**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-K**

**FORANNUAL AND TRANSITION REPORTSPURSUANT TO SECTIONS 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**(Mark One)**

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

**For the fiscal year ended December 31,2005**

**OR**

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

**Forthe transition period from***               * to *                           *.

**CommissionFile Number 000-50405**

**ACUSPHERE, INC.**

(Exact name of registrantas specified in its charter)

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

 

**Registrant’stelephone number, including area code:   (617) 648-8800Securities registered pursuant to Section 12(b) of the Act:NoneSecurities registered pursuant to Section 12(g) of the Act:Common Stock, $.01 Par Value(Title of class)**

Indicate by check mark whether the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o No x

Indicate by check mark whether the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o No x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes x No o

Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

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

The aggregate market value of Common Stock as of thelast business day of the registrant’s most recently completed second fiscalquarter (based on the last reported sale price on The NASDAQ National Market asof such date) held by non-affiliates of the registrant as of such date was approximately$65.1 million. As of March 16, 2006 there were 22,901,720 shares of theregistrant’s Common Stock outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Part IIIof this report incorporates information by reference from the Company’sdefinitive proxy statement, which proxy statement is due to be filed with theSecurities and Exchange Commission not later than 120 days after December 31,2005.

 

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**INTRODUCTORY NOTE**

This report, including the documents incorporated byreference in this report, includes forward-looking statements. We have basedthese forward-looking statements on our current expectations and projectionsabout future events. Forward-looking statements involve risks anduncertainties. We make such forward-looking statements pursuant to the safeharbor provisions of the Private Securities Litigation Reform Act of 1995. Inthis Annual Report on Form 10-K, words such as “may,” “will,” “should,”“could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,”“predicts,” “intends,” “potential,” and similar expressions (as well as otherwords or expressions referencing future events, conditions or circumstances)are intended to identify forward-looking statements. Forward-looking statementsin these documents include, but are not limited to, those relating to:

·       thetiming of our clinical trials and regulatory milestones for AI-700,including the timing of enrollment, the public announcement of clinical data,the qualification of our manufacturing facility and the filing of our NDA withthe FDA;

·       our estimates regarding ourcapital requirements and our needs for additional financing;

·       our plans to develop andmarket new product candidates and the timing of these development programs;

·       our clinical development ofproduct candidates, clinical trials and our ability to obtain and maintainregulatory approval for our product candidates;

·       our estimates of expensesand future revenues and profitability;

·       our estimates of the sizeof the potential markets for our product candidates;

·       our selection and licensingof product candidates;

·       our ability to attractcollaborators with acceptable development, regulatory and commercializationexpertise;

·       the benefits to be derivedfrom corporate collaborations, license agreements and other collaborativeefforts, including those relating to the development and commercialization ofour 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 aneffective direct sales and marketing infrastructure for products we elect tomarket and sell directly;

·       the rate and degree ofmarket acceptance of our product candidates;

·       the timing and amount ofreimbursement for our product candidates;

·       the success of othercompeting therapies that may become available; and

·       the manufacturing capacityfor our product candidates, including our plans to start-up and qualify acommercial manufacturing facility for AI-700.

Ouractual results and the timing of certain events may differ materially from theresults discussed, projected, anticipated or indicated in any forward-lookingstatements. Any forward-looking statement should be considered in light offactors discussed in Item 7 under “Certain Factors Which May Affect FutureResults” and elsewhere in this Annual Report on Form 10-K. 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.

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**TABLE OF CONTENTS**

| **PART I**     |   |                                                                                                          |   |
|----------------|--------|---------------------------------------------------------------------------------------------------------------|--------|
| Item 1.        |   | Business                                                                                                      | 4      |
| Item 1A.       |   | Risk  Factors                                                                                                 | 26     |
| Item 1B        |   | Unresolved Staff Comments.                                                                                    | 43     |
| Item 2.        |   | Properties                                                                                                    | 43     |
| Item 3.        |   | Legal  Proceedings                                                                                            | 44     |
| Item 4.        |   | Submission of Matters to a Vote of Security Holders                                                           | 44     |
| **PART  II**   |   |                                                                                                          |   |
| Item 5.        |   | Market for Registrant's Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities | 44     |
| Item  6.       |   | Selected  Financial Data                                                                                      | 46     |
| Item 7.        |   | Management's Discussion and Analysis of Financial  Condition and Results of Operations                        | 47     |
| Item 7A.  |   | Quantitative and Qualitative Disclosures about Market  Risk                                                   | 64     |
| Item 8.        |   | Financial Statements and Supplementary Data                                                                   | 64     |
| Item 9.        |   | Changes in and Disagreements with Accountants on  Accounting and Financial   Disclosure                       | 65     |
| Item 9A.       |   | Controls and Procedures                                                                                       | 65     |
| Item  9B.      |   | Other  Information                                                                                            | 65     |
| **PART III**   |   |                                                                                                          |   |
| Item 10.       |   | Directors and Executive Officers of the Registrant                                                            | 66     |
| Item 11.       |   | Executive Compensation                                                                                        | 66     |
| Item 12.       |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters               | 67     |
| Item 13.       |   | Certain Relationships and Related Transactions                                                                | 67     |
| Item 14.       |   | Principal Accountant Fees and Services                                                                        | 67     |
| **PART IV**    |   |                                                                                                          |   |
| Item 15.       |   | Exhibits and Financial Statement Schedules                                                                    | 67     |
| **SIGNATURES** | 74     |

 

| EXHIBIT 14.01 |   | Code of Business Conduct and Ethics         |   |
|---------------|--------|---------------------------------------------|--------|
| EXHIBIT 21.01 |   | List of Subsidiaries                        |   |
| EXHIBIT 23.01 |   | Consent of Deloitte & Touche LLP   |   |
| EXHIBIT 31.1  |   | Rule 13a-14(a)/15d-14(a) Certification |   |
| EXHIBIT 31.2  |   | Rule 13a-14(a)/15d-14(a) Certification |   |
| EXHIBIT 32.1  |   | Section 1350  Certifications           |   |

** **

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**PART I**

**ITEM 1. BUSINESS**

**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 over existing drugs,including improved safety and efficacy, increased patient compliance, greaterease of use, expanded indications or reduced cost. Our three product candidatesfor which we have clinical data are designed to address large unmet clinicalneeds in the areas of cardiology, oncology and asthma. Our lead productcandidate is an ultrasound contrast agent in Phase 3 clinical development forthe detection of coronary heart disease, the leading cause of death in the UnitedStates.

Our proprietarytechnology enables us to control the size and porosity of particles, includingnanoparticles and microparticles, in a versatile manner, so that we cancustomize the particles to address the delivery needs of a variety of drugs. Wehave initially applied this technology in our research and development effortsin the following areas:

·       *AI-700, Intravenous Delivery of Gas for Ultrasound Contrast.  *Wespecifically designed AI-700 to assess myocardial perfusion, or bloodflow in the heart muscle, a sensitive marker for coronary heart disease. AI-700is an ultrasound contrast agent that enables stress echocardiography, orultrasound of the heart, to obtain information on myocardial perfusion.Currently, there is no ultrasound contrast agent that is approved by the U.S.Food and Drug Administration, or FDA, to assess myocardial perfusion. AI-700is in Phase 3 clinical development.

·       *AI-850, First Clinical-Stage Product Candidate from ourHydrophobic Drug Delivery System, HDDS.  *Hydrophobic drugs,which are drugs that do not dissolve well in water, are often difficult toformulate, especially for intravenous delivery. We have demonstrated that ourHydrophobic Drug Delivery System, or HDDS, improves the dissolution rate of avariety of hydrophobic drugs. We have completed a Phase 1 clinical trial for AI-850,which utilizes our HDDS technology and is designed to improve the dissolutionrate of a leading cancer drug.

·       *AI-128, First Clinical-Stage Product Candidate from our PulmonaryDrug Delivery System, PDDS.  *Most asthma drugs delivered viainhalation are immediate release formulations that must be inhaled multipletimes per day, reducing patient compliance. We have completed a Phase 1 studyfor AI-128, a sustained release formulation of an FDA-approved asthmadrug.

**OurPorous Microparticle Technology**

Microparticles are useful in the delivery of a widerange of drugs. The suitability of microparticles for use in drug deliverydepends on a variety of characteristics, including size and porosity. Ourtechnology enables us to control the size and porosity of microparticles andnanoparticles in a versatile manner so that we can customize the particles toaddress the delivery needs of a variety of drugs. We are focused on creatingporous particles that are smaller than red blood cells. Microparticles, ordrugs embedded in these particles, when less than one micron in size arenanoparticles. These microparticles and nanoparticles can be used to delivergases or to deliver drugs to patients through various routes of delivery. Smallmicroparticles are important for delivering drugs intravenously so that theycan pass safely through the body’s smallest blood vessels, for increasing thesurface area of a drug so that it will dissolve more rapidly, and fordelivering drugs via inhalation. Porosity is important for a variety ofapplications, including entrapping gases in microparticles, controlling therelease rate of the drug from a microparticle, and targeting inhaled drugs tospecific regions of the lung. We have developed proprietary spray drying 

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equipment and pore formingprocesses that enable us to produce these porous microparticles in a versatilemanner.

Using ourproprietary technology:

·       We have produced small,porous microparticles containing gas, which are analogous in structure tohoneycombs. Using these microparticles, we are developing AI-700, anultrasound contrast agent for detection of coronary heart disease through theassessment of myocardial perfusion.

·       We have produced smallmicroparticles with tiny pores throughout, which are analogous in structure tosponges. Using these microparticles, we are developing our HDDS technology,which may enable improved dissolution of hydrophobic drugs in water.

·       We have produced smallmicroparticles with large pores throughout, which are analogous in structure towhiffle balls. Using these microparticles, we are developing our PDDStechnology, which may enable improved delivery of drugs via the pulmonaryroute.

**Our Strategy**

In the last thirty years, a large worldwide market hasemerged based on technologies that improve the delivery of established drugs innovel, cost-effective ways by providing significant benefits, such as improvedsafety and efficacy, increased patient compliance, greater ease of use,expanded indications or reduced cost. Drug delivery technologies can improvethe commercial prospects for existing drugs by introducing new formulationsthat offer new delivery methods that may be patented and thereby protected.Traditionally, drug delivery companies have earned royalties by applying theirdelivery technologies to create new formulations of existing drugs owned byothers. Recently, some companies have begun developing new drugs by using theirproprietary drug delivery technologies in combination with off-patent drugs.These companies are often referred to as specialty pharmaceutical companies.

Our goal is to become a leading specialtypharmaceutical company that develops and commercializes new drugs and improvedformulations of existing drugs using our porous microparticle technology. Ourstrategy to accomplish that goal includes the following:

*AdvanceDevelopment of Our Lead Product Candidate, AI-700.**  *We are currently enrolling patientsin a Phase 3 clinical trial program for our lead product candidate, AI-700,a cardiovascular drug for the detection of coronary heart disease.  Data from this program is intended to be usedto seek approval for AI-700 in the United States, Europe and othermarkets.

*Focuson Proprietary Product Opportunities.**  *We intend to focus on proprietaryproduct opportunities, where we own broad patent rights to the products. Due toour ownership interest in these product candidates and technology, we believewe would be able to negotiate corporate collaborations from a stronger positionthan service-oriented companies that develop drug delivery technologies forpatented drugs owned by pharmaceutical or biotechnology companies. We mayretain the sales and marketing rights to our proprietary products in specialtymarkets that we can readily address. For instance, our lead product candidate,AI-700, will initially be used by a subset of cardiologists, calledechocardiologists, who are generally hospital-based. We believeechocardiologists can be reached by a relatively small sales force ofapproximately 60 to 100 people in the United States. Therefore, we believe AI-700may be an attractive candidate for us to market and sell directly in the UnitedStates. In Europe, AI-700 will be marketed through Nycomed Danmark ApS(Nycomed), a company with which we entered into a strategic collaboration in2004. We intend to pursue other strategic partnering opportunities to marketand sell AI-700 outside of the United States and Europe. We may alsoin-license products or technologies which we believe are complementary orsynergistic with our internally-developed product candidates or technologies.

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*ApplyOur Proprietary Technology as Delivery Systems for Patented Drugs.**  *We believe that our porousmicroparticle technology can be applied to a wide variety of marketed as wellas development stage drugs, including patented and off-patent drugs. Manypatented drugs owned by large pharmaceutical companies are hydrophobic or deliveredby inhalation. These drugs could benefit from our HDDS and PDDS technologies.We plan to seek collaborations with companies that have patented drugs thatcould benefit from the most compelling capabilities of our technologies. Byfocusing on drugs where the advantages of our technologies are most compelling,we believe we will be in an attractive position when negotiating the terms ofthese collaborations.

*Focus on Large MarketsWhere Our Product Candidates Can Address Significant Unmet Clinical Needs.*   Weare focused on developing proprietary drugs for large markets withincardiology, oncology and asthma where we believe our porous microparticletechnology can provide compelling clinical advantages over current approaches.For example, we believe our lead product candidate, AI-700, will providea low cost and convenient alternative for the detection of coronary heartdisease with respect to this initially targeted indication. We believe thepotential market opportunity for AI-700 is over $2.0 billion in the United States and even larger worldwide.

**Product Development Programs**

Our proprietary porousmicroparticle technology has been used to create product candidates that mayaddress large unmet clinical needs within cardiology, oncology and asthma.

***AI-700, Intravenous Delivery of Gas forUltrasound Contrast***

*BroadApplications for Ultrasound Contrast.**  *We have developed an intravenousdelivery system for gas that has the potential to expand the usefulness ofultrasound in the detection of coronary heart disease. Ultrasound is one of theleast expensive and most frequently used imaging techniques that permitphysicians to view the inside of the body. However, ultrasound is the onlyfrequently used imaging technique without a commercially significant contrastagent. As a result, the clarity of ultrasound is often inadequate for adefinitive assessment of medical conditions. A contrast agent that couldprovide more detail and clarity and thereby improve the diagnostic imageproduced could expand the usefulness of ultrasound. Gases are attractivecontrast agents for ultrasound because they reflect ultrasound waves moreefficiently than blood or body tissues, enabling their detection by theultrasound machine. Gas injected intravenously can potentially act as a tracerof abnormal blood flow, which is associated with many life-threatening diseasessuch as coronary heart disease. However, gas rapidly dissolves in blood therebylosing its effectiveness. As a result, microparticles that can entrap the gasand be administered intravenously are necessary in order to develop anultrasound contrast agent with broad applications.

*CoronaryHeart Disease Market.**  *Accordingto the American Heart Association, or AHA, over 13.0 million people in the United States suffer from coronaryheart disease, the leading cause of death in the United States. Coronary heartdisease is characterized by the accumulation of plaque, which narrows coronaryarteries and reduces blood flow in the heart muscle. The AHA projects that in 2006, approximately $75.2 billion will be spent ondirect medical expenses for coronary heart disease in the United States. Earlydetection of coronary heart disease can reduce treatment costs, increasepatient survival and improve quality of life.

The definitive method for the detection of coronaryheart disease is coronary angiography, an expensive and invasive procedureimpractical for use as a routine screening tool. Two of the most common methodsfor coronary heart disease screening are nuclear stress imaging and stressechocardiography, which is ultrasound of the heart. We estimate that 11.9 million of these screeningprocedures were performed collectively in the United States in 2005. We believe that a contrast agentthat enables the assessment of blood flow in the heart muscle, or myocardialperfusion, with ultrasound could replace many 

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of these screeningprocedures. We believe that an ultrasound contrast agent capable of myocardialperfusion assessment could be priced at $200 or higher per procedure, includingboth rest and stress evaluations. Assuming all of these procedures wereperformed using ultrasound with an effective contrast agent at this price, weestimate the potential U.S. ultrasound contrast market for the cardiacindication of A1-700 to be over $2.0 billion.

*CurrentPractice for Coronary Heart Disease Screening.**  *Nuclear stress tests assessmyocardial perfusion, or blood flow in the heart muscle. Nuclear stress testsinvolve the intravenous injection of a radioactive compound, followed by scansof the heart using a special camera while the patient is at rest and understressed conditions. These tests typically take about five hours to complete,the results are not available immediately as post-processing is required, donot provide real-time results, cost approximately $770 per procedure, and, due to significant capital equipment costsand complex regulatory requirements associated with the use of radioactivematerials and are not available in many hospital or physician office settings.We estimate that 8.9 million nuclear stress tests were conducted in theUnited States in 2005.

Stress echocardiography, or stress echo, assesses themotion of the heart wall. Advanced coronary heart disease typically results inabnormal blood flow in the heart muscle, which in turn causes abnormal wallmotion that can be detected by the ultrasound machine used in stress echo.Although myocardial perfusion information from nuclear stress tests providesthe most direct information about blood flow in the heart muscle, stress echoprovides dynamic, real-time information about regional heart function. Thisadditional information, along with the greater availability of ultrasound overnuclear equipment, results in the use of stress echo as a screening method inmany hospital and physician office settings. Stress echo involves the use ofhigh-frequency sound waves that are bounced off of the heart wall while thepatient is at rest and under stressed conditions. We estimate that 3.0 millionstress echo procedures were conducted in the United States in 2005. However, stress echo is ofteninadequate for a definitive assessment of coronary heart disease. For instance,the motion of the heart wall can be difficult to see under stress conditions,particularly in obese patients. In addition, the detection of defects inmyocardial perfusion using stress echo is not possible without use of acontrast agent.

There is no ultrasound contrast agent approved by theFDA for use in stress echo or myocardial perfusion imaging. Ultrasound contrastagents have been approved by the FDA for left ventricular opacification (“LVO”)and endocardial border delineation (“EBD”) in patients with suboptimal images.LVO is image enhancement of blood volume in the left ventricular chamber of theheart. EBD is image enhancement of the borders of the ventricular chambers.

*OurSolution, AI-700, a Synthetic Polymer Microparticle.**  *Using our porous microparticletechnology, we specifically designed AI-700 for myocardial perfusionassessment. Currently in Phase 3 clinical trials, AI-700 is an ultrasoundcontrast agent that is being developed to enable stress echo to provideinformation on myocardial perfusion in addition to wall motion. Based on theresults of our Phase 2 clinical trials, we believe that stress echo with AI-700has the potential to provide information comparable to the nuclear stresstests, while retaining the advantages of ultrasound.

We believe we haveovercome many of the limitations of other ultrasound contrast agents bydeveloping an intravenous gas delivery system made from a synthetic polymer.All of the ultrasound contrast agents currently approved by the FDA for LVO andEBD in patients with suboptimal images deliver gas intravenously in fragilesystems made from natural materials. When exposed to the power of theultrasound beam during the imaging procedure, these natural materials are sofragile they often rupture and release the gas into the blood, where itdissolves, thereafter rendering these contrast agents ineffective. Moreover,some ultrasound contrast agents encapsulate nitrogen, which dissolves quicklyin water. Such contrast agents have a very short duration of enhancementbecause the nitrogen is quickly pushed out of the microbubble and displacedwith water. Ultrasound contrast agents made from natural materials orcontaining nitrogen have only been approved by the FDA for LVO and EBD inpatients with 

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suboptimalimages and we believe they are difficult to use in myocardial perfusionimaging, which is more technically demanding. Unlike the natural materials usedin FDA-approved ultrasound contrast agents, the synthetic polymers used in AI-700do not break during the imaging procedure. In addition, perfluorocarbon gasesare less soluble in water and therefore have the propensity to stay inside themicroparticle. As a result, we can deliver a higher concentration of gas to themyocardium over a longer period of time, thereby enabling AI-700 totarget the broader application of myocardial perfusion assessment. AI-700is a dry powder consisting of small, porous microparticles filled with aperfluorocarbon gas. These microparticles are made of a synthetic biodegradablepolymer, called poly (D, L-lactide co-glycolide), or PLGA, that has been usedin other drug delivery systems approved by the FDA. The composition andstructure of the microparticles, which also contain a phospholipid, and theproperties of the perfluorocarbon gas slow the rate at which the gas dissolvesand prevent the microparticles from being quickly broken down inside the body.These microparticles are suspended in sterile water and injected into the bodyby intravenous injection. AI-700 was designed to be easy to use withcommercially available ultrasound equipment and established imaging techniques.

*Potential Benefitsof Stress Echo with AI-700 vs. Nuclear Stress Tests*

Stress echo with AI-700has the potential to significantly reduce the time, cost and resources neededin the assessment of myocardial perfusion.

·       *Less Expensive.  *We estimate that the cost ofperforming an ultrasound imaging procedure using our AI-700 contrastagent will be approximately $400per procedure, representing costs of $200for the contrast agent and $200for administering the procedure. Nuclear stress tests typically costapproximately $770 per procedure. Nuclear stress tests are relatively moreexpensive because the equipment is large and costly and patient throughput islow. Ultrasound equipment is much smaller and generally half the cost ofnuclear equipment used for the detection of coronary heart disease.

·       *Less Time Consuming.  *Nuclear stress tests typicallytake five hours, while ultrasound procedures typically take 30 minutes.

·       *Greater Availability.  *Due to the technical complexity,high cost and the regulatory requirements associated with the use ofradioactive materials, nuclear stress tests are not available in all hospitals,cardiology practices and emergency departments. In the United States,ultrasound equipment is widely available in all of these settings.

·       *More Information.  *Stress echo with AI-700 hasthe potential to provide information on both myocardial perfusion and wallmotion, whereas nuclear stress tests typically provide good information onmyocardial perfusion, but little information on wall motion. Stress echo hasthe potential to provide this information immediately whereas images fromnuclear stress tests require post-processing and analysis.

·       *No Radioactivity.  *AI-700 is made from asynthetic polymer that does not require special licensing, has the potential ofat least a two-year shelf life, and is convenient to use and store. Nuclearstress tests use radioactive materials that create additional costs due to preparation,storage and disposal requirements.

·       *Expanded Opportunity for Cardiologists.  *We believethat many cardiologists will prefer ultrasound with AI-700 over nuclearstress tests because it may allow them to remain in closer contact with theirpatients. To assess myocardial perfusion with nuclear stress tests, manypatients are referred by cardiologists to the radiology department, which isusually a different profit and care center within the hospital.

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*Potential Benefitsof Stress Echo with AI-700 vs. Stress Echo without Contrast*

Stress echo with AI-700has the potential to provide broader information for cardiac evaluation.

·       *More Information.  *Stress echo with AI-700 hasthe potential to provide information on both myocardial perfusion and wallmotion, whereas stress echo without contrast provides information only on wallmotion.

·       *Potential for Increased Sensitivity with Perfusion.  *Cardiologistsseek to identify coronary heart disease early in the disease progression inorder to minimize the risk of heart attack. In early coronary heart disease,the coronary artery is only partially blocked, so there may be little or nowall motion abnormality, but there could be a perfusion abnormality. Thepotential for increased sensitivity has contributed to the popularity ofnuclear stress tests. We estimate that in 2005, 8.9 million nuclear stress tests were performed versus 3.0 million stress echo tests.We believe that an ultrasound contrast agent capable of myocardial perfusionimaging would enable stress echo to compete more effectively with nuclearstress testing.

*ClinicalResults.**  *Priorto commencing our Phase 3 clinical program, we enrolled over 200 human subjectsin our Phase 1 and Phase 2 clinical trials for AI-700. Our Phase 1clinical trials evaluated the safety and feasibility of myocardial perfusionimaging with AI-700. Our Phase 2 clinical trials evaluated thepreliminary safety and efficacy of AI-700 enhanced ultrasound imaging. Inour Phase 2 clinical trials, efficacy was measured by comparing the resultsobtained from myocardial perfusion assessment using AI-700 enhancedultrasound with those obtained using nuclear stress tests. Our Phase 1 andPhase 2 clinical trials were conducted in the U.S. under an Investigational NewDrug Application, or IND. The results of our Phase 2 trials are summarizedbelow. We have filed these results and our protocols for our Phase 3 trialswith the FDA. We initiated the pilot phase of our Phase 3 clinical program inDecember 2003. We completed the pilot phase of our Phase 3 clinical program in2005. We are intentionally blinded to efficacy data from our ongoing Phase 3 pivotaltrials.

*The “20”Trial.**  *Ourobjectives in our first Phase 2 clinical trial, the “20” trial, were toevaluate the safety of AI-700 in subjects with known coronary heartdisease as well as in healthy subjects and to determine the optimal imagingprocedures for myocardial perfusion assessment using AI-700 enhancedechocardiography. The study included 53 subjects, was conducted byechocardiologists and utilized a variety of commercially available equipmentplatforms. Subjects enrolled in the “20” trial received a single injection ofAI-700 at a variety of doses and were imaged under resting conditionsonly. The primary efficacy endpoint was agreement between echocardiography withAI-700 and nuclear stress tests. Agreement was defined as the percentageof subjects who received the same diagnosis using AI-700 enhancedechocardiography as with nuclear stress. At the optimal imaging conditionsidentified during the trial, we met the primary endpoint of this trial.

*The “21”Trial.**  *Ourobjectives in our second Phase 2 clinical trial, the “21” trial, were toevaluate the safety and diagnostic efficacy of AI-700 in patients withsuspected or confirmed coronary heart disease as well as in healthy subjects.The study included 122 subjects, was conducted by echocardiologists andutilized a variety of commercially available ultrasound equipment platforms andimaging techniques. A variety of doses of AI-700 were evaluated in thetrial. Patients enrolled in the “21” trial received two injections of AI-700,one under resting conditions and the other under stressed conditions. Allpatients received a nuclear stress test and either a stress echo with AI-700or a stress echo without contrast. The primary efficacy analysis was based onthe ability of independent echocardiologists, blinded to all other information,to detect myocardial defects when comparing stress echo images to nuclearstress. In the “21” trial we met the primary efficacy endpoints, which  were sensitivity, or the ability to detectthe presence of disease, and specificity, or the ability to determine theabsence of disease.

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*Efficacy data.**  *Comparison of stress echo with AI-700and nuclear stress for subjects in our Phase 2 trials indicated the following:

·       *Stress echo with AI-700 versus stress echo without contrast.  *Stressecho with both low and high doses of AI-700 resulted in a greater than30% increase in sensitivity compared to stress echo without contrast, anddemonstrated a higher level of agreement with nuclear stress tests versusstress echo without contrast.

·       *Stress echo with AI-700 versus the nuclear stress test.  *Stressecho with both low and high doses of AI-700 agreed with nuclear stresstests in more than three-quarters of all patients.

·       *Stress echo with AI-700 versus coronary angiography.  *Nuclearimaging does not always result in a correct diagnosis of coronary heartdisease. The generally agreed gold standard for the diagnosis of coronary heartdisease is coronary angiography. In a retrospective exploratory analysis ofthose patients that underwent coronary angiography, stress echo with AI-700had the same sensitivity as nuclear stress tests when compared to coronaryangiography.

*ThePhase 3 Program: Detection of Coronary Heart Disease in Patients BeingEvaluated for Ischemic Heart Disease.*   Our Phase3 program for AI-700 commenced in 2003 under a U.S. Investigational New Drugapplication and in compliance with applicable European regulatory requirements.The Phase 3 clinical plan provides for a two-part program consisting of a pilotphase (the “pilot study”), under which new investigators and blinded readershave been qualified and trained, and two independent multi-center pivotaltrials (the “32” and “33” trials). Clinical investigators were qualified in thepilot phase on a rolling basis. The pilot phase was completed in 2005, afterwhich more than 20 clinical investigators were qualified to enroll patients inthe pivotal studies. Clinical investigators in the Phase 3 pivotal studies arelocated at clinical sites in North America, Europe and Australia.  Data from the Phase 3 pivotal studies areintended for submission to U.S., European, and potentially other regulatoryauthorities. 

*ThePilot Study.*   Our objectives in the pilot studywere to train and qualify a sufficient number of clinical sites, investigatorsand blinded readers for transition into one of the two pivotal trials. Theseobjectives have been accomplished and enrollment in this trial is completed.Clinical sites that were trained in the pilot study transitioned into a pivotaltrial when, in our judgment, the clinical site demonstrated that it wasprepared to meet the requirements of the clinical trial protocol. Because thepilot study has been conducted for training purposes, there are no definedclinical efficacy endpoints in this study. 

*ThePivotal Trials.**  *As partof the Phase 3 pivotal study design, the evaluation of AI-700 enhanced stressecho and nuclear stress images from the pivotal trials is performed by blindedreaders who receive no information about the patient being evaluated other thanthe images. We have completed blinded reads on more than half the currentlyenrolled patients in each of the 32 and 33 trials. During the pivotal trials,we intentionally have no access to efficacy data. We do not expect to publiclydisclose results from either pivotal trial until after the trial is closed,quality control checks are completed, the database is locked, the data arerevealed to us and we have had an opportunity to review and understand thedata, including data regarding clinical outcomes and safety results. As of thedate of this annual report, over 700 patients with known or suspected coronaryheart disease have been enrolled in the Phase 3 pivotal trials, including over300 patients in each of the two concurrently run pivotal studies. We usestatistical models to predict the number of patients we need in each trial tobe able to reach statistical significance. The estimates and assumptions thatwe are using in our statistical models are primarily derived from our prior clinicalstudies. Based upon these estimates and assumptions and our statisticalanalysis plan, we believe that the number of patients that we have enrolled ineach of the pivotal studies may be sufficient to achieve statisticalsignificance in these trials.   

*The“32” Trial.*   All of the patients enrolled in thistrial receive a stress echo study with AI-700 and a nuclear stress test.Patients in this pivotal trial generally undergo coronary angiography only ifthey have a 

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positive nuclear stresstest result. Patients in this pivotal trial who have a negative nuclear stresstest result will be evaluated for ninety days thereafter for cardiac events.The primary endpoints of the 32 trial are sensitivity and specificity relativeto a truth standard, in comparison to the performance of nuclear stress testingrelative to the same truth standard.  Thetruth standard for both modalities is determined with angiography, wheneveravailable, or coronary heart disease status with nuclear stress if angiographicdata are unavailable.  In December 2005,we ceased enrollment of patients in the 32 trial. In March 2006, we announcedto the clinical sites that we have completed enrollment in this trial. We havenow completed the 90-day follow up period on patients enrolled in this trial.We anticipate making a public announcement regarding the 32 trial resultsbefore the end of the second quarter of 2006.

*The“33” Trial.**  *All ofthe patients enrolled in this trial receive a stress echo study with AI-700 andundergo coronary angiography. The majority of patients, but not all, will havea nuclear stress test. All patients in this trial will be evaluated for up tothirty days following the stress echo study.  The primary endpoints of the33 trial are sensitivity and specificity, relative to a truth standard, incomparison to nuclear stress testing, with angiography as the truth standardfor both modalities.  As of the date of thisannual report, and in accordance with the flexibility permitted by our studyplan, we are continuing to enroll patients in the 33 trial and anticipatecontinuing to enroll patients until the end of Q2 2006. We believe that we cancontinue to enroll patients in the 33 trial through Q2 2006 without delayingour NDA filing date as we project that qualification of our commercialmanufacturing facility is the rate-limiting factor to our NDA filing.  Our clinical plan, unless otherwise amended,permits us to enroll approximately 450 patients in this study.  Once enrollment is closed in this trial andall angiography procedures and the 30-day patient follow-up period arecompleted, we will conduct quality control checks to ensure that all of therequired information has been fully gathered and filed and then lock thedatabase. At that time, the data may be unblinded and available to Acuspherefor analysis. We anticipate that this quality control period should becompleted within three months of completing the angiography procedures and thepost-enrollment follow-up period and that we will have unblinded data from thistrial during the fourth quarter of 2006. We anticipate making a publicannouncement regarding the trial results during the fourth quarter of 2006.

*TrialDesign and Purpose.*   We believe that stress echowith AI-700 has the potential to significantly reduce the time, cost andresources needed in the assessment of myocardial perfusion, compared to nuclearstress testing. Myocardial perfusion is blood flow to the heart muscle, asensitive marker for coronary heart disease.  There is no ultrasoundcontrast agent approved by FDA for use in stress echo or myocardial perfusionimaging. Based upon the end points described above, our 32 and 33 trials aredesigned to demonstrate non-inferiority of stress echo with AI-700 relative tonuclear stress testing. In April 2005, based in part upon feedback from FDA, werevised the statistical analysis plan on which we base our patient enrollmentestimates for the AI-700 Phase 3 clinical trials. Since that time we havecontinued discussions with the FDA regarding trial design and our statisticalanalysis plan.  As a result of ourongoing discussions with FDA, we may make further revisions. These discussionscould lead to delays in the public announcement of the results from our Phase 3clinical trials, change our sample size estimates and affect whether AI-700 isapproved for the indication that we are seeking, the timing of such approval orwhether AI-700 is approved at all. 

The estimates of, patient enrollment requirements andtiming of clinical enrollment, blinded reads, data lock, data release and NDAfiling in our Phase 3 trials described above reflect our currentassumptions, based on our knowledge and experience and the guidance of ouradvisors.  We cannot assure you that these timelines will be met, nor canwe assure you that our estimates and assumptions will not change based uponongoing regulatory feedback or that, when the trials are completed, we will successfullyachieve results that meet or exceed the clinical endpoints of these Phase 3trials.

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*Safety Data.*   During our AI-700clinical studies we have intentionally sought to identify and evaluate alladverse experiences. Any change in how the patient feels after injection ofAI-700 is considered an adverse event. Adverse events are recorded in thesestudies whether or not attributable to AI-700. The adverse experiences observed in our trials have been typically mildin intensity and of short duration.  Thevast majority of people exposed to AI-700 are cardiac patients who areundergoing a stress study and have a pre-study history of chest pain.  Stress echo procedures require stressing theheart through exercise or pharmacologically induced stress.  For purposes of control and consistency ofdata between studies, pharmacologically induced stress was used with allpatients enrolled in the pilot study. 

Many of the adverse eventsobserved in our clinical studies have been consistent with the type of adverseevents associated with the pharmacological stressor. While certain of theseadverse events appear to be attributable to causes other than AI-700 and someto AI-700, the attribution of many of these events is not definitive. The mostprevalent of these observations have been headache, facial flushing and nausea.We have enrolled 393 subjects in the Phase 1, Phase 2 and pilot studies. Inthese studies, one of the observed adverse events was characterized as aserious adverse event (“SAE”), which definition includes any adverse event thatresults in a patient remaining in the hospital overnight for observation. Therewas no residual effect from this event.  

The safety of our clinicalstudies is monitored by an independent third party advisor and all adverseevents are reported to investigators, institutional review boards andregulatory agencies on a periodic basis.  We intend to continue to studythe safety profile of AI-700. While we do not comment on data from ongoing clinicaltrials, based upon observations to date, we believe that AI-700 is generallywell tolerated.  However, there can be no assurance that we will notexperience other adverse events in our clinical trials or that regulatoryauthorities will conclude that AI-700 is safe for approval and broader use.

*Future Indications.**  *Since AI-700 circulates inthe blood and acts as a tracer of blood flow, we believe it has the potentialto assist in the assessment of a wide variety of diseases in addition tocoronary heart disease. Abnormal blood flow is associated with several lifethreatening diseases including various forms of cancer, renal artery stenosisand deep vein thrombosis. These diseases often cannot be adequately assessedwith ultrasound imaging without contrast, and as a result radiologistscurrently detect these diseases with more expensive imaging techniques, such ascomputerized tomography, angiography, nuclear medicine and venography.Ultrasound imaging using AI-700 may offer a cost-effective alternative tothese expensive techniques.

***Products from OurHydrophobic Drug Delivery System, or HDDS***

*Broad Applications for the Delivery of Hydrophobic Drugs.*  We have developed a proprietary formulationtechnology called HDDS that converts drugs that do not dissolve well in water,or hydrophobic drugs, into microparticles or nanoparticles of the drugsembedded in small microparticles, such that the drugs can rapidly dissolve inwater. Formulation of hydrophobic drugs is often challenging. Since the humanbody is primarily composed of water, hydrophobic drugs do not dissolve well inthe body, which can limit the effectiveness of these drugs. Many promisingdrugs never make it to market because they are difficult to dissolve. Drugprograms are often abandoned after significant investment because suitableformulations for these insoluble drugs are elusive. Many hydrophobic drugs thatdo make it to market have less than ideal formulations. Developing intravenousformulations of hydrophobic drugs is particularly challenging. Intravenousformulations of drugs can open new markets for drugs like antibiotics thatcould often be initially prescribed in a hospital setting. In addition,intravenous formulations can expand the market for the oral dosage formulationbecause physicians typically prefer to discharge patients on the oralformulation of the intravenous formulation administered to the patient in thehospital.

*Market for Hydrophobic Drug Delivery.*  We believe that FDA-approved hydrophobicpharmaceuticals generated $176 billionin revenues in 2004 and thatother potential drugs have not achieved FDA approval due to issues associatedwith effectively dissolving these drug candidates.

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*Current Practice.*  Many hydrophobic drugs are comprised of particles that are relativelylarge and therefore have a limited surface area available for interaction withwater. These hydrophobic drugs are often formulated in less than ideal ways inorder to make them dissolve. It is possible to increase the dissolution rate ofsome hydrophobic drugs by increasing their aggregate surface area. Toaccomplish this, many pharmaceutical companies use a process calledmicronization, which entails grinding hydrophobic drugs into smallermicroparticles. However, the drug particles produced by micronization are oftenstill not small enough to adequately improve dissolution, or to be administeredintravenously. Alternatively, oils like Cremophor® are used to dissolve thedrugs. However, these oils are often not well tolerated and can requireprolonged infusion rather than rapid injections to minimize potential sideeffects. In addition, some hydrophobic drugs can be formulated into softgelatin capsules, but these are only suitable for oral administration andencapsulate only a small volume of drug, requiring the administration of manycapsules. Sometimes development of these drugs must be terminated because nosuitable formulation can be found.

*Our Solution: Rapidly Dissolving Sponge-Like Particles.*  We have demonstrated that our HDDS technologyimproves the dissolution rate of a variety of hydrophobic drugs. HDDS hasachieved up to 30-fold increases in the dissolution rate of a variety ofhydrophobic drugs. HDDS has produced drug formulations that are well-toleratedin pre-clinical studies and we believe would be suitable for all routes ofadministration, without resorting to the use of unsafe or unproven additives toformulate the drug.

*AI-850, Human Proof of HDDS Concept.*  AI-850, our initial product candidate utilizingour HDDS technology, is a readily dissolving formulation of the hydrophobicdrug, paclitaxel, the active ingredient in the cancer drug, Taxol®. To dissolvepaclitaxel, Taxol® contains Cremophor®, which is believed to cause severehypersensitivity reactions, including an extreme allergic reaction calledanaphylaxis. Therefore, Taxol® is typically administered using pre-medicationsand by long infusions to patients with cancer. By putting paclitaxel into oursponge-like microparticles, we have created a paclitaxel formulation that isfree of Cremophor®. Despite what we believe is a less than ideal formulation,Taxol® had worldwide revenues of $747 million in 2005 and represents anexample of a hydrophobic drug which we believe our HDDS technology can improve.

*Product Development Status.*  Our Phase 1 human safety study of AI-850 wascompleted during 2004. The primary goal of the study was to provide humanproof-of-concept that our Hydrophobic Drug Delivery System (HDDSTM) is capableof intravenously delivering hydrophobic drugs without the need for co-solventsthat are inconvenient to administer and are associated with undesirable sideeffects. The primary objective of this trial was to determine the maximumtolerated dose (“MTD”) of AI-850. In the dose escalation study, 22patients with solid tumors (taxane naïve patients and patients who previouslyhad received taxane therapy) were treated with AI-850 without standardtaxane pre-medications in doses up to 250 mg/m2. Infusions of AI-850 were delivered in less than 30 minutes atall doses, which is significantly shorter that the three-hour infusiontypically required by Taxol®. The MTD of AI-850 for patients withextensive prior taxane therapy was 205 mg/m2, which is higher than the Taxol® dose of 175 mg/m2 typically used to treat taxanenaïve patients with metastatic breast cancer. It is our current plan to seekstrategic collaborators for AI-850 before commencing additional clinicaltesting of this product candidate.

*Future Hydrophobic Drug Delivery Product Candidates.*  In addition to the human data generated in the AI-850Phase 1 trial, we have demonstrated that our HDDS technology improves thedissolution rate of a variety of orally administered, intravenouslyadministered and inhaled hydrophobic drugs, including COX-2 inhibitors,taxanes, calcium channel blockers and anti-fungals. We will seek opportunitiesto work with other companies on improving their patented hydrophobic drugs andproduct candidates and we will evaluate the feasibility of developing, on ourown or in collaboration with others, improved formulations of off-patenthydrophobic drugs.

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***Products from OurPulmonary Drug Delivery System, or PDDS***

*BroadApplications for Sustained Release in the Lung.   *Asustained release delivery system for drugs delivered locally to the lung wouldbe desirable for the treatment of respiratory disease. Relative to systemicdrug delivery by the oral or injectable routes, local delivery of respiratorydrugs by the pulmonary route allows smaller doses of the drug and minimizessystemic toxicity because the drug can be delivered directly to the site of thedisease. Moreover, sustained release of respiratory drugs may offer significantclinical benefit to millions of respiratory patients, including a growingpercentage of pediatric patients, by allowing them to take treatments for suchdiseases as asthma less frequently, and to receive more prolonged and steadierrelief. We believe sustained delivery of drugs to the lung also offers thepotential for improved safety, by moderating the drug peaks and troughs ofimmediate release drugs, which can cause added toxicity or reduced efficacy.Our initial development efforts have focused on developing sustained releaseformulations of asthma drugs. The worldwide asthma therapeutics market  is estimated at over $12.0 billion in 2005. Webelieve the delivery of long-acting drugs to the lungs represents a significantmedical opportunity.

*Current Practice.*  Current pulmonary delivery systems are not ideal, delivering inaccuratedoses, requiring frequent dosing and losing significant amounts of drug in thedelivery process. Most asthma drugs delivered by inhalation are immediaterelease formulations that must be inhaled multiple times per day, whichdiscourages patient compliance. When patients forget to take their medicineduring the day, they may experience complications which may result in increasedemergency room visits and hospitalizations. In a recent study, two thirds ofall asthma patients did not take their medications as directed. In addition,immediate release formulations often deliver drug levels that peak and trough,causing undesirable toxicity or inadequate efficacy.

*Our Solution: Slowly Dissolving Whiffle Ball-Like Microparticles.*  By controlling particle size, particle porosity andthus density, and particle composition, and therefore the aerodynamicproperties of a particle, our PDDS technology controls where drug particles goin the lung and how quickly they release their drug. This tight control ofrelease rate, and targeting within the lungs, may enable our PDDS technology toaddress many of the hurdles of sustained release pulmonary delivery.

*AI-128, Our Improved Formulation of an Asthma Drug.* AI-128 is our initial product candidateutilizing our PDDS technology. AI-128 is a sustained release, dry powderformulation of a widely used asthma drug. We believe that AI-128 is thefirst human demonstration of sustained release drug administration in the lung.

*Potential Benefits over Approved Formulations.*  With once-a-day dosing, we believe AI-128 wouldbe more convenient for the patient, reducing non-compliance relatedcomplications and costs. By controlling the release rate of the drug to thelung, AI-128 offers the potential for improved safety. Slowing drugrelease in the lung offers the potential for a lower peak concentration of drugin the systemic circulation.

*Clinical Results.*  We completed a European Phase 1 clinical trial with AI-128. Thestudy was conducted in accordance with applicable local regulatoryrequirements. In this trial, we demonstrated that approximately 80% of inhaledAI-128 was delivered to the intended target, the upper lung. These trialsalso demonstrated that the microparticles remained in the lung for up to24 hours, the period of time that we believe is required for once-dailydosing, and that the drug was released from the microparticles in the lung overa 12 to 24-hour period.

*Future Applications.*  We believe our PDDS technology may enable improvedformulations of other locally acting asthma drugs as well as allow drugs thatmust be delivered into the bloodstream for systemic therapy to be administeredby inhalation through the lung. We have demonstrated in pre-clinical studiesthat we can create sustained release, dry-powder reformulations of drugscurrently used to treat respiratory disease. We believe that one or more ofsuch reformulations could have many of the benefits AI-128 potentiallyoffers. Moreover, many large molecule drugs, such as proteins, cannot bedelivered orally because they are destroyed by enzymes in the gastrointestinalsystem. As a result, they often must be 

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*injectedsubcutaneously or intramuscularly several times per week in order to get anadequate amount of the drug into the body’s general circulation. Since the lungdoes not contain these destructive enzymes, systemic delivery of these drugsvia the pulmonary route could be more convenient and require less dosing. Weplan to seek both proprietary and collaborative opportunities for these drugformulations.*

**Research andDevelopment**

Over the past three fiscalyears, we have made material expenditures on research and development. In thefiscal years ending December 31, 2003, 2004, and 2005, research anddevelopment expenses were approximately $14.8 million, $26.0 millionand $42.2****million, respectively.

**OurProprietary Microparticle Technology**

Microparticles are usefulin the delivery of a wide range of drugs. Suitability of microparticles for usein pharmaceuticals depends on a variety of factors, including size andporosity. Smaller microparticles have a broader range of utility, such asintravenous and pulmonary delivery applications. Depending on the targeted siteand desired route of delivery, drug delivery technologies utilizemicroparticles of various sizes. Our porous microparticle technology enables usto produce very small microparticles that are smaller than a red blood cell andwith a wide range of porosities.

***Microparticle Size***

Large microparticles aremicroparticles over 100 microns in size. Large microparticles are used todeliver drugs through relatively large orifices, like the mouth (oraldelivery). Large microparticles have been used in the delivery of bothimmediate and controlled release oral drug formulations. However, theseparticles cannot be delivered by injection, because they are too large to fitthrough a needle. In addition, they are unsuitable for delivery via thepulmonary route, because larger particles tend to get caught in the back of thethroat when inhaled. For these reasons, the use of large microparticles isgenerally limited to oral administration.

Medium microparticles aremicroparticles between 10 and 100 microns in size. These particles are smallenough to fit through a needle, and therefore are suitable for injectionsubcutaneously, which is under the skin, or intramuscularly, which is into themuscle. These microparticles have been used primarily to deliver drugs, whichcannot be delivered orally because they are destroyed in the gastrointestinalsystem. However, medium microparticles cannot be injected intravenously becausethey are too large to fit through the body’s smallest blood vessels, orcapillaries, and like large microparticles, are unsuitable for delivery via thepulmonary route.

Small microparticles aremicroparticles smaller than 10 microns, which is approximately the size of ahuman red blood cell. Small microparticles include nanoparticles, which areparticles smaller than 1 micron. Small microparticles are small enough to passthrough the capillaries for intravenous delivery; are small enough to bereadily inhaled for pulmonary delivery; and have more total surface area perunit of weight relative to larger microparticles, making them a particularlyefficient method for delivering hydrophobic drugs. Intravenous delivery isdesirable in a hospital setting to ensure that the drug is fully bioavailable,or that the entire drug dose is absorbed by the body. Intravenous delivery isalso used for drugs that must be injected but with a dose too high forintramuscular or subcutaneous delivery. Drugs are also administeredintravenously, or directly into the blood, to act as tracers of blood flow,since abnormal blood flow is associated with many life threatening diseases.Therefore, small particles have many potential applications, including use asultrasound contrast agents, as delivery systems for hydrophobic drugs, and asdelivery vehicles for asthma drugs.

***MicroparticlePorosity***

The ability to vary theporosity of microparticles on a consistent basis can be critical to thesuccessful use of microparticles in pharmaceutical products. For instance, inultrasound contrast imaging, we believe it is advantageous to usemicroparticles that are highly porous on the inside but with limited porosityin the 

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shell.Porosity on the inside of microparticles enables them to contain more of theactive ingredient, which is gas, than particles that are dense. Limitingporosity in the shell prevents gas leakage and enables the retention of the gasinside the particle. Furthermore, pores can facilitate absorption of water intoa microparticle, which is useful in getting hydrophobic drugs to dissolve morequickly, and useful for controlling the release of a drug from a sustainedrelease system. Finally, in drug delivery to the lung, it is advantageous touse microparticles of various porosities, which controls density, because thesize and density of the microparticles dictates where in the lung they will bedelivered.

***MicroparticleProduction Using Spray Drying***

We believe the use ofsmall, porous microparticles has not reached its full potential in the deliveryof drugs. We believe that current manufacturing processes for creating smallmicroparticles have low yields, have not been adapted for use withencapsulating materials like synthetic polymers, have low encapsulationefficiency and are difficult to combine with other technologies, such ascoating technologies. We believe that the use of porosity to improve drugformulations has been underutilized because an efficient process for creatingporous microparticles at commercial scale did not exist. Our porousmicroparticle technology was designed to address the limitations of existingmanufacturing processes.

Spraydrying is a production technique widely used in the pharmaceutical industrybecause it is a single-step, continuous process. However, standard spraydrying:

·       *Produces solid microparticles* rather than the porousmicroparticles, which are required for ultrasound contrast imaging and may bebeneficial for hydrophobic and pulmonary drug delivery.

·       *Does not completely remove* moisture from the microparticles,contributing to low yields and making standard spray drying uneconomic for theproduction of drugs made from expensive raw materials.

·       *Results in relatively high levels of residual solvents*,which can be problematic for the stability and safety of the drug.

·       *Often operates at high temperatures*, making it difficult touse with drugs that are unstable at higher temperatures.

·       *Is not well-suited to sterile, or aseptic, processing*, whichis required for most intravenously administered drugs and is beneficial forpulmonary-delivered drugs.

Our proprietary porousmicroparticle technology platform consists of two key components—amulti-chamber spray dryer and pore-forming agents.

***Our Patented SprayDryers***

Webelieve we have overcome the limitations of standard spray drying in producingsmall microparticles and nanoparticles through patented equipment innovationsthat:

·       *Remove nearly all residual solvents such as moisture* fromthe microparticles because our patented spray dryer increases the length oftime the microparticles are dried.

·       *Can be operated at low or high temperatures*, due toincreasing the drying time used for microparticles produced at lowertemperatures, and reducing the drying time for microparticles produced athigher temperatures.

·       *Are well suited to aseptic processing* by using steamsterilization techniques and a positive pressure system, thereby minimizing thecontaminants pulled into the spray dryer from the surrounding environment.

We have improved thedrying capability of standard spray dryers by adding additional drying chambersthrough which the microparticles travel. The additional drying chamber consistsof a large, narrow coil through which the particles can be dried at multipletemperatures and at high linear gas velocities. As a result, our spray dryersallow high throughput drying, higher yield and lower residual solvent thanconventional spray dryers do. The additional drying chamber allows themicroparticles to 

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remainin the drying phase for a longer period of time, thereby increasing the amountof moisture and residual solvents that are removed during the drying phase.This innovation, which is the subject of six of our issued patents, improvesyield by reducing the amount of microparticles that cling to the surfaces ofthe spray dryer due to inefficient drying. Accordingly, we believe that thistechnology is appropriate for the encapsulation of drugs using expensive rawmaterials. This innovation enables us to increase the drying time and lower thedrying temperature for drugs. Accordingly, we believe this technology isappropriate for the encapsulation of drugs, like proteins, which are unstableat higher temperatures.

In order to producemicroparticles and nanoparticles to be used in drugs delivered intravenously,the particles must be produced aseptically. We have improved standard spraydryers by making them suitable for aseptic processing. Our spray dryers operateunder positive pressure, minimizing the risk of pulling contaminants into theprocess from the surrounding environment. In addition, our spray dryers arecomposed of stainless steel and Teflon components to mitigate against sheddinginto the product during processing, and can be sterilized using steamsterilization techniques.

We have made theseimprovements to standard spray drying processes and equipment without alteringthe fundamental advantages of standard spray drying. Like standard spraydryers, our spray dryers enable a single-step, continuous process that isefficient in encapsulating up to 100% of the active ingredient, and can be usedwith either synthetic or natural materials.

***Our PatentedPore-Forming Agents***

We have developed apatented process technology for creating porous microparticles. To create poresin our microparticles we add pore-forming agents to the solution before we putit through the spray dryer. These pore-forming agents create bubbles, similarto the bubbles in carbonated beverages. These bubbles are formed while thesolution is being converted into a microparticle in the spray dryer. Thebubbles create pores in the microparticle and the pore-forming agents areremoved during the drying process. We can vary the number and size of the poresby varying the amount of pore-forming agents we add to the process. In this waywe can design microparticles that are porous or sponge-like.

**Reimbursement**

We intend to focus onobtaining coverage and reimbursement from Medicare, Medicaid and privateinsurers for our product candidates. Although there can be no assurance that wewill be successful in obtaining third-party reimbursement, we believe we willbe successful in obtaining this reimbursement for our lead product candidate,AI-700.

Effective January 2001,the Centers for Medicare and Medicaid Services, formerly known as the HealthCare Financing Administration, implemented a reimbursement code that providesfor reimbursement for the use of injectable contrast material inechocardiography in a physician’s office and hospital outpatient setting.Currently, the reimbursed rate for each of the three ultrasound contrast agentsFDA-approved for use in LVO and EBD in patients with suboptimal images is over$100 per vial. Although private insurers make their own decisions onreimbursement, they typically follow the lead of the Centers for Medicare andMedicaid Services, which manage reimbursement for Medicare and Medicaid.

We plan to apply for a newreimbursement code at a higher rate. We believe ultrasound imaging using AI-700for myocardial perfusion assessment, which involves dosing of patients for aresting echo study followed by a second dose for a stress echo study, willprovide at least the same clinical information as nuclear stress tests (whichalso requires dosing for a rest study followed by dosing for a stress study),but at much lower total study cost, due in part to higher capital equipmentcosts, longer procedure times and radioactive material handling issuesassociated with nuclear stress tests. Given these expected cost advantages, webelieve that AI-700 will ultimately obtain adequate reimbursement in thisera of managed care, where the federal government and private insurers arestriving to lower the total cost of delivering state-of-the-art healthcare.Further, in the treatment of hospital inpatients, who are usually subject to afixed total reimbursement based solely on their diagnosis and not on the testused, we expect that hospital staffs will be encouraged to use the much lowercost ultrasound test with AI-700, if and when it is approved 

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by FDA,rather than the more expensive nuclear test. Our efforts to obtain a higherreimbursement rate can begin prior to our product’s approval and will probablyrequire about two years for completion. The current reimbursement codes coverhospital outpatient and physician offices, which are the locations where almostall stress echoes are performed. In the period immediately following thepotential launch of our product, we believe that the current reimbursementrates for ultrasound contrast agents should enable us to sell our product atattractive margins.

**Manufacturing**

In July 2004, weentered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in 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-700at a commercial manufacturing scale prior to our filing of a NDA for AI-700and, subject to required regulatory approvals, we intend to manufacture AI-700in this facility for commercial use. This commercial manufacturing facilitymust comply with current good manufacturing practices, or cGMPs, enforced bythe FDA and overseas regulatory agencies. We have identified potential primaryand secondary suppliers of the raw materials used in the production of AI-700.

In October 2005, wereceived an occupancy permit for this commercial manufacturing facility uponwhich operations commenced on site. By the end of October 2005, most ofthe procured manufacturing equipment had been subject to start-up activities andwere placed in service. The build-out of the facility is substantiallycomplete, with minor items remaining to be addressed by the contractor. Ourprimary efforts at this facility are currently directed at the substantial workrequired to qualify equipment and operations in compliance with cGMP’s. Completionof such qualification includes significant testing and documentation, includingproduct storage stability studies. It also requires that we successfullydemonstrate that we can produce AI-700 product within specificationswhich are consistent with the clinical trial material used in our Phase 3clinical program. We have demonstrated previously that we can produce AI-700in a qualified manner. We need to repeat this demonstration in our commercialmanufacturing facility prior to filing our NDA. Based upon our current plans,we expect to complete this qualification phase before the end of Q2 2007, afterwhich we will believe that we will have all of the manufacturing related datanecessary to file our NDA.

Although the build-out ofthe facility is substantially complete, we cannot assure you that we will notencounter complications in the qualification of operations in this facilitywhich complications could add additional costs or delay our filing of a NDA forAI-700.

In support of our effortsto qualify our commercial manufacturing facility for AI-700, in February 2006,the Company and Nycomed agreed to amend the 2004 strategic collaboration agreementresulting in commitment by Nycomed to accelerate $1.85 million in payments tothe Company in order to fund certain activities associated with thequalification of our manufacturing. Beginning with costs incurred in February 2006,we may begin to draw down on this $1.85 million non-refundable commitment at arate of up to $370,000 per month.

**Patentsand Proprietary Rights**

Our success depends inpart on our ability to obtain patents, to protect trade secrets, to operatewithout infringing the proprietary rights of others and to prevent others frominfringing our proprietary rights. Our policy is to seek to protect ourproprietary position by, among other methods, filing U.S. and foreign patentapplications related to our proprietary technology, inventions and improvementsthat are important to the development of our business.

Ourpatents include internally developed patents as well as patents acquired fromthird parties. As of March 16,2006, we owned twenty-nine  issued U.S.patents, one allowed U.S. patent and seventeen U.S. patent applications. Wecharge all patent-related expenses to operations as incurred. Six of our issued U.S. patents aredirected to aspects of the spray drying method for manufacturingmicroparticles. Four issued U.S.patents and eight U.S. patent applications are related to various aspects ofour porous microparticle 

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delivery technology. Five issued U.S. patents relate to aspects of the AI-850product and the delivery of hydrophobic drugs. We also own a number of pendinginternational and foreign patent applications corresponding to these U.S.patents and applications. Our issued U.S. patents include the following:

| ** ** | **U.S. Patent No.** | ** **                  | ** ** | **Date Issued**             | ** ** | **Expiration Date**                                                                                                                                                                                   | ** ** | **Subject** |
|------------|-------------------------------|-----------------------------|------------|-----------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|
| 5,425,366  |                          | June 20, 1995          |       | June 20, 2012          |       | Ultrasonic  Contrast Agents for Color Doppler Imaging                                                                                                                                                 |
| 5,611,344  |                          | March 18, 1997         |       | March 05, 2016         |       | Microencapsulated  fluorinated gases for use as imaging agents.                                                                                                                                       |
| 5,837,221  |                          | November 17, 1998      |       | July 29, 2016          |       | Polymer-lipid  microencapsulated gases for use as imaging agents.                                                                                                                                     |
| 5,853,698  |                          | December 29, 1998      |       | March 05, 2016         |       | Method for making  porous microparticles by spray drying.                                                                                                                                             |
| 6,045,777  |                          | April 04, 2000         |       | June 30, 2017          |       | Method for  enhancing the echogenicity and decreasing the attenuation of  microencapsulated gases.                                                                                                    |
| 6,068,857  |                          | May 30, 2000           |       | August 25, 2014        |       | Microparticles  Containing Active Ingredients, Agents Containing these Microparticles, their  use for Ultrasound-Controlled Release of Active Ingredients, as well as a  Process for their Production |
| 6,071,496  |                          | June 06, 2000          |       | June 06, 2017          |       | Polyalkylcyanoacrylate  Agents and Methods for Enhancing Contrast in Ultrasound Imaging                                                                                                               |
| 6,132,699  |                          | October 17, 2000       |       | March 05, 2016         |       | Microencapsulated  fluorinated gases for use as imaging agents.                                                                                                                                       |
| 6,177,062  |                          | January 23, 2001       |       | June 6, 2017           |       | Agents and Methods  for Enhancing Contrast in Ultrasound Imaging                                                                                                                                      |
| 6,223,455  |                          | May 01, 2001           |       | May 03, 2019           |       | Spray drying  apparatus and methods of use.                                                                                                                                                           |
| 6,284,280  |                          | September 04, 2001     |       | August 25, 2014        |       | Microparticles  Containing Active Ingredients, Agents Containing these Microparticles, their  use for Ultrasound-Controlled Release of Active Ingredients, as well as a  Process for their Production |
| 6,306,366  |                          | October 23, 2001       |       | February 10, 2015      |       | Microparticles  that Contain Gas, Galactose and a Saturated Fatty Acid                                                                                                                                |
| 6,308,434  |                          | October 30, 2001       |       | May 03, 2019           |       | Spray dry method.                                                                                                                                                                                     |
| 6,383,470  |                          | May 07, 2002           |       | November 11, 2013      |       | Microparticle  Preparations Made of Biodegradable Copolymers                                                                                                                                          |
| 6,395,300  |                          | May 28, 2002           |       | November 04, 2019 |       | Porous drug  matrices and method of manufacture.                                                                                                                                                      |
| 6,423,345  |                          | July 23, 2002          |       | February 22, 2019      |       | Lipid polymer  compositions for enhanced drug delivery.                                                                                                                                               |
| 6,560,897  |                          | May 13, 2003           |       | June 15, 2019          |       | Spray drying  apparatus and methods of use.                                                                                                                                                           |
| 6,589,557  |                          | July 08, 2003          |       | November 04, 2019      |       | Porous celecoxib  matrices and methods of manufacture.                                                                                                                                                |
| 6,610,317  |                          | August 26, 2003        |       | May 25, 2020           |       | Porous paclitaxel  matrices and methods of manufacture thereof.                                                                                                                                       |
| 6,645,528  |                          | November 11, 2003 |       | November 11, 2019 |       | Porous drug  matrices and methods of manufacture thereof.                                                                                                                                             |
| 6,689,390  |                          | February 10, 2004      |       | February 22, 2019      |       | Matrices Formed of  Polymer and Hydrophobic Compounds for Use in Drug Delivery.                                                                                                                       |
| 6,730,322  |                          | May 04, 2004           |       | February 22, 2019      |       | Matrices Formed of  Polymer and Hydrophobic Compounds for Use in Drug Delivery.                                                                                                                       |
| 6,800,297  |                          | October 05, 2004       |       | November 04, 2019      |       | Porous COX-2  Matrices and Methods of Manufacture Thereof                                                                                                                                             |
| 6,918,991  |                          | July 19, 2005          |       | December 19, 2022      |       | Methods and  Apparatus for Making Particles Using Spray Dryer and In-Line Jet Mill                                                                                                                    |
| 6,921,458  |                          | July 26, 2005          |       | December 19, 2022      |       | Methods and  Apparatus for Making Particles Using Spray Dryer and In-Line Jet Mill                                                                                                                    |
| 6,932,983  |                          | August 23, 2005        |       | July 9, 2021           |       | Porous Drug  Matrices and Methods of Manufacture Thereof                                                                                                                                              |
| 6,962,006  |                          | November 08,  2005     |       | December 19,  2022     |       | Methods and Apparatus for  Making Particles Using Spray Dryer and In-Line Jet Mill                                                                                                                    |

 

In May 2005, pursuant to a Patent TransferAgreement with Schering, we acquired from Schering rights, title and interestin nine patent families, including U.S. and international ultra-sound relatedpatents, and licenses to two other patent families. In consideration of thetransfer and assignment of these patents, we agreed to pay Schering a total of$7.0 million of which $1.0 million was paid in May 2005, $3.0 million isdue in May 2006, and $3.0 million is due in May 2007.

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Our planned and potential products should be protectedfrom unauthorized use by third parties to the extent that they are covered byvalid and enforceable patents or are effectively maintained as trade secrets.Patents owned by or licensed to us may not afford protection againstcompetition, and our pending patent applications now or hereafter filed by orlicensed to us may not result in patents being issued. In addition, the laws ofsome foreign countries may not protect our intellectual property rights to thesame extent as the laws of the United States.

The patent positions of companies like ours involvecomplex legal and factual questions and, therefore, their enforceability cannotbe predicted with certainty. Our patent applications may not issue as patents.Our issued patents and those that may issue in the future, or those licensed tous, may be challenged, invalidated or circumvented, and the rights grantedthereunder may not provide us proprietary protection or competitive advantagesagainst competitors with similar technology. Furthermore, our competitors mayindependently develop similar technologies or duplicate any technologydeveloped by us. Because of the extensive time required for development,testing and regulatory review of a potential product, it is possible that,before any of our products can be commercialized, any related patent may expireor remain in force for only a short period following commercialization. Patentexpiration could adversely affect our ability to protect future productdevelopment and, consequently, our operating results and financial position.

Because patent applications in the United States andmany foreign jurisdictions are typically held in secret and not published untileighteen months after filing, we cannot be certain that we were the first tofile for protection of the inventions set forth in these patent applications.Because publications of discoveries in the scientific literature often lagbehind actual discoveries, we cannot be certain that we were the first to makethe inventions claimed in each of our issued or pending patent applications.

Our planned or potential products may be covered bythird-party patents or other intellectual property rights, in which case we mayneed to obtain a license or sublicense to these rights to continue developingor marketing these products. Although from time to time we receivecorrespondence from and have discussions with third-parties concerning thepatent position of such third-parties, as of the date of this prospectus wehave not received correspondence from any third-party alleging infringement.Any required licenses or sublicenses may not be available to us on acceptableterms, if at all. If we do not obtain any required licenses or sublicense, wecould encounter delays in product introductions while we attempt to designaround these patents, or could find that the development, manufacture or saleof products requiring these licenses is foreclosed.

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. Based on advice from our patent counsel, we believe that theseclaims are not infringed and/or invalid. Absent a license or other businessarrangement, there is a significant possibility that one or more of these thirdparties will use litigation to assert their patents in the United States orEurope.

The owners or licensees of these and other patents mayfile one or more infringement actions against us. Any such infringement ormisappropriation action could cause us to incur substantial costs defending thelawsuit and could distract our management from our business, even if theallegations of infringement or misappropriation are unwarranted. The defense ofmultiple claims could have a disproportionately greater impact. In addition,either in response to or in anticipation of any such infringement ormisappropriation claim, we may enter into commercial agreements with the ownersor licensees of these rights. The terms of these commercial agreements mayinclude substantial payments, including substantial royalty payments onrevenues received by us in connection with the commercialization of ourproducts. These payments could increase our operating losses and reduce ourresources available for development 

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activities. Furthermore, aparty making this type of claim could secure a judgment that requires us to paysubstantial damages, which would increase our operating losses and reduce ourresources available for development activities. A judgment could also includean injunction or other court order that could prevent us from making, using,selling, offering for sale or importing our products or prevent our customersfrom using our products.

Litigation may be necessary to defend against orassert claims of infringement, to enforce patents issued to us, to protecttrade secrets or know-how owned by us, or to determine the scope and validityof the proprietary rights of others. In addition, interference proceedingsdeclared by the U.S. Patent and Trademark Office may be necessary to determinethe priority of inventions with respect to our patent applications. Litigationor interference proceedings could result in substantial costs to and diversionof effort by us, and could have a material adverse effect on our business,financial condition and results of operations. These efforts by us may not besuccessful.

We may rely, in somecircumstances, on trade secrets to protect our technology. However, tradesecrets are difficult to protect. We seek to protect our proprietary technologyand processes, in part, by confidentiality agreements with our employees andcontractors. There can be no assurance that these agreements will not bebreached, that we will have adequate remedies for any breach, or that our tradesecrets will not otherwise become known or be independently discovered bycompetitors. To the extent that our employees, consultants or contractors useintellectual property owned by others in their work for us, disputes may alsoarise as to the rights in related or resulting know-how and inventions.

**Government Regulation**

***U.S. Regulatory Approval***

The FDA and comparable regulatory agencies in stateand local jurisdictions and in foreign countries regulate and imposesubstantial requirements upon the research, development, pre-clinical andclinical testing, manufacture, distribution, record keeping, reporting,storage, approval, advertising, promotion, sale and export of pharmaceuticalproducts. We believe that our products will be regulated as drugs by the FDA.

The processrequired by the FDA under the new drug provisions of the Federal Food, Drug andCosmetic Act before our products may be marketed in the United States generallyinvolves the following:

·       pre-clinicallaboratory and animal tests performed under the FDA’s Good Laboratory Practicesregulation;

·       developmentof manufacturing processes which conform to FDA-mandated cGMPs;

·       submissionand acceptance of an Investigational New Drug application, or IND, which mustbecome effective before clinical trials may begin in the United States;

·       adequateand well-controlled human clinical trials to establish the safety and efficacyof the product candidate in our intended use; and

·       FDAreview and approval of an NDA, prior to any commercial sale or shipment of aproduct.

The testing and approval process requires substantialtime, effort, and financial resources and we cannot be certain that anyapproval will be granted on a timely basis, if at all.

Pre-clinical tests include laboratory evaluation ofthe product candidate, its chemistry, formulation and stability, as well asanimal studies to assess the potential safety and efficacy of the productcandidate. The results of the pre-clinical tests, together with manufacturinginformation and analytical data, are then submitted to the FDA as part of anIND, which must become effective before we may begin human clinical trials.Pre-clinical tests and studies can take several years to complete, and there isno guarantee that an IND based on those tests and studies will become effectiveto permit clinical testing to begin. An IND 

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becomes effective30 days after receipt by the FDA, unless the FDA, within the 30-daytime period, raises concerns or questions about the conduct of the trials asoutlined in the IND and imposes a clinical hold. In this case, the IND sponsorand the FDA must resolve any outstanding concerns before clinical trials canbegin. Prior to initiation of clinical studies, an independent InstitutionalReview Board at each medical site proposing to conduct the clinical trials mustreview and approve each study protocol. Similar requirements exist in othercountries where we may choose to perform clinical trials.

Human clinicaltrials are typically conducted in three sequential phases that may overlap:

·       Phase1:    The drug is initially introduced into healthy humansubjects or patients and tested for safety and dosage tolerance. Absorption,metabolism, distribution and excretion studies are generally performed at thisstage.

·       Phase2:    The drug is studied in exploratory therapeutic trialsin a limited number of subjects with the disease or medical condition for whichthe new drug is intended to be used in order to identify possible adverseeffects and safety risks, to determine the preliminary or potential efficacy ofthe product for specific targeted diseases or medical condition and todetermine dosage tolerance and the optimal effective dose.

·       Phase3:    When Phase 2 evaluations demonstrate that a specificdosage range of the drug is likely to be effective and has an acceptable safetyprofile, Phase 3 trials are undertaken to demonstrate clinical efficacy and tofurther test for safety in an expanded patient population, often atgeographically dispersed clinical study sites.

We cannot be certain that we will successfullycomplete Phase 1, Phase 2 or Phase 3 testing of our product candidates withinany specific time period, if at all. Furthermore, the FDA, the InstitutionalReview Board or the sponsor may suspend or terminate clinical trials at anytime on various grounds, including a finding that the subjects or patients arebeing exposed to an unacceptable health risk.

A description of the manufacturing process and qualitycontrol methods, including data to support the successful qualifiedmanufacturing of product within the designated manufacturing facility, as wellas results of pre-clinical studies, toxicology studies and clinical trials,among other things, are submitted to the FDA as part of an NDA for approvalprior to the marketing and commercial shipment of the product. The FDA may denya new drug application if all applicable regulatory criteria are not satisfiedor may require additional data including clinical, toxicology or manufacturingdata. Even after a new drug application is issued, the FDA may withdraw productapproval if compliance with regulatory standards is not maintained or if safetyproblems occur after the product reaches the market. In addition, the FDArequires surveillance programs to monitor the consistency of manufacturing andthe safety of approved products that have been commercialized. The agency hasthe power to require changes in labeling or to prevent further marketing of aproduct based on new data that may arise after commercialization. Similar requirementsexist in other countries where we may choose to seek marketing approval.

Satisfaction of FDA requirements or similarrequirements of state, local and foreign regulatory agencies typically takesseveral years and the actual time required may vary substantially, based uponthe type, complexity and novelty of the pharmaceutical product. Governmentregulation may delay or prevent marketing of potential products altogether orfor a considerable period of time and imposes costly and time-consuming requirements.We cannot be certain that the FDA or any other regulatory agency will agreewith our judgment and interpretations or will grant approval for any of ourproducts under development on a timely basis, if at all. Success inpre-clinical or early stage clinical trials does not assure success in laterstage clinical trials. Data obtained from pre-clinical and clinical activitiesis not always conclusive and may be susceptible to varying interpretations thatcould delay, limit or prevent regulatory approval. Even if a product receivesregulatory approval, the approval is typically limited to specific clinicalindications. Further, even after regulatory approval is obtained, laterdiscovery of previously unknown problems with a product may result in restrictionson the product or even complete withdrawal of the 

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product from the market.Delays in obtaining, or failures to obtain regulatory approvals would have amaterial adverse effect on our business. Marketing our products abroad willrequire similar regulatory approvals and is subject to similar risks. Inaddition, we cannot predict what adverse governmental regulations may arisefrom future U.S. or foreign governmental action.

Any products manufactured or distributed by uspursuant to FDA clearances or approvals are subject to continuing regulation bythe FDA, including record-keeping requirements and reporting of adverseexperiences. Drug manufacturers and their subcontractors are required toregister their establishments with the FDA and state agencies, and are subjectto periodic unannounced inspections by the FDA and state agencies forcompliance with cGMPs, which impose procedural and documentation requirementsupon us and our third party manufacturers. We cannot be certain that we, or ourpresent or future suppliers, will be able to comply with the cGMP regulationsand other FDA regulatory requirements. Failure to comply with theserequirements can result in, among other things, total or partial suspension ofproduction, failure of the government to grant approval for marketing, andwithdrawal, suspension, or revocation of marketing approvals.

Once the FDA approves a product, a manufacturer mustprovide certain updated safety and efficacy information. Product changes, aswell as certain changes in a manufacturing process or facility or otherpost-approval changes may necessitate additional FDA review and approval.

The FDA regulates drug labeling and promotionactivities. The FDA has actively enforced regulations prohibiting the marketingof products for unapproved uses. Violations of the Federal Food, Drug, andCosmetic Act or regulatory requirements may result in agency enforcementaction, including voluntary or mandatory recall, suspension or revocation ofproduct approval, product seizure, fines, injunctions or civil or criminalpenalties. Our product development and testing activities are also subject to avariety of state laws and regulations. Any applicable state or localregulations may hinder our ability to manufacture or test our products in thosestates or localities. We are also subject to numerous federal, state and locallaws relating to such matters as safe working conditions, manufacturingpractices, environmental protection, fire hazard control, and disposal ofhazardous or potentially hazardous substances. We may incur significant coststo comply with such laws and regulations now or in the future.

The FDA’s policies may change and additionalgovernment regulations may be enacted which could prevent or delay regulatoryapproval of our potential products. Moreover, increased attention to thecontainment of health care costs in the United States and in foreign marketscould result in new government regulations that could have a material adverseeffect on our business. We cannot predict the likelihood, nature or extent ofadverse governmental regulation that might arise from future legislative oradministrative action, either in the United States or abroad.

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We have had ongoingdiscussions with the FDA concerning the statistical analysis plan used inconnection with our Phase 3 clinical trials of AI-700. InApril 2005, based in part upon feedback from FDA, we revised thestatistical analysis plan on which we base our patient enrollment estimates forthe AI-700 Phase 3 clinical trials. Since that time we have continueddiscussions with the FDA. Continued discussions with the FDA could lead toother changes relating to our statistical analysis plans. How, when or if thematters being discussed are resolved may affect whether AI-700 isapproved for the indication that we are seeking, the timing of such approval orwhether AI-700 is approved at all. Such timing could also lead to delaysin the timing of the unblinding of the data from our Phase 3 clinical trials,and therefore public announcement of results from those trials.

***Foreign Regulatory Approval***

Outside the United States, our ability to market ourproducts will also be contingent upon receiving marketing and pricingauthorizations from the appropriate regulatory authorities. The foreignregulatory approval process includes all the risks associated with FDA approvaldescribed above. The requirements governing conduct of clinical trials andmarketing authorization vary widely from country to country.

Under European Union regulatory systems, marketingauthorizations may be submitted either under a centralized or decentralizedprocedure. The centralized procedure provides for the grant of a singlemarketing authorization that is valid for all European Union member states. Thedecentralized procedure provides for mutual recognition of national approvaldecisions. Under this procedure, the holder of a national marketingauthorization may submit an application to the remaining member states. Within90 days of receiving the applications and assessment report, each memberstate must decide whether to recognize approval.

We, or a partner to whomwe have assigned the right, will choose the appropriate route of European regulatoryfiling. In 2004, we entered into a strategic partnership with Nycomed underwhich they are primarily responsible for regulatory strategy and approval inEurope for our lead product candidate, AI-700. However, the chosenregulatory strategy for our product candidates may not secure regulatoryapprovals or approvals of the chosen product indications. These approvals, ifobtained, may take longer than anticipated. We cannot assure you that any ofour product candidates will prove to be safe or effective, will receiveregulatory approvals, or will be successfully commercialized.

**Competition**

The pharmaceutical and biotechnology industries inwhich we operate are characterized by rapidly advancing technologies, intensecompetition and an emphasis on proprietary products. Our competitors includelarge pharmaceutical and biotechnology companies, specialty pharmaceutical andgeneric drug companies, academic institutions, government agencies and researchinstitutions. All of these competitors currently engage in, have engaged in ormay engage in the future in the development, manufacturing, marketing andcommercialization of new pharmaceuticals and pharmaceuticals, some of which maycompete with our present or future product candidates.

We expect that our product candidates, if approved formarketing, will compete with existing drugs, therapies, drug delivery systemsand technological approaches, as well as new drugs, therapies, drug deliverysystems or technological approaches that may be developed or commercialized inthe future. Any of these drugs, therapies, systems or approaches may receivegovernment approval or gain market acceptance more rapidly than our productcandidates, may offer therapeutic or cost advantages over our productcandidates or may cure our targeted diseases or their underlying causescompletely. As a result, our product candidates may become noncompetitive orobsolete.

AI-700, ourultrasound contrast agent for the assessment of myocardial perfusion, ifapproved for marketing and sale, will face intense competition. We believe thatultrasound with AI-700 can be a cost-effective and convenient substitutefor nuclear stress tests, the current standard of care in myocardial 

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perfusion assessment. Inaddition, we believe AI-700 will add useful myocardial perfusioninformation that stress echo cannot provide without a contrast agent. AI-700is designed for use with widely available ultrasound equipment and techniquescurrently used for wall motion studies using stress echo. We expect to faceintense competition from companies that market products related to theseexisting imaging techniques, as well as other companies that are developingultrasound contrast agents for use in stress echo.

Nuclear stress testing is an established technique forassessing myocardial perfusion. Radioactive contrast agents that are approvedby the FDA for use in nuclear stress tests include Cardiolite®, which ismarketed by Bristol-Myers Squibb Company; Myoview®, which is marketed by GEHealthcare; and thallium, which is marketed by GE Healthcare, Bristol-MyersSquibb and Tyco International.

Stress echo without ultrasound contrast is anestablished technique for detecting abnormal wall motion, which somecardiologists may find satisfactory for the detection of coronary heartdisease. However, stress echo without contrast is incapable of assessingmyocardial perfusion. We believe that ultrasound with AI-700 will enablestress echo to provide information on myocardial perfusion in addition to wallmotion.

No ultrasound contrast agent has been approved by theFDA for use in myocardial perfusion imaging or stress echo. However, we areaware of other companies that are or may be developing ultrasound contrastagents for use in stress echo. CardioSphereTM, which is being developed by PointBiomedical Corporation, is an ultrasound contrast agent for the assessment ofmyocardial perfusion. In 2006**,** Point announced that it had fileda NDA for CardioSphere with the FDA. In addition, some companies haveultrasound contrast agents that are FDA approved for LVO and EBD in patientswith suboptimal images or are in development. In the future, these companiesmay seek to broaden their indications to include stress echo and myocardialperfusion assessment. These FDA-approved agents which are currently marketedinclude Optison®, which is marketed by GE Healthcare and Definity®, which ismarketed by Bristol-Myers Squibb. SonoVue®, which is being developed by Bracco,is an ultrasound contrast agent which we believe is in late stage clinicaldevelopment for LVO and EBD and for radiology applications, but as of the dateof this prospectus, to our knowledge, has not received final approval from theFDA.

AI-850, our reformulation of paclitaxel, ifapproved for marketing and sale, will also face intense competition. We areaware of companies, such as American Pharmaceutical Partners, NeoPharm andSonus Pharmaceuticals that are applying significant resources and expertise todeveloping reformulations of paclitaxel for intravenous delivery that willcompete with our current product candidate. In early 2005, AmericanPharmaceutical Partners received FDA approval for and is marketing theirproduct. None of these other reformulations has received approval from the FDA.Other companies, such as Cell Therapeutics, are developing new chemicalentities that involve paclitaxel conjugated, or chemically bound, to anotherchemical. None of these new chemical entities have received final approval fromthe FDA. In addition, a number of companies have developed technology fordelivering hydrophobic drugs. Cardinal Health, CyDex and Elan have createdformulations of hydrophobic drugs that have been approved by the FDA.

AI-128, our initial sustained releaseformulation of an asthma drug, if approved for marketing and sale, will alsoface intense competition. Companies such as Alkermes possess technology thatmay be suitable for sustained release pulmonary drug delivery and may havecompetitive programs that have not been publicly announced or may decide tobegin such programs in the future. We are not aware of any other companycurrently in human clinical development of a sustained release version of theasthma drug that is currently the subject of our research and developmentefforts. In addition, many asthma drugs are marketed by large pharmaceuticalcompanies with much greater resources than us. These companies may bedeveloping sustained release versions of their asthma drugs that would competewith our sustained release product candidate.

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Many of our competitors inthese markets have greater development, financial, manufacturing, marketing,and sales experience and resources than we do and we cannot be certain thatthey will not succeed in developing products or technologies which will renderour technologies and products obsolete or noncompetitive. We cannot assure youthat our products will compete successfully with these newly emergingtechnologies. In addition, many of those competitors have significantly greaterexperience than we do in their respective fields. Many of these competitors mayhave greater name recognition than we do, and may offer discounts as acompetitive tactic.

**Employees**

As of March 1, 2006,we had 110 full-time employees, including 91 in research and development and 19 in general and administrative. Eleven of our employees haveM.D.s and/or Ph.D.s. From time to time, we also employ independent contractorsto support our engineering and administrative organizations. None of ouremployees are represented by a collective bargaining unit and we have never experienceda work stoppage. We consider our relations with our employees to be good.

**Organization and Trademarks**

We were organized as a Delaware corporation on July 12,1993.

We have trademarks in theUnited States and other countries, including “Acusphere,” “HDDS” and “PDDS” andour logo. This Annual Report on Form 10-K also contains thetrademarks and trade names of other entities that are the property of theirrespective owners.

**Financial Information**

The financial informationrequired under this Item 1 is incorporated herein by reference to Item 8 ofthis Annual Report on Form 10-K.

**ITEM 1A. RISK FACTORS**

**Risks Related to Our Company**

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

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. In 2005, we had a net lossavailable to holders of common stock of $47.0 millionAt December 31, 2005 we had an accumulated deficit of $220.1 million. We expect ourresearch and development, general and administrative and sales and marketingexpenses will increase over the next several years.

We expect to continue to incur losses and capitalexpenditures for the foreseeable future. We also anticipate cash out flow fromdebt repayment and payment of other obligations. We believe, based on ouroperating plans, that our existing resources, including scheduled proceeds fromNycomed, are adequate to fund our planned operations through 2006, or beyondtwelve months if we elect to reduce our rate of spending. Unless we reduce ourcurrent rate of spending, we will require significant additional funds to fundour operations, including to develop products, conduct clinical trials, achieveregulatory approvals, qualify commercial manufacturing space and, subject toregulatory approval, commercially launch AI-700, our other productcandidates under development and future product candidates. We may raise thisadditional capital through public or private sales of equity, or fromborrowings, or from strategic partners.

As a result of our limited capital resources, we mayelect to delay the funding of certain development activities, including thefiling of our NDA for AI-700, which would result in a delay in thecommercialization of AI-700. Any such delay in the filing of an NDA orcommercialization of AI-700 

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

***We need to allocate significant amounts of ouravailable capital resources to make payments on our outstanding indebtednessand equipment lease obligations, our patent transfer agreement with ScheringAktiengesellschaft and as dividends on our 6.5% convertible exchangeablepreferred stock, which in turn could reduce our financial flexibility andability to fund other activities.***

As of December 31,2005, we had approximately $21.3 million in aggregate principal indebtednessoutstanding related to capital lease obligations, notes payable and otherlong-term obligations. As of December 31, 2005, we had outstanding 740,000shares of our 6.5% convertible exchangeable preferred stock, which sharesaccrue cumulative cash dividends at the annual rate of $3.25 per share, payablequarterly on the first day of March, June, September, and December. Thesepayments will:

·       reducethe availability of our capital to fund our clinical trials for AI-700,the build-out and qualification of our commercial manufacturing space inTewksbury, Massachusetts and for working capital and other general corporatepurposes and may require us, in order to meet these obligations, to delay orreduce expenditures or forego business opportunities; and

·       potentiallyimpair our ability to obtain additional financing, including intended futureborrowings against our equipment financing line with Oxford FinanceCorporation.

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

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

We must 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 canreceive FDA approval unless human clinical trials show both safety and efficacyfor each target indication in accordance with FDA standards. A number ofcompanies in the pharmaceutical 

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and biotechnologyindustries have suffered significant setbacks in late stage clinical trialseven after achieving promising results in early stage development. In our Phase3 clinical trials for AI-700, we are seeking to demonstratenon-inferiority compared to nuclear stress tests. The clinical effectiveness ofnuclear stress tests may have improved since the time of our Phase 2 clinicaltrials. We therefore cannot assure you that the results from our Phase 2clinical trials for AI-700 will be predictive of results obtained in ourPhase 3 clinical trials.

Many of the patients in our AI-700 clinicaltrials have coronary heart disease. As part of our AI-700 clinicaltrials, patients will be exposed to potential safety risks associated with astress test, including risks associated with a pharmacological stressor, and AI-700.Given the nature of the AI-700 clinical trials, including administeringAI-700 in Phase 3 to larger numbers of at-risk patients and new clinicalsites and administering AI-700 to patients with coexisting disease,adverse events are expected to be encountered during the clinical trials.Adverse events are also likely to be encountered in clinical trials for ourother products, which clinical trials also include at-risk patients. Whensignificant adverse events are detected and these events are attributable toour products, such events could delay, limit or prevent regulatory agencyapproval.

Further, data obtained from pre-clinical and clinicalactivities are subject to varying interpretations that could delay, limit orprevent regulatory agency approval. We cannot assure you that our Phase 3 planfor AI-700 will successfully address the requirements of the FDA or thatthe results of the Phase 3 program will establish the safety and efficacy of AI-700sufficiently for us to obtain regulatory approval. We may also encounterdelays, resulting from the need to enroll more patients than we currentlyestimate for in our clinical trials. This may occur due to a variety of factorsincluding our inability to enroll sufficient proportion of patients with andwithout disease that is consistent with our estimated clinical trialenrollment, based on a higher than expected number of patients enrolled in thetrials who are unevaluable because their nuclear stress or angiography studiesare not compliant with trial protocol or based on a change in the sample sizerequired by regulatory authorities to meet desired study endpoints.  We may also encounter delays or rejectionsbased on our inability to enroll enough patients to complete our clinicaltrials.

We may encounter delays or rejections based on changesin regulatory agency policies or personnel during the period in which wedevelop a drug or the period required for review of any application forregulatory agency approval of a particular compound. In 2004, changes went intoeffect in the regulation of clinical trials in Europe and are currently beingimplemented by the individual member states of the European Union. Ourcontinuing efforts to comply with these changes could lead to delays orrejections of our clinical trials. We also may encounter delays in the event weare unable to produce clinical trial material in sufficient quantities and ofsufficient quality to meet the schedule for our planned clinical trials. Inaddition, we rely on a number of third parties, such as clinical researchorganizations, to help support the clinical trials by performing independentclinical monitoring, data acquisition and data evaluations. Any failure on thepart of these third parties could delay the regulatory approval process.

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

·       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 orsubstantial delays in obtaining approval for our lead product candidate, AI-700,would delay our receipt of product revenues and would have a material adverseaffect our business, financial condition and results of operations. Our stockprice would also be materially adversely affected.

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

***We may need to enroll more patients in our AI-700Phase 3 clinical trials, and any such additional enrollment would requireadditional expenditures, which may be material, and would likely result in adelay of our submitting an NDA with the FDA for AI-700.***

We are intentionally blinded to efficacy data from ourongoing Phase 3 pivotal trials. Estimating the number of patients we need toenroll in our pivotal Phase 3 clinical trials in order to achieve statisticalsignificance in these trials is difficult. We estimate the number of patientswe need to enroll in our pivotal Phase 3 clinical trials based on a variety offactors, including our understanding and analysis of previous trial data for AI-700,our ongoing discussions with the FDA and our own knowledge and past experiencein these and similar matters. However, these estimates are subject to risks anduncertainties, and there can be no assurance that our estimates will prove tobe correct. For example, in April 2005, based in part on feedback from theFDA, we revised the statistical analysis plan from which we base our patientenrollment estimates. This revision had the effect of increasing the number ofpatients we estimate to be needed to complete the Phase 3 clinical trials toapproximately 700 patients. Continued discussions with the FDA could lead toother changes, including changes relating to our statistical analysis plans.How, when or if the matters being discussed are resolved may affect whether AI-700is approved for the indication that we are seeking, the timing of such approvalor whether AI-700 is approved at all. These discussions could also leadto delays in the timing of the unblinding of the data from our Phase 3 clinicaltrials and therefore, the public announcement of results from those trials.Patient enrollment depends on many factors, including the size and diseaseprevalence of the patient population, the nature of the protocol, the proximityof patients to clinical sites, and the eligibility criteria for the study and thefreedom to operate with respect to intellectual property.

Any such delays, or theneed to enroll more patients, will likely result in increased costs, which maybe material and would likely have a harmful effect on our financial positionand results of operations. The market price of our common stock may also bematerially adversely affected in response to any such delays.

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

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

·       theprogress of pre-clinical development and laboratory testing and clinicaltrials;

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

·       thetime and costs involved in obtaining regulatory approvals;

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·       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 assureyou that we can obtain additional funding on reasonable terms, or at all. If weraise additional funds by issuing equity securities, our stock price maydecline, our existing stockholders may experience significant dilution, and thenewly issued securities may have rights superior to those of our common stock.If we raise additional funds by issuing debt, we may be subject to limitationson our operations and such debt may have rights senior to the debentures, ifissued. 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

·       terminate or delaybuild-out and commissioning of our commercial manufacturing facility.

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

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 usein ultrasound imaging procedures which will compete with existing nuclearimaging and stress echocardiography. Hospitals, physicians or patients mayprefer these existing procedures to AI-700 enhanced ultrasound imaging.If our products do not receive market acceptance for any reason, it wouldadversely affect our business, financial condition and results of operations.

Further, our competitorsmay develop new technologies or products that are more effective or lesscostly, or that seem more cost-effective, than our products. We can give noassurance that hospitals, physicians, patients or the medical community ingeneral will accept and use any products that we may develop.

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

Competitors and 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.

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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, which 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 inEurope prior to contesting the counterpart patents in the United States becauseof procedural 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 ofthese and other patents may file one or more infringement actions against us.In addition, a competitor may claim misappropriation of a trade secret by anemployee hired from that competitor. Any such infringement or misappropriationaction could cause us to incur substantial costs defending the lawsuit andcould distract our management from our business, even if the allegations ofinfringement or misappropriation are unwarranted. A need to defend multipleactions or claims could have a disproportionately greater impact. In addition,either in response to or in anticipation of any such infringement ormisappropriation claim, we may enter into commercial agreements with the ownersor licensees of these rights. The terms of these commercial agreements mayinclude substantial payments, including substantial royalty payments onrevenues received by us in connection with the commercialization of ourproducts. We have had discussions which lead us to believe that owners or licenseeswith these rights are interested in out-licensing certain rights to theirpatents. There can be no assurance that we will enter into any such agreementor that, if we elect to enter into such agreements that we will be able to doso on terms which are acceptable. Payments under such agreements could increaseour operating losses and reduce our resources available for developmentactivities. Furthermore, a party making this type of claim could secure ajudgment that requires us to pay substantial damages, which would increase ouroperating losses and reduce our resources available for development activities.A judgment could also include an injunction or other court order that couldprevent us from making, using, selling, offering for sale or importing ourproducts or prevent our customers from using our products. If a courtdetermined or if we independently concluded that any of our products ormanufacturing processes violated third-party proprietary rights, our clinicaltrials could be delayed and there can be no assurance that we would be able toreengineer the product or processes to avoid those rights, or to obtain alicense under those rights on commercially reasonable terms, if at all.

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

The followingfactors 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.

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We will be able to protectour proprietary rights from unauthorized use by third parties only to theextent that our proprietary rights are covered by valid and enforceable patentsor are effectively maintained as trade secrets.

We try to protect ourproprietary position by filing U.S. and foreign patent applications related toour proprietary technology, inventions and improvements that are important tothe development of our business. Because the patent position of pharmaceuticalcompanies involves complex legal and factual questions, the issuance, scope andenforceability of patents cannot be predicted with certainty. Patents, ifissued, may be challenged, invalidated or circumvented. Thus, any patents thatwe own or license from others may not provide any protection againstcompetitors. Our pending patent applications, those we may file in the future,or those we may license from third parties, may not result in patents beingissued. If issued, they may not provide us with proprietary protection orcompetitive advantages against competitors with similar technology.Furthermore, others may independently develop similar technologies or duplicateany technology that we have developed. The laws of many foreign countries donot protect our intellectual property rights to the same extent as do the lawsof the United States.

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

***We may becomeinvolved in lawsuits and administrative proceedings to protect, defend orenforce our patents that would be expensive and time consuming.***

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

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

***We have 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 tocommercialize these products.***

We have no experience inmanufacturing our products for commercial use and limited experience in designingequipment for the manufacture of our products. We are working to start-up andqualify operations at a commercial manufacturing facility in Tewksbury,Massachusetts and to demonstrate that we can produce AI-700 at acommercial manufacturing scale prior to our filing of a NDA for AI-700and, subject to required regulatory approvals, we intend to manufacture AI-700in this facility for commercial 

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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 of which 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 are inthe process of converting into a commercial manufacturing facility for AI-700.Creation and qualification of a commercial manufacturing environment requiressignificant expertise and capital resources, including the development ofadvanced manufacturing techniques and process controls and is subject to localand state planning approvals. Manufacturers of pharmaceutical products oftenencounter difficulties in constructing and qualifying new manufacturingfacilities and in production, especially in scaling-up initial production. Afailure within this new facility to establish and follow cGMPs and to documentadherence to such practices may lead to significant delays in the availabilityof material for our NDA filing or commercial production for AI-700 andmay delay or prevent filing or approval of marketing applications for ourproducts or the ability to continue to manufacture the products. Certain ofthese delays would further require us to continue to operate this facility andincur 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 to the FDA and corresponding state and foreign agencies that thespecifications for the product are consistent with the specifications for theproduct as it was manufactured at a prior qualified site or we must clinicallyor otherwise demonstrate that the safety and efficacy of the product produced inthe new manufacturing site is consistent with the product as it wasmanufactured at the prior site. Demonstrating such consistency may bedifficult, expensive or time consuming. In addition, before we would be able toproduce product for commercial use at a new facility, it will have to undergo apre-approval inspection by the FDA and corresponding state and foreignagencies. Once approved, 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. Failure to maintain compliance with cGMP orwith safety or environmental regulations could result in penalties, productrecalls or restrictions on the use of the manufacturing site.

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 ina timely 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 ourrelationship with 

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Nycomedwould have a material adverse impact on our business, financial condition andresults of operations.

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

To date our productcandidates have been manufactured in small quantities for pre-clinical andclinical trials. If any of these product candidates are approved by the FDA orforeign regulatory authorities for commercial sale, we will need to manufacturethem in larger quantities. For AI-700, it is our intention to seekregulatory approval after we have demonstrated that we can manufacture AI-700at a larger batch scale than is being used for clinical trial materials. Wecannot assure you that we will be able to successfully increase themanufacturing capacity or manufacture at a larger batch scale, whether on ourown or in collaboration with third party manufacturers, for any of our productcandidates in a timely or economic manner, or at all. Significant scale-up ofmanufacturing may require certain additional validation studies, which the FDAmust review and approve. If we are unable to successfully increase themanufacturing capacity for a product candidate, the regulatory approval orcommercial launch of that product candidate may be delayed or there may be ashortage in supply of that product candidate. Our product candidates requireprecise, high-quality manufacturing. Our failure to achieve and maintain thesehigh manufacturing standards, including controlling the incidence ofmanufacturing errors and maintaining reliable product packaging for diverseenvironmental conditions, could result in patient injury or death, productrecalls or withdrawals, delays or failures in product testing or delivery, costoverruns or other problems that could seriously hurt our business.

The Company’s commercialmanufacturing facility in Tewksbury, Massachusetts is designed to meet theCompany’s estimated initial commercial demand for AI-700. The facility isbeing initially equipped to run one production line. In order to supportgreater production capacity, this production line is designed to support alarger lyophilizer (pharmaceutical freeze dryer which can be operated understerile conditions) than has been initially installed in the facility. Space inthe facility has been designated for the future addition of a largerlyophilizer. Purchasing, installing and qualifying manufacturing equipment,such as a lyophilizer, typically requires significant lead times and temporarydiscontinuation of production. Also in the future the Company may need to addadditional production lines at the Tewksbury, Massachusetts site or elsewhereto meet potential commercial demand for AI-700. The Company has made nocommitment to such additions at this time. The cost of such additions can besignificant. There can be no assurance that the Company’s capacity estimateswill be achieved. Any such additions would increase our operating spending,increase our capital requirements and reduce our resources available fordevelopment activities.

***We have removed ourAI-700 manufacturing equipment from the facilities of our third partycontract manufacturer and currently have no facility within which tomanufacture AI-700 until the new commercial manufacturing facility isqualified or until other arrangements are made.***

We have removed our AI-700manufacturing equipment from the facilities of a third-party contractmanufacturer. We believe that we have sufficient inventory of AI-700clinical trial material to complete our Phase 3 program. However, there can beno assurance that such inventory will prove sufficient or that the inventorywill not get damaged or otherwise disqualified. Currently, we have no facilitywithin which to manufacture AI-700 until the new commercial manufacturingfacility is qualified or until other arrangements are made. If we lacksufficient inventory of AI-700 clinical trial material to complete ourPhase 3 program or are unable to manufacture sufficient inventory on a timelybasis, our Phase 3 program could be delayed and would consequently delay ourability to commercialize AI-700. These delays could have a materialadverse effect on our business, financial condition and results of operations.

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***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 mayrely substantially on third-party contract manufacturers to supply, store anddistribute our potential products for our clinical trials and other developmentneeds. Our reliance on these third-party manufacturers will expose us to thefollowing risks, any of which could delay or prevent the completion of ourclinical trials, the approval of our products by the FDA, or thecommercialization of our products, result in higher costs, or deprive us ofadditional product candidates, and any of such effects would have a materialadverse impact on our business, financial condition and results of 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 and distributeour products successfully. Our manufacturing levels, while important to us, canrepresent relatively small fractions of the overall business of most qualifiedcontract manufacturers. As a result, the contract manufacturers may not provideus with the attention that we need or may be unwilling to adapt to necessarychanges in our manufacturing requirements.

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

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

Onlya few facilities manufacture some of the raw materials necessary to manufactureour products. If we need to purchase a raw material that is in limited supplyfor our clinical trials, or for commercial distribution if we obtain marketingapproval of a product candidate, we cannot assure you that one or moresuppliers would be able to sell us that raw material at the time we need it andon commercially reasonable terms. If we change suppliers for any of thesematerials or any of our suppliers experiences a shutdown or disruption in thefacilities used to produce these materials, due to technical, regulatory orother problems, it could harm our ability to manufacture our products. Ourinability to obtain required raw materials for any reason could substantiallyimpair our development activities or the production, marketing and distributionof our products.

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***We have no experience selling, marketing ordistributing our products and no internal capability to do so.***

If we receive regulatory approval to commencecommercial sale of any product, we will face competition with respect tocommercial sales, marketing and distribution. These are areas in which we haveno experience. To market any of our products directly, we must develop a directmarketing and sales force with technical expertise and supporting distributioncapability. Alternatively, we may engage a pharmaceutical or other healthcarecompany with an existing distribution system and direct sales force to assistus. There can be no assurance that we will successfully establish sales anddistribution capabilities either on our own or in collaboration with thirdparties or gain market acceptance for our products. To the extent we have orwill 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.

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

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.  On February 1, 2006, we entered intoexecutive employment agreements with key members of the management team thatprovide for compensation and other benefits in the event these persons areterminated other than for cause, including in connection with a “change ofcontrol” of Acusphere.

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

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

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

·       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;

·       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

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·       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 inus incurring liquidated damages of up to $12 million.

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

***Competition in the pharmaceutical industry is intense,and if we fail to compete effectively our financial 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 expectcompetition to increase as technological advances are made and commercialapplications broaden. In commercializing our initial product candidates and anyadditional products we develop using our HDDS and PDDS technologies, we willface substantial competition from large pharmaceutical, biotechnology and othercompanies, universities and research institutions.

·       AI-700,our ultrasound contrast agent and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear contrast agents thatare approved for use in myocardial perfusion imaging include products marketedby GE Healthcare and Bristol-Myers Squibb. In 2004, the cost of a nuclear stresstest was approximately $770 per procedure. In addition, GE Healthcare andBristol-Myers Squibb have developed and are marketing ultrasound contrastagents that have been approved by the FDA for use in Left VentricularOpacification and Endocardial Border Delineation in patients with suboptimalimages, and in the future they may seek to broaden their products to includestress echo and myocardial perfusion assessment. Moreover, we are aware thatother companies, such as Bracco, are developing ultrasound contrast agents forwall imaging and for radiology applications, and that Point Biomedical isdeveloping an ultrasound contrast agent specifically for myocardial perfusionimaging. In 2006, Pointannounced that it had filed a NDA for CardioSphere with the FDA. Finally, somecardiologists may find it satisfactory to use stress echo without contrast forthe detection of coronary heart disease.

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

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

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

***We expect to develop international operations thatwill expose us to additional business risks.***

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

·       differentregulatory requirements for approval of our product candidates;

·       dependenceon local distributors;

·       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

·       currency risks.

**Risks Related to Our Industry**

***Even if we obtain marketing approval, our productswill 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 

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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 withapplicable regulatory requirements, we may be subject to fines, suspension orwithdrawal of regulatory approvals, product recalls, seizure of products,operating restrictions and criminal prosecution.

***Market acceptance of our products will be limited ifusers of our products are unable to obtain adequate reimbursement fromthird-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, in the United States,Europe and other markets that we may pursue, will consider our productscost-effective or provide reimbursement in whole or in part for their use oragree to the proposed price.

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 maintenanceorganizations, and legislative proposals to reform healthcare and governmentinsurance programs could significantly influence the purchase of healthcareservices and products, resulting in lower prices and reduced demand for ourproducts which could adversely affect our business, financial condition andresults of operations.

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

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

We face an inherentbusiness risk of exposure to product liability claims in the event that the useof our products is alleged to have resulted in harm to others. This risk existsin clinical trials as well as in commercial distribution. In addition, thepharmaceutical and biotechnology industries in general have been subject tosignificant medical malpractice litigation. We may incur significant liabilityif product 

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liabilityor malpractice lawsuits against us are successful. Furthermore, productliability claims, regardless of their merits, could be costly and divert ourmanagement’s attention from other business concerns, or adversely affect ourreputation and the demand for our products. Although we maintain productliability insurance, we cannot be certain that this coverage will be adequateor that it will continue to be available to us on acceptable terms.

***Rapid technological change could make our productsobsolete.***

Pharmaceutical technologieshave undergone rapid and significant change. We expect that pharmaceuticaltechnologies will continue to develop rapidly. Our future will depend in largepart on our ability to maintain a competitive position with respect to thesetechnologies. Any compounds, products or processes that we develop may becomeobsolete before we recover any expenses incurred in connection with theirdevelopment. Rapid technological change could make our products obsolete, whichcould materially adversely affect our business, financial condition and resultsof operations.

***Our products involve the use of hazardous materials,and as a result we are exposed to potential liability claims and to costsassociated with complying with laws regulating 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 theevent of an accident, we could be held liable for any damages, which couldexceed our available financial resources. This liability could materiallyadversely affect our business, financial condition and results of operations.

We are subject to federal,state and local laws and regulations governing the use, manufacture, storage,handling and disposal of hazardous materials and waste products, and we spentapproximately $69,000 during thefiscal year ended December 31, 2005 to dispose of these hazardousmaterials and waste products. We may be required to incur significant costs tocomply with environmental laws and regulations in the future that couldmaterially adversely affect our business, financial condition and results ofoperations.

**Risks Related to Our Common Stock**

***We expect that our stock price will fluctuatesignificantly.***

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

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

·       marketconditions in the pharmaceutical and biotechnology sectors;

·       rumorsrelating to us or our competitors;

·       litigationor public concern about the safety of our potential products;

·       ourquarterly operating results;

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

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·       FDAor international regulatory actions.

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

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

As of March 16, 2006,and based on information provided to us by such entities: Quaker CapitalManagement Corporation and its affiliates will beneficially own approximately 11% of our outstanding common stock;Bank of America Corporation and its affiliates will beneficially ownapproximately 9% of ouroutstanding common stock; the Baupost Group LLC will beneficially ownapproximately 9% of our outstanding common stock; Mr. Peter David Boonewill beneficially own approximately 8%of our outstanding common stock; and Federated Investors, Inc. and itsaffiliates will beneficially own approximately 5% of our outstanding common stock. Collectively these investorswill control approximately 42%of our common stock. These investors, particularly if they were to act togetheras a concentrated group, could exert influence over the election of ourdirectors, direct our policies and operations, including future issuances ofcommon stock or other securities, the payments of dividends, if any, on ourcommon stock, the incurrence of debt by us, amendments to our certificate ofincorporation and bylaws and entering into of extraordinary transactions, andtheir interests, as a concentrated group, may not in all cases be aligned withyour interests. This concentration of ownership among a small number ofinvestors may make it more difficult for other stockholders to influencematters requiring stockholder approval and may have the effect of delaying,preventing or deterring a change in control of our company, thereby possiblydepriving our stockholders of an opportunity to receive a premium for theircommon stock as part of any sale or acquisition.

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

In February 2005, weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of March 16,2006, 740,000 of these shares ofpreferred stock are outstanding. The preferred stock is senior to the commonstock as to liquidation. In the event of our voluntary or involuntarydissolution, liquidation or winding up of Acusphere, holders of our preferredstock will receive a liquidation preference in an amount equal to $50 pershare, plus all accrued and unpaid dividends through the distribution date.Only after holders of the preferred stock have received their liquidationpreference and any accrued and unpaid dividends will we distribute assets, ifany are remaining, to our common stock holders.

***We may be the subject of securities class actionlitigation due to future stock price volatility.***

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

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***Future sales of common stock by our existingstockholders may cause our stock price to fall.***

The market price of ourcommon stock could decline as a result of sales by our existing stockholders ofshares of common stock in the market, or the perception that these sales couldoccur. These sales might also make it more difficult for us to sell equitysecurities at a time and price that we deem appropriate. As of March 16, 2006, we have approximately22,901,720 shares of common stock outstanding and 740,000 shares of convertible preferred stock outstanding that areconvertible into approximately 5.4million shares of our common stock, plus up to a maximum of approximately 1.3 million additional shares of ourcommon stock issuable at our option in satisfaction of the maximum dividendmake-whole payment on these shares of preferred stock. All of the shares ofcommon stock issuable upon conversion of our preferred stock will be freelytradable without restriction under the federal securities laws unless purchasedby our affiliates.

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

In February 2005, we issued and sold 900,000shares of our 6.5% convertible exchangeable preferred stock. As of March 16, 2006, 740,000 of these shares of preferred stock are outstanding. In theevent of our 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 thevote or consent of the holders of at least a majority of the shares ofpreferred stock we may not effect a consolidation or merger with another entityunless the preferred stock that remains outstanding and its rights, privilegesand preferences are unaffected or are converted into or exchanged for preferredstock of the surviving entity having rights, preferences and limitationssubstantially similar, but no less favorable, to the convertible preferredstock. This provision could hamper a third party’s acquisition of us ordiscourage a third party from attempting to acquire control of us via a merger.

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

In February 2005 weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of March 16,2006, 740,000 of these shares ofpreferred stock are outstanding. Cumulative dividends accrue on our preferredstock at an annual rate of $3.25 per share, payable quarterly on the first dayof March, June, September and December, commencing June 1, 2005. Anydividends must be declared by our board of directors and must come from fundsthat are legally available for dividend payments. If we have not paid dividendson the preferred stock in an aggregate amount equal to at least six quarterlydividends whether or not consecutive, we must increase the size of our board ofdirectors by two additional directors. After this time, and for so long asthese dividends remain due and unpaid, holders of the preferred stock, votingseparately as a class with holders of preferred stock ranking on the same basisas to dividends having like voting rights, will be entitled to elect twoadditional directors at any meeting of stockholders at which directors are tobe elected. These directors will be appointed to classes on the board asdetermined by our board of directors. These voting rights will terminate whenwe have declared and either paid or set aside for payment all accrued andunpaid dividends. The terms of office of all directors so elected willterminate immediately upon the termination of these voting rights.

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

Provisions of 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 provisions couldalso limit the price that investors might be willing to pay in the future forshares of our common stock. Further, these provisions make it more difficultfor stockholders to change the composition of our board of directors in any oneyear.

These provisionsinclude:

·       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

·       the application of Delawarelaw prohibiting us from entering into a business combination with thebeneficial owner of 15% or more of our outstanding voting stock for a period ofthree years after the 15% or greater owner first reached that level of stockownership, unless we meet specified criteria.

***We have never paid dividends on our common stock, andwe do not anticipate paying any cash dividends on our common stock in theforeseeable future.***

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

**ITEM 1B. UNRESOLVED STAFF COMMENTS**

None.

**ITEM 2. PROPERTIES**

Our primary offices and laboratory facilities arelocated in one 47,500 square foot facility located in Watertown, Massachusetts.We lease the space in this facility under a ten year , six month operatinglease that expires in June 2012. A limited portion of our 47,500 squarefoot facility has not been internally built-out pending our demand for thespace. We intend to improve and use this space when needed. We anticipate thatthis currently unused space will in the coming years be needed to expand ouremployee office area and our internal laboratory and pilot-manufacturingcapabilities.

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In July 2004, we entered into a lease agreementfor 58,000 square feet of commercial manufacturing space in Tewksbury,Massachusetts. This lease has a five year, nine month term with options toextend the lease for up to two additional five-year terms at predeterminedrental rates. In September 2004, we began to build-out the manufacturingspace portion of this facility to meet the initial commercial manufacturingrequirements of AI-700. We intend to demonstrate that we can produce AI-700at a commercial manufacturing scale prior to our filing of an NDA for AI-700and, subject to required regulatory approvals, we intend to manufacture AI-700in this facility for commercial use. In October 2005 we received anoccupancy permit for this commercial manufacturing facility. The build-out ofthe facility is substantially complete, with minor items remaining to beaddressed by the contractor. Aside from addressing minor items, our primaryefforts at this facility are currently directed at the substantial work requiredto start-up and qualify equipment and operations in compliance with cGMP’s. Weplan to complete this start-up and qualification phase within the next twelve months. Although thebuild-out of the facility is substantially complete, we cannot assure you thatwe will not encounter complications in the qualification of operations in thisfacility which complications could add additional costs or delay our filing ofa NDA for AI-700.

We believe that ourexisting facilities, subject to the successful qualification of the commercialmanufacturing facility in Tewksbury, Massachusetts, are adequate to meet ourcurrent and foreseeable requirements and that suitable additional space will beavailable as needed.

**ITEM 3. LEGAL PROCEEDINGS**

We are not a party to anymaterial legal proceedings.

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**PART II**

**ITEM5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS ANDISSUER PURCHASES OF EQUITY SECURITIES**

**Price Range of Common Stock**

Ourcommon stock is currently traded on The Nasdaq National Market under the symbol“ACUS.” The following table sets forth the high and low closing prices for ourCommon Stock as reported on The Nasdaq National Market for the periodsindicated, as adjusted to the nearest cent.

| ** **                                  | ** ** | **High** | ** ** | **Low** | ** ** |
|---------------------------------------------|------------|----------|------------|---------|------------|
| **Year Ending December 31,  2006:**    |       |     |       |    |       |
| First quarter (through March 16, 2006) |       | $        | 6.59       |    | $5.42      |   |
| **Year Ended December 31,  2005:**     |       |     |       |    |       |
| Fourth quarter                              |       | $        | 5.57       |    | $          | 4.82 |   |
| Third quarter                               |       | $        | 6.20       |    | $          | 4.95 |   |
| Second quarter                              |       | $        | 5.55       |    | $          | 4.05 |   |
| First quarter                               |       | $        | 6.30       |    | $          | 5.12 |   |
| **Year Ended December 31,  2004:**     |       |     |       |    |       |
| Fourth quarter                              |       | $        | 6.90       |    | $          | 6.10 |   |
| Third quarter                               |       | $        | 8.07       |    | $          | 5.98 |   |
| Second quarter                              |       | $        | 8.47       |    | $          | 5.73 |   |
| First quarter                               |       | $        | 10.40      |    | $          | 8.35 |   |

 

On March 16, 2006, the last reported sale priceof our common stock on The Nasdaq National Market was $6.33 per share. As of March 16, 2006, there were approximately 126 holders of record of our common 

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stock,excluding multiple beneficial holders at depositories, banks and brokersincluded as a single holder in the single “street” name of each respectivedepository, bank or broker.

**Dividend Policy**

We have never declared or paid a cash dividend on ourcommon stock, and we currently do not anticipate paying any cash dividends onour common stock in the foreseeable future.

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.Any dividends must be declared by our board of directors and must come fromfunds that are legally available for dividend payments. In 2005, we paid $2.2 million in cash dividends on thethen outstanding shares of our preferred stock.

As of March 16, 2006, there were 740,000 sharesof our preferred stock outstanding. In February 2006, our board ofdirectors declared a quarterly dividend in the amount of $0.8125 per share ofpreferred stock, or $601,000 inaggregate, which was paid on March 1, 2006, to the holders of record as ofthe close of business on February 15, 2006.

Delaware law limits our ability to pay cash dividendson the preferred stock. Under Delaware law, cash dividends may only be paidfrom “surplus” or, if there is no “surplus,” from our net profits for thecurrent or preceding fiscal year. Delaware law defines “surplus” as the amountby which the total assets of a corporation, after subtracting its totalliabilities, exceed the corporation’s capital, as determined by its board ofdirectors. Although we currently intend to pay cash dividends on our preferredstock, our ability to pay these dividends will depend upon our financialresults, liquidity and financial condition. Unless we have paid or set asidecumulative dividends in full on our preferred stock for all past dividendperiods and sufficient funds shall have been set apart for the payment of thedividend for the current period with respect to our preferred stock, we may notdeclare or pay or set aside cash dividends on our common stock and we may notredeem, purchase or otherwise acquire any of our common stock except underlimited circumstances.

Except for dividendspayable on our preferred stock, we currently intend to retain all of our futureearnings, if any, to finance operations. Any future determination relating toour dividend policy will be made at the discretion of our board of directorsand will depend on a number of factors, including future earnings, capitalrequirements, financial conditions, future prospects, contractual restrictionsand other factors that our board of directors may deem relevant.

**EquityCompensation Plan Information**

See Part III, Item 12for information regarding securities authorized for issuance under our equitycompensation plans.

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**ITEM 6. SELECTED FINANCIAL DATA**

Theselected financial data set forth below has been derived from our auditedfinancial statements. This information should be read in conjunction with thefinancial statements and the related notes thereto, “Management’s Discussionand Analysis of Financial Condition and Results of Operations” and otherfinancial information included elsewhere in this Annual Report on Form 10-K.

|                                                                             | ** ** | **Year Ended December 31,**                         | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2001**                                                           | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                  | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statement of Operations Data:**                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Collaboration  Revenue                                                      |       | $                                                                  | —     |   | $ | — |   | $ | — |   | $ | 1,714 |   | $ | 3,428 |   |
| Operating Expenses:                                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Research and development(1)                                                 |       | 11,954                                                             |       | 14,460 |   | 14,818 |   | 25,976 |   | 42,159 |   |
| General and  administrative(1)                                              |       | 4,551                                                              |       | 5,186 |   | 4,890 |   | 6,165 |   | 7,446 |   |
| Total operating expenses                                                    |       | 16,505                                                             |       | 19,646 |   | 19,708 |   | 32,141 |   | 49,605 |   |
| Equity in loss of joint  venture                                            |       | (1,965                                                             | )          | (1,183 | ) | — |   | — |   | — |   |
| Interest and  other income (expense), net                                   |       | 193                                                                |       | (1,067 | ) | (2,215 | ) | 468 |   | 1,551 |   |
| Net loss                                                                    |       | (18,277                                                            | )          | (21,896 | ) | (21,923 | ) | (29,959 | ) | (44,625 | ) |
| Accretion of dividends and offering costs on  preferred stock               |       | (6,249                                                             | )          | (6,666 | ) | (5,948 | ) | — |   | (2,418 | ) |
| Net loss available to common  stockholders                                  |       | $                                                                  | (24,526    | ) | $ | (28,562 | ) | $ | (27,871 | ) | $ | (29,959 | ) | (47,044 | ) |
| Net loss  available to common stockholders per share—Basic and diluted |       | $                                                                  | (50.81     | ) | $ | (35.39 | ) | $ | (6.66 | ) | $ | (1.92 | ) | (2.49 | ) |
| Weighted average shares  outstanding—Basic and diluted                 |       | 483                                                                |       | 807 |   | 4,188 |   | 15,603 |   | 18,897 |   |
|                                                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| (1) Includes stock  based compensation as follows:                     |       |                                                               |       |   |   |   |   |   |   |   |   |
| Research and development                                                    |       | $                                                                  | 418        |   | $ | 915 |   | $ | 590 |   | $ | 356 |   | $ | 199 |   |
| General and administrative expenses                                         |       | 658                                                                |       | 1,280 |   | 717 |   | 584 |   | 375 |   |
|                                                                        |       | $                                                                  | 1,076      |   | $ | 2,195 |   | $ | 1,307 |   | $ | 940 |   | $ | 574 |   |

 

| ** **                                         | ** ** | **As of December 31,**                              | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2001**                                                           | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                         | ** ** | **(in thousands, except per share data)** | ** ** |
| **Balance Sheet Data:**                            |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |       | $                                                                  | 15,599     |   | $ | 7,992 |   | $ | 54,562 |   | $ | 45,180 |   | $ | 51,112 |   |
| Working capital                                    |       | 10,749                                                             |       | 2,899 |   | 50,931 |   | 34,142 |   | 31,011 |   |
| Total assets                                       |       | 24,457                                                             |       | 13,367 |   | 58,924 |   | 62,003 |   | 95,839 |   |
| Long-term debt,  net of current portion            |       | 5,290                                                              |       | 1,726 |   | 205 |   | 3,360 |   | 17,179 |   |
| Redeemable  convertible preferred stock            |       | 97,739                                                             |       | 91,467 |   | — |   | — |   | — |   |
| Total stockholders’  (deficit) equity         |       | (86,228                                                            | )          | (85,348 | ) | 54,375 |   | 45,509 |   | 57,416 |   |
|                                                    |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

*Statements contained herein, including withoutlimitation, “Management’s Discussion and Analysis of Financial Condition andResults of Operation,” contains certain projections, estimates and otherforward-looking statements. “Forward-looking statements,” as that term isdefined in the Private Securities Litigation Reform Act of 1995, are nothistorical facts and involve a number of risks and uncertainties. Words hereinsuch as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,”“believes,” “estimates,” “projects,” “predicts,” “intends,” “potential,” andsimilar expressions (as well as other words or expressions referencing futureevents, conditions or circumstances) are intended to identify forward-lookingstatements.*

*Forward-looking statements include, but are notlimited to: our plans to develop and market new products and the timing ofthese development programs, in particular the timing of clinical trials andregulatory milestones for AI-700; our clinical development of productcandidates, clinical trials and our ability to obtain and maintain regulatoryapproval for our product candidates; our estimates regarding our capitalrequirements and our needs for additional financing; our estimates of expensesand future revenues and profitability; our estimates of the size of thepotential markets for our product candidates; our selection and licensing ofproduct candidates; our ability to attract collaborators with acceptabledevelopment, regulatory and commercialization expertise; the benefits to bederived from corporate collaborations, license agreements and othercollaborative efforts, including those relating to the development and commercializationof our product candidates; sources of revenues and anticipated revenues,including contributions from corporate collaborations, license agreements andother collaborative efforts for the development and commercialization ofproducts; our ability to create an effective direct sales and marketinginfrastructure for products we elect to market and sell directly; the rate anddegree of market acceptance of our product candidates; the timing and amount ofreimbursement for our product candidates; the success of other competingtherapies that may become available; and the manufacturing capacity for ourproduct candidates, including our plans to qualify a commercial manufacturingfacility for AI-700.*

*Our actual results and the timing of certain eventsmay differ materially from the results discussed, projected, anticipated orindicated in any forward-looking statements. Any forward-looking statementshould be considered in light of factors discussed in Item 7 under “CertainFactors Which May Affect Future Results” and elsewhere in this AnnualReport on Form 10-K. We caution readers not to place undue relianceon any such forward-looking statements, which speak only as of the date theyare made. We disclaim any obligation, except as specifically required by lawand the rules of the Securities and Exchange Commission, to publiclyupdate or revise any such statements to reflect any change in companyexpectations or in events, conditions or circumstances on which any suchstatements may be based, or that may affect the likelihood that actual resultswill differ from those set forth in the forward-looking statements.*

*The following discussion should be read in conjunctionwith our consolidated financial statements and related notes thereto includedelsewhere in this Annual Report on Form 10-K.*

**Overview**

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

We created our initialproduct candidates using technology that enables us to control the size andporosity of particles in a versatile manner, so we can customize the particlesto address the delivery needs of a variety of drugs. We are focused on creatingporous microparticles that are smaller than red blood cells. Some of thesemicroparticles are nanoparticles which are smaller than 1 micron. Smallmicroparticles 

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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 for targetinginhaled drugs to specific regions of the lung.

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

**AI-700 Phase 3 Clinical Trial**

Our 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 twoindependent multi-center pivotal trials (the “32” and “33” trials). Clinicalinvestigators were qualified in the pilot phase on a rolling basis. The pilotphase was completed in 2005, after which more than 20 clinical investigatorswere qualified to enroll patients in the pivotal studies. Clinicalinvestigators in the Phase 3 pivotal studies are located at clinical sites inNorth America, Europe and Australia. Data from the Phase 3 pivotal studies are intended for submission toU.S., European, and potentially other regulatory authorities. 

*ThePilot Study.*   Our objectives inthe pilot study were to train and qualify a sufficient number of clinicalsites, investigators and blinded readers for transition into one of the twopivotal trials. These objectives have been accomplished and enrollment in thistrial is completed. Clinical sites that were trained in the pilot studytransitioned into a pivotal trial when, in our judgment, the clinical sitedemonstrated that it was prepared to meet the requirements of the clinicaltrial protocol. Because the pilot study has been conducted for trainingpurposes, there are no defined clinical efficacy endpoints in this study.

*ThePivotal Trials.*   As part of the Phase 3 pivotalstudy design, the evaluation of AI-700 enhanced stress echo and nuclear stressimages from the pivotal trials is performed by blinded readers who receive noinformation about the patient being evaluated other than the images. We havecompleted blinded reads on more than half the currently enrolled patients ineach of the 32 and 33 trials. During the pivotal trials, we intentionally haveno access to efficacy data. We do not expect to publicly disclose results fromeither pivotal trial until after the trial is closed, quality control checksare completed, the database is locked, the data are revealed to us and we havehad an opportunity to review and understand the data, including data regardingclinical outcomes and safety results. As of the date of this annual report,over 700 patients with known or suspected coronary heart disease have beenenrolled in the Phase 3 pivotal trials, including over 300 patients in each ofthe two concurrently run pivotal studies. We use statistical models to predictthe number of patients we need in each trial to be able to reach statisticalsignificance. The estimates and assumptions that we are using in ourstatistical models are primarily derived from our prior clinical studies. Basedupon these estimates and assumptions and our statistical analysis plan, webelieve that the number of patients that we have enrolled in each of thepivotal studies may be sufficient to achieve statistical significance in thesetrials.

*The “32” Trial.*   Allof the patients enrolled in this trial receive a stress echo study with AI-700and a nuclear stress test. Patients in this pivotal trial generally 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 of the 32 trial are sensitivity and specificity relative to a truthstandard, in comparison to the performance of nuclear stress testing relativeto the same truth standard.  The truthstandard for both modalities is determined with 

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angiography, wheneveravailable, or coronary heart disease status with nuclear stress if angiographicdata are unavailable.  In December 2005,we ceased enrollment of patients in the 32 trial. In March 2006, we announcedto the clinical sites that we have completed enrollment in this trial. We havenow completed the 90-day follow up period on patients enrolled in this trial.We anticipate making a public announcement regarding the 32 trial resultsbefore the end of the second quarter of 2006.

*The“33” Trial.*   All of the patients enrolled in thistrial receive a stress echo study with AI-700 and undergo coronary angiography.The majority of patients, but not all, will have a nuclear stress test. Allpatients in this trial will be evaluated for up to thirty days following thestress echo study.  The primary endpoints of the 33 trial are sensitivityand specificity, relative to a truth standard, in comparison to nuclear stresstesting, with angiography as the truth standard for both modalities.  As of the date of this annual report, and inaccordance with the flexibility permitted by our study plan, we are continuing toenroll patients in the 33 trial and anticipate continuing to enroll patientsuntil the end of Q2 2006. We believe that we can continue to enroll patients inthe 33 trial through Q2 2006 without delaying our NDA filing date as we projectthat qualification of our commercial manufacturing facility is therate-limiting factor to our NDA filing. Our clinical plan, unless otherwise amended, permits us to enrollapproximately 450 patients in this study. Once enrollment is closed in this trial and all angiography proceduresand the 30-day patient follow-up period are completed, we will conduct qualitycontrol checks to ensure that all of the required information has been fullygathered and filed and then lock the database. At that time, the data may beunblinded and available to Acusphere for analysis. We anticipate that thisquality control period should be completed within three months of completingthe angiography procedures and the post-enrollment follow-up period and that wewill have unblinded data from this trial during the fourth quarter of 2006. Weanticipate making a public announcement regarding the trial results during thefourth quarter of 2006.

*TrialDesign and Purpose.*   We believe that stress echowith AI-700 has the potential to significantly reduce the time, cost andresources needed in the assessment of myocardial perfusion, compared to nuclearstress testing. Myocardial perfusion is blood flow to the heart muscle, asensitive marker for coronary heart disease.  There is no ultrasoundcontrast agent approved by FDA for use in stress echo or myocardial perfusionimaging. Based upon the end points described above, our 32 and 33 trials aredesigned to demonstrate non-inferiority of stress echo with AI-700 relative tonuclear stress testing. In April 2005, based in part upon feedback from FDA, werevised the statistical analysis plan on which we base our patient enrollmentestimates for the AI-700 Phase 3 clinical trials. Since that time we havecontinued discussions with the FDA regarding trial design and our statisticalanalysis plan.  As a result of ourongoing discussions with FDA, we may make further revisions. These discussionscould lead to delays in the public announcement of the results from our Phase 3clinical trials, change our sample size estimates and affect whether AI-700 isapproved for the indication that we are seeking, the timing of such approval orwhether AI-700 is approved at all. 

The estimates of, patientenrollment requirements and timing of clinical enrollment, blinded reads, datalock, data release and NDA filing in our Phase 3 trials described abovereflect our current assumptions, based on our knowledge and experience and theguidance of our advisors.  We cannot assure you that these timelines willbe met, nor can we assure you that our estimates and assumptions will notchange based upon ongoing regulatory feedback or that, when the trials arecompleted, we will successfully achieve results that meet or exceed theclinical endpoints of these Phase 3 trials.

**AI-700 Manufacturing Facility Update**

In July 2004, weentered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts. In September 2004,we began to build-out the manufacturing space of this facility for commercialmanufacturing of AI-700. This manufacturing facility is designed to meetthe Company’s estimated initial commercial demand for AI-700 and to allowfor increments in capacity. We intend to demonstrate that we can produce AI-700at a commercial 

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manufacturingscale prior to our filing of a NDA for AI-700 and, subject to requiredregulatory approvals, we intend to manufacture AI-700 in this facilityfor commercial use. This commercial manufacturing facility must comply withcurrent good manufacturing practices, or cGMPs, enforced by the FDA andoverseas regulatory agencies. We have identified potential primary andsecondary suppliers of the raw materials used in the production of AI-700.

In October 2005, wereceived an occupancy permit for this commercial manufacturing facility afterwhich operations commenced on site. By the end of October 2005, most ofthe procured manufacturing equipment had been subject to start-up activitiesand were placed in service. The build-out of the facility is substantiallycomplete, with minor items remaining to be addressed by the contractor. Facilityimprovements are being amortized over the remaining initial term of the lease,or approximately five years. Our primary efforts at this facility are currentlydirected at the substantial work required to qualify equipment and operationsin compliance with cGMP’s. Completion of such qualification includessignificant testing and documentation, including stability studies. It alsorequires that we successfully demonstrate that we can produce AI-700product within specifications which are consistent with the clinical trialmaterial used in our Phase 3 clinical program. We have demonstrated previouslythat we can produce AI-700 in a qualified manner. We need to repeat thisdemonstration in our commercial manufacturing facility prior to filing our NDA.Based upon our current plans, we expect to complete this qualification phase bythe end of Q2 2007 after which we believe that we will have all of themanufacturing related data necessary to file our NDA.

Although the build-out ofthe facility is substantially complete, we cannot assure you that we will notencounter complications in the qualification of operations in this facilitywhich complications could add additional costs or delay our filing of a NDA forAI-700.

**EuropeanCollaboration Agreement**

In July 2004, weentered into a collaboration, license and supply agreement with Nycomedpursuant to which we granted Nycomed rights to develop and market AI-700in Europe. As part of the agreement, Nycomed has agreed to provide up to$70 million in license fees, research and development funding, andmilestone payments, including $12 million in payments over the first twoyears, of which $11 million was received by us prior to December 31, 2005with the remaining $1 million payment due to us in 2006. The remaining$58 million in milestone payments are related to regulatory approvals andachievement of certain sales goals. In addition, Nycomed has agreed to pay usto manufacture AI-700 for them and to pay us royalties on Nycomed’s salesof AI-700. Nycomed will be responsible for sales, marketing and theregulatory submissions required for marketing throughout its sales territory,which includes the member states of the European Union, as well as Russia/CISand Turkey. During the fiscal year ended December 31, 2005, we recognized$3.4 million in revenue derived from our collaboration with Nycomed.

In October 2005, theCompany and Nycomed agreed to amend the strategic collaboration agreement inorder to accelerate $150,000 in milestone payments to support activitiesassociated with AI-700 brand development and related trademark activities.In February 2006, the Company and Nycomed agreed to further amend theagreement to accelerate an additional $1.85 million in milestone payments inorder to fund certain activities associated with the qualification of ourmanufacturing facility. Beginning with costs incurred in February 2006, wemay begin to draw down on this $1.85 million in accelerated funding up to$370,000 per month. Any payments received pursuant to these amendments areconsidered advances against a future milestone payment for a Europeanregulatory filing, or Marketing Authorization Application (“MAA”), and will bededucted from that milestone payment. Payments received under these amendmentswill be classified as deferred revenue until the MAA milestone is achieved,provided that the applicable revenue recognition criteria are met.

The Nycomed agreement issubject to termination provisions. Under certain of these terminationprovisions, if we fail in any material respect to use all commerciallyreasonable efforts to carry out referenced obligations under the agreement, wewould be obligated to pay Nycomed liquidated damages of 

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up to$12 million. We plan to carry out all of these obligations, which webelieve are in our control. There can be no assurance that termination of thisagreement will not occur or that such termination would not result in usincurring liquidated damages of up to $12 million.

**FinancialOperations Overview**

*Revenue.**  *We have not generated any revenuefrom product sales since our inception. In connection with our strategiccollaboration agreement with Nycomed, as of December 31, 2005 we havecumulatively received $11.0 million in license fees and research anddevelopment payments and we anticipate receiving an additional $1.0 million insuch contractually scheduled research and development payments in 2006. In October 2005,we and Nycomed agreed to amend the agreement in order to accelerate $150,000 inmilestone payments to support activities associated with AI-700 branddevelopment and related trademark activities. This amount has been deferred asof December 31, 2005. In February 2006, the Company and Nycomedagreed to further amend the agreement to accelerate $1.85 million in milestonepayments in order to fund certain activities associated with the qualificationof our manufacturing facility in Tewksbury, Massachusetts. We anticipate beingpaid this $1.85 million in 2006 as the qualification costs areincurred. Any payments received pursuant to these amendments areconsidered advances against a future milestone payment for a Europeanregulatory filing, or MAA, and will be deducted from that milestone payment. Paymentsreceived under these amendments will be classified as deferred revenue untilthe MAA milestone is achieved provided that the applicable revenue recognitioncriteria are met. Further in the future, we will seek to generate revenue froma combination of product sales, up-front or milestone payments andmanufacturing payments in connection with collaborative or strategicrelationships, and royalties resulting from the license of our products andintellectual property.

*Researchand Development Expense.**  *Research and development expense consists of expensesincurred in developing, manufacturing and testing product candidates. Theseexpenses consist primarily of salaries and related expenses for personnel, feespaid to professional service providers in conjunction with independentlymonitoring our clinical trials and acquiring and evaluating data in conjunctionwith our clinical trials, costs of materials used in clinical trials andresearch and development, costs incurred to validate manufacturing equipmentand facilities, costs of contract manufacturing services, depreciation ofcapital resources used to develop our products, costs of facilities, legal andother costs of pursuing patent protection on select elements of ourintellectual property and stock-based compensation. We expense research anddevelopment costs, including patent related costs, as incurred. We believe thatsignificant investment in product development is a competitive necessity andplan to continue these investments in order to realize the potential of ourproduct candidates and proprietary technologies. Development programs for laterstage product candidates, such as AI-700, tend to cost more than earlierstage programs due to the length and the number of patients enrolled inclinical trials for later stage programs and due to costs of scaling productionto commercial scale.

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

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

*Change in Valuation ofDerivative.**  *The terms of our February 2005 convertibleperferred stock offering and our March 2005 Mass Development loanagreement contain features considered to be embedded derivatives which arerecorded at estimated fair value in accordance with Statement of 

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Financial Accounting Standards No. 133, Accounting for DerivativeInstruments (SFAS 133).**Changein valuation of derivative consists of other income (expense) recognized orincurred on the change in estimated fair value of these derivatives at the endof each reporting period. The change in the value of the derivative related tothe preferred stock is affected by a number of assumptions including the numberof preferred shares outstanding, the amount of dividends paid and theprobability and timing of conversion into common stock. The derivative liabilityis reduced for any make-whole payments made during the period upon conversionsof preferred stock to common stock. The change in the value of the derivativerelated to the loan is affected by the expected timing of future positive netcash flows from operations.

*Dividends on PreferredStock.**  *Forthe year ended December 31, 2005, dividends on preferred stock consistedof dividends paid or accumulated on the convertible exchangeable preferredstock which we issued in February 2005. Dividends on preferred stockexclude any make-whole payments on conversion of preferred stock to commonstock. Dividends on our preferred stock are cumulative from the date oforiginal issue at the annual rate of $3.25 per share, payable quarterly on thefirst day of March, June, September, and December. Any dividend payment must bedeclared by our board of directors and must come from funds that are legallyavailable for dividend payments. Prior to the completion of our initial publicoffering in 2003, we had outstanding convertible preferred stock which wasentitled to accretion of dividends, the amount of which decreased the amount ofstockholders’ equity available to common stockholders and effectively increasedthe loss per share of common stock. This preferred stock all converted incommon stock in conjunction with the initial public offering. All preferredstock dividends which were accreted before October 14, 2003 were forfeitedby the preferred stockholders on that date in connection with the conversion ofthese preferred shares to common stock**.**

**Results ofOperations**

*Revenue.**  *Collaboration revenue was $3.4 million for the year ended December 31,2005, compared to $1.7 million in 2004 and $0.0 collaboration revenuerecognized in 2003. Collaboration revenue was earned under our agreement withNycomed which was entered into in July 2004. Under this agreement,excluding any payments that we might receive based upon the achievement ofspecified milestones, we are scheduled to receive $12 million in licensefees and research and development payments through June 2006, of which $11.0 million was received as of December 31,2005. We recognize revenue associated with these $12 million in paymentsratably over a period of forty-two months, representing the estimateddevelopment period over which such fees are earned. In addition, in October 2005,Nycomed agreed to amend our agreement and paid us $150,000 to fund certainactivities associated with creating a brand name for AI-700 and relatedtrademark activities. This amount has been deferred as of December 31,2005.

*Research and DevelopmentExpense.*   Research and development expense forthe year ended December 31, 2005 was $42.2 million compared to $26.0 million in 2004 and $14.8million in 2003. The $16.2million increase in 2005 over 2004 represented an increase of 62% and the$11.2 million increase in 2004 over 2003 represented an increase of 76%.Included in the increase in research and development expense in 2005 is $6.2million that we expensed in connection with our acquisition of patents fromSchering.

The remaining $10.0million increase during 2005 in research and development expense is primarilydue to a $5.8 million increase in direct costs, including a $1.9 millionincrease in salaries related to increased staffing levels, a $1.1 millionincrease in consulting and contract services and a $2.3 million increase inmaterials and supplies. These increases are primarily due to activitiesrelating to AI-700, including increased Phase 3 clinical program costsand increased costs associated with preparing for commercial manufacturing ofAI-700. The increases reflect costs associated with a higher number ofclinical sites enrolling patients in the AI-700 Phase 3 clinical program,a higher rate of patient enrollment in these clinical trials and relatedincreases in costs for clinical data management and independent clinical sitemonitoring. The increase in research and development costs also includesincreased costs associated 

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withincreasing full and part-time personnel and operating costs associated withefforts to build-out and qualify a commercial manufacturing facility for AI-700.

The higher research anddevelopment expense in 2005 compared to 2004 primarily resulted from increasedactivities in the AI-700 Phase 3 clinical program, including clinicalsite costs, data management costs, independent monitoring costs and costs ofmanufacturing clinical materials. The increase in research and developmentcosts also includes costs associated with increasing full and part-timepersonnel. The increase in research and development costs in 2004 compared to2003 primarily resulted from costs associated with the start of our Phase 3clinical program for AI-700, including increased costs associated withclinical site training and clinical site monitoring. The increase in researchand development costs in 2005 compared to 2004 also includes increases inindirect costs. These increases included a $6.2 million charge under theSchering Patent Transfer Agreement and increased facility and depreciationcosts resulting primarily from the lease agreement entered into in 2004 theCompany’s commercial manufacturing facility in Tewksbury, Massachusetts and thedepreciation of improvements to that facility and equipment installed in thatfacility the majority of which went into service in October 2005.

Thefollowing table summarizes the primary components of our research anddevelopment expense for the years ended December 31, 2003, 2004 and 2005:

| ** **                              | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                              | ** ** | **(In thousands)**                     | ** ** |
| AI-700                                  |       | $                                           | 8,560      |   | $ | 18,522 |   | $ | 24,320 |   |
| AI-850 and  AI-128                      |       | 777                                         |       | 151 |   | 6 |   |
| Other direct  costs                     |       | 1,305                                       |       | 2,022 |   | 2,149 |   |
| Total direct costs                      |       | $                                           | 10,642     |   | $ | 20,695 |   | $ | 26,475 |   |
| Indirect costs:                         |       |                                        |       |   |   |   |   |
| Facility costs                          |       | 1,962                                       |       | 2,745 |   | 4,523 |   |
| Depreciation                            |       | 1,299                                       |       | 1,261 |   | 3,571 |   |
| Stock-based compensation                |       | 590                                         |       | 356 |   | 199 |   |
| Schering patent transfer costs          |       | —                                      |       | — |   | 6,218 |   |
| Other patent costs                      |       | 325                                         |       | 919 |   | 1,173 |   |
| Total indirect  costs                   |       | 4,176                                       |       | 5,281 |   | 15,684 |   |
| Total research and  development expense |       | $                                           | 14,818     |   | $ | 25,976 |   | $ | 42,159 |   |

 

Researchand development costs generally increase as programs progress from early stageclinical trials to late stage clinical trials. Our primary research anddevelopment programs are as follows:

·       LateStage Clinical Development Program (AI-700).  Our lead product candidate, AI-700,which is a cardiovascular drug designed for the detection of coronary heartdisease. We incurred direct research and development expense for AI-700in 2005 of $24.3 million, $18.5 million in 2004 and $8.6 million in2003. Of these amounts, $10.2 million in 2005, $7.9 million in 2004 and $4.0 millionin 2003 were related to materials and manufacturing, validation, qualityassurance and quality control costs, including $1.7 million in contractmanufacturing costs in 2003. Patient enrollment in the Phase 3 clinical programfor AI-700 are anticipated to decline in 2006 as we completed enrollmentin the 32 trial in December 2005 and we seek to complete enrollment in the33 trial during 2006, however, costs associated with clinical data managementand evaluation, as well as regulatory affairs costs and increased costsassociated with qualifying our commercial manufacturing facility for AI-700in Tewksbury, Massachusetts, including depreciation costs on assets placed inservice in late 2005, are likely to offset all or most of the potential expensesavings in 2005 from reduced patient enrollment costs.

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·       Early Stage Clinical Development Programs(AI-850 and AI-128). Our initial clinical applications ofour HDDS technology, AI-850, and our PDDS technology, AI-128, haveeach completed a Phase 1 trial. During 2005, we prioritized our clinicalspending to AI-700 and incurred no clinical costs on AI-850 or AI-128.In late 2005, we commenced a feasibility study regarding the use of our HDDStechnology in connection with a product candidate under development by a largerpharmaceutical company. That company is reimbursing us for the cost of thestudy. In 2006 we anticipate other direct costs of early stage developmentprograms to increase. The amount of such increase will depend upon the extentto which we are successful in commencing new feasibility studies with partnersfor our HDDS and PDDS technologies, if at all, whether such studies result insubsequent development work funded by potential partners, the amount of fundingprovided by such current and potential partners, staffing levels available tosupport such projects and the extent to which we elect to pursue a developmentof HDDS or PDDS product candidates with our own resources.

·       Other*.*Otherdirect research and development costs primarily consist of management andpreclinical evaluation of other product candidates.

Each of our research anddevelopment programs is subject to risks and uncertainties, including therequirement to seek regulatory approvals, which are outside of our control. Forexample, our clinical trials may be subject to delays or rejections based onour inability to enroll patients at the rate that we expect or our inability toproduce clinical trial material in sufficient quantities and of sufficientquality to meet the schedule for our planned clinical trials. Moreover, theproduct candidates identified in these research and development programs,particularly our early stage programs, must overcome significant technological,manufacturing and marketing challenges before they can be successfullycommercialized. As a result of these risks and uncertainties, we are unable topredict with any certainty the period in which material net cash inflows fromsuch projects could be expected to commence or the completion date of theseprograms. Failure to commercialize these product candidates on a timely basiscould have a material adverse affect on our business, financial condition andresults of operations. We may seek to establish collaborative relationships tohelp us commercialize these product candidates, but there can be no assurancethat we will be successful in doing so.

*General and AdministrativeExpense.**  *Generaland administrative expense in the year ended December 31, 2005 was$7.4 million, compared to $6.2 million for 2004 and $4.9 million for2003. The $1.2 million increase in 2005 over 2004 represented an increase of19% while the $1.3 million increase in 2004 over 2003 represented an increaseof 27%. The increase in general and administrative expense in both 2005 and 2004were principally due to additional personnel, consultants and increased costsfor investor relations, business development and other activities.

Thefollowing table summarizes the primary components of our general andadministrative expenses for the years ended December 31, 2003, 2004 and2005:

| ** **                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(In thousands)**                     | ** ** |
| Direct costs                              |       | $                                           | 3,228      |   | $ | 5,251 |   | $ | 6,673 |   |
| Indirect costs:                           |       |                                        |       |   |   |   |   |
| Facility costs                            |       | 511                                         |       | 303 |   | 253 |   |
| Depreciation                              |       | 434                                         |       | 27 |   | 145 |   |
| Stock-based compensation                  |       | 717                                         |       | 584 |   | 375 |   |
| Total indirect  costs                     |       | 1,662                                       |       | 914 |   | 772 |   |
| Total general and  administrative expense |       | $                                           | 4,890      |   | $ | 6,165 |   | $ | 7,446 |   |

 

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We anticipate some overallincrease in general and administrative expense, including increases in costsfor investor relations and business development activities. We intend tocontinue to incur various internal and external business development costs tosupport our various product development efforts, and certain of these expensesare likely to increase overall.

*Interest and Other Income(Expense).**  *Interestand other income (expense) for the year ended December 31, 2005 was $1.6million of net income, compared to $468,000 of net income in 2004 and$2.2 million of net expense in 2003. The $1.1 million increase in netincome in 2005 over 2004 represented an increase of 231%  and the $2.7 million increase in netincome in 2004 over 2003 represented an increase of 121%. During these years,interest and other income (expense) consisted of the following:

| ** **                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(in thousands)**                    | ** ** |
| Interest income                    |       | $                                          | 200        |   | $ | 558 |   | $ | 1,845 |   |
| Other income                       |       | 22                                         |       | 43 |   | — |   |
| Interest expense                   |       | (2,437                                     | )          | (133 | ) | (551 | ) |
| Change in  valuation of derivative |       | —                                     |       | — |   | 257 |   |
| Total, net                         |       | $                                          | (2,215     | ) | $ | 468 |   | $ | 1,551 |   |

 

Theincrease in interest income in 2005 compared to 2004 was primarily due tohigher average fund balances available for investment resulting from the $45.0million preferred stock financing in February 2005 and the$18.7 million common stock offering completed in September 2005. Theincrease in interest income in 2004 compared to 2003 was primarily due tohigher average fund balances available for investing resulting from fundsreceived for the initial public officering in October 2003 and the$21.5 million private placement completed in October 2004. Theincrease in interest expense in 2005 compared to 2004 was primarily related toincreased borrowings under our two equipment financing lines and non-cashinterest accretion charges of $349,000 related to the Schering patent agreement.The interest expense was partially offset by the capitalization of interestassociated with the build out of our Tewksbury facility. The decrease ininterest expense in 2004 compared to 2003 was primarily due to interest costsassociated with bridge loans of $1.9 million, interest paid on subordinatedloans payable of $195,000 and amortization of the discount of $177,000 in 2003compared to zero in 2004.

*Change in Valuation ofDerivative.**  *The change in valuation of derivativeamounted to $257,000 in 2005. The increase in change in valuation of derivativewas related to the embedded derivative instrument from the dividend make-wholepayment feature of the preferred stock offering that closed in February 2005.We determined the initial fair value of the dividend make-whole payment featureto be $3.1 million at February 24, 2005 (the commitment date). As of December 31,2005, the derivative liability was valued at $1.1 million. During 2005, theCompany distributed 288,526 shares of its common stock with a fair value of$1.7 million in satisfaction of  themake-whole provision related to the conversion of 160,000 shares ofpreferred stock into common stock.

*Effect of Preferred Stockon Loss Available to Common Stockholders.**  *Our net loss available to common stockholdersincludes dividends paid as well as dividends accumulated on preferred stock.The accumulated portion represents one month of dividend accumulated but notdeclared as of the end of the period. This amount of dividends accumulated isincluded in the calculation of per share net loss available to commonstockholders.

In 2005, dividends paid or accumulated on preferredstock totaled $2.4 million compared to zero in 2004. The increase in dividendson preferred stock results from the issuance on February 24, 2005 of900,000 shares of 6.5% exchangeable preferred stock. During 2005, $2.2 millionin dividends were paid in cash to holders of this preferred stock. During 2005,certain of the shares of preferred stock were voluntarily converted into commonstock such that at December 31, 2005 740,000 shares of preferred stockwere outstanding. In February 2006,the board of directors declareda dividend on the shares of preferred 

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stock outstanding as of February 15, 2006.This dividend, which totaled $0.6million was paid on March 1, 2006. In addition to dividends paid onpreferred stock, the calculation of per share net loss available to commonstockholders includes $0.2 million of dividends accumulated on preferred stockrepresenting one month of dividend accumulated but not declared as of December 31,2005.

In 2004 , there was noaccretion of dividends on preferred stock because all previously outstandingshares of preferred stock were converted to common stock in conjunction withour initial public offering in October 2003. In 2003, in connection withthis conversion of preferred stock to common stock, all previously accreteddividends on the convertible preferred stock were forfeited by the holders.

**Liquidityand Capital Resources**

Historically, we havefinanced our business through the issuance of equity securities, debtfinancings and equipment leases and, more recently, with funds from ourcollaboration with Nycomed. Our liquidity requirements have arisen primarilyfrom research and development expenditures, equipment expenditures and paymentson outstanding indebtedness. As of December 31, 2005, we had cash and cashequivalents of $51.1 million. As of December 31, 2005 we owed $65,000 fromcapital leases and $21.3 million from notes payable and other long-termobligations. We also had operating lease commitments totaling $18.8 millionfor rent of our facilities.

During the year ended December 31,2005, operating activities used $30.7million of cash. Net cash used by operating activities during this periodresulted primarily from a net loss of $44.6 millionand a decrease in accounts payable of $1.1 million. These uses of cash werepartially offset by an increase, net of amortization, in deferred revenue of$1.7 million, primarily from payments received from Nycomed, a non-cashwrite-off of intellectual property of $6.2 million, net of $1.0 million paid in2005 under the Schering Patent Transfer Agreement, non-cash charges fordepreciation and amortization of $4.0 millionand an increase of $1.5 million in accrued expenses. In 2006 we anticipate that our cash spending from operating activitieswill be higher than in 2005 during quarters in which we continue to enrollpatients. We estimate cash spending from operations during 2006 to approximate$9 to $11 million per quarter during trial enrollment, with a reductiononce clinical trial****enrollment is concluded**.**

During the year ended December 31,2005, investing activities used $32.9million in cash. This use of cash was primarily used for purchases of equipmentand leasehold improvement costs incurred in connection with the build-out ofour commercial manufacturing facility for AI-700. Because the build-outof that facility was substantially completed in 2005, we anticipate equipmentand leasehold improvement costs in 2006 will be substantially less than in2005. Based upon our current plans, we estimate purchases of equipment andleasehold improvements in 2006 to be approximately $3 to $4 million in excessof current outstanding purchase orders of $846,000. We intend to seek financingfor under additional equipment financing lines.

During the year ended December 31,2005, financing activities provided $69.5 million in cash. Net cashprovided by financing activities during this period resulted primarily from thenet proceeds of a redeemable convertible preferred stock financing in February 2005of $41.9 million, net proceeds of a common stock financing in September 2005of $17.6 million and from borrowings under equipment financing lines of$12.2 million, net of repayments under those lines. These fundingactivities were partially offset by the payment of dividends during 2005 on theredeemable convertible preferred stock of $2.2 million.

In September 2005, wesold 3,566,000 shares of its common stock at $5.25 per share resulting in netproceeds of approximately $17.5 million after deducting underwriting discounts,commissions and offering expenses.

In June 2005, we entered into a $7.0 millionequipment financing line with Oxford Finance Corporation (“Oxford”). Borrowingsunder this equipment line can be made against qualified purchases, subject toreview and approval by Oxford, through April 2006. Borrowings arecollateralized by qualified purchases and repaid over 36 to 48 monthsdepending on the nature of the equipment financed. The 

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equipmentline is structured as a loan agreement with interest rates fixed at the time ofeach borrowing based on the U.S. Federal Reserve’s Three Year and Four YearTreasury Constant Maturity Rates. Interest rates on borrowings made through December 31,2005 under this line range from 10.3% to 10.8%, respectively. Loan amounts aresubject to acceleration upon the happening of certain customary events ofdefault including failure to timely pay principal and interest. We havecumulatively borrowed $5.6 million under this line during 2005, of which $5.3million was outstanding at December 31, 2005. The loans under this lineare secured by certain equipment in our Watertown and Tewksbury facilities.

In March 2005,we  borrowed $2.0 million under a loanagreement with MassDevelopment to help finance certain tenant improvements toour commercial manufacturing facility in Tewksbury, Massachusetts. Interestaccrues under the loan at 5.0% per annum with retroactive adjustments to 9%upon our reaching certain defined earning levels. The repayment of principaland accrued interest will coincide with the term of the Tewksbury lease whichhas a five-year, nine-month term with options to extend the lease for up to twoadditional five-year terms. No payments are due under the loan for the firsttwenty-four months. Unpaid interest during this twenty-four month period shallbe accrued and principal and interest shall be repaid on a monthly basisthereafter such that the total amount outstanding shall fully amortize over thebalance of the term in equal installments. The loan is subject to accelerationupon certain customary events of default, including failure to timely payprincipal and interest. The loan is secured by certain of the tenantimprovements made at the Tewksbury facility.

On February 24, 2005,we issued 900,000 shares of 6.5% convertible exchangeable preferred stock (“PreferredStock”) at $50.00 per share resulting in net proceeds of approximately $41.9million after deducting underwriting discounts, commissions and offeringexpenses. Each share of Preferred Stock has a liquidation preference of $50.00per share. Dividends on the Preferred Stock are cumulative from the date oforiginal issue at the annual rate of $3.25 per share, payable quarterly on thefirst day of March, June, September, and December. Any dividends must be declaredby our board of directors and must come from funds that are legally availablefor dividend payments.  During 2005, theCompany paid $2.2 million in dividends on our Preferred Stock. As of December 31,2005, 740,000 shares ofPreferred Stock were outstanding. In February 2006,our board of directors declared a quarterly dividend on the Preferred Stock forall holders as of February 15, 2006. This dividend, which totaled $601,000in aggregate, was paid on March 1, 2006.

We may elect toautomatically convert some or all of the Preferred Stock into shares of ourcommon stock if the closing price of our common stock has exceeded $10.30 pershare (150% of the conversion price) for at least 20 trading days during any 30-daytrading period, ending within five trading days prior to notice of automaticconversion. Prior to March 1, 2009, if we elect to automatically convert,or if any holder elects to voluntarily convert, the Preferred Stock, we willalso make an additional payment, the Make-Whole payment, equal to the aggregateamount of dividends that would have been payable on the Preferred Stock soconverted from the original date of issuance through and including March 1,2009, less any dividends already paid on the Preferred Stock. This additionalpayment is payable by us, at our option, in cash, in additional shares of itscommon stock, or in a combination of cash and shares of common stock.  We have reserved a maximum of approximately2.0 million shares of common stock for issuance under this Make-Whole provision.

As of December 31,2005, 160,000 shares ofPreferred Stock had been voluntarily converted into 1,166,181 shares of the Company’s common stock. In connection withsuch conversions, we issued an additional 288,526 shares of the Company’s common stock in satisfaction ofthe required Make-Whole payment.

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We may elect to redeem the Preferred Stock atdeclining redemption prices on or after March 6, 2009.  The Preferred Stock is exchangeable, in wholebut not in part, at our option on any dividend payment date beginning onMarch 1, 2006 (the “Exchange Date”) for our  6.5% convertiblesubordinated debentures (“Debentures”) at the rate of $50 principal amount ofDebentures for each share of Preferred Stock. The Debentures, if issued, willmature 25 years after the Exchange Date and have terms substantially similar tothose of the Preferred Stock.

In October 2004, we completed the second andfinal closing of a $21.1 million private financing, after deductingunderwriting discounts, commissions and offering expenses. In July 2004 wecompleted the first closing of this financing. In the combined closings of thefinancing we issued to institutional and accredited investors an aggregate of4,014,478 shares of common stock at a price of $6.25 per share and warrants topurchase up to an aggregate of 802,895 additional shares of common stock at anexercise price of $8.50 per share.

In April 2004, we entered into an equipmentfinancing line with General Electric Capital Corporation. In 2004 and 2005, theCompany borrowed an aggregate of $10.5 million against this line. As of December 31,2005, net of repayments, we had $8.4 million outstanding under this line. Suchborrowings are collateralized by corresponding equipment and other capitalpurchases with repayment due in monthly installments over 36 to 48 months,depending on the nature of the equipment financed, with the last such repaymentscheduled for March 2009. Interest rates on these borrowings were fixed atthe time of each borrowing and range from 8.7% to 10.1%. No further additionalamount may be borrowed under this line. The loans under this line are subjectto acceleration upon the happening of certain customary events of default,including failure to timely pay principal and interest.

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. Under the original terms of thisagreement, Nycomed paid us license fees and research and development paymentstotaling $6.0 million in 2004 and $5.0 million in 2005. Nycomed isscheduled to pay us an additional $1.0 million in research and developmentpayments in 2006. The original agreement also provides for Nycomed to pay to usup to $58.0 million in milestone payments upon achievement of certainregulatory milestones and sales goals. Under the agreement, Nycomed has agreedto pay us to manufacture AI-700 for them and to pay us royalties onNycomed’s sales of AI-700. In October 2005, our agreement withNycomed was amended such that Nycomed paid us an additional $150,000 in 2005for activities associated with creating a brand name for AI-700 andrelated trademark activities which amount decreased by $150,000 the potential$58.0 in milestone payments which may be earned under the agreement. InFebruary 2006, the Company and Nycomed agreed to further amend the agreement toaccelerate $1.85 million in milestone payments in order to fund certainactivities associated with the qualification of our manufacturing facility inTewksbury, Massachusetts. We anticipate being paid this $1.85 million in 2006as the qualification costs are incurred. Any payments received pursuant tothese amendments are considered advances against a future milestone payment fora European regulatory filing, or MAA, and will be deducted from that milestone payment.In connection with our original agreement with Nycomed, we are obligated to paya customary fee to our financial advisor. The fee is comprised of cash andwarrants. The total amount of cash payments is dependent upon the timing andmagnitude of the amounts paid to us by Nycomed. In 2004 and 2005, we paid ouradvisor $325,000 and $285,000, respectively, in connection with thistransaction. On November 30, 2004, in connection with the Nycomedtransaction, we issued a warrant to our financial advisor to purchase up to55,732 shares of our common stock at an exercise price of $6.28 per share

In July 2004, we entered into a lease agreementfor 58,000 square feet of commercial manufacturing space in Tewksbury,Massachusetts. This lease has a five year, nine month term with options toextend the lease for up to two additional five-year terms at predeterminedrental rates. Initially, we will receive nine months of occupancy free of baserent, followed by base rent of approximately $400,000 for the next twelve monthswith scheduled annual rental rate increases thereafter. In October 2004,we paid an initial security 

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deposit of$1.0 million to the landlord as part of the lease, subject to reduction ifwe make certain tenant improvements and upon the installation of equipment inthe facility. In August 2004, we entered into a $2.0 million loanagreement with the Massachusetts Development Finance Agency, the economicdevelopment authority of the Commonwealth of Massachusetts, to help fund tenantimprovements to the Tewksbury facility. Financing is available under this loanagreement upon completion by us of certain tenant improvements to the Tewksburyfacility. The term of this facility, if utilized, is expected to coincide withthe term of the Tewksbury lease. As of December 31, 2004**,**no borrowings had been made under thisloan agreement**.**

We believe, based on ouroperating plans, that our existing resources, including scheduled proceeds fromNycomed, will be adequate to fund our planned operations, including spendingnecessary to complete enrollment in our AI-700 Phase 3 clinical programinto early 2007, or longer if we elect to reduce our rate of spending. Unlesswe reduce our current rate of spending, we will require significant additionalfunds, which we may raise through public or private sales of equity, or fromborrowings, or from strategic partners. Our future capital requirements willdepend on many factors, including the scope and progress made in our researchand development activities and our clinical trials and the size and timing ofcreating expanded manufacturing capabilities. We may also need additional fundsfor possible future strategic acquisitions of businesses, patent licenses,products or technologies complementary to our business. We do not expect togenerate significant revenues for AI-700, other than possible license ormilestone payments, unless or until we or current or potential partnerscomplete clinical trials and receive marketing approval from the applicableregulatory authorities. Allowing our resources to become depleted may makefuture funding more difficult or expensive. When additional funds are requiredor, in advance of such requirements, we anticipate that funds will be needed,we may raise such funds from time to time through public or private sales ofequity or from borrowings or from strategic partners or we may delay funding ofcertain development activities which could delay the filing of our AI-700NDA and the commercialization of AI-700 which would have a materiallyadverse impact on our growth plans. We are evaluating our funding alternatives,additional equity financing may be dilutive to our stockholders; debtfinancing, if available, may involve significant cash payment obligations andcovenants that restrict our ability to operate as a business; and strategicpartnerships may result in royalties or other terms which reduce our economicpotential from products under development.

**Shelf Registration Statement**

We have on file with theU.S. Securities and Exchange Commission “SEC” a “universal shelf” registrationstatement on Form S-3 (Registration No. 333-123854) whichprovides for the offer, from time to time, of common stock, preferred stock,debt securities and warrants up to an aggregate of $81.3 million. This shelfregistration statement was declared effective by the SEC on April 15,2005. As of the filing of this report, the shelf registration statement remainseffective and, subject to market conditions and our capital needs, and so longas we are then eligible to use the registration statement under SEC rules, wemay again seek to use any remaining availability under the shelf registrationstatement by making an offering of securities covered for sale under theregistration statement. In addition, we may amend our shelf registrationstatement or file a new shelf registration statement to increase ourpotential access to capital. If we elect to raise additional capital using ashelf registration statement, we may use the net proceeds from the sale ofthese securities for general corporate purposes, which may include fundingclinical trials, research and development, regulatory activities and thequalification of our commercial manufacturing facility in Tewksbury,Massachusetts, acquisitions, including acquisitions of companies, products,intellectual property or other technology, repayment or refinancing of existingindebtedness, investments, capital expenditures, repurchase of our capitalstock and for any other purposes that we may specify in any prospectussupplement. Our management has broad discretion in the use of net proceeds andcould spend net proceeds in ways with which our shareholders may not agree andin ways that do not necessarily improve our operating results or the value ofour common stock. The existence of this shelf 

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registrationstatement is not intended to be indicative of any particular financing plan byus. If and when we pursue additional financing through the issuance ofadditional equity or debt securities, this shelf registration statement isintended to help facilitate such transactions.

**Off-BalanceSheet Financing Arrangements**

We currently do not haveany special purpose entities or off-balance sheet financing arrangements otherthan operating leases.

**Contractual Obligations**

The following tablesummarizes our contractual obligations as of December 31, 2005 and theeffect such obligations are expected to have on our liquidity and cash flow infuture periods:

**Payments Due byPeriod(In Thousands)**

| **Contractual Obligations**                                  | ** ** | ** **              | ** ** | **Total  Obligations  All Years** | ** ** | **2006** | ** ** | **2007 Through  2008** | ** ** | **2009 Through  2010** | ** ** | **After 2010** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|----------|------------|-----------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | **(in thousands)** | ** ** |
| Capital lease  obligations (including interest)                   |       |                    | $          | 77                                     |       |     | $          | 18                          |       |                        | $          | 35                  |       |   |   | $ | 24 |   |   |   | $ | — |   |   |
| Operating lease  obligations                                      |       |                    | 18,821     |                                   |       | 2,746    |       |                        | 5,911      |                        |       |                | 6,022      |   |   |   | 4,142 |   |   |
| Notes payable  (including interest)                               |       |                    | 18,531     |                                   |       | 4,952    |       |                        | 10,508     |                        |       |                | 3,071      |   |   |   | — |   |   |
| Intellectual  property acquisition cost obligations               |       |                    | 6,000      |                                   |       | 3,000    |       |                        | 3,000      |                        |       |                |       |   |   |   |   |   |   |
| Purchase orders  for capital equipment and leasehold improvements |       |                    | 846        |                                   |       | 846      |       |                        | —     |                        |       |                | —     |   |   |   | — |   |   |
| Total contractual  cash obligations                               |       |                    | $          | 44,275                                 |       |     | $          | 11,562                      |       |                        | $          | 19,454              |       |   |   | $ | 9,117 |   |   |   | $ | 4,142 |   |   |

 

Our operating lease obligations relate to our facilityleases.

As of December 31,2005, we have entered into purchase orders for capital equipment and leaseholdimprovements which total approximately **$**6.2 million.Against these purchase orders we have paid approximately $5.3 million in deposits. The tableabove reflects the remaining amounts due on these purchase orders. In 2006, weanticipate expenditures for equipment purchases totaling approximately $3.0 to$4.0 million in excess of the above reflected amounts.

**CriticalAccounting Policies and Estimates**

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. Webase 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.

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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 themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. We do notrecognize revenue in connection with license arrangements until payments arecollected or due and reasonably assured of being collected. In addition, we donot recognize revenue in circumstances where the arrangement includes a refundprovision until the refund condition is no longer applicable unless, in ourjudgment, the refund circumstances are within our operating control andunlikely to occur. Payments received in advance of being recognized as revenueare deferred.

We are recognizing collaboration revenue of $12.0million associated with the initial license and performance-based paymentsunder the Nycomed agreement based on an estimated recognition period offorty-two months over which we are obligated to perform services supporting theagreement and assumes that AI-700 will be ready for commercializationbefore the end of 2007. This estimated recognition period may change ifavailable facts and circumstances change. Were the estimated developmentperiod to be extended, we would record a reduction in cumulative revenuerecognized in our statement of operations in the period in which the change indevelopment period is determined. Our agreement with Nycomed has been modifiedsuch that Nycomed has paid us $150,000 for activities associated with creatinga brand name for AI-700 and related trademark activities and to reimburse us for up to $1.8 millionfor support of activities to support the validation of the our commercialmanufacturing facility for AI-700. These amounts were originallyscheduled to be paid to us upon Nycomed’s filing for regulatory approval of AI-700in Europe. While the amounts are not refundable, we plan to defer recognitionof these amounts until after the original regulatory filing milestone has beenachieved. Payments received for current and potential HDDS and PDDS feasibilitystudies, which are offset by costs incurred for such studies, are recognized asrevenue over the estimated performance period of each such study. A change inthese estimates could result in a significant change to the amount of revenuerecognized in future periods. In addition, if the Nycomed collaborationagreement is terminated for reasons other than certain non-performance by us,we would recognize the remainder of the payments we have received or otherwiseexpect to collect over the amortization period at the time of termination. Wewill not recognize revenue associated with the potential additional $56 millionin milestone-based payments that may be earned under the Nycomed agreementuntil the underlying regulatory and sales milestones are achieved.

*FixedAssets.*   Property and equipment are recorded atcost and depreciated over their estimated useful lives of three to five yearsusing the straight-line method. The majority of our equipment is related to ourongoing research and development activities, including equipment which, subjectto regulatory approvals, we intended to use for commercial manufacture of AI-700.We consider that this equipment is placed in service when operation of theequipment is started-up and begin depreciating the equipment at this time. Theequipment in our commercial manufacturing facility is currently undergoingresearch and 

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development relatedactivities that result in wear and tear on the equipment including includeongoing calibration and testing.

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

*AccruedExpenses.*   As part of the process of preparingconsolidated financial statements we are required to estimate accrued expenses.This process involves identifying services which have been performed on ourbehalf and estimating the level of service performed and the associated costincurred for such service as of each balance sheet date in our consolidatedfinancial statements. Examples of estimated expenses for which we accrueinclude professional service fees, such as lawyers and accountants, andcontract service fees such as amounts paid to clinical monitors, datamanagement organizations and investigators in conjunction with clinical trials,and fees paid to the engineering and construction management contractor used inthe build-out of our commercial manufacturing facility for AI-700. Inconnection with such service fees, our estimates are most affected by ourunderstanding of the status and timing of services provided relative to theactual levels of services incurred by such service providers. The majority ofour service providers invoice us monthly in arrears for services performed. Inthe event that we do not identify certain costs which have begun to be incurredor we under- or over-estimate the level of services performed or the costs ofsuch services, our reported expenses for such period would be too low or toohigh. The date on which certain services commence, the level of servicesperformed on or before a given date and the cost of such services are oftenjudgmental. We make these judgments based upon the facts and circumstancesknown to us in accordance with accounting principles generally accepted in theUnited States of America.

*Stock-BasedCompensation and Other Equity Instruments.**  *We have elected to follow APBOpinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations, in accounting for our stock-based compensation plans, ratherthan the alternative fair 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.  For those stock options that were granted atless than fair market value, are recorded as expense in the financialstatements. In the notes to our consolidated financial statements we providepro forma disclosures in accordance with SFAS No. 123 and relatedpronouncements. We expect to adopt SFAS No. 123R on January 1, 2006using the Statement’s modified prospective application method. We do not yet have an estimate of the effecton our statements of operations of adopting SFAS No. 123. 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*

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*ConvertibleDebt and Debt Issued with Stock Purchase Warrants*. The twofactors which most affect charges or credits to operations related tostock-based compensation are the fair value of the common stock underlyingstock options for which stock-based compensation is recorded and the volatilityof such fair value.

Accounting for equity instruments granted or sold byus under APB No. 14, APB No. 25, SFAS No. 123 and EITF No. 96-18requires fair value estimates of the equity instrument granted or sold. If ourestimates of the fair value of these equity instruments are too high or toolow, it would have the effect of overstating or understating expenses. Whenequity instruments are granted or sold in exchange for the receipt of goods orservices and the value of those goods or services can be readily estimated, weuse the value of such goods or services to determine the fair value of theequity instruments. When equity instruments are granted or sold in exchange forthe receipt of goods or services and the value of those goods or services cannot be readily estimated, as is true in connection with most stock options andwarrants granted to employees or non-employees, we estimated the fair value ofthe equity instruments based upon consideration of factors which we deemed tobe relevant at the time using cost, market and/or income approaches to suchvaluations. Because shares of our common stock were not publicly traded priorto our initial public offering in October 2003, market factorshistorically considered in valuing stock and stock option grants include: (i) comparativevalues of public companies discounted for the risk and limited liquidityprovided for in the shares we are issuing, (ii) pricing of private salesof our convertible preferred stock, (iii) prior valuations of stock grantsand the effect of events that have occurred between the time of such grants, (iv) economictrends, (v) perspective provided by investment banks and (vi) thecomparative rights and preferences of the security being granted compared tothe rights and preferences of our other outstanding equity.

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

*Income Taxes.**  *As part of the process of preparingour consolidated financial statements we are required to estimate our incometaxes in each of the jurisdictions in which we operate. This process involvesus estimating our actual current tax exposure together with assessing temporarydifferences resulting from differing treatments of items for tax and accountingpurposes. These differences result in deferred tax assets and liabilities. Inaddition, as of December 31, 2005, we had federal tax net operating losscarryforwards of $53.6 million,which expire through****2024. We also have research anddevelopment credit carryforwards of $6.1 million.We have recorded a valuation allowance to fully offset against these otherwiserecognizable net deferred tax assets due to the uncertainty surrounding thetiming of the realization of the tax benefit. In the event that we determine inthe future that we will be able to realize all or a portion of its net deferredtax benefit, an adjustment to deferred tax valuation allowance would increasenet income in the period in which such a determination is made. The Tax ReformAct of 1986 

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contains provisionsthat may limit the utilization of net operating loss carryforwards and creditsavailable to be used in any given year in the event of significant changes inownership interest, as defined.

**RecentlyIssued Accounting Pronouncements**

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”).This Statement is a revision of SFAS No. 123 and supersedes AccountingPrinciples Board Opinion No. 25 and its related implementation guidance.SFAS No. 123R focuses primarily on accounting for transactions in which anentity obtains employee services in share-based payment transactions. TheStatement requires entities to recognize stock compensation expense for awardsof equity instruments to employees based on the grant-date fair value of thoseawards (with limited exceptions). In 2006, we expect to adopt SFAS No. 123Rusing the Statement’s modified prospective application method. While we believethe adoption of this standard will cause our annual compensation costs toincrease, we have not yet estimated the amount of additional operating expensewhich will need to be recorded in 2006 upon the adoption of SFAS No.123R.

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

We have not usedderivative financial instruments for speculative or trading purposes. However,we are exposed to market risk related to changes in interest rates. Our currentpolicy is to maintain an investment portfolio consisting mainly of U.S. moneymarket and government-grade securities, directly or through managed funds, withmaturities of one year or less. Our cash is deposited in and invested throughhighly rated financial institutions in North America. Our short-terminvestments are subject to interest rate risk and will fall in value if marketinterest rates increase. If market interest rates were to increase immediatelyand uniformly by 10% from levels at December 31, 2005, we estimate thatthe fair value of our investment portfolio would decline by an immaterialamount. We currently have the ability to hold our fixed income investmentsuntil maturity, and therefore we do not expect our operating results or cashflows to be affected to any significant degree by the effect of a change inmarket interest rates on our investments. Our equipment loans and capitalleases are not subject to interest rate fluctuations because the interest ratesare fixed at the time of borrowing.

**Effects of Inflation**

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

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

Our Financial Statements,together with the independent auditors’ report, appear at pages F-1through F-20, respectively, of this Annual Report on Form 10-K.

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**ITEM9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

Not applicable.

**ITEM 9A. CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

As of December 31, 2005 (the “Evaluation Date”),the Company’s management, with the participation of the Company’s ChiefExecutive Officer and the Company’s Chief Financial Officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”).Based upon that evaluation, the Company’s Chief Executive Officer and theCompany’s Chief Financial Officer concluded that, as of the Evaluation Date,the Company’s disclosure controls and procedures were effective in ensuringthat material information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms, including ensuring that suchmaterial information is accumulated and communicated to the Company’s management,including the Company’s Chief Executive Officer and the Company’s ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

During the periods coveredby this report, the Company was not subject to the provisions of Section 404of the Sarbanes-Oxley Act of 2002.

**InternalControl Over Financial Reporting**

During the fourth quarterof 2005, there have been no changes in the Company’s internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

**ITEM 9B. OTHER INFORMATION**

None.

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**PART III**

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filedwith the Securities and Exchange Commission not later than 120 days afterthe close of our fiscal year ended December 31, 2005.

**Code of Ethics**

We have adopted a “code of ethics” as defined byregulations promulgated under the Securities Act of 1933, as amended, and theExchange Act and a “code of conduct” as defined by qualitative listingrequirements promulgated by The Nasdaq National Market that apply to all of ourdirectors, officers and employees, including our principal executive officer,principal financial officer, principal accounting officer or controller, orpersons performing similar functions. We collectively refer to these codes asour Code of Business Conduct and Ethics, a current copy of which is attached asan exhibit to this Annual Report on Form 10-K. A current copy of ourCode of Business Conduct and Ethics may also be obtained by any person, withoutcharge, upon request directed to our Investor Relations department at:Acusphere, Inc., Attention: Investor Relations, 500 Arsenal Street,Watertown, MA 02472.

We intend to disclosesubstantive amendments to or waivers (including implicit waivers) of anyprovision of the Code of Business Conduct and Ethics that apply to ourprincipal executive officer, principal financial officer, principal accountingofficer or controller, or persons performing similar functions, by posting suchinformation on our website available at http://www.acusphere.com.

**ITEM 11. EXECUTIVE COMPENSATION**

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filedwith the Securities and Exchange Commission not later than 120 days afterthe close of our fiscal year ended December 31, 2005.

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**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filedwith the Securities and Exchange Commission not later than 120 days afterthe close of our fiscal year ended December 31, 2005.

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filedwith the Securities and Exchange Commission not later than 120 days afterthe close of our fiscal year ended December 31, 2005.

**ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filedwith the Securities and Exchange Commission not later than 120 days afterthe close of our fiscal year ended December 31, 2005.

**PART IV**

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

***(a)***

**1.   ConsolidatedFinancial Statements.**

For a list of thefinancial information included herein, see the Index on Page F-1.

**2.   Financial Statement Schedules.**

Except for the schedule ofUnaudited Quarterly Results of Operations****nofinancial statement schedules have been submitted because they are notrequired, not applicable, or because the information required is included inthe financial statements or the notes thereto.

**3.   Exhibit Index.**

| Exhibit   Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                            |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.01             |       | Amended and Restated Certificate of Incorporation of  registrant (incorporated herein by reference to Exhibit 3.01 to the  registrant’s Annual Report on Form 10-K for the Fiscal Year ended  December 31, 2005)                                                                                                                                       |
| 3.02             |       | Amended and Restated By-laws of registrant  (incorporated herein by reference to Exhibit 3.04 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                                                            |
| 3.03             |       | Certificate of Powers, Designations, Preferences and  Rights of the registrant’s 61¤2% Convertible Exchangeable Preferred  Stock (incorporated herein by reference to Exhibit 3.04 to the  registrant’s Annual Report on Form 10-K for the Fiscal Year ended  December 31, 2005)                                                             |
| 4.01             |       | Specimen Certificate for shares of common stock of  registrant (incorporated herein by reference to Exhibit 4.01 to the  registrant’s Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                                         |
| 4.02             |       | Form of Indenture between the registrant and  The Bank of New York, as trustee, relating to the issuance from time to time  in one or more series of debentures, notes, bonds or other evidences of  indebtedness (incorporated herein by reference to Exhibit 4.01 to the registrant’s  Registration Statement on Form S-3, File No. 333-121618) |

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| 4.03        |   | Form of Debt Security (incorporated herein by  reference to Exhibit 4.02 to the registrant’s Registration Statement on  Form S-3, File No. 333-121618)                                                                                                                                                                              |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.04        |   | Form of Debt Warrant Agreement (together with  form of Debt Warrant Certificate (incorporated herein by reference to  Exhibit 4.03 to the registrant’s Registration Statement on Form S-3,  File No. 333-121618)                                                                                                                    |
| 4.05        |   | Form of Common Stock Warrant Agreement  (together with form of Common Stock Warrant Certificate (incorporated herein  by reference to Exhibit 4.04 to the registrant’s Registration Statement  on Form S-3, File No. 333-121618)                                                                                                    |
| 4.06        |   | Form of Preferred Stock Warrant Agreement  (together with form of Preferred Stock Warrant Certificate) (incorporated  herein by reference to Exhibit 4.05 to the registrant’s Registration  Statement on Form S-3, File No. 333-121618)                                                                                             |
| 4.07        |   | Form of Designation for the Preferred Stock  (together with Preferred Stock Certificate) (incorporated herein by reference  to Exhibit 4.06 to the registrant’s Registration Statement on  Form S-3, File No. 333-121618)                                                                                                           |
| 4.08        |   | Indenture between the registrant and The Bank of New  York, as trustee, relating to the issuance of 61¤2% Convertible Subordinated  Debentures (incorporated herein by reference to Exhibit 4.2 to the  registrant’s Current Report on Form 8-K filed February 28,  2005)                                                           |
| 4.09        |   | Amended and Restated Certificate of Incorporation  (incorporated by reference to Exhibit 3.01)                                                                                                                                                                                                                                                          |
| 4.10        |   | Certificate of Powers, Designations, Preferences and  Rights of the registrant’s 61¤2% Convertible Exchangeable Preferred  Stock (incorporated by reference to Exhibit 3.03)                                                                                                                                                                  |
| 10.01† |   | 1994 Stock Plan, as amended (incorporated herein by  reference to Exhibit 10.01 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                                            |
| 10.02† |   | 2003 Stock Plan (incorporated herein by reference to  Exhibit 10.02 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725)                                                                                                                                                                                        |
| 10.03† |   | 2003 Employee Stock Purchase Plan (incorporated  herein by reference to Exhibit 10.03 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                                                                                      |
| 10.04† |   | Acusphere, Inc. 2005 Stock Option and Incentive  Plan, as amended (incorporated herein by reference to Exhibit 10.1 to  the Company’s current report on Form 8-K filed on June 20,  2005)                                                                                                                                           |
| 10.05† |   | Acusphere, Inc. Management Incentive Plan  (incorporated herein by reference to Exhibit 10.1 to the Company’s  current report on Form 8-K filed on March 16, 2005)                                                                                                                                                                  |
| 10.06† |   | Stock Repurchase and Registration Agreement by and  among the registrant, Harry R. Allcock, Sherri C. Oberg, Robert S. Langer,  Richard Kronenthal and Walter Levison, dated as of April 30, 1996  (incorporated herein by reference to Exhibit 10.05 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725) |
| 10.07† |   | Letter Agreement by and among the registrant, Sherri  C. Oberg and Robert S. Langer, dated as of April 30, 1996 (incorporated  herein by reference to Exhibit 10.06 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                   |
| 10.08       |   | Tenth Amended and Restated Investors’ Rights  Agreement by and among registrant, Sherri C. Oberg and the Investors named  therein, dated as of April 11, 2003, as amended (incorporated herein by  reference to Exhibit 10.07 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                    |
| 10.9        |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of June 6, 1997 (incorporated herein by  reference to Exhibit 10.09 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                |
| 10.10       |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of February 26, 1998 (incorporated herein  by reference to Exhibit 10.10 to the registrant’s Registration Statement  on Form S-1, File No. 333-106725)                                                                                           |

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| 10.11 |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of August 19, 1998 (incorporated herein by  reference to Exhibit 10.12 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                            |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.12 |   | Warrant Agreement by and between the registrant and  Gregory Stento, dated as of August 19, 1998 (incorporated herein by  reference to Exhibit 10.14 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                                 |
| 10.13 |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of October 16, 1998 (incorporated herein  by reference to Exhibit 10.15 to the registrant’s Registration Statement  on Form S-1, File No. 333-106725)                                                                                                                                                           |
| 10.14 |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of October 19, 1998 (incorporated herein  by reference to Exhibit 10.16 to the registrant’s Registration Statement  on Form S-1, File No. 333-106725)                                                                                                                                                           |
| 10.15 |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of January 5, 2000 (incorporated herein by  reference to Exhibit 10.17 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                            |
| 10.16 |   | Master Lease Agreement by and among the registrant,  Acusphere Securities Corporation and Transamerica Business Credit  Corporation, dated as of February 21, 2001 (incorporated herein by  reference to Exhibit 10.18 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                               |
| 10.17 |   | Warrant Agreement by and between the registrant and  TBCC Funding Trust I, dated of February 21, 2001 (incorporated  herein by reference to Exhibit 10.19 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                                                                       |
| 10.18 |   | Lease Agreement, by and between registrant and ARE-500  Arsenal Street, LLC, dated as of March 30, 2001 (incorporated herein by  reference to Exhibit 10.20 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                          |
| 10.19 |   | Warrant Agreement by and between the registrant and  Alexandria Real Estate Equities, L.P., dated of March 30, 2001  (incorporated herein by reference to Exhibit 10.21 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                              |
| 10.20 |   | CTM Agreement by and between the registrant and  Hollister-Stier Laboratories LLC, dated as of September 7, 2001  (incorporated herein by reference to Exhibit 10.22 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)  (confidential treatment previously granted)                                                                                                    |
| 10.21 |   | Development and Supply Agreement by and between the  registrant and Hollister-Stier Laboratories LLC dated as of  November 30, 2001 (incorporated herein by reference to  Exhibit 10.23 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725) (confidential treatment previously granted)                                                                             |
| 10.22 |   | Warrant Agreement by and between the registrant and  GATX Ventures, Inc., dated as of September 27, 2001 (incorporated  herein by reference to Exhibit 10.25 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                                                                    |
| 10.23 |   | Warrant Agreement by and between the registrant and  Venture Lending & Leasing III, LLC, dated as of  September 27, 2001 (incorporated herein by reference to  Exhibit 10.26 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725)                                                                                                                           |
| 10.24 |   | Termination Agreement by and among the registrant,  Acusphere Newco, Ltd., Elan Corporation, plc, Elan Pharma  International Limited and Elan International Services, Ltd. dated as of  September 26, 2003 (incorporated herein by reference to  Exhibit 10.27 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725) (confidential treatment previously granted) |

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| 10.25       |   | Form of Indemnification Agreement by and  between the registrant and each of its directors (incorporated herein by  reference to Exhibit 10.28 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                |
|-------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.26       |   | Form of Warrant issued by the registrant dated  as of April 11, 2003 and June 27, 2003 to each of the investors  listed on the schedule of warrantholders attached thereto (incorporated  herein by reference to Exhibit 10.29 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                      |
| 10.27† |   | Form of Indemnification Agreement by and  between the registrant and certain of its employees (incorporated herein by  reference to Exhibit 10.30 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                             |
| 10.28       |   | Form of Stock and Warrant Purchase Agreement  dated as of July 29, 2004 (incorporated herein by reference to  Exhibit 10.01 to the registrant’s Current Report on Form 8-K  filed July 29, 2004 (File No. 000-50405))                                                                                                             |
| 10.29       |   | Form of Warrant issued by the registrant to  certain investors (incorporated herein by reference to Exhibit 10.02 to  the registrant’s Current Report on Form 8-K filed July 29,  2004)                                                                                                                                                     |
| 10.30       |   | Amendment No. 2 to Tenth Amended and Restated  Investors’ Rights Agreement dated as of July 29, 2004 (incorporated  herein by reference to Exhibit 10.03 to the registrant’s Current Report  on Form 8-K filed July 29, 2004)                                                                                                     |
| 10.31       |   | Collaboration, License and Supply Agreement by and  between the registrant and Nycomed Danmark ApS dated July 6, 2004  (incorporated herein by reference to Exhibit 10.04 to the registrant’s  Amendment No. 2 to Form S-1 Registration Statement on  Form S-3, File No. 333-119027) (confidential treatment  previously granted) |
| 10.32       |   | First Amendment to Collaboration, License and Supply  Agreement by and between the registrant and Nycomed Danmark ApS dated  October 19, 2005 (incorporated herein by reference to Exhibit 10.1  to the registrant’s Current Report on Form 8-K filed  October 24, 2005)                                                                    |
| 10.33       |   | Commercial Building Lease by and between 890 East  LLC and the registrant dated as of July 20, 2004 (incorporated herein by  reference to Exhibit 10.05 to the registrant’s Amendment No. 2 to  Form S-1 Registration Statement on Form S-3, File  No. 333-119027) (confidential treatment previously granted)                    |
| 10.34       |   | Promissory Note with Massachusetts Development  Finance Agency (incorporated herein by reference to Exhibit 10.33 to the  registrant’s Registration Statement on Form S-1, File No. 333-119027)                                                                                                                                                  |
| 10.35       |   | Promissory Note with Massachusetts Development  Finance Agency (incorporated herein by reference to Exhibit 10.1 to the  registrant’s Current Report on Form 8-K filed March 25, 2005)                                                                                                                                                           |
| 10.36       |   | Master Security Agreement by and between the  registrant and General Electric Capital Corporation dated April 16, 2004  (incorporated herein by reference to Exhibit 10.34 to the registrant’s  Registration Statement on Form S-1, File No. 333-119027)                                                                                    |
| 10.37       |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed on March 2,  2005)                                                                         |
| 10.38       |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the registrant’s  Current Report on Form 8-K filed December 23, 2004)                                                                         |
| 10.39       |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed January 2,  2005)                                                                          |

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| 10.40 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed March 2, 2005)                                     |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.41 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed April 4, 2005)                                     |
| 10.42 |   | Master Security Agreement by and between the  registrant and Oxford Finance Corporation dated June 20, 2005  (incorporated herein by reference to Exhibit 10.1 to the registrant’s  Current Report on Form 8-K filed June 27, 2005)                                                                 |
| 10.43 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed June 27, 2005)                                               |
| 10.44 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed August 31,  2005)                                            |
| 10.45 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed September 29,  2005)                                         |
| 10.46 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed November 21,  2005)                                          |
| 10.47 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed December 21,  2005)                                          |
| 10.48 |   | Terms and Conditions for Engineering, Procurement  and Construction Management Services (incorporated herein by reference to  Exhibit 10.09 to the registrant’s Quarterly Report on Form 10-Q  for the Quarter Ended September 30, 2004) (confidential treatment  previously granted)                    |
| 10.49 |   | Contract Work Authorization (Form 1) No. 1  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.10 to the registrant’s Quarterly Report on  Form 10-Q for the Quarter Ended September 30, 2004)  (confidential treatment previously granted) |
| 10.50 |   | Contract Work Authorization (Form 1) No. 2  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.2 to the registrant’s Current Report on  Form 8-K filed December 14, 2004)                                                                   |
| 10.51 |   | Contract Work Authorization (Form 1) No. 3  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.2 to the registrant’s Current Report on  Form 8-K filed March 14, 2005)                                                                      |
| 10.52 |   | Contract Work Authorization (Form 1) No. 4  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed April 19, 2005)                                                                      |
| 10.53 |   | Contract Work Authorization (Form 1) No. 5  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed May 2, 2005)                                                                         |
| 10.54 |   | Contract Work Authorization (Form 1) No. 6  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed May 18, 2005)                                                                        |

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| 10.55       |   | Contract Work Authorization (Form 1) No. 7  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed June 20, 2005)                                          |
|-------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.56       |   | Contract Work Authorization (Form 1) No. 8  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed July 20, 2005)                                          |
| 10.57       |   | Contract Work Authorization (Form 1) No. 9  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed August 9, 2005)                                         |
| 10.58       |   | Contract Work Authorization (Form 1)  No. 10 for Engineering and Construction Management Services  (incorporated herein by reference to Exhibit 10.1 to the registrant’s  Current Report on Form 8-K filed September 7, 2005)                                     |
| 10.59       |   | Contract Work Authorization (Form 1)  No. 11 for Engineering and Construction Management Services  (incorporated herein by reference to Exhibit 10.1 to the registrant’s  Current Report on Form 8-K filed October 3, 2005)                                       |
| 10.60       |   | Contract Work Authorization (Form 2) No. 1  for Agency Procurements (incorporated herein by reference to  Exhibit 10.11 to the registrant’s Quarterly Report on Form 10-Q  for the Quarter Ended September 30, 2004) (confidential treatment  previously granted) |
| 10.61       |   | Contract Work Authorization (Form 2) No. 2  for Agency Procurements (incorporated herein by reference to  Exhibit 10.1 to the registrant’s Current Report on Form 8-K  filed March 14, 2005)                                                                      |
| 10.62       |   | Contract Work Authorization (Form 2) No. 2  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed December 14, 2004)                                      |
| 10.63† |   | Form of 2005 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                    |
| 10.64† |   | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                |
| 10.65† |   | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) (incorporated  herein by reference to Exhibit 10.3 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                |
| 10.66† |   | Form of 2003 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.4 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                    |
| 10.67† |   | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.5 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                |
| 10.68† |   | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) (incorporated  herein by reference to Exhibit 10.6 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                |
| 10.69       |   | Amendment No. 3 to Tenth Amended and Restated  Investors’ Rights Agreement dated as of October 26, 2004 (incorporated  herein by reference to Exhibit 10.1 to the registrant’s Current Report  on Form 8-K filed November 1, 2004)                           |
| 10.70       |   | Amendment to Lease between ARE-500 Arsenal  Street, LLC and Acusphere, Inc. (incorporated herein by reference  to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q  for the Quarter Ended March 31, 2005)                                           |

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| 10.71  |   | Patent Transfer agreement dated May 11, 2005  between Schering Aktiengesellschaft and Acusphere, Inc. (incorporated  herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended March 31, 2005) |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 12.01  |   | Computation of Ratios of Earnings to Fixed Charges  (incorporated herein by reference to Exhibit 12.01 to the registrant’s  Registration Statement on Form S-3, File No. 333-121618)                                                                        |
| 14.01* |   | Code of Business Conduct and Ethics                                                                                                                                                                                                                                             |
| 21.01* |   | List of Subsidiaries                                                                                                                                                                                                                                                            |
| 23.01* |   | Consent of Deloitte & Touche LLP                                                                                                                                                                                                                                       |
| 24.01* |   | Power of Attorney (included in signature page)                                                                                                                                                                                                                                  |
| 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                                                                                                                                                                                                                                                |

----

****                   *Filed herewith.

**             Furnished herewith

*†**                   *Indicates a management contractor any compensatory plan, contract or arrangement.

***(b)   *Exhibits.**

We hereby file as part ofthis Form 10-K the exhibits listed in Item 15(a)(3) above.Exhibits which are incorporated herein by reference can be inspected and copiedat the public reference facilities maintained by the Securities and ExchangeCommission, 450 Fifth Street, N.W., Washington, D.C., and at the Commission’sregional offices at Citicorp Center, 500 West Madison Street, Suite 1400,Chicago, IL 60611-2511, and at 233 Broadway, New York, NY 10279. Copiesof such material can also be obtained from the Public Reference Section ofthe Commission, 450 Fifth Street, N.W., Washington, D.C. 29549, at prescribedrates.

***(c) *  FinancialStatement Schedule.**

Except for the schedule of Unaudited Quarterly Resultsof Operations****no financialstatement schedules have been submitted because they are not required, notapplicable, or because the information required is included in the financialstatements or the notes thereto.

73

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|        |   | ACUSPHERE, INC.                    |
|--------|--------|-----------------------------------------|
|   |   | By: /s/ Sherri C.  Oberg           |   |
|   |   | Sherri C. Oberg                         |
|   |   | *President and Chief Executive Officer* |
|   |   | Date: March 20,  2006              |

 

**POWER OF ATTORNEY AND SIGNATURES**

We, the undersigned officers and directors ofAcusphere, Inc., hereby severally constitute and appoint Sherri C. Obergand John F. Thero, and each of them singly, our true and lawful attorneys, withfull power to them and each of them singly, to sign for us in our names in thecapacities indicated below, all amendments to this report, and generally to doall things in our names and on our behalf in such capacities to enableAcusphere, Inc. to comply with the provisions of the Securities ExchangeAct of 1934, as amended, and all requirements of the Securities and ExchangeCommission.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

|                                 | **Signature** | ** **                                          | ** ** |                          | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|---------------------------------|---------------|-----------------------------------------------------|------------|--------------------------|-----------|------------|------------|--|----------|------------|
| /s/ SHERRI C. OBERG             |          | President and  Chief Executive Officer and Director |       | March 20, 2006 |
| Sherri C. Oberg                 |          | (Principal Executive  Officer)                      |       |                     |
| /s/ JOHN F. THERO               |          | Senior Vice  President and Chief Financial Officer  |       | March 20, 2006 |
| John F. Thero                   |          | (Principal Financial and  Accounting Officer)       |       |                     |
| /s/ JR. FRANK BALDINO, JR. |          | Director                                            |       | March 20, 2006 |
| JR. Frank  Baldino, Jr.    |          |                                                |       |                     |
| /s/ GAREN BOHLIN                |          | Director                                            |       | March 20, 2006 |
| Garen Bohlin                    |          |                                                |       |                     |
| /s/ SANDRA L. FENWICK           |          | Director                                            |       | March 20, 2006 |
| Sandra L. Fenwick               |          |                                                |       |                     |
| /s/ MARTYN GREENACRE            |          | Director                                            |       | March 20, 2006 |
| Martyn Greenacre                |          |                                                |       |                     |
| /s/ DEREK LEMKE-VON AMMON       |          | Director                                            |       | March 20, 2006 |
| Derek Lemke-von Ammon           |          |                                                |       |                     |

 

 

74

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**EXHIBIT INDEX**

| Exhibit   Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                            |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   3.01 |       | Amended and Restated Certificate of Incorporation of  registrant (incorporated herein by reference to Exhibit 3.01 to the  registrant’s Annual Report on Form 10-K for the Fiscal Year ended  December 31, 2005)                                                                                                                                       |
|   3.02 |       | Amended and Restated By-laws of registrant  (incorporated herein by reference to Exhibit 3.04 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                                                            |
|   3.03 |       | Certificate of Powers, Designations, Preferences and  Rights of the registrant’s 6.5% Convertible Exchangeable Preferred Stock  (incorporated herein by reference to Exhibit 3.04 to the registrant’s  Annual Report on Form 10-K for the Fiscal Year ended  December 31, 2005)                                                                   |
|   4.01 |       | Specimen Certificate for shares of common stock of  registrant (incorporated herein by reference to Exhibit 4.01 to the  registrant’s Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                                         |
|   4.02 |       | Form of Indenture between the registrant and The  Bank of New York, as trustee, relating to the issuance from time to time in  one or more series of debentures, notes, bonds or other evidences of  indebtedness (incorporated herein by reference to Exhibit 4.01 to the  registrant’s Registration Statement on Form S-3, File No. 333-121618) |
|   4.03 |       | Form of Debt Security (incorporated herein by  reference to Exhibit 4.02 to the registrant’s Registration Statement on  Form S-3, File No. 333-121618)                                                                                                                                                                                            |
|   4.04 |       | Form of Debt Warrant Agreement (together with  form of Debt Warrant Certificate (incorporated herein by reference to  Exhibit 4.03 to the registrant’s Registration Statement on Form S-3,  File No. 333-121618)                                                                                                                                  |
|   4.05 |       | Form of Common Stock Warrant Agreement (together  with form of Common Stock Warrant Certificate (incorporated herein by  reference to Exhibit 4.04 to the registrant’s Registration Statement on  Form S-3, File No. 333-121618)                                                                                                                  |
|   4.06 |       | Form of Preferred Stock Warrant Agreement  (together with form of Preferred Stock Warrant Certificate) (incorporated  herein by reference to Exhibit 4.05 to the registrant’s Registration  Statement on Form S-3, File No. 333-121618)                                                                                                           |
|   4.07 |       | Form of Designation for the Preferred Stock  (together with Preferred Stock Certificate) (incorporated herein by reference  to Exhibit 4.06 to the registrant’s Registration Statement on  Form S-3, File No. 333-121618)                                                                                                                         |
|   4.08 |       | Indenture between the registrant and The Bank of New  York, as trustee, relating to the issuance of 6.5% Convertible Subordinated  Debentures (incorporated herein by reference to Exhibit 4.2 to the  registrant’s Current Report on Form 8-K filed February 28,  2005)                                                                               |
|   4.09 |       | Amended and Restated Certificate of Incorporation  (incorporated by reference to Exhibit 3.01)                                                                                                                                                                                                                                                                        |
|   4.10 |       | Certificate of Powers, Designations, Preferences and  Rights of the registrant’s 6.5% Convertible Exchangeable Preferred Stock  (incorporated by reference to Exhibit 3.03)                                                                                                                                                                                      |
| 10.01†      |       | 1994 Stock Plan, as amended (incorporated herein by  reference to Exhibit 10.01 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                                                          |
| 10.02†      |       | 2003 Stock Plan (incorporated herein by reference to  Exhibit 10.02 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725)                                                                                                                                                                                                      |
| 10.03†      |       | 2003 Employee Stock Purchase Plan (incorporated  herein by reference to Exhibit 10.03 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                                                                                                    |
| 10.04†      |       | Acusphere, Inc. 2005 Stock Option and Incentive  Plan, as amended (incorporated herein by reference to Exhibit 10.1 to  the Company’s current report on Form 8-K filed on June 20,  2005)                                                                                                                                                         |
| 10.05†      |       | Acusphere, Inc. Management Incentive Plan  (incorporated herein by reference to Exhibit 10.1 to the Company’s  current report on Form 8-K filed on March 16, 2005)                                                                                                                                                                                |
| 10.06†      |       | Stock Repurchase and Registration Agreement by and  among the registrant, Harry R. Allcock, Sherri C. Oberg, Robert S. Langer,  Richard Kronenthal and Walter Levison, dated as of April 30, 1996  (incorporated herein by reference to Exhibit 10.05 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)               |
| 10.07†      |       | Letter Agreement by and among the registrant, Sherri  C. Oberg and Robert S. Langer, dated as of April 30, 1996 (incorporated  herein by reference to Exhibit 10.06 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                 |
| 10.08            |       | Tenth Amended and Restated Investors’ Rights  Agreement by and among registrant, Sherri C. Oberg and the Investors named  therein, dated as of April 11, 2003, as amended (incorporated herein by  reference to Exhibit 10.07 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                  |
| 10.9             |       | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of June 6, 1997 (incorporated herein by  reference to Exhibit 10.09 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                              |

----

 

| 10.10       |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of February 26, 1998 (incorporated herein  by reference to Exhibit 10.10 to the registrant’s Registration Statement  on Form S-1, File No. 333-106725)                                                                                                                                                          |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11       |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of August 19, 1998 (incorporated herein by  reference to Exhibit 10.12 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                            |
| 10.12       |   | Warrant Agreement by and between the registrant and  Gregory Stento, dated as of August 19, 1998 (incorporated herein by  reference to Exhibit 10.14 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                                 |
| 10.13       |   | Warrant Agreement by and  between the registrant and Comdisco, Inc., dated as of October 16,  1998 (incorporated herein by reference to Exhibit 10.15 to the  registrant’s Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                                           |
| 10.14       |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of October 19, 1998 (incorporated herein  by reference to Exhibit 10.16 to the registrant’s Registration Statement  on Form S-1, File No. 333-106725)                                                                                                                                                           |
| 10.15       |   | Warrant Agreement by and between the registrant and  Comdisco, Inc., dated as of January 5, 2000 (incorporated herein by  reference to Exhibit 10.17 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                            |
| 10.16       |   | Master Lease Agreement by and among the registrant,  Acusphere Securities Corporation and Transamerica Business Credit  Corporation, dated as of February 21, 2001 (incorporated herein by  reference to Exhibit 10.18 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                               |
| 10.17       |   | Warrant Agreement by and between the registrant and  TBCC Funding Trust I, dated of February 21, 2001 (incorporated  herein by reference to Exhibit 10.19 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                                                                       |
| 10.18       |   | Lease Agreement, by and between registrant and ARE-500  Arsenal Street, LLC, dated as of March 30, 2001 (incorporated herein by  reference to Exhibit 10.20 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                          |
| 10.19       |   | Warrant Agreement by and between the registrant and  Alexandria Real Estate Equities, L.P., dated of March 30, 2001  (incorporated herein by reference to Exhibit 10.21 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)                                                                                                                                              |
| 10.20       |   | CTM Agreement by and between the registrant and  Hollister-Stier Laboratories LLC, dated as of September 7, 2001  (incorporated herein by reference to Exhibit 10.22 to the registrant’s  Registration Statement on Form S-1, File No. 333-106725)  (confidential treatment previously granted)                                                                                                    |
| 10.21       |   | Development and Supply Agreement by and between the  registrant and Hollister-Stier Laboratories LLC dated as of  November 30, 2001 (incorporated herein by reference to  Exhibit 10.23 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725) (confidential treatment previously granted)                                                                             |
| 10.22       |   | Warrant Agreement by and between the registrant and  GATX Ventures, Inc., dated as of September 27, 2001 (incorporated  herein by reference to Exhibit 10.25 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                                                                                                    |
| 10.23       |   | Warrant Agreement by and between the registrant and  Venture Lending & Leasing III, LLC, dated as of  September 27, 2001 (incorporated herein by reference to  Exhibit 10.26 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725)                                                                                                                           |
| 10.24       |   | Termination Agreement by and among the registrant,  Acusphere Newco, Ltd., Elan Corporation, plc, Elan Pharma  International Limited and Elan International Services, Ltd. dated as of  September 26, 2003 (incorporated herein by reference to  Exhibit 10.27 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725) (confidential treatment previously granted) |
| 10.25       |   | Form of Indemnification Agreement by and between  the registrant and each of its directors (incorporated herein by reference to  Exhibit 10.28 to the registrant’s Registration Statement on Form S-1,  File No. 333-106725)                                                                                                                                                                       |
| 10.26       |   | Form of Warrant issued by the registrant dated  as of April 11, 2003 and June 27, 2003 to each of the investors  listed on the schedule of warrantholders attached thereto (incorporated  herein by reference to Exhibit 10.29 to the registrant’s Registration  Statement on Form S-1, File No. 333-106725)                                                                             |
| 10.27† |   | Form of Indemnification Agreement by and between  the registrant and certain of its employees (incorporated herein by reference  to Exhibit 10.30 to the registrant’s Registration Statement on  Form S-1, File No. 333-106725)                                                                                                                                                                    |
| 10.28       |   | Form of Stock and Warrant Purchase Agreement  dated as of July 29, 2004 (incorporated herein by reference to  Exhibit 10.01 to the registrant’s Current Report on Form 8-K  filed July 29, 2004 (File No. 000-50405))                                                                                                                                                                    |

----

 

| 10.29 |   | Form of Warrant issued by the registrant to  certain investors (incorporated herein by reference to Exhibit 10.02 to  the registrant’s Current Report on Form 8-K filed July 29,  2004)                                                                                                                                                     |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.30 |   | Amendment No. 2 to Tenth Amended and Restated  Investors’ Rights Agreement dated as of July 29, 2004 (incorporated  herein by reference to Exhibit 10.03 to the registrant’s Current Report  on Form 8-K filed July 29, 2004)                                                                                                     |
| 10.31 |   | Collaboration, License and Supply Agreement by and  between the registrant and Nycomed Danmark ApS dated July 6, 2004  (incorporated herein by reference to Exhibit 10.04 to the registrant’s  Amendment No. 2 to Form S-1 Registration Statement on  Form S-3, File No. 333-119027) (confidential treatment  previously granted) |
| 10.32 |   | First Amendment to Collaboration, License and Supply  Agreement by and between the registrant and Nycomed Danmark ApS dated  October 19, 2005 (incorporated herein by reference to Exhibit 10.1  to the registrant’s Current Report on Form 8-K filed  October 24, 2005)                                                                    |
| 10.33 |   | Commercial Building Lease by and between 890 East LLC  and the registrant dated as of July 20, 2004 (incorporated herein by  reference to Exhibit 10.05 to the registrant’s Amendment No. 2 to  Form S-1 Registration Statement on Form S-3, File  No. 333-119027) (confidential treatment previously granted)                    |
| 10.34 |   | Promissory Note with Massachusetts Development  Finance Agency (incorporated herein by reference to Exhibit 10.33 to the  registrant’s Registration Statement on Form S-1, File No. 333-119027)                                                                                                                                                  |
| 10.35 |   | Promissory Note with Massachusetts Development  Finance Agency (incorporated herein by reference to Exhibit 10.1 to the  registrant’s Current Report on Form 8-K filed March 25, 2005)                                                                                                                                                           |
| 10.36 |   | Master Security Agreement  by and between the registrant and General Electric Capital Corporation dated  April 16, 2004 (incorporated herein by reference to Exhibit 10.34  to the registrant’s Registration Statement on Form S-1, File  No. 333-119027)                                                                                   |
| 10.37 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed on March 2,  2005)                                                                         |
| 10.38 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed December 23,  2004)                                                                        |
| 10.39 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed January 2,  2005)                                                                          |
| 10.40 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed March 2, 2005)                                                                             |
| 10.41 |   | Form of Promissory Note with General Electric  Capital Corporation under Master Security Agreement, together with schedule  of borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed April 4, 2005)                                                                             |
| 10.42 |   | Master Security Agreement by and between the  registrant and Oxford Finance Corporation dated June 20, 2005  (incorporated herein by reference to Exhibit 10.1 to the registrant’s  Current Report on Form 8-K filed June 27, 2005)                                                                                                         |
| 10.43 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed June 27, 2005)                                                                                       |
| 10.44 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed August 31,  2005)                                                                                    |
| 10.45 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed September 29,  2005)                                                                                 |
| 10.46 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed November 21,  2005)                                                                                  |
| 10.47 |   | Form of Promissory Note with Oxford Finance  Corporation under Master Security Agreement, together with schedule of  borrowing (incorporated herein by reference to Exhibit 10.2 to the  registrant’s Current Report on Form 8-K filed December 21,  2005)                                                                                  |

----

 

| 10.48       |   | Terms and Conditions for Engineering, Procurement and  Construction Management Services (incorporated herein by reference to  Exhibit 10.09 to the registrant’s Quarterly Report on Form 10-Q  for the Quarter Ended September 30, 2004) (confidential treatment  previously granted)                    |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.49       |   | Contract Work Authorization (Form 1) No. 1  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.10 to the registrant’s Quarterly Report on  Form 10-Q for the Quarter Ended September 30, 2004)  (confidential treatment previously granted) |
| 10.50       |   | Contract Work Authorization (Form 1) No. 2  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.2 to the registrant’s Current Report on  Form 8-K filed December 14, 2004)                                                                   |
| 10.51       |   | Contract Work Authorization (Form 1) No. 3  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.2 to the registrant’s Current Report on  Form 8-K filed March 14, 2005)                                                                      |
| 10.52       |   | Contract Work Authorization (Form 1) No. 4  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed April 19, 2005)                                                                      |
| 10.53       |   | Contract Work Authorization (Form 1) No. 5  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed May 2, 2005)                                                                         |
| 10.54       |   | Contract Work Authorization (Form 1) No. 6  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed May 18, 2005)                                                                        |
| 10.55       |   | Contract Work Authorization (Form 1) No. 7  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed June 20, 2005)                                                                       |
| 10.56       |   | Contract Work  Authorization (Form 1) No. 8 for Engineering and Construction  Management Services (incorporated herein by reference to Exhibit 10.1 to  the registrant’s Current Report on Form 8-K filed July 20,  2005)                                                                      |
| 10.57       |   | Contract Work Authorization (Form 1) No. 9  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed August 9, 2005)                                                                      |
| 10.58       |   | Contract Work Authorization (Form 1) No. 10  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed September 7, 2005)                                                                  |
| 10.59       |   | Contract Work Authorization (Form 1) No. 11  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed October 3, 2005)                                                                    |
| 10.60       |   | Contract Work Authorization (Form 2) No. 1  for Agency Procurements (incorporated herein by reference to  Exhibit 10.11 to the registrant’s Quarterly Report on Form 10-Q  for the Quarter Ended September 30, 2004) (confidential treatment  previously granted)                              |
| 10.61       |   | Contract Work Authorization (Form 2) No. 2  for Agency Procurements (incorporated herein by reference to  Exhibit 10.1 to the registrant’s Current Report on Form 8-K  filed March 14, 2005)                                                                                                   |
| 10.62       |   | Contract Work Authorization (Form 2) No. 2  for Engineering and Construction Management Services (incorporated herein by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K filed December 14, 2004)                                                                   |
| 10.63† |   | Form of 2005 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                                                 |
| 10.64† |   | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                                             |
| 10.65† |   | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) (incorporated  herein by reference to Exhibit 10.3 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                                             |
| 10.66† |   | Form of 2003 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.4 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005)                                                 |

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| 10.67† |   | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) (incorporated  herein by reference to Exhibit 10.5 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005) |
|-------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.68† |   | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) (incorporated  herein by reference to Exhibit 10.6 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended June 30, 2005) |
| 10.69       |   | Amendment No. 3 to Tenth Amended and Restated  Investors’ Rights Agreement dated as of October 26, 2004 (incorporated  herein by reference to Exhibit 10.1 to the registrant’s Current Report  on Form 8-K filed November 1, 2004)            |
| 10.70       |   | Amendment to Lease between ARE-500 Arsenal  Street, LLC and Acusphere, Inc. (incorporated herein by reference  to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q  for the Quarter Ended March 31, 2005)                            |
| 10.71       |   | Patent Transfer agreement dated May 11, 2005  between Schering Aktiengesellschaft and Acusphere, Inc. (incorporated  herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report  on Form 10-Q for the Quarter Ended March 31, 2005)  |
| 12.01       |   | Computation of Ratios of Earnings to Fixed Charges  (incorporated herein by reference to Exhibit 12.01 to the registrant’s  Registration Statement on Form S-3, File No. 333-121618)                                                                         |
| 14.01*      |   | Code of Business Conduct and Ethics                                                                                                                                                                                                                                              |
| 21.01*      |   | List of Subsidiaries                                                                                                                                                                                                                                                             |
| 23.01*      |   | Consent of Deloitte & Touche LLP                                                                                                                                                                                                                                        |
| 24.01*      |   | Power of Attorney (included in signature page)                                                                                                                                                                                                                                   |
| 31.1*       |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                 |
| 31.2*       |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                 |
| 32.1*       |   | Section 1350 Certifications                                                                                                                                                                                                                                                 |

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****      *Filed herewith.

**     Furnishedherewith

*†**      *Indicates a management contract or any compensatoryplan, contract or arrangement.

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**ACUSPHERE, INC. AND SUBSIDIARIES**

**TABLE OF CONTENTS**

|                                                                                                                       | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------|
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM                                                              |       | F-2      |
| CONSOLIDATED FINANCIAL  STATEMENTS:                                                                                   |       |     |
| Consolidated  Balance Sheets                                                                                          |       | F-3      |
| Consolidated Statements of Operations                                                                                 |       | F-4      |
| Consolidated Statements of Redeemable Convertible  Preferred Stock, Stockholders’ Equity, and Comprehensive Loss |       | F-5      |
| Consolidated Statements of Cash Flows                                                                                 |       | F-8      |
| Notes to Consolidated Financial Statements                                                                            |       | F-10     |

 

F-1

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

**Tothe Board of Directors and Shareholders of**

**Acusphere, Inc.**

**Watertown, Massachusetts**

We have audited the accompanying consolidated balancesheets of Acusphere, Inc. and subsidiaries (the “Company”) as of December 31,2004 and 2005, and the related consolidated statements of operations,redeemable convertible preferred stock, stockholders’ equity, and comprehensiveloss, and cash flows for each of the three years in the period ended December 31,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion*.* An audit alsoincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of the Company at December 31, 2004 and 2005, and theresults of its operations and its cash flows for each of the three years in theperiod ended December 31, 2005, in conformity with accounting principlesgenerally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Boston, Massachusetts

March 16, 2006

F-2

----

**ACUSPHERE, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                                                                                                                                                                                            | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                            | ** ** | **2004**                              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                            |       |                                  |       |   |   |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                                                                                       |       |                                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                                                                            |       | $                                     | 45,179,915 |   | $ | 51,112,341 |   |
| Other current assets                                                                                                                                                                                                                                                                                                                                                  |       | 2,096,681                             |       | 1,141,721 |   |
| Total current assets                                                                                                                                                                                                                                                                                                                                                  |       | 47,276,596                            |       | 52,254,062 |   |
| PROPERTY AND EQUIPMENT, at cost:                                                                                                                                                                                                                                                                                                                                      |       |                                  |       |   |   |
| Property and equipment                                                                                                                                                                                                                                                                                                                                                |       | 20,876,140                            |       | 53,725,961 |   |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                                                                                                                                       |       | 8,006,819                             |       | 11,886,288 |   |
| Property and equipment,  net                                                                                                                                                                                                                                                                                                                                          |       | 12,869,321                            |       | 41,839,673 |   |
| OTHER ASSETS                                                                                                                                                                                                                                                                                                                                                          |       | 1,857,306                             |       | 1,745,393 |   |
| TOTAL                                                                                                                                                                                                                                                                                                                                                                 |       | $                                     | 62,003,223 |   | $ | 95,839,129 |   |
| **LIABILITIES,  REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                               |       |                                  |       |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                                                                                  |       |                                  |       |   |   |
| Current portion of  long-term obligations                                                                                                                                                                                                                                                                                                                             |       | $                                     | 1,071,627  |   | $ | 6,726,721 |   |
| Current portion of  deferred revenue                                                                                                                                                                                                                                                                                                                                  |       | 3,428,571                             |       | 3,428,571 |   |
| Derivative liability                                                                                                                                                                                                                                                                                                                                                  |       | —                                |       | 1,078,490 |   |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                      |       | 4,237,934                             |       | 3,179,917 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                                      |       | 4,396,020                             |       | 6,829,240 |   |
| Total current  liabilities                                                                                                                                                                                                                                                                                                                                            |       | 13,134,152                            |       | 21,242,939 |   |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                                                                                                |       |                                  |       |   |   |
| Long-term obligations,  net of current portion                                                                                                                                                                                                                                                                                                                        |       | 2,502,579                             |       | 14,600,803 |   |
| Deferred revenue, net of  current portion                                                                                                                                                                                                                                                                                                                             |       | 857,143                               |       | 2,578,571 |   |
| Total long-term  liabilities                                                                                                                                                                                                                                                                                                                                          |       | 3,359,722                             |       | 17,179,374 |   |
| COMMITMENTS (Note 11)                                                                                                                                                                                                                                                                                                                                            |       |                                  |       |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                                                                                            |       |                                  |       |   |   |
| Preferred stock, $0.01  par value per share  Authorized—5,000,000 shares as of December 31, 2004 and 2005 Designated  6.5% convertible exchangeable—none as of December 31, 2004 and 1,000,000  shares as of December 31, 2005;   issued and outstanding, none as of December 31, 2004 and 740,000 shares  as of December 31, 2005 |       | —                                |       | 7,400 |   |
| Common stock, $0.01 par  value per share  Authorized, 98,500,000 shares as of December 31, 2004 and 2005; issued  and outstanding, 17,810,922 shares as of December 31, 2004 and  22,870,559 as of December 31, 2005                                                                                                                                   |       | 178,109                               |       | 228,706 |   |
| Additional paid-in  capital                                                                                                                                                                                                                                                                                                                                           |       | 221,672,237                           |       | 277,591,555 |   |
| Deferred stock-based  compensation                                                                                                                                                                                                                                                                                                                                    |       | (914,492                              | )          | (358,965 | ) |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                                   |       | (175,426,505                          | )          | (220,051,880 | ) |
| Total stockholders’  equity                                                                                                                                                                                                                                                                                                                                      |       | 45,509,349                            |       | 57,416,816 |   |
| TOTAL                                                                                                                                                                                                                                                                                                                                                                 |       | $                                     | 62,003,223 |   | $ | 95,839,129 |   |

 

See notes to consolidated financial statements.

F-3

----

**ACUSPHERE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS**

| ** **                                                                  | ** ** | **Year Ended December 31,** | ** **  |
|-----------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                  | ** ** | **2003**                                   | ** **  | **2004** | ** ** | **2005** | ** ** |
| COLLABORATION  REVENUE                                                      |       | $                                          | —      |   | $ | 1,714,286 |   | $ | 3,428,571 |   |
| OPERATING EXPENSES:                                                         |       |                                       |        |   |   |   |   |
| Research and development                                                    |       | 14,818,253                                 |        | 25,975,601 |   | 42,159,164 |   |
| General and administrative                                                  |       | 4,890,136                                  |        | 6,165,922 |   | 7,446,070 |   |
| Total operating expenses                                                    |       | 19,708,389                                 |        | 32,141,523 |   | 49,605,234 |   |
| Interest income                                                             |       | 199,883                                    |        | 557,747 |   | 1,844,909 |   |
| Other income                                                                |       | 22,701                                     |        | 43,718 |   | — |   |
| Change in  valuation of derivative                                          |       | —                                     |        | — |   | 257,010 |   |
| Interest expense                                                            |       | (2,437,632                                 | )           | (133,276 | ) | (550,631 | ) |
| NET LOSS                                                                    |       | (21,923,437                                | )           | (29,959,048 | ) | (44,625,375 | ) |
| Dividends on  preferred stock                                               |       | (5,948,073                                 | )           | — |   | (2,418,457 | ) |
| NET LOSS AVAILABLE TO COMMON STOCKHOLDERS                                   |       | $                                          | (27,871,510 | ) | $ | (29,959,048 | ) | $ | (47,043,832 | ) |
| NET LOSS AVAILABLE TO COMMON STOCKHOLDERS PER  SHARE—Basic and diluted |       | $                                          | (6.66       | ) | $ | (1.92 | ) | $ | (2.49 | ) |
| WEIGHTED-AVERAGE  SHARES OUTSTANDING—Basic and diluted                 |       | 4,187,672                                  |        | 15,602,832 |   | 18,897,130 |   |

 

See notes to consolidated financial statements.

F-4

----

**ACUSPHERE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF REDEEMABLE CONVERTIBLE PREFERRED STOCK,STOCKHOLDERS’ EQUITY, AND COMPREHENSIVE LOSS**

| ** **                                                                                      | ** ** | ** **                                  | ** ** | **Stockholders’ Equity** | ** ** | ** **                                                                      | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **Redeemable Convertible  Preferred Stock** | ** ** | **Convertible  Preferred Stock**   | ** ** | **Common Stock**                                                           | ** ** | **Additional** | ** ** | **Treasury Stock** | ** ** | **Accumulated  Other** | ** ** | **Deferred** | ** ** | ** ** | ** ** | **Total** | ** ** | ** ** | ** ** |
| ** **                                                                                      | ** ** | **Number of  Shares**                  | ** ** | **Carrying  Value**                | ** ** | **Number of  Shares**                                                      | ** ** | **$0.01  Par Value** | ** ** | **Number of  Shares** | ** ** | **$0.01  Par Value** | ** ** | **Paid-in  Capital** | ** ** | **Number  of  Shares** | ** ** | **Cost** | ** ** | **Comprehensive  Income** | ** ** | **Stock-Based  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** ** | **Comprehensive  Loss** | ** ** |
| **BALANCE,  January 1, 2003**                                                              |       | 31,145,083                                  |       | $ 91,467,075                  |       | $            — |       | $         — |   | 1,218,876 |   | $ 12,189 |   | $ 34,029,519 |   | 6,027 |   | $ (361 | ) | $                288 |   | $ (1,793,404 | ) | $ (117,595,947 | ) | $ (85,347,716 | ) |   |   |
| Exercise of stock  options                                                                      |       |                                        |       |                               |       |                                                                            |       |   |   | 34,395 |   | 344 |   | 67,800 |   |   |   |   |   |   |   |   |   |   |   | 68,144 |   |   |   |
| Issuance of  restricted common stock                                                            |       |                                        |       |                               |       |                                                                            |       |   |   | 14,956 |   | 150 |   | 102,149 |   |   |   |   |   |   |   | (102,299 | ) |   |   | — |   |   |   |
| Warrants issued  with convertible notes                                                         |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   | 761,500 |   |   |   |   |   |   |   |   |   |   |   | 761,500 |   |   |   |
| Retirement of  treasury stock                                                                   |       |                                        |       |                               |       |                                                                            |       |   |   | (6,027 | ) | (60 | ) | (301 | ) | (6,027 | ) | 361 |   |   |   |   |   |   |   | — |   |   |   |
| Conversion of  preferred shares to common                                                       |       | (3,731,999                                  | )          | (9,123,216                         | )          |                                                                            |       |   |   | 732,600 |   | 7,326 |   | 9,115,890 |   |   |   |   |   |   |   |   |   |   |   | 9,123,216 |   |   |   |
| Amortization of  deferred stock-based compensation                                              |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,307,052 |   |   |   | 1,307,052 |   |   |   |
| Deferred  stock-based compensation related to employees                                         |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   | 1,396,347 |   |   |   |   |   |   |   | (1,396,347 | ) |   |   | — |   |   |   |
| Reversal of  deferred compensation                                                              |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   | (261,769 | ) |   |   |   |   |   |   | 261,769 |   |   |   | — |   |   |   |
| Issuance of common  stock from exercise of warrant                                              |       |                                        |       |                               |       |                                                                            |       |   |   | 998 |   | 10 |   | (10 | ) |   |   |   |   |   |   |   |   |   |   | — |   |   |   |
| Unrealized loss on  short-term investments                                                      |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   | (288 | ) |   |   |   |   | (288 | ) | $              (288 | ) |
| Accretion of  dividends and offering costs on preferred stock                                   |       |                                        |       | 5,948,073                          |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (5,948,073 | ) | (5,948,073 | ) |   |   |
| Dividends  forfeited on preferred stock conversion                                              |       |                                        |       | (23,521,685                        | )          |                                                                            |       |   |   |   |   |   |   | 23,521,685 |   |   |   |   |   |   |   |   |   |   |   | 23,521,685 |   |   |   |
| Issuance of common  stock from initial public offering (“IPO”), net of offering costs |       |                                        |       |                               |       |                                                                            |       |   |   | 3,750,000 |   | 37,500 |   | 47,580,943 |   |   |   |   |   |   |   |   |   |   |   | 47,618,443 |   |   |   |
| Issuance of common  stock from convertible notes payable and accrued interest, at IPO           |       |                                        |       |                               |       |                                                                            |       |   |   | 2,411,846 |   | 24,118 |   | 20,400,152 |   |   |   |   |   |   |   |   |   |   |   | 20,424,270 |   |   |   |
| Conversion of  preferred shares to common, at IPO                                               |       | (27,413,084                                 | )          | (64,770,247                        | )          |                                                                            |       |   |   | 6,136,889 |   | 61,368 |   | 64,708,879 |   |   |   |   |   |   |   |   |   |   |   | 64,770,247 |   |   |   |
| Net loss                                                                                        |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (21,923,437 | ) | (21,923,437 | ) | (21,923,437 | ) |
| Comprehensive net  loss                                                                         |       |                                        |       |                               |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ (21,923,725 | ) |
| **BALANCE,  DECEMBER 31, 2003**                                                                 |       | —                                      |       | —                             |       | —                                                                          |       | — |   | 14,294,533 |   | 142,945 |   | 201,422,784 |   | — |   | — |   | — |   | (1,723,229 | ) | (145,467,457 | ) | 54,375,043 |   |   |   |

 

See notes toconsolidated financial statements.

F-5

 

----

**ACUSPHERE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK,STOCKHOLDERS’ EQUITY, AND COMPREHENSIVE LOSS (Continued)**

| ** **                                                              | ** ** | ** **                                  | ** ** | **Stockholders’ Equity**    | ** ** | ** **                 | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|----------------------------|------------|
| ** **                                                              | ** ** | **Redeemable Convertible  Preferred Stock** | ** ** | **Convertible  Preferred Stock** | ** ** | **Common Stock**           | ** ** | **Additional** | ** ** | **Treasury Stock** | ** ** | **Accumulated  Other** | ** ** | **Deferred** | ** ** | ** ** | ** ** | **Total** | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | **Number of  Shares**                  | ** ** | **Carrying  Value**              | ** ** | **Number of  Shares** | ** ** | **$0.01  Par Value** | ** ** | **Number of  Shares** | ** ** | **$0.01  Par Value** | ** ** | **Paid-in  Capital** | ** ** | **Number of  Shares** | ** ** | **Cost** | ** ** | **Comprehensive  Income** | ** ** | **Stock-Based  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** ** | **Comprehensive  Loss** | ** ** |
| **BALANCE, DECEMBER 31, 2003**                                          |       | —                                      |       | —                           |       | —                     |       | — |   | 14,294,533 |   | 142,945 |   | 201,422,784 |   | — |   | — |   | — |   | (1,723,229 | ) | (145,467,457 | ) | 54,375,043 |   |   |   |
| Exercise of stock options                                               |       |                                        |       |                             |       |                       |       |   |   | 68,734 |   | 687 |   | 88,909 |   |   |   |   |   |   |   |   |   |   |   | 89,596 |   |   |   |
| Issuance of common stock from employee stock purchase  plan             |       |                                        |       |                             |       |                       |       |   |   | 3,960 |   | 40 |   | 24,407 |   |   |   |   |   |   |   |   |   |   |   | 24,447 |   |   |   |
| Issuance of common stock to board members for  services performed       |       |                                        |       |                             |       |                       |       |   |   | 3,695 |   | 37 |   | 23,557 |   |   |   |   |   |   |   | (23,594 | ) |   |   | — |   |   |   |
| Amortization of deferred stock-based compensation                       |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 940,078 |   |   |   | 940,078 |   |   |   |
| Deferred stock-based compensation related to  non-employees             |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   | 150,852 |   |   |   |   |   |   |   | (150,852 | ) |   |   | — |   |   |   |
| Reversal of deferred compensation for terminated  employees             |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   | (43,105 | ) |   |   |   |   |   |   | 43,105 |   |   |   | — |   |   |   |
| Warrant issued to financial advisor                                     |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   | 241,639 |   |   |   |   |   |   |   |   |   |   |   | 241,639 |   |   |   |
| Issuance of common stock from private financing, net  of offering costs |       |                                        |       |                             |       |                       |       |   |   | 3,440,000 |   | 34,400 |   | 19,763,194 |   |   |   |   |   |   |   |   |   |   |   | 19,797,594 |   |   |   |
| Net loss                                                                |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (29,959,048 | ) | (29,959,048 | ) | (29,959,048 | ) |
| Comprehensive net loss                                                  |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (29,959,048 | ) |
| **BALANCE,  DECEMBER 31, 2004**                                         |       | —                                      |       | —                           |       | —                     |       | — |   | 17,810,922 |   | 178,109 |   | 221,672,237 |   | — |   | — |   | — |   | (914,492 | ) | (175,426,505 | ) | 45,509,349 |   |   |   |

 

See notes to consolidated financial statements.

F-6

 

----

**ACUSPHERE, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK,STOCKHOLDERS’ EQUITY, AND COMPREHENSIVE LOSS (Continued)**

| ** **                                                                    | ** ** | ** **                                  | ** ** | **Stockholders’  Equity**   | ** ** | ** **                 | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|----------------------------|------------|
| ** **                                                                    | ** ** | **Redeemable Convertible  Preferred Stock** | ** ** | **Convertible  Preferred Stock** | ** ** | **Common Stock**           | ** ** | **Additional** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other** | ** ** | **Deferred** | ** ** | ** ** | ** ** | **Total** | ** ** | ** ** | ** ** |
| ** **                                                                    | ** ** | **Number of  Shares**                  | ** ** | **Carrying  Value**              | ** ** | **Number of  Shares** | ** ** | **$0.01  Par Value** | ** ** | **Number of  Shares** | ** ** | **$0.01  Par Value** | ** ** | **Paid-in  Capital** | ** ** | **Number of  Shares** | ** ** | **Cost** | ** ** | **Comprehensive  Income** | ** ** | **Stock-Based  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** ** | **Comprehensive  Loss** | ** ** |
| **BALANCE, DECEMBER 31, 2004**                                                |       | —                                      |       | —                           |       | —                     |       | — |   | 17,810,922 |   | 178,109 |   | 221,672,237 |   | — |   | — |   | — |   | (914,492 | ) | (175,426,505 | ) | 45,509,349 |   |   |   |
| Exercise of stock options                                                     |       |                                        |       |                             |       |                       |       |   |   | 20,089 |   | 201 |   | 20,884 |   |   |   |   |   |   |   |   |   |   |   | 21,085 |   |   |   |
| Issuance of common stock from employee stock purchase  plan                   |       |                                        |       |                             |       |                       |       |   |   | 8,017 |   | 81 |   | 38,055 |   |   |   |   |   |   |   |   |   |   |   | 38,136 |   |   |   |
| Issuance of common stock to  board members for services performed             |       |                                        |       |                             |       |                       |       |   |   | 10,824 |   | 108 |   | 58,642 |   |   |   |   |   |   |   | (58,750 | ) |   |   | — |   |   |   |
| Amortization of deferred stock-based compensation                             |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 573,822 |   |   |   | 573,822 |   |   |   |
| Deferred stock-based compensation related to  non-employees                   |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   | (37,992 | ) |   |   |   |   |   |   | 37,992 |   |   |   | — |   |   |   |
| Reversal of deferred compensation for terminated employees                    |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   | (2,463 | ) |   |   |   |   |   |   | 2,463 |   |   |   | — |   |   |   |
| Issuance of common and preferred stock from financing,  net of offering costs |       |                                        |       |                             |       | 900,000                    |       | 9,000 |   | 3,566,000 |   | 35,660 |   | 56,350,678 |   |   |   |   |   |   |   |   |   |   |   | 56,395,338 |   |   |   |
| Preferred stock conversion including make-whole dividend                      |       |                                        |       |                             |       | (160,000                   | )          | (1,600 | ) | 1,454,707 |   | 14,547 |   | 1,709,554 |   |   |   |   |   |   |   |   |   |   |   | 1,722,501 |   |   |   |
| Dividends paid on preferred stock                                             |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   | (2,218,040 | ) |   |   |   |   |   |   |   |   |   |   | (2,218,040 | ) |   |   |
| Net loss                                                                      |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (44,625,375 | ) | (44,625,375 | ) | (44,625,375 | ) |
| Comprehensive net loss                                                        |       |                                        |       |                             |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | (44,625,375 | ) |
| **BALANCE,  DECEMBER 31, 2005**                                               |       | —                                      |       | —                           | ** ** | 740,000                    |       | $ | 7,400 |   | 22,870,559 |   | $ | 228,706 |   | $ | 277,591,555 |   | — |   | — |   | — |   | $ | (358,965 | ) | $ | (220,051,880 | ) | $ | 57,416,816 |   |   |   |
|                                                                               |            |                                             |            |                                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to consolidated financial statements.

(concluded)

F-7

 

----

**ACUSPHERE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF CASH FLOWS**

| ** **                                                                   | ** ** | **Year Ended December 31,** | ** **  |
|------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                   | ** ** | **2003**                                   | ** **  | **2004** | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                       |       |                                       |        |   |   |   |   |
| Net loss                                                                     |       | $                                          | (21,923,437 | ) | $ | (29,959,048 | ) | $ | (44,625,375 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                       |        |   |   |   |   |
| Stock-based compensation expense                                             |       | 1,307,052                                  |        | 940,078 |   | 573,822 |   |
| Depreciation and amortization                                                |       | 1,733,417                                  |        | 1,367,837 |   | 4,007,291 |   |
| Loss on disposal of property and equipment                                   |       | —                                     |        | 30,545 |   | — |   |
| Write-off of  noncash IP acquisition cost                                    |       | —                                     |        | — |   | 5,218,132 |   |
| Noncash interest expense                                                     |       | 1,120,526                                  |        | 43,261 |   | 795,133 |   |
| Noncash rent expense                                                         |       | 53,640                                     |        | 244,068 |   | 510,668 |   |
| Noncash amortization of deferred revenue                                     |       | —                                     |        | (1,714,286 | ) | (3,428,572 | ) |
| Noncash amortization of fee to financial advisor                             |       | —                                     |        | 100,000 |   | 269,040 |   |
| Noncash amortization of warrants to financial  advisor                  |       | —                                     |        | 34,520 |   | — |   |
| Noncash change in  valuation of derivative                                   |       | —                                     |        | — |   | (257,009 | ) |
| Changes in  operating assets and liabilities:                                |       |                                       |        |   |   |   |   |
| Deferred revenue                                                             |       | —                                     |        | 6,000,000 |   | 5,150,000 |   |
| Other current assets                                                         |       | (283,836                                   | )           | (1,390,728 | ) | 613,698 |   |
| Accounts payable                                                             |       | 782,267                                    |        | 2,717,952 |   | (1,058,018 | ) |
| Accrued expenses                                                             |       | 1,703,194                                  |        | 2,266,580 |   | 1,548,687 |   |
| Net cash used in operating activities                                        |       | (15,507,177                                | )           | (19,319,221 | ) | (30,682,503 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                       |       |                                       |        |   |   |   |   |
| Purchases of property and equipment                                          |       | (534,713                                   | )           | (12,183,102 | ) | (32,977,643 | ) |
| Increase in other assets                                                     |       | (119,220                                   | )           | (257,506 | ) | 111,913 |   |
| Maturities of short-term investments                                         |       | 195,410                                    |        | — |   | — |   |
| Net cash used in investing activities                                        |       | (458,523                                   | )           | (12,440,608 | ) | (32,865,730 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                       |       |                                       |        |   |   |   |   |
| Payments on long-term obligations                                            |       | (4,395,089                                 | )           | (979,545 | ) | (2,546,510 | ) |
| Proceeds from long-term obligations                                          |       | 19,440,342                                 |        | 3,445,274 |   | 14,732,649 |   |
| Net proceeds from sale of redeemable convertible  preferred stock            |       | —                                     |        | — |   | 41,887,416 |   |
| Net proceeds from sale of common stock in initial  public offering           |       | 47,618,443                                 |        | — |   | — |   |
| Net proceeds from sales of common stock                                      |       | —                                     |        | 19,797,594 |   | 17,565,923 |   |
| Payment of  preferred stock dividends                                        |       | —                                     |        | — |   | (2,218,040 | ) |
| Proceeds from exercise of stock options                                      |       | 68,144                                     |        | 89,596 |   | 21,085 |   |
| Proceeds from issuance of common stock from employee  stock purchase plan    |       | —                                     |        | 24,447 |   | 38,136 |   |
| Net cash provided  by financing activities                                   |       | 62,731,840                                 |        | 22,377,366 |   | 69,480,659 |   |
|                                                                              |            |                                            |             |  |  |  |  |  |  |  |

 

(continued)

See notes to consolidated financial statements.

F-8

----

**ACUSPHERE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)**

 

| ** **                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                        |       | 46,766,140                                 |       | (9,382,463 | ) | 5,932,426 |   |
| CASH AND CASH EQUIVALENTS, Beginning of period                          |       | 7,796,238                                  |       | 54,562,378 |   | 45,179,915 |   |
| CASH AND CASH EQUIVALENTS, End of period                                     |       | $                                          | 54,562,378 |   | $ | 45,179,915 |   | $ | 51,112,341 |   |
| SUPPLEMENTAL  SCHEDULE OF CASH FLOWS INFORMATION:                            |       |                                       |       |   |   |   |   |
| Cash paid during  the period for interest                                    |       | $                                          | 1,317,106  |   | $ | 90,013 |   | $ | 990,241 |   |
| SUPPLEMENTAL  SCHEDULE OF NONCASH FINANCING TRANSACTIONS:                    |       |                                       |       |   |   |   |   |
| Common stock issued for preferred conversion,  including make whole dividend |       | —                                     |       | — |   | 1,722,501 |   |
| Common stock issued to board members for services  performed                 |       | —                                     |       | 23,594 |   | 58,750 |   |
| Common stock warrants issued to financial advisor                            |       | $                                          | —     |   | $ | 241,639 |   | $ | — |   |
| Unrealized gain (loss) on investments                                        |       | $                                          | (288       | ) | $ | — |   | $ | — |   |
| Deferred compensation for services to be performed                           |       | $                                          | 1,236,877  |   | $ | — |   | $ | — |   |
| Accretion of preferred stock dividends and offering  costs                   |       | $                                          | 5,948,073  |   | $ | — |   | $ | — |   |
| Dividends forfeited on preferred stock conversion                            |       | $                                          | 23,521,685 |   | $ | — |   | $ | — |   |
| Common stock warrants issued with convertible notes                          |       | $                                          | 761,500    |   | $ | — |   | $ | — |   |
| Common stock warrants exercised                                              |       | $                                          | 10         |   | $ | — |   | $ | — |   |
| Promissory notes  and accrued interest converted into common stock, at IPO   |       | $                                          | 20,424,270 |   | $ | — |   | $ | — |   |

 

(concluded)

See notes to consolidated financial statements.

F-9

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**ACUSPHERE, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Operations**

Acusphere, Inc. and Subsidiaries (“Acusphere” orthe “Company”) is a specialty pharmaceutical company that develops new drugsand improved formulations of existing drugs using its proprietary microparticletechnology. The Company’s lead product, AI-700, is in Phase 3 clinicaltrials.

Acusphere is devotingsubstantially all of its efforts towards the research and development of itsproduct candidates and raising capital. Acusphere is subject to a number ofrisks. Principal among these risks are the need to develop regulatory approvedcommercially usable products, competition from substitute products and largercompanies and the need to obtain adequate financing necessary to fund productdevelopment.

**2.Summary of Significant Accounting Policies**

The accompanying consolidated financial statementsreflect the application of certain accounting policies described below andelsewhere in the notes to the consolidated financial statements.

***Principles ofConsolidation—******The***accompanyingconsolidated financial statements include the amounts of Acusphere, Inc.and its wholly owned subsidiaries, Acusphere Securities Corporation, Acusphere, Ltd.and Acusphere Newco, Ltd. (to February 2003). Acusphere SecuritiesCorporation was established in December 1996 as a Massachusetts securitiescorporation. Acusphere, Ltd. was established in 2004 for statutorypurposes and has no operations, employees or assets. AcusphereNewco, Ltd., as established in June 2000 by the Company and ElanCorporation, plc. (“Elan”), was 80.1% owned by the Company. In September 2002,the joint venture relationship was terminated at which time AcusphereNewco, Ltd. became a wholly owned subsidiary of the Company. In February 2003,Acusphere Newco, Ltd. was dissolved. The Company’s investment in AcusphereNewco, Ltd. was accounted for under the equity method from inceptionthrough the termination date of the joint venture relationship and consolidatedfrom that date through February 2003. All intercompany balances andtransactions have been eliminated in consolidation.

***Use of Estimates—******The*** preparationof financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of expenses during the reporting period.Actual results could differ from those estimated or assumed.

***Cash and CashEquivalents—******Cash*** equivalentsconsist of short-term, highly liquid investments, including money marketaccounts, with original maturity dates of 90 days or less when purchased.Cash equivalents are carried at cost, which approximates their fair marketvalue.

***Property andEquipment—******Property*** andequipment are recorded at cost and depreciated over their estimated usefullives of three to five years using the straight-line method. The majority ofequipment is related to ongoing research and development activities, includingequipment intended for commercial manufacture of AI-700.  Theequipment in our commercial manufacturing facility was placed in service in October 2005and is being utilized in research and development related activities, includingongoing calibration and testing. Depreciation commences on equipmentwhen it is placed in service. Interest costs associated with the constructionof the facility were capitalized in accordance with the provisions of SFAS No. 34,“Capitalization of Interest.”

Equipment under capital leases and leaseholdimprovements are depreciated over the lesser of their useful lives or theremainder of the lease term. Depreciation of such equipment and leaseholdimprovements commences when it is placed in service. Property and equipment isreviewed for impairment 

F-10

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whenever events or changesin circumstances indicate that the carrying value of certain assets might notbe recoverable and recognizes a loss when it is probable that the estimatedfuture cash flows will be less than the carrying value of the asset.Expenditures for maintenance and repairs are charged to expense as incurred.Expenditures for manufacturing facility start-up and validation are charged toexpense as incurred.

***Other Assets—******Other*** assetsconsist primarily of lease related deposits and deferred rent expense.

***Fair Value ofFinancial Instruments—******The*** carryingamounts of Acusphere’s financial instruments, which include cash equivalents,accounts payable, accrued expenses, and long-term obligations, approximatetheir fair values.

***Concentrations ofCredit Risk and Limited Suppliers—******The*** financialinstruments that potentially subject Acusphere to concentrations of credit riskare cash and cash equivalents. Acusphere’s cash and cash equivalents aremaintained with a highly rated commercial bank and its related investmentmanagement company.

Acusphere relies on certain materials used in itsdevelopment process, each of which is available from limited sources. Thefailure of a supplier or subcontractor to deliver on schedule could delay orinterrupt the development process and thereby adversely affect Acusphere’soperating results.

***CollaborationRevenue—******Collaboration***revenue consists of revenue earned under license arrangements withcollaborative partners in accordance with Staff Accounting Bulletin No. 104,Revenue Recognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”).Revenue from license payments not tied to achieving a specific performancemilestone is recognized ratably over the period over which services areobligated to be performed. The period over which services are obligated to beperformed is estimated based on available facts and circumstances. Revenue isrecognized from performance payments, when such performance is substantially inAcusphere’s control and when Acusphere believes that completion of suchperformance is reasonably probable, ratably over the period over which itestimates that it will perform such performance obligations. Substantiveat-risk milestone payments, which are based on achieving a specific performancemilestone when performance of such milestone is contingent on performance byothers or for which achievement can not be reasonably estimated or assured, arerecognized as revenue when the milestone is achieved and the related payment isdue, provided that there is no substantial future service obligation associatedwith the milestone. Revenue in connection with license arrangements isrecognized over the term of the arrangement and is limited to paymentscollected or due and reasonably assured of collection. In circumstances wherethe arrangement includes a refund provision, the Company defers revenuerecognition until the refund condition is no longer applicable unless, inAcusphere’s judgment, the refund circumstances are within its operating controland unlikely to occur. Payments received in advance of being recognized asrevenue are deferred.

***Research andDevelopment Expenses—******Research*** anddevelopment costs primarily consist of salaries, consulting and contractservices and material costs. These expenses include related costs for clinicalsites enrolling patients in the AI-700 Phase 3 clinical program, costsfor clinical data management and independent clinical site monitoring andoperating costs associated with efforts to build-out and qualify a commercialmanufacturing facility. Research and development expenses also include costs toacquire patents, which are expensed if technological feasibility has yet to be achieved.Acusphere charges all research and development expenses to operations asincurred, net of expenses reimbursed from third parties.

***DerivativeFinancial Instruments—******The*** Company’s6.5% convertible exchangeable preferred stock contains a feature whereby, priorto March 1, 2009, if the Company elects to automatically convert, or ifany holder elects to voluntarily convert, the preferred stock, the Company willalso make an additional payment (“make-whole payment”) equal to the aggregateamount of dividends that would have been 

F-11

----

payable on the preferredstock so converted from the original date of issuance of February 24, 2005through and including March 1, 2009, less any dividends already paid onthe preferred stock. This feature represents an embedded derivative which isrequired to be accounted for separately from the preferred stock. The estimatedfair value of this feature is valued using a risk-weighted binomial model thatincorporates factors such as the Company’s cost of capital, stock price volatilityand the estimated timing of preferred stock conversions. Changes in theestimated fair value of the liability represented by these factors, as well asany make-whole payments, are charged to the consolidated statements ofoperations. These adjustments will be required until the feature is eithertriggered or expires.

The Company’s loan agreement with MassDevelopmentcontains a feature providing for a retroactive interest rate increase in theevent the Company achieves positive operating cash flow as defined in theagreement. This feature represents an embedded derivative which is required tobe accounted for separately from the related loan. The estimated fair value ofthis feature is valued using a risk-weighted discounted cash flow methodology thatincorporates factors such as the Company’s cost of capital and the probabilityand estimated timing of the Company achieving positive operating cash flow, asdefined. Changes in the estimated fair value of the liability represented bythese factors are charged to the consolidated statements of operations. Theseadjustments will be required until the feature is either triggered or expires.

***Income Taxes—******Deferred*** taxliabilities and assets are provided for differences between the book and taxbases of existing assets and liabilities and tax loss carryforwards andcredits, using tax rates expected to be in effect in the years in whichdifferences are expected to reverse. Valuation allowances are provided to theextent realization of tax assets is not considered likely.

***Stock-BasedCompensation—******Acusphere’s*** employeestock option plan is accounted for using the intrinsic-value-based method ofAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations. The intrinsic methodrequires that compensation expense, if any, be determined by calculating thedifference between the fair value of the Company’s common stock and the strikeprice of the option at a measurement date. The measurement date is generallywhen the number of shares and the strike price of the option are known.Acusphere uses the fair-value method to account for nonemployee stock-basedcompensation.

Acuspherehas computed the pro forma disclosures required under SFAS No. 123, “Accountingfor Stock-Based Compensation,” for options granted using the Black-Scholesoption-pricing model prescribed by SFAS No. 123. The assumptions used andweighted-average information are as follows:

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2003**              | ** ** | **2004** | ** ** | **2005** | ** ** |
| Risk-free  interest rate                        |       | 2.53%-3.12            | %          | 2.31%-3.66 | % | 3.46%-4.53 | % |
| Expected dividend  yield                        |       | —                |       | — |   | — |   |
| Expected lives                                  |       | 4 years               |       | 4 years |   | 4 years |   |
| Expected  volatility                            |       | 60.0%-100.0%          |       | 44.3%-54.2% |   | 36.34%-47.98% |   |
| Weighted-average fair  value of options granted |       | $                     | 6.20       |   | $ | 3.21 |   | $ | 2.25 |   |
|                                                 |            |                       |            |  |  |  |  |  |  |  |

 

F-12

----

Hadstock-based compensation expense for the plan been determined consistent withSFAS No. 123, Acusphere’s net loss would have been the following pro formaamounts:

| ** **                                                                            | ** ** | **Year Ended December 31,** | ** **  |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                            | ** ** | **2003**                                   | ** **  | **2004** | ** ** | **2005** | ** ** |
| Applicable to common  stockholders:                                                   |       |                                       |        |   |   |   |   |
| Net loss—as reported                                                             |       | $                                          | (27,871,510 | ) | $ | (29,959,048 | ) | $ | (47,043,832 | ) |
| Add: Stock-based employee compensation expense  included in reported net loss         |       | 1,211,273                                  |        | 776,581 |   | 460,130 |   |
| Deduct: Stock-based employee compensation expense  determined under fair value method |       | (1,184,230                                 | )           | (1,738,994 | ) | (2,094,926 | ) |
| Net loss—proforma                                                                |       | $                                          | (27,844,467 | ) | $ | (30,921,461 | ) | $ | (48,678,628 | ) |
| Net loss per  share (basic and diluted):                                              |       |                                       |        |   |   |   |   |
| As reported                                                                           |       | $                                          | (6.66       | ) | $ | (1.92 | ) | $ | (2.49 | ) |
| Pro forma                                                                             |       | $                                          | (6.65       | ) | $ | (1.98 | ) | $ | (2.58 | ) |

 

***Net Loss Per Share—******Basic***anddiluted 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 consisted of redeemable convertible preferredstock (in 2003 only), convertible exchangeable preferred stock (in 2005 only),stock options, warrants, and restricted common stock that are not included inthe diluted net loss per share calculation, aggregated 1,758,029, 3,155,942 and9,846,627 as of December 31, 2003, 2004, and 2005, respectively. Thefollowing table reconciles the weighted-average common shares outstanding tothe shares used in the computation of basic and diluted weighted-average commonshares outstanding:

| ** **                                                      | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| **Historical**                                                  | ** ** | ** **                                 | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted-average  common shares outstanding                     |       | 4,191,321                                  |       | 15,611,644 |   | 18,900,260 |   |
| Less  weighted-average restricted common shares   outstanding   |       | (3,649                                     | )          | (8,812 | ) | (3,130 | ) |
| Basic and diluted  weighted-average common shares   outstanding |       | 4,187,672                                  |       | 15,602,832 |   | 18,897,130 |   |
|                                                                 |            |                                            |            |  |  |  |  |  |  |

 

***Comprehensive Loss—******Comprehensive***loss is defined as the change in stockholders’ equity during a period fromtransactions and other events and circumstances from non-owner sources.Acusphere has disclosed comprehensive loss for all periods presented in theaccompanying consolidated statements of redeemable convertible preferred stock,stockholders’ equity, and comprehensive loss.

***Disclosures AboutSegments of an Enterprise—******Operating***segmentsare identified as components of an enterprise about which separate discretefinancial information is available for evaluation by the chief operatingdecision-maker, or decision-making group, in making decisions regardingresource allocation and assessing performance. To date, Acusphere has viewedits operations and manages its business as one operating segment.

***Recent Accounting Pronouncements—******In*** December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”).This Statement is a revision of SFAS No. 123, Accounting for Stock-BasedCompensation, and supersedes Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, 

F-13

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and its relatedimplementation guidance. SFAS No. 123R focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. The Statement requires entities to recognize stockcompensation expense for awards of equity instruments to employees based on thegrant-date fair value of those awards (with limited exceptions). Acusphereexpects to adopt SFAS No. 123R using the Statement’s modified prospectiveapplication method. While the adoption of this standard is expected to causeour compensation costs to increase, the Company does not yet have an estimateof the effect on its statement of operations of adopting SFAS No. 123R andis currently evaluating the impact of adoption.

**3. Balance SheetData**

| ** **                                               | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **2004**                              | ** ** | **2005** | ** ** |
| Other assets consist of  the following:                  |       |                                  |       |   |   |
| Deposits                                                 |       | $                                     | 1,212,996  |   | $ | 1,242,495 |   |
| Other assets                                             |       | 644,310                               |       | 502,898 |   |
|                                                     |       | $                                     | 1,857,306  |   | $ | 1,745,393 |   |
| Accrued expenses consist  of the following:              |       |                                  |       |   |   |
| Accrued contract services                                |       | $                                     | 2,500,573  |   | $ | 2,113,458 |   |
| Accrued vacation                                         |       | 398,230                               |       | 479,940 |   |
| Accrued bonus                                            |       | 478,006                               |       | 800,000 |   |
| Accrued  construction, equipment and commissioning costs |       | —                                |       | 1,898,017 |   |
| Other accrued expenses                                   |       | 1,019,211                             |       | 1,537,825 |   |
|                                                     |       | $                                     | 4,396,020  |   | $ | 6,829,240 |   |

 

**4. Property andEquipment**

Propertyand equipment at cost consist of the following:

| ** **                                       | ** ** | **As of December 31,** | ** ** | **Estimated** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|---------------|------------|
| ** **                                       | ** ** | **2004**                              | ** ** | **2005**      | ** ** | **Useful Life** | ** ** |
| Equipment                                        |       | $                                     | 10,279,147 |          | $          | 20,589,088 |   | 3-5 years |   |
| Furniture and  fixtures                          |       | 188,252                               |       | 345,394       |       | 5 years |   |
| Leasehold  improvements                          |       | 171,277                               |       | 30,985,667    |       | Lease term |   |
| Sub-total depreciable assets                     |       | 10,638,676                            |       | 51,920,149    |       |   |   |
| Less: accumulated  depreciation and amortization |       | (8,006,819                            | )          | (11,886,288   | )          |   |   |
| Total depreciable assets, net                    |       | 2,631,857                             |       | 40,033,861    |       |   |   |
| Deposits on  equipment purchases                 |       | 6,774,256                             |       | 1,805,812     |       | N/A |   |
| Construction in  progress                        |       | 3,463,208                             |       | —        |       | N/A |   |
| Total property  and equipment, net               |       | $                                     | 12,869,321 |          | $          | 41,839,673 |   |   |   |

 

Deposits on equipmentpurchases represent progress payments for long-lead time capital equipmentpurchases. Amounts recorded as construction in progress represent costsincurred but not invoiced for the build-out of Acusphere’s commercialmanufacturing facility for AI-700 located in Tewksbury,Massachusetts.  Depreciation on leaseholdimprovements to this commercial manufacturing facility commenced upon thelatter of completion of the improvements or October 2005, at which timethe Company received an occupancy permit and began operating use of thefacility.  Included in leaseholdimprovements is capitalized interest in the amount of $813,000 atDecember 31, 2005.

F-14

----

**5. Long-termObligations**

Thecarrying value of long-term obligations was as follows:

| ** **                     | ** ** | **As of December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| ** **                     | ** ** | **2004**                              | ** ** | **2005** | ** ** |
| Capital lease  obligations     |       | $                                     | 205,419    |   | $ | 64,797 |   |
| Notes payable                  |       | 3,368,787                             |       | 15,695,549 |   |
| Other long-term  obligations   |       | —                                |       | 5,567,178 |   |
| Subtotal                       |       | 3,368,787                             |       | 21,262,727 |   |
| Subtotal long-term obligations |       | 3,574,206                             |       | 21,327,524 |   |
| Less current  maturities       |       | 1,071,627                             |       | 6,726,721 |   |
| Long-term obligations,  net    |       | $                                     | 2,502,579  |   | $ | 14,600,803 |   |

 

Futurepayments under all capital lease, notes payable and other long-term obligationsare as follows as of December 31, 2005:

| ** **                                    | ** ** | **Capital Lease  Obligations** | ** ** | **Notes Payable and Other Long-term  Obligations** | ** ** |
|-----------------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------|------------|
| **Year Ending December 31,**             |       |                                |       |                                                    |       |   |   |
| 2006                                          |       |                                | $          | 17,742                                                  |       |   | $ | 6,713,641 |   |
| 2007                                          |       |                                | 17,742     |                                                    |       | 7,404,226 |   |
| 2008                                          |       |                                | 17,742     |                                                    |       | 4,274,995 |   |
| 2009                                          |       |                                | 17,742     |                                                    |       | 2,653,649 |   |
| 2010                                          |       |                                | 5,816      |                                                    |       | 216,216 |   |
| Thereafter                                    |       |                                | —     |                                                    |       | — |   |
| Total future minimum payments                 |       |                                | 76,784     |                                                    |       | 21,262,727 |   |
| Less amount  representing future interest     |       |                                | 11,987     |                                                    |       | — |   |
| Present value of future minimum payments      |       |                                | 64,797     |                                                    |       | 21,262,727 |   |
| Less current portion of long-term obligations |       |                                | 13,080     |                                                    |       | 6,713,641 |   |
| Long-term portion  of long-term obligations   |       |                                | $          | 51,717                                                  |       |   | $ | 14,549,086 |   |

 

***Capital Lease Obligations***

The Company leases capital equipment through Banc ofAmerica Leasing Corporation. The remaining monthly payments range from $460 to$1,019 with maturities through June 2010. Interest rates for the aboveleases range from 7.3% to 9.2%. Acusphere does not have any additionalborrowing availability under these lease arrangements as of December 31,2005.

At December 31, 2005,the cost and net carrying value of equipment under capital leases amounted toapproximately $73,000 and $65,000, respectively.

***Notes Payable***

***Equipment Promissory Notes—******In*** June 2005,the Company entered into a $7.0 million equipment financing line with OxfordFinance Corporation. Borrowings under this equipment line can be made againstqualified purchases, subject to review and approval by Oxford FinanceCorporation, through April 2006. Such borrowings are to be collateralizedby corresponding qualified purchases and repaid over 36 to 48 months,depending on the nature of the equipment financed. Interest rates are fixed atthe time of each borrowing under the equipment line with such rates adjustedbetween borrowings based on the U.S. Federal Reserve’s Three Year and Four YearTreasury Constant Maturity Rates. Interest rates on borrowings made through December 31,2005 on this line range from 10.3% to 10.8%, respectively. The 

F-15

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loans under thisfinancing line are subject to acceleration upon the happening of certaincustomary events of default, including failure to timely pay principal andinterest. As of December 31, 2005, the Company had cumulatively borrowed$5.6 million under this line, of which $5.3 million was outstanding net ofrepayments. Monthly payments for the amounts outstanding under the equipmentfinancing line are required through December 2010.

In April 2004, theCompany entered into an equipment financing line with General Electric CapitalCorporation. In 2004 and 2005, the Company borrowed an aggregate of $10.5million against this line. As of December 31, 2005, net of repayments, theCompany had $8.4 million outstanding under this line. Such borrowings arecollateralized by corresponding equipment and other capital purchases withrepayment due in monthly installments over 36 to 48 months, depending on thenature of the equipment financed, with the last such repayment scheduled for March 2009.Interest rates on these borrowings were fixed at the time of each borrowing andrange from 8.7% to 10.1%. No further additional amount may be borrowed underthis line. The loans under this line are subject to acceleration upon theoccurrence of certain customary events of default, including failure to timelypay principal and interest.

***Facility Loan Agreement—******In*** August 2004,Acusphere entered into a loan with MassDevelopment under which up to$2.0 million of financing is available upon completion by Acusphere ofcertain tenant improvements to its commercial manufacturing facility inTewksbury, Massachusetts. Interest accrues under the loan at 5.0% per annumwith retroactive adjustments to 9% in the event the Company achieves positiveoperating cash flow as defined in the agreement. The repayment of principal andaccrued interest coincides with the term of the Tewksbury lease which has afive-year, nine-month term with options to extend the lease for up to twoadditional five-year terms. No payments are due under the loan for the firsttwenty-four months. Unpaid interest during this twenty-four month period isaccrued and principal and accrued interest shall be repaid on a monthly basisthereafter such that the total amount outstanding shall fully amortize over thebalance of the term in equal installments. The loan is subject to accelerationupon certain customary events of default, including failure to timely payprincipal and interest. In the first quarter of 2005, the Company borrowed $2.0million under this agreement, secured by certain improvements made at theTewksbury facility. As of December 31, 2005, Acusphere has$2.0 million outstanding under this financing arrangement, and has accruedinterest payable of approximately $77,000 related to this loan.

The retroactive interestrate adjustment feature of the loan agreement was deemed to be an embeddedderivative instrument requiring separate accounting under SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and was initially valued at$62,000. The derivative asset is being amortized as interest expense over aterm beginning with the loan agreement effective date and ending with thecurrently expected payment date of the retroactive 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 inthe estimated fair value of the derivative liability at December 31, 2005.

***OtherLong-Term Obligations***

In May 2005, pursuant to a Patent Transfer Agreementwith Schering, Acusphere acquired from Schering rights, title and interest innine patent families, including various U.S. and international ultra-soundrelated patents, and licenses to two other patent families. In consideration ofthe transfer and assignment of these patents, the company agreed to paySchering a total of $7.0 million of which $1.0 million was paid in May 2005,$3.0 million is due in May 2006, and $3.0 million is due in May 2007.The present value of these future payments was calculated to be $5.6 million,using an imputed interest rate of 9.8%, and was recorded as a liability underother long-term obligations at December 31, 2005. During 2005, the Companyrecorded an expense of $6.2 million, included in research and development, forthese patents since the Company had yet to establish technological feasibility.

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**6. Deferred Revenue**

In July 2004, theCompany entered into a collaboration, license and supply agreement with Nycomedin which the Company granted Nycomed rights to develop and market AI-700in Europe. As part of this agreement, Nycomed paid the Company $6.0 million and$5.0 million in 2004 and 2005, respectively, as a license fee and for Acusphere’sresearch and development efforts. Under the terms of this agreement, Nycomed isscheduled to pay the Company an additional $1.0 million in 2006 for researchand development efforts. The agreement provides for other potential milestonesand royalties to be paid to the Company when earned. The Company is recognizingthe $12 million in scheduled payments over a period of forty-two months fromthe date of the agreement, reflecting the estimated period over which theamount is to be earned.

In October 2005, thisagreement was modified and Nycomed paid the Company an additional $150,000 witha corresponding decrease of equal amount in a future potential milestone whichmay be earned by the Company. The Company intends to defer the $150,000 untilthe time that Nycomed files for regulatory approval of AI-700 in Europe,based upon the originally stated milestone in the agreement. During the yearsended December 31, 2004 and 2005, the Company recognized $1.7 million and$3.4 million, respectively, in collaboration revenue under its agreementwith Nycomed, as amended.

In February 2006, the Company and Nycomed agreed tofurther amend the agreement to accelerate an additional $1.85 million inmilestone payments in order to fund certain activities associated with thequalification of our manufacturing facility. Beginning with costs incurred inFebruary 2006, the Company may begin to draw down on this $1.85 million inaccelerated funding up to $370,000 per month. Any payments received pursuant tothese amendments are considered advances against a future milestone payment fora European regulatory filing, or Marketing Authorization Application (“MAA”),and will be deducted from that milestone payment. Payments received under theseamendments will be classified as deferred revenue until the MAA milestone isachieved, provided that the applicable revenue recognition criteria are met.

In connection with theCompany’s agreement with Nycomed, the Company is obligated to pay a customaryfee to its financial advisor in this transaction. The total fee, of which$325,000 and $285,000 was paid by the Company in 2004 and 2005, respectively,is comprised of cash and warrants and is dependent upon the timing andmagnitude of the amounts to be paid by Nycomed to the Company.

**7. Income Taxes**

At December 31, 2005, Acusphere had a federal netoperating loss (“NOL”) carryforward for income tax purposes of approximately $136,518,000and a Massachusetts NOL of approximately $115,812,000.  Acusphere also has approximately $6,116,000of research and development (“R&D”) credits as of December 31, 2005available to offset future income taxes payable, if any.  The Tax Reform Act of 1986 containsprovisions that may limit the utilization of tax attributes (including NOLcarryforwards and R&D credits) available to be used in any given year inthe event of significant changes in ownership interests, as defined in IRCSection 382.

Thecomponents of Acusphere's deferred tax asset at December 31, 2004 and 2005 areas follows:

| ** **                                     | ** ** | **2004**    | ** ** | **2005**    | ** ** |
|------------------------------------------------|------------|-------------|------------|-------------|------------|
| Net operating  loss carryforwards              |       | $           | 33,144,000 |        | $          | 53,682,000 |   |
| Temporary timing  differences                  |       | 17,694,000  |       | 13,147,000  |       |
| Research and  development credit carryforwards |       | 5,282,000   |       | 6,116,000   |       |
| Deferred tax asset                             |       | 56,120,000  |       | 72,945,000  |       |
| Less valuation  allowance                      |       | (56,120,000 | )          | (72,945,000 | )          |
|                                           |       | $           | —     |        | $          | — |   |

 

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The temporary differencesprincipally consist of capitalized start-up expenses and depreciationadjustments for income tax purposes. Acusphere has established a full valuationallowance equal to the amount of its deferred tax asset as the realization of suchasset is uncertain. The Company’s effective income tax rate is zero for allperiods presented due to the full valuation allowance. The increase in thevaluation allowance over the prior year is primarily due to the increase in theNOL carryforward, the valuation allowance increased $15.5 million from 2003 to2004 primarily as a result of the Company’s net loss.

**8. Stockholders’ Equity**

***Convertible Exchangeable Preferred Stock***

On February 24, 2005, the Company issued 900,000shares of 6.5% convertible exchangeable preferred stock (the “Preferred Stock”)at $50.00 per share resulting in aggregate gross proceeds to the Company of$45.0 million (net proceeds of approximately $41.9 million after deductingunderwriting discounts, commissions and offering expenses). Each share ofPreferred Stock has a liquidation preference of $50.00 per share. Dividends onthe Preferred Stock are cumulative from the date of original issue at theannual rate of $3.25 per share, payable quarterly on the first day of March,June, September, and December. Any dividends must be declared by the Company’sboard of directors and must come from funds that are legally available fordividend payments. During the period ended December 31, 2005, dividendsaccumulated on the Preferred Stock totaled $2.5 million, of which $2.2 millionwere paid as of December 31, 2005.

The Preferred Stock is convertible into the Company’scommon stock at any time at the option of the holder at a conversion rate of7.2886 shares of common stock for each share of Preferred Stock, based on aninitial conversion price of $6.86 per share. The initial conversion price issubject to adjustment in certain customary events, but is not subject to “pricebased” anti-dilution adjustment. The Company has reserved approximately 6.6million shares of common stock for issuance upon such conversion.

The Company may elect to automatically convert some orall of the Preferred Stock into shares of common stock if the closing price ofthe Company’s common stock has exceeded $10.30 per share (150% of theconversion price) for at least 20 trading days during any 30-day tradingperiod, ending within five trading days prior to notice of automaticconversion. Prior to March 1, 2009, if the Company elects to automaticallyconvert, or if any holder elects to voluntarily convert, the Preferred Stock,the Company will also make an additional payment (“Make-Whole” payment) equalto the aggregate amount of dividends that would have been payable on thePreferred Stock so converted from the original date of issuance through andincluding March 1, 2009, less any dividends already paid on the PreferredStock. This additional payment is payable by the Company, at its option, incash, in additional shares of its common stock, or in a combination of cash andshares of common stock. The Company has reserved a maximum of approximately 2.0million shares of common stock for issuance under this Make-Whole provision.

During the year ended December 31, 2005, 160,000shares of Preferred Stock were voluntarily converted into 1,166,181 shares ofthe Company’s common stock. In connection with such conversions, the Companyissued an additional 288,526 shares of the Company’s common stock insatisfaction of the required Make-Whole payment. The fair value of this paymentwas approximately $1.8 million, which was charged to the derivative liabilityduring the fourth quarter of 2005.

In accordance with SFAS No. 133, the Company isrequired to separate and account for as an embedded derivative, the dividendmake-whole payment feature of the Preferred Stock offering. As an embeddedderivative instrument, the dividend make-whole payment feature must be measuredat fair value and reflected as a liability. Changes in the fair value of thederivative are recognized in earnings as a component of other income/(expense).The Company determined the fair value of the dividend make-whole paymentfeature to be $3.1 million at February 24, 2005 (the commitment date).This amount 

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was allocated from theproceeds of the Preferred Stock to the derivative liability. During 2005, make-wholepayments related to the conversion of 160,000 shares were made and thederivative liability was reduced for the fair value of these payments. At December 31,2005, the derivative liability was revalued at approximately $1.1 million.

The Company may elect to redeem the Preferred Stock atdeclining redemption prices on or after March 6, 2009.

The Preferred Stock is exchangeable, in whole but notin part, at the option of the Company on any dividend payment date beginning onMarch 1, 2006 (the “Exchange Date”) for the Company’s 6.5% convertiblesubordinated debentures (“Debentures”) at the rate of $50 principal amount ofDebentures for each share of Preferred Stock. The Debentures, if issued, willmature 25 years after the Exchange Date and have terms substantially similar tothose of the Preferred Stock.

The Preferred Stock has nomaturity date and no voting rights prior to conversion into common stock,except under limited circumstances.

***Common Stock***

On September 28, 2005, the Company sold 3,566,000shares of its common stock at $5.25 per share resulting in aggregate grossproceeds to the Company of $18.7 million (net proceeds of approximately $17.5million after deducting underwriting discounts, commissions and offeringexpenses).

In July 2004, Acusphere entered into definitivepurchase agreements with institutional and accredited investors for a$21.5 million private placement of up to 3,440,000 newly issued shares ofcommon stock at a price of $6.25 per share and warrants to purchase up to anadditional 688,000 shares of common stock at an exercise price of $8.50 pershare. In August 2004, a partial closing of this private placement wasconsummated, resulting in aggregate gross proceeds to Acusphere of approximately$17.9 million (net proceeds of approximately $16.5 million) and theissuance of 2,865,522 shares of common stock and warrants to purchase up to anadditional 573,105 shares of common stock. In October 2004, a second andfinal closing of this private financing resulted in aggregate gross proceeds toAcusphere of approximately $3.6 million (net proceeds of approximately$3.2 million) and the issuance of 574,478 shares of common stock at aprice of $6.25 per share and warrants to purchase up to an additional 114,895shares of common stock at an exercise price of $8.50 per share.

On October 14, 2003, Acusphere’s RegistrationStatement on Form S-1, as amended, was declared effective by theSecurities and Exchange Commission permitting the Company to sell shares ofcommon stock in an initial public offering (“IPO”). On October 7, 2003,Acusphere sold 3,750,000 shares of common stock in the IPO for $14.00 per sharewhich resulted in net proceeds of approximately $47,600,000 to the Company,after deducting $4,900,000 in underwriting fees and offering-related expenses.

Holders of common stock are entitled to one vote foreach share of common stock held on all matters submitted to a vote ofstockholders and do not have cumulative voting rights. Holders of common stockare entitled to receive ratably any dividends as may be declared by the Company’sboard of directors.

***Conversions toCommon Stock—***On July 1, 2003, in connectionwith the issuance of the subordinated convertible promissory notes, 3,731,999shares of outstanding preferred stock converted into 732,600 shares of commonstock. On October 14, 2003, at the time of IPO, all of the remaining thenoutstanding shares of preferred stock and all of the Company’s then outstandingsubordinated convertible promissory notes, including accrued interest,converted into 8,548,735 shares of common stock.

During the year ended December 31, 2005, 160,000shares of Preferred Stock were voluntarily converted into 1,166,181 shares ofthe Company’s common stock. In connection with such conversions, the 

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Company issued anadditional 288,526 shares of the Company’s common stock in satisfaction of therequired Make-Whole payment.

***Stock Plans—***InJune 2005, the 2005 Stock Option and Incentive Plan (the “2005 Plan”) wasapproved. The 2005 Plan became effective on June 16, 2005 and providesthat a maximum of 1,700,000 shares of common stock may be issued as incentivestock options (“ISO’s”), nonqualified stock option, awards of common stock anddirect purchases of common stock by Acusphere employees, officers, directorsand consultants. The maximum number of shares that may be granted to anyemployee under the 2005 Plan shall not exceed 1,000,000 shares of common stockduring any calendar year. No option or share has been issued under the 2005Plan as of December 31, 2005.

In July 2003, the 2003 Stock Option and IncentivePlan (the “2003 Plan”) was approved. The 2003 Plan became effective on theclosing of the Company’s IPO on October 14, 2003 and provides that amaximum of 2,500,000 shares of common stock may be issued as ISO’s,nonqualified stock option, awards of common stock and direct purchases ofcommon stock by Acusphere employees, officers, directors and consultants. Themaximum number of shares that may be granted to any employee under the 2003Plan shall not exceed 583,334 shares of common stock during any calendar year.Acusphere had 471,304 shares available for future stock and option grants underthe 2003 Plan at December 31, 2005.

In March 1994, the 1994 Stock Plan (the “1994Plan”) was approved. The 1994 Plan, as amended provides that a maximum of1,423,663 shares of common stock could be issued as ISO’s, nonqualified stockoptions and stock grants. No new stock options or other stock grants can bemade by the Company under the 1994 Plan after March 7, 2004.

In July 2003, the 2003 Employee Stock PurchasePlan (the “Purchase Plan”) was approved which became effective on the closingof the Company’s IPO on October 14, 2003. The Purchase Plan provides forthe issuance of a maximum of 233,334 shares of common stock. Eligible employeemay contribute up to 10% of their total cash compensation with a maximum of 417shares semi-annually. The first sale of shares under this plan occurred on February 29,2004. During 2004 and 2005, 3,960and 8,017 shares, respectively,of common stock were sold to employees under this plan. Acusphere had  221,357shares available for future sales of common stock under this plan at December 31,2005.

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Stockoption activity under the 1994 and 2003 Plans was as follows:

| ** **                           | ** ** | **Number of  Shares** | ** ** | **Exercise Price  Per Share** | ** **    | **Weighted-  Average  Exercise  Price Per  Share** | ** ** |
|--------------------------------------|------------|----------------------------|------------|-----------------------------------------|---------------|---------------------------------------------------------|------------|
| Balance,  January 1, 2003       |       | 763,930                    |       | $                                       | 0.60 - $7.20  |                                                    |       | $ | 3.36 |   |   |
| Granted                              |       | 505,072                    |       | 0.84 - 13.02                            |          |                                                    | 8.00       |   |   |
| Exercised                            |       | (34,395                    | )          | 0.60 - 7.20                             |          |                                                    | 1.98       |   |   |
| Canceled                             |       | (62,645                    | )          | 0.84 - 7.20                             |          |                                                    | 6.71       |   |   |
| Balance, December 31, 2003      |       | 1,171,962                  |       | $                                       | 0.60 - $13.02 |                                                    |       | $ | 5.23 |   |   |
| Granted                              |       | 783,939                    |       | 6.01 - 9.60                             |          |                                                    | 8.29       |   |   |
| Exercised                            |       | (68,734                    | )          | 0.60 - 7.20                             |          |                                                    | 1.30       |   |   |
| Canceled                             |       | (54,685                    | )          | 0.60 - 13.02                            |          |                                                    | 5.77       |   |   |
| Balance, December 31, 2004      |       | 1,832,482                  |       | $                                       | 0.84 - $13.02 |                                                    |       | $ | 6.67 |   |   |
| Granted                              |       | 1,423,600                  |       | 4.28 - 6.30                             |          |                                                    | 5.59       |   |   |
| Exercised                            |       | (20,089                    | )          | 0.84 - 2.82                             |          |                                                    | 1.05       |   |   |
| Canceled                             |       | (100,960                   | )          | 0.84 - 8.86                             |          |                                                    | 6.22       |   |   |
| Balance, December 31, 2005      |       | 3,135,033                  |       | 0.84 - 13.02                            |          |                                                    | $          | 6.23 |   |   |
| Exercisable, December 31, 2005  |       | 1,420,500                  |       | $                                       | 0.84 - $13.02 |                                                    |       | $ | 5.95 |   |   |
| Exercisable,  December 31, 2004 |       | 777,432                    |       | 0.84 - 13.02                            |          |                                                    | 5.49       |   |   |
| Exercisable,  December 31, 2003 |       | 443,048                    |       | 0.60 - 13.02                            |          |                                                    | 3.63       |   |   |

 

Thefollowing table summarizes information relating to currently outstanding andexercisable options as of December 31, 2005 as follows:

| **Exercise Price**                    | ** ** | ** ** | ** ** | **Number of  Shares** | ** ** | **Outstanding  Weighted-  Average  Remaining  Contractual  Life (in Years)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Exercisable  Number of  Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| $  0.00  - 1.31             |       | 468,693    |       |                       | 6.3        |                                                                                   |       |                                    | $          | 0.86                                    |       |                                    | 372,461    |   |   | $ | 0.87 |   |   |
|     1.31  - 2.61  |       | 61,821     |       |                       | 3.0        |                                                                                   |       |                                    | 1.89       |                                    |       | 61,821                                  |       |   | 1.89 |   |   |
|      2.61 - 3.91       |       | 0          |       |                       | 0          |                                                                                   |       |                                    | 0          |                                    |       | 0                                       |       |   | 0 |   |   |
|     3.91  - 5.21  |       | 294,900    |       |                       | 9.6        |                                                                                   |       |                                    | 4.83       |                                    |       | 56,218                                  |       |   | 4.84 |   |   |
|     5.21  - 6.51  |       | 1,252,603  |       |                       | 8.9        |                                                                                   |       |                                    | 5.84       |                                    |       | 296,882                                 |       |   | 5.90 |   |   |
|     6.51  - 7.81  |       | 226,301    |       |                       | 5.7        |                                                                                   |       |                                    | 7.18       |                                    |       | 212,540                                 |       |   | 7.20 |   |   |
|     7.81  - 9.11  |       | 327,869    |       |                       | 7.5        |                                                                                   |       |                                    | 8.69       |                                    |       | 153,359                                 |       |   | 8.70 |   |   |
|     9.11  - 10.42 |       | 218,500    |       |                       | 8.1        |                                                                                   |       |                                    | 9.59       |                                    |       | 104,443                                 |       |   | 9.59 |   |   |
|   10.42  - 11.72            |       | 0          |       |                       | 0          |                                                                                   |       |                                    | 0          |                                    |       | 0                                       |       |   | 0 |   |   |
|   11.72  - 13.02            |       | 284,346    |       |                       | 7.7        |                                                                                   |       |                                    | 13.02      |                                    |       | 162,776                                 |       |   | 13.02 |   |   |
|                                       |       | 3,135,033  |       |                       | 8.0        |                                                                                   |       |                                    | 6.23       |                                    |       | 1,420,500                               |       |   | $ | 5.95 |   |   |

 

***Grants Resulting inStock-based Compensation Expense***—In 2000,Acusphere issued 1,667 shares of common stock, 1,369 shares of restrictedcommon stock, and 10,000 options to purchase common stock to non-employees inconsideration of services rendered. During 2001 and 2003, Acusphere issued13,791 and 14,956 shares, respectively, of restricted common stock to anon-employee and certain directors in consideration of services rendered. Theseshares of restricted common stock vest ratably from 6 to 48 months fromtheir respective dates of issuance. Acusphere has the right to repurchase theunvested portion of the restricted common stock at the original issue priceupon certain events. Acusphere recorded 

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these issuances ofsecurities (stock options and restricted stock) at fair value at date of grant,which was $53,822, $419,594 and $102,299 in 2000, 2001 and 2003, respectively,and is recording stock-based compensation over the vesting periods. Pursuant toEITF Issue No. 96-18, “Accounting for Equity Instruments Issued toOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices,” Acusphere must periodically remeasure the fair value of unvestednon-employee equity instruments through the earlier of a performance commitmentor performance completion, as defined in EITF Issue No. 96-18. Theperiodic remeasurement of the fair value may result in additional charges tooperations in future periods.

Acusphere issued optionsto employees to purchase approximately 230,119, and 267,723 shares of commonstock during the years ended December 31, 2001 and 2003, respectively, atexercise prices deemed for accounting purposes to be below market value.Acusphere has recorded the difference between the exercise price and the fairvalue of $4,884,975 in 2001 and $1,396,347 in 2003 as deferred stock-basedcompensation and is amortizing this deferred compensation as charges to operationsover the vesting periods of the options.

**9.Convertible Preferred Stock and Warrants**

Prior to the Company’s IPO, sales of convertiblepreferred stock provided the primary source of funding for the Company. On October 14,2003, effective upon the closing of Company’s IPO, all then outstanding sharesof preferred stock were converted to common stock based upon conversion ratiosdefined for each series of preferred stock. There were no shares of thisconvertible preferred stock outstanding as of December 31, 2003. Series Gand Series H Preferred Stock were converted into common shares prior to2003.

***Common StockWarrants***—On November 30, 2004, Acusphereissued a warrant to purchase up to 55,732 shares of its common stock at anexercise price of $6.28 per share to a financial adviser in consideration ofits services to the Company in connection with the consummation of itscollaborative agreement with Nycomed Danmark ApS. The warrant may be exercisedany time and expires on November 30, 2009. The number of shares issuableupon exercise of the warrant and the exercise price thereof is subject toadjustment from time to time in the event of stock subdivisions, stock splitsand stock combinations. The warrant does not include a cashless exercisefeature. Acusphere recorded the deemed fair value of the warrant of $241,639,based upon the Black-Scholes option-pricing model, as a deferred consultingexpense included in other assets, which is being amortized over thecollaborative agreement’s revenue recognition term as consulting expense.$34,520 and $69,040 of amortization has been recorded within general andadministrative expense during 2004 and 2005, respectively.

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As of December 31,2005, warrants to purchase shares of the Company’s stock, the origination of whichwere derived in connection with debt and lease financing transactions and thecollaborative agreement with Nycomed, were outstanding for an aggregate of1,316,508 shares of common stock at an effective weighted average price of$9.73 per shares as follows:

| **Number of  Shares** | ** ** | **Exercise Price  Per Share** | ** ** | **Expiration  Date** | ** ** |
|----------------------------|------------|-----------------------------------------|------------|----------------------|------------|
| 4,724                      |       |                                    | 12.84      |                 |       | August 21,  2006 |   |
| 7,517                      |       |                                    | 12.84      |                 |       | June 6, 2007 |   |
| 5,194                      |       |                                    | 28.50      |                 |       | February 21,  2008 |   |
| 3,404                      |       |                                    | 18.00      |                 |       | February 26,  2008 |   |
| 450,897                    |       |                                    | 8.46       |                 |       | April 11,  2008 |   |
| 684                        |       |                                    | 14.00      |                 |       | April 11,  2008 |   |
| 7,540                      |       |                                    | 8.46       |                 |       | June 27,  2008 |   |
| 573,105                    |       |                                    | 8.50       |                 |       | August 2,  2008 |   |
| 16,212                     |       |                                    | 19.80      |                 |       | October 16,  2008 |   |
| 14,934                     |       |                                    | 19.80      |                 |       | October 19,  2008 |   |
| 114,895                    |       |                                    | 8.50       |                 |       | October 20,  2008 |   |
| 55,732                     |       |                                    | 6.28       |                 |       | November 30,  2009 |   |
| 2,688                      |       |                                    | 19.80      |                 |       | January 5,  2010 |   |
| 30,844                     |       |                                    | 28.50      |                 |       | March 30,  2011 |   |
| 28,138                     |       |                                    | 28.50      |                 |       | September 27,  2011 |   |
| 1,316,508                  |       |                                    |       |                 |       |   |   |

 

During 2003, warrants wereexercised at $9.30 per share resulting in the issuance of 998 shares of commonstock. No warrants were exercised during 2004 or 2005.

**10.Research and License Agreements**

Acusphere has clinical andpre-clinical study research agreements with various institutions. Totalexpenses incurred amounted to approximately $1,818,000, $4,839,000 and$7,605,121 in sponsored-research expenses relating to such agreements duringthe years ended December 31, 2003, 2004 and 2005, respectively.

**11. Commitments**

***Operating Leases***—Acuspherehas leased office, laboratory and manufacturing space under various agreementsclassified as operating leases. During 2003, 2004 and 2005, rent expensetotaled approximately $2,473,000, $2,920,000 and $3,197,000, respectively.

Acusphere’s headquarters is in Watertown, MA where itoperates in a facility under a lease with an original term of 10-yearwhich began in December 2001. Acusphere is required to maintain a securitydeposit totaling $997,500 as a condition of this lease. This deposit amount isincluded in other assets at December 31, 2004 and 2005. In conjunctionwith the lease agreement, Acusphere issued a warrant to the lessor which allowsfor the purchase of 30,844 shares of common stock. Acusphere recorded thedeemed fair value of the warrant of $536,402, based upon the Black-Scholesoption-pricing model, as a deferred rent expense included in other assets,which is being amortized over the lease term as rent expense. $53,640 ofamortization has been recorded within rent expense for each of the years ended December 31,2003, 2004 and 2005. During 2005, the term of this lease was extended by sixmonths.

In July 2004, Acusphere entered into a leaseagreement for 58,000 square feet of commercial manufacturing space inTewksbury, Massachusetts. This lease has a five year, nine month term with 

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options to extend thelease for up to two additional five-year terms at predetermined rental rates.Under the lease, Acusphere received nine months of occupancy free of base rent,followed by base rent of approximately $400,000 for the next twelve months withscheduled annual rental rate increases thereafter. In October 2004,Acusphere paid an initial security deposit of $1.0 million to the landlordas part of the lease, subject to reduction if the Company makes certainimprovements to the facility. A total of $0.9 million of this depositamount is included in other current assets at December 31, 2004, and$0.1 million is included in other assets at December 31, 2004. The$0.9 million was refunded to the Company during 2005.

Futureminimum payments due under the non-cancelable facility leases are as follows asof December 31, 2005:

| **Year Ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                        |       | $          | 2,746,000  |       |
| 2007                                        |       | 2,885,000  |       |
| 2008                                        |       | 3,026,000  |       |
| 2009                                        |       | 3,171,000  |       |
| 2010                                        |       | 2,851,000  |       |
| Thereafter                                  |       | 4,142,000  |       |
|                                        |       | $          | 18,821,000 |       |

 

***Service Contracts***—OnNovember 11, 2004, as amended March 9, 2005, Acusphere entered intoan agency procurement agreement with Parsons Commercial Technology, Inc. (“Parsons”)authorizing Parsons to procure as agent to the Company manufacturing and otherequipment in connection with the build-out of the commercial manufacturingfacility in Tewksbury, Massachusetts. As of December 31, 2005, the totalestimated value of equipment purchased under this agreement was$4.3 million for which the Company had paid $4.1 million.

On November 11, 2004,Acusphere entered into an engineering and construction management servicesagreement with Parsons authorizing Parsons to perform on behalf of the Companyengineering, design and construction management services in connection with thebuild-out of the Company’s commercial manufacturing facility in Tewksbury,Massachusetts. This agreement was amended subsequently in 2004 and in 2005 asthe build-out progressed. The build-out of this facility was substantiallycompleted in 2005. The total estimated value of this cost plus percentage feetype contract is $26.7 million. As of December 31, 2005, Acuspherehad paid approximately $23.7 million against this contract and recorded **$**2.8million****in accrued expensesand accounts payable.

**12.  Employee Benefit Plan**

Acusphere has a 401(k) profit sharing plancovering all employees of the Company who meet certain defined requirements.Under the terms of the 401(k) plan, the employees may elect to maketax-deferred contributions up to 20% of their salaries, subject to certainlimitations as defined by the Internal Revenue Code. During 2005, the Companyaccrued a matching contribution of $142,000 representing a match of 50% ofcontributions per employee up to a maximum Company contribution of $2,500 peremployee. Under the 401(k) plan, employees are not eligible to investdirectly in shares of Acusphere’s stock. The Company made no matchingcontributions in 2004 and 2003.

F-24

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**Item 15.2.Supplemental Financial Statement Schedule**

**QuarterlyResults of Operations (Unaudited)**

Thefollowing is a summary of our unaudited quarterly results of operations for thefiscal years ended December 31, 2004 and 2005:

| ** **                             | ** ** | **Revenue** | ** ** | **Net Loss** | ** ** | **Net Loss  Available to  Common  Stockholders** | ** ** | **Net Loss  Available to  Common  Stockholders  Per Share—  Basic and Diluted** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| **Year Ended December 31,  2004** |       |        |       |              |       |                                                       |       |                                                                                                          |       |   |   |
| First Quarter                          |       | $           | —     |              | $          | (6,924,562                                                 | )          | $                                                                                                             | (6,924,562 | ) |   | $ | (0.48 | ) |   |
| Second Quarter                         |       | —      |       | (7,619,210        | )          | (7,619,210                                                 | )          |                                                                                                          | (0.53      | ) |   |
| Third Quarter                          |       | 857,143     |       | (6,318,640        | )          | (6,318,640                                                 | )          |                                                                                                          | (0.39      | ) |   |
| Fourth Quarter                         |       | 857,143     |       | (9,096,636        | )          | (9,096,636                                                 | )          |                                                                                                          | (0.51      | ) |   |
| **Year Ended December 31,  2005** |       |        |       |              |       |                                                       |       |                                                                                                          |       |   |   |
| First Quarter                          |       | 857,143     |       | (7,972,628        | )          | (7,972,628                                                 | )          |                                                                                                          | (0.45      | ) |   |
| Second Quarter(1)                      |       | 857,143     |       | (15,343,137       | )          | (16,374,927                                                | )          |                                                                                                          | (0.92      | ) |   |
| Third Quarter                          |       | 857,143     |       | (9,710,553        | )          | (10,441,803                                                | )          |                                                                                                          | (0.58      | ) |   |
| Fourth Quarter                         |       | 857,143     |       | (11,599,057       | )          | (12,254,474                                                | )          |                                                                                                          | (0.56      | ) |   |
|                                        |            |             |            |                   |            |                                                            |            |                                                                                                               |            |  |  |  |  |  |  |

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(1)          Our net loss for thesecond quarter of 2005 includes $6.2 million in expense from the Company’sacquisition of certain intellectual property rights from Schering in May 2005.

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