**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**
| **(Mark One)**                                   |
|--------------------------------------------------|
| ** **                                       |
| **x**                                            | ** ** | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** **                                       | ** ** | ** ** |
| **For the quarterly period ended June 30, 2006** |
|                                             | ** ** | ** ** |
| **or**                                           |
|                                             | ** ** | ** ** |
| **o**                                            | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

** **

**For the transition periodfrom              to**

** **

**Commission File Number000-50405**

** **

**ACUSPHERE, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                   |   | **04-3208947**                     |
|------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation |   | (IRS Employer  Identification No.) |
| or organization)                               |   |                               |
|                                           |   |                               |
| **500  Arsenal Street**                        |   |                               |
| **Watertown,  Massachusetts**                  |   | **02472**                          |
| (Address of  principal executive offices)      |   | (Zip Code)                         |

 

Registrant’sTelephone Number, Including Area Code:  **(617)648-8800**

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

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

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

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

As of August 3, 2006 there were 28,813,873 sharesof the registrant’s common stock, $.01 par value per share, outstanding.

 

 

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**ACUSPHERE, INC.**

**Form 10-QFor the Quarterly Period Ended June 30, 2006**

**CONTENTS**
|                                                                                                     | ** ** | **Page  Number** |
|-----------------------------------------------------------------------------------------------------|------------|------------------|
|                                                                                                |       |             |
| PART  I: FINANCIAL INFORMATION                                                                      |       |             |
| Item  1. Consolidated Financial Statements                                                          |       | 3                |
| Condensed  Consolidated Balance Sheets:                                                             |       | 3                |
| June 30, 2006  (Unaudited) and December 31, 2005                                                    |       | 3                |
| Condensed Consolidated Statements of Operations  (Unaudited):                                       |       |             |
| Three and Six  Months ended June 30, 2006 and 2005                                                  |       | 4                |
| Condensed Consolidated Statements of Cash Flows  (Unaudited):                                       |       |             |
| Six Months ended  June 30, 2006 and 2005                                                            |       | 5                |
| Notes to  Condensed Consolidated Financial Statements (Unaudited)                                   |       | 6                |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       | 14               |
| Item 3. Quantitative and Qualitative Disclosure about  Market Risk                                  |       | 26               |
| Item 4. Controls and Procedures                                                                     |       | 26               |
| PART  II: OTHER INFORMATION                                                                         |       | 27               |
| Item  1. Legal Proceedings                                                                          |       | 27               |
| Item 1A. Risk Factors                                                                               |       | 27               |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                |       | 40               |
| Item 3. Defaults Upon Senior Securities                                                             |       | 40               |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        |       | 41               |
| Item  5. Other Information                                                                          |       | 41               |
| Item 6. Exhibits                                                                                    |       | 41               |
| Signature                                                                                           |       | 42               |

 

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**PARTI: FINANCIAL INFORMATIONITEM 1. CONSOLIDATED FINANCIAL STATEMENTSACUSPHERE, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(unaudited, in thousands except share data)**
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **As of**                | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **June 30,   2006** | ** ** | **December 31,  2005** | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                                |       |                          |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                     |       | $                             | 57,625     |   | $ | 51,112 |   |
| Accounts  receivable                                                                                                                                                                                                                                                                                           |       | 752                           |       | — |   |
| Other current  assets                                                                                                                                                                                                                                                                                          |       | 960                           |       | 1,142 |   |
| Total current  assets                                                                                                                                                                                                                                                                                          |       | 59,337                        |       | 52,254 |   |
|                                                                                                                                                                                                                                                                                                           |       |                          |       |   |   |
| PROPERTY AND EQUIPMENT,  at cost:                                                                                                                                                                                                                                                                              |       |                          |       |   |   |
| Property and  equipment                                                                                                                                                                                                                                                                                        |       | 54,646                        |       | 53,726 |   |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                                                                                |       | 17,021                        |       | 11,886 |   |
| Property and  equipment, net                                                                                                                                                                                                                                                                                   |       | 37,625                        |       | 41,840 |   |
|                                                                                                                                                                                                                                                                                                           |       |                          |       |   |   |
| OTHER ASSETS                                                                                                                                                                                                                                                                                                   |       | 1,840                         |       | 1,745 |   |
| TOTAL ASSETS                                                                                                                                                                                                                                                                                                   |       | $                             | 98,802     |   | $ | 95,839 |   |
|                                                                                                                                                                                                                                                                                                           |       |                          |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                 |       |                          |       |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                           |       |                          |       |   |   |
| Current portion  of long-term obligations                                                                                                                                                                                                                                                                      |       | $                             | 12,028     |   | $ | 6,727 |   |
| Current portion  of deferred revenue                                                                                                                                                                                                                                                                           |       | 3,012                         |       | 3,429 |   |
| Derivative  liability                                                                                                                                                                                                                                                                                          |       | 406                           |       | 1,078 |   |
| Accounts payable                                                                                                                                                                                                                                                                                               |       | 2,117                         |       | 3,180 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                               |       | 5,471                         |       | 6,829 |   |
| Total current  liabilities                                                                                                                                                                                                                                                                                     |       | 23,034                        |       | 21,243 |   |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                                         |       |                          |       |   |   |
| Long-term  obligations, net of current portion                                                                                                                                                                                                                                                                 |       | 11,963                        |       | 14,601 |   |
| Deferred  revenue, net of current portion                                                                                                                                                                                                                                                                      |       | 4,630                         |       | 2,578 |   |
| Total long-term  liabilities                                                                                                                                                                                                                                                                                   |       | 16,593                        |       | 17,179 |   |
| COMMITMENTS                                                                                                                                                                                                                                                                                                    |       |                          |       |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                                     |       |                          |       |   |   |
| Preferred stock,  $0.01 par value per share                                                                                                                                                                                                                                                                    |       |                          |       |   |   |
| Authorized—5,000,000  shares as of June 30, 2006 and December 31, 2005; Designated 6.5%  convertible exchangeable—1,000,000 shares as of June 30, 2006 and  December 31, 2005; issued and outstanding 730,000 and 740,000 shares as  of June 30, 2006 and December 31, 2005 |       | 7                             |       | 7 |   |
| Common stock,  $0.01 par value per share                                                                                                                                                                                                                                                                       |       |                          |       |   |   |
| Authorized,  98,500,000 shares as of June 30, 2006 and December 31, 2005; issued and  outstanding 28,809,211 shares as of June 30, 2006 and 22,870,559 as of  December 31, 2005                                                                                                                 |       | 288                           |       | 229 |   |
| Additional  paid-in capital                                                                                                                                                                                                                                                                                    |       | 315,433                       |       | 277,592 |   |
| Deferred  stock-based compensation                                                                                                                                                                                                                                                                             |       | (171                          | )          | (359 | ) |
| Accumulated  deficit                                                                                                                                                                                                                                                                                           |       | (256,382                      | )          | (220,052 | ) |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                               |       | 59,175                        |       | 57,417 |   |
| TOTAL                                                                                                                                                                                                                                                                                                          |       | $                             | 98,802     |   | $ | 95,839 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

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**ACUSPHERE, INC.AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS(unaudited, in thousands except per share data)**
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                   | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| COLLABORATION  REVENUE                                       |       | $                                | 246        |                           | $          | 857 |   | $ | 1,103 |   | $ | 1,714 |   |
| OPERATING  EXPENSES:                                         |       |                             |       |                           |       |   |   |   |   |
| Research and development                                     |       | 21,640                           |       | 15,227                         |       | 32,514 |   | 22,905 |   |
| General and administrative                                   |       | 3,040                            |       | 2,114                          |       | 5,594 |   | 3,861 |   |
| Total operating expenses                                     |       | 24,680                           |       | 17,341                         |       | 38,108 |   | 26,766 |   |
| Interest income                                              |       | 757                              |       | 529                            |       | 1,234 |   | 831 |   |
| Other income  (expense)                                      |       | —                           |       | —                         |       | — |   | — |   |
| Interest expense                                             |       | (655                             | )          | (341                           | )          | (1,134 | ) | (482 | ) |
| Change in  valuation of derivative                           |       | 1,455                            |       | 953                            |       | 575 |   | 1,387 |   |
| NET LOSS                                                     |       | $                                | (22,877    | )                              | $          | (15,343 | ) | $ | (36,330 | ) | $ | (23,316 | ) |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Dividends on  preferred stock                                |       | (593                             | )          | (1,032                         | )          | (1,194 | ) | (1,032 | ) |
| NET LOSS  AVAILABLE TO COMMON STOCKHOLDERS                   |       | $                                | (23,470    | )                              | $          | (16,375 | ) | $ | (37,524 | ) | $ | (24,348 | ) |
| NET LOSS  AVAILABLE TO COMMON STOCKHOLDERS   PER SHARE— |       |                             |       |                           |       |   |   |   |   |
| Basic and  diluted                                           |       | $                                | (0.84      | )                              | $          | (0.92 | ) | $ | (1.47 | ) | $ | (1.37 | ) |
| WEIGHTED-AVERAGE  SHARES OUTSTANDING—                   |       |                             |       |                           |       |   |   |   |   |
| Basic and diluted                                            |       | 28,055                           |       | 17,829                         |       | 25,447 |   | 17,821 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

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**ACUSPHERE, INC.AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited, in thousands)**
| ** **                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **June 30,**              | ** ** | **June 30,** | ** ** |
| ** **                                                                   | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                       |       |                           |       |   |   |
| Net loss                                                                     |       | ($36,330                       | )          | ($23,316 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                           |       |   |   |
| Stock-based compensation expense                                             |       | 1,355                          |       | 321 |   |
| Depreciation and amortization                                                |       | 5,134                          |       | 1,198 |   |
| Write-off of intellectual property acquisition cost                          |       | 1,492                          |       | 5,218 |   |
| Noncash interest expense                                                     |       | 576                            |       | 105 |   |
| Noncash rent expense                                                         |       | 41                             |       | 187 |   |
| Noncash amortization of deferred revenue                                     |       | (857                           | )          | (1,714 | ) |
| Noncash amortization of fee and warrants to financial  advisor               |       | 78                             |       | 135 |   |
| Change in valuation of derivative                                            |       | (576                           | )          | (1,387 | ) |
| Changes in operating assets and liabilities:                                 |       |                           |       |   |   |
| Deferred revenue                                                             |       | 1,740                          |       | 2,000 |   |
| Other current assets                                                         |       | 54                             |       | 938 |   |
| Accounts payable                                                             |       | (1,063                         | )          | (648 | ) |
| Accrued expenses                                                             |       | (1,666                         | )          | 1,135 |   |
| Net cash used in operating activities                                        |       | (30,022                        | )          | (15,828 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                       |       |                           |       |   |   |
| Purchases of property and equipment                                          |       | (920                           | )          | (18,550 | ) |
| Increase in other assets                                                     |       | (95                            | )          | (140 | ) |
| Net cash used in investing activities                                        |       | (1,015                         | )          | (18,690 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                       |       |                           |       |   |   |
| Payments on long-term obligations                                            |       | (2,005                         | )          | (1,054 | ) |
| Proceeds from long-term obligations                                          |       | 2,918                          |       | 9,478 |   |
| Net proceeds from sale of stock                                              |       | 37,689                         |       | 41,887 |   |
| Payment of preferred stock dividends                                         |       | (1,194                         | )          | (788 | ) |
| Net proceeds from exercise of stock options                                  |       | 114                            |       | 14 |   |
| Proceeds from issuance of common stock from employee  stock purchase plan    |       | 28                             |       | 12 |   |
| Net cash provided by financing activities                                    |       | 37,550                         |       | 49,549 |   |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                   |       | 6,513                          |       | 15,031 |   |
| CASH AND CASH  EQUIVALENTS—Beginning of period                          |       | 51,112                         |       | 45,180 |   |
| CASH AND CASH  EQUIVALENTS—End of period                                |       | $                              | 57,625     |   | $ | 60,212 |   |
|                                                                              |            |                                |            |  |  |  |  |

 

The accompanying notesare an integral part of these consolidated financial statements.

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**1.****     Basis of Presentation**

The accompanying unaudited condensed consolidatedfinancial statements of Acusphere, Inc. and Subsidiaries (the “Company”), havebeen prepared in accordance with generally accepted accounting principles inthe United States of America for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles in the United States of America for completefinancial statements. These statements should be read in conjunction with theconsolidated financial statements and notes thereto included in the Company’slatest audited annual financial statements. Those audited statements are includedin our Annual Report on Form 10-K for the year ended December 31, 2005, whichhas been filed with the SEC.

In the opinion of management, all adjustments,consisting only of normal, recurring adjustments considered necessary for afair presentation of the results of these interim periods have been included.The results of operations for the three and six months ended June 30, 2006 maynot be indicative of the results that may be expected for the full fiscal year.

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof expenses during the reporting period. Actual results could differ from thoseestimates or assumptions. The more significant estimates reflected in thesefinancial statements relate to revenue recognition, accrued expenses, embeddedderivatives, and valuation of stock-based compensation.

**2.  Revenue Recognition**

The Company recognizes revenue from license arrangements in accordancewith Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”) andFinancial Accounting Standards Board (“FASB”) Emerging Issue Task Force IssueNo. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF00-21”). The Company recognizes revenue from license payments not tied to achievinga specific performance milestone ratably over the period over which the Companyis obligated to perform services. The period over which the Company isobligated to perform services is estimated based on available facts andcircumstances.  The Company periodicallyevaluates the assumptions underlying these estimates; significant changes inthese assumptions could result in an adjustment to the period over which therevenue is recognized. The Company recognizes revenue from performancepayments, when such performance is substantially in the Company’s control andwhen the Company believes that completion of such performance is reasonablyprobable, ratably over the period over which the Company estimates that it willperform such performance obligations. Substantive at-risk milestone payments,which are based on achieving a specific performance milestone when performanceof such milestone is contingent on performance by others or for whichachievement can not be reasonably estimated or assured, are recognized asrevenue when the milestone is achieved and the related payment is due, providedthat there is no substantial future service obligation associated with themilestone. Revenue in connection with license arrangements is recognized overthe term of the arrangement and is limited to payments collected or due andreasonably assured of collection. In circumstances where the arrangementincludes a refund provision, the Company defers revenue recognition until therefund condition is no longer applicable unless, in the Company’s judgment, therefund circumstances are within its operating control and unlikely tooccur.  Payments received in advance ofbeing recognized as revenue are deferred. Contract amounts which are not due until the customer accepts or verifiesthe research results are not recognized as revenue until customer acceptance,assuming collectibility is reasonably assured.

**3.****     Accounting for Stock-basedCompensation**

*Summary of Stock-Based CompensationPlans*

Under the Company’s 2005Stock Option and Incentive Plan (the “2005 Plan”), the Company may grant up to1,700,000 shares of common stock to be issued as incentive stock options (“ISOs”),nonqualified stock option, awards of common stock and direct purchases ofcommon stock by Acusphere employees, officers, directors and consultants. Themaximum number of shares that may be granted to any employee under the 2005Plan may not exceed 1,000,000 shares of common stock during any calendar year.Options granted have a term of 10 years and generally vest over fouryears. The Company settles employee stock option exercises with newly issuedshares. As of June 30, 2006, there were 0.4 million options outstanding underthe 2005 Plan. As of June 30, 2006, there were 1.3 million shares available forfuture grant.

Under the Company’s 2003Stock Option and Incentive Plan (the “2003 Plan”), the Company may grant up to2,500,000 shares of common stock to be issued as ISOs, nonqualified stockoption, awards of common stock and direct purchases of common stock by 

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Acusphere employees,officers, directors and consultants. The maximum number of shares that may begranted to any employee under the 2003 Plan may not exceed 583,334 shares ofcommon stock during any calendar year. Options granted have a term of10 years and generally vest over four years. The Company settles employeestock option exercises with newly issued shares. As of June 30, 2006, therewere 2.5 million options outstanding under the 2003 Plan.

In March 1994, the1994 Stock Plan (the “1994 Plan”) was approved. The 1994 Plan, as amended,provided that a maximum of 1,423,663 shares of common stock could be issued asISOs, nonqualified stock options and stock grants. The Company ceased grantingawards under the 1994 Plan after March 7, 2004. As of June 30, 2006, therewere 1.0 million options outstanding under the 1994 Plan.

In July 2003, the2003 Employee Stock Purchase Plan (the “Purchase Plan”) was approved. ThePurchase Plan provides for the issuance of a maximum of 233,334 shares ofcommon stock. Eligible employee may contribute up to 10% of their total cashcompensation with a maximum of 417 shares semi-annually. The Company settlesemployee stock purchases under the Purchase Plan with newly issued shares.Acusphere had 215,721 shares available for future sales of common stockunder this plan at June 30, 2006.

**Changein accounting for stock-based compensation plans**

Prior to January 1,2006, the Company had followed Accounting Principles Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees”, and relatedinterpretations, which resulted in the accounting for grants of awards toemployees at their intrinsic value in the consolidated financial statements.Accordingly, no compensation expense was recorded for options issued toemployees in fixed amounts and with fixed exercise prices at least equal to thefair market value of the Company’s common stock at the date of grant.Conversely, when the exercise price for accounting purposes was below fairvalue of the Company’s common stock at the date of grant, a non-cash charge tocompensation expense was recorded ratably over the term of the option vestingperiod in an amount equal to the difference between the value calculated usingthe exercise price and the fair value. The Company did issue options prior toits initial S-1 filing in July 2003 at values less than fair market. Thesegrants resulted in the recording of deferred compensation.  Effective January 1, 2006, the Companyadopted FAS No. 123R, “Accounting for Stock-Based Compensation,” (“FAS 123R”)using the modified prospective method, which results in the provisions of FAS123R being applied to the consolidated financial statements on a going-forwardbasis. FAS 123R requires companies to recognize stock-based compensation awardsgranted to its employees as compensation expense on a fair value method. Underthe fair value recognition provisions of FAS 123R, stock-based compensationcost is measured at the grant date based on the fair value of the award and isrecognized as expense over the service period, which generally represents thevesting period. The grant date fair value of stock options is calculated usingthe Black-Scholes option-pricing model and the grant date fair value ofrestricted stock is based on intrinsic value. The expense recognized over theservice period is required to include an estimate of the awards that will beforfeited. Previously, the Company recorded the impact of forfeitures as theyoccurred. Options granted prior to the initial S-1 filing in 2003 continue tobe accounted for under APB No. 25.

All stock-based awards tonon-employees are accounted for at their fair market value in accordance withFAS 123R and Emerging Issues Task Force No. 96-18, “Accounting for EquityInstruments Than Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services.”

Total stock-basedcompensation expense was $0.7 million and $1.4 million for the three andsix months ending June 30, 2006, respectively. The incremental effect on stockcompensation expense as a result of the adoption of FAS 123R for the three andsix month periods ended June 30, 2006 was an additional charge of approximately$0.6 million, or $0.02 per share, and $1.2 million, or $0.05 per share, respectively.  The Company recognized the full impact of itsequity incentive plans in the consolidated statement of operations for the sixmonths ended June 30, 2006 under FAS 123R. The following table presents stock-basedcompensation expense included in the Company’s consolidated statement ofoperations (in millions):

|                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **June 30, 2006**      | ** ** | **June 30, 2006**    | ** ** |
| Research &  development   |       | $                                | 0.3        |                           | $          | 0.6 |   |
| General &  administrative |       | $                                | 0.4        |                           | $          | 0.8 |   |
| Total                         |       | $                                | 0.7        |                           | $          | 1.4 |   |

 

The Company hadpreviously adopted the provisions of FAS No. 123, “Accounting forStock-Based Compensation,” as amended by FAS No. 148, “Accounting forStock-Based Compensation — Transition and Disclosure,” through disclosure only.The following

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table illustrates theeffect on net loss and net loss per share for the three and six months endedJune 30, 2005, as if the Company had applied the fair value recognitionprovisions of SFAS 123 to all stock awards.
| **(in thousands, except per share amounts)**                                       | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Net loss applicable to  common stockholders, as reported:                                                   |       | $                                                         | (16,375    | )                                                       | $          | (24,348 | ) |
| Add: Stock-based employee compensation expense  included in reported net loss      |       | 128                                                       |       | 265                                                     |       |
| Deduct: Stock-based employee compensation expense  determined under fair value method                       |       | (519                                                      | )          | (1,048                                                  | )          |
| Net loss                                                                                                    |       | $                                                         | (16,766    | )                                                       | $          | (25,131 | ) |
| As reported                                                                                                 |       | $                                                         | (0.92      | )                                                       | $          | (1.37 | ) |
| Pro Forma                                                                                                   |       | $                                                         | (0.94      | )                                                       | $          | (1.41 | ) |

 

As described above, theCompany had previously recorded deferred compensation for below fair valueoptions granted prior to the initial S-1 filing in 2003. As of June 30, 2006,$0.2 million of deferred compensation has yet to be recognized. Such amountswill be recognized over the next 6 months. The Company continues to expensethis deferred stock-based compensation to operations over the vesting period ofthe options, resulting in $0.1 million and $0.1 million as stock-basedcompensation expense for the three months ended June 30, 2006 and June 30,2005, respectively, and $0.2 million and $0.3 million as stock-basedcompensation expense for the six months ended June 30, 2006 and June 30, 2005,respectively.

The Company uses theBlack-Scholes option-pricing model to estimate the fair value of the options atthe grant date. The fair values of stock options granted during the three andsix-month periods ended June 30, 2006 and 2005 were calculated using thefollowing weighted-average assumptions:

|                         | ** ** | ** Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                                  | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Volatility              |       | 46.26                                                     | %          | 46.67                                             | %          | 38.03 | % | 47.2 | % |
| Risk-free interest rate |       | 4.94                                                      | %          | 3.82                                              | %          | 4.62 | % | 3.69 | % |
| Forfeiture rate         |       | 0                                                         | %          | 0                                                 | %          | 0 | % | 0 | % |
| Expected option  life   |       | 5 years                                                   |       | 4 years                                           |       | 5 years |   | 4 years |   |

 

The fair values ofoptions granted during six-month periods ended June 30, 2006 and 2005under the Company’s Purchase Plan were calculated using the followingweighted-average assumptions:

| Volatility              |   | 37.69    | %      | 47.32    | %      |
|-------------------------|--------|----------|--------|----------|--------|
| Risk-free interest rate |   | 4.46     | %      | 3.64     | %      |
| Forfeiture rate         |   | 10       | %      | 10       | %      |
| Expected option life    |   | 6 months |   | 6 months |   |

 

The Company usedthe historical volatility of the Company’s market-traded stock for the expectedvolatility assumption input to the model. This volatility assumption is consistent with the Company’s volatilityassumptions made in accordance with FAS 123 for purposes of the above pro formainformation.   The risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of stock optiongrants and is based upon observed interest rates appropriate for the terms ofsuch grants.

The expected life ofemployee stock options represents the weighted-average period the stock optionsare estimated to remain outstanding. The expected life of employee stockoptions is a function of the options’ remaining contractual life and the extentto which the option is in-the-money (i.e., the average stock price during theperiod is above the strike price of the stock option). The Company estimatesthat, based on these variables, options are likely on average to be exercisedin 5 years.  The option life for optionsunder the Purchase Plan is six months, representing the time period under whichthe option may be exercised as defined in the plan.

As share-basedcompensation expense recognized in the condensed consolidated statement ofoperations for the six months ended June 30, 2006 is based on awards ultimatelyexpected to vest, it should be reduced for estimated forfeitures.  FAS 123R requires forfeitures to be estimatedat the time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Forfeitures were estimated at 0% inthe three and six months ended June 30, 2006 since the effect offorfeitures on the Company’s expense is negligible due to the monthly vestingof option grants.

During the six monthsended June 30, 2006, the Company granted stock options to existing employees,as part of the Company’s performance review process, new employees andDirectors in lieu of cash based compensation. All such options were grantedwith 

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exercise prices equal tothe current market value of the underlying common stock on the date of grant.Aggregate stock options granted during 2006 are as follows:

|                                             | ** ** | ** **         | ** ** | ** **              | ** **       | **Weighted Average** | ** ** |
|---------------------------------------------|------------|--------------------|------------|-------------------------|------------------|---------------------------|------------|
| ** **                                  | ** ** | **Number of** | ** ** | **Exercise Price** | ** **       | **Exercise Price**   | ** ** |
| ** **                                  | ** ** | **Shares**         | ** ** | **Per Share**      | ** **       | **Per Share**        | ** ** |
| For the three  months ended March 31, 2006: |       | 928,829            |       | $                       | 5.42 – $6.5 | 9                         | $          | 5.84 |   |
| For the three months  ended June 30, 2006:  |       | 158,600            |       | $                       | 3.59 – $6.7 | 2                         | $          | 3.93 |   |

 

On February 28, 2006, thecompany issued 5,636 shares of its common stock under the Purchase Plan at$4.96 per share, reflecting 85% of the value of the closing stock price.

***Stock Options***

The following tablesummarizes the stock option activity in the equity incentive plans fromJanuary 1, 2006 through June 30, 2006:**                          **

|                           | ** ** | ** **         | ** ** | ** **              | ** **         | **Weighted** | ** ** |
|---------------------------|------------|--------------------|------------|-------------------------|--------------------|--------------|------------|
| ** **                | ** ** | ** **         | ** ** | ** **              | ** **         | **Average**  | ** ** |
| ** **                | ** ** | **Number of** | ** ** | **Exercise Price** | ** **         | **Exercise** | ** ** |
| ** **                | ** ** | **Shares**         | ** ** | **Per Share**      | ** **         | **Price**    | ** ** |
| Balance, January  1, 2006 |       | 3,135,033          |       | $                       | 0.84 – $13.02 |         | $          | 6.23 |   |
| Granted                   |       | 928,829            |       | 5.42 – 6.59        |               | 5.84         |       |
| Exercised                 |       | (30,648            | )          | 0.84 – 5.57        |               | 2.62         |       |
| Canceled                  |       | (113,330           | )          | 0.84 – 8.50        |               | 5.90         |       |
| Balance, March  31, 2006  |       | 3,919,884          |       | 0.84 – 13.02       |               | 6.18         |       |
| Granted                   |       | 158,600            |       | 3.59 – 6.72        |               | 3.92         |       |
| Exercised                 |       | (35,704            | )          | 0.84 – 1.98        |               | 1.15         |       |
| Canceled                  |       | (145,977           | )          | 0.84 – 8.50        |               | 6.30         |       |
| Balance, June 30, 2006    |       | 3,896,803          |       | $                       | 0.84 – 13.02  |         | $          | 6.13 |   |

 

The following tablesummarizes information related to the Company’s options at June 30, 2006:

 
| ** **                | ** ** | ** **         | ** ** | **Outstanding**           | ** ** | ** **        | ** ** | ** **      | ** ** | ** **         | ** ** |
|---------------------------|------------|--------------------|------------|---------------------------|------------|-------------------|------------|-----------------|------------|--------------------|------------|
| ** **                | ** ** | ** **         | ** ** | **Weighted-Average**      | ** ** | **Weighted**      | ** ** | ** **      | ** ** | **Weighted**       | ** ** |
| ** **                | ** ** | ** **         | ** ** | **Remaining**             | ** ** | **Average**       | ** ** | **Exercisable** | ** ** | **Average**        | ** ** |
| ** **                | ** ** | **Number of** | ** ** | **Contractual Life** | ** ** | **Exercise**      | ** ** | **Number**      | ** ** | **Exercise**       | ** ** |
| **Exercise Price**   | ** ** | ** **         | ** ** | **Shares**                | ** ** | **(in Yrs)** | ** ** | **Price**       | ** ** | **of Shares** | ** ** | **Price** | ** ** |
| $0.00 – 1.30         |       | 420,245            |       | 6.0                       |       | $                 | 0.87       |            | 385,754    |               | $          | 0.87 |   |
|  1.31 –  2.06   |       | 52,093             |       | 2.5                       |       | 1.89              |       | 52,093          |       | 1.89               |       |
|  2.07 –  3.91   |       | 140,000            |       | 9.9                       |       | 3.59              |       | –          |       | –             |       |
|  3.92 –  5.21   |       | 288,941            |       | 9.1                       |       | 4.83              |       | 123,376         |       | 4.85               |       |
|  5.22 –  6.51   |       | 1,908,161          |       | 8.9                       |       | 5.83              |       | 485,119         |       | 5.88               |       |
|  6.52 –  7.81   |       | 296,716            |       | 6.7                       |       | 7.01              |       | 202,151         |       | 7.18               |       |
|  7.82 –  9.11   |       | 287,801            |       | 7.3                       |       | 8.72              |       | 172,202         |       | 8.72               |       |
|  9.12 –  10.42  |       | 218,500            |       | 7.6                       |       | 9.59              |       | 131,756         |       | 9.58               |       |
|  10.43 –  13.02 |       | 284,346            |       | 7.2                       |       | 13.02             |       | 198,318         |       | 13.02              |       |
|                      |       | 3,896,803          |       | 8.1                       |       | $                 | 6.13       |            | 1,750,769  |               | $          | 6.10 |   |
|                           |            |                    |            |                           |            |                   |            |                 |            |                    |            |  |  |  |  |

 

The total cash receivedfrom employees as a result of employee stock option exercises during thesix-month period ended June 30, 2006 was approximately $0.1 million.

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As of June 30, 2006, theaggregate intrinsic value of fully vested and exercisable options is$1.1 million, representing the total pre-tax intrinsic value, based on theCompany’s closing common stock price of $3.43 as of June 30, 2006, which wouldhave been received by the option holders had all option holders exercised theiroptions as of that date.

As of June 30, 2006,there was $4.4 million of total expected unrecognized compensation costrelated to unvested stock options granted under the Company’s stock-basedcompensation plans. That cost is expected to be recognized over aweighted-average period of 2.5 years.

**4.****     Net Loss Per Common Share**

Basic and diluted net loss per common share iscalculated by dividing the net loss available to common stockholders by theweighted-average number of unrestricted common shares outstanding during theperiod. Diluted net loss per common share is the same as basic net loss percommon share, since the effects of potentially dilutive securities areantidilutive for all periods presented. As of June 30, 2006 and 2005,antidilutive securities, which consist of convertible exchangeable preferredstock, stock options, warrants, and restricted common stock that are notincluded in the diluted net loss per share calculation aggregated 12,295,611and 10,721,294 shares, respectively.

The following table reconciles weighted-average commonshares outstanding to the shares used in the computation of basic and dilutedweighted-average common shares outstanding:

 

|                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                           | ** ** | **June 30,  2006**          | ** ** | **June 30,  2005**        | ** ** | **June 30,  2006** | ** ** | **June 30,  2005** | ** ** |
| Weighted-average  common shares outstanding                          | ** ** | 28,055,275                       |       | 17,831,930                     |       | 25,447,887 |   | 17,824,847 | ** ** |
| Less  weighted-average unvested restricted common shares outstanding |       | (375                             | )          | (3,404                         | )          | (633 | ) | (4,128 | ) |
| Basic and diluted  weighted-average common shares outstanding        |       | 28,054,900                       |       | 17,828,526                     |       | 25,447,254 |   | 17,820,719 |   |

 

**5. Property and Equipment**

Property and equipment at cost consist of thefollowing (in thousands):

 

|                                                  | ** ** | **As of:**         | ** ** | ** **                  | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** | **Estimated  Useful Life** | ** ** |
| Equipment                                        |       | $                       | 22,819     |                        | $          | 20,589 |   | 3 –  5 years |   |
| Furniture and  fixtures                          |       | 379                     |       | 345                         |       | 5  years |   |
| Leasehold  improvements                          |       | 31,005                  |       | 30,986                      |       | Lease term (a) |   |
| Sub-total  depreciable assets                    |       | $                       | 54,203     |                        | $          | 51,920 |   |   |   |
| Less:  accumulated depreciation and amortization |       | (17,021                 | )          | (11,886                     | )          |   |   |
| Total depreciable assets, net                    |       | 37,182                  |       | 40,034                      |       |   |   |
| Deposits on  equipment purchases                 |       | 443                     |       | 1,205                       |       | N/A |   |
| Construction in  progress                        |       | —                  |       | 601                         |       | N/A |   |
| Total property and  equipment                    |       | $                       | 37,625     |                        | $          | 41,840 |   |   |   |

 

(a)             Thecompany depreciates leasehold improvements and equipment under capital leasesover the lesser of their useful lives or the remainder of their respectivelease terms.

Leaseholdimprovements primarily represent costs incurred for the build-out of theCompany’s commercial manufacturing facility in Tewksbury, Massachusetts, whichare being depreciated over the remaining lease term. Deposits on equipmentpurchases represent progress payments made for long-lead time capital equipmentpurchases.

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**6.   IntellectualProperty**

The Company expensesintellectual property costs incurred in obtaining license rights and patentsrights to technology or products for which technological feasibility has notbeen commercially demonstrated and no alternative future use has been shown toexist.  No amount has been capitalized by the Company relating to thecosts of intellectual property developed or acquired by the Company.

Effective June 1,2006, the Company entered into an agreement to license on a non-exclusive basisvarious ultrasound-related intellectual property from GE Healthcare (“GE”), adivision of General Electric Company. The agreement provides the Company withuse of GE’s ultrasound contrast agent patents and patent applications incombination with the Company’s lead product candidate AI-700 in the field ofultrasound contrast agents, as well as any patents that GE acquires in thefield within 12 months of the agreement. The term of the agreement extendsuntil expiration of the last of the patents licensed under the agreement.   In consideration of the non-exclusivelicense of these patents, the Company agreed to pay GE $10.0 million prior tocommercial approval of AI-700, of which $5.0 million was paid in June 2006 and$5.0 million is due in June 2007.  Inaddition, the Company agreed to pay GE $5.0 million upon the commercial approvalof AI-700 (defined as the first to occur of the approval of a New DrugApplication in the United States or the approval of a Marketing AuthorizationApplication in Europe) and $5.0 million upon the one year anniversary of suchcommercial approval.  The latter two $5.0million payments are contingent upon achievement of future milestone eventsand, accordingly, have not been recorded at this time.  For accounting purposes the Company has notdemonstrated technological feasibility or an alternative future use for thesepatents.  Therefore, $9.5 million wasexpensed upon the consummation of the agreement, representing the initial $5.0million June 2006 payment and the present value of the $5.0 million June 2007payment.

Also effectiveJune 1, 2006, the Company entered into an agreement to license on anon-exclusive basis various ultrasound-related intellectual property fromBracco International BV (“Bracco”). The agreement provides the Company with useof Bracco’s ultrasound-related patents and patent applications in combinationwith the Company’s lead product candidate AI-700 in the field of ultrasounddiagnostic imaging. The term of the agreement extends until expiration of thelast of the patents licensed under the agreement.  In consideration for the non-exclusivelicense of these patents, the Company agreed to pay Bracco up to a total royalty of Euros 3.0 million,of which Euros 0.5 million (approximately $0.6 million at June 30, 2006) waspaid in June 2006. An additional Euros 2.5 million is payable upon the Company’sachievement of certain defined regulatory milestones.  The Company also agreed to pay a royalty onfuture AI-700 revenue, up to a maximum royalty amount of Euros 10.0 million,less a portion of the above-referenced milestone payments. For accountingpurposes the Company has not demonstrated technological feasibility or analternative future use for these patents. Therefore, the $0.6 million paymentwas expensed in June 2006 when paid, whereas the other obligations have notbeen recorded since they are contingent upon the outcome of future events.

On May 11, 2005, theCompany entered into a Patent Transfer Agreement with ScheringAktiengesellschaft (“Schering”) pursuant to which the Company acquired rights,title and interest in certain ultrasound-related patents from Schering. Inconsideration of the transfer and assignment of these patents, the Companyagreed to pay Schering a total of $7.0 million of which $1.0 million was paidin May 2005, $3.0 million was paid in May 2006, and $3.0 million isdue in May 2007. For accounting purposes the Company has not demonstratedtechnological feasibility or an alternative future use for these patents.  Therefore, the present value of thisacquisition cost, $6.2 million, was expensed in May 2005 at the time ofacquisition.

**7. Long-term Obligations**

The carrying value oflong-term obligations is as follows:

 

|                              | ** ** | **As of:**         | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
| Capital lease  obligations   |       | $                       | 81         |   | $ | 65 |   |
| Notes payable                |       | 16,592                  |       | 15,696 |   |
| Other long-term  obligations |       | 7,319                   |       | 5,567 |   |
|                         |       | 23,992                  |       | 21,328 |   |
| Less current  maturities     |       | (12,028                 | )          | (6,727 | ) |
| Long-term obligations,  net  |       | $                       | 11,964     |   | $ | 14,601 |   |

 

Long-term obligationsoutstanding as of June 30, 2006, including current maturities, consistedof capital equipment leased under various capital lease arrangements, thepresent value of amounts payable to GE and Schering, promissory notes underequipment financing lines, and borrowings under a facility loan agreement. Monthly payments under the capital lease obligations mature through June2011.

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**8.  Deferred Revenue**

In July 2004, theCompany entered into a collaboration, license and supply agreement with Nycomedin which the Company granted Nycomed rights to develop and market AI-700 inEurope.  As of June 30, 2006, Nycomed haspaid $12.0 million in license fees for the Company’s research and developmentefforts which was being recognized ratably in revenue over the developmentperiod, initially estimated at 42 months. During the second quarter of 2006, management reevaluated theassumptions underlying the development term and revised the estimateddevelopment period to 48 months. This change in estimate resulted in no revenuebeing recognized under this collaboration agreement for the three months endedJune 30, 2006. The remaining $6.0 million of the $12.0 million in developmentpayments already received, but yet to be recognized as revenue, are included indeferred revenue at June 30, 2006 and will be recognized over the remainingestimated development period.

In October 2005 andFebruary 2006, the Company and Nycomed amended the collaboration agreementto accelerate $2.0 million in milestone payments in order to fund certainactivities associated with brand development and qualification of a commercialmanufacturing facility. Payments received or invoiced pursuant to theseamendments, including $1.6 million through June 30, 2006, are consideredadvances against a future milestone payment for a European regulatory filing,or Marketing Authorization Application (“MAA”). These amounts are classified asdeferred revenue until the MAA milestone is achieved, provided that theapplicable revenue recognition criteria are met.

During the period ended June 30, 2006 the Companycompleted its portion of a feasibility study with a pharmaceutical companyutilizing the Company’s HDDS technology. The Company recognized $0.2 million from this contract as revenue duringthe second quarter of 2006.

**9.****     Stockholders’ Equity**

On April 12, 2006, theCompany sold 5,772,004 units, each unit consisting of (i) one share of commonstock (ii) one warrant to purchase 0.3 shares of common stock at an exerciseprice of $7.97 per share, for a purchase price of $6.9675 per unit, resultingin aggregate gross proceeds to the Company of $40.2 million (net proceeds ofapproximately $37.8 million after deducting underwriting discounts andcommissions and estimated offering expenses). The shares of common stock and warrants were immediately separable andwere issued separately.   The warrantswill be exercisable beginning on October 12, 2006 and until April 12, 2011.

On February 24, 2005, theCompany issued 900,000 shares of 6.5% convertible exchangeable preferred stock(the “Preferred Stock”) at $50.00 per share resulting in aggregate grossproceeds to the Company of $45.0 million (net proceeds of approximately $41.9million after deducting underwriting discounts, commissions and offeringexpenses).  Each share of Preferred Stockhas a liquidation preference of $50.00 per share.  As of June 30, 2006, 730,000 shares ofPreferred Stock were outstanding.

Dividends on thePreferred Stock are cumulative from the date of original issue at the annualrate of $3.25 per share, payable quarterly on the first day of March, June,September, and December.  Any dividends mustbe declared by the Company’s board of directors and must come from funds thatare legally available for dividend payments. As of June 30, 2006, dividends had been paid on the Company’s PreferredStock through May 31, 2006. In August 2006, the Company’s board of directorsdeclared a quarterly dividend in the amount of $0.8125 per share of PreferredStock, payable on September 1, 2006 to the holders of record as of theclose of business on August 15, 2006.

The Preferred Stock isconvertible into the Company’s common stock at any time at the option of theholder at a conversion rate of 7.2886 shares of common stock for each share ofPreferred Stock, based on an initial conversion price of $6.86 per share. The initial conversion price is subject to adjustment in certain customaryevents, but is not subject to “price based” anti-dilution adjustment. TheCompany has reserved approximately 6.6 million shares of common stock forissuance upon such conversion.

The Company may elect to automaticallyconvert some or all of the Preferred Stock into shares of common stock if theclosing price of the Company’s common stock has exceeded $10.30 per share (150%of the conversion price) for at least 20 trading days during any 30-day tradingperiod, ending within five trading days prior to notice of automaticconversion.  Prior to March 1, 2009, if the Company elects toautomatically convert, or if any holder elects to voluntarily convert, thePreferred Stock, the Company will also make an additional payment (“Make-Whole”payment) equal to the aggregate amount of dividends that would have beenpayable on the Preferred Stock so converted from the original date of issuancethrough and including March 1, 2009, less any dividends already paid onthe Preferred Stock.  This additional payment is payable by the Company,at its option, in cash, in additional shares of its common stock, or in acombination of cash and shares of common stock.   The Company hasreserved a maximum of approximately 2.0 million shares of common stock forissuance under this Make-Whole provision.

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In accordance withStatement of Financial Accounting Standards No. 133, Accounting forDerivative Instruments (SFAS 133), the Company is required to separate andaccount for as an embedded derivative, the dividend make-whole payment featureof the Preferred Stock offering. As an embedded derivative instrument, thedividend make-whole payment feature must be measured at fair value andreflected as a liability. Changes in the fair value of the derivative arerecognized in earnings as a component of other income/(expense).  The Company determined the fair value of thedividend make-whole payment feature to be $3.1 million at February 24,2005 (the commitment date).  This amountwas allocated from the proceeds of the Preferred Stock to the derivativeliability.  During 2005, make-wholepayments related to the conversion of 160,000 shares were made and thederivative liability was reduced for the fair value of these payments.  As of June 30, 2006 and March 31,2006, the derivative liability was valued at $0.4 million and $2.0 million,respectively, resulting in the recognition of $0.6 million and $1.5 million asother income for the three and six month periods ending June 30, 2006, respectively.

In April 2006, one stockholder voluntarily converted10,000 shares of preferred stock into 72,886 shares of the Company’s commonstock.  In connection with theconversion, the Company issued an additional 15,526 shares of the Company’scommon stock in satisfaction of the required Make-Whole payment.  The fair value of this payment wasapproximately $0.1 million, which was charged to the derivative liabilityduring the second quarter of 2006.

The Company may elect toredeem the Preferred Stock on or after March 6, 2009 at decliningredemption prices.

The Preferred Stock isexchangeable, in whole but not in part, at the option of the Company on anydividend payment date beginning on March 1, 2006 (the “Exchange Date”) forthe Company’s 6.5% convertible subordinated debentures (“Debentures”) at therate of $50 principal amount of Debentures for each share of PreferredStock.  The Debentures, if issued, will mature 25 years after the ExchangeDate and have terms substantially similar to those of the Preferred Stock.  The Preferred Stock has no maturity date andno voting rights prior to conversion into common stock, except under limitedcircumstances.

**10.Warrants**

On April 12, 2006, theCompany sold 5,772,004 units, each unit consisting of (i) one share of common stock(ii) one warrant to purchase 0.3 shares of common stock at an exercise price of$7.97 per share, for a purchase price of $6.9675 per unit, resulting inaggregate gross proceeds to the Company of $40.2 million.  Warrants to purchase an additional 1,731,600shares of common stock were issued under this offering and will be exercisablebeginning on October 12, 2006 and until April 12, 2011.

As of June 30, 2006,warrants to purchase shares of the Company’s stock, the origination of whichwere derived in connection with debt and lease financing transactions, thecollaborative agreement with Nycomed and the April 2006 common stock offering,were outstanding for an aggregate of 3,048,108 shares of common stock at aneffective weighted average price of $8.73 per share as follows:

 

|        | ** ** | **Number of  Shares** | ** ** | **Exercise Price  Per Share** | ** ** | **Expiration  Date**     | ** ** |
|--------|------------|----------------------------|------------|-----------------------------------------|------------|--------------------------|------------|
|   |       | 4,724                      |       | 12.84                                   |       | August 21,  2006    |       |
|   |       | 7,517                      |       | 12.84                                   |       | June 6,  2007       |       |
|   |       | 5,194                      |       | 28.50                                   |       | February 21,  2008  |       |
|   |       | 3,404                      |       | 18.00                                   |       | February 26,  2008  |       |
|   |       | 450,897                    |       | 8.46                                    |       | April 11,  2008     |       |
|   |       | 684                        |       | 14.00                                   |       | April 11,  2008     |       |
|   |       | 7,540                      |       | 8.46                                    |       | June 27,  2008      |       |
|   |       | 573,105                    |       | 8.50                                    |       | August 2,  2008     |       |
|   |       | 16,212                     |       | 19.80                                   |       | October 16,  2008   |       |
|   |       | 14,934                     |       | 19.80                                   |       | October 19,  2008   |       |
|   |       | 114,895                    |       | 8.50                                    |       | October 20,  2008   |       |
|   |       | 55,732                     |       | 6.28                                    |       | November 30,  2009  |       |
|   |       | 2,688                      |       | 19.80                                   |       | January 5,  2010    |       |
|   |       | 30,844                     |       | 28.50                                   |       | March 30,  2011     |       |
|   |       | 28,138                     |       | 28.50                                   |       | September 27,  2011 |       |
|   |       | 1,731,600                  |       | 7.97                                    |       | April  12, 2011          |       |
|   |       | 3,048,108                  |       |                                    |       |                     |       |

 

**11. NewAccounting Pronouncements**

In July 2006, theFinancial Accounting Standards Board issued Interpretation No. (FIN) 48, “*Accounting for Uncertainty in Income Taxes*,” which iseffective January 1, 2007. The purpose of FIN 48 is to clarify and set forthconsistent rules for accounting for uncertain tax positions in accordance withSFAS 109, “*Accounting for Income Taxes*” byrequiring the application of a “more likely than not” threshold for therecognition and derecognition of tax positions. The Company is currentlyassessing what impact, if any, the adoption of this statement will have on itsconsolidated financial statements.

 

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**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**ForwardLooking Statements May Prove Inaccurate**

*Statementscontained herein, including without limitation, “Management’s Discussion andAnalysis of Financial Condition and Results of Operation,” contains certainprojections, estimates and other forward-looking statements. “Forward-lookingstatements,” as that term is defined in the Private Securities LitigationReform Act of 1995, are not historical facts and involve a number of risks anduncertainties. Words herein such as “may,” “will,” “should,” “could,” “would,” “expects,”“plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,”“potential,” and similar expressions (as well as other words or expressionsreferencing future events, conditions or circumstances) are intended toidentify forward-looking statements.*

*Forward-lookingstatements include, but are not limited to: our plans to develop and market newproducts and the timing of these development programs, in particular the timingof clinical trials and regulatory milestones for AI-700; our clinicaldevelopment of product candidates, clinical trials and our ability to obtainand maintain regulatory approval for our product candidates; our estimatesregarding our capital requirements and our needs for additional financing; ourestimates of expenses and future revenues and profitability; our estimates ofthe size of the potential markets for our product candidates; our selection andlicensing of product candidates; our ability to attract collaborators withacceptable development, regulatory and commercialization expertise; thebenefits to be derived from corporate collaborations, license agreements andother collaborative efforts, including those relating to the development andcommercialization of our product candidates; sources of revenues andanticipated revenues, including contributions from corporate collaborations,license agreements and other collaborative efforts for the development andcommercialization of products; our ability to create an effective direct salesand marketing infrastructure for products we elect to market and sell directly;the rate and degree of market acceptance of our product candidates; the timingand amount of reimbursement for our product candidates; the success of othercompeting therapies that may become available; and the manufacturing capacityfor our product candidates, including our plans to qualify a commercialmanufacturing facility for AI-700.*

*Our actualresults and the timing of certain events may differ materially from the resultsdiscussed, projected, anticipated or indicated in any forward-lookingstatements. Any forward-looking statement should be considered in light offactors discussed in Part II. Item 1A “Risk Factors” and elsewhere in thisreport. We caution readers not to place undue reliance on any suchforward-looking statements, which speak only as of the date they are made. Wedisclaim any obligation, except as specifically required by law and therules of the Securities and Exchange Commission, to publicly update orrevise any such statements to reflect any change in company expectations or inevents, conditions or circumstances on which any such statements may be based,or that may affect the likelihood that actual results will differ from thoseset forth in the forward-looking statements.*

*Thefollowing discussion should be read in conjunction with our consolidatedfinancial statements and related notes thereto included elsewhere in this Form 10-Q.*

**Overview**

We are a specialtypharmaceutical company that develops new drugs and improved formulations ofexisting drugs using our proprietary porous microparticle technology. We arefocused on developing proprietary drugs that can offer significant benefitssuch as improved safety and efficacy, increased patient compliance, greaterease of use, expanded indications or reduced cost. Our three initial productcandidates are designed to address large unmet clinical needs withincardiology, oncology and asthma. Our lead product candidate is a cardiovasculardrug in Phase 3 clinical development for the detection of coronary heartdisease, the leading cause of death in the United States.

We created our initialproduct candidates using technology that enables us to control the size andporosity of particles in a versatile manner, so we can customize the particlesto address the delivery needs of a variety of drugs. We are focused on creatingporous microparticles that are smaller than red blood cells. Some of thesemicroparticles are nanoparticles which are smaller than 1 micron. Smallmicroparticles are important for delivering drugs intravenously so that theycan pass through the body’s smallest blood vessels, for increasing the surfacearea of a drug so that the drug will dissolve more rapidly, and for deliveringdrugs to the lung via inhalation. Porosity is important for entrapping gases inmicroparticles, for controlling the release rate of the drug from amicroparticle, and for targeting inhaled drugs to specific regions of the lung.

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We have incurredsignificant operating losses to develop our product candidates and weanticipate continuing to incur significant operating losses in the comingyears. In particular, we expect to incur significant additional expenses andexperience other significant capital requirements for the conduct of our Phase3 clinical program for AI-700 and to complete the build-out and qualificationof a manufacturing facility for the initial commercial manufacture of AI-700.Since our inception, we have funded our operations primarily through privateand public placements of equity securities, equipment-backed financings andother debt financings.

**AI-700Phase 3 Clinical Trial**

Our Phase 3 clinical planprovides for a two-part program consisting of a pilot phase (the “pilot study”),under which new investigators and blinded readers have been qualified andtrained, and two independent multi-center pivotal trials.  These two pivotal trials, previously referredto as the “32” and “33” trials, in preparation for completion of the trialshave been re-named RAMP-1 and RAMP-2, respectively. “RAMP” stands for **R**eal-time**A**ssessment of**M**yocardial**P**erfusion with echocardiography. Clinicalinvestigators were qualified in the pilot phase on a rolling basis. The pilotphase was completed in 2005. Clinical investigators in the Phase 3 pivotalstudies are located at clinical sites in North America, Europe andAustralia.  Data from the Phase 3 pivotal studies are intended forsubmission to U.S., European, and potentially other regulatory authorities.

*ThePivotal Trials.*   As part of the Phase 3 pivotalstudy design, the evaluation of AI-700 enhanced stress echo and nuclear stressimages from the pivotal trials is performed by blinded readers who receive noinformation about the patient being evaluated other than the images. During thepivotal trials, we intentionally have no access to efficacy data. We do notpublicly disclose results from a pivotal trial until after the trial is closed,quality control checks are completed, the database is locked, the data arerevealed to us and we have had an opportunity to review and understand thedata, including data regarding clinical outcomes and safety results. A total of777 patients with known or suspected coronary heart disease have been enrolledin the Phase 3 pivotal trials, 320 patients in the RAMP-1 trial and 457patients in the RAMP-2 trial.

*TheRAMP-1 Trial.* All of the patients enrolled in thistrial received a stress echo study with AI-700 and a nuclear stress test.Patients in this pivotal trial generally underwent coronary angiography only ifthey had a positive nuclear stress test result. Patients in this pivotal trialwho had a negative nuclear stress test result were evaluated for ninety daysthereafter for cardiac events. The primary endpoints of the RAMP-1 trial wereaccuracy, sensitivity and specificity relative to a truth standard, incomparison to the performance of nuclear stress testing relative to the sametruth standard. Accuracy is defined as a measure of how faithfully theinformation obtained using AI-700 reflects the “truth” as indicated by thestudy truth standard. Sensitivity and specificity are subsets of accuracy.Sensitivity is defined as the ability to detect disease, specificity is definedas the ability to rule out disease.  Thetruth standard was determined with angiography. If angiographic data wereunavailable, then the truth standard was clinical outcome with nuclear stress,or clinical outcome. On June 5, 2006, we announced preliminary results forthe RAMP-1 trial. RAMP-1 was statistically designed to demonstrate that, for 2out of 3 echo blinded readers, AI-700 enhanced stress echo was non-inferior tonuclear stress in assessing coronary heart disease. The accuracy and specificityresults exceeded the criteria for success of this trial, where 3 out of 3readers met this standard for accuracy and 2 out of 3 readers exceeded thisstandard for specificity. The sensitivity results missed the criteria forsuccess of the trial with 1 out of 3 readers meeting the non-inferioritystandard. Based upon our review of the safety data from this trial, we believeAI-700 was well tolerated.

In the RAMP-1 study, theaccuracy of the nuclear blinded reader was 70%. All three echo blinded readersread with accuracy that was statistically non-inferior to the nuclear blindedreader (all p values<0.005). The specificity of the nuclear blinded readerwas 63% and the specificity of two of the AI-700 echo blinded readers wasstatistically superior (both p values<0.001). The sensitivity of the nuclearblinded reader was 78% and the sensitivity of one of the AI-700 echo blindedreaders was non-inferior to nuclear (p=0.002). Greater than 99% of the AI-700images acquired from patients enrolled in the trial were readable.

The majority of adverseevents (“AEs”) reported were mild in intensity, transient, and resolved withoutresidual effects. The most common AEs reported were headache, chest pain,nausea, flushing and dizziness and the majority of these AEs occurred followingthe administration of the dipyridamole pharmacologic stress agent prior tostress imaging. Serious adverse events (SAEs) and dose discontinuation wasexperienced in four and five of 320 patients, respectively. All SAEs werenon-life threatening, transient, and resolved without residual effects.

*TheRAMP-2 Trial.*   All of the patients enrolled inthis trial received a stress echo study with AI-700 and underwent coronaryangiography. The majority of patients, but not all, will have had a nuclear stresstest. The primary endpoints of the RAMP-2 trial will be accuracy, sensitivityand specificity, relative to a truth standard, in comparison to the performanceof nuclear stress testing, with angiography as the truth standard for bothmodalities. On June 5, 2006, we announced the completion of enrollment inthe RAMP-2

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trial with 457 patientsenrolled.  As dictated by the trial design, all patients in this trialwere evaluated for up to thirty days following the stress echo study. Once this follow-up period is completed, all images have been read, and allpatient angiography data are collected, an independent third-party clinicalresearch organization, on our behalf, will conduct quality control checks.These checks, which can take up to 90 days, are designed to ensure that all ofthe required information has been fully gathered and filed before locking thedatabase. At that time, the data may be unblinded and made available to us foranalysis. We may elect to pursue opportunities to apply some of what we learnedfrom the RAMP-1 trial to the reading of the RAMP-2 images prior to unblindingthe RAMP-2 trial data. If we make such an election, public announcement ofRAMP-2 result could occur in early 2007 rather than in the fourth quarter of2006.  Such an election is notanticipated to affect the timing of our submission of an NDA for AI-700 whichis currently scheduled to occur before the end of the first half of 2007.

*TrialDesign and Purpose.*   We believe that stress echowith AI-700 has the potential to significantly reduce the time, cost andresources needed in the assessment of myocardial perfusion, compared to nuclearstress testing. Myocardial perfusion is blood flow to the heart muscle, asensitive marker for coronary heart disease.  There is no ultrasoundcontrast agent approved by FDA for use in stress echo or myocardial perfusionimaging. Based upon the endpoints described above, our RAMP-1 and RAMP-2 trialsare designed to demonstrate non-inferiority of stress echo with AI-700 relativeto nuclear stress testing. In April 2005, based in part upon feedback from FDA,we revised the statistical analysis plan on which we base our patientenrollment estimates for the AI-700 Phase 3 clinical trials. Since that time wehave continued discussions with the FDA regarding trial design and ourstatistical analysis plan.  As a result of our ongoing discussions withFDA, we may make further revisions. These discussions could lead to delays inthe public announcement of the results from our RAMP-2 clinical trial andaffect whether AI-700 is approved for the indication that we are seeking, thetiming of such approval or whether AI-700 is approved at all.

The estimates of andtiming of blinded reads, data lock, data release and NDA submission in ourPhase 3 trials reflect our current assumptions, based on our knowledge andexperience and the guidance of our advisors.  We cannot assure you thatthese timelines will be met, nor can we assure you that our estimates andassumptions will not change based upon ongoing regulatory feedback or that,when the RAMP-2 trial is completed, we will successfully achieve results thatmeet or exceed the clinical endpoints.

**AI-700Manufacturing Facility Update**

We intend to demonstratethat we can produce AI-700 at a commercial manufacturing scale prior to oursubmission of an NDA for AI-700 and, subject to required regulatory approvals,we intend to manufacture AI-700 in this facility for commercial use. Thiscommercial manufacturing facility must comply with current good manufacturing practices,or cGMPs, enforced by the FDA and overseas regulatory agencies.

In July 2004, weentered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts. In late 2005, wesubstantially completed the build-out of this facility and commenced start-upactivities relating to the manufacturing equipment installed at the site.  Depreciation of costs incurred for thisbuild-out commenced in the fourth quarter of 2005 when the related assets wereplaced into service.  In early 2006 wecompleted commissioning of the manufacturing equipment and utilities within thefacility. We recently produced full commercial scale development batches ofAI-700 in this facility, an important step towards the qualification of theproduction of AI-700 in this facility and reduction of the technology transferrisk. In addition, we are working to qualify the facility in compliance withcurrent good manufacturing practices (“cGMP’s”). Completion of suchqualification includes significant testing and documentation. We havepreviously demonstrated that we can produce AI-700 in a qualified manner atcontract manufacturing sites. We need to repeat this demonstration in ourcommercial manufacturing facility prior to submission of our NDA.

The next steps in thequalification of the manufacturing process are aseptic qualification of thefacility, product stability testing and completion of other validationactivities under cGMPs. Data from the production of AI-700 under cGMPs is intendedto be part of our NDA submission of AI-700. Based upon our current plans, we expect to complete this qualificationphase before the end of the second quarter of 2007, upon which we will believethat we will have all of the manufacturing related data necessary to submit ourNDA.

Although the build-out ofthe facility and the commissioning of the equipment are substantially complete,we cannot assure you that we will not encounter complications in thequalification of operations in this facility, which complications could addadditional costs or delay our submission of a NDA for AI-700. In support of ourefforts to qualify our commercial manufacturing facility for AI-700, inFebruary 2006, we and Nycomed agreed to amend the 2004 strategic collaborationagreement resulting in commitment by Nycomed to accelerate $1.85 million inpayments to us in order to fund certain activities associated with thequalification of our manufacturing facility.

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**EuropeanCollaboration Agreement**

In July 2004, weentered into a collaboration, license and supply agreement with Nycomedpursuant to which we granted Nycomed rights to develop and market AI-700 inEurope. As part of the agreement, Nycomed has agreed to provide up to$70 million in license fees, research and development funding, andmilestone payments, including $12 million in payments over the first twoyears, of which the final $1 million was paid to us in April 2006. Theremaining $58 million in milestone payments are related to regulatoryapprovals and achievement of certain sales goals. In addition, Nycomed hasagreed to pay us to manufacture AI-700 for them and to pay us royalties onNycomed’s sales of AI-700. Nycomed will be responsible for sales, marketing andthe regulatory submissions required for marketing throughout its salesterritory, which includes the member states of the European Union, as well asRussia/CIS and Turkey.

In October 2005, we andNycomed agreed to amend the strategic collaboration agreement in order toaccelerate $150,000 in milestone payments to support activities associated withAI-700 brand development, including related international trademark activities.In February 2006, we and Nycomed further amended the agreement toaccelerate $1.85 million in milestone payments in order to fund certainactivities associated with the qualification of our manufacturing facility.Beginning with costs incurred in February 2006, we began to draw down onthis $1.85 million in accelerated funding up to $370,000 per month. Anypayments received pursuant to these amendments are considered advances againsta future milestone payment for a European regulatory filing, or MarketingAuthorization Application (“MAA”), and will be deducted from that milestonepayment. Payments received under these amendments will be classified asdeferred revenue until the MAA milestone is achieved, provided that theapplicable revenue recognition criteria are met.  As of June 30, 2006, we have billed $1.5million for qualification costs invoiced to Nycomed, and have included thisamount in deferred revenue.

The Nycomed agreement issubject to termination provisions. Under certain of these terminationprovisions, if we fail in any material respect to use all commerciallyreasonable efforts to carry out referenced obligations under the agreement, wewould be obligated to pay Nycomed liquidated damages of   up to $12.0 million. We plan tocarry out all of these obligations, which we believe are in our control.However, there can be no assurance that termination of this agreement will notoccur or that such termination would not result in us incurring liquidateddamages of up to $12.0 million.

**FinancialOperations Overview**

*Revenue.*    Wehave not generated any revenue from product sales since our inception. SinceJuly 2004, when we entered into our collaboration agreement with Nycomed, themajority of our revenue has been collaboration revenue recognized in connectionwith research and development activities performed under this agreement.  As of June 30, 2006 Nycomed has paid us $12.0million in license fees for our research and development efforts. We arerecognizing this $12.0 million of initial license and research and developmentpayments ratably over a period currently estimated at 48 months. The periodover which we are obligated to perform services is estimated based on availablefacts and circumstances. We periodically evaluate the assumptions underlyingthese estimates.

Further in the future, wewill seek to generate revenue from a combination of product sales, up-front ormilestone payments and manufacturing payments in connection with collaborativeor strategic relationships, and royalties resulting from the license of ourproducts and intellectual property.

*Researchand Development Expense.*    Research anddevelopment expense consists of expenses incurred in developing, manufacturingand testing product candidates. These expenses consist primarily of salariesand related expenses for personnel, fees paid to professional service providersin conjunction with independently monitoring our clinical trials and acquiringand evaluating data in conjunction with our clinical trials, costs of materialsused in clinical trials and research and development, depreciation of capitalresources used to develop our products, costs of facilities, the legal costs ofpursuing patent protection on select elements of our intellectual property andstock-based compensation. We expense research and development costs, includingpatent related costs, as incurred. We believe that significant investment inproduct development is a competitive necessity and plan to continue theseinvestments in order to realize the potential of our product candidates andproprietary technologies. Development programs for later stage productcandidates, such as AI-700, tend to cost more than earlier stage programs dueto the length and the number of patients enrolled in clinical trials for laterstage programs and due to costs of scaling production to commercial scale.

*Generaland Administrative Expense.*    Generaland administrative expense consists primarily of salaries and other relatedcosts for personnel in executive, finance, accounting, information technology,business development and human resource functions. Other costs include facilitycosts not otherwise included in research and development expense, professionalfees for legal and accounting services and stock-based compensation.

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*InterestIncome.*    Interest income consists ofinterest earned on our cash and cash equivalents.

*InterestExpense.*    Interest expense consists ofinterest incurred on equipment leases and other financing arrangements. Interest expense also includes interest recognized in connection with embeddedderivatives.

*Changein Valuation of Derivative.*    The terms ofour February 2005 convertible preferred stock offering and ourMarch 2005 Mass Development loan agreement contain features considered tobe embedded derivatives which are recorded at estimated fair value inaccordance with Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments (SFAS 133). Change in valuation of derivative consists of other income(expense) recognized on the change in fair value of the derivative at the endof each reporting period.  The change inthe value of the derivative related to the preferred stock is affected by anumber of assumptions including the number of preferred shares outstanding, theamount of dividends paid and the probability and timing of conversion intocommon stock. The derivative liability is reduced for any make-whole paymentsmade during the period upon conversions of preferred stock to common stock. Thechange in the value of the derivative related to the loan is affected by theexpected timing of future positive net cash flows from operations.

*Dividendson Preferred Stock.  * Dividends on preferred stockconsisted of dividends paid or accumulated on the convertible exchangeablepreferred stock which we issued in February 2005. Dividends on preferredstock exclude any make-whole payments on conversion of preferred stock tocommon stock. Dividends on our preferred stock are cumulative from the date oforiginal issue at the annual rate of $3.25 per share, payable quarterly on thefirst day of March, June, September, and December. Any dividend payment must bedeclared by our board of directors and must come from funds that are legallyavailable for dividend payments.

**Resultsof Operations**

*ThreeMonths Ended June 30, 2006 and 2005*

*Revenue.*   As of June 30, 2006, in connection with our collaboration agreement withNycomed, Nycomed has paid us $12.0 million in license fees for our research anddevelopment efforts. We had previously been recognizing this $12.0 million inresearch and development payments ratably over the estimated development periodof 42 months.  During the three monthsended June 30, 2006 we modified our estimate of the development period overwhich we are obligated to perform services to 48 months. This change inestimate resulted in no revenue being recognized from the license agreement forthe three months ended June 30, 2006.

During the three month period ended June 30, 2006 werecognized revenue of $0.2 million related to a feasibility study with a largepharmaceutical company utilizing our HDDS technology.  Also during the three month period ended June30, 2006 we performed clinical research services on behalf of Nycomed, relatingto AI-700.  We were paid for theseservices on a time and materials basis and recognized approximately $0.1million in revenue during the period.

*Researchand Development Expense*.    Researchand development expense for the three months ended June 30, 2006 increased$6.4 million, or 42%, to $21.6 million versus $15.2 million in the prior yearperiod.  The increase was due primarily to higher intellectual propertyacquisition costs ($3.9 million), higher depreciation primarily due to our newmanufacturing facility ($1.8 million), with the remaining increase ($0.7million) due to higher stock-based compensation expense from the adoption ofFAS 123R and higher personnel costs due to increased headcount, partiallyoffset by lower expenses associated with our clinical trials. Clinical trialcosts were lower than the prior year primarily due to the completion of RAMP-1patient enrollment in December 2005 and the completion of RAMP-2 patientenrollment in June 2006.

Thefollowing table summarizes the primary components of our research anddevelopment expense for the three months ended June 30, 2006 and 2005:

 

|                     | ** ** | **Three Months Ended** | ** ** |
|---------------------|------------|----------------------------------|------------|
| ** **          | ** ** | **June 30,  2006**          | ** ** | **June 30,  2005** | ** ** |
| ** **          | ** ** | **(in thousands)**          | ** ** |
| Total direct  costs |       | $                                | 7,839      |   | $ | 7,085 |   |
|                |       |                             |       |   |   |
| Indirect costs:     |       |                             |       |   |   |
| Facility costs      |       | 998                              |       | 913 |   |
| Depreciation        |       | 2,476                            |       | 634 |   |
|                     |            |                                  |            |  |  |  |  |

 

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| All other indirect costs                             |   | 190    |   | 377    |   |
|------------------------------------------------------|--------|--------|--------|--------|--------|
| Total indirect  costs                                |   | 3,664  |   | 1,924  |   |
| Write-off of  intellectual property acquisition cost |   | 10,137 |   | 6,218  |   |
| Total research and  development expense              |   | $      | 21,640 |   | $      | 15,227 |   |
|                                                      |        |        |        |        |        |  |  |

 

Research and developmentexpense includes $10.1 million and $6.2 million for the three months ended June30, 2006 and 2005, respectively, for the patents acquired or licensed under theGE, Bracco and Schering agreements.

We expect to incur higherexpense for the commercial manufacturing facility during the remainder of 2006versus the prior year due to timing of depreciation expense and costs for theongoing validation of the facility and its equipment, the purchase of rawmaterials and laboratory supplies and the hiring of additional personnel.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our primary research and development programs are as follows:

*LateStage Clinical Development Program*.  Our late stageclinical develop program relates to our lead product candidate, AI-700, whichis a cardiovascular drug for the detection of coronary heart disease. Almostall of our direct research and development expenditures for the three monthsended June 30, 2006 and 2005 relate to our AI-700 program.

*EarlyStage Development Programs*.  The initial clinical applicationsof our HDDS technology, AI-850, and our PDDS technology, AI-128, have eachcompleted a Phase 1 trial. In late 2005, we commenced a feasibility studyregarding the use of our HDDS technology in connection with a product candidateunder development by a large pharmaceutical company.  Our portion of this feasibility study hasbeen completed; potential expansion of this collaboration is pending thecompletion of a review by that pharmaceutical company.  During 2006 the costs of early stagedevelopment programs could increase, depending upon the extent to which we aresuccessful in commencing new feasibility studies with partners, if at all.

*Generaland Administrative Expense.*    Generaland administrative expense for the three months ended June 30, 2006 increased$0.9 million, or 43%, to $3.0 million versus $2.1 million in the prior yearperiod.  The increase was primarily due to additional stock-basedcompensation expense from the adoption of FAS 123R, higher consulting expenserelated to business development activity and higher personnel costs due toincreased headcount.

The following tablesummarizes the primary components of our general and administrative expense forthe three months ended June 30, 2006 and 2005: 

|                                           | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **June 30,  2006**          | ** ** | **June 30,  2005** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| Total direct  costs                       |       | $                                | 2,863      |   | 2,026 |   |
|                                      |       |                             |       |   |   |
| Indirect costs:                           |       |                             |       |   |   |
| Facility costs                            |       | 125                              |       | 59 |   |
| Depreciation                              |       | 52                               |       | 29 |   |
| Total indirect  costs                     |       | 177                              |       | 88 |   |
| Total general and  administrative expense |       | $                                | 3,040      |   | $ | 2,114 |   |
|                                           |            |                                  |            |  |  |  |  |

 

We anticipate an increasein general and administrative expense during 2006 from personnel costs forincreased headcount, in costs for stock-based compensation expense under FAS123R, for business development activities to support product developmentefforts, investor relations and other activities.

*InterestIncome.*    Interest income for the threemonths ended June 30, 2006 increased $0.3 million, or 60%, to $0.8 millionversus $0.5 million in the prior year period.  The increase was primarilydue to higher average cash balances during the period.

*InterestExpense.*    Interest expense for thethree months ended June 30, 2006 increased to $0.7 versus $0.3 million in prioryear period.   The increase was primarily due to higher cumulative borrowingsduring the period under our equipment financing lines.

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*Changein Valuation of Derivative.*     Thechange in the valuation of derivative resulted in income of $1.5 million duringthe three months ended June 30, 2006 versus income of $1.0 million in the prioryear period.  As of June 30, 2006 andMarch 31, 2006, the derivative liability was valued at approximately $0.4million and $2.0 million, respectively.

*SixMonths Ended June 30, 2006 and 2005*

*Revenue.*    Asof June 30, 2006, in connection with our collaboration agreement with Nycomed,Nycomed has paid us $12.0 million in license fees for our research anddevelopment efforts. We had previously been recognizing this $12.0 million inresearch and development payments ratably over the estimated development periodof 42 months.  During the three monthsended June 30, 2006 we modified our estimate of the development period overwhich we are obligated to perform services to 48 months.  This change in estimate resulted in norevenue being recognized from the license agreement during the second quarter.We have recognized $0.9 million under this collaboration agreement for the sixmonths ended June 30, 2006.

During the six month period ended June 30, 2006 werecognized revenue of $0.2 million related to a feasibility study with a largepharmaceutical company utilizing our HDDS technology.  Also during the six month period ended June30, 2006 we performed clinical research services on behalf of Nycomed, relatingto AI-700.  We were paid for theseservices on a time and materials basis and recognized approximately $0.1million in revenue during the period.

*Research and Development Expense.*    Research and development expense for the sixmonths ended June 30, 2006 increased $9.6 million, or 42%, to $32.5million versus $22.9 million in the prior year period.  The increase wasdue primarily to higher intellectual property acquisition costs ($3.9 million),higher depreciation primarily due to our new manufacturing facility ($3.8million), with the remaining increase ($1.9 million) due to higher stock-basedcompensation expense from the adoption of FAS 123R and higher personnel costsdue to increased headcount, partially offset by lower expenses associated withour clinical trials.  Clinical trialcosts were lower than the prior year primarily due to the completion of RAMP-1patient enrollment in December 2005 and the completion of RAMP-2 patientenrollment in June 2006.

The following tablesummarizes the primary components of our research and development expense forthe six months ended June 30, 2006 and 2005: 

|                                                      | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **June 30,  2006**        | ** ** | **June 30,  2005** | ** ** |
| ** **                                           | ** ** | **(in thousands)**        | ** ** |
| Total direct  costs                                  |       | $                              | 14,916     |   | $ | 12,931 |   |
|                                                 |       |                           |       |   |   |
| Indirect costs:                                      |       |                           |       |   |   |
| Facility costs                                       |       | 2,085                          |       | 1,968 |   |
| Depreciation                                         |       | 4,934                          |       | 1,133 |   |
| All other indirect costs                             |       | 441                            |       | 655 |   |
| Total indirect  costs                                |       | 7,460                          |       | 3,756 |   |
| Write-off of  intellectual property acquisition cost |       | 10,137                         |       | 6,218 |   |
| Total research and  development expense              |       | $                              | 32,513     |   | $ | 22,905 |   |

 

Research and developmentexpense includes $10.1 million and $6.2 million for the six months ended June30, 2006 and 2005, respectively, for the patents acquired or licensed under theGE, Bracco and Schering agreements.

We expect to incur higherexpense for the commercial manufacturing facility for the remainder of 2006versus the prior year due to timing of depreciation expense and costs for theongoing validation of the facility and its equipment, the purchase of rawmaterials and laboratory supplies and the hiring of additional personnel.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our primary research and development programs are as follows:

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*LateStage Clinical Development Program*.  Our late stageclinical develop program relates to our lead product candidate, AI-700, whichis a cardiovascular drug for the detection of coronary heart disease. Almostall of our direct research and development expenditures for the six monthsended June 30, 2006 and 2005 relate to our AI-700 program.

*EarlyStage Development Programs*.  The initial clinicalapplications of our HDDS technology, AI-850, and our PDDS technology, AI-128,have each completed a Phase 1 trial. In late 2005, we commenced a feasibilitystudy regarding the use of our HDDS technology in connection with a productcandidate under development by a large pharmaceutical company.  Our portion of this feasibility study hasbeen completed, potential expansion of this collaboration is pending thecompletion of a review by the pharmaceutical company.  During 2006 the costs of early stagedevelopment programs could increase, depending upon the extent to which we aresuccessful in commencing new feasibility studies with partners, if at all.

*Generaland Administrative Expense.*    Generaland administrative expense for the six months ended June 30, 2006 increased$1.7 million, or 44%, to $5.6 million versus $3.9 million in the prior yearperiod.  The increase was primarily due to additional stock-basedcompensation expense from the adoption of FAS 123R, higher consulting expenserelated to business development activity and higher personnel costs due toincreased headcount.

The following tablesummarizes the primary components of our general and administrative expense forthe six months ended June 30, 2006 and 2005: 

|                                          | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **June 30,  2006**        | ** ** | **June 30,  2005** | ** ** |
| ** **                               | ** ** | **(in thousands)**        | ** ** |
| Total direct costs                       |       | $                              | 5,229      |   | 3,683 |   |
|                                     |       |                           |       |   |   |
| Indirect costs:                          |       |                           |       |   |   |
| Facility costs                           |       | 268                            |       | 121 |   |
| Depreciation                             |       | 97                             |       | 57 |   |
| Total indirect costs                     |       | 365                            |       | 178 |   |
| Total general and administrative expense |       | $                              | 5,594      |   | $ | 3,861 |   |
|                                          |            |                                |            |  |  |  |  |

 

We anticipate an increasein general and administrative expense during 2006 from personnel costs forincreased headcount, in costs for stock-based compensation expense under FAS123R, for business development activities to support product developmentefforts, investor relations and other activities.

*InterestIncome.*    Interest income for the sixmonths ended June 30, 2006 increased $0.4 million, or 48%, to $1.2 millionversus $0.8 million in the prior year period.  The increase was primarilydue to higher average cash balances during the period.

*InterestExpense.*    Interest expense for the sixmonths ended June 30, 2006 increased to $1.1 million versus $0.5 million inprior year period.   The increase was primarily due to highercumulative borrowings during the period under our equipment financing lines.

*Changein Valuation of Derivative.*     Thechange in the valuation of derivative resulted in income of $0.6 million duringthe six months ended June 30, 2006 versus income of $1.4 million in the prioryear period.  As of June 30, 2006 andDecember 31, 2005, the derivative liability was valued at approximately $0.4million and $1.1 million, respectively.

**Liquidityand Capital Resources**

Historically, aside frompayments received in connection with our strategic collaboration with Nycomed,we have financed our business through the issuance of equity securities, debtfinancings and equipment leases. Our liquidity requirements have arisenprimarily from research and development expenditures, leasehold improvements,equipment expenditures and payments on outstanding indebtedness. As of June 30,2006 we owed $23.9 million under notes payable and other long-termobligations and $0.1 million under capital leases.  We also had operating lease commitmentstotaling $10.2 million for rent on our facilities.

During the six monthsended June 30, 2006, operating activities used $30.0 million of cash. Net cashused by operating activities during this period resulted primarily from a netloss of $36.3 million, a decrease in accrued expenses of $1.7 million, adecrease in accounts payable of $1.1 million and the non-cash amortization ofdeferred revenue of $0.9 million. These uses of cash were partially

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offset by non-cashcharges for depreciation and amortization of $5.1 million, a decrease indeferred revenue of $1.7 million, the write-off of intellectual propertyacquired of $1.5 million and non-cash stock-based compensation of$1.4 million.

During the six monthsended June 30, 2006, investing activities used $1.0 million in cash, primarilyfor purchases of manufacturing equipment. We intend to seek financing for future equipment purchases underadditional secured lines of credit.

During the six monthsended June 30, 2006, financing activities provided $37.5 million,primarily from an offering on April 12, 2006 of 5,772,004 shares of commonstock and warrants, net of transaction costs.

Effective June 9,2006, we entered into a promissory note with General Electric CapitalCorporation (“GE Capital”) in aggregate original principal amount totaling $1.5million for equipment already purchased by us. The promissory note includes anannual interest rate of 10.69% and is payable over 42 consecutive months. Thepromissory note is secured by the financed equipment pursuant to the terms ofour Master Security Agreement with GE Capital. The promissory note is subjectto acceleration upon the happening of customary events of default, includingthe failure to make timely payments of principal and interest.

Effective June 1,2006, we entered into an agreement to license on a non-exclusive basis variousultrasound-related intellectual property from GE Healthcare (“GE”), a divisionof General Electric Company. The agreement provides us with use of GE’sultrasound contrast agent patents and patent applications in combination withour lead product candidate AI-700 in the field of ultrasound contrast agents,as well as any patents that GE acquires in the field within 12 months of theagreement. In consideration of the non-exclusive license of these patents, weagreed to pay GE $10.0 million prior to commercial approval of AI-700, of which$5.0 million was paid in June 2006 and $5.0 million is due in June 2007.  In addition, we agreed to pay GE $5.0 millionupon the commercial approval (defined as the first to occur of the approval ofa New Drug Application in the United States or the approval of a MarketingAuthorization Application in Europe) of AI-700 and $5.0 million upon the oneyear anniversary of such commercial approval. The latter two $5.0 million payments are contingent upon achievement offuture milestone events and, accordingly, have not been recorded at this time.

Also effectiveJune 1, 2006, we entered into an agreement to license on a non-exclusivebasis various ultrasound-related intellectual property from BraccoInternational BV (“Bracco”). The agreement provides us with use of Bracco’sultrasound-related patents and patent applications in combination with our leadproduct candidate AI-700 in the field of ultrasound diagnostic imaging. Inconsideration the non-exclusive license of these patents, we agreed to payBracco up to a total royalty of Euros3.0 million, of which Euros 0.5 million (approximately $0.6 million atJune 30, 2006) was paid in June 2006. An additional Euros 2.5 million ispayable upon our achievement of certain defined regulatory milestones.  We also agreed to pay a royalty on futureAI-700 revenue, up to a maximum royalty amount of Euros 10.0 million, less aportion of the above-referenced milestone payments. Whereas the otherobligations are contingent upon the outcome of future events, they have notbeen recorded at this time.

On April 12, 2006, wesold 5,772,004 units, each unit consisting of (i) one share of common stock and(ii) one warrant to purchase 0.3 shares of common stock at an exercise price of$7.97 per share, for a purchase price of $6.9675 per unit, resulting inaggregate gross proceeds to us of $40.2 million (net proceeds of approximately$37.8 million after deducting underwriting discounts and commissions andestimated offering expenses).  Units arenot issued or certificated.  The sharesof common stock and warrants were immediately separable and were issuedseparately.   The warrants will beexercisable beginning on October 12, 2006 and until April 12, 2011.

On May 11, 2005, weentered into a Patent Transfer Agreement with Schering pursuant to which weacquired rights, title and interest in certain ultrasound-related patents fromSchering. In consideration of the transfer and assignment of these patents, weagreed to pay Schering a total of $7.0 million of which $1.0 million was paidin May 2005, $3.0 million was paid in May 2006, and $3.0 million isdue in May 2007.

We believe, based on ouroperating plans, that our existing resources, including scheduled proceeds fromNycomed, and proceeds from the above described equity financing completed inApril 2006, will be adequate to fund our planned operations for at least thenext twelve months.  In the future, we will require significant additionalfunds to develop, conduct clinical trials, achieve regulatory approvals,qualify and improve commercial manufacturing space and, subject to regulatoryapproval, commercially launch AI-700, our other product candidates underdevelopment and future product candidates. Our future capital requirements willdepend on many factors, including the scope and progress made in our researchand development activities and our clinical trials and the size and timing ofcreating expanded manufacturing capabilities. We may also need additional fundsfor possible future strategic acquisitions of businesses, products ortechnologies complementary to our business. We do not expect to generatesignificant revenues for AI-700,

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other than possiblelicense or milestone payments, unless or until we or current or potentialpartners complete clinical trials and receive marketing approval from the applicableregulatory authorities. When additional funds are required or, in advance ofsuch requirements, when we anticipate that funds will be needed, we may raisesuch funds from time to time through public or private sales of equity or fromborrowings or we may delay funding of certain development activities whichcould delay the filing of our AI-700 NDA and the commercialization of AI-700which would have a materially adverse impact on our growth plans. Additional equity financing may be dilutive to our stockholders and debtfinancing, if available, may involve significant cash payment obligations andcovenants that restrict our ability to operate as a business.

**UniversalShelf Registration Statement**

We have on file with theU.S. Securities and Exchange Commission (“SEC”) a “universal shelf”registration statement on Form S-3 (Registration No. 333-134263) anda universal shelf registration statement on Form S-3 (RegistrationNo. 333-123854), which provide for the offer, from time to time, of commonstock, preferred stock, debt securities and warrants up to an aggregate remainingavailability of approximately $100.0 million and $27.0 million,respectively. The SEC declared the shelf registration statements effective onJune 1, 2006 and April 15, 2005, respectively. Subject to market conditions and our capital needs, and so long as weare then eligible to use the registration statement under SEC rules, we mayagain seek to use any remaining availability under the shelf registrationstatement by making an offering of securities covered for sale under theregistration statement. In addition, we may amend our shelf registrationstatement or file a new shelf registration statement to increase ourpotential access to capital. If we elect to raise additional capital using ashelf registration statement, we may use the net proceeds from the sale ofthese securities for general corporate purposes, which may include fundingclinical trials, research and development, regulatory activities and theexpansion of our commercial manufacturing facility in Tewksbury, Massachusetts,acquisitions, including acquisitions of companies, products, intellectualproperty or other technology, repayment or refinancing of existingindebtedness, investments, capital expenditures, repurchase of our capitalstock and for any other purposes that we may specify in any prospectussupplement.

**Off-BalanceSheet Financing Arrangements**

We currently donot have any special purpose entities or off-balance sheet financingarrangements other than operating leases.

**ContractualObligations**

The following tablesummarizes our contractual obligations as of June 30, 2006 and the effect suchobligations are expected to have on our liquidity and cash flow in futureperiods:

**Payments Due by Period**
| **Contractual Obligations**                                  | ** ** | **Total  Obligations  All Years** | ** ** | **2006  Remaining** | ** ** | **2007  Through  2008** | ** ** | **2009  Through  2010** | ** ** | **After 2010** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------|------------|-------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | **(in thousands)**                | ** ** |
| Capital lease  obligations (including interest)                   |       | $                                      | 93         |                | $          | 12                      |       | $                       | 49         |                | $          | 32 |   | $ | — |   |
| Operating lease  obligations                                      |       | 10,230                                 |       | 1,238               |       | 3,491                   |       | 3,430                   |       | 2,071               |       |
| Notes payable  (including interest)                               |       | 19,356                                 |       | 2,941               |       | 12,415                  |       | 4,000                   |       | —              |       |
| Intellectual property  acquisition cost obligations               |       | 7,319                                  |       |                |       | 7,319                   |       |                    |       |                |       |
| Purchase orders for  capital equipment and leasehold improvements |       | 265                                    |       | 265                 |       | —                  |       | —                  |       | —              |       |
| Total contractual cash obligations                                |       | $                                      | 37,263     |                | $          | 4,456                   |       | $                       | 23,274     |                | $          | 7,462 |   | $ | 2,071 |   |

 

Our capital leaseobligations relate to leases for business equipment.  Our operating lease obligations relate to ourfacility leases.  Notes payable relateprimarily to financing leases for our equipment and leasehold improvements inour Tewksbury manufacturing facility. Intellectual property acquisition cost obligations relate to thepayments due under our agreements with GE and Schering.  Purchase orders for capital equipment and leaseholdrelate primarily to a final payment due to the contractor for the build-out ofour Tewksbury facility.  The above tableexcludes contingent milestone and royalty obligations.

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**CriticalAccounting Policies and Estimates**

Our discussion andanalysis of our financial condition and results of operations are based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities and expenses. On an on-goingbasis, we evaluate our estimates and judgments, including those related toaccrued expenses, fair valuation of stock related to stock-based compensationand income taxes. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions.  We believe the followingcritical accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements.

*Revenue.  *We recognize revenue from license arrangements in accordance with StaffAccounting Bulletin No. 104, Revenue Recognition (“SAB 104”) and FASBEmerging Issue Task Force Issue No. 00-21, Accounting for RevenueArrangements with Multiple Deliverables (“EITF 00-21”). We recognize revenuefrom license payments not tied to achieving a specific performance milestoneratably over the period over which we are obligated to perform services. Theperiod over which we are obligated to perform services is estimated based onavailable facts and circumstances. We recognize revenue from performancepayments, when such performance is substantially in our control and when we believethat completion of such performance is reasonably probable, ratably over theperiod over which we estimate that we will perform such performanceobligations. Substantive at-risk milestone payments, which are based onachieving a specific performance milestone when performance of such milestoneis contingent on performance by others or for which achievement can not bereasonably estimated or assured, are recognized as revenue when the milestoneis achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. We do notrecognize revenue in connection with license arrangements until payments arecollected or due and reasonably assured of being collected. In addition, we donot recognize revenue in circumstances where the arrangement includes a refundprovision until the refund condition is no longer applicable unless, in ourjudgment, the refund circumstances are within our operating control andunlikely to occur. Payments received in advance of being recognized as revenueare deferred.

In connection with our feasibility study, contractamounts which are not due until the customer accepts or verifies the researchresults are not recognized as revenue until customer acceptance, assumingcollectibility is reasonable assured.

We are recognizingcollaboration revenue of $12.0 million associated with the initial license andperformance-based payments under the Nycomed agreement based on an estimatedrecognition period of forty-eight months over which we are obligated to performservices supporting the agreement and assumes that AI-700 will be ready forcommercialization in 2008. At the time we entered into our agreement withNycomed, we estimated that the development period would be 42 months.  This was revised to 48 months in the secondquarter of 2006.  Our estimatedrecognition period may change again if facts and circumstanceschange. Were the estimated development period to be extended, we may berequired to record a reduction in cumulative revenue recognized in ourstatement of operations in the period in which the change in development periodis determined. Our agreement with Nycomed has been modified such that Nycomedhas paid us $150,000 for activities associated with creating a brand name forAI-700 and related trademark activities and to reimburse us for up to $1.8million for support of activities to support the validation of the ourcommercial manufacturing facility for AI-700. These amounts were originallyscheduled to be paid to us upon Nycomed’s filing for regulatory approval ofAI-700 in Europe. While the amounts are not refundable, we plan to deferrecognition of these amounts until after the original regulatory filingmilestone has been achieved. Payments received for current and potential HDDSand PDDS feasibility studies, which are offset by costs incurred for suchstudies, are recognized as revenue over the estimated performance period ofeach such study. A change in these estimates could result in a significantchange to the amount of revenue recognized in future periods. In addition, ifthe Nycomed collaboration agreement is terminated for reasons other thancertain non-performance by us, we would recognize the remainder of the paymentswe have received or otherwise expect to collect over the amortization period atthe time of termination. We will not recognize revenue associated with thepotential additional $56 million in milestone-based payments that may be earnedunder the Nycomed agreement until the underlying regulatory and salesmilestones are achieved.

*Propertyand Equipment.*   Property and equipment arerecorded at cost and depreciated over their estimated useful lives of three tofive years using the straight-line method. The majority of our equipment isrelated to our ongoing research and development activities, including equipmentwhich, subject to regulatory approvals, we intended to use for commercialmanufacture of AI-700. We consider that this equipment is placed in servicewhen operation of the equipment is started-up and begin depreciating theequipment at this time. The equipment in our commercial manufacturing facilityis currently undergoing research and development related activities that resultin wear and tear on the equipment including include ongoing calibration andtesting.

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Leasehold improvementsand equipment under capital leases are recorded at cost. We depreciateleasehold improvements and equipment under capital leases over the lesser oftheir useful lives or the remainder of their respective lease terms. Duringperiods of leasehold build-out, we record such costs and construction inprogress and do not begin depreciation of such costs until the improvements aresubstantially completed and available for use. We began depreciation ofleasehold improvements at our Tewksbury facility in October 2005 uponreceipt of an occupancy permit and taking occupancy of the facility. Ourleasehold improvements costs on this facility approximate $23.6 million and arebeing depreciated ratably over remaining term of our present lease which isscheduled in expire in April 2010. We believe that the use of the originalterm of the lease for the depreciation period, rather than assuming that thelease term is renewed, is appropriate given the inherent uncertainties with aproduct such as AI-700, which has not yet completed its phase 3 clinical trialsand requires regulatory approvals before it can be marketed.  The RiskFactors included under Section 1A of this document discuss theuncertainties associated with AI-700.

*AccruedExpenses.*   As part of the process of preparingconsolidated financial statements we are required to estimate accrued expenses.This process involves identifying services which have been performed on ourbehalf and estimating the level of service performed and the associated costincurred for such service as of each balance sheet date in our consolidatedfinancial statements. Examples of estimated expenses for which we accrueinclude professional service fees, such as lawyers and accountants, and contractservice fees such as amounts paid to clinical monitors, data managementorganizations and investigators in conjunction with clinical trials, and feespaid to consultants used in the qualification of our commercial manufacturingfacility for AI-700. In connection with such service fees, our estimates aremost affected by our understanding of the status and timing of servicesprovided relative to the actual levels of services incurred by such serviceproviders. The majority of our service providers invoice us monthly in arrearsfor services performed. In the event that we do not identify certain costswhich have begun to be incurred or we under- or over-estimate the level ofservices performed or the costs of such services, our reported expenses for suchperiod would be too low or too high. The date on which certain servicescommence, the level of services performed on or before a given date and thecost of such services are often judgmental. We make these judgments based uponthe facts and circumstances known to us in accordance with accountingprinciples generally accepted in the United States of America.

*Stock-BasedCompensation and Other Equity Instruments.  * Weaccount for stock-based compensation in accordance with the fair valuerecognition provisions of FAS 123R. Under FAS 123R, stock-basedcompensation cost is measured at the grant date based on the value of the awardand is recognized as expense over the appropriate vesting period. Determiningthe fair value of stock-based awards at the grant date requires judgment,including estimating the expected term of stock options, the expectedvolatility of our stock and expected dividends. In addition, judgment isrequired in estimating the amount of stock-based awards that are expected to beforfeited. If actual results differ significantly from these estimates ordifferent key assumptions were used, it could have a material effect on ourConsolidated Financial Statements. See Note 3 of the Notes to theConsolidated Financial Statements for additional information regardingstock-based compensation expense.

Prior to adopting theprovisions of FAS 123R, we recorded estimated compensation expense for employeestock options based upon their intrinsic value on the date of grant pursuant toAccounting Principles Board Opinion 25 (“APB 25”), “Accounting for Stock Issuedto Employees” and provided the required pro forma disclosures of FAS 123.Because we established the exercise price based on the fair market value of ourstock at the date of grant, the stock options had no intrinsic value upongrant, and therefore no estimated expense was recorded prior to adopting FAS123R. Each accounting period, we reported the potential dilutive impact ofstock options in its diluted earnings per common share using the treasury-stockmethod.

*DerivativeLiabilities.  * The terms of our February 2005convertible preferred stock offering and our March 2005 MassDevelopmentloan agreement contain features considered to be embedded derivatives which arerecorded at estimated fair value in accordance with Statement of FinancialAccounting Standards No. 133, Accounting for Derivative Instruments (SFAS133). The estimation of this fair value includes various assumptions andestimates, including assumptions and estimates of risk free interest rates,stock price volatility and the timing of future preferred stock conversions.Changes in these estimates and assumptions can increase or decrease the valueof this derivative liability.  Changes in the fair value of the derivativefinancial instrument are included in other income (expense). The convertiblepreferred stock terms include a dividend make-whole payment provision, whichhas been initially recorded at its estimated fair value. This derivativeliability is reduced upon conversion of the preferred stock as well asdividends declared by our board of directors, if any. The MassDevelopment loanagreement includes a provision for a retroactive interest rate increase in theevent that we achieve certain defined positive operating cash flows. Theinitial fair value of the MassDevelopment loan derivative is being amortizedover a term beginning with the loan agreement effective date and ending withthe estimated payment date of the retroactive interest. The fair value of bothderivative liabilities are re-measured at each reporting period.

*IncomeTaxes.  * As part of the process of preparing ourconsolidated financial statements we are required to estimate our income taxesin each of the jurisdictions in which we operate. This process involves us estimatingour actual current tax exposure together with

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assessing temporarydifferences resulting from differing treatments of items for tax and accountingpurposes. These differences result in deferred tax assets and liabilities. Inaddition, as of December 31, 2005, we had federal tax net operating losscarryforwards of $53.6 million, which expire through 2024. We also haveresearch and development credit carryforwards of $6.1 million. We haverecorded a valuation allowance to fully offset against these otherwiserecognizable net deferred tax assets due to the uncertainty surrounding thetiming of the realization of the tax benefit. In the event that we determine inthe future that we will be able to realize all or a portion of its net deferredtax benefit, an adjustment to deferred tax valuation allowance would increasenet income in the period in which such a determination is made. The Tax ReformAct of 1986 contains provisions that may limit the utilization of net operatingloss carryforwards and credits available to be used in any given year in theevent of significant changes in ownership interest, as defined.

**New Accounting Pronouncements**

In July 2006, theFinancial Accounting Standards Board issued Interpretation No. (FIN) 48, “*Accounting for Uncertainty in Income Taxes*,” which iseffective January 1, 2007. The purpose of FIN 48 is to clarify andset forth consistent rules for accounting for uncertain tax positions inaccordance with SFAS 109, “*Accounting for Income Taxes*”by requiring the application of a “more likely than not” threshold for therecognition and derecognition of tax positions. The Company is currentlyassessing what impact, if any, the adoption of this statement will have on itsconsolidated financial statements.

**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

We have not usedderivative financial instruments for speculative or trading purposes. However,we are exposed to market risk related to changes in interest rates. Our currentpolicy is to maintain an investment portfolio consisting mainly of U.S. moneymarket and government-grade securities, directly or through managed funds, withmaturities of one year or less. Our cash is deposited in and invested throughhighly rated financial institutions in North America. Our short-terminvestments are subject to interest rate risk and will fall in value if marketinterest rates increase. If market interest rates were to increase immediatelyand uniformly by 10% from levels at June 30, 2006, we estimate that the fairvalue of our investment portfolio would decline by an immaterial amount. Wecurrently have the ability to hold our fixed income investments until maturity,and therefore we do not expect our operating results or cash flows to beaffected to any significant degree by the effect of a change in market interestrates on our investments. Our equipment loans and capital leases are notsubject to interest rate fluctuations because the interest rates are fixed atthe time of borrowing.

**Effectsof Inflation**

Our assets are primarilymonetary, consisting of cash, cash equivalents and short-term investments.Because of their liquidity, these assets are not directly affected byinflation. We also believe that we have intangible assets in the value of ourtechnology. In accordance with generally accepted accounting principles, wehave not capitalized the value of this intellectual property on ourconsolidated balance sheet. Due to the nature of this intellectual property, webelieve that these intangible assets are not affected by inflation. Because weintend to retain and continue to use our equipment, furniture and fixtures andleasehold improvements, we believe that the incremental inflation related toreplacement costs of such items will not materially affect our operations. However,the rate of inflation affects our expenses, such as those for employeecompensation and contract services, which could increase our level of expensesand the rate at which we use our resources.

**ITEM4. CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

As of June 30, 2006 (the “EvaluationDate”), our management, with the participation our Chief Executive Officer andChief Financial Officer, evaluated the effectiveness of our disclosure controlsand procedures pursuant to Rule 13a-15(b) promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Based uponthat evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that, as of the Evaluation Date, our disclosure controls and procedureswere effective in ensuring that material information required to be disclosedby us in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, includingensuring that such material information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

**InternalControl Over Financial Reporting**

During the period coveredby this report, there have been no changes in our internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

**ITEM1. LEGAL PROCEEDINGS**

None

**ITEM1A. RISK FACTORS**

**CertainFactors Which May Affect Future Results**

*Ouroperating results and financial condition have varied in the past and may inthe future vary significantly depending on a number of factors. Except for thehistorical information in this report, the matters contained in this reportinclude forward-looking statements that involve risks and uncertainties. Thefollowing factors, among others, could cause actual results to differ materiallyfrom those contained in forward-looking statements made in this report andpresented elsewhere by management from time to time. Such factors, amongothers, may have a material adverse effect upon our business, results ofoperations and financial condition.*

*In Item 1A (“Risk Factors”) ofour Annual Report on Form 10-K for the fiscal year ended December 31, 2005,which was filed with the Securities and Exchange Commission on March 20, 2006,we describe risk factors related to the Company.  For convenience, our updated risk factors areincluded below in this Item 1A.  Therehave been no material changes in our risk factors from those disclosed in Item1A of our Annual Report on Form 10-K for the fiscal year ended December 31,2005.*

**RisksRelated to Our Company**

***We have not generated any product revenue to date, have ahistory of operating losses and our capital resources are limited.***

We are focused on productdevelopment and we have not generated any revenue from commercial sales of ourproducts to date. We have incurred losses each year of our operations. In 2005,we had a net loss available to holders of common stock of $47.0 million,and in the six months ended June 30, 2006 we had a net loss available toholders of common stock of $37.5 million. At June 30, 2006 we had anaccumulated deficit of $256.4 million. We expect our research anddevelopment, general and administrative and sales and marketing expenses willincrease over the next several years.

We expect to continue toincur losses and capital expenditures for the foreseeable future. We alsoanticipate cash out flow from debt repayment and payment of other obligations.We believe, based on our operating plans, that our existing resources,including scheduled proceeds from Nycomed, and proceeds from the abovedescribed equity financing completed in April 2006, will be adequate to fundour planned operations for at least the next twelve months.   Unless wereduce our current rate of spending, we will require significant additionalfunds to fund our operations, including to develop products, conduct clinicaltrials, achieve regulatory approvals, qualify commercial manufacturing spaceand, subject to regulatory approval, commercially launch AI-700, our otherproduct candidates under development and future product candidates. We mayraise this additional capital through public or private sales of equity, orfrom borrowings, or from strategic partners.

As a result of ourlimited capital resources, we may elect to delay the funding of certaindevelopment activities, including the submission of our NDA for AI-700, whichwould result in a delay in the commercialization of AI-700. Any such delay inthe submission of an NDA or commercialization of AI-700 would have a materialadverse impact on our business and would likely have a material adverse effecton the market price of our common stock. To address our capital needs, we mayelect to raise funds through public or private sales of equity or fromborrowings or from strategic partners. Additional equity financing, ifavailable, may be dilutive to our stockholders; debt financing, if available,may involve significant cash payment obligations and covenants that restrictour ability to operate our business; and strategic partnerships, if available,may result in royalties or other terms which reduce our economic potential fromproducts under development. In addition, third parties may attempt to acquireus at valuations our board of directors or stockholders may not findattractive. If our capital resources are not sufficient to fund our plannedoperations for a twelve month period at the time the audit for our 2006financial results is complete, our auditor may require a going concernqualification in its audit report be included in our audit report on Form 10-K.Any such qualification would have a material adverse effect on our ability toraise capital and would have a material adverse effect on the market price ofour common stock.

***We need to allocate significant amounts of our availablecapital resources to make payments on our outstanding indebtedness andequipment lease obligations, our patent transfer agreement with ScheringAktiengesellschaft, our patent license agreement with***

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***GE and as dividends on our 6.5% convertible exchangeablepreferred stock, which in turn could reduce our financial flexibility andability to fund other activities.***

As of June 30, 2006, wehad approximately $23.9 million in aggregate principal indebtedness outstandingrelated to capital lease obligations, notes payable and other long-termobligations. As of June 30, 2006, we had outstanding 730,000 shares of our 6.5%convertible exchangeable preferred stock, which shares accrue cumulative cashdividends at the annual rate of $3.25 per share, payable quarterly on the firstday of March, June, September, and December. These payments will:

·              reduce the availability of ourcapital to fund our clinical trials for AI-700, the build-out and qualificationof our commercial manufacturing space in Tewksbury, Massachusetts and forworking capital and other general corporate purposes and may require us, inorder to meet these obligations, to delay or reduce expenditures or foregobusiness opportunities; and

·              potentially impair our ability toobtain additional financing.

·              To address our capital needs, wemay elect to raise funds through public or private sales of equity or fromborrowings or from strategic partners. Additional equity financing, ifavailable, may be dilutive to our stockholders; debt financing, if available,may involve significant cash payment obligations and covenants that restrictour ability to operate as a business; and strategic partnerships, if available,may result in royalties or other terms which reduce our economic potential fromproducts under development.

***Failure to obtain regulatory approvals for our productcandidates under development, in particular our lead product candidate AI-700,would have a material adverse effect on our business.***

We must receiveregulatory approval of each of our product candidates before we can commercializeor sell that product candidate. The pre-clinical laboratory testing,formulation development, manufacturing and clinical trials of any productcandidates we develop independently or in collaboration with third parties, aswell as the distribution and marketing of these product candidates, areregulated by numerous federal, state and local governmental authorities in theUnited States, principally the FDA, and by similar agencies in other countries.The development and regulatory approval process takes many years, requires theexpenditure of substantial resources, is uncertain and subject to delays, andwill thus delay our receipt of revenues, if any, from any of our productcandidates. We cannot assure you that our clinical trials will demonstrate thesafety and efficacy of any of our product candidates or will result inmarketable products.  No product canreceive FDA approval unless human clinical trials show both safety and efficacyfor each target indication in accordance with FDA standards. A number ofcompanies in the pharmaceutical and biotechnology industries have sufferedsignificant setbacks in late stage clinical trials even after achievingpromising results in early stage development. In our Phase 3 clinical trialsfor AI-700, we are seeking to demonstrate non-inferiority compared to nuclearstress tests.  In such non-inferioritytrials we are required to show that the comparator treatment has been performedat an acceptable level.  The clinicaleffectiveness of nuclear stress tests may have improved since the time of ourPhase 2 clinical trials. We therefore cannot assure you that the results fromour Phase 2 clinical trials for AI-700 will be predictive of results obtainedin our Phase 3 clinical trials.

We did not achieve one ofthe primary clinical endpoints in our RAMP-1 trial.  We cannot assure youthat our RAMP-2 trial results will achieve all of its primary clinicalendpoints.  In addition, while it is possible that AI-700 could receiveregulatory approval without achieving all of the primary clinical endpoints forour Phase 3 clinical trials, we can provide no assurance that such approvalwill be achieved without significant delays, without narrowing the potentialindication for use of AI-700 or that it will be approved at all.

Many of the patients inour AI-700 clinical trials have coronary heart disease. As part of our AI-700clinical trials, patients are exposed to potential safety risks associated witha stress test, including risks associated with a pharmacological stressor, andAI-700. Given the nature of the AI-700 clinical trials, including thecumulative administration of AI-700 to larger numbers of at-risk patients andadministering AI-700 to patients with coexisting disease, adverse events areexpected to be encountered during the clinical trials. Adverse events are alsolikely to be encountered in clinical trials for our other products, whichclinical trials also include at-risk patients. When significant adverse eventsare detected and these events are attributable to our products, such eventscould delay, limit or prevent regulatory agency approval.

Further, data obtainedfrom pre-clinical and clinical activities are subject to varyinginterpretations that could delay, limit or prevent regulatory agency approval.We cannot assure you that our Phase 3 plan for AI-700 will successfully addressthe requirements of the FDA or that the results of the Phase 3 program willestablish the safety and efficacy of AI-700 sufficiently for us to obtainregulatory approval. We anticipate that if and when AI-700 and other productcandidates are approved that the initial use and marketing of these productsmay be limited at least until such time as we conduct additional clinicalstudies or information otherwise becomes available to address the underlyingreasons for such limits.

We may encounter delaysor rejections based on changes in regulatory agency policies or personnelduring the period in which we develop a drug or the period required for reviewof any application for regulatory agency approval of a particular compound. In2004, changes went into effect in the regulation of clinical trials in Europeand are currently being implemented by the individual member

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states of the EuropeanUnion. Our continuing efforts to comply with these changes could lead to delaysor rejections of our clinical trials. We also may encounter delays in the eventwe are unable to produce clinical trial material in sufficient quantities andof sufficient quality to meet the schedule for our planned clinical trials. Inaddition, we rely on a number of third parties, such as clinical researchorganizations, to help support the clinical trials by performing independentclinical monitoring, data acquisition and data evaluations. Any failure on thepart of these third parties could delay the regulatory approval process.

Failure to obtainregulatory approval or any delay or setback in obtaining regulatory agencyapprovals could:

·      adversely affect our ability to market anydrugs we develop independently or with collaborative partners;

·      impose additional costs and diminish anycompetitive advantages that we may attain; or

·      adversely affect our ability to generateroyalties.

In particular, failure to obtain approval or substantial delays inobtaining approval for our lead product candidate, AI-700, would delay ourreceipt of product revenues and would have a material adverse affect ourbusiness, financial condition and results of operations.

Our stock price wouldalso be materially adversely affected.

We cannot be certain thatwe will obtain any regulatory approvals in other countries and the failure toobtain these approvals would have a material adverse affect on our business,financial condition and results of operations. In order to market our productsoutside of the United States, we and our current, and potential future,collaborative partners must establish and comply with numerous and varyingregulatory requirements of other countries regarding safety and efficacy. Theapproval procedures vary among countries and can involve additional producttesting and additional administrative review periods. The time required toobtain approval in other countries might differ from that required to obtainFDA approval. The regulatory approval process in other countries may includeall of the risks associated with obtaining FDA approval detailed above.Approval by the FDA does not ensure approval by the regulatory authorities ofother countries. In addition, many countries outside the United States requirea separate review process prior to marketing to determine whether theirnational health insurance scheme will pay for newly approved products, as wellas the price which may be charged for a product.

***We may need to enroll more patients in additional clinicaltrials, and any such additional enrollment would require additionalexpenditures, which may be material, and would likely result in a delay of oursubmitting an NDA with the FDA for AI-700.***

Estimations of the numberof patients needed to enroll in our clinical trials in order to achievestatistical significance were based on a variety of factors, including ourunderstanding and analysis of previous trial data for AI-700, our ongoingdiscussions with the FDA and our own knowledge and past experience in these andsimilar matters. These estimates are subject to risks and uncertainties, andthere can be no assurance that our estimates will prove to be correct, or ifadditional clinical data will be required. Continued discussions with the FDAcould lead to other changes, including changes relating to our Phase 3 programand statistical analysis plans. How, when or if the matters being discussed areresolved may affect whether AI-700 is approved for the indication that we areseeking, the timing of such approval or whether AI-700 is approved at all.These discussions could also lead to delays in the timing of the un-blinding ofthe data from our RAMP-2 clinical trial and therefore, the public announcementof results from that trial. We may also encounter delays if the reading of imagesby the “blinded readers” in our RAMP-2 trial is not promptly completed, whichdelay could be caused by a variety of factors including time availability ofthe blinded readers.  Any such delayswill likely result in increased costs, which may be material and would likelyhave a harmful effect on our financial position and results of operations. Themarket price of our common stock may also be materially adversely affected inresponse to any such delays.

***If we cannot raise additional capital on acceptable terms,we may be unable to complete planned clinical trials, obtain regulatoryapprovals or commercialize our product candidates.***

We will requiresubstantial future capital in order to continue to conduct the research anddevelopment, clinical and regulatory activities necessary to bring our productcandidates to market and to establish commercial manufacturing, marketing andsales capabilities. Our future capital requirements will depend on manyfactors, including:

·      the progress of pre-clinical developmentand laboratory testing and clinical trials;

·      the timing of construction and size towhich we expand our manufacturing capabilities;

·      the time and costs involved in obtainingregulatory approvals;

·      the number of product candidates wepursue;

·      the costs involved in filing andprosecuting patent applications and enforcing or defending patent claims; and

·      the establishment of selected strategicalliances and activities required for product commercialization.

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We intend to seekadditional funding through strategic collaborations and may seek fundingthrough private or public sales of our securities or by licensing all or aportion of our technology. This funding may significantly dilute existingstockholders or may limit our rights to our technology.

We cannot assure you thatwe can obtain additional funding on reasonable terms, or at all. If we raiseadditional funds by issuing equity securities, our stock price may decline, ourexisting stockholders may experience significant dilution, and the newly issuedsecurities may have rights superior to those of our common stock. If we raiseadditional funds by issuing debt, we may be subject to limitations on ouroperations and such debt may have rights senior to the debentures, if issued.If we cannot obtain adequate funds, we may:

·      terminate or delay clinical trials for oneor more of our product candidates;

·      delay our establishment of sales,marketing and/or manufacturing capabilities;

·      curtail significant product developmentprograms that are designed to identify new product candidates;

·      relinquish rights to our technologies orproduct candidates; and/or

·      terminate or delay build-out andcommissioning of our commercial manufacturing facility.

***Our products, if approved, may fail to achieve marketacceptance.***

There can be no assurancethat any products we successfully develop, if approved for marketing, willachieve market acceptance or generate significant revenues. Each of our productcandidates is intended to replace or alter existing therapies or procedures,and hospitals, physicians or patients may conclude that these products are lesssafe or effective or otherwise less attractive than these existing therapies orprocedures. For example, our lead product candidate, AI-700, is a contrastagent for use in ultrasound imaging procedures which will compete with existingnuclear imaging and stress echocardiography. Hospitals, physicians or patientsmay prefer these existing procedures to AI-700 enhanced ultrasound imaging. Ifour products do not receive market acceptance for any reason, it wouldadversely affect our business, financial condition and results ofoperations.  Further, our competitors maydevelop new technologies or products that are more effective or less costly, orthat seem more cost-effective, than our products. We can give no assurance thathospitals, physicians, patients or the medical community in general will acceptand use any products that we may develop.

***Claims by other parties that we infringe or havemisappropriated their proprietary technology may result in liability fordamages, royalties, or other payments, or stop our development andcommercialization efforts.***

Competitors and otherthird parties may initiate patent litigation against us in the United States orin foreign countries based on existing patents or patents that may be grantedin the future. Many of our competitors have obtained patents covering productsand processes generally related to our products and processes, and they mayassert these patents against us. Moreover, there can be no assurance that thesecompetitors have not sought or will not seek additional patents that may coveraspects of our technology. As a result, there is a greater likelihood of apatent dispute than would be expected if our competitors were pursuing unrelatedtechnologies.

While we conduct patentsearches to determine whether the technologies used in our products infringepatents held by third parties, numerous patent applications are currentlypending and may be filed in the future for technologies generally related toour technologies, including many patent applications that remain confidentialafter filing. Due to these factors and the inherent uncertainty in conductingpatent searches, there can be no guarantee that we will not violate third-partypatent rights that we have not yet identified.

We know of U.S. andforeign patents issued to third parties that relate to aspects of our productcandidates. There may also be patent applications filed by these or otherparties in the United States and various foreign jurisdictions that relate tosome aspects of our product candidates, which, if issued, could subject us toinfringement actions. In particular, we are aware of U.S. and foreign patentsowned by third parties, including potential competitors, which arguably coveraspects of our AI-700 contrast agent. We and several of these parties have beenactively engaged in opposing the grant of European patents with claims thatarguably cover aspects of our AI-700 product. Parties may contest patents in Europeprior to contesting the counterpart patents in the United States because ofprocedural differences between European and U.S. patent laws as well aseconomic considerations.

The owners or licenseesof these and other patents may file one or more infringement actions againstus. In addition, a competitor may claim misappropriation of a trade secret byan employee hired from that competitor. Any such infringement ormisappropriation action could cause us to incur substantial costs defending thelawsuit and could distract our management from our business, even if the

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allegations ofinfringement or misappropriation are unwarranted. A need to defend multipleactions or claims could have a disproportionately greater impact. In addition,either in response to or in anticipation of any such infringement ormisappropriation claim, we may enter into commercial agreements with the ownersor licensees of these rights. The terms of these commercial agreements mayinclude substantial payments, including substantial royalty payments onrevenues received by us in connection with the commercialization of ourproducts.

Payments under suchagreements could increase our operating losses and reduce our resourcesavailable for development activities. Furthermore, a party making this type ofclaim could secure a judgment that requires us to pay substantial damages,which would increase our operating losses and reduce our resources availablefor development activities. A judgment could also include an injunction orother court order that could prevent us from making, using, selling, offeringfor sale or importing our products or prevent our customers from using ourproducts. If a court determined or if we independently concluded that any ofour products or manufacturing processes violated third-party proprietaryrights, our clinical trials could be delayed and there can be no assurance thatwe would be able to reengineer the product or processes to avoid those rights,or to obtain a license under those rights on commercially reasonable terms, ifat all.

***If we are unable to protect our intellectual propertyrights, our competitors may develop and market products with similar featuresthat may reduce demand for our products, and we may be prevented fromestablishing collaborative relationships on favorable terms.***

The following factors areimportant to our success:

·      receiving patent protection for ourproduct candidates;

·      maintaining our trade secrets;

·      not infringing on the proprietary rightsof others; and

·      preventing others from infringing ourproprietary rights.

We will be able toprotect our proprietary rights from unauthorized use by third parties only tothe extent that our proprietary rights are covered by valid and enforceablepatents or are effectively maintained as trade secrets.  We try to protect our proprietary position byfiling U.S. and foreign patent applications related to our proprietarytechnology, inventions and improvements that are important to the developmentof our business. Because the patent position of pharmaceutical companiesinvolves complex legal and factual questions, the issuance, scope andenforceability of patents cannot be predicted with certainty. Patents, ifissued, may be challenged, invalidated or circumvented. Thus, any patents thatwe own or license from others may not provide any protection againstcompetitors. Our pending patent applications, those we may file in the future,or those we may license from third parties, may not result in patents beingissued. If issued, they may not provide us with proprietary protection orcompetitive advantages against competitors with similar technology. Furthermore,others may independently develop similar technologies or duplicate anytechnology that we have developed. The laws of many foreign countries do notprotect our intellectual property rights to the same extent as do the laws ofthe United States.

We also rely on tradesecrets, know-how and technology, which are not protected by patents, tomaintain our competitive position. We try to protect this information byentering into confidentiality agreements with parties that have access to it,such as our corporate partners, collaborators, employees and consultants. Anyof these parties may breach the agreements and disclose our confidentialinformation or our competitors might learn of the information in some otherway. If any trade secret, know-how or other technology not protected by apatent were to be disclosed to or independently developed by a competitor, ourbusiness and financial condition could be materially adversely affected.

***We may become involved in lawsuits and administrativeproceedings to protect, defend or enforce our patents that would be expensiveand time consuming.***

In order to protect orenforce our patent rights, we may initiate patent litigation against thirdparties in the United States or in foreign countries. In addition, we have beenand continue to be subject to certain opposition proceedings conducted inpatent and trademark offices challenging the validity of our patents and maybecome involved in future opposition proceedings. The defense of intellectualproperty rights, including patent rights through lawsuits, interference oropposition proceedings, and other legal and administrative proceedings can becostly and can divert our technical and management personnel from their normalresponsibilities. Such costs increase our operating losses and reduce ourresources available for development activities. An adverse determination of anylitigation or defense proceedings could put one or more of our patents at riskof being invalidated or interpreted narrowly and could put our patent applicationsat risk of not issuing.

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Furthermore, because ofthe substantial amount of discovery required in connection with intellectualproperty litigation, there is a risk that some of our confidential informationcould be compromised by disclosure during this type of litigation. For example,during the course of this kind of litigation and despite protective ordersentered by the court, confidential information may be inadvertently disclosedin the form of documents or testimony in connection with discovery requests,depositions or trial testimony. This disclosure could materially adverselyaffect our business and financial results.

***We have never manufactured any of our product candidates incommercial quantities, and if we fail to develop an effective manufacturingcapability for our products, including our lead product candidate AI-700, wemay be unable to commercialize these products.***

We have no experience inmanufacturing our products for commercial use and limited experience indesigning equipment for the manufacture of our products. We are working tostart-up and qualify operations at a commercial manufacturing facility inTewksbury, Massachusetts and to demonstrate that we can produce AI-700 at acommercial manufacturing scale prior to our filing of a NDA for AI-700 and,subject to required regulatory approvals, we intend to manufacture AI-700 inthis facility for commercial use. We can not assure you that we will be able tosuccessfully manufacture our products in sufficient quantities for commercial sale,or obtain the necessary regulatory approvals for such commercial manufacture,at all or in a timely or economical manner. Our intention to manufacture AI-700or other products exposes us to the following risks, any of which could delayor prevent the approval of our products by the FDA or corresponding state andforeign agencies, or the commercialization of our products, or result in highercosts or inability to meet demand for AI-700 leading to potential revenue loss,and any of which would have a material adverse impact on our business,financial condition and results of operations.

·      Manufacturers often encounter difficultiesin achieving volume production, quality control and quality assurance.Accordingly, we might not be able to manufacture sufficient quantities of drugsto meet our clinical schedules or to commercialize our products.

·      Manufacturers are obliged to manufacturein highly controlled environments and to operate in accordance with FDA andinternational mandated current good manufacturing practices, or cGMPs. For ourclinical trials we have relied on contract manufacturers for such facilitiesand cGMP compliance. In July 2004, we entered into a lease for a facilityin Tewksbury, Massachusetts that we are in the process of converting into acommercial manufacturing facility for AI-700. Creation and qualification of acommercial manufacturing environment requires significant expertise and capitalresources, including the development of advanced manufacturing techniques andprocess controls and is subject to local and state planning approvals.Manufacturers of pharmaceutical products often encounter difficulties inconstructing and qualifying new manufacturing facilities and in production,especially in scaling-up initial production. A failure within this new facilityto establish and follow cGMPs and to document adherence to such practices maylead to significant delays in the availability of material for our NDA filingor commercial production for AI-700 and may delay or prevent filing or approvalof marketing applications for our products or the ability to continue tomanufacture the products. Certain of these delays would further require us tocontinue to operate this facility and incur related costs.

·      Manufacture of our product candidates, inpreparation for filing a NDA and for commercial production, will each initiallyrequire and rely on a single commercial manufacturing site, directly or througha contract manufacturer, without the backup of a second site that is qualifiedfor commercial manufacture of the product. Qualification of anothermanufacturing site can be expensive and time consuming. Prior to using productfrom a new manufacturing site, we must demonstrate to the FDA and correspondingstate and foreign agencies that the specifications for the product areconsistent with the specifications for the product as it was manufactured at aprior qualified site or we must clinically or otherwise demonstrate that thesafety and efficacy of the product produced in the new manufacturing site isconsistent with the product as it was manufactured at the prior site.Demonstrating such consistency may be difficult, expensive or time consuming.In addition, before we would be able to produce product for commercial use at anew facility, it will have to undergo a pre-approval inspection by the FDA andcorresponding state and foreign agencies. Once approved, drug manufacturers aresubject to ongoing periodic unannounced inspection by the FDA and correspondingstate and foreign agencies to ensure strict compliance with cGMPs, othergovernment regulations and corresponding foreign standards. Failure to maintaincompliance with cGMP or with safety or environmental regulations could resultin penalties, product recalls or restrictions on the use of the manufacturingsite.

Under the terms of ourcollaboration agreement with Nycomed, we are responsible for the commercialmanufacture of AI-700 for marketing and sale by Nycomed in Europe. Failure tomanufacture AI-700 in a timely manner or on an economic basis, or in sufficientquantities, could jeopardize our relationship with Nycomed. We do not currentlyhave a European sales force, nor do we have

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experience with regard tothe commercialization, marketing, sale or distribution of pharmaceuticalproducts in Europe, and we rely entirely on Nycomed for this expertise. Anytermination of our relationship with Nycomed would have a material adverseimpact on our business, financial condition and results of operations.

***We may not be able to manufacture our products in commercialquantities, which would prevent us from marketing our products.***

To date our productcandidates have been manufactured in small quantities for pre-clinical andclinical trials. If any of these product candidates are approved by the FDA orforeign regulatory authorities for commercial sale, we will need to manufacturethem in larger quantities. For AI-700, it is our intention to seek regulatoryapproval after we have demonstrated that we can manufacture AI-700 at a largerbatch scale than is being used for clinical trial materials. We cannot assureyou that we will be able to successfully increase the manufacturing capacity ormanufacture at a larger batch scale, whether on our own or in collaborationwith third party manufacturers, for any of our product candidates in a timelyor economic manner, or at all. Significant scale-up of manufacturing mayrequire certain additional validation studies, which the FDA must review andapprove. If we are unable to successfully increase the manufacturing capacityfor a product candidate, the regulatory approval or commercial launch of thatproduct candidate may be delayed or there may be a shortage in supply of thatproduct candidate. Our product candidates require precise, high-qualitymanufacturing. Our failure to achieve and maintain these high manufacturingstandards, including controlling the incidence of manufacturing errors andmaintaining reliable product packaging for diverse environmental conditions,could result in patient injury or death, product recalls or withdrawals, delaysor failures in product testing or delivery, cost overruns or other problemsthat could seriously hurt our business.

Our commercialmanufacturing facility in Tewksbury, Massachusetts is designed to meet ourestimated initial commercial demand for AI-700. The facility is being initiallyequipped to run one production line. In order to support greater productioncapacity, this production line is designed to support a larger lyophilizer(pharmaceutical freeze dryer which can be operated under sterile conditions)than has been initially installed in the facility. Space in the facility hasbeen designated for the future addition of a larger lyophilizer. Purchasing,installing and qualifying manufacturing equipment, such as a lyophilizer,typically requires significant lead times and temporary discontinuation ofproduction. Also in the future we may need to add additional production linesat the Tewksbury, Massachusetts site or elsewhere to meet potential commercialdemand for AI-700. We have made no commitment to such additions at this time.The cost of such additions can be significant. There can be no assurance thatour capacity estimates will be achieved. Any such additions would increase ouroperating spending, increase our capital requirements and reduce our resourcesavailable for development activities.

***We have removed our AI-700 manufacturing equipment from thefacilities of our third party contract manufacturer and currently have nofacility within which to manufacture AI-700 until the new commercialmanufacturing facility is qualified or until other arrangements are made.***

We have removed ourAI-700 manufacturing equipment from the facilities of a third-party contractmanufacturer.  Currently, we have nofacility within which to manufacture AI-700 until the new commercialmanufacturing facility is qualified or until other arrangements are made. If welack sufficient inventory of AI-700 clinical trial material to perform clinicaltrials or are unable to manufacture sufficient inventory on a timely basis, ourprogram could be adversely impacted or delayed. These delays could have amaterial adverse effect on our business, financial condition and results ofoperations.

***If third-party manufacturers of our products fail to devotesufficient time and resources to our concerns, or if their performance issubstandard, our clinical trials may be delayed and our costs may rise.***

We may rely substantiallyon third-party contract manufacturers to supply, store and distribute ourpotential products for our clinical trials and other development needs. Ourreliance on these third-party manufacturers will expose us to the followingrisks, any of which could delay or prevent the completion of our clinicaltrials, the approval of our products by the FDA, or the commercialization ofour products, result in higher costs, or deprive us of additional productcandidates, and any of such effects would have a material adverse impact on ourbusiness, financial condition and results of operations.

·      Contract manufacturers often encounterdifficulties in achieving volume production, quality control and qualityassurance, as well as shortages of qualified personnel. Accordingly, amanufacturer might not be able to manufacture sufficient quantities of drugs tomeet our clinical schedules.

·      Contract manufacturers are obliged tooperate in accordance with FDA-mandated current good manufacturing practices,or cGMPs. A failure of these contract manufacturers to establish and followcGMPs and to document their adherence to such

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practices may lead to significant delays in the availability ofmaterial for clinical study and may delay or prevent filing or approval ofmarketing applications for our products.

·      For production of clinical trial materialfor each of our current product candidates we will initially rely on a singlemanufacturer. Changing these or future manufacturers may be difficult and thenumber of potential manufacturers is limited. Changing manufacturers mayrequire re-validation of the manufacturing processes and procedures inaccordance with FDA-mandated cGMPs. Such re-validation may be costly andtime-consuming. It may be difficult or impossible for us to find replacementmanufacturers on acceptable terms quickly, or at all.

·      Our contract manufacturers may not performas agreed or may not remain in the contract manufacturing business for the timerequired to produce, store and distribute our products successfully. Ourmanufacturing levels, while important to us, can represent relatively smallfractions of the overall business of most qualified contract manufacturers. Asa result, the contract manufacturers may not provide us with the attention thatwe need or may be unwilling to adapt to necessary changes in our manufacturingrequirements.

Drug manufacturers aresubject to ongoing periodic unannounced inspection by the FDA and correspondingstate and foreign agencies to ensure strict compliance with cGMPs, othergovernment regulations and corresponding foreign standards. While we areobligated to audit the performance of third party contractors, we do not havecontrol over our third-party manufacturers’ compliance with these regulationsand standards. Failure by our third-party manufacturers or us to comply withapplicable regulations could result in sanctions being imposed on us, includingfines, injunctions, civil penalties, failure of the government to grant marketapproval of drugs, delays, suspension or withdrawal of approvals, seizures orrecalls of product, operating restrictions and criminal prosecutions, any ofwhich could significantly and adversely affect our business.

***Materials necessary to manufacture our products may not beavailable, which may delay our development and commercialization activities.***

Only a few facilitiesmanufacture some of the raw materials necessary to manufacture our products. Ifwe need to purchase a raw material that is in limited supply for our clinicaltrials, or for commercial distribution if we obtain marketing approval of aproduct candidate, we cannot assure you that one or more suppliers would beable to sell us that raw material at the time we need it and on commerciallyreasonable terms. If we change suppliers for any of these materials or any ofour suppliers experiences a shutdown or disruption in the facilities used toproduce these materials, due to technical, regulatory or other problems, itcould harm our ability to manufacture our products. Our inability to obtainrequired raw materials for any reason could substantially impair ourdevelopment activities or the production, marketing and distribution of ourproducts.

***We have no experience selling, marketing or distributing ourproducts and no internal capability to do so.***

If we receive regulatoryapproval to commence commercial sale of any product, we will face competitionwith respect to commercial sales, marketing and distribution. These are areasin which we have no experience. To market any of our products directly, we mustdevelop a direct marketing and sales force with technical expertise andsupporting distribution capability. Alternatively, we may engage apharmaceutical or other healthcare company with an existing distribution systemand direct sales force to assist us. There can be no assurance that we willsuccessfully establish sales and distribution capabilities either on our own orin collaboration with third parties or gain market acceptance for our products.To the extent we have or will enter co-promotion or other licensingarrangements, any revenues we receive will depend on the efforts of third partiesand there can be no assurance that our efforts will succeed.

***If we are unable to retain key personnel and hire additionalqualified scientific, manufacturing, sales and marketing, and other personnel,we may not be able to successfully achieve our goals.***

We depend on theprincipal members of our scientific and management staff. The loss of theseprincipal members’ services might significantly delay or prevent theachievement of research, development or business objectives and couldmaterially adversely affect our business, financial condition and results ofoperations. We do not maintain key person life insurance on any of theseprincipal members.  On February 1, 2006, we entered into executiveemployment agreements with key members of the management team that provide forcompensation and other benefits in the event these persons are terminated otherthan for cause, including in connection with a “change of control” ofAcusphere.

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Our success depends, inlarge part, on our ability to attract and retain qualified scientific andmanagement personnel such as these individuals. We face intense competition forsuch personnel and consultants. We cannot assure you that we will attract andretain qualified management and scientific personnel in the future.

Further, we expect thatour potential expansion into areas and activities requiring additionalexpertise, such as further clinical trials, governmental approvals, commercialmanufacturing and marketing, will place additional requirements on ourmanagement, operational and financial resources. We expect these demands willrequire an increase in management and scientific personnel and the developmentof additional expertise by existing management personnel. The failure toattract and retain such personnel or to develop such expertise could materiallyadversely affect prospects for our success.

***We will establish collaborative relationships, and thoserelationships may expose us to a number of risks.***

We will rely on a numberof significant collaborative relationships with pharmaceutical or otherhealthcare companies for our manufacturing, research funding, clinicaldevelopment and/or sales and marketing performance. Reliance on collaborativerelationships poses a number of risks, including the following:

·      we cannot effectively control whether ourcorporate partners will devote sufficient resources to our programs or productcandidates;

·      disputes may arise in the future withrespect to the ownership of rights to technology developed with collaborators;

·      disagreements with collaborators coulddelay or terminate the research and development, regulatory approval orcommercialization of product candidates, or result in litigation orarbitration;

·      corporate partners may have considerablediscretion in electing whether to pursue the development of any additionalproduct candidates and may pursue technologies or products either on their ownor in collaboration with our competitors; and

·      collaborators with marketing rights maychoose to devote fewer resources to the marketing of our product candidatesthan they do to product candidates of their own development.

In July 2004, weentered into a collaboration, license and supply agreement with Nycomed inwhich we granted Nycomed rights to develop and market AI-700 in Europe. Therecan be no assurance that the regulatory goals, sales targets and otherobjectives of this agreement will be achieved. Failure to achieve these goals,targets and objectives would result in our inability to receive license,milestone, royalty and other payments under this agreement, which would have amaterial adverse impact on our business, financial condition and results ofoperations including, under certain conditions, reduction of royalty rates,delays in regulatory approvals and product sales, penalties and termination ofthe agreement. Under certain provisions of this collaboration agreement, if wefail in any material respect to use all commercially reasonable efforts tocarry out referenced obligations under the agreement, we would be obligated topay Nycomed liquidated damages of up to $12 million. Although we plan tocarry out all of these obligations, which we believe are in our control, therecan be no assurance that termination of this agreement will not occur or thatsuch termination would not result in us incurring liquidated damages of up to$12 million.

Given these risks, ourcurrent and future collaborative efforts may not be successful. Failure ofthese efforts could delay our product development or impair commercializationof our products, and could have a material adverse effect on our business,financial condition and results of operations.

***Competition in the pharmaceutical industry is intense, andif we fail to compete effectively our financial results will suffer.***

We engage in a businesscharacterized by extensive research efforts, rapid developments and intensecompetition. We cannot assure you that our products will compete successfullyor that research and development by others will not render our productsobsolete or uneconomical. Our failure to compete effectively would materiallyadversely affect our business, financial condition and results of operations.We expect that successful competition will depend, among other things, onproduct efficacy, safety, reliability, availability, timing and scope ofregulatory approval and price. Specifically, we expect important factors willinclude the relative speed with which we can develop products, complete theclinical, development and laboratory testing and regulatory approval processesand supply commercial quantities of the product to the market.

We expect competition toincrease as technological advances are made and commercial applicationsbroaden. In commercializing our initial product candidates and any additionalproducts we develop using our HDDS and PDDS technologies, we will facesubstantial competition from large pharmaceutical, biotechnology and othercompanies, universities and research institutions.

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·      AI-700,our ultrasound contrast agent and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear contrast agents thatare approved for use in myocardial perfusion imaging include products marketedby GE Healthcare and Bristol-Myers Squibb. In 2004, the cost of a nuclearstress test was approximately $770 per procedure. In addition, GE Healthcareand Bristol-Myers Squibb have developed and are marketing ultrasound contrastagents that have been approved by the FDA for use in Left VentricularOpacification and Endocardial Border Delineation in patients with suboptimalimages, and in the future they may seek to broaden their products to include stressecho and myocardial perfusion assessment. Moreover, we are aware that othercompanies, such as Bracco, are developing ultrasound contrast agents for wallimaging and for radiology applications, and that Point Biomedical is developingan ultrasound contrast agent specifically for myocardial perfusion imaging. In2006, Point announced that it had filed a NDA for CardioSphere with the FDA.Finally, some cardiologists may find it satisfactory to use stress echo withoutcontrast for the detection of coronary heart disease.

·     AI-850,our reformulation of paclitaxel, if approved for marketing and sale, will alsoface intense competition from companies such as American PharmaceuticalPartners, NeoPharm and Sonus Pharmaceuticals (in partnership with Schering AG),which are applying significant resources and expertise to developingreformulations of paclitaxel for intravenous delivery. American PharmaceuticalPartners has received FDA approval and is selling their product. Othercompanies, such as Cell Therapeutics, are developing new chemical entities thatinvolve paclitaxel conjugated, or chemically bound, to another chemical.

·      AI-128,our sustained release formulation of an asthma drug, if approved for marketingand sale, will also face intense competition. Companies such as Alkermespossess technology that may be suitable for sustained release pulmonary drugdelivery and may have competitive programs that have not been publiclyannounced or may decide to begin such programs in the future. In addition,large pharmaceutical companies that market FDA-approved asthma drugs may bedeveloping sustained release versions of their asthma drugs that would competewith our product candidates.

Relative to us, most of our competitors have substantially greatercapital resources, research and development staffs, facilities and experiencein conducting clinical trials and obtaining regulatory approvals, as well as inmanufacturing and marketing pharmaceutical products. Many of our competitorsmay achieve product commercialization or patent protection earlier than wewill.

Furthermore, we believethat some of our competitors have used, and may continue to use, litigation togain a competitive advantage. Finally, our competitors may use differenttechnologies or approaches to the development of products similar to theproducts we are seeking to develop.

***We expect to develop international operations that willexpose us to additional business risks.***

We expect, whetherdirectly or through collaborative relationships, to develop operations outsidethe United States in order to market and distribute our products. Regardless ofthe extent to which we seek to develop these operations ourselves or incollaboration with others, we cannot be sure that our international effortswill be successful. Any expansion into international markets will requireadditional resources and management attention and will subject us to newbusiness risks. These risks could lower the prices at which we can sell ourproducts or otherwise have an adverse effect on our operating results. Amongthe risks we believe are most likely to affect any international operationsare:

·      different regulatory requirementsfor approval of our product candidates;

·      dependence on local distributors;

·      longer payment cycles and problemsin collecting accounts receivable;

·      adverse changes in trade and taxregulations;

·      the absence or significant lack oflegal protection for intellectual property rights;

·      political and economic instability;and

·      currencyrisks.

**RisksRelated to Our Industry**

***Even if we obtain marketing approval, our products will besubject to ongoing regulatory review.***

If regulatory approval ofa product is granted, such approval may be subject to limitations on theindicated uses for which the product may be marketed or contain requirementsfor costly, post-marketing follow-up studies. As to products for whichmarketing approval is obtained, the manufacturer of the product and themanufacturing facilities will be subject to continual review and periodicinspections 

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by the FDA and otherregulatory authorities. In addition, the labeling, packaging, adverse eventreporting, storage, advertising, promotion and record keeping related to theproduct will remain subject to extensive regulatory requirements. The subsequentdiscovery of previously unknown problems with the product, manufacturer orfacility may result in restrictions on the product or the manufacturer,including withdrawal of the product from the market. We may be slow to adapt,or we may never adapt, to changes in existing requirements or adoption of newrequirements or policies.

If we fail to comply withapplicable regulatory requirements, we may be subject to fines, suspension orwithdrawal of regulatory approvals, product recalls, seizure of products, operatingrestrictions and criminal prosecution.

***Market acceptance of our products will be limited if usersof our products are unable to obtain adequate reimbursement from third-partypayors.***

Government healthadministration authorities, private health insurers and other organizationsgenerally provide reimbursement for products like our product candidates, andour commercial success will depend in part on these third-party payors agreeingto reimburse patients for the costs of our products. Even if we succeed inbringing any of our proposed products to market, we cannot assure you thatthird-party payors, in the United States, Europe and other markets that we maypursue, will consider our products cost-effective or provide reimbursement inwhole or in part for their use or agree to the proposed price.

Significant uncertaintyexists as to the reimbursement status of newly approved health care products.Each of our product candidates is intended to replace or alter existingtherapies or procedures. These third-party payors may conclude that ourproducts are less safe, effective or cost-effective than these existingtherapies or procedures. Therefore, third-party payors may not approve ourproducts for reimbursement.

If third-party payors donot approve our products for reimbursement or fail to reimburse themadequately, sales will suffer as some physicians or their patients will opt fora competing product that is approved for reimbursement or is adequatelyreimbursed. Even if third-party payors make reimbursement available, thesepayors’ reimbursement policies may adversely affect the ability of us and ourpotential collaborators to sell our products on a profitable basis.

Moreover, the trendtoward managed healthcare in the United States, the growth of organizationssuch as health maintenance organizations, and legislative proposals to reformhealthcare and government insurance programs could significantly influence thepurchase of healthcare services and products, resulting in lower prices andreduced demand for our products which could adversely affect our business,financial condition and results of operations.

In addition, legislationand regulations affecting the pricing of pharmaceuticals may change in waysadverse to us before or after the FDA or other regulatory agencies approve anyof our proposed products for marketing. While we cannot predict the likelihoodof any of these legislative or regulatory proposals, if any government orregulatory agencies adopt these proposals they could materially adversely affectour business, financial condition and results of operations.

***We may be required to defend lawsuits or pay damages inconnection with the alleged or actual harm caused by our products or productcandidates.***

We face an inherentbusiness risk of exposure to product liability claims in the event that the useof our products is alleged to have resulted in harm to others. This risk existsin clinical trials as well as in commercial distribution. In addition, thepharmaceutical and biotechnology industries in general have been subject tosignificant medical malpractice litigation. We may incur significant liabilityif product liability or malpractice lawsuits against us are successful.Furthermore, product liability claims, regardless of their merits, could becostly and divert our management’s attention from other business concerns, oradversely affect our reputation and the demand for our products. Although wemaintain product liability insurance, we cannot be certain that this coveragewill be adequate or that it will continue to be available to us on acceptableterms.

***Rapid technological change could make our products obsolete.***

Pharmaceuticaltechnologies have undergone rapid and significant change. We expect thatpharmaceutical technologies will continue to develop rapidly. Our future willdepend in large part on our ability to maintain a competitive position withrespect to these technologies. Any compounds, products or processes that wedevelop may become obsolete before we recover any expenses incurred 

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in connection with theirdevelopment. Rapid technological change could make our products obsolete, whichcould materially adversely affect our business, financial condition and resultsof operations.

***Our products involve the use of hazardous materials, and asa result we are exposed to potential liability claims and to costs associatedwith complying with laws regulating hazardous waste.***

Our research anddevelopment activities involve the use of hazardous materials, includingchemicals and biological materials. We believe that our procedures for handlinghazardous materials comply with federal and state regulations. However, therecan be no assurance that accidental injury or contamination from thesematerials will not occur. In the event of an accident, we could be held liablefor any damages, which could exceed our available financial resources. Thisliability could materially adversely affect our business, financial conditionand results of operations.

We are subject tofederal, state and local laws and regulations governing the use, manufacture,storage, handling and disposal of hazardous materials and waste products, andwe spent approximately $6,100 during the three months ended June 30, 2006 todispose of these hazardous materials and waste products. We may be required toincur significant costs to comply with environmental laws and regulations inthe future that could materially adversely affect our business, financialcondition and results of operations.

**RisksRelated to Our Common Stock**

***We expect that our stock price will fluctuate significantly.***

We completed our initialpublic offering in October 2003. Prior to this offering, you could not buyor sell our common stock publicly. After this offering, the average dailytrading volume for our common stock has been relatively low. An active publicmarket for our common stock may not continue to develop or be sustained. Thestock market, particularly in recent years, has experienced significantvolatility particularly with respect to pharmaceutical and biotechnologystocks. The volatility of pharmaceutical and biotechnology stocks often doesnot relate to the operating performance of the companies represented by thestock. Factors that could cause this volatility in the market price of ourcommon stock include:

·      announcements of the introductionof new products by us or our competitors;

·      announcements of clinical trialresults;

·      market conditions in thepharmaceutical and biotechnology sectors;

·      rumors relating to us or ourcompetitors;

·      litigation or public concern aboutthe safety of our potential products;

·      our quarterly operating results;

·      deviations in our operating resultsfrom the estimates of securities analysts;

·      sales by us of additional shares ofour common or preferred stock; and

·      FDAor international regulatory actions.

The market price of ourcommon stock may also fluctuate in response to the exercise by us of rightsunder the terms of our 6.5% convertible exchangeable preferred stock. Forexample, we may elect to automatically convert the preferred stock if ourcommon stock price has exceeded 150% of the conversion price of the preferredstock for at least 20 trading days during a 30-day trading period ending withinfive trading days prior to the notice of automatic conversion. There is a riskof fluctuation in the price of our common stock between the time when we mayfirst elect to automatically convert the preferred stock and the automaticconversion date. These fluctuations may adversely affect the value of ourcommon stock.

***Our controlling equity holders may have conflicts ofinterests with us or you in the future.***

As of August 3, 2006, andbased on information provided to us by such entities: Quaker Capital ManagementCorporation and its affiliates beneficially own approximately 9% of ouroutstanding common stock; Bank of America Corporation and its affiliatesbeneficially own approximately 7% of our outstanding common stock; the BaupostGroup LLC beneficially owns approximately 7% of our outstanding common stock;the Endowment Capital Group LLC and its affiliates beneficially ownapproximately 6% of our outstanding common stock and Mr. Peter David Boonebeneficially owns approximately 6% of our outstanding common stock.Collectively these investors will control approximately 35% of our commonstock. These investors, particularly if they were to act together as aconcentrated group, could exert influence over the election of our directors,direct our policies and operations, including future issuances of common stockor other securities, the payments of dividends, if any, on our common stock,the incurrence of debt by us, amendments to our Amended and RestatedCertificate of Incorporation and Amended and Restated Bylaws and entering intoof 

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extraordinarytransactions, and their interests, as a concentrated group, may not in allcases be aligned with your interests. This concentration of ownership among asmall number of investors may make it more difficult for other stockholders toinfluence matters requiring stockholder approval and may have the effect ofdelaying, preventing or deterring a change in control of our company, therebypossibly depriving our stockholders of an opportunity to receive a premium fortheir common stock as part of any sale or acquisition.

***Our common stock is junior to our preferred stock withrespect to the right to receive payments in the event of a dissolution,liquidation or winding up of Acusphere.***

In February 2005, weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of May 9, 2006, 730,000 of these shares of preferred stock areoutstanding. The preferred stock is senior to the common stock as toliquidation. In the event of our voluntary or involuntary dissolution,liquidation or winding up of Acusphere, holders of our preferred stock willreceive a liquidation preference in an amount equal to $50 per share, plus allaccrued and unpaid dividends through the distribution date. Only after holdersof the preferred stock have received their liquidation preference and any accruedand unpaid dividends will we distribute assets, if any are remaining, to ourcommon stock holders.

***We may be the subject of securities class action litigationdue to future stock price volatility.***

In the past, when themarket price of a stock has been volatile, holders of that stock have ofteninstituted securities class action litigation against the company that issuedthe stock. If any of our stockholders brought a lawsuit against us, we couldincur substantial costs defending the lawsuit. The lawsuit could also divertthe time and attention of our management.

***Future sales of common stock by our existing stockholdersmay cause our stock price to fall.***

The market price of ourcommon stock could decline as a result of sales by our existing stockholders ofshares of common stock in the market, or the perception that these sales couldoccur. These sales might also make it more difficult for us to sell equitysecurities at a time and price that we deem appropriate. As of August 3, 2006,we have approximately 28,813,873 shares of common stock outstanding and 730,000shares of convertible preferred stock outstanding that are convertible intoapproximately 5.3 million shares of our common stock, plus up to a maximum ofapproximately 1.0 million additional shares of our common stock issuable at ouroption in satisfaction of the maximum dividend make-whole payment on theseshares of preferred stock. All of the shares of common stock issuable uponconversion of our preferred stock will be freely tradable without restrictionunder the federal securities laws unless purchased by our affiliates.

***The terms of our outstanding shares of preferred stock mayrestrict our ability to raise additional capital or hamper or prevent anacquisition of us.***

In February 2005, weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of June 30, 2006, 730,000 of these shares of preferred stock areoutstanding. In the event of our voluntary or involuntary dissolution,liquidation or winding up of Acusphere, holders of our preferred stock willreceive a liquidation preference in an amount equal to $50 per share, plus allaccrued and unpaid dividends through the distribution date. Only after holdersof the preferred stock have received their liquidation preference and anyaccrued and unpaid dividends will we distribute assets, if any are remaining,to our common stock holders. Without the vote or consent of the holders of atleast a majority of the shares of preferred stock, we can not authorize or sellany equity security that ranks senior to the preferred stock as to dividends ordistributions of assets upon liquidation, dissolution or winding up ofAcusphere. As a result of this liquidation preference, it may be difficult forus to raise additional capital through the sale of common stock or juniorpreferred stock on acceptable terms, or at all.

In addition, without thevote or consent of the holders of at least a majority of the shares ofpreferred stock we may not effect a consolidation or merger with another entityunless the preferred stock that remains outstanding and its rights, privilegesand preferences are unaffected or are converted into or exchanged for preferredstock of the surviving entity having rights, preferences and limitationssubstantially similar, but no less favorable, to the convertible preferredstock. This provision could hamper a third party’s acquisition of us ordiscourage a third party from attempting to acquire control of us via a merger.

***Under some circumstances, the holders of our outstandingshares of preferred stock may be entitled to elect some of the directors ofAcusphere.***

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In February 2005 weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of June 30, 2006, 730,000 of these shares of preferred stock areoutstanding. Cumulative dividends accrue on our preferred stock at an annualrate of $3.25 per share, payable quarterly on the first day of March, June,September and December, commencing June 1, 2005. Any dividends must bedeclared by our board of directors and must come from funds that are legallyavailable for dividend payments. If we have not paid dividends on the preferredstock in an aggregate amount equal to at least six quarterly dividends whetheror not consecutive, we must increase the size of our board of directors by twoadditional directors. After this time, and for so long as these dividendsremain due and unpaid, holders of the preferred stock, voting separately as aclass with holders of preferred stock ranking on the same basis as to dividendshaving like voting rights, will be entitled to elect two additional directorsat any meeting of stockholders at which directors are to be elected. Thesedirectors will be appointed to classes on the board as determined by our boardof directors. These voting rights will terminate when we have declared andeither paid or set aside for payment all accrued and unpaid dividends. Theterms of office of all directors so elected will terminate immediately upon thetermination of these voting rights.

***Provisions of Delaware law or our charter documents coulddelay or prevent an acquisition of us, even if the acquisition would bebeneficial to our stockholders, and could make it more difficult for you tochange management.***

Provisions of Delawarelaw or our charter or by-laws could hamper a third party’s acquisition of us,or discourage a third party from attempting to acquire control of us.Stockholders who wish to participate in these transactions may not have theopportunity to do so. These provisions could also limit the price thatinvestors might be willing to pay in the future for shares of our common stock.Further, these provisions make it more difficult for stockholders to change thecomposition of our board of directors in any one year.

These provisions include:

·      a provision allowing us to issuepreferred stock with rights senior to those of the common stock without anyfurther vote or action by the holders of the common stock;

·      the existence of a staggered boardof directors in which there are three classes of directors serving staggeredthree-year terms, thus expanding the time required to change the composition ofa majority of directors and potentially discouraging someone from making anacquisition proposal for us;

·      the by-laws’ requirement thatstockholders provide advance notice when nominating our directors;

·      the inability of stockholders toconvene a stockholders’ meeting without the chairperson of the board, the chiefexecutive officer, the president or a majority of the board of directors firstcalling the meeting; and

·      theapplication of Delaware law prohibiting us from entering into a businesscombination with the beneficial owner of 15% or more of our outstanding votingstock for a period of three years after the 15% or greater owner first reachedthat level of stock ownership, unless we meet specified criteria.

***We have never paid dividends on our common stock, and we donot anticipate paying any cash dividends on our common stock in the foreseeablefuture.***

We have paid no cashdividends on our common stock to date and, other than cash dividends paid onour preferred stock, we currently intend to retain our future earnings, if any,to fund the development and growth of our businesses. In addition, the terms ofany future debt or credit facility may preclude us from paying these dividends.As a result, capital appreciation, if any, of our common stock will be yoursole source of gain for the foreseeable future.

**ITEM 2.  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None

**ITEM 3.  DEFAULTSUPON SENIOR SECURITIES**

None

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**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

At our Annual Meeting of Stockholders held on June 8,2006, the stockholders approved the following:

Elected two people to serve as a Class III directorsas follows:
| Director                                           |   | Votes For  |   | Votes Withheld |   |    |
|----------------------------------------------------|--------|------------|--------|----------------|--------|---------|
| Frank Baldino,  Jr.                                |   | 20,685,744 |   | 1,844,294      |   |    |
| Martyn Greenacre                                   |   | 21,547,369 |   | 982,669        |   |    |
|                                               |   |       |   |           |   |    |
|                                               |   | Votes For  |   | Votes Against  |   | Abstain |
| Ratification of  Deloitte & Touche LLP         |   |       |   |           |   |    |
| as independent  registered public accounting firm: |   | 22,267,045 |   | 104,337        |   | 158,656 |

 

**ITEM 5. OTHER INFORMATION**

Our policy governingtransactions in its securities by its directors, officers and employees permitsits officers, directors and certain other persons to enter into trading planscomplying with Rule 10b5-1 under the Securities Exchange Act of 1934, asamended. We have been advised that, in accordance with Rule 10b5-1 and ourpolicy governing transactions in its securities, such a plan has been enteredinto with provisions requiring that any trading of securities thereunderis to be reported when and if it occurs in accordance with applicable law.We undertake no obligation to update or revise the information provided herein,including for revision or termination of an established trading plan.

**ITEM 6. EXHIBITS**
| Exhibit  Number | ** ** | **Exhibit Description**                                                                                      |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------|
| 10.1            |       | License Agreement by and between by and between GE  Healthcare Ltd. and the Company dated as of June 1, 2006 |
|            |       |                                                                                                         |
| 10.2*           |       | Patent License Agreement by and between the Company  and Bracco International BV dated as of June 1, 2006    |
|            |       |                                                                                                         |
| 31.1            |       | Rule 13a-14(a) / 15d-14(a) Certification                                                                     |
|            |       |                                                                                                         |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification                                                                     |
|            |       |                                                                                                         |
| 32.1            |       | Section 1350 Certifications                                                                             |

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*                    ConfidentialTreatment requested for certain portions of this Agreement.

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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 on this 9th day of August 2006.
|          | ACUSPHERE, INC. |                                                     |     |
|----------|-----------------|----------------------------------------------------------|----------|
|     |            |                                                     |     |
|     | By:             | /s/ Sherri C. Oberg                                      |     |   |
|     |            | Sherri C. Oberg                                          |     |   |
|     | * *        | *President and Chief Executive Officer*                  | * * | * * |
|     |            |                                                     |     |   |
|     | By:             | /s/ John F. Thero                                        |     |   |
|     |            | John F. Thero                                            |     |   |
| * * | * *        | *Senior Vice President and Chief Financial Officer*      | * * | * * |
|     | * *        | *(Principal Financial  and Accounting Officer  and* | * * | * * |
|     | * *        | *Duly Authorized Officer)*                               | * * | * * |

 

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**EXHIBIT INDEX**
| Exhibit  Number | ** ** | **Exhibit Description**                                                                                      |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------|
| 10.1            |       | License Agreement by and between by and between GE  Healthcare Ltd. and the Company dated as of June 1, 2006 |
|            |       |                                                                                                         |
| 10.2*           |       | Patent License Agreement by and between the Company  and Bracco International BV dated as of June 1, 2006    |
|            |       |                                                                                                         |
| 31.1            |       | Rule 13a-14(a) / 15d-14(a) Certification                                                                     |
|            |       |                                                                                                         |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification                                                                     |
|            |       |                                                                                                         |
| 32.1            |       | Section 1350 Certifications                                                                             |

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*                    ConfidentialTreatment requested for certain portions of this Agreement.

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