists, resulting in a net reduction of approximately 120in sales force headcount.  In addition,the Company also eliminated approximately 20% of its general and administrativepersonnel in connection with this restructuring program.  The Company’s restructured sales force isexpected to be comprised initially of a director of managed care, six accountexecutives, two area business directors and twenty-one cardiovascular businessmanagers.  The Company expects to recordcharges of approximately $3.0 million related to this restructuring in thefourth quarter of 2006.  The Companyestimates that its operating expenses will be reduced on an annualized basis byapproximately $30 million as a result of this restructuring.   

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**Item 2.****           Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

**Overview**

We are an emerging pharmaceutical company withsubstantial expertise and intellectual property in nitric oxide-based drug development.We have devoted substantially all of our efforts towards the research anddevelopment of our product candidates and the commercialization of ourcurrently marketed product, BiDil®. Since our inception, we have mainlyfunded our operations through the sale of equity securities, debt financings,license fees, research and development funding, milestone payments fromcollaborative partners and, more recently, sales of BiDil. We have never beenprofitable and have incurred an accumulated deficit of $303.2 million as of September30, 2006.

In June 2005, the U.S. Food and Drug Administration, or FDA,approved our product, BiDil, for the treatment of heart failure inself-identified black patients as an adjunct to current standard therapies.BiDil is an orally administered fixed-dose combination of isosorbide dinitrateand hydralazine hydrochloride. We commercially launched BiDil inJuly 2005. We have engaged Schwarz Pharma Manufacturing, Inc., or SchwarzPharma, under a five-year exclusive manufacturing and supply agreementexclusively for the three times daily immediate release dosage formulation ofBiDil.

On October 10, 2006, we implemented arevised strategy and business model in a move intended to focus our resourceson the accelerated development of an extended release formulation of BiDil,known as BiDil XRTM. As part of this strategic shift, we eliminated our currentsales force and replaced it with a small team of highlyexperienced senior cardiovascular specialists, resulting in a net reduction ofapproximately 120 in sales force headcount. In addition, we also eliminated approximately 20% of our general andadministrative personnel in connection with this restructuring program.  Our restructured sales force is expected tobe comprised initially of a director of managed care, six account executives,two area business directors and twenty-one cardiovascular business managers.  Our sales and markingorganization will continue to be managed by our senior vice president of salesand our vice president of marketing.  This highlyspecialized team is currently being assembled and will focus on regional andnational thought-leader physicians and current BiDil prescribers, as well askey institutions in major metropolitan centers that treat, and influence thetreatment of, large numbers of African-Americans diagnosed with heartfailure.  Additional marketing methodswill be utilized to reach the broader number of existing and potential BiDilprescribers.  We expect that thisalternative strategy will employ a less costly approach to marketing thecurrent immediate release formulation of BiDil during BiDil XR's planneddevelopment. Furthermore, we believe this revised strategy will allow us toconserve the cash required to seek to accelerate development efforts withrespect to BiDil XR while refocusing the market presence of the current BiDilformulation. Preclinical outcomes with BiDil XR have been positive, and we arecurrently commencing clinical development of BiDil XR.  Our current plan for seeking regulatoryapproval for BiDil XR, that will include our conduct of bioequivalence studies,if successful and accepted as part of the basis for approval, is expected toenable us to achieve an accelerated development timeline.  We expect to provide further updates on theclinical timeline and regulatory pathway for BiDil XR after preliminaryclinical data have been assessed.

In the near term, a key driver of our success will beour ability to successfully commercialize and sustain market penetration ofBiDil with our restructured and smaller specialty sales force and to acceleratethe development of, and obtain regulatory approval for, the commercial sale ofBiDil XR.  Since we commercially launchedBiDil in July 2005, we have generated approximately $13.0 million in productsales, including product sales of $3.4 million during the third quarter of2006. We will need to generate significant revenues from sales of BiDil and, ifapproved, BiDil XR, to achieve profitability. At the present time, we areunable to estimate the level of revenues that we will realize from the sales ofBiDil or, if approved, BiDil XR.  We aretherefore unable to estimate when we will achieve profitability, if at all.

We have also applied our nitric oxide technology todevelop novel pharmaceuticals, as well as safer and more effective versions ofexisting drugs, and to target significant diseases that are characterized by adeficiency in nitric oxide. In connection with our restructuring inMarch 2006, we terminated substantially all of the employees in ourdiscovery research group, resulting in a severance benefit charge of $1.4million, and determined to limit our 

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future internal development activities to thecontinued development of BiDil XR, as well as efforts to out-license our nitricoxide-enhancing technology in exchange for potential milestone payments androyalties on sales.  As a result of the March2006 restructuring, we recorded an impairment charge of $0.6 million related tocertain research laboratory equipment, computer equipment and furniture andfixtures.

We expect that research, development andcommercialization expenses will continue at the current third quarter level forthe remainder of 2006 and will decline in 2007, due primarily to a decrease inresearch and commercialization expenses as a result of our restructurings in Marchand October 2006, partially offset by an increase in ongoing developmentexpenses with respect to our product candidates, particularly BiDil XR. As aresult of our October 2006 restructuring and expense controls that have been inplace during the 2006 fiscal year, we now estimate that our operating expensesfor the year ending December 31, 2006, including restructuring charges andexpenses related to our adoption of Statement of Financial Accounting StandardsNo. 123(R), will be in the range of $85 million to $95 million, excluding costof product sales. We expect to record charges of approximately$3.0 million related to our October 2006 restructuring in the fourthquarter of 2006.  In addition, weestimate that our operating expenses will be reduced on an annualized basis byapproximately $30 million as a result of our October 2006 restructuring. AtSeptember 30, 2006, our principal source of liquidity was $54.6 million ofcash and cash equivalents and marketable securities. We believe that ourexisting sources of liquidity and cash expected to be generated from futureoperations will be sufficient to fund our current business plan forapproximately the next twelve months.

**FinancialOperations Overview**

*Revenue.  *Ourfirst commercial product, BiDil, was launched in July 2005. Prior to thelaunch of BiDil, all of our revenue had been derived from license fees,research and development payments and milestone payments that we received fromour corporate collaborators. In future years, we will seek to generate revenuefrom sales of BiDil, and, if approved, BiDil XR, as well as milestone androyalty payments resulting from the out-licensing of our intellectual property.We currently have no active collaborative agreements and generated no revenuefrom collaborative agreements for the nine month period ending September 30,2006.

*Research and Development.  *Researchand development expense consists of expenses incurred in identifying,developing and testing product candidates. These expenses consist primarily ofsalaries and related expenses for personnel, fees paid to professional serviceproviders for independent monitoring and analysis of our clinical trials, costsof contract research and manufacturing, costs of facilities and BiDil medicalsupport costs. As a result of our restructuring in March 2006, weterminated substantially all of the employees in our discovery research groupand determined to limit our future internal development activities to thecontinued development of BiDil XR. We also intend to seek out-licensing and collaboration arrangements for ourportfolio of pre-clinical nitric oxide-enhancing technologies, includingNMI-3377, a late-stage pre-clinical cardio-renal compound.

The following summarizes our primary research anddevelopment programs. Exceptas provided below, we have not provided cumulative program costs to datebecause prior to 2000 we did not track and accumulate cost information byresearch program.

·               *BiDil.*   From May 2001 to July 2004,we enrolled 1,050 patients at 169 clinical sites in the United States in ourphase III clinical trial for BiDil. The trial was halted in July 2004 basedon the unanimous recommendation of the independent data and safety monitoringboard and steering committee due to a significant survival benefit in thepreliminary data for patients taking BiDil. The FDA approved BiDil onJune 23, 2005, and we launched BiDil in July 2005. The total cost forthe BiDil African American Heart Failure Trial was approximately $43.0 million.

·               *BiDil XR*.   Thecurrent formulation of BiDil is an immediate-release tablet that must be takenthree times daily. We are currently pursuing the development of BiDil XR, anextended release formulation of BiDil, that could be taken once a day. Todate, we have incurred approximately $4.3 million in connection with thedevelopment of BiDil XR. Preclinical outcomes with BiDil XR have been positive, andwe are currently commencing clinical development of BiDil XR.Because of its stage of development, and the uncertainties inherent inpharmaceutical development generally, we may not be able to successfullydevelop and commercialize BiDil XR. Moreover, we cannot reasonably estimate orknow the nature, timing and estimated costs of the efforts necessary tocomplete the development of, or the period in which material cash inflows areexpected to commence, if at all, for BiDil XR.

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·               *NitricOxide-Enhancing**Cardiovascular Compounds*.   Wehave utilized our nitric oxide expertise and proprietary position to develop aproprietary nitric oxide-enhancing cardio-renal compound, referred to asNMI-3377. This product is currently in pre-clinical development. We haveretained all commercial rights to this product candidate and are currentlyseeking out-licensing and collaboration opportunities for this compound.Currently, we do not intend to incur additional internal research anddevelopment expenses related to NMI-3377. Because this compound is inpre-clinical development, the successful development of this product candidateis highly uncertain. In addition, we cannot be certain if we will be able tosecure an out-licensing or collaboration partner for this compound on favorableterms, if at all. As such, we are not able to estimate when material cashinflows from product sales, milestones and royalties could commence, if at all.

·               *OtherDiscovery Research*.   We have used our know-how and expertise innitric oxide to develop drug candidates that are nitric oxide-enhancingversions of existing medicines in the areas of cardiovascular,gastrointestinal/anti-inflammatory and pulmonary medicine. These studies are ata pre-clinical stage of testing, and it remains speculative whether theaddition of nitric oxide will result in an improved clinical profile of thesemedicines. We are currently seeking out-licensing and collaborationopportunities for these product candidates, and are not presently engaging inany internal research and development activities with respect to these drugs.We cannot be certain if we will be able to secure out-licensing orcollaboration partners for these product candidates on favorable terms, if atall. As such, we are not able to estimate when material cash inflows fromproduct sales, milestones and royalties could commence, if ever.

·               *NitricOxide Stents.*   Weformerly had a research agreement with Boston Scientific Corporation, or BostonScientific, to develop cardiovascular stents enhanced with a bio-compatiblepolymer that is capable of releasing nitric oxide. In accordance with the termsof our agreement with Boston Scientific, the research term expired inDecember 2005. See “— Boston Scientific Collaboration” below.  The research program under this agreementfocused on pre-clinical development. We intend to seek out-licensing andcollaboration opportunities for these product candidates, subject to the termsof our agreement with Boston Scientific and pending resolution of the ongoingrights of the parties with respect to this technology. We cannot be certain ifwe will be able to secure out-licensing or collaboration partners for theseproduct candidates on favorable terms, if at all. Significant additionalexpenditures will be required to conduct pre-clinical testing and to apply for,and conduct, clinical trials. We are not presently engaging in any internalresearch and development activities with respect to cardiovascular stents. Becausethis program is in pre-clinical development, the successful development ofproducts based upon this program is highly uncertain. As such, we are unable toestimate when material cash inflows from milestones and royalties couldcommence, if at all.

*Sales, General and Administrative.*   Sales, general and administrativeexpense consists primarily of salaries and other related costs for personnel insales and marketing, executive, finance, investor relations, accounting,business development and human resource functions. Other costs include facilitycosts not otherwise included in research and development expense; costs forpublic relations, advertising and promotional services; professional fees forlegal and accounting services; and costs related to our third party contractsales agreement with Publicis Selling Solutions, Inc., or Publicis.

*Non-Operating Income.  *Interestincome includes interest earned on our cash, cash equivalents and marketablesecurities, and interest expense associated with our long-term debt.

*BostonScientific Collaboration.*   In November 2001,we entered into a research, development and license agreement with BostonScientific in the field of restenosis. The research term of the BostonScientific agreement expired on December 31, 2005, although certain rightsextend beyond this term. In accordance with the terms of the agreement, we grantedBoston Scientific an exclusive worldwide license to develop and commercializenitric oxide-enhancing cardiovascular stents based on certain of ourtechnologies. We also granted to Boston Scientific a right of first refusal toobtain an exclusive license under our nitric oxide technologies tocommercialize products for restenosis, which right of first refusal is for aperiod of three years after the end of the research term. InDecember 2003, we agreed to extend the agreement to continue the researchand development collaboration through December 2005. Boston Scientificmade an up-front license payment of $1.5 million to us in 2001, and madean 

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additionalpayment of $3.0 million in December 2003 in connection with theextension of the research and development collaboration. Boston Scientific alsomade a $3.5 million equity investment in our stock in 2001. InAugust 2003, in connection with a private placement, Boston Scientificmade an additional $500,000 equity investment in our stock.

**Results of Operations**

***Three Months Ended September 30, 2006 and 2005***

*Revenue.  *Totalrevenue for the three months ended September 30, 2006 was $3.4 millioncompared to $1.5 million for the three months ended September 30, 2005.Product sales of BiDil accounted for all of the $3.4 million of revenue for thethree month period ended September 30, 2006. We had no research and developmentrevenue for the three month period ended September 30, 2006 due to thetermination of the Boston Scientific agreement in December 2005, comparedto $0.4 million of research and development revenue related to the BostonScientific agreement for the three month period ended September 30, 2005.

*Cost of Product Sale*s.   Costof product sales was $1.3 million for the three month period ended September 30,2006 compared to $2.9 million for the three months ended September 30,2005. Cost of product sales for the three month period ended September 30,2006 included an impairment charge of commercial trade product and patientsample inventory of $0.8 million. Cost of product sales for the three monthperiod ended September 30, 2005 included an impairment charge ofcommercial trade product and patient sample inventory of $2.6 million. 

*Stock-based Compensation Expense.  *OnJanuary 1, 2006, we adopted Statement of Financial Accounting StandardsNo. 123(R),*Share-Based Payment,*or SFAS 123R, using the modified prospective application method. Compensationcost is calculated on the date of grant using the fair value of the options as calculatedby the Black-Scholes valuation model and is recognized ratably over theemployee’s service period.

Prior to the adoption of SFAS 123R, we accounted forshare-based payments to employees using the intrinsic value method of AccountingPrinciples Board Opinion No. 25,*Accounting for Stock Issued to Employees*, or APB 25.  Under APB 25 we generally recognized nocompensation cost for employee stock options. The adoption of SFAS 123R underthe modified prospective application method allowed us to recognizecompensation cost beginning with the effective date of January 1, 2006 based on(a) the requirements of SFAS 123R for all share-based payments granted afterthe effective date and (b) the requirements of Statement of FinancialAccounting Standards No. 123, *Accounting for Stock BasedCompensation*, or SFAS 123, for all awards granted to employees priorto the effective date of SFAS 123R that remain unvested on the effective date.Under the modified prospective application method, prior periods are notrestated for the effect of SFAS 123R.

As a result of adopting SFAS 123R on January 1,2006, we recognized $1.9 million in stock-based compensation expense for thethree months ended September 30, 2006.

*Research and Development.  *Researchand development expense for the three months ended September 30, 2006 was$4.4 million compared to $7.4 million for the three months ended September 30,2005. The $3.0 million, or 41%, decrease in research and development expensesin the current period was primarily due to decreases in medical expendituressupporting the commercial launch of BiDil, the completion of the extendedAfrican American Heart Failure Trial, or X-A-HeFT, in December 2005, and areduction in salary and benefits costs for the discovery research workforce asa result of the March 2006 restructuring, offset partially by increases instock-based compensation expense related to SFAS 123R.

The following table summarizes the primary componentsof our research and development expense for our principal research anddevelopment programs for the three month periods ended September 30, 2006and September 30, 2005:

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|                                                  | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| **Research  and Development Program**            | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| BiDil                                            |       | $                                                    | 2.8        |   | $ | 3.8 |   |
| BiDil XR                                         |       | 0.9                                                  |       | — |   |
| Nitric  oxide-enhancing cardiovascular compounds |       | 0.4                                                  |       | 1.6 |   |
| Other discovery research                         |       | 0.3                                                  |       | 1.5 |   |
| Nitric oxide  enhanced stents                    |       | —                                               |       | 0.5 |   |
|                                             |       |                                                 |       |   |   |
| Total research and  development expense          |       | $                                                    | 4.4        |   | $ | 7.4 |   |

* *

*Sales, General and Administrative.*Sales,general and administrative expense for the three months ended September 30,2006 was $14.7 million compared to $23.6 million for the three months ended September 30,2005. The $8.9 million, or 38%, decrease in sales, general and administrativeexpense was primarily due to a decrease in sales and marketing expenses relatedto the commercialization of BiDil, including costs related to the contractsales force agreement with Publicis, offset by an increase in stock-basedcompensation expenses related to our adoption of SFAS 123R.

*Non-Operating Income.*Non-operatingincome for the three months ended September 30, 2006 was $459,000 comparedto $297,000 for the three months ended September 30, 2005. The $162,000,or 55%, increase was primarily due to a decrease in interest expense as aresult of paying down our outstanding debt.

***Nine Months Ended September 30, 2006 and 2005***

*Revenue.*Totalrevenue for the nine months ended September 30, 2006 was $8.6 millioncompared to $2.3 million for the nine months ended September 30, 2005. Productsales of BiDil accounted for all of the $8.6 million of revenue for the ninemonth period ended September 30, 2006. We had no research and developmentrevenue for the nine month period ended September 30, 2006 due to thetermination of the Boston Scientific agreement in December 2005, comparedto $1.2 million of research and development revenue related to the BostonScientific agreement for the nine month period ended September 30, 2005.

*Cost of Product Sale*s. Cost ofproduct sales was $2.8 million for the nine month period ended September 30,2006 compared to $2.9 million for the nine months ended September 30,2005. Cost of product sales for the nine month period ended September 30,2006 included an impairment charge of commercial trade product and patientsample inventory of $1.4 million. Cost of product sales for the nine monthperiod ended September 30, 2005 included an impairment charge ofcommercial trade product and patient sample inventory of $2.6 million.

*Stock-based Compensation Expense.*Asa result of adopting SFAS 123R on January 1, 2006, we recognized $6.6million in stock-based compensation expense for the nine months ended September 30,2006. As of September 30, 2006, the total unrecognized compensation costrelated to unvested awards was approximately $13.8 million, which will berecognized over a weighted average period of 1.4 years.

*Research and Development.*Researchand development expense for the nine months ended September 30, 2006 was $15.2million compared to $23.4 million for the nine months ended September 30,2005. The $8.2 million, or 35%, decrease in research and development expensesin the current period was primarily due to decreases in medical expenditures insupport of the commercial launch of BiDil, the completion of X-A-HeFT inDecember 2005, and a reduction in salary and benefits costs for the discoveryresearch workforce as a result of the March 2006 restructuring, offsetpartially by increases in stock-based compensation expense related to SFAS123R.

The following tablesummarizes the primary components of our research and development expense forour principal research and development programs for the nine month periodsended September 30, 2006 and 2005:****

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|                                                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Research  and Development Program**            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| BiDil                                            |       | $                                                   | 8.3        |   | $ | 14.4 |   |
| BiDil XR                                         |       | 2.1                                                 |       | — |   |
| Nitric  oxide-enhancing cardiovascular compounds |       | 2.7                                                 |       | 4.3 |   |
| Other discovery research                         |       | 1.9                                                 |       | 3.2 |   |
| Nitric oxide  enhanced stents                    |       | 0.2                                                 |       | 1.5 |   |
|                                             |       |                                                |       |   |   |
| Total research and  development expense          |       | $                                                   | 15.2       |   | $ | 23.4 |   |

 

*Sales, General and Administrative.*Sales,general and administrative expense for the nine months ended September 30,2006 was $50.8 million compared to $52.2 million for the nine months ended September 30,2005. The $1.4 million, or 3%, decrease in sales, general and administrativeexpense was primarily due to decreases in sales and marketing expenses relatedto the commercialization of BiDil, including costs related to the contractsales force agreement with Publicis, partially offset by an increase instock-based compensation expenses related to our adoption of SFAS 123R.

*Restructuring Charge.*  On March 31, 2006, we recorded chargesof $2.1 million for a restructuring of our discovery research operations thatwas intended to better align costs with revenue and operating expectations. Therestructuring charges pertained to employee severance and impairment of assets.The restructuring charges were recorded in accordance with Statement ofFinancial Accounting Standards No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*, and Statementof Financial Accounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets.*

In connection with the restructuring plan, weterminated 30 employees from our discovery research group, or approximately 30%of our workforce, resulting in a charge of $1.4 million, which was accrued asof March 31, 2006. None of these employees remained employed as ofMarch 31, 2006. At September 30, 2006, we have $350,000 remaining to bepaid to these employees.

As a result of terminating these employees, werecorded an impairment charge for certain research laboratory equipment, computerequipment and furniture and fixtures aggregating $597,000, for which the futureuse is currently uncertain. These assets were written down to their fair valueutilizing a third party appraiser to estimate the fair value of assets based oncurrent market quotes and the current condition of the equipment, furniture andfixtures.

*Non-Operating Income.*Non-operatingincome for the nine months ended September 30, 2006 was $1.5 millioncompared to $1.8 million for the nine months ended September 30, 2005. The$0.3 million, or 17%, decrease in non-operating income was due to increased interestexpense incurred on long-term debt for the nine months ended September 30,2006, offset partially by higher fund balances available for investment as aresult of the closing of our registered direct offering of common stock inJanuary 2006.

**Liquidity and CapitalResources**

Since our inception, we have primarily funded ouroperations through the sale of equity securities, debt financings, licensefees, research and development funding, milestone payments from ourcollaborative partners and, more recently, sales of BiDil. As of September 30,2006, we have received net proceeds of $322.6 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, net proceeds of $81.8million from our follow-on public offering in December 2004, and netproceeds of $58.5 million from our registered direct offering inJanuary 2006. At September 30, 2006, we had $54.6 million in cash,cash equivalents and marketable securities.

During the nine months ended September 30, 2006,operating activities used cash of $61.7 million, primarily due to a net loss of$60.7 million, decreases in deferred revenue of $2.0 million, and decreasesin accounts payable and accrued expenses of $11.1 million, partially offset bydecreases in accounts receivable of $1.0 million, prepaid expenses and othercurrent assets of $2.9 million and non-cash expenses and charges of $7.7million.

During the nine months ended September 30, 2006,investing activities provided cash of $20.0 million, primarily due to netmaturities of marketable securities of $20.1 million.

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During the nine months ended September 30, 2006,financing activities provided cash of $54.8 million, primarily due to $58.5million in net proceeds from the sale of our common stock in January 2006 andproceeds from our stock plan of $0.9 million, offset by long-term debt paymentsof $4.6 million.

OnJune 28, 2005, we borrowed (i) $10.0 million from Oxford FinanceCorporation, or Oxford, and (ii) $10.0 million from General ElectricCapital Corporation, or GECC, pursuant to the terms of promissory notes made byus with both Oxford and GECC, respectively. The notes bear interest at a fixedrate of 9.95% per annum and are payable in 36 consecutive monthly installmentsof principal and accrued interest, beginning July 1, 2005. The notes aresecured by a security interest in all our personal property and fixtures withthe exception of any intellectual property or products acquired, whether bypurchase, license or otherwise, on or after the execution of the notes,provided that debt or non-cash equity is used to acquire the new property. Theagreements that we entered into with each of Oxford and GECC in connection withthe notes also contain a material adverse change clause with both Oxford andGECC. Under this clause, if Oxford or GECC reasonably determine that ourability to repay the notes has been materially impaired, we would be consideredin default. As of September 30,2006, we were in compliance with this clause.

On August 3, 2005, we filed a registrationstatement utilizing a “shelf” registration process with the Securities andExchange Commission, or SEC. Under this shelf process, we may sell fromtime to time, in one or more offerings, shares of our common stock and debtsecurities up to a total dollar amount of $250 million. This shelf registrationis more fully detailed in a Registration Statement on Form S-3 that wefiled with the SEC on August 3, 2005. On January 25, 2006, wecompleted a direct offering of shares of our common stock previously registeredunder our effective shelf registration statement. Pursuant to this offering, wesold approximately 6.1 million shares of our common stock to selectedinstitutional investors at a price of $10.25 per share. Proceeds to us fromthis registered direct offering, net of offering expenses and placement agencyfees, totaled $58.5 million.

*Contractual Obligations*

The following tablesummarizes our contractual obligations at September 30, 2006, 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         |       | $          | 12,830,000 |                              | $          | 1,505,000          |       | $                  | 3,025,000  |                                | $          | 3,376,000 |   | $ | 4,924,000 |   |
| Purchase  obligations (1)           |       | 648,000    |       | 648,000                           |       | —             |       | —             |       | —                              |       |
| Long term debt                      |       | 13,431,000 |       | 7,675,000                         |       | 5,756,000          |       | —             |       | —                              |       |
| Total contractual cash  obligations |       | $          | 26,909,000 |                              | $          | 9,828,000          |       | $                  | 8,781,000  |                                | $          | 3,376,000 |   | $ | 4,924,000 |   |

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(1)             Inthe third quarter of 2006, we placed binding purchase orders in the approximateamount of $648,000 with Schwarz Pharma Manufacturing, Inc. for productionof BiDil finished goods during the fourth quarter of 2006.

We believe that our existing sources of liquidity andcash expected to be generated from future operations will be sufficient to fundour current business plan for approximately the next twelve months. Wemay seek additional funding through collaborative arrangements and publicor private financings. However, additional funding may not be available tous on acceptable terms, if at all. In addition, the terms of any financingmay adversely affect the holdings or the rights of our stockholders. Forexample, if we raise additional funds by issuing equity securities orconvertible debt securities, further dilution to our existing stockholdersmay result. If we are unable to obtain funding on a timely basis, wemay be required to significantly curtail certain of our sales andmarketing efforts. We also could be required to seek funds through arrangementswith collaborators or others that may require us to relinquish rights tosome of our technologies, product candidates or products.

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Even if we are able to raise additional funds in atimely manner, our future capital requirements may vary from what weexpect and will depend on many factors, including the following:

·   the magnitude of product sales of BiDil;

·   the successful commercialization of BiDil;

·   the cost of manufacturing, marketing andselling BiDil;

·   the timing of when we receive significantrevenue from BiDil, if at all;

·   the time and costs involved in completing theclinical trials and further development of, and obtaining regulatory approvalsfor, BiDil XR, if at all;

·   our ability to establish and maintain co-promotion,out-licensing and collaborative arrangements;

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

·   the effect of competing technological andmarket developments;

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

·   the cost of obtaining and maintaininglicenses to use patented technologies.

**CriticalAccounting Policies and Estimates**

Our discussion and analysis of our financial conditionand results of operations are based on our financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting periods. On an ongoing basis, we evaluate our estimatesand judgments, including those related to revenue and related reserves,accounts receivable, inventories, accrued expenses and the factors used todetermine the fair value assigned to our stock options. We base our estimateson historical experience, known trends and events and various other factorsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.  For a detailed explanationof the judgments made in these areas, refer to Management’s Discussion andAnalysis of Financial Condition and Results of Operations within our AnnualReport on Form 10-K for the year ended December 31, 2005, which is onfile with the SEC. The following represents a material change in our judgmentsor estimates discussed in our Annual Report on Form10-K for the year endedDecember 31, 2005. 

***Stock-Based Compensation***.**  ** On January 1, 2006, we adopted the fair valuerecognition provisions of Statement of Financial Accounting StandardsNo. 123(R),*Share-Based Payment*, using themodified-prospective-transition method. Under that transition method,compensation cost recognized for the first nine months of 2006 includes(a) compensation cost for all stock-based payments granted, but not yetvested as of January 1, 2006, based on the grant-date fair value estimatedin accordance with the original provisions of Statement of Financial AccountingStandards No. 123, *Accounting for Stock BasedCompensation* and (b) compensation cost for all stock-basedpayments granted subsequent to January 1, 2006, based on the grant-datefair value estimated in accordance with the provisions of SFAS 123R. Suchamounts have been reduced by our estimate of forfeitures of all unvestedawards. Results for prior periods have not been restated. For stock optionsgranted to non-employees, we recognize compensation expense in accordance withthe requirements of Emerging Issues Task Force No. 96-18, *Accounting for Equity Instruments That Are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods or Services*,or EITF 96-18. EITF 96-18 requires that companies recognize compensationexpense based on the estimated fair value of options granted to non-employeesover their vesting period, which is generally the period during which servicesare rendered by such non-employees. The fair value of unvested stock awardsgranted to

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non-employees is remeasured at each reporting period.

The fair value of each stock award is estimated on thegrant date using the Black-Scholes option-pricing model based on assumptionsfor volatility, risk-free interest rates, expected life of the option, anddividends (if any). Expected volatility is determined exclusively on historicalvolatility data of our common stock based on the period of time since ourcommon stock has been publicly traded. The expected life of our stock optionsis based exclusively on our historical data and represents the period of timethat stock options granted are expected to be outstanding. The risk-freeinterest rate is based on the U.S. Treasury yield curve in effect at thetime of grant commensurate with the expected life assumption.

We are using the straight-line attribution method torecognize stock-based compensation expense. The amount of stock-basedcompensation recognized during a period is based on the value of the portion ofthe awards that are ultimately expected to vest. SFAS 123R requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. The term“forfeitures” is distinct from “cancellations” or “expirations” and representsonly the unvested portion of the surrendered option. We have applied an annualforfeiture rate of 5.5% to all unvested options as of September 30, 2006. Thisanalysis will be re-evaluated quarterly and the forfeiture rate will beadjusted as necessary. Ultimately, the actual expense recognized over thevesting period will only be for those shares that vest.

We use our judgment in determining the fair value ofour common stock, including in selecting the inputs in the Black-Scholesvaluation model.  Equity instrumentvaluation models are by their nature highly subjective.  Any significant changes in any of ourjudgments, including those used in the application of the Black-Scholesvaluation model, could have a significant impact on the fair value of theequity instruments granted or sold and the associated compensation charge, ifany, that we record in our financial statements.

**Inflation**

We believe the effects of inflation generally do nothave a material adverse impact on our operations or financial condition.

**Off-Balance SheetArrangements**

We do not have any material off-balance sheetarrangements.

**Forward-LookingStatements**

This Quarterly Report on Form 10-Q includes forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, which we refer to as the Exchange Act. For thispurpose, any statements contained herein regarding our strategy, futureoperations, financial position, future revenues, projected costs, prospects,plans and objectives of management, other than statements of historical facts,are forward-looking statements. The words “anticipates,” “believes,”“estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would”and similar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifying words. Wecannot guarantee that we actually will achieve the plans, intentions orexpectations disclosed in our forward-looking statements. There are a number ofimportant factors that could cause actual results or events to differmaterially from those disclosed in the forward-looking statements we make.These important factors include the risk factors set forth below under thecaption “Risk Factors.” Although we may elect to update forward-looking statementsin the future, we specifically disclaim any obligation to do so, even if ourestimates change, except as specifically required by law or the rules ofthe SEC, and readers should not rely on those forward-looking statements asrepresenting our views as of any date subsequent to the date of this quarterlyreport.

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

We are exposed to market risk related to changes ininterest rates. Our current investment policy is to maintain an investment portfolioconsisting mainly of U.S. money market and high-grade corporate and U.S.government-related securities, directly or through managed funds, with averagecontractual maturities of less than

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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 marketinterest rates increase. If market interest rates were to increase immediatelyand uniformly by 10% from levels at September 30, 2006, we estimate that thefair value of our investment portfolio would decline by an immaterial amount.We have the ability to hold our fixed income investments until maturity, andtherefore we do not expect our operating results or cash flows to be affectedto any significant degree by the effect of a change in market interest rates onour investments.

**Item 4.**                          Controlsand Procedures

Our management, with the participation of our interimchief executive officer and chief financial officer, evaluated theeffectiveness of our disclosure controls and procedures as of September 30,2006. The term “disclosure controls and procedures,” as defined inRules 13a-15(e) and 15d-15(e) under the Exchange Act, meanscontrols and other procedures of a company that are designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the SEC’s rules and forms.Disclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed by acompany in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the company’s management, including itsprincipal executive and principal financial officers, as appropriate, to allow timelydecisions regarding required disclosure. Management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives, and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Based on the evaluation of our disclosurecontrols and procedures as of September 30, 2006, our interim chiefexecutive officer and chief financial officer concluded that, as of such date,our disclosure controls and procedures were effective at the reasonableassurance level.

No change in our internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act)occurred during the fiscal quarter ended September 30, 2006, that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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** **

**PART II.OTHER INFORMATION**

**Item 1A.**                 Risk Factors

You should carefully consider the following riskfactors, in addition to other information included in this Quarterly Report onForm 10-Q, in evaluating NitroMed and our business. If any of thefollowing risks occur, our business, financial condition and operating resultscould be materially adversely affected.

The risk factors previously disclosed in Item 1A.of our Annual Report on Form 10-K for the fiscal year ended December 31,2005 have been materially and substantially revised herein to reflect therestructuring of our research and development operations in March 2006 and therestructuring of our administrative and sales force operations in October 2006,as well as additional risks relating to our commercialization of BiDil and thedevelopment of BiDil XR. Accordingly, the risk factors set forth belowsupersede in their entirety the risk factors previously disclosed in our AnnualReport on Form 10-K. For a further discussion of the ongoing commercializationof BiDil, the development of BiDil XR, the restructuring of our research anddevelopment operations in March 2006 and the restructuring of ouradministrative and sales force operations in October 2006, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Overview.”

**Risks Relating toour Business**

**Our business is substantially dependent on thecommercial success of BiDil, and if we do not maintain market presence of BiDilduring the development of BiDil XR, our business will be materially harmed andour stock price will decline.**

On June 23, 2005, the FDA approved BiDil for thetreatment of heart failure in self-identified black patients as an adjunct tocurrent standard therapy. We launched BiDil in July 2005 and thereforehave only recently begun to receive revenue from sales of BiDil. BiDil iscurrently our only commercial product, and we expect that it will account forall of our product sales and substantially all of our total revenues for thenear future. We face a number of significant risks relating to our ability tosuccessfully commercialize BiDil, including risks relating to:

·                   our ability tosuccessfully market and sell BiDil with our significantly reduced sales forceand centralized marketing efforts;

·                   the success ofour revised sales and marketing strategies for BiDil;

·                   our ability to recruitand train our proposed specialty sales force and the effectiveness of our newsales force in influencing prescribing behavior with heart failure specialistsand key institutions;

·                   our ability tosuccessfully secure preferable reimbursement treatment from government andthird-party insurers for BiDil;

·                   our ability tosuccessfully enter into a co-promotion agreement for BiDil on favorable terms,if at all;

·                   our ability togain market acceptance of BiDil as safe, effective and medically necessary;

·                   theavailability of substantial amounts of cash to fund our BiDil commercializationplans;

·                   competitivefactors, including competition resulting from physicians prescribing the twolower cost generically available components of BiDil (isosorbide dinitrate andhydralazine hydrochloride) as a substitute for BiDil, and adverse effects onpricing or reimbursement resulting from this substitution;

·                   our ability toeffectively develop and/or contract for adequate marketing, manufacturing, anddistribution capabilities;

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·                   our ability tomaintain the necessary patent protection, licenses and regulatory approvalsrequired to market and sell BiDil; and

·                   the variousother factors discussed in detail throughout this section titled “RiskFactors.”

In order for us to successfully commercialize BiDil, wemust maintain our market presence of BiDil in the near term and must lay asufficient commercial foundation from which to launch BiDil XR in the future.If we fail to sustain market awareness of BiDil, our near-term ability togenerate product revenue, our reputation and our ability to raise additionalcapital will be materially impaired, and the value of our stock will decline.

**Poor performance by our restructured sales force,or difficulties arising from the restructuring of our sales organization, couldprevent us from achieving the results we need to maintain market presence of BiDil.**

On October 10, 2006, we initiated a restructuringprogram that included a reduction of our sales force and administrativeheadcount. As part of the restructuring program, we eliminated and replaced ourexisting sales force with a small team of highly experienced seniorcardiovascular specialists, resulting in a net reduction of approximately 120in sales force headcount. In addition, we also eliminated approximately 20% ofour general and administrative personnel in connection with this restructuringprogram. Our restructured sales force is expected to be comprised initially ofa director of managed care, six account executives, two area business directorsand twenty-one cardiovascular business managers. Our near-term revenue forBiDil will depend significantly upon the efforts and success of our restructuredsales organization. Accordingly, if our sales organization does not devote thetime and resources necessary to attain sales projections, our ability toachieve revenue from sales of BiDil will be harmed.

In addition, during the first quarter of 2006, weelected to reduce the number of sales territories in which we have salesrepresentation. As a result of our October 2006 restructuring, we significantlyreduced the number of individuals in our sales organization who cover theseterritories. Any failure to adequately cover our current sales territories, orto cover through alternative marketing efforts the territories in which we haveelected not to have sales representation, will result in reduced salesproductivity and loss of revenue related to BiDil.

The success of our revised selling strategy will alsodepend on our ability to recruit the caliber of representatives necessary toimplement our new strategy. Since launching BiDil, we have reduced our salesforce representation from 195 to the current plan of twenty-one through variousterritory realignments and restructurings, which could significantly limit ourability to successfully recruit and retain highly qualified salesrepresentatives. In addition, we are seeking sales representatives with a veryhigh level of technical, selling and institutional experience to fill our newlycreated cardiovascular business manager positions. These are highly specializedskills and we may not be able to hire sales representatives who meet thesequalifications. Any delay in our ability to recruit the required number ofindividuals to cover our revised sales territories, or any failure to attractand retain qualified personnel, could significantly delay or hinder the successof our revised selling strategy. 

**If we do not successfully market and sell BiDil, eitherdirectly through our small, restructured sales force or indirectly throughthird-party co-promotion arrangements, our future revenue will be limited.**

We launched BiDil in the United States ourselves, usinga contract sales force. We transitioned to the use of a smaller sales forceduring the first quarter of 2006, we internalized this sales force during thesecond quarter of 2006, and in October 2006 we replaced this sales force with asmall team of highly experienced senior cardiovascular specialists. Thetransition to this specialized sales force could adversely affect our marketingof BiDil and depress the value of our stock. 

As part of our October 2006 restructuring, we revisedour marketing strategy to reduce the level of our direct face-to-face marketingefforts and adopted a more centralized approach to marketing that will involvevarious non-personal methods of contacting current and potential prescribers. Thedirect marketing efforts in which we will continue to engage through our small,specialized sales team will be focused on national thought leaders, regionalheart failure specialists and key institutions in major metropolitan centersthat treat, and influence the treatment of, large numbers of African Americanswho have been diagnosed with heart failure. Our approach is to convince those

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thought leaders and institutions of the value ofBiDil, and then leverage their influence to impact the broader base ofprescribers. If we are unable to convince these thought leaders andinstitutions that BiDil is safe, effective and medically necessary, we will beunsuccessful in our marketing approach. In addition, even if we are successfulin gaining acceptance of BiDil with these key targets, these thought leadersand institutions may not be willing or able to influence the prescribingactivity of other physicians, or to do so within a timeframe that will impactBiDil prescriptions in the near term. Furthermore, our indirect marketingefforts may not be successful in maintaining market awareness of BiDil withcurrent and potential prescribers.

If we decide to expand our marketing reach for BiDil,we will likely pursue sales, marketing and distribution arrangements with thirdparties, including co-promotion arrangements. We may not be able tosuccessfully enter into sales, marketing and/or distribution agreements withthird parties on terms that are favorable to us, if at all. In addition, wemay have limited or no control over the sales, marketing and distributionactivities of these third parties. If we decide to rely on third-party entitiesfor sales, marketing and distribution support, our future revenues for BiDilwill depend heavily on the success of the efforts of these third parties.

**If the government or third-party payors do notreimburse patients for BiDil, or do not reimburse for BiDil at favorablelevels, BiDil might not be used or purchased, and our revenues and profits willbe adversely affected.**

Our revenues and profits depend heavily upon the availabilityof coverage and favorable reimbursement for the use of BiDil from third-partyhealthcare and state and federal government payors. Reimbursement by a thirdparty payor may depend upon a number of factors, including the third-partypayor’s determination that use of a product is:

·                   safe, effectiveand medically necessary;

·                   appropriate forthe specific patient;

·                   cost-effective;and

·                   neitherexperimental nor investigational.

Since reimbursement approval for a product is requiredfrom third-party and government payors in order for patients to be reimbursedfor the cost of a product, seeking this approval, particularly when seekingapproval for a preferred form of reimbursement over other competitiveproducts, is a time-consuming and costly process. Third-party payors conductclinical reviews of pharmaceutical products to determine whether a product issafe, effective and medically necessary. These third-party payors may find thatBiDil is not sufficiently effective to justify reimbursement approval or thatthe effectiveness of BiDil does not justify its cost. In addition, third-partypayors may require cost-benefit analysis data from us in order todemonstrate the cost-effectiveness of BiDil. For any individual third-partypayor, we may not be able to provide data sufficient to gain reimbursementon a similar or preferred basis to competitive products, if at all. Furthermore,some third-party payors may consider the generically available individualcomponents of BiDil to be substitutable for, or therapeutically equivalent to,BiDil, despite the lack of FDA approval for the use of those individualcomponents in the treatment of heart failure. This misconception amongthird-party payors may further limit our ability to obtain preferentialreimbursement, if at all, from those third-party payors.

Even after reimbursement at an agreed level isapproved by a third-party payor, we may lose that reimbursement entirely,or we may lose the similar or better reimbursement we receive compared tocompetitive products. As reimbursement is often approved for a period of time,this risk is greater at the end of the time period, if any, for which thereimbursement was approved. In addition, legislative or regulatory efforts tocontrol or reduce healthcare costs or reform government healthcareprograms could result in lower prices or rejection of BiDil. Changes incoverage and reimbursement policies or healthcare cost containment initiativesthat limit or restrict reimbursement for BiDil may cause our revenues todecline. Any failure by us to obtain reimbursement for BiDil, or to secure apreferred form of reimbursement that reduces costs to patients,may negatively impact market acceptance of BiDil and adversely affect ourability to generate revenues from sales.

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Many private insurers, and many of the MedicarePart D plans that cover BiDil, cover the product at the Tier III level.Tier level is a term generally used to denote the level of reimbursement and,consequently, the level of patient co-pay, for a product that is approved by athird-party payor. At Tier III, patient co-pays are at a significantly higherlevel than they would be at Tier II, ranging from approximately $30.00 to$50.00. Tier II reimbursement denotes a preferential level of reimbursement atwhich patient co-pays range from approximately $15.00 to $30.00. Wemay not be able to obtain reimbursement coverage for BiDil from manyprivate insurers or Medicare Part D plans or, even if we obtain such coverage,we may not be able to obtain preferential reimbursement treatment. Any failureby us to secure such coverage, or to secure it at preferential levels, wouldhave a substantially negative effect on sales of BiDil, market acceptance ofBiDil would be negatively impacted and our ability to generate revenues from saleswould be significantly impaired. Although we have been added to preferredformularies covering approximately 50% of insured African Americans over theage of 45, we have not achieved preferential reimbursement on all plans. Furthermore,we cannot know if BiDil will continue to be listed on any of these plans at apreferential reimbursement level, if at all. In addition, although preferentialreimbursement for BiDil removes a financial barrier to accessing the product,it does not require or guarantee that physicians will prescribe the drug. Accordingly,we cannot assess the impact that the current listing of BiDil on any given planwill have on our future revenues, if any.

**Physicians, third-party payors and patientsmay not be receptive to BiDil, which could prevent us from achievingprofitability.**

Our business is substantially dependent on marketacceptance of BiDil. We currently market BiDil only in the United States, andkey participants in the U.S. pharmaceutical marketplace, such as physicians,third-party payors and patients, may not accept and use BiDil.

Factors that we believe will materially affect marketacceptance of BiDil include:

·                   theavailability of favorable government and third-party payor reimbursement;

·                   the ability toproduce and sell BiDil at a competitive price;

·                   theavailability in generic form of the individual components that constitute BiDiland the misperception that these generic components are equivalent to BiDil;

·                    the failure ofphysicians, third-party payors and patients to accept a product intended toimprove therapeutic results based on ethnicity;

·                   the success ofour promotional programs, which will be centralized in nature going forward;

·                   the timing ofour receipt of marketing approval, if any, for our next-generation BiDilproduct, BiDil XR, or for any expansion of our current label for BiDil, such asextended product dating or inclusion of new data;

·                   the safety,efficacy and ease of administration of BiDil; and

·                   the timing ofour receipt of any marketing approvals outside the U.S., the terms of anynon-U.S. approval, including labeling requirements and/or limitations, and thecountries in which approvals are obtained, if any.

**The availability of lower priced generic forms ofthe components of BiDil may adversely affect our sales of BiDil and thepricing or reimbursement we are able to obtain for BiDil.**

BiDil is a fixed-dosed combination of two individualcomponents, both of which are available in generic form and are separatelymarketed (isosorbide dinitrate for angina and hydralazine for hypertension), indosages similar to those we include in BiDil, at prices substantially below theprices we are charging for BiDil. While neither of these two generic drugs isapproved for the treatment of heart failure, as a practical matter itmay be impossible

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for us to prevent physicians from prescribing acombination of these two, lower cost generic drugs as a substitute forprescribing BiDil. If substantial numbers of physicians prescribe thecombination of these two generic drugs, rather than BiDil, we could fail toachieve the sales of BiDil necessary for successful commercialization whichwould severely limit our ability to generate revenue from the sales of BiDil.Our ability to generate revenue could also be limited if:

·                   potential largepurchasers of BiDil, such as hospitals or health maintenance organizations,require substitution of these generic drugs for BiDil;

·                   stateformularies, other government agencies or private payors that approvereimbursement for drugs require substitution of these generic drugs for BiDil;or

·                   theavailability of these generic drugs reduces the price or reimbursement amountswe are able to achieve for BiDil.

**We will require substantial additional amounts ofcash to fund our operating plan, including commercializing BiDil and seeking todevelop and commercialize BiDil XR, and, if additional capital is notavailable, we may need to limit, scale back or cease our operations.**

We have used and will continue to require substantialfunds to manufacture, market and sell BiDil during 2006 and beyond. We alsoexpect to incur additional expenses relating to the ongoing development ofBiDil XR, which is currently commencing clinical development. We believe thatour existing sources of liquidity and cash expected to be generated from futureoperations will be sufficient to fund the current business plan forapproximately the next twelve months.

However, our future capital requirements, and theperiod in which we expect our current cash to support our operations, may varyfrom what we expect due to a number of factors, including the following:

·                    the magnitudeof product sales of BiDil;

·                    the successfulcommercialization of BiDil;

·                    the cost ofmanufacturing, marketing and selling BiDil;

·                    the timing ofwhen we receive significant revenue from BiDil, if at all;

·                    the time andcosts involved in completing the clinical trials and further development of,and obtaining regulatory approvals for, BiDil XR, if at all;

·                    our ability toestablish and maintain co-promotion, out-licensing and collaborativearrangements;

·                    the timing,receipt and amount of royalties, milestone and other payments, if any, frompotential collaborators;

·                    the effect ofcompeting technological and market developments;

·                    the costsinvolved in preparing, filing, prosecuting, maintaining and enforcing patentclaims; and

·                    the cost ofobtaining and maintaining licenses to use patented technologies.

We may berequired to seek additional funding in the future and may seek to do sothrough collaborative co-promotion arrangements and/or public or privatefinancings. Additional financing may not be available to us on acceptableterms, if at all. In addition, the terms of the financing may adverselyaffect the holdings or the rights of our stockholders. For example, if we raiseadditional funds by issuing equity securities, further dilution to our then-existingstockholders will result. If we are unable to obtain funding on a timely basis,we may be compelled to

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significantly curtail our marketing efforts for BiDiland/or our development efforts with respect to BiDil XR. We may also becompelled to seek funds through arrangements with collaborators or others thatmay require us to relinquish rights to some of our technologies, productcandidates or products.

**We do not have the internal technology tosuccessfully develop BiDil XR and we may not be able to acquire suchtechnology on favorable terms, if at all.**

Although we intend to pursue the accelerated developmentof BiDil XR, we do not currently have the internal technology to pursue thisdevelopment on our own. The technology underlying extended release formulationsof pharmaceutical products is highly proprietary and would take years and theexpenditure of significant amounts of capital for us to develop. If we areunable to license proprietary extended release technology from a third partywhich is compatible for use with BiDil, we would be prevented from pursuing thedevelopment of BiDil XR. Even if we are able to identify compatible extendedrelease technology, we may not be able to acquire rights to suchtechnology on favorable terms, if at all. We are currently in the process ofnegotiating agreements with respect to the drug delivery technology of onevendor with which we have done extensive preclinical development, but we maynot be able to reach agreement on favorable terms, if at all. In addition, evenif we are successful in acquiring such rights, we may be required toforfeit certain rights to our BiDil XR product to the owner of such technology,thereby reducing our future potential revenue from commercialization of thisproduct.

**We cannot becertain that clinical testing of BiDil XR will be successful, nor can we becertain that we will beable to obtain regulatory approval for BiDil XR.**

Even if we obtain the technology necessary to developBiDil XR, we cannot predict whether the results of any clinical studiesconducted with respect to BiDil XR will be successful. Furthermore, we cannotpredict the number or the type of clinical trials that will be necessary toadequately support a marketing application for BiDil XR, nor can we predict theamount of time that will be required in order to complete those clinicaltrials. The fact that BiDil is a combination of two active ingredients(isosorbide dinitrate and hydralazine hydrochloride) may further complicate thedevelopment of the extended release formulation. Depending on the results ofinitial clinical studies, additional testing with alternate formulations ofBiDil XR may also be required. If these studies and testing are not successful,we will incur increased costs and the filing for marketing approval of BiDil XRwith the FDA and other health authorities will be significantly delayed. 

In addition, even if clinical testing of BiDil XR issuccessful, we still may not be able to obtain regulatory approval for BiDilXR. The FDA may conclude that the data provided is insufficient and may requirethat we perform additional studies. If we are ultimately unable to produce aformulation of BiDil XR that meets regulatory requirements, if we are delayedin our efforts to obtain regulatory approval for BiDil XR, or if we arerequired by the FDA to conduct large-scale outcomes studies, we may not be ableto successfully develop and commercialize this product and our ability togenerate revenue from BiDil XR will be materially impaired.

**The developmentand future commercialization of BiDil XR may be terminated or delayed, andthe cost of developmentand future commercialization may increase, if third parties on whom werely to manufacture BiDil XR do not fulfill their obligations.**

We do not have manufacturing capabilities for BiDil XRand have no current plans to develop any such capacity in the future. In orderto continue to develop BiDil XR, apply for regulatory approvals andcommercialize this product, we plan to rely on third parties for the productionof clinical and commercial quantities of BiDil XR. We may not be able tosecure a third-party manufacturer for BiDil XR on commercially favorable terms,if at all. In addition, contract manufacturers are subject to ongoing periodic,unannounced inspection by the FDA and corresponding state and foreign agenciesor their designees to ensure strict compliance with current Good ManufacturingPractices, or cGMP, and other governmental regulations and correspondingforeign standards. The cGMP requirements govern quality control of themanufacturing process and documentation of policies and procedures. Other thanthrough contract, we do not have control over compliance by our contractmanufacturers with these regulations and standards. Our present or futurecontract manufacturers may not be able to comply with cGMP and other FDArequirements or similar regulatory requirements outside the United States.Failure of our contract manufacturers to comply with applicable regulationscould result in sanctions being imposed on us in some cases, including fines,injunctions, failure of regulatory authorities to grant marketing approval ofour product

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candidate, delays, suspension or withdrawal ofapprovals, seizures or recalls of such product candidate, operatingrestrictions, and criminal prosecutions, any of which could significantly andadversely affect our business. We will depend upon these third parties toperform their obligations in a timely manner and in accordance withapplicable laws and regulations. If we fail to secure a third-partymanufacturer on commercially favorable terms, or to the extent that third-partymanufacturers with whom we contract fail to perform their obligations inaccordance with applicable laws and regulations, we may be adverselyaffected in a number of ways, including:

·                    wemay not be able to initiate or continue clinical trials of BiDil XR;

·                    we may bedelayed in submitting applications for regulatory approvals for BiDil XR; and

·                    even if wesuccessfully commercialize BiDil XR, we may be required to ceasedistribution and/or recall some or all batches of the product and wemay not be able to meet commercial demands for our products or achieveprofitability.

**Currently, we are engaging in limited internalresearch and development activities and, accordingly, our ability to generatefuture revenue from our nitric oxide technology portfolio is completelydependent on our ability to enter into scientifically and commerciallysuccessful out-licensing or collaborative arrangements with third parties.**

At the end of the first quarter of 2006, we scaledback our research and development staff in a restructuring of our company andhave limited our internal research and development activities to the continueddevelopment of BiDil XR. We are currently seeking out-licensing andcollaboration opportunities for our other potential product candidates based onour proprietary nitric oxide technology, including NMI-3377, a late-stagepre-clinical cardio-renal compound. The application of our proprietary nitricoxide technology is unproven in humans and, as a result, we may not beable to successfully out-license any products based on this technology. Ourproduct candidates include nitric oxide enhancements of existing drugs; inthese cases, we are modifying compounds whose chemical and pharmacologicalprofiles are well-documented and understood. Many of our potential productcandidates, however, are new molecules with chemical and pharmacologicalprofiles that differ from that of the existing drugs. These compoundsmay not demonstrate in patients the chemical and pharmacologicalproperties shown in laboratory studies, and they may interact with humanbiological systems in unforeseen, ineffective or harmful ways. In addition, itis possible that existing drugs or newly-discovered drugs may not benefitfrom the application of our nitric oxide technology. We may not be able tosecure out-licensing or collaboration partners for these potential productcandidates. Even if we are successful in entering into out-licensing orcollaborative arrangements with respect to our potential product candidates, wehave no assurance that we will be able to secure such arrangements on termscompletely favorable to us. If our out-licensing or collaboration arrangementsinclude unfavorable financial terms, our ability to generate revenue from ourtechnology portfolio will be severely limited.

Additional factors that may affect the success ofour potential future collaborations include the following:

·                    our futurelicensing partners or collaborators may be pursuing alternativetechnologies or developing alternative product candidates, either on their ownor in collaboration with others, that may be competitive with the productcandidate which they have licensed from us or will be collaborating with us andwhich could affect their commitment to our future collaboration;

·                    futurereductions in marketing or sales efforts or a discontinuation of marketing orsales of our products by our licensing partners or collaborators would reduceour revenues which would be based on a percentage of net sales by the partner;

·                    our futurelicensing partners or collaborators may terminate their agreements withus, which could make it difficult for us to attract new partners or adverselyaffect how we are perceived in the business and financial communities; and

·                    our futurelicensing partners or collaborators may pursue higher-priority programs orchange the focus 

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of their development programs, which could affect thepartners’ commitment to us.

As a result of the foregoing factors, our potentialstrategic partners may not be successful in developing and commercializingany products based on our proprietary nitric oxide technology. Any failure ofsuch potential partners at any stage of the development or commercializationprocess with respect to our potential product candidates would significantlyreduce the possibility that we would realize any future revenue from ourtechnology portfolio.

**Because we have a history of losses and our futureprofitability is uncertain, an investment in our common stock is highlyspeculative.**

We have experienced significant operating losses sinceour inception in 1992. For the nine months ended September 30, 2006, wehad a net loss of $60.7 million. As of September 30, 2006, we had anaccumulated deficit of $303.2 million. We expect that we will continue toincur substantial losses and that our cumulative losses will increase as ourcommercialization efforts continue. We expect that the losses that we incurwill fluctuate from quarter to quarter and that these fluctuations may besubstantial.

A large portion of our expenses is fixed, includingexpenses related to facilities, equipment and personnel. We have spentsignificant amounts to launch our first product, BiDil, and we expect to incursignificant operating expenses in connection with our ongoing commercializationactivities related to BiDil. We received approval for BiDil from the FDA onJune 23, 2005, and launched commercial sales of BiDil in July 2005.We have also spent significant amounts to fund research, development andcommercialization of our product candidates and to enhance our coretechnologies. Currently, our research and development activities are limited tothe continued development BiDil XR. We are not engaging in any internalresearch and development activities with respect to other potential productcandidates and, therefore, do not expect to incur substantial research anddevelopment expenses in the near term. Although we currently estimate that ouroperating expenses will decrease in fiscal year 2007, we will still need togenerate significant revenue to achieve profitability. We are currently unableto estimate the level of revenues that we will realize from thecommercialization of BiDil. We are therefore unable to estimate when we willachieve profitability, if at all. Even if we do achieve profitability, wemay not be able to sustain or increase profitability on a quarterly orannual basis. Our failure to become and remain profitable could depress themarket price of our common stock and could impair our ability to raise capitalor continue our operations.

Our BiDil product revenues have been and will continueto be subject to considerable variation due to the significant reduction in ourdirect sales force, volatility in prescription volume, the manner in which weaccount for product sales considering product returns rates, the level ofpurchases by individual customers and other matters related to thecommercialization of this product. We have experienced and are likely tocontinue to experience significant revenue deferrals and product returns, aswell as additional charges and expenses associated with stocking incentives, rebates,discounts, and other promotional incentives, and other matters related to thecommercialization of this product. Significant inventory adjustmentsmay also occur due to sales forecast variances or other factors. Anydeferrals, returns or adjustments that negatively impact revenue, or ourfailure, for this or any other reason, to generate significant near-termrevenue growth, would reduce our stock price and adversely affect our abilityto raise capital.

**If the third-party manufacturer of BiDilencounters delays or difficulties in production, we may not be able tomeet demand for the product and we may lose potential revenue, which couldcause the price of our common stock to decline.**

We do not manufacture BiDil and have no plans to doso. We have engaged Schwarz Pharma Manufacturing, Inc., which we refer to asSchwarz Pharma, under a five-year exclusive manufacturing and supply agreementsolely for the three times daily immediate release dosage formulation of BiDil.Under the supply agreement, we have the right to engage a backup manufacturerbut do not currently have any backup manufacturing agreement in place. Theterms of the supply agreement provide that it may be terminated by eitherus or Schwarz Pharma under specified circumstances, including a material breachof the supply agreement by either party, the occurrence of a payment default byus, our material impairment of the manufacturing licenses we have granted toSchwarz Pharma or a failure of Schwarz Pharma to supply conforming products. Inaddition, either party may terminate the supply agreement in the event theFDA takes any action, the result of which is to permanently 

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prohibit the manufacture, sale or use of the product.

Furthermore, Schwarz Pharma may encounterdifficulties in production. These problems may include, but are notlimited to:

·                    difficultieswith production costs and yields;

·                    qualitycontrol and assurance;

·                    difficultiesobtaining ingredients for our products;

·                    shortages ofqualified personnel;

·                    compliance withstrictly enforced federal, state and foreign regulations; and

·                    lack ofcapital funding.

If we are unable to maintain a commercially reasonablemanufacturing agreement for the production of BiDil with Schwarz Pharma, wehave no back-up manufacturing facility and thus we would not be able tomanufacture and sell BiDil until another facility was qualified.  The number of third-party manufacturers withthe manufacturing and regulatory expertise and facilities necessary tomanufacture finished products for us on a commercial scale is limited, and itwould take a significant amount of time to arrange, qualify, and receivenecessary regulatory approval for alternative arrangements. We may not beable to contract for alternative manufacturing on acceptable terms, if at all.

If we are unable to successfully contract forthird-party manufacturing, or if Schwarz Pharma or any other third-partymanufacturer of BiDil fails to deliver the required commercial quantities offinished product on a timely basis and at commercially reasonable prices, wemay be unable to meet the demand for our product and we may losepotential revenues, all of which could cause the price of our common stock todecline.

**We rely on a single source supplier for one of thetwo active ingredients in BiDil, and the loss of this supplier could prevent usfrom selling BiDil, which would materially harm our business.**

We rely on Sumitomo Corp. for our supply ofhydralazine hydrochloride, one of the two active ingredients in BiDil. Sumitomois currently the only supplier of hydralazine hydrochloride worldwide. We donot have any agreement with Sumitomo regarding the supply of hydralazinehydrochloride. If Sumitomo stops manufacturing or is unable to manufacturehydralazine hydrochloride, or if we are unable to procure hydralazinehydrochloride from Sumitomo on commercially favorable terms, we may beunable to continue to sell BiDil on commercially viable terms, if at all.Furthermore, because Sumitomo is currently the sole supplier of hydralazine hydrochloride,Sumitomo has unilateral control over the price of hydralazine hydrochloride.Any increase in the price for hydralazine hydrochloride may reduce ourgross margins and adversely affect our ability to achieve profitability.

**If our collaborative partners do not obtain andmaintain the regulatory approvals required to market and sell our potential nitric-oxidebased product candidates in the United States, then our business may beunsuccessful, and the market price of our stock may substantially decline.**

We are currently seeking out-licensing andcollaboration opportunities for our potential product candidates based on ourproprietary nitric oxide technology, including NMI-3377, a late-stagepre-clinical cardio-renal compound. Our partners will not be able to market anyof our potential nitric-oxide based product candidates in the United Stateswithout marketing approval from the FDA. The process of obtaining FDA approvalof pharmaceutical products is costly and time consuming. Any new pharmaceuticalproduct must undergo rigorous pre-clinical and clinical testing and anextensive regulatory approval process mandated by the FDA. Such regulatoryreview includes the determination of manufacturing capability and productperformance. The approval process is affected by such factors as:

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·                    the severityof the disease;

·                    the quality ofthe regulatory submission;

·                    the clinicalefficacy and safety;

·                    the strengthof the chemistry and manufacturing control of the process;

·                    themanufacturing facility compliance;

·                    theavailability of alternative treatments;

·                    the risks andbenefits demonstrated in clinical trials; and

·                    the patentstatus and marketing exclusivity rights of certain innovative products.

The regulatory process to obtain market approval for anew drug takes many years and requires expenditures of substantial resources.There can be no assurance that our strategic partners will be successful inobtaining FDA approval for our potential nitric-oxide based product candidates.If our strategic partners do not receive required regulatory approval orclearance to market any of our potential product candidates, these partnerswill not be able to develop and commercialize these product candidates, whichwill significantly hinder our ability to realize revenue from these productcandidates and which may affect our ability to achieve profitability andcause the market price of our common stock to substantially decline.

**We or our potential strategiccollaborators may not be able to obtain the necessary regulatory approvalsin order to market and sell BiDil, or our product candidates, in foreigncountries.**

Our marketing approval for BiDil is limited to theUnited States. Until we or our potential strategic collaborators obtain therequired regulatory approvals for BiDil or any potential product candidates inany specific foreign country, neither we nor our collaborators will be able tosell these products in that country. International regulatory authorities haveimposed numerous and varying regulatory requirements, and the approvalprocedures could involve testing in addition to that required by the FDA.Furthermore, approval by one regulatory authority does not ensure approval byany other regulatory authority. In addition, if we enter into collaborativepartnerships in order to obtain foreign regulatory approval for BiDil or any ofour product candidates, we may be dependent upon these collaborators toconduct clinical testing and to obtain such regulatory approvals. We or ourcollaborators may not be able to obtain final regulatory approvals forBiDil or for any of our other potential product candidates in foreigncountries. Any failure to obtain the necessary governmental approvals orfailure to obtain approvals of the scope requested could delay, oreven preclude, us or our licensees or other collaborators from marketingBiDil or our product candidates, or limit the commercial use of BiDil or ourproduct candidates in these foreign jurisdictions. Alternatively, foreignregulatory approvals may entail limitations on the indicated uses of BiDilor our product candidates and impose labeling requirements which may alsoadversely impact our ability to market BiDil or our product candidates.

**Even if we or our strategic partners obtainregulatory approvals, our marketed products, including BiDil, will be subjectto ongoing regulatory review. If we, or our strategic partners, fail to complywith continuing United States and any future foreign regulations, we could loseour approvals to market BiDil, and our strategic partners could lose approvalsto market our out-licensed products based on our proprietary nitric oxidetechnology and our business would be seriously harmed.**

Even after approval, any products we or our potentialstrategic partners develop will be subject to ongoing regulatory review andrestrictions, including the review of clinical results which are reported aftersuch products are made commercially available, and restrictions on theindications for which we or our potential strategic partners can market theproduct. The FDA can propose to withdraw approval if new clinical data orexperience shows that a product is not safe for use under the approvedconditions of use. The FDA, we or our potential strategic partnersmay need to send important information about such products to healthcareproviders. The marketing claims we or 

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our potential strategic partners are permitted to makein labeling or advertising regarding our marketed products are limited to thosespecified in any FDA approval.

For example, because BiDil is specifically approvedfor labeling with respect to self-identified black patients, we may notpromote BiDil for use in other patient populations. For BiDil, we must submitcopies of our advertisements and promotional labeling, including, for example,professional journal advertisements, website pages, professional directmailers, direct-to-consumer advertisements, convention booth panels andhandouts, to the FDA at the time of initial publication or dissemination. Ifthe FDA believes these materials or statements made by our salesrepresentatives or other company officials promote our products for unapprovedindications, the FDA could allege that our promotional activities misbrand ourproducts. Specifically, the FDA could issue an untitled letter or warningletter, which requests, among other things, that we cease such promotionalactivities, including disseminating the advertisements and promotionallabeling, and that we issue corrective advertisements and labeling, includingsending letters to healthcare providers. The FDA also could take enforcementaction including seizure of allegedly misbranded product, injunction orcriminal prosecution against us and our officers or employees. If we repeatedlyor deliberately fail to submit such advertisements and labeling to the agency,the FDA could withdraw our approvals. The FDA also monitors manufacturers’support of continuing medical education, or CME, programs where the programsinvolve the manufacturers’ or a competitor’s products to ensure thatmanufacturers do not influence the CME content as a means of promoting theirproducts for off-label uses.

In addition, the manufacturer and the manufacturingfacilities we use to produce BiDil, or that our potential strategic partnersmay use to produce product candidates based on our nitric oxidetechnology, are subject to periodic review and inspection by the FDA. We or ourpotential strategic partners are required to report any serious and unexpectedadverse experiences and certain quality problems with BiDil or the respectiveproduct candidate and make other periodic reports to the FDA. The discovery ofany previously unknown problems with a product, manufacturer or facilitymay result in restrictions on the product or manufacturer or manufacturingfacility, including withdrawal of the product from the market. Certain changesto an approved product, including the way it is manufactured or promoted, oftenrequire prior FDA approval before the product as modified may be marketed.If we or our potential strategic partners fail to comply with applicablecontinuing regulatory requirements, we or our potential strategic partnersmay be subject to fines, untitled letters, warning letters, civilpenalties, suspension or withdrawal of regulatory approvals, product recallsand seizures, injunctions, operating restrictions and/or criminal prosecutionsand penalties.

**If we, our third-party manufacturers or ourservice providers fail to comply with applicable laws and regulations, we orthey could be subject to enforcement actions, which could affect our ability tomarket and sell BiDil and harm our reputation.**

If we or our third-party manufacturers or serviceproviders fail to comply with applicable federal, state or foreign laws orregulations, we could be subject to enforcement actions which could affect ourability to develop, market and sell BiDil successfully and could harm ourreputation and lead to lower acceptance of BiDil by the market. Theseenforcement actions include:

·                    productseizures;

·                    voluntary ormandatory recalls;

·                    patient orphysician notifications, including letters to healthcare professionals andcorrective advertising;

·                    withdrawal ofproduct approvals;

·                    restrictionson, or prohibitions against, marketing our products;

·                    fines;

·                    restrictionson importation of our products;

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·                    injunctions;

·                    debarments;

·                    civil andcriminal penalties; and

·                    suspension ofreview of, or refusal to approve, pending applications.

**If the clinical trials for any product candidatesour strategic partners advance into clinical testing are not successful, thesepartners may not be able to successfully develop and commercialize ourpotential product candidates.**

In order to obtain regulatory approvals for thecommercial sale of product candidates that we out-license, our collaboratorswill be required to complete extensive clinical trials in humans to demonstratethe safety and efficacy of our product candidates. Our strategic partnersmay not be able to obtain authority from the FDA or other regulatoryagencies to commence or complete these clinical trials. If permitted, suchclinical testing may not prove that our product candidates aresufficiently safe and effective to permit our strategic partners to obtainmarketing approvals from regulatory authorities. Moreover, positive results demonstratedin pre-clinical studies and clinical trials that our strategic partnerscomplete may not be indicative of results obtained in future clinicaltrials. Furthermore, one of our collaborators, institutional review boards orregulatory agencies may suspend clinical trials at any time if it isbelieved that the patients participating in such trials are being exposed tounacceptable health risks. Adverse or inconclusive clinical trial resultsconcerning any of our product candidates could require our strategic partnersto conduct additional clinical trials, result in increased costs andsignificantly delay the filing for marketing approval for those productcandidates with the FDA, result in a filing for a narrower indication than wasoriginally sought or result in a decision to discontinue development of thoseproduct candidates.

The successful completion of our strategic partners’clinical trials will depend on, among other things, the rate of patientenrollment. Patient enrollment is a function of many factors, including thesize of the patient population, the nature of the clinical protocol, theavailability of alternative treatments, the proximity of patients to clinicalsites and the eligibility criteria for the study. Our strategic partners may beunable to enroll the number of patients we need to complete a trial on a timelybasis. Moreover, delays in planned patient enrollment for clinical trialsmay cause our strategic partners to incur increased costs and delaycommercialization. Because we will need to rely on third parties for thedevelopment of our product candidates, we will have less control over thetiming and other aspects of these clinical trials than if we conducted them onour own.

As a result of these factors, third parties on whom werely may not successfully begin or complete clinical trials on ourpotential product candidates in a timely manner, if at all. Moreover, if ourstrategic partners do not successfully develop and commercialize our products,our future revenues may be materially impaired.

**The expiration of the research term under ourcollaboration agreement with Boston Scientific has resulted in the loss ofpotential royalty-based revenue from the collaboration and may indicatethat the development of nitric oxide-enhancing stents is not viable.**

In November 2001, we entered into a research,development and license agreement with Boston Scientific pursuant to which wegranted Boston Scientific an exclusive worldwide license to develop andcommercialize certain of our nitric oxide-enhancing compounds for use withtheir stents or specialty catheters in the area of restenosis. InDecember 2003, we extended the research collaboration to develop nitricoxide-enhancing paclitaxel-coated stents until December 31, 2005. The researchterm of this agreement expired on December 31, 2005, although certainrights extend beyond this term. Weintend to seek out-licensing and collaboration opportunities for thistechnology, subject to the terms of our agreement with Boston Scientific andpending resolution of the ongoing rights of the parties with respect to thistechnology. If we are not able to out-license the technology developedunder this agreement, or if we are unable to resolve the ongoing rights of theparties with respect to this technology in a manner favorable to us, wemay lose any investment made in the development of, and any potentialrevenue that may have resulted from, the development, sale or licensing ofnitric oxide-enhancing stents.

**If the estimates we make and the assumptions onwhich we rely in preparing our financial statements prove**

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**inaccurate, our actual results may varysignificantly.**

Our financial statements have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of our assets, liabilities, revenuesand expenses, the amounts of charges taken by us and related disclosure. Suchestimates and judgments include revenue recognition, the carrying value of ouraccounts receivable, inventory and assets, our estimates of accrued expenses andliabilities and our estimates of the fair value of equity instruments grantedor sold by us. We base our estimates and judgments on historical experience andon various 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 ourfinancial statements. For a further discussion of the estimates and judgmentsthat we make and the critical accounting policies that affect these estimatesand judgments, see “Management’s Discussion and Analysis of Financial Conditionand Results of Operations - Critical Accounting Policies and Estimates” above.

**RisksRelating to our Intellectual Property Rights**

**Our patent protection for BiDil, the individualcomponents of which are available in generic form, is limited, and wemay be subject to generic substitution or competition and resultingpricing pressure.**

We have no composition of matter patent coveringBiDil, our product for the treatment of heart failure in self-identified blackpatients as an adjunct to current standard therapy. BiDil is a fixed-dosecombination of two individual components, isosorbide dinitrate and hydralazinehydrochloride, both of which are available in generic form, which are approvedand separately 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 hydralazinehydrochloride to reduce the incidence of mortality associated with chroniccongestive heart failure, expiring in 2007, and the others covering thetreatment of heart failure in black patients, expiring in 2020. As a practicalmatter, we may not be able to enforce these method-of-use patents toprevent physicians from prescribing isosorbide dinitrate and hydralazinehydrochloride separately for the treatment of heart failure in black patients,even though neither drug is approved for such use. We also may not be ableto enforce these method-of-use patents to prevent hospitals and pharmacies fromsupplying such patients with these individual components separately in lieu ofBiDil.

Other factors may also adversely affect ourpatent protection for BiDil. If we are successful in marketing BiDil,manufacturers of generic drugs will have an incentive to challenge our patentposition. The combination therapy of isosorbide dinitrate and hydralazinehydrochloride for use in heart failure was developed through lengthy,publicly-sponsored clinical trials conducted during the 1980s, prior to thefiling of the patent application that resulted in the 2007 patent. The U.S.Patent and Trademark Office, or U.S. patent office, considered publishedreports on these clinical trials and concluded that they did not constituteprior art that would prevent the issuance of the 2007 patent. The U.S. patentoffice also considered the question of whether the 2007 patent constitutedprior art with respect to the 2020 patents, and determined that the claims ofthe 2020 patents were non-obvious and patentable. A court considering thevalidity of the 2007 or 2020 patents with respect to questions of prior artmight be presented with other alleged prior art or might reach conclusionsdifferent than those reached by the U.S. patent office. If the 2007 or 2020patents were to be invalidated or if physicians were to prescribe isosorbidedinitrate and hydralazine hydrochloride separately for heart failure in blackpatients, our BiDil revenue could be significantly reduced, we could fail torecover the cost of developing BiDil and BiDil might not be a viable commercialproduct.

**If we are not able to obtain and enforce patentprotection for our discoveries, our ability to secure out-licensing orcollaborative arrangements with respect to our product candidates will beharmed, and we may not be able to operate our business profitably.**

Our success depends, in part, on our ability toprotect proprietary methods and technologies that we developed under the patentand other intellectual property laws of the United States and other countries,in order to prevent others from using our inventions and proprietaryinformation. Because certain United States patent applications are confidentialuntil patents issue, such as applications filed prior to November 29,2000, or applications filed after such date which will not be filed in foreigncountries, third parties may have filed patent 

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applications for technology covered by our pendingpatent applications without our being aware of those applications, and ourpatent applications may not have priority over patent applications ofothers.

Prior to the restructuring of our research anddevelopment activities, our intellectual property strategy depended on ourability to rapidly identify and seek patent protection for our discoveries.This process is expensive and time consuming, and we may not be able toprosecute all necessary or desirable patent applications or maintain all issuedpatents at a reasonable cost. Despite our efforts to protect our proprietaryrights, unauthorized parties may be able to obtain and use informationthat we regard as proprietary. The mere issuance of a patent does not guaranteethat it is valid or enforceable; even if we have obtained patents, theymay not be valid or enforceable against third parties.

The issued patents and patent applications for ourproduct candidates and nitric oxide technology include claims with respect toboth the composition of specific products or compounds and specific methods ofusing these products or compounds in therapeutic areas. In some cases, likeBiDil, our only patent protection is with respect to the method of using aproduct or compound, and we do not have patent claims covering the underlyingcomposition of the product or compound. Method-of-use patents may provideless protection for our product candidates and products because it may bemore difficult to prove direct infringement against a pharmaceuticalmanufacturer or distributor once they have gained approval for an alternativeindication. In addition, if any other company gains FDA approval for anindication separate from the one we or our potential strategic partners arepursuing and markets a product that we or our potential strategic partnersexpect to market under the protection of a method-of-use patent, physicianswill be able to prescribe that product for use in the indication for which weor our potential strategic partners have obtained approval, even though theproduct is not approved for such indication. As a practical matter, we or ourpotential strategic partners may not be able to enforce our method-of-usepatents against physicians prescribing products for such off-label use.Off-label use and any resulting off-label sales could make it more difficult toobtain the price we or our potential strategic partners would otherwise wish toachieve for, or to successfully commercialize, our products. In addition, inthose situations where we have only method-of-use patent coverage for a productcandidate, it may be more difficult to find a pharmaceutical companypartner to license or support development of our product candidate.

Our pending patent applications may not result inissued patents. The patent position of pharmaceutical or biotechnologycompanies, including ours, is generally uncertain and involves complex legaland factual considerations. The standards which the U.S. patent office and itsforeign counterparts use to grant patents are not always applied predictably oruniformly and can change over time. There is also no uniform, worldwide policyregarding the subject matter and scope of claims granted or allowable inpharmaceutical or biotechnology patents. Accordingly, we do not know the degreeof future protection for our proprietary rights or the breadth of claimsallowed in any patents issued to us or to others.

We also rely on trade secrets, know-how andtechnology, which are not protected by patents, to maintain our competitiveposition. If any trade secret, know-how or other technology not protected by apatent were to be disclosed to or independently developed by a competitor, ourbusiness and financial condition could be materially adversely affected.

**If we become involved in patent litigation orother proceedings to enforce our patent rights, we would incur substantialcosts and expenses, as well as substantial liability for damages, and/or we, orour strategic partners, could be required to stop product development andcommercialization efforts.**

A third party may sue us or our potentialstrategic partners for infringing on its patent rights. Likewise, we or ourpotential strategic partners may need to resort to litigation to enforce apatent issued to us or to determine the scope and validity of third-party proprietaryrights. The cost to us or our potential strategic partners of any litigation orother proceeding relating to intellectual property rights, even if resolved inour or our partner’s favor, could be substantial, and the litigation woulddivert management efforts. Some of our competitors may be able to sustainthe costs of complex patent litigation more effectively than we can becausethey have substantially greater resources. In addition, our strategy ofproviding nitric oxide-enhancing versions of existing products could lead tomore patent litigation due to the fact that the markets for these existingproducts are very large and competitive. Uncertainties resulting from theinitiation and continuation of any litigation could limit our ability tocontinue our operations.

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For example, we have filed an opposition in theEuropean Patent Office, or EPO, to revoke NicOx S.A.’s European PatentNo. 904 110, which we refer to as EP ’110. This patent is directed tothe use of organic compounds containing a nitrate group or inorganic compoundscontaining a nitric oxide group to reduce the toxicity caused by certain drugs,including non-steroidal anti-inflammatory drugs. The basis for our opposition,in part, is that the claims in EP ’110 are anticipated and thereforeinvalid if they are construed to cover a single compound chemically linked to anitrate moiety. While we believe that the claims in EP ’110 will beinvalidated, or be narrowed, we cannot predict with certainty the outcome ofthe opposition. If the EPO finds that there are valid claims in EP ’110that cover compounds chemically linked to nitrates, we may be adverselyaffected in our ability to market our product candidates for reducinggastrointestinal toxicity without first obtaining a license from NicOx, whichmay not be available on favorable terms, if at all.

If any parties are able to successfully claim that thecreation or use by us or our potential strategic partners of proprietarytechnologies infringes upon their intellectual property rights, we or ourpotential strategic partners might be forced to pay damages, potentiallyincluding treble damages, if we or our potential strategic partners are foundto have willfully infringed on such parties’ patent rights. In addition to anydamages we or our potential strategic partners might have to pay, a court couldrequire us or our potential strategic partners to stop the infringing activityor obtain a license on terms that are unfavorable to us. In addition, somelicenses may be non-exclusive, and therefore our competitors may haveaccess to the same technology licensed to us. If we or our potential strategicpartners fail to obtain a required license or are unable to design around apatent, we or our potential strategic partners 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 sufficient revenue to sustain our operations.

**We in-license a significant portion of ourprincipal proprietary technologies, and if we fail to comply with ourobligations under any of the related agreements, we could lose license rightsthat are necessary to commercializing BiDil and out-licensing our other productcandidates.**

We are a party to a number of licenses that give usrights to third-party intellectual property that are necessary for ourbusiness. In particular, we have obtained the exclusive right to develop andcommercialize BiDil pursuant to a license agreement with Dr. Jay N. Cohn,and some of our intellectual property rights relating to nitric oxide compoundshave been obtained pursuant to license agreements with the Brigham and Women’sHospital and Boston University. In addition, we may enter into additionallicenses in the future. These licenses impose various development,commercialization, funding, royalty, diligence, and other obligations on us. Ifwe breach these obligations, the licensor may have the right to terminatethe license or render the license non-exclusive, which would result in us beingunable to develop, manufacture and sell products that are covered by thelicensed technology.

**RisksRelating to our Industry**

**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 to various federal and state lawspertaining to healthcare fraud and abuse, including anti-kickback laws andphysician self-referral laws. Violations of these laws are punishable bycriminal and civil sanctions, including, in some instances, imprisonment andexclusion from participation in federal and state healthcare programs,including the Medicare, Medicaid and Veterans Administration health programs.Because of the far-reaching nature of these laws, we may be required toalter or discontinue one or more of our practices to be in compliance withthese laws. Healthcare fraud and abuse regulations are complex, and even minorirregularities can potentially give rise to claims that a statute orprohibition has been violated. Any violations of these laws, or any actionagainst us for violation of these laws, even if we successfully defend againstit, could result in a material adverse effect on our business, financialcondition and results of operations. If there is a change in law, regulation oradministrative or judicial interpretations, we may have to change ordiscontinue our business practices or our existing business practices could bechallenged as unlawful, which could have a material adverse effect on ourbusiness, financial condition and results of operations. 

In addition, we could become subject to false claimslitigation under federal statutes, which can lead to treble damages based onthe reimbursements by federal healthcare programs, civil money penalties(including 

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penalties levied on a per false claim basis),restitution, criminal fines and imprisonment, and exclusion from participationin Medicare, Medicaid and other federal and state healthcare programs. Thesefalse claims statutes include the False Claims Act, which allows any person tobring suit on behalf of the federal government alleging the submission of falseor fraudulent claims, or causing to present such false or fraudulent claims,under federal programs or contracts claims or other violations of the statuteand to share in any amounts paid by the entity to the government in fines orsettlement. These suits against biotechnology companies have increasedsignificantly in recent years and have increased the risk that a healthcarecompany will have to defend a false claim action, pay fines or restitution, orbe excluded from the Medicare, Medicaid or other federal and state healthcareprograms as a result of an investigation arising out of such action. It is possiblethat we could become subject to such litigation and, if we are not successfulin defending against it, such litigation would have a material adverse effecton our business, financial condition and results of operations. In addition,the cost of defending claims or allegations under the False Claims Act, even ifsuccessful, would also have a material adverse effect on our business,financial condition and results of operations.

**We face significant competition, whichmay result in others commercializing products more successfully than ours.**

The pharmaceutical industry is highly competitive andcharacterized by rapid and significant technological change. Our principalcompetitors in the markets we have targeted, including cardiovascular disease,are large, multinational pharmaceutical companies that have substantiallygreater financial and other resources than we do and are conducting extensiveresearch and development activities on technologies and product candidatessimilar to or competitive with ours. Many of our competitors are moreexperienced than we are in pharmaceutical development and commercialization,obtaining regulatory approvals and product marketing and manufacturing. As aresult, they may:

·                    develop andcommercialize products that render BiDil obsolete or non-competitive or thatcause our product candidates to be less desirable as a result of patent ornon-patent exclusivity;

·                    developproduct candidates and market products that are less expensive or moreeffective than BiDil;

·                    commercializecompeting products before our partners can launch any products developed fromour product candidates;

·                    initiate orwithstand substantial price competition more successfully than we can;

·                    have greatersuccess in recruiting skilled scientific workers from the limited pool ofavailable talent;

·                    moreeffectively negotiate third-party licenses and strategic relationships; and

·                    take advantageof product acquisition or other opportunities more readily than we can.

There are a number of companies currently marketingand selling products to treat heart failure in the general population that willcompete with BiDil. These include GlaxoSmithKline, plc, which currently marketsCoreg®, Merck & Co., Inc., which currently markets Vasotec® andAstra Zeneca, plc, which currently markets Toprol XL®.

We also face competition from other pharmaceuticalcompanies seeking to develop drugs using nitric oxide technology. For example,we are aware of at least seven companies working in the area of nitric oxidebased therapeutics.  These companies are:Angiogenix Inc., GB Therapeutics, NicOx S.A., OxoN Medica, RenoPharm,Vasopharm BIOTECH GmbH and Nitrox LLC.

**We may be exposed to product liability claimsand may not be able to obtain or maintain adequate product liabilityinsurance.**

Our business exposes us to the risk of productliability claims that is inherent in the manufacturing and 

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marketing of human therapeutic products. Ourcommercial product liability insurance is subject to deductibles and coveragelimitations. We may not be able to obtain or maintain insurance onacceptable terms, if at all. Moreover, any insurance that we do obtainmay not provide adequate protection against potential liabilities, and ourcapital resources could be depleted as a result.

**RisksRelating to our Common Stock**

**The price of our common stock is likely tocontinue to be volatile in the future.**

The stock market has from time to time experiencedsignificant price and volume fluctuations that may be unrelated to theoperating performance of particular companies. In particular, the market priceof our common stock, like that of the securities of other biopharmaceuticalcompanies, has been and may continue to be highly volatile. During theperiod from January 1, 2005 to September 30, 2006, our stock pricehas ranged from a low of $2.38 per share (on September 15, 2006) to a high of$27.99 per share (on February 2, 2005). The following factors, amongothers, may affect the price of our common stock:

·                   fluctuations inour financial results, including with respect to sales of BiDil;

·                   announcementsconcerning fundamental or material corporate transactions, restructuring or thelike;

·                   general marketconditions;

·                   announcementsof technological innovations or new commercial products by our competitors;

·                   announcementsof actual or potential medical results relating to products under developmentby our potential strategic partners or our competitors’ products;

·                   governmentalregulations and regulatory developments in both the U.S. and foreign countriesaffecting us or our competitors;

·                   disputesrelating to patents or other proprietary rights affecting us, our potentialstrategic partners or our competitors;

·                   public concernas to the safety of products developed by us, our potential strategic partnersor other biotechnology and pharmaceutical companies;

·                   fluctuations inprice and volume in the stock market in general, or in the trading of the stockof biopharmaceutical and biotechnology companies in particular, that areunrelated to our operating performance;

·                   issuances ofsecurities in equity, debt or other financings;

·                   sales of commonstock by existing stockholders; and

·                   the perceptionthat such issuances or sales could occur.

**Insiders have substantial control over us andcould delay or prevent a change in corporate control.**

As of October 30, 2006, our directors, executiveofficers and principal stockholders, together with their affiliates, owned, inthe aggregate, approximately 42.3% of our outstanding common stock. As aresult, these stockholders, if acting together, may have the ability todetermine the outcome of matters submitted to our stockholders for approval,including the election and removal of directors and any merger, consolidationor sale of all or substantially all of our assets. In addition, these persons,if acting together, will have the ability to control the management and affairsof our company. Accordingly, this concentration of ownership may harm themarket price of our common stock by:

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·                   delaying,deferring or preventing a change in control of our company;

·                   impeding amerger, consolidation, takeover or other business combination involving ourcompany; or

·                   discouraging apotential acquirer from making a tender offer or otherwise attempting to obtaincontrol of our company.

**Provisions in our charter documents and underDelaware law may prevent or frustrate attempts by stockholders to changecurrent management and hinder efforts to acquire a controlling interest in our company.**

Provisions of our restated certificate ofincorporation and bylaws may discourage, delay or prevent a merger,acquisition or other change in control that stockholders may considerfavorable, including transactions in which stockholders might otherwise receivea premium for their shares. These provisions may prevent or frustrateattempts by stockholders to replace or remove our current management. Theseprovisions include:

·                   a prohibitionon stockholder action through written consent;

·                   a requirementthat special meetings of stockholders be called only by a majority of the boardof directors, the chairman of the board or the chief executive officer;

·                   advance noticerequirements for stockholder proposals and nominations;

·                   limitations onthe ability of stockholders to amend, alter or repeal our certificate of incorporationor bylaws; and

·                   the authorityof the board of directors to issue preferred stock with such terms as the boardof directors may determine.

In addition, Section 203 of the Delaware GeneralCorporation Law prohibits a publicly held Delaware corporation from engaging ina business combination with an interested stockholder, generally defined as aperson or entity which together with its affiliates owns or within the lastthree years has owned 15% of our voting stock, for a period of three years afterthe date of the transaction in which the person became an interestedstockholder, unless the business combination is approved in a prescribedmanner. Accordingly, Section 203 may discourage, delay or prevent achange in control of our company.

**Substantially all of our outstanding common stockmay be sold into the market at any time. This could cause the market priceof our common stock to drop significantly.**

Sales of a substantial number of shares of our commonstock in the public market could occur at any time. These sales, or theperception in the market that the holders of a large number of shares intend tosell shares, could reduce the market price of our common stock. As of October30, 2006, there were 37,145,372 shares of common stock outstanding.Substantially all of these shares may also be resold in the public marketat any time. In addition, we have a significant number of shares that aresubject to outstanding options. The exercise of these options and thesubsequent sale of the underlying common stock could cause a further decline inour stock price. These sales also might make it difficult for us to sell equitysecurities in the future at a time and at a price that we deem appropriate.

**We may incur significant costs and suffermanagement distraction and reputational damage from class actionlitigation.**

Our stock price has been, and is likely to continue tobe, volatile. When the market price of a company’s stock is volatile, holdersof that company’s stock may bring securities class action litigationagainst the company that issued the stock. If any of our stockholders were tobring a lawsuit of this type against us, even if the lawsuit was without merit,we could incur substantial costs defending the lawsuit.

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**Item6.**                          Exhibits

See the Exhibit Index on thepage immediately preceding the exhibits for a list of exhibits filed aspart of this Quarterly Report on Form 10-Q, which Exhibit Indexis incorporated herein by this reference.

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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/ KENNETH M. BATE |
|                   |                | Kenneth M. Bate |
|                   |                | Chief Operating Officer, Chief Financial Officer,  Treasurer and Secretary *(Principal Financial  Officer)* |
| Date: November 2, 2006 | * *            | * * |

 

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**EXHIBIT INDEX**
| Exhibit  Number | ** ** | **Description** | ** ** |
|-----------------|------------|-----------------|------------|
|            | 10.1       |            |       | Amendment  No. 1 to NitroMed, Inc. Executive Severance Benefit Plan, filed as an  exhibit to NitroMed’s Current Report on Form 8-K (File  No. 000-50439) filed August 22, 2006 and incorporated herein by  reference |   |
|            |       |            |       |   |   |
|            | 10.2       |            |       | Form  of Amendment No. 1 to Agreement entered into by and between NitroMed, Inc.  and certain of its executive officers, together with a schedule of such  officers, filed as an exhibit to NitroMed’s Current Report on  Form 8-K (File No. 000-50439) filed August 22, 2006 and  incorporated herein by reference |   |
|            |       |            |       |   |   |
|            | 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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