**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549**

 

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**FORM 10-Q**

 

**(MarkOne)**

**ý****  QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For The Quarterly Period Ended June30, 2004**

** **

**or**

** **

**o****  TRANSITION REPORT PURSUANT TOSECTION 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  Incorporation or Organization) |       | (I.R.S. Employer  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**

 

Indicate by checkmark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes ý  No o

 

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Indicate by checkmark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).  Yes o  No ý

 

As of August 10,2004, the registrant had 26,221,460 shares of Common Stock, $0.01 par value pershare, outstanding.

 

 

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NITROMED, INC. FORM 10-Q FORTHE QUARTERLY PERIOD ENDED JUNE 30, 2004 

 

**TABLE OF CONTENTS**

** **
| PART I.      | Financial Information                                                                           |   |
|--------------|-------------------------------------------------------------------------------------------------|--------|
| Item 1.      | Financial Statements                                                                            |   |
|         | Balance Sheets as of June 30, 2004  (unaudited) and December 31, 2003                           |   |
|         | Statements of Operations for the three and six months ended June 30,  2004 and 2003 (unaudited) |   |
|         | Statements of Cash Flows for the six months ended June 30, 2004 and  2003 (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  2.     | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities               |   |
| Item 4. | Submission of Matters to a Vote of Security  Holders                                            |   |
| Item  6.     | Exhibits and Reports on Form 8-K                                                                |   |
|         | SIGNATURES                                                                                      |   |
|         | EXHIBIT INDEX                                                                                   |   |

 

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**PART I. Financial Information**

# ** **

## **Item1.    Financial Statements**

## ** **

**NITROMED, INC.**

**BALANCE SHEETS**

**(inthousands, except par value amounts)**

 
| ** **                                                                                                                                                                                                       | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                       | ** ** | **(unaudited)**    | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                                                                       |       |               |       |                   |       |
| Current assets:                                                                                                                                                                                                  |       |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                        |       | $                  | 21,041     |                   | $          | 67,614 |   |
| Marketable securities                                                                                                                                                                                            |       | 61,502             |       | 29,474                 |       |
| Accounts receivable                                                                                                                                                                                              |       | 17                 |       | —                 |       |
| Prepaid expenses and other current assets                                                                                                                                                                        |       | 1,370              |       | 1,296                  |       |
| Total current assets                                                                                                                                                                                             |       | 83,930             |       | 98,384                 |       |
| Property and equipment, net                                                                                                                                                                                      |       | 1,604              |       | 686                    |       |
| Other assets                                                                                                                                                                                                     |       | 907                |       | 100                    |       |
|                                                                                                                                                                                                             |       |               |       |                   |       |
| Total assets                                                                                                                                                                                                     |       | $                  | 86,441     |                   | $          | 99,170 |   |
|                                                                                                                                                                                                             |       |               |       |                   |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                    |       |               |       |                   |       |
| Current liabilities:                                                                                                                                                                                             |       |               |       |                   |       |
| Notes payable                                                                                                                                                                                                    |       | $                  | —     |                   | $          | 22 |   |
| Accounts payable                                                                                                                                                                                                 |       | 783                |       | 832                    |       |
| Accrued expenses                                                                                                                                                                                                 |       | 1,771              |       | 2,067                  |       |
| Deferred revenue                                                                                                                                                                                                 |       | 7,525              |       | 7,525                  |       |
|                                                                                                                                                                                                             |       |               |       |                   |       |
| Total current liabilities                                                                                                                                                                                        |       | 10,079             |       | 10,446                 |       |
|                                                                                                                                                                                                             |       |               |       |                   |       |
| Deferred revenue, long-term                                                                                                                                                                                      |       | 3,462              |       | 6,925                  |       |
| Stockholders’ Equity:                                                                                                                                                                                       |       |               |       |                   |       |
| Preferred stock, $0.01 par value; 5,000  shares authorized; no shares issued or outstanding at June 30, 2004 and  December 31, 2003                                                                              |       | —             |       | —                 |       |
| Common stock, $.01 par value; 65,000 shares  authorized at June 30, 2004 and December 31, 2003; 25,824 shares and 25,601  shares issued and outstanding as of June 30, 2004 and December 31, 2003,  respectively |       | 258                |       | 256                    |       |
| Additional paid-in capital                                                                                                                                                                                       |       | 191,876            |       | 191,604                |       |
| Deferred stock compensation                                                                                                                                                                                      |       | (2,768             | )          | (3,240                 | )          |
| Accumulated deficit                                                                                                                                                                                              |       | (116,102           | )          | (106,846               | )          |
| Accumulated other comprehensive income  (loss)                                                                                                                                                                   |       | (364               | )          | 25                     |       |
| Total stockholders’ equity                                                                                                                                                                                  |       | 72,900             |       | 81,799                 |       |
|                                                                                                                                                                                                             |       |               |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                  |       | $                  | 86,441     |                   | $          | 99,170 |   |

 

See accompanying notes.

 

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**NITROMED, INC.**

**STATEMENTS OF OPERATIONS**

**(in thousands, except pershare amounts) (unaudited)**

 
| ** **                                                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Revenues:                                                                                                 |       |                             |       |                           |       |   |   |   |   |
| Research and development                                                                                  |       | $                                | 2,331      |                           | $          | 1,694 |   | $ | 4,662 |   | $ | 3,388 |   |
| Operating expenses:                                                                                       |       |                             |       |                           |       |   |   |   |   |
| Research and development                                                                                  |       | 5,085                            |       | 4,242                          |       | 10,713 |   | 8,677 |   |
| General and administrative                                                                                |       | 2,261                            |       | 687                            |       | 3,797 |   | 1,252 |   |
| Total operating expenses                                                                                  |       | 7,346                            |       | 4,929                          |       | 14,510 |   | 9,929 |   |
| Loss from operations                                                                                      |       | (5,015                           | )          | (3,235                         | )          | (9,848 | ) | (6,541 | ) |
| Non-operating income (expense):                                                                           |       |                             |       |                           |       |   |   |   |   |
| Interest expense                                                                                          |       | —                           |       | (1                             | )          | (1 | ) | (2 | ) |
| Interest income                                                                                           |       | 295                              |       | 53                             |       | 573 |   | 124 |   |
| Other income                                                                                              |       | 20                               |       | 33                             |       | 20 |   | 82 |   |
|                                                                                                      |       | 315                              |       | 85                             |       | 592 |   | 204 |   |
| Net loss                                                                                                  |       |                             | (4,700     | )                              |       | (3,150 | ) |   | (9,256 | ) |   | (6,337 | ) |
| Dividends and accretion to redemption value  of redeemable convertible preferred stock                    |       | —                           |       | (675                           | )          | — |   | (1,349 | ) |
| Net loss attributable to common  stockholders                                                             |       | $                                | (4,700     | )                              | $          | (3,825 | ) | $ | (9,256 | ) | $ | (7,686 | ) |
| Basic and diluted net loss attributable to  common stockholders per common share                          |       | $                                | (0.18      | )                              | $          | (3.88 | ) | $ | (0.36 | ) | $ | (7.80 | ) |
| Shares used in computing basic and diluted  net loss attributable to common stockholders per common share |       | 25,696                           |       | 985                            |       | 25,648 |   | 985 |   |

 

See accompanying notes.

 

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**NITROMED, INC.**

**STATEMENTS OF CASH FLOWS**

**(in thousands)(unaudited)**

 
| ** **                                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                       | ** ** | **2003** | ** ** |
| **Operating activities**                                                                   |       |                           |       |   |   |
| Net loss                                                                                   |       | $                              | (9,256     | ) | $ | (6,337 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                              |       | 162                            |       | 124 |   |
| Stock-based compensation expense                                                           |       | 521                            |       | 458 |   |
| Changes in operating assets and  liabilities:                                              |       |                           |       |   |   |
| Accounts receivable                                                                        |       | (17                            | )          | 10,000 |   |
| Prepaid expenses and other assets                                                          |       | (74                            | )          | (423 | ) |
| Deferred revenue                                                                           |       | (3,463                         | )          | 3,862 |   |
| Accounts payable and accrued expenses                                                      |       | (345                           | )          | (433 | ) |
| Net cash provided by (used in) operating  activities                                       |       | (12,472                        | )          | 7,251 |   |
| **Investing activities**                                                                   |       |                           |       |   |   |
| Purchases of property and equipment                                                        |       | (1,080                         | )          | (284 | ) |
| Purchases of marketable securities                                                         |       | (44,255                        | )          | (5,039 | ) |
| Sales of marketable securities                                                             |       | 11,838                         |       | 5,958 |   |
| Other assets                                                                               |       | (807                           | )          | — |   |
| Net cash provided by (used in) investing  activities                                       |       | (34,304                        | )          | 635 |   |
| **Financing activities**                                                                   |       |                           |       |   |   |
| Proceeds from exercise of stock options                                                    |       | 225                            |       | — |   |
| Principal payments on notes payable                                                        |       | (22                            | )          | (20 | ) |
| Net cash provided by (used in) financing  activities                                       |       | 203                            |       | (20 | ) |
| Net increase (decrease) in cash and cash  equivalents                                      |       | (46,573                        | )          | 7,866 |   |
| Cash and cash equivalents at beginning of  period                                          |       | 67,614                         |       | 5,160 |   |
| Cash and cash equivalents at end of period                                                 |       | $                              | 21,041     |   | $ | 13,026 |   |

 

See accompanying notes.

 

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**NITROMED, INC.**

**NOTESTO UNAUDITED FINANCIAL STATEMENTS**

**JUNE 30, 2004**

** **

### **(1)**                                 Basisof 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 results arenot necessarily indicative of results to be expected for the entire fiscal yearending December 31, 2004. These unaudited financial statements should beread in conjunction with the audited financial statements and related notesthereto included in the Company’s latest audited annual financial statements.Those audited financial statements are included in the Company’s annual reporton Form 10-K, as amended, for the fiscal year ended December 31, 2003, whichhas been filed with the Securities and Exchange Commission (SEC). 

 

### **(2)**                                 Stock-BasedCompensation

### ** **

The Company haselected to account for its stock-based compensation plans under the intrinsicvalue method pursuant to Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations, rather than the alternative fair value accountingprovided under Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*(SFAS 123). In accordance with Emerging Issues Task Force (EITF) 96-18, *Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring, or in Connection with Selling Goods orServices*, the Company records compensation expense equal to the fairvalue of the options granted to non-employees over the vesting period, which isgenerally the period of service. 

 

For the yearsended December 31, 2003 and December 31, 2002, the Company granted 413,250and 241,000 options, respectively, to employees at exercise prices below thefair value of the Company’s common stock. The Company recorded deferred stockcompensation expense related to these grants of $3,317,000 and $566,000 in 2003and 2002, respectively. These amounts are being recognized ratably over thevesting period of four years. Included in the results of operations for thethree month periods ended June 30, 2004 and 2003 is compensation expense of$243,000 and $83,000, respectively. Included in the results of operations forthe six month periods ended June 30, 2004 and 2003 is compensation expense of $472,000and $118,000, respectively.

 

For purposes ofpro forma disclosures, the estimated fair value of the option is amortized overthe option’s vesting period. Had compensation expense for the Company’sstock-based compensation plans been determined based on the fair value at thegrant dates for awards under those plans consistent with the method ofSFAS 123, the Company’s net loss and net loss per share would have been asfollows: 

 

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| ** **                                                                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in  thousands, except per share amounts)**                                               | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                        |       |                             |       |                           |       |   |   |   |   |
| Net loss attributable to common  stockholders as reported                                   |       | $                                | (4,700     | )                              | $          | (3,825 | ) | $ | (9,256 | ) | $ | (7,686 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss               |       | 255                              |       | 128                            |       | 560 |   | 259 |   |
| Deduct: Stock-based employee compensation  expense determined under fair value based method |       | (1,341                           | )          | (3,216                         | )          | (1,661 | ) | (3,498 | ) |
| Pro forma net loss                                                                          |       | $                                | (5,786     | )                              | $          | (6,913 | ) | $ | (10,357 | ) | $ | (10,925 | ) |
|                                                                                        |       |                             |       |                           |       |   |   |   |   |
| Basic and diluted net loss per share                                                        |       |                             |       |                           |       |   |   |   |   |
| As reported                                                                                 |       | $                                | (0.18      | )                              | $          | (3.88 | ) | $ | (0.36 | ) | $ | (7.80 | ) |
| Pro forma                                                                                   |       | $                                | (0.23      | )                              | $          | (7.02 | ) | $ | (0.40 | ) | $ | (11.09 | ) |
|                                                                                             |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

### **(3)**                                 ComprehensiveIncome (Loss)

### ** **

Components ofcomprehensive income (loss) include net income (loss) and certain transactionsthat have generally been reported in the statement of stockholders’equity.  Comprehensive loss for the threemonths ended June 30, 2004 and June 30, 2003 was $5,105,000 and $3,828,000,respectively. Comprehensive loss for the six months ended June 30, 2004 andJune 30, 2003 was $9,645,000 and $7,689,000, respectively.

 

### **(4)**                                 NetLoss Per Share 

### ** **

Basic net loss pershare is 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, warrants and redeemableconvertible preferred stock. Since the Company has a net loss for all periodspresented, the effect of all potentially dilutive securities is antidilutive.Accordingly, basic and diluted net loss per share is the same. 

 

The followingtable sets forth the computation of basic and diluted net loss per share forthe respective periods. 

 
| ** **                                                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(in  thousands, except per share amounts)**                                          | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                             | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Basic and Diluted:*                                                                   |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                                                               |       | $                                     | (4,700     | )                                   | $          | (3,150 | ) | $ | (9,256 | ) | $ | (6,337 | ) |
| Dividends and accretion to redemption value  of redeemable convertible preferred stock |       | —                                |       | (675                                | )          | — |   | (1,349 | ) |
| Net loss attributable to common  stockholders                                          |       | $                                     | (4,700     | )                                   | $          | (3,825 | ) | $ | (9,256 | ) | $ | (7,686 | ) |
|                                                                                   |       |                                  |       |                                |       |   |   |   |   |
| Weighted average common shares used to  compute net loss per share                     |       | 25,696                                |       | 985                                 |       | 25,648 |   | 985 |   |
| Basic and diluted net loss per share                                                   |       | $                                     | (0.18      | )                                   | $          | (3.88 | ) | $ | (0.36 | ) | $ | (7.80 | ) |

 

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### **(5)**                                 Commitmentsand Contingencies

### ** **

We have enteredinto an agreement with a consulting firm for services related to thedevelopment approval process for BiDil.  Theagreement requires us to pay certain deferred legal and consulting fees within45 days after the date on which we receive written FDA approval, if any, forBiDil.  In addition, under acollaboration and license agreement with a third party, we have agreed to makemilestone payments to such party upon FDA approval, if any, and upon the firstsale of BiDil.  Assuming that BiDilreceives FDA approval and is commercially launched, we estimate that on orabout such time we will be required to make payments aggregating approximately$3.0 million to these third parties.  

 

An academicinstitution has asserted that patents and patent applications which relate tothe nitric oxide stent program may require a license from suchinstitution.  It is the opinion of theCompany’s management and legal counsel that the disputed intellectual propertyhas been validly licensed to, or is validly owned by, the Company.  Accordingly, the accompanying financialstatements do not include any provision related to this claim.

 

In July 2004,we entered into a letter of intent to negotiate the terms of an agreement tolease approximately $3.0 million of capital equipment in 2004, principallyrelated to laboratory and manufacturing equipment.  We cannot be assured that we will enter intothe capital equipment lease on favorable terms, if at all.

 

 

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## **Item 2.**           Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

## ** **

**Overview**

** **

We are an emergingpharmaceutical company that discovers, develops and seeks to commercializeproprietary pharmaceuticals. We have devoted substantially all of our effortstowards the research and development

 

7

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of ourproduct candidates. Since our inception, we have had no revenue from productsales and have funded our operations through the sale of equity securities,debt financings, license fees, research and development funding and milestonepayments from our collaborative partners. We have never been profitable andhave incurred an accumulated deficit of $116.1 million as of June 30,2004. 

 

Research,development and commercialization expenses relating to our product candidatesand to enhancing our core technologies will continue to increase in the nearterm and may vary significantly from our current estimates. In particular, weexpect to incur increased costs beginning in the third quarter of 2004 as weseek regulatory approval for BiDil, our lead product in development for thetreatment of African Americans with heart failure. In July 2004, following therecommendation of the independent Data and Safety Monitoring Board and thetrial’s steering committee, we halted our BiDil trial because of thesignificant survival benefit seen in the preliminary trial results for patientstaking the drug.  The BiDil trial wasdesigned to evaluate the efficacy of BiDil, when taken daily in addition to thebest current therapy.  BiDil is an orallyadministered nitric oxide-enhancing medicine, which combines isosorbidedinitrate and hydralazine.  At the timethe trial was halted, 1,050 patients in 162 clinical sites across the UnitedStates were enrolled in the double-blind placebo controlled trial.

 

General andadministrative costs will increase as we prepare for the plannedcommercialization of BiDil in 2005, assuming approval from the United StatesFood and Drug Administration, or FDA, and as we continue in our first fullfiscal year operating as a public company. As a result of our decision to haltthe BiDil trial and submit an amended new drug application to the FDA earlierthan initially planned, we expect to incur operating expenses in excess of ourprevious estimates for the fiscal year ended December 31, 2004, primarilyrelating to the development of our sales and marketing competencies, pre-launchrelated expenses and manufacturing costs in connection with the procurement ofcommercial supplies of BiDil.  Inaddition, we currently estimate that our existing cash and marketablesecurities, as well as cash we expect to receive under our collaborations withMerck and Boston Scientific, will be sufficient to support our operating plan,including increased operating expenses in preparation for the planned launch ofBiDil, for at least the next 12 months.

 

We will need togenerate significant revenues to achieve profitability.  At the present time we are unable to estimatethe level of revenues, if any, that we will realize from the commercializationof our product candidates, including BiDil. We are therefore unable to estimate when we will achieve profitability,if at all.

 

**Financial OperationsOverview**

** **

*Revenue.*  We have not generated any revenue fromproduct sales since our inception and do not expect to generate any revenuefrom the sale of products until at least 2005. All of our revenue to date hasbeen derived from license fees, research and development payments and milestonepayments that we have received from our corporate collaborators. We expect togenerate revenue from our corporate collaborators in a range of approximately$8.0 million to $10.0 million for the fiscal year ending December 31, 2004. Infuture years, we will seek to generate revenue from a combination of productsales, up-front fees and milestone payments in connection with collaborative orstrategic relationships, and royalties resulting from the license of ourintellectual property. We expect that any revenue we generate will fluctuatefrom quarter to quarter as a result of the timing and amount of research anddevelopment, milestone and other payments received under our collaborative orstrategic relationships and related continuing obligations, and the amount andtiming of payments we receive upon the sale of our products, to the extent anyare successfully commercialized. 

 

*Researchand Development.* Research and development expense consists of expenses incurred inidentifying, developing and testing product candidates. These expenses consistprimarily of salaries and related expenses for personnel, fees paid to professionalservice providers for independent monitoring and analysis of our clinicaltrials, costs of contract research and manufacturing, costs of facilities andthe legal costs of pursuing patent protection of our intellectual property. Weexpense research and development costs, including patent-related costs, asincurred. 

 

The followingsummarizes our primary research and development programs. We have not providedprogram costs since inception because prior to 2000 we did not track andaccumulate cost information by research program. 

 

8

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•                                          *BiDil.* From May 2001 to July 2004, weenrolled 1,050 patients at 162 clinical sites in the U.S.  in our phase III confirmatory clinical trialfor BiDil. We halted the trial in July 2004 due to a significant survivalbenefit in the preliminary data for patients taking the drug.  We expect to incur significant additionalexpenditures for BiDil as we complete the analysis of our clinical trial data,apply for regulatory approval, expand our operations and, if FDA approval isobtained, seek to launch BiDil in 2005. For example, we anticipate incurringincreased costs related to hiring of additional personnel associated withpreparations to launch BiDil. We estimate that the total direct cost for thistrial will be at least $39.0 million. However, the actual total cost ofthe clinical trial, including any costs associated with the ongoing monitoringof patients and any costs incident to our expected launch of the drug, isdependent on a number of factors, including potential unanticipated delays aswe complete our data analysis and prepare and submit an amendment to ourpreviously-submitted new drug application to the FDA and other uncertaintiesrelating to the regulatory approval process. We do not anticipate receivingrevenue from BiDil until 2005, if ever. Our failure to commercialize BiDil on atimely basis would have a material adverse effect on our business, financialcondition and results of operations. 

 

•                                          *Nitric Oxide-Enhancing COX-2 Inhibitors.*We are currently working with Merck Frosst Canada & Co., awholly-owned subsidiary of Merck & Co., or Merck, to screenproprietary nitric oxide-enhanced COX-2 inhibitors in advance of clinicaltesting as analgesic and anti-inflammatory agents and in other specifieddisease areas. These agents are intended to be second-generation COX-2inhibitors.  Merck advanced the firstsuch nitric-oxide enhanced COX-2 inhibitor into phase II clinical trials duringthe second quarter of 2004.  We expectthat additional expenditures will be required to conduct pre-clinical testingand to apply for and conduct clinical trials. Because these agents are inpre-clinical or clinical development, their successful development is highlyuncertain. As such, we are unable to estimate the cost to complete the researchand development phase nor are we able to estimate the timing of bringingpotential products to market and, therefore, when material cash inflows frommilestones and royalties could commence. Our failure, or our partner’s failure,to commercialize these products under development on a timely basis could havea material adverse effect on our business, financial condition and results ofoperations. 

 

•                                          *Nitric Oxide Stents.* We are currentlyworking with Boston Scientific Corporation, or Boston Scientific, to developstents coated with nitric oxide-releasing compounds. This program is inpre-clinical development. We expect that additional expenditures will berequired to conduct pre-clinical testing and, if such pre-clinical testing issuccessful, to apply for and conduct clinical trials. Because this program isin pre-clinical development, the successful development of products based uponthis program is highly uncertain. As such, we are unable to estimate the costto complete the research and development phase, nor are we able to estimate thetiming of bringing potential products to market and, therefore, when materialcash inflows from milestones and royalties could commence. Our failure, or ourpartner's failure, to commercialize products based upon this program on atimely basis could have a material adverse effect on our business, financialcondition and results of operations. 

 

•                                          *Other Discovery Research.* We are alsocurrently utilizing our nitric oxide expertise to develop products foradditional medical conditions, including cardiovascular, gastrointestinal, andpulmonary diseases.  Our efforts in theseareas consist of discovery-stage research primarily directed to establishingour intellectual property position.  Weexpect that additional expenditures will be required to conduct pre-clinicaltesting and, if such pre-clinical testing is successful, to apply for andconduct clinical trials for any such programs. Because these programs are inpre-clinical development, the successful development of products based uponthese programs is highly uncertain. As such, we are unable to estimate the costto complete research and development, nor are we able to estimate the timing ofbringing potential products to market and, therefore, when material cashinflows from milestones and royalties could commence.

 

*Generaland Administrative.* General and administrative expense consists primarily of salaries andother related costs for personnel in executive, finance, accounting, businessdevelopment and human resource functions.

 

9

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Othercosts include facility costs not otherwise included in research and developmentexpense and professional fees for legal and accounting services. 

 

As a result of theconsummation of our initial public offering on November 10, 2003, we haveincurred, and will continue to incur, increased general and administrativeexpense for investor relations and other activities associated with operating asa publicly-traded company. These increases will include the hiring ofadditional personnel. We intend to continue to incur increased internal andexternal business development costs to support our various product developmentefforts, which can vary from period to period. Beginning in the third quarterof 2004, we also anticipate incurring significant increased expenses inconnection with the expected commercial introduction of BiDil in 2005, assumingBiDil receives FDA approval.

 

*NonOperating Income (Expense).* Other income includes interest earned on our cash, cash equivalents andmarketable securities, as well as rental income from a sublease of a portion ofour facilities in 2003. Other income is net of interest expense. 

 

*MerckCollaboration.*  In December 2002,we entered into an exclusive, worldwide research, collaboration and licensingagreement that granted Merck marketing and sales rights for nitricoxide-enhancing COX-2 inhibitors. The research portion of the agreement is forthree years and can be extended by mutual agreement. In 2003, we received anupfront non-refundable license payment of $10.0 million and two payments,each of $5.0 million, for achieving the first two milestones. The licensefee revenue and the revenue from the first $5.0 million milestone paymentare being recognized over the contractual term of the research and developmentprogram, which ends December 31, 2005. The revenue from the second$5.0 million payment was recognized in the fourth quarter of 2003, theperiod in which Merck achieved the milestone. We received $0.6 million inresearch and development fees from Merck during the three months ended June 30,2004 and $1.2 million during the six months ended June 30, 2004, all of whichhas been recognized as revenue for the three months and six months,respectively. We expect to receive additional research and development fundingthrough 2005 and milestone payments upon the successful achievement ofspecified research objectives and royalties on any product sales. 

 

*BostonScientific Collaboration.* In November 2001, we entered into a development and licenseagreement with Boston Scientific to develop stents coated with nitricoxide-releasing compounds. We have granted Boston Scientific an exclusive worldwidelicense to develop and commercialize products for restenosis incorporating twonitric oxide-releasing compounds. In consideration of this license, BostonScientific made an upfront non-refundable license payment of $1.5 million,which is being recognized over the estimated time period of our contractualobligation to provide research and development services. In the event thatspecified research, development and commercialization milestones are achieved,Boston Scientific is obligated to make milestone payments to us. Boston Scientificis also obligated to pay royalties to us on the sale of any products resultingfrom the collaboration. In December 2003, we entered into an extension to theagreement that continues the research and development collaboration throughDecember 2005 and we received an additional $3.0 million, which is beingrecognized ratably over the research and development collaboration term. BostonScientific made a $3.5 million investment in our series F juniorredeemable convertible preferred stock in 2001 and made an additional $500,000investment in our series E redeemable convertible preferred stock inAugust 2003. 

 

**Results of Operations**

** **

***Three Months Ended June 30, 2004 and2003***

*** ***

*Revenue.*  Total revenue for the three months ended June30, 2004 was $2.3 million compared to $1.7 million for the three monthsended June 30, 2003. The $0.6 million, or 35% increase in revenue in the 2004period is primarily attributable to milestone revenue recognized under ouragreement with Merck, and is being recognized ratably over the collaborationperiod. Revenue for the three months ended June 30, 2004 was comprised ofresearch and development payments made to us by Merck and Boston Scientific.

 

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*Researchand Development.*  Research and development expense for the threemonths ended June 30, 2004 was $5.1 million compared to $4.2 millionfor the three months ended June 30, 2003. The $0.9 million, or 21% increase inresearch and development expense was primarily due to additional clinicalrelated costs of $0.9 million associated with the BiDil trial. The followingtable summarizes the primary components of our research and development expensefor our principal research and development programs for the three months endedJune 30, 2004 and 2003. 

 
| ** **                              | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **2004**                         | ** ** | **2003** | ** ** |
| **Research and Development Program**    |       |                             |       |   |   |
|                                    |       |                             |       |   |   |
| BiDil                                   |       | $                                | 3.8        |   | $ | 2.9 |   |
| Nitric oxide-enhancing COX-2 inhibitors |       | 0.5                              |       | 0.5 |   |
| Nitric oxide stents                     |       | 0.4                              |       | 0.4 |   |
| Other discovery research                |       | 0.4                              |       | 0.4 |   |
| Total research and development expense  |       | $                                | 5.1        |   | $ | 4.2 |   |

* *

*Generaland Administrative.* General and administrative expense for the three months ended June 30,2004 was $2.3 million compared to $0.7 million for the three months ended June30, 2003.  The $1.6 million, or 230%  increase in general and administrativeexpense was primarily attributable to increasedcosts of approximately $0.8 million associated with operating as a publiccompany and $0.6 million for the preparation of the possible launch of BiDil. 

* *

*NonOperating Income (Expense).* Other income, net for the three months ended June 30, 2004 was $0.3million compared to $0.1 million for the three months ended June 30, 2003. The$0.2 million, or 200% increase was due to higher fund balances available forinvestment, net of lower rental income due to our sublease rental agreementwhich ended in May 2003.

 

***Six Months Ended June 30, 2004 and2003***

*** ***

*Revenue.*  Total revenue for the six months ended June30, 2004 was $4.7 million compared to $3.4 million for the six monthsended June 30, 2003. The $1.3 million, or 38% increase in revenue in the 2004period is attributable to milestone revenue recognized under our agreement withMerck, and is being recognized ratably over the collaboration arrangement.Revenue for the six months ended June 30, 2004 was comprised of research anddevelopment payments made to us by Merck and Boston Scientific.

 

*Researchand Development.* Research and development expense for the six months ended June 30, 2004was $10.7 million compared to $8.7 million for the six months endedJune 30, 2003. The $2.0 million, or 23% increase in research and developmentexpense was primarily due to additional clinical related costs of $1.8 millionassociated with the BiDil trial. The following table summarizes the primarycomponents of our research and development expense for our principal researchand development programs for the six months ended June 30, 2004 and 2003. 

 
| ** **                              | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **2004**                       | ** ** | **2003** | ** ** |
| **Research and Development Program**    |       |                           |       |   |   |
|                                    |       |                           |       |   |   |
| BiDil                                   |       | $                              | 7.7        |   | $ | 5.9 |   |
| Nitric oxide-enhancing COX-2 inhibitors |       | 1.3                            |       | 1.0 |   |
| Nitric oxide stents                     |       | 0.9                            |       | 0.8 |   |
| Other discovery research                |       | 0.8                            |       | 1.0 |   |
| Total research and development expense  |       | $                              | 10.7       |   | $ | 8.7 |   |

 

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*Generaland Administrative.* General and administrative expense for the six months ended June 30,2004 was $3.8 million compared to $1.3 million for the six months ended June30, 2003.  The $2.5 million, or 192%  increase in general and administrativeexpense was attributable, in part, to increasedcosts of approximately $1.5 million associated with operating as a publiccompany and $0.9 million for the preparation of the possible launch of BiDil.

* *

*NonOperating Income (Expense).* Other income, net for the six months ended June 30, 2004 was $0.6million compared to $0.2 million for the six months ended June 30, 2003. The $0.4million, or 190% increase was due to higher fund balances available forinvestment, net of lower rental income due to our sublease rental agreementwhich ended in May 2003.

 

**Liquidity and CapitalResources**

** **

We have financedour operations since inception through the sale of equity, debt and paymentsfrom collaborative partners for licenses, research and development andachievement of milestones. As of June 30, 2004, we have received net proceedsof $159.4 million from the issuance of equity securities, primarily as theresult of the sale of $99.1 million of our redeemable convertible preferredstock and net proceeds of $60.1 million from our initial public offering inNovember 2003.  At June 30, 2004, we had$82.5 million in cash, cash equivalents and marketable securities. 

 

During the sixmonths ended June 30, 2004, operating activities used cash of $12.5 million,driven by a net loss of $9.3 million, an increase in prepaid and otherassets of $0.1 million, and a decrease in payables, deferred revenue and otherliabilities of $3.8 million, with adjustments for non-cash charges forstock-based compensation and depreciation and amortization aggregating $0.7million.

 

During the sixmonths ended June 30, 2004, investing activities used cash of $34.3 million dueto net purchase of marketable securities of $32.4 million, purchases ofcomputer and lab equipment and expenditures related to our new facility inLexington, Massachusetts of $1.1 million, and a $0.8 million security depositfor our new facility lease. In July 2004, we entered into a letter of intent tonegotiate the terms of an agreement to lease approximately $3.0 million ofcapital equipment in 2004, principally related to laboratory and manufacturingequipment. We cannot be assured that we will enter into the capital equipmentlease on favorable terms, if at all.

 

The followingtable summarizes our contractual obligations at June 30, 2004 and the effectssuch obligations are expected to have on our liquidity and cash flows in futureperiods. 

 
| ** **                         | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations**       | ** ** | **Total**                  | ** ** | **Less than  one year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **More than  five years** | ** ** |
| ** **                         | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating lease obligations(1)     |       | $                          | 15,345,000 |   | $ | 1,067,000 |   | $ | 4,347,000 |   | $ | 3,178,000 |   | $ | 6,753,000 |   |
| Total contractual cash obligations |       | $                          | 15,345,000 |   | $ | 1,067,000 |   | $ | 4,347,000 |   | $ | 3,178,000 |   | $ | 6,753,000 |   |

 

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(1)                                  OnJanuary 30, 2004, we entered into a lease for approximately 52,000 square feetof laboratory and office space at 125 Spring Street, Lexington, Massachusetts.The rent obligation for the building commenced on August 7, 2004 which was 30days after the date we commenced occupancy of the building.  The lease is for a term of ten years withoptions that permit renewals for additional 5 year periods.  The expected minimum rental obligations areincluded in the above table. 

 

On August 10,2004, we entered into a letter agreement with Publicis Selling Solutions, Inc.,or Publicis, pursuant to which Publicis will begin establishing a sales forcefor BiDil. We intend to execute a definitive contract with Publicis under whichPublicis is expected to assist us in creating a specialized sales force of upto approximately 200 people.  Pursuant tothe letter, we agreed to make an advance payment of $500,000 to Publicis, whichis creditable against any amounts due to Publicis under the final agreement, orrefundable to us together with any resulting work product generated, less anyfees or expenses incurred by Publicis, in the event a definitive contract isnot entered into.  There can be no assurancethat we will enter into a definitive agreement with Publicis.

 

We have enteredinto an agreement with a consulting firm for services related to thedevelopment approval process for BiDil. The agreement requires us to pay certain deferred legal and consultingfees within 45 days after the date on which we receive written FDA approval, ifany, for BiDil.  In addition, under acollaboration and license agreement with a third party, we have agreed to makemilestone payments to such party upon FDA approval, if any, and upon the firstsale of BiDil.  Assuming that BiDilreceives FDA approval and is commercially launched, we estimate that on orabout such time we will be required to make payments aggregating approximately$3.0 million to these third parties.

 

We expect toachieve research and development revenue of $8 to $10 million for the yearended December 31, 2004. We believe that our existing cash, cash equivalentsand marketable securities, and cash we expect to receive under ourcollaborations with Merck and Boston Scientific, will be sufficient to fund ourplanned operations, including increases in spending for our BiDil clinicalprogram, for at least the next twelve months. However, we may requiresignificant additional funds earlier than we currently expect to conduct theclinical trial and to obtain regulatory approvals necessary to launch BiDil andto develop our other product candidates. 

 

We may seekadditional funding through collaborative arrangements and public or privatefinancings. Additional funding may not be available to us on acceptable terms,or at all. In addition, the terms of any financing may adversely affect theholdings or the rights of our stockholders. For example, if we raise additionalfunds by issuing equity securities, further dilution to our existing stockholdersmay result. If we are unable to obtain funding on a timely basis, we may berequired to significantly curtail one or more of our research or developmentprograms. We also could be required to seek funds through arrangements withcollaborators or others that may require us to relinquish rights to some of ourtechnologies, product candidates, or products which we would otherwise pursueon our own. 

 

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

 

•                                          the costs oflaunching BiDil, if and when it is approved by regulatory authorities; 

 

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

 

•                                          the timing,receipt and amount of sales and royalties, if any, from our potential products;

 

•                                          the resourcesrequired to successfully complete our clinical trials; 

 

•                                          the time andcosts involved in obtaining regulatory approvals; 

 

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

 

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•                                          the cost ofmanufacturing, marketing and sales activities; 

 

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

 

•                                          the cost ofobtaining and maintaining licenses to use patented technologies; and 

 

•                                          our abilityto establish and maintain additional collaborative arrangements. 

 

**Off-Balance SheetArrangements**

** **

We do not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,which would have been established for the purpose of facilitating off-balancesheet arrangements or other contractually narrow or limited purposes.  As such, we are not exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in suchrelationships.

 

**Critical AccountingPolicies and Estimates**

** **

Our discussion andanalysis of our financial condition and results of operations are based on ourfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting periods. On an on-goingbasis, we evaluate our estimates and judgments, including those related torevenue, accrued expenses and the fair value assigned to our common stock andstock awards. We base our estimates on historical experience, known trends andevents and various other factors that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates under differentassumptions or conditions. 

 

We believe thefollowing critical accounting policies affect our more significant judgmentsand estimates used in the preparation of our financial statements. 

 

*Revenue.*  We record revenue on an accrual basis as itis earned and when amounts are considered collectible. Revenues received inadvance of performance obligations, or in cases where we have 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 we are required to defer revenue, the period over which suchrevenue should be recognized is subject to estimates by management and maychange over the course of the collaborative agreement. 

 

*AccruedExpenses.*  As part ofthe process of preparing financial statements, we are required to estimateaccrued expenses. This process involves identifying services that have beenperformed on our behalf and estimating the level of service performed and theassociated cost incurred for such service as of each balance sheet date in ourfinancial statements. Examples of estimated expenses we accrue include contractservice fees such as amounts paid to clinical monitors, data managementorganizations and investigators in conjunction with clinical trials, as well asfees paid to contract manufacturers in conjunction with the production ofclinical materials and professional service fees, such as lawyers andaccountants. In connection with such service fees, our estimates are mostaffected by our understanding of the status and timing of services providedrelative to the actual levels of services incurred by such service providers.The majority of our service providers invoice us monthly in arrears forservices performed. In the event that we do not identify certain costs thathave begun to be incurred, or we under- or

 

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over-estimatethe level of services performed or the costs of such services, our reportedexpenses for such period would be too low or too high. The date on whichcertain services commence, the level of services performed on or before a givendate and the cost of such services are often determined based on subjectivejudgments. We make these judgments based upon the facts and circumstances knownto us in accordance with generally accepted accounting principles. 

 

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

 

Accounting forequity instruments granted or sold by us under APB 25, SFAS 123 and EITF96-18 requires fair value estimates of the equity instrument granted or sold.If our estimates of the fair value of these equity instruments are too high ortoo low, our expenses may be over- or under-stated. For equity instrumentsgranted or sold in exchange for the receipt of goods or services, we estimatethe fair value of the equity instruments based upon consideration of factorsthat we deem to be relevant at that time. Because shares of our common stockwere not publicly traded prior to the commencement of our public offering onNovember 5, 2003, market factors historically considered in valuing stockand stock option grants included comparative values of public companies discountedfor the risk and limited liquidity provided for in the shares we were issuing,pricing of private sales of our redeemable convertible preferred stock, priorvaluations of stock grants and the effect of events that had occurred betweenthe time of such grants, economic trends, and the comparative rights andpreferences of the security granted compared to the rights and preferences ofour other outstanding equity. 

 

Prior to ourinitial public offering, the fair value of our common stock was determined byour board of directors contemporaneously with the grant. In the absence of apublic trading market for our common stock, our board of directors considerednumerous objective and subjective factors in determining the fair value of ourcommon stock. At the time of option grants and other stock issuances, our boardof directors considered the liquidation preferences, dividend rights, votingcontrol and anti-dilution protection attributable to our then-outstandingredeemable convertible preferred stock, the status of private and publicfinancial markets, valuations of comparable private and public companies, thelikelihood of achieving a liquidity event such as an initial public offering,our existing financial resources, our anticipated continuing operating losses andincreased spending levels required to complete our clinical trials, dilution tocommon stockholders from anticipated future financings and a general assessmentof future business risks. 

 

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**Forward-LookingStatements**

** **

This quarterlyreport on Form 10-Q includes forward-looking statements within the meaningof Section 21E of the Securities Exchange Act of 1934, as amended, whichwe refer to as the Exchange Act. For this purpose, any statements contained hereinregarding our strategy, future operations, financial position, future revenues,projected costs, prospects, plans and objectives of management, other thanstatements of historical facts, are forward-looking statements. The words“anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,”“projects,” “will,” “would” and similar expressions are intended to identifyforward-looking statements, although not all forward-looking statements containthese identifying words. We cannot guarantee that we actually will achieve theplans, intentions or expectations disclosed in our forward-looking statements.There are a number of important factors that could cause actual results orevents to differ materially from those disclosed in the forward-lookingstatements we make. These important factors include our “critical accountingestimates” and the risk factors set forth below under the caption “Factors ThatMay Affect Future Results.” Although we may elect to update forward-lookingstatements in the future, we specifically disclaim any obligation to do so,even if our estimates change, and readers should not rely on thoseforward-looking statements as representing our views as of any date subsequentto the date of this quarterly report. 

 

**Factors That May AffectFuture Results**

** **

**Risks Relating to ourBusiness**

** **

**Because we have a historyof losses and our future profitability is uncertain, our common stock is ahighly speculative investment.**

** **

We haveexperienced significant operating losses since our inception in 1992. For thethree months and six months ended June 30, 2004, we had a net loss of$4.7 million and $9.3 million, respectively. As of June 30, 2004, we hadan accumulated deficit of approximately $116.1 million. We expect that wewill continue to incur substantial losses and that our cumulative losses willincrease as our research, development and commercialization efforts expand. Weexpect that the losses that we incur will fluctuate from quarter to quarter andthat these fluctuations may be substantial. To date, we have not recorded anyrevenue from the sale of products and we will not be able to do so unless anduntil one of our products completes clinical trials and receives regulatoryapproval. BiDil is our only product candidate that has advanced into late-stageclinical trials and we do not anticipate receiving revenues from BiDil until atleast 2005, if ever. All of our other product candidates are in research,pre-clinical or clinical development, will require significant additional testingprior to submission of any regulatory applications and, as such, are notexpected to be commercially available for many years, if at all. 

 

A large portion ofour expenses is fixed, including expenses related to facilities, equipment andpersonnel. In addition, we expect to spend significant amounts to fundresearch, development and commercialization of our product candidates and toenhance our core technologies. As a result, we expect that our operatingexpenses will

 

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continueto increase significantly in the near term and, consequently, we will need togenerate significant revenue to achieve profitability. At the present time weare unable to estimate the level of revenues, if any, that we will realize fromthe commercialization of our product candidates, including BiDil. We aretherefore unable to estimate when we will achieve profitability, if at all.Even if we do achieve profitability, we may not be able to sustain or increaseprofitability on a quarterly or annual basis. Our failure to become and remainprofitable could depress the market price of our common stock and could impairour ability to raise capital, expand our business, diversify our productofferings or continue our operations. 

 

**We will requiresubstantial additional funds and, if additional capital is not available, wemay need to limit, scale back or cease our operations.**

** **

We have used andwill continue to require substantial funds to conduct research and development,including preclinical testing and clinical trials of our potential products,and to manufacture and market any products that are approved for commercialsale. For example, we estimate that we will incur significant expenses in thesecond half of 2004 and during 2005 as we develop sales and marketingcompetencies and prepare for the anticipated 2005 launch of BiDil, assuming FDAapproval.  Moreover, we will incursignificant additional expenditures to conduct pre-clinical testing and anyclinical trials of our nitric oxide-enhancing COX-2 inhibitors, nitric-oxidestents and other early-stage development programs. Because their successfuldevelopment is uncertain, we are unable to estimate the actual funds we willrequire to complete research and development and commercialize our productsunder development. We believe that our existing cash and marketable securities,and cash we expect to receive under our collaborations with Merck and BostonScientific, will be sufficient to support our current operating plan for atleast the next 12 months. 

 

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

 

•                                          the time andcosts involved in obtaining regulatory approvals for BiDil and our otherproducts under development; 

 

•                                          the costs oflaunching BiDil, if and when it is approved by regulatory authorities; 

 

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

 

•                                          the timing,receipt and amount of sales and royalties, if any, from our potential products;

 

•                                          the resourcesrequired to successfully complete our clinical trials; 

 

•                                          the time andcosts involved in obtaining regulatory approvals; 

 

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

 

•                                          the cost ofmanufacturing, marketing and sales activities; 

 

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

 

•                                          the cost ofobtaining and maintaining licenses to use patented technologies; and 

 

•                                          our abilityto establish and maintain additional collaborative arrangements. 

 

We will berequired to seek additional funding in the future and may do so through collaborativearrangements and public or private financings. Additional financing may not beavailable to us on acceptable terms, or at all. In addition, the terms of thefinancing may adversely affect the holdings or the rights of our stockholders.For example, if we raise additional funds by issuing equity securities, furtherdilution to our then-existing stockholders will result. If we are unable toobtain funding on a timely basis, we may be required to significantly curtailone or more of our research or development programs. We also could be requiredto seek funds through

 

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arrangementswith collaborators or others that may require us to relinquish rights to someof our technologies, product candidates or products which we would otherwisepursue on our own. 

 

**We are heavily dependenton obtaining regulatory approval for and successfully commercializing BiDil,our most advanced drug candidate.**

** **

Our research,development and management resources are primarily dedicated to our mostadvanced drug candidate, BiDil, which is not expected to be commerciallyavailable until at least 2005, if at all. In July 2004, we halted our phase IIIconfirmatory clinical trial of BiDil on the recommendation of the independentData and Safety Monitoring Board and the steering committee for the trialbecause of the significant survival benefit seen in the preliminary data withpatients taking the drug.  Although thepreliminary data from our BiDil trial showed a significant survival benefit forthe patients on BiDil, a final and detailed analysis of the data will berequired before we can request FDA approval. If we obtain unfavorable or only marginally favorable results from thefinal analysis of our BiDil trial, or fail to achieve regulatory approval ormarket acceptance of BiDil, our near-term ability to generate product revenue,our reputation and our ability to raise additional capital will be materiallyimpaired and the value of an investment in our stock will decline. 

 

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

** **

A key component ofour strategy is to seek to improve existing medicines with our proprietarynitric oxide technology. Our product candidates include nitric oxideenhancements of existing drugs. Thus, we are modifying compounds whose chemicaland pharmacological profiles are well-documented and understood. However, each ofour product candidates is a new molecule with a chemical and pharmacologicalprofile that differs from that of the existing drug. None of our productcandidates has been sufficiently studied or tested for its chemical andpharmacological properties to have been fully explored and documented. Thesecompounds may not demonstrate in patients the chemical and pharmacologicalproperties ascribed to them in laboratory studies, and they may interact withhuman 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 develop and commercialize drugs based upon our technologicalapproaches, we will not become profitable and the value of our stock willdecline. 

 

**If our clinical trialsfor BiDil and any other product candidates we advance into clinical testing arenot successful, we may not be able to successfully develop and commercializeour products.**

** **

In order to obtainregulatory approvals for the commercial sale of our product candidates, we andour collaborators will be required to complete extensive clinical trials inhumans to demonstrate the safety and efficacy of our product candidates. We maynot be able to obtain authority from the FDA or other regulatory agencies tocommence or complete these clinical trials. If permitted, such clinical testingmay not prove that our drug candidates are safe and effective to the extentnecessary to permit us to obtain marketing approvals from regulatoryauthorities. Moreover, positive results demonstrated in preclinical studies andclinical trials that we complete may not be indicative of results obtained infuture clinical trials. Furthermore, we, one of our collaborators,institutional review boards, or regulatory agencies may suspend clinical trialsat any time if it is believed that the subjects or patients participating insuch trials are being exposed to unacceptable health risks. Adverse orinconclusive clinical trial results concerning any of our drug candidates couldrequire us to conduct additional clinical trials, result in increased costs andsignificantly delay the filing for marketing approval for those drug candidateswith the FDA or result in a filing for a narrower indication. 

 

The successfulcompletion of our clinical trials will depend on, among other things, the rateof patient enrollment. Patient enrollment is a function of many factors,including the size of the patient population, the nature of the clinicalprotocol, the availability of alternative treatments, the proximity of patientsto clinical sites and the eligibility criteria for the study.We may be unableto enroll the number of patients we need to complete a trial on a timely basis.Moreover, delays in planned patient enrollment for the trials may cause us toincur increased costs and delay commercialization. 

 

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We rely onacademic institutions or clinical research organizations to supervise ormonitor some or all aspects of our BiDil trial and we expect to rely onacademic institutions and clinical research organizations for other productcandidates we advance into clinical testing. Accordingly, we have less controlover the timing and other aspects of these clinical trials than if we conductedthem entirely on our own. 

 

As a result ofthese factors, we or third parties on whom we rely may not successfully beginor complete our clinical trials in the time periods we have forecasted, if atall. Moreover, if we incur costs and delays in our programs or if we do notsuccessfully develop and commercialize our products, our stock price coulddecline. 

 

**If we and our partners donot obtain and maintain the regulatory approvals required to market and sellBiDil and our other products under development, then our business will beunsuccessful and the market price of our stock will substantially decline.**

** **

We and ourpartners will not be able to market any of our products in the United States,Europe or in any other country without marketing approval from the FDA orequivalent foreign regulatory agency. The regulatory process to obtain marketapproval for a new drug or medical device takes many years and requiresexpenditures of substantial resources. We have had only limited experience inpreparing applications and obtaining regulatory approvals. 

 

We are seekingregulatory approval of our lead drug candidate, BiDil, for the treatment ofheart failure in African Americans.  InJuly 2004, we halted our phase III confirmatory clinical trial of BiDil on therecommendation of the independent Data and Safety Monitoring Board and thesteering committee for the trial because of the significant survival benefitseen in the preliminary data with patients taking the drug.  Although the preliminary data from our BiDiltrial showed a significant survival benefit for the patients on BiDil, a finaland detailed analysis of the data will be required before we can request FDAapproval.  There can be no assurance thatthe final data will show the same significant mortality benefit as seen in thepreliminary data.  Moreover, the FDA maynot approve BiDil even if the final data confirm the preliminary findings. 

 

We did not conductthe prior clinical trials involving the two generic drugs that comprise theBiDil composition, which were conducted in the 1980s and were not specificallydesigned to study the safety or efficacy of the therapeutic for AfricanAmericans. These prior trials generated the data that served as the basis forthe original new drug application for BiDil filed by Medco Research, now KingPharmaceuticals, a third-party pharmaceutical company with whom we have norelationship. Medco received a non-approvable letter from the FDA with respectto its new drug application in 1997. The FDA deemed the original new drugapplication filed by Medco Research seeking approval for use of BiDil in thegeneral heart failure population non-approvable because the data did not show astatistically significant benefit in that population. After re-analysis of thisdata and extensive discussions with the FDA, in 1999 we acquired the new drugapplication from Dr. Jay Cohn, Professor of the Department of Medicine atthe University of Minnesota, who had acquired the new drug application fromMedco Research. The data generated in these prior trials also served as thebasis for our 2000 amendment to that new drug application and the FDA’sresulting request for a confirmatory trial. 

 

In 2001, the FDAissued us a letter stating that, in addition to the data in African Americanheart failure patients already submitted to the agency, a clearly positivetrial in African Americans with heart failure would, together with thesatisfaction of other conditions, including its approval of our manufacturingprocess and marketing materials, provide a basis for approval of BiDil. Thisletter from the FDA was not an “approvable” letter, which means that the FDAretains broad discretion in determining whether to ultimately approve BiDil. 

 

In addition, ourBiDil trial was performed exclusively on subjects who are self-identified asAfrican American. To our knowledge, the FDA has never approved a drug productfor use particularly in an ethnic population. The FDA’s receptiveness to drugsthat are approved and marketed on the basis of different ethnicity-basedtherapeutic outcomes is untested and we believe may be adversely affected bycontrary scientific or public health evidence or political or legal factors.For example, scientific evidence could emerge that suggests that there is nophysiological basis to support pharmaceutical development of drugs based uponethnicity. Moreover, others may express the view that ethnicity is only asociological concept and, accordingly, there is not a valid basis for thecommercialization of medicines based on ethnicity. These factors may impede orprevent us from obtaining FDA approval of BiDil even if the data from our BiDiltrial is positive. 

 

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If we do notreceive required regulatory approval or clearance to market BiDil or any of ourother products under development, we will not be able to develop andcommercialize these products, which will affect our ability to achieveprofitability, and will cause the value of our common stock to substantiallydecline. 

 

**Even if we receiveregulatory approval to market our product candidates, the market may not bereceptive to BiDil or our other product candidates upon their commercialintroduction, which will prevent us from being profitable.**

** **

BiDil and theother product candidates that we are developing are based upon new technologiesor therapeutic approaches. Assuming we receive FDA approval, we expect tolaunch BiDil in 2005.  We plan to marketBiDil only in the U.S. Key participants in the U.S. pharmaceutical marketplace,such as physicians, payors and consumers, may not accept a product intended toimprove therapeutic results based on ethnicity. As a result, it may be moredifficult for us to convince the medical community and third-party payors andpatients to accept and use our products. If we are unable to launch and commercialize BiDil we will not generaterevenue and our stock price may decline.

 

Other factors thatwe believe will materially affect market acceptance of BiDil and our otherproduct candidates under development include: 

 

•                                          the timing ofour receipt of any marketing approvals, the terms of any approval and thecountries in which approvals are obtained; 

 

•                                          the safety,efficacy and ease of administration; 

 

•                                          the successof our physician education programs; and 

 

•                                          theavailability of government and third-party payor reimbursement. 

 

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

** **

If we or our thirdparty manufacturers or service providers fail to comply with applicablefederal, state or foreign laws or regulations, we could be subject toenforcement actions which could affect our ability to develop, market and sellour products successfully and could harm our reputation and lead to lessacceptance of our products by the market. These enforcement actions include: 

 

•                                          productseizures; 

 

•                                          voluntary ormandatory recalls; 

 

•                                          voluntary ormandatory patient or physician notification; 

 

•                                          withdrawal ofproduct approvals; 

 

•                                          restrictionson, or prohibitions against, marketing our products; 

 

•                                          fines; 

 

•                                          restrictionson importation of our products; 

 

•                                          injunctions; 

 

•                                          civil andcriminal penalties; and 

 

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**•**                                          suspensionof review, refusal to approve pending applications or withdrawal of approval. 

 

**We depend on Merck andBoston Scientific, and expect to depend on additional collaborative partners inthe future, for a significant portion of our revenues and to develop, conductclinical trials with, obtain regulatory approvals for, and manufacture, marketand sell some of our products under development, and these collaborations maynot be successful.**

** **

We are relying onMerck to fund the development of and to commercialize products based upon ournitric oxide-enhancing COX-2 inhibitor technologies, and we are relying onBoston Scientific to fund the development of and to commercialize nitricoxide-enhancing stents using our technology to treat the re-closure ofarteries, or restenosis, following balloon angioplasty, a treatment to widenblocked arteries. All of our $12.8 million of revenues for 2003 and our $4.7million of revenues for the six months ended June 30, 2004 were derived fromlicensing, research and development and milestone payments paid to us by Merckand Boston Scientific. Our agreements with Merck and Boston Scientific, whichprovide to us research and development funding for certain of our leadprograms, generally are terminable upon short notice by the collaborator andadditional payments due to us under the collaboration agreements are generallybased on the achievement of specific development and commercializationmilestones that may not be met. These collaborations also entitle us to royaltypayments that are based on the sales of products developed and marketed throughthe collaboration. These future royalty payments may not materialize or be lessthan expected if the related products are not successfully developed ormarketed, or if we or our collaborators are forced to license intellectualproperty from third parties. Accordingly, we cannot predict with certaintywhen, if ever, either of these collaborations will continue to generaterevenues for us. The loss of either of these large collaborations would likelysignificantly decrease our near term revenues and future prospects. We intendto enter into collaborative agreements with other parties in the futurerelating to other product candidates, and we are likely to have similar riskswith regard to any such future collaborations. 

 

In addition, ourexisting collaborations and any future collaborative arrangements that we seekto enter into with third parties may not be scientifically or commerciallysuccessful. Factors that may affect the success of our collaborations includethe following: 

 

•                                          ourcollaborators may be pursuing alternative technologies or developingalternative products, either on their own or in collaboration with others, thatmay be competitive with the product on which they are collaborating with us orwhich could affect our collaborative partners’ commitment to the collaborationwith us; 

 

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

 

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

 

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

 

**We have no sales andmarketing experience and may depend significantly on third parties who may notsuccessfully commercialize our products.**

** **

We have no sales,marketing and distribution experience. We intend to independently launch andmarket BiDil and, in the future, certain other products not already subject tomarketing agreements where we believe the target physician market can beeffectively reached by the sales force we intend to establish. In order todevelop sales, distribution and marketing capability, we will have to investsignificant amounts of money and management resources. Because we haveminimized these expenditures prior to obtaining the results of our BiDil trial,we may have insufficient time to build our sales and marketing capabilities inadvance of BiDil’s

 

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expectedlaunch. If the approval of BiDil is delayed substantially, or BiDil is notapproved, we will have incurred significant unrecoverable expenses. 

 

For BiDil and anyother product candidates for which we decide to perform sales, marketing anddistribution functions ourselves, we could face a number of additional risks,including: 

 

•                                          we may not beable to attract and build a significant marketing or sales force; 

 

•                                          the cost ofestablishing a marketing or sales force may not be justifiable in light of therevenues generated by any particular product; and 

 

•                                          our directsales and marketing efforts may not be successful. 

 

For productcandidates with larger target physician markets, we plan to rely significantlyon sales, marketing and distribution arrangements with third parties. Forexample, on August 10, 2004, we entered into a letter agreement with PublicisSelling Solutions, or Publicis, pursuant to which Publicis will beginestablishing a sales force for BiDil. We intend to execute a definitivecontract with Publicis under which Publicis is expected to assist us increating a specialized sales force of up to approximately 200 people.  In addition, we plan to rely on our existingcollaborative partners for the commercialization of nitric oxide-enhancingCOX-2 inhibitors and stents coated with nitric oxide-releasing compounds. Wemay have to enter into additional marketing arrangements in the future. We maynot be able to successfully enter into a definitive agreement with Publicis orsales, marketing and/or distribution agreements with any other third parties inthe future, on terms which are favorable to us, if at all. In addition, we mayhave limited or no control over the sales, marketing and distributionactivities of these third parties. Our future revenues for BiDil and any otherproducts for which we rely on third party sales, marketing and distributionsupport will depend heavily on the success of the efforts of these thirdparties. 

 

**We have limitedmanufacturing experience and resources and we must incur significant costs todevelop this expertise or rely on third parties to manufacture our products.**

** **

We have nomanufacturing experience. In order to continue to develop products, apply forregulatory approvals and commercialize our products, we will need to develop,contract for, or otherwise arrange for the necessary manufacturingcapabilities. We currently rely on third parties for the production of certainof our products, including BiDil, for preclinical and clinical testingpurposes, and we expect to continue to do so in the future. Only a limitednumber of manufacturers can supply nitric oxide-based medicines, and we havenot secured a long-term commercial supply arrangement for any of our productcandidates, including BiDil. The manufacturing process for any of our productsis an element of the FDA approval process and we will need to contract withmanufacturers who can meet the FDA requirements on an ongoing basis. As part ofobtaining regulatory approval for BiDil, we will need to engage a commercialmanufacturer that will be required, among other things, to produce validationbatches of the drug consistent with regulatory approval requirements. Althoughwe are currently negotiating the terms and conditions of manufacturingagreements for BiDil, we cannot assure you that we will be able to enter intosuch agreements on a timely basis or on terms that are favorable to us. To theextent we enter into manufacturing arrangements with third parties, includingwith respect to BiDil, we will be dependent upon these third parties to performtheir obligations in a timely manner and in accordance with applicablegovernment regulations. In addition, if we receive the necessary regulatoryapproval for our products, we also expect to rely on third parties, includingour collaborative partners, to produce materials required for commercialproduction. We may experience difficulty in obtaining adequate manufacturingcapacity or manufacturing quality for our needs. If we are unable to obtain ormaintain contract manufacturing of BiDil and these other products, or to do soon commercially reasonable terms, we may not be able to successfully developand commercialize our products and our stock price will decline. 

 

To the extent thatthird-party manufacturers with whom we contract fail to perform theirobligations, we may be adversely affected in a number of ways, including: 

 

•                                          we may not beable to initiate or continue clinical trials of products that are underdevelopment; 

 

•                                          we may bedelayed in submitting applications for regulatory approvals for our products; 

 

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

 

•                                          ultimately,we may not be able to meet commercial demands for our products. 

 

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

** **

We have nocomposition of matter patent covering our lead product candidate, BiDil, whichwe intend to market for the treatment of heart failure in African Americans.BiDil is a combination of two generic drugs, isosorbide dinitrate andhydralazine, which are approved and separately marketed, in dosages similar tothose we include in BiDil, for indications other than heart failure, at pricesbelow the prices we expect to charge for BiDil. We have two issuedmethod-of-use patents covering, respectively, the use of the combination ofisosorbide dinitrate and hydralazine to reduce the incidence of mortalityassociated with chronic congestive heart failure, expiring in 2007, and totreat heart failure in African Americans, expiring in 2020. As a practicalmatter, we may not be able to enforce these method-of-use patents to preventphysicians from prescribing isosorbide dinitrate and hydralazine for thetreatment of heart failure in African Americans, even though neither drug isapproved for such use. 

 

Other factors mayalso adversely affect our patent protection for BiDil. The combination therapyof isosorbide dinitrate and hydralazine for use in heart failure was developedthrough lengthy, publicly-sponsored clinical trials conducted during the 1980s,prior to the filing of the patent application that resulted in the 2007 patent.The U.S. Patent and Trademark Office, or U.S. patent office, consideredpublished reports on these clinical trials and concluded that they did notconstitute prior art that would prevent the issuance of the 2007 patent. TheU.S. patent office also considered the question of whether the 2007 patentconstituted prior art with respect to the 2020 patent, but determined that theclaims of the 2020 patent were non-obvious and patentable. A court consideringthe validity of the 2007 or 2020 patents with respect to questions of prior artmight be presented with other alleged prior art or might reach conclusionsdifferent from those reached by the U.S. patent office. If the 2007 or 2020patents were to be invalidated or if physicians were to prescribe isosorbidedinitrate and hydralazine rather than BiDil for heart failure in AfricanAmericans, our BiDil revenue could be significantly reduced, we could fail torecover the cost of developing BiDil and BiDil might not be a viable product. 

 

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

** **

Our successdepends, in part, on our ability to protect proprietary methods and technologiesthat we develop under the patent and other intellectual property laws of theUnited States 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 filed patentapplications for technology covered by our pending patent applications withoutour being aware of those applications, and our patent applications may not havepriority over any patent applications of others. 

 

Our strategydepends on our ability to rapidly identify and seek patent protection for ourdiscoveries. This process is expensive and time consuming, and we may not beable to file and prosecute all necessary or desirable patent applications at areasonable cost or in a timely manner. 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 obtain patents,they may not be valid or enforceable against third parties. 

 

The issued patentsand patent applications for our drug development candidates and nitric oxidetechnology include claims with respect to both the composition of specificdrugs or compounds and specific methods of using these drugs or compounds intherapeutic areas. In some cases, like BiDil, our only patent protection iswith respect to the method of using a drug or compound and we do not havepatent claims covering the underlying composition of the drug or compound.Method-of-use patents may provide less protection for our product candidatesbecause it may be more difficult to prove direct infringement against apharmaceutical manufacturer or distributor. In addition,

 

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if anyother company markets a drug that we expect to market under the protection of amethod-of-use patent, physicians will be able to prescribe that drug for use inthe indication for which we have obtained approval, even though the drug is notapproved for such indication. As a practical matter, we may not be able toenforce our method-of-use patents against physicians prescribing drugs for suchoff-label use. Off-label use and any resulting off-label sales could make itmore difficult to obtain the price we would otherwise wish to achieve for, orto successfully commercialize, our product. In addition, in those situationswhere we have only method-of-use patent coverage for a product candidate, itmay be more difficult to find a pharmaceutical company partner to license orsupport development of our product candidate. 

 

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 ontrade secrets, 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 become involved inpatent litigation or other proceedings to enforce our patent rights, we couldincur substantial costs and expenses, substantial liability for damages or berequired to stop our product development and commercialization efforts.**

** **

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

 

For example, wehave filed an opposition in the European Patent Office, or EPO, to revoke NicOxS.A.’s European 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, orNSAIDs. 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. While we believe that the claims in EP‘110 will be invalidated, or be narrowed, we cannot predict with certainty theoutcome of the opposition. If the EPO finds that there are valid claims in EP‘110 that cover compounds chemically linked to nitrates, we may be adverselyaffected in our ability to market our product candidates for reducinggastrointestinal toxicity without first obtaining a license from NicOx, whichmay not be available on favorable terms, if at all. We do not know whetherNicOx has filed claims of similar scope to the EP ‘110 patent in the U.S. 

 

If any parties areable to successfully claim that our creation or use of proprietary technologiesinfringes upon their intellectual property rights, we might be forced to paydamages, potentially including treble damages, if we are found to havewillfully infringed on such parties’ patent rights. In addition to any damageswe might have to pay, a court could require us to stop the infringing activityor obtain a license on unfavorable terms. Moreover, any legal action against usor our partners claiming damages and seeking to enjoin commercial activitiesrelating to the affected products and processes could, in addition tosubjecting us to potential liability for damages, require us or our partners toobtain a license in order to continue to manufacture or market the affectedproducts and processes. Any license required under any patent may not be madeavailable on commercially-acceptable terms, if at all. In addition, somelicenses may be non-exclusive, and therefore our competitors may have access tothe same 

 

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technologylicensed to us. If we fail to obtain a required license or are unable to designaround a patent, we may be unable to effectively market some of our technologyand products, which could limit our ability to generate revenues or achieveprofitability and possibly prevent us from generating revenue sufficient tosustain our operations. In addition, a number of our collaborations providethat royalties payable to us for licenses to our intellectual property may beoffset by amounts paid by our collaboration partners to third parties who havecompeting or superior intellectual property positions in the relevant fields,which could result in significant reductions in our revenues from productsdeveloped through collaborations. 

 

**We in-license asignificant portion of our principal proprietary technologies and if we fail tocomply with our obligations under any of the related agreements, we could loselicense rights that are necessary to developing BiDil and our other productcandidates.**

** **

We are a party toa number of licenses that give us rights to third party intellectual propertythat is 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.We expect to enter into additional licenses in the future. These licensesimpose various development, commercialization, funding, royalty, diligence, andother obligations on us. If we breach these obligations, the licensor may havethe right to terminate the license or render the license non-exclusive, whichwould result in us being unable to develop, manufacture and sell products thatare covered by the licensed technology. 

 

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

** **

The pharmaceuticaland medical device industries are highly competitive and characterized by rapidand significant technological change. Our principal competitors in the marketswe have targeted, such as cardiovascular disease and inflammation, are large,multinational pharmaceutical and medical device companies that havesubstantially greater financial and other resources than we do and areconducting extensive research and development activities on technologies andproducts similar to or competitive with ours. Moreover, there are a number ofcompanies currently marketing and selling products to treat heart failure inthe general population that will compete with BiDil, if it is approved. Theseinclude GlaxoSmithKline, plc, which currently markets Coreg; Merck &Co., Inc., which currently markets Vasotec; Pfizer Inc., whichcurrently markets Inspra; and Astra Zeneca, plc, which currently markets TropolXL. We also face competition from other pharmaceutical companies seeking todevelop drugs using nitric oxide technology. For example, we are aware of atleast four companies working in the area of nitric-oxide based therapeutics.These companies are GB Therapeutics, of Ontario, Canada, which we believe is inearly stage preclinical development of nitrate medicines for Alzheimer’sdisease, Parkinson’s disease and dementia; NicOx S.A., a French company, whichwe believe is engaged in the research and development of nitric-oxide releasingderivatives of existing drug classes; OxoN Medica, of California, which webelieve is in preclinical development of drug targets for diseases resultingfrom dysfunction of the endothelial cells that line the inside of blood vesselwalls; and Vasopharm BIOTECH GmbH, of Germany, which we believe is focused ondisease mechanisms involving nitric oxide signaling pathways within thevascular wall. 

 

Many of ourcompetitors are more experienced than we are in drug development andcommercialization, obtaining regulatory approvals and product marketing andmanufacturing. As a result, our competitors may develop and commercializepharmaceutical products before we do. In addition, our competitors may developand commercialize products that render our products obsolete ornon-competitive. 

 

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

** **

Our businessexposes us to the risk of product liability claims that is inherent in themanufacturing, testing, and marketing of human therapeutic products. Ourclinical trial liability insurance is subject to deductibles and coveragelimitations. We do not currently have any commercial product liabilityinsurance. We may not be able to obtain or maintain insurance on acceptableterms, or at all. Moreover, any insurance that we do obtain may not provideadequate protection against potential liabilities. 

 

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**Risks Relating to OurCommon Stock**

** **

**Our stock price issubject to fluctuation, which may cause an investment in our stock to suffer adecline in value.**

** **

The market priceof our common stock may fluctuate significantly in response to factors that arebeyond our control. The stock market in general has recently experiencedextreme price and volume fluctuations. The market prices of securities ofpharmaceutical, biotechnology and other life sciences companies have beenextremely volatile, and have experienced fluctuations that often have beenunrelated or disproportionate to the operating performance of these companies.For example, our stock price could be adversely affected if drugs developed byothers that utilize nitric oxide technology are not successful in clinicaltesting, fail to achieve regulatory approval or are not accepted in themarketplace, even though these failures may not be related to our productcandidates or technology. These broad market fluctuations could result inextreme fluctuations in the price of our common stock, which could cause adecline in the value of our common stock. 

 

**We may incur significantcosts from class action litigation due to our expected stock volatility.**

** **

Our stock pricemay fluctuate for many reasons, including as a result of public announcementsregarding the progress of our development and marketing efforts, the additionor departure of key personnel, variations in our quarterly operating resultsand changes in market valuations of pharmaceutical, biotechnology or other lifesciences companies. Recently, when the market price of a company’s stock hasbeen volatile as our stock price may be, holders of that company’s stock haveoccasionally brought securities class action litigation against the companythat issued the stock. If any of our stockholders were to bring a lawsuit ofthis type against us, even if the lawsuit was without merit, we could incursubstantial costs defending the lawsuit. A stockholder lawsuit could alsodivert the time and attention of our management. 

 

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

** **

As of June 30,2004, our directors, executive officers and principal stockholders, togetherwith their affiliates, own, in the aggregate, approximately 56% of ouroutstanding common stock. As a result, these stockholders, if acting together,will have the ability to determine the outcome of matters submitted to ourstockholders for approval, including the election and removal of directors andany merger, consolidation or sale of all or substantially all of our assets. Inaddition, these persons, if acting together, will have the ability to controlthe management and affairs of our company. Accordingly, this concentration ofownership may harm the market price of our common stock by: 

 

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

 

•                                          impeding amerger, consolidation, takeover or other business combination involving our company;or 

 

•                                          discouraginga potential acquirer from making a tender offer or otherwise attempting toobtain control of our company. 

 

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

** **

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

 

•                                          a prohibitionon stockholder action through written consent; 

 

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•                                          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; 

 

•                                          advancenotice requirements for stockholder proposals and nominations; 

 

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

 

## **Item3.**           Quantitative and Qualitative DisclosuresAbout Market Risk

## ** **

We are exposed tomarket risk related to changes in interest rates. Our current investment policyis to maintain an investment portfolio consisting mainly of U.S. money marketand high-grade corporate securities, directly or through managed funds, withaverage contractual maturities of less than two years. Our cash is deposited inand invested through highly rated financial institutions in North America. Ourmarketable securities are subject to interest rate risk and will fall in valueif market interest rates increase. If market interest rates were to increaseimmediately and uniformly by 10% from levels at June 30, 2004, we estimate thatthe fair value of our investment portfolio would decline by an immaterialamount. We have the ability to hold our fixed income investments untilmaturity, and therefore we do not expect our operating results or cash flows tobe affected to any significant degree by a change in market interest rates onour investments. 

 

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

## ** **

Our management, withthe participation of our chief executive officer and chief financial officer,evaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as ofJune 30, 2004. Based on this evaluation, our chief executive officer and chieffinancial officer concluded that, as of June 30, 2004, our disclosure controlsand procedures were (1) designed to ensure that material informationrelating to us is made known to our chief executive officer and chief financialofficer by others within our company, particularly during the period in whichthis report was being prepared and (2) effective, in that they providereasonable assurance that information required to be disclosed by us in the reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms. 

 

No change in ourinternal control over financial reporting (as defined in Rules 13a-15(f)and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter endedJune 30, 2004 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting. 

 

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# **PART II  OTHER INFORMATION**

# ** **

**Item 2.**           Changes in Securities, Use of Proceeds and IssuerPurchases of Equity Securities.

** **

***Use of Proceeds from Registered Securities***

 

OnNovember 10, 2003, we completed an initial public offering of 6,000,000shares of our common stock at a price to the public of $11.00 per share. Theoffer and sale of all of the shares in the initial public offering wereregistered under the Securities Act of 1933, as amended, pursuant to aregistration statement on Form S-1 (File No. 333-108104), which wasdeclared effective by the Securities and Exchange Commission onNovember 5, 2003. Deutsche Bank Securities Inc., J.P. MorganSecurities Inc. and Pacific Growth Equities were the managing underwritersof the initial public offering. The offering commenced on November 5, 2003and did not terminate until after the sale of all of the securities registeredin the Registration Statement. As part of the initial public offering, wegranted these underwriters an over-allotment option to purchase up to anadditional 900,000 shares of our common stock from us. The underwriters did notexercise the over-allotment option. There were no selling stockholders in theoffering.

 

The aggregateprice of the offering amount registered on our behalf was $66.0 million.In connection with the offering, we paid approximately $4.6 million inunderwriting discounts and commissions to the underwriters and incurred anestimated $1.3 million in other offering expenses. None of theunderwriting discounts and commissions or offering expenses were incurred orpaid to directors or officers of ours or their associates or to persons owning10 percent or more of our common stock or to any affiliates of ours. Afterdeducting the underwriting discounts and commissions and offering expenses, wereceived net proceeds from the offering of approximately $60.1 million. Asof June 30, 2004, all of such proceeds remain from the offering, and pendinguse of the proceeds, we have invested these funds in short-term, interest-bearing,investment-grade securities.

 

**Item 4.****           Submission of Matters to a Vote ofSecurity Holders.**

** **

Our Annual Meeting ofShareholders was held on June 14, 2004. At the Annual Meeting, the followingmatters were voted upon by holders of 55.4% of the total outstanding shares: 

 

1.                                       Toelect the following eight directors: 

 
| ** **                   | ** ** | **VOTES  FOR** | ** ** | **VOTES  AGAINST** | ** ** | **VOTES  WITHHELD** | ** ** |
|------------------------------|------------|----------------|------------|--------------------|------------|---------------------|------------|
| Argeris Karabelas, Ph.D.     |       | 14,192,162     |       | 11,200             |       | —              |       |
| Michael D.  Loberg, Ph.D.    |       | 14,014,272     |       | 189,090            |       | —              |       |
| Robert S. Cohen              |       | 14,192,162     |       | 11,200             |       | —              |       |
| Zola Horovitz, Ph.D.         |       | 10,997,153     |       | 3,206,209          |       | —              |       |
| Mark Leschly                 |       | 14,192,162     |       | 11,200             |       | —              |       |
| John W. Littlechild          |       | 10,997,153     |       | 3,206,209          |       | —              |       |
| Joseph Loscalzo, M.D., Ph.D. |       | 14,014,272     |       | 189,090            |       | —              |       |
| Davey Scoon                  |       | 14,192,162     |       | 11,200             |       | —              |       |

 

Each of the abovenamed individuals was elected as a director.

 

2.                                       Toratify the selection of Ernst & Young LLP as the independent publicaccountants of the Company for the current fiscal year:

 

| **VOTES  FOR** | ** ** | **VOTES  AGAINST** | ** ** | **VOTES  WITHHELD** |
|----------------|------------|--------------------|------------|---------------------|
| 14,197,102     |       | 3,150              |       | 3,110               |

 

The proposal wasapproved.

 

 

**Item6.**           Exhibits and Reports on Form 8-K.

** **

(a)                  Theexhibits listed in the accompanying exhibit index are filed as part of thisQuarterly Report on Form 10-Q.

 

(b)                  Thefollowing reports on Form 8-K were filed for the quarter for which this reportis filed:

 

A Current Report on Form 8-K was furnished to theSecurities and Exchange Commission on May 12, 2004 to report, pursuant to Item12 (Results of Operations and Financial Condition) that we announced on May 11,2004 our financial results for the quarter ended March 31, 2004.

 

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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/ Joseph Grimm |   |
|                  |           | Joseph Grimm |
|                  |           | Senior Vice President,  Business Development and Chief  Financial Officer, Treasurer and Secretary *(Principal  Financial Officer)* |
| Date: August 16, 2004 |           |
|                       |                |  |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                 |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
| 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 adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
| 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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