**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                 |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                              |
| ** ** | **For the  quarterly period ended March 31, 2005**                                                                                                                                                           |
|       |                                                                                                                                                                                                              |
| ** ** | **or**                                                                                                                                                                                                            |
|       |                                                                                                                                                                                                              |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                |
|       |                                                                                                                                                                                                              |
| ** ** | **For the  transition period from                to                ** |

 

**CommissionFile Number 000-50405**

 

**ACUSPHERE, INC.**

(Exact name ofregistrant as specified in its charter)

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

 

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

** **

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). Yes oNo ý

 

As ofMay 6, 2005 there were 17,831,954 shares of the registrant’s common stock, $.01par value per share, outstanding.

 

 

----

 

**ACUSPHERE, INC.**

 

**Form 10-Q**

**For the Quarterly Period Ended March 31, 2005**

 

**CONTENTS**

 
| ** **                                                                                                     | **Page  Number** |
|----------------------------------------------------------------------------------------------------------------|------------------|
| PART I: FINANCIAL  INFORMATION                                                                                 |             |
| Item 1. Consolidated  Financial Statements                                                                     | 3                |
| Condensed Consolidated Balance Sheets: March 31,  2005 (Unaudited) and December 31, 2004             | 3                |
| Condensed  Consolidated Statements of Operations (Unaudited): Three Months ended  March 31, 2005 and 2004 | 4                |
| Condensed  Consolidated Statements of Cash Flows (Unaudited): Three Months ended  March 31, 2005 and 2004 | 5                |
| Notes  to Condensed Consolidated Financial Statements (Unaudited)                                              | 6                |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations           | 12               |
| Item 3.  Quantitative and Qualitative Disclosure about Market Risk                                             | 35               |
| Item 4.  Controls and Procedures                                                                               | 35               |
| PART II:  OTHER INFORMATION                                                                                    | 36               |
| Item 1.  Legal Proceedings                                                                                     | 36               |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                           | 36               |
| Item 3.  Defaults Upon Senior Securities                                                                       | 36               |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                   | 36               |
| Item 5.  Other Information                                                                                     | 36               |
| Item 6.  Exhibits                                                                                              | 37               |
| Signature                                                                                                      | 38               |

 

2

----

 

**PART I: FINANCIAL INFORMATION**

**ITEM 1. CONSOLIDATED FINANCIAL STATEMENT****S**

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **March 31,  2005** | ** **  | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                  | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                  | ** ** | ** **               | ** **  | ** **                  | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                                                                                             |       |                     |        |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                                                                                  |       | $                        | 79,766,676  |                        | $          | 45,179,915 |   |
| Other current assets                                                                                                                                                                                                                                                                                                                                                        |       | 2,808,124                |        | 2,096,681                   |       |
| Total current assets                                                                                                                                                                                                                                                                                                                                                        |       | 82,574,800               |        | 47,276,596                  |       |
| PROPERTY AND EQUIPMENT,  at cost:                                                                                                                                                                                                                                                                                                                                           |       |                     |        |                        |       |
| Property and equipment  (Note 5)                                                                                                                                                                                                                                                                                                                                            |       | 27,215,183               |        | 20,876,140                  |       |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                                                                                                                                             |       | 8,535,011                |        | 8,006,819                   |       |
| Property and equipment,  net                                                                                                                                                                                                                                                                                                                                                |       | 18,680,172               |        | 12,869,321                  |       |
| OTHER ASSETS                                                                                                                                                                                                                                                                                                                                                                |       | 1,832,820                |        | 1,857,306                   |       |
| TOTAL                                                                                                                                                                                                                                                                                                                                                                       |       | $                        | 103,087,792 |                        | $          | 62,003,223 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                                               | ** ** | ** **               | ** **  | ** **                  | ** ** |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                                                                                        |       |                     |        |                        |       |
| Current portion of  long-term obligations (Note 6)                                                                                                                                                                                                                                                                                                                          |       | $                        | 2,384,655   |                        | $          | 1,071,627 |   |
| Current portion of  deferred revenue (Note 7)                                                                                                                                                                                                                                                                                                                               |       | 3,428,571                |        | 3,428,571                   |       |
| Derivative liability (Note  8)                                                                                                                                                                                                                                                                                                                                              |       | 2,624,000                |        | —                      |       |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                            |       | 2,527,776                |        | 4,237,934                   |       |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                                            |       | 4,779,759                |        | 4,396,020                   |       |
| Total current  liabilities                                                                                                                                                                                                                                                                                                                                                  |       | 15,744,761               |        | 13,134,152                  |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                                                                                                      |       |                     |        |                        |       |
| Long-term obligations,  net of current portion                                                                                                                                                                                                                                                                                                                              |       | 9,777,901                |        | 2,502,579                   |       |
| Deferred revenue, net  of current portion                                                                                                                                                                                                                                                                                                                                   |       | 1,000,000                |        | 857,143                     |       |
| Total long-term  liabilities                                                                                                                                                                                                                                                                                                                                                |       | 10,777,901               |        | 3,359,722                   |       |
| COMMITMENTS                                                                                                                                                                                                                                                                                                                                                                 |       |                     |        |                        |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                                                                                                  |       |                     |        |                        |       |
| Preferred stock, $0.01  par value per share Authorized - 5,000,000 shares as of March 31, 2005  and December 31, 2004 Designated 6.5% convertible exchangeable -  1,000,000 shares as of March 31, 2005 and none as of December 31,  2004 Issued and outstanding – 900,000 shares as of March 31, 2005 and  none as of December 31, 2004 |       | 9,000                    |        | —                      |       |
| Common stock, $0.01 par  value per share Authorized - 98,500,000 shares as of March 31, 2005 and December 31,  2004 Issued and outstanding - 17,829,756 shares as of March 31, 2005 and  17,810,922 as of December 31, 2004                                                                                                                             |       | 178,298                  |        | 178,109                     |       |
| Additional paid-in  capital                                                                                                                                                                                                                                                                                                                                                 |       | 260,508,180              |        | 221,672,237                 |       |
| Deferred stock-based  compensation                                                                                                                                                                                                                                                                                                                                          |       | (731,215                 | )           | (914,492                    | )          |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                                         |       | (183,399,133             | )           | (175,426,505                | )          |
| Total stockholders’  equity                                                                                                                                                                                                                                                                                                                                            |       | 76,565,130               |        | 45,509,349                  |       |
| TOTAL                                                                                                                                                                                                                                                                                                                                                                       |       | $                        | 103,087,792 |                        | $          | 62,003,223 |   |

 

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

 

3

----

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPE****RATIONS**

**(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **March 31,**     | ** ** | **March 31,** | ** ** |
| ** **                                                  | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                                                        |       |                   |       |   |   |
| COLLABORATION REVENUE                                       |       | $                      | 857,143    |   | $ | — |   |
| OPERATING EXPENSES:                                         |       |                   |       |   |   |
| Research and  development(1)                                |       | 7,678,079              |       | 5,602,803 |   |
| General and  administrative(1)                              |       | 1,747,308              |       | 1,404,112 |   |
| Total operating  expenses                                   |       | 9,425,387              |       | 7,006,915 |   |
| Interest income                                             |       | 302,309                |       | 107,773 |   |
| Interest expense                                            |       | (140,693               | )          | (25,420 | ) |
| Change in valuation of  derivative                          |       | 434,000                |       | — |   |
| NET LOSS                                                    |       | $                      | (7,972,628 | ) | $ | (6,924,562 | ) |
| NET LOSS AVAILABLE TO  COMMON STOCKHOLDERS PER SHARE – |       |                   |       |   |   |
| Basic and diluted                                           |       | $                      | (0.45      | ) | $ | (0.48 | ) |
| WEIGHTED-AVERAGE SHARES  OUTSTANDING –                 |       |                   |       |   |   |
| Basic and diluted                                           |       | 17,812,912             |       | 14,286,093 |   |
|                                                        |       |                   |       |   |   |

----

| (1) Includes  stock-based compensation as follows: |   |    |    |    |   |
|----------------------------------------------------|--------|---------|---------|---------|--------|
| Research and  development                          |   | $       | 58,489  |    | $      | 89,949 |   |
| General and  administrative                        |   | 110,932 |    | 142,732 |   |
|                                               |   | $       | 169,421 |    | $      | 232,681 |   |

 

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

 

4

----

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CAS**HFLOWS

**(unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**     | ** ** | **March 31,** | ** ** |
| ** **                                                                   | ** ** | **2005**               | ** ** | **2004** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                       |       |                   |       |   |   |
| Net loss                                                                     |       | $                      | (7,972,628 | ) | $ | (6,924,562 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                   |       |   |   |
| Stock-based  compensation expense                                            |       | 169,421                |       | 232,681 |   |
| Depreciation and  amortization                                               |       | 528,192                |       | 320,973 |   |
| Noncash interest  expense                                                    |       | 13,381                 |       | 4,565 |   |
| Noncash rent expense                                                         |       | 127,667                |       | 13,410 |   |
| Noncash amortization of  deferred revenue                                    |       | (857,143               | )          | — |   |
| Noncash amortization of  fee and warrants to financial advisor               |       | 67,261                 |       | — |   |
| Change in valuation of  derivative                                           |       | (434,000               | )          | — |   |
| Changes in operating  assets and liabilities:                                |       |                   |       |   |   |
| Deferred revenue                                                             |       | 1,000,000              |       | — |   |
| Other current assets                                                         |       | (711,443               | )          | (116,299 | ) |
| Accounts payable                                                             |       | (1,710,158             | )          | (289,958 | ) |
| Accrued expenses                                                             |       | 269,482                |       | 103,850 |   |
| Net cash used in  operating activities                                       |       | (9,509,968             | )          | (6,655,340 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                       |       |                   |       |   |   |
| Purchases of property  and equipment                                         |       | (6,339,043             | )          | (924,297 | ) |
| Increase in other  assets                                                    |       | (65,000                | )          | — |   |
| Net cash used in  investing activities                                       |       | (6,404,043             | )          | (924,297 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                       |       |                   |       |   |   |
| Payments on long-term  obligations                                           |       | (453,990               | )          | (225,379 | ) |
| Proceeds from long-term  obligations                                         |       | 9,037,775              |       | — |   |
| Net proceeds from sale  of preferred stock                                   |       | 41,891,066             |       | — |   |
| Net proceeds from  exercise of stock options                                 |       | 13,761                 |       | 5,772 |   |
| Proceeds from issuance  of common stock from employee stock purchase plan    |       | 12,160                 |       | 12,164 |   |
| Net cash provided by  (used in) financing activities                         |       | 50,500,772             |       | (207,443 | ) |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                        |       | 34,586,761             |       | (7,787,080 | ) |
| CASH AND CASH  EQUIVALENTS – Beginning of period                        |       | 45,179,915             |       | 54,562,378 |   |
| CASH AND CASH  EQUIVALENTS – End of period                              |       | $                      | 79,766,676 |   | $ | 46,775,298 |   |

 

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

 

5

----

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIA****L STATEMENTS**

**(unaudited)**

 

**1.****     Basisof Presentation**

 

Theaccompanying unaudited condensed consolidated financial statements ofAcusphere, Inc. and Subsidiaries (the “Company”), have been prepared inaccordance with generally accepted accounting principles in the United Statesof America for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not includeall of the information and footnotes required by generally accepted accountingprinciples in the United States of America for complete financial statements.These statements should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s latest audited annualfinancial statements. Those audited statements are included in our AnnualReport on Form 10-K for the year ended December 31, 2004, which has beenfiled with the SEC.

 

In theopinion of management, all adjustments, consisting only of normal, recurringadjustments considered necessary for a fair presentation of the results ofthese interim periods have been included. The results of operations for the threemonths ended March 31, 2005 may not be indicative of the results that maybe expected for the full fiscal year.

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of expenses during the reportingperiod. Actual results could differ from those estimates or assumptions. Themore significant estimates reflected in these financial statements include revenuerecognition, accrued expenses, embedded derivatives, and valuation ofstock-based compensation.

 

**2.****     RevenueRecognition**

 

The Company recognizesrevenue from license arrangements in accordance with Staff Accounting BulletinNo. 104, Revenue Recognition (“SAB 104”) and FASB Emerging Issue Task ForceIssue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables(“EITF 00-21”). The Company recognizes revenue from license payments not tiedto achieving a specific performance milestone ratably over the period overwhich the Company is obligated to perform services. The period over which theCompany is obligated to perform services is estimated based on available factsand circumstances. The Company recognizes revenue from performance payments,when such performance is substantially in the Company’s control and when theCompany believes that completion of such performance is reasonably probable,ratably over the period over which the Company estimates that it will performsuch performance obligations. Substantive at-risk milestone payments, which arebased on achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably estimated or assured, are recognized as revenue when themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. Revenue inconnection with license arrangements is recognized over the term of thearrangement and is limited to payments collected or due and reasonably assuredof collection. In circumstances where the arrangement includes a refundprovision, the Company defers revenue recognition until the refund condition isno longer applicable unless, in the Company’s judgment, the refundcircumstances are within its operating control and unlikely to occur.  Payments received in advance of beingrecognized as revenue are deferred.

 

**3.****     Accountingfor Stock-based Compensation**

 

TheCompany’s employee stock option plans are accounted for using theintrinsic-value-based method of Accounting Principles Board (“APB”) Opinion No.25, “Accounting for Stock Issued to Employees,” and related interpretations.Accordingly, no compensation expense is recorded for options issued toemployees with fixed amounts and fixed exercise prices which for accountingpurposes are at least equal to the fair value of the Company’s common stock atthe date of grant. Conversely, when the exercise price for accounting purposesis below fair value of the Company’s common stock on the date of grant, anon-cash charge to compensation expense is recorded ratably over the term ofthe option vesting period in an amount equal to the difference between thevalue calculated using the exercise price and the fair value. The Company usesthe fair-value method to account for non-employee stock-based compensation.

 

6

----

 

Stockoptions granted during 2005 are as follows:

 

| ** **                   | ** ** | **Number  of  Shares** | ** ** | **Exercise  Price  Per Share** | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
|------------------------------|------------|------------------------|------------|--------------------------------|------------|---------------------------------------------------|------------|
| For the three months  ended: |       |                   |       |                           |       |                                              |       |
| March 31, 2005          |       | 847,500                |       | $5.43 – 6.30              |       | $                                                 | 5.83       |   |
|                              |            |                        |            |                                |            |                                                   |            |  |

 

Thestock options granted in the three months ended March 31, 2005 weregranted at fair market value on the date of grant.

 

Hadcompensation cost for grants issued during the current and prior periods beendetermined consistent with Statement of Financial Accounting Standard (“SFAS”)No. 123, “Accounting for Stock-based Compensation,” pro forma net loss and netloss per share would have been the following:

 

| ** **                                                                            | ** ** | **Three Months Ended**   | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                            | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
| Applicable to common  stockholders:                                                   |       |                     |       |   |   |
| Net loss – as reported                                                           |       | $                        | (7,972,628 | ) | $ | (6,924,562 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss         |       | 136,814                  |       | 195,227 |   |
| Deduct: Stock-based  employee compensation expense determined under fair value method |       | (528,978                 | )          | (425,600 | ) |
| Net loss – proforma                                                              |       | $                        | (8,364,792 | ) | $ | (7,154,935 | ) |
| Net loss per common  share (basic and diluted):                                       |       |                     |       |   |   |
| As reported                                                                           |       | $                        | (0.45      | ) | $ | (0.48 | ) |
| Pro forma                                                                             |       | $                        | (0.47      | ) | $ | (0.50 | ) |

 

In December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123R, Share-BasedPayment (“SFAS No. 123R”). This Statement is a revision of SFASNo. 123, Accounting forStock-Based Compensation, and supersedes Accounting Principles BoardOpinion No. 25, Accounting forStock Issued to Employees, and its related implementation guidance.  SFAS No. 123R focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. The Statement requires entities to recognizestock compensation expense for awards of equity instruments to employees basedon the grant-date fair value of those awards (with limited exceptions). Inaccordance with a recently-issued rule by the SEC, SFAS No. 123R iseffective as of the beginning of the first annual reporting period that beginsafter June 15, 2005.  The Companyexpects to adopt SFAS No. 123R on January 1, 2006 using the Statement’smodified prospective application method. The Company does not yet have an estimate of the effect on itsstatements of operations of adopting SFAS No. 123.

 

**4.****     NetLoss Per Common Share**

 

Basicand diluted net loss per common share is calculated by dividing the net lossapplicable to common stockholders by the weighted-average number ofunrestricted common shares outstanding during the period. Diluted net loss percommon share is the same as basic net loss per common share, since the effectsof potentially dilutive securities are antidilutive for all periods presented.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 10,539,401 and2,282,412 as of March 31, 2005 and 2004, respectively.

 

Thefollowing table reconciles weighted-average common shares outstanding to theshares used in the computation of basic and diluted weighted-average commonshares outstanding:

 

7

----

 

| ** **                                                           | ** ** | **Three Months Ended**   | ** ** |
|----------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                           | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
| Weighted-average common  shares outstanding                          |       | 17,817,764               |       | 14,297,281 |   |
| Less weighted-average  unvested restricted common shares outstanding |       | (4,852                   | )          | (11,188 | ) |
| Basic and diluted  weighted-average common shares outstanding        |       | 17,812,912               |       | 14,286,093 |   |

 

**5.****     Propertyand Equipment**

 

Propertyand equipment at cost consist of the following:

 
| ** **                                       | ** ** | **As of:**               | ** ** | ** **                  | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** | **Estimated  Useful Life** | ** ** |
| Equipment                                        |       | $                        | 17,623,283 |                        | $          | 10,279,147 |   | 3 – 5 years |   |
| Furniture and fixtures                           |       | 188,252                  |       | 188,252                     |       | 5 years |   |
| Leasehold improvements                           |       | 560,351                  |       | 171,277                     |       | Lease term |   |
| Sub-total depreciable  assets                    |       | 18,371,886               |       | 10,638,676                  |       |   |   |
| Less: accumulated  depreciation and amortization |       | (8,535,011               | )          | (8,006,819                  | )          |   |   |
| Total depreciable  assets, net                   |       | 9,836,875                |       | 2,631,857                   |       |   |   |
| Deposits on equipment  purchases                 |       | 1,193,819                |       | 6,774,256                   |       | N/A |   |
| Construction in  progress                        |       | 7,649,478                |       | 3,463,208                   |       | N/A |   |
| Total property and  equipment                    |       | $                        | 18,680,172 |                        | $          | 12,869,321 |   |   |   |

 

Depositson equipment purchases represent progress payments for long-lead time capitalequipment purchases, the majority of which are associated with development andexpansion of the Company’s manufacturing operations for AI-700.

 

Amountsrecorded for construction in progress represent costs incurred through March 31,2005 for the build-out of the Company’s commercial manufacturing facility inTewksbury, Massachusetts.  The Companyhas entered into an engineering and construction management services agreementwith Parsons Commercial Technology, Inc., as last amended April 29, 2005,authorizing Parsons to perform on behalf of the Company, during the periodending May 15, 2005, engineering, design and construction management services inconnection with the build-out of the commercial manufacturing facility inTewksbury, Massachusetts.  The totalvalue of this cost-plus percentage fee type contract is $12.9 million of which$6.2 million was paid on or before March 31, 2005.  The Company anticipates that furtheramendment to this contract will be necessary to complete this build-outproject.  The Company expects that itstotal payments for substantially completing the build-out of the commercialmanufacturing facility, excluding equipment purchases, will be approximately$18.0 million in excess of the amounts that have already been paid through March 31,2005.

 

**6.****     Long-termObligations**

 

Thecarrying value of long-term obligations is as follows:

 

| ** **                  | ** ** | **As of:**               | ** ** |
|-----------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
| Capital lease  obligations  |       | $                        | 14,849     |   | $ | 205,419 |   |
| Notes payable               |       | 12,147,707               |       | 3,368,787 |   |
|                        |       | 12,162,556               |       | 3,574,206 |   |
| Less current maturities     |       | (2,384,655               | )          | (1,071,627 | ) |
| Long-term obligations,  net |       | $                        | 9,777,901  |   | $ | 2,502,579 |   |

 

Long-termobligations, including current maturities, outstanding as of March 31,2005 consisted of capital equipment leased under 

 

8

----

 

various capitallease arrangements, promissory notes under an equipment financing line (describedbelow), and borrowings under a facility loan agreement (described below).  Monthly payments under the capital leaseobligations mature through April 2005.

 

In April 2004,the Company entered into an equipment financing line with an equipmentfinancing company. In August 2004, the amount of this equipment financingline increased from $8.0 million to $11.3 million.  Borrowings under this equipment line can bemade against qualified purchases approved by the equipment financing companythrough August 2005. Such borrowings are to be secured by the qualifiedpurchases and repaid over 36 to 48 months, depending on the nature of theequipment financed.  Interest rates arefixed at the time of each borrowing under the equipment line with such ratesadjusted between borrowings based on the U.S. Federal Reserve’s Three Year andFour Year Treasury Constant Maturity Rates. The loans under this financing lineare subject to acceleration upon the happening of certain customary events ofdefault, including failure to timely pay principal and interest. As of March 31,2005, the Company has approximately $0.8 million available in additionalborrowings under this equipment line. Monthly payments for the amountsoutstanding under the equipment financing line mature through March 2009.

 

In August 2004,the Company entered into a loan agreement with MassDevelopment under which upto $2.0 million of financing is available upon completion by the Company ofcertain tenant improvements to its commercial manufacturing facility in Tewksbury,Massachusetts.  In March 2005, theCompany borrowed $2.0 million under this loan agreement.  Interest accrues under the loan at 5.0% perannum with retroactive adjustments to 9% upon reaching certain defined earninglevels. The repayment of principal and accrued interest will coincide with theterm of the Tewksbury lease which has a five-year, nine-month term with optionsto extend the lease for up to two additional five-year terms. No payments aredue under the loan until April 2007. Unpaid interest during thistwenty-four month period shall be accrued and principal and interest shall berepaid on a monthly basis thereafter such that the total amount outstandingshall fully amortize over the balance of the term in equal installments. Theloan is subject to acceleration upon certain customary events of default,including failure to timely pay principal and interest. The loan is secured bycertain of the tenant improvements made at the Tewksbury facility.

 

Theretroactive interest rate adjustment feature of the MassDevelopment loanagreement was deemed to be an embedded derivative instrument requiring separateaccounting under FASB 133, Accounting for Derivative Instruments and HedgingActivities, and was initially valued at $62,000. The derivative asset will beamortized as interest expense over a term beginning with the loan agreementeffective date and ending with the currently expected payment date of theretroactive interest.  The fair value ofthe derivative liability will be re-measured at each reporting period, with anychange in value charged or credited to interest expense.  There was no change in the estimated fairvalue of the derivative liability at March 31, 2005.

 

**7.****     Deferred Revenue**

 

In July 2004,the Company entered into a collaboration, license and supply agreement withNycomed in which the Company granted Nycomed rights to develop and marketAI-700 in Europe. As part of this agreement, as of March 31, 2005, Nycomedhas paid the Company $4.0 million in license fees and the first three of eightconsecutive quarterly installments of $1.0 million each for the Company’sresearch and development efforts. As of March 31, 2005, the Company hascumulatively recognized $2.6 million in revenue, reflecting an estimated periodof forty-two months over which the $12 million in scheduled payments areexpected to be earned, and $4.4 million of such payments were reported by theCompany as deferred revenue.

 

Duringthe three months ended March 31, 2005, in connection with this agreement,the Company paid fees of $130,000 to an advisor retained in connection with theNycomed collaboration agreement. Additional fees payable to this advisor aredependent upon the timing and magnitude of the amounts paid by Nycomed to theCompany.  The maximum cash amount payableto this advisor in connection with the Nycomed collaboration agreement isapproximately $1.1 million of which $0.5 million has been paid through March 31,2005.

 

**8.****     Stockholders’Equity**

 

On February 24,2005, the Company issued 900,000 shares of 6.5% convertible exchangeablepreferred stock (the “Preferred Stock”) at $50.00 per share resulting in aggregategross proceeds to the Company of $45.0 million (net proceeds of approximately$41.9 million after deducting underwriting discounts and commissions andestimated offering expenses).  Each shareof Preferred Stock has a liquidation preference of $50.00 per share.  Dividends on the Preferred Stock will becumulative from the date of original issue at the annual rate of $3.25 pershare, payable quarterly on the first day of March, June, September, andDecember, commencing on June 1, 2005. Any dividends must be declared by the Company’s board of directors andmust come from funds that are legally 

 

9

----

 

available fordividend payments.  As of March 31,2005, no such dividend was declared. In May 2005, the Company’s board ofdirectors declared a quarterly dividend in the amount of $0.8756 per share ofPreferred Stock, which is scheduled to be paid on June 1, 2005, to theholders of record as of the close of business on May 16, 2005.

 

ThePreferred Stock is convertible into the Company’s common stock at any time atthe option of the holder at a conversion rate of 7.2886 shares of common stockfor each share of Preferred Stock, based on an initial conversion price of$6.86 per share.  The initial conversionprice is subject to adjustment in certain customary events, but is not subjectto “price based” anti-dilution adjustment. The Company has reserved approximately6,559,740 shares of common stock for issuance upon such conversion.  As of March 31, 2005, no holders hadvoluntarily converted shares of Preferred Stock.

 

TheCompany may elect to automatically convert some or all of the Preferred Stock intoshares of common stock if the closing price of the Company’s common stock hasexceeded $10.30 per share (150% of the conversion price) for at least 20trading days during any 30-day trading period, ending within five trading daysprior to notice of automatic conversion.  Prior to March 1, 2009, if the Companyelects to automatically convert, or if any holder elects to voluntarilyconvert, the Preferred Stock, the Company will also make an additional payment(“Make-Whole” payment) equal to the aggregate amount of dividends that wouldhave been payable on the Preferred Stock so converted from the original date ofissuance through and including March 1, 2009, less any dividends alreadypaid on the Preferred Stock.  Thisadditional payment is payable by the Company, at its option, in cash, in additionalshares of its common stock, or in a combination of cash and shares of commonstock.   The Company has reserved amaximum of approximately 2 million shares of common stock for issuance underthis Make-Whole provision.

 

Inaccordance with SFAS 133, the Company is required to separate and account for,as an embedded derivative, the dividend make-whole payment feature of thePreferred Stock offering. As an embedded derivative instrument, the dividendmake-whole payment feature must be measured at fair value and reflected as aliability. Changes in the fair value of the derivative are recognized inearnings as a component of Other Income (Expense). The Company determined thefair value of the dividend make-whole payment feature to be $3.0 million at February 24,2005 (the commitment date). This amount was allocated from the proceeds of thePreferred Stock to the derivative liability. At March 31, 2005, thederivative liability was valued at $2.6 million, resulting in the recognitionof $0.4 million as other income for the three months ending March 31,2005.

 

TheCompany may elect to redeem the Preferred Stock on or after March 6, 2009at declining redemption prices ranging from $51.95 per share to $50.00 pershare.

 

ThePreferred Stock is exchangeable, in whole but not in part, at the option of theCompany on any dividend payment date beginning on March 1, 2006 (the “ExchangeDate”) for the Company’s 6.5% convertible subordinated debentures (“Debentures”)at the rate of $50 principal amount of Debentures for each share of PreferredStock.  The Debentures, if issued, willmature 25 years after the Exchange Date and have terms substantially similar tothose of the Preferred Stock.

 

ThePreferred Stock has no maturity date and no voting rights prior to conversioninto common stock, except under limited circumstances.

 

**9.****     SubsequentEvents**

 

On May11, 2005, the Company signed an amendment to its Watertown, MA facility lease.  The amendment extends the base term of the originallease from an ending date of December 31, 2011 to an ending date of June 30,2012 in return for the landlord providing the Company a tenant improvementallowance of up to $270,000 for certain improvements to the facility.   Theextension of the lease term will result in additional rent payments by theCompany of approximately $1.4 million over the life of the extended lease. Thefacility improvements will be constructed by the landlord and the improvementallowance will be disbursed in accordance with a work letter entered into bythe landlord and the Company on May 11, 2005. All other terms of the original lease remain in full force and effect.

 

On May11, 2005, Acusphere entered into a Patent Transfer Agreement with ScheringAktiengesellschaft (“Schering”) under which the Company acquired all right,title and interest in certain ultrasound-related patents from Schering.  As part of the agreement, Acusphere grantedSchering a non-exclusive, royalty-free, worldwide license to certain of theacquired patents in connection with the sale of Schering’s ultrasound productLevovist®.  Acusphere acquired these patents to expand its intellectual propertyportfolio for ultrasound contrast agents and the use of ultrasound contrastagents generally for drug delivery applications. In consideration of thetransfer and 

 

10

----

 

assignment ofthese patents, the Company agreed to pay Schering a total of $7.0 million, with$1.0 million due in May 2005, $3.0 million due in May 2006, and $3.0 million duein May 2007.

 

11

----

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANAL****YSIS OF FINANCIAL CONDITION AND RESULTS****OFOPERATIONS**

 

**ForwardLooking Statements May Prove Inaccurate**

 

*Statements made in this Form 10-Q,including without limitation, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operation,” contain certain projections,estimates and other forward-looking statements. “Forward-looking statements,”as that term is defined in the Private Securities Litigation Reform Act of1995, are not historical facts and involve a number of risks and uncertainties.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 expressions referencingfuture events, conditions or circumstances) are intended to identifyforward-looking statements.*

 

*Forward-looking statements include,but are not limited to: our plans to develop and market new products and thetiming of these development programs, in particular the timing, size andenrollment of clinical trials and timing of regulatory milestones for AI-700;our clinical development of product candidates, clinical trials and our abilityto obtain and maintain regulatory approval for our product candidates; ourestimates regarding our capital requirements and our needs for additionalfinancing; our estimates of future expenditures for and the timing of ourbuild-out of our commercial manufacturing facility in Tewksbury, Massachusetts;our estimates of expenses and future revenues and profitability; our estimatesof the size of the potential markets for our product candidates; our selectionand licensing 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 build out and qualify acommercial manufacturing facility for AI-700.*

 

*Our actual results and the timing ofcertain events may differ materially from the results discussed, projected,anticipated or indicated in any forward-looking statements. Any forward-lookingstatement should be considered in light of factors discussed in “CertainFactors Which May Affect Future Results” and elsewhere in this report. Wecaution readers not to place undue reliance on any such forward-lookingstatements, which speak only as of the date they are made. We disclaim anyobligation, except as specifically required by law and the rules of theSecurities and Exchange Commission, to publicly update or revise any suchstatements to reflect any change in company expectations or in events,conditions or circumstances on which any such statements may be based, or thatmay affect the likelihood that actual results will differ from those set forthin the forward-looking statements.*

 

*The following discussion should beread in conjunction with our consolidated financial statements and relatednotes thereto included elsewhere in this Form 10-Q.*

 

**Overview**

 

We are a specialty pharmaceutical company thatdevelops new drugs and improved formulations of existing drugs using ourproprietary porous microparticle technology. We are focused on developingproprietary drugs that can offer significant benefits such as improved safetyand efficacy, increased patient compliance, greater ease of use, expandedindications or reduced cost. Our three initial product candidates are designedto address large unmet clinical needs within cardiology, oncology and asthma.Our lead product candidate is a cardiovascular drug in Phase 3 clinicaldevelopment for the detection of coronary heart disease, the leading cause ofdeath in the United States.

 

We created our initial product candidates usingtechnology that enables us to control the size and porosity of particles in aversatile manner, so we can customize the particles to address the deliveryneeds of a variety of drugs. We are focused on creating porous microparticlesthat are smaller than red blood cells. Some of these microparticles arenanoparticles which are smaller than 1 micron. Small microparticles areimportant for delivering drugs intravenously so that they can pass through thebody’s smallest blood vessels, for increasing the surface area of a drug sothat the drug will dissolve more rapidly, and for delivering drugs to the lungvia inhalation. Porosity is important for entrapping gases in microparticles,for controlling the release rate of the drug from a microparticle, and fortargeting inhaled drugs to specific regions of the lung.

 

12

----

 

We have incurred significant operating losses todevelop our product candidates and we anticipate continuing to incursignificant operating losses in the coming years. In particular, we expect toincur significant additional expenses and experience other significant capitalrequirements for the conduct of our Phase 3 clinical program for AI-700 and tocomplete the build-out and qualification of a manufacturing facility for theinitial commercial manufacture of AI-700. Since our inception, we have fundedour operations primarily through private and public placements of equitysecurities, equipment-backed financings and other debt financings.

 

**AI-700 Clinical Trial Update {to beupdated closer to timing of 10-Q release}**

 

The Phase 3 clinical plan provides for a two-partprogram consisting of a pilot phase (the “pilot study”), under which newinvestigators and blinded readers have been qualified and trained, and twomulti-center pivotal trials (the “32” and “33” trials), which together seek toenroll approximately 700 patients with known or suspected coronary heartdisease. The Phase 3 pivotal studies are currently taking place at clinicalsites located in North America, Europe and Australia with data from the trialsintended for submission to U.S., European and potentially other regulatoryauthorities. As of May 11, 2005, over 400 patients have been enrolled in thePhase 3 pivotal trials and over 500 patients have been enrolled in the Phase 3program, including the pivotal trials and the pilot study. We currentlyanticipate completing cumulative enrollment of at least 700 patients in thepivotal trials during the first quarter of 2006.

 

*The Pilot Study.*    Ourobjectives in the pilot study were to train and qualify a sufficient number ofclinical sites, investigators and blinded readers for transition into one ofthe two pivotal trials. These objectives have been accomplished and enrollmentin this trial is completed. Clinical sites trained in the pilot studytransitioned into a pivotal trial when, in our judgment, the clinical sitedemonstrated that it is prepared to meet the requirements of the clinical trialprotocol which, in the pivotal trial requiring nuclear stress tests in allpatients, includes conducting both stress echo and stress nuclear studies onthe same patient on the same day. Because the pilot study has been conductedfor training purposes, there are no defined clinical efficacy endpoints in thisstudy.

 

*The Pivotal Trials.*    Morethan twenty clinical sites are participating in the pivotal trials, and bothtrials are active in enrolling patients. As part of the Phase 3 pivotal studydesign, the evaluation of the stress echo and nuclear stress images from thepivotal trials is performed by panels of blinded readers who receive noinformation about the patient being evaluated other than the images. Safetywill continue to be tested and evaluated during our pivotal trials.

 

*The “32” Trial.*    Allof the patients enrolled in this trial will receive a stress echo study withAI-700 and a nuclear stress test. Patients in this pivotal trial will undergocoronary angiography only if they have a positive nuclear stress test result.Patients in this pivotal trial who have a negative nuclear stress test resultwill be evaluated for ninety days thereafter for cardiac events. The primaryendpoints for this pivotal trial are sensitivity and specificity in comparisonto nuclear stress testing, angiography or clinical outcome.

 

*The “33” Trial.*    Allof the patients enrolled in this trial will receive a stress echo study withAI-700 and will undergo coronary angiography. The majority of patients, but notall, will receive a nuclear stress test. The primary endpoints for this pivotaltrial are sensitivity and specificity in comparison to angiography.

 

Although we are targeting these clinical endpoints andtiming for clinical enrollment in our Phase 3 trials, we cannot assure youthat we will successfully achieve results that meet or exceed these clinicalendpoints or that enrollment will be completed in the first quarter of 2006.

 

**AI-700 Manufacturing Facility Update**

 

In July 2004, we entered into a lease agreementfor 58,000 square feet of commercial manufacturing and office space inTewksbury, Massachusetts.  In September 2004,we began to build-out the manufacturing space of this facility to meet theinitial commercial manufacturing requirements of AI-700.  We intend to demonstrate that we can produceAI-700 at a commercial manufacturing scale prior to our filing of a NDA forAI-700 and, subject to required regulatory approvals, we intend to manufactureAI-700 in this facility for commercial use. We plan to substantially completethe build-out of this facility commencing in 2005 and to complete ourqualification of the facility in 2006. This commercial manufacturing facility must comply with current goodmanufacturing practices, or cGMPs, enforced by the FDA and overseas regulatoryagencies. We have identified potential primary and secondary suppliers of theraw materials used in the production of AI-700.

 

Inaddition to the amounts that we have spent relating to the build-out of thisfacility which, for the period July 2004 through March 31, 2005, totaledapproximately $6.2 million, we estimate that we may spend an additional $18.0million to substantially 

 

13

----

 

complete thisbuild-out in 2005 with the majority of the remaining expenditures scheduled tooccur between April and July 2005. These historical and prospectiveamounts exclude the cost of our manufacturing equipment.  We have entered into an agency procurementagreement with a contractor covering the purchase of equipment in connectionwith the build-out of the Tewksbury facility. As of May 11, 2005, the total estimated value of equipment to bepurchased under this agreement was $4.6 million, of which $0.6 million was paidfor as of March 31, 2005. We have also entered into an engineering andconstruction management services agreement with the same contractor coveringthe provision of engineering, design and construction management servicesthrough the period ending May 15, 2005. As of May 11, 2005, the total value of this contract was $12.9 million.

 

Historically,we have manufactured AI-700, using our manufacturing equipment and involvingour employees, at a manufacturing facility operated by a third-party contractmanufacturer. During the three months ended March 31, 2005, we removed ourequipment from the third-party contract manufacturer’s facilities andtransferred it to the Watertown facility.

 

In August 2004,we entered into a $2.0 million loan agreement with the MassachusettsDevelopment Finance Agency, the economic development authority of the Commonwealthof Massachusetts, to help fund build-out costs related to the Tewksburyfacility. In March 2005, we borrowed $2.0 million under this loanagreement.

 

**FinancialOperations Overview**

 

*Revenue.*    Wehave not generated any revenue from product sales since our inception. Inconnection with our collaboration agreement with Nycomed, as of March 31,2005 we have received $7 million in license fees and research anddevelopment payments and we anticipate receiving an additional $5 million insuch research and development payments in quarterly installments of $1 millionthrough June 2006. We are recognizing this $12.0 million of initiallicense and research and development payments over an estimated recognition periodof forty-two months over which we are obligated to perform services supportingthe agreement. Further in the future, we will seek to generate revenue from acombination of product sales, up-front or milestone payments and manufacturingpayments in connection with collaborative or strategic relationships, androyalties resulting from the license of our products and intellectual property.Upon commencement of our collaboration agreement with Nycomed, we emerged from thedevelopment stage for accounting purposes.

 

*Research and Development Expense.*    Researchand development expense consists of expenses incurred in developing,manufacturing and testing product candidates. These expenses consist primarilyof salaries and related expenses for personnel, fees paid to professionalservice providers in conjunction with independently monitoring our clinicaltrials and acquiring and evaluating data in conjunction with our clinicaltrials, costs of contract manufacturing services, costs of materials used inclinical trials and research and development, depreciation of capital resourcesused to develop our products, costs of facilities, the legal costs of pursuingpatent 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.

 

*General and 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.

 

*Interest Income.*    Interestincome consists of interest earned on our cash and cash equivalents.

 

*Interest Expense.*   Interest expense consists of interest incurred on equipment leases and otherfinancing arrangements.  Interest expensealso includes interest recognized in connection with embedded derivatives.

 

*Change in Valuation of Derivative.*   Change in valuation of derivative consists of other income (expense) recognizedon the change in fair value of the derivative at the end of each reportingperiod.

 

*Stock-Based Compensation Expense.*    Includedwithin research and development expenses and general and administrativeexpenses is stock-based compensation expense. Stock-based compensation expense,which is a non-cash charge, results principally from stock option grants to ouremployees at exercise prices deemed for accounting purposes to be below thefair market value of our stock on the date the stock options were granted (“fixedawards”). Prior to our initial public offering, which closed on October 14,

 

14

----

 

2003, we granted certain stock options for which the exercise priceswere deemed for accounting purposes to be below the fair value of theunderlying common stock resulting in our recording stock-based compensationexpense associated with such grants. Stock-based compensation expense is alsorecorded for stock option grants to non-employees and for restricted stockgrants provided to directors and advisors in lieu of cash compensation.Deferred compensation (for accounting purposes) on fixed awards is amortized asa charge to operations over the vesting periods of the options and grants,subject to adjustment for forfeiture during the vesting period.

 

**Resultsof Operations**

 

*ThreeMonths Ended March 31, 2005 and 2004*

 

*Revenue.*    Collaborationrevenue was $0.9 million in the three months ended March 31, 2005compared to no collaboration revenue recognized in the three months ended March 31,2004. Collaboration revenue was earned under our agreement with Nycomed whichwas entered into in July 2004. Under this agreement, excluding anypayments that we might receive based upon the achievement of specifiedmilestones, we are scheduled to receive $12 million in license fees andresearch and development payments through June 2006, of which $7.0 millionwas received through March 31, 2005. We are recognizing revenue associatedwith these payments ratably over a period of forty-two months, representing theestimated development period over which such fees are earned.

 

*Research and Development Expense.*    Researchand development expense increased $2.1 million, or 37%, to $7.7 million in thethree months ended March 31, 2005 from $5.6 million in the three monthsended March 31, 2004.  The increasein research and development expense primarily resulted from increased activitiesin our AI-700 Phase 3 clinical program.

 

The following table summarizes the primary componentsof our research and development expense for the three months ended March 31,2005 and 2004:

 

| ** **                             | ** ** | **Three Months Ended**   | ** ** |
|----------------------------------------|------------|--------------------------|------------|
| ** **                             | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
| ** **                             | ** ** | **(in thousands)**       | ** ** |
| Total direct costs                     |       | $                        | 5,846      |   | $ | 4,255 |   |
|                                   |       |                     |       |   |   |
| Indirect costs:                        |       |                     |       |   |   |
| Facility costs                         |       | 1,056                    |       | 786 |   |
| Depreciation                           |       | 499                      |       | 300 |   |
| Stock-based  compensation              |       | 58                       |       | 90 |   |
| All other indirect  costs              |       | 219                      |       | 172 |   |
| Total indirect costs                   |       | 1,832                    |       | 1,348 |   |
| Total research and development expense |       | $                        | 7,678      |   | $ | 5,603 |   |

 

*Late Stage Clinical Development Program*.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our late stage clinical develop program relates to our leadproduct candidate, AI-700, which is a cardiovascular drug for the detection ofcoronary heart disease. Almost all of our direct research and development expendituresfor the three months ended March 31, 2005 and 2004 related to our AI-700program. The increase in direct research and development costs in the threemonths ended March 31, 2005 compared to the same period in 2004 reflects ahigher number of clinical sites enrolling patients in the AI-700 Phase 3 clinicalprogram, a higher rate of patient enrollment in these clinical trials andrelated increases in costs for clinical data management and independentclinical site monitoring. Patient enrollment and related costs are anticipated tovary from quarter to quarter but are generally anticipated to be higher in 2005than in 2004.  The increase in researchand development costs also includes costs associated with increasing full andpart-time personnel.

 

We have historically outsourced the production ofAI-700 used in our clinical trials to qualified third parties. For example, weproduced the clinical trial materials to be used in our Phase 3 clinical trialsfor AI-700 at Hollister-Stier Laboratories with the involvement of ourmanufacturing personnel.  In July 2004, we entered into a leaseagreement for 58,000 square feet of commercial manufacturing and office spacein Tewksbury, Massachusetts.  In September 2004,we began to build-out the manufacturing space of this facility for commercialmanufacturing of AI-700. We intend to demonstrate that we can produce AI-700 ata commercial 

 

15

----

 

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.  Theincrease in research and development costs in the three months ended March 31,2005 compared to the same period in 2004 reflects operating costs associatedwith our Tewksbury, MA facility and increased depreciation expense due tocapital purchases primarily relating to our manufacturing operations.  During 2005, we anticipate incurringincreased costs associated with the build-out of our new commercialmanufacturing space, including rent and other facility costs, the purchase ofraw materials and laboratory supplies, the increased use of consultants, and thehiring of additional research and development personnel.

 

*Early Stage Clinical Development Programs*.  Our initial clinical applications of our HDDStechnology, AI-850, and our PDDS technology, AI-128, have completed a Phase 1trial. Until we are closer to commercialization of AI-700 or until we enterinto an agreement with a strategic collaborator to help us fund HDDS or PDDSrelated product development, we anticipate spending less than $1 million peryear on HDDS and PDDS product development.

 

Each of our research and development programs issubject to risks and uncertainties, including the requirement to seekregulatory approvals, which are outside of our control. For example, ourclinical trials may be subject to delays or rejections based on changes in thesize of the trials to meet statistical requirements, our inability to enrollpatients at the rate that we expect or our inability to produce clinical trialmaterial in sufficient quantities and of sufficient quality to meet the schedule forour planned clinical trials. Moreover, the product candidates identified inthese research and development programs, particularly our early stage programs,must overcome significant technological, manufacturing and marketing challengesbefore they can be successfully commercialized. As a result of these risks anduncertainties, we are unable to predict with any certainty the period in whichmaterial net cash inflows from such projects could be expected to commence orthe completion date of these programs. Failure to commercialize these productcandidates on a timely basis could have a material adverse affect on ourbusiness, financial condition and results of operations. We may seek toestablish collaborative relationships to help us commercialize these productcandidates, but there can be no assurance that we will be successful in doingso.

 

*General and Administrative Expense.*    Generaland administrative expense increased $0.3 million, or 24%, to $1.7 million forthe three months ended March 31, 2005 from $1.4 million in the threemonths ended March 31, 2004.  Theincrease in general and administrative expense was principally due to additionalpersonnel, including the increased use of consultants in business development activities.

 

We anticipate some overall increase in general andadministrative expense during 2005, including increases in costs for investorrelations and other activities. These increases will also likely include thehiring of additional personnel. We intend to continue to incur various internaland external business development costs to support our various productdevelopment efforts, and certain of these expenses are likely to increaseoverall.

 

*Interest Income.*    Interestincome increased $0.2 million, or 181%, to $0.3 million in the three monthsended March 31, 2005 from $0.1 million in the three months ended March 31,2004.  The increase in interest income was primarily due to higher averagefund balances available for investment resulting from the $45.0 millionPreferred Stock financing in February 2005 and the $21.5 millionprivate placement completed in October 2004.

 

*Interest Expense.*    Interestexpense increased $115,000, or 454%, to $140,000 in the three months ended March 31,2005 from $25,000 in the three months ended March 31, 2004.   The increase in interest expense was primarilyrelated to cumulative borrowings of approximately $10.5 million through March 31,2005under our equipment financing line which we entered into in April 2004.

 

*Change in Valuation of Derivative.*    Changein valuation of derivative increased to $434,000 in the three months ended March 31,2005 from zero in the three months ended March 31, 2004. The increase in changein valuation of derivative was related to the embedded derivative instrumentfrom the dividend make-whole payment feature of the Preferred Stock offeringthat closed in February 2005. We determined the fair value of the dividendmake-whole payment feature to be $3.0 million at February 24, 2005 (thecommitment date).

 

**Liquidity and Capital Resources**

 

Historically, aside from payments received inconnection with our strategic collaboration with Nycomed, we have financed ourbusiness through the issuance of equity securities, debt financings andequipment leases. Our liquidity requirements have arisen primarily fromresearch and development expenditures, equipment expenditures and payments onoutstanding indebtedness. As of March 31, 2005, we had cash and cashequivalents of $79.8 million. As of March 31, 2005 we owed $12.2 millionin notes payable 

 

16

----

 

and had commitments totaling $19.3 million for rent under ourfacility leases, including the lease agreement signed in July 2004 forcommercial manufacturing space in Tewksbury, Massachusetts.

 

During the three months ended March 31, 2005,operating activities used $9.5 million of cash. Net cash used by operatingactivities during this period resulted primarily from a net loss of $8.0 million,a decrease in accounts payable of $1.7 million, non-cash amortization ofdeferred revenue of $0.9 million and an increase in other current assets of$0.7 million.  These uses of cash werepartially offset by an increase in deferred revenue of $1.0 million, anincrease in accrued expenses of $0.3 million, non-cash charges for depreciationand amortization of $0.5 million and non-cash charges for stock-basedcompensation expense of $0.2 million.  We anticipate that our operating spending willbe higher in 2005 than in 2004 due to an estimated higher rate of patientenrollment in our Phase 3 clinical program and higher costs in connectionwith the build-out of our manufacturing facility.  We estimate that our net cash used byoperations during 2005 will be approximately $8 to $10 million per quarter**.**

 

During the three months ended March 31, 2005,investing activities used $6.4 million in cash. This use of cash was primarilyfor purchases of equipment and costs incurred through March 31, 2005 forthe build-out and expansion of our manufacturing operations for AI-700.

 

During the three months ended March 31, 2005,financing activities provided $50.5 million in cash. Net cash provided byfinancing activities during this period resulted primarily from net proceeds inconnection with the sale of our convertible exchangeable Preferred Stock of $41.9 million,entering into promissory notes under the equipment financing line of $7.0 million,and borrowings of $2.0 million under a loan agreement with MassDevelopment.These proceeds were partially offset by payments on the capital leases andpromissory notes of $0.5 million.

 

In August 2004,we entered into a loan agreement with MassDevelopment under which up to $2.0million of financing is available upon completion by us of certain tenantimprovements to our commercial manufacturing facility in Tewksbury,Massachusetts.  In March 2005, weborrowed $2.0 million under this loan agreement.  Interest accrues under the loan at 5.0% perannum with retroactive adjustments to 9% upon reaching certain defined earninglevels. The repayment of principal and accrued interest will coincide with theterm of the Tewksbury lease which has a five-year, nine-month term with optionsto extend the lease for up to two additional five-year terms. No payments aredue under the loan for the first twenty-four months. Unpaid interest duringthis twenty-four month period shall be accrued and principal and interest shallbe repaid on a monthly basis thereafter such that the total amount outstandingshall fully amortize over the balance of the term in equal installments. Theloan is subject to acceleration upon certain customary events of default,including failure to timely pay principal and interest. The loan is secured bycertain of the tenant improvements made at the Tewksbury facility.

 

On February 24,2005, we issued 900,000 shares of 6.5% convertible exchangeable preferred stock,or Preferred Stock, at $50.00 per share resulting in aggregate gross proceedsto us of $45.0 million (net proceeds of approximately $41.9 million afterdeducting underwriting discounts and commissions and estimated offeringexpenses).  Each share of Preferred Stockhas a liquidation preference of $50.00 per share.  Dividends on the Preferred Stock will becumulative from the date of original issue at the annual rate of $3.25 pershare, payable quarterly on the first day of March, June, September, andDecember, commencing on June 1, 2005. Any dividends must be declared by our board of directors and must comefrom funds that are legally available for dividend payments.

 

ThePreferred Stock is convertible into shares of our common stock at any time atthe option of the holder at a conversion rate of 7.2886 shares of common stockfor each share of Preferred Stock, based on an initial conversion price of$6.86 per share.  The initial conversionprice is subject to adjustment upon certain customary events, but is notsubject to “price based” anti-dilution adjustment. We reserved approximately 6,559,740shares of common stock for issuance upon conversion.  As of March 31, 2005, no holders hadvoluntarily converted shares of Preferred Stock.  In May 2005, our board of directors declareda quarterly dividend in the amount of $0.8756 per share of Preferred Stock,which is scheduled to be paid on June 1, 2005, to the holders of record asof the close of business on May 16, 2005.

 

We mayelect to automatically convert some or all of the Preferred Stock into sharesof our common stock if the closing price of our common stock has exceeded$10.30 per share (150% of the conversion price) for at least 20 trading daysduring any 30-day trading period, ending within five trading days prior tonotice of automatic conversion.  Prior toMarch 1, 2009, if we elect to automatically convert, or if any holderelects to voluntarily convert, the Preferred Stock, we will also make anadditional payment, the Make-Whole payment, equal to the aggregate amount ofdividends that would have been payable on the Preferred Stock so converted fromthe original date of issuance through and including March 1, 2009, lessany dividends already paid on the Preferred Stock.  This additional payment is payable by us, atour option, in cash, in additional shares of its common stock, or in a combinationof cash and shares of common stock.   Wehave reserved a maximum of approximately 2 million shares of common stock forissuance under this Make-Whole provision.

 

17

----

 

Inaccordance with SFAS 133, the Company is required to separate and account, for,as an embedded derivative, the dividend make-whole payment feature of thePreferred Stock offering. As an embedded derivative instrument, the dividendmake-whole payment feature must be measured at fair value and reflected as aliability. Changes in the fair value of the derivative are recognized inearnings as a component of Other Income(Expense). The Company determined thefair value of the dividend make-whole payment feature to be $3.0 million at February 24,2005 (the commitment date). This amount was allocated from the proceeds of thePreferred Stock to the derivative liability. At March 31, 2005, thederivative liability was valued at $2.6 million, resulting in the recognitionof $0.4 million as other income for the three months ending March 31,2005.

 

We mayelect to redeem the Preferred Stock on or after March 6, 2009 at decliningredemption prices ranging from $51.95 per share to $50.00 per share.

 

ThePreferred Stock is exchangeable, in whole but not in part, at our option on anydividend payment date beginning on March 1, 2006 (the “Exchange Date”) forour 6.5% convertible subordinated debentures (“Debentures”) at the rate of $50principal amount of Debentures for each share of Preferred Stock.  The Debentures, if issued, will mature 25years after the Exchange Date and have terms substantially similar to those ofthe Preferred Stock.

 

ThePreferred Stock has no maturity date and no voting rights prior to conversioninto common stock, except under limited circumstances.

 

On May11, 2005, we entered into a Patent Transfer Agreement with ScheringAktiengesellschaft (“Schering”) under which we acquired all right, title andinterest in certain ultrasound-related patents from Schering.  In consideration of the transfer andassignment of these patents, we agreed to pay Schering a total of $7.0 million,with $1.0 million due in May 2005, $3.0 million due in May 2006, and $3.0million due in May 2007.

 

We believe, based on our operating plans, that ourexisting resources, including scheduled proceeds from Nycomed, will be adequateto fund our planned operations, including increases in spending for our AI-700Phase 3 clinical program, for at least the next twelve months.  In the future, we will require significantadditional funds to develop, conduct clinical trials, achieve regulatoryapprovals, build-out and qualify commercial manufacturing space and, subject toregulatory approval, commercially launch AI-700, our other product candidatesunder development and future product candidates. Our future capitalrequirements will depend on many factors, including the scope and progress madein our research and development activities and our clinical trials and the sizeand timing of creating expanded manufacturing capabilities. We may also needadditional funds for possible future strategic acquisitions of businesses,products or technologies complementary to our business. We do not expect togenerate significant revenues for AI-700, other than possible license or milestonepayments, unless or until we or current or potential partners complete clinicaltrials and receive marketing approval from the applicable regulatoryauthorities. When additional funds are required or, in advance of suchrequirements, when we anticipate that funds will be needed, we may raise suchfunds 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 dilutiveto our stockholders and debt financing, if available, may involve significantcash payment obligations and covenants that restrict our ability to operate asa business.

 

**Universal Shelf RegistrationStatement**

 

On April 5, 2005, we filed with the Securitiesand Exchange Commission a “universal shelf” registration statement onForm S-3 (Registration No. 333-121618) which, when combined with ourpreviously filed universal shelf registration statement on Form S-3, providesfor the offer, from time to time, of common stock, preferred stock, debtsecurities and warrants up to an aggregate of $100.0 million. On April 15,2005, the SEC declared the shelf registration statement effective. As of thefiling of this report, the shelf registration statement remains effective and,subject to market conditions and our capital needs, we may again seek to useany remaining availability under the shelf registration statement by making anoffering of securities covered for sale under the registration statement. Inaddition, we may amend our shelf registration statement or file a newshelf registration statement to increase our potential access to capital. If weelect to raise additional capital using a shelf registration statement, we mayuse the net proceeds from the sale of these securities for general corporatepurposes, which may include funding clinical trials, research and development,regulatory activities and the build-out of our commercial manufacturingfacility in Tewksbury, Massachusetts, acquisitions, including acquisitions ofcompanies, products, intellectual property or other technology, repayment orrefinancing of existing indebtedness, 

 

18

----

 

investments, capital expenditures, repurchase of our capital stock andfor any other purposes that we may specify in any prospectus supplement.

 

**Off-Balance Sheet FinancingArrangements**

 

We currently do not have any special purpose entitiesor off-balance sheet financing arrangements other than operating leases.

 

**Contractual Obligations**

 

The following table summarizes our contractual obligationsas of March 31, 2005 and the effect such obligations are expected to haveon our liquidity and cash flow in future periods:

 

**Payments Due by Period**

 
| **Contractual Obligations**                     | ** ** | **Total  Obligations  All Years** | ** ** | **2005  Through  2006** | ** ** | **2007  Through  2008** | ** ** | **2009  Through  2010** | ** ** | **After 2010** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|----------------|------------|
| ** **                                      | ** ** | **(in thousands)**                | ** ** |
| Capital lease  obligations (including interest) |       | $                                 | 16         |                    | $          | 16                      |       | $                       | —     |           | $          | — |   | $ | — |   |
| Operating lease  obligations                    |       | 19,347                            |       | 4,684                   |       | 5,911                   |       | 6,022                   |       | 2,730          |       |
| Notes payable  (including interest)             |       | 14,540                            |       | 5,667                   |       | 7,065                   |       | 1,808                   |       | —         |       |
| Purchase orders for  capital equipment          |       | 4,821                             |       | 4,821                   |       | —                  |       | —                  |       | —         |       |
| Purchase orders for  leasehold improvements     |       | 2,215                             |       | 2,215                   |       | —                  |       | —                  |       | —         |       |
| Total contractual cash  obligations             |       | $                                 | 40,939     |                    | $          | 17,403                  |       | $                       | 12,976     |           | $          | 7,830 |   | $ | 2,730 |   |

 

Our operating lease obligations relate to our facilityleases.

 

A substantial portion of the purchase orders forcapital equipment and leasehold improvements in the table above is needed forexpanded manufacturing of AI-700.  As of March 31,2005, we had outstanding purchase orders for capital equipment which totalapproximately $6.5 million. Against these purchase orders we have paidapproximately $1.7 million in deposits. The table above reflects theremaining amounts due on these purchase orders. In 2005, we anticipateexpenditures for equipment purchases totaling approximately $4.3 millionin excess of the above reflected amounts. On November 11, 2004, we entered into an engineering andconstruction management services agreement with a contractor to perform on ourbehalf, engineering, design and construction management services in connectionwith the build-out of the commercial manufacturing facility in Tewksbury,Massachusetts. The total estimated value of this cost plus percentage fee typecontract, as amended on April 29, 2005, is $12.9 million.  As of March 31, 2005, we had outstandingpurchase orders for leasehold improvements related to this contract which totalapproximately $8.4 million. Against these purchase orders we have paidapproximately $6.2 million in deposits. The table above reflects theremaining amounts due on these purchase orders.  We expect that the build-out of thiscommercial manufacturing facility will be substantially completed in 2005 andthat our total payments for substantially completing this build-out, excludingequipment purchases, will be approximately $18.0 million in excess of theamounts that we have already paid through March 31, 2005.

 

The above table does not include obligations fromagreements we entered into after March 31, 2005.

 

**Critical Accounting Policies andEstimates**

 

Our discussion and analysis of our financial conditionand results of operations are based on our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities and expenses. On an on-going basis, we evaluate ourestimates and judgments, including those related to accrued expenses, fairvaluation of stock related to stock-based compensation and income taxes. Webased our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

 

19

----

 

We believe the following critical accounting policiesaffect our more significant judgments and estimates used in the preparation ofour consolidated financial statements.

 

*Revenue.*   We recognize revenue from licensearrangements in accordance with Staff Accounting Bulletin No. 104, RevenueRecognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”).We recognize revenue from license payments not tied to achieving a specificperformance milestone ratably over the period over which we are obligated toperform services. The period over which we are obligated to perform services isestimated based on available facts and circumstances. We recognize revenue fromperformance payments, when such performance is substantially in our control andwhen we believe that completion of such performance is reasonably probable,ratably over the period over which we estimate that we will perform suchperformance obligations. Substantive at-risk milestone payments, which arebased on achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably 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 inadvance of being recognized as revenue are deferred.

 

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-two months over which we are obligated to performservices supporting the agreement.  Thisestimated recognition period may change if available facts and circumstanceschange.  A change in this estimate couldresult in a significant change to the amount of revenue recognized in futureperiods.  In addition, if the Nycomedcollaboration agreement is terminated for reasons other than certain non-performanceby us, we would recognize the remainder of the payments we have received orotherwise expect to collect over the amortization period at the time oftermination. We will not recognize revenue associated with the potential $58million in milestone-based payments that may be earned under the Nycomedagreement until the underlying regulatory and sales milestones are achieved.

 

*Accrued Expenses.*    Aspart of the process of preparing consolidated financial statements we arerequired to estimate accrued expenses. This process involves identifyingservices which have been performed on our behalf and estimating the level ofservice performed and the associated cost incurred for such service as of eachbalance sheet date in our consolidated financial statements. Examples ofestimated expenses for which we accrue include professional service fees, suchas lawyers and accountants, and contract service fees such as amounts paid toclinical monitors, data management organizations and investigators inconjunction with clinical trials, and fees paid to contract manufacturers inconjunction with the production of clinical materials. In connection with suchservice fees, our estimates are most affected by our understanding of thestatus and timing of services provided relative to the actual levels ofservices incurred by such service providers. The majority of our serviceproviders invoice us monthly in arrears for services performed. In the eventthat we do not identify certain costs which have begun to be incurred or weunder- or over-estimate the level of services performed or the costs of suchservices, our reported expenses for such period would be too low or too high.The date on which certain services commence, the level of services performed onor before a given date and the cost of such services are often judgmental. Wemake these judgments based upon the facts and circumstances known to us inaccordance with generally accepted accounting principles.

 

*Stock-Based Compensation and OtherEquity Instruments.*    We have elected tofollow APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations, inaccounting for our stock-based compensation plans, rather than the alternativefair value accounting method provided for under SFAS No. 123, *Accounting for Stock-Based Compensation*.Accordingly, we have not recorded stock-based compensation expense for stockoptions issued to employees in fixed amounts with exercise prices at leastequal to the fair value of the underlying common stock on the date of grant. Inthe notes to our consolidated financial statements we provide pro formadisclosures in accordance with SFAS No. 123 and related pronouncements. Weaccount for transactions in which services are received in exchange for equityinstruments based on the fair value of such services received fromnon-employees or of the equity instruments issued, whichever is more reliablymeasured, in accordance with SFAS No. 123 and EITF Issue No. 96-18, *Accounting for Equity Instruments that Are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*. We account for transactions in which we grant warrants inconnection with the issuance of debt in accordance with APB 14, *Accounting for Convertible Debt and Debt Issued withStock Purchase Warrants*. The two factors which most affect chargesor credits to operations related to stock-based compensation are the fair valueof the common stock underlying stock options for which stock-based compensationis recorded and the volatility of such fair value.

 

20

----

 

 

Accounting for equity instruments granted or sold byus under APB No. 14, APB No. 25, SFAS No. 123 and EITFNo. 96-18 requires fair value estimates of the equity instrument grantedor sold. If our estimates of the fair value of these equity instruments are toohigh or too low, it would have the effect of overstating or understatingexpenses. When equity instruments are granted or sold in exchange for thereceipt of goods or services and the value of those goods or services can bereadily estimated, we use the value of such goods or services to determine thefair value of the equity instruments. When equity instruments are granted orsold in exchange for the receipt of goods or services and the value of thosegoods or services can not be readily estimated, as is true in connection withmost stock options and warrants granted to employees or non-employees, weestimated the fair value of the equity instruments based upon consideration offactors which we deemed to be relevant at the time using cost, market and/orincome approaches to such valuations. Because shares of our common stock werenot publicly traded prior to our initial public offering in October 2003,market factors historically considered in valuing stock and stock option grantsinclude comparative values of public companies discounted for the risk andlimited liquidity provided for in the shares we are issuing, pricing of privatesales of our convertible preferred stock, prior valuations of stock grants andthe effect of events that have occurred between the time of such grants,economic trends, perspective provided by investment banks and the comparativerights and preferences of the security being granted compared to the rights andpreferences of our other outstanding equity.

 

*Derivative Liability.*    Theterms of our February 2005 convertible preferred stock offering include adividend make-whole payment feature. This feature is considered to be anembedded derivative and is recorded at fair value in accordance with SFAS No.133, *Accounting for Derivative Instruments*. Ifour estimates of the fair value of this derivative are too high or too low, itwould have the effect of understating or overstating our net loss.  The derivative liability is reduced formake-whole payments triggered upon conversion of the preferred stock as well asdividends declared by the Company, if any, on the convertible preferred stock.The changes in the fair value of the derivative financial instrument areincluded in other income (expense) in each reporting period.

 

*Income Taxes.*    Aspart of the process of preparing our consolidated financial statements we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. This process involves us estimating our actual current tax exposuretogether with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. In addition, as of December 31,2004, we had federal tax net operating loss carryforwards of$84.0 million, which expire through 2024. We also have research anddevelopment credit carryforwards of $5.3 million. We have recorded avaluation allowance to fully offset against these otherwise recognizable netdeferred tax assets due to the uncertainty surrounding the timing of therealization of the tax benefit. In the event that we determine in the futurethat we will be able to realize all or a portion of its net deferred taxbenefit, an adjustment to deferred tax valuation allowance would increase netincome in the period in which such a determination is made. The Tax Reform Actof 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.

 

**CertainFactors Which May Affect Future Results**

 

*Ouroperating results and financial condition have varied in the past and**may in the future vary significantly depending on anumber of factors. Except**for the historicalinformation in this report, the matters contained in this**report include forward-looking statements that involve risks anduncertainties.**The following factors,among others, could cause actual results to differ**materially from those contained in forward-looking statements made inthis**report and presented elsewhere by managementfrom time to time. Such factors,**among others, may have amaterial adverse effect upon our business, results of**operations and financial condition.*

 

**Risks Relatedto Our Company**

 

***We have notgenerated any product revenue to date, and we may not achieve profitability forsome time, if at all.***

 

We are focused on product development and we have notgenerated any revenue from commercial sales of our products to date. We haveincurred losses each year of our operations and we expect to continue to incuroperating losses for the next several years. The process of developing ourproducts requires significant clinical, development and laboratory testing andclinical trials as well as regulatory approvals. In addition, commercializationof our product candidates will require us to establish sales, marketing andmanufacturing capabilities, either through internal hiring or throughcontractual relationships with others. We expect our research and developmentand general and administrative expenses will increase over the next severalyears.

 

21

----

 

***If we fail toobtain regulatory approvals for our product candidates under development, andin particular our lead product candidate AI-700, we will not be able togenerate revenues from the commercialization or sale of our product candidates.***

 

We must receive regulatory approval of each of ourproduct candidates before we can commercialize or sell that product candidate.The pre-clinical laboratory testing, formulation development, manufacturing andclinical trials of any product candidates we develop independently or incollaboration with third parties, as well as the distribution and marketing ofthese product candidates, are regulated by numerous federal, state and localgovernmental authorities in the United States, principally the FDA, and bysimilar agencies in other countries. The development and regulatory approvalprocess takes many years, requires the expenditure of substantial resources, isuncertain and subject to delays, and will thus delay our receipt of revenues,if any, from any of our product candidates. We cannot assure you that ourclinical trials will demonstrate the safety and efficacy of any of our productcandidates or will result in marketable products.

 

No product can receive FDA approval unless humanclinical trials show both safety and efficacy for each target indication inaccordance with FDA standards. A number of companies in the pharmaceutical andbiotechnology industries have suffered significant setbacks in late stageclinical trials even after achieving promising results in early stagedevelopment. We therefore cannot assure you that the results from our Phase 2clinical trials for AI-700 will be predictive of results obtained in our Phase3 clinical trials. Many of the patients in our AI-700 clinical trial havecoronary heart disease. As part of our AI-700 Phase 3 clinical trials, patientswill be exposed to potential safety risks associated with a stress test,including risks associated with a pharmacological stressor, and AI-700. Giventhe nature of the AI-700 Phase 3 clinical trial, including administering AI-700to larger numbers of at-risk patients and new clinical sites, adverse eventsare expected to be encountered during the clinical trial. Adverse events arealso likely to be encountered in clinical trials for our other products, whichclinical trials also include at-risk patients. If significant adverse eventsare detected and these events are attributable to our products, such eventscould delay, limit or prevent regulatory agency approval. Further, dataobtained from 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 concerns 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 may also encounter delays or rejections based onour inability to enroll enough patients to complete our clinical trials. We mayalso encounter delays, resulting from the need to enroll more patients than wecurrently plan for in our clinical trials, based on our inability to enroll amix of patients that is consistent with our estimated clinical trial enrollmentor a change in the sample size required to meet the study endpoints. Patientenrollment depends on many factors, including the size of the patientpopulation, the nature of the protocol, the proximity of patients to clinicalsites, and the eligibility criteria for the study and the freedom to operatewith respect to intellectual property. Delays in planned patient enrollment, orthe need to enroll more patients, may result in increased costs and delays,which could have a harmful effect on our ability to develop products. We mayencounter delays or rejections based on changes in regulatory agency policiesduring the period in which we develop a drug or the period required for reviewof any application for regulatory agency approval of a particular compound. OnMay 1, 2004, changes went into effect in the regulation of clinical trialsin Europe. Our continuing compliance with these changes could lead to delays toour clinical trials. We also may encounter delays in the event we are unable toproduce clinical trial material in sufficient quantities and of sufficientquality to meet the schedule for our planned clinical trials. In addition,we rely on a number of third parties, such as clinical research organizations,to help support the clinical trials by performing independent clinicalmonitoring, data acquisition and data evaluations. Any failure on the part ofthese third parties could delay the regulatory approval process.

 

Failure to obtain regulatory approval or any delay orsetback in obtaining regulatory agency approvals could:

 

**•***                                         *adverselyaffect our ability to market any drugs we develop independently or withcollaborative partners;

 

**•***                                         *imposeadditional costs and diminish any competitive advantages that we may attain; or

 

**•***                                         *adverselyaffect our ability to generate royalties.

 

In particular, failure to obtain approval or substantial delays in obtainingapproval for our lead product candidate, AI-700, would delay our receipt ofproduct revenues and materially adversely affect our business, financialcondition and results of operations.

 

We cannot be certain that we will obtain anyregulatory approvals in other countries and the failure to obtain theseapprovals may materially adversely affect our business, financial condition andresults of operations. In order to market our products outside of the 

 

22

----

 

United States, we and our current, and potential future, collaborativepartners must establish and comply with numerous and varying regulatoryrequirements of other countries regarding safety and efficacy. The approvalprocedures vary among countries and can involve additional product testing andadditional administrative review periods. The time required to obtain approvalin other countries might differ from that required to obtain FDA approval. Theregulatory approval process in other countries may include all of the risksassociated with obtaining FDA approval detailed above. Approval by the FDA doesnot ensure approval by the regulatory authorities of other countries. Inaddition, many countries outside the United States require a separate review processprior to marketing to determine whether their national health insurance schemewill pay for newly approved products, as well as the price which may be chargedfor a product.

 

***Our products, ifapproved, may fail to achieve market acceptance.***

 

There can be no assurance that any products wesuccessfully develop, if approved for marketing, will achieve market acceptanceor generate significant revenues. Each of our product candidates is intended toreplace or alter existing therapies or procedures, and hospitals, physicians orpatients may conclude that these products are less safe or effective orotherwise less attractive than these existing therapies or procedures. Forexample, our lead product candidate, AI-700, is a contrast agent for use inultrasound imaging procedures which will compete with existing nuclear imagingand stress echocardiography. Hospitals, physicians or patients may prefer theseexisting procedures to AI-700 enhanced ultrasound imaging. If our products donot receive market acceptance for any reason, it would adversely affect ourbusiness, financial condition and results of operations.

 

Further, our competitors may develop new technologiesor products that are more effective or less costly, or that seem morecost-effective, than our products. We can give no assurance that hospitals,physicians, patients or the medical community in general will accept and useany products that we may develop.

 

***If we cannot raiseadditional capital on acceptable terms, we may be unable to complete plannedclinical trials, obtain regulatory approvals or commercialize our productcandidates.***

 

We will require substantial future capital in order tocontinue to conduct the research and development, clinical and regulatoryactivities necessary to bring our product candidates to market and to establishcommercial manufacturing, marketing and sales capabilities. Our future capitalrequirements will depend on many factors, including:

 

**•***                                         *theprogress of pre-clinical development and laboratory testing and clinical trials;

 

**•***                                         *thetiming of construction and size to which we expand our manufacturingcapabilities;

 

**•***                                         *thetime and costs involved in obtaining regulatory approvals;

 

**•***                                         *thenumber of product candidates we pursue;

 

**•***                                         *thecosts involved in filing and prosecuting patent applications and enforcing ordefending patent claims; and

 

**•***                                         *theestablishment of selected strategic alliances and activities required forproduct commercialization.

 

We intend to seek additional funding through strategiccollaborations and may seek funding through private or public sales of oursecurities or by licensing all or a portion of our technology. This funding maysignificantly dilute existing stockholders or may limit our rights to ourtechnology.

 

We cannot assure you that we can obtain additionalfunding on reasonable terms, or at all. If we raise additional funds by issuingequity securities, our stock price may decline, our existing stockholders mayexperience significant dilution, and the newly issued securities may haverights superior to those of our common stock. If we raise additional funds byissuing debt, we may be subject to 

 

23

----

 

limitations on our operations and such debt may have rights senior tothe debentures, if issued. If we cannot obtain adequate funds, we may:

 

**•***                                         *terminateor delay clinical trials for one or more of our product candidates;

 

**•***                                         *delayour establishment of sales, marketing and/or manufacturing capabilities;

 

**•***                                         *curtailsignificant product development programs that are designed to identify newproduct candidates;

 

**•***                                         *relinquishrights to our technologies or product candidates; and/or

 

**•***                                         *terminateor delay build-out and commissioning of our commercial manufacturing facility.

 

***Claims by othercompanies that we infringe their proprietary technology may result in liabilityfor damages or stop our development and commercialization efforts.***

 

Competitors and other third parties may initiatepatent litigation against us in the United States or in foreign countries basedon existing patents or patents that may be granted in the future. Many of ourcompetitors have obtained patents covering products and processes generallyrelated to our products and processes, and they may assert these patentsagainst us. Moreover, there can be no assurance that these competitors have notsought or will not seek additional patents that may cover aspects of ourtechnology. As a result, there is a greater likelihood of a patent dispute thanwould be expected if our competitors were pursuing unrelated technologies.

 

While we conduct patent searches to determine whetherthe technologies used in our products infringe patents held by third parties,numerous patent applications are currently pending and may be filed in thefuture for technologies generally related to our technologies, including manypatent applications that remain confidential after filing. Due to these factorsand the inherent uncertainty in conducting patent searches, there can be noguarantee that we will not violate third-party patent rights that we have notyet identified.

 

We know of U.S. and foreign patents issued to thirdparties that relate to aspects of our product candidates. There may also bepatent applications filed by these or other parties in the United States andvarious foreign jurisdictions that relate to some aspects of our productcandidates, which, if issued, could subject us to infringement actions. Inparticular, we are aware of U.S. and foreign patents owned by third parties,including potential competitors, that arguably cover aspects of our AI-700contrast agent. We and several of these parties have recently been activelyengaged in opposing the grant of European patents with claims that arguablycover 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. There is a significant possibility that one or more ofthese third parties will use litigation to assert their patents in the UnitedStates or Europe.

 

The owners or licensees of these and other patents mayfile one or more infringement actions against us. In addition, a competitor mayclaim misappropriation of a trade secret by an employee hired from thatcompetitor. Any such infringement or misappropriation action could cause us toincur substantial costs defending the lawsuit and could distract our managementfrom our business, even if the allegations of infringement or misappropriationare unwarranted. The defense of multiple claims could have a disproportionatelygreater impact. Furthermore, a party making this type of claim could secure ajudgment that requires us to pay substantial damages. A judgment could alsoinclude an injunction or other court order that could prevent us from making,using, selling, offering for sale or importing our products or prevent ourcustomers from using our products. If a court determined or if we independentlyconcluded that any of our products or manufacturing processes violatedthird-party proprietary rights, our clinical trials could be delayed and therecan be no assurance that we would be able to reengineer the product orprocesses to avoid those rights, or to obtain a license under those rights oncommercially reasonable terms, if at all.

 

***If we are unable toprotect our intellectual propriety rights, our competitors may develop andmarket products with similar features that may reduce demand for our products,and we may be prevented from establishing collaborative relationships onfavorable terms.***

 

24

----

 

The following factors are important to our success:

 

**•***                                         *receivingpatent protection for our product candidates;

 

**•***                                         *maintainingour trade secrets;

 

**•***                                         *notinfringing on the proprietary rights of others; and

 

**•***                                         *preventingothers from infringing our proprietary rights.

 

We will be able to protect our proprietary rights fromunauthorized use by third parties only to the extent that our proprietary rightsare covered by valid and enforceable patents or are effectively maintained astrade secrets.

 

We try to protect our proprietary position by filingU.S. and foreign patent applications related to our proprietary technology,inventions and improvements that are important to the development of ourbusiness. Because the patent position of pharmaceutical companies involvescomplex legal and factual questions, the issuance, scope and enforceability ofpatents cannot be predicted with certainty. Patents, if issued, may bechallenged, invalidated or circumvented. Thus, any patents that we own orlicense from others may not provide any protection against competitors. Ourpending patent applications, those we may file in the future, or those we maylicense from third parties, may not result in patents being issued. If issued,they may not provide us with proprietary protection or competitive advantagesagainst competitors with similar technology. Furthermore, others mayindependently develop similar technologies or duplicate any technology that wehave developed. The laws of many foreign countries do not protect ourintellectual property rights to the same extent as do the laws of the UnitedStates.

 

We also rely on trade secrets, know-how andtechnology, which are not protected by patents, to maintain our competitiveposition. We try to protect this information by entering into confidentialityagreements with parties that have access to it, such as our corporate partners,collaborators, employees and consultants. Any of these parties may breach theagreements and disclose our confidential information or our competitors mightlearn of the information in some other way. If any trade secret, know-how orother technology not protected by a patent were to be disclosed to orindependently developed by a competitor, our business and financial conditioncould be materially adversely affected.

 

***We may becomeinvolved in lawsuits to protect or enforce our patents that would be expensiveand time consuming.***

 

In order to protect or enforce our patent rights, wemay initiate patent litigation against third parties in the United States or inforeign countries. In addition, we may become subject to interference oropposition proceedings conducted in patent and trademark offices to determinethe priority of inventions. The defense of intellectual property rights,including patent rights through lawsuits, interference or oppositionproceedings, and other legal and administrative proceedings would be costly anddivert our technical and management personnel from their normalresponsibilities. An adverse determination of any litigation or defenseproceedings could put one or more of our patents at risk of being invalidatedor interpreted narrowly and could put our patent applications at risk of notissuing.

 

Furthermore, because of the substantial amount ofdiscovery required in connection with intellectual property litigation, thereis a risk that some of our confidential information could be compromised bydisclosure during this type of litigation. For example, during the course ofthis kind of litigation, confidential information may be inadvertentlydisclosed in the form of documents or testimony in connection with discoveryrequests, depositions or trial testimony. This disclosure could materiallyadversely affect our business and financial results.

 

***We have nevermanufactured any of our product candidates in commercial quantities, and if wefail to develop an effective manufacturing capability for our products,including our lead product candidate AI-700, we may be unable to commercializethese products.***

 

We have no experience in manufacturing our productsfor commercial use and limited experience in designing equipment for themanufacture of our products. We are working to build out and qualify acommercial manufacturing facility in Tewksbury, 

 

25

----

 

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, subjectto required regulatory approvals, we intend to manufacture AI-700 in thisfacility for commercial use. We can not assure you that we will be able tosuccessfully manufacture our products in sufficient quantities for commercialsale, or obtain the necessary regulatory approvals for such commercialmanufacture, at all or in a timely or economical manner. Our intention tomanufacture AI-700 or other products exposes us to the following risks, any ofwhich could delay or prevent the approval of our products by the FDA orcorresponding state and foreign agencies, or the commercialization of ourproducts, or result in higher costs or inability to meet demand for AI-700leading to potential revenue loss, and any of which would have a materialadverse impact on our business, financial condition and results of operations.

 

**•***                                         *Manufacturersoften encounter difficulties in achieving volume production, quality controland quality assurance. Accordingly, we might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules or tocommercialize our products.

 

**•***                                         *Manufacturersare obliged to manufacture in highly controlled environments and to operate inaccordance with FDA and international mandated current good manufacturingpractices, or cGMPs. For our clinical trials we have relied on contractmanufacturers for such facilities and cGMP compliance. In July 2004, weentered into a lease for a facility in Tewksbury, Massachusetts that we intendto convert into a commercial manufacturing facility for AI-700. Creation andqualification of a commercial manufacturing environment requires significantexpertise and capital resources, including the development of advancedmanufacturing techniques and process controls and is subject to local and stateplanning approvals. Manufacturers of pharmaceutical products often encounterdifficulties in constructing and qualifying new manufacturing facilities and inproduction, especially in scaling-up initial production. A failure within thisnew facility to establish and follow cGMPs and to document adherence to suchpractices may lead to significant delays in the availability of material forour NDA filing or commercial production for AI-700 and may delay or preventfiling or approval of marketing applications for our products or the ability tocontinue to manufacture the products. Certain of these delays would furtherrequire us to continue to operate this facility and incur related costs.

 

**•***                                         *Manufactureof our product candidates, in preparation for filing a NDA and for commercialproduction, will each initially require and rely on a single commercialmanufacturing site, directly or through a contract manufacturer, without thebackup of a second site that is qualified for commercial manufacture of theproduct. Qualification of another manufacturing site can be expensive and timeconsuming. Prior to using product from a new manufacturing site, we mustdemonstrate that the specifications for the product are consistent with thespecifications for the product as it was manufactured at a prior qualified siteor we must clinically or otherwise demonstrate that the safety and efficacy ofthe product produced in the new manufacturing site is consistent with theproduct as it was manufactured at the prior site. Demonstrating suchconsistency may be difficult, expensive or time consuming. In addition, beforewe would be able to produce product for commercial use at a new facility, itwill have to undergo a pre-approval inspection by the FDA and correspondingstate and foreign agencies. Once approved, drug manufacturers are subject toongoing periodic unannounced inspection by the FDA and corresponding state andforeign agencies to ensure strict compliance with cGMPs, other governmentregulations and corresponding foreign standards. Failure to maintain compliancewith cGMP or with safety or environmental regulations could result inpenalties, product recalls or restrictions on the use of the manufacturingsite.

 

Under the terms of our collaboration agreement withNycomed, we are responsible for the commercial manufacture of AI-700 formarketing and sale by Nycomed in Europe. Failure to manufacture AI-700 in atimely manner or on an economic basis, or in sufficient quantities, couldjeopardize our relationship with Nycomed. We do not currently have a Europeansales force, nor do we have experience with regard to the commercialization,marketing, sale or distribution of pharmaceutical products in Europe, and werely entirely on Nycomed for this expertise. Any termination of our relationshipwith Nycomed would have a material adverse impact on our business, financialcondition and results of operations.

 

26

----

 

***We have removed ourAI-700 manufacturing equipment from the facilities of our third party contractmanufacturer and currently have no facility within which to manufacture AI-700until the new commercial manufacturing facility is built-out and qualified oruntil other arrangements are made.***

 

We have removed our AI-700 manufacturing equipmentfrom the facilities of a third-party contract manufacturer. We believe that wehave sufficient inventory of AI-700 clinical trial material to complete ourPhase 3 program. However, there can be no assurance that such inventory willprove sufficient or that the inventory will not get damaged or otherwisedisqualified. Currently, we have no facility within which to manufacture AI-700until the new commercial manufacturing facility is built-out and qualified oruntil other arrangements are made. If we lack sufficient inventory of AI-700clinical trial material to complete our Phase 3 program or are unable tomanufacture sufficient inventory on a timely basis, our Phase 3 program couldbe delayed and would consequently delay our ability to commercialize AI-700.These delays could have a material adverse effect on our business, financialcondition and results of operations.

 

***If third-partymanufacturers of our products fail to devote sufficient time and resources toour concerns, or if their performance is substandard, our clinical trials maybe delayed and our costs may rise.***

 

We may rely substantially on third-party contractmanufacturers to supply, store and distribute our potential products for ourclinical trials and other development needs. Our reliance on these third-partymanufacturers will expose us to the following risks, any of which could delayor prevent the completion of our clinical trials, the approval of our productsby the FDA, or the commercialization of our products, result in higher costs,or deprive us of additional product candidates, and any of such effects wouldhave a material adverse impact on our business, financial condition and resultsof operations.

 

**•***                                         *Contractmanufacturers often encounter difficulties in achieving volume production,quality control and quality assurance, as well as shortages of qualifiedpersonnel. Accordingly, a manufacturer might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules.

 

**•***                                         *Contractmanufacturers are obliged to operate in accordance with FDA-mandated currentgood manufacturing practices, or cGMPs. A failure of these contractmanufacturers to establish and follow cGMPs and to document their adherence tosuch practices may lead to significant delays in the availability of materialfor clinical study and may delay or prevent filing or approval of marketingapplications for our products.

 

**•***                                         *Forproduction of clinical trial material for each of our current productcandidates we will initially rely on a single manufacturer. Changing these orfuture manufacturers may be difficult and the number of potential manufacturersis limited. Changing manufacturers may require re-validation of themanufacturing processes and procedures in accordance with FDA-mandated cGMPs.Such re-validation may be costly and time-consuming. It may be difficult orimpossible for us to find replacement manufacturers on acceptable termsquickly, or at all.

 

**•***                                         *Ourcontract manufacturers may not perform as agreed or may not remain in thecontract manufacturing business for the time required to produce, store anddistribute our products successfully. Our manufacturing levels, while importantto us, can represent relatively small fractions of the overall business of mostqualified contract manufactures. As a result, the contract manufacturers maynot provide us with the attention that we need or may be unwilling to adapt tonecessary changes in our manufacturing requirements.

 

Drug manufacturers are subject to ongoing periodicunannounced inspection by the FDA and corresponding state and foreign agenciesto ensure strict compliance with cGMPs, other government regulations andcorresponding foreign standards. While we are obligated to audit theperformance of third party contractors, we do not have control over ourthird-party manufacturers’ compliance with these regulations and standards.Failure by our third-party manufacturers or us to comply with applicableregulations could result in sanctions being imposed on us, including fines,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.

 

27

----

 

***We may not be ableto manufacture our products in commercial quantities, which would prevent usfrom marketing our products.***

 

To date our product candidates have been manufacturedin small quantities for pre-clinical and clinical trials. If any of theseproduct candidates are approved by the FDA or foreign regulatory authoritiesfor commercial sale, we will need to manufacture them in larger quantities. ForAI-700, it is our intention to seek regulatory approval after we havedemonstrated that we can manufacture AI-700 at a larger batch scale than isbeing used for clinical trial materials. We cannot assure you that we will beable to successfully increase the manufacturing capacity or manufacture at alarger batch scale, whether on our own or in collaboration with third partymanufacturers, for any of our product candidates in a timely or economicmanner, or at all. Significant scale-up of manufacturing may require certainadditional validation studies, which the FDA must review and approve. If we areunable to successfully increase the manufacturing capacity for a productcandidate, the regulatory approval or commercial launch of that productcandidate may be delayed or there may be a shortage in supply of that productcandidate. Our product candidates require precise, high-quality manufacturing.Our failure to achieve and maintain these high manufacturing standards,including controlling the incidence of manufacturing errors and maintainingreliable product packaging for diverse environmental conditions, could resultin patient injury or death, product recalls or withdrawals, delays or failuresin product testing or delivery, cost overruns or other problems that couldseriously hurt our business.

 

***Materials necessaryto manufacture our products may not be available, which may delay ourdevelopment and commercialization activities.***

 

Only a few facilities manufacture some of the rawmaterials necessary to manufacture our products. If we need to purchase a rawmaterial that is in limited supply for our clinical trials, or for commercialdistribution if we obtain marketing approval of a product candidate, we cannotassure you that one or more suppliers would be able to sell us that rawmaterial at the time we need it and on commercially reasonable terms. If wechange suppliers for any of these materials or any of our suppliers experiencesa shutdown or disruption in the facilities used to produce these materials, dueto technical, regulatory or other problems, it could harm our ability tomanufacture our products. Our inability to obtain required raw materials forany reason could substantially impair our development activities or theproduction, marketing and distribution of our products.

 

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

 

If we receive regulatory approval to commencecommercial sales of any of our products, we will face competition with respectto commercial sales, marketing and distribution. These are areas in which wehave no experience. To market any of our products directly, we must develop adirect marketing and sales force with technical expertise and supportingdistribution capability. Alternatively, we may engage a pharmaceutical or otherhealthcare company with an existing distribution system and direct sales forceto assist us. There can be no assurance that we will successfully establishsales and distribution capabilities either on our own or in collaboration withthird parties or gain market acceptance for our products. To the extent we haveor will enter co-promotion or other licensing arrangements, any revenues wereceive will depend on the efforts of third parties and there can be noassurance that our efforts will succeed.

 

***We will establishcollaborative relationships, and those relationships may expose us to a numberof risks.***

 

We will rely on a number of significant collaborativerelationships with pharmaceutical or other healthcare companies for ourmanufacturing, research funding, clinical development and/or sales andmarketing performance. Reliance on collaborative relationships poses a numberof risks, including the following:

 

**•***                                         *wecannot effectively control whether our corporate partners will devotesufficient resources to our programs or product candidates;

 

**•***                                         *disputesmay arise in the future with respect to the ownership of rights to technologydeveloped with collaborators;

 

**•***                                         *disagreementswith collaborators could delay or terminate the research and development,regulatory approval or commercialization of product candidates, or result inlitigation or arbitration;

 

28

----

 

**•***                                         *corporatepartners may have considerable discretion in electing whether to pursue thedevelopment of any additional product candidates and may pursue technologies orproducts either on their own or in collaboration with our competitors; and

 

**•***                                         *collaboratorswith marketing rights may choose to devote fewer resources to the marketing ofour product candidates than they do to product candidates of their owndevelopment.

 

In July 2004, we entered into a collaboration,license and supply agreement with Nycomed in which we granted Nycomed rights todevelop and market AI-700 in Europe. There can be no assurance that theregulatory goals, sales targets and other objectives of this agreement will beachieved. Failure to achieve these goals, targets and objectives would resultin our inability to receive license, milestone, royalty and other paymentsunder this agreement, which would have a material adverse impact on ourbusiness, financial condition and results of operations including, undercertain conditions, reduction of royalty rates, delays in regulatory approvalsand product sales, penalties and termination of the agreement. Under certainprovisions of this collaboration agreement, if we fail in any material respectto use all commercially reasonable efforts to carry out referenced obligationsunder the agreement, we would be obligated to pay Nycomed liquidated damages ofup to $12 million. Although we plan to carry out all of these obligations,which we believe are in our control, there can be no assurance that terminationof this agreement will not occur or that such termination would not result in usincurring liquidated damages of up to $12 million.

 

Given these risks, our current and futurecollaborative efforts may not be successful. Failure of these efforts coulddelay our product development or impair commercialization of our products, andcould have a material adverse effect on our business, financial condition andresults of operations.

 

***Competition in thepharmaceutical industry is intense, and if we fail to compete effectively ourfinancial results will suffer.***

 

We engage in a business characterized by extensiveresearch efforts, rapid developments and intense competition. We cannot assureyou that our products will compete successfully or that research anddevelopment by others will not render our products obsolete or uneconomical.Our failure to compete effectively would materially adversely affect ourbusiness, financial condition and results of operations. We expect thatsuccessful competition will depend, among other things, on product efficacy,safety, reliability, availability, timing and scope of regulatory approval andprice. Specifically, we expect important factors will include the relativespeed with which we can develop products, complete the clinical, developmentand laboratory testing and regulatory approval processes and supply commercialquantities of the product to the market.

 

We expect competition to increase as technologicaladvances are made and commercial applications broaden. In commercializing ourinitial product candidates and any additional products we develop using ourHDDS and PDDS technologies, we will face substantial competition from largepharmaceutical, biotechnology and other companies, universities and researchinstitutions.

 

**•***                                         *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, Bristol-Myers Squibb and Tyco International. In 2004, thecost of a nuclear stress test was approximately $770 per procedure. Inaddition, GE Healthcare, Bristol-Myers Squibb and Imcor have developedultrasound contrast agents that have been approved by the FDA for use in LVOand EBD in patients with suboptimal images, and in the future they may seek tobroaden their products to include stress echo and myocardial perfusionassessment. Moreover, we are aware that other companies, such as Bracco, aredeveloping ultrasound contrast agents for wall imaging and for radiologyapplications, and that Point Biomedical is developing an ultrasound contrastagent specifically for myocardial perfusion imaging. In 2004, Point announcedthat it had recently completed two pivotal Phase 3 trials for this contrastagent and planned to file an NDA with the FDA. Finally, some cardiologists mayfind it satisfactory to use stress echo without contrast for the detection ofcoronary heart disease.

 

29

----

 

**•***                                         *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, which are applying significantresources and expertise to developing reformulations of paclitaxel forintravenous delivery. In early 2005, American Pharmaceutical Partners receivedFDA approval for their product. Other companies, such as Cell Therapeutics, aredeveloping new chemical entities that involve paclitaxel conjugated, orchemically 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 havesubstantially greater capital resources, research and development staffs,facilities and experience in conducting clinical trials and obtainingregulatory approvals, as well as in manufacturing and marketing pharmaceuticalproducts. Many of our competitors may achieve product commercialization orpatent protection earlier than we will.

 

Furthermore, we believe that some of our competitorshave used, and may continue to use, litigation to gain a competitive advantage.Finally, our competitors may use different technologies or approaches to thedevelopment of products similar to the products we are seeking to develop.

 

***If we are unable toretain key personnel and hire additional qualified scientific, sales andmarketing, and other personnel, we may not be able to successfully achieve ourgoals.***

 

We depend on the principal members of our scientificand management staff. The loss of these principal members’ services mightsignificantly delay or prevent the achievement of research, development orbusiness objectives and could materially adversely affect our business,financial condition and results of operations. We do not maintain key personlife insurance on any of these principal members. We do not have employmentcontracts with any of these principal members.

 

Our success depends, in large part, on our ability toattract and retain qualified scientific and management personnel such as theseindividuals. We face intense competition for such personnel and consultants. Wecannot assure you that we will attract and retain qualified management andscientific personnel in the future.

 

Further, we expect that our potential expansion intoareas and activities requiring additional expertise, such as further clinicaltrials, governmental approvals, commercial manufacturing and marketing, willplace additional requirements on our management, operational and financialresources. We expect these demands will require an increase in management andscientific personnel and the development of additional expertise by existingmanagement personnel. The failure to attract and retain such personnel or todevelop such expertise could materially adversely affect prospects for oursuccess.

 

***We expect todevelop international operations that will expose us to additional businessrisks.***

 

We expect, whether directly or through collaborativerelationships, to develop operations outside the United States in order tomarket and distribute our products. Regardless of the extent to which we seekto develop these operations ourselves or in collaboration with others, wecannot be sure that our international efforts will be successful. Any expansioninto international markets will require additional resources and managementattention and will subject us to new business risks. These risks could lowerthe prices at which we can sell our products or otherwise have an adverseeffect on our operating results. Among the risks we believe are most likely toaffect any international operations are:

 

**•***                                         *differentregulatory requirements for approval of our product candidates;

 

**•***                                         *dependenceon local distributors;

 

30

----

 

**•***                                         *longerpayment cycles and problems in collecting accounts receivable;

 

**•***                                         *adversechanges in trade and tax regulations;

 

**•***                                         *theabsence or significant lack of legal protection for intellectual propertyrights;

 

**•***                                         *politicaland economic instability; and

 

**•***                                         *currencyrisks.

 

**Risks Relating to Our Industry**

 

***Even if we obtainmarketing approval, our products will be subject to ongoing regulatory review.***

 

If regulatory approval of a product is granted, suchapproval may be subject to limitations on the indicated uses for which theproduct may be marketed or contain requirements for costly, post-marketingfollow-up studies. As to products for which marketing approval is obtained, themanufacturer of the product and the manufacturing facilities will be subject tocontinual review and periodic inspections by the FDA and other regulatoryauthorities. In addition, the labeling, packaging, adverse event reporting,storage, advertising, promotion and record keeping related to the product willremain subject to extensive regulatory requirements. The subsequent discoveryof previously unknown problems with the product, manufacturer or facility mayresult in restrictions on the product or the manufacturer, including withdrawalof the product from the market. We may be slow to adapt, or we may never adapt,to changes in existing requirements or adoption of new requirements orpolicies.

 

If we fail to comply with applicable regulatoryrequirements, we may be subject to fines, suspension or withdrawal of regulatoryapprovals, product recalls, seizure of products, operating restrictions andcriminal prosecution.

 

***Market acceptanceof our products will be limited if users of our products are unable to obtainadequate reimbursement from third-party payors.***

 

Government health administration authorities, privatehealth insurers and other organizations generally provide reimbursement forproducts like our product candidates, and our commercial success will depend inpart on these third-party payors agreeing to reimburse patients for the costsof our products. Even if we succeed in bringing any of our proposed products tomarket, we cannot assure you that third-party payors will consider our productscost-effective or provide reimbursement in whole or in part for their use.

 

Significant uncertainty exists as to the reimbursementstatus of newly approved health care products. Each of our product candidatesis intended to replace or alter existing therapies or procedures. Thesethird-party payors may conclude that our products are less safe, effective orcost-effective than these existing therapies or procedures. Therefore,third-party payors may not approve our products for reimbursement.

 

If third-party payors do not approve our products forreimbursement or fail to reimburse them adequately, sales will suffer as somephysicians or their patients will opt for a competing product that is approvedfor reimbursement or is adequately reimbursed. Even if third-party payors makereimbursement available, these payors’ reimbursement policies may adverselyaffect the ability of us and our potential collaborators to sell our productson a profitable basis.

 

Moreover, the trend toward managed healthcare in theUnited States, the growth of organizations such as health maintenance organizations,and legislative proposals to reform healthcare and government insuranceprograms could significantly influence the purchase of healthcare services andproducts, resulting in lower prices and reduced demand for our products whichcould adversely affect our business, financial condition and results ofoperations.

 

In addition, legislation and regulations affecting thepricing of pharmaceuticals may change in ways adverse to us before or after theFDA or other regulatory agencies approve any of our proposed products formarketing. While we cannot predict the likelihood of 

 

31

----

 

any of these legislative or regulatory proposals, if any government orregulatory agencies adopt these proposals they could materially adverselyaffect our business, financial condition and results of operations.

 

***We may be requiredto defend lawsuits or pay damages in connection with the alleged or actual harmcaused by our products or product candidates.***

 

We face an inherent business risk of exposure toproduct liability claims in the event that the use of our products is allegedto have resulted in harm to others. This risk exists in clinical trials as wellas in commercial distribution. In addition, the pharmaceutical and biotechnologyindustries in general have been subject to significant medical malpracticelitigation. We may incur significant liability if product liability ormalpractice lawsuits against us are successful. Furthermore, product liabilityclaims, regardless of their merits, could be costly and divert our management’sattention from other business concerns, or adversely affect our reputation andthe demand for our products. Although we maintain product liability insurance,we cannot be certain that this coverage will be adequate or that it willcontinue to be available to us on acceptable terms.

 

***Rapid technologicalchange could make our products obsolete.***

 

Pharmaceutical technologies have undergone rapid andsignificant change. We expect that pharmaceutical technologies will continue todevelop rapidly. Our future will depend in large part on our ability tomaintain a competitive position with respect to these technologies. Anycompounds, products or processes that we develop may become obsolete before werecover any expenses incurred in connection with their development. Rapidtechnological change could make our products obsolete, which could materiallyadversely affect our business, financial condition and results of operations.

 

***Our productsinvolve the use of hazardous materials, and as a result we are exposed topotential liability claims and to costs associated with complying with lawsregulating hazardous waste.***

 

Our research and development activities involve theuse of hazardous materials, including chemicals and biological materials. Webelieve that our procedures for handling hazardous materials comply withfederal and state regulations. However, there can be no assurance thataccidental injury or contamination from these materials will not occur. In the eventof an accident, we could be held liable for any damages, which could exceed ouravailable financial resources. This liability could materially adversely affectour business, financial condition and results of operations.

 

We are subject to federal, state and local laws andregulations governing the use, manufacture, storage, handling and disposal ofhazardous materials and waste products, and we spent approximately $30,500during the fiscal year ended December 31, 2004 to dispose of thesehazardous materials and waste products. We may be required to incur significantcosts to comply with environmental laws and regulations in the future thatcould materially adversely affect our business, financial condition and resultsof operations.

 

**Risks Related to Our Common Stock**

 

***We expect that ourstock price will fluctuate significantly.***

 

We completed our initial public offering in October 2003.Prior to this offering, you could not buy or sell our common stock publicly.After this offering, the average daily trading volume for our common stock hasbeen relatively low. An active public market for our common stock may notcontinue to develop or be sustained. The stock market, particularly in recentyears, has experienced significant volatility particularly with respect topharmaceutical and biotechnology stocks. The volatility of pharmaceutical andbiotechnology stocks often does not relate to the operating performance of thecompanies represented by the stock. Factors that could cause this volatility inthe market price of our common stock include:

 

**•***                                         *announcementsof the introduction of new products by us or our competitors;

 

**•***                                         *marketconditions in the pharmaceutical and biotechnology sectors;

 

**•***                                         *rumorsrelating to us or our competitors;

 

32

----

 

**•***                                         *litigationor public concern about the safety of our potential products;

 

**•***                                         *ourquarterly operating results;

 

**•***                                         *deviationsin our operating results from the estimates of securities analysts; and

 

**•***                                         *FDAor international regulatory actions.

 

The market price of our common stock may alsofluctuate in response to the exercise by us of rights under the terms of ourconvertible preferred stock. For example, we may elect to automatically convertthe preferred stock if our common stock price has exceeded 150% of theconversion price of the preferred stock for at least 20 trading days during a30-day trading period ending within five trading days prior to the notice ofautomatic conversion. There is a risk of fluctuation in the price of our commonstock between the time when we may first elect to automatically convert thepreferred stock and the automatic conversion date. These fluctuations mayadversely affect the value of the common stock.

 

***Our common stock isjunior to our preferred stock with respect to the right to receive payments inthe event of a dissolution, liquidation or winding up of Acusphere.***

 

In February 2005, we issued and sold 900,000shares of our 6.5% convertible exchangeable preferred stock. The preferredstock is senior to the common stock as to liquidation. In the event of ourvoluntary or involuntary dissolution, liquidation or winding up of Acusphere,holders of our preferred stock will receive a liquidation preference in anamount equal to $50 per share, plus all accrued and unpaid dividends throughthe distribution date. Only after holders of the preferred stock have receivedtheir liquidation preference and any accrued and unpaid dividends will wedistribute assets, if any are remaining, to our common stock holders.

 

***We may be thesubject of securities class action litigation due to future stock pricevolatility.***

 

In the past, when the market price of a stock has beenvolatile, holders of that stock have often instituted securities class actionlitigation against the company that issued the stock. If any of ourstockholders brought a lawsuit against us, we could incur substantial costsdefending the lawsuit. The lawsuit could also divert the time and attention ofour management.

 

***Future sales ofcommon stock by our existing stockholders may cause our stock price to fall.***

 

The market price of our common stock could decline asa result of sales by our existing stockholders of shares of common stock in themarket, or the perception that these sales could occur. These sales might alsomake it more difficult for us to sell equity securities at a time and pricethat we deem appropriate. As of May 6, 2005, we have 17,831,954 shares ofcommon stock outstanding and 900,000 shares of convertible preferred stockoutstanding that are convertible into approximately 6,559,740 shares of ourcommon stock, plus up to a maximum of approximately 1,959,799 additional sharesof our common stock issuable at our option in satisfaction of the maximumdividend make- whole payment on these shares of preferred stock. All of theshares of common stock issuable upon conversion of our preferred stock will befreely tradable without restriction under the federal securities laws unlesspurchased by our affiliates.

 

***Our directors andmanagement will exercise significant control over our company.***

 

Our directors and executive officers and theiraffiliates collectively control approximately 12.0% of our outstanding commonstock, excluding unexercised options and warrants. As a result, thesestockholders, if they act together, will be able to influence our managementand affairs and all matters requiring stockholder approval, including theelection of directors and approval of significant corporate transactions. Thisconcentration of ownership may have the effect of delaying or preventing achange in control of our company and might affect the market price of ourcommon stock.

 

***The terms of ouroutstanding shares of preferred stock may restrict our ability to raiseadditional capital or hamper or prevent an acquisition of us.***

 

33

----

 

In February 2005 we issued and sold 900,000shares of our 6.5% convertible exchangeable preferred stock. In the event ofour voluntary or involuntary dissolution, liquidation or winding up ofAcusphere, holders of our preferred stock will receive a liquidation preferencein an amount equal to $50 per share, plus all accrued and unpaid dividendsthrough the distribution date. Only after holders of the preferred stock havereceived their liquidation preference and any accrued and unpaid dividends willwe distribute assets, if any are remaining, to our common stock holders.Without the vote or consent of the holders of at least a majority of the sharesof preferred stock, we can not authorize or sell any equity security that rankssenior to the preferred stock as to dividends or distributions of assets uponliquidation, dissolution or winding up of Acusphere. As a result of thisliquidation preference, it may be difficult for us to raise additional capitalthrough the sale of common stock or junior preferred stock on acceptable terms,or at all.

 

In addition, without the vote or consent of theholders of at least a majority of the shares of preferred stock we may noteffect a consolidation or merger with another entity unless the preferred stockthat remains outstanding and its rights, privileges and preferences areunaffected or are converted into or exchanged for preferred stock of thesurviving entity having rights, preferences and limitations substantiallysimilar, but no less favorable, to the convertible preferred stock. Thisprovision could hamper a third party’s acquisition of us or discourage a thirdparty from attempting to acquire control of us via a merger.

 

***Under somecircumstances, the holders of our outstanding shares of preferred stock may beentitled to elect some of the directors of Acusphere.***

 

In February 2005 we issued and sold 900,000shares of our 6.5% convertible exchangeable preferred stock. Cumulativedividends accrue on our preferred stock at an annual rate of $3.25 per share,payable quarterly on the first day of March, June, September and December,commencing June 1, 2005. Any dividends must be declared by our board ofdirectors and must come from funds that are legally available for dividendpayments. If we have not paid dividends on the preferred stock in an aggregateamount equal to at least six quarterly dividends whether or not consecutive, wemust increase the size of our board of directors by two additional directors.After this time, and for so long as these dividends remain due and unpaid,holders of the preferred stock, voting separately as a class with holders ofpreferred stock ranking on the same basis as to dividends having like votingrights, will be entitled to elect two additional directors at any meeting ofstockholders at which directors are to be elected. These directors will beappointed to classes on the board as determined by our board of directors.These voting rights will terminate when we have declared and either paid or setaside for payment all accrued and unpaid dividends. The terms of office of alldirectors so elected will terminate immediately upon the termination of thesevoting rights.

 

***Provisions ofDelaware law or our charter documents could delay or prevent an acquisition ofus, even if the acquisition would be beneficial to our stockholders, and couldmake it more difficult for you to change management.***

 

Provisions of Delaware law or our charter or by-lawscould hamper a third party’s acquisition of us, or discourage a third partyfrom attempting to acquire control of us. Stockholders who wish to participatein these transactions may not have the opportunity to do so. These provisionscould also limit the price that investors might be willing to pay in the futurefor shares of our common stock. Further, these provisions make it moredifficult for stockholders to change the composition of our board of directorsin any one year.

 

These provisions include:

 

**•***                                         *aprovision allowing us to issue preferred stock with rights senior to those ofthe common stock without any further vote or action by the holders of thecommon stock;

 

**•***                                         *theexistence of a staggered board of directors in which there are three classes ofdirectors serving staggered three-year terms, thus expanding the time requiredto change the composition of a majority of directors and potentiallydiscouraging someone from making an acquisition proposal for us;

 

**•***                                         *theby-laws’ requirement that stockholders provide advance notice when nominatingour directors;

 

**•***                                         *theinability of stockholders to convene a stockholders’ meeting without thechairperson of the board, the chief executive officer, the president or amajority of the board of directors first calling the meeting; and

 

34

----

 

**•***                                         *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 paiddividends on our capital stock, and we do not anticipate paying any cashdividends on our common stock in the foreseeable future.***

 

We have paid no cash dividends on our common stock todate and, other than cash dividends paid on our preferred stock, we currentlyintend to retain our future earnings, if any, to fund the development andgrowth of our businesses. In addition, the terms of any future debt or creditfacility may preclude us from paying these dividends. As a result, capitalappreciation, if any, of our common stock will be your sole source of gain forthe foreseeable future.

 

**ITEM 3****.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We havenot used derivative financial instruments for speculation or trading purposes.However, we are exposed to market risk related to changes in interest rates.Our current policy is to maintain an investment portfolio consisting mainly ofU.S. money market and government-grade securities, directly or through managedfunds, with maturities of one year or less. Our cash is deposited in andinvested through highly rated financial institutions in North America. Our cashequivalents 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 March 31, 2005, we estimate that thefair value of our investment portfolio would decline by an immaterial amount.We currently have the ability to hold our fixed income investments untilmaturity, and therefore we do not expect our operating results or cash flows tobe affected to any significant degree by the effect of a change in marketinterest rates on our investments.

 

**Effectsof Inflation**

 

Ourassets are primarily monetary, consisting of cash, and cash equivalents.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.

 

**ITEM 4****. CONTROLSAND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

As of March 31,2005 (the “Evaluation Date”), the our management, with the participation of ourChief Executive Officer and our Senior Vice President and Chief FinancialOfficer, evaluated the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15(b) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”). Based upon that evaluation, our ChiefExecutive Officer and our Senior Vice President and Chief Financial Officerconcluded that, as of the Evaluation Date, our disclosure controls andprocedures were effective in ensuring that material information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, including ensuringthat such material information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and our Senior Vice Presidentand Chief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

**InternalControl Over Financial Reporting**

 

Duringthe period covered by this report, there have been no changes in our internalcontrol over financial reporting that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

35

----

 

**PART II****. OTHERINFORMATION**

 

**ITEM 1****. LEGALPROCEEDINGS**

 

None

 

**ITEM 2****.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

On October 14, 2003, we closed the sale of anaggregate of 3,750,000 shares of our common stock, $0.01 par value, in ourinitial public offering at a price to the public of $14.00 per share. Themanaging underwriters in the offering were SG Cowen Securities Corporation,Thomas Weisel Partners LLC, U.S. Bancorp Piper Jaffray and Friedman BillingsRamsey. All of the shares of common stock sold in the offering were registeredunder the 1933 Act on a Registration Statement on Form S-1 (Reg. No.333-106725) that was declared effective by the SEC on October 7, 2003 anda Registration Statement filed pursuant to Rule 424(b) under the Securities Actthat was filed on October 8, 2003 (Reg. No. 333-106725). The offeringcommenced on October 7, 2003 and did not terminate until after the sale ofall of the securities registered in the Registration Statement. As part of theinitial public offering, we granted the several underwriters an overallotmentoption to purchase up to an additional 562,500 shares of our common stock fromus. The underwriters did not exercise the overallotment option. There were noselling stockholders in the offering.

 

The aggregate price of the offering amount registeredon our behalf was $52.5 million. In connection with the offering, we paid $3.7million in underwriting discounts and commissions to the underwriters andincurred an estimated $1.2 million in other offering expenses. None of theunderwriting discounts and commissions or offering expenses were incurred orpaid to directors or officers of ours or their associates or to persons owning10 percent or more of our common stock or to any affiliates of ours. Afterdeducting the underwriting discounts and commissions and offering expenses, wereceived net proceeds from the offering of approximately $47.6 million. Theproceeds to us have conformed with our intended use outlined in the prospectusrelated to the offering.

 

**ITEM 3****. DEFAULTSUPON SENIOR SECURITIES**

 

None

 

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

 

None

 

**ITEM 5****. OTHERINFORMATION**

 

On May11, 2005, the Company signed an amendment to its Watertown, MA facilitylease.  The amendment extends the baseterm of the original lease from an ending date of December 31, 2011 to anending date of June 30, 2012 in return for the landlord providing theCompany a tenant improvement allowance of up to $270,000 for certainimprovements to the facility.   Theextension of the lease term will result in additional rent payments by theCompany of approximately $1.4 million over the life of the extended lease. Thefacility improvements will be constructed by the landlord and the improvementallowance will be disbursed in accordance with a work letter entered into bythe landlord and the Company on May 11, 2005. All other terms of the original lease remain in full force and effect.

 

On May11, 2005, Acusphere entered into a Patent Transfer Agreement with ScheringAktiengesellschaft (“Schering”) under which the Company acquired all right,title and interest in certain ultrasound patents from Schering.  As part of the agreement, Acusphere grantedSchering a non-exclusive, royalty-free, worldwide license to certain of theacquired patents in connection with the sale of Schering’s ultrasound productLevovist®.  Acusphere acquired these patents to expand its intellectual propertyportfolio for ultrasound contrast agents and the use of ultrasound contrastagents generally for drug delivery applications.  In consideration of the transfer andassignment of these patents, the Company agreed to pay Schering a total of $7.0million, with $1.0 million due in May 2005, $3.0 million due in May 2006, and$3.0 million due in May 2007.

 

36

----

 

**ITEM 6****. EXHIBITS**

 
| **Exhibit  Number** |   | **Exhibit Description**                                                                                |
|---------------------|--------|--------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                   |
| 10.1                |   | Amendment to  Lease between ARE-500 Arsenal Street, LLC and Acusphere, Inc.                       |
|                |   |                                                                                                   |
| 10.2                |   | Patent Transfer  agreement dated May 11, 2005 between Schering Aktiengesellschaft and Acusphere,  Inc. |
|                |   |                                                                                                   |
| 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                                                                      |

 

37

----

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on this 12th day of May 2005.

 

 
|     | 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)* |

 

38

----

 

**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                |
|---------------------|------------|--------------------------------------------------------------------------------------------------------|
| 10.1                |       | Amendment to  Lease between ARE-500 Arsenal Street, LLC and Acusphere, Inc.                       |
|                |       |                                                                                                   |
| 10.2                |       | Patent Transfer  agreement dated May 11, 2005 between Schering Aktiengesellschaft and Acusphere,  Inc. |
|                |       |                                                                                                   |
| 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                                                                      |

 

39

----