**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
|           |   |
| **ý**     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |
| ** **     | **For the quarterly period ended June 30,  2005** |
|           |   |
| ** **     | **or** |
|           |   |
| **o**          | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from             to             .**

 

**Commission File Number 000-50405**

 

**ACUSPHERE, INC.**

(Exact name of registrant as specified in itscharter)

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

 

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

** **

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ýNo o

 

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

 

As of August 12, 2005 there were 17,837,146 shares of theregistrant’s common stock, $.01 par value per share, outstanding.

 

 

----

 

**ACUSPHERE, INC.**

 

**Form 10-Q**

**For the Quarterly Period Ended June 30,2005**

 

**CONTENTS**

 
| PART I: FINANCIAL INFORMATION                                                                  |   |   |
|-----------------------------------------------------------------------------------------------------|--------|--------|
| Item 1. Consolidated Financial Statements                                                           |   |   |
| Condensed Consolidated Balance Sheets:                                                              |   |   |
| June 30, 2005 (Unaudited) and December 31, 2004                                           |   |   |
| Condensed Consolidated Statements of Operations (Unaudited):                                        |   |   |
| Three and Six Months ended June 30, 2005 and 2004                                              |   |   |
| Condensed Consolidated Statements of Cash Flows (Unaudited):                                        |   |   |
| Six Months ended June 30, 2005 and 2004                                                        |   |   |
| Notes to Condensed Consolidated Financial Statements (Unaudited)                                    |   |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   |   |
| Item 3. Quantitative and Qualitative  Disclosure about Market Risk                                  |   |   |
| Item 4. Controls and Procedures                                                                     |   |   |
| PART II: OTHER INFORMATION                                                                     |   |   |
| Item 1. Legal Proceedings                                                                           |   |   |
| Item 2. Unregistered Sales of Equity  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                                                                                    |   |   |
| Signature                                                                                           |   |   |

 

2

----

 

**PART I: FINANCIAL INFORMATION**

**ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS**

 

**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                                                                                                 | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                 |       |                    |       |                        |       |
| CURRENT  ASSETS:                                                                                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                                                                                                                                 |       | $                       | 60,211,905 |                        | $          | 45,179,915 |   |
| Other  current assets                                                                                                                                                                                                                                                                                                                                                      |       | 1,049,226               |       | 2,096,681                   |       |
| Total  current assets                                                                                                                                                                                                                                                                                                                                                      |       | 61,261,130              |       | 47,276,596                  |       |
| PROPERTY AND  EQUIPMENT, at cost:                                                                                                                                                                                                                                                                                                                                          |       |                    |       |                        |       |
| Property and  equipment (Note 5)                                                                                                                                                                                                                                                                                                                                           |       | 39,371,182              |       | 20,876,140                  |       |
| Less  accumulated depreciation and amortization                                                                                                                                                                                                                                                                                                                            |       | 9,149,696               |       | 8,006,819                   |       |
| Property and  equipment, net                                                                                                                                                                                                                                                                                                                                               |       | 30,221,486              |       | 12,869,321                  |       |
| OTHER ASSETS                                                                                                                                                                                                                                                                                                                                                               |       | 1,823,345               |       | 1,857,306                   |       |
| TOTAL                                                                                                                                                                                                                                                                                                                                                                      |       | $                       | 93,305,960 |                        | $          | 62,003,223 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                                             |       |                    |       |                        |       |
| CURRENT  LIABILITIES:                                                                                                                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| Current  portion of long-term obligations (Note 6)                                                                                                                                                                                                                                                                                                                         |       | $                       | 5,260,052  |                        | $          | 1,071,627 |   |
| Current  portion of deferred revenue (Note 8)                                                                                                                                                                                                                                                                                                                              |       | 3,428,571               |       | 3,428,571                   |       |
| Derivative  liability (Note 9)                                                                                                                                                                                                                                                                                                                                             |       | 1,670,657               |       | —                      |       |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                           |       | 3,590,107               |       | 4,237,934                   |       |
| Accrued  expenses                                                                                                                                                                                                                                                                                                                                                          |       | 5,668,729               |       | 4,396,020                   |       |
| Total  current liabilities                                                                                                                                                                                                                                                                                                                                                 |       | 19,618,115              |       | 13,134,152                  |       |
| LONG-TERM  LIABILITIES:                                                                                                                                                                                                                                                                                                                                                    |       |                    |       |                        |       |
| Long-term  obligations, net of current portion                                                                                                                                                                                                                                                                                                                             |       | 11,962,816              |       | 2,502,579                   |       |
| Deferred  revenue, net of current portion                                                                                                                                                                                                                                                                                                                                  |       | 1,142,858               |       | 857,143                     |       |
| Total  long-term liabilities                                                                                                                                                                                                                                                                                                                                               |       | 13,105,674              |       | 3,359,722                   |       |
| COMMITMENTS                                                                                                                                                                                                                                                                                                                                                                |       |                    |       |                        |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                                                                                                                                                                                                |       |                    |       |                        |       |
| Preferred  stock, $0.01 par value per share  Authorized - 5,000,000 shares as of June 30, 2005 and December 31,  2004  Designated 6.5% convertible exchangeable - 1,000,000 shares as of June 30,  2005 and none as of December 31, 2004  Issued and outstanding – 900,000 shares as of June 30, 2005 and none as  of December 31, 2004 |       | 9,000                   |       | —                      |       |
| Common  stock, $0.01 par value per share  Authorized - 98,500,000 shares as of June 30, 2005 and December 31,  2004  Issued and outstanding - 17,831,954 shares as of June 30, 2005 and  17,810,922 as of December 31, 2004                                                                                                                            |       | 178,320                 |       | 178,109                     |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                                                                                                                |       | 259,712,974             |       | 221,672,237                 |       |
| Deferred  stock-based compensation                                                                                                                                                                                                                                                                                                                                         |       | (575,853                | )          | (914,492                    | )          |
| Accumulated  deficit                                                                                                                                                                                                                                                                                                                                                       |       | (198,742,268            | )          | (175,426,505                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                                                                                           |       | 60,582,172              |       | 45,509,349                  |       |
| TOTAL                                                                                                                                                                                                                                                                                                                                                                      |       | $                       | 93,305,960 |                        | $          | 62,003,223 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

3

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**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** **  | **Six Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|-------------|----------------------|------------|
| ** **                                                  | ** ** | **June 30,**      | ** **  | **June 30,**    | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                  | ** ** | **2005**               | ** **  | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                        |       |                   |        |                 |       |   |   |   |   |
| COLLABORATION  REVENUE                                      |       | $                      | 857,143     |                 | $          | — |   | $ | 1,714,286 |   | $ | — |   |
| OPERATING  EXPENSES:                                        |       |                   |        |                 |       |   |   |   |   |
| Research and  development                                   |       | 15,226,869             |        | 6,192,615            |       | 22,904,948 |   | 11,795,418 |   |
| General and  administrative                                 |       | 2,113,815              |        | 1,544,933            |       | 3,861,123 |   | 2,949,045 |   |
| Total  operating expenses                                   |       | 17,340,684             |        | 7,737,548            |       | 26,766,071 |   | 14,744,463 |   |
| Interest  income                                            |       | 529,032                |        | 93,761               |       | 831,341 |   | 201,534 |   |
| Other income  (expense)                                     |       | —                 |        | 74,268               |       |   |   | 74,268 |   |
| Interest  expense                                           |       | (341,971               | )           | (49,691              | )          | (482,664 | ) | (75,111 | ) |
| Change in  valuation of derivative                          |       | 953,343                |        | —               |       | 1,387,343 |   | — |   |
| NET LOSS                                                    |       | $                      | (15,343,137 | )                    | $          | (7,619,210 | ) | $ | (23,315,765 | ) | $ | (14,543,772 | ) |
| Dividends  paid on preferred stock (Note 8)                 |       | (788,040               | )           | —               |       | (788,040 | ) | — |   |
| Dividends  accumulated on preferred stock (Note 8)          |       | (243,750               | )           | —               |       | (243,750 | ) | — |   |
| NET LOSS  AVAILABLE TO COMMON STOCKHOLDERS                  |       | $                      | (16,374,927 | )                    | $          | (7,619,210 | ) | $ | (24,347,555 | ) | $ | (14,543,772 | ) |
| NET LOSS  AVAILABLE TO COMMON STOCKHOLDERS PER SHARE – |       |                   |        |                 |       |   |   |   |   |
| Basic and  diluted                                          |       | $                      | (0.92       | )                    | $          | (0.53 | ) | $ | (1.37 | ) | $ | (1.02 | ) |
| WEIGHTED-AVERAGE  SHARES OUTSTANDING –                 |       |                   |        |                 |       |   |   |   |   |
| Basic and  diluted                                          |       | 17,828,526             |        | 14,310,311           |       | 17,820,719 |   | 14,298,202 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

4

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**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Six Months Ended** | ** **  |
|------------------------------------------------------------------------------|------------|----------------------|-------------|
| ** **                                                                   | ** ** | **June 30,**    | ** **  | **June 30,** | ** ** |
| ** **                                                                   | ** ** | **2005**             | ** **  | **2004** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                       |       |                 |        |   |   |
| Net loss                                                                     |       | $                    | (23,315,765 | ) | $ | (14,543,772 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                 |        |   |   |
| Stock-based  compensation expense                                            |       | 321,290              |        | 459,052 |   |
| Depreciation  and amortization                                               |       | 1,197,755            |        | 634,719 |   |
| Write-off of  intellectual property acquisition cost (Note 6)                |       | 6,218,132            |        | — |   |
| Noncash  interest expense                                                    |       | 105,469              |        | 34,132 |   |
| Noncash rent  expense                                                        |       | 187,203              |        | 26,820 |   |
| Noncash  amortization of deferred revenue                                    |       | (1,714,286           | )           | — |   |
| Noncash  amortization of fee and warrants to financial advisor               |       | 134,520              |        | — |   |
| Change in  valuation of derivative                                           |       | (1,387,343           | )           | — |   |
| Changes in  operating assets and liabilities:                                |       |                 |        |   |   |
| Deferred  revenue                                                            |       | 2,000,000            |        | — |   |
| Other  current assets                                                        |       | 937,934              |        | 20,575 |   |
| Accounts  payable                                                            |       | (647,825             | )           | 311,757 |   |
| Accrued  expenses                                                            |       | 1,134,585            |        | 684,069 |   |
| Net cash  used in operating activities                                       |       | (14,828,331          | )           | (12,372,648 | ) |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                       |       |                 |        |   |   |
| Purchases of  property and equipment                                         |       | (18,549,920          | )           | (3,353,258 | ) |
| Payment for  purchase of intellectual property rights (note 6)               |       | (1,000,000           | )           | — |   |
| Increase in  other assets                                                    |       | (139,500             | )           | (26,999 | ) |
| Net cash  used in investing activities                                       |       | (19,689,420          | )           | (3,380,257 | ) |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                       |       |                 |        |   |   |
| Payments on  long-term obligations                                           |       | (1,053,826           | )           | (464,528 | ) |
| Proceeds  from long-term obligations                                         |       | 9,478,269            |        | 424,153 |   |
| Net proceeds  from sale of preferred stock                                   |       | 41,887,416           |        | — |   |
| Payment of  preferred stock dividends (note 9)                               |       | (788,040             | )           | — |   |
| Net proceeds  from exercise of stock options                                 |       | 13,761               |        | 35,960 |   |
| Proceeds  from issuance of common stock from employee stock purchase plan    |       | 12,160               |        | 12,164 |   |
| Net cash  provided by financing activities                                   |       | 49,549,740           |        | 7,749 |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                        |       | 15,031,989           |        | (15,745,156 | ) |
| CASH AND  CASH EQUIVALENTS – Beginning of period                        |       | 45,179,915           |        | 54,562,378 |   |
| CASH AND  CASH EQUIVALENTS – End of period                              |       | $                    | 60,211,905  |   | $ | 38,817,222 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

5

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**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

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

 

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

 

In the opinion of management, all adjustments, consisting only ofnormal, recurring adjustments considered necessary for a fair presentation ofthe results of these interim periods have been included. The results ofoperations for the three and six months ended June 30, 2005 may not beindicative of the results that may be expected for the full fiscal year.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of expensesduring the reporting period. Actual results could differ from those estimatesor assumptions. The more significant estimates reflected in these financialstatements include revenue recognition, accrued expenses, embedded derivatives,and valuation of stock-based compensation.

 

**2. Revenue Recognition**

 

The Company recognizesrevenue from license arrangements in accordance with Staff Accounting Bulletin No. 104,Revenue Recognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”).The Company recognizes revenue from license payments not tied to achieving aspecific performance milestone ratably over the period over which the Companyis obligated to perform services. The period over which the Company is obligatedto perform services is estimated based on available facts and circumstances.The Company recognizes revenue from performance payments, when such performanceis substantially in the Company’s control and when the Company believes thatcompletion of such performance is reasonably probable, ratably over the periodover which the Company estimates that it will perform such performanceobligations. Substantive at-risk milestone payments, which are based onachieving a specific performance milestone when performance of such milestoneis contingent on performance by others or for which achievement can not bereasonably estimated or assured, are recognized as revenue when the milestoneis achieved and the related payment is due, provided that there is no substantialfuture service obligation associated with the milestone. Revenue in connectionwith license arrangements is recognized over the term of the arrangement and islimited to payments collected or due and reasonably assured of collection. Incircumstances where the arrangement includes a refund provision, the Companydefers revenue recognition until the refund condition is no longer applicableunless, in the Company’s judgment, the refund circumstances are within itsoperating control and unlikely to occur. Payments received in advance of being recognized as revenue aredeferred.

 

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

 

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

 

6

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Stock options granted during 2005 are as follows:

 
| ** **                   | ** ** | **Number  of  Shares** | ** ** | **Exercise  Price  Per Share** | ** **  | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
|------------------------------|------------|------------------------|------------|--------------------------------|-------------|---------------------------------------------------|------------|
| For the  three months ended: |       |                   |       |                           |        |                                              |       |
| March 31,  2005         |       | 847,500                |       | $                              | 5.43 - 6.30 |                                              | $          | 5.83 |   |
| June 30,  2005          |       | 221,100                |       | $                              | 4.28 - 5.35 |                                              | $          | 4.85 |   |

 

The stock options granted in the three and six months ended June 30,2005 were granted at fair market value on the date of grant.

 

Had compensation cost for grants issued during the current and priorperiods been determined consistent with Statement of Financial AccountingStandard (“SFAS”) No. 123, “Accounting for Stock-based Compensation,” proforma net loss and net loss per share would have been the following:

 
| ** **                                                                            | ** ** | **Three Months Ended**  | ** **  | **Six Months Ended**    | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------|-------------|-------------------------|------------|
| ** **                                                                            | ** ** | **June 30,  2005** | ** **  | **June 30,  2004** | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| Applicable  to common stockholders:                                                   |       |                    |        |                    |       |   |   |   |   |
| Net loss —  as reported                                                          |       | $                       | (16,374,927 | )                       | $          | (7,619,210 | ) | $ | (24,347,555 | ) | $ | (14,543,772 | ) |
| Add:  Stock-based employee compensation expense included in reported net loss         |       | 127,979                 |        | 194,815                 |       | 264,793 |   | 390,042 |   |
| Deduct:  Stock-based employee compensation expense determined under fair value method |       | (518,655                | )           | (446,614                | )          | (1,047,633 | ) | (872,214 | ) |
| Net loss —  pro forma                                                            |       | $                       | (16,765,603 | )                       | $          | (7,871,009 | ) | $ | (25,130,395 | ) | $ | (15,025,944 | ) |
| Net loss per  common share (basic and diluted):                                       |       |                    |        |                    |       |   |   |   |   |
| As reported                                                                           |       | $                       | (.92        | )                       | $          | (0.53 | ) | $ | (1.37 | ) | $ | (1.02 | ) |
| Pro forma                                                                             |       | $                       | (.94        | )                       | $          | (0.55 | ) | $ | (1.41 | ) | $ | (1.05 | ) |

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”).This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedesAccounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its relatedimplementation guidance.  SFAS No. 123Rfocuses primarily on accounting for transactions in which an entity obtainsemployee services in share-based payment transactions. The Statement requiresentities to recognize stock compensation expense for awards of equityinstruments to employees based on the grant-date fair value of those awards(with limited exceptions). In accordance with a recently-issued rule bythe SEC, SFAS No. 123R is effective as of the beginning of the firstannual reporting period that begins after June 15, 2005.  The Company expects to adopt SFAS No. 123Ron January 1, 2006 using the Statement’s modified prospective applicationmethod.  The Company does not yet have anestimate of the effect on its statements of operations of adopting SFAS No. 123.

 

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

 

Basic and diluted net loss per common share is calculated by dividingthe net loss available to common stockholders by the weighted-average number ofunrestricted common shares outstanding during the period. Diluted net loss percommon share is the same as basic net loss per common share, since the effectsof potentially dilutive securities are antidilutive for all periods presented.Antidilutive securities, which consist of convertible exchangeable preferredstock, stock options, warrants, and restricted common stock that are notincluded in the diluted net loss per share calculation, aggregated 10,721,294and 2,401,058 as of June 30, 2005 and 2004, respectively.

 

7

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

 
| ** **                                                           | ** ** | **Three Months Ended**  | ** ** | **Six Months Ended**    | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                           | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| Weighted-average  common shares outstanding                          |       | 17,831,930              |       | 14,319,915              |       | 17,824,847 |   | 14,308,598 |   |
| Less  weighted-average unvested restricted common shares outstanding |       | (3,404                  | )          | (9,604                  | )          | (4,128 | ) | (10,396 | ) |
| Basic and  diluted weighted-average common shares outstanding        |       | 17,828,526              |       | 14,310,311              |       | 17,820,719 |   | 14,298,202 |   |

 

**5.****     Property and Equipment**

 

Property and equipment at cost consist of the following:

 
| ** **                                       | ** ** | **As of:**              | ** ** | ** **                  | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** | **Estimated  Useful Life** | ** ** |
| Equipment                                        |       | $                       | 18,263,104 |                        | $          | 10,279,147 |   | 3 – 5 years |   |
| Furniture  and fixtures                          |       | 265,983                 |       | 188,252                     |       | 5 years |   |
| Leasehold  improvements                          |       | 604,158                 |       | 171,277                     |       | Lease term |   |
| Sub-total depreciable  assets                    |       | 19,133,245              |       | 10,638,676                  |       |   |   |
| Less:  accumulated depreciation and amortization |       | (9,149,696              | )          | (8,006,819                  | )          |   |   |
| Total  depreciable assets, net                   |       | 9,983,549               |       | 2,631,857                   |       |   |   |
| Deposits on  equipment purchases                 |       | 1,757,214               |       | 6,774,256                   |       | N/A |   |
| Construction  in progress                        |       | 18,480,723              |       | 3,463,208                   |       | N/A |   |
| Total  property and equipment                    |       | $                       | 30,221,486 |                        | $          | 12,869,321 |   |   |   |

 

Deposits on equipment purchases represent progress payments forlong-lead time capital equipment purchases, the majority of which are associatedwith development and expansion of the Company’s manufacturing operations for AI-700.

 

Construction in progress amounts represent costs incurred through June 30,2005 for the build-out of the Company’s commercial manufacturing facility inTewksbury, Massachusetts.  The Companyhas entered into an engineering and construction management services agreementwith Parsons Commercial Technology, Inc., as last amended August 3,2005, authorizing Parsons to perform on behalf of the Company, during theperiod ending August 31, 2005, engineering, design and constructionmanagement services in connection with the build-out of the commercialmanufacturing facility in Tewksbury, Massachusetts.  The total value of this cost-plus percentage feetype contract is $23.5 million of which $14.6 million was paid on or before June 30,2005.  The Company anticipates thatfurther amendment to this contract will be necessary to complete this build-outproject.   The Company expects that itstotal payments for substantially completing the build-out of the commercialmanufacturing facility, excluding equipment purchases, will be approximately$11.7 million in excess of the amounts that the Company has already paidthrough June 30, 2005.

 

**6.   Intellectual Property**

 

The Company expenses intellectual propertycosts incurred in obtaining license rights and patents rights to technology orproducts for which technological feasibility has not been commerciallydemonstrated and no alternative future use has been shown to exist.  Noamount has been capitalized by the Company relating to the costs ofintellectual property developed or acquired by the Company.

 

On May 11, 2005, the Company enteredinto a Patent Transfer Agreement with Schering Aktiengesellschaft (“Schering”)pursuant to which the Company acquired rights, title and interest in certainultrasound-related patents from Schering. In consideration of the transfer andassignment of these patents, the Company agreed to pay Schering a total of $7.0million of which $1.0 million was paid in May 2005, $3.0 million is due inMay 2006, and $3.0 million is due in May 2007. Because the Companyhas not demonstrated technological feasibility or an alternative future use forthese patents, the present value of this acquisition cost, $6.2 million, wasexpensed at the time of acquisition.

 

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**7.****     Long-term Obligations**

 

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

 
| ** **                   | ** ** | **As of:**              | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| Capital  lease obligations   |       | $                       | 70,963     |   | $ | 205,419 |   |
| Notes  payable               |       | 11,933,773              |       | 3,368,787 |   |
| Other  long-term obligations |       | 5,218,132               |       | — |   |
|                         |       | 17,222,868              |       | 3,574,206 |   |
| Less current  maturities     |       | (5,260,052              | )          | (1,071,627 | ) |
| Long-term  obligations, net  |       | $                       | 11,962,816 |   | $ | 2,502,579 |   |

 

Long-term obligations, including current maturities, outstanding as of June 30,2005 consisted of capital equipment leased under various capital leasearrangements, promissory notes under an equipment financing line (describedbelow), borrowings under a facility loan agreement and amounts due under apatent transfer agreement.  Monthlypayments under the capital lease obligations mature through June 2010.

 

In April 2004, the Company entered into an equipment financingline with General Electric Capital Corporation. In 2004 and 2005, the Companyborrowed an aggregate of $10.5 million against this line. As of June 30,2005, net of repayments, the Company had $9.6 million outstanding under thisline. Such borrowings are collateralized by corresponding equipment and other capitalpurchases with repayment due in monthly installments over 36 to 48 months,depending on the nature of the equipment financed, with the last such repaymentscheduled for March 2009. Interest rates on these borrowings were fixed atthe time of each borrowing and range from 8.9% to 10.1%. No further additionalamount may be borrowed under this line. The loans under this line are subjectto acceleration upon the happening of certain customary events of default,including failure to timely pay principal and interest.

 

In June 2005, the Company entered into a $7.0 million equipmentfinancing line with Oxford Finance Corporation. Borrowings under this equipmentline can be made against qualified purchases, subject to review and approval byOxford Finance Corporation, through April 2006. Such borrowings are to becollateralized by corresponding qualified purchases and repaid over 36 to48 months, depending on the nature of the equipment financed. No warrantswere granted in connection with this equipment line. The $7.0 millionequipment line is structured as a loan agreement. Interest rates are fixed atthe time of each borrowing under the equipment line with such rates adjustedbetween borrowings based on the U.S. Federal Reserve’s Three Year and Four YearTreasury Constant Maturity Rates. Interest rates on borrowings made through June 30,2005 on this line range from 10.3% to 10.4%, respectively. The loans under thisfinancing line are subject to acceleration upon the happening of certaincustomary events of default, including failure to timely pay principal andinterest. As of June 30, 2005, the Company had borrowed $0.4 million underthis line. Monthly payments for the amounts outstanding under the equipmentfinancing line mature through June 2009.

 

In August 2004, the Company entered into a loan agreement withMassDevelopment under which up to $2.0 million of financing is available uponcompletion by the Company of certain tenant improvements to its commercialmanufacturing facility in Tewksbury, Massachusetts.  In March 2005, the Company borrowed $2.0million under this loan agreement. Interest accrues under the loan at 5.0% per annum with retroactiveadjustments to 9% upon reaching certain defined earning levels. The repaymentof principal and accrued interest will coincide with the term of the Tewksburylease which has a five-year, nine-month term with options to extend the leasefor up to two additional five-year terms. No payments are due under the loanuntil April 2007. Unpaid interest during this twenty-four month periodshall be accrued and principal and interest shall be repaid on a monthly basisthereafter such that the total amount outstanding shall fully amortize over thebalance of the term in equal installments. The loan is subject to accelerationupon certain customary events of default, including failure to timely payprincipal and interest. The loan is secured by certain of the tenantimprovements made at the Tewksbury facility.

 

The retroactive interest rate adjustment feature of the MassDevelopmentloan agreement was deemed to be an embedded derivative instrument requiringseparate accounting under “FASB 133”, Accounting for Derivative Instruments andHedging Activities, and was initially valued at $62,000. The derivative assetis amortized as interest expense over a term beginning with the loan agreementeffective date and ending with the currently expected payment date of theretroactive interest.  The fair value ofthe derivative liability will be re-measured at each reporting period, with anychange in value charged or credited to interest expense.  There was no change in the estimated fairvalue of the derivative liability at June 30, 2005.

 

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On May 11, 2005, Acusphere entered into a Patent TransferAgreement with Schering. In consideration of the agreement, the Company agreedto pay Schering a total of $7.0 million of which $1.0 million was paid in May 2005,$3.0 million is due in May 2006, and $3.0 million is due in May 2007.The $6.2 million present value of these future payments is recorded asobligations of the Company of which $2.7 million is classified as currentmaturities.

 

**8. Deferred Revenue**

 

 In July 2004, the Companyentered into a collaboration, license and supply agreement with Nycomed inwhich the Company granted Nycomed rights to develop and market AI-700 inEurope. As part of this agreement, as of June 30, 2005, Nycomed has paidthe Company $4.0 million in license fees and the first four of eightconsecutive quarterly installments of $1.0 million each for the Company’sresearch and development efforts. As of June 30, 2005, the Company hascumulatively recognized $3.4 million in revenue, reflecting an estimated periodof forty-two months over which the $12 million in scheduled payments areexpected to be earned, and $4.6 million of such payments were reported by theCompany as deferred revenue.

 

During the three and six months ended June 30, 2005, in connectionwith this agreement, the Company paid fees of $65,000 and $195,000, respectivelyto an advisor retained in connection with the Nycomed collaboration agreement.Additional fees payable to this advisor are dependent upon the timing andmagnitude of the amounts paid by Nycomed to the Company.  The maximum cash amount payable to thisadvisor in connection with the Nycomed collaboration agreement is approximately$1.1 million of which $520,000 has been paid through June 30, 2005.

 

**9.****     Stockholders’ Equity**

 

On February 24, 2005, the Company issued 900,000 shares of 6.5%convertible exchangeable preferred stock (the “Preferred Stock”) at $50.00 pershare resulting in aggregate gross proceeds to the Company of $45.0 million(net proceeds of approximately $41.9 million after deducting underwritingdiscounts and commissions and estimated offering expenses).  Each share of Preferred Stock has aliquidation preference of $50.00 per share. Dividends on the Preferred Stock will be cumulative from the date oforiginal issue at the annual rate of $3.25 per share, payable quarterly on thefirst day of March, June, September, and December.  Any dividends must be declared by the Company’sboard of directors and must come from funds that are legally available fordividend payments.  On June 1, 2005,a quarterly dividend payment on shares of Preferred Stock in the aggregateamount of $788,000 was paid to the holders of record as of the close ofbusiness on May 16, 2005. In August 2005, the Company’s board ofdirectors declared a quarterly dividend in the amount of $0.8125 per share ofPreferred Stock, which is scheduled to be paid on September 1, 2005, tothe holders of record as of the close of business on August 15, 2005.

 

The Preferred Stock is convertible into the Company’s common stock atany time at the option of the holder at a conversion rate of 7.2886 shares ofcommon stock for each share of Preferred Stock, based on an initial conversionprice of $6.86 per share.  The initialconversion price is subject to adjustment in certain customary events, but is notsubject to “price based” anti-dilution adjustment. The Company has reservedapproximately 6,559,740 shares of common stock for issuance upon suchconversion.  As of June 30, 2005, noholders had voluntarily converted shares of Preferred Stock.

 

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

 

In accordance with SFAS 133, the Company is required to separate andaccount, for, as an embedded derivative, the dividend make-whole paymentfeature of the Preferred Stock offering. As an embedded derivative instrument,the dividend make-whole payment feature must be measured at fair value andreflected as a liability. Changes in the fair value of the derivative arerecognized in earnings as a component of Other Income (Expense). The Companydetermined the fair value of the dividend make-whole payment 

 

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feature to be$3.0 million at February 24, 2005 (the commitment date). This amount wasallocated from the proceeds of the Preferred Stock to the derivative liability.As of June 30, 2005 and March 31, 2005, the derivative liability wasvalued at $1.6 million and $2.6 million, respectively, resulting in therecognition of $1.0 million and $1.4 million as other income for the three andsix month periods ending June 30, 2005, respectively.

 

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

 

The Preferred Stock is exchangeable, in whole but not in part, at theoption of the Company on any dividend payment date beginning on March 1,2006 (the “Exchange Date”) for the Company’s 6.5% convertible subordinateddebentures (“Debentures”) at the rate of $50 principal amount of Debentures foreach share of Preferred Stock.  TheDebentures, if issued, will mature 25 years after the Exchange Date and haveterms substantially similar to those of the Preferred Stock.

 

The Preferred Stock has no maturity date and no voting rights prior toconversion into common stock, except under limited circumstances.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS****OF OPERATIONS**

 

**ForwardLooking Statements May Prove Inaccurate**

 

*Statements made inthis Form 10-Q, including without limitation, “Management’s Discussion andAnalysis of Financial Condition and Results of Operation,” contain certainprojections, estimates and other forward-looking statements. “Forward-lookingstatements,” as that term is defined in the Private Securities LitigationReform Act of 1995, are not historical facts and involve a number of risks anduncertainties. Words herein such as “may,” “will,” “should,” “could,” “would,” “expects,”“plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,”“potential,” and similar expressions (as well as other words or expressionsreferencing future events, conditions or circumstances) are intended toidentify forward-looking statements.*

 

*Forward-lookingstatements include, but are not limited to: our plans to develop and market newproducts and the timing of these development programs, in particular thetiming, size and enrollment of clinical trials and timing of regulatorymilestones for AI-700; our clinical development of product candidates, clinicaltrials and our ability to obtain and maintain regulatory approval for ourproduct candidates; our estimates regarding our capital requirements and ourneeds for additional financing; our estimates of future expenditures for andthe timing of our build-out of our commercial manufacturing facility inTewksbury, Massachusetts; our estimates of expenses and future revenues andprofitability; our estimates of the size of the potential markets for ourproduct candidates; our selection and licensing of product candidates; ourability to attract collaborators with acceptable development, regulatory andcommercialization expertise; the benefits to be derived from corporatecollaborations, license agreements and other collaborative efforts, includingthose relating to the development and commercialization of our productcandidates; sources of revenues and anticipated revenues, includingcontributions from corporate collaborations, license agreements and othercollaborative efforts for the development and commercialization of products;our ability to create an effective direct sales and marketing infrastructurefor products we elect to market and sell directly; the rate and degree ofmarket acceptance of our product candidates; the timing and amount ofreimbursement for our product candidates; the success of other competingtherapies that may become available; and the manufacturing capacity for ourproduct candidates, including our plans to build-out and qualify a commercialmanufacturing facility for AI-700.*

 

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

 

*The followingdiscussion should be read in conjunction with our consolidated financialstatements and related notes thereto included elsewhere in this Form 10-Q.*

 

**Overview**

 

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

 

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

 

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

 

**AI-700 Phase 3 Clinical Trial Update**

 

The Phase 3 clinical plan provides for atwo-part program consisting of a pilot phase (the “pilot study”), under whichnew investigators and blinded readers have been qualified and trained, and twomulti-center pivotal trials (the “32” and “33” trials), which together seek toenroll approximately 700 patients with known or suspected coronary heartdisease. The Phase 3 pivotal studies are currently taking place at clinicalsites located in North America, Europe and Australia with data from the trialsintended for submission to U.S., European and potentially other regulatoryauthorities. As of August 12, 2005, over 500 patients have been enrolledin the Phase 3 pivotal trials and over 600 patients have been enrolled in thePhase 3 program, including the pivotal trials and the pilot study. We currentlyanticipate completing cumulative enrollment of at least 700 patients in thepivotal trials in early 2006. Currently we plan to file a NDA for AI-700 in2006.

 

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

 

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

 

*The “32” Trial.*    Allof the patients enrolled in this trial will receive a stress echo study with AI-700and a nuclear stress test. Patients in this pivotal trial will generallyundergo coronary angiography only if they have a positive nuclear stress testresult. Patients in this pivotal trial who have a negative nuclear stress testresult will be evaluated for ninety days thereafter for cardiac events. Theprimary endpoints for this pivotal trial are sensitivity and specificity incomparison to nuclear stress testing, angiography or clinical outcome.

 

*The “33” Trial.*    All of the patients enrolled in thistrial will receive a stress echo study with AI-700 and will undergo coronaryangiography. The majority of patients, but not all, will receive a nuclearstress test. The primary endpoints for this pivotal trial are sensitivity andspecificity in comparison to angiography.

 

Although we are targeting these clinical endpoints and timingfor clinical enrollment and blinded reads in our Phase 3 trials, we cannotassure you that we will successfully achieve results that meet or exceed theseclinical endpoints or that enrollment will be completed in early 2006 or thatan NDA will be submitted to the FDA in 2006.

 

**AI-700 Manufacturing Facility Update**

 

In July 2004, weentered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts.  In September 2004, we began to build-outthe manufacturing space portion of this facility to meet the initial commercialmanufacturing requirements of AI-700.  Weintend to demonstrate that we can produce AI-700 at a commercial manufacturingscale prior to our filing of a NDA for AI-700 and, subject to requiredregulatory approvals, we intend to manufacture AI-700 in this facility forcommercial use. We plan to substantially complete the build-out of thisfacility commencing in 2005 and to complete our qualification of the facilityin 2006. This commercial manufacturing facility must comply with current goodmanufacturing practices, or cGMPs, enforced by the FDA and overseas regulatoryagencies. We have identified potential primary and secondary suppliers of theraw materials used in the production of AI-700.

 

We estimate that the total cost ofbuilding-out this facility will be $26.3 million. Of this amount, we have paid$14.6 million 

 

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during the period July 2004 through June 30, 2005 and weestimate that we will spend an additional $11.7 million to substantiallycomplete this build-out in 2005. The majority of this remaining amount isscheduled to be paid during the quarter ending September 30, 2005. Thesehistorical and prospective capital amounts exclude the cost of ourmanufacturing equipment.  We have enteredinto an agency procurement agreement with a contractor covering the purchase ofequipment in connection with the build-out of the Tewksbury facility.  As of August 12, 2005, the totalestimated value of equipment to be purchased under this agreement was $4.3million, of which $2.8 million was paid for as of June 30, 2005. We havealso entered into an engineering and construction management services agreementwith the same contractor covering the provision of engineering, design andconstruction management services through the period ending August 31,2005.  As of August 3, 2005, thetotal value of this cost-plus percentage fee type contract was $23.5 million.We anticipate future amendments to this contract to cover the total cost ofthis build-out. Although a considerable amount of the build-out is alreadycomplete, we cannot assure you that we will not incur costs in excess of thecurrent estimated amounts or that we will complete this build-out on schedule.

 

In March 2005 we borrowed $2.0 million under a loan agreement withthe Massachusetts Development Finance Agency, the economic developmentauthority of the Commonwealth of Massachusetts, to help fund build-out costsrelated to the Tewksbury facility.

 

**FinancialOperations Overview**

 

*Revenue.*    Wehave not generated any revenue from product sales since our inception. Inconnection with our collaboration agreement with Nycomed, as of June 30,2005 we have received $8.0 million in license fees and research anddevelopment payments and we anticipate receiving an additional $4.0 million insuch research and development payments in quarterly installments of $1.0million through June 2006. Further in the future, we will seek to generaterevenue from a combination of product sales, up-front or milestone payments andmanufacturing payments in connection with collaborative or strategicrelationships, and royalties resulting from the license of our products andintellectual property.

 

*Research andDevelopment Expense.*    Researchand development expense consists of expenses incurred in developing,manufacturing and testing product candidates. These expenses consist primarilyof salaries and related expenses for personnel, fees paid to professionalservice providers in conjunction with independently monitoring our clinicaltrials and acquiring and evaluating data in conjunction with our clinicaltrials, costs of contract manufacturing services, costs of materials used inclinical trials and research and development, costs incurred to validatemanufacturing equipment and facilities, depreciation of capital resources usedto develop our products, costs of facilities, the legal costs of pursuingpatent protection on select elements of our intellectual property andstock-based compensation. We expense research and development costs, includingpatent related costs, as incurred. We believe that significant investment inproduct development is a competitive necessity and plan to continue theseinvestments in order to realize the potential of our product candidates andproprietary technologies. Development programs for later stage product candidates,such as AI-700, tend to cost more than earlier stage programs due to the lengthand the number of patients enrolled in clinical trials for later stage programsand due to costs of scaling production to commercial scale.

 

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

 

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

 

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

 

*Change in Valuationof Derivative.*    Change in valuationof derivative consists of other income (expense) recognized or incurred on thechange in estimated fair value of derivatives at the end of each reportingperiod.

 

*Stock-BasedCompensation Expense.*    Includedwithin research and development expenses and general and administrativeexpenses is stock-based compensation expense. Stock-based compensation expense,which is a non-cash charge, results principally from stock option grants to ouremployees at exercise prices deemed for accounting purposes to be below thefair market value of our stock on the date the stock options were granted (“fixedawards”). Prior to our initial public offering, which closed on October 14,2003, we granted certain stock options for which the exercise prices weredeemed for accounting purposes to be below the fair value of the underlyingcommon stock resulting in our recording stock-based compensation expenseassociated with such grants. Stock-based

 

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compensation expense is also recorded for stock option grants tonon-employees and for restricted stock grants provided to directors andadvisors in lieu of cash compensation. Deferred compensation (for accountingpurposes) on fixed awards is amortized as a charge to operations over thevesting periods of the options and grants, subject to adjustment for forfeitureduring the vesting period.

 

**Results ofOperations**

 

*ThreeMonths Ended June 30, 2005 and 2004*

 

*Revenue.*    Collaborationrevenue was $0.9 million in the three months ended June 30, 2005compared to no collaboration revenue recognized in the three months ended June 30,2004. Collaboration revenue was earned under our agreement with Nycomed whichwas entered into in July 2004. Under this agreement, excluding anypayments that we might receive based upon the achievement of specifiedmilestones, we are scheduled to receive $12 million in license fees andresearch and development payments through June 2006, of which$8.0 million was received through June 30, 2005. We are recognizingrevenue associated with these payments ratably over a period of forty-twomonths, representing the estimated development period over which such fees areearned.

 

*Research andDevelopment Expense.*    Researchand development expense increased $9.0 million, or 146%, to $15.2 million inthe three months ended June 30, 2005 from $6.2 million in the three monthsended June 30, 2004.  The increasein research and development expense resulted from a $7.0 million PatentTransfer Agreement with Schering. Under this agreement, we acquired fromSchering rights, title and interest in nine patent families, including variousU.S. and international ultra-sound related patents and licenses to two otherpatent families.  In consideration of thetransfer and assignment of these patents, we agreed to pay Schering a total of$7.0 million of which $1.0 million was paid in May 2005, $3.0 million isdue in May 2006, and $3.0 million is due in May 2007.  During the three months ended June 30,2005, we expensed $6.2 million, the estimated present value of this acquisitioncost, with $5.2 million of this amount recorded as liabilities in ourconsolidated balance sheet as of June 30, 2005. Additionally, we incurred$0.1million in non-cash interest expense relating to the acquisition. Theremaining $0.7 million is expected to be amortized as non-cash interest expenseover the remaining terms of the scheduled payments to Schering. The remaining$2.8 increase in research and development expense resulted from increasedactivities relating to AI-700, including increased Phase 3 clinical programcosts and increased costs associated with validating our commercialmanufacturing facility for AI-700 and preparing for filing a NDA for AI-700.

 

The following table summarizes the primarycomponents of our research and development expense for the three months ended June 30,2005 and 2004:

 
| ** **                                          | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| ** **                                          | ** ** | **(in thousands)**      | ** ** |
| Total direct  costs                                 |       | $                       | 7,085      |   | $ | 4,821 |   |
|                                                |       |                    |       |   |   |
| Indirect  costs:                                    |       |                    |       |   |   |
| Facility costs                                      |       | 913                     |       | 745 |   |
| Depreciation                                        |       | 634                     |       | 293 |   |
| Stock-based  compensation                           |       | 56                      |       | 90 |   |
| All other  indirect costs                           |       | 321                     |       | 245 |   |
| Total  indirect costs                               |       | 1,924                   |       | 1,372 |   |
| Write-off of intellectual property acquisition cost |       | 6,218                   |       | — |   |
| Total research and development expense              |       | $                       | 15,227     |   | $ | 6,193 |   |

 

*Late Stage Clinical Development Program*.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our late stage clinical development program relates to ourlead product candidate, AI-700, which is a cardiovascular drug for thedetection of coronary heart disease. Almost all of our direct research anddevelopment expenditures for the three months ended June 30, 2005 and 2004related to our AI-700 program. The increase in direct research and developmentcosts in the three months ended June 30, 2005 compared to the same periodin 2004 reflects a higher number of clinical sites enrolling patients in the AI-700Phase 3 clinical program, a higher rate of patient enrollment in these clinicaltrials and related increases in costs for clinical data management andindependent clinical site monitoring. Patient enrollment and related costs areanticipated to vary from quarter to quarter but are generally anticipated to behigher in 2005 than in 2004.  Theincrease in research and development costs also includes costs associated withincreasing full and part-time personnel.

 

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In July 2004, we entered into a leaseagreement for 58,000 square feet of commercial manufacturing and office spacein Tewksbury, Massachusetts.  In September 2004,we began to build-out the manufacturing space of this facility for commercialmanufacturing of AI-700. We intend to demonstrate that we can produce AI-700 ata commercial manufacturing scale prior to our filing of a NDA for AI-700 and,subject to required regulatory approvals, we intend to manufacture AI-700 inthis facility for commercial use.  Theincrease in research and development costs in the three months ended June 30,2005 compared to the same period in 2004 reflects operating costs associatedwith our Tewksbury, Massachusetts facility, including costs associated withvalidating the facility, and increased depreciation expense due to capitalpurchases primarily relating to our manufacturing operations.  We intend to begin depreciation of thebuild-out costs associated with this facility in 2005 after the build-out issubstantially complete. We anticipate incurring increased costs associated withvalidation of this facility and its equipment and processes the purchase of rawmaterials and laboratory supplies, the increased use of consultants, and thehiring of additional personnel.

 

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

 

Each of our research and development programsis subject to risks and uncertainties, including the requirement to seekregulatory approvals, which are outside of our control. For example, our AI-700clinical trials may be subject to delays or rejections based on changes in thesize of the trials to meet statistical requirements, our inability to enrollpatients at the rate and in the proportion of patients with and without diseasethat we expect or our inability to produce clinical trial material insufficient quantities and of sufficient quality to meet the schedule forour planned clinical trials. Moreover, the product candidates identified inthese research and development programs, particularly our early stage programs,must overcome significant technological, manufacturing and marketing challengesbefore they can be successfully commercialized. As a result of these risks anduncertainties, we are unable to predict with any certainty the period in whichmaterial net cash inflows from such projects could be expected to commence orthe completion date of these programs. Failure to commercialize these productcandidates on a timely basis could have a material adverse affect on ourbusiness, financial condition and results of operations. We may seek toestablish collaborative relationships to help us commercialize these productcandidates, but there can be no assurance that we will be successful in doingso.

 

*General andAdministrative Expense.*    Generaland administrative expense increased $0.6 million, or 37%, to $2.1 million forthe three months ended June 30, 2005 from $1.5 million in the three monthsended June 30, 2004.  The increasein general and administrative expense was principally due to additionalpersonnel and consultants.

 

We anticipate some overall increase ingeneral and administrative expense during 2005, including increases in costsfor investor relations and other activities. These increases will also likelyinclude the hiring of additional personnel. We intend to continue to incurvarious internal and external business development costs to support our variousproduct development efforts, and certain of these expenses are likely toincrease overall.

 

*Interest Income.*    Interestincome increased $435,000, or 464%, to $529,000 in the three months ended June 30,2005 from $94,000 in the three months ended June 30, 2004.  Theincrease in interest income was primarily due to higher average fund balancesavailable for investment resulting from the $45.0 million Preferred Stockfinancing in February 2005.

 

*Interest Expense.*    Interestexpense increased $292,000, or 588%, to $342,000 in the three months ended June 30,2005 from $50,000 in the three months ended June 30, 2004.   The increase in interest expense wasprimarily related to cumulative borrowings of approximately $10.8 millionthrough June 30, 2005 under our two equipment financing lines and non-cashinterest related to the Schering patent agreement.

 

*Change in Valuationof Derivative.*    Change invaluation of derivative increased to $953,000 in the three months ended June 30,2005 from zero in the three months ended June 30, 2004. The increase inchange in valuation of derivative was related to the embedded derivativeinstrument from the dividend make-whole payment feature of the Preferred Stockoffering that closed in February 2005. We determined the fair value of thedividend make-whole payment feature to be $3.0 million at February 24,2005 (the commitment date). As of June 30, 2005 and March 31, 2005,the derivative liability was valued at $1.6 million and $2.6 million,respectively, resulting in the recognition of $1.0 million as other income forthe three month period ending June 30, 2005.

 

*Effect of Preferred Stock on Loss Available to Common Stockholders*.Dividends paid on preferred stock increased to $788,000 in the three monthsended June 30, 2005 from zero in the three months ended June 30, 2004.  The increase in dividends paid on preferred

 

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stock wasrelated to the quarterly dividend declared on May 16, 2005 and paid on June 1,2005.  In addition to dividends paid onpreferred stock, during the three months ended June 30, 2005, the Company’snet loss available to common stockholders includes $244,000 of dividendsaccumulated on preferred stock representing one month of dividend accumulatedbut not declared as of the end of the period. This amount of dividendsaccumulated is included in the calculation of per share net loss available tocommon stockholders.

 

*Six MonthsEnded June 30, 2005 and 2004*

 

*Revenue.*    Collaborationrevenue was $1.7 million in the six months ended June 30, 2005compared to no collaboration revenue recognized in the six months ended June 30,2004. Collaboration revenue was earned under our agreement with Nycomed whichwas entered into in July 2004. Under this agreement, excluding anypayments that we might receive based upon the achievement of specifiedmilestones, we are scheduled to receive $12 million in license fees andresearch and development payments through June 2006, of which$8.0 million was received through June 30, 2005. We are recognizingrevenue associated with these payments ratably over a period of forty-twomonths, representing the estimated development period over which such fees areearned.

 

* Research andDevelopment Expense.*    Researchand development expense increased $11.1 million, or 94%, to $22.9 million inthe six months ended June 30, 2005 from $11.8 million in the six monthsended June 30, 2004.  The increasein research and development expense resulted from a $7 million Patent TransferAgreement with Schering. During the six months ended June 30, 2005, weexpensed $6.2 million, the estimated present value of this acquisition cost,with $5.2 million of this amount recorded as liabilities in our consolidatedbalance sheet as of June 30, 2005. Additionally, we incurred $0.1millionin non-cash interest expense relating to the acquisition. The remaining $0.7million is expected to be amortized as non-cash interest expense over theremaining terms of the scheduled payments to Schering. The remaining $4.9increase in research and development expense resulted from increased activitiesrelating to AI-700, including increased Phase 3 clinical program costs andincreased costs associated with validating our commercial manufacturingfacility for AI-700 and preparing for filing a NDA for AI-700.

 

The following table summarizes the primarycomponents of our research and development expense for the six months ended June 30,2005 and 2004:

 
| ** **                                          | ** ** | **Six Months Ended**    | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| ** **                                          | ** ** | **(in thousands)**      | ** ** |
| Total direct  costs                                 |       | $                       | 12,931     |   | $ | 9,076 |   |
|                                                |       |                    |       |   |   |
| Indirect  costs:                                    |       |                    |       |   |   |
| Facility  costs                                     |       | 1,968                   |       | 1,531 |   |
| Depreciation                                        |       | 1,133                   |       | 593 |   |
| Stock-based  compensation                           |       | 115                     |       | 180 |   |
| All other  indirect costs                           |       | 540                     |       | 417 |   |
| Total  indirect costs                               |       | 3,756                   |       | 2,719 |   |
| Write-off of intellectual property acquisition cost |       | 6,218                   |       | — |   |
| Total research and development expense              |       | $                       | 22,905     |   | $ | 11,795 |   |

 

*Late Stage Clinical Development Program*.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our late stage clinical development program relates to ourlead product candidate, AI-700, which is a cardiovascular drug for thedetection of coronary heart disease. Almost all of our direct research anddevelopment expenditures for the six months ended June 30, 2005 and 2004related to our AI-700 program. The increase in direct research and developmentcosts in the six months ended June 30, 2005 compared to the same period in2004 reflects a higher number of clinical sites enrolling patients in the AI-700Phase 3 clinical program, a higher rate of patient enrollment in these clinicaltrials and related increases in costs for clinical data management andindependent clinical site monitoring. Patient enrollment and related costs areanticipated to vary from quarter to quarter but are generally anticipated to behigher in 2005 than in 2004.  Theincrease in research and development costs also includes costs associated withincreasing full and part-time personnel.

 

In July 2004, we entered into a leaseagreement for 58,000 square feet of commercial manufacturing and office spacein Tewksbury, Massachusetts.  In September 2004,we began to build-out the manufacturing space of this facility for commercialmanufacturing of AI-700. We intend to demonstrate that we can produce AI-700 ata commercial manufacturing scale prior to our 

 

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filing of a NDA for AI-700 and, subject to required regulatoryapprovals, we intend to manufacture AI-700 in this facility for commercial use. The increase in research and developmentcosts in the six months ended June 30, 2005 compared to the same period in2004 reflects operating costs associated with our Tewksbury, Massachusettsfacility, including costs associated with validating this facility and itsequipment and processes and increased depreciation expense due to capitalpurchases primarily relating to our manufacturing operations. We intend tobegin depreciation of the build-out costs associated with this facility in 2005after the build-out is substantially complete. We anticipate incurringincreased costs associated with validation of this facility, the purchase ofraw materials and laboratory supplies, the increased use of consultants, andthe hiring of additional personnel.

 

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

 

Each of our research and development programsis subject to risks and uncertainties, including the requirement to seekregulatory approvals, which are outside of our control. For example, ourclinical trials may be subject to delays or rejections based on changes in thesize of the trials to meet statistical requirements, our inability to enrollpatients at the rate and in the proportion of patients with and without diseasethat we expect or our inability to produce clinical trial material insufficient quantities and of sufficient quality to meet the schedule forour planned clinical trials. Moreover, the product candidates identified inthese research and development programs, particularly our early stage programs,must overcome significant technological, manufacturing and marketing challengesbefore they can be successfully commercialized. As a result of these risks anduncertainties, we are unable to predict with any certainty the period in whichmaterial net cash inflows from such projects could be expected to commence orthe completion date of these programs. Failure to commercialize these productcandidates on a timely basis could have a material adverse affect on ourbusiness, financial condition and results of operations. We may seek toestablish collaborative relationships to help us commercialize these productcandidates, but there can be no assurance that we will be successful in doingso.

 

*General and**Administrative Expense.*    Generaland administrative expense increased $0.9 million, or 31%, to $3.9 million forthe six months ended June 30, 2005 from $2.9 million in the six monthsended June 30, 2004.  The increasein general and administrative expense was principally due to additionalpersonnel and consultants.

 

We anticipate some overall increase ingeneral and administrative expense during 2005, including increases in costsfor investor relations and other activities. These increases will also likelyinclude the hiring of additional personnel. We intend to continue to incurvarious internal and external business development costs to support our variousproduct development efforts, and certain of these expenses are likely toincrease overall.

 

*Interest Income.*    Interestincome increased $630,000, or 313%, to $831,000 in the six months ended June 30,2005 from $201,000 in the six months ended June 30, 2004.  Theincrease in interest income was primarily due to higher average fund balancesavailable for investment resulting from the $45.0 million Preferred Stockfinancing in February 2005.

 

*Interest Expense.*    Interestexpense increased $408,000, or 543%, to $483,000 in the six months ended June 30,2005 from $75,000 in the six months ended June 30, 2004.   The increase in interest expense wasprimarily related to cumulative borrowings of approximately $10.8 millionthrough June 30, 2005 under our two equipment financing lines and non-cashinterest related to the Schering patent agreement.

 

* Change in Valuation of Derivative.*    Changein valuation of derivative increased to $1.4 million in the six months ended June 30,2005 from zero in the six months ended June 30, 2004. The increase inchange in valuation of derivative was related to the embedded derivativeinstrument from the dividend make-whole payment feature of the Preferred Stockoffering that closed in February 2005. We determined the fair value of thedividend make-whole payment feature to be $3.0 million at February 24,2005 (the commitment date). As of June 30, 2005, the derivative liabilitywas valued at $1.6 million resulting in the recognition of $1.4 million asother income for the six month period ending June 30, 2005.

 

*Effect of Preferred Stock on Loss Availableto Common Stockholders*. Dividends paid on PreferredStock increased to $788,040 in the six monthsended June 30, 2005 from zero in the six months ended June 30, 2004.The increase in dividends paid on Preferred Stock was related to the quarterlydividend declared on May 16, 2005 and paid on June 1, 2005.  In addition to dividends paid on preferredstock, during the six months ended June 30, 2005, the Company’s net lossavailable to common stockholders includes $244,000 of dividends accumulated onpreferred stock representing one month of dividend accumulated but not declaredas of the end 

 

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of the period.This amount of dividends accumulated is included in the calculation of pershare net loss available to common stockholders.

 

**Liquidity and Capital Resources**

 

Historically, we have financed our businessthrough the issuance of equity securities, debt financings, equipment leasesand since the third quarter of 2004, a strategic collaboration with Nycomed.Our liquidity requirements have arisen primarily from research and developmentexpenditures, equipment expenditures and payments on outstanding indebtedness.As of June 30, 2005, we had cash and cash equivalents of $60.2 million. Asof June 30, 2005 we owed $11.9 million in notes payable and hadcommitments totaling $20.1 million for rent under our facility leases,including the lease agreement signed in July 2004 for commercialmanufacturing space in Tewksbury, Massachusetts.

 

During the six months ended June 30,2005, operating activities used $14.8 million of cash. Net cash used byoperating activities during this period resulted primarily from a net loss of$24.0 million and a decrease in accounts payable of $0.6 million. Theseuses of cash were partially offset by an increase in deferred revenue of$2.0 million, an increase in accrued expenses of $1.1 million, adecrease in other current assets of $0.9 million, non-cash charges fordepreciation and amortization of $1.2 million and non-cash charges forstock-based compensation expense of $0.3 million, non-cash charges for thewrite-off of intellectual property acquisition costs of $7.0 million related tothe Schering agreement and non-cash change in valuation of derivative of $1.4million.  We anticipate that ouroperating spending will be higher in 2005 than in 2004 due to an estimatedhigher rate of patient enrollment in our Phase 3 clinical program andhigher costs in connection with the validation of our manufacturingfacility.  We estimate such spending fromoperating activities will be approximately $8 to $10 million per quarterthrough completion of enrollment in our AI-700 Phase 3 clinical trials in 2006**.**

 

During the six months ended June 30,2005, investing activities used $19.7 million in cash. These uses of cash wereprimarily used for purchases of equipment and costs incurred through June 30,2005 for the build-out and expansion of our manufacturing operations for AI-700of $18.6 million. These uses also included $1.0 million paid in cash inconnection with the Schering agreement.

 

During the six months ended June 30,2005, financing activities provided $49.5 million in cash. Net cashprovided by financing activities during this period resulted primarily from netproceeds in connection with the sale of our convertible exchangeable PreferredStock of $41.9 million, entering into promissory notes under the equipmentfinancing line of $7.5 million, and borrowings of $2.0 million under aloan agreement with MassDevelopment. These proceeds were partially offset bypayments on the capital leases and promissory notes of $1.0 million and paymentof Preferred Stock dividend of $0.8 million.

 

In June 2005, we entered into a $7.0 million equipment financingline with Oxford Finance Corporation. Borrowings under this equipment line canbe made against qualified purchases, subject to review and approval by OxfordFinance Corporation, through April 2006. Such borrowings are to be securedby qualified purchases and repaid over 36 to 48 months, depending on thenature of the equipment financed. No warrants were granted in connection withthis equipment line. The $7.0 million equipment line is structured as aloan agreement. Interest rates are fixed at the time of each borrowing underthe equipment line with such rates adjusted between borrowings based on theU.S. Federal Reserve’s Three Year and Four Year Treasury Constant MaturityRates. The loans under this financing line are subject to acceleration upon thehappening of certain customary events of default, including failure to timelypay principal and interest. As of June 30, 2005, we had borrowed $0.4million under this line. Monthly payments for the amounts outstanding under theequipment financing line mature through June 2009.

 

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

 

On February 24, 2005, we issued 900,000 shares of 6.5% convertibleexchangeable preferred stock, or Preferred Stock, at $50.00 

 

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per shareresulting in aggregate gross proceeds to us of $45.0 million (net proceeds ofapproximately $41.9 million after deducting underwriting discounts andcommissions and estimated offering expenses). Each share of Preferred Stock has a liquidation preference of $50.00 pershare.  Dividends on the Preferred Stockwill be cumulative from the date of original issue at the annual rate of $3.25per share, payable quarterly on the first day of March, June, September, andDecember, commencing on June 1, 2005. Any dividends must be declared by our board of directors and must comefrom funds that are legally available for dividend payments.

 

The Preferred Stock is convertible into shares of our common stock atany time at the option of the holder at a conversion rate of 7.2886 shares ofcommon stock for each share of Preferred Stock, based on an initial conversionprice of $6.86 per share.  The initialconversion price is subject to adjustment upon certain customary events, but isnot subject to “price based” anti-dilution adjustment. We reservedapproximately 6,559,740 shares of common stock for issuance uponconversion.  As of June 30, 2005, noholders had voluntarily converted shares of Preferred Stock. On June 1,2005, a quarterly dividend payment on shares of Preferred Stock in the amountof $788,000 was paid to the holders of record as of the close of business on May 16,2005. In August 2005, our board of directors declared a quarterly dividend inthe amount of $0.8125 per share of Preferred Stock, which is scheduled to bepaid on September 1, 2005, to the holders of record as of the close ofbusiness on August 15, 2005.

 

We may elect to automatically convert some or all of the PreferredStock into shares of our common stock if the closing price of our common stockhas exceeded $10.30 per share (150% of the conversion price) for at least 20trading days during any 30-day trading period, ending within five trading daysprior to notice of automatic conversion. Prior to March 1, 2009, if we elect to automatically convert, or ifany holder elects to voluntarily convert, the Preferred Stock, we will alsomake an additional payment, the Make-Whole payment, equal to the aggregateamount of dividends that would have been payable on the Preferred Stock so convertedfrom the original date of issuance through and including March 1, 2009,less any dividends already paid on the Preferred Stock.  This additional payment is payable by us, atour option, in cash, in additional shares of its common stock, or in a combinationof cash and shares of common stock.   Wehave reserved a maximum of approximately 2 million shares of common stock forissuance under this Make-Whole provision.

 

In accordance with Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments “SFAS 133”, we are required to separateand account, for, as an embedded derivative, the dividend make-whole paymentfeature of the Preferred Stock offering. As an embedded derivative instrument,the dividend make-whole payment feature must be measured at fair value andreflected as a liability. Changes in the fair value of the derivative arerecognized in earnings as a component of Other Income (Expense). We determinedthe fair value of the dividend make-whole payment feature to be $3.0 million atFebruary 24, 2005 (the commitment date). This amount was allocated fromthe proceeds of the Preferred Stock to the derivative liability. At June 30,2005, the derivative liability was valued at $1.6 million, resulting in therecognition of $1.4 million as other income for the six months ending June 30,2005.

 

We may elect to redeem the Preferred Stock at declining redemptionprices on or after March 6, 2009.

 

The Preferred Stock is exchangeable, in whole but not in part, at ouroption on any dividend payment date beginning on March 1, 2006 (the “ExchangeDate”) for our 6.5% convertible subordinated debentures (“Debentures”) at therate of $50 principal amount of Debentures for each share of PreferredStock.  The Debentures, if issued, will mature25 years after the Exchange Date and have terms substantially similar to thoseof the Preferred Stock.

 

The Preferred Stock has no maturity date and no voting rights prior toconversion into common stock, except under limited circumstances.

 

We believe, based on our operating plans, that our existing resources,including scheduled proceeds from Nycomed, will be adequate to fund our plannedoperations, including spending necessary to complete enrollment in our AI-700Phase 3 clinical program, through the first half of 2006, or longer if we electto reduce our rate of spending. Unless we reduce our rate of spending,  we will require significant additional funds,which we may raise through public or private sales of equity, or fromborrowings, or from strategic partners, within the next twelve months. Ourfuture capital requirements will depend on many factors, including the scopeand progress made in our research and development activities and our clinicaltrials and the size and timing of creating expanded manufacturing capabilities.We may also need additional funds for possible future strategic acquisitions ofbusinesses, products or technologies complementary to our business. We do notexpect to generate significant revenues for AI-700, other than possible licenseor milestone payments, unless or until we or current or potential partnerscomplete clinical trials and receive marketing approval from the applicableregulatory authorities. When additional funds are required or, in advance ofsuch requirements, we anticipate that funds will be needed, we may raise suchfunds from time to time through public or private sales of equity or fromborrowings or from strategic partners or we may delay funding of certaindevelopment activities which could delay the filing of our AI-700 NDA and the 

 

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commercializationof AI-700 which would have a materially adverse impact on our growthplans.  Additional equity financing maybe dilutive to our stockholders; debt financing, if available, may involvesignificant cash payment obligations and covenants that restrict our ability tooperate as a business; and strategic partnerships may result in royalties orother terms which reduce our economic potential from products underdevelopment.

 

**Universal Shelf Registration Statement**

 

We have on file with the U.S. Securities andExchange Commission “SEC” a “universal shelf” registration statement on Form S-3(Registration No. 333-121618) which, when combined with our previouslyfiled universal shelf registration statement on Form S-3, provides for theoffer, from time to time, of common stock, preferred stock, debt securities andwarrants up to an aggregate of $100.0 million. This shelf registrationstatement was declared effective by the SEC on April 15, 2005. As of thefiling of this report, the shelf registration statement remains effective, theaggregate amount available has not changed and, subject to market conditionsand our capital needs, and so long as we are then eligible to use theregistration statement under SEC rules we may again seek to use anyremaining availability under the shelf registration statement by making anoffering of securities covered for sale under the registration statement. Inaddition, we may amend our shelf registration statement or file a newshelf registration statement to increase our potential access to capital. If weelect to raise additional capital using a shelf registration statement, we mayuse the net proceeds from the sale of these securities for general corporatepurposes, which may include funding clinical trials, research and development,regulatory activities and the build-out of our commercial manufacturingfacility in Tewksbury, Massachusetts, acquisitions, including acquisitions ofcompanies, products, intellectual property or other technology, repayment orrefinancing of existing indebtedness, investments, capital expenditures,repurchase of our capital stock and for any other purposes that we may specifyin any prospectus supplement. The existence of this shelf registrationstatement is not intended to be indicative of any particular financing plan byus. If and when we pursue additional financing through the issuance ofadditional equity or debt securities, this shelf registration statement isintended to help facilitate such transactions.

 

**Off-Balance Sheet Financing Arrangements**

 

We currently do not have any special purposeentities or off-balance sheet financing arrangements other than operatingleases.

 

**Contractual Obligations**

 

The following table summarizes ourcontractual obligations as of June 30, 2005 and the effect suchobligations are expected to have on our liquidity and cash flow in futureperiods:

 

**PaymentsDue by Period**

 
| **Contractual Obligations**                         | ** ** | **Total  Obligations  All Years** | ** ** | **2005  Through  2006** | ** ** | **2007  Through  2008** | ** ** | **2009  Through  2010** | ** ** | **After 2010** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|----------------|------------|
| ** **                                          | ** ** | **(in thousands)**                | ** ** |
| Capital  lease obligations (including interest)     |       | $                                 | 86         |                    | $          | 27                      |       | $                       | 35         |           | $          | 24 |   | $ | — |   |
| Operating  lease obligations                        |       | 20,136                            |       | 4,061                   |       | 5,911                   |       | 6,022                   |       | 4,142          |       |
| Notes payable  (including interest)                 |       | 14,148                            |       | 5,034                   |       | 7,275                   |       | 1,839                   |       | —         |       |
| Intellectual  property acquisition cost obligations |       | 6,000                             |       | 3,000                   |       | 3,000                   |       |                    |       |           |       |
| Purchase  orders for capital equipment              |       | 2,105                             |       | 2,105                   |       | —                  |       | —                  |       | —         |       |
| Purchase  orders for leasehold improvements         |       | 7,303                             |       | 7,303                   |       | —                  |       | —                  |       | —         |       |
| Total  contractual cash obligations                 |       | $                                 | 49,778     |                    | $          | 21,530                  |       | $                       | 16,221     |           | $          | 7,885 |   | $ | 4,142 |   |

 

With the exception of costs in the abovetable relating to purchase orders, and operating lease obligations, the amountabove are recorded as liabilities in our consolidated balance sheet as of June 30,2005.

 

Our operating lease obligations relate to ourfacility leases.

 

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A substantial portion of the purchase orders forcapital equipment and leasehold improvements in the table above is needed forexpanded manufacturing of AI-700.  As of June 30,2005, we had outstanding purchase orders for capital equipment which total approximately$6.6 million. Against these purchase orders we have paid approximately $4.5 millionin deposits. The table above reflects the remaining amounts due on thesepurchase orders. In 2005, we anticipate expenditures for equipment purchasestotaling approximately $1.1 million in excess of the above reflectedamounts.  On November 11, 2004, weentered into an engineering and construction management services agreement witha contractor to perform on our behalf, engineering, design and constructionmanagement services in connection with the build-out of the commercialmanufacturing facility in Tewksbury, Massachusetts. The total estimated valueof this cost plus percentage fee type contract, as amended on August 3,2005, is $23.5 million.  As of June 30,2005, we had outstanding purchase orders for leasehold improvements related tothis contract which total approximately $21.9 million. Against thesepurchase orders we have paid approximately $14.6 million in deposits. Thetable above reflects the remaining amounts due on these purchase orders.  We expect that the build-out of thiscommercial manufacturing facility will be substantially completed in 2005 andthat our total payments for substantially completing this build-out, excludingequipment purchases, will be approximately $11.7 million in excess of theamounts that we have already paid through June 30, 2005, or $1.8 millionin excess of the current contract value. We anticipate making amendments to this cost plus percentage fee typecontact to increase its value from $23.5 to cover this estimated total cost,which amount may change from time to time based upon experience.

 

**Critical Accounting Policies andEstimates**

 

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

 

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

 

*Revenue.*   We recognize revenue from licensearrangements in accordance with Staff Accounting Bulletin No. 104, RevenueRecognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”).We recognize revenue from license payments not tied to achieving a specificperformance milestone ratably over the period over which we are obligated toperform services. The period over which we are obligated to perform services isestimated based on available facts and circumstances. We recognize revenue fromperformance payments, when such performance is substantially in our control andwhen we believe that completion of such performance is reasonably probable,ratably over the period over which we estimate that we will perform suchperformance obligations. Substantive at-risk milestone payments, which arebased on achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably estimated or assured, are recognized as revenue when themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. We do notrecognize revenue in connection with license arrangements until payments arecollected or due and reasonably assured of being collected. In addition, we donot recognize revenue in circumstances where the arrangement includes a refundprovision until the refund condition is no longer applicable unless, in ourjudgment, the refund circumstances are within our operating control andunlikely to occur.  Payments received inadvance of being recognized as revenue are deferred.

 

We are recognizingcollaboration revenue of $12.0 million associated with the initial license andperformance-based payments under the Nycomed agreement based on an estimatedrecognition period of forty-two months over which we are obligated to perform servicessupporting the agreement.  This estimatedrecognition period may change if available facts and circumstances change.  A change in this estimate could result in asignificant change to the amount of revenue recognized in future periods.  In addition, if the Nycomed collaborationagreement is terminated for reasons other than certain non-performance by us,we would recognize the remainder of the payments we have received or otherwiseexpect to collect over the amortization period at the time of termination. Wewill not recognize revenue associated with the potential $58 million inmilestone-based payments that may be earned under the Nycomed agreement untilthe underlying regulatory and sales milestones are achieved.

 

*Accrued Expenses.*    Aspart of the process of preparing consolidated financial statements we arerequired to estimate accrued expenses. This process involves identifyingservices which have been performed on our behalf and estimating the level ofservice 

 

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performed and the associated cost incurred for such service as of eachbalance sheet date in our consolidated financial statements. Examples ofestimated expenses for which we accrue include professional service fees, suchas lawyers and accountants, and contract service fees such as amounts paid toclinical monitors, data management organizations and investigators inconjunction with clinical trials, and fees paid to contract manufacturers inconjunction with the production of clinical materials. In connection with suchservice

fees, our estimates are most affected by our understanding of thestatus and timing of services provided relative to the actual levels ofservices incurred by such service providers. The majority of our serviceproviders invoice us monthly in arrears for services performed. In the eventthat we do not identify certain costs which have begun to be incurred or weunder- or over-estimate the level of services performed or the costs of suchservices, our reported expenses for such period would be too low or too high.The date on which certain services commence, the level of services performed onor before a given date and the cost of such services are often judgmental. Wemake these judgments based upon the facts and circumstances known to us inaccordance with generally accepted accounting principles.

 

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

 

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

 

*Derivative Liability.*    Theterms of our February 2005 convertible preferred stock offering and March 2005MassDevelopment loan agreement include a dividend make-whole payment feature.This feature is considered to be an embedded derivative and is recorded at fairvalue in accordance with Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments (SFAS 133). The derivative liability isreduced for make-whole payments triggered upon conversion of the preferredstock as well as dividends declared by our board of director’s, if any, on theconvertible preferred stock. The changes in the fair value of the derivativefinancial instrument are included in Other Income (Expense) in each reportingperiod.

 

*Income Taxes.*    Aspart of the process of preparing our consolidated financial statements we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. This process involves us estimating our actual current tax exposuretogether with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. In addition, as of December 31,2004, we had federal tax net operating loss carryforwards of $84.0 million,which expire through 2024. We also have research and development creditcarryforwards of $5.3 million. We have recorded a valuation allowance tofully offset against these otherwise recognizable net deferred tax assets dueto the uncertainty surrounding the timing of the realization of the taxbenefit. In the event that we determine in the future that we will be able torealize all or a portion of its net deferred tax benefit, an adjustment todeferred tax valuation allowance would increase net income in the 

 

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period in which such a determination is made. The Tax Reform Act of1986 contains provisions that may limit the utilization of net operating losscarryforwards and credits available to be used in any given year in the eventof significant changes in ownership interest, as defined.

 

**CertainFactors Which May Affect Future Results**

 

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

 

**RisksRelated to Our Company**

 

***We have notgenerated any product revenue to date, have a history of operating losses andour capital resources are limited.***

 

We are focused on product development and we have notgenerated any revenue from commercial sales of our products to date. We haveincurred losses each year of our operations. In 2004 we had a net lossavailable to holders of common stock of $30.0 million, and in the six monthsended June 30, 2005, we had a net loss available to holders of commonstock of $24.3 million. At June 30, 2005 we had an accumulated deficit of$198.7 million. We expect our research and development, general andadministrative and sales and marketing expenses will increase over the nextseveral years.

 

We expect to continue to incur losses and capitalexpenditures for the foreseeable future. We also anticipate cash out flow from debt repayment and payment ofother obligations. We believe, based on our operating plans, that our existingresources, including scheduled proceeds from Nycomed, will be adequate to fundour planned operations, including spending necessary to complete enrollment inour AI-700 Phase 3 clinical program, through the first half of 2006, or longerif we elect to reduce our rate of spending. Unless we reduce our rate ofspending, we will require significant additional funds, which we may raisethrough public or private sales of equity, or from borrowings, or fromstrategic partners, within the next twelve months.

 

As a result of our limitedcapital resources, we may elect to delay the funding of certain developmentactivities, including the filing of our AI-700 for NDA, which would result in adelay in the commercialization of AI-700. Any such delay in the filing of a NDA or commercialization of AI-700would have a material adverse impact on our financial position and business andwould likely have a material adverse effect on the market price of our commonstock.  To address our capital needs, wemay elect to raise funds through public or private sales of equity or fromborrowings or from strategic partners. Additional equity financing, if available, may be dilutive to ourstockholders; debt financing, if available, may involve significant cashpayment obligations and covenants that restrict our ability to operate as abusiness; and strategic partnerships, if available, may result in royalties orother terms which reduce our economic potential from products underdevelopment. In addition, third parties may attempt to acquire us at valuationsour board of directors or stockholders may not find attractive. If our capitalresources are not sufficient to fund our planned operations for a twelve monthperiod at the time the audit for our 2005 financial results is complete, ourauditor may require a going concern qualification in its audit report beincluded in our audit report on Form 10-K. Any such qualification wouldhave a material adverse effect on our ability to raise capital and would have amaterial adverse effect on the market price of our Common Stock.

 

***We need to allocatesignificant amounts of our available capital resources to make payments on ouroutstanding indebtedness and equipment lease obligations, our patent transferagreement with Schering Aktiengesellschaft and as dividends on our 6.5%convertible exchangeable preferred stock, which in turn could reduce ourfinancial flexibility and ability to fund other activities.***

 

As of June 30, 2005, wehad approximately $12.0 million in aggregate principal indebtednessoutstanding, including $86,000 in capital lease obligations. Pursuant to ourpatent transfer agreement with Schering, we have agreed to pay Schering anadditional $6.0 million, including $3.0 million in May 2006 and $3.0million in May 2007.  As of June 30,2005, we had outstanding 900,000 shares of our 6.5% convertible exchangeablepreferred stock, which shares accrue cumulative cash dividends at the annualrate of $3.25 per share, payable quarterly on the first day of March, June,September, and December.  These paymentswill:

 

•                  reduce the availability of our capital tofund our clinical trials for AI-700, the build-out and qualification of ourcommercial manufacturing space in Tewksbury, Massachusetts and for workingcapital and other general corporate 

 

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purposes and may require us,in order to meet these obligations, to delay or reduce expenditures or foregobusiness opportunities; and

 

•                  potentially impair our ability to obtainadditional financing, including intended future borrowings against ourequipment financing line with Oxford Finance Corporation.

 

To address our capital needs, we may elect to raise funds throughpublic or private sales of equity or from borrowings or from strategicpartners.  Additional equity financing,if available, may be dilutive to our stockholders; debt financing, ifavailable, may involve significant cash payment obligations and covenants thatrestrict our ability to operate as a business; and strategic partnerships, ifavailable, may result in royalties or other terms which reduce our economicpotential from products under development.

 

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

 

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

 

No product can receive FDA approval unless humanclinical trials show both safety and efficacy for each target indication inaccordance with FDA standards. A number of companies in the pharmaceutical andbiotechnology industries have suffered significant setbacks in late stageclinical trials even after achieving promising results in early stagedevelopment. We therefore cannot assure you that the results from our Phase 2clinical trials for AI-700 will be predictive of results obtained in our Phase3 clinical trials. Many of the patients in our AI-700 clinical trials havecoronary heart disease. As part of our AI-700 clinical trials, patients will beexposed to potential safety risks associated with a stress test, includingrisks associated with a pharmacological stressor, and AI-700. Given the natureof the AI-700 clinical trials, including administering AI-700 in Phase 3 tolarger numbers of at-risk patients and new clinical sites and administering AI-700to patients with coexisting disease, adverse events are expected to beencountered during the clinical trial. Adverse events are also likely to beencountered in clinical trials for our other products, which clinical trialsalso include at-risk patients. If significant adverse events are detected andthese events are attributable to our products, such events could delay, limitor prevent regulatory agency approval. Further, data obtained from pre-clinicaland clinical activities are subject to varying interpretations that coulddelay, limit or prevent regulatory agency approval. We cannot assure you thatour Phase 3 plan for AI-700 will successfully address the concerns of the FDAor that the results of the Phase 3 program will establish the safety andefficacy of AI-700 sufficiently for us to obtain regulatory approval.

 

We may also encounter delays or rejections based onour inability to enroll enough patients to complete our clinical trials. We mayalso encounter delays, resulting from the need to enroll more patients than wecurrently plan for in our clinical trials, based on our inability to enroll thecorrect proportion of patients with and without disease that is consistent withour estimated clinical trial enrollment, a higher than expected number ofpatients enrolled in the trials who are unevaluable because their nuclearstress or angiography studies are not compliant with trial protocol or a changein the sample size required to meet desired study endpoints. In April 2005,we revised the statistical analysis plan for our AI-700 Phase 3 clinical trialsbased upon feedback from the FDA and this revision had the effect of increasingthe number of patients estimated to be needed to complete the Phase 3 clinicaltrials to approximately 700 patients based on assumptions that we believed werethe most appropriate at the time.  Weintend to seek continued discussions with the FDA, which could lead to otherchanges relating to the Phase 3 clinical trials or related statistical analysisplans.  Patient enrollment depends onmany factors, including the size and disease prevalence of the patientpopulation, the nature of the protocol, the proximity of patients to clinicalsites, and the eligibility criteria for the study and the freedom to operatewith respect to intellectual property. During the Phase 3 pivotal trials, weare blinded to the disease prevalence of patients in the trials. However, anindependent data monitoring board may look at the patient disease prevalencedata and can, at certain intervals, provide us with feedback as to whether itappears that the number of patients needed to achieve statistical significanceis appropriate. This may lead to an increase in the number of patients requiredto complete either or both trials. Separately, the independent data monitoring board may perform aprospectively planned re-estimation of the patient sample size required for thetrials. This re-estimation may result in the need to enroll more patients.Delays in planned patient enrollment, or the need to enroll more patients, mayresult in increased costs and delays, which could have a harmful effect on ourfinancial position and business. We may encounter delays or rejections based onchanges in regulatory agency policies or personnel during the period in whichwe develop a drug or the period required for review of 

 

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any application for regulatory agency approval of a particularcompound. On May 1, 2004, changes went into effect in the regulation ofclinical trials in Europe. Our continuing compliance with these changes couldlead to delays to our clinical trials. We also may encounter delays in theevent we are unable to produce clinical trial material in sufficient quantitiesand of sufficient quality to meet the schedule for our planned clinicaltrials. In addition, we rely on a number of third parties, such as clinicalresearch organizations, to help support the clinical trials by performingindependent clinical monitoring, data acquisition and data evaluations. Anyfailure on the part of these third parties could delay the regulatory approvalprocess.

 

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

 

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

 

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

 

•*                                         *adverselyaffect our ability to generate royalties.

 

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

 

We cannot be certain that we will obtain anyregulatory approvals in other countries and the failure to obtain theseapprovals may materially adversely affect our business, financial condition andresults of operations. In order to market our products outside of the UnitedStates, we and our current, and potential future, collaborative partners mustestablish and comply with numerous and varying regulatory requirements of othercountries regarding safety and efficacy. The approval procedures vary amongcountries and can involve additional product testing and additionaladministrative review periods. The time required to obtain approval in othercountries might differ from that required to obtain FDA approval. Theregulatory approval process in other countries may include all of the risksassociated with obtaining FDA approval detailed above. Approval by the FDA doesnot ensure approval by the regulatory authorities of other countries. Inaddition, many countries outside the United States require a separate reviewprocess prior to marketing to determine whether their national health insurancescheme will pay for newly approved products, as well as the price which may becharged for a product.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

•*                                         *thenumber of product candidates we pursue;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We know of U.S. and foreign patents issued to thirdparties that relate to aspects of our product candidates. There may also be patentapplications filed by these or other parties in the United States and variousforeign jurisdictions that relate to some aspects of 

 

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our product candidates, which, if issued, could subject us to infringementactions. In particular, we are aware of U.S. and foreign patents owned by thirdparties, including potential competitors that arguably cover aspects of our AI-700contrast agent. We and several of these parties have recently been activelyengaged in opposing the grant of European patents with claims that arguablycover aspects of our AI-700 product. Parties may contest patents in Europeprior to contesting the counterpart patents in the United States because ofprocedural differences between European and U.S. patent laws as well aseconomic considerations. There is a significant possibility that one or more ofthese third parties will use litigation to assert their patents in the UnitedStates or Europe.

 

The owners or licensees of these and other patents mayfile one or more infringement actions against us. In addition, a competitor mayclaim misappropriation of a trade secret by an employee hired from thatcompetitor. Any such infringement or misappropriation action could cause us toincur substantial costs defending the lawsuit and could distract our managementfrom our business, even if the allegations of infringement or misappropriationare unwarranted. The defense of multiple claims could have a disproportionatelygreater impact. Furthermore, a party making this type of claim could secure ajudgment that requires us to pay substantial damages, which would increase ouroperating losses and reduce our resources available for development activities.A judgment could also include an injunction or other court order that couldprevent us from making, using, selling, offering for sale or importing ourproducts or prevent our customers from using our products. If a courtdetermined or if we independently concluded that any of our products ormanufacturing processes violated third-party proprietary rights, our clinicaltrials could be delayed and there can be no assurance that we would be able toreengineer the product or processes to avoid those rights, or to obtain alicense under those rights on commercially reasonable terms, if at all.

 

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

 

The following factors are important to our success:

 

•*                                         *receivingpatent protection for our product candidates;

 

•*                                         *maintainingour trade secrets;

 

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

 

•*                                         *preventingothers from infringing our proprietary rights.

 

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

 

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

 

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

 

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

 

In order to protect or enforce our patent rights, wemay initiate patent litigation against third parties in the United States or inforeign countries. In addition, we may become subject to interference oropposition proceedings conducted in patent and trademark offices to determinethe priority of inventions. The defense of intellectual property rights,including patent rights through lawsuits, interference or oppositionproceedings, and other legal and administrative proceedings would be costly anddivert our technical and management personnel from their normalresponsibilities. Such costs would increase our operating losses and reduce ourresources available for development activities. An adverse determination of anylitigation or defense proceedings could put one or more of our patents at riskof being invalidated or interpreted narrowly and could put our patentapplications at risk of not issuing.

 

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

 

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

 

We have no experience in manufacturing our productsfor commercial use and limited experience in designing equipment for themanufacture of our products. We are working to build out and qualify acommercial manufacturing facility in Tewksbury, Massachusetts and todemonstrate that we can produce AI-700 at a commercial manufacturing scaleprior to our filing of a NDA for AI-700 and, subject to required regulatoryapprovals, we intend to manufacture AI-700 in this facility for commercial use.We can not assure you that we will be able to successfully manufacture ourproducts in sufficient quantities for commercial sale, or obtain the necessaryregulatory approvals for such commercial manufacture, at all or in a timely oreconomical manner. Our intention to manufacture AI-700 or other productsexposes us to the following risks, any of which could delay or prevent theapproval of our products by the FDA or corresponding state and foreignagencies, or the commercialization of our products, or result in higher costsor inability to meet demand for AI-700 leading to potential revenue loss, andany of which would have a material adverse impact on our business, financialcondition and results of operations.

 

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

 

•*                                         *Manufacturersare obliged to manufacture in highly controlled environments and to operate inaccordance with FDA and international mandated current good manufacturingpractices, or cGMPs. For our clinical trials we have relied on contractmanufacturers for such facilities and cGMP compliance. In July 2004, weentered into a lease for a facility in Tewksbury, Massachusetts that we are inthe process of converting into a commercial manufacturing facility for AI-700.Creation and qualification of a commercial manufacturing environment requiressignificant expertise and capital resources, including the development ofadvanced manufacturing techniques and process controls and is subject to localand state planning approvals. Manufacturers of pharmaceutical products oftenencounter difficulties in constructing and qualifying new manufacturingfacilities and in production, especially in scaling-up initial production. Afailure within this new facility to establish and follow cGMPs and to documentadherence to such practices may lead to significant delays in the availabilityof material for our NDA filing or commercial production for AI-700 and maydelay or prevent filing or approval of marketing applications for our productsor the ability to continue to manufacture the products. Certain of these delayswould further require us to continue to operate this facility and incur relatedcosts.

 

•*                                         *Manufactureof our product candidates, in preparation for filing a NDA and for commercialproduction, will each initially require and rely on a single commercialmanufacturing site, directly or through a contract manufacturer, without thebackup of a second site that is qualified for commercial manufacture of theproduct. Qualification of another manufacturing site can be expensive and timeconsuming. Prior to using 

 

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product from a new manufacturing site, we mustdemonstrate that the specifications for the product are consistent with thespecifications for the product as it was manufactured at a prior qualified siteor we must clinically or otherwise demonstrate that the safety and efficacy ofthe product produced in the new manufacturing site is consistent with theproduct as it was manufactured at the prior site. Demonstrating suchconsistency may be difficult, expensive or time consuming. In addition, beforewe would be able to produce product for commercial use at a new facility, itwill have to undergo a pre-approval inspection by the FDA and correspondingstate and foreign agencies. Once approved, drug manufacturers are subject toongoing periodic unannounced inspection by the FDA and corresponding state andforeign agencies to ensure strict compliance with cGMPs, other governmentregulations and corresponding foreign standards. Failure to maintain compliancewith cGMP or with safety or environmental regulations could result inpenalties, product recalls or restrictions on the use of the manufacturingsite.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

•*                                         *Forproduction of clinical trial material for each of our current product candidateswe will initially rely on a single manufacturer. Changing these or futuremanufacturers may be difficult and the number of potential 

 

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manufacturers is limited. Changing manufacturers mayrequire re-validation of the manufacturing processes and procedures inaccordance with FDA-mandated cGMPs. Such re-validation may be costly andtime-consuming. It may be difficult or impossible for us to find replacementmanufacturers on acceptable terms quickly, or at all.

 

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

 

Drug manufacturers are subject to ongoing periodicunannounced inspection by the FDA and corresponding state and foreign agenciesto ensure strict compliance with cGMPs, other government regulations andcorresponding foreign standards. While we are obligated to audit theperformance of third party contractors, we do not have control over ourthird-party manufacturers’ compliance with these regulations and standards.Failure by our third-party manufacturers or us to comply with applicableregulations could result in sanctions being imposed on us, including fines,injunctions, civil penalties, failure of the government to grant marketapproval of drugs, delays, suspension or withdrawal of approvals, seizures orrecalls of product, operating restrictions and criminal prosecutions, any ofwhich could significantly and adversely affect our business.

 

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

 

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

 

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

 

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

 

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

 

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

 

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collaboration with third parties or gain market acceptance for ourproducts. To the extent we have or will enter co-promotion or other licensingarrangements, any revenues we receive will depend on the efforts of thirdparties and there can be no assurance that our efforts will succeed.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

•*                                         *AI-700,our ultrasound contrast agent and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear contrast agents thatare approved for use in myocardial perfusion imaging include products marketedby GE Healthcare, Bristol-Myers Squibb and Tyco International. In 2004, thecost of a nuclear stress test was approximately $770 per procedure. Inaddition, GE Healthcare, Bristol-Myers Squibb and Imcor have developedultrasound contrast agents that have been approved by the FDA for use in LVOand EBD in patients with suboptimal images, and in the future they may seek tobroaden their products to include stress echo and myocardial perfusion assessment.Moreover, we are aware that other companies, such as Bracco, are developingultrasound contrast agents for wall imaging and for radiology applications, andthat Point Biomedical is developing an ultrasound contrast agent specificallyfor myocardial perfusion imaging. In 2004, Point announced that it had recentlycompleted two pivotal Phase 3 trials for this contrast agent and planned tofile an NDA with the FDA. Finally, some cardiologists may find it satisfactoryto use stress echo without contrast for the detection of coronary heartdisease.

 

•*                                         *AI-850,our reformulation of paclitaxel, if approved for marketing and sale, will alsoface intense competition from companies such as American PharmaceuticalPartners, NeoPharm and Sonus Pharmaceuticals, which are applying significantresources and expertise to developing reformulations of paclitaxel forintravenous delivery. In early 2005, American Pharmaceutical Partners receivedFDA approval for their product. Other companies, such as Cell Therapeutics, aredeveloping new chemical entities that involve paclitaxel conjugated, orchemically bound, to another chemical.

 

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

 

Relative to us, most of our competitors havesubstantially greater capital resources, research and development staffs,facilities and experience in conducting clinical trials and obtainingregulatory approvals, as well as in manufacturing and marketing pharmaceuticalproducts. Many of our competitors may achieve product commercialization orpatent protection earlier than we will.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

•*                                         *dependenceon local distributors;

 

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

 

•*                                         *adversechanges in trade and tax regulations;

 

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

 

•*                                         *politicaland economic instability; and

 

•*                                         *currencyrisks.

 

**Risks Relating to Our Industry**

 

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

 

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

 

If we fail to comply with applicable regulatoryrequirements, we may be subject to fines, suspension or withdrawal ofregulatory approvals, product recalls, seizure of products, operatingrestrictions and criminal prosecution.

 

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

 

Government health administration authorities, privatehealth insurers and other organizations generally provide reimbursement forproducts like our product candidates, and our commercial success will depend inpart on these third-party payors agreeing to 

 

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reimburse patients for the costs of our products. Even if we succeed inbringing any of our proposed products to market, we cannot assure you thatthird-party payors, in the United States, Europe and other markets that we maypursue, will consider our products cost-effective or provide reimbursement inwhole or in part for their use or agree to the proposed price.

 

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

 

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

 

Moreover, the trend toward managed healthcare in theUnited States, the growth of organizations such as health maintenanceorganizations, and legislative proposals to reform healthcare and governmentinsurance programs could significantly influence the purchase of healthcareservices and products, resulting in lower prices and reduced demand for ourproducts which could adversely affect our business, financial condition andresults of operations.

 

In addition, legislation and regulations affecting thepricing of pharmaceuticals may change in ways adverse to us before or after theFDA or other regulatory agencies approve any of our proposed products formarketing. While we cannot predict the likelihood of any of these legislativeor regulatory proposals, if any government or regulatory agencies adopt theseproposals they could materially adversely affect our business, financialcondition and results of operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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**Risks Related to Our Common Stock**

 

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

 

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

 

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

 

•*                                         *marketconditions in the pharmaceutical and biotechnology sectors;

 

•*                                         *rumorsrelating to us or our competitors;

 

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

 

•*                                         *ourquarterly operating results;

 

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

 

•*                                         *FDAor international regulatory actions.

 

The market price of our common stock may alsofluctuate in response to the exercise by us of rights under the terms of ourconvertible preferred stock. For example, we may elect to automatically convertthe preferred stock if our common stock price has exceeded 150% of theconversion price of the preferred stock for at least 20 trading days during a 30-daytrading period ending within five trading days prior to the notice of automaticconversion. There is a risk of fluctuation in the price of our common stockbetween the time when we may first elect to automatically convert the preferredstock and the automatic conversion date. These fluctuations may adverselyaffect the value of the common stock.

 

***Our controllingequity holders may have conflicts of interests with us or you in the future.***

 

Based on information provided to us by such entities:Quaker Capital Management Corporation and its affiliates beneficially ownapproximately 14% of our outstanding common stock; Bank of America Corporationand its affiliates beneficially own approximately 11% of our outstanding commonstock; The Baupost Group LLC beneficially owns approximately 11% of ouroutstanding common stock; Mr. Peter David Boone beneficially ownsapproximately 9% of our outstanding common stock; and Polygon InvestmentPartners LLP and its affiliates beneficially owns approximately 6% of our outstandingcommon stock. Collectively these investors control approximately 51% of ourcommon stock.  These investors,particularly if they were to act together as a concentrated group, could exertinfluence over the election of our directors, direct our policies andoperations, including future issuances of common stock or other securities, thepayments of dividends, if any, on our common stock, the incurrence of debt byus, amendments to our certificate of incorporation and bylaws and entering intoof extraordinary transactions, and their interests, as a concentrated group,may not in all cases be aligned with your interests.  This concentration of ownership among a smallnumber of investors may make it more difficult for other stockholders toinfluence matters requiring stockholder approval and may have the effect ofdelaying, preventing or deterring a change in control of our company, therebypossibly depriving our stockholders of an opportunity to receive a premium fortheir common stock as part of any sale or acquisition.

 

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

 

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

 

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

 

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

 

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

 

The market price of our common stock could decline asa result of sales by our existing stockholders of shares of common stock in themarket, or the perception that these sales could occur. These sales might alsomake it more difficult for us to sell equity securities at a time and pricethat we deem appropriate. As of August 12, 2005 we have 17,837,146 sharesof common stock outstanding and 900,000 shares of convertible preferred stockoutstanding that are convertible into approximately 6,559,740 shares of ourcommon stock, plus up to a maximum of approximately 1,837,312 additional sharesof our common stock issuable at our option in satisfaction of the maximumdividend make- whole payment on these shares of preferred stock. All of theshares of common stock issuable upon conversion of our preferred stock will befreely tradable without restriction under the federal securities laws unlesspurchased by our affiliates.

 

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

 

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

 

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

 

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

 

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

 

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the board as determined by our board of directors. These voting rightswill terminate when we have declared and either paid or set aside for paymentall accrued and unpaid dividends. The terms of office of all directors soelected will terminate immediately upon the termination of these voting rights.

 

***Provisions ofDelaware 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 makeit more difficult for you to change management.***

 

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

 

These provisions include:

 

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

 

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

 

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

 

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

 

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

 

***We have never paiddividends on our common stock, and we do not anticipate paying any cashdividends on our common stock in the foreseeable future.***

 

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

 

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

 

We have not used derivative financial instruments forspeculation or trading purposes. However, we are exposed to market risk relatedto changes in interest rates. Our current policy is to maintain an investmentportfolio consisting mainly of U.S. money market and government-gradesecurities, directly or through managed funds, with maturities of one year orless. Our cash is deposited in and invested through highly rated financialinstitutions in North America. Our cash equivalents are subject to interestrate risk and will fall in value if market interest rates increase. If marketinterest rates were to increase immediately and uniformly by 10% from levels atJune 30, 2005, we estimate that the fair value of our investment portfoliowould decline by an immaterial amount. We currently have the ability to holdour fixed income investments until maturity, and therefore we do not expect ouroperating results or cash flows to be affected to any significant degree by theeffect of a change in market interest rates on our investments. Interest rateson our outstanding borrowings are at fixed rates of interest and, therefore, wedo not expect our operating results or cash flows to be affected to anysignificant degree by the effect of a change in market interest rates on ouroutstanding borrowing.

 

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**Effectsof Inflation**

 

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

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

As of June 30,2005 (the “Evaluation Date”), the our management, with the participation of ourChief Executive Officer and our Senior Vice President and Chief FinancialOfficer, evaluated the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15(b) promulgated under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”). Based upon that evaluation, ourChief Executive Officer and our Senior Vice President and Chief Financial Officerconcluded that, as of the Evaluation Date, our disclosure controls andprocedures were effective in ensuring that material information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, includingensuring that such material information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and our Senior Vice Presidentand Chief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

**InternalControl Over Financial Reporting**

 

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

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

None

 

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

 

None

 

**ITEM 3.DEFAULTS UPON SENIOR SECURITIES**

 

None

 

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

 

At theCompany’s Annual Meeting of Stockholders held on June 16, 2005, thestockholders approved the following:

 

Electedtwo Class II directors as follows:

 
| **Director**          | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|-----------------------|------------|---------------|------------|--------------------|------------|
| Derek Lemke-Von Ammon |       | 12,253,711    |       | 3,090,711          |       |
| Garen Bohlin          |       | 12,457,894    |       | 2,886,528          |       |

 

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| ** **                                         | ** ** | **Votes For** | ** ** | **Votes Against** | ** ** | **Abstain** | ** ** |
|----------------------------------------------------|------------|---------------|------------|-------------------|------------|-------------|------------|
| Approval of 2005 Stock  Option and Incentive Plan: |       | 8,176,027     |       | 4,640,463         |       | 460,416     |       |

 

**ITEM 5. OTHER INFORMATION**

 

**None**

 

**ITEM 6. EXHIBITS**

 

List of exhibits:

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                      |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                              |
| *10.1               |       | Form of 2005 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule)     |
|                |       |                                                                                                              |
| *10.2               |       | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) |
|                |       |                                                                                                              |
| *10.3               |       | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) |
|                |       |                                                                                                              |
| *10.4               |       | Form of 2003 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule)     |
|                |       |                                                                                                              |
| *10.5               |       | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) |
|                |       |                                                                                                              |
| *10.6               |       | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) |
|                |       |                                                                                                              |
| *10.7 (1)           |       | Acusphere, Inc. 2005 Stock Option and Incentive  Plan, as amended                                            |
|                |       |                                                                                                              |
| 31.1                |       | Rule 13a-14(a) /  15d-14(a) Certification                                                          |
|                |       |                                                                                                              |
| 31.2                |       | Rule 13a-14(a) /  15d-14(a) Certification                                                          |
|                |       |                                                                                                              |
| 32.1                |       | Section 1350  Certifications                                                                                 |

 

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(1) Incorporatedherein by reference to the Company’s Form 8-K filed on June 20, 2005

 

40

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on this 15th day of August 2005.

 

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

 

41

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                      |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                              |
| *10.1               |       | Form of 2005 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule)     |
|                |       |                                                                                                              |
| *10.2               |       | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) |
|                |       |                                                                                                              |
| *10.3               |       | Form of 2005 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (1 year vesting schedule) |
|                |       |                                                                                                              |
| *10.4               |       | Form of 2003 Stock Option and Incentive Plan  Incentive Stock Option Agreement (4 year vesting schedule)     |
|                |       |                                                                                                              |
| *10.5               |       | Form of 2003 Stock Option and Incentive Plan  Non-Statutory Stock Option Agreement (4 year vesting schedule) |
|                |       |                                                                                                              |
| *10.6               |       | Form of 2003 Stock Option and Incentive Plan Non-Statutory  Stock Option Agreement (1 year vesting schedule) |
|                |       |                                                                                                              |
| *10.7 (1)           |       | Acusphere, Inc. 2005 Stock Option and Incentive  Plan, as amended                                            |
|                |       |                                                                                                              |
| 31.1                |       | Rule 13a-14(a) /  15d-14(a) Certification                                                          |
|                |       |                                                                                                              |
| 31.2                |       | Rule 13a-14(a) /  15d-14(a) Certification                                                          |
|                |       |                                                                                                              |
| 32.1                |       | Section 1350  Certifications                                                                                 |

 

----

(1) Incorporatedherein by reference to the Company’s Form 8-K filed on June 20, 2005

 

42

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