**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

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**FORM 10-K**

**FOR ANNUAL AND TRANSITION REPORTS 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, 2005**                                                                                                                     |
|                                                                                                                                                                      | ** ** | ** **                                                                                              |
| **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 ofregistrant 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 codes: **(781) 266-4000**

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**Securities registeredpursuant to Section 12(b) of the Act:**None

**Securities registeredpursuant to Section 12(g) of the Act:**CommonStock, $.01 par value per share(Titleof class)

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o No ý.

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 ý.

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 ý 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. ý

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  ý               Non-acceleratedfiler  o

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

The aggregate market value of the registrant’s commonstock held by nonaffiliates of the registrant was approximately $299,486,000,based on the price at which the registrant’s common stock was last sold on June 30,2005.

As ofFebruary 23, 2006, there were 36,632,342 shares of the registrant’s commonstock outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Specifiedportions of the registrant’s proxy statement for the annual meeting ofstockholders to be held on May 17, 2006, which are to be filed pursuant toRegulation 14A within 120 days after the end of the registrant’sfiscal year ended December 31, 2005, are incorporated by reference intoItem 5 of Part II and 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                                                                                                      |       |     | 22 |   |
| Item 1b.      |       | Unresolved Staff Comments                                                                                          |       |     | 40 |   |
| Item 2.       |       | Properties                                                                                                         |       |     | 40 |   |
| Item 3.       |       | Legal  Proceedings                                                                                                 |       |     | 40 |   |
| Item 4.       |       | Submission of Matters to a Vote of Security Holders                                                                |       |     | 40 |   |
| PART II  |       |                                                                                                               |       |     |   |   |
| Item 5.       |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |     | 41 |   |
| Item  6.      |       | Selected  Financial Data                                                                                           |       |     | 42 |   |
| Item 7.       |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |     | 43 |   |
| Item 7A.      |       | Quantitative and Qualitative Disclosures About Market  Risk                                                        |       |     | 55 |   |
| Item 8.       |       | Financial Statements and Supplementary Data                                                                        |       |     | 56 |   |
| Item 9.       |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       |     | 85 |   |
| Item 9A.      |       | Controls and Procedures                                                                                            |       |     | 85 |   |
| Item  9B.     |       | Other  Information                                                                                                 |       |     | 88 |   |
| PART III |       |                                                                                                               |       |     |   |   |
| Item 10.      |       | Directors and Executive Officers of the Registrant                                                                 |       |     | 88 |   |
| Item 11.      |       | Executive Compensation and Related Stockholder Matters                                                             |       |     | 89 |   |
| Item 12.      |       | Security Ownership of Certain Beneficial Owners and  Management                                                    |       |     | 89 |   |
| Item 13.      |       | Certain Relationships and Related Transactions                                                                     |       |     | 89 |   |
| Item 14.      |       | Principal Accountant Fees and Services                                                                             |       |     | 89 |   |
| PART IV  |       |                                                                                                               |       |     |   |   |
| Item 15.      |       | Exhibits and Financial Statement Schedules                                                                         |       |     | 89 |   |
| SIGNATURES    |       |                                                                                                               | 90         |     |

 

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**PART I**

*Thisannual report on Form 10-K contains forward-looking statementsthat involve risks and uncertainties, as well as assumptions that, if theynever materialize or prove incorrect, could cause our results to differmaterially from those expressed or implied by such forward-lookingstatements. All statements other than statements of historical fact arestatements that could be deemed forward-looking statements, including anyprojections of revenue, expenses, earnings or losses from operations, or otherfinancial items; any statements of the plans, strategies and objectives ofmanagement for future operations; any statements concerning product research,development and commercialization timelines or outcomes; any statements ofexpectation or belief; and any statements of assumptions underlying any of theforegoing. The risks, uncertainties and assumptions referred to above includerisks that are described in “Risk Factors” and elsewhere in this annual reportand that are otherwise described from time to time in our Securities andExchange Commission reports filed after this report.*

*Theforward-looking statements included in this annual report represent ourestimates as of the date of this annual report. We specifically disclaim anyobligation to update these forward-looking statements in the future,except as specifically required by law or the rules of the Securities andExchange Commission. These forward-looking statements should not berelied upon as representing our estimates or views as of any date subsequent tothe date of this annual report.*

**ITEM 1.**                BUSINESS

**Overview**

We are an emergingpharmaceutical company with substantial expertise and intellectual property innitric oxide-based drug development. Our goal is to become a leading, multi-productpharmaceutical company by developing innovative nitric oxide-basedproducts and by building on our BiDil® development experience andcommercialization infrastructure to identify and market additional products forcardiovascular and metabolic diseases. We have devoted substantially all of ourefforts towards the research and development of our product candidates and thecommercialization of our currently marketed product, BiDil. Since ourinception, we have funded our operations mainly through the sale of equitysecurities, debt financings, license fees, research and development funding andmilestone payments from our collaborative partners. We have never beenprofitable and have incurred an accumulated deficit of $242.5 million as of December 31,2005.

In June 2005, theU.S. Food and Drug Administration, or FDA, approved our first commercialproduct, BiDil, for the treatment of heart failure in self-identified blackpatients as an adjunct to current standard therapies. BiDil is an orallyadministered fixed-dose combination of isosorbide dinitrate and hydralazinehydrochloride. We commercially launched BiDil in July 2005 and generatedproduct sales of $4.5 million during the year ended December 31, 2005. Wemarket BiDil primarily to cardiologists and primary care physicians who treatAfrican Americans with heart failure. Our sales and marketing organization iscomprised internally of a senior vice president of sales and marketing, a vicepresident of sales, a vice president of marketing, three regional sales directorsand fifteen district sales managers. In addition, we have an agreement withPublicis Selling Solutions pursuant to which, on our behalf, Publicis hasemployed and trained a cardiovascular specialty sales force currentlyconsisting of 144 sales representatives to sell BiDil to our target prescribermarkets. We have also engaged Schwarz Pharma under a five-year exclusivemanufacturing and supply agreement for the three times daily immediate releasedosage formulation of BiDil.

We are also applying ournitric oxide technology to develop additional novel pharmaceuticals, as well assafer and more effective versions of existing drugs, to target significantdiseases that are characterized by a deficiency in nitric oxide and to treatunderserved patient populations. Our nitric oxide-development strategy involvesthe internal development of proprietary nitric oxide-enhancing productcandidates, such 

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asBiDil, the co-development of nitric oxide-enhancing drugs withcollaborators and the out-licensing of our nitric oxide-enhancing technology inexchange for potential milestone payments and royalties on sales.

We expect that research,development and commercialization expenses relating to our products and productcandidates and to enhancing our core technologies will continue to fluctuate inthe near-term and may vary significantly from our current estimates. Ouroperating expenses related to our research and development efforts and oursales, general and administrative costs for the year ended December 31,2005, total $105.9 million. We currently estimate that our operating expensesfor fiscal year 2006 will range between $95.0 and $110.0 million, excludingcost of product sales and expenses related to the adoption of Statement ofFinancial Accounting Standards (“SFAS”) No. 123R, *Share-BasedPayment*. We believe that our existing cash, cash equivalents andmarketable securities, together with the proceeds from our recent equityoffering in January 2006, will be sufficient to fund our current operatingplan, including operating expenses in support of the launch andcommercialization of BiDil, for at least the next 21 months.

In the near-term, a keydriver of our success will be our ability to successfully launch, commercializeand achieve market penetration of BiDil. We will need to generate significantrevenues to achieve profitability. At the present time we are unable toestimate the level of revenues that we will realize from sales of BiDil or thecommercialization of other product candidates that we may successfully developand commercialize. We are therefore unable to estimate when we will achieveprofitability, if at all.

We were incorporated inDelaware in 1992. Our principal executive office is located at 125 SpringStreet, Lexington, Massachusetts 02421, and our telephone number is(781) 266-4000. Our Internet address is www.nitromed.com. Theinformation on our website is not incorporated by reference into this annualreport on Form 10-K and should not be considered to be a part ofthis annual report. Our website address is included in this annual report on Form 10-Kas an inactive technical reference only.

When used in this annualreport on Form 10-K, the terms “NitroMed,” “we,” “our” and “us”refer to NitroMed, Inc., unless otherwise specified. We own the trademarksNitroMed®,NitRx®, BiDil®,and NitroMed’s logo “N.” Other trademarks and service marks appearing in thisannual report on Form 10-K are the property of their respectiveholders.

**OurNitric Oxide-Enhancing Medicines**

Nitric oxide is anaturally occurring compound that is synthesized in cells to regulate a broadrange of cellular reactions. Many disease states are associated with adeficiency in nitric oxide and might benefit from nitric oxide-enhancingmedicines. For example, depleted levels of nitric oxide have been implicated indiseases such as heart failure, pulmonary hypertension and sexual dysfunction.Additionally, nitric oxide-enhancing medicines have been shown to reduceside effects associated with a variety of medications, including a broad range ofanti-inflammatory medications.

**BiDil:Treatment for Heart Failure in African Americans**

*Heart Failure in African Americans*

Heart failure, also calledcongestive heart failure or dilated cardiomyopathy, is a progressivelyworsening condition that occurs when the heart muscle weakens and cannot pumpblood efficiently enough to meet the metabolic needs of the body. The loss ofpump function is usually caused by an underlying condition, such ashypertension or coronary artery disease, which weakens the heart muscle andincreases a person’s risk of heart failure. The most common symptoms of heartfailure include shortness of breath from congestion in the lungs, fatigue,sleeping problems due to the inability to lay flat, sudden awakening withshortness of breath and swelling in the feet, ankles and other parts of thebody.

Heart failure affectsapproximately five million Americans and there is currently no cure for thedisease. After a patient is diagnosed with heart failure, their prognosis isgenerally poor, with approximately 50 percent of patients dying within fiveyears. Heart failure is the primary reason for 

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hospitalizationsamong people over the age of 65 and is one of the most expensive diseases facedby Americans, costing more than all cancers combined.

An estimated 750,000African Americans are currently diagnosed with heart failure, with the numberexpected to increase to nearly 900,000 by 2010, based on data from the U.S.census bureau and the Centers for Disease Control and Prevention. AfricanAmericans between the ages of 45 and 64 are 2.5 times more likely to die fromheart failure than Caucasians in the same age range. The African Americancommunity also presents with the disease at a younger age than their whitecounterparts, resulting in earlier disability, and higher rates of bothhospitalization and premature death. In addition, some medicines approved forthe treatment of heart failure appear to be less effective in controlling highblood pressure in African American patients. Ethnic disparities in theprevalence of heart failure have been attributed to a variety of factors,including access to medical care, disease management, socioeconomic factors,lifestyle habits and a higher incidence of diabetes, hypertension and metabolicsyndrome.

*African American Heart Failure Trial (A-HeFT)*

In 2001, we partnered withthe Association of Black Cardiologists, Inc. to conduct the AfricanAmerican Heart Failure Trial (A-HeFT), the first trial conducted in a heartfailure population in which all of the participants identified themselves asblack. A retrospective analysis of an earlier study with a combination ofisosorbide dinitrate and hydralazine hydrochloride had suggested a trend forimproved survival in the subset of patients with mild to moderate heart failurewho self-identified as black. The randomized, double-blind, placebo-controlledA-HeFT study enrolled 1,050 self-identified black patients with New York HeartAssociation, or NYHA, class III or IV heart failure at 169 clinical researchsites. The classification system means that patients had marked limitation ofphysical activity (class III) or were unable to carry out any physical activitywithout discomfort (class IV). Participants in A-HeFT were required to bestable while receiving standard heart failure therapy at the time of thebeginning of the trial, per their physicians. The primary end point for thetrial was a composite score made up of weighted values for death from anycause, a first hospitalization for heart failure, and change in the quality oflife.

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 in additionto current therapies experienced a significant 43% decrease in the risk ofmortality (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 heart failure,both moderate and severe, which were significantly more frequent in the placebogroup.

*BiDil: Launch and Commercialization Strategy*

BiDil,an orally administered fixed-dose combination of isosorbide dinitrate andhydralazine hydrochloride, was approved by the FDA in June 2005 for thetreatment of heart failure in self-identified black patients. BiDil isindicated for the treatment of heart failure as an adjunct to standard therapyin self-identified black patients to improve survival, to prolong time tohospitalization for heart failure, and to improve patient-reported functionalstatus. There is little experience in patients with NYHA class IV heartfailure. Most patients in the clinical trial supporting effectiveness, referredto as A-HeFT, received, in addition to BiDil or placebo, a loop diuretic, anangiotensin converting enzyme inhibitor or an angiotensin receptor blocker, anda beta blocker, and many also received a cardiac glycoside or an aldosteroneantagonist. BiDil is a fixed-dose combination of isosorbide dinitrate, avasodilator with effects on arteries 

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and veins, and hydralazine hydrochloride, apredominantly arterial vasodilator. The mechanism of action underlying thebeneficial effects of BiDil in the treatment of heart failure has not beenestablished.

Sincelaunch in July 2005, our sales strategy for BiDil has been focused on:

·       concentratedsales efforts through a dedicated sales force:

·       ensuringpatient access through

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

·        ourpatient assistance program, and

·        coalitionbuilding with advocacy organizations; and

·       creatingphysician awareness through our publications strategy.

We market BiDil tocardiologists, primary care physicians and other caregivers who treat AfricanAmericans with heart failure through a dedicated sales and marketingorganization. Our sales and marketing organization is comprised internally of asenior vice president of sales and marketing, a vice president of sales, a vicepresident of marketing, three regional sales directors and fifteen districtsales managers. In addition, we have an agreement with Publicis SellingSolutions pursuant to which, on our behalf, Publicis has employed and trained aspecialty sales force currently consisting of 144 sales representatives to sellBiDil to our target prescriber markets. Under this agreement, we have the rightto hire some or all of the Publicis representatives directly at any time uponthe payment to Publicis of an agreed upon fee and after July 2006 withoutpenalty. Under separate agreements, Publicis has recruited, hired and trainedseven account executives and one national director who are assisting us ingaining formulary access and preferential reimbursement treatment for BiDil,and has hired five medical science liaisons to report into our medical affairsgroup.

We launched BiDil in July 2005with 195 sales territories that were estimated to account for 90% of AfricanAmerican patients with heart failure, covering approximately one-third of thenation’s postal zip codes. Based on six-month post-launch experience, we havefound that the African American heart failure market is more concentrated thanprojected, with approximately 90% of BiDil prescriptions coming from only 141of these 195 territories. With this knowledge, we have reduced our sales forcerepresentation to approximately 144 sales representatives in order to furtherfocus our sales force efforts and to generate greater cost-effectiveness in oursales strategy. As part of our effort to make our sales force more effectiveand cost-efficient, we intend to transition the sales force from contractors toNitroMed employees by the third quarter of 2006, as permitted under ourexisting Publicis contract.

With respect tomanufacturing, we have engaged Schwarz Pharma under a five-year exclusivemanufacturing and supply agreement for the three times daily immediate releasedosage formulation of BiDil. Under the supply agreement, we have the right toengage a backup manufacturer. As part of the manufacturing process, we orderbulk materials of hydralazine hydrochloride from Flavine International, Inc.,the U.S. representative of Sumitomo Corp., and isosorbide dinitrate fromDottikon ES Holding AG, and have them delivered directly to Schwarz Pharma formanufacturing.

Our current efforts toexpand patient access to BiDil focus on gaining improved insurance coverage. Weobtained approximately 100% private insurance coverage at launch at Tier III, aterm generally used to denote the level of reimbursement at which access to aproduct is approved by a third-party payor but at which patient co-paysare at their highest level, ranging from approximately $30.00 to $50.00. We arecurrently seeking to secure Tier II reimbursement, a term generally used todenote a preferential level of reimbursement at which patient co-pays rangefrom approximately $15.00 to $25.00, for 35% of privately covered lives duringthe first quarter of 2006, and 50% of privately covered lives by July 2006.With respect to Medicare Part D, a Medicare prescription drug plan, as of February 2,2006, in the 21 states that comprise 90% of the African American patientpopulation, BiDil was listed on 38% of existing plans. Out 

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of allsuch plans on which BiDil was listed, 24% listed BiDil at a Tier IIpreferential reimbursement level. BiDil is currently covered under Medicaidplans covering 99% of the African American patient population covered underMedicaid plans.

With respect to ourcoalition-building efforts, we recently announced a strategic alliancewith the National Association for the Advancement of Colored People (NAACP) toimplement measures to narrow health care disparities that exist between AfricanAmericans and Caucasians in areas of access, affordability, quality,infrastructure and compliance. As part of the partnership, NitroMed isproviding a $1.5 million grant to establish an organizationalinfrastructure to allow the NAACP to develop the necessary grass roots healthadvocacy initiatives. We have also developed coalitions with other advocacy andprofessional organizations as part of our efforts to address racial and ethnicdisparities in cardiovascular disease, including the Association of BlackCardiologists and the Congressional Black Caucus.

In 2006, our efforts tocontinue to enhance physician awareness of BiDil and its effectiveness will besupported by the expected submission of up to 6 primary publications related toBiDil based on data from the A-HeFT trial.

***Internal DevelopmentPrograms***

*BiDil XR and BiDil Combination*

The current formulation ofBiDil is an immediate-release tablet that must be taken three times daily. Weare currently pursuing the development of an extended release formulation of BiDil(BiDil XR) that could be taken either once or twice a day, depending on theparticular formulation we pursue. BiDil XR could enhance the BiDil market byfacilitating greater compliance by patients with their medications schedule, anissue which is more pronounced in a patient population already on a substantialnumber of concomitant medications.

We are also engaging inresearch and development efforts to develop BiDil Combination products whichwould combine BiDil with existing, marketed medicines, such as ACE inhibitors,beta blockers, or aldosterone receptor blockers. BiDil and the existingmedicines can be combined together through either a chemical linkage topotentially create a proprietary new chemical entity or through the directmixing of the medicines and BiDil to potentially create a patentable new useand dosage form. We generally pursue development opportunities with respect tonitric oxide-enhancing drugs from among those marketed medicines whose safetyand efficacy we believe can be improved by increased nitric oxide levels in thebody. We believe that the probability of clinical success for ournext-generation BiDil Combination product candidates is increased becauseregulatory approvals have already been achieved for the existing medicines thatwe are seeking to improve. We also believe that the commercial risk associatedwith these product candidates is mitigated because many of these existingmedicines have already generated significant sales in their markets.

*Cardiovascular Portfolio*

We are utilizing ournitric oxide expertise and proprietary position to develop product candidatesfor a variety of additional medical conditions. As part of this effort, werecently announced that we expect to file an Investigational New DrugApplication for NMI 3377, a proprietary nitric oxide-enhancingcardiovascular agent, in the second quarter of 2006. We currently have retainedall development rights to this product candidate.

*Other Nitric Oxide Enhancing Product Candidates*

**Overview**

In the 1980s, nitric oxidewas identified as a significant molecule that regulates a wide range ofimportant cellular functions. Professor Robert R. Furchgott, a member of ourscientific advisory board 

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untilhis retirement in 2005, and two other individuals were awarded the Nobel Prizein Physiology and Medicine in 1998 for this discovery.

Recent research has shownthat nitric oxide also plays important biochemical and physiological roles inmany diseases or medical conditions, including the following:

*Cardiovascular Disease.*   Theformation of nitric oxide in the cells that line the inner walls of bloodvessels, referred to as the endothelium, has been found to play a crucial rolein maintaining the dilation of the blood vessels, a process essential for theregulation of blood pressure. Nitric oxide produced by the endothelium alsoinhibits the clumping of platelets, which are cells in the blood that promoteclotting, and the adhesion of platelets and white blood cells to the bloodvessels’ inner walls, thereby significantly reducing the obstruction of bloodvessels that is associated with blood clots and stroke. Numerous othercardiovascular actions of nitric oxide have been reported, includingmaintaining sufficient blood flow to the heart muscle and regulation of thecontraction of the heart muscle. Cardiovascular diseases associated with nitricoxide imbalance include atherosclerosis, high cholesterol levels, high bloodpressure, pulmonary hypertension and heart failure.

*Gastrointestinal andInflammatory Disease.*   Nitric oxide iscapable of influencing many of the biochemical and physiological reactions thatare key to preventing or repairing injury to the gastrointestinal tract, suchas stimulating mucus secretion from the mucus membrane lining the stomach andintestines and regulating the blood flow feeding the wall of thegastrointestinal tract and the mucus membrane. Nitric oxide can controlinflammatory cell activation and is active on other chemical mediators in theinflammatory process. Gastrointestinal diseases in which nitric oxide haspotential beneficial actions include gastric injury, inflammatory boweldisease, and peptic ulcer induced by non-steroidal anti-inflammatory drugs, orNSAID’s.

*Central Nervous SystemDisorders.*   Nitric oxide isalso synthesized in nerve cells, or neurons, of the central nervous system,where it performs many physiological functions, including the formation ofmemory and the modulation of pain. Nitric oxide-based therapies fordiseases such as epilepsy, stroke, neuroinflammatory disorders and trauma maybe able to provide protection to neurons.

*Sexual Dysfunction.*   Inthe peripheral nervous system, nitric oxide is now known to play a role inregulating some forms of vasodilation and certain gastrointestinal, respiratoryand genito-urinary functions. For example, male penile erection isdependent upon nitric oxide-relaxation of genital smooth muscles, anddrugs like Viagra enhance the nitric oxide-signaling pathway.

*Respiratory Disease.*   Nitricoxide inhalation reduces pulmonary hypertension and improves oxygenation, theabsorption of oxygen by the lungs. In inflammatory pulmonary diseases, such asasthma and chronic obstructive pulmonary disease, nitric oxide has thepotential to promote airway dilation and reduce inflammation, thus reducingairway sensitivity to airborne irritants and allergens.

We estimate that candidatemedicines for our nitric oxide technology have current annual worldwide salesin excess of $30 billion. We seek to produce our nitric oxide-enhancing drugcandidates by combining an existing, marketed medicine with a nitric oxidedonor, which is a molecule capable of increasing nitric oxide levels in thebody. The nitric oxide donor and the existing medicine can be combined togetherthrough either a chemical linkage to potentially create a proprietary newchemical entity or through the direct mixing of the medicine and the nitricoxide enhancing compound to potentially create a patentable new use and dosageform. We believe that the probability of clinical success for our drugcandidates is increased because regulatory approvals have already been achievedfor the existing medicines that we are seeking to improve. We also believe thatthe commercial risk associated with these drug candidates is mitigated becausemany of these existing medicines have already generated significant sales intheir markets.

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We have generatedsignificant intellectual property rights for our nitric oxide technology andcompounds to protect our interests and support our discovery and development ofadditional product candidates.

**NitricOxide Enhancing Medicines for the Treatment of Cardiovascular Disease**

We have initiated severalnew and novel cardiovascular drug discovery programs based on the therapeuticpotential of nitric oxide-enhancing drugs in the treatment of diseasesassociated with Endothelial Dysfunction. Endothelial Dysfunction is recognizedas one of the common denominators underlying many cardiovascular diseasesincluding atherosclerosis, hypertension, heart failure, diabetes, pulmonaryhypertension and metabolic syndrome. Abnormal function of the endotheliumprecedes vascular morphological changes in the early stages of cardiovasculardisease. Nitric oxide has many important roles in maintaining the function ofnormal endothelium. These include vasodilatation, inhibition of plateletadhesion and activation, inhibition of smooth muscle growth, inhibition ofleukocyte adhesion and a reduction in chemotactic factor expression. Loss ofnitric oxide therefore is a primary feature of endothelial dysfunction.Restoration of nitric oxide from the endothelium has been clinicallydemonstrated to reduce cardiovascular risk in many disease states. We thereforeare using our nitric oxide expertise and proprietary patent position to addnitric oxide-donating capacity to existing classes of drugs which have beenshown to have clinical utility in the treatment of cardiovascular diseaseswhere endothelial dysfunction plays a critical role.

Thefollowing table highlights those classes of nitric oxide-enhancingcardiovascular medicines where we have created, or are seeking to create,intellectual property rights, and where we believe we may offer a clinicalbenefit compared to existing FDA-approved medicines.
| **Product Candidate and Therapeutic Area**                           | ** ** | **Potential Clinical Benefit**     |   |
|----------------------------------------------------------------------|------------|------------------------------------|--------|
| **Nitric Oxide-Enhancing Angiotensin  Receptor Blockers**            | ** ** | ** **                         |   |
| •                                                               |       | Hypertension                       |   | • |   | Improved endothelial function; accelerated blood pressure lowering;  enhanced renal protection |
| **Nitric Oxide-Enhancing Beta Blockers**                             |       |                               |   |   |
| •                                                               |       | Hypertension, Heart Failure        |   | • |   | Better tolerated (reduction in impotence, insulin resistance);  improved endothelial function |
| **Nitric Oxide-Enhancing Diuretics**                                 |       |                               |   |   |
| •                                                               |       | Hypertension, Heart Failure, Edema |   | • |   | Better side effect profile; enhanced diuresis/natriuresis; enhanced  renal protection |
| **Nitric Oxide-Enhancing  Angiotensin-Converting Enzyme Inhibitors** |       |                               |   |   |
| •                                                               |       | Hypertension                       |   | • |   | Improved efficacy; enhanced renal protection |
| **Nitric Oxide-Enhancing Renin Inhibitors**                          |       |                               |   |   |
| •                                                               |       | Hypertension                       |   | • |   | Improved efficacy |
| **Nitric Oxide-Enhancing  Statins**                                  |       |                               |   |   |
| •                                                               |       | Hypertension                       |   | • |   | Enhanced activity; faster onset |
| **Nitric Oxide-Enhancing  Aldosterone Antagonists**                  |       |                               |   |   |
| •                                                               |       | Hypertension                       |   | • |   | Improved blood pressure control |
|                                                                      |            |                                    |        |  |  |  |  |  |

 

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**NitricOxide-Based Medicines 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 on thedevelopment of early stage projects to a point where they can be furtherdeveloped by the commercial sector.

**Other Development Programs**

We areutilizing our nitric oxide expertise and proprietary position to developproduct candidates for a variety of additional medical conditions. Thefollowing table highlights those classes of nitric oxide-enhancingmedicines where we have created, or are seeking to create, intellectualproperty rights and where we believe we may offer a clinical benefit comparedto existing FDA-approved medicines. Our efforts in these areas primarilyconsist of discovery-stage research primarily directed to establishingour intellectual property position.
| **Product Candidate and Therapeutic Area**               | **Potential Clinical Benefit**                                 |   |
|----------------------------------------------------------|----------------------------------------------------------------|--------|
| **Nitric Oxide-Enhancing NSAID’s**                  |                                                           |   |
| •                                                   | Pain, inflammation, cancer and central nervous system diseases | • | Improved gastrointestinal tolerance; accelerated ulcer healing;  reduced kidney damage and hypertension |
| **Nitric Oxide-Enhancing  Phosphodiesterase Inhibitors** |                                                           |   |
| •                                                   | Pain, inflammation, cancer and central nervous system diseases | • | Anti-nociceptive; anti-inflammatory; enhanced efficacy; fewer side  effects |
|                                                     |                                                           | • | Increased airway circulation; reduced lung |
| •                                                   | Asthma                                                         |   | inflammation and decreased sensitivity to airborne allergens |
| •                                                   | Male erectile dysfunction                                      | • | Increased response rate; rapid onset of action |
| •                                                   | Pulmonary hypertension                                         | • | Increased efficacy; longer duration of action |
| •                                                   | Chronic obstructive airway disease                             | • | Increased airway circulation |
|                                                     |                                                           |   |   |
| **Nitric Oxide-Enhancing  Steroids**                     |                                                           |   |
| •                                                   | Allergy and Asthma                                             | • | Faster onset of action; increased airway circulation |
| •                                                   | Dermatology                                                    | • | Faster onset of action; increased efficacy |
| **Nitric Oxide-Enhancing  Gastrointestinal Protectants** |                                                           |   |
| •                                                   | Peptic ulcer                                                   | • | Improved efficacy; faster onset of action |
|                                                          |                                                                |        |  |  |

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| **Nitric Oxide-Enhancing Arginines**    |            |   |
|-----------------------------------------|-----------------|--------|
| •                                  | Kidney failure  | • | Improved sodium and water balance |
|                                    |            |   |   |
| **Nitric Oxide-Enhancing  Antibiotics** |            |   |
| •                                  | Cystic Fibrosis | • | Improved antibacterial activity; increased mucus production |

 

**Corporate Collaborations**

As part of our strategy toaccelerate our product development efforts, we established collaborations withBoston Scientific Corporation in the area of nitric oxide-enhancing paclitaxel-coatedstents to reduce restenosis and with Merck Frosst Canada & Co., aMerck & Co., Inc. subsidiary, in the area of nitric oxide-enhancingCOX-2 inhibitors for use in the treatment of various diseases. In November 2004,we agreed to terminate our collaboration with Merck. In addition, on December 31,2005, the research term under our agreement with Boston Scientific expired. Thesecollaborations were designed to provide us with capital and research,development and marketing capabilities. We intend to pursue othercollaborations, as appropriate. Since inception, a substantial portion of ourrevenue has been derived from our collaborations with third parties. For theyears ended December 31, 2005, 2004 and 2003, our collaboration withBoston Scientific accounted for $1,592,000, $1,592,000 and $442,000 in revenue.

***Boston Scientific Agreement***

In November 2001, we entered into a research,development and license agreement with Boston Scientific in the field ofrestenosis. We granted Boston Scientific an exclusive worldwide license todevelop and commercialize nitric oxide-enhancing cardiovascular stents.We also granted to Boston Scientific a right of first refusal to obtain anexclusive license under our nitric oxide technologies to commercialize productsfor restenosis, which right of first refusal is for a period of three yearsafter the end of the research term. In December 2003, we agreed to extendthe agreement to continue the research and development collaboration through December 2005.

Boston Scientific made an up-front license payment of$1.5 million to us in 2001, and made an additional payment of$3.0 million in December 2003 in connection with the extension of theresearch and development collaboration. In the event that specified research,development and commercialization milestones were achieved, Boston Scientificwould have been obligated to make milestone payments to us. In addition, BostonScientific would have been obligated to pay royalties to us on the sale of anyproducts resulting from the collaboration. Boston Scientific made a$3.5 million equity investment in our stock in 2001. In August 2003,in connection with a private placement, Boston Scientific made an additional$500,000 equity investment in our stock.

The research term of theBoston Scientific agreement expired on December 31, 2005, although certainrights extend beyond this term. We intend to evaluate the continued developmentof this technology and in the future may seek collaboration with otherpotential partners.

***Merck Agreement***

In December 2002, we entered into a research,development and license agreement with Merck to jointly develop pharmaceuticalproducts containing nitric oxide-enhancing COX-2 inhibitors. Underthe terms of the agreement, we granted Merck an exclusive worldwide, royalty-bearinglicense to develop, make and sell nitric oxide-enhancing COX-2inhibitors for use in the treatment or prevention of various diseases,conditions or disorders.

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Merck paid an up-front license fee of$10.0 million under the agreement and also made research and developmentpayments over the three-year term of the research program totaling $7.2million. In 2003, Merck made two payments, each of $5.0 million, forachieving the first two milestones.

On September 30,2004, Merck halted the phase II trial of our lead candidate in nitric oxide-enhancingCOX-2 inhibitors. This lead nitric-oxide candidate is composed of aderivative of rofecoxib. Rofecoxib is the active ingredient in Vioxx, a COX-2inhibitor which Merck voluntarily withdrew from worldwide markets on September 30,2004. In November 2004, we agreed with Merck to terminate thecollaboration agreement. Merck paid us a lump sum of $1.8 million,representing the full amount of the research funding owed to us for 2005, butis not required to provide us with any further funding. We retain all rights toour technology in the field of nitric oxide-enhancing COX-2inhibitors, and intend to evaluate the continued development of this technologyin collaboration with other potential partners.

**Our Strategy**

Our goal is to become a leading, multi-productpharmaceutical company by developing additional innovative nitric oxideproducts and by building on our BiDil development experience andcommercialization infrastructure to identify and market additional products forcardiovascular and metabolic diseases. Key elements of our strategy include:

*Successfully commercializing BiDil*.   Wecurrently have an internal marketing and sales infrastructure and a dedicatedcontract sales force, which sales force we intend to internalize by the thirdfiscal quarter of 2006, to promote BiDil for the treatment of heart failure inAfrican Americans. Based on the number of physicians serving the AfricanAmerican heart failure market and the experience we have gained six months intoBiDil’s launch, we believe we can successfully promote BiDil with approximately144 sales representatives, a reduction of over fifty sales representatives fromour initial pre-launch estimates. This reduction in sales force representativescould result in our failure to realize certain market potential in areas inwhich we have chosen not to provide representation.

We have also seen steady prescription growth for BiDilsince launch, with total prescriptions for BiDil increasing from an average ofapproximately 1,100 per month in the third quarter of 2005 to an average ofapproximately 3,500 per month in the fourth quarter of 2005, with December 2005at approximately 4,700, based on aggregate weekly data derived from SourceProjected Launchtrac, Wolters Kluwer Health. We will need to substantiallyincrease the number of prescriptions being written for BiDil in order tosuccessfully commercialize this product. Because BiDil is the only heartfailure treatment specifically indicated to treat African Americans with heartfailure, we believe that we will continue to achieve market acceptance andpenetration in this population and the physicians serving this population.

In addition, we believe that the documented efficacyand cost-effectiveness of BiDil will bolster our continuing efforts to expandthe level of preferential reimbursement treatment received by BiDil both frompublic and private payors. Our failure to achieve preferential reimbursementtreatment for BiDil in the near term could significantly hinder marketacceptance of BiDil by physicians and patients.

*Successfully leveraging our BiDil sales force*.   Oursales force targets high prescribing physicians who treat African Americanswith cardiovascular and metabolic diseases. We believe the African Americancommunity is an underserved patient population and suffers a disproportionateincidence of cardiovascular and other diseases. We believe that we canin-license or otherwise acquire rights to drugs and drug candidates to furtherserve this population.

*Capitalizing on our clinical development expertise*.   Webelieve the experience we gained in designing and executing our BiDil clinicaltrial program makes us an attractive clinical development partner for companiesdeveloping product candidates in the cardiovascular field.

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*Focusing our internal development projects andpotential collaborations on nitric oxide-enhancing versions of existingmedicines*.   We believe thatmany pharmaceutical companies have currently marketed drugs and products thatcan benefit from the therapeutic attributes and the potential patent protectionof our nitric oxide-enhancing technology. We are currently conductingresearch and development on several drug classes and have consolidated anintellectual property position from which we believe we can generatesignificant value. We intend to pursue collaborations with leading health carecompanies where our product candidates will benefit from the marketing reach,clinical expertise and technology of the partner.

*Continuingto protect and enhance our product-specific and nitric oxide intellectualproperty rights and capabilities*.   Because of itscritical role in our on-going product development efforts, we intend toaggressively pursue the protection of our intellectual property. In order toprotect and expand our current intellectual property position, we intend toinvest significantly in nitric oxide-related research and developmentefforts, including attracting and retaining highly talented and experiencedpersonnel.

**Research and Development**

As of December 31, 2005, our research anddevelopment group consisted of 45 employees, including 19 biologists,11 medicinal chemists, 9 persons engaged in clinical development and6 persons engaged in patent and other research and development-relatedfunctions. Our research and development group is focusing on the continuousimprovement of our core technology, the development of new materials andplatforms, complementary products and new initiatives aimed at leveraging ourcore technology in new market areas.

During the fiscal yearsended December 31, 2005, 2004 and 2003, we estimate that our total company-sponsoredresearch and development expenses were $29.6 million, $23.0 million, and$15.1 million, respectively, and that our collaborator-sponsoredresearch and development expenses were $2.3 million, $5.0 million,$3.8 million, respectively.

**Proprietary**Rights and Licensing

Our policy is to prosecute and enforce our patents andproprietary technology. We intend to continue to file United States and foreignpatent applications to protect technology, inventions and improvements that areconsidered important to the development of our business. We will be able toprotect our proprietary technologies from unauthorized use by third partiesonly to the extent that our proprietary rights are covered by valid andenforceable patents or are effectively maintained as trade secrets.

As of December 31, 2005, we have 86 issued U.S.patents and 62 pending U.S. patent applications. We also have 66 issued patentsand 122 pending patent applications in certain major industrial countries,including Canada, the major European market countries, Australia and Japan. Ourissued U.S. and foreign patents expire on various dates between 2007 and 2025.

*BiDil.*   Wehave three U.S. patents, one expiring in 2007 and the other two in 2020, andone Canadian patent expiring in 2008, which relate to co-administration of thecomponents of BiDil. The first U.S. patent and the Canadian patent covermethods for reducing mortality associated with chronic congestive heartfailure. The second U.S. patent covers methods for reducing mortalityassociated with chronic congestive heart failure, for improving the quality oflife, for improving oxygen consumption or improving exercise tolerance in blackpatients. The third U.S. patent covers additional claims to specificindications and dosing ranges for the treatment of heart failure and otherconditions in black patients. We have not filed any patent applications outsideof the United States and Canada for BiDil, as pertains to the patent expiringin 2007. We have filed applications claiming priority relative to the patentsexpiring in 2020 in Canada and Europe. In addition, we have filed tenadditional U.S. patent applications and corresponding foreign patentapplications that could provide additional patent protection for BiDil.

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*NitricOxide Stents.**  *We haveseven U.S. patents expiring on dates between 2013 and 2021 which cover thecoating of medical devices with nitric oxide compounds, prevention of adverseeffects associated with the use of a medical device, treatment of a damagedvessel or treatment of a damaged vascular surface in a patient byadministration of a nitric oxide compound. We have five pending U.S. patentapplications which, if issued, will have expiration dates between 2021 and 2025and which cover the composition of matter of specific nitric oxide donors ornitric oxide-linked compounds and their methods of use for the treatmentof restenosis. We have filed additional patent applications worldwide. We havebeen issued one Australian patent, one European patent, and one Canadian patent,all of which expire in 2014.

*NitricOxide-Enhancing COX-2 Inhibitors and Nitric Oxide-EnhancingNSAID’s for Inflammation.*   We have three 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 coverdifferent compositions 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-enhancingNSAID’s.

We have filed additional patent applications worldwideand have been issued four Australian patents, three of which expire in 2016 andone in 2019, and one issued Canadian patent, which expires in 2016

*NitricOxide Enhancing Cardiovascular Compounds.*   Wehave nine pending U.S. patent applications and five pending Patent CooperationTreaty, or PCT, patent applications, which if issued, will have expirationdates between 2024 and 2026 and which disclose and claim novel nitricoxide-enhancing cardiovascular compounds. These applications also disclose kitsand methods of use for the treatment of several diseases and disorders

*Other Development Programs.**  *We also have a U.S. patent and a pending U.S. patentapplication, both of which expire in 2019, which disclose the methods of use ofN-hydroxyguanidine compounds in the treatment of renal failure. We have alsofiled additional foreign patents applications covering this technology.

**License,Manufacturing and Commercialization Agreements**

*SchwarzPharma Manufacturing, Inc.*   InFebruary 2005, we entered into a five-year exclusive manufacturing andsupply agreement with Schwarz Pharma for the three times daily immediaterelease dosage formulation of BiDil. Under the supply agreement, we have theright to engage a backup manufacturer but do not currently have any backupmanufacturing agreement in place. The agreement renews automatically upon theexpiration of the then-current term for successive one year terms unless eitherparty provides written notice of termination at least six months prior to theexpiration of the then-current term. The agreement is also terminable upon theoccurrence of certain specified events.

*CardinalHealth PTC, LLC.*   In June 2005, we enteredinto a three-year exclusive distribution agreement with Cardinal Health for thedistribution of BiDil in all formulations. We are obligated to pay CardinalHealth fees for the services provided under the agreement. Pursuant to theterms of the agreement, Cardinal Health has the right of first negotiation forany new pharmaceutical product to be sold by us during the term. The agreementrenews automatically unless either party provides written notice 

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of termination at leastninety days prior to the expiration of the then-current term. The agreement isterminable without cause upon 120-days notice. However, we are obligatedto pay certain fees if we exercise this termination right during the initialterm of the agreement. The agreement is also terminable upon the occurrence ofcertain specified events.

*PublicisSelling Solutions, Inc.**  *InNovember 2004, as amended in May 2005, we entered into an agreementwith Publicis, a contract sales organization, pursuant to which, on our behalf,Publicis has employed and trained a specialty sales force currently consistingof approximately 144 sales representatives to sell BiDil to our targetprescriber markets. The agreement is for a current term of 24 months beginningon January 31, 2005, with our option to continue the agreement beyond thisterm. We have the right to terminate this agreement upon 90 days written noticeto Publicis. If we had terminated this agreement during the period between January 31,2005 and January 30, 2006, we would have been required to pay atermination fee in the amount of $1.0 million. If we terminate during theperiod between January 31, 2006 and July 31, 2006, the terminationfee will be $750,000. If we terminate the agreement after July 31, 2006,Publicis is not eligible for a termination fee.

*Dr. JayN. Cohn.*   In January 1999,as amended in January 2001 and March 2002, we entered into acollaboration and license agreement with Dr. Jay N. Cohn. Under theagreement, 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 and are currently making royalty payments to Dr. Cohn since FDAapproval and since first commercial sale of BiDil. The agreement imposes uponus an obligation to use reasonable best efforts to develop and, upon receipt ofregulatory approval, manufacture, market and commercialize products based uponthe licensed rights. If we fail to meet this obligation, Dr. Cohn has theright to terminate the agreement and the license granted to us under theagreement. Dr. Cohn also has the right to terminate the agreement if wematerially breach the agreement and fail to remedy the breach within30 days. We have the right to terminate the agreement at any time upon30 days’ prior written notice. Unless earlier terminated, the agreementcontinues in perpetuity. Pursuant to the agreement, Dr. Cohn was appointedto our scientific advisory board, entered into a consulting agreement with usand was granted an option to purchase 10,000 shares of our common stock.

*TheBrigham and Women’s Hospital.**  *InAugust 1992, as amended in November 1996, we entered into a researchand license agreement with The Brigham and Women’s Hospital, Inc (BWH).Under the agreement, we sponsored a research program at BWH for a period ofapproximately 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.

*BostonUniversity.*   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 (BU). Under the agreement, we have agreed to sponsor a multi-yearresearch program at BU in the area of nitric oxide-enhancing medicines.Under the agreement, in exchange for our sponsored research funding, BU hasgranted us exclusive worldwide royalty-bearing rights to technology andinventions owned by BU and/or for the principal investigator named in theresearch proposal at the effective time of, or developed in the course of, thesponsored research program. We have agreed to pay royalties to BU on allproducts sold or distributed by us or our affiliates which incorporate or utilizeinventions, material or 

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information specified inthe agreement. The agreement imposes on us due diligence obligations withrespect to the development and commercialization of products based upon thelicensed rights. If we fail to meet these obligations, then upon notice by BU,the parties are required to enter into good faith negotiations, and if theparties cannot reach resolution, the license will become non-exclusive withoutthe right to sublicense. BU has the right to terminate the agreement if we materiallybreach the 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 (FoxKiser) forservices related to the regulatory approval process for BiDil. The agreementprovided for payment of legal consulting fees upon receipt of written FDAapproval of BiDil. In addition, the agreement requires us to pay royalties toFoxKiser on commercial sales of BiDil. The royalty term ends six months afterthe date of market introduction of an FDA-approved generic version of BiDil.During the third quarter of 2005, we entered into a separate consultingagreement with FoxKiser following the approval by the FDA of BiDil. During theyears ended December 31, 2005 and 2004, we recorded charges of $1.6 and$1.9 million, respectively, pertaining to the legal consulting feesrelated to these agreements. On June 23, 2005, we received written FDAapproval of BiDil, and in July 2005, we paid $2.4 million pursuant to theterms of these agreements.

*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 nitric oxideadducts in exchange for a royalty on any products, methods or services sold ordistributed by us or our licensees that are covered by the assigned patents.These patents cover technologies that were used in our former nitric oxide-coatedstent development program with Boston Scientific.

**Trademarks,Trade Secrets and Other Proprietary Information**

We also currentlyown the following U.S. trademarks:

·       BiDil;

·       NitroMed;

·       NitRx;and

·       NitroMed“N” logo.

In addition, we dependupon trade secrets, know-how and continuing technological improvements todevelop and maintain our competitive position. To maintain the confidentialityof trade secrets and proprietary information, we require our employees,scientific advisors, consultants and collaborators, upon commencement of arelationship with us, to execute confidentiality agreements and, in the case ofparties other than our research and development collaborators, to agree toassign their inventions to us. These agreements are designed to protect ourproprietary information and to grant us ownership of technologies that aredeveloped in connection with their relationship with us. These agreements maynot, however, provide protection for our trade secrets in the event ofunauthorized disclosure of such information.

**Competition**

We face intense competition from a wide range ofpharmaceutical and life science companies, as well as academic and researchinstitutions and government agencies. These competitors include organizationsthat are pursuing the same or similar technologies to those which constituteour technology platform and organizations that are developing andcommercializing pharmaceutical products that may be competitive with ourproduct or product candidates.

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We believe that competition for BiDil and our othernitric oxide-enhancing cardiovascular medicines that we may develop 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.

We also face competition from other companies that areactive in or entering into the area of nitric oxide-based therapeutics.We are aware of six companies working in the area of nitric-oxidetherapeutics: Angiogenix, Inc., GB Therapeutics, NicOx S.A., OxoN Medica,RenoPharm and Vasopharm BIOTECH GmbH.

Weintend to compete with these companies on the basis of BiDil’s strong label anddocumented efficacy and cost-effectiveness, our intellectual property portfolio,the expertise of our scientific and marketing and sales personnel and ournitric oxide technologies. Principal competitive factors in our industryinclude:

·       improvedpatient outcomes;

·       cost-effectiveness;

·       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. Accordingly, our competitors may succeed more rapidly than wewill in obtaining FDA approval for product candidates and achieving widespreadmarket acceptance of products. In addition, we also compete with thesecompanies with respect to manufacturing efficiency and marketing capabilitieswith respect to BiDil, our only approved product. We have no internalmanufacturing capabilities, and our marketing and sales resources may besignificantly more limited than those of our competitors.

**GovernmentRegulation and Reimbursement**

***FDA Requirements for New Drug Compounds***

The research,testing, manufacture and marketing of drug products are extensively regulatedby numerous governmental authorities in the United States and other countries.In the United States, drugs are subject to rigorous regulation by the FDA. TheFederal Food, Drug, and Cosmetic Act, and other federal and state statutes andregulations, govern, among other things, the research, development, testing,manufacture, storage, recordkeeping, labeling, promotion and marketing anddistribution of pharmaceutical products. Failure to comply with applicableregulatory requirements may subject a company to a variety of enforcementactions, including:

·       product seizures;

·       voluntaryor mandatory recalls;

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·       voluntaryor mandatory patient or physician notification;

·       withdrawalof product approvals;

·       restrictionson, or prohibitions against, marketing our products;

·       fines;

·       restrictionson importation of our products;

·       injunctions;

·       debarment;

·       civiland criminal penalties; and

·       suspensionof review, refusal to approve pending applications.

The steps ordinarily required before a newpharmaceutical product may be marketed in the United States includepre-clinical laboratory tests, animal tests and formulation studies, thesubmission to the FDA of a notice of claimed investigational exemption or aninvestigational new drug application, or IND, which must become effective beforeclinical testing may commence, and adequate and well-controlled clinical trialsto establish the safety and efficacy of the drug for each indication for whichFDA approval is sought. 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 potentialcandidates for a considerable period of time and impose costly procedures upona manufacturer’s activities. Success in early stage clinical trials does notassure success in later stage clinical trials. Data obtained from clinicalactivities is not always conclusive and may be susceptible to varyinginterpretations that could delay, limit or prevent regulatory approval. Even ifa product receives regulatory approval, later discovery of previously unknownproblems with a product may result in restrictions on the product or evencomplete withdrawal of the product from the market.

Pre-clinical tests include laboratory evaluation ofproduct chemistry and formulation, as well as animal trials to assess thepotential safety and efficacy of the product. The conduct of the pre-clinicaltests and formulation of compounds for testing must comply with federalregulations and requirements. The results of pre-clinical testing are submittedto the FDA as part of an IND.

A 30-day waiting period after the filing of eachIND is required prior to the commencement of clinical testing in humans. If theFDA has not commented on or questioned the IND within this 30-day period,clinical trials may begin. If the FDA has comments or questions, the questionsmust be answered to the satisfaction of the FDA before initial clinical testingcan begin. In addition, the FDA may, at any time, impose a clinical hold onongoing clinical trials. If the FDA imposes a clinical hold, clinical trialscannot commence or recommence without FDA authorization and then only underterms authorized by the FDA. In some instances, the IND process can result insubstantial delay and expense.

Clinical trials involvethe administration of the investigational new drug to healthy volunteers orpatients under the supervision of a qualified investigator. Clinical trials mustbe conducted in compliance with federal regulations and requirements, underprotocols detailing the objectives of the trial, the parameters to be used inmonitoring safety and the effectiveness criteria to be evaluated. Each protocolinvolving testing on U.S. subjects must be submitted to the FDA as part of theIND. The study protocol and informed consent information for patients inclinical trials must be submitted to institutional review boards for approval.

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Clinical trials to support a New Drug Application, orNDA, for marketing approval are typically conducted in three sequential phases,but the phases may overlap. In phase I, the initial introduction of the druginto healthy human subjects or patients, the drug is tested to assess safety,including side effects associated with increasing doses, metabolism,pharmacokinetics and pharmacological actions. Phase II usually involves trialsin a limited patient population, to determine dosage tolerance and optimumdosage, identify possible adverse effects and safety risks, and providepreliminary support for the efficacy of the drug in the indication beingstudied.

If a compound demonstrates evidence of effectivenessand an acceptable safety profile in phase II evaluations, phase III trials areundertaken to further evaluate clinical efficacy and to further test for safetywithin an expanded patient population, typically at geographically dispersedclinical trial sites. Phase I, phase II or phase III testing of any productcandidate may not be completed successfully within any specified time period,if at all.

After successful completion of the required clinicaltesting, generally an NDA is prepared and submitted to the FDA. FDA approval ofthe NDA is required before marketing of the product may begin in the UnitedStates. The NDA must include the results of extensive clinical and othertesting and a compilation of data relating to the product’s pharmacology,chemistry, manufacture, and controls. The cost of preparing and submitting anNDA is substantial. Under Federal law, the submission of NDAs are additionallysubject to substantial application user fees, currently exceeding $750,000, andthe manufacturer and/or sponsor under an approved application are also subjectto annual product and establishment user fees, currently exceeding $30,000 perproduct and $200,000 per establishment. Additional user fees exceeding $300,000apply for NDA supplements containing clinical data. These fees are typicallyincreased annually.

The FDA has 60 days from its receipt of an NDA todetermine whether the application will be accepted for filing based on theagency’s threshold determination that the NDA is sufficiently complete topermit substantive review. Once the submission is accepted for filing, the FDAbegins an in-depth review of the NDA. Under federal law, the FDA has agreed tocertain performance goals in the review of NDAs. Most such applications fornon-priority drug products are reviewed within ten months. The review processis often significantly extended by FDA requests for additional information orclarification regarding information already provided in the submission. The FDAmay also refer applications for novel drug products or drug products whichpresent difficult questions of safety or efficacy to an advisory committee,typically a panel that includes clinicians and other experts, for review,evaluation and a recommendation as to whether the application should beapproved. The FDA is not bound by the recommendation of an advisory committee.

If FDA evaluations of the NDA and the manufacturingfacilities are favorable, the FDA may issue an approval letter, or, in somecases, an approvable letter followed by an approval letter. An approvableletter generally contains a statement of specific conditions that must be metin order to secure final approval of the NDA. If and when those conditions havebeen met to the FDA’s satisfaction, the FDA will typically issue an approvalletter. An approval letter authorizes commercial marketing of the drug withspecific prescribing information for specific indications. As a condition ofNDA approval, the FDA may require post approval testing and surveillance tomonitor the drug’s safety or efficacy and may impose other conditions,including labeling restrictions which can materially impact the potentialmarket and profitability of the drug. Once granted, product approvals may bewithdrawn if compliance with regulatory standards is not maintained or problemsare identified following initial marketing. On July 20, 2004, the FDAissued a proposed rule that would replace not approvable and approvableletters with complete response letters. Complete response letters woulddescribe all specific deficiencies in an NDA but would not characterize theapplication as approvable or not.

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Once the NDA is approved, a product will be subject tocertain post-approval requirements, including requirements for adverse eventreporting and submission of periodic reports and/or supplemental NDA’s forapproval of changes to the originally approved prescribing information, productformulation, and manufacturing and testing requirements. Following approval,drug products are required to be manufactured and tested for compliance withNDA and/or compendial specifications prior to release for commercial distributions.The manufacture and testing must be performed in approved manufacturing andtesting sites complying with current Good Manufacturing Practice requirementsand subject to FDA inspection authority.

Approved drug products must be promoted in a mannerwhich is consistent with their terms and conditions of approval. In addition,the FDA requires substantiation of any claims of superiority of one productover another including, in many cases, requirements that such claims be provenby adequate and well controlled head-to-head clinical trials. To the extentthat market acceptance of our product candidates may depend on theirsuperiority over existing therapies, any restriction on our ability toadvertise or otherwise promote claims of superiority, or requirements toconduct additional expensive clinical trials to provide proof of such claims,could negatively affect the sales of our products and/or our expenses.

If the FDA’s evaluation of the NDA submission ormanufacturing facilities is not favorable, the FDA may refuse to approve theNDA or issue a not approvable letter.

A not approvable letter outlines the deficiencies inthe submission and often requires additional testing or information in orderfor the FDA to reconsider the application. Even with submission of thisadditional information, the FDA ultimately may decide that the application doesnot satisfy the regulatory criteria for approval. With limited exceptions, theFDA may withhold approval of an NDA regardless of prior advice it may haveprovided or commitments it may have made to the sponsor.

Once an NDA is approved, the product covered therebybecomes a “listed drug” which can, in turn, be cited by potential competitorsin support of approval of an abbreviated NDA. An abbreviated NDA provides formarketing of a drug product that has the same active ingredients in the samestrengths and dosage form as the listed drug and has been shown throughbioequivalence testing to be therapeutically equivalent to the listed drug.There is no requirement, other than the requirement for bioequivalence testing,for an abbreviated NDA applicant to conduct or submit results of pre-clinicalor clinical 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 a period of three years ofexclusivity following approval of a listed drug that contains previouslyapproved active ingredients but is approved in a new dosage, dosage form, routeof administration or combination, or for a new use, the approval of which wasrequired to be supported by new clinical trials conducted by or for thesponsor. During this three year period, the FDA cannot grant effective approvalof an abbreviated NDA 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 abbreviated NDA’s for genericversions of those drugs cannot be submitted unless the submission accompanies achallenge to a listed patent, in which case the submission may be made fouryears following the original product approval. Additionally, in the event thatthe sponsor of the listed drug has properly informed the FDA of patentscovering its listed drug, applicants submitting an abbreviated NDA referencingthat drug are required to certify whether they intend to market their genericproducts prior to expiration of those patents. If an abbreviated NDA applicantcertifies that it believes all listed patents are invalid or not infringed, itis required to provide notice of its filing to the NDA sponsor and the patentholder. If the patent holder then initiates a suit for patent infringementagainst the abbreviated NDA sponsor within 45 days of receipt of thenotice, the FDA cannot grant effective approval of the abbreviated NDA untileither 30 months has passed or there has been a court decision holdingthat the patents in 

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question are invalid ornot infringed. If the abbreviated NDA applicant certifies that it does notintend to market its generic product before some or all listed patents on thelisted drug expire, then the FDA cannot grant effective approval of theabbreviated NDA until those patents expire. The first abbreviated new drugapplicant(s) submitting substantially complete applications certifyingthat all listed patents for a particular product are invalid or not infringedmay qualify for a period of 180 days against other generics after a finalcourt decision of invalidity or non-infringement or after it begins marketingits product, whichever occurs first, during which subsequently submitted abbreviatedNDA’s cannot be granted effective approval.

From time to time, legislation is drafted andintroduced in Congress that could significantly change the statutory provisionsgoverning the approval, manufacturing and marketing of drug products. In addition,FDA regulations and guidance are often revised or reinterpreted by the agencyor the courts in ways that may significantly affect our business and ourproducts candidates. It is impossible to predict whether legislative changeswill be enacted, or FDA regulations, guidance or interpretations changed, orwhat the impact of such changes, if any, may be.

***Foreign Regulation of New Drug Compounds***

Approval of a product by comparable regulatoryauthorities may be necessary in foreign countries prior to the commencement ofmarketing of the product in those countries, whether or not FDA approval hasbeen obtained. The approval procedure varies among countries and can involverequirements for additional testing. The time required may differ from thatrequired for FDA approval. Although there are some procedures for unifiedfilings for some European countries with the sponsorship of the country whichfirst granted marketing approval, in general each country has its ownprocedures and requirements, many of which are time consuming and expensive.Thus, there can be substantial delays in obtaining required approvals fromforeign regulatory authorities after the relevant applications are filed.

In Europe, marketingauthorizations may be submitted at a centralized, a decentralized or a nationallevel. The centralized procedure is mandatory for the approval of biotechnologyproducts and provides for the grant of a single marketing authorization whichis valid in all European Union member states. As of January 1995, a mutualrecognition procedure is available at the request of the applicant for allmedicinal products which are not subject to the centralized procedure. We willchoose the appropriate route of European regulatory filing to accomplish themost rapid regulatory approvals. However, our chosen regulatory strategy maynot secure regulatory approvals on a timely basis or at all.

***Hazardous Materials***

Our research anddevelopment processes involve 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.

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**Scientific Advisors**

***Scientific Advisory Board***

We seek advice froma number of leading scientists and physicians on scientific and medicalmatters. In 2005 our scientific advisory board was chaired by our founder andmember of our board of directors, Joseph Loscalzo, M.D., Ph.D. The board met toassess:

·       ourresearch and development programs;

·       thedesign and implementation of our clinical programs;

·       ourpatent and publication strategies;

·       marketopportunities from a clinical perspective;

·       newtechnologies relevant to our research and development programs; and

·       specificscientific and technical issues relevant to our business.

The  members of our 2005 scientific advisory boardwere:

| **Name**                         | ** ** | ** **                                                                                                                                                                                                                 | ** ** | **Position/Institutional Affiliation** |
|----------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|
| Joseph Loscalzo, M.D.,  Ph.D.    |       | Chairman, Department of  Medicine; Physician in Chief, Brigham and Women’s Hospital; member, NitroMed  board of directors                                                                                             |
| Jay N. Cohn, M.D.                |       | Professor of  Medicine, Cardiovascular Division, University of Minnesota Medical School                                                                                                                                    |
| Martin Feelisch, Ph.D.           |       | Professor of  Medicine, Boston University School of Medicine                                                                                                                                                               |
| John D. Folts, Ph.D.             |       | Director,  Coronary Thrombosis Research and Prevention Laboratory, Department of  Medicine, University of Wisconsin-Madison and Professor of Medicine and  Nutritional Science, University of Wisconsin School of Medicine |
| Robert F. Furchgott,  Ph.D.      |       | Professor of  Pharmacology, Medical University of South Carolina and Nobel Laureate for his  work on nitric oxide                                                                                                          |
| Michael A. Marletta,  Ph.D.      |       | Professor of  Biochemistry and Molecular Biology, University of California, Berkeley                                                                                                                                       |
| Kevin McIntyre, M.D.,  J.D.      |       | Associate  Clinical Professor of Medicine, Harvard Medical School                                                                                                                                                          |
| Ínigo Saenz de Tejada, M.D. |       | President, Fundación  para la Investigación y el Desarrollo en Andrología, Madrid, Spain                                                                                                                    |

 

In December 2005, ourscientific advisory board was replaced by our technical review committee.

***Technical Review Committee***

Since the beginning of fiscal year 2006, we havesought advice for our drug research and development efforts from a technical reviewcommittee which is chaired by our founder and member of our board of directors,Joseph Loscalzo, M.D., Ph.D. The technical review committee meets regularly toassess the same research and development matters addressed by our formerscientific advisory board.

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Thecurrent members of our technical review committee are:

| **Name**                       | ** ** | ** **                                                                                                                                                   | ** ** | **Position/Institutional Affiliation** |
|--------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|
| Joseph Loscalzo, M.D.,  Ph.D.  |       | Chairman, Department of  Medicine; Physician-in-Chief, Brigham & Women’s Hospital; member,  NitroMed board of directors                        |
| Frank L. Douglas, M.D.,  Ph.D. |       | Executive Director,  Massachusetts Institute of Technology Center for Biomedical Innovation,  Professor of the Practice; member, NitroMed board of directors |
| Zola Horovitz, Ph.D.           |       | Consultant; formerly  member of management at Bristol-Myers Squibb; member, NitroMed board of  directors                                                     |

 

**Employees**

As of December 31,2005, we had 96 full-time employees, 30 of whom were engaged in sales andmarketing, 45 of whom were engaged in research and development and 21 of whomwere engaged in management, administration and finance. Of our employees, 25hold M.D. or Ph.D. degrees. 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.

**ProductLiability Insurance**

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.

**Significant Customers**

Mckesson, Cardinal Healthand AmerisourceBergen accounted for approximately 44%, 21% and 14% of ourproduct sales, and Boston Scientific accounted for 100% of our research anddevelopment revenues in fiscal 2005. No other company accounted for more than10% of our total revenues in fiscal 2005. Merck accounted for 90% and 96% ofour total research and development revenues in fiscal 2004 and 2003respectively. Another company accounted for the remainder of our revenues in2004 and 2003.

**Research andDevelopment**

We have dedicated asignificant portion of our resources to research and development as a method ofproducing new products, improving existing products and growing our revenues.We estimate that approximately 48% to 51% of our employees’ time has beendevoted to research and development for each of the last three fiscal years. Weincurred research and development expenses of $31.9 million, $28.0 million, and$18.9 million in fiscal 2005, 2004 and 2003, respectively. We anticipate that asignificant portion our operating expenses will continue to be related toresearch and development activities in fiscal 2006.

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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.

**Subsequent Event**

In January 2006, wecompleted a direct offering of shares of our common stock previously registeredunder our effective shelf registration statement, which was filed with theSecurities and Exchange Commission (SEC) in August 2005. Pursuant to thisoffering, we sold approximately 6.1 million shares of our common stock toselected institutional investors at a price of $10.25 per share. Proceeds to usfrom this registered direct offering, net of offering expenses and placementagency fees, totaled $58.6 million. The net proceeds of the financing will beused for general corporate purposes, including the continued commercial launchof BiDil.

**AvailableInformation**

Our internet websiteaddress is http://www.nitromed.com. Through our website, we make available,free of charge, our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and any amendmentsto 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 SEC. These SEC reports can beaccessed through the “Investors” section of our website. The information foundon our website is not part of this or any other report we file with, or furnishto, 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.

**RisksRelating to our Business**

**Ourbusiness is substantially dependent on the commercial success of BiDil, and ifsales of BiDil do not increase our business will be materially harmed and ourstock price will decline.**

On June 23, 2005, theFDA approved BiDil for the treatment of heart failure in self-identified black patientsas an adjunct to current standard therapy. We launched BiDil in July 2005and therefore have only recently begun to receive revenue from sales of BiDil.BiDil is currently our only commercial product, and we expect that it willaccount for all of our product sales and substantially all of our totalrevenues for the next several years. We face a number of significant risksrelating to our ability to successfully commercialize BiDil, including risksrelating to: our ability to successfully secure preferable reimbursementtreatment from government and third-party insurers for BiDil; our abilityto effectively and efficiently transition our contract field sales force toNitroMed and our ability to continue to increase the productivity of our salesforce; our ability to effectively develop and/or contract for adequatemarketing and manufacturing capabilities; our ability to gain market acceptanceof BiDil as safe, effective and medically necessary; our ability to maintainthe necessary patent protection, licenses and regulatory 

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approvalsrequired to market and sell BiDil; the availability of substantial cash to fundour BiDil commercialization plans; competitive factors, including thepossibility of physicians prescribing the two lower cost generic drugs thatcompose BiDil itself as a substitute for BiDil, and adverse effects on pricingor reimbursement resulting from the possibility of this generic substitution;and the various other factors discussed in detail throughout this sectiontitled “Risk Factors.” In order for us to successfully commercialize BiDil, oursales of BiDil must increase significantly from their current levels. If wefail to significantly increase BiDil sales, our near-term ability to generateproduct revenue, our reputation and our ability to raise additional capitalwill be materially impaired, and the value of an investment in our stock willdecline.

**If wedo not successfully market and sell BiDil or our other product candidates,either directly or through third parties, our future revenue will be limited.**

Wecurrently have limited sales, marketing and distribution experience. We havelaunched BiDil in the United States ourselves, using a contract sales force. Wetransitioned to the use of a smaller sales force during the first quarter of2006, and we intend to internalize this sales force by the third quarter of2006. This transition could adversely affect our marketing of BiDil, and anyadverse effect on BiDil sales will depress the value of our stock. In thefuture, we may also seek to market other products ourselves which are notalready subject to marketing agreements and where we believe the targetphysician market can be effectively reached by the  sales force we have established. In order todevelop our internal sales force or to contract for sales and marketingcapabilities, we will have to invest significant amounts of money andmanagement resources. For BiDil and any other product candidates for which wedecide to perform the sales, marketing and distribution functions ourselves, wecould face a number of additional risks, including:

·       wemay not be able to effectively or efficiently transition our contract salesforce to NitroMed or to attract, build and retain a significant and qualifiedmarketing or sales force;

·       the cost of establishing amarketing and sales force may not be justifiable in light of the revenuesgenerated by any particular product or combination of products; and

·       ourdirect sales and marketing efforts may not be successful.

For potential futureproducts with larger target physician markets, we plan to rely significantly onsales, marketing and distribution arrangements with third parties. We may notbe able to successfully enter into sales, marketing and/or distributionagreements with third parties in the future, on terms that are favorable to us,if at all. In addition, we may have limited or no control over the sales,marketing and distribution activities of these third parties. Our futurerevenues for any products for which we rely on third-party sales, marketingand distribution support will depend heavily on the success of the efforts ofthese third parties.

**Physicians,payors and patients may not be receptive to BiDil or our other productcandidates, if approved, which could prevent us from achieving and maintainingprofitability.**

**Wecurrently market BiDil only in the United States. Key participants in the U.S.pharmaceutical marketplace, such as physicians, payors and patients, may notaccept a product intended to improve therapeutic results based on ethnicity. Asa result, it may be more difficult for us to convince the medical community,third-party payors and patients to accept and use BiDil. Our business issubstantially dependent on market acceptance of BiDil.**

Otherfactors that we believe will materially affect market acceptance of BiDilinclude:

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

·       thetiming of our receipt of marketing approval, if any, for next-generation BiDilproducts, such as BiDil XR and BiDil Combination products, or for any expansionof our current label for BiDil, such as extended product dating or inclusion ofnew data;

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·       thesuccess of our promotional programs;

·       thetiming of our receipt of any marketing approvals outside the U.S., the terms ofany non-U.S. approval (including labeling requirements and/or limitations), andthe countries in which approvals are obtained, if any;

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

·       the ability to produceBiDil at a competitive price.

**Wewill require substantial additional cash to fund our operating plan, includingcommercializing BiDil, and, if additional capital is not available, we may needto limit, scale back or cease our operations.**

We have used and will continue to require substantialfunds to sell, market and manufacture BiDil, which was commercially launched inJuly 2005, to conduct research and development, including pre-clinicaltesting and clinical trials of our product candidates, and to market andmanufacture any future products that are approved for commercial sale. Inparticular, we expect that we will incur significant expenses during 2006 andbeyond relating to manufacturing, sales and marketing of BiDil. Moreover, wemay incur significant additional expenditures to conduct clinical testing ofour proprietary nitric oxide-enhancing cardiovascular agent andpre-clinical testing of our early-stage development programs. Because thesuccessful commercialization of BiDil, and the timing of when we might receivesignificant revenue from BiDil, if at all, is uncertain, and because thesuccessful development of any other product candidates is uncertain, we areunable to estimate the actual funds we will require to commercialize BiDil andto complete research and development of our product candidates. We believe thatour existing cash, cash equivalents and marketable securities, together withthe proceeds from our recent offering, will be sufficient to fund our currentoperating plan, including increased operating expenses in support of the launchand commercialization of BiDil, for at least the next 21 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:

·       the cost of successfully commercializing BiDil;

·       thetiming, receipt and amount of revenue from sales of BiDil;

·       thetiming and costs of obtaining regulatory approvals, if any, for our otherproduct candidates;

·       thetiming, receipt and amount of milestone and other payments, if any, fromcollaborators;

·       thetiming, receipt and amount of sales and royalties, if any, from our productcandidates;

·       theresources required to successfully complete our clinical trials, if any;

·       continued progress in our research and development programs,as well as the magnitude of these programs;

·       theeffect of competing technological and market developments;

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

·       the costs related to acquiring and/or in-licensing newtechnologies and/or products or product candidates; and

·       ourability to establish and maintain additional collaborative arrangements.

We may be required to seekadditional funding in the future and may do so through collaborativearrangements and/or public or private financings. Additional financing may notbe available to us on acceptable terms, or at all. In addition, the terms ofthe financing may adversely affect the holdings or the 

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rightsof our stockholders. For example, if we raise additional funds by issuingequity securities, further dilution to our then-existing stockholders willresult. If we are unable to obtain funding on a timely basis, we may berequired to significantly curtail our marketing efforts for BiDil or one ormore of our research or development programs. We also could be required to seekfunds through arrangements with collaborators or others that may require us torelinquish rights to some of our technologies, product candidates or productswhich we would otherwise pursue on our own.

**Poorperformance by our contract sales organization or difficulties arising in ourplanned transition to an internal sales force could prevent us from achievingthe significant growth we need to achieve in BiDil revenues.**

We have an agreement with Publicis, a contract salesorganization, pursuant to which, on our behalf, Publicis has employed andtrained a specialty sales force currently consisting of 144 salesrepresentatives, to sell BiDil to our target prescriber markets. Under separateagreements, Publicis has recruited, hired and trained seven account executivesand one national director, who are dedicated to NitroMed on a non-exclusivebasis, who assist us in gaining formulary access for BiDil and has hired sixmedical science liaisons to report into our medical affairs group. Ournear-term revenue for BiDil will depend heavily upon the efforts and success ofPublicis. If Publicis does not devote the resources, time and training requiredto establish, manage and maintain an effective and qualified sales force, ourability to achieve revenue from sales of BiDil will be harmed.

We intend to transitionthe contract sales representatives to NitroMed by the third quarter of 2006. Wemay not be able to effectively or efficiently complete this transition. Anyfailure to transition our current contract sales representatives, or electionby us not to transition certain of these representatives, to NitroMed, willresult in the need to recruit and train new sales representatives to cover ourrevised sales territories. We may not be able to successfully recruit and trainnew sales representatives, and the efforts to do so will result in additionalcosts and expenses related to our sales efforts. In addition, we have recentlyelected to reduce the number of sales territories in which we have salesrepresentation. Any failure to adequately cover our current sales territories,or to cover through alternative marketing efforts the territories in which we haveelected not to have sales representation, may result in reduced salesproductivity and loss of revenue related to BiDil.

**Becausewe have a history of losses and our future profitability is uncertain, ourcommon stock is a highly speculative investment.**

We have experienced significant operating losses sinceour inception in 1992. For the year ended December 31, 2005, we had a netloss of $105.9 million. As of December 31, 2005, we had anaccumulated deficit of $242.5 million. We expect that we will continue toincur substantial losses and that our cumulative losses will increase as ourresearch, development and commercialization efforts expand. We expect that thelosses that we incur will fluctuate from quarter to quarter and that thesefluctuations may be substantial. We received approval for our first product,BiDil, from the FDA on June 23, 2005, and launched commercial sales ofBiDil in July 2005. All of our other product candidates, with theexception of NMI-3377 for which we expect to file an IND in the secondquarter of 2006, are in research or pre-clinical development and will requiresignificant additional testing prior to submission of any regulatoryapplications and, as such, are not expected to be commercially available formany years, if at all.

A large portion of our expenses is fixed, includingexpenses related to facilities, equipment and personnel. We have spentsignificant amounts to launch BiDil, and we expect to incur significantoperating expenses in connection with our ongoing commercialization activitiesrelated to BiDil. We have also spent significant amounts to fund research,development and commercialization of our product candidates and to enhance ourcore technologies. Although we currently estimate that our operating expenses willdecrease during fiscal year 2006, we will still need to generate significantrevenue to achieve profitability. 

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We are currently unable toestimate the level of revenues that we will realize from the commercializationof BiDil or any of our other product candidates. We are therefore unable toestimate when we will achieve profitability, if at all. Even if we do achieveprofitability, we may not be able to sustain or increase profitability on aquarterly or annual basis. Our failure to become and remain profitable coulddepress the market price of our common stock and could impair our ability toraise capital, expand our business, diversify our product offerings or continueour operations.

Our BiDil product revenueshave been and will continue to be subject to considerable variation due tovolatility in prescription volume, the manner in which we account for productsales considering product returns rates, level of purchases by individualcustomers and other matters related to the commercialization of this product.We have experienced and are likely to continue to experience significantrevenue deferrals and product returns, as well as additional charges andexpenses associated with stocking incentives, other promotional incentives, andother matters related to the launch and commercialization of this product.Significant inventory adjustments may also occur due to the 12-monthshelf life of BiDil, sales forecast variances, or other factors. Any deferrals,returns or adjustments that negatively impact revenue, or our failure, for thisor any other reason, to generate significant near-term revenue growth, coulddepress our stock price and adversely affect our ability to raise capital.

**Theavailability of lower priced generic substitutes for BiDil may adversely affectour sales of BiDil and the pricing or reimbursement we are able to obtain forBiDil.**

BiDil is a fixed-dosedcombination of two generic drugs, which are approved and separately marketed,in dosages similar to those we include in BiDil, at prices substantially belowthe prices we are charging for BiDil. While neither of these two generic drugsis approved for the treatment of heart failure, as a practical matter it may beimpossible for us to prevent physicians from prescribing a combination of thesetwo, lower cost generic drugs as a substitute for prescribing BiDil. Ifsubstantial numbers of physicians prescribe the combination of these twogeneric drugs, rather than BiDil, we could fail to achieve the sales of BiDilnecessary for successful commercialization which would severely limit ourability to generate revenue from the sales of BiDil. Our ability to generaterevenue could also be limited if potential large purchasers of BiDil such ashospitals or health maintenance organizations require the substitution of thesegeneric drugs for BiDil, or if state formularies or other government agenciesor private payors that approve reimbursement for drugs require suchsubstitution, or if the availability of these generic drugs reduces the priceor reimbursement amounts we are able to achieve for BiDil.

**Wemay not have the technology internally to successfully develop BiDil XR and wemay not be able to acquire such technology on favorable terms, if at all.**

Although we intend topursue the development of an extended release formulation of BiDil, calledBiDil XR, to be taken either once or twice a day, we do not currently have thetechnology internally to pursue this development on our own. The technologyunderlying extended release formulations of pharmaceutical products is highlyproprietary and would take years and the expenditure of significant amounts ofcapital to develop by us. If we are unable to find extended release technologyfrom a third party which is compatible for use with BiDil, we would beprevented from pursuing the development of BiDil XR. Even if we are able toidentify compatible extended release technology, we may not be able to acquirerights to such technology on favorable terms, if at all. In addition, even ifwe are successful in acquiring such rights, we may be required to forfeitcertain rights to our BiDil XR product to the owner of such technology, therebyreducing our future potential revenue from commercialization of this product.

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**If the third-partymanufacturer of BiDil encounters delays or difficulties in production, we maynot be able to meet demand for the product, and we may lose potential revenue.**

We do not manufacture BiDil and have no plans to doso. We have engaged Schwarz Pharma Manufacturing, under a five-year exclusivemanufacture and supply agreement solely for the three times daily immediaterelease dosage formulation of BiDil. Under the supply agreement, we have theright to engage a backup manufacturer but do not currently have any backupmanufacturing agreement in place. The terms of the supply agreement providethat it may 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 party mayterminate the supply agreement in the event the FDA takes any action, theresult of which is to permanently prohibit the manufacture, sale or use of theproduct. If we are unable to maintain a commercially reasonable manufacturingagreement for the production of BiDil with Schwarz Pharma, we may not be ableto successfully commercialize BiDil and our stock price may decline.

Furthermore,Schwarz Pharma may encounter difficulties in production. These problems mayinclude, 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.

The number of third-party manufacturers with themanufacturing and regulatory expertise and facilities necessary to manufacturefinished products for us on a commercial scale is limited, and it would take asignificant amount of time to arrange, qualify, and receive necessary regulatoryapproval for alternative arrangements. We may not be able to contract formanufacturing on acceptable terms, if at all.

Any of these factors could increase our costs andresult in our inability to effectively commercialize BiDil. Furthermore, if SchwarzPharma or any other third-party manufacturer of BiDil fails to deliverthe required commercial quantities of finished product on a timely basis and atcommercially reasonable prices, we may be unable to meet the demand for ourproduct, and we may lose potential revenues.

**The development andcommercialization of our product candidates may be terminated or delayed, andthe cost of development and commercialization may increase, if third parties onwhom we rely to manufacture our products do not fulfill their obligations.**

We do notmanufacture any of our product candidates and have no current plans to developany capacity to do so in the future. In order to continue to develop productcandidates, apply for regulatory approvals and commercialize our products, weplan to rely on third parties for the production of clinical and commercialquantities of our product candidates. We may not be able to secure a third-partymanufacturer for our product candidates on commercially favorable terms, if atall. In addition, contract manufacturers are subject to ongoing periodic,unannounced inspection by the FDA and corresponding state and foreign agenciesor their designees to ensure strict compliance with current Good ManufacturingPractices, or cGMP, and other governmental regulations and correspondingforeign standards. The cGMP requirements govern quality control of themanufacturing process and documentation of policies and procedures. Other thanthrough contract, we do not have control over compliance by our contractmanufacturers with these regulations and standards. Our present or futurecontract manufacturers may not 

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beable to comply with cGMPs and other FDA requirements or similar regulatoryrequirements outside the United States. Failure of our contract manufacturersto comply with applicable regulations could result in sanctions being imposedon us in some cases, including fines, injunctions, failure of regulatoryauthorities to grant marketing approval of our product candidates, delays,suspension or withdrawal of approvals, seizures or recalls of productcandidates, 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. If we fail to secure a third-partymanufacturer on commercially favorable terms, or to the extent that third-partymanufacturers with whom we contract fail to perform their obligations inaccordance with applicable laws and regulations, we may be adversely affectedin a number of ways, including:

·       wemay not be able to initiate or continue clinical trials of our productcandidates, including BiDil XR and BiDil Combination products;

·       wemay be delayed in submitting applications for regulatory approvals for ourproduct candidates, including BiDil XR and BiDil Combination products;

·       wemay be required to cease distribution and/or recall some or all batches of ourproducts; and

·       wemay not be able to meet commercial demands for our products or achieveprofitability.

**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 be unable tocontinue to sell BiDil on commercially viable terms, if at all. Furthermore,because Sumitomo is currently the sole supplier of hydralazine hydrochloride,Sumitomo has unilateral control over the price of hydralazine hydrochloride.Any increase in the price for hydralazine hydrochloride may reduce our grossmargins and adversely affect our ability to achieve profitability.

**If our partners andwe do not obtain and maintain the regulatory approvals required to market andsell our product candidates, then our business will be unsuccessful, and themarket price of our stock will substantially decline.**

Our partners and wewill not be able to market any of our product candidates in the United States,Europe or in any other country without marketing approval from the FDA orequivalent foreign regulatory agency. The process of obtaining FDA approval ofpharmaceutical products is costly and time consuming. Any new pharmaceuticalproduct must undergo rigorous preclinical and clinical testing and an extensiveregulatory approval process mandated by the FDA. Such regulatory reviewincludes the determination of manufacturing capability and product performance.The approval process is affected by such factors as:

·       theseverity of the disease;

·       thequality of the regulatory submission;

·       theclinical efficacy and safety;

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

·       themanufacturing facility compliance;

·       theavailability of alternative treatments;

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·       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 expenditures of substantial resources.We have had only limited experience in preparing applications and obtainingregulatory approvals.

There can be no assurance that our pharmaceuticalproducts currently in development, or those product candidates acquired orin-licensed by us, will be approved by the FDA. In addition, there can be noassurance that all necessary approvals will be granted for future productcandidates or that FDA review or actions will not involve delays caused by theFDA’s request for additional information or testing that could adversely affectthe time to market and sale of these product candidates.

If we do not receive required regulatory approval orclearance to market any of our product candidates, we will not be able todevelop and commercialize these product candidates, which will affect ourability to achieve profitability and may cause the market price of our commonstock to substantially decline.

**Even if we obtainregulatory approvals, our marketed products, including BiDil, will be subjectto ongoing regulatory review. If we fail to comply with continuing UnitedStates and foreign regulations, we could lose our approvals to market ourproducts and our business would be seriously harmed.**

Even after approval, any products we develop will besubject to ongoing regulatory review and restrictions, including the review ofclinical results which are reported after our products are made commerciallyavailable, and restrictions on the indications for which we can market theproduct. The FDA can propose to withdraw our approval if new clinical data orexperience shows that a product is not safe for use under the approvedconditions of use. The FDA or we may need to send important information aboutour products to healthcare providers. The marketing claims we are permitted tomake in labeling or advertising regarding our marketed products are limited tothose specified in any FDA approval. For example, because BiDil is specificallyapproved for labeling for self-identified black patients, we may not promoteBiDil for use in other patient populations. For our prescription drugs, we mustsubmit copies of our advertisements and promotional labeling, including, forexample, professional journal advertisements, website pages, professionaldirect mailers, direct-to-consumer advertisements, convention booth panels andhandouts, to the FDA at the time of initial publication or dissemination. Ifthe FDA believes these materials or statements made by sales representatives orother Company officials promote our products for unapproved indications, theFDA could 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 the Company and its officers or employees. If we repeatedly ordeliberately failed to submit such advertisements and labeling to the agency,the FDA could withdraw our approvals. The FDA also monitors manufacturers’support of continuing medical education, or CME, programs where the programsinvolve the manufacturers’ or a competitor’s products to ensure thatmanufacturers do not influence the CME content as a means of promoting theirproducts for off label uses.

In addition, the manufacturer and manufacturingfacilities we use to produce any of our product candidates will be subject toperiodic review and inspection by the FDA. We will be required to report anyserious and unexpected adverse experiences and certain quality problems with ourproducts and make other periodic reports to the FDA. The discovery of anypreviously unknown problems with the product, manufacturer or facility mayresult in restrictions on the product or manufacturer or facility, including 

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withdrawal of the productfrom the market. Certain changes to an approved product, including the way itis manufactured or promoted, often require prior FDA approval before theproduct as modified may be marketed. If we fail to comply with applicablecontinuing regulatory requirements, we may be subject to fines, untitledletters, warning letters, civil penalties, suspension or withdrawal ofregulatory approvals, product recalls and seizures, injunctions, operatingrestrictions and/or criminal prosecutions and penalties.

**If we, our third-partymanufacturers or our service providers fail to comply with applicable laws andregulations, we or they could be subject to enforcement actions, which couldaffect our ability to market and sell our products and harm our reputation.**

If we or our third-partymanufacturers or service providers fail to comply with applicable federal,state or foreign laws or regulations, we could be subject to enforcementactions which could affect our ability to develop, market and sell our productssuccessfully and could harm our reputation and lead to fewer acceptances of ourproducts 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;

·       fines;

·       restrictionson importation of our products;

·       injunctions;

·       debarments;

·       civiland criminal penalties; and

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

**The application ofour nitric oxide technology is unproven in humans and, as a result, we may notbe able to successfully develop and commercialize any products based upon thistechnology.**

A component of our strategy is to seek to improveexisting medicines with our proprietary nitric oxide technology, such as anyfuture BiDil Combination product. Our product candidates include nitric oxideenhancements of existing drugs. Thus, we are modifying compounds whose chemicaland pharmacological profiles are well-documented and understood. However, manyof our potential product candidates are new molecules with chemical andpharmacological profiles that differ from that of the existing drugs. Thesecompounds may 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 benefit fromthe application of our nitric oxide technology. If we are not able tosuccessfully develop and commercialize drugs based upon our technology, we willnot generate revenue based on these drugs, and the value of our stock willdecline.

**If our clinicaltrials for any product candidates we advance into clinical testing are notsuccessful, we may not be able to successfully develop and commercialize theseproduct candidates.**

In order to obtain regulatory approvals for thecommercial sale of our product candidates, our collaborators or we will berequired to complete extensive clinical trials in humans to demonstrate the 

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safety and efficacy of ourproduct candidates. We may not be able to obtain authority from the FDA orother regulatory agencies to commence or complete these clinical trials. Ifpermitted, such clinical testing may not prove that our product candidates aresufficiently safe and effective to permit us to obtain marketing approvals fromregulatory authorities. Moreover, positive results demonstrated in pre-clinicalstudies and clinical trials that we complete may not be indicative of resultsobtained in future clinical trials. Furthermore, we, one of our collaborators,institutional review boards or regulatory agencies may suspend clinical trialsat any time if it is believed that the patients participating in such trialsare being exposed to unacceptable health risks. Adverse or inconclusiveclinical trial results concerning any of our product candidates could requireus to conduct additional clinical trials, result in increased costs andsignificantly delay the filing for marketing approval for those productcandidates with the FDA, result in a filing for a narrower indication than wasoriginally sought or result in a decision to discontinue development of thoseproduct candidates.

The successful completion of our clinical trials willdepend on, among other things, the rate of patient enrollment. Patientenrollment is a function of many factors, including the size of the patientpopulation, the nature of the clinical protocol, the availability ofalternative treatments, the proximity of patients to clinical sites and theeligibility criteria for the study. We may be unable to enroll the number of patientswe need to complete a trial on a timely basis. Moreover, delays in plannedpatient enrollment for clinical trials may cause us to incur increased costsand delay commercialization.

We have relied on academic institutions or clinicalresearch organizations to supervise or monitor some or all aspects of ourAfrican American Heart Failure Trial (A-HeFT), and we expect to rely onacademic institutions and clinical research organizations for other productcandidates we advance into clinical testing. In addition, we may need to relyon third parties for technology to support the development of our productcandidates. Accordingly, we have less control over the timing and other aspectsof these clinical trials than if we conducted them entirely on our own.

As a result of these factors, we, or third parties onwhom we rely, may not successfully begin or complete our clinical trials in thetime periods we have forecasted, if at all. Moreover, if we incur costs anddelays in our programs or if we do not successfully develop and commercializeour products, our future revenues may be materially impaired.

**Our failure tosuccessfully acquire, develop and market additional drug candidates or approveddrugs would impair our ability to grow.**

As part of our strategy, we intend to acquire, developand market additional products and product candidates for cardiovascular andmetabolic diseases. The success of this strategy depends upon our ability toidentify, select and acquire appropriate pharmaceutical product candidates andproducts.

Any product candidate we license or acquire mayrequire additional development efforts prior to commercial sale, includingextensive clinical testing and approval by the FDA and applicable foreignregulatory authorities. All product candidates are prone to the risks offailure inherent in pharmaceutical product development, including thepossibility that the product candidate will not be shown to be sufficientlysafe and effective for approval by regulatory authorities. In addition, wecannot guarantee that any products that we develop or acquire that are approvedwill be manufactured economically, or successfully commercialized.

Proposing, negotiating and implementing aneconomically viable acquisition of a product or product candidate is a lengthyand complex process. Other companies, including those with substantiallygreater financial, marketing and sales resources, may compete with us for theacquisition of product candidates and approved products. We may not be able toacquire the rights to additional product candidates and approved products onterms that we find acceptable, if at all.

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**The expiration of the research term under ourcollaboration agreement with Boston Scientific has resulted in the loss ofpotential royalty-based revenue from the collaboration and may indicatethat the development of nitric oxide-enhancing stents is not 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 usewith their 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 termof this agreement expired on December 31, 2005, although certain rightsextend beyond this term. If we are not able to continue the development of thetechnology developed under this agreement, we may lose any investment made inthe development of, and any potential revenue that may have resulted from, thedevelopment, sale or licensing of, nitric oxide-enhancing stents.

**The termination ofour collaboration agreement with Merck, resulting from Merck’s decision towithdraw its COX-2 inhibitor, Vioxx, from worldwide markets, hasresulted in the loss of potential milestone and royalty-based revenue from thecollaboration and may indicate that the development of nitric oxide-enhancingCOX-2 inhibitors is not viable.**

In December 2002, we entered into an exclusive,worldwide research, collaboration and licensing agreement with Merck pursuantto which we granted Merck marketing and sales rights to our technology fornitric oxide-enhancing COX-2 inhibitors. On September 30, 2004,Merck halted the phase II trial of our lead candidate in nitric oxide-enhancingCOX-2 inhibitors. We and Merck terminated our collaboration agreementduring November 2004, which will result in the loss of any potentialmilestone or royalty revenue from the sale of products that may have resultedfrom the collaboration as well as any research and development funding that wemay have received beyond the end of the initial research term in December 2005.In April 2005, the FDA imposed several restrictions on the labeling andsale of non-steroidal anti-inflammatory drugs, including COX-2inhibitors. If the FDA imposes additional regulatory burdens for the approvalof new COX-2 inhibitors, if COX-2 inhibitors continue to posesafety concerns, or if the market for COX-2 inhibitors contracts, then wemay lose any investment made in the development of, and any potential revenuethat may have resulted from, the development, sale or licensing of nitricoxide-enhancing COX-2 inhibitors.

**Any futurecollaborative arrangements that we seek to enter into with third parties maynot be scientifically or commercially successful.**

Factors that mayaffect the success of our future collaborations include the following:

·       ourfuture collaborators may be pursuing alternative technologies or developingalternative product candidates, either on their own or in collaboration withothers, that may be competitive with the product candidate on which they willbe collaborating with us and which could affect their commitment to our futurecollaboration;

·       futurereductions in marketing or sales efforts or a discontinuation of marketing orsales of our products by our collaborators would reduce our revenues whichwould be based on a percentage of net sales by the collaborator;

·       ourfuture collaborators may terminate their collaborations with us, which couldmake it difficult for us to attract new collaborators or adversely affect howwe are perceived in the business and financial communities; and

·       ourfuture collaborators may pursue higher-priority programs or change thefocus of their development programs, which could affect the collaborators’commitment to us.

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**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 and judgments that affect the reported amounts of our assets,liabilities, revenues and expenses, the amounts of charges taken by us andrelated disclosure. Such estimates and judgments include revenue recognition,the carrying value of our accounts receivables, inventory and assets, ourestimates of accrued expenses and our estimates of the fair value of equityinstruments granted or sold by us. We base our estimates and judgments onhistorical experience and on various other assumptions that we believe to bereasonable under the circumstances. However, these estimates and judgments, orthe assumptions underlying them, may prove to be incorrect. Accordingly, ouractual financial results may vary significantly from the estimates contained inour financial statements. For a further discussion of the estimates andjudgments that we make and the critical accounting policies that affect theseestimates and judgments, see “Management’s Discussion and Analysis of FinancialCondition and Results of Operations - Critical Accounting Policies andEstimates” above.

**Risks Relating to our Intellectual Property Rights**

**Our patentprotection for BiDil, which is a combination of two generic drugs, is limited,and we may 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 generic drugs, isosorbide dinitrate and hydralazinehydrochloride, which are approved and separately marketed, in dosages similarto those we include in BiDil, for indications other than heart failure, atprices below the prices we are charging for BiDil. We have three issuedmethod-of-use patents, one of which covers the use of the combination ofisosorbide dinitrate and hydralazine hydrochloride to reduce the incidence ofmortality associated with chronic congestive heart failure, expiring in 2007,and the others covering the treatment of heart failure in black patients,expiring in 2020. As a practical matter, we may not be able to enforce thesemethod-of-use patents to prevent physicians from prescribing isosorbidedinitrate and hydralazine hydrochloride separately for the treatment of heartfailure in black patients, even though neither drug is approved for such use.We also may not be able to enforce these method-of-use patents to preventhospitals and pharmacies from supplying such patients with these generic drugsseparately in lieu of BiDil.

Other factors may also adversely affect our patentprotection for BiDil. If we are successful in marketing BiDil, manufacturers ofgeneric drugs will have an incentive to challenge our patent position. Thecombination therapy of isosorbide dinitrate and hydralazine hydrochloride foruse in heart failure was developed through lengthy, publicly-sponsoredclinical trials conducted during the 1980s, prior to the filing of the patentapplication that resulted in the 2007 patent. The U.S. Patent and TrademarkOffice, or U.S. patent office, considered published reports on these clinicaltrials and concluded that they did not constitute prior art that would preventthe issuance of the 2007 patent. The U.S. patent office also considered thequestion of whether the 2007 patent constituted prior art with respect to the2020 patents, and determined that the claims of the 2020 patents werenon-obvious and patentable. A court considering the validity of the 2007 or2020 patents with respect to questions of prior art might be presented withother alleged prior art or might reach conclusions different from those reachedby the U.S. patent office. If the 2007 or 2020 patents were to be invalidatedor if physicians were to prescribe isosorbide dinitrate and hydralazinehydrochloride separately for heart failure in black patients, our BiDil revenuecould be significantly reduced, we could fail to recover the cost of developingBiDil and BiDil might not be a viable commercial product.

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**If we are not ableto obtain and enforce patent protection for our discoveries, our ability todevelop and commercialize our product candidates will be harmed, and we may notbe able to operate our business profitably.**

Our success depends, in part, on our ability toprotect proprietary methods and technologies that we develop 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 over patentapplications of others.

Our strategy depends on our ability to rapidlyidentify and seek patent protection for our discoveries. This process isexpensive and time consuming, and we may not be able to file and prosecute allnecessary or desirable patent applications at a reasonable cost or in a timelymanner. Despite our efforts to protect our proprietary rights, unauthorizedparties may be able to obtain and use information that we regard asproprietary. The mere issuance of a patent does not guarantee that it is validor enforceable, so even if we obtain patents, they may not be valid orenforceable 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 provide lessprotection for our product candidates and products because it may be moredifficult to prove direct infringement against a pharmaceutical manufacturer ordistributor once they have gained approval for an alternative indication. Inaddition, if any other company gains FDA approval for an indication separatefrom the one we are pursuing and markets a product that we expect to marketunder the protection of a method-of-use patent, physicians will be able toprescribe that product for use in the indication for which we have obtainedapproval, even though the product is not approved for such indication. As apractical matter, we may not be able to enforce our method-of-use patentsagainst physicians prescribing products for such off-label use. Off-label useand any resulting off-label sales could make it more difficult to obtain theprice we would otherwise wish to achieve for, or to successfully commercialize,our products. In addition, in those situations where we have only method-of-usepatent coverage for a product candidate, it may be more difficult to find apharmaceutical company partner to license or support development of our productcandidate.

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. There is also no uniform, worldwide policy regardingthe 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 apatent were to be disclosed to or independently developed by a competitor, ourbusiness and financial condition could be materially adversely affected.

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**If we become involved inpatent litigation or other proceedings to enforce our patent rights, we wouldincur substantial costs and expenses, substantial liability for damages and/orbe required to stop our product development and commercialization efforts.**

A third party may sue us for infringing on its patentrights. Likewise, we may need to resort to litigation to enforce a patentissued to us or to determine the scope and validity of third-party proprietaryrights. The cost to us of any litigation or other proceeding relating tointellectual property rights, even if resolved in our favor, could besubstantial, and the litigation would divert our management’s efforts. Some ofour competitors may be able to sustain the costs of complex patent litigationmore effectively than we can because they have substantially greater resources.In addition, our strategy of providing nitric oxide-enhancing versions ofexisting products could lead to more patent litigation as 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, or NSAID’s. The basis for ouropposition, in part, is that the claims in EP ’110 are anticipated andtherefore invalid if they are construed to cover a single compound chemicallylinked to a nitrate moiety. While we believe that the claims in EP ’110will be invalidated, or be narrowed, we cannot predict with certainty theoutcome of the opposition. If the EPO finds that there are valid claims inEP ’110 that cover compounds chemically linked to nitrates, we may beadversely affected in our ability to market our product candidates for reducinggastrointestinal toxicity without first obtaining a license from NicOx, whichmay not be available on favorable terms, if at all.

If any parties are able to successfully claim that ourcreation or use of proprietary technologies infringes upon their intellectualproperty rights, we might be forced to pay damages, potentially includingtreble damages, if we are found to have willfully infringed on such parties’patent rights. In addition to any damages we might have to pay, a court couldrequire us to stop the infringing activity or obtain a license on unfavorableterms. Moreover, any legal action against us or our partners claiming damagesand seeking to enjoin commercial activities relating to the affected productsand processes could, in addition to subjecting us to potential liability fordamages, require us or our partners to obtain a license in order to continue tomanufacture or market the affected products and processes. Any license requiredunder any patent may not be made available on commercially-acceptableterms, if at all. In addition, some licenses may be non-exclusive, andtherefore our competitors may have access to the same technology licensed tous. If we fail to obtain a required license or are unable to design around apatent, we may be unable to effectively market some of our technology andproduct candidates, which could limit our ability to generate revenues orachieve profitability and possibly prevent us from generating revenuesufficient to sustain our operations.

**We in-license asignificant portion of our principal proprietary technologies, and if we failto comply with our obligations under any of the related agreements, we couldlose license rights that are necessary to commercializing BiDil and developingour other product candidates.**

We are a party to a numberof licenses that give us rights to third-party intellectual property thatare necessary for our business. In particular, we have obtained the exclusiveright to 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. We expect to enter into additionallicenses in the future. These licenses impose various development,commercialization, funding, royalty, diligence, and other obligations on us. Ifwe breach these obligations, the licensor may have the right to terminate the 

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licenseor render the license non-exclusive, which would result in us being unable todevelop, manufacture and sell products that are covered by the licensed technology.

**Risks Relating to our Industry**

**If the governmentor third-party payors do not reimburse patients for BiDil or any of ourproduct candidates that are approved for marketing, or do not reimburse suchproducts at favorable levels, they 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 and any of our other product candidates thatmay be approved for marketing, from third-party healthcare and state andfederal government payors, both in the United States and in foreign markets.Reimbursement by a third party payor may depend upon a number of factors,including the third-party payor’s determination that use of a product is:

·       safe,effective and medically necessary;

·       appropriatefor the specific patient;

·       cost-effective;and

·       neitherexperimental nor investigational.

Since reimbursement approval for a product is requiredfrom third-party and government payors in order for patients to bereimbursed for the cost of a product, seeking this approval, particularly whenseeking approval for a preferred form of reimbursement over other competitiveproducts, is a time-consuming and costly process. Third-party payors mayrequire cost-benefit analysis data from us in order to demonstrate thecost-effectiveness of any product we might bring to market. For any individualthird-party payor, we may not be able to provide data sufficient to gainreimbursement on a similar or preferred basis to competitive products or atall. Once reimbursement at an agreed level is approved by a third-partypayor, we may lose that reimbursement entirely, or we may lose the similar orbetter reimbursement we receive compared to competitive products. Asreimbursement is often approved for a period of time, this risk is greater atthe end of the time period, if any, for which the reimbursement was approved.In addition, legislative or regulatory efforts to control or reduce healthcarecosts or reform government healthcare programs could result in lower prices orrejection of our products. Changes in coverage and reimbursement policies orhealthcare cost containment initiatives that limit or restrict reimbursementfor our products may cause our revenue to decline. Any failure by us to obtainreimbursement for our products, or to secure a preferred form of reimbursementthat reduces costs to patients, may negatively impact market acceptance of ourproducts and adversely affect our ability to generate revenues from sales.

Most private insurers, and the majority of Medicare Part Dplans, cover BiDil at the Tier III level. We may not be able to obtainpreferential reimbursement treatment for BiDil from many private insurers. Anyfailure by us to secure such preferential reimbursement treatment would have asubstantially negative effect on sales of BiDil. In addition, although someMedicare Part D plans are currently providing reimbursement for BiDil atTier II levels, the number of overall plans providing this preferentialreimbursement is small. Moreover, because Medicare Part D was onlyimplemented on January 1, 2006, the Medicare Part D plans are stillactively in the process of enrolling participants. We cannot know if any of theplans on which we are currently listed will have a significant number ofAfrican American participants, if any at all. We also cannot know if BiDil willcontinue to be listed on any of these plans at a preferential reimbursementlevel, if at all. Accordingly, we cannot assess the impact that the currentlisting of BiDil on any given plan will have on our future revenues, if any. Ifthe plans on which BiDil is currently listed do not enroll a significant numberof African American participants, we will not benefit from these listings. Inaddition, if BiDil is not listed on any plans that do succeed in enrollingAfrican American participants, or if BiDil does not receive preferablereimbursement treatment on such plans, market 

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acceptance of BiDil couldbe negatively impacted and our ability to generate revenues from salessignificantly impaired.

**We could be negatively impacted by theapplication or enforcement of federal and state fraud and abuse laws, includinganti-kickback laws and other federal 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 to alter ordiscontinue one or more of our practices to be in compliance with these laws.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 couldbecome subject to false claims litigation under federal statutes, which canlead to treble damages based on the reimbursements by federal healthcareprograms, civil money penalties (including penalties levied on a per falseclaim basis), restitution, criminal fines and imprisonment, and exclusion fromparticipation in Medicare, Medicaid and other federal and state healthcareprograms. These false claims statutes include the False Claims Act, which allowsany person to bring suit on behalf of the federal government alleging thesubmission of false or fraudulent claims, or causing to present such false orfraudulent claims, under federal programs or contracts claims or otherviolations of the statute and to share in any amounts paid by the entity to thegovernment in fines or settlement. These suits against biotechnology companieshave increased significantly in recent years and have increased the risk that ahealthcare company will have to defend a false claim action, pay fines orrestitution, or be excluded from the Medicare, Medicaid or other federal andstate healthcare programs as a result of an investigation arising out of suchaction. We cannot assure you that we will not become subject to such litigationor, if we are not successful in defending against such actions, that suchactions will not have a material adverse effect on our business, financialcondition and results of operations. In addition, we cannot assure you that thecosts of defending claims or allegations under the False Claims Act will nothave a material adverse effect on our business, financial condition and resultsof operations.

**We face significantcompetition, which may result in others discovering, developing orcommercializing products before or more successfully than we do.**

The pharmaceuticalindustry is highly competitive and characterized by rapid and significanttechnological change. Our principal competitors in the markets we havetargeted, including cardiovascular disease, are large, multinationalpharmaceutical companies that have substantially greater financial and otherresources than we do and are conducting extensive research and developmentactivities on technologies and product candidates similar to or competitive withours. Many of our competitors are more experienced than we are inpharmaceutical development and commercialization, obtaining regulatoryapprovals and product marketing and manufacturing. As a result, they may:

·       developand commercialize products that render our products obsolete or non-competitiveor that block or delay approval of our product candidates as a result of patentor non-patent exclusivity;

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

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·       commercializecompeting products before we or our partners can launch any products developedfrom our 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; and

·       moreeffectively negotiate third-party licenses and strategic relationships;and take advantage of product acquisition or other opportunities more readilythan we can.

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 exposedto product liability claims and may not be able to obtain or maintain adequateproduct liability insurance.**

Our business exposes us tothe risk of product liability claims that is inherent in the manufacturing,testing, and marketing of human therapeutic products. Our clinical trialliability and commercial product liability insurance is subject to deductiblesand coverage limitations. We may not be able to obtain or maintain insurance onacceptable terms, or at all. Moreover, any insurance that we do obtain may notprovide adequate protection against potential liabilities, and our capitalresources could be depleted as a result.

**Risks Relating to our Common Stock**

**The price of ourcommon stock is likely to continue to be 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 particular companies. Inparticular, the market price of our common stock, like that of the securitiesof other biopharmaceutical companies, has been and may continue to be highlyvolatile. During the period from January 1, 2003 to January 1, 2006,our stock price has ranged from a low of $5.70 per share (on July 16,2004) to a high of $27.99 per share (on February 2, 2005). The followingfactors, among others, may affect the price of our common stock:

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

·       announcementsof technological innovations or new commercial products by us or ourcompetitors;

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

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

·       disputesrelating to patents or other proprietary rights affecting us or ourcompetitors;

·       publicconcern as to the safety of products developed by us or other biotechnology andpharmaceutical companies;

·       generalmarket conditions;

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·       fluctuationsin price and volume in the stock market in general, or in the trading of the stockof 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 havesubstantial control over us and could delay or prevent a change in corporatecontrol.**

As of February 15,2006, our directors, executive officers and principal stockholders, togetherwith their affiliates, owned, in the aggregate, approximately 40% 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 ofownership may 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 ourcharter documents and under Delaware law may prevent or frustrate attempts bystockholders to change current management and hinder efforts to acquire acontrolling interest in our c**ompany.

Provisions of ourrestated certificate of incorporation and bylaws may discourage, delay orprevent a merger, acquisition or other change in control that stockholders mayconsider favorable, including transactions in which stockholders mightotherwise receive a premium for their shares. These provisions may prevent orfrustrate attempts by stockholders to replace or remove our current management.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

·       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 prescribed manner.Accordingly, Section 203 may discourage, delay or prevent a change incontrol of our company.

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**Substantially allof our outstanding common stock may be sold into the market at any time. Thiscould cause the market price of our common 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 February 23, 2006, there were36,632,342 shares of common stock. Substantially all of these shares mayalso be resold in the public market at any time. In addition, we have asignificant number of shares that are subject to outstanding options. Theexercise of these options and the subsequent sale of the underlying commonstock could cause a further decline in our stock price. These sales also mightmake it difficult for us to sell equity securities in the future at a time andat a price that we deem appropriate.

**We may incursignificant costs and suffer management distraction and reputational damagefrom class action litigation and regulatory or government investigations andactions due to trading in our common stock.**

Our stock price has been, and is likely to continue tobe, volatile. When the market price of a company’s stock is volatile, holdersof that company’s stock may bring securities class action litigation againstthe company that issued the stock. If any of our stockholders were to bring alawsuit of this type against us, even if the lawsuit was without merit, wecould incur substantial costs defending the lawsuit.

On July 20, 2004, the Market RegulationDepartment of the NASD advised us that it initiated a review of tradingactivity in our common stock surrounding our July 19, 2004 announcementthat we had halted our phase III clinical trial of BiDil due to the significantsurvival benefit seen with BiDil. The NASD is reviewing, among other things,information on relationships between our officers, directors and serviceproviders and individuals and institutions that may have traded in our commonstock prior to the July 19, 2004 announcement. We have cooperated withthis review and have identified certain persons on the list provided to us bythe NASD as having a relationship with our chief executive officer and othersat NitroMed. We have established a special committee of our board of directorsto oversee our response to this review.

The SEC or othersecurities regulators may investigate trading activity of insiders and othersaround events that result in stock price volatility, such as our July 19,2004 announcement, and we may incur substantial costs in connection with anysuch government investigation or related action. A stockholder lawsuit, SEC orother investigation or action could also damage our reputation or that of ourofficers or directors and divert their time and attention away from ourmanagement.

**ITEM 1B. UNRESOLVED STAFF COMMENTS**

None.

**ITEM 2. PROPERTIES**

We lease a facility thatcontains approximately 52,000 square feet of laboratory and office space inLexington, Massachusetts. The lease has a term ending in 2014. We believe thatour current facility is adequate for our needs for the foreseeable future, andthat, should it be needed, suitable additional space will be available toaccommodate expansion of our operations on commercially reasonable terms.

**ITEM 3. LEGAL PROCEEDINGS**

We are currently not aparty to any material legal proceedings.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

No matters were submitted to a vote of securityholders of our company, through solicitations of proxies or otherwise, duringthe quarter ended December 31, 2005.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**(a)   MarketPrice of and Dividends on NitroMed’s Common Stock and Related StockholderMatters; Recent Sales of Unregistered Securities.**

*MarketPrice and Dividends*

Our common stock is traded on the NASDAQ NationalMarket under the symbol “NTMD”. The following table sets forth the high and lowsale prices per share of our common stock as reported on the NASDAQ NationalMarket for the periods indicated.

| ** **                                    | ** ** | **Common stock price** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **High**                         | ** ** | **Low** | ** ** |
| **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 |   |
| **Fiscal  year ended December 31, 2004** |       |                             |       |   |   |
| First quarter                                 |       | $                                | 9.65       |   | $ | 6.90 |   |
| Second quarter                                |       | $                                | 8.15       |   | $ | 5.75 |   |
| Third quarter                                 |       | $                                | 25.78      |   | $ | 5.70 |   |
| Fourth quarter                                |       | $                                | 27.30      |   | $ | 19.14 |   |

 

On February  23, 2006, the reported lastsale price of our common stock on the NASDAQ National Market was $11.80 pershare, and we had approximately 56 holders of record of our common stock.

We have never paid ordeclared any cash dividends on our common stock. We currently intend to retainearnings, if any, to finance the growth and development of our business, and wedo not expect to pay any cash dividends on our common stock in the foreseeablefuture. Payment of future dividends, if any, will be at the discretion of ourboard of directors.

*Recent Sales of UnregisteredSecurities*

On June 28, 2005, we 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 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. We issued these promissory notes to Oxford and GECC in reliance on theexemption provided by Section 4(2) of the Securities Act of 1933, asamended, which we refer to as the Securities Act. The notes are secured by asecurity interest in all our personal property and fixtures with the exceptionof any intellectual property or products acquired, whether by purchase, licenseor otherwise, on or after the execution of the notes. The agreements that weentered into with each of Oxford and GECC in connection with the notes alsocontain a material adverse change clause with both Oxford and GECC. Under thisclause, if Oxford or GECC reasonably determine that our ability to repay thenotes has been materially impaired, we would be considered in default. As of December 31,2005, we were in compliance with this clause.

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**(b)   Use of Proceeds from RegisteredSecurities**

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 gross proceeds of $87.6 million. The offer and sale of all the shares in thefollow-on public offering were registered under the Securities Act pursuant toa registration statement on Form S-1 (File No. 333-120280),which was declared effective by the SEC on December 7, 2004. Deutsche BankSecurities Inc., J.P. Morgan Securities Inc., Pacific Growth Equities and Bear,Sterns & Co. Inc. were the managing underwriters of the follow-onpublic offering. In connection 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 underwriting discounts and commissions oroffering expenses were incurred or paid to directors or officers of ours ortheir associates or to persons owning 10 percent or more of our common stock orto any affiliates of ours. After deducting the underwriting discounts andcommissions and offering expenses, we received net proceeds from the offeringof  $81.8 million.

On November 10, 2003, we completed an initialpublic offering of 6,000,000 shares of our common stock at a price to thepublic of $11.00 per share. The offer and sale of all of the shares in theinitial public offering were registered under the Securities Act pursuant to aregistration 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 aggregate price of theinitial 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 offeringexpenses were incurred or paid to directors or officers of ours or theirassociates or to persons owning 10 percent or more of our common stock orto any affiliates of ours. After deducting the underwriting discounts and commissionsand offering expenses, we received net proceeds from the offering of  $60.1 million.

**ITEM 6. SELECTED FINANCIAL 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.

We derived the statement of operations data for theyears ended December 31, 2005, 2004 and 2003 and the balance sheet data asof December 31, 2005 and 2004 from our audited financial statements, whichare included elsewhere in this report. We derived the statement of operationsdata for the years ended December 31, 2002 and 2001 and the balance sheetdata as of December 31, 2003, 2002 and 2001 from our audited financialstatements which are not included herein. Historical results are notnecessarily indicative of future results. See the notes to the financialstatements for an explanation of the method used to determine the number ofshares used in computing basic and diluted net loss per common share.

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| ** **                                                                                             | ** ** | **Year Ended December 31,**                         | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                             | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statement  of Operations Data:**                                                                     |       |                                                               |       |   |   |   |   |   |   |   |   |
| Revenue                                                                                                |       | $                                                                  | 6,047      |   | $ | 16,458 |   | $ | 12,775 |   | $ | 750 |   | $ | 250 |   |
| Cost and  operating expenses:                                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cost of product sales                                                                                  |       | 8,009                                                              |       | — |   | — |   | — |   | — |   |
| Research and development                                                                               |       | 31,930                                                             |       | 27,995 |   | 18,907 |   | 16,133 |   | 10,214 |   |
| Sales, general and administrative                                                                      |       | 74,006                                                             |       | 19,591 |   | 3,114 |   | 2,531 |   | 2,362 |   |
| Total costs and  operating expenses                                                                    |       | 113,945                                                            |       | 47,586 |   | 22,021 |   | 18,664 |   | 12,576 |   |
| Loss from  operations                                                                                  |       | (107,898                                                           | )          | (31,128 | ) | (9,246 | ) | (17,914 | ) | (12,326 | ) |
| Other income, net                                                                                      |       | 2,046                                                              |       | 1,355 |   | 477 |   | 572 |   | 697 |   |
| Net loss                                                                                               |       | (105,852                                                           | )          | (29,773 | ) | (8,769 | ) | (17,342 | ) | (11,629 | ) |
| Deemed dividends  related to beneficial conversion features of redeemable convertible preferred  stock |       | —                                                             |       | — |   | (19,357 | ) | — |   | — |   |
| Accretion of  dividends and redemption value                                                           |       | —                                                             |       | — |   | (2,794 | ) | (2,697 | ) | (1,662 | ) |
| Net loss  attributable to common stockholders                                                          |       | $                                                                  | (105,852   | ) | $ | (29,773 | ) | $ | (30,920 | ) | $ | (20,039 | ) | $ | (13,291 | ) |
| Net loss per common share:                                                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                                                      |       | $                                                                  | (3.49      | ) | $ | (1.14 | ) | $ | (6.95 | ) | $ | (20.66 | ) | $ | (17.91 | ) |
| Weighted average basic  and diluted common shares outstanding                                          |       | 30,355                                                             |       | 26,152 |   | 4,447 |   | 970 |   | 742 |   |

 

| ** **                                        | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                        | ** ** | **(in thousands)**               | ** ** |
| **Balance Sheet Data:**                           |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and marketable securities |       | $                                     | 61,541     |   | $ | 142,367 |   | $ | 97,088 |   | $ | 11,843 |   | $ | 28,331 |   |
| Working capital                                   |       | 39,924                                |       | 133,238 |   | 87,938 |   | 15,838 |   | 25,401 |   |
| Total assets                                      |       | 76,521                                |       | 149,357 |   | 99,170 |   | 22,492 |   | 29,809 |   |
| Long-term  debt                                   |       | 10,653                                |       | — |   | — |   | 22 |   | 64 |   |
| Redeemable  convertible preferred stock           |       | —                                |       | — |   | — |   | 82,884 |   | 80,187 |   |
| Accumulated  deficit                              |       | (242,471                              | )          | (136,619 | ) | (106,846 | ) | (75,926 | ) | (55,887 | ) |
| Total stockholders’  equity (deficit)        |       | $                                     | 33,066     |   | $ | 137,012 |   | $ | 81,799 |   | $ | (73,353 | ) | $ | (54,275 | ) |

 

**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. Our goal is to become a leading, multi-productpharmaceutical company by developing innovative nitric oxide-basedproducts and by building on our BiDil development experience andcommercialization infrastructure to identify and market additional products forcardiovascular and metabolic diseases. We have devoted substantially all of ourefforts towards the research and development of our product candidates and thecommercialization of our currently marketed product, BiDil. Since ourinception, we have mainly funded our operations through the sale of equitysecurities, debt financings, license fees, research and development funding andmilestone payments from our collaborative partners. We have never beenprofitable and have incurred an accumulated deficit of $242.5 million as of December 31,2005.

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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 and generated product sales of$4.5 million during the year ended December 31, 2005.We market BiDil toprimary care physicians and cardiologists who treat African Americans withheart failure. Our sales and marketing organization is comprised internally ofa senior vice president of sales and marketing, a vice president of sales, avice president of marketing, three regional sales directors and fifteendistrict sales managers. In addition, we have an agreement with PublicisSelling Solutions pursuant to which, on our behalf, Publicis has employed andtrained a specialty sales force currently consisting of 144 salesrepresentatives to sell BiDil to our target prescriber markets. We have alsoengaged Schwarz Pharma under a five-year exclusive manufacturing and supplyagreement exclusively for the three times daily immediate release dosageformulation of BiDil.

We are also applying our nitric oxide technology todevelop novel pharmaceuticals, as well as safer and more effective versions ofexisting drugs, to target significant diseases that are characterized by adeficiency in nitric oxide and to treat underserved patient populations. Ournitric oxide-development strategy involves the internal development ofproprietary nitric oxide-enhancing product candidates, such as BiDil, theco-development of nitric oxide-enhancing drugs with partners and theout-licensing of our nitric oxide-enhancing technology in exchange forpotential milestone payments and royalties on sales.

We expect that research, development and commercializationexpenses relating to our products and product candidates and to enhancing ourcore technologies will continue to fluctuate in the near-term and may varysignificantly from our current estimates. Our operating expenses related to ourresearch and development efforts and our sales, general and administrativecosts for the year ended December 31, 2005, total  $105.9 million. We currently estimate thatour operating expenses for fiscal year 2006 will range between $95.0 millionand $110.0 million, excluding cost of product sales and expenses related to theadoption of Statement of Financial Accounting Standards (“SFAS”) No. 123R,*Share-Based Payment*. We believe that ourexisting cash, cash equivalents and marketable securities, together with theproceeds from our recent equity offering in January 2006, which generatednet proceeds to the Company of $58.6 million, will be sufficient to fund ourcurrent operating plan, including operating expenses in support of the launchand commercialization of BiDil, for at least the next 21 months.

In the near-term, a keydriver of our success will be our ability to successfully launch, commercializeand achieve market penetration of BiDil. We will need to generate significantrevenues to achieve profitability. At the present time we are unable toestimate the level of revenues that we will realize from sales of BiDil or fromthe other products that we may successfully develop and commercialize. We aretherefore unable to estimate when we will achieve profitability, if at all.

**Financial Operations Overview**

*Revenue.*   Ourfirst commercial product, BiDil, was launched in July 2005, and generatedproduct sales of  $4.5 million for theyear ended December 31, 2005. 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 combination of productsales, license fees, 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 the timingand amount of research and development, milestone and other payments receivedunder our collaborative or strategic relationships and related continuingobligations, as well as the timing and amount of revenue we recognize for thesale of our products, to the extent any are successfully commercialized.

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*Research and Development.*   Researchand development expense consists of expenses incurred in identifying,developing and testing product candidates. These expenses consist primarily ofsalaries and related expenses for personnel, fees paid to professional serviceproviders for independent monitoring and analysis of our clinical trials, costsof contract research and manufacturing, costs of facilities and BiDil medicalsupport costs.

Thefollowing summarizes our primary research and development programs. We have notprovided program costs because prior to 2000 we did not track and accumulatecost information by research program.

·       *BiDil*.   From May 2001 to July 2004, weenrolled 1,050 patients at 169 clinical sites in the United States in our phaseIII clinical trial for BiDil. We halted the trial in July 2004 due to asignificant survival benefit in the preliminary data for patients taking BiDil.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 Life Cycle Management: BiDil XR and BiDil Combination*.   Thecurrent formulation of BiDil is an immediate-release tablet that must be takenthree times daily. We are currently pursuing the development of an extendedrelease formulation of BiDil, BiDil XR, that could be taken either once ortwice a day, depending on the particular formulation we pursue. We are alsoengaging in research and development efforts to develop BiDil Combinationproducts which would combine BiDil with existing, marketed medicines, such asACE inhibitors, beta blockers, or aldosterone receptor blockers.

·       *Cardiovascular Portfolio*.   We are utilizing our nitricoxide expertise and proprietary position to develop product candidates for avariety of additional medical conditions. As part of this effort, we recentlyannounced that we expect to file an Investigational New Drug Application (IND)for NMI 3377, a proprietary nitric oxide-enhancing cardiovascular agent,in the second quarter of 2006. We have retained all commercial rights to thisproduct candidate. Because these programs are in pre-clinical development, thesuccessful development of products based upon these programs is highlyuncertain. As such, we are not able to estimate the cost to complete researchand development, nor are we able to estimate the timing of bringing productcandidates to market and, therefore, when material cash inflows from productsales, milestones and royalties could commence.

·       *Nitric Oxide-Enhancing Product Candidates*.   We areusing our know-how and expertise in nitric oxide to develop new chemicalentities, or drugs, that are nitric oxide-enhancing versions of existingmedicines in the areas of cardiovascular medicine, acute renal failure andother areas. These studies are at a pre-clinical stage of testing, and itremains speculative whether the addition of nitric oxide will result in an improvedclinical profile of these medicines. The many uncertainties involved with thedevelopment of successful new products will exist until a new product candidatesuccessfully passes all preclinical safety testing as well as clinicalevaluation. A new and novel nitric oxide-enhancing medicine will take severalyears and involve a significant and largely unknown sum of expenditures. Thesuccess of achieving a new nitric oxide-enhancing medicine is important as itis needed to fill our pipeline. Failure to produce and successfullycommercialize a new product in a timely fashion may have a material adverseeffect on our business, financial position and results of operations.

·       *Nitric Oxide Stents*.   We formerly had a researchagreement with Boston Scientific to develop cardiovascular stents enhanced witha bio-compatible polymer that is capable of releasing nitric oxide. Theresearch program under this agreement focused on pre-clinical development. Inaccordance with the terms of our agreement with Boston Scientific, the researchterm expired in December 2005. We expect that additional expenditures willbe required in the area of nitric oxide stents development, if we should chooseto pursue this area either alone or together with another collaborative partnerto conduct pre-clinical testing and, if such pre-clinical testing issuccessful, to 

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apply for andconduct clinical trials. Because our former program was in pre-clinicaldevelopment, the successful development of products based upon this program ishighly uncertain. As such, we are unable to estimate the cost to complete anyfuture research and development, nor are we able to estimate the timing ofbringing any product candidates to market and, therefore, when material cashinflows from milestones and royalties could commence. Our failure, or anyfuture partner’s failure, to commercialize products based upon this program ona timely basis could have a material adverse effect on our business, financialposition and results of operations.

·       *Nitric Oxide-Enhancing COX-2 Inhibitors*.   From December 2002until November 2004, we had a collaboration with Merck Frosst Canada &Co., a wholly-owned subsidiary of Merck & Co., or Merck, to screenproprietary nitric oxide-enhanced COX-2 inhibitors in advance of clinicaltesting as analgesic and anti-inflammatory agents and in other specifieddisease areas. These agents are intended to be second-generation COX-2inhibitors. On September 30, 2004, Merck halted the phase II trial of ourlead candidate in nitric oxide-enhancing COX-2 inhibitors. In November 2004,we agreed with Merck to terminate the collaboration agreement. We retain allrights to our technology in the field of nitric oxide-enhancing COX-2inhibitors and may seek collaborations with other potential partners to utilizethe full value, if any, of this technology in the development of new analgesicand anti-inflammatory agents. Significant additional expenditures will berequired to conduct pre-clinical testing and to apply for, and conduct,clinical trials. Because these agents are in pre-clinical development, theirsuccessful development is highly uncertain. As such, we are not able toestimate the cost to complete the research and development phase, nor are weable to estimate the timing of bringing potential candidates to market and,therefore, when material cash inflows from milestones and royalties couldcommence. Our failure, or any future partner’s failure, to commercialize theseproduct candidates under development on a timely basis could have a materialadverse effect on our business, financial condition and results of operations.

*Sales, General andAdministrative.*   Consists primarily of salariesand other related costs for personnel in sales and marketing, executive,finance, investor relations, accounting, business development and humanresource functions. Other costs include facility costs not otherwise included inresearch and development expense; costs for public relations, advertising andpromotion services; professional fees for legal and accounting services; andcosts related to our third party contract sales agreement with Publicis SellingSolutions, Inc., or Publicis.

*Non-Operating Income.*   Includesinterest earned on our cash, cash equivalents and marketable securities, andinterest expense associated with our long-term debt.

*Boston ScientificCollaboration.*   In November 2001, we enteredinto a research, development and license agreement with Boston Scientific inthe field of restenosis. We granted Boston Scientific an exclusive worldwidelicense to develop and commercialize nitric oxide-enhancingcardiovascular stents. We also granted to Boston Scientific a right of firstrefusal to obtain 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. In December 2003,we agreed to extend the agreement to continue the research and developmentcollaboration through December 2005. Boston Scientific made an up-frontlicense payment of $1.5 million to us in 2001, and made an additionalpayment of $3.0 million in December 2003 in connection with theextension of the research and development collaboration. In the event thatspecified research, development and commercialization milestones were achieved,Boston Scientific would have been obligated to make milestone payments to us.In addition, Boston Scientific also would have been obligated to pay royaltiesto us on the sale of any products resulting from the collaboration. BostonScientific made a $3.5 million equity investment in our stock in 2001. In August 2003,in connection with a private placement, Boston Scientific made an additional$500,000 equity investment in our stock. The research term of the BostonScientific agreement expired on December 31, 2005, although certain rightsextend beyond this term. We intend to evaluate the continued development ofthis technology and in the future may seek collaboration with other potentialpartners.

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*MerckCollaboration.*   From December 2002 untilNovember 2004, we were party to an exclusive, worldwide research,collaboration and licensing agreement that granted Merck marketing and salesrights for nitric oxide-enhancing COX-2 inhibitors. The research portionof the agreement was for three years. In 2003, we 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 werebeing recognized ratably over the contractual term of the research anddevelopment program, which was expected to end on December 31, 2005. Therevenue from the second $5.0 million payment was recognized in the fourthquarter of 2003, the period in which Merck achieved the milestone. OnSeptember 30, 2004, Merck halted the phase II trial of our lead candidatein nitric oxide-enhancing COX-2 inhibitors. This lead nitric oxidecandidate is composed of a derivative of rofecoxib. Rofecoxib is the activeingredient in Vioxx, a COX-2 inhibitor which Merck voluntarily withdrewfrom worldwide markets on September 30, 2004. In November 2004, weagreed with Merck to terminate the collaboration agreement. Merck paid us alump sum of $1.8 million in 2004, representing the full amount of theresearch funding that was owed to us for 2005. We will not receive anycommercialization milestones or royalty payments from Merck. As a result of thetermination of this agreement, we accelerated the recognition of deferredlicense revenue of $5.3 million in the fourth quarter of 2004, and werecognized the lump sum payment of $1.8 million as revenue in the fourthquarter of 2004.

**Results ofOperations**

***Years Ended December 31, 2005, 2004 and 2003***

*Revenue.*   Totalrevenue for the year ended December 31, 2005 was $6.0 million, compared to$16.5 million in 2004 and $12.8 million in 2003.

Product sales were $4.5 million for the year ended December 31,2005 due to the commercial launch of BiDil in July 2005. There were noproduct sales for the years ended December 31, 2004, and 2003.

Research and development revenues were $1.6 millionfor the year ended December 31, 2005, compared to $16.5 million for 2004and $12.8 million for 2003. The $14.9 million, or 90% decrease in revenue in2005 compared to 2004, is primarily due to the termination of the Merckagreement in November 2004. For the year ended December 31, 2004,research and development revenues totaled $16.5 million, a 29% or $3.7 millionincrease in revenue in 2004 compared to 2003. This increase is primarilyattributable to our collaboration agreement with Merck, which was terminated inNovember 2004. In 2004 we recognized $14.9 million in revenue under thisagreement, which included all amounts previously deferred. Due to thetermination of this collaboration agreement, we no longer have any futureperformance obligations, and accordingly, we recognized previously deferredlicense revenue of $5.3 million. In addition, we recognized $1.8 million thatwas originally scheduled to be paid to us during 2005 for research anddevelopment funding, but was instead paid to us in 2004 when the agreement wasterminated. We also recognized an additional $1.2 million in revenue in 2004over 2003 relating to the December 2003 extension of our agreement withBoston Scientific. The research term of this agreement with Boston Scientificexpired on December 31, 2005 in accordance with its terms, and we do notexpect to receive any additional payments under this agreement.

*Cost ofProduct Sales.  **Cost of product sales increased to $8.0 millionin 2005 from $0 in 2004 due to the launch of BiDil in July 2005. Included incost of product sales is an inventory impairment charge of $5.6 millionrelated to short dated commercial trade and patient sample inventory, and a$1.5 million charge for contractual purchase commitments. The charges aredue to the Company’s current estimate of inventory requirements based on itssales forecast.*

*Researchand Development.*   Research anddevelopment expense for the year ended December 31, 2005 was $31.9million, compared to $28.0 million in 2004 and $18.9 million in 2003. The $3.9million, or 14% increase in research and development expenses in 2005 comparedwith 2004 is primarily the result of 

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increased clinical andmedical expenses which support the commercial launch of BiDil in the areas ofcontinuing medical 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 is a decrease of $10.2 million inclinical 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. The $9.1 million, or 48% increase inresearch and development expenses in 2004 compared with 2003 is primarily theresult of an additional $2.8 million of expenses associated with the BiDiltrial, including costs associated with the halt of the A-HeFT trial,commencement of the open label A-HeFT trial (X-A-HeFT), and the preparation andfiling of an amended NDA with the FDA. We also incurred increased research anddevelopment expenses in 2004 of $2.0 million related to compensation-relatedexpenses due to additional headcount and non-cash stock-based compensationrelated expense; $1.2 million related to preparation of contract manufacturingcapabilities relating to the potential BiDil product line; $1.0 millionpertaining to milestone payments under a collaboration and license agreementfor BiDil; and increased outside consulting costs of $0.8 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, 2005, 2004 and 2003.

| ** **                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|
| **Research and Development Program** | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| BiDil                                               |       | $                     | 19,052,000 |   | $ | 20,000,000 |   | $ | 11,751,000 |   |
| Nitric oxide-enhancing  cardiovascular compounds    |       | 6,073,000             |       | 500,000 |   | — |   |
| Nitric oxide-enhancing  COX-2 inhibitors            |       | —                |       | 2,500,000 |   | 2,358,000 |   |
| Nitric oxide  stents                                |       | 2,279,000             |       | 2,500,000 |   | 1,447,000 |   |
| Other                                               |       | 4,526,000             |       | 2,495,000 |   | 3,351,000 |   |
| Total research and  development expense             |       | $                     | 31,930,000 |   | $ | 27,995,000 |   | $ | 18,907,000 |   |
|                                                     |            |                       |            |  |  |  |  |  |  |  |  |  |

 

*Sales,General and Administrative.*   Sales,general and administrative expense for the year ended December 31, 2005was $74.0 million, compared to $19.6 million in 2004 and $3.1 million in 2003.The $54.4 million, or 278% increase in sales, general and administrativeexpenses in 2005 compared to 2004 was primarily due to an increase of $25.6million for the implementation of our contract sales force under our agreementwith Publicis, $4.0 million for the hiring of sales and marketing managementpersonnel, and $20.9 million for advertising and promotional services andpublic relations. We also incurred higher general and administrative expense in2005 due to increased costs of $1.1 million associated with the accrual ofbusiness development expenses pertaining to the approval process for BiDil;$1.8 million pertaining to additional legal and consulting expenses; $0.4million related to the hiring of executive management and additionaladministrative personnel. Sales, general and administrative expense for theyear ended December 31, 2004 was $19.6 million, compared to $3.1 millionin 2003. The $16.5 million, or 529% increase in sales, general andadministrative expenses in 2004 compared to 2003 was primarily due to $10.2million for the preparation for the potential launch of BiDil, including costsrelating to the payment of contract sales personnel; hiring of sales andmarketing management personnel; public relations services; and advertising andpromotion services. We also incurred higher general and administrative expensein 2004 due to increased costs of $1.9 million associated with businessdevelopment and milestone payment expenses pertaining to the approval processfor BiDil; $1.2 million pertaining to additional legal and consulting expenses;$1.0 million related to the hiring of executive management and additionaladministrative personnel; an increase in insurance costs of $0.7 million due tooperating as a public company; and higher infrastructure related expenses of$0.7 million, including moving to a new facility.

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*Non-OperatingIncome.  **Non-operating income increased to $2.0 million in2005 compared to $1.4 million in 2004 and $0.5 million in 2003. The $0.6million, or 51% increase in non-operating income in 2005 compared to 2004 wasprimarily related to higher interest income due to higher average investmentbalances and higher interest rates in 2005, offset by interest expense relatedto long—term debt. The $0.9 million, or 184% increase in non-operating incomein 2004 compared to 2003 was primarily related to higher average fund balancesavailable for investment and higher interest rates due to investing in longermaturity securities*.

**   Liquidity and Capital Resources**

We have financed our operations since inceptionthrough the sale of equity, debt and payments from collaborative partners forlicenses, research and development and achievement of milestones. As of December 31,2005, we have received net proceeds of $263.2 million from the issuance ofequity securities and debt instruments, primarily as the result of the sale of$99.1 million of our redeemable convertible preferred stock; net proceeds of$60.1 million from our initial public offering in November 2003; netproceeds of $81.8 million from our follow-on public offering in December 2004,and $20 million in debt financing in June 2005, which is described below.At December 31, 2005, we had $61.5 million in cash, cash equivalentsand marketable securities, and in January 2006, we raised an additional$58.6 million in net proceeds from an equity financing from the sale of 6.1million shares of our common stock.

In January 2006, we completed a direct offeringof shares of our common stock previously registered under our effective shelfregistration statement, which was filed with the Securities and ExchangeCommission, or the SEC, in August 2005. Pursuant to this offering, we soldapproximately 6.1 million shares of our common stock to selected institutionalinvestors at a price of $10.25 per share. Proceeds to us from this offering,net of offering expenses and placement agency fees, totaled approximately $58.6million.

On June 28, 2005, we 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 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 be consideredin default. As ofDecember 31,2005, we were in compliance with this clause. As of December 31, 2005 we had paid aggregate principal in theamount of $3.1 million.

During the year ended December 31, 2005,operating activities used cash of $98.2 million primarily due to a net loss of$105.9 million, and increases in accounts receivable of $4.1 million andinventories of $3.2 million due to launching BiDil, capitalizing inventory, andshipping product. These cash flow decreases are offset by adjustments fornon-cash charges for stock-based compensation and depreciation andamortization of $1.4 million, an increase in accounts payable and accruedexpenses of $12.3 million, and an increase in deferred revenue of  $1.9 million.

During the year ended December 31, 2005,investing activities provided cash of $55.4 million due to the net salesof marketable securities of $56.3 million, offset by the purchases ofcomputer and lab equipment of $0.9 million due to an increase in personnel. Weexpect to invest $1.5 million to $2.5 million for capital expenditures in 2006,principally related to the purchase of laboratory equipment and computerequipment to support headcount growth.

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During the year ended December 31, 2005,financing activities provided cash of $18.1 million due to proceeds from$20.0 million in long-term debt and $1.2 million from the issuance of commonstock under our employee stock plans, offset by $3.1 million in principalpayments on long-term debt.

The following tablesummarizes our contractual obligations at December 31, 2005 and theeffects such obligations are expected to have on our liquidity and cash flowsin future periods.

**Payments Due byPeriod**

| **Contractual Obligations**    | ** ** | ** ** | ** ** | **Total**  | ** ** | **Less than  one year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  five years** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|-----------------------------------|------------|--------------------|------------|--------------------|------------|-------------------------------------|------------|
| Operating lease  obligation         |       | $          | 13,879,000 |       | $          | 1,425,000                         |       | $                  | 3,010,000  |               | $          | 3,254,000                           |       | $ | 6,190,000 |   |
| Long-term debt                      |       | 19,187,000 |       | 7,675,000  |       | 11,512,000                        |       | —             |       | —             |       |
| Purchase Obligations (1)            |       | 28,603,000 |       | 26,637,000 |       | 1,966,000                         |       | —             |       | —             |       |
| Total contractual cash  obligations |       | $          | 61,669,000 |       | $          | 35,737,000                        |       | $                  | 16,488,000 |               | $          | 3,254,000                           |       | $ | 6,190,000 |   |

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(1)          In November 2004,as amended in May 2005, we entered into an agreement with Publicis, acontract sales organization, pursuant to which, on our behalf, Publicis hasemployed and trained a specialty sales force currently consisting ofapproximately 144 sales representatives to sell BiDil to our target prescribermarkets. The agreement is for a current term of 24 months beginning on January 31,2005, with our option to continue the agreement beyond this term. Year onecosts recorded in 2005 were $29.8 million, excluding one-time start-up costs,and year two costs under the agreement are projected at approximately $24.3million. We have the right to terminate this agreement upon 90 days writtennotice to Publicis. If we had terminated this agreement during the periodbetween January 31, 2005 and January 30, 2006, we would have beenrequired to pay a termination fee in the amount of $1.0 million. If weterminate during the period between January 31, 2006 and July 31,2006, the termination fee will be $750,000. If we terminate the agreement afterJuly 31, 2006, Publicis is not eligible for a termination fee. Otherpurchase obligations are $2.4 million in purchase commitments to Schwarz Pharmafor manufacture of finished goods in the first and second quarter of 2006.

We believe that our existing cash, cash equivalentsand marketable securities, including the net proceeds received from the sale of6.1 million shares of our common stock in January 2006, will be sufficientto fund our planned operations, including increases in spending for the launchand commercialization of BiDil and our current development programs, for atleast 21 months from the date of this report. However, we may requiresignificant additional funds earlier than we currently expect to continue tosupport the commercial launch of BiDil, and to obtain regulatory approvalsnecessary to develop and launch our other product candidates.

We may seek additional funding through collaborativearrangements and public or private financings. Additional funding may not beavailable to us on acceptable terms or at all. In addition, the terms of anyfinancing may adversely affect the holdings or the rights of our stockholders.For example, if we raise additional funds by issuing equity securities, furtherdilution to our existing stockholders may result. If we are unable to obtainfunding on a timely basis, we may be required to significantly curtail one ormore of our research or development programs. We also could be required to seekfunds through arrangements with collaborators or others that may require us torelinquish rights to some of our technologies, product candidates, or productswhich we would otherwise pursue on our own.

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:

·       thecosts of launching and commercializing BiDil;

·       themagnitude of product sales of BiDil;

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·       thetiming, receipt, and amount of milestone and other payments, if any, frompotential collaborators;

·       thetiming, receipt, and amount of sales and royalties, if any, from our potentialproduct candidates;

·       theresources required to successfully complete our clinical trials;

·       thetime and costs involved in obtaining regulatory approvals;

·       continuedprogress in our research and development programs, as well as the magnitude ofthese programs;

·       thecost of manufacturing, marketing and sales activities;

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

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

·       ourability to establish and maintain additional collaborative arrangements.

**Applicationof**Critical Accounting 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, inventory, accrued expensesand the factors used to determine the fair value of our stock options. We baseour estimates on historical experience, known trends and events and variousother factors that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions.

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.**  *Wefollow the provisions of Staff Accounting Bulletin No. 104, *Revenue Recognition* and recognize revenue from product salesupon delivery of product to wholesalers or pharmacies, when persuasive evidenceof an arrangement exists, the fee is fixed or determinable, title to productand associated risk of loss has passed to the wholesaler and collect-ability ofthe related receivable is reasonably assured. All revenues from product salesare recorded net of applicable allowances for sales returns, 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, remainingshelf-life of the product shipped and quarterly forecasted sales. As a resultof this evaluation, we deferred $2.1 million of revenue from December shipmentsand recorded this amount in deferred revenue as of December 31, 2005.Also, the cost of BiDil associated with amounts recorded as deferred revenueare recorded in inventory until such time as risk of loss has passed.

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*SalesReturns, Allowances, Rebates and Discounts.**  *Our product sales are subject to returns,allowances, rebates and discounts that are customary in the pharmaceuticalindustry.

A large portion of our product sales are made topharmaceutical wholesalers for further distribution through pharmacies topatients, who are consumers of the product. All revenues from product sales arerecorded net of applicable allowances for sales returns, wholesaler allowances,rebates and cash and contract discounts. We determine our provisions for salesreturns, allowances, rebates and discounts based primarily on estimates and oncontractual terms. In developing a reasonable estimate for the reserve forproduct returns, we considered the factors in paragraph 8 of SFAS 48, *Revenue Recognition When a Right of Return Exists*. Althoughwe have not yet developed our own history of product returns because of therecent launch of BiDil, we believe we can develop a reasonable estimate ofreturns. BiDil is a heart failure drug that is similar to other drugs in themarketplace which have similar channels of distribution, similar shelf livesand similar return rights. We were able to verify through discussions withother pharmaceutical firms that promote and sell these other drugs that ourinitial estimate of returns is reasonable in relation to product launch. Wewill continue to monitor actual returns as we gain more sales experience withBiDil.

*ProductReturns.**  *Consistentwith industry practice, we offer contractual return rights that allow customersto return product only during the period that is three 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 August 2006. Factors that areconsidered in our estimate of future product returns include an analysis of theamount of product in the wholesaler and pharmacy channels, discussions with keywholesalers and other customers regarding inventory levels and shipment trends,review of consumer consumption data as reported by Source Projected Launchtrac,Wolters Kluwer Health, return rates for similar pharmaceutical products thatare sold in the same distribution channel, the remaining time to expiration ofour product and our forecast of future sales of our product. At December 31,2005, our product return reserve was $98,000. 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 has 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. As of December 31, 2005, theremaining balance of deferred revenue related to these units is $1.2 million.

*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.

*SampleVoucher 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(approximately 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*(EITF No. 01-09). These initial sample vouchers had an expirationdate of September 30, 2005 at which time we reduced revenue for the actualamount of reimbursement claims received for the vouchers distributed during thethird quarter of 2005. This program was repeated during the fourth quarter withsample vouchers that had an expiration date of December 31, 2005, at whichtime we reduced revenue  for the actualamount of reimbursement claims received for the vouchers distributed during thefourth quarter of 2005. As a result 

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of this program, werecorded a reduction to revenue of $786,000 for the year ended December 31,2005. We expect to continue to offer sample voucher incentives in futureperiods.

*SalesDiscounts, Rebates and Allowances.**  *Salesdiscounts, rebates and allowances result primarily from sales under contractwith wholesalers, healthcare providers, Medicaid programs and othergovernmental agencies. We estimate rebates and contractual allowances, cash andcontract discounts and other rebates by considering the following factors:current contract prices and terms, estimated customer and wholesaler inventorylevels and current average rebate rates. For the year end December 31,2005, we recorded cash discounts, rebates and other allowances of $125,000.

*CollaborationRevenue.**  *Werecord revenue on an accrual basis as it is earned and when amounts areconsidered collectible. Revenues received in advance of performance obligationsor in cases where we have 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 we are required to deferrevenue, the period over which such revenue should be recognized is subject toestimates by management and may change over the course of the collaborativeagreement. In future periods, we expect revenues derived from collaborationagreements will continue to decrease as a percentage of total revenue, andproduct revenues will continue to increase based on anticipated increasedvolume of prescriptions of BiDil.

**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 reportingperiod. BiDil currently has a twelve month shelf life.****Ona quarterly basis, we analyze our current inventory levels and futureirrevocable inventory purchase commitments and write down inventory that hasbecome un-saleable, inventory that has a cost basis in excess of its expectednet realizable value and irrevocable inventory purchase commitments that are inexcess of expected future inventory requirements based on our sales forecasts.Expired inventory will be disposed of, and the related costs will be writtenoff. For the year ended December 31, 2005, we recorded an inventoryimpairment charge of $5.6 million to cost of sales related to commercial tradeand patient sample inventory, and a $1.5 million charge to cost of sales forcontractual purchase commitments.

**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 each balance sheet date in ourfinancial 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 forservices performed. In the event that we do not identify certain costs, whichhave begun to be incurred, or we over or under- estimate the level ofservices performed or the costs of such services, our reported expenses forsuch period would be too low or too high. The date on which certain servicescommence, the level of services performed on or before a given date and thecost of such services are often determined based on subjective judgments. Wemake these judgments based upon the facts and circumstances known to us inaccordance with generally accepted accounting principles.

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**Stock-BasedCompensation.****  **We haveelected to follow Accounting Principle Board, or APB, Opinion No. 25, *Accounting for Stock Issued to Employees*, or APB 25, andrelated interpretations, in accounting for our stock-based compensationplans, rather than the alternative fair value method provided for underStatement of Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation*, or SFAS 123. In 2003 and2002, certain grants of stock options were made at exercise prices less thanthe fair value of our common stock and, as a result, we recorded deferred stockcompensation expense. In the notes to our financial statements, we provide proforma disclosures in accordance with SFAS 123. We account for transactionsin which services are received from non-employees in exchange for equityinstruments based on the fair value of such services received or of the equityinstruments issued, whichever is more reliably measured, in accordance withSFAS 123 and the Emerging Issues Task Force, or EITF, Issue 96-18, *Accounting for Equity Instruments that Are Issued to Other thanEmployees for Acquiring, or in Conjunction with Selling, Goods or Services*,or EITF 96-18.

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 expensesmay be over or under stated. For equity instruments granted or sold in exchangefor the 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 to common stockholders from anticipated future financings and ageneral assessment of 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.

**RecentlyIssued Accounting Pronouncement**

On December 16, 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards, or SFAS, No. 123(revised 2004), referred to as SFAS 123R, *Share-Based Payment*,which is a revision of SFAS No. 123, *Accounting for Stock-BasedCompensation*. SFAS 123R supersedes 

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Accounting PrinciplesBoard Opinion No. 25, *Accounting for StockIssued to Employees*, or APB 25, and amends SFAS No. 95, *Statement of Cash Flows*. Generally, the approach in SFAS123R is similar to the approach described in SFAS 123. However, SFAS 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the income statement based on their fairvalues at the date of grant. Pro forma disclosure is no longer an alternative.SFAS 123R must be adopted in fiscal periods beginning after June 15, 2005.We will adopt SFAS 123R on January 1, 2006, the commencement of our firstquarter of fiscal 2006.

SFAS 123R permits companies to adopt its requirementsusing one of two methods. A “modified prospective” method in which compensationcost is recognized beginning with the effective date (a) based on therequirements of SFAS 123R for all share-based payments granted after theeffective date and (b) based on the requirements of SFAS 123 for allawards granted to employees prior to the effective date of SFAS 123R thatremain unvested on the effective date. A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures for either (a) all priorperiods presented or (b) prior interim periods of the year of adoption.The Company anticipates adopting the “modified prospective” method.

As permitted by SFAS 123,we currently account for share-based payments to employees using APB 25’sintrinsic value method and, as such, generally recognize no compensation costfor employee stock options. Accordingly, the adoption of SFAS 123R’s fair valuemethod may have a significant impact on our result of operations, although itwill have no impact on our overall financial position. The impact of adoptionof SFAS 123R cannot be predicted at this time because it will depend on levelsof share-based payments granted in the future. However, had we adopted SFAS123R in prior periods, the impact of that standard would have approximated theimpact of SFAS 123 as described in the disclosure of pro forma net loss and netloss per share in Note 2 to our financial statements. We are currentlyevaluating the impact of the adoption of SFAS 123R on our financial position andresults of operations, including the valuation methods and support for theassumptions that underlie the valuation of the awards.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes ininterest rates. Our current investment policy is to maintain an investmentportfolio consisting mainly of U.S. money market and high-grade corporate andU.S. government-related securities, directly or through managed funds, withmaturities of two years or less. Our cash is deposited in and invested throughhighly rated financial institutions in North America. Our marketable securitiesare subject to interest rate risk and will fall in value if market interestrates increase. If market interest rates were to increase immediately anduniformly by 10% from levels at December 31, 2005, we estimate that thefair value of our investment portfolio would decline by an immaterial amount.We have the ability to hold our fixed income investments until maturity, andtherefore we do not expect our operating results or cash flows to be affectedto any significant degree by the effect of a change in market interest rates onour investments.

55

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**INDEXTO FINANCIAL STATEMENTS**

|                                                                                                                                                           | Page   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                      |   |
| Report of Independent Registered Public Accounting  Firm                                                                                                  | 57     |
| Financial Statements:                                                                                                                                     |   |
| Balance  Sheets as of December 31, 2005 and 2004                                                                                                     | 58     |
| Statements  of Operations for the Years Ended December 31, 2005, 2004, and 2003                                                                      | 59     |
| Statements of Redeemable Convertible Preferred Stock  and Stockholders’ Equity (Deficit) for the Years Ended December 31,  2005, 2004, and 2003 | 60     |
| Statements  of Cash Flows for the Years Ended December 31, 2005, 2004, and 2003                                                                      | 63     |
| Notes to Financial Statements                                                                                                                             | 64     |

 

56

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and StockholdersNitroMed, Inc.

We have audited the accompanying balance sheets ofNitroMed, Inc. as of December 31, 2005 and 2004, and the relatedstatements of operations, redeemable convertible preferred stock andstockholders’ equity (deficit), and cash flows for each of the three years inthe period ended December 31, 2005. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards 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, 2005 and 2004, and the results of itsoperations and its cash flows for each of the three years in the period ended December 31,2005, in conformity with U.S. generally accepted accounting principles.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of NitroMed, Inc.’sinternal control over financial reporting as of December 31, 2005, basedon criteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated February 28, 2006 expressed an unqualified opinion thereon.

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

 

Boston, MassachusettsFebruary 28, 2006

57

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**NITROMED, INC.**

**BALANCE SHEETS**

**(inthousands, except par value amounts)**

| ** **                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                           |       |                  |       |   |   |
| Current Assets:                                                                                                                                                      |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                           |       | $                     | 11,091     |   | $ | 35,882 |   |
| Marketable  securities                                                                                                                                               |       | 50,450                |       | 106,485 |   |
| Accounts  receivable                                                                                                                                                 |       | 4,078                 |       | — |   |
| Inventories                                                                                                                                                          |       | 3,247                 |       | — |   |
| Prepaid expenses  and other current assets                                                                                                                           |       | 3,860                 |       | 3,216 |   |
| Total current assets                                                                                                                                                 |       | 72,726                |       | 145,583 |   |
| Property and  equipment, net                                                                                                                                         |       | 2,992                 |       | 2,963 |   |
| Restricted cash                                                                                                                                                      |       | 803                   |       | 811 |   |
| Total assets                                                                                                                                                         |       | $                     | 76,521     |   | $ | 149,357 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                  |       |   |   |
| Current Liabilities:                                                                                                                                                 |       |                  |       |   |   |
| Accounts payable                                                                                                                                                     |       | $                     | 11,810     |   | $ | 2,662 |   |
| Accrued expenses                                                                                                                                                     |       | 11,269                |       | 8,091 |   |
| Deferred revenue                                                                                                                                                     |       | 3,451                 |       | 1,592 |   |
| Current portion  of long-term debt                                                                                                                                   |       | 6,272                 |       | — |   |
| Total current liabilities                                                                                                                                            |       | 32,802                |       | 12,345 |   |
| Long-term debt                                                                                                                                                       |       | 10,653                |       | — |   |
| Commitments and  contingencies                                                                                                                                       |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                           |       |                  |       |   |   |
| Preferred stock,  $0.01 par value; 5,000 shares authorized; no shares issued or outstanding                                                                          |       | —                |       | — |   |
| Common stock,  $.01 par value; authorized 65,000 shares; issued and outstanding 30,512  shares and 30,124 shares as of December 31, 2005 and 2004, respectively |       | 305                   |       | 301 |   |
| Additional paid-in  capital                                                                                                                                          |       | 276,510               |       | 275,727 |   |
| Deferred stock  compensation                                                                                                                                         |       | (1,208                | )          | (2,095 | ) |
| Accumulated  deficit                                                                                                                                                 |       | (242,471              | )          | (136,619 | ) |
| Accumulated other  comprehensive loss                                                                                                                                |       | (70                   | )          | (302 | ) |
| Total stockholders’ equity                                                                                                                                      |       | 33,066                |       | 137,012 |   |
| Total liabilities  and stockholders’ equity                                                                                                                     |       | $                     | 76,521     |   | $ | 149,357 |   |

 

The accompanyingnotes are an integral part of the financial statements.

58

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

| ** **                                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                                                                  |       |                                       |       |   |   |   |   |
| Product sales                                                                                              |       | $                                          | 4,455      |   | $ | — |   | $ | — |   |
| Research and development                                                                                   |       | 1,592                                      |       | 16,458 |   | 12,775 |   |
| Total revenues                                                                                             |       | 6,047                                      |       | 16,458 |   | 12,775 |   |
| Cost and  operating expenses:                                                                              |       |                                       |       |   |   |   |   |
| Cost of product sales                                                                                      |       | 8,009                                      |       | — |   | — |   |
| Research and development                                                                                   |       | 31,930                                     |       | 27,995 |   | 18,907 |   |
| Sales, general and administrative                                                                          |       | 74,006                                     |       | 19,591 |   | 3,114 |   |
| Total cost and operating expenses                                                                          |       | 113,945                                    |       | 47,586 |   | 22,021 |   |
| Loss from  operations                                                                                      |       | (107,898                                   | )          | (31,128 | ) | (9,246 | ) |
| Non-operating  income:                                                                                     |       |                                       |       |   |   |   |   |
| Interest expense                                                                                           |       | (930                                       | )          | (1 | ) | (4 | ) |
| Interest income                                                                                            |       | 2,976                                      |       | 1,336 |   | 399 |   |
| Rental and other income                                                                                    |       | —                                     |       | 20 |   | 82 |   |
|                                                                                                       |       | 2,046                                      |       | 1,355 |   | 477 |   |
| Net loss                                                                                                   |       | (105,852                                   | )          | (29,773 | ) | (8,769 | ) |
| Deemed dividends  related to beneficial conversion feature of redeemable convertible preferred  stock      |       | —                                     |       | — |   | (19,357 | ) |
| Dividends and  accretion to redemption value of redeemable convertible preferred stock                     |       | —                                     |       | — |   | (2,794 | ) |
| Net loss attributable  to common stockholders                                                              |       | $                                          | (105,852   | ) | $ | (29,773 | ) | $ | (30,920 | ) |
| Basic and diluted  net loss attributable to common stockholders per common share                           |       | $                                          | (3.49      | ) | $ | (1.14 | ) | $ | (6.95 | ) |
| Shares used in computing  basic and diluted net loss attributable to common stockholders per common  share |       | 30,355                                     |       | 26,152 |   | 4,447 |   |

 

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

59

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**NITROMED, INC.STATEMENTS OF REDEEMABLECONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)(in thousands, except per share amounts)**

| ** **                                                                                                                 | ** ** | **Redeemable  Convertible  Preferred Stock** | ** ** | ** ** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Deferred  Stock** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|-----------------------|------------|-------------------------|------------|---------------------|------------|-----------------|------------|---------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                 | ** ** | **Shares**                                        | ** ** | **Amount** | ** ** | ** **            | ** ** | **Shares**              | ** ** | **Par Value**  | ** ** | **Capital**     | ** ** | **Compensation**                      | ** ** | **Deficit**                   | ** ** | **Income (Loss)** | ** ** | **Equity (Deficit)** | ** ** |
| Balance at December 31, 2002                                                                                          |       | 30,770                                            |       | $          | 82,884     |                  |       |                    | 985        |                |       | $               | 10         |                                  |       |                          | $          | 3,090 |   |   |   | $ | (527 | ) |   |   | $ | (75,926 | ) |   |   | $ | — |   |   |   | $ | (73,353 | ) |   |
| Exercise of stock options                                                                                                  |       |                                              |       |       |       |                  |       | 217                     |       |                | 2          |            |       |                                  | 131        |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 133 |   |   |
| Deferred stock compensation expense associated with  stock options                                                         |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  | 3,317      |                          |       |   | (3,317 | ) |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Amortization of deferred stock compensation                                                                                |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   | 604 |   |   |   |   |   |   |   |   |   |   |   | 604 |   |   |
| Compensation expense associated with options issued  to non-employees and performance options issued to employees          |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  | 303        |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 303 |   |   |
| Accretion of Series E dividends                                                                                       |       |                                              |       | 2,469      |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   |   |   |   |   | (2,469 | ) |   |   |   |   |   |   | (2,469 | ) |   |
| Accretion of preferred stock to redemption value                                                                           |       |                                              |       | 325        |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   |   |   |   |   | (325 | ) |   |   |   |   |   |   | (325 | ) |   |
| Beneficial conversion feature of Series E                                                                             |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  | 19,320     |                          |       |   |   |   |   |   | (19,320 | ) |   |   |   |   |   |   | — |   |   |
| Beneficial conversion feature of Series F                                                                             |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  | 37         |                          |       |   |   |   |   |   | (37 | ) |   |   |   |   |   |   | — |   |   |
| Issuance of Series E preferred stock in  August 2003 at $7.20 per share for cash (net of issuance costs of $100) |       | 2,776                                             |       | 19,900     |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock from initial public offering  (“IPO”) (net of issuance costs of $5,928)                 |       |                                              |       |       |       |                  |       | 6,000                   |       |                | 60         |            |       |                                  | 60,012     |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 60,072 |   |   |
| Conversion of preferred stock to common stock at IPO                                                                       |       | (33,546                                           | )          | (105,578   | )          |                  |       | 18,399                  |       |                | 184        |            |       |                                  | 105,394    |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 105,578 |   |   |
| Unrealized gains on cash equivalents and marketable  securities                                                            |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   | 25 |   |   |   | 25 |   |   |
| Net loss                                                                                                                   |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   |   |   |   |   | (8,769 | ) |   |   |   |   |   |   | (8,769 | ) |   |
| Comprehensive loss                                                                                                         |       |                                              |       |       |       |                  |       |                    |       |                |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (8,744 | ) |   |
| Balance at  December 31, 2003                                                                                         |       | —                                            |       | $          | —     |                  |       |                    | 25,601     |                |       | $               | 256        |                                  |       |                          | $          | 191,604 |   |   |   | $ | (3,240 | ) |   |   | $ | (106,846 | ) |   |   | $ | 25 |   |   |   | $ | 81,799 |   |   |

 

The accompanying notes arean integral part of the financial statements.

60

 

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**NITROMED, INC.STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY(DEFICIT)(in thousands, except per share amounts)**

|                                                                                                                         | ** ** | **Redeemable  Convertible  Preferred Stock** | ** ** | ** ** | ** ** | **Common Stock** | ** **    | **Additional  Paid-in** | ** ** | **Deferred  Stock** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|-----------------------|---------------|-------------------------|------------|---------------------|------------|-----------------|------------|---------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                              | ** ** | **Shares**                                        | ** ** | **Amount** | ** ** | ** **            | ** **    | **Shares**              | ** ** | **Par Value**  | ** ** | **Capital**     | ** ** | **Compensation**                      | ** ** | **Deficit**                   | ** ** | **Income (Loss)** | ** ** | **Equity (Deficit)** | ** ** |
| 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 accompanying notes arean integral part of the financial statements.

61

 

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**NITROMED, INC.STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY(DEFICIT)(in thousands, except per share amounts)**

|                                                                                                                                | ** ** | **Redeemable  Convertible  Preferred Stock** | ** ** | ** ** | ** ** | **Common Stock** | ** **    | **Additional  Paid-in** | ** ** | **Deferred  Stock** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total  Stockholders’** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|-----------------------|---------------|-------------------------|------------|---------------------|------------|-----------------|------------|-----------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                     | ** ** | **Shares**                                        | ** ** | **Amount** | ** ** | ** **            | ** **    | **Shares**              | ** ** | **Par Value**  | ** ** | **Capital**     | ** ** | **Compensation**                              | ** ** | **Deficit**                   | ** ** | **(Loss)** | ** ** | **Equity (Deficit)** | ** ** |
| 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 accompanying notes arean integral part of the financial statements.

62

 

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

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                                     |       |                                       |       |   |   |   |   |
| Net loss                                                                                   |       | $                                          | (105,852   | ) | $ | (29,773 | ) | $ | (8,769 | ) |
| Adjustments to  reconcile net loss to net cash (used in) provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                              |       | 896                                        |       | 421 |   | 251 |   |
| Stock-based compensation expense                                                           |       | 493                                        |       | 2,522 |   | 907 |   |
| Changes in  operating assets and liabilities:                                              |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                        |       | (4,078                                     | )          | — |   | — |   |
| Inventories                                                                                |       | (3,247                                     | )          | — |   | — |   |
| Prepaid expenses and other current assets                                                  |       | (644                                       | )          | (1,920 | ) | 8,971 |   |
| Deferred revenue                                                                           |       | 1,859                                      |       | (12,858 | ) | 3,825 |   |
| Accounts payable and accrued expenses                                                      |       | 12,326                                     |       | 7,854 |   | 627 |   |
| Net cash (used in) provided by operating activities                                        |       | (98,247                                    | )          | (33,754 | ) | 5,812 |   |
| Cash flows from  investing activities:                                                     |       |                                       |       |   |   |   |   |
| Purchases of property and equipment                                                        |       | (925                                       | )          | (2,698 | ) | (655 | ) |
| Purchases of marketable securities                                                         |       | (126,159                                   | )          | (131,410 | ) | (37,562 | ) |
| Sales of marketable securities                                                             |       | 182,426                                    |       | 54,072 |   | 14,796 |   |
| Restricted cash                                                                            |       | 8                                          |       | (711 | ) | — |   |
| Net cash provided by (used in) investing activities                                        |       | 55,350                                     |       | (80,747 | ) | (23,421 | ) |
| Cash flows from  financing activities:                                                     |       |                                       |       |   |   |   |   |
| Proceeds from long-term debt                                                               |       | 20,000                                     |       | — |   | — |   |
| Principal payments on long-term debt                                                       |       | (3,075                                     | )          | — |   | — |   |
| Net proceeds from sale of common stock in public  offering                                 |       | —                                     |       | 81,758 |   | 60,072 |   |
| Proceeds from employee stock plans                                                         |       | 1,181                                      |       | 1,033 |   | 133 |   |
| Principal payments on notes payable                                                        |       | —                                     |       | (22 | ) | (42 | ) |
| Net proceeds from sale of redeemable convertible  preferred stock                          |       | —                                     |       | — |   | 19,900 |   |
| Net cash provided by financing activities                                                  |       | 18,106                                     |       | 82,769 |   | 80,063 |   |
| Net (decrease)  increase in cash and cash equivalents                                      |       | (24,791                                    | )          | (31,732 | ) | 62,454 |   |
| Cash and cash  equivalents, beginning balance                                              |       | 35,882                                     |       | 67,614 |   | 5,160 |   |
| Cash and cash  equivalents, ending balance                                                 |       | $                                          | 11,091     |   | $ | 35,882 |   | $ | 67,614 |   |
| Supplemental  disclosure:                                                                  |       |                                       |       |   |   |   |   |
| Cash paid during the  year for interest                                                    |       | $                                          | 790        |   | $ | 1 |   | $ | 4 |   |

 

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

63

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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 emerging pharmaceutical company focused on the research, development andcommercialization of proprietary pharmaceuticals based on the therapeuticbenefits of nitric oxide. In June 2005, the U.S. Food and DrugAdministration (FDA) approved the Company’s product, BiDil, for the treatmentof heart failure in self-identified black patients. BiDil is an orallyadministered fixed-dose combination of isosorbide dinitrate and hydralazinehydrochloride. The Company commercially launched BiDil in July 2005 andgenerated product sales of  $4.5 millionduring the year ended December 31, 2005. The Company’s goal is to become aleading, multi-product pharmaceutical company by developing additionalinnovative nitric oxide products and by building on the Company’s BiDildevelopment experience and commercialization infrastructure to identify andmarket additional products for cardiovascular and metabolic diseases. TheCompany is applying its nitric oxide technology to develop novelpharmaceuticals, as well as safer and more effective versions of existingdrugs, to target significant diseases that are characterized by a deficiency innitric oxide and to treat underserved patient populations. The Company’s nitricoxide-development strategy involves the internal development of proprietarynitric oxide-enhancing product candidates, such as BiDil, theco-development of nitric oxide-enhancing drugs with partners and theout-licensing of our nitric oxide-enhancing technology in exchange forpotential milestone payments and royalties on sales.

On January 25, 2006,the Company completed a registered direct public offering of shares of itscommon stock previously registered under an effective shelf registrationstatement, which was filed with the Securities and Exchange Commission 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 registered direct offering, net ofoffering expenses and placement agency fees, totaled $58.6 million.

**2.Summary of Significant Accounting Policies**

**CashEquivalents and 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 anddesignated as available-for-sale. Cash equivalents consist of institutionalmoney market funds. Available-for-sale securities are carried at fair marketvalue, as reported by the custodian, and unrealized gains and losses arereported as a separate component of accumulated other comprehensive incomewithin stockholders’ equity. Realized gains and losses were not material forthe years ended December 31, 2005, 2004 and 2003.

**FairValue of Financial 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  $13.3 million.

**Researchand Development Expenses**

Research and developmentexpenses primarily consist of salaries and related expenses for personnel, feespaid to consultants and outside service providers, materials used in clinicaltrials and research and development, and medical support costs related to thelaunch and commercialization of BiDil. The 

64

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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)**

Companycharges research and development expenses, including costs associated withacquiring patents, to operations as incurred.

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 principalsource of revenue is the sale of BiDil (isosorbide dinitrate/hydralazinehydrochloride), the Company’s product for the treatment of heart failure inself-identified black patients as an adjunct to current standard therapies.BiDil was launched and began shipping in the third quarter of 2005. Other sourcesof revenue include collaboration revenue, which has generally been recognizedratably over the research and development collaboration term. The Companyexpects that revenues derived from its collaboration agreements will continueto decrease as a percentage of total revenue in future periods, and productrevenues will continue to increase based on anticipated increased volume ofprescriptions of BiDil.

*Product Sales/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 collectability of therelated receivable is reasonably assured. All revenues from product sales arerecorded net of applicable allowances for sales returns, rebates,  and discounts. For arrangements where therisk of loss has not passed to wholesalers or pharmacies, the Company defersthe recognition of revenue by recording deferred revenue until such time thatrisk of loss has passed. In addition, the Company evaluates its level ofshipments to wholesalers and pharmacies on a quarterly basis compared to theestimated level of inventory in the channel, remaining shelf-life of theproduct shipped and quarterly forecasted sales. As a result of this evaluation,the Company deferred $2.1 million of revenue from December shipments andrecorded this amount in deferred revenue as of December 31, 2005. The costof BiDil associated with amounts recorded as deferred revenue are recorded ininventory until such time as risk of loss has passed.

65

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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)**

*Sales Returns, Allowances, Rebates and Discounts.  *The Company’s product sales are subject to returns,allowances, rebates and discounts that are customary in the pharmaceuticalindustry.

**A large portion of the Company’sproduct sales are made to pharmaceutical wholesalers for further distributionthrough pharmacies to patients, who are consumers of the product. All revenuesfrom product sales are recorded net of applicable allowances for sales returns,wholesaler allowances, rebates and cash and contract discounts. The Companydetermines provisions for sales returns, allowances, rebates and discountsbased primarily on estimates and on contractual terms. In developing areasonable estimate for the reserve for product returns, the Company consideredthe factors in paragraph 8 of Statement of Financial Accounting Standards(SFAS) No. 48, *Revenue Recognition When aRight of Return Exists*. Although the Company has not yet developedits own history of product returns because of the recent launch of BiDil, theCompany believes it can develop a reasonable estimate of returns. BiDil is aheart failure drug that is similar to other drugs in the marketplace which havesimilar channels of distribution, similar shelf lives and similar returnrights. The Company was able to verify through discussions with other pharmaceuticalfirms that promote and sell these other drugs that the Company’s initialestimate of returns is reasonable in relation to product launch. The Companywill continue to monitor actual returns as the Company gains more salesexperience with BiDil.**

*Product Returns.*   Consistent with industry practice, the Company offerscontractual return rights that allow customers to return product only duringthe period that is three 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 August 2006. Factors that are considered in the Company’s estimate offuture product returns include an analysis of the amount of product in the wholesalerand pharmacy channels, discussions with key wholesalers and other customersregarding inventory levels and shipment trends, review of consumer consumptiondata as reported by Source Projected Launchtrac, Wolters Kluwer Health, returnrates for similar pharmaceutical products that are sold in the samedistribution channel  the remaining timeto expiration of the Company’s product and the Company’s forecast of futuresales of the product. At December 31, 2005, the Company’s product returnreserve was $98,000. This reserve is evaluated on a quarterly basis, assessingeach of the factors described above, and adjusted accordingly. Based on thefactors noted above, the Company believes its estimate of product returns isreasonable, and changes, if any, from this estimate would not have a materialimpact to the Company’s financial statements.

*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 theseunits has not passed to the customer. Accordingly, the Company deferred allrevenue related to these units until such time as the unit is provided to apatient with a prescription. As of December 31, 2005, the remainingbalance of deferred revenue related to these units is $1.2 million.

*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 in the amount of$328,000. The Company recorded this amount as a reduction to revenue for theyear ended December 31, 2005.

66

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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)**

*Sample Voucher Program.*   Beginning in the third quarter of 2005, the Companyinitiated a sample voucher program whereby the Company offered an incentive topatients in the form of a free 30-day trial (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 a Customer (EITF No. 01-09). These initial samplevouchers had an expiration date of September 30, 2005 at which time theCompany reduced revenue for the actual amount of reimbursement claims receivedfor the vouchers distributed during the third quarter of 2005. This program wasrepeated during the fourth quarter with sample vouchers that had an expirationdate of December 31, 2005, at which time the Company reduced revenue forthe actual amount of reimbursement claims received for the vouchers distributedduring the fourth quarter of 2005. As a result of this program, the Companyrecorded a reduction to revenue of $786,000 for the year ended December 31,2005. The Company expects to continue to offer sample voucher incentives infuture periods.

*Sales Discounts, Rebates and Allowances.*   Sales discounts, rebates and contractual allowancesresult primarily from sales under contract with healthcare providers,wholesalers, Medicaid programs and other governmental agencies. The Companyestimates rebates and contractual allowances, cash and contract discounts andother rebates by considering the following factors: current contract prices andterms, estimated customer and wholesaler inventory levels and current averagerebate rates. For the year end December 31, 2005, the Company recordedcash discounts, rebates and other allowances of $125,000.

*Collaboration Revenue.*   The Company records collaboration revenue on anaccrual basis as it is earned and when amounts are considered collectible.Revenues received in advance of performance obligations or in cases where theCompany has a continuing obligation to perform services are deferred andrecognized over the contractual or estimated performance period. Revenues frommilestone payments that represent the culmination of a separate earningsprocess are recorded when the milestone is achieved. Contract revenues arerecorded as the services are performed. When the Company is required to deferrevenue, the period over which such revenue should be recognized is subject toestimates by management and may change over the course of the collaborativeagreement. In future periods, the Company expects revenues derived fromcollaboration agreements will continue to decrease as a percentage of totalrevenue in future periods and product revenues will continue to increase basedon anticipated increased volume of prescriptions of BiDil.

**Accounts Receivable**

Accounts receivableconsists of amounts due from wholesalers and pharmacies for the purchase ofBiDil. Ongoing evaluations of customers are performed and collateral isgenerally not required. As of December 31, 2005, the Company has not reservedany amount for bad debts related to the sale of BiDil. The Company continuouslyreviews all customer accounts to determine if an allowance for uncollectibleaccounts is necessary. The Company currently provides substantially all of itsdistributors with payment terms of up to 30 days on purchases of BiDil. Amountspast due from customers are determined based on contractual payment terms.Through December 31, 2005, 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 SignificantAccounting Policies (Continued)

**Property andEquipment**

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 valuedetermined by either a quoted market price or by a discounted cash flowtechnique, whichever is more appropriate under the circumstances.

**Inventories**

Inventoriesare stated at the lower of cost or market, with cost determined on a first-in,first-out basis. Inventories consisted of the following:

| ** **           | ** ** | **December 31,**   | ** ** |
|----------------------|------------|-------------------------|------------|
| ** **           | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **           | ** ** | **(in thousands)** | ** ** |
| Raw materials        |       | $                       | 2,599      |   |   | $ | — |   |   |
| Finished goods       |       | 481                     |       |   | — |   |   |
| Consigned  inventory |       | 167                     |       |   | — |   |   |
| Total                |       | $                       | 3,247      |   |   | $ | — |   |   |

 

During the year ended December 31, 2005, theCompany purchased and capitalized inventories to be used for commercial tradesales and samples related to the July 2005 product launch of BiDil. BiDilcurrently has a twelve month shelf life.

On a quarterly basis, theCompany analyzes its current inventory levels and future irrevocable inventorypurchase commitments and writes down inventory that has become un-saleable,inventory that has a cost basis in excess of its expected net realizable valueand future irrevocable inventory purchase commitments that are in excess ofexpected future product sales. Expired inventory is disposed of, and therelated costs are written off. For the year ended December 31, 2005, theCompany recorded an inventory impairment charge of $5.6 million to cost ofsales related to commercial trade and patient sample inventory product, and a$1.5 million charge to cost of sales for contractual purchase commitments inexcess of expected future inventory requirements based on the Company’s salesforecast.

**Net Loss Per Share**

Basic net loss per share is computed by dividing netloss available to common stockholders by the weighted average number of sharesof common stock outstanding during the period. Diluted net loss per share iscomputed by dividing net loss available to common stockholders by the weightedaverage number of shares of common stock and the dilutive potential commonstock equivalents then outstanding. Potential common stock equivalents consistof stock options, warrants and redeemable convertible preferred stock. Sincethe Company has a net loss for all periods presented, the effect of allpotentially dilutive securities is antidilutive. Accordingly, basic and dilutednet loss per share is the same.

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

**2.**   Summary of SignificantAccounting Policies (Continued)

The following table setsforth the computation of basic and diluted net loss per share for therespective periods:

| ** **                                                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| *Basic and Diluted:*                                                                                        |       |                                       |       |   |   |   |   |
| Net loss                                                                                                    |       | $                                          | (105,852   | ) | $ | (29,773 | ) | $ | (8,769 | ) |
| Deemed dividends  related to beneficial conversion feature of redeemable convertible preferred  stock       |       | —                                     |       | — |   | (19,357 | ) |
| Dividends and  accretion to redemption value of redeemable convertible preferred stock prior  to conversion |       | —                                     |       | — |   | (2,794 | ) |
| Net loss  attributable to common stockholders                                                               |       | $                                          | (105,852   | ) | $ | (29,773 | ) | $ | (30,920 | ) |
| Weighted average common shares used to compute net  loss per share                                          |       | 30,355                                     |       | 26,152 |   | 4,447 |   |
| Basic and diluted  net loss per share                                                                       |       | $                                          | (3.49      | ) | $ | (1.14 | ) | $ | (6.95 | ) |

 

Options to purchase3,819,676, 3,246,631 and 2,898,584 shares of common stock for the years ended December 31,2005, 2004 and 2003, respectively, and warrants to purchase 1,319, 13,861 and275,096 shares of common stock for the years ended December 31, 2005, 2004and 2003, respectively, have been excluded from the computation of net loss pershare as their effects would have been antidilutive.

**Single Source Suppliers**

The Company currentlyobtains one of the key active pharmaceutical ingredients for its commercialrequirements for BiDil from a single source. The disruption or termination ofthe supply of the commercial requirement for BiDil or a significant increase inthe cost of the key active pharmaceutical ingredient from this single sourcecould have a material adverse effect on the Company’s business, financialposition and results of operations.

**Concentration of Credit Risk**

SFAS No. 105, *Disclosure of Informationabout Financial Instruments with Off-Balance-Sheet Risk and FinancialInstruments with Concentrations of Credit Risk*, requires disclosureof any significant 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 foreignhedging arrangements. The Company maintains its cash and cash equivalents andmarketable securities balances with several nonaffiliated institutions.

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

**2.**   Summary of SignificantAccounting Policies (Continued)

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 from which the Company recognized revenue in 2005, 2004 and 2003from solely two collaborative partners:

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

 

Thefollowing table summarizes the number of customers that individually comprisegreater than 10% of total accounts receivable and their respective percentageof the Company’s total accounts receivable:

| ** **                    | ** ** | **Number of  Significant  Customers** | ** ** | **Percentage of  Total  Accounts  Revenues  by Customer** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                    | ** ** | ** **                                 | ** ** | **A**                                                               | ** ** | **B** | ** ** |
| As of December 31,  2005 |       |                                       | 2          |                                                                |       | 21 | % | 59 | % |
|                               |            |                                            |            |                                                                     |            |  |  |  |  |

 

**Advertising Costs**

All advertising costs areexpensed as incurred. Advertising expenses were $20.1 million and $2.0 millionfor the years ended December 31, 2005 and 2004, respectively. There wereno advertising costs for the year ended December 31, 2003.

**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 receivableand customer returns rates, the net realizable value of inventory, useful livesof fixed assets, and accrued liabilities. Actual results could differ fromthose estimates, and such differences may be material to the financialstatements.

**Stock-BasedCompensation**

TheCompany has elected to account for its stock-based compensation plansunder the intrinsic value method pursuant to Accounting Principles BoardOpinion No. 25, *Accounting for StockIssued to Employees* (APB 25), and related Interpretations, ratherthan the alternative fair value accounting provided under SFAS No. 123, *Accounting for Stock-Based Compensation*(SFAS 123). In accordance with EITF 96-18, *Accountingfor Equity Instruments that are Issued to Other than Employees for Acquiring,or in Connection with Selling Goods or Services* (EITF 96-18),the Company records compensation expense equal to the fair value of the optiongranted to non-employees over the vesting period, which is generally the periodof service.

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

**2. Summary of SignificantAccounting Policies (Continued)**

SFAS 123requires pro forma information regarding net loss and net loss per share as ifthe Company had accounted for its stock-based awards to employees underthe fair value method of SFAS 123. The fair value of the Company’s stockoptions used to compute pro forma net loss is the estimated fair value at thegrant date using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions:

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free  interest rate |       |                  | 4.0        | % |   | 3.6 | % | 2.8 | % |
| Expected  volatility     |       |                  | 73         | % |   | 94 | % | 80 | % |
| Expected lives           |       |                  | 6 years    |   |   | 4 years |   | 4 years |   |
| Expected dividend        |       |                  | —     |   |   | — |   | — |   |

 

The per-share, weighted-average grant date fairvalue of options granted during the years ended December 31, 2005, 2004and 2003 was $11.51, $9.66 and $6.49, respectively.

Forpurposes of pro forma disclosures, the estimated fair value of the options isamortized over the option vesting period. Had compensation expense for theCompany’s stock-based compensation plans been determined based on thefair value at the grant dates for awards under those plans consistent with themethod of SFAS 123, the Company’s net loss and net loss per share wouldhave been as follows:

| ** **                                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss  attributable to common stockholders as reported                                   |       | $                                           | (105,852   | ) | $ | (29,773 | ) | $ | (30,920 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss               |       | 626                                         |       | 1,512 |   | 722 |   |
| Deduct: Stock-based  employee compensation expense determined under fair value based method |       | (5,961                                      | )          | (2,645 | ) | (850 | ) |
| Pro forma net loss                                                                          |       | $                                           | (111,187   | ) | $ | (30,906 | ) | $ | (31,048 | ) |
| Basic and diluted net  loss per share:                                                      |       |                                        |       |   |   |   |   |
| As reported                                                                                 |       | $                                           | (3.49      | ) | $ | (1.14 | ) | $ | (6.95 | ) |
| Pro forma                                                                                   |       | $                                           | (3.66      | ) | $ | (1.18 | ) | $ | (6.98 | ) |

 

**AccumulatedOther Comprehensive Income (Loss)**

TheCompany presents comprehensive income (loss) in accordance with SFAS No. 130,*Reporting ComprehensiveIncome*. Accumulatedother comprehensive income is comprised entirely of unrealized gains and losseson available-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.

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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)**

**Segment Information**

Duringthe three years ended December 31, 2005, 2004 and 2003, the Companyoperated in one reportable business segment, developing nitric oxide enhancingmedicines, under the management approach of SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information.*

**New Accounting Standard**

On December 16, 2004, the Financial AccountingStandards Board issued SFAS No. 123 (revised 2004) (SFAS 123R), *Share-Based Payment*, which is a revision of SFAS No. 123,*Accounting for**Stock-BasedCompensation*. SFAS 123R supersedes APB 25 and amends SFAS No. 95*, Statement of Cash Flows*. Generally, the approach in SFAS123R is similar to the approach described in SFAS 123. However, SFAS 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the income statement based on their fairvalues at the date of grant. Pro forma disclosure is no longer an alternative.The Company will adopt SFAS 123R on January 1, 2006, the commencement ofits first quarter of fiscal 2006.

SFAS 123R permits companies to adopt its requirementsusing one of two methods. A “modified prospective” method in which compensationcost is recognized beginning with the effective date (a) based on therequirements of SFAS 123R for all share-based payments granted after theeffective date and (b) based on the requirements of SFAS 123 for allawards granted to employees prior to the effective date of SFAS 123R thatremain unvested on the effective date. A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures for either (a) allprior periods presented or (b) prior interim periods of the year ofadoption. The Company anticipates adopting the “modified prospective” method.

As permitted by SFAS 123,the Company currently accounts for share-based payments to employees using APB25’s intrinsic value method and, as such, generally recognizes no compensationcost for employee stock options. Accordingly, the adoption of SFAS 123R’s fairvalue method may have a significant impact on the Company’s result ofoperations, although it will have no impact on the Company’s overall financialposition. The impact of adoption of SFAS 123R cannot be predicted at this timebecause it will depend on levels of share-based payments granted in the future.However, had the Company adopted SFAS 123R in prior periods, the impact of thatstandard would have approximated the impact of SFAS 123 as described in thedisclosure of pro forma net loss and net loss per share in Note 2 to thesefinancial statements. The Company is currently evaluating the impact of theadoption of SFAS 123R on its financial position and results of operations,including the valuation methods and support for the assumptions that underliethe valuation of the awards.

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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**

The following is a summaryof the fair market value of available-for-sale money market funds andmarketable securities the Company held at December 31, 2005 and 2004:

| **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      |       |       |       |                    |       |                             |       |                              |       |                           |       |   |   |   |   |   |   |
| Due in one to three  years      |       |       | 32,725     |                    |       |                             | —     |                              |       |                           | —     |   |   |   | 32,725 |   |   |
| Corporate notes                 |       |       |       |                    |       |                             |       |                              |       |                           |       |   |   |   |   |   |   |
| Due in one year or less         |       |       | 9,045      |                    |       |                             | —     |                              |       |                           | (33        | ) |   |   | 9,012 |   |   |
| Total marketable  securities    |       |       | $          | 50,520                  |       |                             |       | $                                 | —     |                           |       |   | $ | (70 | ) |   |   | $ | 50,450 |   |   |

 

| ** **                      | ** ** | ** ** | ** ** | **Gross Unrealized** | ** ** | **Gross Unrealized** | ** ** | **Estimated Fair** | ** ** |
|---------------------------------|------------|------------|------------|---------------------------|------------|---------------------------|------------|-------------------------|------------|
| **December 31, 2004** | ** ** | ** ** | ** ** | **Amortized Cost**   | ** ** | **Gains**                 | ** ** | **Losses**              | ** ** | **Value** | ** ** |
| Cash and money  market funds    |       |       | $          | 35,882                    |       |                      |       | $                       | —     |   |   |   | $ | — |   |   |   | $ | 35,882 |   |   |
| Commercial paper                |       |       | $          | 11,962                    |       |                      |       | $                       | —     |   |   |   | $ | — |   |   |   | $ | 11,962 |   |   |
| U.S. Government  agencies       |       |       |       |                      |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Due in one year or less         |       |       | 5,905      |                      |       |                      | —     |                    |       |   | (28 | ) |   |   | 5,877 |   |   |
| Due in one to three years       |       |       | 7,759      |                      |       |                      | —     |                    |       |   | (82 | ) |   |   | 7,677 |   |   |
| Asset-backed  securities        |       |       |       |                      |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Due in one to three years       |       |       | 8,243      |                      |       |                      | —     |                    |       |   | (31 | ) |   |   | 8,212 |   |   |
| Taxable auction  securities     |       |       |       |                      |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Due in one to three years       |       |       | 50,200     |                      |       |                      | —     |                    |       |   | — |   |   |   | 50,200 |   |   |
| Corporate notes                 |       |       |       |                      |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Due in one year or less         |       |       | 9,384      |                      |       |                      | —     |                    |       |   | (38 | ) |   |   | 9,346 |   |   |
| Due in one to three years       |       |       | 13,334     |                      |       |                      | —     |                    |       |   | (123 | ) |   |   | 13,211 |   |   |
| Total marketable  securities    |       |       | $          | 106,787                   |       |                      |       | $                       | —     |   |   |   | $ | (302 | ) |   |   | $ | 106,485 |   |   |
|                                 |            |            |            |                           |            |                           |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**4. Property and Equipment**

Propertyand equipment consist of the following:

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Laboratory  furniture, fixtures and equipment   |       | $                     | 3,033      |   | $ | 2,538 |   |
| Office furniture,  fixtures and equipment       |       | 1,514                 |       | 1,144 |   |
| Leasehold  improvements                         |       | 422                   |       | 362 |   |
|                                            |       | 4,969                 |       | 4,044 |   |
| Less accumulated  depreciation and amortization |       | (1,977                | )          | (1,081 | ) |
| Total                                           |       | $                     | 2,992      |   | $ | 2,963 |   |

 

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

**5**.Accrued Expenses

Accrued expenses consistof the following:

| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Clinical trial and  related costs   |       | $                     | 1,250      |   | $ | 4,611 |   |
| Sales and marketing                 |       | 3,596                 |       | 1,722 |   |
| Compensation, and related  benefits |       | 1,446                 |       | 861 |   |
| Contracted purchase  commitments    |       | 1,468                 |       | — |   |
| Other                               |       | 3,509                 |       | — |   |
| Total                               |       | $                     | 11,269     |   | $ | 8,091 |   |

 

**6**.Long-Term Debt

On June 28, 2005, theCompany borrowed (i) $10.0 million from Oxford Finance Corporation (“Oxford”),and (ii) $10.0 million from General Electric Capital Corporation (“GECC”)pursuant to the terms of Promissory Notes (“the Notes”). The Notes bearinterest at a fixed rate of 9.95% per annum and are payable in 36 consecutivemonthly installments of principal and accrued interest, beginning on July 1,2005. Also on June 28, 2005, the Company entered into Master SecurityAgreements with both Oxford and GECC (“the Agreements”). Under terms ofthese Agreements, the Company granted to both Oxford and GECC a securityinterest in and against all of the property of the Company and in and againstall additions, attachments, accessories and accessions to such property, allsubstitutions, replacements or exchanges, and all insurance and/or otherproceeds (“the Collateral”). The Collateral comprises all of the Company’spersonal property and fixtures including, but not limited to, all inventory,equipment, fixtures, accounts, deposit accounts, documents, investmentproperty, instruments, general intangibles, chattel paper and any and allproceeds (but excluding intellectual property). The Collateral does notinclude any intellectual property or products (or interests in any intellectualproperty or products (including any royalties)) acquired, whether by purchase,license or otherwise, on or after the execution of the Agreements(collectively, “New Property”), nor do the Agreements limit any indebtednesssecured by any New Property provided that debt or non-cash equity (e.g.,stock) is used to acquire New Property. In the event that the Companyuses cash to purchase New Property, Oxford’s and GECC’s existing lienswill extend to such New Property. The Agreements also contain a MaterialAdverse Change clause with both Oxford and GECC. Under this clause, if Oxfordor GECC reasonably determine that the Company’s ability to repay the Notes hasbeen materially impaired, the Company would be considered in default. As of December 31,2005 the Company 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-TermDebt (Continued)**

The following schedulesets forth the principal payments due as of December 31, 2005:

| 2006  |   |   | $     | 6,272  |   |   |
|-------|--------|--------|-------|--------|--------|--------|
| 2007  |   |   | 6,925 |   |   |
| 2008  |   |   | 3,728 |   |   |
| Total |   |   | $     | 16,925 |   |   |

 

**7**.Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

**Stockholders’Equity (Deficit)**

*Public Offerings*

On November 10, 2003,the Company completed its initial public offering and sold 6,000,000 shares ofcommon stock for $11.00 per share for net proceeds of $60.1 million. Inconnection with the initial public offering all of the outstanding shares ofthe Company’s redeemable convertible preferred stock (Series A, B, C, D, Eand F), including accrued but unpaid Series E dividends of$6.4 million, converted into 18,398,496 shares of the Company’s commonstock based upon the conversion ratios then applicable.

On December 20, 2004,the Company completed a follow-on public offering of its common stock at aprice of $24.46 per share. The Company sold an aggregate of 3,579,476 shares ofits common stock resulting in gross proceeds of $87.6 million. In connectionwith the offering, the Company paid $5.3 million in underwriting discounts andcommissions and incurred $0.5 million in other offering expenses. Afterdeducting the underwriting discounts and commissions and offering expenses, theCompany received net proceeds from the offering of $81.8 million.

*Private Offerings*

OnAugust 1, 2003, the Company completed the sale of 2,776,347 shares of Series Eredeemable convertible preferred stock for net proceeds of $19.9 million.Those shares automatically converted to common stock upon the closing of theCompany’s initial public offering of common stock on November 10, 2003.Those shares contained a beneficial conversion feature based on the fair valueof the common stock into which the shares were convertible. In accordance withEITF 98-5, *Accounting for ConvertibleSecurities with Beneficial Conversion Features or Contingently AdjustableConversion Ratios,*the value of such beneficial conversion feature of  $8.3 million was recognized as a deemeddividend in the three month period ended September 30, 2003.

TheSeries F conversion ratio provided for additional shares of common stockwhen the Company issued equity securities, as defined, for consideration ofless than $14 per share, the purchase price of Series F. As a result ofthe above sale of these Series E shares, the Series F conversionratio was increased from 1:1 to 1:1.073364. The adjustment to the Series Fconversion ratio is a beneficial conversion feature. In accordance 

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

**7. RedeemableConvertible Preferred Stock and Stockholders’ Equity (Deficit)(Continued)**

withEITF 00-27, *Application of Issue 98-5to Certain Convertible Instruments,* the value of such beneficial conversionfeature of  $37,000 was recognized as adeemed dividend in the three month period ended September 30, 2003.

Subsequent to the August 2003sale of the Series E shares, the Series E stockholders and theCompany agreed to increase the Series E conversion ratio from 1:1 to1:1.1526 in consideration of the Series E stockholders waiving theirrights to certain anti-dilution provisions. The adjustment to the conversionratio, which was contingent on the initial public offering, was a beneficialconversion feature. In accordance with EITF 00-27, the value of the Series Ebeneficial conversion feature of $11.0 million was recognized as a deemed dividend in the period ofissuance, which occurred in the fourth quarter of 2003 as a result of theinitial public offering. In addition, the conversion of the Series Eshares in the initial public offering caused the accrued but unpaid Series Edividends of  $6.4 million to becomepayable through the issuance of 513,033 shares of common stock at the time ofthe initial public offering.

**Stock PurchaseWarrants**

At December 31, 2005and 2004, there were stock purchase warrants outstanding to purchase 1,319 and13,861 shares of common stock, respectively, at exercise prices between $.01and $.08 per share, which expire through 2007.

**Stock Option Plans**

The Company’s Restated1993 Equity Incentive Plan (the “1993 plan”) provided for the grant ofincentive stock options, nonstatutory stock options and restricted stock awardsto purchase up to 2,288,200 shares of common stock. Officers, employees,directors, consultants and advisors of the Company were eligible to be grantedoptions under the 1993 plan at a price not less than 100% (110% in the case ofincentive stock options granted to 10% or greater stockholders) of the fairmarket value of such stock, as determined by the Board of Directors, at thetime the option is granted. In May 2003, the Company’s stockholdersapproved the 2003 Stock Incentive Plan (the “2003 Plan”), under which 800,000shares of common stock were authorized for issuance. In October 2003, thestockholders of the Company approved an amended and restated 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 amended plan which provided for an increase of sharesauthorized for issuance under the 2003 Plan to 3,600,000, and the adoption of a“evergreen provision” that allows for an annual increase in the number ofshares of the Company’s common stock available for issuance under the 2003Plan. The evergreen provision provides for an annual increase to be added onthe first day of each fiscal year of the Company during the period beginning infiscal year 2006 and ending on the second day of fiscal year 2013, suchincrease to be equal to the lesser of (i) 1,400,000 shares of the Company’scommon stock, (ii) 4% of the outstanding shares on that date or (iii) anamount determined by the Company’s board of directors.

While the Company maygrant options to employees, which become exercisable at different times orwithin different periods, the Company generally has granted options toemployees that are exercisable in annual installments of 25% each on the firstfour anniversary dates of the grant.

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

**7. Redeemable Convertible Preferred Stock andStockholders’ Equity (Deficit) (Continued)**

Informationwith respect to activity under the 1993 and 2003 Plans is as follows:

| **Stock Option Activity** | ** ** | ** ** | ** ** | **Number of Options** | ** ** | **Weighted-Average  Exercise Price Per  Share** | ** ** |
|-------------------------------------|------------|------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| Balance at  December 31, 2002  |       |       | 2,141      |                            |       |                                                      | $          | 1.19 |   |   |
| Options granted                     |       |       | 978        |                            |       |                                                      | 5.30       |   |   |
| Options canceled                    |       |       | (3         | )                               |       |                                                      | 1.95       |   |   |
| Options exercised                   |       |       | (217       | )                               |       |                                                      | 0.61       |   |   |
| Balance at  December 31, 2003  |       |       | 2,899      |                            |       |                                                      | 2.62       |   |   |
| Options granted                     |       |       | 1,129      |                            |       |                                                      | 13.94      |   |   |
| Options canceled                    |       |       | (105       | )                               |       |                                                      | 6.86       |   |   |
| Options exercised                   |       |       | (676       | )                               |       |                                                      | 1.30       |   |   |
| Balance at  December 31, 2004  |       |       | 3,247      |                            |       |                                                      | 6.70       |   |   |
| Options granted                     |       |       | 984        |                            |       |                                                      | 16.43      |   |   |
| Options canceled                    |       |       | (72        | )                               |       |                                                      | 19.50      |   |   |
| Options exercised                   |       |       | (339       | )                               |       |                                                      | 1.94       |   |   |
| Balance at  December 31, 2005  |       |       | 3,820      |                            |       |                                                      | $          | 9.39 |   |   |

 

Thefollowing table summarizes information about options outstanding at December 31,2005:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | ** **                 | ** ** | **Options Exercisable**                | ** ** |
|---------------------------------------------|------------|------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual Life  (In years)** | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $0.08-$2.65                                 |       |                         | 1,360      |                       |       |                                        | $          | 1.48 |   |   |   | 4.5 |   |   |   | 1,074 |   |   |   | $ | 1.36 |   |   |
| $5.31-$7.96                                 |       |                         | 459        |                       |       |                                        | 7.09       |   |   |   | 8.4 |   |   |   | 114 |   |   |   | 7.09 |   |   |
| $7.97-$10.62                                |       |                         | 565        |                       |       |                                        | 8.52       |   |   |   | 8.0 |   |   |   | 241 |   |   |   | 8.32 |   |   |
| $13.27-$15.92                               |       |                         | 601        |                       |       |                                        | 15.00      |   |   |   | 9.4 |   |   |   | — |   |   |   | — |   |   |
| $15.93-$18.58                               |       |                         | 154        |                       |       |                                        | 16.62      |   |   |   | 9.5 |   |   |   | 1 |   |   |   | 18.17 |   |   |
| $18.59-$21.23                               |       |                         | 430        |                       |       |                                        | 19.29      |   |   |   | 9.0 |   |   |   | 66 |   |   |   | 19.17 |   |   |
| $21.24-$23.88                               |       |                         | 144        |                       |       |                                        | 22.74      |   |   |   | 8.8 |   |   |   | 31 |   |   |   | 22.99 |   |   |
| $23.89-$26.54                               |       |                         | 107        |                       |       |                                        | 24.69      |   |   |   | 8.9 |   |   |   | 25 |   |   |   | 24.60 |   |   |
|                                        |       |                         | 3,820      |                       |       |                                        | $          | 9.39 |   |   |   | 7.3 |   |   |   | 1,552 |   |   |   | $ | 4.44 |   |   |
|                                             |            |                              |            |                            |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Options to purchase 1,277,266 and 1,526,761 shares ofcommon stock were exercisable at December 31, 2004 and 2003, respectively.At December 31, 2005, there were 700,891 options available for futuregrant in the 2003 Plan and no options available for future grant under the 1993Plan.

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 arerequired to be accounted for as variable, and compensation expense is measuredas the 

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

**7. RedeemableConvertible Preferred Stock and Stockholders’ Equity (Deficit) (Continued)**

difference between thefair market value of the Company’s common stock at the reporting period dateand the exercise price of the award. Compensation expense is recognized overthe vesting period. The Company recognized a reversal of stock basedcompensation expense of ($261,000) for the year ended December 31, 2005,and an expense of $529,000 and $118,000 for the years ended December 31,2004 and 2003, respectively.

Since 1999, the Company has granted options topurchase a total of 201,000 shares of common stock to nonemployees at a weighted-averageexercise price of $3.50 per share, of which 128,750 remained outstanding at December 31,2005. The Company has applied the recognition provisions of SFAS 123 andEITF 96-18 related to these stock options and utilized the Black-Scholesoption pricing model to determine the fair value of these stock options at eachreporting date. In connection with these awards, the Company recognized areversal of stock based compensation expense of ($133,000) for the year ended December 31,2005 and an expense of $1,011,000 and $185,000 for the years ended December 31,2004 and 2003, respectively.

During 2003 and 2002, theCompany granted options to purchase 413,250 and 241,000 shares of common stock,respectively, to employees at exercise prices below the fair value 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 are 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, 2004 and2003 is stock based compensation expense of $887,000, $982,000 and $604,000,respectively.

**Employee Stock Purchase Plan**

On August 18, 2003, the Board of Directorsadopted the 2003 Employee Stock Purchase Plan (the “Stock Purchase Plan”),which provides for the sale of up to 75,000 shares of common stock toparticipating employees. Under the Stock Purchase Plan, eligible employees maypurchase common stock at a price per share equal to 85% of the lower of thefair market value of the common stock at the beginning or end of each six monthperiod during the term of the Stock Purchase Plan. Participation in theoffering is limited to 10% of the employee’s compensation or $25,000 in anycalendar year. The first offering period began on January 1, 2004. Duringthe years ended December 31, 2005 and 2004, the Company issued 37,358 and30,342 shares of common stock, respectively, under the Stock Purchase Plan.

At December 31, 2005,there were 7,300 shares available for grant under the Stock Purchase Plan.

**8. Operating Lease**

The Company leased its previous research facilitiesunder an operating lease that expired on September 30, 2004. Annual rentexpense was $532,000 for 2004 and $580,000 for 2003. The Company sub-leased aportion of its premises and recognized rental income of $82,000 in 2003. Thesublease agreement ended in 2003.

On January 30, 2004,the Company executed a lease for 52,000 square feet of laboratory and officespace in Lexington, Massachusetts. The rent obligation for the buildingcommenced on August 7, 2004, 

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

**8. OperatingLease (Continued)**

whichwas 30 days after the date the Company commenced occupancy of thebuilding. The lease is for a term of ten years with options that permitrenewals for additional five-year periods. The Company has the option toterminate the lease at the end of the fifth year for a fee of$4.2 million. The expected minimum rental commitments under the leaseagreement are $1,425,000, $1,505,000, $1,505,000, $1,566,000. and $1,688,000for each year in the five calendar year period ending December 31, 2010,respectively, and $6.2 million in total for the remainder of the leaseterm. In addition to the minimum lease commitment, the lease agreement requiresthe Company to pay its pro rata share of property taxes and building operatingexpenses. Rent expense for 2005 and 2004 under this lease was $1.7 million and$0.6 million, respectively. Under the lease, a security deposit of  $800,000 is required to be held in escrow forthe life of the lease. This amount has been recorded as restricted cash.

**9. License, Manufacturing and CommercializationAgreements**

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

*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.Boston Scientific made an up-front license payment of $1.5 million to theCompany in 2001, and made an additional payment of $3.0 million in December 2003in connection with the extension of the research and development collaboration.The Company had been recognizing the up-front license payment of $1.5 millionand $3.0 million extension fee ratably over the term of the contractualperformance obligation. For the years ended December 31, 2005, 2004 and2003, the Company recognized revenue of $1,592,000, $1,592,000 and $442,000,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. The research term of the BostonScientific agreement expired on December 31, 2005, although certain rightsextend beyond this term.

*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 received an upfront non-refundable license payment of$10.0 million, and two payments, each of 

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

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

$5.0 million,for achieving the first two milestones. The license fee revenue and the revenuefrom the first $5.0 million milestone payment were being recognizedratably over the contractual term of the research and development program,which was expected to end on December 31, 2005. The revenue from thesecond $5.0 million payment was recognized in the fourth quarter of 2003,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 and $12.3 million for the years ended December 31,2004 and 2003, respectively.

*Dr. Jay N. Cohn.*   In January 1999,as amended in January 2001 and March 2002, the Company entered into acollaboration and license agreement with Dr. Jay N. Cohn. Under theagreement, Dr. Cohn licensed to the Company an exclusive worldwide royalty-bearingrights to technology and inventions owned or controlled by Dr. Cohn andthat relate to BiDil for the treatment of cardiovascular disease. Uponachieving certain developmental events, the Company was required to makemilestone payments totaling $1.0 million, which were recorded as a charge toresearch and development expenses in 2004. Upon commercial sale of BiDil, theCompany is required to make royalty payments based on net sales at varyingrates depending on sales volume. The royality terms expires upon the later ofthe expiration of the patent rights or ten years from the first commercialsale. The agreement imposes upon the Company 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 theCompany fails to meet this obligation, Dr. Cohn has the right to terminatethe agreement and the license granted to the Company under the agreement. Dr. Cohnalso has the right to terminate the agreement if the Company materiallybreaches the agreement and fails to remedy the breach within 30 days. TheCompany has the right to terminate the agreement at any time upon 30 days’prior written notice. Unless earlier terminated, the agreement continues inperpetuity. Pursuant to the agreement, Dr. Cohn was appointed to theCompany’s scientific advisory board (which in 2006 has been replaced by thetechnical review committee of which Dr. Cohn is not a member), 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)**

**10. Income Taxes**

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

| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Benefit at federal  statutory tax rate |       | $                                          | (35,990    | ) | $ | (10,123 | ) | $ | (2,982 | ) |
| State taxes, net of  federal benefit   |       | (6,637                                     | )          | (1,867 | ) | (550 | ) |
| Non-deductible  expenses               |       | 254                                        |       | 157 |   | 357 |   |
| Unbenefited operating  losses          |       | 42,373                                     |       | 11,833 |   | 3,175 |   |
| Income tax provision                   |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

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

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred tax assets:                             |       |                  |       |   |   |
| Net operating loss  carryforwards                |       | $                     | 59,805     |   | $ | 20,724 |   |
| Capitalized research  costs, net of amortization |       | 24,991                |       | 18,908 |   |
| Tax credit carryforwards                         |       | 6,245                 |       | 5,807 |   |
| Deferred revenue                                 |       | 1                     |       | 641 |   |
| Depreciation                                     |       | (29                   | )          | 409 |   |
| Accrued expenses                                 |       | 991                   |       | 1,600 |   |
| Other                                            |       | 146                   |       | 31 |   |
|                                             |       | 92,150                |       | 48,120 |   |
| Valuation allowance                              |       | (92,150               | )          | (48,120 | ) |
| Net deferred tax assets                          |       | $                     | —     |   | $ | — |   |

 

The Company has increasedits valuation allowance by $44,030,000 in 2005 to provide a full valuationallowance for deferred tax assets since the realization of these benefits isnot considered more likely than not. At December 31, 2005, the Company hadunused net operating loss carryforwards of $151,132,000 available to reduce federal taxable income expiring in 2010through 2025 and $134,291,000 available to reduce state taxable income expiringin 2006 through 2010. The Company also has federal and state research taxcredits of  $7,279,000 available tooffset federal and state income taxes, both of which expire beginning in 2010.The net operating losses and tax credit carryforwards may be subject to theannual limitation provisions of Internal Revenue Code (IRC) Sections 382 and383. No income tax payments were made in 2005, 2004 or 2003.

**11. Commitments and Contingencies**

In connection with the Company’s efforts to obtain theapproval of BiDil from the FDA, the Company contracted with the law firm ofFoxKiser LLC (FoxKiser) for services related to the regulatory approval processfor BiDil. The agreement provided for payment of legal consulting fees uponreceipt of written FDA approval of BiDil. In addition, the agreement requiresthe Company to pay royalties to FoxKiser on commercial sales of BiDil. Theroyalty term ends six months after the date of market introduction of an 

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

**11. Commitmentsand 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, 2005 and 2004, the Companyrecorded charges of $1.6 and $1.9 million, respectively, pertaining to thelegal consulting fees related to these agreements. On June 23, 2005, theCompany received written FDA approval of BiDil, and in July 2005, theCompany paid $2.4 million pursuant to the terms of 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.

On July 20, 2004, the Market RegulationDepartment of the National Association of Securities Dealers, Inc. (“NASD”)advised the Company that it initiated a review of trading activity in theCompany’s common stock surrounding the Company’s July 19, 2004,announcement that it had halted its phase III clinical trial of BiDil due tothe significant survival benefit seen with BiDil. The NASD is reviewing, amongother things, information on relationships between the Company’s officers,directors and service providers and individuals and institutions that may havetraded in the Company’s common stock prior to the July 19, 2004announcement. The Company has cooperated with this review and has identifiedcertain persons on the list provided to the Company by the NASD as having arelationship with the Company’s chief executive officer and others at theCompany. The Company has established a special committee of its board ofdirectors to oversee the Company’s response to this review. The Company ispresently unable to predict the outcome of this matter or the timing of itsresolution.

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’sbehalf, Publicis has employed and trained a specialty sales force currentlyconsisting of approximately 144 sales representatives to sell BiDil to theCompany’s target prescriber markets. The agreement is for a current term of 24months beginning on January 31, 2005, with the Company’s option tocontinue the agreement beyond this term. Year one costs recorded in 2005 were$29.8 million, excluding one-time start-up costs, and year two costs under theagreement are projected at approximately $24.3 million. The Company has theright to terminate this agreement upon 90 days written notice to Publicis. Ifthe Company had terminated this agreement during the period between January 31,2005 and January 30, 2006, the Company would have been required to pay atermination fee in the amount of $1.0 million. If the Company were to terminateduring the period between January 31, 2006 and July 31, 2006, thetermination fee will be $750,000. If the Company terminates the agreement afterJuly 31, 2006, Publicis is not eligible for a termination fee.

On February 16, 2005, the Company engaged SchwarzPharma Manufacturing, Inc. (“Schwarz Pharma”) under a five-year exclusivemanufacturing and supply agreement solely for the three times daily immediaterelease dosage formulation of BiDil. Under the supply agreement, the Companyhas the right to engage a backup manufacturer. In connection with this supplyagreement, the Company placed binding purchase orders of $1.1 million and $1.3million for production of BiDil finished goods during the first and secondquarters of 2006, respectively.

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

**12**. 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 Company Common Stock equal to 50% of employee contributions, limited tothe first 6% of salary contributed to the 401(k) plan. For the year ended December 31,2005, the Company recorded expenses of $88,000 related to the plan.

**13**. Related Party Transactions - Boston University

Dr. JosephLoscalzo, a member of the Company’s board of directors, is thePhysician-in-Chief and Chair of the Department of Medicine at Brigham and Women’sHospital in Boston, Massachusetts. Dr. Loscalzo has served as a consultantto the Company since 1992, as the chair of the Company’s scientific advisoryboard since 1999 and currently is the chair of the Company’s technical reviewcommittee, which replaced the Company’s scientific review board at thebeginning of fiscal year 2006. In October 2003, the 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 2005 and 2004, the Company paid Dr. Loscalzo anaggregate of $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 2005, 2004 and 2003, the Company made paymentsto BU of $120,000, $221,500 and $265,000, respectively, pursuant to thisagreement, excluding the lease payments described below.

In May 2003, the Company entered into an oralagreement with BU pursuant to which the Company leases approximately 1,500square feet of laboratory space from BU at its Evans Biomedical Research Centerin Boston, Massachusetts. The lease has a term of three years, and the Companymakes annual rental payments of $60,000 pursuant to the lease. As providedabove, the Company has agreed to make this space available to Dr. Feelishof BU. In 2005 and 2004, the Company made payments to BU under this agreementof $60,000.

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

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

Thefollowing table presents unaudited quarterly financial data of the Company:

| ** **                                                         | ** ** | **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 |   |

 

| ** **                                                         | ** ** | **Year Ended December 31, 2004** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                         | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| Net revenues                                                       |       | $                                                    | 2,331      |   | $ | 2,331 |   | $ | 2,332 |   | $ | 9,464 |   |
| Net loss                                                           |       | (4,556                                               | )          | (4,700 | ) | (10,801 | ) | (9,716 | ) |
| Basic and diluted  net loss per share                              |       | $                                                    | (0.18      | ) | $ | (0.18 | ) | $ | (0.41 | ) | $ | (0.36 | ) |
| Weighted average common  shares used to compute net loss per share |       | 25,601                                               |       | 25,696 |   | 26,187 |   | 27,115 |   |

 

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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 and Procedures.*Our management, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of December 31, 2005. The term “disclosure controls andprocedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure.Management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and management necessarily applies its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of December 31,2005, 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’s Report on Internal Control OverFinancial Reporting.*

**Management’s Report on Internal Control Over FinancialReporting**

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting. Internal control over financial reporting isdefined in Rule 13a-15(f) or 15d-15(f) promulgatedunder the Exchange Act as a process designed by, or under the supervision of,the company’s principal executive and principal financial officers and effectedby the company’s board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles and includes those policies andprocedures 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 assessedthe effectiveness of our internal control over financial reporting as ofDecember 31, 2005. In making this assessment, the company’s managementused the criteria set forth by the Committee of Sponsoring Organizations of theTreadway Commission (COSO) in Internal Control-Integrated Framework.

Based on this assessment,our management concluded that, as of December 31, 2005, our internal controlover financial reporting is effective based on those criteria.

Our independent auditorshave issued an audit report on our assessment of our internal control overfinancial reporting. This report appears below.

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**Report of Independent Registered Public AccountingFirm**

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, 2005, 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, 2005, 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, 2005, based on****the COSO criteria**.**

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the balance sheets of NitroMed, Inc. as of December 31,2005 and 2004, and the related statements of operations, redeemable convertiblepreferred stock and stockholders’ equity (deficit), and cash flows for each ofthe three years in the period ended December 31, 2005 of NitroMed, Inc.and our report dated February 28, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & YoungLLP

Boston, MassachusettsFebruary 28, 2006

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*(c)   Changesin Internal Controls.*

No change in our internalcontrol over financial reporting occurred during the fiscal year ending December 31,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

**Directors and Executive Officers**

Information regarding ourdirectors and executive officers may be found under the captions “Election ofDirectors” and “Executive Officers” in the Proxy Statement for our 2006 AnnualMeeting of Stockholders. Such information is incorporated 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 2006 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

**Audit Committee Financial 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 2006 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

**Code of Business Conduct 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 “Directors’ Compensation,” “CompensationCommittee Interlocks and Insider Participation,” “Executive Compensation,” and “EmploymentAgreements,” in the Proxy Statement for our 2006 Annual Meeting of Stockholders.Such information is incorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN 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 2006 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Information with respectto this item may be found under the caption “Certain Relationships and RelatedTransactions” in the Proxy Statement for our 2006 Annual Meeting ofStockholders. Such information is incorporated herein by reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

Information with respectto this item may be found under the caption “Audit Fees” in the Proxy Statementfor our 2006 Annual Meeting of Stockholders. Such information is incorporatedherein by reference.

**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(a)(1)                    FinancialStatements.

For a list of thefinancial information included herein, see “Index to Financial Statements” on page 56.

(a)(2)                    FinancialStatement Schedules.

All schedules are omittedbecause they are not applicable or the required information is shown in theFinancial Statements or Notes 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**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned.

|                               |   | NITROMED, INC.                   |
|-------------------------------|--------|---------------------------------------|
| Date: February 28,  2006 | By:    | /s/ MICHAEL D. LOBERG, PH.D.          |
|                          |   | Michael D. Loberg, Ph.D.              |
|                          |   | 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/ MICHAEL D. LOBERG, PH.D.      |          | President and  Chief Executive Officer     |       | February 28,  2006 |
| Michael D. Loberg, Ph.D.          |          | and Director(Principal  Executive Officer) |       |                    |
| /s/ LAWRENCE E. BLOCH, M.D., J.D. |          | Chief Financial  Officer, Chief Business   |       | February 28,  2006 |
| Lawrence E. Bloch, M.D.,  J.D.    |          | Officer, Treasurer and  Secretary          |       |                    |
|                              |          | (Principal Financial  Officer)             |       |                    |
| /s/ JAMES G. HAM, III        |          | Vice President of  Finance (Principal      |       | February 28,  2006 |
| James G. Ham, III            |          | Accounting Officer)                        |       |                    |
| /s/ ROBERT S. COHEN               |          | Director                                   |       | February 28,  2006 |
| Robert S. Cohen                   |          |                                       |       |                    |
| /s/ FRANK L. DOUGLAS, M.D., PH.D. |          | Director                                   |       | February 28,  2006 |
| Frank L. Douglas, M.D.,  Ph.D.    |          |                                       |       |                    |
| /s/ ZOLA HOROVITZ, PH.D.          |          | Director                                   |       | February 28,  2006 |
| Zola Horovitz, Ph.D.              |          |                                       |       |                    |
| /s/ ARGERIS KARABELAS, PH.D.      |          | Director                                   |       | February 28,  2006 |
| Argeris Karabelas, Ph.D.          |          |                                       |       |                    |
| /s/ MARK LESCHLY                  |          | Director                                   |       | February 28,  2006 |
| Mark Leschly                      |          |                                       |       |                    |
| /s/ JOHN W. LITTLECHILD           |          | Director                                   |       | February 28,  2006 |
| John W. Littlechild               |          |                                       |       |                    |
| /s/ JOSEPH LOSCALZO, M.D., PH.D.  |          | Director                                   |       | February 28,  2006 |
| Joseph Loscalzo, M.D.,  Ph.D.     |          |                                       |       |                    |
| /s/ DAVEY S. SCOON                |          | Director                                   |       | February 28,  2006 |
| Davey S. Scoon                    |          |                                       |       |                    |

 

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**EXHIBIT INDEX**

| Exhibit No.     | ** ** | **Description**                                                                                                                                                                                                       |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(1)          |       | Restated Certificate of Incorporation of the Company                                                                                                                                                                  |
| 3.2(1)          |       | Amended and Restated  Bylaws of the Company                                                                                                                                                                           |
| *10.1(1)        |       | Restated 1993 Equity  Incentive Plan                                                                                                                                                                                  |
| *10.2(1)        |       | Amended and Restated  2003 Stock Incentive Plan                                                                                                                                                                       |
| *10.3(1)        |       | 2003 Employee Stock  Purchase Plan                                                                                                                                                                                    |
| 10.4†(1)   |       | Development and License  Agreement between the Company and Boston Scientific Corporation dated  November 20, 2001                                                                                                |
| 10.5†(1)   |       | Research and License  Agreement between the Company and Brigham and Women’s Hospital, Inc.  dated August 1, 1992, as amended November 22, 1996                                                    |
| 10.6†(1)   |       | 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                                            |
| 10.7(4)         |       | Amendment No. 1 to  Collaboration and License Agreement between the Company and Professor Jay N.  Cohn dated August 10, 2000                                                                                |
| 10.8†(1)   |       | Research and License  Agreement between the Company and Trustees of Boston University dated  June 1, 1993, as amended January 1, 1999                                                                       |
| 10.9†(1)   |       | Agreement between the  Company and FoxKiser dated April 26, 2001                                                                                                                                                 |
| 10.10†(1)  |       | Agreement between the  Company and John D. Folts dated March 13, 1995, , as amended,  November 22, 1996 and December 2, 1998                                                                           |
| 10.11†(1)  |       | Professional Service  Agreement between the Company and MIMC, Inc. dated May 1, 2001, as  amended                                                                                                           |
| *10.12(1)       |       | Letter Agreement between  the Company and Michael D. Loberg dated July 14, 1997                                                                                                                                  |
| *10.13(1)       |       | Letter Agreement between  the Company and Manuel Worcel dated July 29, 1993                                                                                                                                      |
| *10.14(1)       |       | Letter Agreement between  the Company and L. Gordon Letts dated November 4, 1993                                                                                                                                 |
| 10.15(1)        |       | 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 |
| 10.16(1)        |       | Form of Warrant to  purchase shares of the Company’s Common Stock, together with a schedule of  warrant holders                                                                                             |
| 10.17(2)        |       | Lease between the  Company and PM Atlantic Lexington, LLC dated January 30, 2004                                                                                                                                 |
| 10.18(2)        |       | Letter Agreement between  the Company, Boston University School of Medicine and Martin Feelisch, Ph.D.  dated May 5, 2003                                                                                        |
| 10.19(4)        |       | Consulting Agreement  between the Company and Joseph Loscalzo, M.D., Ph.D. dated October 27,  2003, as amended on April 1, 2004                                                                             |
| 10.120†(3) |       | Professional Detailing  Services Agreement between the Company and Publicis Selling  Solutions, Inc. dated November 4, 2004                                                                                 |
| 10.21(3)        |       | Letter Agreement between  the Company and Merck Frosst Canada & Co. dated November 8,  2004                                                                                                             |
| *10.22(4)       |       | Letter Agreement between  the Company and James G. Ham, III dated September 3, 2004                                                                                                                         |

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| *10.23(4)      |   | Letter Agreement between  the Company and Lawrence E. Bloch dated August 30, 2004                                                                                                                            |
|----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.24†(4) |   | Supply Agreement between  the Company and Schwarz Pharma Manufacturing, Inc. dated as of  February 16, 2005                                                                                             |
| *10.25(4)      |   | Letter Agreement between  the Company and Mark Pavao dated June 30, 2004                                                                                                                                     |
| *10.26(5)      |   | Letter Agreement between  the Company and Manuel Worcel dated January 6, 2006                                                                                                                                |
| *10.27         |   | Base Salaries of Named  Executive Officers of the Company                                                                                                                                                         |
| *10.28         |   | Compensation of  Directors of the Company                                                                                                                                                                         |
| *10.29(4)      |   | Form of Incentive  Stock Option Agreement Granted Under Amended and Restated 2003 Stock  Incentive Plan                                                                                                      |
| *10.30(4)      |   | Form of  Nonstatutory Stock Option Agreement Granted Under Amended and Restated 2003  Stock Incentive Plan                                                                                                   |
| 14.1(2)        |   | Code of Business Conduct  and Ethics                                                                                                                                                                              |
| 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

†                    Confidential treatment requested as tocertain portions, which portions have been filed separately with the Securitiesand Exchange Commission

(1)          Incorporated byreference to the exhibits to the Company’s Registration Statement on Form S-1(File No. 333-108104)

(2)          Incorporated byreference to the exhibits to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2003 (File No. 000-50439).

(3)          Incorporated byreference to the exhibits to the Company’s Current Report on Form 8-Kfiled on November 8, 2004 (File No. 000-50439).

(4)          Incorporated byreference to the exhibits to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004 (File No. 000-50439)

(5)          Incorporated byreference to the exhibits to the Company’s Current Report on Form 8-Kfiled on November 12, 2005 (File No. 000-50439).

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