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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 or [   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from  to . Commission File Number 000-50405 ACUSPHERE, INC.  Delaware
    
    04-3208947(State or other jurisdiction of incorporation
    
    (IRS Employer Identification No.)or organization)
 500 Arsenal StreetWatertown, Massachusetts
    
    02472(Address of principal executive offices)
    
    (Zip Code)
 Registrants Telephone Number, Including Area Code: (617) 648-8800 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [   ] No [X] As
of May 3, 2004 there were 14,317,260 shares of the registrants common
stock, $.01 par value per share, outstanding.




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ACUSPHERE, INC. Form 10-Q
For the Quarterly Period Ended March 31, 2004 CONTENTS PageNumberPART I: FINANCIAL INFORMATIONItem 1. Consolidated Financial StatementsConsolidated Balance Sheets:December 31, 2003 and March 31, 2004 (Unaudited)
    
    
    3Consolidated
Statements of Operations (Unaudited):Three Months ended March 31, 2003 and 2004 and the period from inception
(July 12, 1993) to March 31, 2004
    
    
    4Consolidated
Statements of Cash Flows (Unaudited):Three Months ended March 31, 2003 and 2004 and the period from inception
(July 12, 1993) to March 31, 2004
    
    
    5Notes to Consolidated Financial Statements (Unaudited)
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3. Quantitative and Qualitative Disclosure about Market Risk
    
    
    30Item 4. Controls and Procedures
    
    
    31PART II: OTHER INFORMATION
    
    
    31Item 1. Legal Proceedings
    
    
    31Item 2. Changes in Securities and Use of Proceeds
    
    
    31Item 3. Defaults Upon Senior Securities
    
    
    32Item 4. Submission of Matters to a Vote of Security Holders
    
    
    32Item 5. Other Information
    
    
    32Item 6. Exhibits and Reports on Form 8-K
    
    
    32Signature
    
    
    33EX-31.1 SECT. 302 CERTIFICATION OF C.E.O.EX-31.2 SECT. 302 CERTIFICATION OF C.F.O.EX-32.1 SECT. 906 CERTIFICATIONS




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PART I: FINANCIAL INFORMATION 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
 ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company) 
 CONSOLIDATED BALANCE
SHEETS(unaudited) December 31,
    
    March 31,2003
    
    2004(unaudited)ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    54,562,378
    
    
    $
    46,775,298Other current assets
    
    
    712,673
    
    
    
    895,328Total current assets
    
    
    55,275,051
    
    
    
    47,670,626PROPERTY AND EQUIPMENT, At cost:Property and equipment (Note 4)
    
    
    9,959,855
    
    
    
    10,944,347Less accumulated depreciation and amortization
    
    
    7,935,450
    
    
    
    8,256,423Property and equipment, net
    
    
    2,024,405
    
    
    
    2,687,924OTHER ASSETS
    
    
    1,624,797
    
    
    
    1,484,834TOTAL
    
    $
    58,924,253
    
    
    $
    51,843,384LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND
STOCKHOLDERS EQUITYCURRENT LIABILITIES:Current portion of long-term obligations (Note 5)
    
    $
    884,799
    
    
    $
    854,555Accounts payable
    
    
    1,519,981
    
    
    
    1,230,024Accrued expenses
    
    
    1,939,012
    
    
    
    2,042,861Total current liabilities
    
    
    4,343,792
    
    
    
    4,127,440LONG-TERM OBLIGATIONS, net of current portion
    
    
    205,418
    
    
    
    14,847COMMITMENTSREDEEMABLE CONVERTIBLE PREFERRED STOCK, at carrying
value; including accrued dividends; authorized,
5,000,000 shares as of December 31, 2003 and March
31, 2004; no shares issued and outstanding as of
December 31, 2003 and March 31, 2004
    
    
    
    
    
    
    STOCKHOLDERS EQUITY:Common stock, $0.01 par value; authorized,
98,500,000 shares as of December 31, 2003 and
March 31, 2004; issued and outstanding
14,294,533 shares as of December 31, 2003 and
14,301,464 shares as of March 31, 2004
    
    
    142,945
    
    
    
    143,015Additional paid-in capital
    
    
    201,422,784
    
    
    
    201,688,194Deferred stock-based compensation
    
    
    (1,723,229
    )
    
    
    (1,738,093
    )Deficit accumulated during development stage
    
    
    (145,467,457
    )
    
    
    (152,392,019
    )Total stockholders equity
    
    
    54,375,043
    
    
    
    47,701,097TOTAL
    
    $
    58,924,253
    
    
    $
    51,843,384
 The accompanying notes are an integral part of these consolidated financial statements. 3




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ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company) 
 CONSOLIDATED STATEMENTS OF OPERATIONS  Period fromThree Months Ended
    
    Inception (July 12,1993) toMarch 31,
    
    March 31,
    
    March 31,2003
    
    2004
    
    2004OPERATING EXPENSES:Research and development(1)
    
    $
    3,102,286
    
    
    $
    5,512,854
    
    
    $
    78,065,952General and administrative(1)
    
    
    863,568
    
    
    
    1,261,380
    
    
    
    21,386,302Stock-based compensation
    
    
    319,998
    
    
    
    232,681
    
    
    
    4,900,266Total operating expenses
    
    
    4,285,852
    
    
    
    7,006,915
    
    
    
    104,352,520Equity in loss of joint venture
    
    
    
    
    
    
    
    
    
    
    15,164,257Interest income
    
    
    22,106
    
    
    
    107,773
    
    
    
    4,081,711Other income (expense)
    
    
    
    
    
    
    
    
    
    
    31,815Interest expense
    
    
    (224,442
    )
    
    
    (25,420
    )
    
    
    (6,731,318
    )NET LOSS
    
    
    (4,488,188
    )
    
    
    (6,924,562
    )
    
    
    (122,134,569
    )Accretion of dividends and
offering costs on preferred
stock
    
    
    1,609,167
    
    
    
    
    
    
    
    30,257,450NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS
    
    ($
    6,097,355
    )
    
    ($
    6,924,562
    )
    
    ($
    152,392,019
    )NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS PER SHARE Basic and diluted
    
    $
    (5.07
    )
    
    $
    (0.48
    )WEIGHTED-AVERAGE SHARES
OUTSTANDING Basic and diluted
    
    
    1,202,312
    
    
    
    14,286,093(1) Excludes stock-based
compensation as follows:Research and development
    
    $
    128,000
    
    
    $
    89,949
    
    
    $
    2,084,092General and administrative
    
    
    191,998
    
    
    
    142,732
    
    
    
    2,816,174$
    319,998
    
    
    $
    232,681
    
    
    $
    4,900,266
 The accompanying notes are an integral part of these consolidated financial statements. 4




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ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company) 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  Period fromThree Months Ended
    
    Inception (July12, 1993) toMarch 31,
    
    March 31,
    
    March 31,2003
    
    2004
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    ($
    4,488,188
    )
    
    ($
    6,924,562
    )
    
    ($
    122,134,569
    )Adjustments to reconcile net loss to cash
used in operating activities:Stock-based compensation expense
    
    
    319,998
    
    
    
    232,681
    
    
    
    4,900,266Depreciation and amortization
    
    
    477,737
    
    
    
    320,973
    
    
    
    9,070,737Noncash interest expense
    
    
    70,697
    
    
    
    4,565
    
    
    
    1,973,833Noncash rent expense
    
    
    13,410
    
    
    
    13,410
    
    
    
    120,690Equity in loss from joint venture
    
    
    
    
    
    
    
    
    
    
    15,164,257Changes in operating assets and liabilities:Due from joint venture
    
    
    
    
    
    
    
    
    
    
    (3,149,257
    )Other current assets
    
    
    37,482
    
    
    
    (116,299
    )
    
    
    (946,233
    )Accounts payable
    
    
    164,872
    
    
    
    289,958
    
    
    
    1,230,025Accrued expenses
    
    
    (159,282
    )
    
    
    103,850
    
    
    
    3,026,789Net cash used in operating activities
    
    
    (3,563,274
    )
    
    
    (6,655,340
    )
    
    
    (90,743,462
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (88,582
    )
    
    
    (924,297
    )
    
    
    (2,701,895
    )Increase in other assets
    
    
    (68,477
    )
    
    
    
    
    
    
    (1,738,246
    )Investment in joint venture
    
    
    
    
    
    
    
    
    
    
    (12,015,000
    )Maturities of short-term investments
    
    
    195,412
    
    
    
    
    
    
    
    17,499Net cash provided by (used in)
investing activities
    
    
    38,353
    
    
    
    (924,297
    )
    
    
    (16,437,642
    )CASH FLOWS FROM FINANCING ACTIVITIES:Payments on
long-term obligations
    
    
    (981,717
    )
    
    
    (225,379
    )
    
    
    (18,006,597
    )Proceeds
from long-term obligations
    
    
    
    
    
    
    
    
    
    
    29,440,342Proceeds from financing of equipment
    
    
    
    
    
    
    
    
    
    
    347,960Net proceeds from sale of redeemable
convertible preferred stock
    
    
    
    
    
    
    
    
    
    
    94,337,203Net proceeds from sale of common stock in
initial public offering
    
    
    
    
    
    
    
    
    
    
    47,618,443Net proceeds from exercise of stock options
    
    
    
    
    
    
    5,772
    
    
    
    208,247Proceeds from issuance of common stock from
employee stock purchase plan
    
    
    
    
    
    
    12,164
    
    
    
    12,164Purchase and retirement of treasury stock
    
    
    
    
    
    
    
    
    
    
    (1,360
    )Net cash provided by (used in)
financing activities
    
    
    (981,717
    )
    
    
    (207,443
    )
    
    
    153,956,402NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS
    
    
    (4,506,638
    )
    
    
    (7,787,080
    )
    
    
    46,775,298CASH AND CASH EQUIVALENTS  Beginning of period
    
    
    7,796,238
    
    
    
    54,562,378
    
    
    
    CASH AND CASH EQUIVALENTS  End of period
    
    $
    3,289,600
    
    
    $
    46,775,298
    
    
    $
    46,775,298
 The accompanying notes are an integral part of these consolidated financial statements. 5




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ACUSPHERE, INC. AND SUBSIDIARY
(A Development Stage Company) 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)  1.
    
    Basis of Presentation The accompanying unaudited consolidated financial statements of Acusphere,
Inc. and Subsidiary (the Company), have been prepared in accordance with
generally accepted accounting principles in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
in the United States of America for complete financial statements. These
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Companys latest audited annual
financial statements. Those audited statements are included in our Annual
Report on Form 10-K for the year ended December 31, 2003, which has been filed
with the SEC. On September 12, 2003, the Company effected a one for six reverse stock
split of its common stock. All share and per share amounts included in these
unaudited consolidated financial statements have been retroactively adjusted
for all periods presented to give effect to the reverse stock split. In the opinion of management, all adjustments, consisting only of normal,
recurring adjustments (with the exception of the effect of the reverse stock
split) considered necessary for a fair presentation of the results of these
interim periods have been included. The results of operations for the three
months ended March 31, 2004 may not be indicative of the results that may be
expected for the full fiscal year. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of expenses
during the reporting period. Actual results could differ from those estimates
or assumptions. The more significant estimates reflected in these financial
statements include judgmental accrued expenses and valuation of stock-based
compensation.  2.
    
    Accounting for Stock-based Compensation The Companys employee stock option plans are accounted for using the
intrinsic-value-based method of Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, no compensation expense is recorded for options issued to
employees with fixed amounts and fixed exercise prices which for accounting
purposes are at least equal to the fair value of the Companys common stock at
the date of grant. Conversely, when the exercise price for accounting purposes
is below fair value of the Companys common stock on the date of grant, a
non-cash charge to compensation expense is recorded ratably over the term of
the option vesting period in an amount equal to the difference between the
value calculated using the exercise price and the fair value. The Company uses
the fair-value method to account for non-employee stock-based compensation. Stock options granted during 2004 are as follows: WeightedAverageNumber
    
    Exercise
    
    Exerciseof
    
    Price
    
    Price PerShares
    
    Per Share
    
    ShareFor the three months ended:March 31, 2004
    
    
    541,139
    
    
    $
    8.50 - 9.60
    
    
    $
    9.08
 6




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The stock options granted in the three months ended March 31, 2004 were
granted at fair market value on the date of grant. Had compensation cost for grants issued during the current and prior
periods been determined consistent with Statement of Financial Accounting
Standard (SFAS) No. 123, Accounting for Stock-based Compensation, pro forma
net loss and net loss per share would have been the following: Three Months EndedMarch 31,
    
    March 31,2003
    
    2004Applicable to common stockholders:Net loss  as reported
    
    $
    (6,097,355
    )
    
    $
    (6,924,562
    )Add: Stock-based employee
compensation expense included
in reported net loss
    
    
    319,998
    
    
    
    195,227Deduct: Stock-based
employee compensation expense
determined under fair value
method
    
    
    (501,579
    )
    
    
    (425,600
    )Net loss  proforma
    
    $
    (6,278,936
    )
    
    $
    (7,154,935
    )Net loss per common share (basic
and diluted):As reported
    
    $
    (5.07
    )
    
    $
    (0.48
    )Pro forma
    
    $
    (5.22
    )
    
    $
    (0.50
    )
  3.
    
    Net Loss Per Common Share Basic and diluted net loss per common share is calculated by dividing the
net loss applicable to common stockholders by the weighted-average number of
unrestricted common shares outstanding during the period. Diluted net loss per
common share is the same as basic net loss per common share, since the effects
of potentially dilutive securities are antidilutive for all periods presented.
Antidilutive securities, which consist of redeemable convertible preferred
stock prior to 2004, stock options, warrants, and restricted common stock that
are not included in the diluted net loss per share calculation, aggregated
8,014,147 and 2,282,412 as of March 31, 2003 and 2004, respectively. The following table reconciles weighted-average common shares outstanding
to the shares used in the computation of basic and diluted weighted-average
common shares outstanding: Three Months EndedMarch 31,
    
    March 31,2003
    
    2004Weighted-average common shares
outstanding
    
    
    1,213,374
    
    
    
    14,297,281Less weighted-average unvested
restricted common shares
outstanding
    
    
    (11,062
    )
    
    
    (11,188
    )Basic and diluted
weighted-average common shares
outstanding
    
    
    1,202,312
    
    
    
    14,286,093
   7




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4.
    
    Property and Equipment Property and equipment at cost consist of the following: As of:December 31,
    
    March 31,2003
    
    2004Equipment
    
    $
    9,655,685
    
    
    $
    9,926,927Furniture and fixtures
    
    
    181,665
    
    
    
    185,060Leasehold improvements
    
    
    122,505
    
    
    
    122,505Deposits on equipment purchases
    
    
    
    
    
    
    709,855Total property and equipment
    
    $
    9,959,855
    
    
    $
    10,944,347
  5.
    
    Long-term Obligations The carrying value of long-term obligations is as follows: As of:December 31,
    
    March 31,2003
    
    2004Capital lease obligations
    
    $
    1,090,217
    
    
    $
    869,402Less current maturities
    
    
    884,799
    
    
    
    854,555Long-term obligations, net
    
    $
    205,418
    
    
    $
    14,847
 Long-term obligations, including current maturities, outstanding as of March 31,
2004 consisted of capital equipment leased under various capital lease
arrangements. Monthly payments range from $3,708 to $46,222 with maturities
through April 2005. In
April 2004, the Company entered into an $8.0 million equipment
financing line with an equipment financing company. Borrowings under
this equipment line can be made against qualified purchases through
March 2005. Such borrowings are to be secured by the qualified
purchases and repaid over 36 to 48 months, depending on the
nature of the equipment financed. No warrants were granted in
connection with this equipment line. The $8.0 million equipment
line is structured as a loan agreement. However, the Company may elect
to borrow up to $4.0 million of this amount in the form of a
capital lease. The interest rate on this facility varies depending
upon whether the borrowing is in the form of a loan or lease and
whether the term is 36 months or 48 months. Such interest rates are fixed at the time of each borrowing under the equipment line
with such rates adjusted between borrowings based on the
U.S. Federal Reserves Three Year and Four Year Treasury
Constant Maturity Rates. The equipment line includes provisions to
increase the line to $11.3 million upon the occurrence of
certain defined events.  6.
    
    Stockholders Equity On July 1, 2003, 3,731,999 shares of several series of preferred stock
were converted into 732,600 shares of common stock. These conversions were
based upon the conversion ratios then applicable for each series of preferred
stock. On October 14, 2003, upon the closing of the Companys initial public
offering, all remaining outstanding shares of preferred stock were converted
into shares of common stock based upon the conversion ratios then applicable. The Companys 1994 Stock Plan expired as of March 7, 2004 and there are no
more shares available for issuance under this plan. As of March 31, 2004, there
were 1,235,739 shares of common stock reserved for outstanding stock options
previously issued under the 1994 Stock Plan. On September 12, 2003, the Company effected a one for six reverse stock
split, the effect of which has been retroactively applied to all common stock
outstanding and to all common stock equivalents.  7.
    
    Comprehensive Income (Loss) Comprehensive loss is defined as the change in stockholders deficit
during a period from transactions and other events and circumstances from
nonowner sources. During the three months ended March 31, 2003 and 2004, other 8




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than reported net loss, the only other component of comprehensive loss
incurred by the Company were unrealized losses of $288 and zero, respectively,
on short term investments.  8.
    
    Recently Issued Accounting Pronouncements In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46),
which was amended by FIN 46R issued in December 2003. This interpretation of
Accounting Research Bulletin No. 51, Consolidated Financial Statements,
addresses consolidation by business enterprises of variable interest entities
(VIEs) that either: (1) do not have sufficient equity investment at risk to
permit the entity to finance its activities without additional subordinated
financial support, or (2) for which the equity investors lack an essential
characteristic of a controlling financial interest. This Interpretation applies
immediately to VIEs created after January 31, 2003. It also applies in the
first fiscal year or interim period ending after March 15, 2004, to VIEs
created before February 1, 2003 in which an enterprise holds a variable
interest. FIN 46 requires disclosure of VIEs in financial statements issued
after January 31, 2003, if it is reasonably possible that as of the transition
date: (1) the company will be the primary beneficiary of an existing VIE that
will require consolidation or, (2) the company will hold a significant variable
interest in, or have significant involvement with, an existing VIE. Adoption of
this interpretation did not have any impact on the Companys financial
statements. 9




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS Forward Looking Statements May Prove Inaccurate From time to time, information provided by us, statements made by our
employees or information included in our filings with the Securities and
Exchange Commission (including this quarterly report on Form 10-Q) may contain
statements that are not historical facts, so-called forward-looking
statements, that involve known and unknown risks, uncertainties and other
factors that may cause our actual results, performance or achievements to be
materially different from any future results, performance or achievements
expressed or implied by these forward-looking statements. Such forward-looking
statements are made pursuant to the safe harbor provisions of Section 21E of
the Securities Exchange Act of 1934, as amended. Forward-looking statements made in connection with this Form 10-Q include,
but are not limited to our estimates of expenses, staffing and capital
requirements and our abilities to raise additional financing; timing of our
clinical trials and regulatory milestones for AI-700; and our manufacturing
capabilities and timing of manufacturing production for our product candidates. In some cases, you can identify forward-looking statements by terms such
as may, will, should, could, would, expect, plans, anticipates,
believes, estimates, projects, predicts, intends, potential and
similar expression intended to identify forward-looking statements. These
statements reflect our current views with respect to future events, and are
based on assumptions and subject to risks and uncertainties. Also, these
forward-looking statements represent our estimates and assumptions only as of
the date of this report. Given these uncertainties, you should not place undue
reliance on these forward-looking statements. When considering forward-looking
statements, you should keep in mind the Factors That May Affect Future
Results and other cautionary statements included in this report. You should read this report with the understanding that our actual future
results may be materially different from what we expect. Our business,
financial condition, results of operations and prospects may change. We may not
update these forward-looking statements, even though our situation may change
in the future, unless we have obligations under the Federal securities laws to
update and disclose material developments related to previously disclosed
information. We qualify all of the information presented in this report, and
particularly our forward-looking statements, by these cautionary statements. Overview We are a specialty pharmaceutical company that develops new drugs and
improved formulations of existing drugs using our proprietary porous
microparticle technology. We are focused on developing proprietary drugs that
can offer significant benefits over existing drugs such as improved safety and
efficacy, increased patient compliance, greater ease of use, expanded
indications or reduced cost. Our three initial product candidates are in
clinical development and are designed to address large unmet clinical needs
within cardiology, oncology and asthma. Our lead product candidate is a
cardiovascular drug in Phase III clinical development for the detection of
coronary artery disease, the leading cause of death in the United States. We created our three initial product candidates using technology that
enables us to control the size and porosity of particles in a versatile manner,
so we can customize the particles to address the delivery needs of a variety of
drugs. We are focused on creating porous microparticles that are smaller than
red blood cells. Some of these microparticles are nanoparticles, which we refer
to as particles that are smaller than 1 micron. Small microparticles are
important for delivering drugs intravenously so that they can pass through the
bodys smallest blood vessels, for increasing the surface area of a drug so
that the drug will dissolve more rapidly, and for delivering drugs to the lung
via inhalation. Porosity is important for entrapping gases in microparticles,
for controlling the release rate of the drug from a microparticle, and for
targeting inhaled drugs to specific regions of the lung. 10




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We are a development stage company and have devoted substantially all of
our efforts towards the research and development of our product candidates and
raising capital. Since our inception, we have had no revenue from product sales
and have funded our operations almost exclusively through the private and
public placement of equity securities, equipment leases and debt financings. We
have not been profitable and have incurred a cumulative net loss of $122.0
million from inception through March 31, 2004. We expect to incur significant operating losses for the next several
years. Research and development expenses relating to our product candidates
will continue to increase. In particular, we expect to incur increased costs
for Phase III clinical trials of AI-700. General and administrative costs will
increase as we prepare for the commercialization of our product candidates and
as we incur costs associated with operating as a newly public company.
Manufacturing expenses, which are currently part of research and development
expenses, will also increase as we prepare for the commercialization of AI-700. AI-700 Clinical Trial Update Our Phase III program for AI-700 commenced in 2003 under a U.S.
Investigational New Drug application (IND) and in compliance with applicable
European regulatory requirements. The Phase III clinical plan provides for a
two-part program consisting of a pilot phase, which is designed to qualify and
train new investigators, and two multi-center pivotal trials each for
approximately 300 patients with suspected coronary artery disease. The Phase
III pilot and pivotal phase studies are taking place at clinical sites in North
America and Europe with data from the trials intended for submission to U.S.,
Canadian and European regulatory authorities. The endpoints for the trials are
sensitivity and specificity in comparison to nuclear stress testing,
angiography or clinical outcome. As of May 6, 2004,
we have enrolled 100 patients in the AI-700 Phase
III program and have initiated over twenty clinical sites. The Companys primary
current emphasis in the Phase III program is to continue advancing sites from
the pilot phase to the pivotal phase, which commenced in December 2003.
We plan to cumulatively enroll 300 patients in the Phase III
program by the end of 2004, to complete cumulative enrollment of approximately 600
patients in the Phase III pivotal trials by the end of 2005 and to file a New
Drug Application (NDA) for AI-700 in the first half of 2006. Although these
projected enrollment rates, milestones and target completion dates reflect our
current plans, we cannot assure you that we will complete these activities on
this schedule, if at all. Patent Update During the three months ended March 31, 2004, we were issued one
additional U.S. patent as follows: U.S. Patent No.
    
    Date Issued
    
    Expiration Date
    
    Subject6,689,390
    
    February 10, 2004
    
    February 22, 2019

    
    Matrices Formed of Polymer
and Hydrophobic Compounds for
Use in Drug Delivery
 As of March 31, 2004, we own fourteen issued U.S. patents, one allowed
U.S. patent application and eleven U.S. patent applications. We also own a
number of pending international and foreign patent applications corresponding
to these U.S. patents and applications. Financial Operations Overview Revenues.We have not generated any operating revenues since our inception
and do not expect operating revenues in the near future. Further in the future,
we will seek to generate revenues from a combination of product sales, up-front
or milestone payments in connection with collaborative or strategic
relationships, and royalties resulting from the license of our intellectual
property. 11




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Research and Development Expense.Research and development expense
consists of expenses incurred in developing and testing product candidates.
These expenses consist primarily of salaries and related expenses for
personnel, fees paid to professional service providers in conjunction with
independently monitoring our clinical trials and acquiring and evaluating data
in conjunction with our clinical trials, costs of contract manufacturing
services, costs of materials used in clinical trials and research and
development, depreciation of capital resources used to develop our products,
costs of facilities and the legal costs of pursuing patent protection on select
elements of our intellectual property. We expense research and development
costs, including patent related costs, as incurred. We believe that significant
investment in product development is a competitive necessity and plan to
continue these investments in order to realize the potential of our product
candidates and proprietary technologies. Development programs for later stage
product candidates, such as AI-700, tend to cost more than earlier stage
programs due to the length and the number of patients enrolled in clinical
trials for later stage programs. From inception through March 31, 2004, we
cumulatively spent $78.0 million on research and development. Additionally,
from June 2000 through September 2002, we performed research and development
through a joint venture, as discussed below. General and Administrative Expense.General and administrative expense
consists primarily of salaries and other related costs for personnel in
executive, finance, accounting, information technology and human resource
functions. Other costs include facility costs not otherwise included in
research and development expense and professional fees for legal and accounting
services. From inception through March 31, 2004, we have cumulatively incurred
$21.4 million in general and administrative expense. Stock-Based Compensation Expense.Stock-based compensation expense, which
is a non-cash charge, results principally from stock option grants to our
employees at exercise prices deemed for accounting purposes to be below the
fair market value of our stock on the date the stock options were granted
(fixed awards). Prior to our initial public offering, which closed on October
14, 2003, we granted certain stock options for which the exercise prices were
deemed for accounting purposes to be below the fair value of the underlying
common stock resulting in our recording stock-based compensation expense
associated with such grants. Stock-based compensation expense is also recorded
for stock option grants to non-employees and for restricted stock grants
provided to directors and advisors in lieu of cash compensation. Deferred
compensation on fixed awards is amortized as a charge to operations over the
vesting periods of the options and grants, subject to adjustment for forfeiture
during the vesting period. As of March 31, 2004, we deferred $1.7 million in
stock-based compensation and, from inception through March 31, 2004, recognized
stock-based compensation expense of $4.9 million. Equity in Loss of Joint Venture.In June 2000, we established in
collaboration with Elan Corporation, plc and its affiliates a joint venture,
Acusphere Newco, Ltd., a Bermuda corporation, to develop and commercialize
pulmonary drug delivery product candidates. In September 2002, we reached an
agreement with Elan terminating the joint venture in a cash-free transaction.
Equity in loss of joint venture consists of our portion of the losses from
Acusphere Newco, Ltd. from June 2000, when the joint venture was established,
until September 2002, when the joint venture was terminated. During that
period, we owned an 80.1% interest in the joint venture and Elan owned a 19.9%
interest in the joint venture on a fully diluted basis. Elan had retained
significant minority investor rights that prevented us from exercising full
control over the joint venture. Accordingly, during the period from June 2000
to September 2002, we recorded net losses of the joint venture in accordance
with our percentage ownership (80.1%) of such entity and reported such loss
using the equity method of accounting. In connection with the termination of
the joint venture we recorded a loss of $381,413 for an amount previously
recorded as due from Elan. Including this amount, from inception through the
date on which we terminated our joint venture with Elan, we cumulatively
incurred $15.2 million in equity in loss of joint venture. Interest and Other Income (Expense).Interest income consists of interest
earned on our cash, and cash equivalents . Interest expense consists of
interest incurred on equipment leases and on debt financings. Accretion of Dividends and Offering Costs on Convertible Preferred Stock.
Accretion of dividends and offering costs on convertible preferred stock
primarily consists of dividends on convertible preferred stock. Prior to
conversion of convertible preferred stock to common stock, which occurred on
October 14, 2003 upon the completion of the Companys initial public offering,
our convertible preferred stock was entitled to accretion of 12




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dividends, the amount of which decreased the amount of stockholders
equity available to common stockholders and effectively increases the loss per
share of common stock. After October 14, 2003, no existing convertible
preferred stock is outstanding, and accordingly there will be no further
accretion of dividends and offering costs on these shares. All preferred stock
dividends which were accreted before October 14, 2003 were forfeited by the
preferred stockholders on that date in connection with the conversion of these
preferred shares to common stock. Results of Operations Three Months Ended March 31, 2003 and 2004 Research and Development Expense.Research and development expense
increased $2.4 million, or 78%, to $5.5 million in the three months ended March
31, 2004 from $3.1 million in the three months ended March 31, 2003. Research
and development expense increased primarily due to increased activities in the
AI-700 Phase III clinical program, including clinical site costs, data
management costs, independent clinical monitoring costs and costs of
manufacturing of clinical materials. The increase in research and development
costs also includes costs associated with increased full and part-time
personnel at the Company. The following table summarizes the primary components of our research and
development expense for the three months ended March 31, 2003 and 2004. Because
of our ability to utilize resources across several projects, many of our
research and development costs are not tied to any individual project and are
allocated among multiple projects. We record direct costs on a
project-by-project basis. We record indirect costs in aggregate in support of
all research and development. Three Months EndedMarch 31,2003
    
    2004(in thousands)AI-700
    
    $
    1,502
    
    
    $
    3,781AI-850 and AI-128
    
    
    292
    
    
    
    81Other
    
    
    378
    
    
    
    393Total direct costs
    
    
    2,172
    
    
    
    4,255Facility costs and depreciation
    
    
    848
    
    
    
    1,086Patent costs
    
    
    82
    
    
    
    172Total research and development expense
    
    $
    3,102
    
    
    $
    5,513
 Research and development costs generally increase as programs progress
from early stage clinical trials to late stage clinical trials. Our primary
research and development programs are as follows: 13




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
    
    Late Stage Clinical Development Program (AI-700).Our lead product
candidate, AI-700, is a cardiovascular drug for the detection of
coronary artery disease. We incurred direct research and development
expense for AI-700 in the three months ended March 31, 2004 of $3.8
million compared to $1.5 million in the three months ended March 31,
2003. Of these amounts, $938,000 for the three months ended March 31,
2004 and $150,000 for the three months ended March 31, 2003 were
incurred in connection with the production of clinical trial material by
a third-party contract manufacturer. In 2003, we commenced clinical
studies in our Phase III clinical program for AI-700, and we identified
and began training additional clinical sites to be part of this Phase
III clinical program. We commenced the pivotal phase studies of our
Phase III clinical program at select clinical sites in December 2003. As
increasing numbers of patients are enrolled in the Phase III clinical
program, we anticipate incurring increased costs from professional
service firms helping to support the clinical trial by providing
services such as independent clinical monitoring, data acquisition and
data evaluation. We also anticipate incurring increased costs related to
hiring of additional research and development and clinical personnel. In
addition, we anticipate incurring increased costs associated with
preparation for commercial production.  
    
    Early Stage Clinical Development Programs (AI-850 and AI-128).Our
initial clinical applications of our HDDS technology, AI-850, and our
PDDS technology, AI-128, are in early stages of clinical development. We
incurred direct research and development expense for AI-850 and AI-128
in the three months ended March 31, 2004 of $81,000 compared to $292,000
in the three months ended March 31, 2003. There were no contract
manufacturing costs incurred in connection with these product
development programs during the three months ended March 31, 2004 or for
the three months ended March 31, 2003. We anticipate that we will
complete our Phase I study of AI-850 in 2004 and that our costs
associated with these clinical programs will not increase until we are
prepared to commence further pre-clinical and clinical testing using our
own resources or through strategic collaborations.  
    
    Other. Other direct research and development costs primarily consist
of management and preclinical evaluation of other product candidates. Each of our research and development programs are subject to risks and
uncertainties, including the requirement to seek regulatory approvals, which
are outside of our control. For example, our clinical trials may be subject to
delays or rejections based on our inability to enroll patients at the rate that
we expect or our inability to produce clinical trial material in sufficient
quantities and of sufficient quality to meet the schedule for our planned
clinical trials. Moreover, the product candidates identified in these research
and development programs, particularly our early stage programs, must overcome
significant technological, manufacturing and marketing challenges before they
can be successfully commercialized. As a result of these risks and
uncertainties, we are unable to predict with any certainty the period in which
material net cash inflows from such projects could be expected to commence or
the completion date of these programs. Failure to commercialize these product
candidates on a timely basis could have a material adverse affect on our
business, financial condition and results of operations. We may seek to
establish collaborative relationships to help us commercialize these product
candidates, but there can be no assurance that we will be successful in doing
so. General and Administrative Expense. General and administrative expense
increased $397,000, or 46%, to $1.3 million in the three months ended March 31,
2004 from $864,000 in the three months ended March 31, 2003. The higher general
and administrative expense incurred in the three months ended March 31, 2004
was principally due to the various costs of being a public company, including
costs associated with investor relations, legal counsel and auditing. Also
contributing to the higher expenses are increased activities in business
development and marketing, including market research expenses. Stock-Based Compensation Expense. Stock-based compensation expense
decreased $87,000, or 27%, to $233,000 in the three months ended March 31, 2004
from $320,000 in the three months ended March 31, 2003. Stock-based
compensation expense incurred in both periods resulted principally from the
vesting of stock options 14




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granted in prior periods on which deferred compensation had previously
been recorded and decreased as a result of certain prior year awards becoming
fully vested in the current period. Equity in Loss of Joint Venture. Our joint venture with Elan was
terminated in September 2002. Research and development costs for pulmonary drug
delivery product candidates in the three months ended March 31, 2004 and for
the three months ended March 31, 2003 are included in research and development
expense, as discussed above. Interest and Other Income (Expense).Interest and other income (expense)
increased $284,000, or 141%, to a net income of $82,000 in the three months
ended March 31, 2004 from a net expense of $202,000 in the three months ended
March 31, 2003. During these periods, interest and other income (expense)
consisted of the following: Three Months Ended March 31,2003
    
    2004Interest income
    
    $
    22,000
    
    
    $
    108,000Other income (expense)
    
    
    
    
    
    
    Interest expense
    
    
    (224,000
    )
    
    
    (26,000
    )Total, net
    
    $
    (202,000
    )
    
    $
    82,000
 The increase in interest income in the three months ended March 31, 2004
compared to the three months ended March 31, 2003 was primarily due to higher
average fund balances available for investment resulting from funds received
from the initial public offering in October 2003. The decrease in interest
expense in the three months ended March 31, 2004 compared to the three months
ended March 31, 2003 was primarily due to interest paid on the subordinated
loans payable of $109,000 and amortization of the discount of $60,000 in the
three months ended March 31, 2003 compared to zero in the three months ended
March 31, 2004. The subordinated loans were paid off in June of 2003. In
addition to this, the interest expense on the lower capital lease balances has
decreased $16,000 from the three months ended March 31, 2003 compared to the
three months ended March 31, 2004. Accretion of Dividends and Offering Costs on Convertible Preferred Stock.
Accretion of dividends and offering costs on convertible preferred stock
decreased $1.6 million, or 100%, to zero in the three months ended March 31,
2004 from $1.6 million in the three months ended March 31, 2003. The decrease
was primarily due to the conversion of all outstanding preferred stock into the
Companys common stock upon completion of the Companys Initial Public Offering
on October 14, 2003. All preferred stock dividends which were accreted before
October 14, 2003 were forfeited by the preferred stockholders on that date in
connection with the conversion of these preferred shares to common stock. After
October 14, 2003, no existing convertible preferred stock is outstanding, and
accordingly there will be no further accretion of dividends and offering costs
on these shares. Liquidity and Capital Resources Historically, we have financed our business through the issuance of equity
securities, debt financings and equipment leases. Our liquidity requirements
have arisen primarily from research and development expenditures, equipment
expenditures and payments on outstanding indebtedness. As of March 31, 2004, we
had cash and cash equivalents of $46.8 million. Since our inception in July
1993 through March 31, 2004, we have raised $161.6 million through the issuance
of equity securities, including $47.6 million from our initial public offering
in October 2003 and the $19.4 million in convertible promissory notes which
converted to common stock upon the Companys initial public offering. As of
March 31, 2004 we owed $869,000 from capital leases and had commitments
totaling $18.9 million for rent under our facility lease. During the three months ended March 31, 2004, operating activities used
$6.7 million of cash. Net cash used by operating activities during this period
resulted primarily from a net loss of $6.9 million. This use of cash was
supplemented by a decrease in accounts payable of $290,000 and an increase in
other current assets of $116,000 and was partially offset by non-cash charges
for depreciation and amortization of $321,000 and non-cash charges for
stock-based compensation expense of $233,000. 15




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During the three months ended March 31, 2004, investing activities used
$924,000 in cash. This use of cash was solely for purchases of equipment. During the three months ended March 31, 2004, financing activities used
$207,000 in cash. Net cash used by financing activities during this period
resulted primarily from scheduled payments of debt and was partially offset by
proceeds from common stock issuances of $18,000. In April 2004, we entered into an $8.0 million equipment financing line
with an equipment financing company. Borrowings under this equipment line can
be made against qualified purchases through March 2005. Such borrowings are to
be secured by the qualified purchases and repaid over 36 to 48 months,
depending on the nature of the equipment financed. No warrants were granted in
connection with this equipment line. The $8.0 million equipment line is
structured as a loan agreement. However, we may elect to borrow up to $4.0
million of this amount in the form of a capital lease. The interest rate on
this facility varies depending upon whether the borrowing is in the form of a
loan or lease and whether the term is 36 months or 48 months. Such interest
rates are fixed at the time of each borrowing under the equipment line with
such rates adjusted between borrowings based on the U.S. Federal Reserves
Three Year and Four Year Treasury Constant Maturity Rates. The equipment line
includes provisions to increase the line to $11.3 million upon the occurrence
of certain defined events. We believe, based on our operating plans, that our existing resources will
be sufficient to fund our planned operations, including increases in spending
for our AI-700 Phase III clinical program, for at least the next twelve months.
However, over the next several years we may require significant additional
funds to develop, conduct clinical trials, achieve regulatory approvals and,
subject to regulatory approval, commercially launch AI-700, our other product
candidates under development and future product candidates. Our future capital
requirements will depend on many factors, including the scope and progress made
in our research and development activities and our clinical trials. We may also
need additional funds for possible future strategic acquisitions of businesses,
products or technologies complementary to our business. We do not expect to
generate significant revenues, other than possible license or milestone
payments, from commercial sale of our products unless or until we or potential
partners complete clinical trials for our products and receive marketing
approval from the applicable regulatory authorities. If additional funds are
required, we may raise such funds from time to time through public or private
sales of equity or from borrowings. Financing may not be available on
acceptable terms, or at all, and our failure to raise capital when needed could
materially adversely impact our growth plans and our financial condition and
results of operations. Additional equity financing may be dilutive to the
holders of our common stock and debt financing, if available, may involve
significant cash payment obligations and covenants that restrict our ability to
operate our business. Contractual Obligations The following table summarizes our contractual obligations as of December
31, 2003 and the effect such obligations are expected to have on our liquidity
and cash flow in future periods: Payments Due by Period Total
    
    2004
    
    2006
    
    2008Obligations
    
    Through
    
    Through
    
    Through
    
    AfterAll Years
    
    2005
    
    2007
    
    2009
    
    2009(In thousands)Capital lease obligations
    
    $
    1,090
    
    
    $
    1,090
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating lease obligations
    
    
    19,419
    
    
    
    4,366
    
    
    
    4,677
    
    
    
    5,010
    
    
    
    5,367Total contractual cash obligations
    
    $
    20,509
    
    
    $
    5,456
    
    
    $
    4,677
    
    
    $
    5,010
    
    
    $
    5,367
 Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the 16




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United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities and expenses. On an on-going basis, we evaluate our estimates and
judgments, including those related to accrued expenses, fair valuation of stock
related to stock-based compensation and income taxes. We based our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. Accrued Expenses.As part of the process of preparing consolidated
financial statements we are required to estimate accrued expenses. This process
involves identifying services which have been performed on our behalf and
estimating the level of service performed and the associated cost incurred for
such service as of each balance sheet date in our consolidated financial
statements. Examples of estimated expenses for which we accrue include
professional service fees, such as lawyers and accountants, and contract
service fees such as amounts paid to clinical monitors, data management
organizations and investigators in conjunction with clinical trials, and fees
paid to contract manufacturers in conjunction with the production of clinical
materials. In connection with such service fees, our estimates are most
affected by our understanding of the status and timing of services provided
relative to the actual levels of services incurred by such service providers.
The majority of our service providers invoice us monthly in arrears for
services performed. In the event that we do not identify certain costs which
have begun to be incurred or we under- or over-estimate the level of services
performed or the costs of such services, our reported expenses for such period
would be too low or too high. The date on which certain services commence, the
level of services performed on or before a given date and the cost of such
services are often judgmental. We make these judgments based upon the facts and
circumstances known to us in accordance with generally accepted accounting
principles. Stock-Based Compensation and Other Equity Instruments.We have elected to
follow APB Opinion No. 25, Accounting for Stock Issued to Employees,and
related interpretations, in accounting for our stock-based compensation plans,
rather than the alternative fair value accounting method provided for under
SFAS No. 123, Accounting for Stock-Based Compensation.Accordingly, we have not
recorded stock-based compensation expense for stock options issued to employees
in fixed amounts with exercise prices at least equal to the fair value of the
underlying common stock on the date of grant. In the notes to our consolidated
financial statements we provide pro forma disclosures in accordance with SFAS
No. 123 and related pronouncements. We account for transactions in which
services are received in exchange for equity instruments based on the fair
value of such services received from non-employees or of the equity instruments
issued, whichever is more reliably measured, in accordance with SFAS No. 123
and EITF Issue No. 96-18, Accounting for Equity Instruments that Are Issued to
Other than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services. We account for transactions in which we grant warrants in connection
with the issuance of debt in accordance with APB 14, Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants.The two factors which most
affect charges or credits to operations related to stock-based compensation are
the fair value of the common stock underlying stock options for which
stock-based compensation is recorded and the volatility of such fair value. Accounting for equity instruments granted or sold by us under APB No. 14,
APB No. 25, SFAS No. 123 and EITF No. 96-18 requires fair value estimates of
the equity instrument granted or sold. If our estimates of the fair value of
these equity instruments are too high or too low, it would have the effect of
overstating or understating expenses. When equity instruments are granted or
sold in exchange for the receipt of goods or services and the value of those
goods or services can be readily estimated, we use the value of such goods or
services to determine the fair value of the equity instruments. When equity
instruments are granted or sold in exchange for the receipt of goods or
services and the value of those goods or services can not be readily estimated,
as is true in connection with most stock options and warrants granted to
employees or non-employees, we estimated the fair value of the equity
instruments based upon consideration of factors which we deemed to be relevant
at the time using cost, market and/or income approaches to such valuations.
Because shares of our common stock were not publicly traded prior to 17




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our initial public offering in October 2003, market factors historically
considered in valuing stock and stock option grants included comparative values
of public companies discounted for the risk and limited liquidity provided for
in the shares we are issuing, pricing of private sales of our convertible
preferred stock, prior valuations of stock grants and the effect of events that
have occurred between the time of such grants, economic trends, perspective
provided by investment banks and the comparative rights and preferences of the
security being granted compared to the rights and preferences of our other
outstanding equity. Income Taxes.As part of the process of preparing our consolidated
financial statements we are required to estimate our income taxes in each of
the jurisdictions in which we operate. This process involves estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatments of items for tax and accounting purposes.
These differences result in deferred tax assets and liabilities. In addition,
as of December 31, 2003, we had federal tax net operating loss carryforwards of
$68.5 million, which expire through 2023. We also have research and development
credit carryforwards of $2.6 million. We have recorded a valuation allowance to
fully offset against these otherwise recognizable net deferred tax assets due
to the uncertainty surrounding the timing of the realization of the tax
benefit. In the event that we determine in the future that we will be able to
realize all or a portion of its net deferred tax benefit, an adjustment to
deferred tax valuation allowance would increase net income in the period in
which such a determination is made. The Tax Reform Act of 1986 contains
provisions that may limit the utilization of net operating loss carryforwards
and credits available to be used in any given year in the event of significant
changes in ownership interest, as defined. Recently Issued Accounting Pronouncements In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46),
which was amended by FIN 46R issued in December 2003. This interpretation of
Accounting Research Bulletin No. 51, Consolidated Financial Statements,
addresses consolidation by business enterprises of variable interest entities
(VIEs) that either: (1) do not have sufficient equity investment at risk to
permit the entity to finance its activities without additional subordinated
financial support, or (2) for which the equity investors lack an essential
characteristic of a controlling financial interest. This Interpretation applies
immediately to VIEs created after January 31, 2003. It also applies in the
first fiscal year or interim period ending after March 15, 2004, to VIEs
created before February 1, 2003 in which an enterprise holds a variable
interest. FIN 46 requires disclosure of VIEs in financial statements issued
after January 31, 2003, if it is reasonably possible that as of the transition
date: (1) the company will be the primary beneficiary of an existing VIE that
will require consolidation or, (2) the company will hold a significant variable
interest in, or have significant involvement with, an existing VIE. Adoption of
this interpretation did not have any impact on the Companys financial
statements. Certain Factors Which May Affect Future Results Our operating results and financial condition have varied in the past and
may in the future vary significantly depending on a number of factors. Except
for the historical information in this report, the matters contained in this
report include forward-looking statements that involve risks and uncertainties.
The following factors, among others, could cause actual results to differ
materially from those contained in forward-looking statements made in this
report and presented elsewhere by management from time to time. Such factors,
among others, may have a material adverse effect upon our business, results of
operations and financial condition. Risks Related to Our Company We have not generated revenues to date, and we may not achieve
profitability for some time, if at all. We are focused on product development and we have not generated any
revenues to date. We have incurred losses each year of our operations and we
expect to continue to incur operating losses for the next several years. The
process of developing our products requires significant clinical, development
and laboratory testing and clinical trials as well as regulatory approvals. In
addition, commercialization of our product candidates will require us to
establish sales, marketing and manufacturing capabilities, either through
internal hiring or through contractual 18




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relationships with others. We expect our research and development and
general and administrative expenses will increase over the next several years.
As of March 31, 2004, our cumulative net loss was $122.0 million. If we fail to obtain regulatory approvals for our product candidates under
development, and in particular our lead product candidate AI-700, we will
not be able to generate revenues from the commercialization or sale of our
product candidates. We must receive regulatory approval of each of our product candidates
before we can commercialize or sell that product candidate. The pre-clinical
laboratory testing, formulation development, manufacturing and clinical trials
of any product candidates we develop independently or in collaboration with
third parties, as well as the distribution and marketing of these product
candidates, are regulated by numerous federal, state and local governmental
authorities in the United States, principally the FDA, and by similar agencies
in other countries. The development and regulatory approval process takes many
years, requires the expenditure of substantial resources, is uncertain and
subject to delays, and will thus delay our receipt of revenues, if any, from
any of our product candidates. We cannot assure you that our clinical trials
will demonstrate the safety and efficacy of any of our product candidates or
will result in marketable products. No product can receive FDA approval unless human clinical trials show both
safety and efficacy for each target indication in accordance with FDA
standards. A number of companies in the pharmaceutical and biotechnology
industries have suffered significant setbacks in late stage clinical trials
even after achieving promising results in early stage development. We therefore
cannot assure you that the results from our Phase II clinical trials for AI-700
will be predictive of results obtained in our Phase III clinical trials. Many
of the patients in our AI-700 clinical trial have coronary heart disease. As
part of our AI-700 Phase III clinical trials, patients will be exposed to
potential safety risks associated with a stress test, including risks
associated with a pharmacological stressor, and AI-700. Given the nature of the
AI-700 Phase III clinical trial, including administering AI-700 to larger
numbers of at-risk patients and new clinical sites, adverse events are expected
to be encountered during the clinical trial. Adverse events are also likely to
be encountered in clinical trials for our other products, which clinical trials
also include at-risk patients. For example, our AI-850 trial consists of
patients being treated for late-stage cancer. If significant adverse events are
detected and these events are attributable to our products, such events could
delay, limit or prevent regulatory agency approval. Further, data obtained from
pre-clinical and clinical activities are subject to varying interpretations
that could delay, limit or prevent regulatory agency approval. We cannot assure
you that our Phase III plan for AI-700 will successfully address the concerns
of the FDA or that the results of the Phase III program will establish the
safety and efficacy of AI-700 sufficiently for us to obtain regulatory
approval. We may also encounter delays or rejections based on our inability to
enroll enough patients to complete our clinical trials. We may also encounter
delays, resulting in the need to enroll more patients than expected in our
clinical trials, based on our inability to enroll a mix of patients that is
consistent with our estimated clinical trial enrollment. Patient enrollment
depends on many factors, including the size of the patient population, the
nature of the protocol, the proximity of patients to clinical sites, and the
eligibility criteria for the study and the freedom to operate with respect to intellectual property. Delays in planned patient enrollment, or
the need to enroll more patients, may result in increased costs and delays,
which could have a harmful effect on our ability to develop products. We may
encounter delays or rejections based on changes in regulatory agency policies
during the period in which we develop a drug or the period required for review
of any application for regulatory agency approval of a particular compound. On
May 1, 2004, changes went into effect in the regulation of clinical trials in
Europe. Implementation of these changes could lead to delays to our clinical
trials. We also may encounter delays in the event we are unable to produce
clinical trial material in sufficient quantities and of sufficient quality to
meet the schedule for our planned clinical trials. In addition, we rely on a
number of third parties, such as clinical research organizations, to help
support the clinical trials by performing independent clinical monitoring, data
acquisition and data evaluations. Any failure on the part of these third
parties could delay the regulatory approval process. Failure to obtain regulatory approval or any delay or setback in obtaining
regulatory agency approvals could:  
    
    adversely affect our ability to market any drugs we develop
independently or with collaborative partners; 19




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
    
    impose additional costs and diminish any competitive advantages that we may attain; or
    
    adversely affect our ability to generate royalties. In particular, failure to obtain approval or substantial delays in obtaining
approval for our lead product candidate, AI-700, would delay our receipt of
product revenues and materially adversely affect our business, financial
condition and results of operations. We cannot be certain that we will obtain any regulatory approvals in other
countries and the failure to obtain these approvals may materially adversely
affect our business, financial condition and results of operations. In order to
market our products outside of the United States, we and our collaborative
partners, if any, must establish and comply with numerous and varying
regulatory requirements of other countries regarding safety and efficacy. The
approval procedures vary among countries and can involve additional product
testing and additional administrative review periods. The time required to
obtain approval in other countries might differ from that required to obtain
FDA approval. The regulatory approval process in other countries may include
all of the risks associated with obtaining FDA approval detailed above.
Approval by the FDA does not ensure approval by the regulatory authorities of
other countries. In addition, many countries outside the United States require
a separate review process prior to marketing to determine whether their
national health insurance scheme will pay for newly approved products, as well
as the price which may be charged for a product. Our products, if approved, may fail to achieve market acceptance. There can be no assurance that any products we successfully develop, if
approved for marketing, will achieve market acceptance or generate significant
revenues. Each of our product candidates is intended to replace or alter
existing therapies or procedures, and hospitals, physicians or patients may
conclude that these products are less safe or effective or otherwise less
attractive than these existing therapies or procedures. For example, our lead
product candidate, AI-700, is a contrast agent for use in ultrasound imaging
procedures which will compete with existing nuclear imaging and stress
echocardiography. Hospitals, physicians or patients may prefer these existing
procedures to AI-700 enhanced ultrasound imaging. If our products do not
receive market acceptance for any reason, it would adversely affect our
business, financial condition and results of operations. Further, our competitors may develop new technologies or products that are
more effective or less costly, or that seem more cost-effective, than our
products. We can give no assurance that hospitals, physicians, patients or the
medical community in general will accept and use any products that we may
develop. If we cannot raise additional capital on acceptable terms, we may be unable
to complete planned clinical trials, obtain regulatory approvals or
commercialize our product candidates. We will require substantial future capital in order to continue to conduct
the research and development, clinical and regulatory activities necessary to
bring our product candidates to market and to establish commercial
manufacturing, marketing and sales capabilities. Our future capital
requirements will depend on many factors, including:  
    
    the progress of pre-clinical development and laboratory testing and clinical trials;
    
    the time and costs involved in obtaining regulatory approvals;
    
    the number of product candidates we pursue;
    
    the costs involved in filing and prosecuting patent applications
and enforcing or defending patent claims; and 20




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
    
    the establishment of selected strategic alliances and activities
required for product commercialization. We intend to seek additional funding through strategic collaborations and may
seek funding through private or public sales of our securities or by licensing
all or a portion of our technology. This funding may significantly dilute
existing stockholders or may limit our rights to our technology. We cannot assure you that we can obtain additional funding on reasonable
terms, or at all. If we cannot obtain adequate funds, we may:  
    
    terminate or delay clinical trials for one or more of our product candidates;
    
    delay our establishment of sales, marketing and/or manufacturing capabilities;
    
    curtail significant product development programs that are designed
to identify new product candidates; and/or
    
    relinquish rights to our technologies or product candidates. We believe that existing cash reserves will fund our planned activities
for at least twelve months. Claims by other companies that we infringe their proprietary technology may
result in liability for damages or stop our development and commercialization
efforts. Competitors and other third parties may initiate patent litigation against
us in the United States or in foreign countries based on existing patents or
patents that may be granted in the future. Many of our competitors have
obtained patents covering products and processes generally related to our
products and processes, and they may assert these patents against us. Moreover,
there can be no assurance that these competitors have not sought or will not
seek additional patents that may cover aspects of our technology. As a result,
there is a greater likelihood of a patent dispute than would be expected if our
competitors were pursuing unrelated technologies. While we conduct patent searches to determine whether the technologies
used in our products infringe patents held by third parties, numerous patent
applications are currently pending and may be filed in the future for
technologies generally related to our technologies, including many patent
applications that remain confidential after filing. Due to these factors and
the inherent uncertainty in conducting patent searches, there can be no
guarantee that we will not violate third-party patent rights that we have not
yet identified. We know of U.S. and foreign patents issued to third parties that relate to
aspects of our product candidates. There may also be patent applications filed
by these or other parties in the United States and various foreign
jurisdictions that relate to some aspects of our product candidates, which, if
issued, could subject us to infringement actions. In particular, we are aware
of U.S. and foreign patents owned by third parties, including potential
competitors, that arguably cover aspects of our AI-700 contrast agent. We and
several of these parties have recently been actively engaged in opposing the
grant of European patents with claims that arguably cover aspects of our AI-700
product. Parties may contest patents in Europe prior to contesting the
counterpart patents in the United States because of procedural differences
between European and U.S. patent laws as well as economic considerations. There
is a significant possibility that one or more of these third parties will use
litigation to assert their patents in the United States or Europe. The owners or licensees of these and other patents may file one or more
infringement actions against us. In addition, a competitor may claim
misappropriation of a trade secret by an employee hired from that competitor.
Any such infringement or misappropriation action could cause us to incur
substantial costs defending the lawsuit and could distract our management from
our business, even if the allegations of infringement or misappropriation are
unwarranted. The defense of multiple claims could have a disproportionately
greater impact. Furthermore, a party 21




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making this type of claim could secure a judgment that requires us to pay
substantial damages. A judgment could also include an injunction or other court
order that could prevent us from making, using, selling, offering for sale or
importing our products or prevent our customers from using our products. If a
court determined or if we independently discovered that any of our products or
manufacturing processes violated third-party proprietary rights, our
clinical trials could be delayed and there can be
no assurance that we would be able to reengineer the product or processes to
avoid those rights, or to obtain a license under those rights on commercially
reasonable terms, if at all. If we are unable to protect our intellectual propriety rights, our
competitors may develop and market products with similar features that may
reduce demand for our products, and we may be prevented from establishing
collaborative relationships on favorable terms. The following factors are important to our success:  
    
    receiving patent protection for our product candidates;
    
    maintaining our trade secrets;
    
    not infringing on the proprietary rights of others; and
    
    preventing others from infringing our proprietary rights. We will be able to protect our proprietary rights from unauthorized use by
third parties only to the extent that our proprietary rights are covered by
valid and enforceable patents or are effectively maintained as trade secrets. We try to protect our proprietary position by filing U.S. and foreign
patent applications related to our proprietary technology, inventions and
improvements that are important to the development of our business. Because the
patent position of pharmaceutical companies involves complex legal and factual
questions, the issuance, scope and enforceability of patents cannot be
predicted with certainty. Patents, if issued, may be challenged, invalidated or
circumvented. Thus, any patents that we own or license from others may not
provide any protection against competitors. Our pending patent applications,
those we may file in the future, or those we may license from third parties,
may not result in patents being issued. If issued, they may not provide us with
proprietary protection or competitive advantages against competitors with
similar technology. Furthermore, others may independently develop similar
technologies or duplicate any technology that we have developed. The laws of
many foreign countries do not protect our intellectual property rights to the
same extent as do the laws of the United States. We also rely on trade secrets, know-how and technology, which are not
protected by patents, to maintain our competitive position. We try to protect
this information by entering into confidentiality agreements with parties that
have access to it, such as our corporate partners, collaborators, employees and
consultants. Any of these parties may breach the agreements and disclose our
confidential information or our competitors might learn of the information in
some other way. If any trade secret, know-how or other technology not protected
by a patent were to be disclosed to or independently developed by a competitor,
our business and financial condition could be materially adversely affected. We may become involved in lawsuits to protect or enforce our patents that
would be expensive and time consuming. In order to protect or enforce our patent rights, we may initiate patent
litigation against third parties in the United States or in foreign countries.
In addition, we may become subject to interference or opposition proceedings
conducted in patent and trademark offices to determine the priority of
inventions. The defense of intellectual property rights, including patent
rights through lawsuits, interference or opposition proceedings, and other
legal and administrative proceedings would be costly and divert our technical
and management personnel from their normal responsibilities. An adverse
determination of any litigation or defense proceedings could put one or more of
our patents at risk of being invalidated or interpreted narrowly and could put
our patent applications at risk of not 22




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issuing. Furthermore, because of the substantial amount of discovery required in
connection with intellectual property litigation, there is a risk that some of
our confidential information could be compromised by disclosure during this
type of litigation. For example, during the course of this kind of litigation,
confidential information may be inadvertently disclosed in the form of
documents or testimony in connection with discovery requests, depositions or
trial testimony. This disclosure could materially adversely affect our business
and financial results. If third-party manufacturers of our products fail to devote sufficient time
and resources to our concerns, or if their performance is substandard, our
clinical trials and product introductions may be delayed and our costs may
rise. We have limited manufacturing facilities, and we have no experience in the
commercial manufacturing of drugs and limited experience in designing drug
manufacturing equipment. We have contracted with third party manufacturers to
produce, in collaboration with us, our product candidates for clinical trials.
We intend to rely, in part, on third-party contract manufacturers to supply,
store and distribute our potential products for our clinical trials. We may
continue to rely on third-parties to manufacture and distribute our potential
products. Our reliance on these third-party manufacturers will expose us to the
following risks, any of which could delay or prevent the completion of our
clinical trials, the approval of our products by the FDA, or the
commercialization of our products, result in higher costs, or deprive us of
potential product revenues:  
    
    Contract manufacturers often encounter difficulties in achieving
volume production, quality control and quality assurance, as well as
shortages of qualified personnel. Accordingly, a manufacturer might not
be able to manufacture sufficient quantities of drugs to meet our
clinical schedules or to commercialize our products.
    
    Contract manufacturers are obliged to operate in accordance with
FDA-mandated current good manufacturing practices, or cGMPs. A failure
of these contract manufacturers to establish and follow cGMPs and to
document their adherence to such practices may lead to significant
delays in the availability of material for clinical study and may delay
or prevent filing or approval of marketing applications for our
products.
    
    For each of our current product candidates we will initially rely
on a single manufacturer. Changing these or future manufacturers may be
difficult and the number of potential manufacturers is limited.
Changing manufacturers may require re-validation of the manufacturing
processes and procedures in accordance with FDA-mandated cGMPs. Such
re-validation may be costly and time-consuming. It may be difficult or
impossible for us to find replacement manufacturers on acceptable terms
quickly, or at all.
    
    Our contract manufacturers may not perform as agreed or may not
remain in the contract manufacturing business for the time required to
produce, store and distribute our products successfully. Drug manufacturers are subject to ongoing periodic unannounced inspection
by the FDA, the U.S. Drug Enforcement Agency, or the DEA, and corresponding
state and foreign agencies to ensure strict compliance with cGMPs, other
government regulations and corresponding foreign standards. While we are
obligated to audit the performance of third party contractors, we do not have
control over our third-party manufacturers compliance with these regulations
and standards. Failure by our third-party manufacturers or us to comply with
applicable regulations could result in sanctions being imposed on us, including
fines, injunctions, civil penalties, failure of the government to grant market
approval of drugs, delays, suspension or withdrawal of approvals, seizures or
recalls of product, operating restrictions and criminal prosecutions, any of
which could significantly and adversely affect our business. In the event that we decide to manufacture all or a portion of our
potential products for commercial use, we may encounter similar difficulties
and challenges as well as the need to create cGMP compliant facilities. 23




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We may not be able to manufacture our products in commercial quantities,
which would prevent us from marketing our products. To date our product candidates have been manufactured in small quantities
for pre-clinical and clinical trials. If any of these product candidates are
approved by the FDA or foreign regulatory authorities for commercial sale, we
will need to manufacture them in larger quantities. We cannot assure you that
we will be able to successfully increase the manufacturing capacity, whether on
our own or in collaboration with third party manufacturers, for any of our
product candidates in a timely or economic manner, or at all. Significant
scale-up of manufacturing may require certain additional validation studies,
which the FDA must review and approve. If we are unable to successfully
increase the manufacturing capacity for a product candidate, the regulatory
approval or commercial launch of that product candidate may be delayed or there
may be a shortage in supply of that product candidate. Our product candidates
require precise, high quality manufacturing. Our failure to achieve and
maintain these high manufacturing standards, including the incidence of
manufacturing errors, could result in patient injury or death, product recalls
or withdrawals, delays or failures in product testing or delivery, cost
overruns or other problems that could seriously hurt our business. Materials necessary to manufacture our products may not be available, which
may delay our development and commercialization activities. Only a few facilities manufacture some of the raw materials necessary to
manufacture our products. For example, the manufacture of AI-850 will require
bulk quantities of paclitaxel, a natural substance that is difficult to produce
and is in limited supply. We currently have no supply agreements in place with
any supply facility. If we need to purchase a raw material that is in limited
supply for our clinical trials, or for commercial distribution if we obtain
marketing approval of a product candidate, we cannot assure you that one or
more suppliers would be able to sell us that raw material at the time we need
it and on commercially reasonable terms. If we change suppliers for any of
these materials or any of our suppliers experiences a shutdown or disruption in
the facilities used to produce these materials, due to technical, regulatory or
other problems, it could harm our ability to manufacture our products. Our
inability to obtain required raw materials for any reason could substantially
impair our development activities or the production, marketing and distribution
of our products. We have no experience selling, marketing or distributing our products and
no internal capability to do so. If we receive regulatory approval to commence commercial sales of any of
our products, we will face competition with respect to commercial sales,
marketing and distribution. These are areas in which we have no experience. To
market any of our products directly, we must develop a direct marketing and
sales force with technical expertise and supporting distribution capability.
Alternatively, we may engage a pharmaceutical or other healthcare company with
an existing distribution system and direct sales force to assist us. There can
be no assurance that we will successfully establish sales and distribution
capabilities either on our own or in collaboration with third parties or gain
market acceptance for our products. To the extent we enter co-promotion or
other licensing arrangements, any revenues we receive will depend on the
efforts of third parties and there can be no assurance that our efforts will
succeed. We will establish collaborative relationships, and those relationships may
expose us to a number of risks. We will rely on a number of significant collaborative relationships with
pharmaceutical or other healthcare companies for our manufacturing, research
funding, clinical development and/or sales and marketing performance. Reliance
on collaborative relationships poses a number of risks, including the
following:  
    
    we cannot effectively control whether our corporate partners will
devote sufficient resources to our programs or product candidates;
    
    disputes may arise in the future with respect to the ownership of
rights to technology developed with collaborators; 24




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
    
    disagreements with collaborators could delay or terminate the
research and development, regulatory approval or commercialization of
product candidates, or result in litigation or arbitration;
    
    corporate partners have considerable discretion in electing whether
to pursue the development of any additional product candidates and may
pursue technologies or products either on their own or in collaboration
with our competitors; and
    
    collaborators with marketing rights may choose to devote fewer
resources to the marketing of our product candidates than they do to
product candidates of their own development. For example, we established a joint venture with Elan Corporation, plc and
affiliates in 2000. At the time, we anticipated that we would share the cost of
pre-clinical and clinical trials for product candidates being developed by the
joint venture with Elan. In 2002, for reasons beyond our control, Elan ceased
funding the joint venture and the joint venture was terminated. In connection
with the termination, we agreed to pay Elan a royalty if we commercialize the
asthma product candidate that was being developed by the joint venture. Future
development of product candidates will require that we provide all the funding
for the cost of development and clinical trials or identify collaborators to
share in the costs. Given these risks, our current and future collaborative efforts may not be
successful. Failure of these efforts could delay our product development or
impair commercialization of our products, and have a material adverse effect on
our business, financial condition and results of operations. Competition in the pharmaceutical industry is intense, and if we fail to
compete effectively our financial results will suffer. We engage in a business characterized by extensive research efforts, rapid
developments and intense competition. We cannot assure you that our products
will compete successfully or that research and development by others will not
render our products obsolete or uneconomical. Our failure to compete
effectively would materially adversely affect our business, financial condition
and results of operations. We expect that successful competition will depend,
among other things, on product efficacy, safety, reliability, availability,
timing and scope of regulatory approval and price. Specifically, we expect
important factors will include the relative speed with which we can develop
products, complete the clinical, development and laboratory testing and
regulatory approval processes and supply commercial quantities of the product
to the market. We expect competition to increase as technological advances are made and
commercial applications broaden. In commercializing our initial product
candidates and any additional products we develop using our HDDS and PDDS
technologies, we will face substantial competition from large pharmaceutical,
biotechnology and other companies, universities and research institutions.  
    
    AI-700, our ultrasound contrast agent and lead product candidate,
if approved for marketing and sale, will compete with nuclear stress
tests, the current standard of care in myocardial perfusion imaging.
Nuclear contrast agents that are approved for use in myocardial
perfusion imaging include products marketed by Amersham, Bristol-Myers
Squibb and Tyco International. In addition, Amersham, Bristol-Myers
Squibb and Imcor have developed ultrasound contrast agents that have
been approved by the FDA for resting wall motion studies, and in the
future they may seek to broaden their products to include stress echo
and myocardial perfusion assessment. Moreover, we are aware that other
companies, such as Bracco, are developing ultrasound contrast agents
for wall imaging and for radiology applications, and that Point
Biomedical is developing an ultrasound contrast agent specifically for
myocardial perfusion imaging. In March 2004, Point announced that it
had recently completed two pivotal Phase III trials for this contrast
agent and plans to file an NDA with the FDA later this year. Finally,
some cardiologists may find it satisfactory to use stress echo without
contrast for the detection of coronary artery disease. 25




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
    
    AI-850, our reformulation of paclitaxel, if approved for marketing
and sale, will also face intense competition from companies such as
American Pharmaceutical Partners, NeoPharm and Sonus Pharmaceuticals,
which are applying significant resources and expertise to developing
reformulations of paclitaxel for intravenous delivery. Other companies,
such as Cell Therapeutics, are developing new chemical entities that
involve paclitaxel conjugated, or chemically bound, to another
chemical.
    
    AI-128, our sustained release formulation of an asthma drug, if
approved for marketing and sale, will also face intense competition.
Companies such as Alkermes possess technology that may be suitable for
sustained release pulmonary drug delivery and may have competitive
programs that have not been publicly announced or may decide to begin
such programs in the future. In addition, large pharmaceutical
companies that market FDA-approved asthma drugs may be developing
sustained release versions of their asthma drugs that would compete
with our product candidates. Relative to us, most of our competitors have substantially greater capital
resources, research and development staffs, facilities and experience in
conducting clinical trials and obtaining regulatory approvals, as well as in
manufacturing and marketing pharmaceutical products. Many of our competitors
may achieve product commercialization or patent protection earlier than we
will. Furthermore, we believe that some of our competitors have used, and may
continue to use, litigation to gain a competitive advantage. Finally, our
competitors may use different technologies or approaches to the development of
products similar to the products we are seeking to develop. If we are unable to retain key personnel and hire additional qualified
scientific, sales and marketing, and other personnel, we may not be able to
successfully achieve our goals. We depend on the principal members of our scientific and management staff,
including Sherri C. Oberg, our president and chief executive officer, John F.
Thero, our senior vice president and chief financial officer, Howard Bernstein,
our senior vice president of research and development, Charles P. Cox, our
senior vice president of corporate development and marketing, and Michael R.
Slater, our senior vice president of operations. The loss of any of these
individuals services might significantly delay or prevent the achievement of
research, development or business objectives and could materially adversely
affect our business, financial condition and results of operations. We do not
maintain key person life insurance on any of these individuals. Ms. Oberg and Dr. Bernstein are critical to the development of our
technologies and business. Dr. Cox, who joined us in August 2003, Mr. Thero,
who joined us in February 2003, and Mr. Slater, who joined us in October 2001,
are key additions to our management team and are also critical to directing and
managing our growth and development in the future. We are not aware of any
present intention of any of these individuals to leave our company. We have no
employment contracts with any of our employees. Our success depends, in large part, on our ability to attract and retain
qualified scientific and management personnel such as these individuals. We
face intense competition for such personnel and consultants. We cannot assure
you that we will attract and retain qualified management and scientific
personnel in the future. Further, we expect that our potential expansion into areas and activities
requiring additional expertise, such as further clinical trials, governmental
approvals, commercial manufacturing and marketing, will place additional
requirements on our management, operational and financial resources. We expect
these demands will require an increase in management and scientific personnel
and the development of additional expertise by existing management personnel.
The failure to attract and retain such personnel or to develop such expertise
could materially adversely affect prospects for our success. We expect to develop international operations that will expose us to
additional business risks. 26




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In the future, we expect to develop operations outside the United States
in order to market and distribute our products. We cannot be sure that our
international efforts will be successful. Any expansion into international
markets will require additional resources and management attention and will
subject us to new business risks. These risks could lower the prices at which
we can sell our products or otherwise have an adverse effect on our operating
results. Among the risks we believe are most likely to affect any international
operations are:  
    
    different regulatory requirements for approval of our product candidates;
    
    dependence on local distributors;
    
    longer payment cycles and problems in collecting accounts receivable;
    
    adverse changes in trade and tax regulations;
    
    the absence or significant lack of legal protection for intellectual property rights;
    
    political and economic instability; and
    
    currency risks. Risks Relating to Our Industry Even if we obtain marketing approval, our products will be subject to
ongoing regulatory review. If regulatory approval of a product is granted, such approval may be
subject to limitations on the indicated uses for which the product may be
marketed or contain requirements for costly, post-marketing follow-up studies.
As to products for which marketing approval is obtained, the manufacturer of
the product and the manufacturing facilities will be subject to continual
review and periodic inspections by the FDA and other regulatory authorities. In
addition, the labeling, packaging, adverse event reporting, storage,
advertising, promotion and record keeping related to the product will remain
subject to extensive regulatory requirements. The subsequent discovery of
previously unknown problems with the product, manufacturer or facility may
result in restrictions on the product or the manufacturer, including withdrawal
of the product from the market. We may be slow to adapt, or we may never adapt,
to changes in existing requirements or adoption of new requirements or
policies. If we fail to comply with applicable regulatory requirements, we may be
subject to fines, suspension or withdrawal of regulatory approvals, product
recalls, seizure of products, operating restrictions and criminal prosecution. Market acceptance of our products will be limited if users of our
products are unable to obtain adequate reimbursement from third-party
payors. Government health administration authorities, private health insurers and
other organizations generally provide reimbursement for products like our
product candidates, and our commercial success will depend in part on these
third-party payors agreeing to reimburse patients for the costs of our
products. Even if we succeed in bringing any of our proposed products to
market, we cannot assure you that third-party payors will consider our products
cost-effective or provide reimbursement in whole or in part for their use. Significant uncertainty exists as to the reimbursement status of newly
approved health care products. Each of our product candidates is intended to
replace or alter existing therapies or procedures. These third-party payors may 27




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conclude that our products are less safe, effective or cost-effective than
these existing therapies or procedures. Therefore, third-party payors may not
approve our products for reimbursement. If third-party payors do not approve our products for reimbursement or
fail to reimburse them adequately, sales will suffer as some physicians or
their patients will opt for a competing product that is approved for
reimbursement or is adequately reimbursed. Even if third-party payors make
reimbursement available, these payors reimbursement policies may adversely
affect the ability of us and our potential collaborators to sell our products
on a profitable basis. Moreover, the trend toward managed healthcare in the United States, the
growth of organizations such as health maintenance organizations, and
legislative proposals to reform healthcare and government insurance programs
could significantly influence the purchase of healthcare services and products,
resulting in lower prices and reduced demand for our products which could
adversely affect our business, financial condition and results of operations. In addition, legislation and regulations affecting the pricing of
pharmaceuticals may change in ways adverse to us before or after the FDA or
other regulatory agencies approve any of our proposed products for marketing.
While we cannot predict the likelihood of any of these legislative or
regulatory proposals, if any government or regulatory agencies adopt these
proposals they could materially adversely affect our business, financial
condition and results of operations. We may be required to defend lawsuits or pay damages in connection with the
alleged or actual harm caused by our products or product candidates. We face an inherent business risk of exposure to product liability claims
in the event that the use of our products is alleged to have resulted in harm
to others. This risk exists in clinical trials as well as in commercial
distribution. In addition, the pharmaceutical and biotechnology industries in
general have been subject to significant medical malpractice litigation. We may
incur significant liability if product liability or malpractice lawsuits
against us are successful. Furthermore, product liability claims, regardless or
their merits, could be costly and divert our managements attention from other
business concerns, or adversely affect our reputation and the demand for our
products. Although we maintain product liability insurance, we cannot be
certain that this coverage will be adequate or that it will continue to be
available to us on acceptable terms. Rapid technological change could make our products obsolete. Pharmaceutical technologies have undergone rapid and significant change.
We expect that pharmaceutical technologies will continue to develop rapidly.
Our future will depend in large part on our ability to maintain a competitive
position with respect to these technologies. Any compounds, products or
processes that we develop may become obsolete before we recover any expenses
incurred in connection with their development. Rapid technological change could
make our products obsolete, which could materially adversely affect our
business, financial condition and results of operations. Our products involve the use of hazardous materials, and as a result we are
exposed to potential liability claims and to costs associated with complying
with laws regulating hazardous waste. Our research and development activities involve the use of hazardous
materials, including chemicals and biological materials. We believe that our
procedures for handling hazardous materials comply with federal and state
regulations. However, there can be no assurance that accidental injury or
contamination from these materials will not occur. In the event of an accident,
we could be held liable for any damages, which could exceed our available
financial resources. This liability could materially adversely affect our
business, financial condition and results of operations. We are subject to federal, state and local laws and regulations governing
the use, manufacture, storage, handling and disposal of hazardous materials and
waste products, and we spent approximately $7,000 in the three months 28




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ended March 31, 2004 to dispose of these hazardous materials and waste
products. We may be required to incur significant costs to comply with
environmental laws and regulations in the future that could materially
adversely affect our business, financial condition and results of operations. Risks Related to Our Common Stock We expect that our stock price will fluctuate significantly. We only recently completed our initial public offering. Prior to this
offering, you could not buy or sell our common stock publicly. After this
offering, the average daily trading volume for our common stock has been
relatively low. An active public market for our common stock may not continue
to develop or be sustained. The stock market, particularly in recent years, has
experienced significant volatility particularly with respect to pharmaceutical
and biotechnology stocks. The volatility of pharmaceutical and biotechnology
stocks often does not relate to the operating performance of the companies
represented by the stock. Factors that could cause this volatility in the
market price of our common stock include:  
    
    announcements of the introduction of new products by us or our competitors;
    
    market conditions in the pharmaceutical and biotechnology sectors;
    
    rumors relating to us or our competitors;
    
    litigation or public concern about the safety of our potential products;
    
    our quarterly operating results;
    
    deviations in our operating results from the estimates of securities analysts; and
    
    FDA or international regulatory actions. We may be the subject of securities class action litigation due to future
stock price volatility. In the past, when the market price of a stock has been volatile, holders
of that stock have often instituted securities class action litigation against
the company that issued the stock. If any of our stockholders brought a lawsuit
against us, we could incur substantial costs defending the lawsuit. The lawsuit
could also divert the time and attention of our management. Future sales of common stock by our existing stockholders may cause our
stock price to fall. The market price of our common stock could decline as a result of sales by
our existing stockholders of shares of common stock in the market, or the
perception that these sales could occur. These sales might also make it more
difficult for us to sell equity securities at a time and price that we deem
appropriate. In connection with our recently completed initial public offering,
our executive officers and directors and substantially all of our pre-initial
public offering stockholders and optionholders executed lock-up agreements that
prohibit them from offering, selling, contracting to sell, granting an option
to purchase, making a short sale or otherwise disposing of any shares of our
common stock for the 180 day period from the date of our initial public
offering through April 4, 2004. Our directors and management will exercise significant control over our
company. Our directors and executive officers and their affiliates collectively
control approximately 43.2% of our outstanding common stock, excluding
unexercised options and warrants. As a result, these stockholders, if they act
together, will be able to influence our management and affairs and all matters
requiring stockholder approval, 29




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including the election of directors and approval of significant corporate
transactions. This concentration of ownership may have the effect of delaying
or preventing a change in control of our company and might affect the market
price of our common stock. Provisions of Delaware law or our charter documents could delay or prevent an
acquisition of us, even if the acquisition would be beneficial to our
stockholders, and could make it more difficult for you to change management. Provisions of Delaware law or our charter or by-laws could hamper a third
partys acquisition of us, or discourage a third party from attempting to
acquire control of us. Stockholders who wish to participate in these
transactions may not have the opportunity to do so. These provisions could also
limit the price that investors might be willing to pay in the future for shares
of our common stock. Further, these provisions make it more difficult for
stockholders to change the composition of our board of directors in any one
year. These provisions include:  
    
    a provision allowing us to issue preferred stock with rights senior
to those of the common stock without any further vote or action by the
holders of the common stock;
    
    the existence of a staggered board of directors in which there are
three classes of directors serving staggered three-year terms, thus
expanding the time required to change the composition of a majority of
directors and potentially discouraging someone from making an
acquisition proposal for us;
    
    the by-laws requirement that stockholders provide advance notice
when nominating our directors;
    
    the inability of stockholders to convene a stockholders meeting
without the chairperson of the board, the chief executive officer, the
president or a majority of the board of directors first calling the
meeting; and
    
    the application of Delaware law prohibiting us from entering into a
business combination with the beneficial owner of 15% or more of our
outstanding voting stock for a period of three years after the 15% or
greater owner first reached that level of stock ownership, unless we
meet specified criteria. We have never paid dividends on our capital stock, and we do not anticipate
paying any cash dividends in the foreseeable future. We have paid no cash dividends on any of our classes of capital stock to
date and we currently intend to retain our future earnings, if any, to fund the
development and growth of our businesses. In addition, the terms of any future
debt or credit facility may preclude us from paying these dividends. As a
result, capital appreciation, if any, of our common stock will be your sole
source of gain for the foreseeable future. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have not used derivative financial instruments for speculation or
trading purposes. However, we are exposed to market risk related to changes in
interest rates. Our current policy is to maintain an investment portfolio
consisting mainly of U.S. money market and government-grade securities,
directly or through managed funds, with maturities of one year or less. Our
cash is deposited in and invested through highly rated financial institutions
in North America. Our short-term investments are subject to interest rate risk
and will fall in value if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 10% from levels at March
31, 2004, we estimate that the fair value of our investment portfolio would
decline by an immaterial amount. We currently have the ability to hold our
fixed income investments until maturity, and therefore we do not expect our 30




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operating results or cash flows to be affected to any significant degree
by the effect of a change in market interest rates on our investments. Effects of Inflation Our assets are primarily monetary, consisting of cash, and cash
equivalents. Because of their liquidity, these assets are not directly
affected by inflation. We also believe that we have intangible assets in the
value of our technology. In accordance with generally accepted accounting
principles, we have not capitalized the value of this intellectual property on
our consolidated balance sheet. Due to the nature of this intellectual
property, we believe that these intangible assets are not affected by
inflation. Because we intend to retain and continue to use our equipment,
furniture and fixtures and leasehold improvements, we believe that the
incremental inflation related to replacement costs of such items will not
materially affect our operations. However, the rate of inflation affects our
expenses, such as those for employee compensation and contract services, which
could increase our level of expenses and the rate at which we use our
resources. 
 ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures As of March 31, 2004 (the Evaluation Date), the Companys management,
with the participation of the Companys Chief Executive Officer and the
Companys Senior Vice President and Chief Financial Officer, evaluated the
effectiveness of the Companys disclosure controls and procedures pursuant to
Rule 13a-15(b) promulgated under the Securities Exchange Act of 1934, as
amended (the Exchange Act). Based upon that evaluation, the Companys Chief
Executive Officer and the Companys Senior Vice President and Chief Financial
Officer concluded that, as of the Evaluation Date, the Companys disclosure
controls and procedures were effective in ensuring that material information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commissions rules
and forms, including ensuring that such material information is accumulated and
communicated to the Companys management, including the Companys Chief
Executive Officer and the Companys Senior Vice President and Chief Financial
Officer, as appropriate to allow timely decisions regarding required
disclosure. Internal Control Over Financial Reporting During the period covered by this report, there have been no changes in
the Companys internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS None 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (d) On October 14, 2003, we closed the sale of an aggregate of 3,750,000 shares
of our common stock, $0.01 par value, in our initial public offering at a price
to the public of $14.00 per share. The managing underwriters in the offering
were SG Cowen Securities Corporation, Thomas Weisel Partners LLC, U.S. Bancorp
Piper Jaffray and Friedman Billings Ramsey. All of the shares of common stock
sold in the offering were registered under the 1933 Act on a Registration
Statement on Form S-1 (Reg. No. 333-106725) that was declared effective by the
SEC on October 7, 2003 and a Registration Statement filed pursuant to Rule
424(b) under the Securities Act that was filed on October 8, 2003 (Reg. No.
333-106725). The offering commenced on October 7, 2003 and did not terminate
until 31




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after the sale of all of the securities registered in the Registration
Statement. As part of the initial public offering, we granted the several
underwriters an overallotment option to purchase up to an additional 562,500
shares of our common stock from us. The underwriters did not exercise the
overallotment option. There were no selling stockholders in the offering. The aggregate price of the offering amount registered on our behalf was
$52.5 million. In connection with the offering, we paid $3.7 million in
underwriting discounts and commissions to the underwriters and incurred an
estimated $1.2 million in other offering expenses. None of the underwriting
discounts and commissions or offering expenses were incurred or paid to
directors or officers of ours or their associates or to persons owning 10
percent or more of our common stock or to any affiliates of ours. After
deducting the underwriting discounts and commissions and offering expenses, we
received net proceeds from the offering of approximately $47.6 million. The
proceeds to us have conformed with our intended use outlined in the prospectus
related to the offering. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 
 ITEM 5. OTHER INFORMATION None 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) List of exhibits: ExhibitNumber
    
    Exhibit Description31.1
    
    Certification of the Chief Executive Officer under Section 302 of the
Sarbanes-Oxley Act of 2002
as defined in Exchange Act Rules 13a-14 and 15d-1431.2
    
    Certification of the Chief Financial Officer under Section 302 of the
Sarbanes-Oxley Act of 2002
as defined in Exchange Act Rules 13a-14 and 15d-1432.1
    
    Certifications of the Chief Executive Officer and Chief Financial Officer under
Section 906 of the
Sarbanes-Oxley Act of 2002 pursuant to 18 U.S.C. Section 1350
 (b) Reports on Form 8-K: On March 17, 2004, we furnished with the Securities and Exchange
Commission a Current Report on Form 8-K reporting the public dissemination
of a press release announcing our financial results for the fourth quarter
of 2003 and the calendar year then ended. 32




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on this 6th day of May 2004. ACUSPHERE, INC.By:
    /s/ Sherri C. ObergSherri C. ObergPresident and Chief Executive Officer By:
    /s/ John F. TheroJohn F. TheroSenior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and
Duly Authorized Officer) 33




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EXHIBIT INDEX ExhibitNumber
    
    Exhibit Description31.1
    
    Certification of the Chief Executive Officer under Section 302 of the
Sarbanes-Oxley Act of 2002
as defined in Exchange Act Rules 13a-14 and 15d-1431.2
    
    Certification of the Chief Financial Officer under Section 302 of the
Sarbanes-Oxley Act of 2002
as defined in Exchange Act Rules 13a-14 and 15d-1432.1
    
    Certifications of the Chief Executive Officer and Chief Financial Officer under
Section 906 of the
Sarbanes-Oxley Act of 2002 pursuant to 18 U.S.C. Section 1350
 34