**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**FORM 10-Q**

 

| **(Mark One)**                                                                                                                                                                |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                          |
| **ý**                                                                                                                                                                    | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                          |
| **For The Quarterly Period Ended March 31,  2006**                                                                                                                       |
|                                                                                                                                                                          |
| **or**                                                                                                                                                                        |
|                                                                                                                                                                          |
| **o**                                                                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                          |
| **For the Transition Period from              to             ** |
|                                                                                                                                                                          |
| **Commission File Number 000-50439**                                                                                                                                          |

 

**NitroMed, Inc.**

(Exact Name of Registrant as Specified in Its Charter)

 

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

 

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

 

Former Name, FormerAddress and Formal Fiscal Year, if Changed Since Last Report

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(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 ý     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” in Rule 12b-2of the Exchange Act.  (Check one):

 

| Large Accelerated Filer  o |   | Accelerated Filer  ý |   | Non-Accelerated Filer   o |
|--------------------------------------|--------|-------------------------------------|--------|-------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o     No  ý

 

As of April 28, 2006, theregistrant had 36,662,018 shares of Common Stock, $0.01 par value per share,outstanding.

 

 

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NITROMED, INC.

 

FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

 

**TABLE OF CONTENTS**

 
| PART I.       |   | FINANCIAL INFORMATION                                                                                   |   |   |
|--------------------|--------|---------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.            |   | Financial Statements                                                                                    |   |   |
|               |   | Condensed Balance Sheets as of March 31, 2006 and  December 31, 2005 (unaudited)              |   |   |
|               |   | Condensed Statements of Operations for the three months ended  March 31, 2006 and 2005 (unaudited) |   |   |
|               |   | Condensed Statements of Cash Flows for the three months ended  March 31, 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 |   |                                                                                                    |

 

2

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**PART I. FINANCIAL INFORMATION**

 

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

 

**NITROMED, INC.**

**CONDENSEDBALANCE SHEETS(in thousands, except par value amounts)**

 
| ** **                                                                                                                                                                  | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                                                                             |       |                     |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                  |       | $                        | 35,541     |                        | $          | 11,091 |   |
| Marketable  securities                                                                                                                                                      |       | 58,351                   |       | 50,450                      |       |
| Accounts  receivable                                                                                                                                                        |       | 702                      |       | 4,078                       |       |
| Inventories                                                                                                                                                                 |       | 3,156                    |       | 3,247                       |       |
| Prepaid  expenses and other current assets                                                                                                                                  |       | 3,320                    |       | 3,860                       |       |
| Total current assets                                                                                                                                                        |       | 101,070                  |       | 72,726                      |       |
| Property and equipment, net                                                                                                                                                 |       | 2,259                    |       | 2,992                       |       |
| Restricted cash                                                                                                                                                             |       | 802                      |       | 803                         |       |
|                                                                                                                                                                        |       |                     |       |                        |       |
| Total assets                                                                                                                                                                |       | $                        | 104,131    |                        | $          | 76,521 |   |
|                                                                                                                                                                        |       |                     |       |                        |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                               |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                                        |       |                     |       |                        |       |
| Accounts  payable                                                                                                                                                           |       | $                        | 9,646      |                        | $          | 11,810 |   |
| Accrued  expenses                                                                                                                                                           |       | 9,535                    |       | 11,269                      |       |
| Accrued  restructuring                                                                                                                                                      |       | 1,441                    |       | —                      |       |
| Deferred  revenue                                                                                                                                                           |       | 520                      |       | 3,451                       |       |
| Current  portion of long–term debt                                                                                                                                     |       | 6,429                    |       | 6,272                       |       |
|                                                                                                                                                                        |       |                     |       |                        |       |
| Total current liabilities                                                                                                                                                   |       | 27,571                   |       | 32,802                      |       |
|                                                                                                                                                                        |       |                     |       |                        |       |
| Long-term debt                                                                                                                                                              |       | 8,986                    |       | 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; 36,640 and 30,512 shares  issued and outstanding at March 31, 2006 and December 31, 2005,  respectively |       | 367                      |       | 305                         |       |
| Additional  paid-in capital                                                                                                                                                 |       | 335,623                  |       | 276,510                     |       |
| Deferred  stock-based compensation                                                                                                                                          |       | —                   |       | (1,208                      | )          |
| Accumulated  deficit                                                                                                                                                        |       | (268,395                 | )          | (242,471                    | )          |
| Accumulated  other comprehensive loss                                                                                                                                       |       | (21                      | )          | (70                         | )          |
| Total stockholders’ equity                                                                                                                                             |       | 67,574                   |       | 33,066                      |       |
|                                                                                                                                                                        |       |                     |       |                        |       |
| Total liabilities and stockholders’ equity                                                                                                                             |       | $                        | 104,131    |                        | $          | 76,521 |   |

 

See accompanying notes.

 

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**NITROMED, INC.**

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

 
| ** **                                                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Revenues:                                                             |       |                                   |       |   |   |
| Product  sales                                                        |       | $                                      | 2,316      |   | $ | — |   |
| Research and  development                                             |       | —                                 |       | 398 |   |
| Total revenues                                                        |       | 2,316                                  |       | 398 |   |
|                                                                  |       |                                   |       |   |   |
| Cost and operating expenses:                                          |       |                                   |       |   |   |
| Cost of  product sales                                                |       | 896                                    |       | — |   |
| Research and  development (1)                                         |       | 6,152                                  |       | 7,696 |   |
| Sales,  general and administrative (1)                                |       | 19,632                                 |       | 13,063 |   |
| Restructuring  charge                                                 |       | 2,038                                  |       | — |   |
| Total cost and operating expenses                                     |       | 28,718                                 |       | 20,759 |   |
| Loss from operations                                                  |       | (26,402                                | )          | (20,361 | ) |
| Non-operating income:                                                 |       |                                   |       |   |   |
| Interest  expense                                                     |       | (396                                   | )          | — |   |
| Interest  income                                                      |       | 874                                    |       | 772 |   |
|                                                                  |       | 478                                    |       | 772 |   |
|                                                                  |       |                                   |       |   |   |
| Net loss                                                              |       | $                                      | (25,924    | ) | $ | (19,589 | ) |
|                                                                  |       |                                   |       |   |   |
| Basic and  diluted net loss per common share                          |       | $                                      | (0.75      | ) | $ | (0.65 | ) |
| Shares used  in computing basic and diluted net loss per common share |       | 34,597                                 |       | 30,234 |   |

 

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(1)          Includes employee and non-employee stock-based compensation expense forthe three months ended March 31, 2006 and 2005 in the amounts of $1.7 million,and ($0.2) million, respectively.

 

See accompanying notes.

 

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**NITROMED, INC.**

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

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| **Operating activities**                                                     |       |                                   |       |   |   |
| Net loss                                                                     |       | $                                      | (25,924    | ) | $ | (19,589 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                   |       |   |   |
| Depreciation  and amortization                                               |       | 236                                    |       | 204 |   |
| Non-cash  restructuring charge                                               |       | 597                                    |       | — |   |
| Stock-based  compensation expense                                            |       | 1,734                                  |       | (207 | ) |
| Changes in  operating assets and liabilities:                                |       |                                   |       |   |   |
| Accounts  receivable                                                         |       | 3,376                                  |       | — |   |
| Inventories                                                                  |       | 91                                     |       | (2,719 | ) |
| Prepaid  expenses and other current assets                                   |       | 540                                    |       | (746 | ) |
| Deferred  revenue                                                            |       | (2,931                                 | )          | (398 | ) |
| Accounts  payable and accrued expenses                                       |       | (3,898                                 | )          | 6,222 |   |
| Accrued  restructuring charge                                                |       | 1,441                                  |       | — |   |
| Net cash used in operating activities                                        |       | (24,738                                | )          | (17,233 | ) |
| **Investing activities**                                                     |       |                                   |       |   |   |
| Purchases of property and equipment                                          |       | (100                                   | )          | (568 | ) |
| Purchases of marketable securities                                           |       | 24,375                                 |       | (45,965 | ) |
| Sales of marketable securities                                               |       | (32,227                                | )          | 46,745 |   |
| Other assets                                                                 |       | 1                                      |       | (4 | ) |
| Net cash provided by (used in) investing  activities                         |       | (7,951                                 | )          | 208 |   |
| **Financing activities**                                                     |       |                                   |       |   |   |
| Proceeds from sale of common stock                                           |       | 58,562                                 |       | — |   |
| Principal payments on long-term debt                                         |       | (1,510                                 | )          | — |   |
| Proceeds from employee stock plans                                           |       | 87                                     |       | 280 |   |
| Net cash provided by financing activities                                    |       | 57,139                                 |       | 280 |   |
| Net change in cash and cash equivalents                                      |       | 24,450                                 |       | (16,745 | ) |
| Cash and cash equivalents at beginning of  period                            |       | 11,091                                 |       | 35,882 |   |
| Cash and cash equivalents at end of period                                   |       | $                                      | 35,541     |   | $ | 19,137 |   |

 

See accompanying notes.

 

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**NITROMED, INC.**

**NOTESTO UNAUDITED FINANCIAL STATEMENTSMARCH 31, 2006**

** **

### **(1)**                                 Basis of Presentation

### ** **

The accompanyingunaudited financial statements of NitroMed, Inc. (“NitroMed” or the “Company”)have been prepared in accordance with accounting principles generally acceptedin the United States (“GAAP”) for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby GAAP for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary forthe fair presentation of the results for the interim periods have beenincluded. The preparation of financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Interim resultsare not necessarily indicative of results to be expected for the entire fiscalyear ending December 31, 2006. These unaudited financial statements shouldbe read in conjunction with the Company’s latest annual audited financialstatements and related 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 principalsource of revenue is the sale of BiDil® (isosorbidedinitrate/hydralazine hydrochloride), the Company’s product for the treatmentof heart failure in self-identified black patients as an adjunct to currentstandard therapies. BiDil was launched and began shipping in the third quarterof 2005. Other sources of revenue include collaboration revenue, which hasgenerally been recognized ratably over the research and developmentcollaboration term.

 

*ProductSales/Deferred Revenue.*The Company follows the provisions ofStaff Accounting Bulletin No. 104, *Revenue Recognition*and recognizes revenue from product sales upon delivery of product towholesalers or pharmacies, when persuasive evidence of an arrangement exists,the fee is fixed or determinable, title to product and associated risk of losshas passed to the wholesaler and collectability of the related receivable isreasonably assured. All revenues from product sales are recorded net ofapplicable allowances for sales returns, rebates, and discounts. Forarrangements where the risk of loss has not passed to wholesalers orpharmacies, the Company defers the recognition of revenue by recording deferredrevenue until such time that risk of loss has passed. In addition, the Companyevaluates the level of shipments to wholesalers and pharmacies on a quarterlybasis compared to the estimated level of inventory in the channel, remainingshelf-life of the product shipped and quarterly forecasted sales. As a resultof this evaluation, the Company deferred $2.1 million of revenue from December 2005 shipmentsand recorded this amount in deferred revenue as of December 31, 2005. Inthe first quarter of 2006, the Company reversed $1.4 million of this deferredrevenue and recognized $672,000 of revenue. The cost of BiDil associated withamounts recorded as deferred revenue are recorded in inventory until such timeas risk of loss has passed. As of March 31, 2006, the Company deferred $411,000related to shipments in the first quarter of 2006.

 

*SalesReturns, Allowances, Rebates and Discounts.  *The Company’sproduct sales are subject to returns, allowances, rebates and discounts thatare customary in the pharmaceutical industry. A large portion of the Company’sproduct sales are made to pharmaceutical wholesalers for further distributionthrough pharmacies to patients, who are consumers of the product. All revenuesfrom product sales are recorded net of applicable allowances for sales returns,wholesaler allowances, rebates and cash and contract discounts. The Companydetermines provisions for sales returns, allowances, rebates and discountsbased primarily on estimates and on contractual terms. In developing areasonable estimate for the reserve for product returns, the Company considersthe factors in paragraph 8 of Statement of Financial Accounting Standards(SFAS) No. 48, *Revenue Recognition When aRight of Return Exists*. Although the Company has not yet developedits own history of product returns because of the recent launch of BiDil, theCompany believes it has developed a reasonable estimate of returns. BiDil hascharacteristics that are similar to drugs for the broader heart failure market,such as similar channels of distribution, similar shelf lives and similarreturn rights. The Company has been able to verify through discussions withother pharmaceutical firms that promote and sell other heart failure drugs thatthe Company’s initial estimate of returns is reasonable in relation to productlaunch. The Company will continue to monitor actual returns as the Companygains more sales experience with BiDil.

 

*ProductReturns*.   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 quarter of 2006 had a shelf-life of twelve monthsfrom date of manufacture with expiration dates ranging from April 2006 to December 2006.Factors that are considered in the Company’s

 

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estimate of futureproduct returns include an analysis of the amount of product in the wholesalerand pharmacy channels, discussions with key wholesalers and other customersregarding inventory levels and shipment trends, review of consumer consumptiondata as reported by Source Projected Launchtrac, and Wolters Kluwer Health,return rates 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. For the three monthsended March 31, 2006, the Company recorded a reduction to revenue of$364,000 for product returns. At March 31, 2006, and December 31,2005 the Company’s product return reserve was $142,000 and $98,000, respectively.This reserve is evaluated on a quarterly basis, assessing each of the factorsdescribed above, and adjusted accordingly. Based on the factors noted above,the Company believes its estimate of product returns is reasonable, andchanges, if any, from this estimate would not have a material impact to theCompany’s financial statements.

 

*InitialTrade Shipments Incentive*.   During July  2005, the Company offeredcertain product stocking incentives to a number of wholesalers and pharmacycustomers. These incentives included units with guaranteed sales provisions andextended payment terms. As a result of these provisions, the Company concludedthat these sales were essentially consignment sales as the risk of loss ofthese units has not passed to the customer. Accordingly, the Company deferredall revenue related to these units until such time as the unit is provided to apatient with a prescription and $1.2 million was recorded as deferred revenueat December 31, 2005. At March 31, 2006, the Company had eitherrecognized the revenue related to these units, or the units had been returnedor estimated to be returned.

 

*CashIncentives*.   Duringthe third quarter of 2005, the Company offered certain additional incentives toa number 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 for the year ended December 31, 2005. Nocash incentives were offered during the three month period ended March 31,2006.

 

*SampleVoucher Program*.   Beginningin the 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* (EITF No. 01-09). These sample vouchers have 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 third quarter. The amount of reimbursement is recordedas a reduction to revenue. This program has been repeated quarterly. As aresult of this program, the Company recorded a reduction to revenue of $343,000for the three month period ended March 31, 2006. The Company expects tocontinue to offer sample voucher incentives in future periods.

 

*SalesDiscounts, Rebates and Allowances*.   Sales discounts, rebates and contractualallowances result primarily from sales under contract with healthcareproviders, wholesalers, Medicaid programs and other governmental agencies. TheCompany estimates rebates and contractual allowances, cash and contractdiscounts and other rebates by considering the following factors: currentcontract prices, terms, sales volume, estimated customer and wholesalerinventory levels and current average rebate rates. For the three month periodended March 31, 2006, the Company recorded cash discounts, rebates andother allowances of $397,000.

 

*CollaborationRevenue*.   TheCompany records collaboration revenue on an accrual basis as it is earned andwhen amounts are considered collectible. Revenues received in advance ofperformance obligations or in cases where the Company has a continuingobligation to perform services are deferred and recognized over thecontractual or estimated performance period. Revenues from milestone paymentsthat represent the culmination of a separate earnings process are recorded whenthe milestone is achieved. Contract revenues are recorded as the services areperformed. When the Company is required to defer revenue, the period over whichsuch revenue should be recognized is subject to estimates by management and may changeover the course of the collaborative agreement. The Company had no collaborationrevenue for the three month period ended March 31, 2006.

 

**(3)****                                 AccountsReceivable**

 

Accounts receivableconsists of amounts due from wholesalers and pharmacies for the purchase ofBiDil. Ongoing evaluations of customers are performed and collateral isgenerally not required. As of March 31, 2006, the Company has not reservedany amount 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 itsdistributors with payment terms of up to 30 days on purchases of BiDil. Amountspast due from customers are determined based on contractual payment terms.Through March 31, 2006, payments have generally been made in a timelymanner.

 

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**(4)****                                ****Inventories**

 

### **Inventories are stated at the lower of cost or market, withcost determined on a first-in, first-out basis. Inventories consisted of thefollowing (in thousands):**

### ** **

| ** **          | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials       |       | $                        | 2,474      |                        | $          | 2,599 |   |
| Finished goods      |       | 661                      |       | 481                         |       |
| Consigned inventory |       | 21                       |       | 167                         |       |
| Total               |       | $                        | 3,156      |                        | $          | 3,247 |   |

 

On a quarterly basis, the Company analyzesits current inventory levels and future irrevocable inventory purchasecommitments and writes down inventory that has become un-saleable, inventorythat has a cost basis in excess of its expected net realizable value and futureirrevocable inventory purchase commitments that are in excess of expectedfuture product sales. Expired inventory is disposed of, and the related costsare written off. For the three month period ended March 31, 2006, theCompany recorded an inventory impairment charge of $482,000 to cost of productsales related to commercial trade and patient sample inventory product inexcess of expected future inventory requirements based on the Company’s currentsales forecast.

 

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

### ** **

Effective January 1, 2006, the Companyadopted the fair value recognition provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 123(R),*Share-Based Payment* (“SFAS123R”), using the modified-prospective-transition method. Under thistransition method, compensation cost recognized for the first three months of 2006includes: (a) compensation cost for all stock-based payments granted, butnot yet vested as of January 1, 2006, based on the grant-date fair valueestimated in accordance with the original provisions of SFAS No. 123, *Accounting for Stock Based Compensation*, and (b) compensationcost for all stock-based payments granted subsequent to January 1, 2006,based on the grant-date fair value estimated in accordance with the provisionsof SFAS 123R. 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 EmergingIssues Task Force (“EITF”) No. 96-18, *Accounting forEquity Instruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services*. EITF 96-16requires that companies recognize compensation expense based on the estimatedfair value of options granted to non-employees over their vesting period, whichis generally the period during which services are rendered by suchnon-employees. The fair value of unvested non-employee stock awards isre-measured at each reporting period.

 

*StockOption Plans.*The Company’s Restated 1993 Equity IncentivePlan (the “1993 plan”) provided for the grant of incentive stock options,nonstatutory stock options and restricted stock awards to purchase up to2,288,200 shares of common stock. Officers, employees, directors, consultantsand advisors of the Company were eligible to be granted options under the 1993plan at a price not less than 100% (110% in the case of incentive stock optionsgranted to 10% or greater stockholders) of the fair market value of such stock,as determined by the Board of Directors, at the time the option is granted. In May 2003,the Company’s stockholders approved the 2003 Stock Incentive Plan (the “2003Plan”), under which 800,000 shares of common stock were authorized forissuance. In October 2003, the stockholders of the Company approved anamended and restated plan which provided, among other things, for an increaseof shares authorized for issuance under the 2003 Plan to 2,500,000. In May 2005,the stockholders of the Company approved an amended plan which provided for anincrease of shares authorized for issuance under the 2003 Plan to 3,600,000,and the adoption of a “evergreen provision” that allows for an annual increasein the number of shares of the Company’s common stock available for issuanceunder the 2003 Plan. The evergreen provision provides for an annual increase tobe added on the first day of each fiscal year of the Company during the periodbeginning in fiscal year 2006 and ending on the second day of fiscal year 2013,such increase to be equal to the lesser of (i) 1,400,000 shares of theCompany’s common stock, (ii) 4% of the outstanding shares on that date or (iii) anamount determined by the Company’s board of directors.

 

While the Company may grantoptions to employees, which become exercisable at different times or withindifferent periods, the Company generally has granted options to employees thatare exercisable in annual installments of 25% each on the first fouranniversary dates of the grant.

 

*Employee Stock Purchase Plan*   TheCompany also has an employee stock purchase plan (“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

 

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common stock at the beginning or end of each six month period duringthe term of the ESPP. The current offering period began January 1, 2006and is scheduled to end on June 30, 2006; therefore, January 1, 2006is considered the grant date for the purposes of recognizing the stock-basedcompensation expense for this offering period. Under Accounting PrinciplesBoard Opinion No. 25, *Accounting for StockIssued to Employees* (“APB 25”), the Company was not required torecognize stock-based compensation expense for the cost of stock options orshares issued under the Company’s ESPP. Upon adoption of SFAS 123R, the Companybegan recording stock-based compensation expense related to the ESPP.

 

As a result of the January 1, 2006 adoptionof SFAS 123R and stock compensation expense related to options granted tonon-employees, the Company recognized $1.7 million in stock based compensationexpense for the three months ended March 31, 2006.

 

The following table illustrates the effect onnet loss and net loss per share had the Company applied the fair valuerecognition provisions of SFAS 123R in the first quarter of 2005. For purposesof this pro-forma disclosure, the value of the options is estimated using aBlack-Scholes option-pricing model and amortized to expense over the options’vesting periods.

 
| ** **                                                                                   | ** ** | **Three Months  Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| **(in thousands, except per share amounts)**                                                 | ** ** | **March 31, 2005** | ** ** |
| Net loss as  reported                                                                        |       | $                       | (19,589    | ) |
| Add:  Stock-based employee compensation expense included in reported net loss                |       | 19                      |       |
| Deduct:  Stock-based employee compensation expense determined under fair value based  method |       | (1,082                  | )          |
| Pro forma  net loss                                                                          |       | $                       | (20,652    | ) |
|                                                                                         |       |                    |       |
| Basic and diluted net loss per share                                                         |       |                    |       |
| As reported                                                                                  |       | $                       | (0.65      | ) |
| Pro forma                                                                                    |       | $                       | (0.68      | ) |

 

The fair value of each stock award is estimated onthe grant date using the Black-Scholes option-pricing model based on theassumptions noted in the following table:

 
| ** **              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------|------------|----------------------------------------|------------|
| ** **              | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Volatility              |       | 73                                     | %          | 73 | % |
| Risk-free interest rate |       | 4.6                                    | %          | 4.1 | % |
| Expected life (years)   |       | 6.5                                    |       | 6.0 |   |
| Dividend                |       | None                                   |       | None |   |

 

Volatility is determined exclusively on historicalvolatility data of the Company’s common stock based on the period of time sincethe Company’s common stock has been publicly traded. The expected life of stockoptions granted is based exclusively on historical data and represents the weightedaverage period of time that stock options granted are expected to beoutstanding. The expected life is applied to one group as a whole as theCompany does not expect substantially different exercise or post-vestingtermination behavior amongst its employee population. The risk-free interest rate isbased on the U.S. Treasury yield curve in effect at the time of grantcommensurate with the expected life assumption.

 

The Company is using the straight-lineattribution method to recognize stock-based compensation expense. The amount ofstock-based compensation recognized during a period is based on the value ofthe portion of the awards that are ultimately expected to vest. SFAS 123Rrequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. The term “forfeitures” is distinct from “cancellations” or “expirations”and represents only the unvested portion of the surrendered option. The Companyhas applied an annual forfeiture rate of 4.4% to all unvested options as of March 31,2006. 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 shares that vest.

 

Using the Black-Scholes option-pricing model, theweighted average grant date fair values of options granted during the threemonths ended March 31, 2006 and 2005 were $6.59 and $14.53, respectively.For the three months ended March 31, 2005, the Company granted 62,100 instock options with a weighted average exercise price of $21.61.

 

9

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A summary of option activity under the Company’s2003 Plan as of March 31, 2006, and changes during the three month periodthen ended is presented below (in thousands, except weighted average data):

 
| ** **                            | ** ** | **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                               |       | 2,139                    |       | $                                      | 9.46       |                                                       |       |                            |       |   |
| Exercised                             |       | (37                      | )          | $                                      | 2.34       |                                                       |       |                            |       |   |
| Forfeited/Cancelled                   |       | (795                     | )          | $                                      | 13.21      |                                                       |       |                            |       |   |
| Outstanding at March 31, 2006    |       | 5,127                    |       | $                                      | 8.88       |                                                       | 7.47       |                            | $          | 10,072 |   |
| Exercisable at March 31, 2006    |       | 1,592                    |       | $                                      | 4.58       |                                                       | 3.40       |                            | $          | 7,882 |   |

 

During the three months ended March 31,2006, 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 $345,000 and the total amount of cash received fromexercise of these options was $87,000. The total grant-date fair value of stockoptions that vested during the three months ended March 31, 2006 wasapproximately $755,000.

 

As of March 31, 2006, there was $20.4 millionof total unrecognized compensation cost related to unvested share based awards.This cost is expected to be recognized over a weighted average period of 1.5years. The Company expects approximately 4,280,000 in unvested options to vestat some point in the future. Options expected to vest is calculated by applyingan estimated forfeiture rate to the unvested options.

 

**(6)**                                 Restructuring

** **

On March 31, 2006, the Company recordedcharges of $2.0 million for a restructuring of its discovery researchoperations that is intended to better align costs with revenue and operating expectations.The restructuring charges pertain to employee severance benefits and impairmentof assets. The restructuring charges were recorded in accordance withSFAS No. 146,*Accounting for CostsAssociated with Exit or Disposal Activities,* and SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets.*

 

In connection with the restructuring plan, theCompany terminated 30 employees from its discovery research group, or approximately30% of the Company’s workforce, resulting in a charge of $1.4 million, whichwas accrued as of March 31, 2006. None of these employees remainedemployed as of March 31, 2006.

 

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

 

**(7)**                                 AccumulatedOther Comprehensive Loss

** **

TheCompany presents comprehensive loss in accordance with SFAS No. 130, *Reporting Comprehensive Income*. Accumulated othercomprehensive income is comprised entirely of unrealized gains and losses onavailable-for-sale marketable securities. For the three months ended March 31,2006 and 2005, total comprehensive loss equaled $25,973,000 and $19,620,000respectively.

 

**(8)****                                 Saleof Common Stock**

 

On January 25, 2006,the Company completed a direct offering of shares of the Company’s common stockpreviously registered under an effective shelf registration statement. Pursuantto this offering, the Company sold approximately 6.1 million shares of theCompany’s common stock to selected institutional investors at a price of $10.25per share. Proceeds to the Company from this registered direct offering, net ofoffering expenses and placement agency fees, totaled $58.6 million.

 

10

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### **(9)**                                 Net Loss Per Share

### ** **

Basic net loss per shareis computed by dividing net loss available to common stockholders by theweighted average number of shares of common stock outstanding during theperiod. Diluted net loss per share is computed by dividing net loss availableto common stockholders by the weighted average number of shares of common stockand the dilutive potential common stock equivalents then outstanding. Potentialcommon stock equivalents consist of stock options and warrants. Since theCompany has a net loss for all periods presented, the effect of all potentiallydilutive securities is antidilutive. Accordingly, basic and diluted net lossper share are the same.

 

The following table setsforth the computation of basic and diluted net loss per share for therespective periods.

 
| ** **                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(in thousands, except per share amounts)**                       | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| *Basic and Diluted:*                                               |       |                                   |       |   |   |
| Net loss                                                           |       | $                                      | (25,924    | ) | $ | (19,589 | ) |
|                                                               |       |                                   |       |   |   |
| Weighted  average common shares used to compute net loss per share |       | 34,597                                 |       | 30,234 |   |
| Basic and diluted net loss per share                               |       | $                                      | (0.75      | ) | $ | (0.65 | ) |

 

### **As of March 31, 2006 and 2005, options to purchase 5,126,666and 3,156,449 shares of common stock, respectively, and warrants to purchase -0-and 13,861 shares of common stock, respectively, were not included in thecomputation of diluted net loss per share since their inclusion would beantidilutive.**

### ** **

### **(10)**                          Single Source Suppliers

### ** **

### **The Company currently obtains one of the key activepharmaceutical ingredients for its commercial requirements for BiDil from a singlesource. The disruption or termination of the supply of the commercialrequirement for BiDil or a significant increase in the cost of the key activepharmaceutical ingredient from this single source could have a material adverseeffect on the Company’s business, financial position and results of operations.**

### ** **

### **(11)**                          Concentration of Credit Risk

### ** **

SFAS No. 105, “Disclosure of Information aboutFinancial Instruments with Off-Balance-Sheet Risk and Financial Instrumentswith Concentrations of Credit Risk,” requires disclosure of any significantoff-balance-sheet and credit risk concentrations. The Company has nooff-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.

 

The following table summarizes the number of trade customersthat individually comprise greater than 10% of total revenues and theirrespective percentage of the Company’s total revenues. This table excludesrevenues from two collaboration agreements which the Company recognized as revenuesin 2005:

 
| ** **          | ** ** | **Number of  Significant** | ** ** | **Percentage of Total Revenues by  Customer** | ** ** |
|---------------------|------------|---------------------------------|------------|-----------------------------------------------|------------|
| ** **          | ** ** | **Customers**                   | ** ** | **A**                                         | ** ** | **B** | ** ** | **C** | ** ** |
| Three months ended: | ** ** | ** **                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| March 31, 2006 |       | 3                               |       | 35                                            | %          | 27 | % | 21 | % |

 

The following table summarizes the number ofcustomers that individually comprise greater than 10% of total accountsreceivable and their respective percentage of the Company’s total accountsreceivable:

 

11

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| ** **             | ** ** | **Number of  Significant** | ** ** | **Percentage  of Total Accounts Receivable by Customer** | ** ** |
|------------------------|------------|---------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **             | ** ** | **Customers**                   | ** ** | **A**                                                                             | ** ** | **B** | ** ** |
| As of:                 |       |                            |       |                                                                              |       |   |   |
| March 31, 2006    |       | 2                               |       | 37                                                                                | %          | 35 | % |
| December 31, 2005 |       | 2                               |       | 21                                                                                | %          | 59 | % |

 

To date, the Company has not written off anysignificant accounts receivable.

 

### **(12)**                          Long Term Debt

### ** **

OnJune 28, 2005, the Company borrowed (i) $10.0 million from OxfordFinance Corporation (“Oxford”), and (ii) $10.0 million from GeneralElectric Capital Corporation (“GECC”) pursuant to the terms of Promissory Notes(“the Notes”). The Notes bear interest at a fixed rate of 9.95% per annum andare payable in 36 consecutive monthly installments of principal and accruedinterest, beginning on July 1, 2005. Also on June 28, 2005, theCompany entered into Master Security Agreements with both Oxford and GECC (“theAgreements”). Under terms of these Agreements, the Company granted to bothOxford and GECC a security interest in and against all of the property of theCompany and in and against all additions, attachments, accessories andaccessions to such property, all substitutions, replacements or exchanges, andall insurance and/or other proceeds (“the Collateral”). The Collateralcomprises all of the Company’s personal property and fixtures including, butnot limited to, all inventory, equipment, fixtures, accounts, deposit accounts,documents, investment property, instruments, general intangibles, chattel paperand any and all proceeds (but excluding intellectual property). TheCollateral does not include any intellectual property or products (or interestsin any intellectual property or products (including any royalties)) acquired,whether by purchase, license or otherwise, on or after the execution of theAgreements (collectively, “New Property”), nor do the Agreements limit anyindebtedness secured by any New Property provided that debt ornon-cash equity (e.g., stock) is used to acquire NewProperty. In the event that the Company uses cash to purchase NewProperty, Oxford’s and GECC’s existing liens will extend to such New Property.The Agreements also contain a material adverse change clause with both Oxfordand GECC. Under this clause, if Oxford or GECC reasonably determines that theCompany’s ability to repay the Notes has been materially impaired, the Companywould be considered in default. As of March 31,2006, the Company was in compliance with this clause.

 

### **(13)**                          Commitments and Contingencies

### ** **

In connection with theCompany’s efforts to obtain the approval of BiDil from the FDA, the Companycontracted with the law firm of FoxKiser LLC (“FoxKiser”) for services relatedto the regulatory approval process for BiDil. The agreement provided forpayment of legal consulting fees upon receipt of written FDA approval of BiDil.In addition, 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. During the threemonth periods ended March 31, 2006 and 2005, the Company recorded chargesof $330,000 and $266,000, respectively, pertaining to the legal consulting feesrelated to these agreements. On June 23, 2005, the Company receivedwritten FDA approval of BiDil, and in July 2005, the Company paid $2.4million pursuant to the terms of these agreements.

 

An academic institutionhas asserted that patents and patent applications which relate to the nitricoxide stent program may require a license from such institution. It is theopinion of the Company’s management and outside legal counsel that the disputedintellectual property has been validly licensed to, or is validly owned by, theCompany. Accordingly, the accompanying financial statements do not include anyprovision related to this claim.

 

On July 20, 2004,the Market Regulation Department of the National Association of SecuritiesDealers, Inc. (“NASD”) advised the Company that it initiated a review oftrading activity in the Company’s common stock surrounding the Company’s July 19,2004 announcement that it had halted its phase III clinical trial of BiDil dueto the significant survival benefit seen with BiDil. The NASD is reviewing,among other things, information on relationships between the Company’sofficers, directors and service providers and individuals and institutions thatmay have traded in the Company’s common stock prior to the July 19,2004 announcement. The Company has cooperated with this review and hasidentified certain persons on the list provided to the Company by the NASD ashaving a relationship with the Company’s former chief executive officer andothers at the Company. The Company has established a special committee of itsboard of directors to oversee the Company’s response to this review. TheCompany is presently unable to predict the outcome of this matter or the timingof its resolution.

 

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In November 2004, asamended in May 2005, the Company executed an agreement with PublicisSelling Solutions, Inc. (“Publicis”), a contract sales organization,pursuant to which, on the Company’s behalf, Publicis has employed and trained aspecialty sales force currently consisting of approximately 144 salesrepresentatives to sell BiDil to the Company’s target prescriber markets. Theagreement is for a current term of 24 months beginning on January 31,2005, with the Company’s option to continue the agreement beyond this term. TheCompany recorded costs in 2005 of $29.8 million, excluding one-time start-upcosts, and projects costs in 2006 under the agreement to be approximately $24.3million. The Company has the right to terminate this agreement upon 90 dayswritten notice to Publicis. If the Company elects to terminate the agreement duringthe period between January 31, 2006 and July 31, 2006, the Companywill be required to pay a termination fee of $750,000. If the Companyterminates the agreement after July 31, 2006, Publicis is not eligible fora termination fee.

 

On February 16,2005, the Company engaged Schwarz Pharma Manufacturing, Inc. (“SchwarzPharma”) under a five-year exclusive manufacturing and supply agreement solelyfor the three times daily immediate release dosage formulation of BiDil. Underthe supply agreement, the Company has the right to engage a backup manufacturerbut to date has not elected to use this right. In connection with this supplyagreement, the Company placed binding purchase orders of $1.3 million and $1.3million for production of BiDil finished goods to occur during the second andthird quarter of 2006.

 

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

 

**Overview**

** **

We are an emergingpharmaceutical company with substantial expertise and intellectual property innitric oxide-based drug development. We have devoted substantially all of ourefforts towards the research and development of our product candidates and thecommercialization of our currently marketed product, BiDil®. Sinceour inception, we have mainly funded our operations through the sale of equitysecurities, debt financings, license fees, research and development funding,milestone payments from collaborative partners and, more recently, sales ofBiDil. We have never been profitable and have incurred an accumulated deficitof $268.4 million as of March 31, 2006.

 

In June 2005, the U.S. Food and Drug Administration, or FDA,approved our product, BiDil, for the treatment of heart failure in self-identifiedblack patients as an adjunct to current standard therapies. BiDil is an orally administered fixed-dosecombination of isosorbide dinitrate and hydralazine hydrochloride. We commercially launched BiDil in July 2005and generated product sales of $2.3 million during the first quarter of 2006. Wemarket BiDil to primary care physicians and cardiologists who treat AfricanAmericans with heart failure. Our sales and marketing organization is comprisedinternally of a senior vice president of sales and marketing, a senior vicepresident of sales, a vice president of marketing, three regional salesdirectors and fifteen district sales managers. In addition, we have anagreement with Publicis Selling Solutions pursuant to which, on our behalf,Publicis has employed and trained a specialty sales force currently consistingof 144 sales representatives to sell BiDil to our target prescriber markets. Wehave also engaged Schwarz Pharma under a five-year exclusive manufacturing andsupply agreement exclusively for the three times daily immediate release dosageformulation of BiDil.

 

We have also applied ournitric oxide technology to develop novel pharmaceuticals, as well as safer andmore effective versions of existing drugs, and to target significant diseasesthat are characterized by a deficiency in nitric oxide. In March 2006, werestructured our research and development operations, including the terminationof 30 employees in our discovery research group and recorded an impairmentcharge related to certain research laboratory equipment, computer equipment andfurniture and fixtures. We intend to focus on the continued development of bothan extended release formulation of BiDil, which we refer to as BiDil XR, as wellas- out-licensing of our nitric oxide-enhancing technology in exchange forpotential milestone payments and royalties on sales.

 

We expect that research, development andcommercialization expenses relating to our product candidates and to enhancingour core technologies will continue to decrease significantly in the near term.We also estimate that sales, general and administrative costs will continueto increase in connection with the commercialization of BiDil. Wecurrently estimate that our operating expenses related to research anddevelopment, and sales, general and administrative for the year ended December 31,2006, will be in the range of $95million to $110 million, excluding cost of product sales. At March 31,2006, our principal source of liquidity was $93.9 million of cash and cashequivalents and marketable securities. We believe that our existing sources ofliquidity and cash expected to be generated from future operations will besufficient to fund the current business plan for at least the next twelvemonths.

 

In the near-term, a key driver of our success willbe our ability to successfully commercialize and achieve market penetration of BiDil.We will need to generate significant revenues to achieve profitability. At thepresent time, we are unable to estimate the level of revenues that we willrealize from the sales of BiDil. We are therefore unable to estimate when wewill achieve profitability, if at all.

 

**Financial Operations Overview**

 

*Revenue.*Our first commercial product, BiDil, was launchedin July 2005, and generated product sales of $2.3 million in the first quarterof 2006. Prior to the launch of BiDil, all of our revenue had been derived fromlicense fees, research and development payments and milestone payments that wehave received from our corporate collaborators. In future years, we will seekto generate revenue from a combination of product sales, up-front fees,milestone and royalty payments in connection with collaborative or strategicrelationships, as well as royalties resulting from the out-licensing of ourintellectual property. We currently have no collaborative agreements andgenerated no revenue from collaborative agreements in the first quarter of2006. We expect that any collaborative revenue we generate in the future willfluctuate from quarter to quarter as a result of the timing and amount ofresearch and development, milestone and other payments received under ourcollaborative or strategic relationships and related continuing obligations, aswell as the timing and amount of revenue we recognize for the sale of our productcandidates, to the extent any are successfully commercialized.

 

14

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*Research and Development.*Research and development expense consists ofexpenses incurred in identifying, developing and testing product candidates.These expenses consist primarily of salaries and related expenses forpersonnel, fees paid to professional service providers for independentmonitoring and analysis of our clinical trials, costs of contract research andmanufacturing, costs of facilities and BiDil medical support costs.

 

The following summarizes our primary research anddevelopment programs. As a result of a restructuring in March 2006,we terminated substantially all of the employees in our discovery researchgroup and determined to limit our future internal development activities to thecontinued development of BiDil XR. We 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. Except as providedbelow, we have not provided cumulativeprogram costs to date because prior to 2000 we did not track and accumulatecost information by research program.

 

•*    BiDil.* From May 2001 to July 2004, we enrolled 1,050 patients at 169clinical sites in the United States in our phase III clinical trial for BiDil.We halted the trial in July 2004 due to a significant survival benefit inthe preliminary data for patients taking BiDil. The FDA approved BiDil on June 23,2005, and we launched BiDil in July 2005. The total cost for the BiDil A-HeFTtrial 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 an extendedrelease formulation of BiDil, which we refer to as BiDil XR, that could betaken either once or twice a day, depending on the particular formulation we pursue.Since inception to date we have incurred approximately $2.3 million on thedevelopment of BiDil XR. This product is currently in a pre-clinical stage ofdevelopment. Because of its stage of development, and the uncertaintiesinherent in pharmaceutical development generally, we may not be able tosuccessfully develop and commercialize BiDil XR. Moreover, we cannot reasonablyestimate or know the nature, timing and estimated costs of the effortsnecessary to complete the development of, or the period in which material cashinflows are expected to commence, if at all, for BiDil XR.

 

•    *Nitric Oxide-Enhancing**Cardiovascular Compounds*. We haveutilized our nitric oxide expertise and proprietary position to develop aproprietary nitric oxide-enhancing cardio-renal compound, referred to as NMI-3377.This product is currently in pre-clinical development. We have retained allcommercial rights to this product candidate and are currently seekingout-licensing and collaboration opportunities for this compound. Currently, wedo not intend to incur additional internal research and development expensesrelated to NMI-3377. Because this compound is in pre-clinical development, thesuccessful development of this product candidate is highly uncertain. Inaddition, we cannot be certain if we will be able to secure an out-licensing orcollaboration partner for this compound on favorable terms, if at all. As such,we are not able to estimate when material cash inflows from product sales,milestones and royalties could commence.

 

•    *Other Discovery Research*. We have used our know-how and expertise in nitric oxide to develop newchemical entities, or drugs, that are nitric oxide-enhancing versions ofexisting 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. Wecannot be certain if we will be able to secure out-licensing or collaborationpartners for these product candidates on favorable terms, if at all. As such,we are not able to estimate when material cash inflows from product sales,milestones and royalties could commence, if ever.

 

•    *Nitric Oxide Stents.* We formerly had a research agreement with Boston Scientific Corporation,or Boston Scientific, to develop cardiovascular stents enhanced with a bio-compatiblepolymer that is capable of releasing nitric oxide. The research program underthis agreement focused on pre-clinical development. In accordance with theterms of our agreement with Boston Scientific, the research term expired in December 2005.We intend to seek out-licensing and collaboration opportunities for theseproduct candidates, subject to the terms of our agreement with Boston Scientificand pending resolution of the ongoing rights of the parties with respect tothis technology. We cannot be certain if we will be able to secureout-licensing or collaboration partners for these product candidates onfavorable terms, if at all. Significant additional expenditures will berequired to conduct pre-clinical testing and to apply for, and conduct,clinical trials. We are not presently engaging in any internal research anddevelopment activities with respect to cardiovascular stents. Because thisprogram is in pre-clinical development, the successful development of productsbased upon this program is highly uncertain. As such, we are unable to estimatewhen material cash inflows from milestones and royalties could commence.

 

*Sales,**General and Administrative.*Sales, general and administrative expenseconsists primarily of salaries and other related costs for personnel in salesand marketing, executive, finance, investor relations, accounting, business

 

15

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developmentand human resource functions. Other costs include facility costs not otherwiseincluded in research and development expense; costs for public relations,advertising and promotion services; professional fees for legal and accountingservices; and costs related to our third party contract sales agreement withPublicis.

 

We have incurred, and expect to continue to incur,increased sales, general and administrative expense for investor relations andother activities associated with operating as a public company. We expect tocontinue to incur increased internal and external business development costs tosupport our various product development and out-licensing efforts, which canvary from period to period.

 

*Non-Operating Income.*Interest income includes interest earned onour cash, cash equivalents and marketable securities, and interest expenseassociated with our long-term debt.

 

*Boston Scientific Collaboration.*   InNovember 2001, we entered into a research, development and license agreementwith Boston Scientific in the field of restenosis. The research term of theBoston Scientific agreement expired on December 31, 2005, although certainrights extend beyond this term. In accordance with the terms of the agreement,we granted Boston Scientific an exclusive worldwide license to develop andcommercialize nitric oxide-enhancing cardiovascular stents. We also granted toBoston Scientific a right of first refusal to obtain an exclusive license underour nitric oxide technologies to commercialize products for restenosis, whichright of first refusal is for a period of three years after the end of theresearch term. In December 2003, we agreed to extend the agreement tocontinue the research and development collaboration through December 2005.Boston Scientific made an up-front license payment of $1.5 million to usin 2001, and made an additional payment of $3.0 million in December 2003in connection with the extension of the research and development collaboration.Boston Scientific also made a $3.5 million equity investment in our stockin 2001. In August 2003, in connection with a private placement, BostonScientific made an additional $500,000 equity investment in our stock.

 

**Results of Operations**

 

***ThreeMonths Ended March 31, 2006 and 2005***

** **

*Revenue.*Total revenue for the three months ended March 31, 2006was $2.3 million compared to $0.4 million for the three months ended March 31,2005.

 

Product sales of BiDilaccounted for all of the $2.3 million of revenue for the three month periodended March 31, 2006. We commercially launched BiDil in July 2005.There were no product sales for the three month period ended March 31, 2005.

 

We had no research anddevelopment revenue for the three month period ended March 31, 2006compared to $0.4 million of research and development revenue for the threemonth period ended March 31, 2005, due to the termination of the BostonScientific agreement in December 2005.

 

*Cost ofProduct Sale*s. Cost of product sales was $896,000 for thethree month period ended March 31, 2006. There were no cost of productsales for the three month period ended March 31, 2005. Cost of productsales for the three month period ended March 31, 2006 includes animpairment charge of commercial trade product and patient sample inventory of $482,000.

 

*Stock-basedCompensation Expense.*On January 1, 2006, weadopted the Statement of Financial Accounting Standards No. 123 (revised2004),*Share-Based Payment,* orSFAS 123R, using the modified prospective application method. Compensation costis calculated on the date of grant using the fair value of the options asdetermined by the Black-Scholes valuation model and is recognized ratably overthe employee’s service period.

 

Prior to the adoption of SFAS 123R, weaccounted for share-based payments to employees using the intrinsic valuemethod of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,and, as such, generally recognized no compensation cost for employee stockoptions. The adoption of SFAS 123R under the modified prospective applicationmethod allowed us to recognize compensation cost beginning with the effectivedate (a) based on the requirement of SFAS 123R for all share-basedpayments granted after the effective date and (b) based on therequirements of Statement of Financial Accounting Standards (SFAS) No. 123,*Accounting for Stock Based Compensation*(SFAS 123) for all awards granted to employees prior to the effective date ofSFAS 123R that remain unvested on the effective date. Under the modified prospectiveapplication method, prior periods are not restated for the effect of SFAS 123R.

 

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As a result of adopting SFAS 123(R) on January 1,2006, we recognized $1.7 million in stock based compensation expense for thethree months ended March 31, 2006.

 

As of March 31, 2006, the total unrecognizedcompensation cost related to unvested awards was approximately $20.4 million,which will be recognized over a weighted average period of 1.5 years.

 

*Researchand Development.*Research and development expense for thethree months ended March 31, 2006 was  $6.2 million compared to $7.7 million forthe three months ended March 31, 2005. The $1.5 million, or 19% decreasein research and development expenses in the current period was primarily due todecreases in medical expenditures supporting the commercial launch of BiDil andthe completion of the extended African American Heart Failure Trial (“XA-HeFT”)in December 2005, offset partially by increases in compensation expenserelated to SFAS 123R, and other stock based compensation expenses related tonon-employees.

 

The following tablesummarizes the primary components of our research and development expense forour principal research and development programs for the three month periodsended March 31, 2006 and 2005:

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| **Research and Development Program**             |       |                                   |       |   |   |
| BiDil                                            |       | $                                      | 3.3        |   | $ | 5.8 |   |
| BiDil XR                                         |       | 0.1                                    |       | — |   |
| Other discovery research                         |       | 1.1                                    |       | 0.4 |   |
| Nitric oxide-enhancing cardiovascular  compounds |       | 1.5                                    |       | 1.1 |   |
| Nitric oxide enhanced stents                     |       | 0.2                                    |       | 0.4 |   |
|                                             |       |                                   |       |   |   |
| Total research and development expense           |       | $                                      | 6.2        |   | $ | 7.7 |   |

 

*Sales,General and Administrative.*Sales, general and administrativeexpense for the three months ended March 31, 2006 was $19.6 millioncompared to $13.1 million for the three months ended March 31, 2005. The $6.5million, or 50% increase in sales, general and administrative expense wasprimarily due to $4.9 million in advertising and promotional expenses relatedto the commercialization of BiDil, including costs related to the contractsales force agreement with Publicis, and $1.3 million in compensation expensesrelated to SFAS 123R, and $722,000 of severance benefits related to thecessation of service on March 20, 2006 of our then President and ChiefExecutive Officer and then Chief Financial Officer, Chief Business Officer andTreasurer, partially offset by decreases in professional, sales training andmeeting fees.

 

*Restructuring charge*  On March 31, 2006, we recorded chargesof $2.0 million for a restructuring of our discovery research operations thatis intended to better align costs with revenue and operating expectations. Therestructuring charges pertain to employee severance benefits and impairment ofassets. The restructuring charges were recorded in accordance with SFAS No. 146,*Accounting for Costs Associated with Exit orDisposal Activities,* and SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-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 of March 31,2006.

 

As a result of terminating these employees werecorded an impairment charge for certain research laboratory equipment,computer equipment, and furniture and fixtures aggregating $597,000, for whichtheir future use is currently uncertain. These assets were written down totheir fair value utilizing a third party appraiser to estimate fair value basedon current market quotes and the current condition of the equipment, furnitureand fixtures.

 

*Non-OperatingIncome.*Non-operating income for the three months ended March 31,2006 was $478,000 compared to $772,000 for the three months ended March 31,2005. The $294,000, or 38% decrease, was primarily due to $396,000 in interestexpense incurred on long-term debt for the three months ended March 31,2006, partially offset by higher fund balances available for investment as aresult of the closing of our registered direct offering of common stock in January 2006.

 

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**Liquidityand Capital Resources**

** **

Since our inception, wehave primarily funded our operations through the sale of equity securities,debt financings, license fees, research and development funding, milestonepayments from our collaborative partners and, more recently, sales of BiDil. Asof March 31, 2006, we have received net proceeds of $321.9 million fromthe issuance of equity securities, primarily as the result of the sale of $99.1million of our redeemable convertible preferred stock, net proceeds of$60.1 million from our initial public offering in November 2003, netproceeds of $81.8 million from our follow-on public offering in December 2004,and net proceeds of $58.6 million from our registered direct offering in January 2006.At March 31, 2006, we had $93.9 million in cash, cash equivalents andmarketable securities.

 

During the three months ended March 31, 2006,operating activities used cash of $24.7 million, primarily due to a net loss of$25.9 million, and decreases in deferred revenue of $2.9 million, andaccounts payable and accrued expenses of $3.9 million, partially offset by adecrease in accounts receivable of $3.4 million. The changes in accountsreceivable and deferred revenue are primarily due to reversing approximately$2.4 million for product returns in the first quarter of 2006.

 

During the three months ended March 31, 2006,investing activities used cash of $8.0 million primarily due to net purchasesof marketable securities of $7.9 million.

 

During the three months ended March 31,2006, financing activities provided cash of $57.1 million due to $58.6 millionin proceeds from the sale of common stock in January 2006, offset bylong-term debt payments of $1.5 million.

 

On June 28, 2005, weborrowed (i) $10.0 million from Oxford Finance Corporation (Oxford) and (ii) $10.0million from General Electric Capital Corporation (GECC) pursuant to the terms ofpromissory notes made by us with both Oxford and GECC, respectively. The notesbear interest at a fixed rate of 9.95% per annum and are payable in 36consecutive monthly installments of principal and accrued interest, beginning July 1,2005. The notes are secured by a security interest in all our personal propertyand fixtures with the exception of any intellectual property or productsacquired, whether by purchase, license or otherwise, on or after the executionof the notes, provided that debt or non-cash equity is used to acquire the newproperty. The agreements that we entered into with each of Oxford and GECC inconnection with the notes also contain a material adverse change clause withboth Oxford and GECC. Under this clause, if Oxford or GECC reasonably determinethat our ability to repay the notes has been materially impaired, we would beconsidered in default. As of March 31,2006, we were in compliance with this clause.

 

On August 3, 2005, wefiled a registration statement utilizing a “shelf” registration process withthe Securities and Exchange Commission, or SEC. Under this shelf process, we may sellfrom time to time, in one or more offerings of common stock and debt securitiesup to a total dollar amount of $250 million. This shelf registration is morefully detailed in a Registration Statement on Form S-3 we filed with theSEC on August 3, 2005. On January 25, 2006, we completed adirect offering of shares of our common stock previously registered under oureffective shelf registration statement. Pursuant to this offering, we soldapproximately 6.1 million shares of our common stock to selected institutionalinvestors at a price of $10.25 per share. Proceeds to us from this registered directoffering, net of offering expenses and placement agency fees, totaled $58.6million.

 

*Contractual Obligations*

 

The following table summarizes our contractualobligations at March 31, 2006, and the effects such obligations areexpected to have on our liquidity and cash flows in future periods.

 
| **Contractual Obligations**        | ** ** | **Total**  | ** ** | **Less than  one year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  five years** | ** ** |
|------------------------------------|------------|------------|------------|-------------------------|------------|---------------|------------|---------------|------------|---------------------------|------------|
|                               |       |       |       |                    |       |          |       |          |       |                      |       |
| Operating lease obligation         |       | $          | 13,532,000 |                    | $          | 1,455,000     |       | $             | 3,010,000  |                      | $          | 3,299,000 |   | $ | 5,768,000 |   |
| Purchase obligations (1)           |       | 22,517,000 |       | 22,517,000              |       | —        |       | —        |       | —                    |       |
| Long term debt                     |       | 17,269,000 |       | 7,675,000               |       | 9,594,000     |       | —        |       | —                    |       |
| Total contractual cash obligations |       | $          | 53,318,000 |                    | $          | 31,647,000    |       | $             | 12,604,000 |                      | $          | 3,299,000 |   | $ | 5,768,000 |   |

 

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(1) On October 3, 2004, we entered into anagreement with Publicis, a contract sales organization, pursuant to which, onour behalf, Publicis has employed and trained a specialized cardiovascularsales force of approximately 144 sales representatives to sell BiDil to ourtarget prescriber markets. The agreement is for a term of 24 months, with ouroption to continue the agreement beyond this term. We have the right toterminate this agreement upon 90 days written notice to Publicis. If weterminate this agreement during months one through eighteen of the term of the

 

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agreement, we will be required to pay a terminationfee. If we terminate the agreement after month eighteen, no termination feewill be assessed. In December 2005 and January 2006, we placedbinding purchase orders in the approximate amount of $2.6 million with SchwarzPharma Manufacturing, Inc. for production of BiDil finished goods duringthe second and third quarters of 2006.

 

We believe that our existing sources ofliquidity and cash expected to be generated from future operations, will besufficient to fund the current business plan for at least the next twelvemonths, however, we may seek additional funding throughcollaborative arrangements and public or private financings. Additional fundingmay not be available to us on acceptable terms or at all. In addition, theterms of any financing may adversely affect the holdings or the rights ofour stockholders. For example, if we raise additional funds by issuing equitysecurities or convertible debt securities, further dilution to our existingstockholders may result. If we are unable to obtain funding on a timelybasis, we may be required to significantly curtail certain of our salesand marketing efforts. We also could be required to seek funds througharrangements with collaborators or others that may require us torelinquish rights to some of our technologies, product candidates or products.

 

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:

 

•                  thecosts of successfully commercializing BiDil;

 

•                  the magnitude of product sales of BiDil;

 

•                  ourability to establish and maintain out-licensing and collaborative arrangements;

 

•                  thetiming, receipt, and amount of royalties, milestone and other payments, if any,from potential collaborators;

 

•                  thetiming, receipt, and amount of milestone payments and royalties, if any, fromour potential product candidates;

 

•                  thetime and costs involved in obtaining regulatory approvals for BiDil XR, if atall;

 

•                  thecost of manufacturing, marketing and sales activities;

 

•                  the effect of competing technologicaland market developments;

 

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

 

•                  thecost of obtaining and maintaining licenses to use patented technologies.

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of our financialcondition and results of operations are based on our financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets and liabilities and the disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting periods. On an on-going basis, we evaluateour estimates and judgments, including those related to revenue and relatedreserves, accounts receivable, inventories, accrued expenses and the factorsused to determine the fair value assigned to our stock options. We base ourestimates on historical experience, known trends and events and various otherfactors that are believed to be reasonable under the circumstances, the resultsof which 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. The following represents the only material changes in ourjudgments or estimates during the first quarter of 2006. For a more detailedexplanation of the other judgments made in these areas, refer to Management’sDiscussion and Analysis of Financial Condition and Results of Operations withinour Annual Report on Form 10-K for the year ended December 31, 2005, whichis on file with the Securities and Exchange Commission, or SEC.

 

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***Stock-Based Compensation***.**  ** On January 1, 2006, we adopted the fair valuerecognition provisions of Statement of Financial Accounting Standards No. 123(R),*Share-Based Payment*, which we refer to as SFAS 123R,using the modified-prospective-transition method. Under that transition method,compensation cost recognized for the first three months of 2006 includes: (a) compensationcost for all 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 (SFAS) No. 123,*Accounting for Stock Based Compensation*,or SFAS 123, and (b) compensation cost for all stock-based paymentsgranted subsequent to January 1, 2006, based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123(R). Such amountshave been reduced by our estimate of forfeitures of all unvested awards.Results for prior periods have not been restated. For stock options granted tonon-employees, we recognize compensation expense in accordance with therequirements of Emerging Issues TaskForce, or EITF, No. 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services*. EITF 96-16requires that companies recognize compensation expense based on the estimatedfair value of options granted to non-employees over their vesting period, whichis generally the period during which services are rendered by suchnon-employees. The fair value of unvested stock awards granted to non-employeesis remeasured at each reporting period.

 

The fair value of each stock award is estimated onthe grant date using the Black-Scholes option-pricing model based onassumptions for volatility, risk-free interest rates, expected life of theoption, and dividends (if any). Expected volatility is determined exclusivelyon historical volatility data of our common stock based on the period of timesince our common stock has been publicly traded. The expected life of our stockoptions is based exclusively on our historical data and represents the periodof time that stock options granted are expected to be outstanding. Therisk-free interest rate is based on the U.S. Treasury yield curve ineffect at the time 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 No. 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 represents only theunvested portion of the surrendered option. We have applied an annualforfeiture rate of 4.4% to all unvested options as of March 31, 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.

 

**Inflation**

** **

We believe the effects of inflation generallydo not have a material adverse impact on our operations or financial condition.

 

**Off-Balance Sheet Arrangements**

** **

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, plansand objectives of management, other than statements of historical facts, areforward-looking statements. The words “anticipates,” “believes,” “estimates,” “expects,”“intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressionsare intended to identify forward-looking statements, although not allforward-looking statements contain these identifying words. We cannot guaranteethat we actually will achieve the plans, intentions or expectations disclosedin our forward-looking statements. There are a number of important factors thatcould cause actual results or events to differ materially from those disclosedin the forward-looking statements we make. These important factors include therisk factors set forth below under the caption “Risk Factors.” Although we may electto update forward-looking statements in the future, we specifically disclaimany obligation to do so, even if our estimates change, except asspecifically required by law or the rules of the Securities and ExchangeCommission, and readers shouldnot rely on those forward-looking statements as representing our views as ofany date subsequent to the date of this quarterly report.

 

**Item 3.****           Quantitative andQualitative Disclosures About Market Risk**

 

We are exposed to marketrisk related to changes in interest rates. Our current investment policy is tomaintain an investment portfolio consisting mainly of U.S. money market andhigh-grade corporate and U.S. government-related securities, directly orthrough managed funds, with average contractual maturities of less than twoyears. Our cash is deposited in and invested through highly rated financialinstitutions in North America. Our marketable securities are subject tointerest rate risk and will fall in value if market interest rates increase. Ifmarket interest rates were to increase immediately and uniformly by 10% fromlevels at March 31, 2006, we estimate that the fair value of ourinvestment portfolio would decline by an immaterial amount. We have the abilityto hold our fixed income investments until maturity, and therefore we do notexpect our operating results or cash flows to be affected to any significantdegree by the effect of a change in market interest rates on our investments.

 

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**Item 4.****           Controls and Procedures**

 

Our management, with theparticipation of our chief executive officer and chief financial officer,evaluated the effectiveness of our disclosure controls and procedures as of March 31,2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms. Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure.Management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives, and management necessarily applies its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of March 31, 2006,our chief executive officer and chief financial officer concluded that, as of suchdate, 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 March 31, 2006, that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II. OTHER INFORMATION**

 

**Item1A. Risk Factors**

 

You should carefully consider the following risk factors,in addition to other information included in this quarterly report on Form 10-Q,in evaluating NitroMed and our business. If any of the following risks occur,our business, financial condition and operating results could be materiallyadversely affected.

 

The following risk factors have been materiallyrevised to address the restructuring of our research and development operationsin March 2006 and supersede the risk factors previously disclosed inItem 1A. of our 2005 Annual Report on Form 10-K. For a furtherdiscussion of the restructuring, see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Overview.”

 

**Risks Relating to our Business**

 

**Ourbusiness is substantially dependent on the commercial success of BiDil, and ifsales of BiDil do not increase our business will be materially harmed and ourstock price will decline.**

 

On June 23, 2005,the FDA approved BiDil for the treatment of heart failure in self-identifiedblack patients as an adjunct to current standard therapy. We launched BiDil in July 2005and therefore have only recently begun to receive revenue from sales of BiDil.BiDil is currently our only commercial product, and we expect that it willaccount for all of our product sales and substantially all of our totalrevenues for the next several years. We face a number of significant risksrelating to our ability to successfully commercialize BiDil, including risksrelating to:

 

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

 

•                  our ability toeffectively and efficiently transition our contract field sales force toNitroMed and our ability to continue to increase the productivity of our salesforce;

 

•                  our ability toeffectively develop and/or contract for adequate marketing and manufacturingcapabilities;

 

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

 

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

 

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•                  the availabilityof substantial cash to fund our BiDil commercialization plans;

 

•                  competitivefactors, including the possibility of physicians prescribing the two lower costgeneric drugs that compose BiDil itself as a substitute for BiDil, and adverseeffects on pricing or reimbursement resulting from the possibility of thisgeneric substitution; and

 

•                  the variousother factors discussed in detail throughout this section titled “RisksFactors.”

 

In order for us tosuccessfully commercialize BiDil, our sales of BiDil must increasesignificantly from their current levels. If we fail to significantly increaseBiDil sales, our near-term ability to generate product revenue, our reputationand our ability to raise additional capital will be materially impaired, andthe value of an investment in our stock will decline.

 

**If we donot successfully market and sell BiDil, either directly or through third–partyco-promotion arrangements, our future revenue will be limited.**

 

We currently have limitedsales, marketing and distribution experience. We have launched BiDil in theUnited States ourselves, using a contract sales force. We transitioned to theuse of a smaller sales force during the first quarter of 2006, and we intend tointernalize this sales force during the second quarter of 2006. This transitioncould adversely affect our marketing of BiDil, and any adverse effect on BiDilsales will depress the value of our stock. In order to develop our internalsales force, we will have to invest significant amounts of money and managementresources. We could face a number of additional risks for BiDil, including:

 

•                    we may notbe able to effectively or efficiently transition our contract sales force toNitroMed or to attract, build and retain a significant and qualified marketingor sales force;

 

•                    the cost ofestablishing a marketing and sales force may not be justifiable in lightof the revenues generated by BiDil; and

 

•                    our directsales and marketing efforts may not be successful.

 

In order to expand ourmarketing reach for BiDil, we plan to pursue sales, marketing and distributionarrangements with third parties, including co-promotion arrangements. We may notbe able to successfully enter into sales, marketing and/or distributionagreements with third parties in the future, on terms that are favorable to us,if at all. In addition, we may have limited or no control over the sales,marketing and distribution activities of these third parties. Our futurerevenues for BiDil, if we rely on third-party sales, marketing and distributionsupport, will depend heavily on the success of the efforts of these thirdparties.

 

**Physicians,payors and patients may not be receptive to BiDil, which could prevent usfrom achieving and maintaining profitability.**

 

We currently market BiDilonly in the United States. Key participants in the U.S. pharmaceuticalmarketplace, such as physicians, payors and patients, may not accept aproduct intended to improve therapeutic results based on ethnicity. As aresult, it may be more difficult for us to convince the medical community,third-party payors and patients to accept and use BiDil. Our business issubstantially dependent on market acceptance of BiDil.

 

Other factors that webelieve will materially affect market acceptance of BiDil include:

 

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

 

•                   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 success ofour promotional programs;

 

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

 

•                   the ability toproduce BiDil at a competitive price; and

 

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•                   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.

 

**We willrequire substantial additional cash to fund our operating plan, includingcommercializing BiDil, and, if additional capital is not available, we may needto limit, scale back or cease our operations.**

 

We have used and will continue to requiresubstantial funds to sell, market and manufacture BiDil, which was commerciallylaunched in July 2005. We expect that we will incur significant expensesduring 2006 and beyond relating to manufacturing, sales and marketing of BiDil.Because the successful commercialization of BiDil, and the timing of when wemight receive significant revenue from BiDil, if at all, is uncertain, we areunable to estimate the actual funds we will require to commercialize BiDil. Webelieve that our existing sources of liquidity and cash expected to begenerated from future operations, will be sufficient to fund the currentbusiness plan for at least the next twelve months.

 

However, our futurecapital requirements, and the period in which we expect our current cash tosupport our operations, may vary from what we expect due to a number offactors, including the following:

 

•                    the cost ofsuccessfully commercializing BiDil;

 

•                    the magnitudeof product sales of BiDil;

 

•                    our ability toestablish and maintain out-licensing and collaborative arrangements;

 

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

 

•                    the timing,receipt and amount of milestone payments and royalties, if any, from ourpotential product candidates;

 

•                    the time andcosts involved in obtaining regulatory approvals for BiDil XR, if at all;

 

•                    the cost ofmanufacturing, marketing and sales activities;

 

•                    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 be requiredto seek additional funding in the future and may seek to do so throughcollaborative arrangements and/or public or private financings. Additionalfinancing may not be available to us on acceptable terms, or at all. Inaddition, the terms of the financing may adversely affect the holdings orthe rights of our stockholders. For example, if we raise additional funds byissuing equity securities, further dilution to our then-existing stockholderswill result. If we are unable to obtain funding on a timely basis, we may berequired to significantly curtail our marketing efforts for BiDil. We alsocould be required to seek funds through arrangements with collaborators orothers that may require us to relinquish rights to some of ourtechnologies, product candidates or products.

 

**Poorperformance by our contract sales organization or difficulties arising in ourplanned transition to an internal sales force could prevent us from achievingthe significant growth we need to achieve in BiDil revenues.**

 

We have an agreement withPublicis, a contract sales organization, pursuant to which, on our behalf,Publicis has employed and trained a specialty sales force currently consistingof 144 sales representatives, to sell BiDil to our target prescriber markets.Under separate agreements, Publicis has recruited, hired and trained sevenaccount executives and one national director, who are dedicated to NitroMed ona non-exclusive basis, who assist us in gaining formulary access for BiDil andhas hired six medical science liaisons to report into our medical affairsgroup. Our near-term revenue for BiDil will depend heavily upon the efforts andsuccess of Publicis. If Publicis does not devote the resources, time andtraining required to establish, manage and maintain an effective and qualifiedsales force, our ability to achieve revenue from sales of BiDil will be harmed.

 

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We intend to transitionthe contract sales representatives to NitroMed during the second quarter of2006. We may not be able to effectively or efficiently complete thistransition. Any failure to transition our current contract salesrepresentatives, or election by us not to transition certain of theserepresentatives, to NitroMed, will result in the need to recruit and train newsales representatives to cover our revised sales territories. We may notbe able to successfully recruit and train new sales representatives, and theefforts to do so will result in additional costs and expenses related to oursales efforts. In addition, we have recently elected to reduce the number ofsales territories in which we have sales representation. Any failure toadequately cover our current sales territories, or to cover through alternativemarketing efforts the territories in which we have elected not to have salesrepresentation, may result in reduced sales productivity and loss ofrevenue related to BiDil.

 

**Currently,we are engaging in limited internal research and development activities and,accordingly, our ability to generate future revenue from our nitric oxidetechnology portfolio is completely dependent on our ability to enter intoout-licensing or collaborative arrangements with third parties.**

 

At the end of the firstquarter of 2006, we announced that we were scaling back our research anddevelopment staff in a restructuring of our Company. We have limited ourinternal research and development activities to the continued development of anextended release formulation of BiDil, which we refer to as BiDil XR. We arecurrently seeking out-licensing and collaboration opportunities for our otherpotential product candidates based on our proprietary nitric oxide technology,including NMI-3377, a late-stage pre-clinical cardio-renal compound. We may notbe able to secure out-licensing or collaboration partners for these potentialproduct candidates. The application of our proprietary nitric oxide technologyis unproven in humans and, as a result, we may not be able to successfullyout-license any products based on this technology. Our product candidates includenitric oxide enhancements of existing drugs. Thus, we are modifying compoundswhose chemical and pharmacological profiles are well-documented and understood.However, many of our potential product candidates are new molecules withchemical and pharmacological profiles that differ from that of the existingdrugs. These compounds may not demonstrate in patients the chemical andpharmacological properties shown in laboratory studies, and they may interactwith human biological systems in unforeseen, ineffective or harmful ways. Inaddition, it is possible that existing drugs or newly-discovered drugs may notbenefit from the application of our nitric oxide technology. If we are not ableto successfully secure strategic partners to develop and commercialize drugsbased upon our technology, we will not be able to generate revenue from thistechnology.

 

In addition, even if weare successful in entering into out-licensing or collaborative arrangementswith respect to our potential product candidates, we have no assurance that wewill be able to secure such arrangements on favorable terms. If ourout-licensing or collaboration arrangements include unfavorable financialterms, our ability to generate revenue from our technology portfolio will beseverely limited. In addition, even if we are able to enter into such strategictransactions, our ability to generate revenue from these arrangements will besubstantially dependent on the efforts and success of our collaborativepartners. Our potential strategic partners may not be successful indeveloping and commercializing any products based on our proprietary nitricoxide technology. Any failure of such potential partners at any stage of thedevelopment or commercialization process with respect to our potential productcandidates would significantly reduce the possibility that we would realize anyfuture revenue from our technology portfolio.

 

**Anyfuture out-licensing or collaborative arrangements that we seek to enter intowith third parties may not be scientifically or commercially successful.**

 

Factors that may affectthe success of our 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

 

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•                    our futurelicensing partners or collaborators may pursue higher-priority programs orchange the focus of their development programs, which could affect the partners’commitment to us.

 

**Becausewe have a history of losses and our future profitability is uncertain, ourcommon stock is a highly speculative investment.**

 

We have experiencedsignificant operating losses since our inception in 1992. For the three monthsended March 31, 2006, we had a net loss of $25.9 million. As of March 31,2006, we had an accumulated deficit of $268.4 million. We expect that wewill continue to incur substantial losses and that our cumulative losses willincrease as our commercialization efforts continue. We expect that the lossesthat we incur will fluctuate from quarter to quarter and that thesefluctuations may be substantial.

 

A large portion of ourexpenses is fixed, including expenses related to facilities, equipment andpersonnel. We have spent significant amounts to launch our first product,BiDil, and we expect to incur significant operating expenses in connection withour ongoing commercialization activities related to BiDil. We received approvalfor BiDil from the FDA on June 23, 2005, and launched commercial sales ofBiDil in July 2005. We have also spent significant amounts to fundresearch, development and commercialization of our product candidates and toenhance our core technologies. Currently, our research and developmentactivities are limited to the continued development BiDil XR. We are notengaging in any internal research and development activities with respect toother potential product candidates and, therefore, do not expect to incursubstantial research and development expenses in the near term. Although wecurrently estimate that our operating expenses will decrease during fiscal year2006, we will still need to generate significant revenue to achieveprofitability. We are currently unable to estimate the level of revenues thatwe will realize from the commercialization of BiDil. We are therefore unable toestimate when we will achieve profitability, if at all. Even if we do achieveprofitability, we may not be able to sustain or increase profitability ona quarterly or annual basis. Our failure to become and remain profitable coulddepress the market price of our common stock and could impair our ability toraise capital or continue our operations.

 

Our BiDil productrevenues have been and will continue to be subject to considerable variationdue to volatility in prescription volume, the manner in which we account forproduct sales considering product returns rates, the level of purchases byindividual customers and other matters related to the commercialization of thisproduct. We have experienced and are likely to continue to experience significantrevenue deferrals and product returns, as well as additional charges andexpenses associated with stocking incentives, other promotional incentives, andother matters related to the commercialization of this product. Significantinventory adjustments may also occur due to the 12-month shelf life ofBiDil, sales forecast variances, or other factors. Any deferrals, returns oradjustments that negatively impact revenue, or our failure, for this or anyother reason, to generate significant near-term revenue growth, would depressour stock price and adversely affect our ability to raise capital.

 

**Theavailability of lower priced generic substitutes for BiDil may adverselyaffect our sales of BiDil and the pricing or reimbursement we are able toobtain for BiDil.**

 

BiDil is a fixed-dosedcombination of two generic drugs, which are approved and separately marketed,in dosages similar to those we include in BiDil, at prices substantially belowthe prices we are charging for BiDil. While neither of these two generic drugsis approved for the treatment of heart failure, as a practical matter it may beimpossible for us to prevent physicians from prescribing a combination of thesetwo, lower cost generic drugs as a substitute for prescribing BiDil. Ifsubstantial numbers of physicians prescribe the combination of these twogeneric drugs, rather than BiDil, we could fail to achieve the sales of BiDilnecessary for successful commercialization which would severely limit ourability to generate revenue from the sales of BiDil. Our ability to generaterevenue could also be limited if potential large purchasers of BiDil such ashospitals or health maintenance organizations require the substitution of thesegeneric drugs for BiDil, or if state formularies or other government agenciesor private payors that approve reimbursement for drugs require suchsubstitution, or if the availability of these generic drugs reduces the priceor reimbursement amounts we are able to achieve for BiDil.

 

**We may nothave the technology internally to successfully develop BiDil XR and we may notbe able to acquire such technology on favorable terms, if at all.**

 

Although we intend topursue the development of an extended release formulation of BiDil, calledBiDil XR, to be taken either once or twice a day, we do not currently have thetechnology internally to pursue this development on our own. The technologyunderlying extended release formulations of pharmaceutical products is highlyproprietary and would take years and the expenditure of significant amounts ofcapital to develop by us. If we are unable to find extended release technologyfrom a third party which is compatible for use with BiDil, we would beprevented from pursuing the development of BiDil XR. Even if we are able toidentify compatible extended release technology, we may not be able toacquire rights to

 

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such technology onfavorable terms, if at all. In addition, even if we are successful in acquiringsuch rights, we may be required to forfeit certain rights to our BiDil XRproduct to the owner of such technology, thereby reducing our future potentialrevenue from commercialization of this product.

 

**If thethird-party manufacturer of BiDil encounters delays or difficulties inproduction, we may not be able to meet demand for the product, and we may losepotential revenue.**

 

We do not manufactureBiDil and have no plans to do so. We have engaged Schwarz Pharma Manufacturing,under a five-year exclusive manufacture and supply agreement solely for thethree times daily immediate release dosage formulation of BiDil. Under thesupply agreement, we have the right to engage a backup manufacturer but do notcurrently have any backup manufacturing agreement in place. The terms of thesupply agreement provide that it may be terminated by either us or SchwarzPharma under specified circumstances, including a material breach of the supplyagreement by either party, the occurrence of a payment default by us, ourmaterial impairment of the manufacturing licenses we have granted to SchwarzPharma 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 prohibit the manufacture,sale or use of the product. If we are unable to maintain a commerciallyreasonable manufacturing agreement for the production of BiDil with SchwarzPharma, we may not be able to successfully commercialize BiDil and ourstock price may decline.

 

Furthermore, SchwarzPharma may encounter difficulties in production. These problems may include,but are not limited to:

 

•                    difficultieswith production costs and yields;

 

•                    qualitycontrol and assurance;

 

•                    difficultiesobtaining ingredients for our products;

 

•                    shortages ofqualified personnel;

 

•                    compliancewith strictly enforced federal, state and foreign regulations; and

 

•                    lack ofcapital funding.

 

The number of third-partymanufacturers with the manufacturing and regulatory expertise and facilitiesnecessary to manufacture finished products for us on a commercial scale islimited, and it would take a significant amount of time to arrange, qualify,and receive necessary regulatory approval for alternative arrangements. We may notbe able to contract for alternative manufacturing on acceptable terms, if atall.

 

Any of these factorscould increase our costs and result in our inability to effectivelycommercialize BiDil. Furthermore, 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, we may beunable to meet the demand for our product, and we may lose potentialrevenues.

 

**Thedevelopment and commercialization of BiDil XR may be terminated ordelayed, and the cost of development and commercialization may increase,if third parties on whom we rely to manufacture BiDil XR do not fulfill theirobligations.**

 

We do not havemanufacturing capabilities and have no current plans to develop any suchcapacity in the future. In order to continue to develop BiDil XR, apply forregulatory approvals and commercialize this product, we plan to rely on thirdparties for the production of clinical and commercial quantities of BiDil XR.We may not be able to secure a third-party manufacturer for BiDil XR oncommercially favorable terms, if at all. In addition, contract manufacturersare subject to ongoing periodic, unannounced inspection by the FDA andcorresponding state and foreign agencies or their designees to ensure strictcompliance with current Good Manufacturing Practices, or cGMP, and othergovernmental regulations and corresponding foreign standards. The cGMPrequirements govern quality control of the manufacturing process and documentationof policies and procedures. Other than through contract, we do not have controlover compliance by our contract manufacturers with these regulations andstandards. Our present or future contract manufacturers may not be able tocomply with cGMPs and other FDA requirements or similar regulatory requirementsoutside the United States. Failure of our contract manufacturers to comply withapplicable regulations could result in sanctions being imposed on us in somecases, including fines, injunctions, failure of regulatory authorities to grantmarketing approval of our product candidate, delays, suspension or withdrawalof approvals, seizures or recalls of such product candidate, operatingrestrictions, and criminal

 

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prosecutions, anyof which could significantly and adversely affect our business. We will dependupon these third parties to perform their obligations in a timely mannerand in accordance with applicable laws and regulations. If we fail to secure athird-party manufacturer on commercially favorable terms, or to the extent thatthird-party manufacturers with whom we contract fail to perform theirobligations in accordance with applicable laws and regulations, we may beadversely affected in a number of ways, including:

 

•                    we may notbe able to initiate or continue clinical trials of BiDil XR;

 

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

 

•                    we may berequired to cease distribution and/or recall some or all batches of ourproducts; and

 

•                    we may notbe able to meet commercial demands for our products or achieve profitability.

 

**We relyon a single source supplier for one of the two active ingredients in BiDil, andthe loss of this supplier could prevent us from selling BiDil, which wouldmaterially harm our business.**

 

We rely on Sumitomo Corp.for our supply of hydralazine hydrochloride, one of the two active ingredientsin BiDil. Sumitomo is currently the only supplier of hydralazine hydrochlorideworldwide. We do not have any agreement with Sumitomo regarding the supply ofhydralazine hydrochloride. If Sumitomo stops manufacturing or is unable tomanufacture hydralazine hydrochloride, or if we are unable to procurehydralazine hydrochloride 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 hydralazinehydrochloride, Sumitomo has unilateral control over the price of hydralazinehydrochloride. Any increase in the price for hydralazine hydrochloride may reduceour gross margins and adversely affect our ability to achieve profitability.

 

**If ourcollaborative partners do not obtain and maintain the regulatory approvalsrequired to market and sell our potential product candidates in the UnitedStates, then our business will be unsuccessful, and the market price of ourstock will substantially decline.**

 

We are currently seekingout-licensing and collaboration opportunities for our potential productcandidates based on our proprietary nitric oxide technology, includingNMI-3377, a late-stage pre-clinical cardio-renal compound. Our partners willnot be able to market any of our potential 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:

 

•                    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 toobtain market approval for a new drug takes many years and requiresexpenditures of substantial resources. There can be no assurance that ourstrategic partners will be successful in obtaining FDA approval for ourpotential product candidates. If our strategic partners do not receive requiredregulatory approval or clearance to market any of our potential productcandidates, these partners will not be able to develop and commercialize theseproduct

 

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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 collaborators may notbe able to obtain the necessary regulatory approvals in order to market andsell BiDil, or our product candidates, in foreign countries.**

 

Our marketing approval for BiDil is limitedto the United States. Until we or our marketing partners obtain therequired regulatory approvals for BiDil or any potential product candidates inany specific foreign country, neither we nor our marketing partners will beable to sell these products in that country. International regulatoryauthorities have imposed numerous and varying regulatory requirements, and theapproval procedures could involve testing in addition to that required by theFDA. Furthermore, approval by one regulatory authority does not ensure approvalby any 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 any other of our potential product candidates, in foreign countries. Anyfailure to obtain the necessary governmental approvals or failure to obtainapprovals of the scope requested could delay, and may preclude us or ourlicensees or other collaborators from marketing BiDil or our product candidatesor limit the commercial use of BiDil or our product candidates in these foreignjurisdictions. Alternatively, foreign regulatory approvals may entaillimitations on the indicated uses of BiDil or our product candidates and imposelabeling requirements which may also adversely impact our ability tomarket BiDil or our product candidates.

 

**Even ifour strategic partners obtain regulatory approvals, our marketed products,including BiDil, will be subject to ongoing regulatory review. If we, or our strategicpartners, fail to comply with continuing United States and foreign regulations,we could lose our approvals to market BiDil, and our strategic partners couldlose approvals to market our out-licensed products based on our proprietarynitric oxide technology and our business would be seriously harmed.**

 

Even after approval, anyproducts we or our potential strategic partners develop will be subject toongoing regulatory review and restrictions, including the review of clinicalresults which are reported after such products are made commercially available,and restrictions on the indications for which we or our potential strategicpartners can market the product. The FDA can propose to withdraw approval ifnew clinical data or experience shows that a product is not safe for use underthe approved conditions 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 our potential strategic partners arepermitted to make in labeling or advertising regarding our marketed productsare limited to those specified in any FDA approval.

 

For example, becauseBiDil is specifically approved for labeling for self-identified black patients,we may not promote BiDil for use in other patient populations. For BiDil,we must submit copies of our advertisements and promotional labeling,including, for example, professional journal advertisements, website pages,professional direct mailers, direct-to-consumer advertisements, conventionbooth panels and handouts, to the FDA at the time of initial publication ordissemination. If the FDA believes these materials or statements made by 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, themanufacturer and manufacturing facilities we use to produce BiDil, or that ourpotential strategic partners may use to produce product candidates basedon our nitric oxide technology, are subject to periodic review and inspectionby the FDA. We or our potential strategic partners will be required to reportany serious and unexpected adverse experiences and certain quality problemswith BiDil or the respective product candidate and make other periodic reportsto the FDA. The discovery of any previously unknown problems with a product,manufacturer or facility may result in restrictions on the product ormanufacturer or facility, including withdrawal of the product from the market.Certain changes to an approved product, including the way it is manufactured orpromoted, often require prior FDA approval before the product as modified may bemarketed. If we or our potential strategic partners fail to comply withapplicable continuing

 

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regulatoryrequirements, we or our potential strategic partners may be subject tofines, untitled letters, warning letters, civil penalties, suspension orwithdrawal of regulatory approvals, product recalls and seizures, injunctions,operating restrictions and/or criminal prosecutions and penalties.

 

**If we,our third-party manufacturers or our service providers fail to comply withapplicable laws and regulations, we or they could be subject to enforcementactions, which could affect our ability to market and sell BiDil and harm ourreputation.**

 

If we or our third-partymanufacturers or service providers fail to comply with applicable federal,state or foreign laws or regulations, we could be subject to enforcementactions which could affect our ability to develop, market and sell BiDilsuccessfully and could harm our reputation and lead to fewer acceptances ofBiDil by the market. These enforcement 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;

 

•                    injunctions;

 

•                    debarments;

 

•                    civil andcriminal penalties; and

 

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

 

**If theclinical trials for any product candidates our strategic partners advance intoclinical testing are not successful, these partners may not be able to successfullydevelop and commercialize our potential product candidates.**

 

In order to obtainregulatory approvals for the commercial sale of our product candidates, ourcollaborators will be required to complete extensive clinical trials in humansto demonstrate the safety and efficacy of our product candidates. Our strategicpartners may not be able to obtain authority from the FDA or otherregulatory agencies to commence or complete these clinical trials. Ifpermitted, such clinical testing may not prove that our product candidatesare sufficiently safe and effective to permit our strategic partners to obtainmarketing approvals from regulatory authorities. Moreover, positive resultsdemonstrated in pre-clinical studies and clinical trials that our strategicpartners complete may not be indicative of results obtained in futureclinical trials. Furthermore, one of our collaborators, institutional reviewboards or regulatory agencies may suspend clinical trials at any time ifit is believed that the patients participating in such trials are being exposedto unacceptable 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 completionof our strategic partners’ clinical trials will depend on, among other things,the rate of patient enrollment. Patient enrollment is a function of manyfactors, including the size of the patient population, the nature of theclinical protocol, the availability of alternative treatments, the proximity ofpatients to clinical sites and the eligibility criteria for the study. Ourstrategic partners may be unable to enroll the number of patients we needto complete a trial on a timely basis. Moreover, delays in planned patientenrollment for clinical trials may cause our strategic partners to incurincreased costs and delay commercialization. Because we will need to rely onthird parties for the development of our

 

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productcandidates, we will have less control over the timing and other aspects ofthese clinical trials than if we conducted them on our own.

 

As a result of thesefactors, third parties on whom we rely may not successfully begin orcomplete clinical trials on our potential product candidates in a timelymanner, if at all. Moreover, if our strategic partners do not successfullydevelop and commercialize our products, our future revenues may bematerially impaired.

 

**Theexpiration of the research term under our collaboration agreement with BostonScientific has resulted in the loss of potential royalty-based revenue from thecollaboration and may indicate that the development of nitricoxide-enhancing stents is not viable.**

 

In November 2001, weentered into a research, development and license agreement with BostonScientific pursuant to which we granted Boston Scientific an exclusiveworldwide license to develop and commercialize certain of our nitricoxide-enhancing compounds for use with their stents or specialty catheters inthe area of restenosis. In December 2003, we extended the researchcollaboration to develop nitric oxide-enhancing paclitaxel-coated stents until December 31,2005. The research term of this agreement expired on December 31, 2005,although certain rights extend beyond this term. We intend 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, we may loseany investment made in the development of, and any potential revenue that may haveresulted from, the development, sale or licensing of, nitric oxide-enhancingstents.

 

**Thetermination of our collaboration agreement with Merck, resulting from Merck’sdecision to withdraw its COX-2 inhibitor, Vioxx, from worldwide markets,has resulted in the loss of potential milestone and royalty-based revenue fromthe collaboration and may indicate that the development of nitricoxide-enhancing COX-2 inhibitors is not viable.**

 

In December 2002, weentered into an exclusive, worldwide research, collaboration and licensingagreement with Merck pursuant to which we granted Merck marketing and salesrights to our technology for nitric oxide-enhancing COX-2 inhibitors. On September 30,2004, Merck halted the phase II trial of our lead candidate in nitricoxide-enhancing COX-2 inhibitors. We and Merck terminated our collaborationagreement during November 2004, which resulted in the loss of any potentialmilestone or royalty revenue from the sale of products that may haveresulted from the collaboration as well as any research and development fundingthat we may have received beyond the end of the initial research term in December 2005.In April 2005, the FDA imposed several restrictions on the labeling andsale of non-steroidal anti-inflammatory drugs, including COX-2 inhibitors. Ifthe FDA imposes additional regulatory burdens for the approval of new COX-2inhibitors, if COX-2 inhibitors continue to pose safety concerns, or if themarket for COX-2 inhibitors contracts, then we may lose any investmentmade in the development of, and any potential revenue that may haveresulted from, the development, sale or licensing of nitric oxide-enhancingCOX-2 inhibitors.

 

**If theestimates we make and the assumptions on which we rely in preparing ourfinancial statements prove inaccurate, our actual results may varysignificantly.**

 

Our financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of our assets,liabilities, revenues and expenses, the amounts of charges taken by us and relateddisclosure. Such estimates and judgments include revenue recognition, thecarrying value of our accounts receivables, inventory and assets, our estimatesof accrued expenses and our estimates of the fair value of equity instrumentsgranted or sold by us. We base our estimates and judgments on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances. However, these estimates and judgments, or theassumptions underlying them, may prove to be incorrect. Accordingly, ouractual financial results may vary significantly from the estimatescontained in our financial statements. For a further discussion of theestimates and judgments that we make and the critical accounting policies thataffect these estimates and judgments, see “Management’s Discussion and Analysisof Financial Condition and Results of Operations - Critical Accounting Policiesand Estimates” above.

 

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**Risks Relating to our Intellectual Property Rights**

 

**Ourpatent protection for BiDil, which is a combination of two generic drugs, islimited, and we may be subject to generic substitution or competition andresulting pricing pressure.**

 

We have no composition ofmatter patent covering BiDil, our product for the treatment of heart failure inself-identified black patients as an adjunct to current standard therapy. BiDilis a fixed-dose combination of two generic drugs, isosorbide dinitrate andhydralazine hydrochloride, which are approved and separately marketed, indosages similar to those we include in BiDil, for indications other than heartfailure, at prices below the prices we are charging for BiDil. We have threeissued method-of-use patents, one of which covers the use of the combination ofisosorbide dinitrate and hydralazine hydrochloride to reduce the incidence ofmortality associated with chronic congestive heart failure, expiring in 2007,and the others covering the treatment of heart failure in black patients,expiring in 2020. As a practical matter, we may not be able to enforcethese method-of-use patents to prevent physicians from prescribing isosorbidedinitrate and hydralazine hydrochloride separately for the treatment of heartfailure in black patients, even though neither drug is approved for such use.We also may not be able to enforce these method-of-use patents to preventhospitals and pharmacies from supplying such patients with these generic drugsseparately in lieu of BiDil.

 

Other factors may alsoadversely affect our patent protection for BiDil. If we are successful inmarketing BiDil, manufacturers of generic drugs will have an incentive tochallenge our patent position. The combination therapy of isosorbide dinitrateand hydralazine hydrochloride for use in heart failure was developed throughlengthy, publicly-sponsored clinical trials conducted during the 1980s, priorto the filing of the patent application that resulted in the 2007 patent. TheU.S. Patent and Trademark Office, or U.S. patent office, considered published reportson these clinical trials and concluded that they did not constitute prior artthat would prevent the issuance of the 2007 patent. The U.S. patent office alsoconsidered the question of whether the 2007 patent constituted prior art withrespect to the 2020 patents, and determined that the claims of the 2020 patentswere non-obvious and patentable. A court considering the validity of the 2007or 2020 patents with respect to questions of prior art might be presented withother alleged prior art or might reach conclusions different from those reachedby the U.S. patent office. If the 2007 or 2020 patents were to be invalidatedor if physicians were to prescribe isosorbide dinitrate and hydralazinehydrochloride separately for heart failure in black patients, our BiDil revenuecould be significantly reduced, we could fail to recover the cost of developingBiDil and BiDil might not be a viable commercial product.

 

**If we arenot able to obtain and enforce patent protection for our discoveries, ourability to secure out-licensing or collaborative arrangements with respect toour product candidates will be harmed, and we may not be able to operateour business profitably.**

 

Our success depends, inpart, on our ability to protect proprietary methods and technologies that wedevelop under the patent and other intellectual property laws of the UnitedStates and other countries, in order to prevent others from using ourinventions and proprietary information. Because certain United States patentapplications are confidential until patents issue, such as applications filedprior to November 29, 2000, or applications filed after such date whichwill not be filed in foreign countries, third parties may have filedpatent applications for technology covered by our pending patent applicationswithout our being aware of those applications, and our patent applications may nothave priority over patent applications of others.

 

Prior to the scaling backof our research and development activities, our intellectual property strategydepended on our ability to rapidly identify and seek patent protection for ourdiscoveries. This process is expensive and time consuming, and we may notbe able to prosecute all necessary or desirable patent applications or maintainall issued patents at a reasonable cost. Despite our efforts to protect ourproprietary rights, unauthorized parties may be able to obtain and useinformation that we regard as proprietary. The mere issuance of a patent doesnot guarantee that it is valid or enforceable, so even if we have obtainedpatents, they may not be valid or enforceable against third parties.

 

The issued patents andpatent applications for our product candidates and nitric oxide technologyinclude claims with respect to both the composition of specific products orcompounds and specific methods of using these products or compounds intherapeutic areas. In some cases, like BiDil, our only patent protection iswith respect to the method of using a product or compound, and we do not havepatent claims covering the underlying composition of the product or compound.Method-of-use patents may provide less protection for our productcandidates and products because it may be more difficult to prove directinfringement against a pharmaceutical manufacturer or distributor once theyhave gained approval for an alternative indication. In addition, if any othercompany gains FDA approval for an indication separate from the one we or ourpotential strategic partners are pursuing and markets a product that we or ourpotential strategic partners expect to market under the protection of amethod-of-use patent, physicians will be able to prescribe that product for usein the indication for which we or our potential strategic partners haveobtained approval, even though the product is not approved for such

 

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indication. As apractical matter, we or our potential strategic partners may not be ableto enforce our method-of-use patents against physicians prescribing productsfor such off-label use. Off-label use and any resulting off-label sales couldmake it more difficult to obtain the price we or our potential strategicpartners would otherwise wish to achieve for, or to successfully commercialize,our products. In addition, in those situations where we have only method-of-usepatent coverage for a product candidate, it may be more difficult to finda pharmaceutical company partner to license or support development of ourproduct candidate.

 

Our pending patentapplications may not result in issued patents. The patent position ofpharmaceutical or biotechnology companies, including ours, is generallyuncertain and involves complex legal and factual considerations. The standardswhich the U.S. patent office and its foreign counterparts use to grant patentsare not always applied predictably or uniformly and can change. There is alsono uniform, worldwide policy regarding the subject matter and scope of claimsgranted or allowable in pharmaceutical or biotechnology patents. Accordingly,we do not know the degree of future protection for our proprietary rights orthe breadth of claims allowed in any patents issued to us or to others.

 

We also rely on tradesecrets, know-how and technology, which are not protected by patents, tomaintain our competitive position. If any trade secret, know-how or othertechnology not protected by a patent were to be disclosed to or independentlydeveloped by a competitor, our business and financial condition could bematerially adversely affected.

 

**If we becomeinvolved in patent litigation or other proceedings to enforce our patentrights, we would incur substantial costs and expenses, substantial liabilityfor damages and/or we, or our strategic partners, could be required to stopproduct development and commercialization efforts.**

 

A third party may sueus or our potential strategic partners for infringing on its patent rights.Likewise, we or our potential strategic partners may need to resort tolitigation to enforce a patent issued to us or to determine the scope andvalidity of third-party proprietary rights. The cost to us or our potentialstrategic partners of any litigation or other proceeding relating tointellectual property rights, even if resolved in our or our partner’s favor,could be substantial, and the litigation would divert management efforts. Someof our competitors may be able to sustain the costs of complex patentlitigation more effectively than we can because they have substantially greaterresources. In addition, our strategy of providing nitric oxide-enhancingversions of existing products could lead to more patent litigation as themarkets for these existing products are very large and competitive.Uncertainties resulting from the initiation and continuation of any litigationcould limit our ability to continue our operations.

 

For example, we havefiled an opposition in the European Patent Office, or EPO, to revoke NicOx S.A.’sEuropean Patent No. 904 110, which we refer to as EP ’110. Thispatent is directed to the use of organic compounds containing a nitrate groupor inorganic compounds containing a nitric oxide group to reduce the toxicitycaused by certain drugs, including non-steroidal anti-inflammatory drugs, orNSAID’s. The basis for our opposition, in part, is that the claims in EP ’110are anticipated and therefore invalid if they are construed to cover a singlecompound chemically linked to a nitrate moiety. While we believe that theclaims in EP ’110 will be invalidated, or be narrowed, we cannot predictwith certainty the outcome of the opposition. If the EPO finds that there arevalid claims in EP ’110 that cover compounds chemically linked tonitrates, we may be adversely affected in our ability to market ourproduct candidates for reducing gastrointestinal toxicity without firstobtaining a license from NicOx, which may not be available on favorableterms, if at all.

 

If any parties are ableto successfully claim that the creation or use by us or our potential strategicpartners of proprietary technologies infringes upon their intellectual propertyrights, we or our potential strategic partners might be forced to pay damages,potentially including treble damages, if we or our potential strategic partnersare found to have willfully infringed on such parties’ patent rights. Inaddition to any damages we or our potential strategic partners might have topay, a court could require us or our potential strategic partners to stop theinfringing activity or obtain a license on unfavorable terms. Moreover, anylegal action against us or our partners claiming damages and seeking to enjoincommercial activities relating to the affected products and processes could, inaddition to subjecting us to potential liability for damages, require us or ourpartners to obtain a license in order to continue to manufacture or market theaffected products and processes. Any license required under any patent may notbe made available on commercially-acceptable terms, if at all. In addition,some licenses may be non-exclusive, and therefore our competitors may haveaccess to the same technology licensed to us. If we 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 revenue sufficient to sustain our operations.

 

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**Wein-license a significant portion of our principal proprietary technologies, andif we fail to comply with our obligations under any of the related agreements,we could lose license rights that are necessary to commercializing BiDil andout-licensing our other product candidates.**

 

We are a party to anumber of licenses that give us rights to third-party intellectual propertythat are necessary for our business. In particular, we have obtained theexclusive right to develop and commercialize BiDil pursuant to a licenseagreement with Dr. Jay N. Cohn and some of our intellectual propertyrights relating to nitric oxide compounds have been obtained pursuant tolicense agreements with the Brigham and Women’s Hospital and Boston University.In addition, we may enter into additional licenses in the future. Theselicenses impose various development, commercialization, funding, royalty,diligence, and other obligations on us. If we breach these obligations, thelicensor may have the right to terminate the license or render the licensenon-exclusive, which would result in us being unable to develop, manufactureand sell products that are covered by the licensed technology.

 

**Risks Relating to our Industry**

 

**If thegovernment or third-party payors do not reimburse patients for BiDil, or do notreimburse for BiDil at favorable levels, BiDil might not be used or purchased,and our revenues and profits will be adversely affected.**

 

Our revenues and profitsdepend heavily upon the availability of coverage and favorable reimbursementfor the use of BiDil from third-party healthcare and state and federalgovernment payors, both in the United States and in foreign markets.Reimbursement by a third party payor may depend upon a number of factors,including the third-party payor’s determination that use of a product is:

 

•                   safe, effectiveand medically necessary;

 

•                   appropriate forthe specific patient;

 

•                   cost-effective;and

 

•                   neitherexperimental nor investigational.

 

Since reimbursementapproval for a product is required from third-party and government payors inorder for patients to be reimbursed for the cost of a product, seeking thisapproval, particularly when seeking approval for a preferred form ofreimbursement over other competitive products, is a time-consuming and costlyprocess. Third-party payors may require cost-benefit analysis data from usin order to demonstrate the cost-effectiveness of BiDil. For any individualthird-party payor, we may not be able to provide data sufficient to gainreimbursement on a similar or preferred basis to competitive products or atall. Once reimbursement at an agreed level is approved by a third-party payor,we may lose that reimbursement entirely, or we may lose the similaror better reimbursement we receive compared to competitive products. Asreimbursement is often approved for a period of time, this risk is greater atthe end of the time period, if any, for which the reimbursement was approved.In addition, legislative or regulatory efforts to control or reduce healthcarecosts or reform government healthcare programs could result in lowerprices or rejection of BiDil. Changes in coverage and reimbursement policies orhealthcare cost containment initiatives that limit or restrict reimbursementfor BiDil may cause our revenue to decline. Any failure by us to obtainreimbursement for BiDil, or to secure a preferred form of reimbursementthat reduces costs to patients, may negatively impact market acceptance ofBiDil and adversely affect our ability to generate revenues from sales.

 

Most private insurers,and the majority of Medicare Part D plans, cover BiDil at the Tier IIIlevel. We may not be able to obtain preferential reimbursement treatmentfor BiDil from many private insurers. Any failure by us to secure suchpreferential reimbursement treatment would have a substantially negative effecton sales of BiDil. In addition, although some Medicare Part D plans arecurrently providing reimbursement for BiDil at Tier II levels, the number ofoverall plans providing this preferential reimbursement is small. Moreover,because Medicare Part D was only implemented on January 1, 2006, theMedicare Part D plans are still actively in the process of enrollingparticipants. We cannot know if any of the plans on which we are currentlylisted will have a significant number of African American participants, if anyat all. We also cannot know if BiDil will continue to be listed on any of theseplans at a preferential reimbursement level, if at all. Accordingly, we cannotassess the impact that the current listing of BiDil on any given plan will haveon our future revenues, if any. If the plans on which BiDil is currently listeddo not enroll a significant number of African American participants, we willnot benefit from these listings. In addition, if BiDil is not listed on anyplans that do succeed in enrolling African American participants, or if BiDildoes not receive preferable reimbursement treatment on such plans, marketacceptance of BiDil could be negatively impacted and our ability to generate revenuesfrom sales significantly impaired.

 

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**We could be negativelyimpacted by the application or enforcement of federal and state fraud and abuselaws, including anti-kickback laws and other federal and state anti-referrallaws.**

 

We are subject to variousfederal and state laws pertaining to healthcare fraud and abuse, includinganti-kickback laws and physician self-referral laws. Violations of these lawsare punishable by criminal and civil sanctions, including, in some instances,imprisonment and exclusion from participation in federal and state healthcareprograms, including the Medicare, Medicaid and Veterans Administration healthprograms. Because of the far-reaching nature of these laws, we may be requiredto alter 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 couldbecome subject to false claims litigation under federal statutes, which canlead to treble damages based on the reimbursements by federal healthcareprograms, civil money penalties (including penalties levied on a per falseclaim basis), restitution, criminal fines and imprisonment, and exclusion fromparticipation in Medicare, Medicaid and other federal and state healthcareprograms. These false claims statutes include the False Claims Act, whichallows any person to bring suit on behalf of the federal government allegingthe submission of false or fraudulent claims, or causing to present such falseor fraudulent claims, under federal programs or contracts claims or otherviolations of the statute and to share in any amounts paid by the entity to thegovernment in fines or settlement. These suits against biotechnology companieshave increased significantly in recent years and have increased the risk that ahealthcare company will have to defend a false claim action, pay fines orrestitution, or be excluded from the Medicare, Medicaid or other federal andstate healthcare programs as a result of an investigation arising out of suchaction. We cannot assure you that we will not become subject to such litigationor, if we are not successful in defending against such actions, that suchactions will not have a material adverse effect on our business, financialcondition and results of operations. In addition, we cannot assure you that thecosts of defending claims or allegations under the False Claims Act will nothave a material adverse effect on our business, financial condition and resultsof operations.

 

**We facesignificant competition, which may result in others commercializingproducts more successfully than ours.**

 

The pharmaceuticalindustry is highly competitive and characterized by rapid and significanttechnological change. Our principal competitors in the markets we havetargeted, including cardiovascular disease, are large, multinationalpharmaceutical companies that have substantially greater financial and otherresources than we do and are conducting extensive research and developmentactivities on technologies and product candidates similar to or competitivewith ours. Many of our competitors are more experienced than we are inpharmaceutical development and commercialization, obtaining regulatoryapprovals and product marketing and manufacturing. As a result, 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; and

 

•                    moreeffectively negotiate third-party licenses and strategic relationships; andtake advantage of product acquisition or other opportunities more readily thanwe can.

 

There are a number ofcompanies currently marketing and selling products to treat heart failure inthe general population that will compete with BiDil. These includeGlaxoSmithKline, plc, which currently markets Coreg®, Merck & Co., Inc.,which currently markets Vasotec® and Astra Zeneca, plc, which currently marketsToprol XL®.

 

We also face competitionfrom other pharmaceutical companies seeking to develop drugs using nitric oxidetechnology. For example, we are aware of at least seven companies working inthe area of nitric oxide based therapeutics.

 

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These companiesare: Angiogenix Inc., GB Therapeutics, NicOx S.A., OxoN Medica, RenoPharm,Vasopharm BIOTECH GmbH and Nitrox LLC.

 

**We may beexposed to product liability claims and may not be able to obtain ormaintain adequate product liability insurance.**

 

Our business exposes usto the risk of product liability claims that is inherent in the manufacturingand marketing of human therapeutic products. Our commercial product liabilityinsurance is subject to deductibles and coverage limitations. We may notbe able to obtain or maintain insurance on acceptable terms, or at all.Moreover, any insurance that we do obtain may not provide adequateprotection against potential liabilities, and our capital resources could bedepleted as a result.

 

**Risks Relating to our Common Stock**

 

**The priceof our common stock is likely to continue to be volatile in the future.**

 

The stock market has fromtime to time experienced significant price and volume fluctuations that may beunrelated to the operating performance of particular companies. In particular,the market price of our common stock, like that of the securities of otherbiopharmaceutical companies, has been and may continue to be highlyvolatile. During the period from January 1, 2003 to March 31, 2006,our stock price has ranged from a low of $5.70 per share (on July 16,2004) to a high of $27.99 per share (on February 2, 2005). The followingfactors, among others, may affect the price of our common stock:

 

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

 

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

 

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

 

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

 

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

 

•                   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;

 

•                   general marketconditions;

 

•                   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.

 

**Insidershave substantial control over us and could delay or prevent a change incorporate control.**

 

As of April 28, 2006, ourdirectors, executive officers and principal stockholders, together with theiraffiliates, owned, in the aggregate, approximately 38% of our outstanding commonstock. As a result, these stockholders, if acting together, may have theability to determine the outcome of matters submitted to our stockholders forapproval, including the election and removal of directors and any merger,consolidation or sale of all or substantially all of our assets. In addition,these persons, if acting together, will have the ability to control themanagement and affairs of our company. Accordingly, this concentration ofownership may harm the market 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.

 

**Provisionsin our charter documents and under Delaware law may prevent or frustrateattempts by stockholders to change current management and hinder efforts toacquire a controlling interest in our company.**

 

Provisions of ourrestated certificate of incorporation and bylaws may discourage, delay orprevent 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 ofincorporation or bylaws; and

 

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

 

In addition, Section 203of the Delaware General Corporation Law prohibits a publicly held Delawarecorporation from engaging in a business combination with an interestedstockholder, generally defined as a person or entity which together with itsaffiliates owns or within the last three years has owned 15% of our votingstock, for a period of three years after the date of the transaction in whichthe person became an interested stockholder, unless the business combination isapproved in a prescribed manner. Accordingly, Section 203 may discourage,delay or prevent a change in control of our company.

 

**Substantiallyall of our outstanding common stock may be sold into the market at anytime. This could cause the market price of our common stock to drop significantly.**

 

Sales of a substantialnumber of shares of our common stock in the public market could occur at anytime. These sales, or the perception in the market that the holders of a largenumber of shares intend to sell shares, could reduce the market price of ourcommon stock. As of April 28, 2006, there were 36,662,018 shares of commonstock outstanding. Substantially all of these shares may also be resold inthe public market at any time. In addition, we have a significant number ofshares that are subject to outstanding options. The exercise of these optionsand the subsequent sale of the underlying common stock could cause a furtherdecline in our stock price. These sales also might make it difficult for us tosell equity securities in the future at a time and at a price that we deemappropriate.

 

**We may incursignificant costs and suffer management distraction and reputational damagefrom class action litigation and regulatory or government investigationsand actions due to trading in our common stock.**

 

Our stock price has been,and is likely to continue to be, volatile. When the market price of a company’sstock is volatile, holders of that company’s stock may bring securities class actionlitigation against the company that issued the stock. If any of ourstockholders were to bring a lawsuit of this type against us, even if thelawsuit was without merit, we could incur substantial costs defending thelawsuit.

 

On July 20, 2004,the Market Regulation Department of the NASD advised us that it initiated areview of trading activity in our common stock surrounding our July 19,2004 announcement that we had halted our phase III clinical trial of BiDil dueto the significant survival benefit seen with BiDil. The NASD is reviewing,among other things, information on relationships between our officers,directors and service providers and individuals and institutions that may havetraded in our

 

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common stock priorto the July 19, 2004 announcement. We have cooperated with this review andhave identified certain persons on the list provided to us by the NASD ashaving a relationship with our chief executive officer and others at NitroMed.We have established a special committee of our board of directors to overseeour response to this review.

 

The SEC or othersecurities regulators may investigate trading activity of insiders andothers around events that result in stock price volatility, such as our July 19,2004 announcement, and we may incur substantial costs in connection withany such government investigation or related action. A stockholder lawsuit, SECor other investigation or action could also damage our reputation or that ofour officers or directors and divert their time and attention away from our management.

 

**Item6.****           Exhibits**

 

See the Exhibit Indexon the page immediately preceding the exhibits for a list of exhibitsfiled as part of this Quarterly Report on Form 10-Q, which Exhibit Indexis incorporated herein by this reference.

 

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**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                   | NITROMED, INC. |
|------------------------|---------------------|
|                   |                |
|                   |                |
|                   | By:                 | /s/  KENNETH M. BATE |
|                   |                | Kenneth  M. Bate |
|                   |                | Chief  Operating Officer, Chief Financial Officer, Treasurer |
|                   |                | and  Secretary *(Principal Financial Officer)* |
| Date: May 2, 2006 |                |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                      |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                           |
| 10.1                |       | Offer Letter by and between NitroMed, Inc. and Manuel Worcel,  M.D. dated as of January 6, 2006, filed as an exhibit to NitroMed’s  Current Report on Form 8-K (File No. 000-50439) filed January 12,  2006 and incorporated herein by reference. |
| 10.2                |       | Compensation of Executive Officers of NitroMed, Inc., filed as  an exhibit to NitroMed’s Current Report on Form 8-K (File No. 000-50439)  filed March 13, 2006 and incorporated herein by reference.                                                   |
| 10.3                |       | Employment Offer Letter dated March 20, 2006 between NitroMed, Inc.  and Argeris Karabelas, Ph.D., filed as an exhibit to NitroMed’s Current  Report on Form 8-K (File No. 000-50439) filed March 24, 2006  and incorporated herein by reference. |
| 10.4                |       | Employment Offer Letter dated March 20, 2006 between NitroMed, Inc.  and Kenneth M. Bate, filed as an exhibit to NitroMed’s Current Report on  Form 8-K (File No. 000-50439) filed March 24, 2006 and  incorporated herein by reference.          |
| 10.5                |       | Form of Agreement entered into by and between NitroMed, Inc.  and certain of its executive officers, together with a schedule of such  officers.                                                                                                                      |
| 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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