**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

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**FORM 10-K**

**ANNUALREPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

| (Mark One)                                                                                                                                                                 | ** ** | ** **                                                                                               |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| x                                                                                                                                                                          | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
| **For the  fiscal year ended December 31, 2006**                                                                                                                      |
| **OR**                                                                                                                                                                     |
| o                                                                                                                                                                          | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(f) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| **For the  transition period  from                      to** |
| **Commission  file number 000-50439**                                                                                                                                      |

 

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**NITROMED, INC.**(Exact name of registrant as specified in its charter)

| **Delaware**                                                    |   | **22-3159793**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (IRS Employer  Identification No.) |
| **125 Spring Street, Lexington, Massachusetts**                 |   | **02421**                          |
| (Address of  principal executive offices)                       |   | (Zip Code)                         |

 

Registrant’s telephone number, including area code: **(781) 266-4000**

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**Securitiesregistered pursuant to Section 12(b) of the Act:**

| **Title of Each Class**  | ** ** | **Name of Each Exchange on Which Registered** |
|-----------------------------------------|------------|-----------------------------------------------------------------------------|
| Common Stock, $.01  par value per share |       | NASDAQ Global  Market                                                       |

 

**Securities registeredpursuant to Section 12(g) of the Act:**

**None**

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

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

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x No o.

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, andwill not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. x

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

Large acceleratedfiler  o              Acceleratedfiler  x               Non-acceleratedfiler  o

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

The aggregate market value of the registrant’s commonstock held by nonaffiliates of the registrant was approximately $102,706,000,based on the price at which the registrant’s common stock was last sold on June 30,2006.

As of March 1, 2007, there were 37,259,870 sharesof the registrant’s common stock outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

Specified portions of the registrant’s proxy statementfor the annual meeting of stockholders to be held on May 25, 2007, whichare to be filed pursuant to Regulation 14A within 120 days after theend of the registrant’s fiscal year ended December 31, 2006, areincorporated by reference into Part III of this report.

 

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**NITROMED, INC.ANNUAL REPORTON FORM 10-K**

**INDEX**

|               | ** ** | ** **                                                                                                         | ** ** | **PAGE** | ** ** |
|---------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| PART I   |       |                                                                                                               |       |     |       |   |   |
| Item 1.       |       | Business                                                                                                           |       |     | 1          |   |   |
| Item  1a.     |       | Risk  Factors                                                                                                      |       |     | 19         |   |   |
| Item 1b.      |       | Unresolved Staff Comments                                                                                          |       |     | 39         |   |   |
| Item 2.       |       | Properties                                                                                                         |       |     | 39         |   |   |
| Item  3.      |       | Legal  Proceedings                                                                                                 |       |     | 39         |   |   |
| Item 4.       |       | Submission of Matters to a Vote of Security Holders                                                                |       |     | 39         |   |   |
| PART II  |       |                                                                                                               |       |     |       |   |   |
| Item 5.       |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |     | 40         |   |   |
| Item  6.      |       | Selected  Financial Data                                                                                           |       |     | 43         |   |   |
| Item 7.       |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |     | 44         |   |   |
| Item 7A.      |       | Quantitative and Qualitative Disclosures About Market  Risk                                                        |       |     | 56         |   |   |
| Item 8.       |       | Financial Statements and Supplementary Data                                                                        |       |     | 57         |   |   |
| Item 9.       |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       |     | 88         |   |   |
| Item 9A.      |       | Controls and Procedures                                                                                            |       |     | 88         |   |   |
| Item  9B.     |       | Other  Information                                                                                                 |       |     | 91         |   |   |
| PART III |       |                                                                                                               |       |     |       |   |   |
| Item 10.      |       | Directors, Executive Officers and Corporate Governance                                                             |       |     | 91         |   |   |
| Item 11.      |       | Executive Compensation                                                                                             |       |     | 92         |   |   |
| Item 12.      |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       |     | 92         |   |   |
| Item 13.      |       | Certain Relationships and Related Transactions, and  Director Independence                                         |       |     | 92         |   |   |
| Item 14.      |       | Principal Accounting Fees and Services                                                                             |       |     | 92         |   |   |
| PART IV  |       |                                                                                                               |       |     |       |   |   |
| Item 15.      |       | Exhibits, Financial Statement Schedules                                                                            |       |     | 92         |   |   |
| SIGNATURES    |       |                                                                                                               | 93         |     |       |

 

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**PART I**

*This annual reporton Form 10-K contains forward-looking statements that involverisks and uncertainties, as well as assumptions that, if they never materializeor prove incorrect, could cause our results to differ materially from thoseexpressed or implied by such forward-looking statements. All statementsother than statements of historical fact are statements that could be deemedforward-looking statements, including any projections of revenue,expenses, earnings or losses from operations, or other financial items; anystatements of the plans, strategies and objectives of management for futureoperations; any statements concerning product development and commercializationtimelines or outcomes; any statements of expectation or belief; and any statementsof assumptions underlying any of the foregoing. The risks, uncertainties andassumptions referred to above include risks that are described in “Item 1A—RiskFactors” and elsewhere in this annual report and that are otherwise describedfrom time to time in our Securities and Exchange Commission reports filed afterthis report.*

*The forward-looking statements included in thisannual report represent our estimates as of the date of this annual report. Wespecifically disclaim any obligation to update these forward-lookingstatements in the future, except as specifically required by law or the rules ofthe Securities and Exchange Commission. These forward-looking statementsshould not be relied upon as representing our estimates or views as of any datesubsequent to the date of this annual report.*

**ITEM 1.**                BUSINESS

**Overview**

We are an emerging pharmaceutical company withsubstantial expertise and intellectual property in nitric oxide-based drugdevelopment. We have devoted substantially all of our efforts towards theresearch and development of our product candidates and the commercialization ofour currently marketed product, BiDil®.

In June 2005, the U.S. Food and DrugAdministration, or FDA, approved our first commercial product, BiDil, for thetreatment of heart failure in self-identified black patients as an adjunct tocurrent standard therapies. BiDil is an orally administered fixed-dosecombination of isosorbide dinitrate and hydralazine hydrochloride. Wecommercially launched BiDil in July 2005. We engaged Schwarz PharmaManufacturing, Inc., or Schwarz Pharma, under a five-year exclusivemanufacturing and supply agreement for the three times daily immediate releasedosage formulation of BiDil.

In March 2006, we eliminated our discoveryresearch program and terminated substantially all of the employees in ourdiscovery research group in a restructuring of our company that was intended tobetter align costs with revenue and operating expectations. In October 2006,we implemented a revised strategy and business model in order to focus ourresources on the accelerated development of an extended release formulation ofBiDil, known as BiDil XRTM. As part of this strategic shift, we eliminated ourthen-current sales force and replaced it with a small team of highlyexperienced senior cardiovascular specialists, resulting in a net reduction ofapproximately 120 in sales force headcount. In addition, we eliminatedapproximately 20% of our general and administrative personnel in connectionwith this restructuring program. Our restructured sales force will be comprisedinitially of a director of managed markets, six national account directors, twoarea business directors and twenty-one cardiovascular business managers. Oursales and marketing organization continues to be managed by our senior vicepresident of commercial operations and our vice president of marketing and businessdevelopment. Our highly specialized field force is focused on regional andnational thought-leader physicians, current BiDil prescribers, as well as keyinstitutions in major metropolitan centers that treat, and influence thetreatment of, large numbers of African-Americans diagnosed with heart failure. Additionalnon-personal marketing methods are being utilized to reach the broader numberof existing and potential BiDil prescribers. We expect that this alternativestrategy will employ a less costly approach to marketing the current immediaterelease 

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formulation of BiDil,allowing us to conserve the cash required to pursue the accelerated developmentof BiDil XR. Preliminary clinical studies with BiDil XR have demonstrated proofof principle, and we continue to proceed with early-stage clinical developmentof the product.

In connection with our efforts to develop BiDil XR, onFebruary 9, 2007, we entered into a license agreement with Elan PharmaInternational Limited, or Elan. Pursuant to the agreement, Elan granted to usan exclusive worldwide royalty-bearing license, with specified sublicenserights, to specified intellectual property of Elan, as well as any improvementsto any of the foregoing developed by either party during the term of theagreement. Pursuant to the license, we may import, use, offer for sale and sellan oral capsule formulation incorporating specified technology owned orcontrolled by Elan and containing, as its sole active combination ofingredients, the combination of the active drug substances isosorbide dinitrateand hydralazine hydrochloride. In consideration for the grant of the license,we have agreed to pay Elan royalties that are calculated by reference to annualnet sales parameters set forth in the agreement. In addition, we have alsoagreed to pay Elan specified amounts upon the achievement of specifieddevelopment and commercialization milestone events set forth in the agreement.We have also generated significant intellectual property rights relating to ournitric-oxide enhancing technologies and we are seeking out-licensing andcollaboration opportunities to further exploit these proprietary technologies. Wedo not have any current plans to conduct any further internal research withrespect to these technologies.

We were incorporated in Delaware in 1992. Our officeis currently located at 125 Spring Street, Lexington, Massachusetts 02421, andour telephone number is (781) 266-4000. On February 23, 2007,we entered into a lease for office space at 45-55 Hayden Avenue inLexington, Massachusetts, and expect to move to our new office location in March 2007.Our Internet address is www.nitromed.com. The information on our website is notincorporated by reference into this annual report on Form 10-K andshould not be considered to be a part of this annual report. Our websiteaddress is included in this annual report on Form 10-K as aninactive technical reference only.

When used in this annualreport on Form 10-K, the terms “NitroMed,” “we,” “our” and “us” referto NitroMed, Inc., unless otherwise specified. We own the trademarksNitroMed®,BiDil® and NitroMed’s logo “N.” In addition, we havefiled an application for BiDil XRTM. Other trademarks and service marksappearing in this annual report on Form 10-K are the property oftheir respective holders.

**BiDil: Treatmentfor Heart Failure in African Americans**

*Heart Failure inAfrican Americans*

Heart failure, also called congestive heart failure ordilated cardiomyopathy, is a progressively worsening condition that occurs whenthe heart muscle weakens and cannot pump blood efficiently enough to meet themetabolic needs of the body. The loss of pump function is usually caused by anunderlying condition, such as hypertension or coronary artery disease, whichweakens the heart muscle and increases a person’s risk of heart failure. Themost common symptoms of heart failure include shortness of breath fromcongestion in the lungs, fatigue, sleeping problems due to the inability to layflat, sudden awakening with shortness of breath and swelling in the feet,ankles and other parts of the body.

Heart failure affects approximately five millionAmericans and there is currently no cure for the disease. After a patient isdiagnosed with heart failure, their prognosis is generally poor, withapproximately 50 percent of patients dying within five years. Heart failure isthe primary reason for hospitalizations among people over the age of 65 and isone of the most expensive diseases faced by Americans, costing more than allcancers combined.

An estimated 750,000African Americans are currently diagnosed with heart failure. African Americansbetween the ages of 45 and 64 are 2.5 times more likely to die from heartfailure than caucasians in the same age range. The African American communityis also more likely to be subject to the 

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diseaseat a younger age than their caucasian counterparts, resulting in earlierdisability and higher rates of both hospitalization and premature death. Inaddition, some medicines approved for the treatment of heart failure appear tobe less effective in controlling high blood pressure in African Americanpatients. Ethnic disparities in the prevalence of heart failure have beenattributed to a variety of factors, including access to medical care, diseasemanagement, socioeconomic factors, lifestyle habits and a higher incidence ofdiabetes, hypertension and metabolic syndrome.

*African AmericanHeart Failure Trial (A-HeFT)*

In 2001, we partnered with the Association of BlackCardiologists, Inc. to conduct the African American Heart Failure Trial,or A-HeFT, the first trial conducted in a heart failure population in which allof the participants identified themselves as black. A retrospective analysis ofan earlier study with a combination of isosorbide dinitrate and hydralazinehydrochloride had suggested a trend for improved survival in the subset ofpatients with mild to moderate heart failure who self-identified themselves asblack. The randomized, double-blind, placebo-controlled A-HeFT study enrolled1,050 self-identified black patients with New York Heart Association, or NYHA,class III or IV heart failure at 169 clinical research sites. Theclassification system means that patients had marked limitation of physicalactivity (class III) or were unable to carry out any physical activity withoutdiscomfort (class IV). Participants in A-HeFT were required to be stable whilereceiving standard heart failure therapy at the time of the beginning of thetrial, per their physicians. The primary end point for the trial was acomposite score made up of weighted values for death from any cause, a first hospitalizationfor heart failure, and change in the quality of life.

After a unanimousrecommendation from the independent A-HeFT Data and Safety Monitoring Board andSteering Committee in July 2004, A-HeFT was halted early due to asignificant survival benefit seen with the drug. Patients taking BiDil inaddition to current therapies experienced a significant 43% decrease in therisk of mortality (p=0.012) (absolute mortality rate: BiDil, 6.2% vs. placebo,10.2%), a 39% reduction in the risk of first hospitalization for heart failure(p<0.001) (absolute first hospitalization rate: BiDil, 16.4% vs. placebo,24.4%) and a statistically significant improvement at most time points inresponse to the Minnesota Living with Heart Failure Questionnaire, which is aself-report of the patient’s functional status, versus patients taking placeboin addition to current standard therapies. Adverse events reported in the trialincluded symptoms of headache and dizziness, which were significantly morefrequent in the group given BiDil, and exacerbations of congestive heartfailure, both moderate and severe, which were significantly more frequent inthe placebo group.

*BiDil:Commercialization Strategy*

BiDil, an orally administered fixed-dose combinationof isosorbide dinitrate and hydralazine hydrochloride, was approved by the FDAin June 2005 for the treatment of heart failure in self-identified blackpatients. BiDil is indicated for the treatment of heart failure as an adjunctto standard therapy in self-identified black patients to improve survival, toprolong time to hospitalization for heart failure, and to improvepatient-reported functional status. There is little experience in patients withNYHA class IV heart failure. Most patients in the clinical trial supportingeffectiveness, referred to as A-HeFT, received, in addition to BiDil orplacebo, concomitant therapy with one or more of the following other heartfailure medicines: a loop diuretic, an angiotensin converting enzyme inhibitoror an angiotensin receptor blocker, and a beta blocker. In addition, manypatients also received a cardiac glycoside or an aldosterone antagonist. BiDilis a fixed-dose combination of isosorbide dinitrate, a vasodilator with effectson arteries and veins, and hydralazine hydrochloride, a predominantly arterialvasodilator. The mechanism of action underlying the beneficial effects of BiDilin the treatment of heart failure has not been established.

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Our current salesstrategy for BiDil is focused on:

·       concentratedsales efforts through a small team of highly experienced senior cardiovascularspecialists targeting:

·        leadingheart failure academic institutions and specialized clinics,

·        keyopinion leaders in cardiology who influence the treatment of heart failure, and

·        highprescibers of BiDil and other heart failure medications;

·       ensuringpatient access through:

·        effortsto obtain public and private insurance coverage and to secure preferentialreimbursement status among third-party payors,

·        ourpatient assistance program, and

·        coalitionbuilding with advocacy organizations; and

·       creatingphysician awareness and demand through centralized promotional efforts.

With respect to manufacturing, we engaged SchwarzPharma under a five-year exclusive manufacturing and supply agreement for thethree times daily immediate release dosage formulation of BiDil. Under thesupply agreement, we have the right to engage a backup manufacturer. As part ofthe manufacturing process, we order bulk materials of hydralazine hydrochloridefrom Flavine International, Inc., the U.S. representative of SumitomoCorp., and isosorbide dinitrate from Dottikon ES Holding AG.

Our current efforts to expand patient access to BiDilfocus on gaining improved insurance coverage. We estimate that approximatelytwo-thirds of African American patients have access to BiDil at Tier IIreimbursement, a term generally used to denote a preferential level ofreimbursement at which patient co-pays range from approximately $15.00 to$30.00 per prescription. Our estimates are drawn from published databases,subscription databases and external consultants who have expertise in this area.Due to the fact that ethnicity data is not generally collected by commercialand Medicare Part D insurers, exact figures cannot be determined.

With respect to our coalition-building efforts,we have maintained a strategic alliance with the National Association for theAdvancement of Colored People, or NAACP, to implement measures to narrow healthcare disparities that exist between African Americans and Caucasians in areasof access, affordability, quality, infrastructure and compliance. We have alsodeveloped coalitions with other advocacy and professional organizations as partof our efforts to address racial and ethnic disparities in cardiovasculardisease, including the Association of Black Cardiologists, the CongressionalBlack Caucus and the National Minority Quality Forum.

Those clinicianswhom we can not reach by direct personal methods will receive non-personalpromotional efforts, driven centrally by our marketing department. Thesetactics include, but are not limited to:

·       tele-detailing;

·       e-detailing;

·       directmail;

·       Internetadvertising; and

·       professional journaladvertising.

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*BiDil XR: InternalDevelopment Strategy*

The current formulation of BiDil is animmediate-release tablet that must be taken three times daily. We are currentlypursuing the development of an extended release formulation of BiDil, known asBiDil XR, that is designed to be taken once a day. We believe that BiDil XRcould enhance the BiDil market by facilitating greater compliance by patientswith their medications schedule, an issue which is more pronounced in a patientpopulation already on a substantial number of concomitant medications.

In connection with our efforts to develop BiDil XR, onFebruary 9, 2007, we entered into a license agreement with Elan, which werefer to as Elan. Pursuant to the agreement, Elan granted to us an exclusiveworldwide license, for the term of the agreement, to certain know-how, patentsand technology, and any improvements to any of the foregoing developed byeither party during the term of the agreement. Pursuant to this license, wehave the right to import, use, offer for sale and sell the oral capsuleformulation incorporating specified technology referred to in the agreement andcontaining, as its sole active combination of ingredients, the combination ofthe active drug substances isosorbide dinitrate and hydralazine hydrochloride,including BiDil XR.

Preliminary clinical studieswith BiDil XR have demonstrated proof of principle, and we continue to proceedwith early-stage clinical development of the product. Our current plan forseeking regulatory approval for BiDil XR, which will include the conduct ofbioequivalence studies, if successful and accepted as part of the basis forapproval, is expected to enable the development of BiDil XR as expeditiously aspossible.

**Nitric OxideEnhancing Intellectual Property**

In the 1980s, nitric oxide was identified as asignificant molecule that regulates a wide range of important cellularfunctions. Professor Robert R. Furchgott, a member of our scientific advisoryboard until his retirement in 2005, and two other individuals were awarded theNobel Prize in Physiology and Medicine in 1998 for this discovery. Recentresearch has shown that nitric oxide also plays important biochemical andphysiological roles in many diseases or medical conditions, includingcardiovascular disease, gastrointestinal and inflammatory disease, centralnervous system disorders, sexual dysfunction and respiratory disease.

In the past, we have utilized our nitric oxideexpertise and proprietary position to seek to develop product candidates for avariety of such medical conditions. Our previous efforts in these areasconsisted of discovery and preclinical stage research primarily directed to establishing our intellectual propertyposition and, in certain  cases,validating our discoveries in preclinical studies.

Our previous discovery research efforts sought toproduce nitric oxide-enhancing drug candidates by combining an existing,marketed medicine with a nitric oxide donor, which is a molecule capable of increasingnitric oxide levels in the body. The nitric oxide donor and the existingmedicine can be combined together through either a chemical linkage topotentially create a proprietary new chemical entity or through the directmixing of the medicine and the nitric oxide enhancing compound to potentiallycreate a patentable new use and dosage form. We believe that the probability ofclinical success for those drug candidates is increased because regulatoryapprovals have already been achieved for the existing medicines that we wereseeking to improve. We also believe that the commercial risk associated withthese drug candidates is mitigated because many of these existing medicineshave already generated significant sales in their markets.

In March 2006, we eliminated our discoveryresearch program in a restructuring of our company. In connection with our October 2006restructuring of our sales force, we implemented a revised strategy andbusiness model in a move intended to focus our resources on the accelerateddevelopment of BiDil XR. As a result of these restructurings, we have limitedour internal development activities to the development of 

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BiDil XR and we do nothave any current plans to conduct any further discovery research efforts withrespect to our product candidates. We are currently seeking out-licensing andcollaboration opportunities for these product candidates, including NMI-3377,a pre-clinical cardio-renal compound. We have generated significantintellectual property rights related to our nitric oxide-enhancing technologyand compounds to protect our interests and will continue to maintain andpreserve those rights.

The following is a summaryof the key nitric oxide programs we have previously pursued.

*Nitric OxideEnhancing Medicines for the Treatment of Cardiovascular Disease*

We previously initiatedseveral new and novel cardiovascular drug discovery programs based on thetherapeutic potential of nitric oxide-enhancing drugs in the treatment ofdiseases associated with endothelial dysfunction. Endothelial dysfunction isrecognized as one of the common denominators underlying many cardiovasculardiseases including atherosclerosis, hypertension, heart failure, diabetes,pulmonary hypertension and metabolic syndrome. Abnormal function of the endothelium,which is the layer of cells that lines blood vessels, precedes vascularmorphological changes in the early stages of cardiovascular disease. Nitricoxide has many important roles in maintaining the function of normalendothelium. These include vasodilatation, inhibition of adhesion of a type ofred blood cell called platelets and activation, inhibition of smooth musclegrowth, inhibition of white blood cell adhesion and a reduction in chemotacticfactor expression. Loss of nitric oxide therefore is a primary feature ofendothelial dysfunction. Restoration of nitric oxide from the endothelium hasbeen clinically demonstrated to reduce cardiovascular risk in many diseasestates. Our prior discovery research efforts utilized our nitric oxide expertiseand proprietary patent position to add nitric oxide-donating capacity toexisting classes of drugs which have been shown to have clinical utility in thetreatment of cardiovascular diseases where endothelial dysfunction plays acritical role.

*Nitric Oxide-BasedMedicines for Acute Renal Failure*

Acute renal failure is characterized as a suddendeterioration in kidney function and affects about 5% of all hospitalizedpatients. The condition is often associated with trauma, burns, systemicinfections and shock. It is a serious and life threatening condition from whichmore than half of the affected patients die. Currently, there are no effectivedrug therapies for acute renal failure. Disease management is costly andincludes kidney dialysis and transplantation. Nitric oxide plays a pivotal rolein kidney homeostasis at the level of the renal vasculature, glomerulus, andrenal tubule. All three subtypes of nitric oxide synthase (endothelial,neuronal and inducible) are expressed in various kidney structures andparticipate in the control of glomerular and medullary hemodynamics,tubuloglomerular feedback responses, the renin-angiotensin system, andelectrolyte/fluid balance through endogenous generation of nitric oxide.

In February 2004, wesigned a licensing and commercialization agreement with the University ofEdinburgh and the University of St. Andrews in Scotland to research nitricoxide-based medicines with the goal of identifying treatment of acute renalfailure. Our agreement with the universities supports a healthcare innovationstechnology transfer program funded by the Wellcome Trust, which is focused onthe development of early stage projects to a point where they can be furtherdeveloped by the commercial sector.

*Other NitricOxide-Based Programs*

Set forth below isa list of additional classes of nitric oxide-enhancing medicines where wehave created intellectual property rights and where we believe nitricoxide-enhancing drugs may offer a clinical benefit compared to existingFDA-approved medicines. Our previous efforts in these areas consisted ofdiscovery-stage research primarily directed to establishing ourintellectual property position.

·       Nitricoxide-enhancing nonsteroidal anti-inflammatory drugs;

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·       Nitricoxide-enhancing phosphodiesterase inhibitors;

·       Nitricoxide-enhancing steroids;

·       Nitricoxide-enhancing gastrointestinal protectants;

·       Nitricoxide-enhancing arginines; and

·       Nitric oxide-enhancingantibiotics.

*Boston ScientificAgreement*

In November 2001, we entered into a research,development and license agreement with Boston Scientific in the field ofrestenosis. In accordance with the terms of the agreement, we granted BostonScientific an exclusive worldwide license to develop and commercialize nitricoxide-enhancing cardiovascular stents based on certain of ourtechnologies. We also granted to Boston Scientific a right of first refusal toobtain an exclusive license under our nitric oxide technologies tocommercialize products for restenosis, which right of first refusal is for aperiod of three years after the end of the research term. The research term ofthe Boston Scientific agreement expired on December 31, 2005, althoughcertain rights extend beyond this term.

Boston Scientific made anup-front license payment of $1.5 million to us in 2001, and made anadditional payment of $3.0 million in December 2003 in connectionwith the extension of the research and development collaboration. BostonScientific also made a $3.5 million equity investment in our stock in2001. In August 2003, in connection with a private placement, BostonScientific made an additional $500,000 equity investment in our stock.

**Our Strategy**

In October 2006, we implemented a revisedstrategy and business model in order to focus our resources on the accelerateddevelopment of BiDil XR. Key elements of our revised strategy include:

*Maintenanceof BiDil Market Presence.*   As part of thisstrategic shift, we eliminated our then-current sales force and replaced itwith a small team of highly experienced senior cardiovascular specialists,resulting in a net reduction of approximately 120 in sales force headcount.This highly specialized team is focused on regional and national thought-leaderphysicians, current BiDil prescribers, as well as key institutions in majormetropolitan centers that treat, and influence the treatment of, large numbersof African-Americans diagnosed with heart failure. Additional non-personalmarketing methods are being utilized to reach the broader number of existingand potential BiDil prescribers. We expect that this alternative strategy willemploy a less costly approach to marketing the current immediate releaseformulation of BiDil, allowing us to conserve the cash required to pursue the developmentof BiDil XR as expeditiously as possible.

In addition, as part of our revised strategy andbusiness model we are developing an internal team of six account directors tobe lead by a director of managed markets whose focus will be ensuring patientaccess through targeted efforts to obtain public and private insurance coverageand to secure preferential reimbursement status among third-party payors. Webelieve that the documented efficacy and cost-effectiveness of BiDil willbolster these continuing efforts to expand the level of favorable reimbursementtreatment received by BiDil both from public and private payors. Our failure toachieve broad preferential reimbursement treatment for BiDil in the near termcould significantly hinder market acceptance of BiDil by physicians andpatients.

*Conservationof Resources and Accelerated Development of BiDil XR.*   Weexpect that this alternative strategy will employ a less costly approach tomarketing the current immediate release formulation of BiDil, allowing us toconserve the cash required to pursue the development of BiDil XR asexpeditiously as 

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possible. Preliminaryclinical studies with BiDil XR have demonstrated proof of principle, and wecontinue to proceed in early-stage clinical development of the product.

*Continuingto Protect our Product-Specific and Nitric Oxide Intellectual Property Rightsand Focusing on Potential Collaborations.*   Through ourprevious discovery research efforts, we have developed an extensive patentportfolio in nitric-oxide enhancing technology. Because of the value of this portfolio and its critical role in ouron-going product development efforts, we intend to aggressively pursue theprotection of our intellectual property. We believe that many pharmaceuticalcompanies have currently marketed drugs and products that could benefit fromthe therapeutic attributes and the potential patent protection of our nitric oxide-enhancingtechnology.

We will continue toentertain opportunities for collaboration with other businesses that may offerincremental value to our commercial portfolio or though which our productcandidates will benefit from the marketing reach, clinical expertise andtechnology of the partner.

**Research andDevelopment**

During the fiscal years ended December 31, 2006,2005 and 2004, our total company-sponsored research and developmentexpenses were $17.0 million, $29.0 million, and $22.4 million,respectively, and that our collaborator-sponsored research anddevelopment expenses were $-0- million, $2.3 million and$5.0 million, respectively.

In March 2006, weeliminated our discovery research program in a restructuring of our company. Inconnection with our October 2006 restructuring of our sales force, weimplemented a revised strategy and business model in order to focus ourresources on the accelerated development of BiDil XR. As a result of theserestructurings, we have limited our internal development activities to thecontinued development of BiDil XR, and we do not have any current plans toconduct any further discovery research efforts with respect to our productcandidates. We are currently seeking out-licensing and collaboration opportunitiesfor these product candidates, including NMI-3377, a pre-clinicalcardio-renal compound. We have generated significant intellectual propertyrights related to our nitric oxide-enhancing technology and compounds toprotect our interests and will continue to maintain and preserve those rights.

**Proprietary**Rights and Licensing

Our policy is to prosecuteand enforce our patents and proprietary technology. We intend to continue tofile United States and foreign patent applications to protect technology,inventions and improvements that are considered important to the development ofour business. We will be able to protect our proprietary technologies fromunauthorized use by third parties only to the extent that our proprietaryrights are covered by valid and enforceable patents or are effectivelymaintained as trade secrets.

As of December 31,2006, we have 87 issued U.S. patents and 53 pending U.S. patent applications.We also have 79 issued patents and 163 pending patent applications in certainmajor industrial countries, including Canada, the major European marketcountries, Australia and Japan. Our issued U.S. and foreign patents expire onvarious dates between 2007 and 2025.

*BiDil.*   Wehave three U.S. patents, one expiring in April 2007 and the other two in 2020,and one Canadian patent expiring in 2008, which relate to co-administration ofthe components of BiDil. The first U.S. patent and the Canadian patent covermethods for reducing mortality associated with chronic congestive heart failure.We are currently pursuing an extension of this patent with the United StatesPatent and Trademark Office, or PTO, and the FDA. We have filed for an interimextension of one year during the processing of the extension application, buthave not yet received a response from the PTO regarding the disposition of thisinterim extension. We have no assurance that we will be able to obtain anextension of this patent and our inability to do so would result in the loss ofthe protections afforded by this 

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patent. The secondU.S. patent covers methods for reducing mortality associated with chroniccongestive heart failure, for improving the quality of life, for improvingoxygen consumption or improving exercise tolerance in black patients. The thirdU.S. patent covers additional claims to specific indications and dosing rangesfor the treatment of heart failure and other conditions in black patients. Wehave not filed any patent applications outside of the United States and Canadafor BiDil, as pertains to the patent expiring in 2007. We have filedapplications claiming priority relative to the patents expiring in 2020 inCanada and Europe. In addition, we have filed ten additional U.S. patentapplications and corresponding foreign patent applications that could provideadditional patent protection for BiDil.

*Nitric Oxide Stents.**  *We have seven U.S. patents expiring on dates between2013 and 2021 which cover the coating of medical devices with nitric oxidecompounds, prevention of adverse effects associated with the use of a medicaldevice, treatment of a damaged vessel or treatment of a damaged vascularsurface in a patient by administration of a nitric oxide compound. We have fivepending U.S. patent applications which, if issued, will have expiration datesbetween 2021 and 2025 and which cover the composition of matter of specificnitric oxide donors or nitric oxide-linked compounds and their methods ofuse for the treatment of restenosis. We have filed additional patentapplications worldwide. We have been issued one Australian patent, one Europeanpatent, and one Canadian patent, all of which expire in 2014.

*Nitric Oxide-EnhancingCOX-2 Inhibitors and Nitric Oxide-Enhancing NonsteroidalAnti-Inflammatory Drugs.*   We have four issued and nine pending U.S.patent applications, which, if issued, will have expiration dates between 2020and 2026 and which disclose and claim novel nitric oxide-enhancing COX-2inhibitors. These applications also disclose kits and methods of use for thetreatment of pain, inflammation and fever, gastrointestinal disorders,disorders resulting from elevated levels of COX-2 inhibitors, forreducing renal and respiratory toxicity, for facilitating wound healing and forimproving the cardiovascular profile of COX-2 inhibitors. We have alsofiled additional foreign patent applications relating to this technology. Wehave three U.S. patents expiring in 2015, two U.S. patents expiring in 2018,and one patent application which, if issued, will expire in 2018, which cover differentcompositions of matter and methods of use for the treatment of pain,inflammation, fever and gastrointestinal disorders with novel nitric oxide-enhancingNSAID’s. One pending patent application, which, if issued, will expire in 2023,discloses specific composition of matter and methods of use for the treatmentof pain, inflammation and gastrointestinal disorders of novel nitric oxide-enhancingnonsteroidal anti-inflammatory drugs.

We have filed additionalpatent applications worldwide and have been issued four Australian patents,three of which expire in 2016 and one in 2019, and one issued Canadian patent,which expires in 2016.

*Nitric Oxide EnhancingCardiovascular Compounds.*   We have nine pending U.S. patent applicationsand five pending Patent Cooperation Treaty, or PCT, patent applications, whichif issued, will have expiration dates between 2024 and 2026 and which discloseand claim novel nitric oxide-enhancing cardiovascular compounds. Theseapplications also disclose kits and methods of use for the treatment of severaldiseases and disorders.

*Other DevelopmentPrograms.**  *We alsohave a U.S. patent and a pending U.S. patent application, both of which expirein 2019, which disclose the methods of use of N-hydroxyguanidine compounds inthe treatment of renal failure. We have also filed additional foreign patentsapplications covering this technology.

**Corporate Collaborations and Business Arrangements**

*Elan.  **In February 2007,*inconnection with our efforts to develop BiDil XR, we entered into a licenseagreement with Elan. Pursuant to the agreement, Elan granted to us an exclusiveworldwide license, for the term of the agreement, to certain know-how, patentsand technology, and any improvements to any of the foregoing developed byeither party during the term of the agreement. 

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Pursuant to thislicense, we have the right to import, use, offer for sale and sell the oralcapsule formulation incorporating specified technology referred to in theagreement and containing, as its sole active combination of ingredients, thecombination of the active drug substances isosorbide dinitrate and hydralazinehydrochloride, including BiDil XR. In consideration for the grant of thelicense, we have agreed to pay Elan royalties that are calculated by referenceto annual net sales parameters set forth in the agreement. In addition, we havealso agreed to pay Elan specified amounts upon the achievement of specifieddevelopment and commercialization milestone events set forth in the agreement.

The term of the agreementruns in the United States from the effective date of the agreement until thelater of (a) the 20th anniversary of the date of the first sale of theproduct by us or a permitted sublicensee to an unaffiliated third party, whichis referred to in the agreement as the first in market sale, or (b) theexpiration of the last-to-expire patent for the product listed in the FDA’s“Orange Book.”  Elsewhere in the world, the term will run on a country bycountry basis from the effective date of the agreement until the later of(a) the 20th anniversary of the date of the first in market sale ofthe product in the country concerned or (b) the expiration of the life ofthe last to expire patent included in the Elan intellectual property in thatcountry. Following the expiration of the initial term, the agreement shallcontinue automatically for rolling 3 year periods thereafter, unless theagreement has been terminated by either of the parties by serving 1 year’swritten notice on the other party immediately prior to the end of the initialterm or any such additional 3 year period. Either Elan or we may terminate theagreement in the event of a material, uncured breach by the other party, or ifthe other party goes into liquidation or becomes bankrupt or insolvent. Inaddition, we may terminate the agreement in the event of a technical failure,which is defined as the inability to achieve a pharmacokinetic profile for theproduct consistent with that of BiDil administered three times daily (at 6 hourintervals). Elan may terminate the agreement with respect to a particularcountry in the territory in the event that we do not meet certain obligationsset forth in the agreement with respect to such country, provided that Elanmust first consult with us and, if applicable, provide us with an opportunityto meet such obligations prior to exercising Elan’s termination rights.

*Schwarz PharmaManufacturing, Inc.*   In February 2005, we entered into afive-year exclusive manufacturing and supply agreement with Schwarz Pharma forthe three times daily immediate release dosage formulation of BiDil. Under thesupply agreement, we have the right to engage a backup manufacturer but do notcurrently have any backup manufacturing agreement in place. The agreementrenews automatically upon the expiration of the then-current term forsuccessive one year terms unless either party provides written notice oftermination at least six months prior to the expiration of the then-currentterm. The agreement is also terminable upon the occurrence of certain specifiedevents.

*Cardinal Health PTC, LLC.*   InJune 2005, we entered into a three-year exclusive distribution agreementwith Cardinal Health for the distribution of BiDil in all formulations. We areobligated to pay Cardinal Health fees for the services provided under theagreement. Pursuant to the terms of the agreement, Cardinal Health has theright of first negotiation for any new pharmaceutical product to be sold by usduring the term. The agreement renews automatically unless either partyprovides written notice of termination at least ninety days prior to theexpiration of the then-current term. The agreement may be terminated withoutcause upon 120-days notice. However, we are obligated to pay certain feesif we exercise this termination right during the initial term of the agreement.The agreement is also terminable upon the occurrence of certain specifiedevents.

*Dr. Jay N. Cohn.*   InJanuary 1999, as amended in January 2001 and March 2002, weentered into a collaboration and license agreement with Dr. Jay N. Cohn.Under the agreement, Dr. Cohn licensed to us exclusive worldwide royalty-bearingrights to technology and inventions owned or controlled by Dr. Cohn andthat relate to BiDil for the treatment of cardiovascular disease. We have mademilestone payments and are currently making royalty payments to Dr. Cohnupon sales of BiDil. During the years ended December 31, 2006, and 2005,we incurred royalties to Dr. Cohn in the approximate amounts of $364,000, 

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and $134,000,respectively. The agreement imposes upon us an obligation to use reasonablebest efforts to develop and, upon receipt of regulatory approval, manufacture,market and commercialize products based upon the licensed rights. If we fail tomeet this obligation, Dr. Cohn has the right to terminate the agreementand the license granted to us under the agreement. Dr. Cohn also has theright to terminate the agreement if we materially breach the agreement and failto remedy the breach within 30 days. We have the right to terminate theagreement at any time upon 30 days’ prior written notice. Unless earlierterminated, the agreement continues in perpetuity. Pursuant to the agreement,Dr. Cohn was appointed to our then-current scientific advisory board,entered into a consulting agreement with us and was granted an option topurchase 10,000 shares of our common stock.

*Boston Scientific.*   Aspart of our strategy to accelerate our product development efforts, in the pastwe have established collaborations with several large pharmaceutical companies.These collaborations have been designed to provide us with capital andresearch, development and marketing capabilities. We entered into one sucharrangement with Boston Scientific Corporation in the area of nitric oxide-enhancingpaclitaxel-coated stents to reduce restenosis. On December 31, 2005,the research term under our agreement with Boston Scientific expired, althoughcertain rights extend beyond this term.

*The Brigham and Women’sHospital.**  *In August 1992,as amended in November 1996, we entered into a research and licenseagreement with The Brigham and Women’s Hospital, Inc., which we refer toas BWH. Under the agreement, we sponsored a research program at BWH for aperiod of approximately two years relating to the diagnostic, therapeutic andprophylactic use of nitric oxide and related compounds. Under the agreement, inexchange for our sponsored research funding, BWH granted us exclusive worldwideroyalty-bearing rights to technology and inventions owned at theeffective time of, or developed in the course of, the sponsored researchprogram. We were applying the patents, patent applications and otherintellectual property rights licensed to us by the BWH in our former nitricoxide-stent program. The agreement imposes on us due diligence obligations withrespect to the research, development and commercialization of products basedupon the licensed rights. If we fail to meet these obligations, then uponwritten notice the license will become non-exclusive. BWH has the right toterminate the agreement if we materially breach the agreement and fail toremedy the breach within 60 days.

*Boston University.*   In June 1993,as amended in July 1997, January 1999, December 2002 and February 2005,we entered into a research and license agreement with the Trustees of BostonUniversity, which we refer to as BU. Under the agreement, we have agreed tosponsor a multi-year research program at BU in the area of nitric oxide-enhancingmedicines. Under the agreement, in exchange for our sponsored research funding,BU has granted us exclusive worldwide royalty-bearing rights totechnology and inventions owned by BU and/or for the principal investigatornamed in the research proposal at the effective time of, or developed in thecourse of, the sponsored research program. We have agreed to pay royalties toBU on all products sold or distributed by us or our affiliates which incorporateor utilize inventions, material or information specified in the agreement. Theagreement imposes on us due diligence obligations with respect to thedevelopment and commercialization of products based upon the licensed rights.If we fail to meet these obligations, then upon notice by BU, the parties arerequired to enter into good faith negotiations, and if the parties cannot reachresolution, the license will become non-exclusive without the right tosublicense. BU has the right to terminate the agreement if we materially breachthe agreement and fail to remedy the breach within 60 days. We mayterminate funding of any sponsored research program on three months’ priorwritten notice.

*FoxKiser.*   Inconnection with our efforts to obtain the approval of BiDil from the FDA, weentered into an agreement with the law firm of FoxKiser LLC, which we refer toas FoxKiser, for services related to the regulatory approval process for BiDil.The agreement provided for payment of legal consulting fees upon receipt ofwritten FDA approval of BiDil. On June 23, 2005, we received written FDAapproval of BiDil, and in July 2005, we paid $2.4 million pursuant to theterms of this agreement. In addition, the agreement requires us to payroyalties to FoxKiser on commercial sales of BiDil. The royalty term ends six 

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months after thedate of market introduction of an FDA-approved generic version of BiDil. Duringthe third quarter of 2005, we entered into a separate consulting agreement withFoxKiser following the approval by the FDA of BiDil, which ceased to beeffective during the third quarter of 2006. During the years ended December 31,2006, 2005 and 2004, we recorded charges of $0.9 million, $1.6 million, and$1.9 million, respectively, pertaining to the legal consulting feesrelated to these agreements. During the years ended December 31, 2006, and2005, we incurred royalties to FoxKiser in the approximate amounts of $364,000,and $134,000, respectively.

*Dr. John D. Folts.**  *In March 1995, as amended in November 1996and December 1998, we entered into an agreement with Dr. John D.Folts, pursuant to which Dr. Folts assigned to us his rights to anypending patent applications and issued patents relating to the use of nitricoxide adducts in exchange for a royalty on any products, methods or servicessold or distributed by us or our licensees that are covered by the assignedpatents. These patents cover technologies that were used in our former nitricoxide-coated stent development program with Boston Scientific.

**Trademarks, Trade Secrets and Other ProprietaryInformation**

We ownthe following U.S. trademarks:

·       BiDil;

·       NitroMed;and

·       NitroMed“N” logo.

We have also filedapplications for BiDil XR, NitroMed Cares, More Life to Live and HeartHealthHeritage.In addition, we depend upon trade secrets, know-how and continuingtechnological improvements to develop and maintain our competitive position. Tomaintain the confidentiality of trade secrets and proprietary information, werequire our employees, scientific advisors, consultants and collaborators, uponcommencement of a relationship with us, to execute confidentiality agreementsand, in the case of parties other than our research and developmentcollaborators, to agree to assign their inventions to us. These agreements aredesigned to protect our proprietary information and to grant us ownership oftechnologies that are developed in connection with their relationship with us.These agreements may not, however, provide protection for our trade secrets inthe event of unauthorized disclosure of such information.

**Competition**

We face intensecompetition from a wide range of pharmaceutical and life science companies, aswell as academic and research institutions and government agencies. Thesecompetitors include organizations that are pursuing the same or similartechnologies to those which constitute our technology platform andorganizations that are developing and commercializing pharmaceutical productsthat may be competitive with BiDil and BiDil XR.

We believe thatcompetition for BiDil and BiDil XR, if it is successfully developed, willinitially come from companies currently marketing and selling therapeutics totreat heart failure in the general population. These competitors includeGlaxoSmithKline, plc, Merck & Co., Inc., Pfizer Inc. andAstraZeneca plc.

Wecompete with these companies on the basis of BiDil’s strong label anddocumented efficacy and cost-effectiveness, our intellectual property portfolioand the expertise of our marketing and sales personnel. Principal competitivefactors in our industry include:

·       improvedpatient outcomes;

·       cost-effectiveness;

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·       acceptanceby patients, physicians, other health care providers and third-party public andprivate payors;

·       thequality and breadth of an organization’s technology;

·       theskill of an organization’s employees and its ability to recruit and retainskilled employees;

·       anorganization’s intellectual property protection;

·       development,sales and marketing capabilities; and

·       theavailability of substantial capital resources to fund development andcommercialization activities.

Many of the companiescompeting against us have financial and other resources substantially greaterthan our own. In addition, many of our competitors have significantly greaterexperience in marketing and selling pharmaceutical products, includingcardiovascular medicines, testing pharmaceutical and other therapeuticproducts, and obtaining FDA and other regulatory approvals of products for usein health care. In addition, we also compete with these companies with respectto manufacturing efficiency and marketing capabilities with respect to BiDil,our only approved product. We have no internal manufacturing capabilities, andour marketing and sales resources may be significantly more limited than thoseof our competitors.

We also face competitionfrom other pharmaceutical companies seeking to develop drugs using nitric oxidetechnology. For example, we are aware of at least seven companies working inthe area of nitric oxide based therapeutics. These companies are:Angiogenix Inc., GB Therapeutics, NicOx S.A., OxoN Medica, RenoPharm,Vasopharm BIOTECH GmbH and Nitrox LLC.

**Government Regulation and Reimbursement**

***FDA Requirementsfor New Drug Compounds***

Theresearch, testing, manufacture, import, export and marketing of drug products(including their components) are extensively regulated by numerous governmentalauthorities in the United States and other countries. In the United States,drugs are subject to rigorous regulation by the FDA. The Federal Food, Drug,and Cosmetic Act, and other federal and state statutes and regulations, govern,among other things, the research, development, testing, manufacture, storage,recordkeeping, labeling, promotion, sampling, marketing and distribution ofpharmaceutical products. Failure to comply with applicable regulatoryrequirements may subject a company to a variety of enforcement actions,including:

·       productseizures;

·       voluntaryor mandatory product recalls;

·       voluntaryor mandatory patient or physician notification;

·       withdrawalof product approvals;

·       clinicalholds;

·       restrictionson, or prohibitions against, marketing our products;

·       warningletters from the FDA;

·       fines;

·       restrictionson importation of our products;

·       totalor partial suspension of our operations;

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·       injunctions;

·       debarment;

·       civilpenalties or criminal prosecution; and

·       suspensionof review by the FDA or refusal by the FDA to approve pending applications.

The steps ordinarilyrequired before a new pharmaceutical product may be marketed in the UnitedStates include pre-clinical laboratory tests, animal tests and formulationstudies under the FDA’s good laboratory practice regulations, or GLP, thesubmission to the FDA of a notice of claimed investigational exemption or aninvestigational new drug application, or IND, which must become effectivebefore clinical testing may commence, adequate and well-controlled clinicaltrials to establish the safety and efficacy of the drug for each indication forwhich FDA approval is sought, submission to the FDA of a new drug application,or NDA, satisfactory completion of an FDA inspection of the manufacturingfacility or facilities at which the product is produced to assess compliancewith current good manufacturing practice, or cGMP, requirements and FDA reviewand approval of the NDA. Satisfaction of FDA pre-market approval requirementstypically takes several years, and the actual time required may varysubstantially based upon the type, complexity and novelty of the product ordisease. Government regulation may delay or prevent marketing of potentialproduct candidates for a considerable period of time and impose costlyprocedures upon a manufacturer’s activities. Success in early stage clinicaltrials does not assure success in later stage clinical trials. Data obtainedfrom clinical activities is not always conclusive and may be susceptible tovarying interpretations that could delay, limit or prevent regulatory approval.Even if a product receives regulatory approval, later discovery of previouslyunknown problems with a product, including new safety risks, may result inrestrictions on the product or even complete withdrawal of the product from themarket.

Pre-clinical tests includelaboratory evaluation of product chemistry and formulation, as well as animaltrials to assess the potential safety and efficacy of the product. The conductof the pre-clinical tests and formulation of compounds for testing must complywith federal regulations and requirements. Preclinical testing may not becompleted successfully within any specified time period, if at all, andsuccessful completion of pre-clinical trials does not assure success inclinical (human) trials. The results of pre-clinical testing are submitted tothe FDA as part of an IND.

A 30-day waitingperiod after the filing of each IND is required prior to the commencement ofclinical testing in humans. If the FDA has not commented on or questioned theIND within this 30-day period, clinical trials may begin. If the FDA hascomments or questions relating to the proposed clinical trials outlined in theIND, the questions must be answered to the satisfaction of the FDA beforeinitial clinical testing can begin. In addition, the FDA may, at any time,impose a clinical hold on ongoing clinical trials. If the FDA imposes aclinical hold, clinical trials cannot commence or recommence without FDAauthorization and then only under terms authorized by the FDA. In someinstances, the IND process can result in substantial delay and expense.

Clinical trials involvethe administration of the investigational new drug to healthy volunteers orpatients under the supervision of a qualified investigator. Clinical trialsmust be conducted in compliance with federal regulations and requirements, underprotocols detailing, among other things, the objectives of the trial, theparameters to be used in monitoring safety and the effectiveness criteria to beevaluated. Each protocol involving testing on U.S. subjects must be submittedto the FDA as part of the IND. The study protocol and informed consent form forpatients in clinical trials must be submitted to institutional review boards,or IRBs, for approval.

Clinical trials to supportan NDA for marketing approval are typically conducted in three sequentialphases, but the phases may overlap. In phase I, the initial introduction of thedrug into healthy human subjects or patients, the drug is tested to assesssafety, including side effects associated with increasing 

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doses,metabolism, pharmacokinetics and pharmacological actions. Phase II usuallyinvolves trials in a limited patient population, to determine dosage toleranceand optimum dosage, identify possible adverse effects and safety risks, andprovide preliminary support for the efficacy of the drug in the indicationbeing studied.

If a compound demonstratesevidence of effectiveness and an acceptable safety profile in phase IIevaluations, phase III trials are undertaken to further evaluate clinicalefficacy and to further test for safety within an expanded patient population,typically at geographically dispersed clinical trial sites. Phase I, phase IIor phase III testing of any product candidate may not be completed successfullywithin any specified time period, if at all. The FDA closely monitors theprogress of each of the three phases of clinical trials that are conducted inthe United States and may, at its discretion, reevaluate, alter, suspend orterminate the testing based upon the data accumulated to that point and the FDA’sassessment of the risk/benefit ratio to the patient. The FDA, an IRB, or aclinical trial sponsor may suspend or terminate clinical trials at any time forvarious reasons, including a finding that the subjects or patients are beingexposed to an unacceptable health risk. The FDA can also request additionalclinical trials be conducted as a condition to product approval.

After successfulcompletion of the required clinical testing, generally an NDA is prepared andsubmitted to the FDA. FDA approval of the NDA is required before marketing ofthe product may begin in the United States. The NDA must include the results ofextensive pre-clinical, clinical and other testing and a compilation of datarelating to the product’s pharmacology, chemistry, manufacture, and controls.The cost of preparing and submitting an NDA is substantial. Under federal law,the submission of NDAs are additionally subject to substantial application userfees, currently approximately $900,000, and the manufacturer and/or sponsorunder an approved application are also subject to annual product andestablishment user fees, currently approximately $50,000 per product and$300,000 per establishment. Additional user fees exceeding $400,000 apply forNDA supplements containing clinical data. These fees are typically increasedannually.

The FDA has 60 daysfrom its receipt of an NDA to determine whether the application will beaccepted for filing based on the agency’s threshold determination that the NDAis sufficiently complete to permit substantive review. Once the submission isaccepted for filing, the FDA begins an in-depth review of the NDA. Underfederal law, the FDA has agreed to certain performance goals in the review ofNDAs. Most such applications for non-priority drug products are reviewed withinten months. The review process is often significantly extended by FDA requestsfor additional information or clarification regarding information alreadyprovided in the submission. The FDA may also refer applications for novel drugproducts or drug products which present difficult questions of safety orefficacy to an advisory committee, typically a panel that includes cliniciansand other experts, for review, evaluation and a recommendation as to whetherthe application should be approved. The FDA is not bound by the recommendationof an advisory committee.

If the FDA’s evaluationsof the NDA and inspection of the manufacturing facilities are favorable, theFDA may issue an approval letter, or, in some cases, an approvable letter. Anapprovable letter generally contains a statement of specific conditions thatmust be met in order to secure final approval of the NDA. If and when thoseconditions have been met to the FDA’s satisfaction, the FDA will typicallyissue an approval letter. An approval letter authorizes commercial marketing ofthe drug with specific prescribing information for specific indications. As acondition of NDA approval, the FDA may require post-approval commitments,including testing and surveillance to monitor the drug’s safety or efficacy,and may also impose other conditions, including labeling restrictions which canmaterially impact the potential market and profitability of the drug. Oncegranted, product approvals may be withdrawn if compliance with regulatorystandards is not maintained or problems are identified following initialmarketing. On July 20, 2004, the FDA issued a proposed rule thatwould replace not approvable and approvable letters with 

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completeresponse letters. Complete response letters would describe all specificdeficiencies in an NDA but would not characterize the application as approvableor not.

Once the NDA is approved,a product will be subject to certain post-approval requirements, includingrequirements for adverse event reporting and submission of periodic reports and/orsupplemental NDAs for approval of changes to the originally approvedprescribing information, product formulation, and manufacturing and testingrequirements. Following approval, drug products are required to be manufacturedand tested for compliance with NDA and/or compendial specifications prior torelease for commercial distribution. The manufacture and testing must beperformed in approved manufacturing and testing sites complying with currentGood Manufacturing Practice, or cGMP, requirements and subject to FDAinspection authority. Drug manufacturers and their subcontractors are requiredto register their facilities with the FDA and are subject to periodicunannounced inspections by the FDA to assess compliance with cGMPs. Accordingly,after approval manufacturers must continue to expend time, money and effort inthe area of production and quality control, and employee training, to maintaincompliance with cGMPs and other aspects of regulatory compliance.

The FDA strictly regulatesthe promotional claims that may be made about prescription drug products.Approved drug products must be promoted in a manner which is consistent withtheir terms and conditions of approval. In particular, a drug may not bepromoted for uses that are not approved by the FDA as reflected in the drug’sapproved labeling. Moreover, the Department of Justice can bring civil orcriminal actions against companies that promote drugs for unapproved uses,based on the False Claims Act and other federal laws governing reimbursement fordrugs under the Medicare, Medicaid and other federally supported healthcareprograms. Monetary penalties in such cases have often been in excess of $100million. Civil penalties can include costly mandatory compliance programs andexclusion from federal healthcare programs. In addition, the FDA requiressubstantiation of any claims of superiority of one product over anotherincluding, in many cases, requirements that such claims be proven by adequateand well-controlled head-to-head clinical trials. To the extent that marketacceptance of our product candidates may depend on their superiority overexisting therapies, any restriction on our ability to advertise or otherwisepromote claims of superiority, or requirements to conduct additional expensiveclinical trials to provide proof of such claims, could negatively affect thesales of our products and/or our expenses.

If the FDA’s evaluation ofthe NDA submission or manufacturing facilities is not favorable, the FDA mayrefuse to approve the NDA or issue a not approvable letter. A not approvableletter outlines the deficiencies in the submission and often requiresadditional testing or information in order for the FDA to reconsider theapplication. Even with submission of this additional information, the FDAultimately may decide that the application does not satisfy the regulatorycriteria for approval. With limited exceptions, the FDA may withhold approvalof an NDA regardless of prior advice it may have provided or commitments it mayhave made to the sponsor.

Once an NDA is approved,the product covered thereby becomes a “listed drug” which can, in turn, becited by potential competitors in support of approval of an abbreviated NDA, orANDA. An approved ANDA provides for marketing of a drug product that has thesame active ingredients in the same strength, dosage form and route ofadministration as the listed drug and has been shown through bioequivalencetesting to be therapeutically equivalent to the listed drug. There is norequirement, other than the requirement for bioequivalence testing, for anabbreviated NDA applicant to conduct or submit results of pre-clinical orclinical tests to prove the safety or efficacy of its drug product. Drugsapproved in this way are commonly referred to as “generic equivalents” to thelisted drug, are listed as such by the FDA, and can often be substituted bypharmacists under prescriptions written for the original listed drug.

Federal law provides for aperiod of three years of exclusivity following approval of a listed drug thatcontains previously approved active ingredients but is approved in a newdosage, dosage form, route of 

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administrationor combination, or for a new use, if the FDA deems that the approval of thedrug was required to be supported by new clinical trials that were conducted byor for the sponsor. During this three-year period, the FDA cannot grant finalapproval of an ANDA based on that listed drug. Federal law also provides aperiod of five years following approval of a drug containing no previouslyapproved active ingredients, during which ANDAs for generic versions of thosedrugs cannot be submitted unless the submission accompanies a challenge to alisted patent, in which case the submission may be made four years followingthe original product approval. Additionally, in the event that the sponsor ofthe listed drug has properly informed the FDA of patents covering its listeddrug, applicants submitting an ANDA referencing that drug are required tocertify whether they intend to market their generic products prior toexpiration of those patents. If an ANDA applicant certifies that it believesall listed patents are invalid or not infringed, it is required to providenotice of its filing to the NDA sponsor and the patent holder. If the patentholder then initiates a suit for patent infringement against the ANDA sponsorwithin 45 days of receipt of the notice, the FDA cannot grant effectiveapproval of the ANDA until either 30 months has passed or there has been acourt decision holding that the patents in question are invalid, unenforceableor not infringed. If the ANDA applicant certifies that it does not intend tomarket its generic product before some or all listed patents on the listed drugexpire, then the FDA cannot grant effective approval of the ANDA until thosepatents expire. The first abbreviated new drug applicant(s) submittingsubstantially complete applications certifying that one or more listed patentsfor a particular product are invalid or not infringed may qualify for a periodof 180 days against other generics after a final court decision ofinvalidity or non-infringement or after it begins marketing its product,whichever occurs first, during which subsequently submitted ANDAs cannot begranted effective approval.

From time to time,legislation is drafted and introduced in Congress that could significantlychange the statutory provisions governing the approval, manufacturing andmarketing of drug products. In addition, FDA regulations and guidance are oftenrevised or reinterpreted by the agency or the courts in ways that maysignificantly affect our business and our products candidates. It is impossibleto predict whether legislative changes will be enacted, or FDA regulations,guidance or interpretations changed, or what the impact of such changes, ifany, may be.

***Foreign Regulationof New Drug Compounds***

Approval of a drug productby comparable regulatory authorities will be necessary in all or most foreigncountries prior to the commencement of marketing of the product in thosecountries, whether or not FDA approval has been obtained. The approvalprocedure varies among countries and can involve requirements for additionaltesting. The time required may differ from that required for FDA approval.Although there are some procedures for unified filings in the European Union,in general each country has its own procedures and requirements, many of whichare time consuming and expensive. Thus, there can be substantial delays inobtaining required approvals from foreign regulatory authorities after therelevant applications are filed.

In Europe, marketingauthorizations may be submitted either under a centralized or decentralizedprocedure. The centralized procedure is mandatory for the approval ofbiotechnology products and provides for the grant of a single marketingauthorization which is valid in all European Union member states. Thedecentralized procedure is a mutual recognition procedure that is available atthe request of the applicant for medicinal products which are not subject tothe centralized procedure. We will strive to choose the appropriate route ofEuropean regulatory filing to accomplish the most rapid regulatory approvals.However, our chosen regulatory strategy may not secure regulatory approvals ona timely basis or at all.

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***Hazardous Materials***

Our previous research anddevelopment processes involved the controlled use of hazardous materials,chemicals and radioactive materials and produce waste products. We are subjectto federal, state and local laws and regulations governing the use,manufacture, storage, handling and disposal of hazardous materials and wasteproducts. We do not expect the cost of complying with these laws andregulations to be material.

***Reimbursement***

In both the United Statesand foreign markets, our ability to successfully commercialize BiDil and anyfuture products successfully depends in part on the extent to whichreimbursement for the costs of such products will be available from governmenthealth administration authorities, private health insurers and otherthird-party payors. Significant uncertainty exists as to the reimbursementstatus of newly-approved health care products, products used for indicationsnot approved by the FDA and products which have competitors for their approvedindications. If we are unable to achieve preferential reimbursement treatmentfor BiDil, or any of our other product candidates, from government and otherthird-party payors, our ability to sell our products may be limited or ourability to establish acceptable pricing schemes for our products may beimpaired, thereby reducing our revenue.

**Employees**

As of December 31,2006, we had 50 full-time employees, 23 of whom were engaged in sales andmarketing and 27 of whom were engaged in management, administration, finance,and research and development. Our success depends in part on our ability torecruit and retain talented and trained scientific personnel and seniormanagement. We have been successful to date in obtaining and retaining suchpersonnel, but may not be successful in the future. None of our employees arerepresented by a labor union or covered by a collective bargaining agreement,nor have we experienced work stoppages. We believe that relations with ouremployees are good.

**Product LiabilityInsurance**

The administration of ourproducts to humans, whether in clinical trials or after marketing approvals areobtained and the product is in use commercially, may expose us to liabilityclaims. These claims might be made by customers, including corporate partners,clinical trial subjects, patients, pharmaceutical companies or others. Wemaintain product liability insurance coverage for claims arising from the useof our products, whether in clinical trials or approved commercial usage.However, coverage is becoming increasingly expensive, and our insurance may notprovide sufficient coverage to fully protect us against liability. If we areunable to maintain sufficient levels of insurance due to increased costs or ifour insurance does not provide sufficient coverage against liability claims, afinding of liability could deplete our resources and reduce the assetsavailable for our daily operations.

**SignificantCustomers**

In 2006, McKesson Corporation, Cardinal Health andAmerisourceBergen Corporation accounted for approximately 34%, 36% and 18%,respectively, of our product sales. In 2005, McKesson, Cardinal Health andAmerisourceBergen accounted for approximately 44%, 21% and 14%, respectively,of our product sales. We received no research and development revenue in 2006.In 2005, Boston Scientific accounted for 100% of our research and developmentrevenues and in 2004, a prior collaborator, Merck Frosst Canada & Co.,a subsididary of Merck & Co., Inc., accounted for 90% of ourresearch and development revenue. No other company accounted for more than 10%of our total revenues in fiscal 2006, 2005 or 2004.

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**Raw Materials**

We order bulk materialsfrom the same suppliers that were used for the clinical trial batches of BiDil:hydralazine hydrochloride from Flavine International, Inc., the U.S.representative of Sumitomo Corp., and isosorbide dinitrate from Dottikon ESHolding AG, and have them delivered directly to Schwarz Pharma formanufacturing. Sumitomo is currently the only supplier of hydralazinehydrochloride worldwide. We do not have any agreement with Sumitomo regardingthe supply of hydralazine hydrochloride.

**AvailableInformation**

Our internet website address ishttp://www.nitromed.com. Through our website, we make available, free ofcharge, our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and any amendments to those reports,proxy and registration statements, and all of our insider Section 16reports, as soon as reasonably practicable after such material iselectronically filed with, or furnished to, the Securities and ExchangeCommission, or SEC. These SEC reports can be accessed through the “Investors”section of our website. We also make available on our website our corporategovernance guidelines, the charters for our audit committee, compensationcommittee, and nominating and corporate governance committee, our stock optiongranting policies and our code of business conduct and ethics, and suchinformation is available in print to any stockholder of NitroMed who requestsit. In addition, we intend to disclose on our website any amendments to, orwaivers from, our code of business conduct and ethics that are required to bepublicly disclosed pursuant to rules of the Securities and ExchangeCommission and the NASDAQ Global Market. The information found on our websiteis not part of this or any other report we file with, or furnish to, the SEC.

For additional informationregarding our segment reporting, please refer to Note 2 of Notes to FinancialStatements included in Part II, Item 8 “Financial Statements andSupplementary Data” of this annual report on Form 10-K.

**ITEM 1A.**        RISKFACTORS

You should carefullyconsider the following risk factors, in addition to other information includedin this annual report, in evaluating NitroMed and our business. If any of thefollowing risks occur, our business, financial condition and operating resultscould be materially adversely affected.

**Risks Relating toour Business**

**Our business issubstantially dependent on the commercial success of BiDil, and if we do notmaintain market presence of BiDil during the development of BiDil XR, ourbusiness will be materially harmed and our stock price will decline.**

On June 23,2005, the FDA approved BiDil for the treatment of heart failure inself-identified black patients as an adjunct to current standard therapy. Welaunched BiDil in July 2005 and therefore have only recently begun toreceive revenue from sales of BiDil. BiDil is currently our only commercialproduct, and we expect that it will account for all of our product sales andsubstantially all of our total revenues for the near future. We face a numberof significant risks relating to our ability to successfully commercializeBiDil, including risks relating to:

·       ourability to successfully market and sell BiDil with our significantly reducedsales force and centralized marketing efforts;

·       thesuccess of our revised sales and marketing strategies for BiDil;

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·       ourability to recruit and train our proposed specialty sales force and theeffectiveness of our new sales force in influencing prescribing behavior withheart failure specialists and key institutions;

·       ourability to successfully secure preferable reimbursement treatment fromgovernment and third-party insurers for BiDil;

·       ourability to successfully enter into a co-promotion agreement for BiDil onfavorable terms, if at all;

·       ourability to gain market acceptance of BiDil as safe, effective and medicallynecessary;

·       theavailability of substantial amounts of cash to fund our BiDil commercializationplans;

·       competitivefactors, including competition resulting from physicians prescribing the twolower cost generically available components of BiDil (isosorbide dinitrate andhydralazine hydrochloride) as a substitute for BiDil, and adverse effects on pricingor reimbursement resulting from this substitution;

·       ourability to effectively develop and/or contract for adequate marketing,manufacturing, and distribution capabilities;

·       ourability to maintain the necessary patent protection, licenses and regulatoryapprovals required to market and sell BiDil; and

·       thevarious other factors discussed in detail throughout this section titled “RiskFactors.”

In order for us tosuccessfully commercialize BiDil, we must maintain our market presence of BiDilin the near term and must build a sufficient commercial foundation from whichto launch BiDil XR in the future. If we fail to sustain market awareness ofBiDil, our near-term ability to generate product revenue, our reputation andour ability to raise additional capital will be materially impaired, and thevalue of our stock will decline.

**Poor performance byour restructured sales force, or difficulties arising from the restructuring ofour sales organization, could prevent us from achieving the results we need tomaintain market presence of BiDil.**

In October 2006, we initiated a restructuringprogram that included a reduction of our sales force and administrativeheadcount. As part of the restructuring program, we eliminated our existingsales force and replaced it with a small team of highly experienced seniorcardiovascular specialists, resulting in a net reduction of approximately 120in sales force headcount. In addition, we also eliminated approximately 20% ofour general and administrative personnel in connection with this restructuringprogram. Our restructured sales force is expected to be comprised initially ofa director of managed markets, six national account directors, two areabusiness directors and twenty-one cardiovascular business managers. Our near-termrevenue for BiDil will depend significantly upon the efforts and success of ourrestructured sales organization.

In addition, during the first quarter of 2006, weelected to reduce the number of sales territories in which we have salesrepresentation. As a result of our October 2006 restructuring, wesignificantly reduced the number of individuals in our sales organization whocover these territories. Any failure to adequately cover our current salesterritories, or to cover through alternative marketing efforts the territoriesin which we have elected not to have sales representation, will result inreduced sales productivity and loss of revenue related to BiDil.

The success of our revisedselling strategy will also depend on our ability to recruit the caliber ofrepresentatives necessary to implement our new strategy. Since launching BiDil,we have reduced our sales force representation from 195 to the current plan of21 through various territory realignments and 

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restructurings,which could significantly limit our ability to successfully recruit and retainhighly qualified sales representatives. In addition, we are seeking salesrepresentatives with a very high level of technical, selling and institutionalexperience to fill our newly created cardiovascular business manager positions.These are highly specialized skills and we may not be able to hire salesrepresentatives who meet these qualifications. Any delay in our ability torecruit the required number of individuals to cover our revised sales territories,or any failure to attract and retain qualified personnel, could significantlydelay or hinder the success of our revised selling strategy.

**If we do notsuccessfully market and sell BiDil, either directly through our small,restructured sales force or indirectly through third-party co-promotionarrangements, our future revenue will be limited.**

We launched BiDil in the United States ourselves,using a contract sales force. We transitioned to the use of a smaller salesforce during the first quarter of 2006, we internalized this sales force duringthe second quarter of 2006, and in October 2006 we replaced this salesforce with a small team of highly experienced senior cardiovascularspecialists. The transition to this specialized sales force could adverselyaffect our marketing of BiDil and depress the value of our stock.

As part of our October 2006 restructuring, werevised our marketing strategy to reduce the level of our direct face-to-facemarketing efforts and adopted a more centralized approach to marketing thatwill involve various non-personal methods of contacting current and potentialprescribers. The direct marketing efforts in which we will continue to engagethrough our small, specialized sales team will be focused on national thought leaders,regional heart failure specialists and key institutions in major metropolitancenters that treat, and influence the treatment of, large numbers of AfricanAmericans who have been diagnosed with heart failure. Our approach is toeducate those thought leaders and institutions on the value of BiDil, and thenleverage their influence to impact the broader base of prescribers. If we areunable to convince these thought leaders and institutions that BiDil is safe,effective and medically necessary, we will be unsuccessful in our marketingapproach. In addition, even if we are successful in gaining acceptance of BiDilwith these key targets, these thought leaders and institutions may not bewilling or able to influence the prescribing activity of other physicians, orto do so within a timeframe that will impact BiDil prescriptions in the nearterm. Furthermore, our indirect marketing efforts may not be successful inmaintaining market awareness of BiDil with current and potential prescribers.

If we decide to expand ourmarketing reach for BiDil, we will likely pursue sales, marketing anddistribution arrangements with third parties, including co-promotionarrangements. We may not be able to successfully enter into sales,marketing and/or distribution agreements with third parties on terms that arefavorable to us, if at all. In addition, we may have limited or no controlover the sales, marketing and distribution activities of these third parties.If we decide to rely on third-party entities for sales, marketing anddistribution support, our future revenues for BiDil will depend heavily on thesuccess of the efforts of these third parties.

**If the governmentor third-party payors do not reimburse patients for BiDil, or do not reimbursefor BiDil at favorable levels, BiDil might not be used or purchased, and ourrevenues and profits will be adversely affected.**

Our revenues andprofits depend heavily upon the availability of coverage and favorablereimbursement for the use of BiDil from third-party healthcare and state andfederal government payors. Reimbursement by a third party payor may dependupon a number of factors, including the third-party payor’s determination thatuse of a product is:

·       safe,effective and medically necessary;

·       appropriatefor the specific patient;

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·       cost-effective;and

·       neitherexperimental nor investigational.

Since reimbursement approval for a product is requiredfrom third-party and government payors in order for patients to be reimbursedfor the cost of a product, seeking this approval, particularly when seekingapproval for a preferred form of reimbursement over other competitiveproducts, is a time-consuming and costly process. Third-party payors conductclinical reviews of pharmaceutical products to determine whether a product issafe, effective and medically necessary. These third-party payors may find thatBiDil is not sufficiently effective to justify reimbursement approval or thatthe effectiveness of BiDil does not justify its cost. In addition, third-partypayors may require cost-benefit analysis data from us in order todemonstrate the cost-effectiveness of BiDil. For any individual third-party payor,we may not be able to provide data sufficient to gain reimbursement on asimilar or preferred basis to competitive products, if at all. Furthermore,some third-party payors may consider the generically available individualcomponents of BiDil to be substitutable for, or therapeutically equivalent to,BiDil, despite the lack of FDA approval for the use of those individual componentsin the treatment of heart failure. This misconception among third-party payorsmay further limit our ability to obtain preferential reimbursement, if at all,from those third-party payors.

Even after reimbursement at an agreed level isapproved by a third-party payer, we may lose that reimbursement entirely,or we may lose the similar or better reimbursement we receive compared tocompetitive products. As reimbursement is often approved for a period of time,this risk is greater at the end of the time period, if any, for which thereimbursement was approved. In addition, legislative or regulatory efforts tocontrol or reduce healthcare costs or reform government healthcareprograms could result in lower prices or rejection of BiDil. Changes in coverageand reimbursement policies or healthcare cost containment initiatives thatlimit or restrict reimbursement for BiDil may cause our revenues todecline. Any failure by us to obtain reimbursement for BiDil, or to secure apreferred form of reimbursement that reduces costs to patients,may negatively impact market acceptance of BiDil and adversely affect ourability to generate revenues from sales.

Many private insurers, andmany of the Medicare Part D plans that cover BiDil, cover the product atthe Tier III level. Tier level is a term generally used to denote the level ofreimbursement and, consequently, the level of patient co-pay, for a productthat is approved by a third-party payor. At Tier III, patient co-pays are at asignificantly higher level than they would be at Tier II, ranging fromapproximately $30.00 to $50.00 per prescription. Tier II reimbursement denotesa preferential level of reimbursement at which patient co-pays range fromapproximately $15.00 to $30.00 per prescription. We may not be able toobtain reimbursement coverage for BiDil from many private insurers or Medicare Part Dplans or, even if we obtain such coverage, we may not be able to obtainpreferential reimbursement treatment. Any failure by us to secure suchcoverage, or to secure it at preferential levels, would have a substantiallynegative effect on sales of BiDil, market acceptance of BiDil would benegatively impacted and our ability to generate revenues from sales would besignificantly impaired. Although we have been added to preferred formulariescovering approximately 50% of insured African Americans over the age of 45, wehave not achieved preferential reimbursement on all plans. Furthermore, wecannot know if BiDil will continue to be listed on any of these plans at apreferential reimbursement level, if at all. In addition, although preferentialreimbursement for BiDil removes a financial barrier to accessing the product,it does not require or guarantee that physicians will prescribe the drug.Accordingly, we cannot assess the impact that the current listing of BiDil onany given plan will have on our future revenues, if any.

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**Physicians,third-party payors and patients may not be receptive to BiDil, which couldprevent us from achieving profitability.**

Our business is substantially dependent on marketacceptance of BiDil. We currently market BiDil only in the United States, andkey participants in the U.S. pharmaceutical marketplace, such as physicians,third-party payors and patients, may not accept and use BiDil.

Factors that webelieve will materially affect market acceptance of BiDil include:

·       theavailability of favorable government and third-party payor reimbursement;

·       theability to produce and sell BiDil at a competitive price;

·       theavailability in generic form of the individual components that constitute BiDiland the misperception that these generic components are equivalent to BiDil;

·       thefailure of physicians, third-party payors and patients to accept a productintended to improve therapeutic results based on ethnicity;

·       thesuccess of our promotional programs, which will be centralized in nature goingforward;

·       thetiming of our receipt of marketing approval, if any, for our next-generationBiDil product, BiDil XR, or for any expansion of our current label for BiDil,such as extended product dating or inclusion of new data;

·       thesafety, efficacy and ease of administration of BiDil; and

·       the timing of our receiptof any marketing approvals outside the U.S., the terms of any non-U.S.approval, including labeling requirements and/or limitations, and the countriesin which approvals are obtained, if any.

**The availability oflower priced generic forms of the components of BiDil may adversely affectour sales of BiDil and the pricing or reimbursement we are able to obtain forBiDil.**

BiDil is afixed-dosed combination of two individual components, both of which areavailable in generic form and are separately marketed (isosorbide dinitrate forangina and hydralazine hydrochloride for hypertension), in dosages similar tothose we include in BiDil, at prices substantially below the prices we arecharging for BiDil. While neither of these two generic drugs is approved forthe treatment of heart failure, as a practical matter it may be impossiblefor us to prevent physicians from prescribing a combination of these two, lowercost generic drugs as a substitute for prescribing BiDil. If substantialnumbers of physicians prescribe the combination of these two generic drugs,rather than BiDil, we could fail to achieve the sales of BiDil necessary forsuccessful commercialization which would severely limit our ability to generaterevenue from the sales of BiDil. Our ability to generate revenue could also belimited if:

·       potentiallarge purchasers of BiDil, such as hospitals or health maintenanceorganizations, require substitution of these generic drugs for BiDil;

·       stateformularies, other government agencies or private payors that approvereimbursement for drugs require substitution of these generic drugs for BiDil;or

·       the availability of thesegeneric drugs reduces the price or reimbursement amounts we are able to achievefor BiDil.

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**We will requiresubstantial additional amounts of cash to fund our operating plan, includingcommercializing BiDil and seeking to develop and commercialize BiDil XR, and,if additional capital is not available, we may need to limit, scale backor cease our operations.**

We have used and will continue to require substantialfunds to manufacture, market and sell BiDil during 2007 and beyond. We alsoexpect to incur additional expenses relating to the ongoing development ofBiDil XR, which is currently commencing clinical development. We believe thatour existing sources of liquidity and cash expected to be generated from futureoperations will be sufficient to fund the current business plan for at leastthe next twelve months.

However, our futurecapital requirements, and the period in which we expect our current cash tosupport our operations, may vary from what we expect due to a number offactors, including the following:

·       themagnitude of product sales of BiDil;

·       thesuccessful commercialization of BiDil;

·       thecost of manufacturing, marketing and selling BiDil;

·       thetiming of when we receive significant revenue from BiDil, if at all;

·       thetime and costs involved in completing the clinical trials and furtherdevelopment of, and obtaining regulatory approvals for, BiDil XR, if at all;

·       ourability to establish and maintain co-promotion, out-licensing and collaborativearrangements;

·       thetiming, receipt and amount of royalties, milestone and other payments, if any,from potential collaborators;

·       theeffect of competing technological and market developments;

·       thecosts involved in preparing, filing, prosecuting, maintaining and enforcing patentclaims; and

·       thecost of obtaining and maintaining licenses to use patented technologies.

We will require additionalfunding in the future and may seek to do so through collaborativeco-promotion arrangements and/or public or private financings. Additionalfinancing may not be available to us on acceptable terms, if at all. Inaddition, the terms of any financing may adversely affect the holdings orthe rights of our stockholders. For example, if we raise additional funds byissuing equity securities, further dilution to our then-existing stockholderswill result. If we are unable to obtain funding on a timely basis, wemay be compelled to significantly curtail our marketing efforts for BiDiland/or our development efforts with respect to BiDil XR. We may also becompelled to seek funds through arrangements with collaborators or others thatmay require us to relinquish rights to some of our technologies, productcandidates or products.

**We do not havethe internal technology to successfully develop BiDil XR and our success willdepend on our ability to co-develop such technology with a collaborativepartner.**

Although we intend topursue the development of BiDil XR as expeditiously as possible, we do notcurrently have the internal technology to pursue this development on our own.The technology underlying extended release formulations of pharmaceuticalproducts is highly proprietary and would take years and the expenditure ofsignificant amounts of capital for us to develop. We have entered into alicense agreement with Elan, pursuant to which we have licensed proprietaryextended release technology which we believe is compatible for use with BiDil.We have done extensive preclinical development with Elan, but we cannot be surethat our development efforts will result in a successful extended releaseformulation of BiDil.

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**We cannot becertain that clinical testing of BiDil XR will be successful, nor can we becertain that we will be able to obtain regulatory approval for BiDil XR.**

We cannot predictwhether the results of any clinical studies conducted with respect to BiDil XRwill be successful. Furthermore, we cannot predict the number or the type ofclinical trials that will be necessary to adequately support a marketingapplication for BiDil XR, nor can we predict the amount of time that will berequired in order to complete those clinical trials. The fact that BiDil is acombination of two active ingredients (isosorbide dinitrate and hydralazinehydrochloride) may further complicate the development of the extended releaseformulation. Depending on the results of initial clinical studies, additionaltesting with alternate formulations of BiDil XR may also be required. If thesestudies and testing are not successful, we will incur increased costs and thefiling for marketing approval of BiDil XR with the FDA and other healthauthorities will be significantly delayed. We could also experience delays orfailures in clinical trials for a number of other reasons. For example:

·       theresults from early clinical trials may not be statistically significant orpredictive of results that will be obtained from expanded, advanced clinicaltrials;

·       wemay encounter difficulties or delays in manufacturing sufficient quantities ofBiDil XR used in any clinical trials;

·       thetiming and completion of clinical trials of BiDil XR depend on, among otherfactors, the number of patients we will be required to enroll in the clinicaltrials and the rate at which those patients are enrolled and any increase inthe required number of patients, decrease in recruitment rates or difficultiesretaining study participants may result in increased costs, program delays orprogram termination;

·       BiDilXR may prove to have undesirable or unintended side effects, toxicities orother characteristics that may prevent or limit its commercial use;

·       we,along with our collaborators and subcontractors, may not employ, in anycapacity, persons who have been debarred under the FDA’s Application IntegrityPolicy. Employment of such a debarred person (even if inadvertently) may resultin delays in FDA’s review or approval of our products, or the rejection of datadeveloped with the involvement of such person(s); and

·       institutionalreview boards or regulators, including the FDA, or our collaborators may hold,suspend or terminate our clinical research or the clinical trials of BiDil XRfor various reasons, including failure to achieve established success criteria,noncompliance with regulatory requirements or if, in their opinion, theparticipating subjects are being exposed to unacceptable health risks.

In addition, even ifclinical testing of BiDil XR is successful, we still may not be able to obtainregulatory approval for BiDil XR. The FDA may conclude that the data providedis insufficient and may require that we perform additional studies. If we areultimately unable to produce a formulation of BiDil XR that meets regulatoryrequirements, if we are delayed in our efforts to obtain regulatory approvalfor BiDil XR, or if we are required by the FDA to conduct large-scale outcomesstudies, we may not be able to successfully develop and commercialize thisproduct and our ability to generate revenue from BiDil XR will be materiallyimpaired.

**The development andfuture commercialization of BiDil XR may be terminated or delayed, and thecost of development and future commercialization may increase, if thirdparties on whom we rely to manufacture BiDil XR do not fulfill theirobligations.**

We do not havemanufacturing capabilities for BiDil XR and have no current plans to developany such capacity in the future. In order to continue to develop BiDil XR,apply for regulatory approvals and 

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commercializethis product, we plan to rely on our collaborative licensor, Elan, for theproduction of clinical and commercial quantities of BiDil XR. Although we arein the process of negotiating a manufacturing and supply agreement with Elan,we may not be able to finalize an agreement on commercially favorableterms, if at all. In addition, contract manufacturers are subject to ongoingperiodic, unannounced inspection by the FDA and corresponding state and foreignagencies or their designees to ensure strict compliance with current GoodManufacturing Practices, or cGMP, and other governmental regulations andcorresponding foreign standards. The cGMP requirements govern, among otherthings, quality control of the manufacturing process and documentation ofpolicies and procedures. Other than through contract, we do not have controlover compliance by our contract manufacturers with these regulations andstandards. Our present or future contract manufacturers may not be able tocomply with cGMP and other FDA requirements or similar regulatory requirementsoutside the United States. Any failure by our contract manufacturers or us tocomply with applicable regulations could result in sanctions being imposed onus, including fines, injunctions, civil penalties, failure of regulatoryauthorities to grant marketing approval of our product candidate, delays,suspension or withdrawal of approvals, seizures or recalls of such productcandidate, operating restrictions, and criminal prosecutions, any of whichcould significantly and adversely affect our business. We will depend uponthese third parties to perform their obligations in a timely manner and inaccordance with applicable laws and regulations, including those related toquality control and quality assurance. To the extent that third-partymanufacturers with whom we contract fail to perform their obligations inaccordance with applicable laws and regulations, we may be adverselyaffected in a number of ways, including:

·       wemay not be able to initiate or continue clinical trials of BiDil XR;

·       wemay be delayed in submitting applications for regulatory approvals forBiDil XR; and

·       even if we successfullycommercialize BiDil XR, we may be required to cease distribution and/orrecall some or all batches of the product and we may not be able to meetcommercial demands for our products or achieve profitability.

**Currently, we areengaging in limited internal research and development activities and,accordingly, our ability to generate future revenue from our nitric oxidetechnology portfolio is completely dependent on our ability to enter intoscientifically and commercially successful out-licensing or collaborativearrangements with third parties.**

At the end of the first quarter of 2006, we scaledback our research and development staff in a restructuring of our company andhave limited our internal research and development activities to the continueddevelopment of BiDil XR. We are currently seeking out-licensing andcollaboration opportunities for our other potential product candidates based onour proprietary nitric oxide technology, including NMI-3377, apre-clinical cardio-renal compound. The application of our proprietary nitricoxide technology is unproven in humans and, as a result, we may not beable to successfully out-license any products based on this technology. Ourproduct candidates include nitric oxide enhancements of existing drugs; inthese cases, we are modifying compounds whose chemical and pharmacologicalprofiles are well-documented and understood. Many of our potential productcandidates, however, are new molecules with chemical and pharmacologicalprofiles that differ from that of the existing drugs. These compoundsmay not demonstrate in patients the chemical and pharmacologicalproperties shown in laboratory studies, and they may interact with humanbiological systems in unforeseen, ineffective or harmful ways. In addition, itis possible that existing drugs or newly-discovered drugs may not benefitfrom the application of our nitric oxide technology. We may not be able tosecure out-licensing or collaboration partners for these potential productcandidates. Even if we are successful in entering into out-licensing orcollaborative arrangements with respect to our potential product candidates, wehave no assurance that we will be able to secure such arrangements on termscompletely favorable to us. If our out-licensing or collaboration 

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arrangements includeunfavorable financial terms, our ability to generate revenue from ourtechnology portfolio will be severely limited.

Additional factorsthat may affect the success of our potential future collaborations includethe following:

·       ourfuture licensing partners or collaborators may be pursuing alternativetechnologies or developing alternative product candidates, either on their ownor in collaboration with others, that may be competitive with the productcandidate which they have licensed from us or will be collaborating with us andwhich could affect their commitment to our future collaboration;

·       futurereductions in marketing or sales efforts or a discontinuation of marketing orsales of our products by our licensing partners or collaborators would reduceour revenues, which would be based on a percentage of net sales by the partneror collaborator;

·       ourfuture licensing partners or collaborators may terminate their agreementswith us, which could make it difficult for us to attract new partners orcollaborators or adversely affect how we are perceived in the business andfinancial communities; and

·       ourfuture licensing partners or collaborators may pursue higher-priorityprograms or change the focus of their development programs, which could affecta partner’s or collaborator’s commitment to us.

As a result of the foregoing factors, our potentialstrategic partners or collaborators may not be successful in developingand commercializing any products based on our proprietary nitric oxidetechnology. Any failure of such potential partners or collaborators at anystage of the development or commercialization process with respect to ourpotential product candidates would significantly reduce the possibility that wewould realize any future revenue from our technology portfolio.

**Because we have ahistory of losses and our future profitability is uncertain, an investment inour common stock is highly speculative.**

We have experienced significant operating losses sinceour inception in 1992. For the year ended December 31, 2006, we had a netloss of $71.3 million. As of December 31, 2006, we had an accumulateddeficit of $313.8 million. We expect that we will continue to incursubstantial losses and that our cumulative losses will increase as ourcommercialization efforts continue. We expect that the losses that we incurwill fluctuate from quarter to quarter and that these fluctuations may besubstantial.

A large portion of our expenses is fixed, includingexpenses related to facilities, equipment and personnel. We have spentsignificant amounts to launch our first product, BiDil, and we expect to incursignificant operating expenses in connection with our ongoing commercializationactivities related to BiDil. We received approval for BiDil from the FDA on June 23,2005, and launched commercial sales of BiDil in July 2005. We have alsospent significant amounts to fund research, development and commercializationof our product candidates and to enhance our core technologies. Currently, ourresearch and development activities are limited to the continued development ofBiDil XR. We are not engaging in any internal research and developmentactivities with respect to other potential product candidates and, therefore,do not expect to incur substantial research and development expenses in thenear term. Although we currently estimate that our operating expenses willdecrease in fiscal year 2007, we will still need to generate significantrevenue to achieve profitability. We are currently unable to estimate the levelof revenues that we will realize from the commercialization of BiDil. We aretherefore unable to estimate when we will achieve profitability, if at all.Even if we do achieve profitability, we may not be able to sustain orincrease profitability on a quarterly or annual basis. Our failure to becomeand remain profitable could depress the market price of our common stock andcould impair our ability to raise capital or continue our operations.

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Our BiDil product revenues have been and will continueto be subject to considerable variation due to the significant reduction in ourdirect sales force, volatility in prescription volume, the manner in which weaccount for product sales considering product returns rates, level of discountsincurred, the level of purchases by individual customers and other matters relatedto the commercialization of this product. We have experienced and are likely tocontinue to experience significant revenue deferrals and product returns, aswell as additional charges and expenses associated with stocking incentives,rebates, discounts, and other promotional incentives, and other matters relatedto the commercialization of this product. Significant inventory adjustmentsmay also occur due to sales forecast variances or other factors. Anydeferrals, returns or adjustments that negatively impact revenue, or ourfailure, for this or any other reason, to generate significant near-termrevenue growth, would reduce our stock price and adversely affect our abilityto raise capital.

**If the third-partymanufacturer of BiDil encounters delays or difficulties in production, wemay not be able to meet demand for the product and we may losepotential revenue, which could cause the price of our common stock to decline.**

We do not manufacture BiDil and have no plans to doso. We engaged Schwarz Pharma under a five-year exclusive manufacturing andsupply agreement solely for the three times daily immediate release dosageformulation of BiDil. Under the supply agreement, we have the right to engage abackup manufacturer but do not currently have any backup manufacturingagreement in place. The terms of the supply agreement provide that itmay be terminated by either us or Schwarz Pharma under specifiedcircumstances, including a material breach of the supply agreement by eitherparty, the occurrence of a payment default by us, our material impairment ofthe manufacturing licenses we have granted to Schwarz Pharma or a failure ofSchwarz Pharma to supply conforming products. In addition, either partymay terminate the supply agreement in the event the FDA takes any action,the result of which is to permanently prohibit the manufacture, sale or use ofthe product.

Furthermore,Schwarz Pharma may encounter difficulties in production. These problemsmay include, but are not limited to:

·       difficultieswith production costs and yields;

·       qualitycontrol and assurance;

·       difficultiesobtaining ingredients for our products;

·       shortagesof qualified personnel;

·       compliancewith strictly enforced federal, state and foreign regulations; and

·       lackof capital funding.

If we are unable to maintain a commercially reasonablemanufacturing agreement for the production of BiDil with Schwarz Pharma, wehave no back-up manufacturing facility and thus we would not be able tomanufacture and sell BiDil until another facility was qualified. The number ofthird-party manufacturers with the manufacturing and regulatory expertise andfacilities necessary to manufacture finished products for us on a commercialscale is limited, and it would take a significant amount of time to arrange,qualify, and receive necessary regulatory approval for alternativearrangements. We may not be able to contract for alternative manufacturingon acceptable terms, if at all.

If we are unable to successfully contract forthird-party manufacturing, or if Schwarz Pharma or any other third-partymanufacturer of BiDil fails to deliver the required commercial quantities offinished product on a timely basis and at commercially reasonable prices, wemay be unable to meet the demand for our product and we may losepotential revenues, all of which could cause the price of our common stock todecline.

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**We rely on a singlesource supplier for one of the two active ingredients in BiDil, and the loss ofthis supplier could prevent us from selling BiDil, which would materially harmour business.**

We rely on Sumitomo Corp. for our supply ofhydralazine hydrochloride, one of the two active ingredients in BiDil. Sumitomois currently the only supplier of hydralazine hydrochloride worldwide. We donot have any agreement with Sumitomo regarding the supply of hydralazinehydrochloride. If Sumitomo stops manufacturing or is unable to manufacturehydralazine hydrochloride, or if we are unable to procure hydralazinehydrochloride from Sumitomo on commercially favorable terms, we may beunable to continue to sell BiDil on commercially viable terms, if at all.Furthermore, because Sumitomo is currently the sole supplier of hydralazinehydrochloride, Sumitomo has unilateral control over the price of hydralazinehydrochloride. Any increase in the price for hydralazine hydrochloridemay reduce our gross margins and adversely affect our ability to achieveprofitability.

**If ourcollaborative partners do not obtain and maintain the regulatory approvalsrequired to market and sell our potential nitric-oxide based product candidatesin the United States, then our business may be unsuccessful, and the marketprice of our stock may substantially decline.**

We are currentlyseeking out-licensing and collaboration opportunities for our potential productcandidates based on our proprietary nitric oxide technology, including NMI-3377,a pre-clinical cardio-renal compound. Our partners will not be able to marketany of our potential nitric-oxide based product candidates in the United Stateswithout marketing approval from the FDA. The process of obtaining FDA approvalof pharmaceutical products is costly, complex and time consuming. Any newpharmaceutical product must undergo rigorous pre-clinical and clinical testingand an extensive regulatory approval process mandated by the FDA. Suchregulatory review includes the determination of manufacturing capability andproduct performance. The drug approval process is affected by such factors as:

·       theseverity of the disease;

·       thequality of the regulatory submission;

·       thedrug’s clinical efficacy and safety;

·       thestrength of the chemistry and manufacturing control of the process;

·       themanufacturing facility’s compliance with cGMP requirements and other applicableregulatory requirements;

·       theavailability of alternative treatments;

·       therisks and benefits demonstrated in clinical trials; and

·       thepatent status and marketing exclusivity rights of certain innovative products.

The regulatory process to obtain market approval for anew drug takes many years and requires substantial expenditures. There can beno assurance that our strategic partners will be successful in obtaining FDAapproval for our potential nitric-oxide based product candidates. If ourstrategic partners do not receive the required regulatory approval or clearanceto market any of our potential product candidates, these partners will not beable to develop and commercialize these product candidates, which willsignificantly impair our ability to realize revenue from these productcandidates and which will likely affect our ability to achieveprofitability and cause the market price of our common stock to substantiallydecline.

**We or our potentialstrategic collaborators may not be able to obtain the necessary regulatoryapprovals in order to market and sell BiDil, or our product candidates, inforeign countries.**

Our marketing approval for BiDil is limited to theUnited States. Until we or our potential strategic collaborators obtain therequired regulatory approvals for BiDil or any potential product candidates inany 

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specific foreign country,neither we nor our collaborators will be able to sell these products in thatcountry. International regulatory authorities have imposed numerous and varyingregulatory requirements, and the approval procedures could involve testing inaddition to that required by the FDA. Furthermore, approval by one regulatoryauthority does not ensure approval by any other regulatory authority. Inaddition, if we enter into collaborative partnerships in order to obtain foreignregulatory approval for BiDil or any of our product candidates, we may bedependent upon these collaborators to conduct clinical or other testing and toobtain such regulatory approvals. We or our collaborators may not be ableto obtain final regulatory approvals for BiDil or for any of our otherpotential product candidates in foreign countries. Any failure to obtain thenecessary governmental approvals or failure to obtain approvals of the scoperequested could delay, or even preclude, us or our licensees or othercollaborators from marketing BiDil or our product candidates, or limit thecommercial use of BiDil or our product candidates in these foreignjurisdictions. Alternatively, foreign regulatory approvals may entaillimitations on the indicated uses of BiDil or our product candidates and imposelabeling requirements which may also adversely impact our ability tomarket BiDil or our product candidates.

**Even if we or ourstrategic partners obtain regulatory approvals, our marketed products, includingBiDil, will be subject to ongoing regulatory review and oversight. If we, orour strategic partners, fail to comply with continuing United States andforeign regulations, we could lose our approvals to market BiDil, our strategicpartners could lose approvals to market our out-licensed products based on ourproprietary nitric oxide technology, and our business would be seriouslyharmed.**

Even after approval, any products we or our potentialstrategic partners develop will be subject to ongoing regulatory review andrestrictions, including the review of clinical results which are reported aftersuch products are made commercially available, and restrictions on theindications for which we or our potential strategic partners can market theproduct. The FDA can propose to withdraw approval if new clinical data orexperience shows that a product is not safe for use under the approvedconditions of use. The FDA, we or our potential strategic partnersmay need to send important information about such products to healthcareproviders. The marketing claims we or our potential strategic partners arepermitted to make in labeling or advertising regarding our marketed productsare limited to those specified in any FDA approval.

For example, because BiDil is specifically approvedfor use by self-identified black patients, we may not promote BiDil foruse in other patient populations. We must submit copies of our advertisementsand promotional labeling for BiDil, including, for example, professionaljournal advertisements, website pages, professional direct mailers,direct-to-consumer advertisements, convention booth panels and handouts, to theFDA at the time of initial publication or dissemination. If the FDA believesthese materials or statements made by our sales representatives or othercompany officials promote our products for unapproved indications, the FDAcould allege that our promotional activities misbrand our products.Specifically, the FDA could issue an untitled letter or warning letter, whichrequests, among other things, that we cease such promotional activities,including disseminating the advertisements and promotional labeling, and thatwe issue corrective advertisements and labeling, including sending letters tohealthcare providers. The FDA also could take enforcement action includingseizure of allegedly misbranded product, injunction or criminal prosecutionagainst us and our officers or employees. If we repeatedly or deliberately failto submit such advertisements and labeling to the agency, the FDA couldwithdraw our approvals. The FDA also monitors manufacturers’ support ofcontinuing medical education, or CME, programs where the programs involve themanufacturers’ or a competitor’s products to ensure that manufacturers do notinfluence the CME content as a means of promoting their products for off-labeluses. In addition, the Department of Justice enforces laws prohibitingkickbacks to healthcare providers and false claims in connection withgovernment-funded reimbursement programs for drug purchases, such as Medicareand Medicaid, and any off-label marketing of BiDil could subject us to civil orcriminal prosecution, for which the government could seek to recoversubstantial monetary penalties, the 

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imposition of restrictionson our marketing activities, and the exclusion of BiDil from eligibility forgovernment reimbursement programs.

In addition, the manufacturer and the manufacturingfacilities we use to produce BiDil, or that our potential strategic partnersmay use to produce product candidates based on our nitric oxidetechnology, are subject to periodic review and inspection by the FDA. We or ourpotential strategic partners are required to report any serious and unexpectedadverse experiences and certain quality problems with BiDil or the respectiveproduct candidate and make other periodic reports to the FDA. The discovery ofany previously unknown problems with a product, manufacturer or facilitymay result in restrictions on the product, manufacturer or manufacturingfacility, including withdrawal of the product from the market. Certain changesto an approved product, including the way it is manufactured or promoted, oftenrequire prior FDA approval before the product as modified may be marketed.If we or our potential strategic partners fail to comply with applicablecontinuing regulatory requirements, we or our potential strategic partnersmay be subject to fines, untitled letters, warning letters, civilpenalties, suspension or withdrawal of regulatory approvals, product recallsand seizures, injunctions, operating restrictions and/or criminal prosecutionsand penalties.

**If we, ourthird-party manufacturers or our service providers fail to comply withapplicable laws and regulations, we or they could be subject to enforcementactions, which could affect our ability to develop, market and sell BiDil, orany potential product candidates, and harm our reputation.**

If we or ourthird-party manufacturers or service providers fail to comply with applicablefederal, state or foreign laws or regulations, we or they could be subject toenforcement actions which could affect our ability to develop, market and sellBiDil, or any potential product candidates, successfully and could harm ourreputation and lead to lower acceptance of BiDil, or any potential productcandidates, by the market. These enforcement actions include:

·       productseizures;

·       voluntaryor mandatory recalls;

·       patientor physician notifications, including letters to healthcare professionals andcorrective advertising;

·       withdrawalof product approvals;

·       restrictionson, or prohibitions against, marketing our products;

·       operatingrestrictions;

·       fines;

·       restrictionson importation or exportation of our products;

·       injunctions;

·       debarments;

·       civiland criminal penalties; and

·       suspensionof review of, or refusal to approve, pending applications.

**If the clinicaltrials for any product candidates our strategic partners advance into clinicaltesting are not successful, these partners may not be able to successfullydevelop and commercialize our potential product candidates.**

In order to obtain regulatory approvals for thecommercial sale of product candidates that we out-license, our collaboratorswill be required to complete extensive clinical trials in humans to demonstrate

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the safety and efficacy ofour product candidates. Our strategic partners may not be able to obtainauthority from the FDA or other regulatory agencies to commence or completethese clinical trials. Even if permitted, such clinical testing may notprove that our product candidates are sufficiently safe and effective to permitour strategic partners to obtain marketing approvals from regulatoryauthorities. Moreover, positive results demonstrated in pre-clinical studiesand early clinical trials that our strategic partners complete may not beindicative of results obtained in future clinical trials. Furthermore, ourcollaborators, institutional review boards or regulatory agenciesmay suspend, hold or terminate clinical trials at any time for variousreasons, including failure to achieve established success criteria,noncompliance with regulatory requirements or if it is believed that thepatients participating in such trials are being exposed to unacceptable healthrisks. Adverse or inconclusive clinical trial results concerning any of ourproduct candidates could require our strategic partners to conduct additionalclinical trials, result in increased costs and significantly delay the filingfor marketing approval for those product candidates with the FDA, result in afiling for a narrower indication than was originally sought or result in adecision to discontinue development of those product candidates.

The successful completion of our strategic partners’clinical trials will depend on, among other things, the rate of patientenrollment. Patient enrollment is a function of many factors, including thesize of the patient population, the nature of the clinical protocol, theavailability of alternative treatments, the proximity of patients to clinicalsites and the eligibility criteria for the study. Our strategic partnersmay be unable to enroll the number of patients we need to complete a trialon a timely basis, if at all. Moreover, delays in planned patient enrollmentfor clinical trials may cause our strategic partners to incur increasedcosts and delay commercialization. Because we will need to rely on thirdparties for the development of our product candidates, we will have lesscontrol over the timing and other aspects of these clinical trials than if weconducted them on our own. These third parties may not complete activities onschedule, or may not conduct clinical trials in accordance with regulatoryrequirements or the trial design.

As a result of these factors, third parties on whom werely may not successfully begin or complete clinical trials on ourpotential product candidates in a timely manner, if at all. Moreover, if ourstrategic partners do not successfully develop, obtain the necessary regulatoryapprovals for, and commercialize our products, our future revenues may bematerially impaired.

**The expiration ofthe research term under our collaboration agreement with Boston Scientific hasresulted in the loss of potential royalty-based revenue from the collaborationand may indicate that the development of nitric oxide-enhancing stents isnot viable.**

In November 2001, we entered into a research,development and license agreement with Boston Scientific pursuant to which wegranted Boston Scientific an exclusive worldwide license to develop andcommercialize certain of our nitric oxide-enhancing compounds for use withtheir stents or specialty catheters in the area of restenosis. In December 2003,we extended the research collaboration to develop nitric oxide-enhancingpaclitaxel-coated stents until December 31, 2005. The research term ofthis agreement expired on December 31, 2005, although certain rightsextend beyond this term. We intend toseek out-licensing and collaboration opportunities for this technology, subjectto the terms of our agreement with Boston Scientific and pending resolution ofthe ongoing rights of the parties with respect to this technology. If weare not able to out-license the technology developed under this agreement, orif we are unable to resolve the ongoing rights of the parties with respect tothis technology in a manner favorable to us, we may lose any investmentmade in the development of, and any potential revenue that may haveresulted from, the development, sale or licensing of nitric oxide-enhancingstents.

**If the estimates wemake and the assumptions on which we rely in preparing our financial statementsprove inaccurate, our actual results may vary significantly.**

Our financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates 

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andjudgments that affect the reported amounts of our assets, liabilities, revenuesand expenses, the amounts of charges taken by us and related disclosure. Suchestimates and judgments include revenue recognition, product returns, thecarrying value of our accounts receivable, inventory and property andequipment, our estimates of accrued expenses and liabilities and our estimatesof the fair value of equity instruments granted or sold by us. We base ourestimates and judgments on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances. However,these estimates and judgments, or the assumptions underlying them, may proveto be incorrect. Accordingly, our actual financial results may varysignificantly from the estimates contained in our financial statements. For afurther discussion of the estimates and judgments that we make and the criticalaccounting policies that affect these estimates and judgments, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Applicationof Critical Accounting Policies and Estimates” below.

**Risks Relating toour Intellectual Property Rights**

**Our patent protection for BiDil, the individualcomponents of which are available in generic form, is limited, and wemay be subject to generic substitution or competition and resultingpricing pressure.**

We have no composition of matter patent coveringBiDil, our product for the treatment of heart failure in self-identified blackpatients as an adjunct to current standard therapy. BiDil is a fixed-dosecombination of two individual components, isosorbide dinitrate and hydralazinehydrochloride, both of which are available in generic form, which are approvedand separately marketed, in dosages similar to those we include in BiDil, forindications other than heart failure, at prices below the prices we arecharging for BiDil. We have three issued method-of-use patents, one of whichcovers the use of the combination of isosorbide dinitrate and hydralazinehydrochloride to reduce the incidence of mortality associated with chroniccongestive heart failure, expiring in 2007, and the others covering thetreatment of heart failure in black patients, expiring in 2020. As a practicalmatter, we may not be able to enforce these method-of-use patents toprevent physicians from prescribing isosorbide dinitrate and hydralazinehydrochloride separately for the treatment of heart failure in black patients,even though neither drug is approved for such use. We also may not be ableto enforce these method-of-use patents to prevent hospitals and pharmacies fromsupplying such patients with these individual components separately in lieu ofBiDil.

Other factors may also adversely affect ourpatent protection for BiDil. If we are successful in marketing BiDil,manufacturers of generic drugs will have an incentive to challenge our patentposition. The combination therapy of isosorbide dinitrate and hydralazinehydrochloride for use in heart failure was developed through lengthy,publicly-sponsored clinical trials conducted during the 1980s, prior to thefiling of the patent application that resulted in the 2007 patent. The U.S.Patent and Trademark Office, or U.S. patent office, considered publishedreports on these clinical trials and concluded that they did not constituteprior art that would prevent the issuance of the 2007 patent. The U.S. patentoffice also considered the question of whether the 2007 patent constitutedprior art with respect to the 2020 patents, and determined that the claims ofthe 2020 patents were non-obvious and patentable. A court considering thevalidity of the 2007 or 2020 patents with respect to questions of prior artmight be presented with other alleged prior art or might reach conclusionsdifferent than those reached by the U.S. patent office. If the 2007 or 2020patents were to be invalidated or if physicians were to prescribe isosorbidedinitrate and hydralazine hydrochloride separately for heart failure in blackpatients, our BiDil revenue could be significantly reduced, we could fail torecover the cost of developing BiDil and BiDil might not be a viable commercialproduct.

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**If we are not able to obtain and enforce patentprotection for our discoveries, our ability to secure out-licensing orcollaborative arrangements with respect to our product candidates will beharmed, and we may not be able to operate our business profitably.**

Our success depends, in part, on our ability toprotect proprietary methods and technologies that we developed under the patentand other intellectual property laws of the United States and other countries,in order to prevent others from using our inventions and proprietaryinformation. Because certain United States patent applications are confidentialuntil patents issue, such as applications filed prior to November 29,2000, or applications filed after such date which will not be filed in foreigncountries, third parties may have filed patent applications for technologycovered by our pending patent applications without our being aware of thoseapplications, and our patent applications may not have priority overpatent applications of others.

Prior to the restructuring of our research anddevelopment activities, our intellectual property strategy depended on ourability to rapidly identify and seek patent protection for our discoveries.This process is expensive and time consuming, and we may not be able toprosecute all necessary or desirable patent applications or maintain all issuedpatents at a reasonable cost. Despite our efforts to protect our proprietaryrights, unauthorized parties may be able to obtain and use informationthat we regard as proprietary. The mere issuance of a patent does not guaranteethat it is valid or enforceable; even if we have obtained patents, theymay not be valid or enforceable against third parties.

The issued patents and patent applications for ourproduct candidates and nitric oxide technology include claims with respect toboth the composition of specific products or compounds and specific methods ofusing these products or compounds in therapeutic areas. In some cases, likeBiDil, our only patent protection is with respect to the method of using aproduct or compound, and we do not have patent claims covering the underlyingcomposition of the product or compound. Method-of-use patents may provideless protection for our product candidates and products because it may bemore difficult to prove direct infringement against a pharmaceuticalmanufacturer or distributor once they have gained approval for an alternativeindication. In addition, if any other company gains FDA approval for anindication separate from the one we or our potential strategic partners arepursuing and markets a product that we or our potential strategic partnersexpect to market under the protection of a method-of-use patent, physicianswill be able to prescribe that product for use in the indication for which weor our potential strategic partners have obtained approval, even though theproduct is not approved for such indication. As a practical matter, we or ourpotential strategic partners may not be able to enforce our method-of-usepatents against physicians prescribing products for such off-label use.Off-label use and any resulting off-label sales could make it more difficult toobtain the price we or our potential strategic partners would otherwise wish toachieve for, or to successfully commercialize, our products. In addition, inthose situations where we have only method-of-use patent coverage for a productcandidate, it may be more difficult to find a pharmaceutical companypartner to license or support development of our product candidate.

Our pending patent applications may not result inissued patents. The patent position of pharmaceutical or biotechnologycompanies, including ours, is generally uncertain and involves complex legaland factual considerations. The standards which the U.S. patent office and itsforeign counterparts use to grant patents are not always applied predictably oruniformly and can change over time. There is also no uniform, worldwide policyregarding the subject matter and scope of claims granted or allowable in pharmaceuticalor biotechnology patents. Accordingly, we do not know the degree of futureprotection for our proprietary rights or the breadth of claims allowed in anypatents issued to us or to others.

We also rely on trade secrets, know-how andtechnology, which are not protected by patents, to maintain our competitiveposition. If any trade secret, know-how or other technology not protected by a 

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patent were to bedisclosed to or independently developed by a competitor, our business andfinancial condition could be materially adversely affected.

**If we become involved in patent litigation or otherproceedings to enforce our patent rights, we would incur substantial costs andexpenses, as well as substantial liability for damages, and/or we, or ourstrategic partners, could be required to stop product development andcommercialization efforts.**

A third party may sue us or our potentialstrategic partners for infringing on its patent rights. Likewise, we or ourpotential strategic partners may need to resort to litigation to enforce apatent issued to us or to determine the scope and validity of third-partyproprietary rights. The cost to us or our potential strategic partners of anylitigation or other proceedings relating to intellectual property rights, evenif resolved in our or our partner’s favor, could be substantial, and thelitigation would divert management efforts. Some of our competitors may beable to sustain the costs of complex patent litigation more effectively than wecan because they have substantially greater resources. In addition, ourstrategy of providing nitric oxide-enhancing versions of existing productscould lead to more patent litigation due to the fact that the markets for theseexisting products are very large and competitive. Uncertainties resulting fromthe initiation and continuation of any litigation could limit our ability tocontinue our operations. For example, we have filed an opposition in theEuropean Patent Office, or EPO, to revoke NicOx S.A.’s European Patent No. 904110, which we refer to as EP ’110. This patent is directed to the use oforganic compounds containing a nitrate group or inorganic compounds containinga nitric oxide group to reduce the toxicity caused by certain drugs, includingnon-steroidal anti-inflammatory drugs. The basis for our opposition, in part,is that the claims in EP ’110 are anticipated and therefore invalid ifthey are construed to cover a single compound chemically linked to a nitratemoiety. While we believe that the claims in EP ’110 will be invalidated,or be narrowed, we cannot predict with certainty the outcome of the opposition.If the EPO finds that there are valid claims in EP ’110 that covercompounds chemically linked to nitrates, we may be adversely affected inour ability to market our product candidates for reducing gastrointestinaltoxicity without first obtaining a license from NicOx, which may not beavailable on favorable terms, if at all.

If any parties are able to successfully claim that thecreation or use by us or our potential strategic partners of proprietarytechnologies infringes upon their intellectual property rights, we or ourpotential strategic partners might be forced to pay damages, potentiallyincluding treble damages, if we or our potential strategic partners are foundto have willfully infringed on such parties’ patent rights. In addition to anydamages we or our potential strategic partners might have to pay, a court couldrequire us or our potential strategic partners to stop the infringing activityor obtain a license on terms that are unfavorable to us. In addition, somelicenses may be non-exclusive, and therefore our competitors may haveaccess to the same technology licensed to us. If we or our potential strategicpartners fail to obtain a required license or are unable to design around apatent, we or our potential strategic partners may be unable toeffectively market some of our technology and product candidates, which couldlimit our ability to generate revenues or achieve profitability and possibly preventus from generating sufficient revenue to sustain our operations.

**We in-license a significant portion of our principalproprietary technologies, and if we fail to comply with our obligations underany of the related agreements, we could lose license rights that are necessaryto commercializing BiDil and out-licensing our other product candidates.**

We are a party to a numberof licenses that give us rights to third-party intellectual property that arenecessary for our business. In particular, we have obtained the exclusive rightto develop and commercialize BiDil pursuant to a license agreement with Dr. JayN. Cohn, and some of our intellectual property rights relating to nitric oxidecompounds have been obtained pursuant to license agreements with the Brighamand Women’s Hospital and Boston University. In addition, we may enter intoadditional licenses in the future. These licenses impose various development,commercialization, funding, royalty, 

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diligence,and other obligations on us. If we breach these obligations, the licensormay have the right to terminate the license or render the licensenon-exclusive, which would result in us being unable to develop, manufactureand sell products that are covered by the licensed technology.

**Risks Relating toour Industry**

**We could be negatively impacted by the application or enforcement offederal and state fraud and abuse laws, including anti-kickback laws and otherfederal and state anti-referral laws.**

We are subject to various federal and state lawspertaining to healthcare fraud and abuse, including anti-kickback laws andphysician self-referral laws. Violations of these laws are punishable bycriminal and civil sanctions, including, in some instances, imprisonment andexclusion from participation in federal and state healthcare programs,including the Medicare, Medicaid and Veterans Administration health programs.Because of the far-reaching nature of these laws, we may be required toalter or discontinue one or more of our practices to be in compliance with theselaws. Healthcare fraud and abuse regulations are complex, and even minorirregularities can potentially give rise to claims that a statute orprohibition has been violated. Any violations of these laws, or any actionagainst us for violation of these laws, even if we successfully defend againstit, could result in a material adverse effect on our business, financialcondition and results of operations. If there is a change in law, regulation oradministrative or judicial interpretations, we may have to change ordiscontinue our business practices or our existing business practices could bechallenged as unlawful, which could have a material adverse effect on ourbusiness, financial condition and results of operations.

In addition, we could become subject to false claimslitigation under federal statutes, which can lead to treble damages based onthe reimbursements by federal healthcare programs, civil money penalties(including penalties levied on a per false claim basis), restitution, criminalfines and imprisonment, and exclusion from participation in Medicare, Medicaidand other federal and state healthcare programs. These false claims statutesinclude the False Claims Act, which allows any person to bring suit on behalfof the federal government alleging the submission of false or fraudulentclaims, or causing to present such false or fraudulent claims, under federalprograms or contracts claims or other violations of the statute and to share inany amounts paid by the entity to the government in fines or settlement. Thesesuits against biotechnology companies have increased significantly in recentyears and have increased the risk that a healthcare company will have to defenda false claim action, pay fines or restitution, or be excluded from theMedicare, Medicaid or other federal and state healthcare programs as a resultof an investigation arising out of such action. It is possible that we couldbecome subject to such litigation and, if we are not successful in defendingagainst it, such litigation would have a material adverse effect on ourbusiness, financial condition and results of operations. In addition, the costof defending claims or allegations under the False Claims Act, even ifsuccessful, would also have a material adverse effect on our business, financialcondition and results of operations.

**We face significant competition, which may resultin others commercializing products more successfully than ours.**

The pharmaceuticalindustry is highly competitive and characterized by rapid and significant technologicalchange. Our principal competitors in the markets we have targeted, includingcardiovascular disease, are large, multinational pharmaceutical companies thathave substantially greater financial and other resources than we do and areconducting extensive research and development activities on technologies andproduct candidates similar to or competitive with ours. Many of our competitorsare more experienced than we are in pharmaceutical development andcommercialization, obtaining regulatory approvals and product marketing andmanufacturing. As a result, they may:

·                    developand commercialize products that render BiDil obsolete or non-competitive orthat cause our product candidates to be less desirable as a result of patent ornon-patent exclusivity;

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·                    developproduct candidates and market products that are less expensive or moreeffective than BiDil;

·                    commercializecompeting products before our partners can launch any products developed fromour product candidates;

·                    initiateor withstand substantial price competition more successfully than we can;

·                    havegreater success in recruiting skilled scientific workers from the limited poolof available talent;

·                    moreeffectively negotiate third-party licenses and strategic relationships; and

·                    takeadvantage of product acquisition or other opportunities more readily than wecan.

There are a number of companies currently marketingand selling products to treat heart failure in the general population that willcompete with BiDil. These include GlaxoSmithKline, plc, which currently marketsCoreg®, Merck & Co., Inc., which currently markets Vasotec® andAstra Zeneca, plc, which currently markets Toprol XL®.

We also face competition from other pharmaceuticalcompanies seeking to develop drugs using nitric oxide technology. For example,we are aware of at least seven companies working in the area of nitric oxidebased therapeutics. These companies are: Angiogenix Inc., GB Therapeutics,NicOx S.A., OxoN Medica, RenoPharm, Vasopharm BIOTECH GmbH and Nitrox LLC.

**We may be exposed to product liability claims andmay not be able to obtain or maintain adequate product liabilityinsurance.**

Our business exposes us tothe risk of product liability claims that is inherent in the manufacturing andmarketing of human therapeutic products. Our commercial product liabilityinsurance is subject to deductibles and coverage limitations. We may notbe able to obtain or maintain insurance on acceptable terms, if at all.Moreover, any insurance that we do obtain may not provide adequateprotection against potential liabilities, and our capital resources could bedepleted as a result.

**Risks Relating toour Common Stock**

**The price of our common stock is likely to continue tobe volatile in the future.**

The stock markethas from time to time experienced significant price and volume fluctuationsthat may be unrelated to the operating performance of particularcompanies. In particular, the market price of our common stock, like that ofthe securities of other biopharmaceutical companies, has been andmay continue to be highly volatile. During the period from January 1,2005 to December 31, 2006, our stock price has ranged from a low of $2.04per share (on October 13, 2006) to a high of $27.99 per share (on February 2,2005). The following factors, among others, may affect the price of ourcommon stock:

·                    fluctuationsin our financial results, including with respect to sales of BiDil;

·                    announcementsconcerning fundamental or material corporate transactions, restructuring or thelike;

·                    generalmarket conditions;

·                    announcementsof technological innovations or new commercial products by our competitors;

·                    announcementsof actual or potential medical results relating to products under developmentby our potential strategic partners or our competitors’ products;

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·                    governmentalregulations and regulatory developments in both the U.S. and foreign countriesaffecting us or our competitors;

·                    disputesrelating to patents or other proprietary rights affecting us, our potentialstrategic partners or our competitors;

·                    publicconcern as to the safety of products developed by us, our potential strategicpartners or other biotechnology and pharmaceutical companies;

·                    fluctuationsin price and volume in the stock market in general, or in the trading of thestock of biopharmaceutical and biotechnology companies in particular, that areunrelated to our operating performance;

·                    issuancesof securities in equity, debt or other financings;

·                    salesof common stock by existing stockholders; and

·                    theperception that such issuances or sales could occur.

**Insiders have substantial control over us and coulddelay or prevent a change in corporate control.**

As of March 1,2007, our directors, executive officers and principal stockholders, togetherwith their affiliates, owned, in the aggregate, approximately 41% of ouroutstanding common stock. As a result, these stockholders, if acting together,may have the ability to determine the outcome of matters submitted to ourstockholders for approval, including the election and removal of directors andany merger, consolidation or sale of all or substantially all of our assets. Inaddition, these persons, if acting together, will have the ability to controlthe management and affairs of our company. Accordingly, this concentration of ownershipmay harm the market price of our common stock by:

·                    delaying,deferring or preventing a change in control of our company;

·                    impedinga merger, consolidation, takeover or other business combination involving ourcompany; or

·                    discouraginga potential acquirer from making a tender offer or otherwise attempting toobtain control of our company.

**Provisions in our charter documents and under Delawarelaw may prevent or frustrate attempts by stockholders to change currentmanagement and hinder efforts to acquire a controlling interest in our company.**

Provisions of ourrestated certificate of incorporation and bylaws may discourage, delay orprevent a merger, acquisition or other change in control that stockholdersmay consider favorable, including transactions in which stockholders mightotherwise receive a premium for their shares. These provisions may preventor frustrate attempts by stockholders to replace or remove our currentmanagement. These provisions include:

·                    aprohibition on stockholder action through written consent;

·                    arequirement that special meetings of stockholders be called only by a majorityof the board of directors, the chairman of the board or the chief executiveofficer;

·                    advancenotice requirements for stockholder proposals and nominations;

·                    limitationson the ability of stockholders to amend, alter or repeal our certificate ofincorporation or bylaws; and

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·                    theauthority of the board of directors to issue preferred stock with such terms asthe board of directors may determine.

In addition, Section 203 of the Delaware GeneralCorporation Law prohibits a publicly held Delaware corporation from engaging ina business combination with an interested stockholder, generally defined as aperson or entity which together with its affiliates owns or within the lastthree years has owned 15% of our voting stock, for a period of three yearsafter the date of the transaction in which the person became an interestedstockholder, unless the business combination is approved in a prescribedmanner. Accordingly, Section 203 may discourage, delay or prevent achange in control of our company.

**Substantially all of our outstanding common stock may besold into the market at any time. This could cause the market price of ourcommon stock to drop significantly.**

Sales of a substantial number of shares of our commonstock in the public market could occur at any time. These sales, or theperception in the market that the holders of a large number of shares intend tosell shares, could reduce the market price of our common stock. As of March 1,2007, there were 37,259,870 shares of common stock outstanding. Substantiallyall of these shares may also be resold in the public market at any time.In addition, we have a significant number of shares that are subject to outstandingoptions. The exercise of these options and the subsequent sale of theunderlying common stock could cause a further decline in our stock price. Thesesales also might make it difficult for us to sell equity securities in thefuture at a time and at a price that we deem appropriate.

**We may incur significant costs and suffer managementdistraction and reputational damage from class action litigation.**

Our stock price has been,and is likely to continue to be, volatile. When the market price of a company’sstock is volatile, holders of that company’s stock may bring securitiesclass action litigation against the company that issued the stock. If anyof our stockholders were to bring a lawsuit of this type against us, even ifthe lawsuit was without merit, we could incur substantial costs defending thelawsuit.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES

On February 23, 2007,we entered into a lease for 19,815 square feet of office space at a facilitylocated at 45-55 Hayden Avenue in Lexington, Massachusetts. The initialterm of the lease is for sixty-six months. We are in the process of negotiatingan assignment of our lease related to approximately 52,000 square feet of laboratoryand office space in our current location in Lexington, Massachusetts. Webelieve that our new facility is adequate for our needs for the foreseeablefuture, and that, should it be needed, suitable additional space will beavailable to accommodate expansion of our operations on commercially reasonableterms.

**ITEM 3.**                LEGALPROCEEDINGS

We are currently not aparty to any material legal proceedings.

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

No matters were submitted to a vote of securityholders of our company, through solicitations of proxies or otherwise, duringthe quarter ended December 31, 2006.

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**PART II**

**ITEM5.**             MARKET FOR REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Market Price of and Dividends on NitroMed’s CommonStock and Related Stockholder Matters; Recent Sales of Unregistered Securities.**

*Market Price andDividends*

Ourcommon stock is traded on the NASDAQ National Market under the symbol “NTMD”.The following table sets forth the high and low sale prices per share of ourcommon stock as reported on the NASDAQ Global Market for the periods indicated.

| ** **                                    | ** ** | **Common stock price** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **High**               | ** ** | **Low** | ** ** |
| **Fiscal year ended  December 31, 2006** | ** ** | ** **             | ** ** | ** ** | ** ** |
| First quarter                                 |       | $                      | 14.90      |   | $ | 7.51 |   |
| Second quarter                                |       | $                      | 8.86       |   | $ | 3.59 |   |
| Third quarter                                 |       | $                      | 4.90       |   | $ | 2.38 |   |
| Fourth quarter                                |       | $                      | 3.20       |   | $ | 2.04 |   |
| **Fiscal  year ended December 31, 2005** | ** ** | ** **             | ** ** | ** ** | ** ** |
| First quarter                                 |       | $                      | 27.99      |   | $ | 16.54 |   |
| Second quarter                                |       | $                      | 21.09      |   | $ | 13.80 |   |
| Third quarter                                 |       | $                      | 24.45      |   | $ | 17.10 |   |
| Fourth quarter                                |       | $                      | 22.61      |   | $ | 13.24 |   |

 

On March 1, 2007, the reported last sale price ofour common stock on the NASDAQ Global Market was $3.59 per share, and we hadapproximately 60 holders of record of our common stock. This number doesnot include shareholders for whom shares are held in a “nominee” or “street”name.

We have never paid or declared any cash dividends onour common stock. We currently intend to retain earnings, if any, to financethe growth and development of our business, and we do not expect to pay anycash dividends on our common stock in the foreseeable future. Payment of futuredividends, if any, will be at the discretion of our board of directors.

Information regarding ourequity compensation plans and the securities authorized for issuance thereunderis set forth in Item 12 below.

*Recent Sales ofUnregistered Securities*

None.

**Use of Proceedsfrom Registered Securities**

On January 30, 2006, we completed a directoffering of shares of our common stock previously registered under oureffective shelf registration statement, which was filed with the Securities andExchange Commission, or SEC, in August 2005. Pursuant to this offering, wesold approximately 6.1 million shares of our common stock to selectedinstitutional investors at a price of $10.25 per share. Proceeds to us fromthis registered direct offering, net of offering expenses and placement agencyfees, totaled $58.5 million.

On December 20, 2004, we completed a follow-onpublic offering of our common stock at a price to the public of $24.46 pershare. We sold an aggregate of 3,579,476 shares of our common stock resultingin 

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gross proceeds of $87.6million. The offer and sale of all the shares in the follow-on public offeringwere registered under the Securities Act pursuant to a registration statementon Form S-1 (File No. 333-120280), which was declaredeffective by the SEC on December 7, 2004. Deutsche Bank Securities Inc.,J.P. Morgan Securities Inc., Pacific Growth Equities and Bear, Sterns &Co. Inc. were the managing underwriters of the follow-on public offering. Inconnection with the offering we paid $5.3 million in underwriting discounts andcommissions and incurred $0.5 million in other offering expenses. As part ofthe initial public offering, we granted these underwriters an over-allotmentoption to purchase up to an additional 431,581 shares of our common stock fromus. The underwriters exercised a portion of the over-allotment option. Therewere no selling stockholders in the offering. None of the underwritingdiscounts and commissions or offering expenses were incurred or paid todirectors or officers of ours or their associates or to persons owning 10 percentor more of our common stock or to any affiliates of ours. After deducting theunderwriting discounts and commissions and offering expenses, we received netproceeds from the offering of $81.8 million.

On November 10, 2003,we completed an initial public offering of 6,000,000 shares of our common stockat a price to the public of $11.00 per share. The offer and sale of all of theshares in the initial public offering were registered under the Securities Actpursuant to a registration statement on Form S-1 (File No. 333-108104),which was declared effective by the SEC on November 5, 2003. Deutsche BankSecurities Inc., J.P. Morgan Securities Inc. and Pacific GrowthEquities were the managing underwriters of the initial public offering. Theoffering commenced on November 5, 2003 and did not terminate until afterthe sale of all of the securities registered in the Registration Statement. Aspart of the initial public offering, we granted these underwriters anover-allotment option to purchase up to an additional 900,000 shares of ourcommon stock from us. The underwriters did not exercise the over-allotmentoption. There were no selling stockholders in the offering. The gross proceedsof the initial public offering amount registered on our behalf was $66.0 million.In connection with the offering, we paid $4.6 million in underwriting discounts and commissions to theunderwriters and incurred an estimated $1.3 million in other offeringexpenses. None of the underwriting discounts and commissions or offering expenseswere incurred or paid to directors or officers of ours or their associates orto persons owning 10 percent or more of our common stock or to anyaffiliates of ours. After deducting the underwriting discounts and commissionsand offering expenses, we received net proceeds from the offering of$60.1 million.

**Comparative StockPerformance Graph**

The comparative stock performance graph below comparesthe cumulative total stockholder return (assuming reinvestment of dividends, ifany) from investing $100 on November 6, 2003, the date on which our commonstock was first publicly traded, and plotted at the close of the last tradingday of the fiscal years ended December 31, 2003, 2004, 2005 and 2006, ineach of (i) our common stock, (ii) the Nasdaq Global Stock MarketIndex of U.S. Companies, which we refer to as the Nasdaq Composite Index, and (iii) theNasdaq Global Stock Market Pharmaceutical Index, which we refer to as theNasdaq Pharmaceutical Index; except that, in the case of the Nasdaq CompositeIndex and the Nasdaq Pharmaceutical Index, the stock performance graph belowreflects an investment date of October 31, 2003.

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**COMPARISON OF CUMULATIVE TOTAL RETURN***

**Among NitroMed Inc., The NASDAQ Composite IndexAnd The NASDAQ Pharmaceutical Index**

****

| **Measurement Period  (Fiscal Year Covered)** | ** ** | ** ** | ** ** | **NitroMed, Inc.** | ** ** | **NASDAQ  Composite Index** | ** ** | **NASDAQ  Pharmaceutical  Index** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-------------------------|------------|----------------------------------|------------|-----------------------------------|------------|
| 11/6/2003                                                    |       |       | $          | 100.00                  |       |                             |       | $                                 | 100.00     |   |   |   | $ | 100.00 |   |   |
| 12/31/2003                                                   |       |       | $          | 77.34                   |       |                             |       | $                                 | 104.45     |   |   |   | $ | 102.32 |   |   |
| 12/31/2004                                                   |       |       | $          | 286.87                  |       |                             |       | $                                 | 114.09     |   |   |   | $ | 111.71 |   |   |
| 12/31/2005                                                   |       |       | $          | 150.16                  |       |                             |       | $                                 | 117.43     |   |   |   | $ | 125.65 |   |   |
| 12/31/2006                                                   |       |       | $          | 26.37                   |       |                             |       | $                                 | 133.53     |   |   |   | $ | 128.40 |   |   |

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*                    $100 investedon November 6, 2003 in our common stock and October 31, 2003 in either theNASDAQ Composite Index or the NASDAQ Pharmaceutical Index, including reinvestmentof dividends.

The information included under the heading “ComparativeStock Performance Graph” in this Item 5 of our annual report on Form 10-Kshall not be deemed to be “soliciting material” or subject to Regulation 14A or14C, shall not be deemed “filed” for purposes of Section 18 of theSecurities Exchange Act of 1934, as amended, or otherwise subject to theliabilities of that section, nor shall it be deemed incorporated by referencein any filing under the Securities Act of 1933, as amended, or the ExchangeAct.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

You should read carefully the financial statementsincluded in this report, including the notes to the financial statements and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.” Theselected financial data in this section are not intended to replace thefinancial statements.

Wederived the statement of operations data for the years ended December 31,2006, 2005 and 2004 and the balance sheet data as of December 31, 2006 and2005 from our audited financial statements, which are included elsewhere inthis report. We derived the statement of operations data for the years ended December 31,2003 and 2002 and the balance sheet data as of December 31, 2004, 2003 and2002 from our audited financial statements which are not included herein.Historical results are not necessarily indicative of future results. See thenotes to the financial statements for an explanation of the method used todetermine the number of shares used in computing basic and diluted net loss percommon share.

| ** **                                                                                             | ** ** | **Year Ended December 31,**               | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006(1)**                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                             | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statement of Operations Data:**                                                                      | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                                |       | $                                         | 12,086     |   | $ | 6,047 |   | $ | 16,458 |   | $ | 12,775 |   | $ | 750 |   |
| Cost and operating  expenses:                                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Cost of product sales                                                                                  |       | 3,560                                     |       | 8,009 |   | — |   | — |   | — |   |
| Research and development                                                                               |       | 17,029                                    |       | 31,340 |   | 27,401 |   | 18,447 |   | 15,670 |   |
| Sales, general and administrative                                                                      |       | 59,403                                    |       | 74,596 |   | 20,185 |   | 3,574 |   | 2,994 |   |
| Restructuring charges                                                                                  |       | 5,283                                     |       | — |   | — |   | — |   | — |   |
| Total costs and  operating expenses                                                                    |       | 85,275                                    |       | 113,945 |   | 47,586 |   | 22,021 |   | 18,664 |   |
| Loss from  operations                                                                                  |       | (73,189                                   | )          | (107,898 | ) | (31,128 | ) | (9,246 | ) | (17,914 | ) |
| Other income, net                                                                                      |       | 1,852                                     |       | 2,046 |   | 1,355 |   | 477 |   | 572 |   |
| Net loss                                                                                               |       | (71,337                                   | )          | (105,852 | ) | (29,773 | ) | (8,769 | ) | (17,342 | ) |
| Deemed dividends  related to beneficial conversion features of redeemable convertible preferred  stock |       | —                                    |       | — |   | — |   | (19,357 | ) | — |   |
| Accretion of  dividends and redemption value                                                           |       | —                                    |       | — |   | — |   | (2,794 | ) | (2,697 | ) |
| Net loss attributable to common stockholders                                                           |       | $                                         | (71,337    | ) | $ | (105,852 | ) | $ | (29,773 | ) | $ | (30,920 | ) | $ | (20,039 | ) |
| Net loss per common  share:                                                                            |       |                                      |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                                                      |       | $                                         | (1.96      | ) | $ | (3.49 | ) | $ | (1.14 | ) | $ | (6.95 | ) | $ | (20.66 | ) |
| Weighted average basic  and diluted common shares outstanding                                          |       | 36,399                                    |       | 30,355 |   | 26,152 |   | 4,447 |   | 970 |   |

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(1)          The Company includes theexpense associated with employee stock options in the Statement of Operationseffective in 2006 upon the adoption of SFAS 123R, which resulted in anaggregate of $8 million recorded in the line items of research anddevelopment and sales, general and administrative expenses.

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| ** **                                        | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **(in thousands)**     | ** ** |
| **Balance Sheet Data:**                           | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash, cash  equivalents and marketable securities |       | $                      | 42,153     |   | $ | 61,541 |   | $ | 142,367 |   | $ | 97,088 |   | $ | 11,843 |   |
| Working capital                                   |       | 31,041                 |       | 39,924 |   | 133,238 |   | 87,938 |   | 15,838 |   |
| Total assets                                      |       | 48,705                 |       | 76,521 |   | 149,357 |   | 99,170 |   | 22,492 |   |
| Long-term  debt                                   |       | 3,728                  |       | 10,653 |   | — |   | — |   | 22 |   |
| Redeemable  convertible preferred stock           |       | —                 |       | — |   | — |   | — |   | 82,884 |   |
| Accumulated  deficit                              |       | (313,808               | )          | (242,471 | ) | (136,619 | ) | (106,846 | ) | (75,926 | ) |
| Total stockholders’  equity (deficit)        |       | $                      | 29,079     |   | $ | 33,066 |   | $ | 137,012 |   | $ | 81,799 |   | $ | (73,353 | ) |

 

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Overview**

We are an emerging pharmaceutical company withsubstantial expertise and intellectual property in nitric oxide-based drugdevelopment. We have devoted substantially all of our efforts towards theresearch and development of our product candidates and the commercialization ofour currently marketed product, BiDil. Since our inception, we have mainlyfunded our operations through the sale of equity securities, debt financings,license fees, research and development funding, milestone payments from ourcollaborative partners, and more recently, sales of BiDil. We have never beenprofitable and have incurred an accumulated deficit of $313.8 million as of December 31,2006.

In June 2005, the FDA approved our product,BiDil, for the treatment of heart failure in self-identified black patients asan adjunct to current standard therapies. BiDil is an orally administeredfixed-dose combination of isosorbide dinitrate and hydralazine hydrochloride.We commercially launched BiDil in July 2005. We engaged Schwarz Pharmaunder a five-year exclusive manufacturing and supply agreement exclusively forthe three times daily immediate release dosage formulation of BiDil.

In March 2006, we eliminated our discoveryresearch program and terminated substantially all of the employees in ourdiscovery research group in a restructuring of our company that was intended tobetter align costs with revenue and operating expectations. In connection withour restructuring in March 2006, we terminated substantially all of theemployees in our discovery research group and determined to limit our futureinternal development activities to the continued development of BiDil XR, aswell as efforts to out-license our nitric oxide-enhancing technology inexchange for potential milestone payments and royalties on sales.

In October 2006, we implemented a revisedstrategy and business model in order to focus our resources on the developmentof BiDil XR as expeditiously as possible. As part of this strategic shift, weeliminated our current sales force and replaced it with a small team of highlyexperienced senior cardiovascular specialists, resulting in a net reduction ofapproximately 120 in sales force headcount. In addition, we also eliminatedapproximately 20% of our general and administrative personnel in connectionwith this restructuring program. Our restructured sales force will be comprisedof a director of managed markets, six national account directors, two areabusiness directors and twenty-one cardiovascular business managers. Our salesand marketing organization will continue to be managed by our senior vicepresident of commercial operations. This highly specialized team is currentlybeing assembled and will focus on regional and national thought-leaderphysicians, current BiDil prescribers, as well as key institutions in majormetropolitan centers that treat, and influence the treatment of, large numbersof African-Americans diagnosed with heart failure. Additional marketing methodswill be utilized to reach the broader number of existing and potential BiDilprescribers. We expect that this alternative strategy will employ a less costly

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approach to marketing thecurrent immediate release formulation of BiDil during BiDil XR’s planneddevelopment. We believe this revised strategy will allow us to conserve thecash required to accelerate development efforts with respect to BiDil XR whilerefocusing the market presence of the current BiDil formulation. Preclinical studieswith BiDil XR have been positive, and we commenced early-stage clinicaldevelopment of BiDil XR in October 2006. Our current plan for seekingregulatory approval for BiDil XR, that will include conducting ofbioequivalence studies, if successful and accepted as part of the basis forapproval, is expected to enable us to achieve an accelerated developmenttimeline. We expect to provide further updates on the clinical timeline andregulatory pathway for BiDil XR after preliminary clinical data have beenassessed.

In connection with our efforts to develop BiDil XR, inFebruary 2007, we entered into a license with Elan, pursuant to which Elangranted to us an exclusive worldwide royalty-bearing license, with specifiedsublicense rights, to specified intellectual property of Elan, as well as anyimprovements to any of the foregoing developed by either party during the termof the agreement. Pursuant to the license, we may import, use, offer for saleand sell an oral capsule formulation incorporating specified technology ownedor controlled by Elan and containing, as its sole active combination ofingredients, the combination of the active drug substances isosorbide dinitrateand hydralazine hydrochloride. In consideration for the grant of the license,we have agreed to pay Elan royalties that are calculated by reference to annualnet sales parameters set forth in the agreement. In addition, we have alsoagreed to pay Elan specified amounts upon the achievement of specifieddevelopment and commercialization milestone events set forth in the agreement.

In the near-term, a key driver of our success will beour ability to successfully commercialize and sustain market penetration ofBiDil with our restructured and smaller specialty sales force and to acceleratethe development of, and obtain regulatory approval for, the commercial sale ofBiDil XR. Since we commercially launched BiDil in July 2005, we havegenerated approximately $16.5 million in product sales, including product salesof $12.1 million in 2006. We will need to generate significant revenues fromsales of BiDil and, if approved, BiDil XR, to achieve profitability. At thepresent time, we are unable to estimate the level of revenues that we willrealize from the sales of BiDil or, if approved, BiDil XR. We are thereforeunable to estimate when we will achieve profitability, if at all. We have alsoapplied our nitric oxide technology to develop novel pharmaceuticals, as wellas safer and more effective versions of existing drugs, and to targetsignificant diseases that are characterized by a deficiency in nitric oxide.

As a result of ourrestructurings in March and October 2006, we expect that research,development and commercialization expenses will decline in 2007, due primarilyto a decrease in headcount and research and commercialization activities,partially offset by an increase in ongoing development expenses for BiDil XR.We estimate that our operating expenses related to research and development andsales, general and administrative functions for the year ended December 31,2007 will be approximately $55 million, excluding cost of product salesand including stock-based compensation related to Statement of FinancialAccounting Standards No. 123(R). We estimate that our operating expenseswill be reduced on an annualized basis by approximately $30 million as a resultof our March 2006 and October 2006 restructurings. At December 31, 2006,our principal source of liquidity was $42.2 million of cash and cashequivalents and marketable securities. We believe that our existing sources ofliquidity and cash expected to be generated from future operations will besufficient to fund our current business plan for at least the next twelvemonths.

**FinancialOperations Overview**

*Revenue.*   Ourfirst commercial product, BiDil, was launched in July 2005, and generatedproduct sales of  $12.1 million for theyear ended December 31, 2006. Prior to the launch of BiDil, all of ourrevenue had been derived from license fees, research and development paymentsand milestone payments that we received from our corporate collaborators. Infuture years, we will seek to generate revenue from a 

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combination of productsales, license fees, and milestone and royalty payments in connection withcollaborative or strategic relationships, as well as royalties resulting fromthe license of our intellectual property. We expect that any collaborativerevenue we generate will fluctuate from quarter to quarter as a result of thetiming and amount of research and development, milestone and other paymentsreceived under our collaborative or strategic relationships and relatedcontinuing obligations, as well as the timing and amount of revenue werecognize for the sale of our products, to the extent any are successfully commercialized.

*Researchand Development.*   Research and developmentexpense consists of expenses incurred in identifying, developing and testingproduct candidates. These expenses consist primarily of salaries and relatedexpenses for personnel, fees paid to professional service providers for independentmonitoring and analysis of our clinical trials, costs of contract research andmanufacturing, costs of facilities and BiDil medical support costs.

The followingsummarizes our primary research and development programs. We have not providedprogram costs because prior to 2000 we did not track and accumulate costinformation by research program.

·                    *BiDil*.   From May 2001 to July 2004,we enrolled 1,050 patients at 169 clinical sites in the United States in ourphase III clinical trial for BiDil. We halted the trial in July 2004 dueto a significant survival benefit in the preliminary data for patients takingBiDil. The FDA approved BiDil on June 23, 2005, and we launched BiDil in July 2005.The total cost for the BiDil A-HeFT trial was approximately $43.0 million.

·                    *BiDil XR*.   The currentformulation of BiDil is an immediate-release tablet that must be taken threetimes daily. We are currently pursuing the development of BiDil XR, an extendedrelease formulation of BiDil, that could be taken once a day. To date, we haveincurred approximately $2.8 million in connection with the development of BiDilXR. Preclinical studies with BiDil XR have been positive, and we have commencedclinical development of BiDil XR. Because of its stage of development, and theuncertainties inherent in pharmaceutical development generally, we may notbe able to successfully develop and commercialize BiDil XR. Moreover, we cannotreasonably estimate or know the nature, timing and estimated costs of theefforts necessary to complete the development of, or the period in whichmaterial cash inflows are expected to commence, if at all, for BiDil XR.

·                    *Nitric Oxide-Enhancing**Cardiovascular Compounds*.   Wehave utilized our nitric oxide expertise and proprietary position to develop aproprietary nitric oxide-enhancing cardio-renal compound, referred to as NMI-3377.We have retained all commercial rights to this product candidate and arecurrently seeking out-licensing and collaboration opportunities for thiscompound. Currently, we do not intend to incur additional internal research anddevelopment expenses related to NMI-3377. Because this compound has notbeen developed beyond the pre-clinical stage, the successful development ofthis product candidate is highly uncertain. In addition, we cannot be certainif we will be able to secure an out-licensing or collaboration partner for thiscompound on favorable terms, if at all. As such, we are not able to estimatewhen material cash inflows from product sales, milestones and royalties couldcommence, if at all.

·                    *Other Discovery Research*.   We have used ourknow-how and expertise in nitric oxide to develop drug candidates that arenitric oxide-enhancing versions of existing medicines in the areas ofcardiovascular, gastrointestinal/anti-inflammatory and pulmonary medicine.These studies have not progressed beyond a discovery stage of testing, and itremains speculative whether the addition of nitric oxide will result in animproved clinical profile of these medicines. We are currently seekingout-licensing and collaboration opportunities for these product candidates, andare not presently engaging in any internal research and development activitieswith respect to 

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these drugs. Wecannot be certain if we will be able to secure out-licensing or collaborationpartners for these product candidates on favorable terms, if at all. As such,we are not able to estimate when material cash inflows from product sales,milestones and royalties could commence, if ever.

·                    *Nitric Oxide Stents.*   Weformerly had a research program with Boston Scientific Corporation, or BostonScientific, to develop cardiovascular stents enhanced with a bio-compatiblepolymer that is capable of releasing nitric oxide. In accordance with the termsof our agreement with Boston Scientific, the research term expired in December 2005.The research program under this agreement focused on pre-clinical development.We intend to seek out-licensing and collaboration opportunities for theseproduct candidates, subject to the terms of our agreement with BostonScientific and pending resolution of the ongoing rights of the parties withrespect to this technology. We cannot be certain if we will be able to secureout-licensing or collaboration partners for these product candidates onfavorable terms, if at all. Significant additional expenditures will berequired to conduct pre-clinical testing and to apply for, and conduct,clinical trials. We are not presently engaging in any internal research anddevelopment activities with respect to cardiovascular stents. Because thisprogram has not progressed beyond a pre-clinical stage of development, thesuccessful development of products based upon this program is highly uncertain.As such, we are unable to estimate when material cash inflows from milestonesand royalties could commence, if at all.

*Sales,General and Administrative.*   Sales, general andadminstrative expense consists primarily of salaries and other related costsfor personnel in sales and marketing, executive, finance, investor relations,accounting, business development and human resource functions. Other costsinclude facility costs not otherwise included in research and developmentexpense; costs for public relations, advertising and promotion services;professional fees for legal and accounting services; and costs related to our formercontract sales agreement with Publicis Selling Solutions, Inc., orPublicis.

*Non-Operating Income.*   Non-operatingincome includes interest earned on our cash, cash equivalents and marketablesecurities, and interest expense associated with our long-term debt.

**Results ofOperations**

***Years Ended December 31, 2006, 2005 and 2004***

*Revenue.*   Total revenuefor the year ended December 31, 2006 was $12.1 million, compared to $6.0million in 2005 and $16.5 million in 2004.

Product sales for the year ended December 31,2006 were $12.1 million, compared to $4.5 million in 2005. We commerciallylaunched BiDil in July 2005. There were no product sales for the yearended December 31, 2004.

Research and development revenues were $-0-for the year ended December 31, 2006, compared to $1.6 million for 2005and $16.5 million for 2004. The $1.6 million, or 100% decrease in research anddevelopment revenues in 2006 compared to 2005 was due to the termination of theresearch term under our collaboration agreement with Boston Scientific in December 2005.For the year ended December 31, 2005, research and development revenuestotaled $1.6 million, a 90% or $14.9 million decrease in revenue compared to2004. The decrease in research revenue in 2005 was due to the termination of anagreement with Merck in November 2004. In 2004 we recognized $14.9 millionin revenue under this agreement, which included all amounts previouslydeferred. Due to the termination of this collaboration agreement, we no longerhave any future performance obligations, and accordingly, we recognizedpreviously deferred license revenue of $5.3 million. In addition, we recognized$1.8 million that was originally scheduled to be 

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paid to us during 2005 forresearch and development funding, but was instead paid to us in 2004 when theagreement was terminated.

*Costof Product Sales.  **Cost of product sales decreased to$3.6 million in 2006 from $8.0 million in 2005. The $4.4 million, or 56%decrease in cost of product sales in 2006 compared to 2005 is primarily due toa $4.5 million decrease in inventory impairment charges from $5.6 million in2005 to $1.1 million in 2006. Included in cost of product sales are charges forcontractual purchase commitments in the amounts of $0.4 million in 2006 and$1.5 million in 2005. The charges were due to our current estimate of inventoryrequirements based on our sales forecast. Offsetting the decrease in inventoryimpairment charges were higher product costs and higher royalty costs due toincreased sales.*

*Researchand Development.*   Research and development expense for the yearended December 31, 2006 was $17.0 million, compared to $31.3 million in2005 and $27.4 million in 2004. The $14.3 million, or 46% decrease in researchand development expenses in 2006 compared with 2005 was primarily the result ofdecreased clinical and medical expenses needed to support the commercial launchof BiDil, a decrease in payroll and benefits due to our restructuring in March 2006,and decreases in the areas of continuing medical education, clinical advisoryboards, medical services fees, publications and other various contractedservices totaling $16.6 million. These decreases were offset by increases inthe amount of $2.9 million for stock-based compensation expense related tothe adoption of Statement of Financial Accounting Standards No. 123(R),*Share-Based Payment*, or SFAS 123R, in January 2006.The $3.9 million, or 14% increase in research and development expenses in 2005compared with 2004 was primarily the result of increased clinical and medicalexpenses to support the commercial launch of BiDil in the areas of continuingmedical education, clinical advisory boards, medical services fees,publications and other various contracted services totaling $13.2 million. Wealso incurred increased research and development expenses in 2005 of $2.6million related to product development projects. Offsetting the increasedmedical support and research expenses in 2005 was a decrease of $10.2 millionin clinical trial expenses as a result of the completion of the A-HeFT trial in2004, a decrease in drug manufacturing expense of $1.1 million and a decreasein compensation expense of $0.6 million.

Thefollowing table summarizes the primary components of our research anddevelopment expense for our principal research and development programs for thefiscal years ended December 31, 2006, 2005 and 2004.

| ** **                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------|------------|
| **Research and Development Program** | ** ** | ** **       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| BiDil                                               |       | $                | 9,603,000  |   | $ | 19,052,000 |   | $ | 20,000,000 |   |
| BiDil XR                                            |       | 2,774,000        |       | — |   | — |   |
| Nitric oxide-enhancing  cardiovascular compounds    |       | 2,568,000        |       | 6,073,000 |   | 500,000 |   |
| Nitric oxide-enhancing  COX-2 inhibitors            |       | —           |       | — |   | 2,500,000 |   |
| Nitric oxide  stents                                |       | 206,000          |       | 2,279,000 |   | 2,500,000 |   |
| Other                                               |       | 1,878,000        |       | 3,936,000 |   | 1,901,000 |   |
| Total research and  development expense             |       | $                | 17,029,000 |   | $ | 31,340,000 |   | $ | 27,401,000 |   |
|                                                     |            |                  |            |  |  |  |  |  |  |  |  |  |

 

*Sales,General and Administrative.  *Sales, general andadministrative expense for the year ended December 31, 2006 was $59.4million, compared to $74.6 million in 2005 and $20.2 million in 2004. The $15.2million, or 20% decrease in sales, general and administrative expenses in 2006compared to 2005 was primarily due to a decrease of $11.4 million related tothe termination our sales force and $7.4 million for advertising and promotionalservices and public relations. These decreases are offset by increases in theamount of $5.1 million for stock-based compensation expense related to theadoption of SFAS 123R in January 2006. Sales, general and administrativeexpense for the year ended December 31, 2005 was $74.6 million,compared to $20.2 million in 2004. The $54.4 million, or 270% increase insales, general and administrative expenses in 2005 compared to 2004 wasprimarily due to an increase of $25.6 million for the 

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implementation of ourcontract sales force under our agreement with Publicis, $4.0 million for thehiring of sales and marketing management personnel, and $20.9 million foradvertising and promotional services and public relations. We also incurredhigher general and administrative expense in 2005 due to increased costs of$1.1 million associated with the accrual of business development expensespertaining to the approval process for BiDil, $1.8 million pertaining toadditional legal and consulting expenses and $0.4 million related to thehiring of executive management and additional administrative personnel.

*Restructurings.*   Inthe first quarter of 2006, we recorded a restructuring charge of $2.0 millionrelated to a restructuring of our discovery research operations that wasintended to better align costs with revenue and operating expectations. Therestructuring charges pertained to employee severance and impairment of assetsand were recorded in accordance with Statement of Financial AccountingStandards No. 146,  *Accounting for Costs Associated with Exit or DisposalActivities,* or SFAS 146, and Statement of Financial AccountingStandards No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets,* or SFAS 144.

In connection with the restructuring plan, weterminated 30 employees in our discovery research group, or approximately 30%of our workforce, resulting in a charge of $1.4 million. None of theseemployees remained employed as of March 31, 2006. As a result ofterminating these employees, we recorded an impairment charge for certainresearch laboratory equipment, computer equipment, and furniture and fixturesaggregating $597,000, for which the future use was uncertain. These assets werewritten down to their fair value utilizing a third party appraiser to estimatethe fair value of the assets based on current market quotes and the currentcondition of the equipment, furniture and fixtures.

In the fourth quarter of 2006, we recorded arestructuring charge of $3.2 million comprised of severance benefits of $2.5million and impairment charges of $0.7 million for certain research anddevelopment equipment, leasehold improvements, furniture and fixtures, andcomputers. The restructuring charges were recorded in accordance with SFAS 146 and SFAS 144. This restructuring program included the elimination of120 sales personnel and 8 general and administrative and research anddevelopment personnel. These employees were terminated in October 2006, and noemployee remained employed at December 31, 2006. Due to these actions,certain research and development equipment, leasehold improvements, furnitureand fixtures and computers became impaired. These assets were written down tothe fair value based on either a third-party quote, or the estimated discountedcash flows they will generate over the remaining economic life.

*Stock-basedCompensation Expense.**  *OnJanuary 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R),*Share-Based Payment,* or SFAS 123R, usingthe modified prospective application method. Compensation cost is calculated onthe date of grant using the fair value of the options as calculated by theBlack-Scholes valuation model and is recognized ratably over the employee’sservice period.

Prior to the adoption of SFAS 123R, we accounted forshare-based payments to employees using the intrinsic value method ofAccounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*, or APB 25. UnderAPB 25, we generally recognized no compensation cost for employee stockoptions. The adoption of SFAS 123R under the modified prospective applicationmethod allowed us to recognize compensation cost beginning with the effectivedate of January 1, 2006 based on (a) the requirements of SFAS 123Rfor all share-based payments granted after the effective date and (b) therequirements of Statement of Financial Accounting Standards No. 123, *Accounting for Stock Based Compensation*, or SFAS 123, forall awards granted to employees prior to the effective date of SFAS 123R thatremain unvested on the effective date. Under the modified prospectiveapplication method, prior periods are not restated for the effect of SFAS 123R.

As a result of adopting SFAS 123R on January 1,2006, our net loss and net loss per share were $8.0 million and $0.22,respectively, higher than if we had continued to account for share-based 

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compensation under APB 25.As of December 31, 2006, the total compensation cost related to unvestedawards to employees not yet recognized in the statement of operations wasapproximately $10.9 million, which will be recognized over a weighted averageperiod of 1.4 years.

*Non-Operating Income.  **Non-operating income decreased to $1.9million in 2006 compared to $2.0 million in 2005 and $1.4 million in 2004. The$0.1 million, or 9% decrease in non-operating income in 2006 compared to 2005was primarily related to $0.4 million in higher interest expense associated withour debt, which was outstanding all of 2006 compared to six months in 2005,offset by $0.2 million in higher interest income. The $0.6 million, or 51%increase in non-operating income in 2005 compared to 2004 was primarily relatedto higher interest income due to higher average investment balances and higherinterest rates in 2005, offset by interest expense related to long-term debt.*

**Liquidity andCapital Resources**

Since our inception, we have primarily funded ouroperations through the sale of equity securities, debt financings, licensefees, research and development funding, milestone payments from ourcollaborative partners and, more recently, sales of BiDil. As of December 31,2006, we have received net proceeds of $322.5 million from the issuance ofequity securities, primarily as the result of the sale of $99.1 million of ourredeemable convertible preferred stock, net proceeds of $60.1 million from ourinitial public offering in November 2003, net proceeds of $81.8 millionfrom our follow-on public offering in December 2004, and net proceeds of$58.5 million from our registered direct offering in January 2006. At December 31,2006, we had $42.2 million in cash, cash equivalents and marketablesecurities.

On June 28, 2005, we borrowed (i) $10.0 millionfrom Oxford Finance Corporation, or Oxford, and (ii) $10.0 million fromGeneral Electric Capital Corporation, or GECC, pursuant to the terms ofpromissory notes made by us with both Oxford and GECC, respectively. The notesbear interest at a fixed rate of 9.95% per annum and are payable in 36consecutive monthly installments of principal and accrued interest, beginning July 1,2005. The notes are secured by a security interest in all our personal propertyand fixtures with the exception of any intellectual property or productsacquired, whether by purchase, license or otherwise, on or after the executionof the notes. The agreements that we entered into with each of Oxford and GECCin connection with the notes also contain a material adverse change clause withboth Oxford and GECC. Under this clause, if Oxford or GECC reasonably determinethat our ability to repay the notes has been materially impaired, we would beconsidered in default. As of December 31,2006, we were in compliance with this clause. As of December 31, 2006, we had paid aggregate principal in theamount of $9.3 million.

During the year ended December 31, 2006,operating activities used cash of $72.4 million primarily due to a net loss of$71.3 million, the use of $9.9 million in cash for accounts payable, and $4.6million for accrued expenses, offset by decreases in accounts receivable of$1.2 million, and prepaid expenses and other current assets of $3.3 million.These cash flow decreases are offset by adjustments for non-cash impairmentcharges for restructuring of $1.3 million, stock-based compensation expense of $7.9 million and depreciationand amortization of $0.8 million.

During the year ended December 31, 2006,investing activities provided cash of $29.3 million primarily due to thenet sales of marketable securities of $29.4 million, offset by $0.1million in fixed asset purchases. We expect to invest $250,000 to $750,000 forcapital expenditures in 2007, principally related to the leaseholdimprovements, and computer equipment to support the current headcount.

During the year ended December 31, 2006,financing activities provided cash of $53.0 million due to proceeds of $58.5million from our registered direct offering, and $0.8 million from the issuanceof common stock under our employee stock plans, offset by $6.3 million inprincipal payments on long-term debt.

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The following tablesummarizes our contractual obligations at December 31, 2006 and theeffects such obligations are expected to have on our liquidity and cash flowsin future periods.

**Payments Due by Period**

| **Contractual Obligations**    | ** ** | ** ** | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  five years** | ** ** |
|-------------------------------------|------------|------------|------------|-----------|------------|-----------------------------------|------------|--------------------|------------|--------------------|------------|-------------------------------------|------------|
| Operating lease  obligation(1)      |       | $          | 15,585,000 |      | $          | 1,906,000                         |       | $                  | 4,173,000  |               | $          | 4,548,000                           |       | $4,958,000 |   |
| Long-term debt                      |       | 11,512,000 |       | 7,675,000 |       | 3,837,000                         |       | —             |       | —             |       |
| Purchase obligations(2)             |       | 1,080,000  |       | 1,080,000 |       | —                            |       | —             |       | —             |       |
| License milestones(3)               |       | 250,000    |       | 250,000   |       | —                            |       | —             |       | —             |       |
| Total contractual cash  obligations |       | $          | 28,427,000 |      | $          | 10,911,000                        |       | $                  | 8,010,000  |               | $          | 4,548,000                           |       | $4,958,000 |   |

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(1)          The amounts reflectobligations related to (i) our lease for 52,000 square feet of laboratory andoffice space at 125 Spring Street in Lexington, Massachusetts and (ii) ourlease for 19,815 square feet at 45-55 Hayden Avenue in Lexington,Massachusetts. We entered into the lease for the Spring Street premises onJanuary 30, 2004, and the lease is for a term of ten years with options thatpermit renewals for additional five-year periods. The expected minimum rentalcommitments under the Spring Street lease are $1,505,000, $1,505,000,$1,566,000 $1,688,000, and $1,688,000 for each year in the five calendar yearperiod ending December 31, 2011, respectively, and $4.5 million intotal for the remainder of the lease term. We are in the process of negotiatingthe assignment of this lease. We entered into the lease for the Hayden Avenuepremises on February 23, 2007. The term of the Hayden Avenue lease is forsixty-six months beginning on the commencement date, which is defined in thelease as the earlier of (a) the day immediately following the substantialcompletion of certain improvements to the premises as set forth in the lease or(b) the first day on which we occupy all or any portion of the premises for theconduct of our business. The expected minimum rental commitments under theHayden Avenue lease are $401,000, $542,000, $560,000, $580,000 and $592,000 foreach year in the five calendar year period ending December 31, 2011,respectively, and $456,000 in total for the remainder of the lease term.

(2)          Other purchaseobligations are $1.1 million in purchase commitments to Schwarz Pharma formanufacture of finished goods in the first quarter of 2007.

(3)          On February 9,2007, NitroMed entered into a License Agreement with Elan, pursuant to whichNitroMed may be obligated to pay certain milestone payments in the aggregateamount of $2,500,000 of which $250,000 was paid in the first quarter of 2007.

We believe that our existing sources of liquidity andcash expected to be generated from future operations will be sufficient to fundour current business plan for at least the next 12 months. We will requireadditional funding in the future and may seek to do so throughcollaborative co-promotion arrangements and/or public or private financings.However, additional funding may not be available to us on acceptable terms, ifat all. In addition, the terms of any financing may adversely affect theholdings or the rights of our stockholders. For example, if we raise additionalfunds by issuing equity securities or convertible debt securities, furtherdilution to our existing stockholders may result.

If we are unable to obtain funding on a timely basis,we may be required to significantly curtail certain of our sales andmarketing efforts, and our development efforts with respect to BiDil XR, and wemay be required to limit, scale back or cease our operations. We also could berequired to seek funds through arrangements with collaborators or others thatmay require us to relinquish rights to some of our technologies, productcandidates or products.

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Even if we are ableto raise additional funds in a timely manner, our future capital requirementsmay vary from what we expect and will depend on many factors, including thefollowing:

·       themagnitude of product sales of BiDil;

·       thesuccessful commercialization of BiDil;

·       thecost of manufacturing, marketing and selling BiDil;

·       thetiming of when we receive significant revenue from BiDil, if at all;

·       thetime and costs involved in completing the clinical trials and furtherdevelopment of, and obtaining regulatory approvals for, BiDil XR, if at all;

·       ourability to establish and maintain co-promotion, out-licensing and collaborativearrangements;

·       thetiming, receipt and amount of royalties, milestone and other payments, if any,from potential collaborators;

·       theeffect of competing technological and market developments;

·       thecosts involved in preparing, filing, prosecuting, maintaining and enforcingpatent claims; and

·       the cost of obtaining andmaintaining licenses to use patented technologies.

**Application of**CriticalAccounting Policies and Estimates

Our discussion and analysis of our financial conditionand results of operations are based on our financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting periods. On an on-going basis, we evaluate our estimatesand judgments, including those related to revenue, accounts receivable,inventory, accrued expenses and the factors used to determine the fair value ofour stock options. We base our estimates on historical experience, known trendsand events and various other factors that are believed to be reasonable underthe circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. Actual results may differ from these estimatesunder different assumptions or conditions.

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

**Revenue.**   Ourprincipal source of revenue is the sale of BiDil, which began shipping in July of2005. Other sources of revenue to date include license fees, research anddevelopment payments and milestone payments that we have received from ourcorporate collaborators.

*ProductSales/Deferred Revenue.**  *We follow the provisionsof Staff Accounting Bulletin No. 104, *Revenue Recognition,*and recognize revenue from product sales upon delivery of product towholesalers or pharmacies, when persuasive evidence of an arrangement exists,the fee is fixed or determinable, title to product and associated risk of losshas passed to the wholesaler and collectibility of the related receivable isreasonably assured. All revenues from product sales are recorded net ofapplicable allowances for sales returns, wholesaler allowances, rebates, anddiscounts. For arrangements where the risk of loss has not passed towholesalers or pharmacies, we defer the recognition of revenue by recordingdeferred revenue until such time that risk of loss has passed. In addition, weevaluate our level of shipments to wholesalers and pharmacies on a quarterlybasis compared to the estimated level of inventory in the channel, 

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remaining shelf-life ofthe product shipped and quarterly forecasted sales. As a result of thisevaluation, we deferred $2.1 million of revenue from the December 2005shipments and recorded this amount in deferred revenue as of December 31,2005. During 2006, we reversed $1.8 million of this deferred revenue andrecognized the remainder as revenue.

*SalesReturns, Allowances, Rebates and Discounts.**  *Our productsales are subject to returns, wholesaler allowances, rebates and cash andcontract discounts that are customary in the pharmaceutical industry. A largeportion of our product sales are made to pharmaceutical wholesalers for furtherdistribution through pharmacies to patients, who are consumers of the product.All revenues from product sales are recorded net of applicable allowances forsales returns, wholesaler allowances, rebates and discounts. We determine ourprovisions for sales returns, allowances, rebates and discounts based primarilyon estimates and contractual terms. In developing a reasonable estimate for thereserve for product returns, we considered the factors in paragraph 8 of SFAS48, *Revenue Recognition When a Right of Return Exists*.Although we have not yet developed a significant history of product returnsbecause of the recent launch of BiDil, we believe we have developed areasonable estimate of returns based on actual returns data compared to productshipped. We will continue to monitor actual returns as we gain more salesexperience with BiDil.

*ProductReturns.**  *Consistentwith industry practice, we offer contractual return rights that allow customersto return product only during the period that is six months prior to, andtwelve months after product expiration. Commercial product shipped during 2005had a shelf-life of twelve months from date of manufacture with expirationdates ranging from April 2006 to November 2006. During the thirdquarter of 2006, we began shipping commercial product with an expiration dateof 18 months. Factors that are considered in our estimate of future productreturns include an analysis of the amount of product in the wholesaler andpharmacy channels, discussions with key wholesalers and other customersregarding inventory levels and shipment trends, review of consumer consumptiondata as reported by Source Projected Launchtrac provided by Wolters KluwerHealth, and, the remaining time to expiration of our product. As a result ofthis ongoing evaluation, our product return reserve was $1.3 million at December 31,2006 and $0.1 million at December 31, 2005. This reserve is evaluated on aquarterly basis, assessing each of the factors described above, and adjustedaccordingly. Based on the factors noted above, we believe our estimate ofproduct returns is reasonable, and changes, if any, from this estimate wouldnot have a material impact to our financial statements.

*InitialTrade Shipments Incentive.**  *DuringJuly of 2005, we offered certain product stocking incentives to a numberof wholesalers and pharmacy customers. These incentives included units withguaranteed sales provisions and extended payment terms. As a result of theseprovisions, we concluded that these sales were essentially consignment sales asthe risk of loss of these units had not passed to the customer. Accordingly, wehave deferred all revenue related to these units until such time as the unit isprovided to a patient with a prescription. At December 31, 2005, theremaining balance of deferred revenue related to these units was $1.2 million.Through December 31, 2006, we had either recognized the revenue related tothese units, or the product had been returned or estimated to be returned.

*CashIncentives.**  *Duringthe third quarter of 2005, we offered certain additional incentives to a numberof pharmacy customers. These cash incentives included placement and advertisingassistance in the amount of $328,000. We recorded this amount as a reduction torevenue during the year ended December 31, 2005. No cash incentives wereoffered during the twelve month period ended December 31, 2006.

*SampleVoucher and Co-Pay Card Program.**  *Beginningin the third quarter of 2005, we initiated a sample voucher program whereby weoffered an incentive to patients in the form of a free 30-day trial orapproximately 100 tablets, of BiDil. We have accounted for this program inaccordance with Emerging Issues Task Force Issue No. 01-09, *Accounting for Consideration Given by a Vendor to a Customer,*orEITF 

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No. 01-09.These sample programs have historically had quarterly expiration dates suchthat each sample voucher program is only active for one quarter at a time. As aresult, at the end of each quarter we can determine the actual amount ofreimbursement claims received for the vouchers distributed during the quarter.The amount of reimbursement is recorded as a reduction to revenue. During thethird quarter 2006, we initiated a six month co-pay program. As a result ofthese programs, we recorded a reduction to revenue of $0.5 million, and $0.8million for the years ended December 31, 2006, and 2005, respectively. Weexpect to continue to offer co-pay incentives in future periods.

*SalesDiscounts, Rebates and Allowances.**  *Salesdiscounts, rebates and allowances result primarily from sales under contractwith healthcare providers, wholesalers, Medicare and Medicaid programs andother governmental agencies. We estimate rebates and contractual allowances,cash and contract discounts and other rebates by considering the followingfactors: current contract prices and terms, sales volume, estimated customerand wholesaler inventory levels and current average rebate rates. For the yearsended December 31, 2006, and 2005, we recorded cash discounts, rebates andother allowances of $1.5 million and $0.5 million, respectively.

*CollaborationRevenue.**  *Werecord collaboration revenue on an accrual basis as it is earned and whenamounts are considered collectible. Revenues received in advance of performanceobligations or in cases where we have a continuing obligation to performservices, are deferred and recognized over the contractual or estimatedperformance period. Revenues from milestone payments that represent theculmination of a separate earnings process are recorded when the milestone isachieved. Contract revenues are recorded as the services are performed. When weare required to defer revenue, the period over which such revenue should berecognized is subject to estimates by management and may change over the courseof the collaborative agreement. We had no collaboration revenue during the yearended December 31, 2006.

**AccountsReceivable.****  **Accountsreceivable consists of amounts due from wholesalers and pharmacies for thepurchase of BiDil. Ongoing evaluations of customers’ credit worthiness areperformed and collateral is generally not required. As of December 31,2006, we have not reserved any amount for bad debts related to the sale ofBiDil. We continuously review all customer accounts to determine if anallowance for uncollectible accounts is necessary. We currently providesubstantially all of our customers with payment terms of net 30 days. Amountspast due from customers are determined based on contractual payment terms.Through December 31, 2006, payments have generally been made in a timelymanner.

**Inventories.****  **We review our estimates of the net realizable valueof our inventories at each reporting period. Our estimate of the netrealizable value of our inventories is subject to judgment andestimation. The actual net realizable value of our inventories could varysignificantly from our estimates and could have a material effect on ourfinancial condition and results of operations in any reporting period.****On a quarterly basis, we analyze our current inventorylevels and future irrevocable inventory purchase commitments and write downinventory that has become un-saleable, inventory that has a cost basis inexcess of its expected net realizable value and irrevocable inventory purchasecommitments that are in excess of expected future inventory requirements basedon our sales forecasts. For the year ended December 31, 2006, we recordedan inventory impairment charge of $1.1 million to cost of sales related tocommercial trade and patient sample inventory, and a $0.4 million charge tocost of sales for contractual purchase commitments. For the year ended December 31,2005, we recorded an inventory impairment charge of $5.6 million to cost ofsales related to commercial trade and patient sample inventory, and a $1.5 millioncharge to cost of sales for contractual purchase commitments. During the firstquarter of 2007, BiDil’s shelf life for newly produced finished goods wasextended to 24 months.

**AccruedExpenses.****  **As partof the process of preparing financial statements, we are required to estimateaccrued expenses. This process involves identifying services which have beenperformed on our behalf, and estimating the level of service performed and theassociated cost incurred for such service as of 

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each balance sheet date inour financial statements. Examples of estimated expenses for which we accrueinclude contract service fees such as amounts paid to clinical monitors, datamanagement organizations and investigators in conjunction with clinical trials,fees paid to contract manufacturers for the production of finished goods,marketing and medical support fees, such as advisory boards, and publications,marketing service fees and professional service fees, such as lawyers andaccountants. In connection with such service fees, our estimates are mostaffected by our understanding of the status and timing of services providedrelative to the actual levels of services incurred by such service providers.The majority of our service providers invoice us monthly in arrears for servicesperformed. In the event that we do not identify certain costs, which have begunto be incurred, or we over or under- estimate the level of servicesperformed or the costs of such services, our reported expenses for such periodwould be too low or too high. The date on which certain services commence, thelevel of services performed on or before a given date and the cost of suchservices are often determined based on subjective judgments. We make thesejudgments based upon the facts and circumstances known to us in accordance withgenerally accepted accounting principles.

**Stock-BasedCompensation.****  **EffectiveJanuary 1, 2006, we adopted the fair value recognition provisions of SFAS 123R to recognize compensation costassociated with stock option issued to employees. Determining the amountof stock-based compensation expense to be recorded requires us to developestimates to be used in calculating the grant-date fair value of a stockoption. The fair value of each stock award is estimated on the grant date usingthe Black-Scholes option-pricing model. The use of the Black-Scholesoption-pricing model requires us to make estimates for volatility, risk-freeinterest rate, expected term, and expected dividend yield. Volatility isdetermined exclusively using historical volatility data of our common stockbased on the period of time since our common stock has been publicly traded.The risk-free interest rate is based on the U.S. Treasury yield curve ineffect at the time of grant commensurate with the expected life assumption. Theexpected life of stock options granted is based exclusively on historical dataand represents the weighted average period of time that stock options grantedare expected to be outstanding. The expected life is applied to the stockoption grant group as a whole, as we do not expect substantially differentexercise or post-vesting termination behavior amongst its employee population.

Accounting for equity instruments granted or sold byus under APB 25, SFAS 123 and EITF 96-18 requires fair valueestimates of the equity instrument granted or sold. If our estimates of thefair value of these equity instruments are too high or too low, our expenses maybe over or under stated. For equity instruments granted or sold in exchange forthe receipt of goods or services, we estimate the fair value of the equityinstruments based upon consideration of factors which we deem to be relevant atthat time. Because shares of our common stock were not publicly traded prior tothe commencement of our public offering on November 5, 2003, marketfactors historically considered in valuing stock and stock option grantsinclude comparative values of public companies discounted for the risk andlimited liquidity provided for in the shares we are issuing, pricing of privatesales of our redeemable convertible preferred stock, prior valuations of stockgrants and the effect of events that have occurred between the time of suchgrants, economic trends, and the comparative rights and preferences of thesecurity being granted compared to the rights and preferences of our otheroutstanding equity.

Prior to our initialpublic offering, the fair value of our common stock was determined by our boardof directors contemporaneously with the grant. In the absence of a publictrading market for our common stock, our board of directors considered numerousobjective and subjective factors in determining the fair value of our commonstock. At the time of option grants and other stock issuances, our board ofdirectors considered the liquidation preferences, dividend rights, votingcontrol and anti-dilution protection attributable to our then-outstandingredeemable convertible preferred stock, the status of private and publicfinancial markets, valuations of comparable private and public companies, thelikelihood of achieving a liquidity event such as an initial public offering,our existing financial resources, our anticipated continuing operating lossesand increased spending levels required to complete our clinical trials,dilution 

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tocommon stockholders from anticipated future financings and a general assessmentof future business risks.

**Inflation**

We believe the effects ofinflation generally do not have a material adverse impact on our operations orfinancial condition.

**Off-Balance Sheet Arrangements**

We do not have anymaterial off-balance sheet arrangements.

**Recently Issued Accounting Pronouncements**

In July 2006, the FinancialAccounting Standards Board, or FASB, issued FIN 48, *Accountingfor Uncertainty in Income Taxes*, or FIN 48. This interpretationrequires that we recognize in our financial statements the impact of a taxposition if that position is more likely than not of being sustained on audit,based on the technical merits of the position. The provisions of FIN 48are effective for fiscal years beginning after December 15, 2006(beginning with our 2007 fiscal year), with the cumulative effect of the changein accounting principle recorded as an adjustment to opening retained earnings.We do not believe the adoption of FIN 48 will have a material impact onour financial position or results of operations.

In September 2006,the SEC released Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements,* or SAB 108.SAB 108 provides interpretive guidance on the SEC’s views regarding theprocess of quantifying materiality of financial statement misstatements.SAB 108 is effective for fiscal years ending after November 15, 2006(beginning with our 2006 fiscal year). The adoption of SAB 108 did nothave any impact on our results of operations or financial position.

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements*, or SFAS No. 157. SFASNo. 157 defines fair value, establishes a framework for measuring fairvalue in accordance with generally accepted accounting principles and expandsdisclosures about fair value measurements. SFAS No. 157 codifies thedefinition of fair value as the price that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date, clarifies the principle that fair valueshould be based on the assumptions market participants would use when pricingthe asset or liability and establishes a fair value hierarchy that prioritizesthe information used to develop those assumptions. SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007 and interimperiods within those years. We do not currently believe that adoption will havea material impact on our results of operations, financial position or cashflows.

**ITEM7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to marketrisk related to changes in interest rates. Our current investment policy is tomaintain an investment portfolio consisting mainly of U.S. money market andhigh-grade corporate and U.S. government-related securities, directly orthrough managed funds, with maturities of two years or less. In addition, wehold auction rate securities that reset monthly, however the maturities ofsecurities at December 31, 2006 range from 2007 to 2045. Our cash isdeposited in and invested through highly rated financial institutions in NorthAmerica. Our marketable securities are subject to interest rate risk and willfall in value if market interest rates increase. If market interest rates wereto increase immediately and uniformly by 10% from levels at December 31,2006 or December 31, 2005, we estimate that the fair value of ourinvestment portfolio would decline by an immaterial amount. We have the abilityto hold our fixed income investments until maturity, and therefore we do notexpect our operating results or cash flows to be affected to any significantdegree by the effect of a change in market interest rates on our investments.

56

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**INDEXTO FINANCIAL STATEMENTS**

|                                                                                                     | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                            |       |     | 58         |   |   |
| Financial Statements:                                                                               |       |     |       |   |   |
| Balance Sheets as of December 31, 2006 and 2005                                                |       |     | 59         |   |   |
| Statements of Operations for the Years Ended  December 31, 2006, 2005, and 2004                |       |     | 60         |   |   |
| Statements of Stockholders’ Equity for the Years Ended  December 31, 2006, 2005, and 2004 |       |     | 61         |   |   |
| Statements  of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004                |       |     | 64         |   |   |
| Notes  to Financial Statements                                                                      |       |     | 65         |   |   |

 

57

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersNitroMed, Inc.

We have audited the accompanying balance sheets ofNitroMed, Inc. as of December 31, 2006 and 2005, and the relatedstatements of operations, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2006. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofNitroMed, Inc. at December 31, 2006 and 2005, and the results of itsoperations and its cash flows for each of the three years in the period ended December 31,2006, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of NitroMed, Inc.’s internal control over financialreporting as of December 31, 2006, based on criteria established inInternal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 6,2007, expressed an unqualified opinion thereon.

As discussed in Note 2 andNote 8 of the financial statements, effective January 1, 2006, the Companyadopted Statement of Financial Accounting Standards No. 123 (R), *Share-Based Payment*, using the modified-prospectivetransition method. 

|  | /s/ Ernst & Young LLP |
|--|--------------------------------|

 

Boston, MassachusettsMarch 6, 2007

58

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**NITROMED, INC.BALANCE SHEETS(in thousands, except par value amounts)**

| ** **                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                           |       |                  |       |   |   |
| Current Assets:                                                                                                                                                      |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                           |       | $                     | 21,074     |   | $ | 11,091 |   |
| Marketable  securities                                                                                                                                               |       | 21,079                |       | 50,450 |   |
| Accounts  receivable                                                                                                                                                 |       | 1,370                 |       | 4,078 |   |
| Inventories                                                                                                                                                          |       | 2,846                 |       | 3,247 |   |
| Prepaid expenses  and other current assets                                                                                                                           |       | 570                   |       | 3,860 |   |
| Total current assets                                                                                                                                                 |       | 46,939                |       | 72,726 |   |
| Property and  equipment, net                                                                                                                                         |       | 963                   |       | 2,992 |   |
| Restricted cash                                                                                                                                                      |       | 803                   |       | 803 |   |
| Total assets                                                                                                                                                         |       | $                     | 48,705     |   | $ | 76,521 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                  |       |   |   |
| Current Liabilities:                                                                                                                                                 |       |                  |       |   |   |
| Accounts payable                                                                                                                                                     |       | $                     | 1,923      |   | $ | 11,810 |   |
| Accrued expenses                                                                                                                                                     |       | 6,545                 |       | 11,269 |   |
| Accrued  restructuring                                                                                                                                               |       | 299                   |       | — |   |
| Deferred revenue                                                                                                                                                     |       | 206                   |       | 3,451 |   |
| Current portion  of long-term debt                                                                                                                                   |       | 6,925                 |       | 6,272 |   |
| Total current liabilities                                                                                                                                            |       | 15,898                |       | 32,802 |   |
| Long-term debt                                                                                                                                                       |       | 3,728                 |       | 10,653 |   |
| Commitments and  contingencies (Note 12)                                                                                                                             |       |                  |       |   |   |
| Stockholders’ Equity:                                                                                                                                           |       |                  |       |   |   |
| Preferred stock,  $0.01 par value; 5,000 shares authorized; no shares issued or outstanding                                                                          |       | —                |       | — |   |
| Common stock,  $.01 par value; 65,000 shares authorized; 37,181 shares and 30,512 shares  issued and outstanding as of December 31, 2006 and 2005, respectively |       | 372                   |       | 305 |   |
| Additional paid-in  capital                                                                                                                                          |       | 342,528               |       | 276,510 |   |
| Deferred stock  compensation                                                                                                                                         |       | —                |       | (1,208 | ) |
| Accumulated  deficit                                                                                                                                                 |       | (313,808              | )          | (242,471 | ) |
| Accumulated other  comprehensive loss                                                                                                                                |       | (13                   | )          | (70 | ) |
| Total stockholders’ equity                                                                                                                                      |       | 29,079                |       | 33,066 |   |
| Total liabilities  and stockholders’ equity                                                                                                                     |       | $                     | 48,705     |   | $ | 76,521 |   |

 

The accompanying notes are an integral part of the financial statements.

59

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**NITROMED, INC.STATEMENTS OF OPERATIONS(in thousands, except per share amounts)**

| ** **                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                      |       |                                       |       |   |   |   |   |
| Product sales                                                  |       | $                                          | 12,086     |   | $ | 4,455 |   | $ | — |   |
| Research and development                                       |       | —                                     |       | 1,592 |   | 16,458 |   |
| Total revenues                                                 |       | 12,086                                     |       | 6,047 |   | 16,458 |   |
| Cost and operating  expenses:                                  |       |                                       |       |   |   |   |   |
| Cost of product sales                                          |       | 3,560                                      |       | 8,009 |   | — |   |
| Research and development(1)                                    |       | 17,029                                     |       | 31,340 |   | 27,401 |   |
| Sales, general and administrative(1)                           |       | 59,403                                     |       | 74,596 |   | 20,185 |   |
| Restructuring charges                                          |       | 5,283                                      |       | — |   | — |   |
| Total cost and operating expenses                              |       | 85,275                                     |       | 113,945 |   | 47,586 |   |
| Loss from  operations                                          |       | (73,189                                    | )          | (107,898 | ) | (31,128 | ) |
| Non-operating income:                                          |       |                                       |       |   |   |   |   |
| Interest expense                                               |       | (1,352                                     | )          | (930 | ) | (1 | ) |
| Interest income                                                |       | 3,204                                      |       | 2,976 |   | 1,336 |   |
| Rental and other income                                        |       | —                                     |       | — |   | 20 |   |
|                                                           |       | 1,852                                      |       | 2,046 |   | 1,355 |   |
| Net loss                                                       |       | (71,337                                    | )          | (105,852 | ) | (29,773 | ) |
| Basic and diluted net loss per share                           |       | $                                          | (1.96      | ) | $ | (3.49 | ) | $ | (1.14 | ) |
| Shares used in  computing basic and diluted net loss per share |       | 36,399                                     |       | 30,355 |   | 26,152 |   |

----

(1)          Includes stock-basedcompensation expense as follows:

| Research and  development          |   | $ | 2,795 |   | $ | 298 |   | $ | 2,065 |   |
|------------------------------------|--------|---|-------|--------|---|-----|--------|---|-------|--------|
| Sales, general and  administrative |   | $ | 5,119 |   | $ | 195 |   | $ | 457   |   |

 

The accompanying notes are an integral part of the financial statements.

60

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**NITROMED, INC.**

**STATEMENTSOF STOCKHOLDERS’ EQUITY**

**(in thousands)**

| ** **                                                                                                        | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | ** **      | ** ** | **Accumulated**        | ** ** | ** **             | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                        | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Deferred** | ** ** | ** **       | ** ** | **Other**       | ** ** | **Total**              | ** ** |
| ** **                                                                                                        | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-in**  | ** ** | **Stock**        | ** ** | **Accumulated** | ** ** | **Comprehensive**      | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                        | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital**  | ** ** | **Compensation** | ** ** | **Deficit**     | ** ** | **Income (Loss)** | ** ** | **Equity**             | ** ** |
| Balance at December 31, 2003                                                                                 |       | 25,601                |       |           | $          | 256          |       |             |       | $               | 191,604    |                   |       |                   | $          | (3,240 | ) |   |   | $ | (106,846 | ) |   |   | $ | 25 |   |   |   | $ | 81,799 |   |   |
| Exercise of stock options                                                                                         |       | 676                   |       |           | 7          |         |       |             | 871        |            |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   | 878 |   |   |
| Exercise of warrants                                                                                              |       | 237                   |       |           | 2          |         |       |             | (2         | )               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Amortization of deferred stock compensation                                                                       |       |                  |       |           |       |         |       |             |       |            |       |                   | 982        |                   |       |   |   |   |   |   |   |   |   |   | 982 |   |   |
| Compensation expense associated with options issued  to non-employees and performance options issued to employees |       |                  |       |           |       |         |       |             | 1,540      |            |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   | 1,540 |   |   |
| Issuance of stock under employee stock purchase plan                                                              |       | 30                    |       |           | —     |         |       |             | 155        |            |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   | 155 |   |   |
| Issuance of common stock from public offering (net of  issuance costs of $5,796)                                  |       | 3,580                 |       |           | 36         |         |       |             | 81,722     |            |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   | 81,758 |   |   |
| Cancellation of compensatory stock options                                                                        |       |                  |       |           |       |         |       |             | (163       | )               |       |                   | 163        |                   |       |   |   |   |   |   |   |   |   |   | — |   |   |
| Unrealized losses on marketable securities                                                                        |       |                  |       |           |       |         |       |             |       |            |       |                   |       |                   |       |   |   |   |   |   | (327 | ) |   |   | (327 | ) |   |
| Net loss                                                                                                          |       |                  |       |           |       |         |       |             |       |            |       |                   |       |                   |       |   | (29,773 | ) |   |   |   |   |   |   | (29,773 | ) |   |
| Comprehensive loss.                                                                                               |       |                  |       |           |       |         |       |             |       |            |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   | (30,100 | ) |   |
| Balance at  December 31, 2004                                                                                |       | 30,124                |       |           | $          | 301          |       |             |       | $               | 275,727    |                   |       |                   | $          | (2,095 | ) |   |   | $ | (136,619 | ) |   |   | $ | (302 | ) |   |   | $ | 137,012 |   |   |

 

The accompanyingnotes are an integral part of the financial statements.

61

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**NITROMED, INC.**

**STATEMENTSOF STOCKHOLDERS’ EQUITY**

**(in thousands)**
|                                                                                                                                | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | **Accumulated** | ** **        | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|------------------|-----------------|-------------------|------------|------------|
|                                                                                                                                | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | **Other**       | ** **        | ** ** | ** ** |
| ** **                                                                                                                     | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Deferred** | ** ** | ** **       | ** **      | **Comprehensive** | ** ** | **Total**  | ** ** |
| ** **                                                                                                                     | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-in**  | ** ** | **Stock**        | ** **      | **Accumulated**   | ** ** | **Income** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                                     | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital**  | ** ** | **Compensation** | ** **      | **Deficit**       | ** ** | **(Loss)** | ** ** | **Equity** | ** ** |
| Balance at  December 31, 2004                                                                                             |       |                  | 30,124     |           |       |         | $          | 301              |            |              |       | $          | 275,727 |   |   |   | $ | (2,095 | ) |   |   | $ | (136,619 | ) |   |   | $ | (302 | ) |   |   | $ | 137,012 |   |   |
| Exercise of stock  options                                                                                                     |       |                  | 339        |           |       |         | 3          |             |            |              | 653        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 656 |   |   |
| Exercise of  warrants                                                                                                          |       |                  | 12         |           |       |         | —     |             |            |              | 1          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1 |   |   |
| Amortization of  deferred stock compensation                                                                                   |       |                  |       |           |       |         |       |             |            |              |       |       |   |   | 887 |   |   |   |   |   |   |   |   |   |   |   | 887 |   |   |
| Reversal of  compensation expense associated with options issued to non-employees and  performance options issued to employees |       |                  |       |           |       |         |       |             |            |              | (394       | )          |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (394 | ) |   |
| Issuance of stock  under employee stock purchase plan                                                                          |       |                  | 37         |           |       |         | 1          |             |            |              | 523        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 524 |   |   |
| Unrealized gains  on marketable securities                                                                                     |       |                  |       |           |       |         |       |             |            |              |       |       |   |   |   |   |   |   |   |   |   |   | 232 |   |   |   | 232 |   |   |
| Net loss                                                                                                                       |       |                  |       |           |       |         |       |             |            |              |       |       |   |   |   |   |   |   | (105,852 | ) |   |   |   |   |   |   | (105,852 | ) |   |
| Comprehensive  loss.                                                                                                           |       |                  |       |           |       |         |       |             |            |              |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (105,620 | ) |   |
| Balance at  December 31, 2005                                                                                             |       |                  | 30,512     |           |       |         | $          | 305              |            |              |       | $          | 276,510 |   |   |   | $ | (1,208 | ) |   |   | $ | (242,471 | ) |   |   | $ | (70 | ) |   |   | $ | 33,066 |   |   |

 

The accompanyingnotes are an integral part of the financial statements.

62

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**NITROMED, INC.**

**STATEMENTS OF STOCKHOLDERS’ EQUITY**

**(inthousands)**

| ** **                                                                               | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                               | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | **Other**         | ** ** | ** ** | ** ** |
|                                                                                          | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Deferred** | ** ** | ** **       | ** ** | **Comprehensive** | ** ** | **Total**  | ** ** |
| ** **                                                                               | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-in**  | ** ** | **Stock**        | ** ** | **Accumulated**   | ** ** | **Income** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                               | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital**  | ** ** | **Compensation** | ** ** | **Deficit**       | ** ** | **(Loss)** | ** ** | **Equity** | ** ** |
| Balance at December 31, 2005                                                        |       |                  | 30,512     |           |       |         | $          | 305              |       |              |       | $          | 276,510    |   |   |   | $ | (1,208 | ) |   |   | $ | (242,471 | ) |   |   | $ | (70 | ) |   |   | $ | 33,066 |   |   |
| Elimination of deferred stock compensation in  accordance with the adoption of SFAS 123R |       |                  |       |           |       |         |       |             |       |              | (1,208     | )          |       |   | 1,208 |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Exercise of stock options                                                                |       |                  | 461        |           |       |         | 5          |             |       |              | 688        |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 693 |   |   |
| Compensation expense associated with options issued  to employees                        |       |                  |       |           |       |         |       |             |       |              | 8,042      |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 8,042 |   |   |
| Reversal of compensation expense associated with  options issued to non-employees        |       |                  |       |           |       |         |       |             |       |              | (239       | )          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (239 | ) |   |
| Issuance of stock under employee stock purchase plan                                     |       |                  | 32         |           |       |         | —     |             |       |              | 93         |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 93 |   |   |
| Issuance of stock in connection with employee benefit  plan                              |       |                  | 78         |           |       |         | 1          |             |       |              | 198        |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 199 |   |   |
| Issuance of common stock from public offering (net of  issuance costs of $4,056)         |       |                  | 6,098      |           |       |         | 61         |             |       |              | 58,444     |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 58,505 |   |   |
| Unrealized gains on marketable securities                                                |       |                  |       |           |       |         |       |             |       |              |       |       |       |   |   |   |   |   |   |   |   |   | 57 |   |   |   | 57 |   |   |
| Net loss                                                                                 |       |                  |       |           |       |         |       |             |       |              |       |       |       |   |   |   |   |   | (71,337 | ) |   |   |   |   |   |   | (71,337 | ) |   |
| Comprehensive loss.                                                                      |       |                  |       |           |       |         |       |             |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (71,280 | ) |   |
| Balance at  December 31, 2006                                                       |       |                  | 37,181     |           |       |         | $          | 372              |       |              |       | $          | 342,528    |   |   |   | $ | — |   |   |   | $ | (313,808 | ) |   |   | $ | (13 | ) |   |   | $ | 29,079 |   |   |

 

The accompanyingnotes are an integral part of the financial statements.

63

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**NITROMED, INC.STATEMENTS OF CASH FLOWS(in thousands)**

| ** **                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                       |       |                                       |       |   |   |   |   |
| Net loss                                                                     |       | $                                          | (71,337    | ) | $ | (105,852 | ) | $ | (29,773 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                |       | 798                                        |       | 896 |   | 421 |   |
| Stock-based compensation expense                                             |       | 7,914                                      |       | 493 |   | 2,522 |   |
| Non-cash restructuring charges.                                              |       | 1,342                                      |       | — |   | — |   |
| Changes in  operating assets and liabilities:                                |       |                                       |       |   |   |   |   |
| Accounts receivable                                                          |       | 1,236                                      |       | (4,078 | ) | — |   |
| Inventories                                                                  |       | 401                                        |       | (3,247 | ) | — |   |
| Prepaid expenses and other current assets                                    |       | 3,290                                      |       | (644 | ) | (1,920 | ) |
| Deferred revenue                                                             |       | (1,773                                     | )          | 1,859 |   | (12,858 | ) |
| Accounts payable                                                             |       | (9,887                                     | )          | 9,148 |   | 1,830 |   |
| Accrued expenses                                                             |       | (4,636                                     | )          | 3,178 |   | 6,024 |   |
| Accrued restructuring charge                                                 |       | 299                                        |       | — |   | — |   |
| Net cash used in operating activities                                        |       | (72,353                                    | )          | (98,247 | ) | (33,754 | ) |
| Cash flows from  investing activities:                                       |       |                                       |       |   |   |   |   |
| Purchases of property and equipment                                          |       | (111                                       | )          | (925 | ) | (2,698 | ) |
| Purchases of marketable securities                                           |       | (150,092                                   | )          | (126,159 | ) | (131,410 | ) |
| Sales of marketable securities                                               |       | 179,520                                    |       | 182,426 |   | 54,072 |   |
| Restricted cash                                                              |       | —                                     |       | 8 |   | (711 | ) |
| Net cash provided by (used in) investing activities                          |       | 29,317                                     |       | 55,350 |   | (80,747 | ) |
| Cash flows from  financing activities:                                       |       |                                       |       |   |   |   |   |
| Proceeds from sale of common stock                                           |       | 58,505                                     |       | — |   | 81,758 |   |
| Proceeds from long-term debt                                                 |       | —                                     |       | 20,000 |   | — |   |
| Principal payments on long-term debt                                         |       | (6,272                                     | )          | (3,075 | ) | — |   |
| Proceeds from employee stock plans                                           |       | 786                                        |       | 1,181 |   | 1,033 |   |
| Principal payments on notes payable                                          |       | —                                     |       | — |   | (22 | ) |
| Net cash provided by financing activities                                    |       | 53,019                                     |       | 18,106 |   | 82,769 |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | 9,983                                      |       | (24,791 | ) | (31,732 | ) |
| Cash and cash  equivalents, beginning balance                                |       | 11,091                                     |       | 35,882 |   | 67,614 |   |
| Cash and cash  equivalents, ending balance                                   |       | $                                          | 21,074     |   | $ | 11,091 |   | $ | 35,882 |   |
| Supplemental  disclosure:                                                    |       |                                       |       |   |   |   |   |
| Cash paid during the  year for interest                                      |       | $                                          | 1,403      |   | $ | 790 |   | $ | 1 |   |

 

The accompanying notes are an integral part of the financial statements.

64

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (all tabular amounts in thousands except per share amounts)**

**1. The Company**

NitroMed, Inc. (the “Company”) is an emergingpharmaceutical company with substantial expertise and intellectual property innitric oxide-based drug development. The Company has devoted substantially allof its efforts towards the research and development of its product candidatesand the commercialization of its currently marketed product, BiDil®. Since its inception, theCompany has funded its operations mainly through the sale of equity securities,debt financings, license fees, research and development funding, milestonepayments from its collaborative partners and, more recently, sales of BiDil. InJune 2005, the U.S. Food and Drug Administration (“FDA”) approved theCompany’s product, BiDil, for the treatment of heart failure in self-identifiedblack patients as an adjunct to current standard therapies. BiDil is an orallyadministered fixed-dose combination of isosorbide dinitrate and hydralazinehydrochloride. The Company commercially launched BiDil in July 2005, andhas since generated approximately $16.5 million in product sales, includingproduct sales of $3.5 million during the fourth quarter of 2006, and totalproduct sales of $12.1 million during the year ended December 31, 2006.

The Company has used and will continue to require substantialfunds to manufacture, market and sell BiDil during 2007 and beyond. The Companyalso expects to incur additional expenses related to the ongoing development ofan extended release formulation of BiDil, called BiDil XRTM, for which theCompany has recently commenced clinical development. The Company believes thatits existing sources of liquidity and cash expected to be generated from futureoperations will be sufficient to fund the current business plan for at least thenext twelve months.

The Company will requireadditional funding in the future and may seek to do so through collaborativeco-promotion arrangements and/or public or private financings. If the Companyis unable to obtain funding on a timely basis, the Company may be requiredto significantly curtail certain of its sales and marketing efforts, and itsdevelopment efforts with respect to BiDil XR, and the Company may be requiredto limit, scale back or cease its operations. The Company could be required toseek funds through arrangements with collaborators or others thatmay require the Company to relinquish rights to some of its technologies,product candidates or products.

**2. Summary of SignificantAccounting Policies**

**Cash Equivalentsand Marketable Securities**

Cash equivalents areshort-term, highly liquid investments with maturities of three months or lessat the time of acquisition. Investments with maturities in excess of threemonths at the time of acquisition are classified as marketable securities and designatedas available-for-sale. Cash equivalents consist of institutional money marketfunds. Available-for-sale securities are carried at fair market value, asreported by the custodian, and unrealized gains and losses are reported as aseparate component of accumulated other comprehensive loss within stockholders’equity. Realized gains and losses were not material for the years ended December 31,2006, 2005 and 2004.

**Fair Value ofFinancial Instruments**

Financial instrumentsmainly consist of cash and cash equivalents, marketable securities andlong-term debt. The carrying amounts of these cash and cash equivalents, andmarketable securities approximate their fair values. The fair value oflong-term debt is $9.3 million.

65

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2.Summary of Significant Accounting Policies (Continued)**

**Research andDevelopment Expenses**

Research and development expenses primarily consist ofsalaries and related expenses for research and development personnel, fees paidto consultants and outside service providers, materials used in clinical trialsand research and development, and medical support costs related to the launchand commercialization of BiDil. The Company charges research and developmentexpenses, including costs associated with acquiring patents, to operations asincurred.

The Company enters intocontracts with professional service providers to conduct clinical trials andrelated services. These professional service providers render services over anextended period of time, generally one to three years. Typically, the Companyenters into two types of vendor contracts, patient-based or time-based.Under a patient-based contract, the Company first determines anappropriate per patient cost using critical factors contained within thecontract, which include the estimated number of patients, the cost assigned toeach patient based on a patient’s number of visits and the total dollar valueof the contract. The Company then records expense based upon the total numberof patients enrolled during the period and the status of each patient. Under atime-based contract, using critical factors contained within the contract suchas the stated duration of the contract and the timing of services provided, theCompany records the contractual expense for each service provided ratably overthe period during which the Company estimates the service will be performed. Ona monthly basis, the Company reviews both the timetable of services to berendered and the timing of services actually received based on regularcommunications with its vendors in order to gauge the reasonableness of itsestimates. Based upon this review, revisions may be made to the forecastedtimetable or the extent of services performed, or both, in order to reflect theCompany’s most current estimate of the contract.

**Revenue Recognition**

The Company’s principal source of revenue is the saleof BiDil, which began shipping in July of 2005. Other sources of revenueto date include license fees, research and development payments and milestonepayments that the Company has received from our corporate collaborators.

*ProductSales/Deferred Revenue.*   The Company follows theprovisions of Staff Accounting Bulletin No. 104, *RevenueRecognition,* and recognizes revenue from product sales upon deliveryof product to wholesalers or pharmacies, when persuasive evidence of anarrangement exists, the fee is fixed or determinable, title to product andassociated risk of loss has passed to the wholesaler and collectibility of therelated receivable is reasonably assured. All revenues from product sales arerecorded net of applicable allowances for sales returns, wholesaler allowances,rebates, and discounts. For arrangements where the risk of loss has not passedto wholesalers or pharmacies, the Company defers the recognition of revenue byrecording deferred revenue until such time that risk of loss has passed. Inaddition, the Company evaluates its level of shipments to wholesalers andpharmacies on a quarterly basis compared to the estimated level of inventory inthe channel, remaining shelf-life of the product shipped and quarterlyforecasted sales. As a result of this evaluation, the Company deferred $2.1million of revenue from the December 2005 shipments and recorded thisamount in deferred revenue as of December 31, 2005. During 2006, theCompany reversed $1.8 million of this deferred revenue and recognized theremainder as revenue.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2.Summary of Significant Accounting Policies (Continued)**

*Sales Returns, Allowances,Rebates and Discounts.**  *The Company’s productsales are subject to returns, wholesaler allowances, rebates and cash andcontract discounts that are customary in the pharmaceutical industry. A largeportion of the Company’s product sales are made to pharmaceutical wholesalersfor further distribution through pharmacies to patients, who are consumers ofthe product. All revenues from product sales are recorded net of applicableallowances for sales returns, wholesaler allowances, rebates and discounts. TheCompany determines its provisions for sales returns, allowances, rebates anddiscounts based primarily on estimates and contractual terms. In developing areasonable estimate for the reserve for product returns, the Company considersthe factors in paragraph 8 of SFAS 48, *Revenue Recognition When aRight of Return Exists*. Although the Company has not yet developed asignificant history of product returns because of the recent launch of BiDil,the Company believes it has developed a reasonable estimate of returns based onactual return data compared to product shipped. The Company will continue tomonitor actual returns as it gains more sales experience with BiDil.

*Product Returns.**  *Consistent with industry practice, the Company offerscontractual return rights that allow customers to return product only duringthe period that is six months prior to, and twelve months after productexpiration. Commercial product shipped during 2005 had a shelf-life of twelvemonths from date of manufacture with expiration dates ranging from April 2006to November 2006. During the third quarter of 2006, the Company beganshipping commercial product with an expiration date of 18 months. Factors thatare considered in the Company’s estimate of future product returns include ananalysis of the amount of product in the wholesaler and pharmacy channels,discussions with key wholesalers and other customers regarding inventory levelsand shipment trends, review of consumer consumption data as reported by SourceProjected Launchtrac provided by Wolters Kluwer Health, and the remaining timeto expiration of the Company’s product. As a result of this ongoing evaluation,the Company’s product return reserve was $1.3 million at December 31, 2006and $0.1 million at December 31, 2005. This reserve is evaluated on aquarterly basis, assessing each of the factors described above, and adjustedaccordingly. Based on the factors noted above, the Company believes its estimateof product returns is reasonable, and changes, if any, from this estimate wouldnot have a material impact to the Company’s financial statements. During thefirst quarter of 2007 BiDil’s shelf life was increased to 24 months.

*Initial Trade Shipments Incentive.**  *During July of 2005, the Company offered certainproduct stocking incentives to a number of wholesalers and pharmacy customers.These incentives included units with guaranteed sales provisions and extendedpayment terms. As a result of these provisions, the Company concluded thatthese sales were essentially consignment sales as the risk of loss of thisproduct had not passed to the customer. Accordingly, the Company deferred allrevenue related to this product until such time as the product is provided to apatient with a prescription. As of December 31, 2005, the remainingbalance of deferred revenue related to this product was $1.2 million. Through December 31,2006, the Company had either recognized the revenue related to these units, orthe product had been returned or estimated to be returned.

*Cash Incentives.**  *During the third quarter of 2005, the Company offeredcertain additional incentives to a number of pharmacy customers. These cashincentives included placement and advertising assistance 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2. Summaryof Significant Accounting Policies (Continued)**

in the amount of $328,000.The Company recorded this amount as a reduction to revenue during the yearended December 31, 2005. The Company did not offer cash incentives duringthe twelve month period ended December 31, 2006.

*SampleVoucher and Co-Pay Card Program.**  *Beginningin the third quarter of 2005, the Company initiated a sample voucher programwhereby the Company offered an incentive to patients in the form of a free 30-daytrial, or approximately 100 tablets, of BiDil. The Company accounted for thisprogram in accordance with Emerging Issues Task Force Issue No. 01-09,*Accounting for Consideration Given by a Vendor to aCustomer* (“EITF No. 01-09”). These sample programs havehistorically had quarterly expiration dates such that each sample voucherprogram is only active for one quarter at a time. As a result, at the end ofeach quarter the Company can determine the actual amount of reimbursementclaims received for the vouchers distributed during the quarter. The amount ofreimbursement is recorded as a reduction to revenue. During the third quarter2006, the Company initiated a six month co-pay program. As a result of theseprograms, the Company recorded a reduction to revenue of $0.5 million and $0.8million for the years ended December 31, 2006 and 2005, respectively. TheCompany expects to continue to offer co-pay incentives in future periods.

*SalesDiscounts, Rebates and Allowances.**  *Salesdiscounts, rebates and allowances result primarily from sales under contractwith healthcare providers, wholesalers, Medicare and Medicaid programs andother governmental agencies. The Company estimates rebates and contractualallowances, cash and contract discounts and other rebates by considering thefollowing factors: current contract prices and terms, sales volume, and currentactual average rebate rates. For the years ended December 31, 2006 and December 31,2005, the Company recorded cash discounts, rebates and other allowances of $1.5million and $0.5 million, respectively.

*Collaboration Revenue.**  *The Company records collaborationrevenue on an accrual basis as it is earned and when amounts are consideredcollectible. Revenues received in advance of performance obligations or incases where the Company has a continuing obligation to perform services, aredeferred and recognized over the contractual or estimated performance period.Revenues from milestone payments that represent the culmination of a separateearnings process are recorded when the milestone is achieved. Contract revenuesare recorded as the services are performed. When the Company is required todefer revenue, the period over which such revenue should be recognized issubject to estimates by management and may change over the course of thecollaborative agreement. The Company had no collaboration revenue during theyear ended December 31, 2006.

**Accounts Receivable**

Accounts receivableconsists of amounts due from wholesalers and pharmacies for the purchase ofBiDil. Ongoing evaluations of customers payment histories are performed and collateralis generally not required. As of December 31, 2006 and 2005, the Companyhas not reserved any amount for bad debts related to the sale of BiDil. TheCompany continuously reviews all customer accounts to determine if an allowancefor uncollectible accounts is necessary. The Company currently providessubstantially all of its customers with payment terms of net 30 days. Amountspast due from customers are determined based on contractual payment terms.Through December 31, 2006, payments have generally been made in a timelymanner.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2.Summary of Significant Accounting Policies (Continued)**

**Property and Equipment**

Property and equipment arerecorded at cost and depreciated using the straight-line method over theirestimated useful lives, which range between three to five years. Leaseholdimprovements are amortized based upon the lesser of the term of the lease orthe useful life of the asset. The Company reviews its property and equipmentfor impairment whenever events or changes in circumstances indicate that thecarrying amount of the assets may not be recoverable and recognizes animpairment loss when the estimated undiscounted cash flows are less than thecarrying value of the asset. The asset is written down to its fair value,determined by either a quoted market price or by a discounted cash flowtechnique, whichever is more appropriate under the circumstances. During 2006,the Company recorded impairment charges of $1.3 million (See Note 7).

**Inventories**

Inventories are stated atthe lower of cost or market, with cost determined on a first-in, first-outbasis. Inventories consisted of the following:

| ** **           | ** ** | **December 31,**   | ** ** |
|----------------------|------------|-------------------------|------------|
| ** **           | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **           | ** ** | **(in thousands)** | ** ** |
| Raw materials        |       | $                       | 2,123      |   | $ | 2,599 |   |
| Finished goods       |       | 723                     |       | 481 |   |
| Consigned  inventory |       | —                  |       | 167 |   |
| Total                |       | $                       | 2,846      |   | $ | 3,247 |   |

 

On a quarterly basis, theCompany analyzes its current inventory levels and future irrevocable inventorypurchase commitments and writes down inventory that has become un-saleable, orhas a cost basis in excess of its expected net realizable value. In addition,the Company evaluates its future irrevocable inventory purchase commitmentscompared to forecasted product sales, the current level of inventory, and itsrelated product dating. For the year ended December 31, 2006, the Companyrecorded inventory impairment charges of $1.1 million to cost of sales relatedto commercial trade and patient sample inventory product, and a $0.4 millioncharge to cost of sales for contractual purchase commitments in excess ofexpected future inventory requirements based on the Company’s sales forecast.For the year ended December 31, 2005, the Company recorded an inventoryimpairment charge of $5.6 million to cost of sales related to commercial tradeand patient sample inventory product, and a $1.5 million charge to cost ofsales for contractual purchase commitments in excess of expected futureinventory requirements based on the Company’s sales forecast. At December 31,2006, BiDil had an eighteen month shelf life. During the first quarter of 2007,BiDil’s shelf life for newly produced finished goods was increased to 24 months.

**Net Loss Per Share**

Basic net loss per shareis computed by dividing net loss  by theweighted average number of shares of common stock outstanding during theperiod. Diluted net loss per share is computed by dividing net loss by theweighted average number of shares of common stock and the dilutive potentialcommon stock equivalents then outstanding. Potential common stock equivalentsconsist of stock options and warrants. 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2.Summary of Significant Accounting Policies (Continued)**

Since the Company has anet loss for all periods presented, the effect of all potentially dilutivesecurities is antidilutive. Accordingly, basic and diluted net loss per shareis the same.

Options to purchase 4,935,930,3,819,676 and 3,246,631 shares of common stock for the years ended December 31,2006, 2005 and 2004, respectively, and warrants to purchase -0-,1,319 and 13,861 shares of common stock for the years ended December 31,2006, 2005 and 2004, respectively, have been excluded from the computation ofnet loss per share as their effects would have been antidilutive.

**Concentration ofCredit Risk**

SFAS No. 105, *Disclosure of Informationabout Financial Instruments with Off-Balance-Sheet Risk and Financial Instrumentswith Concentrations of Credit Risk*, requires disclosure of anysignificant off-balance-sheet and credit risk concentrations. Financialinstruments that potentially subject the Company to concentration of creditrisk consists principally of marketable securities and trade accountsreceivable. The Company has no off-balance-sheet or concentrations of creditrisk such as foreign exchange contracts, options contracts or other  hedging arrangements. The Company maintainsits cash and cash equivalents and marketable securities balances with severalhigh credit quality financial institutions.

The following tablesummarizes the number of trade customers that individually comprise greaterthan 10% of total revenues and their respective percentage of the Company’stotal product revenues. This table excludes revenues from collaborationagreements. The Company recognized revenue in 2005 and 2004 from twocollaborative partners:

| ** **              | ** ** | **Number of  Significant  Customers** | ** ** | **Percentage of Total  Product Revenues  by Customer** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **Year ended:**    | ** ** | ** **                                 | ** ** | **A**                                                                      | ** ** | **B** | ** ** | **C** | ** ** |
| December 31,  2006 |       |                                       | 3          |                                                                       |       | 34 | % | 36 | % | 18 | % |
| December 31, 2005  |       |                                       | 3          |                                                                       |       | 44 | % | 21 | % | 14 | % |

 

The following tablesummarizes the number of customers that individually comprise greater than 10%of total accounts receivable and their respective percentage of the Company’stotal accounts receivable:

| ** **              | ** ** | **Number of  Significant  Customers** | ** ** | **Percentage of Total  Accounts Receivables  by Customer** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| **As of:**         | ** ** | ** **                                 | ** ** | **A**                                                                          | ** ** | **B** | ** ** | **C** | ** ** |
| December 31,  2006 |       |                                       | 3          |                                                                           |       | 37 | % | 30 | % | 16 | % |
| December 31, 2005  |       |                                       | 2          |                                                                           |       | 21 | % | 59 | % | — | % |

 

**Concentration of Other Risks**

The Company currentlyobtains one of the key active pharmaceutical ingredients for its commercialrequirements for BiDil from a single source. The Company also utilizes onemanufacturer to produce BiDil. The disruption or termination of the contractwith the manufacturer of BiDil or of the supply of the commercial requirementfor BiDil or a significant increase in the cost of the key activepharmaceutical 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2.Summary of Significant Accounting Policies (Continued)**

ingredientfrom this single source could have a material adverse effect on the Company’sbusiness, financial position and results of operations.

**Advertising Costs**

All advertising costs areexpensed as incurred. Advertising expenses were $12.8 million, $20.1 millionand $2.0 million for the years ended December 31, 2006, 2005 and 2004,respectively.

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period. Such estimates relate to allowances for accounts receivable,product returns rates, contract rebates, the net realizable value of inventory,useful lives of fixed assets, accrued liabilities, and stock-basedcompensation. Actual results could differ from those estimates, and suchdifferences may be material to the financial statements.

**Accumulated Other Comprehensive Income (Loss)**

The Company presentscomprehensive income (loss) in accordance with SFAS No. 130, *Reporting Comprehensive Income*. Accumulated othercomprehensive income is comprised entirely of unrealized gains and losses onavailable-for-sale marketable securities.

**Income Taxes**

Deferred tax assets andliabilities are determined based on differences between the financial reportingand income tax basis of assets and liabilities, as well as net operating losscarryforwards and tax credits, and are measured using the enacted tax rates andlaws that will be in effect when the differences are expected to reverse.Deferred tax assets are reduced by a valuation allowance to reflect theuncertainty associated with their ultimate realization.

**Segment Information**

During the three yearsended December 31, 2006, 2005 and 2004, the Company operated in onereportable business segment, developing nitric oxide enhancing medicines, underthe management approach of SFAS No. 131, *Disclosuresabout Segments of an Enterprise and Related Information.*

**Stock-Based Compensation**

On December 16, 2004,the Financial Accounting Standards Board issued SFAS No. 123 (revised2004) (“SFAS 123R”), *Share-Based Payment*,which is a revision of SFAS No. 123, *Accounting for**Stock-Based Compensation*. SFAS 123R supersedes APB 25 andamends SFAS No. 95*, Statement of Cash Flows*.Generally, the approach in SFAS 123R is similar to the approach described inSFAS 123. However, SFAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values at the date of grant. Pro forma disclosureis no longer an alternative.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**2.Summary of Significant Accounting Policies (Continued)**

On January 1, 2006, the Company adopted SFAS 123Rusing the modified prospective method as permitted under SFAS 123R. Under thistransition method, compensation cost recognized for the year ending December 31,2006 includes:  (a) compensationcost for all share-based payments granted prior to but not yet vested as of December 31,2005, based on the grant-date fair value estimated in accordance with theprovisions of SFAS 123, and (b) compensation cost for all share-basedpayments granted subsequent to December 31, 2005, based on the grant-datefair value estimated in accordance with the provisions of SFAS 123R. Inaccordance with the modified prospective method of adoption, the Company’sresults of operations and financial position for prior periods has not beenrestated.

See Note 8 for additionalinformation relating to stock-based compensation.

**New AccountingStandards**

In July 2006, the FASB issued FIN 48 “Accountingfor Uncertainty in Income Taxes” (“FIN 48”). This interpretation requiresthat the Company recognize in its financial statements the impact of a taxposition if that position is more likely than not of being sustained on audit,based on the technical merits of the position. The provisions of FIN 48are effective for fiscal years beginning after December 15, 2006(beginning with the Company’s 2007 fiscal year), with the cumulative effect ofthe change in accounting principle recorded as an adjustment to openingretained earnings. The Company does not believe the adoption of this standardwill have a material impact on its financial position or results of operations.

In September 2006, the SEC released StaffAccounting Bulletin No. 108, “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements” (“SAB 108”). SAB 108 provides interpretive guidance onthe SEC’s views regarding the process of quantifying materiality of financialstatement misstatements. SAB 108 is effective for fiscal years endingafter November 15, 2006 (beginning with the Company’s 2006 fiscal year).The adoption of SAB 108 did not have any impact on the Company’s resultsof operations or financial position.

In September 2006, the Financial AccountingStandards Board issued Statement of Financial Accounting StandardsNo. 157, *Fair Value Measurements*, or SFASNo. 157. SFAS No. 157 defines fair value, establishes a framework formeasuring fair value in accordance with generally accepted accountingprinciples and expands disclosures about fair value measurements. SFASNo. 157 codifies the definition of fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date, clarifies theprinciple that fair value should be based on the assumptions marketparticipants would use when pricing the asset or liability and establishes afair value hierarchy that prioritizes the information used to develop thoseassumptions. SFAS No. 157 is effective for fiscal years beginning after November 15,2007 and interim periods within those years. The Company does not currentlybelieve that adoption will have a material impact on its results of operations,financial position or cash flows.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**3. Cash Equivalents andMarketable Securities**

Thefollowing is a summary of the fair market value of available-for-sale moneymarket funds and marketable securities the Company held at December 31,2006 and 2005:

| **December 31, 2006** | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|---------------------------------|------------|------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| Cash and money  market funds    |       |       | $          | 21,074              |       |                         |       | $                             | —     |                       |       |   | $ | — |   |   |   | $ | 21,074 |   |   |
| U.S. Government agencies        |       |       |       |                |       |                         |       |                          |       |                       |       |   |   |   |   |   |   |
| Due in one year or less         |       |       | $          | —              |       |                         |       | $                             | —     |                       |       |   | $ | — |   |   |   | $ | — |   |   |
| Due in one to three years       |       |       | 1,000      |                |       |                         | —     |                          |       |                       | (13        | ) |   |   | 987 |   |   |
| Taxable auction  securities     |       |       | 18,400     |                |       |                         | —     |                          |       |                       | —     |   |   |   | 18,400 |   |   |
| Corporate securities            |       |       |       |                |       |                         |       |                          |       |                       |       |   |   |   |   |   |   |
| Due in one to three years       |       |       | 1,692      |                |       |                         | —     |                          |       |                       | —     |   |   |   | 1,692 |   |   |
| Total marketable  securities    |       |       | $          | 21,092              |       |                         |       | $                             | —     |                       |       |   | $ | (13 | ) |   |   | $ | 21,079 |   |   |

 

| **December 31, 2005** | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|---------------------------------|------------|------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| Cash and money  market funds    |       |       | $          | 11,091              |       |                         |       | $                             | —     |                       |       |   | $ | — |   |   |   | $ | 11,091 |   |   |
| U.S. Government agencies        |       |       |       |                |       |                         |       |                          |       |                       |       |   |   |   |   |   |   |
| Due in one year or less         |       |       | $          | 7,750               |       |                         |       | $                             | —     |                       |       |   | $ | (20 | ) |   |   | $ | 7,730 |   |   |
| Due in one to three years       |       |       | 1,000      |                |       |                         | —     |                          |       |                       | (17        | ) |   |   | 983 |   |   |
| Taxable auction  securities     |       |       | 32,725     |                |       |                         | —     |                          |       |                       | —     |   |   |   | 32,725 |   |   |
| Corporate securities            |       |       |       |                |       |                         |       |                          |       |                       |       |   |   |   |   |   |   |
| Due in one year or less         |       |       | 9,045      |                |       |                         | —     |                          |       |                       | (33        | ) |   |   | 9,012 |   |   |
| Total marketable  securities    |       |       | $          | 50,520              |       |                         |       | $                             | —     |                       |       |   | $ | (70 | ) |   |   | $ | 50,450 |   |   |

 

As of December 31,2006, taxable auction securities have maturity dates that range from 2007 to2045. Marketable securities with maturity dates in excess of one year areclassified as short term because they are available-for-sale securities and areavailable to be used in current operations.

**4. Property and Equipment**

Propertyand equipment consist of the following:

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Laboratory  furniture, fixtures and equipment   |       | $                     | 2,343      |   | $ | 3,033 |   |
| Office furniture,  fixtures and equipment       |       | 903                   |       | 1,514 |   |
| Leasehold  improvements                         |       | 221                   |       | 422 |   |
|                                            |       | 3,467                 |       | 4,969 |   |
| Less accumulated  depreciation and amortization |       | (2,504                | )          | (1,977 | ) |
| Total                                           |       | $                     | 963        |   | $ | 2,992 |   |

 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**4. Property and Equipment (Continued)**

On February 22, 2007, theCompany sold certain equipment previously used in research and developmentactivities and received proceeds in the amount of $528,000, which approximates theequipment’s net book value.

**5**. AccruedExpenses

Accruedexpenses consist of the following:

| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Clinical trial  and related costs   |       | $                     | 362        |   | $ | 1,250 |   |
| Sales and  marketing                |       | 817                   |       | 3,596 |   |
| Compensation, and  related benefits |       | 1,425                 |       | 1,446 |   |
| Contracted  purchase commitments    |       | 386                   |       | 1,468 |   |
| Returns reserves                    |       | 1,339                 |       | 99 |   |
| Other                               |       | 2,216                 |       | 3,410 |   |
| Total                               |       | $                     | 6,545      |   | $ | 11,269 |   |

 

**6**. Long-Term Debt

On June 28, 2005, the Company borrowed (i) $10.0million from Oxford Finance Corporation (“Oxford”), and (ii) $10.0 millionfrom General Electric Capital Corporation (“GECC”) pursuant to the terms ofPromissory Notes (“the Notes”). The Notes bear interest at a fixed rate of9.95% per annum and are payable in 36 consecutive monthly installments ofprincipal and accrued interest, beginning on July 1, 2005. Also on June 28,2005, the Company entered into Master Security Agreements with both Oxford andGECC (“the Agreements”). Under the terms of these Agreements, the Companygranted to both Oxford and GECC a security interest in and against all of theproperty of the Company and in and against all additions, attachments,accessories and accessions to such property, all substitutions, replacements orexchanges, and all insurance and/or other proceeds (“the Collateral”). TheCollateral comprises all of the Company’s personal property and fixturesincluding, but not limited to, all inventory, equipment, fixtures, accounts,deposit accounts, documents, investment property, instruments, generalintangibles, chattel paper and any and all proceeds (but excluding intellectualproperty). The Collateral does not include any intellectual property orproducts (or interests in any intellectual property or products (including anyroyalties)) acquired, whether by purchase, license or otherwise, on or afterthe execution of the Agreements (collectively, “New Property”), nor do theAgreements limit any indebtedness secured by any New Property provided thatdebt or non-cash equity (e.g., stock) is used to acquire NewProperty. In the event that the Company uses cash to purchase NewProperty, Oxford’s and GECC’s existing liens will extend to such NewProperty. The Agreements also contain a Material Adverse Change clause withboth Oxford and GECC. Under this clause, if Oxford or GECC reasonably determinethat the Company’s ability to repay the Notes has been materially impaired, theCompany would be considered in default. As of December 31, 2006, theCompany was in compliance with this clause.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**6.Long-Term Debt (Continued)**

The following schedulesets forth the principal payments due as of December 31, 2006:

| 2007  |   | $     | 6,925  |   |
|-------|--------|-------|--------|--------|
| 2008  |   | 3,728 |   |
| Total |   | $     | 10,653 |   |

 

**7**.Restructuring

In the first quarter of 2006, the Company recorded arestructuring charge of $2.0 million related to a restructuring of itsdiscovery research operations that was intended to better align costs withrevenue and operating expectations. The restructuring charges pertained toemployee severance and impairment of assets and were recorded in accordancewith Statement of Financial Accounting Standards No. 146,*Accounting for Costs Associated with Exit orDisposal Activities*(“SFAS146”)*,* and Statement ofFinancial Accounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*(“SFAS 144”)*.*

In connection with the restructuring plan, the Companyterminated 30 employees in its discovery research group, or approximately 30%of the Company’s workforce, resulting in a charge of $1.4 million, which wasaccrued as of March 31, 2006. None of these employees remained employed asof March 31, 2006.

As a result of terminating these employees, theCompany recorded an impairment charge for certain research laboratoryequipment, computer equipment, and furniture and fixtures aggregating $597,000,for which the future use was uncertain. These assets were written down to theirfair value utilizing a third party appraiser to estimate the fair value of theassets based on current market quotes and the current condition of theequipment, furniture and fixtures.

Thefollowing table summarizes the restructuring activity as of December 31,2006 as part of the March 31, 2006 restructuring plan:

| ** **           | ** ** | **Charge** | ** ** | **Cash Payments  and Write-offs** | ** ** | **Accrued at   December 31,  2006** | ** ** |
|----------------------|------------|------------|------------|---------------------------------------------|------------|----------------------------------------------------|------------|
| Workforce  reduction |       | $          | 1,441,000  |                                        |       | $                                                  | (1,371,000 | ) |   |   | $ | 70,000 |   |   |
| Impairment           |       | 597,000    |       |                                        | (597,000   | )                                                  |       |   | — |   |   |
| Total                |       | $          | 2,038,000  |                                        |       | $                                                  | (1,968,000 | ) |   |   | $ | 70,000 |   |   |

 

In the fourth quarter of 2006, the Company recorded arestructuring charge of $3.2 million comprised of severance benefits of $2.5million and impairment charges of $0.7 million for certain research anddevelopment equipment, leasehold improvements, furniture and fixtures, andcomputers. The restructuring charges were recorded in accordance with SFAS 146 and SFAS 144. The October 2006 restructuring program included theelimination of 120 sales personnel and 8 general and administrative andresearch and development personnel. None of these employees remained employedas of December 31, 2006. As a result of these terminations, the Company’sdecision to no longer pursue research and development internally, and theCompany’s decision to move to a smaller facility, certain 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**7.Restructuring (Continued)**

research and developmentequipment, leasehold improvements, furniture and fixtures, and computers becameimpaired. These assets were written down to the fair value based on either athird-party quote, or the estimated discounted cash flows they will generateover the estimated remaining economic life to the Company.

Thefollowing table summarizes the restructuring activity as of December 31,2006 as part of the October 2006 restructuring plan:

| ** **           | ** ** | **Charge** | ** ** | **Cash Payments  and Write-offs** | ** ** | **Accrued at   December 31, 2006** | ** ** |
|----------------------|------------|------------|------------|---------------------------------------------|------------|--------------------------------------------------------|------------|
| Workforce  reduction |       | $          | 2,500,000  |                                        |       | $                                                      | (2,271,000 | ) |   |   | $ | 229,000 |   |   |
| Impairment           |       | 745,000    |       |                                        | (745,000   | )                                                      |       |   | — |   |   |
| Total                |       | $          | 3,245,000  |                                        |       | $                                                      | (3,016,000 | ) |   |   | $ | 229,000 |   |   |

 

**8**.Stockholders’ Equity

**Stockholders’Equity**

*Public Offering*

On January 2006, theCompany completed a direct offering of shares of its common stock previouslyregistered under its effective shelf registration statement, which was filedwith the Securities and Exchange Commission, or the SEC, in August 2005.Pursuant to this offering, the Company sold approximately 6.1 million shares ofits common stock to selected institutional investors at a price of $10.25 pershare. Proceeds to the Company from this offering, net of offering expenses andplacement agency fees, totaled approximately $58.5 million.

**Stock PurchaseWarrants**

**At December 31,2005 and 2004, there were stock purchase warrants outstanding to purchase 1,319and 13,861 shares of common stock, respectively, at exercise prices between$.01 and $.08 per share, which expire through 2007. During 2006 the remainingstock purchase warrants were exercised, and as a result there were nooutstanding stock purchase warrants at December 31, 2006.**

**Stock BasedCompensation**

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of Statement of Financial AccountingStandards No. 123(R),*Share-BasedPayment* (“SFAS 123R”),using the modified-prospective-transition method. Under this transition method,compensation cost recognized in 2006 includes (a) compensation cost forall stock-based payments granted, but not yet vested as of January 1,2006, based on the grant-date fair value estimated in accordance with theoriginal provisions of Statement of Financial Accounting Standards No. 123,*Accounting for Stock Based Compensation*(“SFAS 123”)*,* and (b) compensation cost for allstock-based payments granted subsequent to January 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of SFAS 123R.Results for prior periods have not been restated. For stock options granted tonon-employees, the Company recognizes compensation expense in accordance withthe requirements of Emerging Issues Task Force No. 96-18, 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**8.Stockholders’ Equity (Continued)**

*Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services* (“EITF 96-18”). EITF96-18 requires that companies recognize compensation expense based on theestimated fair value of options granted to non-employees over their vestingperiod, which is generally the period during which services are rendered bysuch non-employees. The fair value of unvested non-employee stock awards isre-measured at each reporting period.

*StockOption Plans.*   The Company’s Restated 1993 Equity IncentivePlan (the “1993 Plan”), which expired in accordance with its terms in 2003,provided for the grant of incentive stock options, nonstatutory stock optionsand restricted stock awards to purchase up to 2,288,200 shares of the Company’scommon stock. Officers, employees, directors, consultants and advisors of theCompany were eligible to receive grants of options under the 1993 Plan at aprice not less than 100% (or 110% in the case of incentive stock options grantedto 10% or greater stockholders) of the fair market value of the Company’scommon stock, as determined by the Company’s Board of Directors, at the timethe option was granted. In May 2003, the Company’s stockholders approvedthe 2003 Stock Incentive Plan (the “2003 Plan”), under which 800,000 shares ofcommon stock were authorized for issuance. In October 2003, thestockholders of the Company approved an amended and restated 2003 Plan whichprovided, among other things, for an increase of shares authorized for issuanceunder the 2003 Plan to 2,500,000. In May 2005, the stockholders of theCompany approved an amendment to the 2003 Plan which provided for an increaseof shares authorized for issuance under the 2003 Plan to 3,600,000, and theadoption of an “evergreen” provision that allows for an annual increase in thenumber of shares of the Company’s common stock available for issuance under the2003 Plan. The evergreen provision provides for an annual increase to be addedon the first day of each fiscal year of the Company during the period beginningin fiscal year 2006 and ending on the second day of fiscal year 2013. Theincrease provided by the evergreen provision is equal to the lesser of (i) 1,400,000shares of the Company’s common stock, (ii) 4% of the outstanding shares onthat date or (iii) an amount determined by the Company’s Board ofDirectors. In January 2006, an additional 1,219,679 shares of common stockwere reserved for issuance under the 2003 Plan. Pursuant to the evergreenprovision, in January 2007 an additional 1,400,000 shares of common stockwere reserved for issuance under the 2003 Plan.

While the Company may grant options to employeesthat become exercisable at different times or within different periods, theCompany generally has granted options to employees that are exercisable inequal annual installments of 25% on each of the first four anniversary dates ofthe grant.

*EmployeeStock Purchase Plan.*   On August 18, 2003, the Board ofDirectors adopted the 2003 Employee Stock Purchase Plan (the “ESPP”), whichallows eligible employees to purchase common stock at a price per share equalto 85% of the lower of the fair market value of the common stock at thebeginning or end of each six month period during the term of the ESPP. Thefirst offering period began on January 1, 2004. During the years ended December 31,2006, 2005, and 2004, the Company issued and sold 32,398, 37,358 and 30,342shares of common stock, respectively, under the ESPP. In May 2006, thestockholders of the Company approved an amendment to the ESPP, which providedfor an increase of shares available for issuance under the ESPP to 150,000, andthe adoption of an “evergreen” provision that allows for an annual increase inthe number of shares of the Company’s common stock available for issuance underthe ESPP. The evergreen provision provides for an annual increase to be addedon the first day of each fiscal year of the Company during the period beginningin fiscal year 2007 and ending on the 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**8.Stockholders’ Equity (Continued)**

last day of fiscal year2010, such increase to be equal to the lesser of (i) 150,000 shares of theCompany’s common stock or (ii) a lesser amount determined by the Company’sBoard of Directors. Under Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(“APB 25”)*,* which the Company applied to awards under the ESPP priorto January 1, 2006, the Company was not required to recognize stock-basedcompensation expense for the stock options or shares issued under the ESPP. Uponadoption of SFAS 123R, the Company began recording stock-based compensationexpense related to the ESPP. Pursuant to the evergreen provision, in January 2007an additional 150,000 shares of common stock were reserved for issuance andsale under the ESPP.

*Grant-date Fair Value.**  *The fair value of each stock award is estimated onthe grant date using the Black-Scholes option-pricing model based on theassumptions noted in the following table:

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected  volatility     |       | 74                    | %          | 73 | % | 94 | % |
| Risk-free  interest rate |       | 4.7                   | %          | 4.0 | % | 3.6 | % |
| Expected lives           |       | 5.4 years             |       | 6.0 years |   | 4.0 years |   |
| Expected dividend        |       | —                |       | — |   | — |   |

 

Using the Black-Scholes option-pricing model, theweighted average grant date fair values of options granted during the yearsended December 31, 2006, 2005 and 2004 were  $4.14, $11.51 and $9.66, respectively.

Volatility is determined exclusively using historicalvolatility data of the Company’s common stock based on the period of time sincethe Company’s common stock has been publicly traded. The risk-free interestrate is based on the U.S. Treasury yield curve in effect at the time ofgrant commensurate with the expected life assumption. The expected life ofstock options granted is based exclusively on historical data and represents theweighted average period of time that stock options granted are expected to beoutstanding. The expected life is applied to the stock option grant group as awhole, as the Company does not expect substantially different exercise orpost-vesting termination behavior amongst its employee population.

*Stock-Based *Compensation Expense.**   TheCompany is using the straight-line attribution method to recognize stock-basedcompensation expense. The amount of stock-based compensation expense recognizedduring a period is based on the value of the portion of the awards that areultimately expected to vest. SFAS 123R requires forfeitures to be estimated atthe time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates.

The term “forfeitures” is distinct from “cancellations”or “expirations” and represents only the unvested portion of the surrenderedoption. The Company has applied an annual forfeiture rate of 6.4% to allunvested options as of December 31, 2006. This analysis will bere-evaluated quarterly and the forfeiture rate will be adjusted as necessary.Ultimately, the actual expense recognized over the vesting period will only befor those options that vest.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**8.Stockholders’ Equity (Continued)**

The adoption of SFAS 123R on January 1, 2006 hadthe following impact on fiscal 2006 results: net loss was higher by $8.0million, and diluted loss per share was higher by $0.22, than if the Companyhad continued to account for stock-based compensation under APB 25.

Thefollowing table illustrates the effect on net loss and net loss per share hadthe Company applied the fair value recognition provisions of SFAS 123 for theyears ended 2005 and 2004. For purposes of this pro-forma disclosure, the valueof the options is estimated using the Black-Scholes option-pricing modeland amortized to expense over the options’ vesting periods.

| ** **                                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Net loss as  reported                                                                        |       | $                                           | (105,852   | ) | $ | (29,773 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                |       | 626                                         |       | 1,512 |   |
| Deduct:  Stock-based employee compensation expense determined under fair value based  method |       | (5,961                                      | )          | (2,645 | ) |
| Pro forma net loss                                                                           |       | $                                           | (111,187   | ) | $ | (30,906 | ) |
| Basic and diluted  net loss per share                                                        |       |                                        |       |   |   |
| As reported                                                                                  |       | $                                           | (3.49      | ) | $ | (1.14 | ) |
| Pro forma                                                                                    |       | $                                           | (3.66      | ) | $ | (1.18 | ) |

 

*Stock-BasedCompensation Activity*

Asummary of the activity under the Company’s stock options plans as of December 31,2006 and changes during the year then ended is presented below:

| ** **                                             | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise Price  Per Share** | ** ** | **Weighted-  Average  remaining  Contractual  Term in Years** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Options  outstanding at December 31, 2005         |       |                        | 3,820      |                                                        |       |                                                                    | $          | 9.39                                |       |   |   |   |   |   |   |   |   |   |
| Options granted                                        |       |                        | 3,833      |                                                        |       |                                                                    | $          | 6.65                                |       |   |   |   |   |   |   |   |   |   |
| Options exercised                                      |       |                        | (461       | )                                                           |       |                                                                    | $          | 1.50                                |       |   |   |   |   |   |   |   |   |   |
| Options canceled                                       |       |                        | (2,256     | )                                                           |       |                                                                    | $          | 11.80                               |       |   |   |   |   |   |   |   |   |   |
| Options  outstanding at December 31, 2006         |       |                        | 4,936      |                                                        |       |                                                                    | $          | 6.90                                |       |   |   | 7.9 |   |   |   | $ | 34,050 |   |   |
| Options  exercisable at December 31, 2006         |       |                        | 2,050      |                                                        |       |                                                                    | $          | 6.58                                |       |   |   | 6.2 |   |   |   | $ | 13,486 |   |   |
| Options expected  to vest at December 31, 2006(1) |       |                        | 2,406      |                                                        |       |                                                                    | $          | 7.13                                |       |   |   | 9.1 |   |   |   | $ | 17,149 |   |   |

----

(1)          Options expected to vestis calculated by applying an estimated forfeiture rate to unvested options.

During the year ended December 31, 2006, thetotal intrinsic value of options exercised (i.e., the difference between themarket price at exercise and the price paid by the employee to exercise theoptions) was $1,887,000, and the total amount of cash received from exercise ofthese options was $693,000. The 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**8.Stockholders’ Equity (Continued)**

total grant-date fairvalue of stock options that vested during the year ended December 31, 2006was approximately $3.7 million.

As of December 31, 2006, there was $10.9 millionof total unrecognized compensation cost related to unvested share based awards.This cost is expected to be recognized over a weighted average period of 1.4years.

During 1999 and 2000, the Company grantedperformance-based options to purchase 75,100 and 100,000 shares of commonstock, respectively, with an exercise price of $1.30, to certain employees,which allow for acceleration of the vesting period upon the occurrence ofcertain defined events. Of the 100,000 options granted in 2002, 5,000 optionswere forfeited in 2002. Based on the terms of the arrangements, the awards wererequired to be accounted for as variable, and compensation expense was measuredas the difference between the fair market value of the Company’s common stockat the reporting period date and the exercise price of the award. Compensationexpense is recognized over the vesting period. The Company recognized areversal of stock based compensation expense of ($261,000) for the year ended December 31,2005, and an expense of $529,000 for the year ended December 31, 2004. Inconnection with the adoption of SFAS123R, these awards became fixed and theirassociated expense is included in stock-based compensation expense for the yearended December 31, 2006.

During 2003 and 2002, the Company granted options topurchase 413,250 and 241,000 shares of common stock, respectively, to employeesat exercise prices below the deemed fair value for accounting purposes of theCompany’s common stock. The weighted average exercise price of these options is$2.00 per share. The Company recorded deferred stock compensation expenserelated to these grants of $3,317,000 and $566,000 for the years ended December 31,2003 and 2002, respectively. These amounts were being recognized as stock-basedcompensation expense ratably over the vesting period of four years. Included inthe results of operations for the years ended December 31, 2005 and 2004is stock based compensation expense of $887,000 and $982,000, respectively. Inconnection with the adoption of SFAS 123R in January 2006, the Companyreversed the remaining deferred stock compensation balance of $1,208,000. Thefair value of these awards is accounted for in accordance with SFAS 123R, andrelated stock compensation expense is included in the statement of operationsfor the year ended December 31, 2006.

Since 1999, the Companyhas granted options to purchase a total of 201,000 shares of common stock tononemployees at a weighted-average exercise price of $3.50 per share, ofwhich 125,000 remained outstanding at December 31, 2006. The Company hasapplied the recognition provisions of EITF 96-18 related to thesestock options and utilized the Black-Scholes option pricing model todetermine the fair value of these stock options at each reporting date. Inconnection with these awards, the Company recognized a reversal of stock basedcompensation expense of ($239,000), and ($133,000) for the years ended December 31,2006, and 2005, respectively, and an expense of $1,011,000 for the year ended December 31,2004.

**9. Operating Lease**

On January 30, 2004, the Company executed a leasefor 52,000 square feet of laboratory and office space in Lexington,Massachusetts. The rent obligation for the building commenced on August 7,2004, 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**9.Operating Lease (Continued)**

which was 30 daysafter the date the Company commenced occupancy of the building. The lease isfor a term of ten years with options that permit renewals for additionalfive-year periods. The Company has the option to terminate the lease at the endof the fifth year for a fee of $4.2 million. The expected minimum rentalcommitments under the lease agreement are $1,505,000, $1,505,000, $1,566,000, $1,688,000and $1,688,000 for each year in the five calendar year period endingDecember 31, 2011, respectively, and $4.5 million in total for theremainder of the lease term. In addition to the minimum lease commitment, thelease agreement requires the Company to pay its pro rata share of propertytaxes and building operating expenses. Rent expense was $1.7 million, $1.7million and $0.6 million for the years ended 2006, 2005 and 2004, respectively.Under the lease, a security deposit of $800,000 is required to be held inescrow for the life of the lease. This amount has been recorded as restrictedcash. The Company is in the process of negotiating the assignment of thislease.

On February 23, 2007, theCompany entered into a lease pursuant to which the Company agreed to lease19,815 square feet at another facility located in Lexington, Massachusetts toaccommodate its smaller workforce. The term of this lease is for sixty-sixmonths beginning on the commencement date, which is defined in the lease as theearlier of (i) the day immediately following the substantial completion ofcertain improvements to the premises as set forth in the lease or (ii) thefirst day on which the Company occupies all or any portion of the premises forthe conduct of its business. The expected minimum rental commitments under thelease agreement are $401,000, $542,000, $560,000, $580,000 and $592,000 foreach year in the five calendar year period ending December 31, 2011, respectively,and $456,000 in total for the remainder of the lease term. In addition, theCompany is obligated to pay a certain portion of the operating expenses and thereal property taxes associated with the premises, as calculated pursuant to theterms of the lease. Under the lease, a security deposit in the amount of $190,000is required to be held in escrow for the term of the lease.

**10. License, Manufacturingand Commercialization Agreements**

The Company has entered into various research, licenseand commercialization agreements to support its research and development andcommercialization activities.

*Elan*.   In February 2007, inconnection with the Company’s efforts to develop BiDil XR, the Company enteredinto a license agreement with Elan Pharma International Limited (“Elan”).Pursuant to the agreement, Elan granted to the Company an exclusive worldwidelicense, for the term of the agreement, to certain know-how, patents andtechnology, and any improvements to any of the foregoing developed by eitherparty during the term of the agreement. Pursuant to this license, the Company has the right to import, use,offer for sale and sell the oral capsule formulation incorporating specifiedtechnology referred to in the agreement and containing, as its sole activecombination of ingredients, the combination of the active drug substancesisosorbide dinitrate and hydralazine hydrochloride, including BiDil XR.  In consideration for the grant of thelicense, the Company has agreed to pay Elan royalties that are calculated byreference to annual net sales parameters set forth in the agreement.  In addition, the Company has also agreed topay Elan specified amounts upon the achievement of specified development andcommercialization milestone events of up to $2.5 million.

The term of the agreement runs in the United Statesfrom the effective date of the agreement until the later of (a) the 20thanniversary of the date of the first sale of the product by us or a permitted 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**10.License, Manufacturing and Commercialization Agreements (Continued)**

sublicensee to anunaffiliated third party, which is referred to in the agreement as the first inmarket sale, or (b) the expiration of the last-to-expire patent for theproduct listed in the FDA’s “Orange Book.” Elsewhere in the world, the term will run on a country by country basisfrom the effective date of the agreement until the later of (a) the 20th anniversaryof the date of the first in market sale of the product in the country concernedor (b) the expiration of the life of the last to expire patent included in theElan intellectual property in that country. Following the expiration of the initial term, the agreement shallcontinue automatically for rolling 3 year periods thereafter, unless theagreement has been terminated by either of the parties by serving 1 year’swritten notice on the other party immediately prior to the end of the initialterm or any such additional 3 year period. Either Elan or the Company may terminate the agreement in the event of amaterial, uncured breach by the other party, or if the other party goes intoliquidation or becomes bankrupt or insolvent. In addition, the Company may terminate the agreement in the event of atechnical failure, which is defined as the inability to achieve apharmacokinetic profile for the product consistent with that of BiDiladministered three times daily (at 6 hour intervals).  Elan may terminate the agreement with respectto a particular country in the territory in the event that the Company does notmeet certain obligations set forth in the agreement with respect to suchcountry, provided that Elan must first consult with us and, if applicable, provideus with an opportunity to meet such obligations prior to exercising Elan’stermination rights.

*BostonScientific Collaboration.*   In November 2001,the Company entered into a research, development and license agreement withBoston Scientific in the field of restenosis. The Company granted BostonScientific an exclusive worldwide license to develop and commercialize nitricoxide-enhancing cardiovascular stents. The Company also granted to BostonScientific a right of first refusal to obtain an exclusive license under theCompany’s nitric oxide technologies to commercialize products for restenosis,which right of first refusal is for a period of three years after the end ofthe research term. In December 2003, the Company agreed to extend theagreement to continue the research and development collaboration through December 2005.The research term of the Boston Scientific agreement expired on December 31,2005, although certain rights extend beyond this term. Boston Scientific madean up-front license payment of $1.5 million to the Company in 2001, andmade an additional payment of $3.0 million in December 2003 inconnection with the extension of the research and development collaboration.The Company recognized the up-front license payments ratably over the term ofthe contractual performance obligation. For the years ended December 31,2005, and 2004, the Company recognized revenue of $1.6 million,respectively. In the event that specified research, development andcommercialization milestones were achieved, Boston Scientific would have beenobligated to make milestone payments to the Company. In addition, BostonScientific also would have been obligated to pay royalties to the Company onthe sale of any products resulting from the collaboration. Boston Scientificmade a $3.5 million equity investment in the Company’s stock in 2001. In August 2003,in connection with a private placement, Boston Scientific made an additional$500,000 equity investment the Company’s stock.

*MerckCollaboration.*   From December 2002 until November 2004,the Company was party to an exclusive, worldwide research, collaboration andlicensing agreement that granted Merck a license to certain existing nitricoxide-enhancing COX-2 technology and any technology pertaining to thelicense technology developed by the Company under this agreement. The researchportion of the agreement was for three years, and the Company was obligated toperform certain research and development activities in consideration ofquarterly fees totaling $7.2 million. In consideration of this license in 2003,the Company 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**10.License, Manufacturing and Commercialization Agreements (Continued)**

received an upfrontnon-refundable license payment of $10.0 million, and two payments, each of$5.0 million, for achieving the first two milestones. The license feerevenue and the revenue from the first $5.0 million milestone payment wererecognized ratably over the contractual term of the research and developmentprogram, which was expected to end on December 31, 2005. The revenue fromthe second $5.0 million payment was recognized in the fourth quarter of2003, the period in which Merck achieved the milestone. On September 30,2004, Merck halted the phase II trial of the Company’s lead candidate in nitricoxide-enhancing COX-2 inhibitors. This lead nitric oxide candidate iscomposed of a derivative of rofecoxib. Rofecoxib is the active ingredient inVioxx, a COX-2 inhibitor which Merck voluntarily withdrew from worldwidemarkets on September 30, 2004. In November 2004, the Company agreedwith Merck to terminate the collaboration agreement. Merck paid the Company alump sum of $1.8 million, representing the full amount of the researchfunding owed to the Company for 2005, however, the Company will not receive anycommercialization milestones or royalty payments from Merck. As a result of thetermination of this agreement, the Company accelerated the recognition ofdeferred license revenue of $5.3 million in the fourth quarter of 2004,and the Company recognized the lump sum payment of $1.8 million as revenuein the fourth quarter of 2004. Under this agreement the Company recognizedrevenue of $14.9 million for the year ended December 31, 2004.

*Dr. JayN. Cohn.*   In January 1999, as amended in January 2001and March 2002, the Company entered into a collaboration and licenseagreement with Dr. Jay N. Cohn. Under the agreement, Dr. Cohnlicensed to the Company an exclusive worldwide royalty-bearing license totechnology and inventions owned or controlled by Dr. Cohn and that relateto BiDil for the treatment of cardiovascular disease. Upon achieving certaindevelopmental events, the Company was required to make milestone paymentstotaling $1.0 million, which were recorded as a charge to research anddevelopment expenses in 2004. Upon commercial sale of BiDil, the Company isrequired to make royalty payments based on net sales at varying rates dependingon sales volume. The royalty terms expires upon the later of the expiration ofthe patent rights or ten years from the first commercial sale. During the yearsended December 31, 2006 and 2005, the Company incurred royalty expenses of$364,000 and $134,000, respectively. The agreement imposes upon the Company anobligation to use reasonable best efforts to develop and, upon receipt ofregulatory approval, manufacture, market and commercialize products based uponthe licensed rights. If the Company fails to meet this obligation, Dr. Cohnhas the right to terminate the agreement and the license granted to the Companyunder the agreement. Dr. Cohn also has the right to terminate theagreement if the Company materially breaches the agreement and fails to remedythe breach within 30 days. The Company has the right to terminate theagreement at any time upon 30 days’ prior written notice. Unless earlierterminated, the agreement continues in perpetuity. Pursuant to the agreement, Dr. Cohnwas appointed to the Company’s then-current scientific advisory board, enteredinto a consulting agreement with the Company and was granted an option topurchase 10,000 shares of the Company’s common stock.

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**11. Income Taxes**

Areconciliation of federal statutory income tax provision to the Company’sactual provision is as follows:

| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Benefit at  federal statutory tax rate |       | $                                          | (24,255    | ) | $ | (35,990 | ) | $ | (10,123 | ) |
| State taxes, net  of federal benefit   |       | (4,473                                     | )          | (6,637 | ) | (1,867 | ) |
| Non-deductible  expenses               |       | 910                                        |       | 254 |   | 157 |   |
| Unbenefited  operating losses          |       | 27,818                                     |       | 42,373 |   | 11,833 |   |
| Income tax provision                   |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

Thesignificant components of the Company’s deferred tax assets are as follows:

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Deferred tax assets:                             |       |                  |       |   |   |
| Net operating  loss carryforwards                |       | $                     | 81,642     |   | $ | 59,805 |   |
| Capitalized  research costs, net of amortization |       | 27,386                |       | 24,991 |   |
| Tax credit  carryforwards                        |       | 6,663                 |       | 6,245 |   |
| Deferred revenue                                 |       | 83                    |       | 1 |   |
| Depreciation                                     |       | 422                   |       | (29 | ) |
| Accrued expenses                                 |       | 218                   |       | 991 |   |
| Other                                            |       | 3,979                 |       | 146 |   |
|                                             |       | 120,393               |       | 92,150 |   |
| Valuation  allowance                             |       | (120,393              | )          | (92,150 | ) |
| Net deferred tax assets                          |       | $                     | —     |   | $ | — |   |

 

The Company has increasedits valuation allowance by $28,243,000 in 2006 to provide a full valuationallowance for deferred tax assets since the realization of these benefits isnot considered more likely than not. At December 31, 2006, the Company hadunused net operating loss carryforwards of $206,896,000 available to reducefederal taxable income expiring in 2010 through 2025 and $190,072,000 availableto reduce state taxable income expiring in 2006 through 2010. The Company alsohas federal and state research tax credits of $7,755,000 available to offset federal and state income taxes, both ofwhich expire beginning in 2010. The net operating losses and tax creditcarryforwards may be subject to the annual limitation provisions of InternalRevenue Code Sections 382 and 383. No income tax payments were made in 2006,2005 or 2004.

**12. Commitments andContingencies**

In connection with theCompany’s efforts to obtain the approval of BiDil from the FDA, the Companycontracted with the law firm of FoxKiser LLC (“FoxKiser”) for services relatedto the regulatory approval process for BiDil. The agreement provided forpayment of legal consulting fees upon receipt of written FDA approval of BiDil.In addition, the agreement requires the Company to pay royalties to FoxKiser oncommercial sales of BiDil. The royalty term ends six months after the date ofmarket introduction of an 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**12.Commitments and Contingencies (Continued)**

FDA-approved genericversion of BiDil. During the third quarter of 2005, the Company entered into aseparate consulting agreement with FoxKiser following the approval by the FDAof BiDil. During the years ended December 31, 2006, 2005 and 2004, theCompany recorded charges of $0.9 million, $1.6 million and$1.9 million, respectively, pertaining to the legal consulting fees, and$364,000, $134,000 and $-0-, respectively, pertaining to royaltyexpenses related to these agreements.

An academic institution has asserted that patents andpatent applications which relate to the nitric oxide stent program may requirea license from such institution. It is the opinion of the Company’s managementand outside legal counsel that the disputed intellectual property has beenvalidly licensed to, or is validly owned by, the Company. Accordingly, theaccompanying financial statements do not include any provision related to thisclaim.

In November 2004, as amended in May 2005,the Company executed an agreement with Publicis Selling Solutions, Inc. (“Publicis”),a contract sales organization, pursuant to which, on the Company’s behalf, Publicisemployed and trained a specialty sales force consisting of approximately 142sales representatives to sell BiDil to the Company’s target prescriber markets.The Company recorded costs in 2006 and 2005 of $10.8 million and $29.8 million,respectively, excluding one-time start-up costs and project costs. The Companytransitioned the Publicis sales force internally to NitroMed in May 2006and paid a liquidated damages fee of $500,000 and a sales force transition feeof $348,000 in the second quarter of 2006. As a result of the sales forcetransition, the Company no longer has a significant contractual commitment withPublicis.

On February 16, 2005,the Company engaged Schwarz Pharma Manufacturing, Inc. (“Schwarz Pharma”)under a five-year exclusive manufacturing and supply agreement solely for thethree times daily immediate release dosage formulation of BiDil. Under thesupply agreement, the Company has the right to engage a backup manufacturer. AtDecember 31, 2006, the Company has outstanding binding purchase orders of$1.1 million for production of BiDil finished goods.

**13**.Retirement Plan

The Company sponsors a 401(k) plancovering substantially all employees. The plan provides for salary deferralcontributions by participants of up to 75% of eligible wages not to exceedFederal requirements. Those employees over 50 years old are permitted tocontribute an additional amount per Federal limits ($4,000 per year for 2005).In October 2005, the Board of Directors approved an employee match in theform of shares of the Company’s common stock equal to 50% of employeecontributions, limited to the first 6% of salary contributed to the 401(k) plan.For the years ended December 31, 2006, and 2005, the Company recordedexpenses of $411,000 and $88,000, respectively, related to the plan.

**14**.Related Party Transactions—Boston University

Dr. Joseph Loscalzo,a member of the Company’s board of directors, is the Physician-in-Chief andChair of the Department of Medicine at Brigham and Women’s Hospital in Boston,Massachusetts. Dr. Loscalzo has served as a consultant to the Companysince 1992, as the chair of the Company’s scientific advisory board since 1999and currently as the chair of the Company’s technical review committee, whichreplaced the Company’s scientific review board at the beginning of fiscal year2006. In October 2003, the 

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**14.Related Party Transactions—Boston University (Continued)**

Company entered into aconsulting agreement with Dr. Loscalzo, as amended in April 2004,pursuant to which the Company agreed to pay Dr. Loscalzo an annualretainer of $55,000 for his services. The agreement is for a period of tenyears, subject to the Company’s right to terminate the agreement at any time on30 days’ notice. In 2006, 2005 and 2004, the Company paid Dr. Loscalzoan aggregate of $58,000, $68,000 and $75,000, respectively.

In June 1993, as amended in July 1997, January 1999and December 2002, the Company entered into a research and licenseagreement with the Trustees of Boston University (“BU”). Under the agreement,the Company agreed to fund a multi-year research program under Dr. Loscalzo’sdirection at BU in the area of nitric oxide-enhancing medicines. TheCompany’s funding is principally for laboratory equipment and supplies as wellas a portion of the salary of Martin Feelish, Ph.D., a professor of medicine atBU and a member of the Company’s scientific advisory board (which was replacedat the beginning of 2006 by the technical review committee of which Dr. Feelishis not a member). The Company has also agreed to provide Dr. Feelish withaccess to the Company’s research facilities at the BU School of Medicine. Underthe agreement, in exchange for the Company’s sponsored research funding, BU hasgranted the Company exclusive worldwide royalty-bearing rights totechnology and inventions owned by BU at the effective time of, or developed inthe course of, the sponsored research program. The Company has agreed to payroyalties to BU on all products sold or distributed by the Company or itsaffiliates that incorporate or utilize inventions, material or informationspecified in the agreement. In 2006, 2005 and 2004, the Company made paymentsto BU of $36,000, $120,000 and $221,000, respectively, pursuant to thisagreement, excluding the lease payments described below.

In May 2003, theCompany entered into an oral agreement with BU pursuant to which the Companyleases approximately 1,500 square feet of laboratory space from BU at its EvansBiomedical Research Center in Boston, Massachusetts. The lease had a term ofthree years, and the Company makes annual rental payments of $60,000 pursuantto the lease. As provided above, the Company has agreed to make this spaceavailable to Dr. Feelish of BU. In each of 2006, 2005 and 2004, theCompany made payments to BU under this agreement of $30,000, $60,000, and$60,000, respectively.

**15**.Quarterly Results of Operations (Unaudited)

Thefollowing table presents unaudited quarterly financial data of the Company:

| ** **                                                         | ** ** | **Year Ended December 31, 2006** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                         | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| Net revenues                                                       |       | $                                                    | 2,316      |   | $ | 2,855 |   | $ | 3,427 |   | $ | 3,488 |   |
| Net loss                                                           |       | (25,924                                              | )          | (18,280 | ) | (16,520 | ) | (10,613 | ) |
| Basic and diluted  net loss per share                              |       | $                                                    | (0.75      | ) | $ | (0.50 | ) | $ | (0.45 | ) | $ | (0.29 | ) |
| Weighted average common  shares used to compute net loss per share |       | 34,597                                               |       | 36,724 |   | 37,090 |   | 37,147 |   |

** **

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**NITROMED, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (all tabular amounts in thousands except per share amounts)**

**15. Quarterly Results of Operations (Unaudited)(Continued)**

| ** **                                                         | ** ** | **Year Ended December 31, 2005** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                         | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| Net revenues                                                       |       | $                                                    | 398        |   | $ | 398 |   | $ | 1,515 |   | $ | 3,736 |   |
| Net loss                                                           |       | (19,589                                              | )          | (22,624 | ) | (32,072 | ) | (31,567 | ) |
| Basic and diluted  net loss per share                              |       | $                                                    | (0.65      | ) | $ | (0.75 | ) | $ | (1.05 | ) | $ | (1.04 | ) |
| Weighted average common  shares used to compute net loss per share |       | 30,234                                               |       | 30,275 |   | 30,421 |   | 30,486 |   |

 

 

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

(a)*   Evaluation of Disclosure Controls andProcedures.*   Our management, with the participation of ourchief executive officer and chief financial officer, evaluated theeffectiveness of our disclosure controls and procedures as of December 31,2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by a company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms. Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. Management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving their objectives and management necessarily applies its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Based on the evaluation of our disclosure controls and procedures as of December 31,2006, our chief executive officer and chief financial officer concluded that,as of such date, our disclosure controls and procedures were effective at thereasonable assurance level.

(b)*   Management’sReport on Internal Control Over Financial Reporting.*

**Management’s Reporton Internal Control Over Financial Reporting**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or15d-15(f) promulgated under the Exchange Act as a process designedby, or under the supervision of, the company’s principal executive andprincipal financial officers and effected by the company’s board of directors,management and other personnel, to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples and includes those policies and procedures that:

·       Pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of the assets of the company;

·       Providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and

·       Providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

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Our management assessed the effectiveness of ourinternal control over financial reporting as of December 31, 2006. Inmaking this assessment, the company’s management used the criteria set forth bythe Committee of Sponsoring Organizations of the Treadway Commission(COSO) in Internal Control-Integrated Framework.

Based on this assessment, our management concludedthat, as of December 31, 2006, our internal control over financialreporting is effective based on those criteria.

Our independent registered public accounting firm hasissued an audit report on our assessment of our internal control over financialreporting. This report appears below.

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**Reportof Independent Registered Public Accounting Firm**

The Board of Directors andStockholdersNitroMed, Inc.

We have audited management’sassessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting,that NitroMed, Inc. maintained effective internal control over financialreporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (the COSOcriteria). NitroMed, Inc.’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that NitroMed, Inc. maintained effective internal control overfinancial reporting as of December 31, 2006, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, NitroMed, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2006, based on****the COSO criteria**.**

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the balance sheets of NitroMed, Inc.as of December 31, 2006 and 2005, and the related statements ofoperations, stockholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2006 of NitroMed, Inc. and our reportdated March 6, 2007 expressed anunqualified opinion thereon.

|  |   | /s/ Ernst & Young LLP |
|--|--------|--------------------------------|

 

Boston, MassachusettsMarch 6, 2007

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*(c)**           Changesin Internal Controls.*

No change in our internalcontrol over financial reporting occurred during the fiscal year ending December 31,2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

**Directors andExecutive Officers**

Information regarding ourdirectors and executive officers may be found under the captions “Election ofDirectors,” “Executive Officers” and “Corporate Governance” in the ProxyStatement for our 2007 Annual Meeting of Stockholders. Such information isincorporated herein by reference.

**Audit Committee**

We have a separately-designatedstanding Audit Committee established in accordance with Section 3(a)(58)(A) ofthe Exchange Act. Additional information regarding the Audit Committee may befound under the captions “Board of Directors Meetings and Committee Meetings”and “Report of the Audit Committee” in the Proxy Statement for our 2007 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

**Audit CommitteeFinancial Expert**

The Board of Directors hasdetermined that it has at least one “Audit Committee Financial Expert” (asdefined by Item 401(h)(2) of Regulation S-K of the Exchange Act) onthe Audit Committee of the Board of Directors, Davey S. Scoon. The Board ofDirectors has further determined that Mr. Scoon is “independent” frommanagement within the meaning of Item 7(d)(3)(iv) of Schedule 14Aunder the Exchange Act.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Information regarding Section 16(a) BeneficialOwnership Reporting Compliance may be found under the caption “Section 16(a) BeneficialOwnership Reporting Compliance” in the Proxy Statement for our 2007 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

**Code of BusinessConduct and Ethics**

We have adopted a code ofbusiness conduct and ethics, which applies to all of our officers, directorsand employees, including our principal executive officer, principal financialofficer, principal accounting officer or controller, or persons performingsimilar functions. Our code of business conduct and ethics was filed with theSEC as an exhibit to our annual report on Form 10-K for the fiscalyear ended December 31, 2003. In addition, we intend to post on ourwebsite, which is located at www.nitromed.com, all disclosures that arerequired by law or NASDAQ Stock Market listing standards concerning anyamendments to, or waivers from, any provision of our code of business conductand ethics.

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**ITEM 11.**         EXECUTIVECOMPENSATION

Information with respectto this item may be found under the captions “Compensation Discussion andAnalysis,” “Directors’ Compensation,” “Compensation Committee Interlocks andInsider Participation,” “Executive Compensation,” and “Employment Agreements,”in the Proxy Statement for our 2007 Annual Meeting of Stockholders. Suchinformation is incorporated herein by reference.

**ITEM12.**         SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

Information with respectto this item may be found under the caption “Security Ownership of CertainBeneficial Owners and Management” in the Proxy Statement for our 2007 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

**ITEM13.**         CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information with respectto this item may be found under the caption “Certain Relationships and RelatedTransactions” and “Director Independence” in the Proxy Statement for our 2007Annual Meeting of Stockholders. Such information is incorporated herein byreference.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

Information with respectto this item may be found under the caption “Audit Fees” in the Proxy Statementfor our 2007 Annual Meeting of Stockholders. Such information is incorporatedherein by reference.

**PART IV**

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

(a)(1)                    FinancialStatements.

For a list of the financial information includedherein, see “Index to Financial Statements” on page 57.

(a)(2)                    FinancialStatement Schedules.

All schedules are omitted because they are notapplicable or the required information is shown in the Financial Statements orNotes thereto.

(a)(3)                    Exhibits.The list of Exhibits filed as a part of this Annual Report on Form 10-Kare set forth on the Exhibit Index immediately preceding such Exhibits,and is incorporated herein by this reference.

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned.

|                          | NITROMED, INC. |
|--------------------------|---------------------|
| Date: March 8, 2007 | By:                 | /s/ KENNETH M. BATE |
|                     |                | Kenneth M. Bate |
|                     |                | President and Chief Executive Officer |

 

Pursuantto the requirements of the Securities Act of 1933, this report has been signedby the following persons in the capacities and on the dates indicated.

|                                   | **Signature** | ** **                                                      | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-----------------------------------|---------------|-----------------------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/ KENNETH M. BATE               |          | President and  Chief Executive Officer                          |       | March 8,  2007 |
| Kenneth M. Bate                   |          | and Director (Principal  Executive Officer)                     |       |                |
| /s/ JAMES G. HAM, III        |          | Vice President,  Chief Financial Officer,                       |       | March 8, 2007  |
| James G. Ham, III            |          | Treasurer and Secretary                                         |       |                |
|                              |          | (Principal Financial  Officer and Principal Accounting Officer) |       |                |
| /s/ ROBERT S. COHEN               |          | Director                                                        |       | March 8,  2007 |
| Robert S. Cohen                   |          |                                                            |       |                |
| /s/ FRANK L. DOUGLAS, M.D., PH.D. |          | Director                                                        |       | March 8,  2007 |
| Frank L. Douglas, M.D.,  Ph.D.    |          |                                                            |       |                |
| /s/ ZOLA HOROVITZ, PH.D.          |          | Director                                                        |       | March 8,  2007 |
| Zola Horovitz, Ph.D.              |          |                                                            |       |                |
| /s/ ARGERIS KARABELAS, PH.D.      |          | Director                                                        |       | March 8,  2007 |
| Argeris Karabelas, Ph.D.          |          |                                                            |       |                |
| /s/ MARK LESCHLY                  |          | Director                                                        |       | March 8,  2007 |
| Mark Leschly                      |          |                                                            |       |                |
| /s/ JOHN W. LITTLECHILD           |          | Director                                                        |       | March 8,  2007 |
| John W. Littlechild               |          |                                                            |       |                |
| /s/ JOSEPH LOSCALZO, M.D., PH.D.  |          | Director                                                        |       | March 8,  2007 |
| Joseph Loscalzo, M.D.,  Ph.D.     |          |                                                            |       |                |
| /s/ DAVEY S. SCOON                |          | Director                                                        |       | March 8,  2007 |
| Davey S. Scoon                    |          |                                                            |       |                |
| /s/ CHRISTOPHER J. SOBECKI        |          | Director                                                        |       | March 8,  2007 |
| Christoper J. Sobecki             |          |                                                            |       |                |

 

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**EXHIBITINDEX**

| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                     |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Restated Certificate of Incorporation of the Company  (Incorporated by reference to the exhibits to the Company’s Registration  Statement on Form S-1 (File No. 333-108104))                                                                                                                         |
| 3.2              |       | Amended and Restated  Bylaws of the Company (Incorporated by reference to the exhibits to the  Company’s Registration Statement on Form S-1 (File No. 333-108104))                                                                                                                                   |
| *10.1            |       | Restated 1993 Equity  Incentive Plan (Incorporated by reference to the exhibits to the Company’s  Registration Statement on Form S-1 (File No. 333-108104))                                                                                                                                          |
| *10.2            |       | Amended and Restated  2003 Stock Incentive Plan, as amended                                                                                                                                                                                                                                                         |
| *10.3            |       | Form of Incentive  Stock Option Agreement Granted Under Amended and Restated 2003 Stock  Incentive Plan (Incorporated by reference to the exhibits to the Company’s  Annual Report on Form 10-K for the year ended December 31,  2004 (File No. 000-50439))                                |
| *10.4            |       | Form of  Nonstatutory Stock Option Agreement Granted Under Amended and Restated 2003  Stock Incentive Plan (Incorporated by reference to the exhibits to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 2004 (File No. 000-50439))                             |
| *10.5            |       | 2003 Employee Stock  Purchase Plan, as amended                                                                                                                                                                                                                                                                      |
| 10.6†       |       | Development and License  Agreement between the Company and Boston Scientific Corporation dated  November 20, 2001 (Incorporated by reference to the exhibits to the  Company’s Registration Statement on Form S-1 (File No. 333-108104))                                                        |
| 10.7†       |       | Research and License  Agreement between the Company and Brigham and Women’s Hospital, Inc.  dated August 1, 1992, as amended November 22, 1996 (Incorporated by  reference to the exhibits to the Company’s Registration Statement on  Form S-1 (File No. 333-108104))           |
| 10.8†       |       | Collaboration and  License Agreement between the Company and Professor Jay N. Cohn dated  January 22, 1999, as amended January 29, 2001 and March 15,  2002 (Incorporated by reference to the exhibits to the Company’s Registration  Statement on Form S-1 (File No. 333-108104))    |
| 10.9             |       | Amendment No. 1 to  Collaboration and License Agreement between the Company and Professor Jay N.  Cohn dated August 10, 2000 2004 (Incorporated by reference to the  exhibits to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2004 (File No. 000-50439)) |
| 10.10†      |       | Research and License  Agreement between the Company and Trustees of Boston University dated  June 1, 1993, as amended January 1, 1999 (Incorporated by reference  to the exhibits to the Company’s Registration Statement on Form S-1  (File No. 333-108104))                              |
| 10.11†      |       | Agreement between the  Company and FoxKiser dated April 26, 2001 (Incorporated by reference to  the exhibits to the Company’s Registration Statement on Form S-1  (File No. 333-108104))                                                                                                        |
| 10.12†      |       | Agreement between the  Company and John D. Folts dated March 13, 1995, as amended,  November 22, 1996 and December 2, 1998 (Incorporated by reference  to the exhibits to the Company’s Registration Statement on Form S-1  (File No. 333-108104))                                    |
| *10.13           |       | Letter Agreement between  the Company and L. Gordon Letts dated November 4, 1993 (Incorporated by  reference to the exhibits to the Company’s Registration Statement on  Form S-1 (File No. 333-108104))                                                                                        |

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| 10.14       |   | Fourth Amended and  Restated Stockholders’ Agreement among the Company and the stockholders named  therein dated May 22, 2001, as amended November 20, 2001,  May 12, 2003 and July 31, 2003 (Incorporated by reference to the  exhibits to the Company’s Registration Statement on Form S-1 (File  No. 333-108104)) |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15       |   | Form of Warrant to  purchase shares of the Company’s Common Stock, together with a schedule of  warrant holders (Incorporated by reference to the exhibits to the Company’s  Registration Statement on Form S-1 (File No. 333-108104))                                                                                              |
| 10.16       |   | Letter Agreement between  the Company, Boston University School of Medicine and Martin Feelisch, Ph.D.  dated May 5, 2003 (Incorporated by reference to the exhibits to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 2003 (File No. 000-50439))                                                       |
| 10.17       |   | Consulting Agreement  between the Company and Joseph Loscalzo, M.D., Ph.D. dated October 27,  2003, as amended on April 1, 2004 (Incorporated by reference to the  exhibits to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2004 (File No. 000-50439))                                            |
| 10.18       |   | Letter Agreement between  the Company and Merck Frosst Canada & Co. dated November 8,  2004 (Incorporated by reference to the exhibits to the Company’s Current  Report on Form 8-K filed on November 8, 2004 (File  No. 000-50439))                                                                                       |
| *10.19      |   | Letter Agreement between  the Company and James G. Ham, III dated September 3, 2004  (Incorporated by reference to the exhibits to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2004 (File  No. 000-50439))                                                                                       |
| 10.20† |   | Supply Agreement between  the Company and Schwarz Pharma Manufacturing, Inc. dated as of  February 16, 2005 (Incorporated by reference to the exhibits to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 2004 (File No. 000-50439))                                                                |
| *10.21      |   | Letter Agreement between  the Company and Michael D. Loberg, Ph.D., dated as of June 16, 2006  (Incorporated by reference to the exhibits to the Company’s Current Report on  Form 8-K filed on June 22, 2006 (File No. 000-50439))                                                                                                 |
| *10.22      |   | Executive Severance  Benefit Plan (Incorporated by reference to the exhibits to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 30,  2006 (File No. 000-50439))                                                                                                                                                  |
| *10.23      |   | Amendment No. 1 to  Executive Severance Benefit Plan (Incorporated by reference to the exhibits  to the Company’s Current Report on Form 8-K filed on  August 22, 2006 (File No. 000-50439))                                                                                                                                        |
| *10.24      |   | Form of Agreement  entered into by and between the Company and certain of its executive officers,  together with a schedule of such officers (Incorporated by reference to the  exhibits to the Company’s Quarterly Report on Form 10-Q for the  quarter ended March 31, 2006 (File No. 000-50439))                                 |
| *10.25      |   | Form of Amendment  No. 1 to Agreement entered into by and between the Company and certain  of its executive officers, together with a schedule of such officers  (Incorporated by reference to the exhibits to the Company’s Current Report on  Form 8-K filed on August 22, 2006 (File No. 000-50439))                        |
| *10.26      |   | Employment Offer Letter  between the Company and Kenneth M. Bate, dated as of January 19, 2007  (Incorporated by reference to the exhibits to the Company’s Current Report on  Form 8-K filed on January 25, 2007 (File No. 000-50439))                                                                                             |

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| *10.27      |   | Retention Agreement  between the Company and Kenneth M. Bate, dated as of January 23, 2007  (Incorporated by reference to the exhibits to the Company’s Current Report on  Form 8-K filed on January 25, 2007 (File No. 000-50439))  |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.28      |   | Severance Agreement  between the Company and Kenneth M. Bate, dated as of January 23, 2007  (Incorporated by reference to the exhibits to the Company’s Current Report on  Form 8-K filed on January 25, 2007 (File No. 000-50439))  |
| *10.29      |   | Employment Offer Letter  between the Company and Gerald Bruce, dated as of January 10, 2006, as  amended on April 24, 2006                                                                                                                          |
| 10.30† |   | License Agreement  between the Company and Elan Pharma International Limited, dated as of  February 9, 2007                                                                                                                                              |
| 10.31       |   | Lease between the  Company and The Realty Associates Fund VI, L.P., dated as of  February 23, 2007                                                                                                                                                       |
| 10.32       |   | Lease between the  Company and PM Atlantic Lexington, LLC dated January 30, 2004 (Incorporated  by reference to the exhibits to the Company’s Annual Report on Form 10-K  for the year ended December 31, 2003 (File No. 000-50439)) |
| 14.1        |   | Code of Business Conduct  and Ethics (Incorporated by reference to the exhibits to the Company’s Annual  Report on Form 10-K for the year ended December 31, 2003  (File No. 000-50439))                                                  |
| 21.1        |   | Subsidiaries of the  Company                                                                                                                                                                                                                                  |
| 23.1        |   | Consent of  Ernst & Young LLP, Independent Registered Public Accounting Firm                                                                                                                                                                         |
| 31.1        |   | Certification of the  Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14  of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                             |
| 31.2        |   | Certification of the  Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14  of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                             |
| 32.1        |   | Certification of the  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                             |
| 32.2        |   | Certification of the  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                             |

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*                    Managementcontract or compensation plan or arrangement required to be filed as an exhibitpursuant to Item 15(c) of Form 10-K

†                    Confidentialtreatment requested as to certain portions, which portions have been filedseparately with the Securities and Exchange Commission

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