##### Table of Contents



---

---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

(Mark One)

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

For the quarterly period ended September 30, 2003

or

[   ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

For the transition period from ___________ to ___________.

Commission File Number 000-50405

ACUSPHERE, INC.

(Exact name of registrant as specified in its charter)


|                                                                        |  |                                             
|----------------------------------------------------------------------- |  | --------------------------------------------
|Delaware
(State or other jurisdiction of incorporation
or organization) |  | 04-3208947
(IRS Employer Identification No.)

|                                                                                     |  |                 
|------------------------------------------------------------------------------------ |  | ----------------
|500 Arsenal Street
Watertown, Massachusetts
(Address of principal executive offices) |  | 02472
(Zip Code)

Registrants Telephone Number, Including Area Code: (617) 648-8800

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [  ] No [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

As of November 7, 2003 there were 14,293,535 shares of the registrants
common stock, $.01 par value per share, outstanding.



---

---





---

TABLE OF CONTENTS



|                                                |                                                                                               |                                            |  |  |  |  |  | 
|----------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I: FINANCIAL INFORMATION                  
|                                                | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                                                |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                                                |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                                | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                                                | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II. OTHER INFORMATION                     
|                                                | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                                                | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                                                | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                                                | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                                                | ITEM 5. OTHER INFORMATION                                                                    
|                                                | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                     
|EXHIBIT INDEX                                  
|EX-31.1 SECTION 302 CERTIFICATION OF THE C.E.O.
|EX-31.2 SECTION 302 CERTIFICATION OF THE C.F.O.
|EX-32.1 SECTION 906 CERTIFICATION OF CEO & CFO 



---



##### Table of Contents



ACUSPHERE, INC.

Form 10-Q
For the Quarterly Period Ended September 30, 2003

CONTENTS

|          |  |                                                                                       |  |                                                                                                                                                                     |    |        |   | 
|--------- |  | ------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -- | ------ | - | 
|          |  |                                                                                       |  |                                                                                                                                                                     |    | Page  
|          |  |                                                                                       |  |                                                                                                                                                                     |    | Number
|          |  |                                                                                       |  |                                                                                                                                                                     |    |       
|PART I:   |  | FINANCIAL INFORMATION                                                                 |  |                                                                                                                                                                     |    |       
|Item 1.   |  | Consolidated Financial Statements (Unaudited)                                         |  |                                                                                                                                                                     |    |       
|          |  |                                                                                       |  | Consolidated Balance Sheets: 
December 31, 2002 and September 30, 2003                                                                                              |    |        | 3 | 
|          |  |                                                                                       |  | Consolidated Statements of Operations: 
Three and Nine Months ended September 30, 2002 and 2003 and the
period from inception (July 12, 1993) to September 30, 2003 |    |        | 4 | 
|          |  |                                                                                       |  | Consolidated Statements of Cash Flows: 
Nine Months ended September 30, 2002 and 2003 and the period from
inception (July 12, 1993) to September 30, 2003           |    |        | 5 | 
|          |  |                                                                                       |  | Notes to Consolidated Financial Statements                                                                                                                          |    |        | 6 | 
|Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations |  |                                                                                                                                                                     | 12 |       
|Item 3.   |  | Quantitative and Qualitative Disclosure about Market Risk                             |  |                                                                                                                                                                     | 36 |       
|Item 4.   |  | Controls and Procedures                                                               |  |                                                                                                                                                                     | 36 |       
|PART II:  |  | OTHER INFORMATION                                                                     |  |                                                                                                                                                                     | 37 |       
|Item 1.   |  | Legal Proceedings                                                                     |  |                                                                                                                                                                     | 37 |       
|Item 2.   |  | Changes in Securities and Use of Proceeds                                             |  |                                                                                                                                                                     | 37 |       
|Item 3.   |  | Defaults Upon Senior Securities                                                       |  |                                                                                                                                                                     | 37 |       
|Item 4.   |  | Submission of Matters to a Vote of Security Holders                                   |  |                                                                                                                                                                     | 37 |       
|Item 5.   |  | Other Information                                                                     |  |                                                                                                                                                                     | 38 |       
|Item 6.   |  | Exhibits and Reports on Form 8-K                                                      |  |                                                                                                                                                                     | 38 |       
|Signature |  |                                                                                       |  |                                                                                                                                                                     | 39 |       





---



##### Table of Contents









PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company)




CONSOLIDATED BALANCE SHEETS

|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |              |            |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ---------- | ------------ | ----------- | ------------- | ---------- | ------------ | ---------- | -
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            | December 31, |             | September 30,
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            | 2002         |             | 2003         
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |              
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            | (unaudited) 
|ASSETS                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                       
|CURRENT ASSETS:                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               | Cash and cash equivalents                                                                                                                                                                                                                                                                                                              |                             | $          | 7,796,238    |             |               | $          | 9,378,300    |           
|                                                                                                                                                                                                                                                                                                               | Short-term investments                                                                                                                                                                                                                                                                                                                 |                             |            | 195,698      |             |               |            | 1,997,623    |           
|                                                                                                                                                                                                                                                                                                               | Other current assets                                                                                                                                                                                                                                                                                                                   |                             |            | 428,837      |             |               |            | 433,747      |           
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        | Total current assets        |            |              | 8,420,773   |               |            |              | 11,809,670 |  
|PROPERTY AND EQUIPMENT, At cost:                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               | Property and equipment (Note 5)                                                                                                                                                                                                                                                                                                        |                             |            | 8,986,125    |             |               |            | 9,838,958    |           
|                                                                                                                                                                                                                                                                                                               | Less accumulated depreciation and amortization                                                                                                                                                                                                                                                                                         |                             |            | 6,202,033    |             |               |            | 7,613,548    |           
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        | Property and equipment, net |            |              | 2,784,092   |               |            |              | 2,225,410  |  
|OTHER ASSETS                                                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                                                                                                                                        |                             | 2,162,196  |              |             |               | 2,184,127  |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|TOTAL                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                        | $                           | 13,367,061 |              |             | $             | 16,219,207 |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK, AND STOCKHOLDERS DEFICIT                                                                                                                                                                                                                                 |                                                                                                                                                                                                                                                                                                                                       
|CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               | Convertible notes (Note 6)                                                                                                                                                                                                                                                                                                             |                             | $          |             |             |               | $          | 18,992,217   |           
|                                                                                                                                                                                                                                                                                                               | Current portion of long-term debt (Note 7)                                                                                                                                                                                                                                                                                             |                             |            | 3,564,655    |             |               |            | 888,536      |           
|                                                                                                                                                                                                                                                                                                               | Accounts payable                                                                                                                                                                                                                                                                                                                       |                             |            | 737,715      |             |               |            | 1,001,145    |           
|                                                                                                                                                                                                                                                                                                               | Accrued expenses                                                                                                                                                                                                                                                                                                                       |                             |            | 1,219,744    |             |               |            | 2,091,023    |           
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        | Total current liabilities   |            |              | 5,522,114   |               |            |              | 22,972,921 |  
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|LONG-TERM DEBT, Net of current portion                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                        |                             | 1,725,588  |              |             |               | 418,118    |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|REDEEMABLE CONVERTIBLE PREFERRED STOCK, At
carrying value; including accrued dividends;
authorized, 32,106,077 shares as of December
31, 2002 and 56,265,576 shares as of September
30, 2003; issued and outstanding, 31,145,083
shares as of December 31, 2002 and 27,413,084
shares as of September 30, 2003 |                                                                                                                                                                                                                                                                                                                                        |                             | 91,467,075 |              |             |               | 82,885,082 |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|STOCKHOLDERS DEFICIT:                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             
|                                                                                                                                                                                                                                                                                                               | Common stock, $0.01 par value; authorized,
11,741,127 shares as of December 31, 2002 and
16,000,000 shares as of September 30, 2003;
issued 1,218,876 shares as of December 31,
2002 and 1,993,632 shares as of September 30,
2003; outstanding 1,212,849 shares as of
December 31, 2002 and 1,993,632 shares as of
September 30, 2003 |                             |            | 12,189       |             |               |            | 19,937       |           
|                                                                                                                                                                                                                                                                                                               | Additional paid-in capital                                                                                                                                                                                                                                                                                                             |                             |            | 34,029,519   |             |               |            | 49,452,849   |           
|                                                                                                                                                                                                                                                                                                               | Less treasury stock, at cost                                                                                                                                                                                                                                                                                                           |                             |            | (361         | )           |               |            |             |           
|                                                                                                                                                                                                                                                                                                               | Accumulated other comprehensive income                                                                                                                                                                                                                                                                                                 |                             |            | 288          |             |               |            |             |           
|                                                                                                                                                                                                                                                                                                               | Deferred stock-based compensation                                                                                                                                                                                                                                                                                                      |                             |            | (1,793,404   | )           |               |            | (2,082,743   | )         
|                                                                                                                                                                                                                                                                                                               | Deficit accumulated during development stage                                                                                                                                                                                                                                                                                           |                             |            | (117,595,947 | )           |               |            | (137,446,957 | )         
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |              |           
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        | Total stockholders deficit |            |              | (85,347,716 | )             |            |              | (7,171,832 | )
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |              |           
|TOTAL                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                        | $                           | 13,367,061 |              |             | $             | 16,219,207 |             
|                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                        |                             |            |              |             |               |            |             

The accompanying notes are an integral part of these consolidated financial statements.

3



---



##### Table of Contents



ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company)




CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            |             |           | 
|------------------------------------------------------------ | ----------------------------- | ------------------------ | -------------------------- | --------- | ------------------ | ------- | ----------------- | --------- | ------------------- | ------- | ------------- | ---------- | ------------- | --------- | ----------- | --------- | ---------- | ------- | ------------ | ---------- | ----------- | --------- | 
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            | Period from
|                                                             |                               |                          |                            |           | Three Months Ended |         | Nine Months Ended |           | Inception (July 12,
|                                                             |                               |                          |                            |           |                    |         |                   |           | 1993) to           
|                                                             |                               |                          |                            |           | September 30,      |         | September 30,     |           | September 30,       |         | September 30, |            | September 30,
|                                                             |                               |                          |                            |           | 2002               |         | 2003              |           | 2002                |         | 2003          |            | 2003         
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |              
|OPERATING EXPENSES:                                          |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           
|                                                             | Research and development(1)   |                          | $                          | 3,509,602 |                    |         | $                 | 3,376,467 |                     |         | $             | 10,935,507 |               |           | $           | 9,624,782 |            |         | $            | 67,949,269 |            
|                                                             | General and administrative(1) |                          |                            | 1,024,001 |                    |         |                   | 916,449   |                     |         |               | 2,848,911  |               |           |             | 2,770,857 |            |         |              | 18,723,053 |            
|                                                             | Stock-based compensation      |                          |                            | 545,547   |                    |         |                   | 359,975   |                     |         |               | 1,667,362  |               |           |             | 1,071,788 |            |         |              | 4,432,321  |            
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           
|                                                             |                               | Total operating expenses |                            |           | 5,079,150          |         |                   |           | 4,652,891           |         |               |            | 15,451,780    |           |             |           | 13,467,427 |         |              |            | 91,104,643  |          
|Equity in loss of joint venture                              |                               |                          | 373,650                    |           |                    |         |                  |           |                     |         | 1,181,894     |            |               |           |            |           |            |         | 15,164,257   |           
|Interest income                                              |                               |                          | 66,486                     |           |                    |         | 30,817            |           |                     |         | 182,922       |            |               |           | 99,927      |           |            |         | 3,873,982    |           
|Other income (expense)                                       |                               |                          | 370                        |           |                    |         | 37,500            |           |                     |         | 9,114         |            |               |           | (83,708     | )         |            |         | (74,594      | )         
|Interest expense                                             |                               |                          | (315,492                   | )         |                    |         | (699,997          | )         |                     |         | (1,033,562    | )          |               |           | (1,740,005  | )         |            |         | (6,008,271   | )         
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           
|NET LOSS                                                     |                               |                          | (5,701,436                 | )         |                    |         | (5,284,571        | )         |                     |         | (17,475,200   | )          |               |           | (15,191,213 | )         |            |         | (108,477,783 | )         
|Accretion of dividends and
offering costs on preferred
stock |                               |                          | 1,700,349                  |           |                    |         | 1,424,853         |           |                     |         | 4,984,435     |            |               |           | 4,659,798   |           |            |         | 28,969,175   |           
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            |            
|NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS                    |                               | ($                       | 7,401,785                  | )         |                    | ($      | 6,709,424         | )         |                     | ($      | 22,459,635    | )          |               | ($        | 19,851,011  | )         |            | ($      | 137,446,958  | )         
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            |            
|NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS PER SHARE         |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           
|Basic and diluted                                            |                               | $                        | (7.19                      | )         |                    | $       | (3.42             | )         |                     | $       | (33.27        | )          |               | $         | (13.59      | )         |            |         |              |           
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            |            
|WEIGHTED-AVERAGE SHARES
OUTSTANDING                         |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           
|Basic and diluted                                            |                               |                          | 1,029,932                  |           |                    |         | 1,964,203         |           |                     |         | 675,032       |            |               |           | 1,460,946   |           |            |         |              |           
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            |            
|                                                            
|(1) Excludes stock-based
compensation as follows:            |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           
|                                                             |                               |                          | Research and development   |           | $                  | 217,605 |                   |           | $                   | 161,829 |               |            | $             | 660,008   |             |           | $          | 486,857 |              |            | $           | 1,891,358 | 
|                                                             |                               |                          | General and administrative |           |                    | 327,942 |                   |           |                     | 198,146 |               |            |               | 1,007,354 |             |           |            | 584,931 |              |            |             | 2,540,963 | 
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |            |            
|                                                             |                               | $                        | 545,547                    |           |                    | $       | 359,975           |           |                     | $       | 1,667,362     |            |               | $         | 1,071,788   |           |            | $       | 4,432,321    |           
|                                                             |                               |                          |                            |           |                    |         |                   |           |                     |         |               |            |               |           |             |           |            |         |              |           

The accompanying notes are an integral part of these consolidated financial statements.

4



---



##### Table of Contents



ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company)




CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |             |            |             |             |  
|----------------------------------------------- | ----------------------------------------------------------------------- | -------------------------------------------- | ---------------------- | --------------------------------------------------- | --------- | ----------------- | ----------- | --------------- | --------- | ------------- | ----------- | ----------- | ---------- | ----------- | ----------- | -
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |             |            | Period from
|                                                |                                                                         |                                              |                        |                                                     |           | Nine Months Ended |             | Inception (July
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             | 12, 1993) to   
|                                                |                                                                         |                                              |                        |                                                     |           | September 30,     |             | September 30,   |           | September 30,
|                                                |                                                                         |                                              |                        |                                                     |           | 2002              |             | 2003            |           | 2003         
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |              
|CASH FLOWS FROM OPERATING ACTIVITIES:           |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|                                                | Net loss                                                                |                                              | ($                     | 17,475,200                                          | )         |                   | ($          | 15,191,213      | )         |               | ($          | 108,477,783 | )         
|                                                | Adjustments to reconcile net loss to cash used
in operating activities: |                                              |                        |                                                     |           |                   |             |                 |           |               |             |             |           
|                                                |                                                                         | Stock-based compensation expense             |                        |                                                     | 1,667,362 |                   |             |                 | 1,071,788 |               |             |             | 4,432,321  |            
|                                                |                                                                         | Depreciation and amortization                |                        |                                                     | 1,263,894 |                   |             |                 | 1,411,515 |               |             |             | 8,427,862  |            
|                                                |                                                                         | Noncash interest expense                     |                        |                                                     | 302,267   |                   |             |                 | 517,370   |               |             |             | 1,366,112  |            
|                                                |                                                                         | Noncash rent expense                         |                        |                                                     | 40,230    |                   |             |                 | 40,230    |               |             |             | 93,870     |            
|                                                |                                                                         | Noncash other expense                        |                        |                                                     |          |                   |             |                 | 68,908    |               |             |             | 68,908     |            
|                                                |                                                                         | Equity in loss from joint venture            |                        |                                                     | 1,181,894 |                   |             |                 |          |               |             |             | 15,164,257 |            
|                                                |                                                                         | Changes in operating assets and liabilities: |                        |                                                     |           |                   |             |                 |           |               |             |             |            |            
|                                                |                                                                         |                                              | Due from joint venture |                                                     |           | (776,162          | )           |                 |           |              |             |             |            | (3,149,257  | )          
|                                                |                                                                         |                                              | Other current assets   |                                                     |           | (114              | )           |                 |           | (4,910        | )           |             |            | (551,008    | )          
|                                                |                                                                         |                                              | Accounts payable       |                                                     |           | (860,803          | )           |                 |           | 263,429       |             |             |            | 1,001,145   |            
|                                                |                                                                         |                                              | Accrued expenses       |                                                     |           | 1,048,385         |             |                 |           | 871,279       |             |             |            | 2,091,024   |            
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|                                                |                                                                         |                                              |                        | Net cash used in operating activities               |           |                   | (13,608,247 | )               |           |               | (10,951,604 | )           |            |             | (79,532,549 | )
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|CASH FLOWS FROM INVESTING ACTIVITIES:           |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|                                                | Purchases of property and equipment                                     |                                              |                        | (638,950                                            | )         |                   |             | (309,464        | )         |               |             | (1,552,349  | )         
|                                                | (Increase) decrease in other assets                                     |                                              |                        | 75,485                                              |           |                   |             | (687,937        | )         |               |             | (2,306,963  | )         
|                                                | Investment in joint venture                                             |                                              |                        |                                                    |           |                   |             |                |           |               |             | (12,015,000 | )         
|                                                | Maturities (purchases) of short-term investments                        |                                              |                        | 9,042,489                                           |           |                   |             | (1,802,213      | )         |               |             | (1,980,124  | )         
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|                                                |                                                                         |                                              |                        | Net cash provided by (used in) investing
activities |           |                   | 8,479,024   |                 |           |               | (2,799,614  | )           |            |             | (17,854,436 | )
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|CASH FLOWS FROM FINANCING ACTIVITIES:           |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|                                                | Payments on long-term debt                                              |                                              |                        | (2,516,890                                          | )         |                   |             | (4,174,086      | )         |               |             | (17,560,215 | )         
|                                                | Proceeds from long-term debt                                            |                                              |                        |                                                    |           |                   |             | 19,440,342      |           |               |             | 29,440,342  |           
|                                                | Proceeds from financing of equipment                                    |                                              |                        |                                                    |           |                   |             |                |           |               |             | 347,960     |           
|                                                | Net proceeds from sale of redeemable convertible
preferred stock        |                                              |                        | 14,283,074                                          |           |                   |             |                |           |               |             | 94,337,203  |           
|                                                | Net proceeds from sale of common stock                                  |                                              |                        | 16,005                                              |           |                   |             | 67,024          |           |               |             | 201,355     |           
|                                                | Purchase and retirement of treasury stock                               |                                              |                        |                                                    |           |                   |             |                |           |               |             | (1,360      | )         
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|                                                |                                                                         |                                              |                        | Net cash provided by financing activities           |           |                   | 11,782,189  |                 |           |               | 15,333,280  |             |            |             | 106,765,285 |  
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|NET INCREASE IN CASH AND CASH EQUIVALENTS       |                                                                         |                                              | 6,652,966              |                                                     |           |                   | 1,582,062   |                 |           |               | 9,378,300   |            
|CASH AND CASH EQUIVALENTS  Beginning of period |                                                                         |                                              | 6,256,468              |                                                     |           |                   | 7,796,238   |                 |           |               |            |            
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            
|CASH AND CASH EQUIVALENTS  End of period       |                                                                         | $                                            | 12,909,434             |                                                     |           | $                 | 9,378,300   |                 |           | $             | 9,378,300   |            
|                                                |                                                                         |                                              |                        |                                                     |           |                   |             |                 |           |               |             |            

The accompanying notes are an integral part of these consolidated financial statements.

5



---



##### Table of Contents






ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



|1. |  | Basis of Presentation
|-- |  | ---------------------

The accompanying unaudited consolidated financial statements of Acusphere,
Inc. and Subsidiary (the Company), have been prepared in accordance with
generally accepted accounting principles in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
in the United States of America for complete financial statements. These
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Companys latest audited annual
financial statements. Those audited statements are included in our Registration
Statement No. 333-106725 on Form S-1, as amended, which has been filed with
the SEC.

On September 12, 2003, the Company effected a one for six reverse stock
split of its common stock. All share and per share amounts included in these
unaudited consolidated financial statements have been retroactively adjusted
for all periods presented to give effect to the reverse stock split.

In the opinion of management, all adjustments, consisting only of normal,
recurring adjustments (with the exception of the effect of the
reverse split)
considered necessary for a fair presentation of the results of these interim
periods have been included. The results of operations for the three and nine
months ended September 30, 2003 may not be indicative of the results that may
be expected for the full fiscal year.

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of expenses
during the reporting period. Actual results could differ from those estimates
or assumptions. The more significant estimates reflected in these financial
statements include judgmental accrued expenses and valuation of stock-based
compensation.



|2. |  | Subsequent Event - Initial Public Offering
|-- |  | ------------------------------------------

On October 14, 2003, the Company completed an initial public offering
which, after deducting underwriting discounts and expenses and estimated
offering-related expenses, resulting in net proceeds to the Company of
approximately $47.3 million and issuance by the Company of 3,750,000 shares of
common stock. In connection with the initial public offering, all of the
outstanding shares of the Companys preferred stock and all of its outstanding
10% convertible promissory notes, including interest accrued thereon through
the closing date of the offering, were converted into shares of our common
stock. Because the offering closed after September 30, 2003, the results of the
offering are not reflected in the accompanying unaudited consolidated financial
statements. A summary of the terms of this offering can be found in our
Registration Statement on Form S-1 as filed with the SEC.

6



---



##### Table of Contents





|3. |  | Accounting for Stock-based Compensation
|-- |  | ---------------------------------------

The Companys employee stock option plans are accounted for using the
intrinsic-value-based method of Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, no compensation expense is recorded for options issued to
employees with fixed amounts and fixed exercise prices which for accounting
purposes are at least equal to the fair value of the Companys common stock at
the date of grant. Conversely, when the exercise price for accounting purposes
is below fair value of the Companys common stock on the date of grant, a
non-cash charge to compensation expense is recorded ratably over the term of
the option vesting period in an amount equal to the difference between the
value calculated using the exercise price and the fair value. The Company uses
the fair-value method to account for nonemployee stock-based compensation.

Stock options granted during 2003 are as follows:

|                            |                    |  |        |         |           |  |           |       |  |  |          |       | 
|--------------------------- | ------------------ |  | ------ | ------- | --------- |  | --------- | ----- |  |  | -------- | ----- | 
|                            |                    |  |        |         |           |  |           |       |  |  | Weighted
|                            |                    |  |        |         |           |  |           |       |  |  | Average 
|                            |                    |  | Number |         | Exercise  |  | Exercise 
|                            |                    |  | of     |         | Price     |  | Price Per
|                            |                    |  | Shares |         | Per Share |  | Share    
|                            |                    |  |        |         |           |  |          
|For the three months ended: |                    |  |        |         |           |  |           |       |  |  |          |      
|                            | March 31, 2003     |  |        | 197,726 |           |  | $         | 0.84  |  |  | $        | 0.84  | 
|                            | June 30, 2003      |  |        |        |           |  |           |      |  |  |          |      | 
|                            | September 30, 2003 |  |        | 285,346 |           |  |           | 13.02 |  |  |          | 13.02 | 

The stock options granted in the three months ended March 31, 2003 were
deemed for accounting purposes to have been granted at exercise prices below
fair value. The Company has recorded the difference between the exercise price
and the fair value of $6.84 as deferred stock-based compensation. The Company
expenses deferred stock-based compensation as charges to operations over the
vesting period of the options.

7



---



##### Table of Contents



Had compensation cost for grants issued during the three and nine months
periods ended September 30, 2002 and 2003 been determined consistent with
Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for
Stock-based Compensation, pro forma net loss and net loss per share would have
been the following:

|                                        |                                                                             |  |                    |            |                   |  |               |            |               |  |   |              |   |  |   |             |  
|--------------------------------------- | --------------------------------------------------------------------------- |  | ------------------ | ---------- | ----------------- |  | ------------- | ---------- | ------------- |  | - | ------------ | - |  | - | ----------- | -
|                                        |                                                                             |  | Three Months Ended |            | Nine Months Ended
|                                        |                                                                             |  |                    |            |                  
|                                        |                                                                             |  | September 30,      |            | September 30,     |  | September 30, |            | September 30,
|                                        |                                                                             |  | 2002               |            | 2003              |  | 2002          |            | 2003         
|                                        |                                                                             |  |                    |            |                   |  |               |            |              
|Applicable to common
stockholders:      |                                                                             |  |                    |            |                   |  |               |            |               |  |   |              |   |  |   |            
|                                        | Net loss  as reported                                                      |  | $                  | (7,401,785 | )                 |  | $             | (6,709,424 | )             |  | $ | ( 22,459,635 | ) |  | $ | (19,851,011 | )
|                                        | Add: Stock-based
compensation expense
included in reported
net loss         |  |                    | 545,547    |                   |  |               | 359,975    |               |  |   | 1,667,362    |   |  |   | 1,071,788   |  
|                                        | Deduct: Stock-based
compensation expense
determined under fair
value method |  |                    | (646,201   | )                 |  |               | (325,297   | )             |  |   | (1,987,992   | ) |  |   | (1,333,761  | )
|                                        |                                                                             |  |                    |            |                   |  |               |            |               |  |   |              |   |  |   |             |  
|                                        | Net loss  proforma                                                         |  | $                  | (7,502,439 | )                 |  | $             | (6,674,746 | )             |  | $ | ( 22,780,265 | ) |  | $ | (20,112,984 | )
|                                        |                                                                             |  |                    |            |                   |  |               |            |               |  |   |              |   |  |   |            
|Net loss per share
(basic and diluted): |                                                                             |  |                    |            |                   |  |               |            |               |  |   |              |   |  |   |            
|                                        | As reported                                                                 |  | $                  | (7.19      | )                 |  | $             | (3.42      | )             |  | $ | (33.27       | ) |  | $ | (13.59      | )
|                                        | Pro forma                                                                   |  | $                  | (7.28      | )                 |  | $             | (3.40      | )             |  | $ | (33.75       | ) |  | $ | (13.77      | )
|                                        |                                                                             |  |                    |            |                   |  |               |            |               |  |   |              |   |  |   |            



|4. |  | Net Loss Per Common Share
|-- |  | -------------------------

Basic and diluted net loss per common share is calculated by dividing the
net loss applicable to common stockholders by the weighted-average number of
unrestricted common shares outstanding during the period. Diluted net loss per
common share is the same as basic net loss per common share, since the effects
of potentially dilutive securities are antidilutive for all periods presented.
Antidilutive securities, which consist of redeemable convertible preferred
stock, 10% convertible promissory notes, including accrued interest thereon,
stock options, warrants, and restricted common stock that are not included in
the diluted net loss per share calculation, aggregated 7,845,298 and
7,968,530 as of September 30, 2002 and 2003, respectively.

8



---



##### Table of Contents



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

|                                                                    |  |                    |           |                   |  |               |           |               |  |  |         |   |  |  |           |  
|------------------------------------------------------------------- |  | ------------------ | --------- | ----------------- |  | ------------- | --------- | ------------- |  |  | ------- | - |  |  | --------- | -
|                                                                    |  | Three Months Ended |           | Nine Months Ended
|                                                                    |  |                    |           |                  
|                                                                    |  | September 30,      |           | September 30,     |  | September 30, |           | September 30,
|                                                                    |  | 2002               |           | 2003              |  | 2002          |           | 2003         
|                                                                    |  |                    |           |                   |  |               |           |              
|Weighted-average
common shares
outstanding                          |  |                    | 1,039,115 |                   |  |               | 1,978,800 |               |  |  | 685,049 |   |  |  | 1,465,474 |  
|Less
weighted-average
unvested restricted
common shares
outstanding |  |                    | (9,183    | )                 |  |               | (14,597   | )             |  |  | (10,017 | ) |  |  | (4,528    | )
|                                                                    |  |                    |           |                   |  |               |           |               |  |  |         |   |  |  |           |  
|Basic and diluted
weighted-average
common shares
outstanding        |  |                    | 1,029,932 |                   |  |               | 1,964,203 |               |  |  | 675,032 |   |  |  | 1,460,946 |  
|                                                                    |  |                    |           |                   |  |               |           |               |  |  |         |   |  |  |           |  



|5. |  | Property and Equipment
|-- |  | ----------------------

Property and equipment at cost consist of the following:

|                       |                              |   |              |           |               |   |           |           | 
|---------------------- | ---------------------------- | - | ------------ | --------- | ------------- | - | --------- | --------- | 
|                       |                              |   | As of:      
|                       |                              |   | December 31, |           | September 30,
|                       |                              |   | 2002         |           | 2003         
|                       |                              |   |              |           |              
|Equipment              |                              | $ | 8,721,004    |           |               | $ | 9,536,060 |          
|Furniture and fixtures |                              |   | 166,926      |           |               |   | 180,393   |          
|Leasehold improvements |                              |   | 98,195       |           |               |   | 122,505   |          
|                       |                              |   |              |           |               |   |           |          
|                       | Total property and equipment |   | $            | 8,986,125 |               |   | $         | 9,838,958 | 
|                       |                              |   |              |           |               |   |           |          



|6. |  | Convertible Notes and Warrants
|-- |  | ------------------------------

On April 11, 2003 and June 27, 2003, the Company raised $19.1 million and
$319,000, respectively, from existing preferred stockholders in exchange for
convertible promissory notes and warrants. The notes bear interest at a rate
of 10% per annum. The notes and accrued interest automatically converted into
common stock on October 14, 2003, the date of the closing of the Companys
initial public offering discussed in Note 2, at a conversion price of $8.46 per
share. Warrants issued in connection with the 10% convertible promissory notes
allow for the purchase of up to an additional 459,120 shares of common stock at
$8.46 per share. The warrants expire five years from the dates of issuance.
Based upon the relative value of the notes and the deemed value of the
warrants, the Company allocated $761,500 of the $19.4 million in cumulative
proceeds to the warrants and reduced the carrying value of the notes by the
unamortized discount. Amortization of this discount for the three and nine
month periods ended September 30, 2003 was $149,375 and $313,375, respectively.
This amortization is recorded as non-cash interest expense.

9



---



##### Table of Contents





|7. |  | Long-term Debt
|-- |  | --------------

The carrying value of long-term debt is as follows:

|                           |  |              |           |               |  |   |           | 
|-------------------------- |  | ------------ | --------- | ------------- |  | - | --------- | 
|                           |  | As of:      
|                           |  | December 31, |           | September 30,
|                           |  | 2002         |           | 2003         
|                           |  |              |           |              
|Capital lease obligations  |  | $            | 2,342,045 |               |  | $ | 1,306,654 | 
|Subordinated loans payable |  |              | 2,948,198 |               |  |   |          | 
|                           |  |              |           |               |  |   |           | 
|                           |  |              | 5,290,243 |               |  |   | 1,306,654 | 
|Less current maturities    |  |              | 3,564,655 |               |  |   | 888,536   | 
|                           |  |              |           |               |  |   |           | 
|Long-term debt, net        |  | $            | 1,725,588 |               |  | $ | 418,118   | 
|                           |  |              |           |               |  |   |           | 

Long-term debt, including current maturities, outstanding as of September
30, 2003 consisted of capital equipment leased under various capital lease
arrangements. Monthly payments range from $3,708 to $46,222 with maturities
through April 2005. The subordinated loans payable which were outstanding as of
December 31, 2002 were repaid in full in June 2003 and, in conjunction with
such payments, the Company was released from the security agreement related to
the subordinated loans payable.



|8. |  | Stockholders Equity
|-- |  | --------------------

On July 1, 2003, 3,731,999 shares of several series of preferred stock
were converted into 732,600 shares of common stock. These conversions were
based upon the conversion ratios then applicable for each series of preferred
stock. On July 1, 2003, the Company filed a registration statement on Form S-1
with the SEC for an initial public offering of its common stock. Upon the
closing of the Companys initial public offering, which occurred on October 14,
2003, subsequent to the end of the Companys third fiscal quarter reported on
herein, all remaining outstanding shares of preferred stock and all outstanding
10% convertible promissory notes, including interest accrued thereon through
the closing date of the offering, were converted into shares of common stock
based upon the conversion ratios then applicable.

In July 2003, the Companys board of directors approved the 2003 Stock
Option and Incentive Plan and the 2003 Employee Stock Purchase Plan, each to
become effective on the closing of the Companys initial public offering, which
occurred on October 14, 2003. The aggregate number of shares which may be
issued under the 2003 Stock Option and Incentive Plan is 2,500,000 shares of
common stock. The aggregate number of shares which may be sold under the 2003
Employee Stock Purchase Plan is 233,334 shares of common stock. In addition,
the Companys board of directors increased the number of shares of common stock
that may be granted under the Companys 1994 Stock Plan such that as of
September 30, 2003, there were 1,251,080 shares reserved for issuance under the
plan of which an aggregate of 1,161,828 shares of common stock were reserved
for outstanding stock options and 89,252 shares of common stock were available
for issuance.

In September 2003, in connection with the Companys registration for its
initial public offering, the Company increased the number of authorized shares
of common stock to an aggregate amount, as adjusted, of 16,000,000. Upon the closing of the Companys initial public
offering on October 14, 2003, the Companys authorized capital stock, consisted
of 98,500,000 shares of common stock, par value $0.01 per share, and 5,000,000
shares of undesignated preferred stock, par value $0.01 per share, issuable in
one or more series designated by the board of directors. No other class of
capital stock is authorized.

10



---



##### Table of Contents



On September 12, 2003, the Company effected a one-for-six share reverse stock
split the effect of which has been retroactively applied to all common stock
outstanding and to all common stock equivalents.



|9. |  | Comprehensive Income
|-- |  | --------------------

Comprehensive loss is defined as the change in stockholders deficit
during a period from transactions and other events and circumstances from
nonowner sources. During the three and nine months ended
September 30, 2002 and
2003, other then reported net loss, the only other component of comprehensive
loss incurred by the company were unrealized losses of $24 and $3,546,
respectively, in 2002 and zero and $288, respectively, in 2003, on short term
investments.



|10. |  | Recently Issued Accounting Pronouncements
|--- |  | -----------------------------------------

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
This statement establishes how a company classifies and measures certain
financial instruments with characteristics of both liabilities and equity,
including redeemable preferred stock. This statement is effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise effective at the beginning of the interim period commencing July 1,
2003, except for mandatorily redeemable financial instruments of nonpublic
companies. Adoption of this statement did not have a material impact on the
Companys financial statements.

11



---



##### Table of Contents






ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Forward Looking Statements May Prove Inaccurate

From time to time, information provided by us, statements made by our
employees or information included in our filings with the Securities and
Exchange Commission (including this quarterly report on Form 10-Q) may contain
statements that are not historical facts, so-called forward-looking
statements, that involve known and unknown risks, uncertainties and other
factors that may cause our actual results, performance or achievements to be
materially different from any future results, performance or achievements
expressed or implied by these forward-looking statements. Such forward-looking
statements are made pursuant to the safe harbor provisions of Section 21E of
the Securities Exchange Act of 1934, as amended.

Forward-looking statements made in
connection with this Form 10-Q include, but are not limited to our plans and abilities to
attract qualified collaborators on acceptable terms; our estimates of expenses, staffing and
capital requirements and our abilities to raise additional financing; and our manufacturing
capabilities and timing of manufacturing production for our product candidates.

In some cases, you can identify forward-looking statements by terms such
as may, will, should, could, would, expect, plans, anticipates,
believes, estimates, projects, predicts, intends, potential and
similar expression intended to identify forward-looking statements. These
statements reflect our current views with respect to future events, and are
based on assumptions and subject to risks and uncertainties. Also, these
forward-looking statements represent our estimates and assumptions only as of
the date of this report. Given these uncertainties, you should not place undue
reliance on these forward-looking statements. When considering forward-looking
statements, you should keep in mind the Factors That May Affect Future
Results and other cautionary statements included in this report.

You should read this report with the understanding that our actual future
results may be materially different from what we expect. Our business,
financial condition, results of operations and prospects may change. We may not
update these forward-looking statements, even though our situation may change
in the future, unless we have obligations under the Federal securities laws to
update and disclose material developments related to previously disclosed
information. We qualify all of the information presented in this report, and
particularly our forward-looking statements, by these cautionary statements.

Overview

We are a specialty pharmaceutical company that develops new drugs and
improved formulations of existing drugs using our proprietary porous
microparticle technology. We are focused on developing proprietary drugs that
can offer significant benefits such as improved safety and efficacy, increased
patient compliance, greater ease of use, expanded indications or reduced cost.
Our three initial product candidates are in clinical development and are
designed to address large unmet clinical needs within cardiology, oncology and
asthma. Our lead product candidate is a cardiovascular drug in Phase III
clinical development for the detection of coronary artery disease, the leading
cause of death in the United States.

12



---



##### Table of Contents



We created our three initial product candidates using technology that
enables us to control the size and porosity of microparticles in a versatile
manner, so we can customize the microparticles to address the delivery needs of
a variety of drugs. We are focused on creating porous microparticles that are
smaller than red blood cells. Small microparticles are important for delivering
drugs intravenously so that they can pass through the bodys smallest blood
vessels, for increasing the surface area of a drug so that the drug will
dissolve more rapidly, and for delivering drugs to the lung via inhalation.
Porosity is important for entrapping gases in microparticles, for controlling
the release rate of the drug from a microparticle, and for targeting inhaled
drugs to specific regions of the lung.

We are a development stage company and have devoted substantially all of
our efforts towards the research and development of our product candidates and
raising capital. Since our inception, we have had no revenue from product sales
and have funded our operations almost exclusively through the private and
public placement of equity securities, equipment leases and debt financings. We
have not been profitable and have incurred a cumulative net loss of $108.5
million from inception through September 30, 2003.

We expect to incur significant operating losses for the next several
years. Research and development expenses relating to our product candidates
will continue to increase. In particular, we expect to incur increased costs
for Phase III clinical trials of AI-700. General and administrative costs will
increase as we prepare for the commercialization of our product candidates and
as we begin operating as a public company. Manufacturing expenses, which are
currently part of research and development expenses, will also increase as we
prepare for the commercialization of our product candidates.

AI-700 Clinical Trial Update

Our Phase III program for AI-700 commenced in 2003 under a U.S.
Investigational New Drug application (IND) and in compliance with applicable
European regulatory requirements. The Phase III clinical plan provides for a
two-part program consisting of a pilot phase, which is currently ongoing at
multiple clinical sites and is designed to qualify and train new investigators,
and two multi-center pivotal trials each for approximately 300 patients with
suspected coronary artery disease. The Phase III pilot and pivotal phase
studies will take place at clinical sites in North America and Europe with data
from the trials intended for submission to U.S., Canadian and European
regulatory authorities. The endpoints for the pivotal trials are sensitivity
and specificity in comparison to nuclear stress, angiography or clinical
outcome.

During the three months ended September 30, 2003, we continued the pilot
phase at clinical sites in the U.S. and Europe in preparation for commencing
the pivotal phase of our Phase III AI-700 clinical trial at select clinical
sites before the end of 2003. In addition, during the three months ended
September 30, 2003 we added clinical staffing of an additional five people, including
two individuals with medical degrees,
representing the balance of our clinical support staff which we believe is
needed at the start of the pivotal phase of our Phase III AI-700 clinical
trial.

Patent Update

During the nine months ended September 30, 2003, we were issued three
additional U.S. patents as follows:

|                |  |                 |  |                  |  |                                                              
|--------------- |  | --------------- |  | ---------------- |  | -------------------------------------------------------------
|U.S. Patent No. |  | Date Issued     |  | Expiration Date  |  | Subject                                                      
|                |  |                 |  |                  |  |                                                              
|6,560,897       |  | May 13, 2003    |  | June 15, 2019    |  | Spray drying apparatus and methods of use                    
|6,589,557       |  | July 8, 2003    |  | November 4, 2019 |  | Porous celecoxib matrices and methods of
manufacture thereof 
|6,610,317       |  | August 26, 2003 |  | May 25, 2020     |  | Porous paclitaxel matrices and methods of
manufacture thereof

13



---



##### Table of Contents



As of September 30, 2003, we owned twelve issued U.S. patents, one allowed
U.S. patent application and twelve U.S. patent applications. We also own more
than one hundred pending international and foreign patent applications
corresponding to our U.S. patents and applications.

On November 11, 2003, we were issued an additional U.S. patent, number
6,645,528, entitled Porous drug matrices and methods of manufacture thereof.

Financial Operations Overview

Revenues.We have not generated any operating revenues since our inception
and do not expect operating revenues in the near future. Further in the future,
we will seek to generate revenues from a combination of product sales, up-front
or milestone payments in connection with collaborative or strategic
relationships, and royalties resulting from the license of our intellectual
property.

Research and Development Expense.Research and development expense
consists of expenses incurred in developing and testing product candidates.
These expenses consist primarily of salaries and related expenses for
personnel, fees paid to professional service providers in conjunction with
independently monitoring our clinical trials and acquiring and evaluating data
in conjunction with our clinical trials, costs of contract manufacturing
services, costs of materials used in clinical trials and research and
development, depreciation of capital resources used to develop our products,
costs of facilities and the legal costs of pursuing patent protection on select
elements of our intellectual property. We expense research and development
costs, including patent related costs, as incurred. We believe that significant
investment in product development is a competitive necessity and plan to
continue these investments in order to realize the potential of our product
candidates and proprietary technologies. Development programs for later stage
product candidates, such as AI-700, tend to cost more than earlier stage
programs due to the length and the number of patients enrolled in clinical
trials for later stage programs. From inception through September 30, 2003, we
cumulatively spent $67.9 million on research and development. Additionally,
from June 2000 through September 2002, we performed research and development
through a joint venture, as discussed below.

General and Administrative Expense.General and administrative expense
consists primarily of salaries and other related costs for personnel in
executive, finance, accounting, information technology and human resource
functions. Other costs include facility costs not otherwise included in
research and development expense and professional fees for legal and accounting
services. From inception through September 30, 2003, we have cumulatively
incurred $18.7 million in general and administrative expense.

Stock-Based Compensation Expense.Stock-based compensation expense, which
is a non-cash charge, results principally from stock option grants to our
employees at exercise prices deemed for accounting purposes to be below the
fair market value of our stock on the date the stock options were granted. We
have granted stock options for which the exercise prices were deemed for
accounting purposes to be below the fair value of the underlying common stock
resulting in our recording stock-based compensation expense associated with
such grants. Stock-based compensation expense is also recorded for stock option
grants to non-employees and for restricted stock grants provided to directors
and advisors in lieu of cash compensation. Deferred compensation on fixed
awards is amortized as a charge to operations over the vesting periods of the
options and grants, subject to adjustment for forfeiture during the vesting
period. As of September 30, 2003, we deferred $2.1 million in stock-based
compensation and, from inception through September 30, 2003, recognized
stock-based compensation expense of $4.4 million.

Equity in Loss of Joint Venture.In June 2000, we established in
collaboration with Elan Corporation, plc and its affiliates a joint venture,
Acusphere Newco, Ltd., a Bermuda corporation, to develop and commercialize
pulmonary drug delivery product candidates. In September 2002, we reached an
agreement with Elan terminating the joint venture in a cash-free transaction.
Equity in loss of joint venture consists of our portion of the losses from
Acusphere Newco, Ltd. from June 2000, when the joint venture was established,
until September 2002, when the joint venture was terminated. During that
period, we owned an 80.1% interest in the joint venture and Elan owned a 19.9%
interest in the joint venture on a fully diluted basis. Elan had retained
significant minority investor rights that prevented us from exercising full
control over the joint venture. Accordingly, during the period from June 2000
to

14



---



##### Table of Contents



September 2002, we recorded net losses of the joint venture in accordance
with our percentage ownership (80.1%) of such entity and reported such loss
using the equity method of accounting. In connection with the termination of
the joint venture we recorded a loss of $381,413 for an amount previously
recorded as due from Elan. Including this
amount, from inception through the date on which we terminated our joint
venture with Elan, we cumulatively incurred $15.2 million in equity in loss of
joint venture.

Interest
and Other Income (Expense). Interest income consists of interest
earned on our cash, cash equivalents and short-term investments. Interest
expense consists of interest incurred on equipment leases and on debt
financings.

Accretion of Dividends and Offering Costs on Convertible Preferred Stock.
Accretion of dividends and offering costs on convertible preferred stock
primarily consists of dividends on convertible preferred stock. Prior to
conversion of convertible preferred stock to common stock, which occurred on
October 14, 2003 upon the completion of the Companys initial public offering,
our convertible preferred stock was entitled to accretion of dividends, the
amount of which decreased the amount of stockholders equity available to
common stockholders and effectively increases the loss per share of common
stock. After October 14, 2003, no existing convertible preferred stock is
outstanding, and accordingly there will be no further accretion of dividends
and offering costs on these shares.

Results of Operations

Three Months Ended September 30, 2002 and 2003

Research and Development Expense.Research and development expense
decreased $133,000, or 4%, to $3.4 million in the three months ended September
30, 2003 from $3.5 million in the three months ended September 30, 2002.
Research and development expense declined in the three months ended September
30, 2003 as compared to the three months ended September 30, 2002 primarily due
to the timing of costs incurred in 2002 related to AI-850 clinical trials,
including trial startup costs and costs of manufacturing of clinical materials
incurred, as well as costs incurred in the third quarter of 2002 to complete our initial AI-128 Phase 1
clinical trial. Higher costs were also incurred in the 2002 period in connection with
evaluating certain other product candidates. These lower costs in the
third quarter of 2003 were partially offset
by $675,000 in increased costs incurred in the 2003 period in connection with the
commencement of our AI-700 Phase III clinical program.

The following table summarizes the primary components of our research and
development expense for the three months ended September 30,
2002 and 2003.
Because of our ability to utilize resources across several projects, many of
our research and development costs are not tied to any individual project and
are allocated among multiple projects. We record direct costs on a
project-by-project basis. We record indirect costs in aggregate in support of
all research and development.

|                                       |  |                    |       |      |  |   |       | 
|-------------------------------------- |  | ------------------ | ----- | ---- |  | - | ----- | 
|                                       |  | Three Months Ended
|                                       |  | September 30,     
|                                       |  |                   
|                                       |  | 2002               |       | 2003
|                                       |  |                    |       |     
|                                       |  | (in thousands)    
|AI-700                                 |  | $                  | 1,522 |      |  | $ | 2,197 | 
|AI-850 and AI-128                      |  |                    | 657   |      |  |   | 155   | 
|Other                                  |  |                    | 451   |      |  |   | 193   | 
|                                       |  |                    |       |      |  |   |       | 
|Total direct costs                     |  |                    | 2,630 |      |  |   | 2,545 | 
|Facility costs                         |  |                    | 512   |      |  |   | 493   | 
|Depreciation                           |  |                    | 322   |      |  |   | 252   | 
|Patent costs                           |  |                    | 46    |      |  |   | 86    | 
|                                       |  |                    |       |      |  |   |       | 
|Total research and development expense |  | $                  | 3,510 |      |  | $ | 3,376 | 
|                                       |  |                    |       |      |  |   |       | 

15



---



##### Table of Contents



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



| |  |  | Late Stage Clinical Development Program (AI-700).Our lead product
candidate, AI-700, is a cardiovascular drug for the detection of
coronary artery disease. We incurred direct research and development
expense for AI-700 in the three months ended September 30, 2003 of $2.2
million compared to $1.5 million in the three months ended September
30, 2002. Of these amounts, $600,000 for the three
months ended September 30, 2003 and $544,000 for the three months ended
September 30, 2002 were incurred in connection with the production of
clinical trial material by a third-party contract manufacturer. In 2003,
we commenced clinical studies in our Phase III clinical program for
AI-700, and we identified and began training additional clinical sites to
be part of this Phase III clinical program. We anticipate that new
clinical sites for this clinical trial, in both Europe and North America,
will be trained and initiated during 2003 and 2004. As clinical sites are
initiated and increasing numbers of patients are enrolled in the Phase
III clinical program, we anticipate incurring increased costs from
professional service firms helping to support the clinical trial by
providing services such as independent clinical monitoring, data
acquisition and data evaluation. We also anticipate incurring increased
costs related to hiring of additional research and development and
clinical personnel. In addition, we anticipate incurring increased costs
associated with production and distribution of clinical trial material,
including production in 2003 and 2004 of clinical trial material which
meets our requirements for the pivotal trials of our Phase III clinical
program and with preparation for commercial production.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Early Stage Clinical Development Programs (AI-850 and AI-128).Our
initial clinical applications of our HDDS technology, AI-850, and our
PDDS technology, AI-128, are in early stages of clinical development.
We incurred direct research and development expense for AI-850 and
AI-128 in the three months ended September 30, 2003 of $155,000
compared to $657,000 in the three months ended September 30, 2002. Of
these amounts, $50,000 for the three months ended September 30, 2002
was incurred in connection with the production of clinical trial
material by a third-party contract manufacturer. There were no contract
manufacturing costs incurred in connection with these product
development programs during the three months ended September 30, 2003.
We anticipate that our overall costs for development of these product
candidates will decline until we are prepared to commence further
pre-clinical and clinical testing using our own resources or through
strategic collaborations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  |  | Other. Other direct research and development costs primarily
consist of management and preclinical evaluation of other product
candidates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

Each of our research and development programs are subject to risks and
uncertainties, including the requirement to seek regulatory approval, that are
outside of our control. For example, our clinical trials may be subject to
delays or rejections based on our inability to enroll patients at the rate that
we expect or our inability to produce clinical trial material in sufficient
quantities and of sufficient quality to meet the schedule for our planned
clinical trials. Moreover, the product 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 successfully commercialized. As a result of these risks and
uncertainties, we are unable to predict with any certainty the period in which
material net cash inflows from such projects could be expected to commence or
the completion date of these programs. Failure to commercialize these product
candidates on a timely basis could have a material adverse affect on our
business, financial condition and results of operations. We may seek to
establish collaborative relationships to help us commercialize these product
candidates, but there can be no assurance that we will be successful in doing
so.

General and Administrative Expense. General and administrative expense
decreased $108,000, or 11%, to $916,000 in the three months ended September 30,
2003 from $1.0 million in the three months ended September 30, 2002. The lower
general and administrative expense incurred in the three months ended September
30, 2003 was principally due to the timing of various costs, none of
which was individually significant.

Stock-Based Compensation Expense. Stock-based compensation expense
decreased $186,000, or 34%, to $360,000 in the three months ended September 30,
2003 from $546,000 in the three months ended September 30, 2002. Stock-based
compensation expense incurred in both periods resulted principally from the
vesting of stock

16



---



##### Table of Contents



options granted in prior periods on which deferred
compensation had previously been recorded and decreased as a result of some
prior year awards becoming fully vested in the current period.

Equity in Loss of Joint Venture. Our joint venture with Elan was
terminated in September 2002. During the three months ended September 30, 2002,
we recognized a $374,000 loss from our 80.1% equity share in the loss of the
Elan joint venture. This amount related to the expense of an amount previously
recorded as due from Elan.

Interest and Other Income (Expense).Interest and other income (expense)
increased $383,000, or 154%, to a net expense of $632,000 in the three months
ended September 30, 2003 from a net expense of $249,000 in the three months
ended September 30, 2002. During these periods, interest and other income
(expense) consisted of the following:

|                       |            |   |                                  |          |      |   |          |          |  
|---------------------- | ---------- | - | -------------------------------- | -------- | ---- | - | -------- | -------- | -
|                       |            |   | Three Months Ended September 30,
|                       |            |   |                                 
|                       |            |   | 2002                             |          | 2003
|                       |            |   |                                  |          |     
|Interest income        |            | $ | 66,000                           |          |      | $ | 31,000   |         
|Other income (expense) |            |   |                                 |          |      |   | 37,000   |         
|Interest expense       |            |   | (315,000                         | )        |      |   | (700,000 | )       
|                       |            |   |                                  |          |      |   |          |         
|                       | Total, net |   | $                                | (249,000 | )    |   | $        | (632,000 | )
|                       |            |   |                                  |          |      |   |          |         

The decrease in interest income in the three months ended September 30,
2003 compared to the three months ended September 30, 2002 was primarily due to
reduced yields on investments resulting from lower average interest rates and
to lower average fund balances available for investment. The increase in
interest expense in the three months ended September 30, 2003 compared to the
three months ended September 30, 2002 was primarily due to $149,000 of costs
incurred from the amortization of the discount recorded for accounting purposes
on the 10% convertible promissory notes
in April and June 2003 and to $490,000 of interest accrued on the 10%
convertible promissory notes, partially offset by a decrease in interest paid
on the subordinated loans payable of $156,000 and the decrease of
$80,000 in amortization of the discount associated with the
subordinated loans payable, both decreases due to the early repayment of debt in 2003.

Accretion of Dividends and Offering Costs on Convertible Preferred Stock.
Accretion of dividends and offering costs on convertible preferred stock
decreased $275,000, or 16%, to $1.4 million in the three months ended September
30, 2003 from $1.7 million in the three months ended September 30, 2002. The
decrease was primarily due to a decrease of $300,000 from dividends on
convertible preferred stock resulting from the conversion of certain shares of
convertible preferred stock to common stock in connection with the 10%
convertible promissory notes financing in April and June of 2003. Upon
completion of the Companys Initial Public Offering in October 2003, no
convertible preferred stock will be outstanding, and accordingly there will be
no further accretion of dividends or offering costs on these shares.

Nine Months Ended September 30, 2002 and 2003

Research and Development Expense.Research and development expense
decreased $1.3 million, or 12%, to $9.6 million in the nine months ended
September 30, 2003 from $10.9 million in the nine months ended September 30,
2002. Research and development expense declined in the nine months ended
September 30, 2003 as compared to the nine months ended September 30, 2002
primarily due to one-time startup costs, including manufacturing of clinical
materials, database development costs and clinical site training costs,
incurred in connection with the commencement in 2002 of our Phase I clinical
trial of AI-850. These lower research and development expenses in the nine
months ended September 30, 2003 were partially offset by $788,000 in increased
costs incurred in 2003 in connection with the commencement of our AI-700 Phase
III clinical program.

The following table summarizes the primary components of our research and
development expense for the nine months ended September 30, 2003 and 2002.
Because of our ability to utilize resources across several projects, many of
our research and development costs are not tied to any individual project and
are allocated among multiple projects. We record direct costs on a
project-by-project basis. We record indirect costs in aggregate in support of
all research and development.

17



---



##### Table of Contents



|                                       |  |                   |        |      |  |   |       | 
|-------------------------------------- |  | ----------------- | ------ | ---- |  | - | ----- | 
|                                       |  | Nine Months Ended
|                                       |  | September 30,    
|                                       |  |                  
|                                       |  | 2002              |        | 2003
|                                       |  |                   |        |     
|                                       |  | (in thousands)   
|AI-700                                 |  | $                 | 4,715  |      |  | $ | 5,503 | 
|AI-850 and AI-128                      |  |                   | 2,274  |      |  |   | 613   | 
|Other                                  |  |                   | 1,134  |      |  |   | 789   | 
|                                       |  |                   |        |      |  |   |       | 
|Total direct costs                     |  |                   | 8,123  |      |  |   | 6,905 | 
|Facility costs                         |  |                   | 1,625  |      |  |   | 1,464 | 
|Depreciation                           |  |                   | 1,028  |      |  |   | 1,058 | 
|Patent costs                           |  |                   | 160    |      |  |   | 198   | 
|                                       |  |                   |        |      |  |   |       | 
|Total research and development expense |  | $                 | 10,936 |      |  | $ | 9,625 | 
|                                       |  |                   |        |      |  |   |       | 

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



| |  |  | Late Stage Clinical Development Program (AI-700).Our lead product
candidate, AI-700, is a cardiovascular drug for the detection of
coronary artery disease. We incurred direct research and development
expense for AI-700 in the nine months ended September 30, 2003 of $5.5
million compared to $4.7 million in the nine months ended September 30,
2002. Of these amounts, $1.1 million for the nine months ended
September 30, 2003 and $1.8 million for the nine months ended September
30, 2002 were incurred in connection with the production of clinical
trial material by a third-party contract manufacturer. In 2003, we
commenced clinical studies in our Phase III clinical program for
AI-700, and we identified and began training additional clinical sites
to be part of this Phase III clinical program. We anticipate that new
clinical sites for this clinical trial, in both Europe and North
America, will be trained and initiated during 2003 and 2004. As
clinical sites are initiated and increasing numbers of patients are
enrolled in the Phase III clinical program, we anticipate incurring
increased costs from professional service firms helping to support the
clinical trial by providing services such as independent clinical
monitoring, data acquisition and data evaluation. We also anticipate
incurring increased costs related to hiring of additional research and
development and clinical personnel. In addition, we anticipate
incurring increased costs associated with production and distribution
of clinical trial material, including production in 2003 and 2004 of
clinical trial material which meets our requirements for the pivotal
trials of our Phase III clinical program, and with preparation for
commercial production.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Early Stage Clinical Development Programs (AI-850 and AI-128).Our
initial clinical applications of our HDDS technology, AI-850, and our
PDDS technology, AI-128, are in early stages of clinical development.
We incurred direct research and development expense for AI-850 and
AI-128 in the nine months ended September 30, 2003 of $613,000 compared
to $2.3 million in the nine months ended September 30, 2002. Of these
amounts, $581,000 for the nine months ended September 30, 2002 was
incurred in connection with the production of clinical trial material
by a third-party contract manufacturer. There were no contract
manufacturing costs incurred in connection with these product
development programs during the nine months ended September 30, 2003.
These amounts exclude direct costs of $731,000 incurred in the nine
months ended September 30, 2002 for pulmonary drug development through
the Elan joint venture, which was terminated in September 2002. We
anticipate that our overall costs for development of these product
candidates will decline until we are prepared to commence further
pre-clinical and clinical testing using our own resources or through
strategic collaborations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  |  | Other. Other direct research and development costs primarily
consist of management and preclinical evaluation of other product
candidates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

Each of our research and development programs are subject to risks and
uncertainties, including the requirement to seek regulatory approval, that are
outside of our control. For example, our clinical trials may be subject to
delays or rejections based on our inability to enroll patients at the rate that
we expect or our inability to produce clinical trial material in sufficient
quantities and of sufficient quality to meet the schedule for our planned
clinical trials. Moreover, the product candidates identified in these research
and development programs, particularly our early

18



---



##### Table of Contents



stage programs, must overcome
significant technological, manufacturing and marketing challenges before they
can be successfully commercialized. As a result of these risks and
uncertainties, we are unable to predict with any certainty the period in which
material net cash inflows from such projects could be expected to commence or
the completion date of these programs. Failure to commercialize these product
candidates on a timely basis could have a material adverse affect on our
business, financial condition and results of operations. We may seek to
establish collaborative relationships to help us commercialize these product
candidates, but there can be no assurance that we will be successful in doing
so.

General and Administrative Expense. General and administrative expense
totaled $2.8 million in each of the nine months ended September 30, 2003 and
September 30, 2002.

Stock-Based Compensation Expense. Stock-based compensation expense
decreased $595,000, or 36%, to $1.1 million in the nine months ended September
30, 2003 from $1.7 million in the nine months ended September 30, 2002.
Stock-based compensation expense incurred in the nine months ended September
30, 2003 resulted principally from the vesting of stock options granted in
prior periods on which deferred compensation had previously been recorded and
on stock options granted during the nine months ended September 30, 2003 and
decreased as a result of some prior awards becoming fully vested within the
periods.

Equity in Loss of Joint Venture. Our joint venture with Elan was
terminated in September 2002. During the nine months ended September 30, 2002,
we recognized a $1.2 million loss from our 80.1% equity share in the loss of
the Elan joint venture. This amount related to research and development of
pulmonary drug delivery product candidates and from the expense of an amount
previously recorded as due from Elan. Research and development costs for
pulmonary drug delivery product candidates in 2003 are included in research and
development expense, as discussed above.

Interest and Other Income (Expense).Interest and other income (expense)
increased $883,000, or 105%, to a net expense of $1.7 million in the nine
months ended September 30, 2003 from a net expense of $841,000 in the nine
months ended September 30, 2002. During these periods, interest and other
income (expense) consisted of the following:

|                       |            |   |                                 |          |      |   |            |            |  
|---------------------- | ---------- | - | ------------------------------- | -------- | ---- | - | ---------- | ---------- | -
|                       |            |   | Nine Months Ended September 30,
|                       |            |   |                                
|                       |            |   | 2002                            |          | 2003
|                       |            |   |                                 |          |     
|Interest income        |            | $ | 183,000                         |          |      | $ | 100,000    |           
|Other income (expense) |            |   | 9,000                           |          |      |   | (84,000    | )         
|Interest expense       |            |   | (1,033,000                      | )        |      |   | (1,740,000 | )         
|                       |            |   |                                 |          |      |   |            |           
|                       | Total, net |   | $                               | (841,000 | )    |   | $          | (1,724,000 | )
|                       |            |   |                                 |          |      |   |            |           

The decrease in interest income in the nine months ended September 30,
2003 compared to the nine months ended September 30, 2002 was primarily due to
reduced yields on investments resulting from lower average interest rates and
to lower average fund balances available for investment. The increase in
interest expense in the nine months ended September 30, 2003 compared to the
nine months ended September 30, 2002 was primarily due to $313,000 of costs
incurred from the amortization of the discount recorded for accounting purposes
on the warrants issued in connection with the 10% convertible promissory notes
in April and June 2003 and to $915,000 of interest accrued on the 10%
convertible promissory notes, partially offset by a decrease of $328,000 in
interest paid on the subordinated loans payable and the decrease of $152,000 in
amortization of the warrants issued in connection with the subordinated loans
payable, due to the early repayment of debt in 2003.

Accretion of Dividends and Offering Costs on Convertible Preferred Stock.
Accretion of dividends and offering costs on convertible preferred stock
decreased $324,000, or 6%, to $4.7 million in the nine months ended September
30, 2003 from $5.0 million in the nine months ended September 30, 2002. In the
nine months ended September 30, 2003, a decrease of $400,000 from dividends on
convertible preferred stock was partially offset by an increase of $79,000 from
the accretion of Series J convertible preferred stock offering costs. The
decrease in accretion of dividends primarily resulted from the conversion of
certain shares of convertible preferred stock to common stock in connection
with our Series J convertible preferred stock financing in June 2002 and in
conjunction with our 10% convertible promissory notes financing in April and
June of 2003. Upon completion of the Companys

19



---



##### Table of Contents



initial public offering in
October 2003, no convertible preferred stock remains outstanding, and
accordingly there will be no further accretion of dividends and offering costs
on these shares after October 2003.

Liquidity and Capital Resources

Historically, we have financed our business through the issuance of equity
securities, debt financings and equipment leases. Our liquidity requirements
have arisen primarily from research and development expenditures, equipment
expenditures and payments on outstanding indebtedness. As of September 30,
2003, we had cash, cash
equivalents and short-term investments of $11.4 million. Since our
inception in July 1993 through September 30, 2003, we have raised $94.5 million
through the issuance of equity securities. As of September 30, 2003 we owed
$19.4 million from convertible promissory notes and $1.3 million from capital
leases and had commitments totaling $19.9 million for rent under our facility
lease.

On April 11, 2003 and June 27, 2003, we raised $19.1 million and $319,000,
respectively, from existing preferred stockholders in exchange for 10%
convertible promissory notes and warrants. Upon completion of our initial
public offering on October 14, 2003, the 10% convertible promissory notes and
interest accrued thereon converted into common stock.

During the nine months ended September 30, 2003, operating activities used
$11.0 million of cash. Net cash used by operating activities during this period
resulted primarily from a net loss of $15.2 million. This use of cash was
partially offset by increases in accrued expenses of $871,000, increases in
accounts payable of $263,000, non-cash charges for depreciation and
amortization of $1.4 million, non-cash charges for stock-based compensation
expense of $1.1 and non-cash interest expense of $517,000.

During the nine months ended September 30, 2003, investing activities used
$2.8 million in cash. Purchases of short term investments used $1.8 million,
$309,000 for purchases of equipment and an increase in other assets of
$688,000.

During the nine months ended September 30, 2003, financing activities
provided $15.3 million in cash, with proceeds of $19.4 million from the
issuance of 10% convertible promissory notes which were partially offset by
$4.2 million for scheduled and early repayment of debt.

On October 14, 2003, subsequent to the end of the Companys third fiscal
quarter reported on herein, we closed our initial public offering at a price to
the public of $14.00 per share. We sold 3,750,000 shares of our common stock
in the offering and the aggregate price of the offering registered on our
behalf was $52.5 million. In connection with the offering, we paid $3.7 million
in underwriting discounts and commissions to underwriters and incurred an
estimated $1.5 million in other offering expenses. After deducting the
underwriting discounts and commissions and estimated offering expenses, we
received net proceeds from the offering of approximately $47.3 million. These
proceeds, and the conversion of our preferred stock to common stock and the
conversion of our 10% convertible promissory notes, and interest accrued
thereon, to common stock are not reflected in the accompanying consolidated
financial statements as of September 30, 2003.

We believe, based on our operating plans, that the proceeds of our initial
public offering that closed October 14, 2003 together with our existing
resources will be sufficient to fund our planned operations, including
increases in spending for our AI-700 Phase III clinical program, for at least
the next twelve months. However, over the next several years we may require
significant additional funds to develop, conduct clinical trials, achieve
regulatory approvals and, subject to regulatory approval, commercially launch
AI-700, our other product candidates under development and future product
candidates. Our future capital requirements will depend on many factors,
including the scope and progress made in our research and development
activities and our clinical trials. We may also need additional funds for
possible future strategic acquisitions of businesses, products or technologies
complementary to our business. We do not expect to generate significant
revenues, other than possible license or milestone payments, from commercial
sale of our products unless or until we or potential partners complete clinical
trials for our products and receive marketing approval from the applicable
regulatory authorities. If additional funds are required, we may raise such
funds from time to time through public or private sales of equity or from
borrowings. Financing may not

20



---



##### Table of Contents



be available on acceptable terms, or at all, and
our failure to raise capital when needed could materially adversely impact our
growth plans and our financial condition and results of operations. Additional
equity financing may be dilutive to the holders of our common stock and debt
financing, if available, may involve significant cash payment obligations and
covenants that restrict our ability to operate our business.

Critical Accounting Policies and Estimates

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

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

Accrued Expenses.As part of the process of preparing consolidated
financial statements we are required to estimate accrued expenses. This process
involves identifying services which have been performed on our behalf and
estimating the level of service performed and the associated cost incurred for
such service as of each balance sheet date in our consolidated financial
statements. Examples of estimated expenses for which we accrue include
professional service fees, such as lawyers and accountants, and contract
service fees such as amounts paid to clinical monitors, data management
organizations and investigators in conjunction with clinical trials, and fees
paid to contract manufacturers in conjunction with the production of clinical
materials. In connection with such service fees, our estimates are most
affected by our understanding of the status and timing of services provided
relative to the actual levels of services incurred by such service providers.
The majority of our service providers invoice us monthly in arrears for
services performed. In the event that we do not identify certain costs which
have begun to be incurred or we under- or over-estimate the level of services
performed or the costs of such services, our reported expenses for such period
would be too low or too high. The date on which certain services commence, the
level of services performed on or before a given date and the cost of such
services are often judgmental. We make these judgments based upon the facts and
circumstances known to us in accordance with generally accepted accounting
principles.

Stock-Based Compensation and Other Equity Instruments.We have elected to
follow APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations, in accounting for our stock-based compensation plans,
rather than 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 stock options issued to employees
in fixed amounts with exercise prices at least equal to the fair value of the
underlying common stock on the date of grant. In the notes to our consolidated
financial statements we provide pro forma disclosures in accordance with SFAS
No. 123 and related pronouncements. We account for transactions in which
services are received in exchange for equity instruments based on the fair
value of such services received from non-employees or of the equity instruments
issued, whichever is more reliably measured, in accordance with SFAS No. 123
and EITF Issue No. 96-18, Accounting for Equity Instruments that Are Issued to
Other than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services. We account for transactions in which we grant warrants in connection
with the issuance of debt in accordance with APB 14, Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants.The two factors which most
affect charges or credits to operations related to stock-based compensation are
the fair value of the common stock underlying stock options for which
stock-based compensation is recorded and the volatility of such fair value.

21



---



##### Table of Contents



Accounting for equity instruments granted or sold by us under APB No. 14,
APB No. 25, SFAS No. 123 and EITF No. 96-18 requires fair value estimates of
the equity instrument granted or sold. If our estimates of the fair value of
these equity instruments are too high or too low, it would have the effect of
overstating or understating expenses. When equity instruments are granted or
sold in exchange for the receipt of goods or services and the value of those
goods or services can be readily estimated, we use the value of such goods or
services to determine the fair value of the equity instruments. When equity
instruments are granted or sold in exchange for the receipt of goods or
services and the value of those goods or services can not be readily estimated,
as is true in connection with most stock options and warrants granted to
employees or non-employees, we estimated the fair value of the equity
instruments based upon consideration of factors which we deemed to be relevant
at the time using cost, market and/or income approaches to such valuations.
Because shares of our common stock have not been publicly traded prior to our
initial public offering in October 2003, market factors historically considered
in valuing stock and stock option grants include comparative values of public
companies discounted for the risk and limited liquidity provided for in the
shares we are issuing, pricing of private sales of our convertible preferred
stock, prior valuations of stock grants and the effect of events that have
occurred between the time of such grants, economic trends, perspective provided
by investment banks and the comparative rights and preferences of the security
being granted compared to the rights and preferences of our other outstanding
equity.

During the three and nine months periods ended September 30, 2003, we
granted zero and 14,956 shares, respectively of restricted common stock at a
price of $0.06 per share in lieu of cash payments. We recorded these grants at
fair value when granted. Because certain of these awards and prior awards,
including stock options to non-employees, vest or can be repurchased over time,
we recorded $78,000 in the three months ended September 30, 2003 and $180,000
in the nine months ended September 30, 2003, of the value of these grants as
deferred stock-based compensation. We amortize the deferred amounts as charges
to operations over the vesting periods of the grants or repurchase options.
This resulted in deferred stock-based compensation expense of $57,000 and
$164,000 in the three and nine month periods ended September 30, 2003. The fair
value of the unvested portion of these grants is periodically remeasured
resulting in charges or credits to operations in periods when such
remeasurement results in differences between the fair value of the underlying
common stock and the exercise price of the options that is greater than or less
than the differences, if any, between the fair value of the underlying common
stock and the exercise price of the options at their respective previous
measurement dates.

We granted options to purchase 285,345 and 483,072 shares of our common
stock to employees during the three and nine month periods ended September 30,
2003 at prices ranging from $0.84 to $13.02 per share. Included in the
options granted during these periods were options deemed for accounting
purposes to have been granted with exercise prices below their then current
market value. We recorded the value of these differences, $1.4 million in the
nine months ended September 30, 2003, as deferred stock-based compensation. We
amortize the deferred amounts as charges to operations over the vesting periods
of the grants. The amortization of this deferred stock based compensation and
the amortization of deferred stock-based compensation from prior periods,
resulted in deferred stock-based compensation expense of $303,000 and $908,000
in the three and nine months ended September 30, 2003, respectively.

During the nine months ended September 30, 2003, we also granted warrants
in connection with the issuance of $19.4 million in 10% convertible promissory
notes. The warrants that we granted in connection with the issuance of these
notes may be exercised to purchase 459,120 shares of common stock. The warrants
are exercisable at a price of $8.46 per share. The value ascribed to the
warrants and related discount recorded using the Black-Scholes pricing model
totaled $761,000 and is being amortized to interest expense through the
maturity date of the notes or June 30, 2004. For the three and nine month
periods ended September 30, 2003, this amortization totaled $149,000 and
$313,000, respectively.

Income Taxes.As part of the process of preparing our consolidated
financial statements we are required to estimate our income taxes in each of
the jurisdictions in which we operate. This process involves us estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatments of items for tax and accounting purposes.
These differences result in deferred tax assets and liabilities. In addition,
as of December 31, 2002, we had federal tax net operating loss carryforwards of
$55.8 million, which expire through 2022. We also have research and development
credit carryforwards of $2.1 million. We have recorded a valuation allowance of
to fully offset against these otherwise recognizable net deferred tax assets
due to the uncertainty

22



---



##### Table of Contents



surrounding the timing of the realization of the tax
benefit. In the event that we determine in the future that we will
be able to realize all or a portion of its net deferred tax benefit, an
adjustment to deferred tax valuation allowance would increase net income in the
period in which such a determination is made. The Tax Reform Act of 1986
contains provisions that may limit the utilization of net operating loss
carryforwards and credits available to be used in any given year in the event
of significant changes in ownership interest, as defined.

Recently Issued Accounting Pronouncements

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
statement establishes how a company classifies and measures certain financial
instruments with characteristics of both liabilities and equity, including
redeemable preferred stock. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise
effective at the beginning of the interim period commencing July 1, 2003,
except for mandatorily redeemable financial instruments of nonpublic companies.
Adoption of this statement did not have a material impact on our financial
statements.

Factors That May Affect Future Results.

In addition to other information contained herein, you should carefully
consider the following factors in evaluating our company. Amy of the following
factors could materially and adversely affect our business, financial position
and results of operations.

Risks Related to Our Company

We have not generated revenues to date, and we may not achieve
profitability for some time, if at all.

We are focused on product development and we have not generated any
revenues to date. We have incurred losses each year of our operations and we
expect to continue to incur operating losses for the next several years. The
process of developing our products requires significant clinical, development
and laboratory testing and clinical trials as well as regulatory approvals. In
addition, commercialization of our product candidates will require us to
establish sales, marketing and manufacturing capabilities, either through
internal hiring or through contractual relationships with others. We expect our
research and development and general and administrative expenses will increase
over the next several years. As of September 30, 2003, our cumulative net loss
was $108.5 million. Our net loss was $21.9 million for the full year 2002 and
$15.2 million for the first nine months of 2003.



|If we fail to obtain regulatory approvals for our product candidates
under development, and in particular our lead product candidate AI-700,
we will not be able to generate revenues from the commercialization or
sale of our product candidates.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We must receive regulatory approval of each of our product candidates
before we can commercialize or sell that product candidate. The pre-clinical
laboratory testing, formulation development, manufacturing and clinical trials
of any product candidates we develop independently or in collaboration with
third parties, as well as the distribution and marketing of these product
candidates, are regulated by numerous federal, state and local governmental
authorities in the United States, principally the FDA, and by similar agencies
in other countries. The development and regulatory approval process takes many
years, requires the expenditure of substantial resources, is uncertain 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 our clinical trials
will demonstrate the safety and efficacy of any of our product candidates or
will result in marketable products.

No product can receive FDA approval unless human clinical trials show both
safety and efficacy for each target indication in accordance with FDA
standards. A number of companies in the pharmaceutical and biotechnology
industries have suffered significant setbacks in late stage clinical trials
even after achieving promising results in

23



---



##### Table of Contents



early stage development. We therefore
cannot assure you that the results from our Phase II clinical trials for AI-700
will be predictive of results obtained in our Phase III clinical trials.
Further, data obtained from pre-clinical and
clinical activities are subject to varying interpretations that could
delay, limit or prevent regulatory agency approval. We cannot assure you that
our Phase III plan for AI-700 will successfully address the concerns of the FDA
or that the results of the Phase III program will establish the safety and
efficacy of AI-700 sufficiently for us to obtain regulatory approval.

We may also encounter delays or rejections based on our inability to
enroll enough patients to complete our clinical trials. Patient enrollment
depends on many factors, including the size of the patient population, the
nature of the protocol, the proximity of patients to clinical sites, and the
eligibility criteria for the study. Delays in planned patient enrollment may
result in increased costs and delays, which could have a harmful effect on our
ability to develop products. We may encounter delays or rejections based on
changes in regulatory agency policies during the period in which we develop a
drug or the period required for review of any application for regulatory agency
approval of a particular compound. We also may encounter delays in the event we
are unable to produce clinical trial material in sufficient quantities and of
sufficient quality to meet the schedule for our planned clinical trials. In
addition, we rely on a number of third parties, such as clinical research
organizations, to help support the clinical trials by performing independent
clinical monitoring, data acquisition and data evaluations. Any failure on the
part of these third parties could delay the regulatory approval process.

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



| |  |  | adversely affect our ability to market any drugs we develop independently or with collaborative partners;
| | - |  | ---------------------------------------------------------------------------------------------------------
|
| |  |  | impose additional costs and diminish any competitive advantages that we may attain; or                   
|
| |  |  | adversely affect our ability to generate royalties.                                                      

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

We cannot be certain that we will obtain any regulatory approvals in other
countries and the failure to obtain these approvals may materially adversely
affect our business, financial condition and results of operations. In order to
market our products outside of the United States, we and our collaborative
partners, if any, must establish and comply with numerous and varying
regulatory requirements of other countries regarding safety and efficacy. The
approval procedures vary among countries and can involve additional product
testing and additional administrative review periods. The time required to
obtain approval in other countries might differ from that required to obtain
FDA approval. The regulatory approval process in other countries may include
all of the risks associated with obtaining FDA approval detailed above.
Approval by the FDA does not ensure approval by the regulatory authorities of
other countries. In addition, many countries outside the United States require
a separate review process prior to marketing to determine whether their
national health insurance scheme will pay for newly approved products, as well
as the price which may be charged for a product.

Our products, if approved, may fail to achieve market acceptance.

There can be no assurance that any products we successfully develop, if
approved for marketing, will achieve market acceptance or generate significant
revenues. Each of our product candidates is intended to replace or alter
existing therapies or procedures, and hospitals, physicians or patients may
conclude that these products are less safe or effective or otherwise less
attractive than these existing therapies or procedures. For example, our lead
product candidate, AI-700, is a contrast agent for use in ultrasound imaging
procedures which will compete with existing nuclear imaging and stress
echocardiography. Hospitals, physicians or patients may prefer these existing
procedures to AI-700 enhanced ultrasound imaging. If our products do not
receive market acceptance for any reason, it would adversely affect our
business, financial condition and results of operations.

24



---



##### Table of Contents



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



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

We will require substantial future capital in order to continue to conduct
the research and development, clinical and regulatory activities necessary to
bring our product candidates to market and to establish commercial
manufacturing, marketing and sales capabilities. Our future capital
requirements will depend on many factors, including:



| |  |  | the progress of pre-clinical development and laboratory testing and clinical trials;                          
| | - |  | --------------------------------------------------------------------------------------------------------------
|
| |  |  | the time and costs involved in obtaining regulatory approvals;                                                
|
| |  |  | the number of product candidates we pursue;                                                                   
|
| |  |  | the costs involved in filing and prosecuting patent applications
and enforcing or defending patent claims; and
|
| |  |  | the establishment of selected strategic alliances and activities
required for product commercialization       

We intend to seek additional funding through strategic collaborations and
may seek funding through private or public sales of our securities or by
licensing all or a portion of our technology. This funding may significantly
dilute existing stockholders or may limit our rights to our technology.

We cannot assure you that we can obtain additional funding on reasonable
terms, or at all. If we cannot obtain adequate funds, we may:



| |  |  | terminate or delay clinical trials for one or more of our product candidates;                                
| | - |  | -------------------------------------------------------------------------------------------------------------
|
| |  |  | delay our establishment of sales, marketing and/or manufacturing capabilities;                               
|
| |  |  | curtail significant product development programs that are designed
to identify new product candidates; and/or
|
| |  |  | relinquish rights to our technologies or product candidates.                                                 



|Claims by other companies that we infringe their proprietary technology may
result in liability for damages or stop our development and
commercialization efforts.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------

Competitors and other third parties may initiate patent litigation against
us in the United States or in foreign countries based on existing patents or
patents that may be granted in the future. Many of our competitors have
obtained patents covering products and processes generally related to our
products and processes, and they may assert these patents against us. Moreover,
there can be no assurance that these competitors have not sought or will not
seek additional patents that may cover aspects of our technology. As a result,
there is a greater likelihood of a patent dispute than would be expected if our
competitors were pursuing unrelated technologies.

While we conduct patent searches to determine whether the technologies
used in our products infringe patents held by third parties, numerous patent
applications are currently pending and may be filed in the future for
technologies generally related to our technologies, including many patent
applications that remain confidential after filing. Due to these factors and
the inherent uncertainty in conducting patent searches, there can be no
guarantee that we will not violate third-party patent rights that we have not
yet identified.

We know of U.S. and foreign patents issued to third parties that relate to
aspects of our product candidates. There may also be patent applications filed
by these or other parties in the United States and various foreign
jurisdictions that relate to some aspects of our product candidates, which, if
issued, could subject us to infringement actions. In particular, we are aware
of U.S. and foreign patents owned by third parties, including potential

25



---



##### Table of Contents



competitors, that arguably cover aspects of our AI-700 contrast agent. We and
several of these parties have recently been actively engaged in opposing the
grant of European patents with claims that arguably cover aspects of our AI-700
product. Parties may contest patents in Europe prior to contesting the
counterpart patents in the United States because of procedural differences
between European and U.S. patent laws as well as economic considerations. There
is a significant possibility that one or more of these third parties will use
litigation to assert their patents in the United States.

The owners or licensees of these and other patents may file one or more
infringement actions against us. In addition, a competitor may claim
misappropriation of a trade secret by an employee hired from that competitor.
Any such infringement or misappropriation action could cause us to incur
substantial costs defending the lawsuit and could distract our management from
our business, even if the allegations of infringement or misappropriation are
unwarranted. The defense of multiple claims could have a disproportionately
greater impact. Furthermore, a party making this type of claim could secure a
judgment that requires us to pay substantial damages. A judgment could also
include an injunction or other court order that could prevent us from making,
using, selling, offering for sale or importing our products or prevent our
customers from using our products. If a court determined or if we independently
discovered that any of our products or manufacturing processes violated
third-party proprietary rights, there can be no assurance that we would be able
to reengineer the product or processes to avoid those rights, or to obtain a
license under those rights on commercially reasonable terms, if at all.



| |  | If we are unable to protect our intellectual propriety rights, our
competitors may develop and market products with similar features that may
reduce demand for our products, and we may be prevented from establishing
collaborative relationships on favorable terms.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The following factors are important to our success:                                                                                                                                                                                                                    



| |  |  | receiving patent protection for our product candidates;  
| | - |  | ---------------------------------------------------------
|
| |  |  | maintaining our trade secrets;                           
|
| |  |  | not infringing on the proprietary rights of others; and  
|
| |  |  | preventing others from infringing our proprietary rights.

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

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

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

26



---



##### Table of Contents





| |  | We may become involved in lawsuits to protect or enforce our patents that
would be expensive and time consuming.
| |  | ----------------------------------------------------------------------------------------------------------------

In order to protect or enforce our patent rights, we may initiate patent
litigation against third parties in the United States or in foreign countries.
In addition, we may become subject to interference or opposition proceedings
conducted in patent and trademark offices to determine the priority of
inventions. The defense of intellectual property rights, including patent
rights through lawsuits, interference or opposition proceedings, and other
legal and administrative proceedings would be costly and divert our technical
and management personnel from their normal responsibilities. An adverse
determination of any litigation or defense proceedings could put one or more of
our patents at risk of being invalidated or interpreted narrowly and could put
our patent applications at risk of not issuing.

Furthermore, because of the substantial amount of discovery required in
connection with intellectual property litigation, there is a risk that some of
our confidential information could be compromised by disclosure during this
type of litigation. For example, during the course of this kind of litigation,
confidential information may be inadvertently disclosed in the form of
documents or testimony in connection with discovery requests, depositions or
trial testimony. This disclosure could materially adversely affect our business
and financial results.



| |  | If third-party manufacturers of our products fail to devote sufficient time
and resources to our concerns, or if their performance is substandard, our
clinical trials and product introductions may be delayed and our costs may
rise.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We have limited manufacturing facilities, and we have no experience in the
commercial manufacturing of drugs and limited experience in designing drug
manufacturing equipment. We have contracted with third party manufacturers to
produce, in collaboration with us, our product candidates for clinical trials.
We intend to rely, in part, on third-party contract manufacturers to supply,
store and distribute our potential products for our clinical trials and
manufacture and distribution of our potential products. Our reliance on these
third-party manufacturers will expose us to the following risks, any of which
could delay or prevent the completion of our clinical trials, the approval of
our products by the FDA, or the commercialization of our products, result in
higher costs, or deprive us of potential product revenues:



| |  |  | Contract manufacturers often encounter difficulties in achieving
volume production, quality control and quality assurance, as well as
shortages of qualified personnel. Accordingly, a manufacturer might not
be able to manufacture sufficient quantities of drugs to meet our
clinical schedules or to commercialize our products.                                                                                                                                                                                            
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Contract manufacturers are obliged to operate in accordance with
FDA-mandated current good manufacturing practices, or cGMPs. A failure
of these contract manufacturers to establish and follow cGMPs and to
document their adherence to such practices may lead to significant
delays in the availability of material for clinical study and may delay
or prevent filing or approval of marketing applications for our
products.                                                                                               
|
| |  |  | For each of our current product candidates we will initially rely
on a single contract manufacturer. Changing these or future
manufacturers may be difficult and the number of potential
manufacturers is limited. Changing manufacturers may require
re-validation of the manufacturing processes and procedures in
accordance with FDA-mandated cGMPs. Such re-validation may be costly
and time-consuming. It may be difficult or impossible for us to find
replacement manufacturers on acceptable terms quickly, or at all.
|
| |  |  | Our contract manufacturers may not perform as agreed or may not
remain in the contract manufacturing business for the time required to
produce, store and distribute our products successfully.                                                                                                                                                                                                                                                                                                                                 

Drug manufacturers are subject to ongoing periodic unannounced inspection
by the FDA, the U.S. Drug Enforcement Agency, or the DEA, and corresponding
state and foreign agencies to ensure strict compliance with cGMPs, other
government regulations and corresponding foreign standards. While we are
obligated to audit the performance of third party contractors, we do not have
control over our third-party manufacturers compliance with these regulations
and standards. Failure by our third-party manufacturers or us to comply with
applicable regulations could result in sanctions being imposed on us, including
fines, injunctions, civil penalties, failure of the government

27



---



##### Table of Contents



to grant market approval of drugs, delays, suspension or withdrawal of
approvals, seizures or recalls of product, operating restrictions and criminal
prosecutions, any of which could significantly and adversely affect our
business.



| |  | We may not be able to manufacture our products in commercial quantities,
which would prevent us from marketing our products.
| |  | ----------------------------------------------------------------------------------------------------------------------------

28



---



##### Table of Contents



To date our product candidates have been manufactured in small quantities
for pre-clinical and clinical trials. If any of these product candidates are
approved by the FDA or foreign regulatory authorities for commercial sale, we
will need to manufacture them in larger quantities. We cannot assure you that
we will be able to successfully increase the manufacturing capacity, whether on
our own or in collaboration with third party manufacturers, for any of our
product candidates in a timely or economic manner, or at all. Significant
scale-up of manufacturing may require certain additional validation studies,
which the FDA must review and approve. If we are unable to successfully
increase the manufacturing capacity for a product candidate, the regulatory
approval or commercial launch of that product candidate may be delayed or there
may be a shortage in supply of that product candidate. Our product candidates
require precise, high quality manufacturing. Our failure to achieve and
maintain these high manufacturing standards, including the incidence of
manufacturing errors, could result in patient injury or death, product recalls
or withdrawals, delays or failures in product testing or delivery, cost
overruns or other problems that could seriously hurt our business.



| |  | Materials necessary to manufacture our products may not be available,
which may delay our development and commercialization activities.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------

Only a few facilities manufacture some of the raw materials necessary to
manufacture our products. For example, the manufacture of AI-850 will require
bulk quantities of paclitaxel, a natural substance that is difficult to produce
and is in limited supply. We currently have no supply agreements in place with
any supply facility. If we need to purchase a raw material that is in limited
supply for our clinical trials, or for commercial distribution if we obtain
marketing approval of a product candidate, we cannot assure you that one or
more suppliers would be able to sell us that raw material at the time we need
it and on commercially reasonable terms. If we change suppliers for any of
these materials or any of our suppliers experiences a shutdown or disruption in
the facilities used to produce these materials, due to technical, regulatory or
other problems, it could harm our ability to manufacture our products. Our
inability to obtain required raw materials for any reason could substantially
impair our development activities or the production, marketing and distribution
of our products.



| |  | We have no experience selling, marketing or distributing our products and no
internal capability to do so.
| |  | ----------------------------------------------------------------------------------------------------------

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



| |  | We will establish collaborative relationships, and those relationships may
expose us to a number of risks.
| |  | ----------------------------------------------------------------------------------------------------------

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



| |  |  | we cannot effectively control whether our corporate partners will
devote sufficient resources to our programs or product candidates;                                                           
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | disputes may arise in the future with respect to the ownership of
rights to technology developed with collaborators;                                                                           
|
| |  |  | disagreements with collaborators could delay or terminate the
research and development, regulatory approval or commercialization of
product candidates, or result in litigation or arbitration;

29



---



##### Table of Contents





| |  |  | corporate partners have considerable discretion in electing whether
to pursue the development of any additional product candidates and may
pursue technologies or products either on their own or in collaboration
with our competitors; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | collaborators with marketing rights may choose to devote fewer
resources to the marketing of our product candidates than they do to
product candidates of their own development.                                                            

For example, we established a joint venture with Elan Corporation, plc and
affiliates in 2000. At the time, we anticipated that we would share the cost of
pre-clinical and clinical trials for product candidates being developed by the
joint venture with Elan. In 2002, for reasons beyond our control, Elan ceased
funding the joint venture and the joint venture was terminated. In connection
with the termination, we agreed to pay Elan a royalty if we commercialize the
asthma product candidate that was being developed by the joint venture. Future
development of product candidates will require that we provide all the funding
for the cost of development and clinical trials or identify collaborators to
share in the costs.

Given these risks, our current and future collaborative efforts may not be
successful. Failure of these efforts could delay our product development or
impair commercialization of our products, and 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 extensive research efforts, rapid
developments and intense competition. We cannot assure you that our products
will compete successfully or that research and development by others will not
render our products obsolete or uneconomical. Our failure to compete
effectively would materially adversely affect our business, financial condition
and results of operations. We expect that successful competition will depend,
among other things, on product efficacy, safety, reliability, availability,
timing and scope of regulatory approval and price. Specifically, we expect
important factors will include the relative speed with which we can develop
products, complete the clinical, development and laboratory testing and
regulatory approval processes and supply commercial quantities of the product
to the market.

We expect competition to increase as technological advances are made and
commercial applications broaden. In commercializing our initial product
candidates and any additional products we develop using our HDDS and PDDS
technologies, we will face substantial competition from large pharmaceutical,
biotechnology and other companies, universities and research institutions.



| |  |  | AI-700, our ultrasound contrast agent and lead product candidate,
if approved for marketing and sale, will compete with nuclear stress
tests, the current standard of care in myocardial perfusion imaging.
Nuclear contrast agents that are approved for use in myocardial
perfusion imaging include products marketed by Amersham, Bristol-Myers
Squibb and Tyco International. In addition, Amersham, Bristol-Myers
Squibb and Photogen have developed ultrasound contrast agents that have
been approved by the FDA for resting wall motion studies, and in the
future they may seek to broaden their products to include stress echo
and myocardial perfusion assessment. Moreover, we are aware that other
companies, such as Bracco, are developing ultrasound contrast agents
for wall imaging and for radiology applications and potentially for
myocardial perfusion imaging, and that Point Biomedical is developing
an ultrasound contrast agent specifically for myocardial perfusion
imaging. Finally, some cardiologists may find it satisfactory to use
stress echo without contrast for the detection of coronary artery
disease.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | AI-850, our reformulation of paclitaxel, if approved for marketing
and sale, will also face intense competition from companies such as
American Pharmaceutical Partners, NeoPharm and Sonus Pharmaceuticals,
which are applying significant resources and expertise to developing
reformulations of paclitaxel for intravenous delivery. Other companies,
such as Cell Therapeutics and Protarga, are developing new chemical
entities that involve paclitaxel conjugated, or chemically bound, to
another chemical.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

30



---



##### Table of Contents





| |  |  | AI-128, our sustained release formulation of an asthma drug, if
approved for marketing and sale, will also face intense competition.
Companies such as Alkermes possess technology that may be suitable for
sustained release pulmonary drug delivery and may have competitive
programs that have not been publicly announced or may decide to begin
such programs in the future. In addition, large pharmaceutical
companies that market FDA-approved asthma drugs, two of which contain
the active ingredient that is currently the subject of our research and
development efforts, may be developing sustained release versions of
their asthma drugs that would compete with our product candidates
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Relative to us, most of our competitors have substantially greater capital
resources, research and development staffs, facilities and experience in
conducting clinical trials and obtaining regulatory approvals, as well as in
manufacturing and marketing pharmaceutical products. Many of our competitors
may achieve product commercialization or patent protection earlier than we
will. Furthermore, we believe that some of our competitors have used, and may
continue to use, litigation to gain a competitive advantage. Finally, our
competitors may use different technologies or approaches to the development of
products similar to the products we are seeking to develop.



| |  | If we are unable to retain key personnel and hire additional qualified
scientific, sales and marketing, and other personnel, we may not be able to
successfully achieve our goals.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We depend on the principal members of our scientific and management staff,
including Sherri C. Oberg, our president and chief executive officer, John F.
Thero, our senior vice president and chief financial officer, Howard Bernstein,
our senior vice president of research and development, Charles P. Cox, our
senior vice president of corporate development and marketing, and Michael R.
Slater, our senior vice president of operations. The loss of any of these
individuals services might significantly delay or prevent the achievement of
research, development or business objectives and could materially adversely
affect our business, financial condition and results of operations. We do not
maintain key person life insurance on any of these individuals.

Ms. Oberg and Dr. Bernstein have been critical to the development of our
technologies and business. Dr. Cox, who joined us in August 2003, Mr. Thero,
who joined us in February 2003, and Mr. Slater, who joined us in October 2001,
are key additions to our management team and will be critical to directing and
managing our growth and development in the future. We are not aware of any
present intention of any of these individuals to leave our company. We have no
employment contracts with any of our employees.

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

Further, we expect that our potential expansion into areas and activities
requiring additional expertise, such as further clinical trials, governmental
approvals, contract manufacturing and marketing, will place additional
requirements on our management, operational and financial resources. We expect
these demands will require an increase in management and scientific personnel
and the development of additional expertise by existing management personnel.
The failure to attract and retain such personnel or to develop such expertise
could materially adversely affect prospects for our success.



| |  | We expect to develop international operations that will expose us to additional business risks.
| |  | -----------------------------------------------------------------------------------------------

In the future, we expect to develop operations outside the United States
in order to market and distribute our products. We cannot be sure that our
international efforts will be successful. Any expansion into international
markets will require additional resources and management attention and will
subject us to new business risks. These risks could lower the prices at which
we can sell our products or otherwise have an adverse effect on our operating
results. Among the risks we believe are most likely to affect any international
operations are:



| |  |  | different regulatory requirements for approval of our product candidates;
| | - |  | -------------------------------------------------------------------------
|
| |  |  | dependence on local distributors;                                        

31



---



##### Table of Contents





| |  |  | longer payment cycles and problems in collecting accounts receivable;                
| | - |  | -------------------------------------------------------------------------------------
|
| |  |  | adverse changes in trade and tax regulations;                                        
|
| |  |  | the absence or significant lack of legal protection for intellectual property rights;
|
| |  |  | political and economic instability; and                                              
|
| |  |  | currency risks.                                                                      

Risks Relating to Our Industry



| |  | Even if we obtain marketing approval, our products will be subject to ongoing regulatory review.
| |  | ------------------------------------------------------------------------------------------------

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

If we fail to comply with applicable regulatory requirements, we may be
subject to fines, suspension or withdrawal of regulatory approvals, product
recalls, seizure of products, operating restrictions and criminal prosecution.



| |  | Market acceptance of our products will be limited if users of our products are
unable to obtain adequate reimbursement from third-party payors.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------

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

Significant uncertainty exists as to the reimbursement status of newly
approved health care products. Each of our product candidates is intended to
replace or alter existing therapies or procedures. These third-party payors may
conclude that our products are less safe, effective or cost-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 for reimbursement or
fail to reimburse them adequately, sales will suffer as some physicians or
their patients will opt for a competing product that is approved for
reimbursement or is adequately reimbursed. Even if third-party payors make
reimbursement available, these payors reimbursement policies may adversely
affect the ability of us and our potential collaborators to sell our products
on a profitable basis.

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

32



---



##### Table of Contents



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



| |  | We may be required to defend lawsuits or pay damages in connection with the
alleged or actual harm caused by our products or product candidates.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------

We face an inherent business risk of exposure to product liability claims
in the event that the use of our products is alleged to have resulted in harm
to others. This risk exists in clinical trials as well as in commercial
distribution. In addition, the pharmaceutical and biotechnology industries in
general have been subject to significant medical malpractice litigation. We may
incur significant liability if product liability or malpractice lawsuits
against us are successful. Furthermore, product liability claims, regardless or
their merits, could be costly and divert our managements attention from other
business concerns, or adversely affect our reputation and the demand for our
products. Although we maintain product liability insurance, we cannot be
certain that this coverage will be adequate or that it will continue to be
available to us on acceptable terms.



| |  | Rapid technological change could make our products obsolete.
| |  | ------------------------------------------------------------

Pharmaceutical technologies have undergone rapid and significant change.
We expect that pharmaceutical technologies will continue to develop rapidly.
Our future will depend in large part on our ability to maintain a competitive
position with respect to these technologies. Any compounds, products or
processes that we develop may become obsolete before we recover any expenses
incurred in connection with their development. Rapid technological change could
make our products obsolete, which could materially adversely affect our
business, financial condition and results of operations.



| |  | Our products involve the use of hazardous materials, and as a result we are
exposed to potential liability claims and to costs associated with complying
with laws regulating hazardous waste.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our research and development activities involve the use of hazardous
materials, including chemicals and biological materials. We believe that our
procedures for handling hazardous materials comply with federal and state
regulations. However, there can be no assurance that accidental injury or
contamination from these materials will not occur. In the event of an accident,
we could be held liable for any damages, which could exceed our available
financial resources. This liability could materially adversely 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 spent approximately $46,000 in 2002 to dispose of these
hazardous materials and waste products. We may be required to incur significant
costs to comply with environmental laws and regulations in the future that
could materially adversely affect our business, financial condition and results
of operations.

Risks Related to Our Common Stock



| |  | We expect that our stock price will fluctuate significantly.
| |  | ------------------------------------------------------------

We only recently completed our initial public offering. Prior to this
offering, you could not buy or sell our common stock publicly. An active public
market for our common stock may not continue to develop or be sustained. The
stock market, particularly in recent years, has experienced significant
volatility particularly with respect to pharmaceutical and biotechnology
stocks. The volatility of pharmaceutical and biotechnology stocks often does
not

33



---



##### Table of Contents



relate to the operating performance of the companies represented by the stock.
Factors that could cause this volatility in the market price of our common
stock include:



| |  |  announcements of the introduction of new products by us or our competitors;       
| |  | ------------------------------------------------------------------------------------
|
| |  |  market conditions in the pharmaceutical and biotechnology sectors;                
|
| |  |  rumors relating to us or our competitors;                                         
|
| |  |  litigation or public concern about the safety of our potential products;          
|
| |  |  our quarterly operating results;                                                  
|
| |  |  deviations in our operating results from the estimates of securities analysts; and
|
| |  |  FDA or international regulatory actions.                                          



| |  | We may be the subject of securities class action litigation due to future stock price volatility.
| |  | -------------------------------------------------------------------------------------------------

In the past, when the market price of a stock has been volatile, holders
of that stock have often instituted securities class action litigation against
the company that issued the stock. If any of our stockholders brought a lawsuit
against us, we could incur substantial costs defending the lawsuit. The lawsuit
could also divert the time and attention of our management.



| |  | Future sales of common stock by our existing stockholders may cause our stock price to fall.
| |  | --------------------------------------------------------------------------------------------

The market price of our common stock could decline as a result of sales by
our existing stockholders of shares of common stock in the market, or the
perception that these sales could occur. These sales might also make it more
difficult for us to sell equity securities at a time and price that we deem
appropriate. In connection with our recently completed initial public offering,
our executive officers and directors and substantially all of our stockholders
and optionholders executed lock-up agreements that prohibit them from offering,
selling, contracting to sell, granting an option to purchase, making a short
sale or otherwise disposing of any shares of our common stock or any option to
purchase shares of our common stock or any securities exchangeable for or
convertible into shares of common stock for a period of 180 days after the date
of our initial public offering without the prior written consent of SG Cowen
Securities Corporation. SG Cowen has no pre-established conditions to waiving
the terms of the lock-up agreements, and any decision by it to waive those
conditions would depend on a number of factors, including market conditions,
the performance of the common stock in the market and our financial condition
at that time.



| |  | Our directors and management exercise significant control over our company.
| |  | ---------------------------------------------------------------------------

Our directors and executive officers and their affiliates collectively
control approximately 42.0% of our outstanding common stock, excluding
unexercised options and warrants. As a result, these stockholders, if they act
together, will be able to influence our management and affairs and all matters
requiring stockholder approval, including the election of directors and
approval of significant corporate transactions. This concentration of ownership
may have the effect of delaying or preventing a change in control of our
company and might affect the market price of our common stock.



| |  | Provisions of Delaware law or our charter documents could delay or prevent an
acquisition of us, even if the acquisition would be beneficial to our
stockholders, and could make it more difficult for you to change management.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Provisions of Delaware law or our charter or by-laws could hamper a third
partys acquisition of us, or discourage a third party from attempting to
acquire control of us. Stockholders who wish to participate in these
transactions may not have the opportunity to do so. These provisions could also
limit the price that investors might

34



---



##### Table of Contents



be willing to pay in the future for shares of our common stock. Further, these
provisions make it more difficult for stockholders to change the composition of
our board of directors in any one year.

These provisions include:



| |  |  | a provision allowing us to issue preferred stock with rights senior to those of the common
stock without any further vote or action by the holders of the common stock;                                                                                                                                     
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the existence of a staggered board of directors in which there are three classes of directors
serving staggered three-year terms, thus expanding the time required to change the composition
of a majority of directors and potentially discouraging someone from making an acquisition
proposal for us;    
|
| |  |  | the by-laws requirement that stockholders provide advance notice when nominating our directors;                                                                                                                                                                                                            
|
| |  |  | the inability of stockholders to convene a stockholders meeting without the chairperson of the
board, the chief executive officer, the president or a majority of the board of directors first
calling the meeting; and                                                                                    
|
| |  |  | the application of Delaware law prohibiting us from entering into a business combination with
the beneficial owner of 15% or more of our outstanding voting stock for a period of three years
after the 15% or greater owner first reached that level of stock ownership, unless we meet
specified criteria.



| |  | We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the
foreseeable future.
| |  | --------------------------------------------------------------------------------------------------------------------------------

We have paid no cash dividends on any of our classes of capital stock to
date and we currently intend to retain our future earnings, if any, to fund the
development and growth of our businesses. In addition, the terms of any 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 your sole
source of gain for the foreseeable future.

35



---



##### Table of Contents






ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have not used derivative financial instruments for speculation or
trading purposes. However, we are exposed to market risk related to changes in
interest rates. Our current policy is to maintain an investment portfolio
consisting mainly of U.S. money market and government-grade securities,
directly or through managed funds, with maturities of one year or less. Our
cash is deposited in and invested through highly rated financial institutions
in North America. Our short-term investments are subject to interest rate risk
and will fall in value if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 10% from levels at
September 30, 2003, we estimate that the fair value of our investment portfolio
would decline by an immaterial amount. We currently have the ability to hold
our fixed income investments until maturity, and therefore we do not expect our
operating results or cash flows to be affected to any significant degree by the
effect of a change in market interest rates on our investments.

Effects of Inflation

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




ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of September 30, 2003 (the Evaluation Date), the Companys
management, with the participation of the Companys Chief Executive Officer and
the Companys Senior Vice President and Chief Financial Officer, evaluated the
effectiveness of the Companys disclosure controls and procedures pursuant to
Rule 13a-15(b) promulgated under the Securities Exchange Act of 1934, as
amended (the Exchange Act). Based upon that evaluation, the Companys Chief
Executive Officer and the Companys Senior Vice President and Chief Financial
Officer concluded that, as of the Evaluation Date, the Companys disclosure
controls and procedures were effective in ensuring that material information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commissions rules
and forms, including ensuring that such material information is accumulated and
communicated to the Companys management, including the Companys Chief
Executive Officer and the Companys Senior Vice President and Chief Financial
Officer, as appropriate to allow timely decisions regarding required
disclosure.

Internal Control Over Financial Reporting

During
the period covered by this report, there have been no changes in the Companys internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting.

36



---



##### Table of Contents






PART II. OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

None




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

During the quarter ended September 30, 2003, we granted options to
purchase an aggregate of 285,346 shares of our common stock to employees under
our 1994 Stock Plan, at a weighted average exercise price of $13.02 per share.
In addition, we issued 32,381 shares of common stock during the quarter ended
September 30, 2003 in connection with the exercise of outstanding options under
our 1994 Stock Plan by six of our employees, at a weighted exercise price of
$2.01 per share. These option exercises resulted in aggregate proceeds to us
of approximately $65,000. No underwriters were involved in the foregoing stock
or option issuances. The foregoing stock and option issuances were exempt from
registration under the Securities Act of 1933, as amended, either pursuant to
Rule 701 under the Act, as transactions pursuant to a compensatory benefit
plan, or pursuant to Section 4(2) under the Act, as a transaction by an issuer
not involving a public offering.

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

The aggregate price of the offering amount registered on our behalf was
$52.5 million. In connection with the offering, we paid $3.7 million in
underwriting discounts and commissions to the underwriters and incurred an
estimated $1.5 million in other offering expenses. None of the underwriting
discounts and commissions or offering expenses were incurred or paid to
directors or officers of ours or their associates or to persons owning 10
percent or more of our common stock or to any affiliates of ours. After
deducting the underwriting discounts and commissions and offering expenses, we
received net proceeds from the offering of approximately $47.3 million. The
proceeds to us have conformed with our intended use outlined in the prospectus
related to the offering.




ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None




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

In August 2003, we sent a written consent to our stockholders requesting
approval of the taking of the following actions in connection with the initial
public offering of our common stock: (1) the approval and adoption of our
Amended and Restated Certificate of Incorporation so as to, among other things,
effect a reverse stock split prior to our initial public offering, (2) the
approval and adoption of our Amended and Restated Certificate of Incorporation
to become effective following the closing of our initial public offering, (3)
the approval and adoption of our Amended and Restated Bylaws to become
effective upon the closing of our initial public offering, (4) the approval and
adoption of our 2003 Stock Option Plan to become effective upon the closing of
our initial public offering and reservation of 2,500,000 shares of common stock
available for issuance thereunder, (5) the approval and adoption of our 2003
Employee Stock Purchase Plan to become effective upon the closing of our
initial public offering and

37



---



##### Table of Contents



reservation of 233,334 shares of common stock available for issuance
thereunder, (6) the approval of an amendment to our 1994 Stock Plan increasing
the number of shares of our common stock which may be issued under the plan to
1,223,663, (7) elect each of Terrance McGuire and Sherri Oberg, effective upon
the effectiveness of our initial public offering, to serve as Class I directors
until the date of annual meeting of stockholders next following the year ending
December 31, 2003 or until his or her earlier death, resignation or removal,
(8) elect each of Derek Lemke-von Ammon and Kate Mitchell, effective upon the
effectiveness of our initial public offering, to serve as Class II directors
until the date of annual meeting of stockholders next following the year ending
December 31, 2004 or until his or her earlier death, resignation or removal,
and (9) elect each of Martyn Greenacre and Frank Baldino, effective upon the
effectiveness of our initial public offering, to serve as Class III directors
until the date of annual meeting of stockholders next following the year ending
December 31, 2005 or until his or her earlier death, resignation or removal.
All such actions were effected pursuant to an action by written consent of our
stockholders in compliance with Section 228 of the Delaware General Corporation
Law. We received the requisite consents on August 19, 2003.

A total of 30,009,540 shares of our stock out of 39,374,704 shares issued
and outstanding voted in favor of these matters.

In September 2003, we sent a written consent to our stockholders
requesting approval of the taking of the following actions in connection with
the initial public offering of our common stock: (1) the authorization to
implement the actions approved by the stockholders by written consent on August
19, 2003 at such times and in such manners as the pricing committee of the
board of directors deems necessary or appropriate, and (2) the approval of an
amendment to our 1994 Stock Plan increasing the number of shares of our common
stock which may be issued under the plan to 1,423,663 . All such actions were
effected pursuant to an action by written consent of our stockholders in
compliance with Section 228 of the Delaware General Corporation Law. We
received the requisite consents on September 12, 2003.

A total of 30,633,390 shares of our stock out of 39,374,704 shares issued
and outstanding voted in favor of these matters.




ITEM 5. OTHER INFORMATION

None




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  List of exhibits:

|        |  |                                                                                                                                                                 
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                 
|Number  |  | Exhibit Description                                                                                                                                             
|        |  |                                                                                                                                                                 
|31.1    |  | Certification of the Chief Executive Officer under Section
302 of the Sarbanes-Oxley Act of 2002 as defined in
Exchange Act Rules 13a-14 and 15d-14             
|        |  |                                                                                                                                                                 
|31.2    |  | Certification of the Chief Financial Officer under Section
302 of the Sarbanes-Oxley Act of 2002 as defined in
Exchange Act Rules 13a-14 and 15d-14             
|        |  |                                                                                                                                                                 
|32.1    |  | Certifications of the Chief Executive Officer and Chief
Financial Officer under Section 906 of the Sarbanes-Oxley
Act of 2002 pursuant to 18 U.S.C. Section 1350

(b)  There were no reports on Form 8-K filed or furnished by the Company
during the fiscal quarter ended September 30, 2003.

38



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on this 12th day of November 2003.

| |  |                          |                                                   | 
| |  | ------------------------ | ------------------------------------------------- | 
| |  | ACUSPHERE, INC.         
| |  |                          |                                                   | 
| |  | By:  /s/ Sherri C. Oberg
| |  |                          |                                                  
| |  |                          | Sherri C. Oberg                                  
| |  |                          | President and Chief Executive Officer            
| |  |                          |                                                   | 
| |  | By:  /s/ John F. Thero  
| |  |                          |                                                  
| |  |                          | John F. Thero                                    
| |  |                          | Senior Vice President and Chief Financial Officer
| |  |                          | (Principal Financial and Accounting Officer      
| |  |                          | and Duly Authorized Officer)                     

39



---



##### Table of Contents






EXHIBIT INDEX

|        |  |                                                                                                                                                                 
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                 
|Number  |  | Exhibit Description                                                                                                                                             
|        |  |                                                                                                                                                                 
|31.1    |  | Certification of the Chief Executive Officer under Section
302 of the Sarbanes-Oxley Act of 2002 as defined in
Exchange Act Rules 13a-14 and 15d-14             
|        |  |                                                                                                                                                                 
|31.2    |  | Certification of the Chief Financial Officer under Section
302 of the Sarbanex-Oxley Act of 2002 as defined in
Exchange Act Rules 13a-14 and 15d-14             
|        |  |                                                                                                                                                                 
|32.1    |  | Certifications of the Chief Executive Officer and Chief
Financial Officer under Section 906 of the Sarbanes-Oxley
Act of 2002 pursuant to 18 U.S.C. Section 1350