UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended March 31, 2005
	or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from               to

 

Commission File Number 000-50405

 

ACUSPHERE, INC.

(Exact name of registrant as specified in its charter)

 

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

 

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

 

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

 

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

 

As of May 6, 2005 there were 17,831,954 shares of the registrant’s common stock, $.01 par value per share, outstanding.

 

 

ACUSPHERE, INC.

 

Form 10-Q

For the Quarterly Period Ended March 31, 2005

 

CONTENTS

 

	Page Number
PART I: FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements	3
Condensed Consolidated Balance Sheets: March 31, 2005 (Unaudited) and December 31, 2004	3
Condensed Consolidated Statements of Operations (Unaudited): Three Months ended March 31, 2005 and 2004	4
Condensed Consolidated Statements of Cash Flows (Unaudited): Three Months ended March 31, 2005 and 2004	5
Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3. Quantitative and Qualitative Disclosure about Market Risk	35
Item 4. Controls and Procedures	35
PART II: OTHER INFORMATION	36
Item 1. Legal Proceedings	36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3. Defaults Upon Senior Securities	36
Item 4. Submission of Matters to a Vote of Security Holders	36
Item 5. Other Information	36
Item 6. Exhibits	37
Signature	38

 

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PART I: FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

ACUSPHERE, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

 

		March 31, 2005			December 31, 2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	79,766,676		$	45,179,915
Other current assets		2,808,124			2,096,681
Total current assets		82,574,800			47,276,596
PROPERTY AND EQUIPMENT, at cost:
Property and equipment (Note 5)		27,215,183			20,876,140
Less accumulated depreciation and amortization		8,535,011			8,006,819
Property and equipment, net		18,680,172			12,869,321
OTHER ASSETS		1,832,820			1,857,306
TOTAL		$	103,087,792		$	62,003,223
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of long-term obligations (Note 6)		$	2,384,655		$	1,071,627
Current portion of deferred revenue (Note 7)		3,428,571			3,428,571
Derivative liability (Note 8)		2,624,000			—
Accounts payable		2,527,776			4,237,934
Accrued expenses		4,779,759			4,396,020
Total current liabilities		15,744,761			13,134,152
LONG-TERM LIABILITIES:
Long-term obligations, net of current portion		9,777,901			2,502,579
Deferred revenue, net of current portion		1,000,000			857,143
Total long-term liabilities		10,777,901			3,359,722
COMMITMENTS
STOCKHOLDERS’ EQUITY:
Preferred stock, $0.01 par value per share Authorized - 5,000,000 shares as of March 31, 2005 and December 31, 2004 Designated 6.5% convertible exchangeable - 1,000,000 shares as of March 31, 2005 and none as of December 31, 2004 Issued and outstanding – 900,000 shares as of March 31, 2005 and none as of December 31, 2004		9,000			—
Common stock, $0.01 par value per share Authorized - 98,500,000 shares as of March 31, 2005 and December 31, 2004 Issued and outstanding - 17,829,756 shares as of March 31, 2005 and 17,810,922 as of December 31, 2004		178,298			178,109
Additional paid-in capital		260,508,180			221,672,237
Deferred stock-based compensation		(731,215		)	(914,492		)
Accumulated deficit		(183,399,133		)	(175,426,505		)
Total stockholders’ equity		76,565,130			45,509,349
TOTAL		$	103,087,792		$	62,003,223

 

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

 

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ACUSPHERE, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

		Three Months Ended
		March 31,			March 31,
		2005			2004
COLLABORATION REVENUE		$	857,143		$	—
OPERATING EXPENSES:
Research and development(1)		7,678,079			5,602,803
General and administrative(1)		1,747,308			1,404,112
Total operating expenses		9,425,387			7,006,915
Interest income		302,309			107,773
Interest expense		(140,693		)	(25,420		)
Change in valuation of derivative		434,000			—
NET LOSS		$	(7,972,628	)	$	(6,924,562	)
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS PER SHARE –
Basic and diluted		$	(0.45	)	$	(0.48	)
WEIGHTED-AVERAGE SHARES OUTSTANDING –
Basic and diluted		17,812,912			14,286,093

(1) Includes stock-based compensation as follows:
Research and development		$	58,489		$	89,949
General and administrative		110,932			142,732
		$	169,421		$	232,681

 

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

 

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ACUSPHERE, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Three Months Ended
		March 31,			March 31,
		2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(7,972,628	)	$	(6,924,562	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense		169,421			232,681
Depreciation and amortization		528,192			320,973
Noncash interest expense		13,381			4,565
Noncash rent expense		127,667			13,410
Noncash amortization of deferred revenue		(857,143		)	—
Noncash amortization of fee and warrants to financial advisor		67,261			—
Change in valuation of derivative		(434,000		)	—
Changes in operating assets and liabilities:
Deferred revenue		1,000,000			—
Other current assets		(711,443		)	(116,299		)
Accounts payable		(1,710,158		)	(289,958		)
Accrued expenses		269,482			103,850
Net cash used in operating activities		(9,509,968		)	(6,655,340		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(6,339,043		)	(924,297		)
Increase in other assets		(65,000		)	—
Net cash used in investing activities		(6,404,043		)	(924,297		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term obligations		(453,990		)	(225,379		)
Proceeds from long-term obligations		9,037,775			—
Net proceeds from sale of preferred stock		41,891,066			—
Net proceeds from exercise of stock options		13,761			5,772
Proceeds from issuance of common stock from employee stock purchase plan		12,160			12,164
Net cash provided by (used in) financing activities		50,500,772			(207,443		)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		34,586,761			(7,787,080		)
CASH AND CASH EQUIVALENTS – Beginning of period		45,179,915			54,562,378
CASH AND CASH EQUIVALENTS – End of period		$	79,766,676		$	46,775,298

 

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

 

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ACUSPHERE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1.     Basis of Presentation

 

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

 

In the opinion of management, all adjustments, consisting only of normal, recurring adjustments considered necessary for a fair presentation of the results of these interim periods have been included. The results of operations for the three months ended March 31, 2005 may not be indicative of the results that may be expected for the full fiscal year.

 

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

 

2.     Revenue Recognition

 

The Company recognizes revenue from license arrangements in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). The Company recognizes revenue from license payments not tied to achieving a specific performance milestone ratably over the period over which the Company is obligated to perform services. The period over which the Company is obligated to perform services is estimated based on available facts and circumstances. The Company recognizes revenue from performance payments, when such performance is substantially in the Company’s control and when the Company believes that completion of such performance is reasonably probable, ratably over the period over which the Company estimates that it will perform such performance obligations. Substantive at-risk milestone payments, which are based on achieving a specific performance milestone when performance of such milestone is contingent on performance by others or for which achievement can not be reasonably estimated or assured, are recognized as revenue when the milestone is achieved and the related payment is due, provided that there is no substantial future service obligation associated with the milestone. Revenue in connection with license arrangements is recognized over the term of the arrangement and is limited to payments collected or due and reasonably assured of collection. In circumstances where the arrangement includes a refund provision, the Company defers revenue recognition until the refund condition is no longer applicable unless, in the Company’s judgment, the refund circumstances are within its operating control and unlikely to occur.  Payments received in advance of being recognized as revenue are deferred.

 

3.     Accounting for Stock-based Compensation

 

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

 

6

 

Stock options granted during 2005 are as follows:

 

 

The stock options granted in the three months ended March 31, 2005 were granted at fair market value on the date of grant.

 

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

 

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.  SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). In accordance with a recently-issued rule by the SEC, SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005.  The Company expects to adopt SFAS No. 123R on January 1, 2006 using the Statement’s modified prospective application method.  The Company does not yet have an estimate of the effect on its statements of operations of adopting SFAS No. 123.

 

4.     Net Loss Per Common Share

 

Basic and diluted net loss per common share is calculated by dividing the net loss applicable to common stockholders by the weighted-average number of unrestricted common shares outstanding during the period. Diluted net loss per common share is the same as basic net loss per common share, since the effects of potentially dilutive securities are antidilutive for all periods presented. Antidilutive securities, which consist of convertible exchangeable preferred stock, stock options, warrants, and restricted common stock that are not included in the diluted net loss per share calculation, aggregated 10,539,401 and 2,282,412 as of March 31, 2005 and 2004, respectively.

 

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

 

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5.     Property and Equipment

 

Property and equipment at cost consist of the following:

 

		As of:
		March 31, 2005			December 31, 2004			Estimated Useful Life
Equipment		$	17,623,283		$	10,279,147		3 – 5 years
Furniture and fixtures		188,252			188,252			5 years
Leasehold improvements		560,351			171,277			Lease term
Sub-total depreciable assets		18,371,886			10,638,676
Less: accumulated depreciation and amortization		(8,535,011		)	(8,006,819		)
Total depreciable assets, net		9,836,875			2,631,857
Deposits on equipment purchases		1,193,819			6,774,256			N/A
Construction in progress		7,649,478			3,463,208			N/A
Total property and equipment		$	18,680,172		$	12,869,321

 

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

 

Amounts recorded for construction in progress represent costs incurred through March 31, 2005 for the build-out of the Company’s commercial manufacturing facility in Tewksbury, Massachusetts.  The Company has entered into an engineering and construction management services agreement with Parsons Commercial Technology, Inc., as last amended April 29, 2005, authorizing Parsons to perform on behalf of the Company, during the period ending May 15, 2005, engineering, design and construction management services in connection with the build-out of the commercial manufacturing facility in Tewksbury, Massachusetts.  The total value of this cost-plus percentage fee type contract is $12.9 million of which $6.2 million was paid on or before March 31, 2005.  The Company anticipates that further amendment to this contract will be necessary to complete this build-out project.  The Company expects that its total payments for substantially completing the build-out of the commercial manufacturing facility, excluding equipment purchases, will be approximately $18.0 million in excess of the amounts that have already been paid through March 31, 2005.

 

6.     Long-term Obligations

 

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

 

 

Long-term obligations, including current maturities, outstanding as of March 31, 2005 consisted of capital equipment leased under

 

8

 

various capital lease arrangements, promissory notes under an equipment financing line (described below), and borrowings under a facility loan agreement (described below).  Monthly payments under the capital lease obligations mature through April 2005.

 

In April 2004, the Company entered into an equipment financing line with an equipment financing company. In August 2004, the amount of this equipment financing line increased from $8.0 million to $11.3 million.  Borrowings under this equipment line can be made against qualified purchases approved by the equipment financing company through August 2005. Such borrowings are to be secured by the qualified purchases and repaid over 36 to 48 months, depending on the nature of the equipment financed.  Interest rates are fixed at the time of each borrowing under the equipment line with such rates adjusted between borrowings based on the U.S. Federal Reserve’s Three Year and Four Year Treasury Constant Maturity Rates. The loans under this financing line are subject to acceleration upon the happening of certain customary events of default, including failure to timely pay principal and interest. As of March 31, 2005, the Company has approximately $0.8 million available in additional borrowings under this equipment line. Monthly payments for the amounts outstanding under the equipment financing line mature through March 2009.

 

In August 2004, the Company entered into a loan agreement with MassDevelopment under which up to $2.0 million of financing is available upon completion by the Company of certain tenant improvements to its commercial manufacturing facility in Tewksbury, Massachusetts.  In March 2005, the Company borrowed $2.0 million under this loan agreement.  Interest accrues under the loan at 5.0% per annum with retroactive adjustments to 9% upon reaching certain defined earning levels. The repayment of principal and accrued interest will coincide with the term of the Tewksbury lease which has a five-year, nine-month term with options to extend the lease for up to two additional five-year terms. No payments are due under the loan until April 2007. Unpaid interest during this twenty-four month period shall be accrued and principal and interest shall be repaid on a monthly basis thereafter such that the total amount outstanding shall fully amortize over the balance of the term in equal installments. The loan is subject to acceleration upon certain customary events of default, including failure to timely pay principal and interest. The loan is secured by certain of the tenant improvements made at the Tewksbury facility.

 

The retroactive interest rate adjustment feature of the MassDevelopment loan agreement was deemed to be an embedded derivative instrument requiring separate accounting under FASB 133, Accounting for Derivative Instruments and Hedging Activities, and was initially valued at $62,000. The derivative asset will be amortized as interest expense over a term beginning with the loan agreement effective date and ending with the currently expected payment date of the retroactive interest.  The fair value of the derivative liability will be re-measured at each reporting period, with any change in value charged or credited to interest expense.  There was no change in the estimated fair value of the derivative liability at March 31, 2005.

 

7.     Deferred Revenue

 

In July 2004, the Company entered into a collaboration, license and supply agreement with Nycomed in which the Company granted Nycomed rights to develop and market AI-700 in Europe. As part of this agreement, as of March 31, 2005, Nycomed has paid the Company $4.0 million in license fees and the first three of eight consecutive quarterly installments of $1.0 million each for the Company’s research and development efforts. As of March 31, 2005, the Company has cumulatively recognized $2.6 million in revenue, reflecting an estimated period of forty-two months over which the $12 million in scheduled payments are expected to be earned, and $4.4 million of such payments were reported by the Company as deferred revenue.

 

During the three months ended March 31, 2005, in connection with this agreement, the Company paid fees of $130,000 to an advisor retained in connection with the Nycomed collaboration agreement. Additional fees payable to this advisor are dependent upon the timing and magnitude of the amounts paid by Nycomed to the Company.  The maximum cash amount payable to this advisor in connection with the Nycomed collaboration agreement is approximately $1.1 million of which $0.5 million has been paid through March 31, 2005.

 

8.     Stockholders’ Equity

 

On February 24, 2005, the Company issued 900,000 shares of 6.5% convertible exchangeable preferred stock (the “Preferred Stock”) at $50.00 per share resulting in aggregate gross proceeds to the Company of $45.0 million (net proceeds of approximately $41.9 million after deducting underwriting discounts and commissions and estimated offering expenses).  Each share of Preferred Stock has a liquidation preference of $50.00 per share.  Dividends on the Preferred Stock will be cumulative from the date of original issue at the annual rate of $3.25 per share, payable quarterly on the first day of March, June, September, and December, commencing on June 1, 2005.  Any dividends must be declared by the Company’s board of directors and must come from funds that are legally

 

9

 

available for dividend payments.  As of March 31, 2005, no such dividend was declared. In May 2005, the Company’s board of directors declared a quarterly dividend in the amount of $0.8756 per share of Preferred Stock, which is scheduled to be paid on June 1, 2005, to the holders of record as of the close of business on May 16, 2005.

 

The Preferred Stock is convertible into the Company’s common stock at any time at the option of the holder at a conversion rate of 7.2886 shares of common stock for each share of Preferred Stock, based on an initial conversion price of $6.86 per share.  The initial conversion price is subject to adjustment in certain customary events, but is not subject to “price based” anti-dilution adjustment. The Company has reserved approximately 6,559,740 shares of common stock for issuance upon such conversion.  As of March 31, 2005, no holders had voluntarily converted shares of Preferred Stock.

 

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

 

In accordance with SFAS 133, the Company is required to separate and account for, as an embedded derivative, the dividend make-whole payment feature of the Preferred Stock offering. As an embedded derivative instrument, the dividend make-whole payment feature must be measured at fair value and reflected as a liability. Changes in the fair value of the derivative are recognized in earnings as a component of Other Income (Expense). The Company determined the fair value of the dividend make-whole payment feature to be $3.0 million at February 24, 2005 (the commitment date). This amount was allocated from the proceeds of the Preferred Stock to the derivative liability. At March 31, 2005, the derivative liability was valued at $2.6 million, resulting in the recognition of $0.4 million as other income for the three months ending March 31, 2005.

 

The Company may elect to redeem the Preferred Stock on or after March 6, 2009 at declining redemption prices ranging from $51.95 per share to $50.00 per share.

 

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

 

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

 

9.     Subsequent Events

 

On May 11, 2005, the Company signed an amendment to its Watertown, MA facility lease.  The amendment extends the base term of the original lease from an ending date of December 31, 2011 to an ending date of June 30, 2012 in return for the landlord providing the Company a tenant improvement allowance of up to $270,000 for certain improvements to the facility.   The extension of the lease term will result in additional rent payments by the Company of approximately $1.4 million over the life of the extended lease. The facility improvements will be constructed by the landlord and the improvement allowance will be disbursed in accordance with a work letter entered into by the landlord and the Company on May 11, 2005.  All other terms of the original lease remain in full force and effect.

 

On May 11, 2005, Acusphere entered into a Patent Transfer Agreement with Schering Aktiengesellschaft (“Schering”) under which the Company acquired all right, title and interest in certain ultrasound-related patents from Schering.  As part of the agreement, Acusphere granted Schering a non-exclusive, royalty-free, worldwide license to certain of the acquired patents in connection with the sale of Schering’s ultrasound product Levovist®.  Acusphere acquired these patents to expand its intellectual property portfolio for ultrasound contrast agents and the use of ultrasound contrast agents generally for drug delivery applications. In consideration of the transfer and

 

10

 

assignment of these patents, the Company agreed to pay Schering a total of $7.0 million, with $1.0 million due in May 2005, $3.0 million due in May 2006, and $3.0 million due in May 2007.

 

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

 

Forward Looking Statements May Prove Inaccurate

 

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

 

Forward-looking statements include, but are not limited to: our plans to develop and market new products and the timing of these development programs, in particular the timing, size and enrollment of clinical trials and timing of regulatory milestones for AI-700; our clinical development of product candidates, clinical trials and our ability to obtain and maintain regulatory approval for our product candidates; our estimates regarding our capital requirements and our needs for additional financing; our estimates of future expenditures for and the timing of our build-out of our commercial manufacturing facility in Tewksbury, Massachusetts; our estimates of expenses and future revenues and profitability; our estimates of the size of the potential markets for our product candidates; our selection and licensing of product candidates; our ability to attract collaborators with acceptable development, regulatory and commercialization expertise; the benefits to be derived from corporate collaborations, license agreements and other collaborative efforts, including those relating to the development and commercialization of our product candidates; sources of revenues and anticipated revenues, including contributions from corporate collaborations, license agreements and other collaborative efforts for the development and commercialization of products; our ability to create an effective direct sales and marketing infrastructure for products we elect to market and sell directly; the rate and degree of market acceptance of our product candidates; the timing and amount of reimbursement for our product candidates; the success of other competing therapies that may become available; and the manufacturing capacity for our product candidates, including our plans to build out and qualify a commercial manufacturing facility for AI-700.

 

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

 

The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Form 10-Q.

 

Overview

 

We are a specialty pharmaceutical company that develops new drugs and improved formulations of existing drugs using our proprietary porous microparticle technology. We are focused on developing proprietary drugs that can offer significant benefits such as improved safety and efficacy, increased patient compliance, greater ease of use, expanded indications or reduced cost. Our three initial product candidates are designed to address large unmet clinical needs within cardiology, oncology and asthma. Our lead product candidate is a cardiovascular drug in Phase 3 clinical development for the detection of coronary heart disease, the leading cause of death in the United States.

 

We created our initial product candidates using technology that enables us to control the size and porosity of particles in a versatile manner, so we can customize the particles to address the delivery needs of a variety of drugs. We are focused on creating porous microparticles that are smaller than red blood cells. Some of these microparticles are nanoparticles which are smaller than 1 micron. Small microparticles are important for delivering drugs intravenously so that they can pass through the body’s smallest blood vessels, for increasing the surface area of a drug so that the drug will dissolve more rapidly, and for delivering drugs to the lung via inhalation. Porosity is important for entrapping gases in microparticles, for controlling the release rate of the drug from a microparticle, and for targeting inhaled drugs to specific regions of the lung.

 

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We have incurred significant operating losses to develop our product candidates and we anticipate continuing to incur significant operating losses in the coming years. In particular, we expect to incur significant additional expenses and experience other significant capital requirements for the conduct of our Phase 3 clinical program for AI-700 and to complete the build-out and qualification of a manufacturing facility for the initial commercial manufacture of AI-700. Since our inception, we have funded our operations primarily through private and public placements of equity securities, equipment-backed financings and other debt financings.

 

AI-700 Clinical Trial Update {to be updated closer to timing of 10-Q release}

 

The Phase 3 clinical plan provides for a two-part program consisting of a pilot phase (the “pilot study”), under which new investigators and blinded readers have been qualified and trained, and two multi-center pivotal trials (the “32” and “33” trials), which together seek to enroll approximately 700 patients with known or suspected coronary heart disease. The Phase 3 pivotal studies are currently taking place at clinical sites located in North America, Europe and Australia with data from the trials intended for submission to U.S., European and potentially other regulatory authorities. As of May 11, 2005, over 400 patients have been enrolled in the Phase 3 pivotal trials and over 500 patients have been enrolled in the Phase 3 program, including the pivotal trials and the pilot study. We currently anticipate completing cumulative enrollment of at least 700 patients in the pivotal trials during the first quarter of 2006.

 

The Pilot Study.    Our objectives in the pilot study were to train and qualify a sufficient number of clinical sites, investigators and blinded readers for transition into one of the two pivotal trials. These objectives have been accomplished and enrollment in this trial is completed. Clinical sites trained in the pilot study transitioned into a pivotal trial when, in our judgment, the clinical site demonstrated that it is prepared to meet the requirements of the clinical trial protocol which, in the pivotal trial requiring nuclear stress tests in all patients, includes conducting both stress echo and stress nuclear studies on the same patient on the same day. Because the pilot study has been conducted for training purposes, there are no defined clinical efficacy endpoints in this study.

 

The Pivotal Trials.    More than twenty clinical sites are participating in the pivotal trials, and both trials are active in enrolling patients. As part of the Phase 3 pivotal study design, the evaluation of the stress echo and nuclear stress images from the pivotal trials is performed by panels of blinded readers who receive no information about the patient being evaluated other than the images. Safety will continue to be tested and evaluated during our pivotal trials.

 

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

 

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

 

Although we are targeting these clinical endpoints and timing for clinical enrollment in our Phase 3 trials, we cannot assure you that we will successfully achieve results that meet or exceed these clinical endpoints or that enrollment will be completed in the first quarter of 2006.

 

AI-700 Manufacturing Facility Update

 

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

 

In addition to the amounts that we have spent relating to the build-out of this facility which, for the period July 2004 through March 31, 2005, totaled approximately $6.2 million, we estimate that we may spend an additional $18.0 million to substantially

 

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complete this build-out in 2005 with the majority of the remaining expenditures scheduled to occur between April and July 2005. These historical and prospective amounts exclude the cost of our manufacturing equipment.  We have entered into an agency procurement agreement with a contractor covering the purchase of equipment in connection with the build-out of the Tewksbury facility.  As of May 11, 2005, the total estimated value of equipment to be purchased under this agreement was $4.6 million, of which $0.6 million was paid for as of March 31, 2005. We have also entered into an engineering and construction management services agreement with the same contractor covering the provision of engineering, design and construction management services through the period ending May 15, 2005.  As of May 11, 2005, the total value of this contract was $12.9 million.

 

Historically, we have manufactured AI-700, using our manufacturing equipment and involving our employees, at a manufacturing facility operated by a third-party contract manufacturer. During the three months ended March 31, 2005, we removed our equipment from the third-party contract manufacturer’s facilities and transferred it to the Watertown facility.

 

In August 2004, we entered into a $2.0 million loan agreement with the Massachusetts Development Finance Agency, the economic development authority of the Commonwealth of Massachusetts, to help fund build-out costs related to the Tewksbury facility. In March 2005, we borrowed $2.0 million under this loan agreement.

 

Financial Operations Overview

 

Revenue.    We have not generated any revenue from product sales since our inception. In connection with our collaboration agreement with Nycomed, as of March 31, 2005 we have received $7 million in license fees and research and development payments and we anticipate receiving an additional $5 million in such research and development payments in quarterly installments of $1 million through June 2006. We are recognizing this $12.0 million of initial license and research and development payments over an estimated recognition period of forty-two months over which we are obligated to perform services supporting the agreement. Further in the future, we will seek to generate revenue from a combination of product sales, up-front or milestone payments and manufacturing payments in connection with collaborative or strategic relationships, and royalties resulting from the license of our products and intellectual property. Upon commencement of our collaboration agreement with Nycomed, we emerged from the development stage for accounting purposes.

 

Research and Development Expense.    Research and development expense consists of expenses incurred in developing, manufacturing and testing product candidates. These expenses consist primarily of salaries and related expenses for personnel, fees paid to professional service providers in conjunction with independently monitoring our clinical trials and acquiring and evaluating data in conjunction with our clinical trials, costs of contract manufacturing services, costs of materials used in clinical trials and research and development, depreciation of capital resources used to develop our products, costs of facilities, the legal costs of pursuing patent protection on select elements of our intellectual property and stock-based compensation. We expense research and development costs, including patent related costs, as incurred. We believe that significant investment in product development is a competitive necessity and plan to continue these investments in order to realize the potential of our product candidates and proprietary technologies. Development programs for later stage product candidates, such as AI-700, tend to cost more than earlier stage programs due to the length and the number of patients enrolled in clinical trials for later stage programs and due to costs of scaling production to commercial scale.

 

General and Administrative Expense.    General and administrative expense consists primarily of salaries and other related costs for personnel in executive, finance, accounting, information technology, business development and human resource functions. Other costs include facility costs not otherwise included in research and development expense, professional fees for legal and accounting services and stock-based compensation.

 

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

 

Interest Expense.    Interest expense consists of interest incurred on equipment leases and other financing arrangements.  Interest expense also includes interest recognized in connection with embedded derivatives.

 

Change in Valuation of Derivative.    Change in valuation of derivative consists of other income (expense) recognized on the change in fair value of the derivative at the end of each reporting period.

 

Stock-Based Compensation Expense.    Included within research and development expenses and general and administrative expenses is stock-based compensation expense. Stock-based compensation expense, which is a non-cash charge, results principally from stock option grants to our employees at exercise prices deemed for accounting purposes to be below the fair market value of our stock on the date the stock options were granted (“fixed awards”). Prior to our initial public offering, which closed on October 14,

 

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2003, we granted certain stock options for which the exercise prices were deemed for accounting purposes to be below the fair value of the underlying common stock resulting in our recording stock-based compensation expense associated with such grants. Stock-based compensation expense is also recorded for stock option grants to non-employees and for restricted stock grants provided to directors and advisors in lieu of cash compensation. Deferred compensation (for accounting purposes) on fixed awards is amortized as a charge to operations over the vesting periods of the options and grants, subject to adjustment for forfeiture during the vesting period.

 

Results of Operations

 

Three Months Ended March 31, 2005 and 2004

 

Revenue.    Collaboration revenue was $0.9 million in the three months ended March 31, 2005 compared to no collaboration revenue recognized in the three months ended March 31, 2004. Collaboration revenue was earned under our agreement with Nycomed which was entered into in July 2004. Under this agreement, excluding any payments that we might receive based upon the achievement of specified milestones, we are scheduled to receive $12 million in license fees and research and development payments through June 2006, of which $7.0 million was received through March 31, 2005. We are recognizing revenue associated with these payments ratably over a period of forty-two months, representing the estimated development period over which such fees are earned.

 

Research and Development Expense.    Research and development expense increased $2.1 million, or 37%, to $7.7 million in the three months ended March 31, 2005 from $5.6 million in the three months ended March 31, 2004.  The increase in research and development expense primarily resulted from increased activities in our AI-700 Phase 3 clinical program.

 

The following table summarizes the primary components of our research and development expense for the three months ended March 31, 2005 and 2004:

 

 

Late Stage Clinical Development Program.  Research and development costs generally increase as programs progress from early stage clinical trials to late stage clinical trials. Our late stage clinical develop program relates to our lead product candidate, AI-700, which is a cardiovascular drug for the detection of coronary heart disease. Almost all of our direct research and development expenditures for the three months ended March 31, 2005 and 2004 related to our AI-700 program. The increase in direct research and development costs in the three months ended March 31, 2005 compared to the same period in 2004 reflects a higher number of clinical sites enrolling patients in the AI-700 Phase 3 clinical program, a higher rate of patient enrollment in these clinical trials and related increases in costs for clinical data management and independent clinical site monitoring. Patient enrollment and related costs are anticipated to vary from quarter to quarter but are generally anticipated to be higher in 2005 than in 2004.  The increase in research and development costs also includes costs associated with increasing full and part-time personnel.

 

We have historically outsourced the production of AI-700 used in our clinical trials to qualified third parties. For example, we produced the clinical trial materials to be used in our Phase 3 clinical trials for AI-700 at Hollister-Stier Laboratories with the involvement of our manufacturing personnel.  In July 2004, we entered into a lease agreement for 58,000 square feet of commercial manufacturing and office space in Tewksbury, Massachusetts.  In September 2004, we began to build-out the manufacturing space of this facility for commercial manufacturing of AI-700. We intend to demonstrate that we can produce AI-700 at a commercial

 

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manufacturing scale prior to our filing of a NDA for AI-700 and, subject to required regulatory approvals, we intend to manufacture AI-700 in this facility for commercial use.  The increase in research and development costs in the three months ended March 31, 2005 compared to the same period in 2004 reflects operating costs associated with our Tewksbury, MA facility and increased depreciation expense due to capital purchases primarily relating to our manufacturing operations.  During 2005, we anticipate incurring increased costs associated with the build-out of our new commercial manufacturing space, including rent and other facility costs, the purchase of raw materials and laboratory supplies, the increased use of consultants, and the hiring of additional research and development personnel.

 

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

 

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

 

General and Administrative Expense.    General and administrative expense increased $0.3 million, or 24%, to $1.7 million for the three months ended March 31, 2005 from $1.4 million in the three months ended March 31, 2004.  The increase in general and administrative expense was principally due to additional personnel, including the increased use of consultants in business development activities.

 

We anticipate some overall increase in general and administrative expense during 2005, including increases in costs for investor relations and other activities. These increases will also likely include the hiring of additional personnel. We intend to continue to incur various internal and external business development costs to support our various product development efforts, and certain of these expenses are likely to increase overall.

 

Interest Income.    Interest income increased $0.2 million, or 181%, to $0.3 million in the three months ended March 31, 2005 from $0.1 million in the three months ended March 31, 2004.  The increase in interest income was primarily due to higher average fund balances available for investment resulting from the $45.0 million Preferred Stock financing in February 2005 and the $21.5 million private placement completed in October 2004.

 

Interest Expense.    Interest expense increased $115,000, or 454%, to $140,000 in the three months ended March 31, 2005 from $25,000 in the three months ended March 31, 2004.   The increase in interest expense was primarily related to cumulative borrowings of approximately $10.5 million through March 31,2005 under our equipment financing line which we entered into in April 2004.

 

Change in Valuation of Derivative.    Change in valuation of derivative increased to $434,000 in the three months ended March 31, 2005 from zero in the three months ended March 31, 2004. The increase in change in valuation of derivative was related to the embedded derivative instrument from the dividend make-whole payment feature of the Preferred Stock offering that closed in February 2005. We determined the fair value of the dividend make-whole payment feature to be $3.0 million at February 24, 2005 (the commitment date).

 

Liquidity and Capital Resources

 

Historically, aside from payments received in connection with our strategic collaboration with Nycomed, we have financed our business through the issuance of equity securities, debt financings and equipment leases. Our liquidity requirements have arisen primarily from research and development expenditures, equipment expenditures and payments on outstanding indebtedness. As of March 31, 2005, we had cash and cash equivalents of $79.8 million. As of March 31, 2005 we owed $12.2 million in notes payable

 

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and had commitments totaling $19.3 million for rent under our facility leases, including the lease agreement signed in July 2004 for commercial manufacturing space in Tewksbury, Massachusetts.

 

During the three months ended March 31, 2005, operating activities used $9.5 million of cash. Net cash used by operating activities during this period resulted primarily from a net loss of $8.0 million, a decrease in accounts payable of $1.7 million, non-cash amortization of deferred revenue of $0.9 million and an increase in other current assets of $0.7 million.  These uses of cash were partially offset by an increase in deferred revenue of $1.0 million, an increase in accrued expenses of $0.3 million, non-cash charges for depreciation and amortization of $0.5 million and non-cash charges for stock-based compensation expense of $0.2 million.  We anticipate that our operating spending will be higher in 2005 than in 2004 due to an estimated higher rate of patient enrollment in our Phase 3 clinical program and higher costs in connection with the build-out of our manufacturing facility.  We estimate that our net cash used by operations during 2005 will be approximately $8 to $10 million per quarter.

 

During the three months ended March 31, 2005, investing activities used $6.4 million in cash. This use of cash was primarily for purchases of equipment and costs incurred through March 31, 2005 for the build-out and expansion of our manufacturing operations for AI-700.

 

During the three months ended March 31, 2005, financing activities provided $50.5 million in cash. Net cash provided by financing activities during this period resulted primarily from net proceeds in connection with the sale of our convertible exchangeable Preferred Stock of $41.9 million, entering into promissory notes under the equipment financing line of $7.0 million, and borrowings of $2.0 million under a loan agreement with MassDevelopment. These proceeds were partially offset by payments on the capital leases and promissory notes of $0.5 million.

 

In August 2004, we entered into a loan agreement with MassDevelopment under which up to $2.0 million of financing is available upon completion by us of certain tenant improvements to our commercial manufacturing facility in Tewksbury, Massachusetts.  In March 2005, we borrowed $2.0 million under this loan agreement.  Interest accrues under the loan at 5.0% per annum with retroactive adjustments to 9% upon reaching certain defined earning levels. The repayment of principal and accrued interest will coincide with the term of the Tewksbury lease which has a five-year, nine-month term with options to extend the lease for up to two additional five-year terms. No payments are due under the loan for the first twenty-four months. Unpaid interest during this twenty-four month period shall be accrued and principal and interest shall be repaid on a monthly basis thereafter such that the total amount outstanding shall fully amortize over the balance of the term in equal installments. The loan is subject to acceleration upon certain customary events of default, including failure to timely pay principal and interest. The loan is secured by certain of the tenant improvements made at the Tewksbury facility.

 

On February 24, 2005, we issued 900,000 shares of 6.5% convertible exchangeable preferred stock, or Preferred Stock, at $50.00 per share resulting in aggregate gross proceeds to us of $45.0 million (net proceeds of approximately $41.9 million after deducting underwriting discounts and commissions and estimated offering expenses).  Each share of Preferred Stock has a liquidation preference of $50.00 per share.  Dividends on the Preferred Stock will be cumulative from the date of original issue at the annual rate of $3.25 per share, payable quarterly on the first day of March, June, September, and December, commencing on June 1, 2005.  Any dividends must be declared by our board of directors and must come from funds that are legally available for dividend payments.

 

The Preferred Stock is convertible into shares of our common stock at any time at the option of the holder at a conversion rate of 7.2886 shares of common stock for each share of Preferred Stock, based on an initial conversion price of $6.86 per share.  The initial conversion price is subject to adjustment upon certain customary events, but is not subject to “price based” anti-dilution adjustment. We reserved approximately 6,559,740 shares of common stock for issuance upon conversion.  As of March 31, 2005, no holders had voluntarily converted shares of Preferred Stock.  In May 2005, our board of directors declared a quarterly dividend in the amount of $0.8756 per share of Preferred Stock, which is scheduled to be paid on June 1, 2005, to the holders of record as of the close of business on May 16, 2005.

 

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

 

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In accordance with SFAS 133, the Company is required to separate and account, for, as an embedded derivative, the dividend make-whole payment feature of the Preferred Stock offering. As an embedded derivative instrument, the dividend make-whole payment feature must be measured at fair value and reflected as a liability. Changes in the fair value of the derivative are recognized in earnings as a component of Other Income(Expense). The Company determined the fair value of the dividend make-whole payment feature to be $3.0 million at February 24, 2005 (the commitment date). This amount was allocated from the proceeds of the Preferred Stock to the derivative liability. At March 31, 2005, the derivative liability was valued at $2.6 million, resulting in the recognition of $0.4 million as other income for the three months ending March 31, 2005.

 

We may elect to redeem the Preferred Stock on or after March 6, 2009 at declining redemption prices ranging from $51.95 per share to $50.00 per share.

 

The Preferred Stock is exchangeable, in whole but not in part, at our option on any dividend payment date beginning on March 1, 2006 (the “Exchange Date”) for our 6.5% convertible subordinated debentures (“Debentures”) at the rate of $50 principal amount of Debentures for each share of Preferred Stock.  The Debentures, if issued, will mature 25 years after the Exchange Date and have terms substantially similar to those of the Preferred Stock.

 

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

 

On May 11, 2005, we entered into a Patent Transfer Agreement with Schering Aktiengesellschaft (“Schering”) under which we acquired all right, title and interest in certain ultrasound-related patents from Schering.  In consideration of the transfer and assignment of these patents, we agreed to pay Schering a total of $7.0 million, with $1.0 million due in May 2005, $3.0 million due in May 2006, and $3.0 million due in May 2007.

 

We believe, based on our operating plans, that our existing resources, including scheduled proceeds from Nycomed, will be adequate to fund our planned operations, including increases in spending for our AI-700 Phase 3 clinical program, for at least the next twelve months.  In the future, we will require significant additional funds to develop, conduct clinical trials, achieve regulatory approvals, build-out and qualify commercial manufacturing space and, subject to regulatory approval, commercially launch AI-700, our other product candidates under development and future product candidates. Our future capital requirements will depend on many factors, including the scope and progress made in our research and development activities and our clinical trials and the size and timing of creating expanded manufacturing capabilities. We may also need additional funds for possible future strategic acquisitions of businesses, products or technologies complementary to our business. We do not expect to generate significant revenues for AI-700, other than possible license or milestone payments, unless or until we or current or potential partners complete clinical trials and receive marketing approval from the applicable regulatory authorities. When additional funds are required or, in advance of such requirements, when we anticipate that funds will be needed, we may raise such funds from time to time through public or private sales of equity or from borrowings or we may delay funding of certain development activities which could delay the filing of our AI-700 NDA and the commercialization of AI-700 which would have a materially adverse impact on our growth plans.  Additional equity financing may be dilutive to our stockholders and debt financing, if available, may involve significant cash payment obligations and covenants that restrict our ability to operate as a business.

 

Universal Shelf Registration Statement

 

On April 5, 2005, we filed with the Securities and Exchange Commission a “universal shelf” registration statement on Form S-3 (Registration No. 333-121618) which, when combined with our previously filed universal shelf registration statement on Form S-3, provides for the offer, from time to time, of common stock, preferred stock, debt securities and warrants up to an aggregate of $100.0 million. On April 15, 2005, the SEC declared the shelf registration statement effective. As of the filing of this report, the shelf registration statement remains effective and, subject to market conditions and our capital needs, we may again seek to use any remaining availability under the shelf registration statement by making an offering of securities covered for sale under the registration statement. In addition, we may amend our shelf registration statement or file a new shelf registration statement to increase our potential access to capital. If we elect to raise additional capital using a shelf registration statement, we may use the net proceeds from the sale of these securities for general corporate purposes, which may include funding clinical trials, research and development, regulatory activities and the build-out of our commercial manufacturing facility in Tewksbury, Massachusetts, acquisitions, including acquisitions of companies, products, intellectual property or other technology, repayment or refinancing of existing indebtedness,

 

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investments, capital expenditures, repurchase of our capital stock and for any other purposes that we may specify in any prospectus supplement.

 

Off-Balance Sheet Financing Arrangements

 

We currently do not have any special purpose entities or off-balance sheet financing arrangements other than operating leases.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of March 31, 2005 and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

 

Payments Due by Period

 

Contractual Obligations		Total Obligations All Years			2005 Through 2006			2007 Through 2008			2009 Through 2010			After 2010
		(in thousands)
Capital lease obligations (including interest)		$	16		$	16		$	—		$	—		$	—
Operating lease obligations		19,347			4,684			5,911			6,022			2,730
Notes payable (including interest)		14,540			5,667			7,065			1,808			—
Purchase orders for capital equipment		4,821			4,821			—			—			—
Purchase orders for leasehold improvements		2,215			2,215			—			—			—
Total contractual cash obligations		$	40,939		$	17,403		$	12,976		$	7,830		$	2,730

 

Our operating lease obligations relate to our facility leases.

 

A substantial portion of the purchase orders for capital equipment and leasehold improvements in the table above is needed for expanded manufacturing of AI-700.  As of March 31, 2005, we had outstanding purchase orders for capital equipment which total approximately $6.5 million. Against these purchase orders we have paid approximately $1.7 million in deposits. The table above reflects the remaining amounts due on these purchase orders. In 2005, we anticipate expenditures for equipment purchases totaling approximately $4.3 million in excess of the above reflected amounts.  On November 11, 2004, we entered into an engineering and construction management services agreement with a contractor to perform on our behalf, engineering, design and construction management services in connection with the build-out of the commercial manufacturing facility in Tewksbury, Massachusetts. The total estimated value of this cost plus percentage fee type contract, as amended on April 29, 2005, is $12.9 million.  As of March 31, 2005, we had outstanding purchase orders for leasehold improvements related to this contract which total approximately $8.4 million. Against these purchase orders we have paid approximately $6.2 million in deposits. The table above reflects the remaining amounts due on these purchase orders.  We expect that the build-out of this commercial manufacturing facility will be substantially completed in 2005 and that our total payments for substantially completing this build-out, excluding equipment purchases, will be approximately $18.0 million in excess of the amounts that we have already paid through March 31, 2005.

 

The above table does not include obligations from agreements we entered into after March 31, 2005.

 

Critical Accounting Policies and Estimates

 

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

 

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

 

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

 

We are recognizing collaboration revenue of $12.0 million associated with the initial license and performance-based payments under the Nycomed agreement based on an estimated recognition period of forty-two months over which we are obligated to perform services supporting the agreement.  This estimated recognition period may change if available facts and circumstances change.  A change in this estimate could result in a significant change to the amount of revenue recognized in future periods.  In addition, if the Nycomed collaboration agreement is terminated for reasons other than certain non-performance by us, we would recognize the remainder of the payments we have received or otherwise expect to collect over the amortization period at the time of termination. We will not recognize revenue associated with the potential $58 million in milestone-based payments that may be earned under the Nycomed agreement until the underlying regulatory and sales milestones are achieved.

 

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

 

Stock-Based Compensation and Other Equity Instruments.    We have elected to follow APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for our stock-based compensation plans, rather than the alternative fair value accounting method provided for under SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, we have not recorded stock-based compensation expense for stock options issued to employees in fixed amounts with exercise prices at least equal to the fair value of the underlying common stock on the date of grant. In the notes to our consolidated financial statements we provide pro forma disclosures in accordance with SFAS No. 123 and related pronouncements. We account for transactions in which services are received in exchange for equity instruments based on the fair value of such services received from non-employees or of the equity instruments issued, whichever is more reliably measured, in accordance with SFAS No. 123 and EITF Issue No. 96-18, Accounting for Equity Instruments that Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. We account for transactions in which we grant warrants in connection with the issuance of debt in accordance with APB 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants. The two factors which most affect charges or credits to operations related to stock-based compensation are the fair value of the common stock underlying stock options for which stock-based compensation is recorded and the volatility of such fair value.

 

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

 

Derivative Liability.    The terms of our February 2005 convertible preferred stock offering include a dividend make-whole payment feature. This feature is considered to be an embedded derivative and is recorded at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments. If our estimates of the fair value of this derivative are too high or too low, it would have the effect of understating or overstating our net loss.  The derivative liability is reduced for make-whole payments triggered upon conversion of the preferred stock as well as dividends declared by the Company, if any, on the convertible preferred stock. The changes in the fair value of the derivative financial instrument are included in other income (expense) in each reporting period.

 

Income Taxes.    As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatments of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. In addition, as of December 31, 2004, we had federal tax net operating loss carryforwards of $84.0 million, which expire through 2024. We also have research and development credit carryforwards of $5.3 million. We have recorded a valuation allowance to fully offset against these otherwise recognizable net deferred tax assets due to the uncertainty surrounding the timing of the realization of the tax benefit. In the event that we determine in the future that we will be able to realize all or a portion of its net deferred tax benefit, an adjustment to deferred tax valuation allowance would increase net income in the period in which such a determination is made. The Tax Reform Act of 1986 contains provisions that may limit the utilization of net operating loss carryforwards and credits available to be used in any given year in the event of significant changes in ownership interest, as defined.

 

Certain Factors Which May Affect Future Results

 

Our operating results and financial condition have varied in the past and may in the future vary significantly depending on a number of factors. Except for the historical information in this report, the matters contained in this report include forward-looking statements that involve risks and uncertainties. The following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by management from time to time. Such factors, among others, may have a material adverse effect upon our business, results of operations and financial condition.

 

Risks Related to Our Company

 

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

 

We are focused on product development and we have not generated any revenue from commercial sales of our products to date. We have incurred losses each year of our operations and we expect to continue to incur operating losses for the next several years. The process of developing our products requires significant clinical, development and laboratory testing and clinical trials as well as regulatory approvals. In addition, commercialization of our product candidates will require us to establish sales, marketing and manufacturing capabilities, either through internal hiring or through contractual relationships with others. We expect our research and development and general and administrative expenses will increase over the next several years.

 

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

 

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

 

No product can receive FDA approval unless human clinical trials show both safety and efficacy for each target indication in accordance with FDA standards. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late stage clinical trials even after achieving promising results in early stage development. We therefore cannot assure you that the results from our Phase 2 clinical trials for AI-700 will be predictive of results obtained in our Phase 3 clinical trials. Many of the patients in our AI-700 clinical trial have coronary heart disease. As part of our AI-700 Phase 3 clinical trials, patients will be exposed to potential safety risks associated with a stress test, including risks associated with a pharmacological stressor, and AI-700. Given the nature of the AI-700 Phase 3 clinical trial, including administering AI-700 to larger numbers of at-risk patients and new clinical sites, adverse events are expected to be encountered during the clinical trial. Adverse events are also likely to be encountered in clinical trials for our other products, which clinical trials also include at-risk patients. If significant adverse events are detected and these events are attributable to our products, such events could delay, limit or prevent regulatory agency approval. Further, data obtained from pre-clinical and clinical activities are subject to varying interpretations that could delay, limit or prevent regulatory agency approval. We cannot assure you that our Phase 3 plan for AI-700 will successfully address the concerns of the FDA or that the results of the Phase 3 program will establish the safety and efficacy of AI-700 sufficiently for us to obtain regulatory approval.

 

We may also encounter delays or rejections based on our inability to enroll enough patients to complete our clinical trials. We may also encounter delays, resulting from the need to enroll more patients than we currently plan for in our clinical trials, based on our inability to enroll a mix of patients that is consistent with our estimated clinical trial enrollment or a change in the sample size required to meet the study endpoints. Patient enrollment depends on many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites, and the eligibility criteria for the study and the freedom to operate with respect to intellectual property. Delays in planned patient enrollment, or the need to enroll more patients, may result in increased costs and delays, which could have a harmful effect on our ability to develop products. We may encounter delays or rejections based on changes in regulatory agency policies during the period in which we develop a drug or the period required for review of any application for regulatory agency approval of a particular compound. On May 1, 2004, changes went into effect in the regulation of clinical trials in Europe. Our continuing compliance with these changes could lead to delays to our clinical trials. We also may encounter delays in the event we are unable to produce clinical trial material in sufficient quantities and of sufficient quality to meet the schedule for our planned clinical trials. In addition, we rely on a number of third parties, such as clinical research organizations, to help support the clinical trials by performing independent clinical monitoring, data acquisition and data evaluations. Any failure on the part of these third parties could delay the regulatory approval process.

 

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

 

•                                          adversely affect our ability to market any drugs we develop independently or with collaborative partners;

 

•                                          impose additional costs and diminish any competitive advantages that we may attain; or

 

•                                          adversely affect our ability to generate royalties.

 

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

 

We cannot be certain that we will obtain any regulatory approvals in other countries and the failure to obtain these approvals may materially adversely affect our business, financial condition and results of operations. In order to market our products outside of the

 

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

 

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

 

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

 

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

 

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

 

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

 

•                                          the progress of pre-clinical development and laboratory testing and clinical trials;

 

•                                          the timing of construction and size to which we expand our manufacturing capabilities;

 

•                                          the time and costs involved in obtaining regulatory approvals;

 

•                                          the number of product candidates we pursue;

 

•                                          the costs involved in filing and prosecuting patent applications and enforcing or defending patent claims; and

 

•                                          the establishment of selected strategic alliances and activities required for product commercialization.

 

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

 

We cannot assure you that we can obtain additional funding on reasonable terms, or at all. If we raise additional funds by issuing equity securities, our stock price may decline, our existing stockholders may experience significant dilution, and the newly issued securities may have rights superior to those of our common stock. If we raise additional funds by issuing debt, we may be subject to

 

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limitations on our operations and such debt may have rights senior to the debentures, if issued. If we cannot obtain adequate funds, we may:

 

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

 

•                                          delay our establishment of sales, marketing and/or manufacturing capabilities;

 

•                                          curtail significant product development programs that are designed to identify new product candidates;

 

•                                          relinquish rights to our technologies or product candidates; and/or

 

•                                          terminate or delay build-out and commissioning of our commercial manufacturing facility.

 

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

 

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

 

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

 

We know of U.S. and foreign patents issued to third parties that relate to aspects of our product candidates. There may also be patent applications filed by these or other parties in the United States and various foreign jurisdictions that relate to some aspects of our product candidates, which, if issued, could subject us to infringement actions. In particular, we are aware of U.S. and foreign patents owned by third parties, including potential competitors, that arguably cover aspects of our AI-700 contrast agent. We and several of these parties have recently been actively engaged in opposing the grant of European patents with claims that arguably cover aspects of our AI-700 product. Parties may contest patents in Europe prior to contesting the counterpart patents in the United States because of procedural differences between European and U.S. patent laws as well as economic considerations. There is a significant possibility that one or more of these third parties will use litigation to assert their patents in the United States or Europe.

 

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

 

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

 

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The following factors are important to our success:

 

•                                          receiving patent protection for our product candidates;

 

•                                          maintaining our trade secrets;

 

•                                          not infringing on the proprietary rights of others; and

 

•                                          preventing others from infringing our proprietary rights.

 

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

 

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

 

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

 

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

 

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

 

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

 

We have never manufactured any of our product candidates in commercial quantities, and if we fail to develop an effective manufacturing capability for our products, including our lead product candidate AI-700, we may be unable to commercialize these products.

 

We have no experience in manufacturing our products for commercial use and limited experience in designing equipment for the manufacture of our products. We are working to build out and qualify a commercial manufacturing facility in Tewksbury,

 

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Massachusetts and to demonstrate that we can produce AI-700 at a commercial manufacturing scale prior to our filing of a NDA for AI-700 and, subject to required regulatory approvals, we intend to manufacture AI-700 in this facility for commercial use. We can not assure you that we will be able to successfully manufacture our products in sufficient quantities for commercial sale, or obtain the necessary regulatory approvals for such commercial manufacture, at all or in a timely or economical manner. Our intention to manufacture AI-700 or other products exposes us to the following risks, any of which could delay or prevent the approval of our products by the FDA or corresponding state and foreign agencies, or the commercialization of our products, or result in higher costs or inability to meet demand for AI-700 leading to potential revenue loss, and any of which would have a material adverse impact on our business, financial condition and results of operations.

 

•                                          Manufacturers often encounter difficulties in achieving volume production, quality control and quality assurance. Accordingly, we might not be able to manufacture sufficient quantities of drugs to meet our clinical schedules or to commercialize our products.

 

•                                          Manufacturers are obliged to manufacture in highly controlled environments and to operate in accordance with FDA and international mandated current good manufacturing practices, or cGMPs. For our clinical trials we have relied on contract manufacturers for such facilities and cGMP compliance. In July 2004, we entered into a lease for a facility in Tewksbury, Massachusetts that we intend to convert into a commercial manufacturing facility for AI-700. Creation and qualification of a commercial manufacturing environment requires significant expertise and capital resources, including the development of advanced manufacturing techniques and process controls and is subject to local and state planning approvals. Manufacturers of pharmaceutical products often encounter difficulties in constructing and qualifying new manufacturing facilities and in production, especially in scaling-up initial production. A failure within this new facility to establish and follow cGMPs and to document adherence to such practices may lead to significant delays in the availability of material for our NDA filing or commercial production for AI-700 and may delay or prevent filing or approval of marketing applications for our products or the ability to continue to manufacture the products. Certain of these delays would further require us to continue to operate this facility and incur related costs.

 

•                                          Manufacture of our product candidates, in preparation for filing a NDA and for commercial production, will each initially require and rely on a single commercial manufacturing site, directly or through a contract manufacturer, without the backup of a second site that is qualified for commercial manufacture of the product. Qualification of another manufacturing site can be expensive and time consuming. Prior to using product from a new manufacturing site, we must demonstrate that the specifications for the product are consistent with the specifications for the product as it was manufactured at a prior qualified site or we must clinically or otherwise demonstrate that the safety and efficacy of the product produced in the new manufacturing site is consistent with the product as it was manufactured at the prior site. Demonstrating such consistency may be difficult, expensive or time consuming. In addition, before we would be able to produce product for commercial use at a new facility, it will have to undergo a pre-approval inspection by the FDA and corresponding state and foreign agencies. Once approved, drug manufacturers are subject to ongoing periodic unannounced inspection by the FDA and corresponding state and foreign agencies to ensure strict compliance with cGMPs, other government regulations and corresponding foreign standards. Failure to maintain compliance with cGMP or with safety or environmental regulations could result in penalties, product recalls or restrictions on the use of the manufacturing site.

 

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

 

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

 

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

 

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

 

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

 

•                                          Contract manufacturers often encounter difficulties in achieving volume production, quality control and quality assurance, as well as shortages of qualified personnel. Accordingly, a manufacturer might not be able to manufacture sufficient quantities of drugs to meet our clinical schedules.

 

•                                          Contract manufacturers are obliged to operate in accordance with FDA-mandated current good manufacturing practices, or cGMPs. A failure of these contract manufacturers to establish and follow cGMPs and to document their adherence to such practices may lead to significant delays in the availability of material for clinical study and may delay or prevent filing or approval of marketing applications for our products.

 

•                                          For production of clinical trial material for each of our current product candidates we will initially rely on a single manufacturer. Changing these or future manufacturers may be difficult and the number of potential manufacturers is limited. Changing manufacturers may require re-validation of the manufacturing processes and procedures in accordance with FDA-mandated cGMPs. Such re-validation may be costly and time-consuming. It may be difficult or impossible for us to find replacement manufacturers on acceptable terms quickly, or at all.

 

•                                          Our contract manufacturers may not perform as agreed or may not remain in the contract manufacturing business for the time required to produce, store and distribute our products successfully. Our manufacturing levels, while important to us, can represent relatively small fractions of the overall business of most qualified contract manufactures. As a result, the contract manufacturers may not provide us with the attention that we need or may be unwilling to adapt to necessary changes in our manufacturing requirements.

 

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

 

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

 

To date our product candidates have been manufactured in small quantities for pre-clinical and clinical trials. If any of these product candidates are approved by the FDA or foreign regulatory authorities for commercial sale, we will need to manufacture them in larger quantities. For AI-700, it is our intention to seek regulatory approval after we have demonstrated that we can manufacture AI-700 at a larger batch scale than is being used for clinical trial materials. We cannot assure you that we will be able to successfully increase the manufacturing capacity or manufacture at a larger batch scale, whether on our own or in collaboration with third party manufacturers, for any of our product candidates in a timely or economic manner, or at all. Significant scale-up of manufacturing may require certain additional validation studies, which the FDA must review and approve. If we are unable to successfully increase the manufacturing capacity for a product candidate, the regulatory approval or commercial launch of that product candidate may be delayed or there may be a shortage in supply of that product candidate. Our product candidates require precise, high-quality manufacturing. Our failure to achieve and maintain these high manufacturing standards, including controlling the incidence of manufacturing errors and maintaining reliable product packaging for diverse environmental conditions, could result in patient injury or death, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously hurt our business.

 

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

 

Only a few facilities manufacture some of the raw materials necessary to manufacture our products. If we need to purchase a raw material that is in limited supply for our clinical trials, or for commercial distribution if we obtain marketing approval of a product candidate, we cannot assure you that one or more suppliers would be able to sell us that raw material at the time we need it and on commercially reasonable terms. If we change suppliers for any of these materials or any of our suppliers experiences a shutdown or disruption in the facilities used to produce these materials, due to technical, regulatory or other problems, it could harm our ability to manufacture our products. Our inability to obtain required raw materials for any reason could substantially impair our development activities or the production, marketing and distribution of our products.

 

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

 

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

 

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

 

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

 

•                                          we cannot effectively control whether our corporate partners will devote sufficient resources to our programs or product candidates;

 

•                                          disputes may arise in the future with respect to the ownership of rights to technology developed with collaborators;

 

•                                          disagreements with collaborators could delay or terminate the research and development, regulatory approval or commercialization of product candidates, or result in litigation or arbitration;

 

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•                                          corporate partners may have considerable discretion in electing whether to pursue the development of any additional product candidates and may pursue technologies or products either on their own or in collaboration with our competitors; and

 

•                                          collaborators with marketing rights may choose to devote fewer resources to the marketing of our product candidates than they do to product candidates of their own development.

 

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

 

Given these risks, our current and future collaborative efforts may not be successful. Failure of these efforts could delay our product development or impair commercialization of our products, and could have a material adverse effect on our business, financial condition and results of operations.

 

Competition in the pharmaceutical industry is intense, and if we fail to compete effectively our financial results will suffer.

 

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

 

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

 

•                                          AI-700, our ultrasound contrast agent and lead product candidate, if approved for marketing and sale, will compete with nuclear stress tests, the current standard of care in myocardial perfusion imaging. Nuclear contrast agents that are approved for use in myocardial perfusion imaging include products marketed by GE Healthcare, Bristol-Myers Squibb and Tyco International. In 2004, the cost of a nuclear stress test was approximately $770 per procedure. In addition, GE Healthcare, Bristol-Myers Squibb and Imcor have developed ultrasound contrast agents that have been approved by the FDA for use in LVO and EBD in patients with suboptimal images, and in the future they may seek to broaden their products to include stress echo and myocardial perfusion assessment. Moreover, we are aware that other companies, such as Bracco, are developing ultrasound contrast agents for wall imaging and for radiology applications, and that Point Biomedical is developing an ultrasound contrast agent specifically for myocardial perfusion imaging. In 2004, Point announced that it had recently completed two pivotal Phase 3 trials for this contrast agent and planned to file an NDA with the FDA. Finally, some cardiologists may find it satisfactory to use stress echo without contrast for the detection of coronary heart disease.

 

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•                                          AI-850, our reformulation of paclitaxel, if approved for marketing and sale, will also face intense competition from companies such as American Pharmaceutical Partners, NeoPharm and Sonus Pharmaceuticals, which are applying significant resources and expertise to developing reformulations of paclitaxel for intravenous delivery. In early 2005, American Pharmaceutical Partners received FDA approval for their product. Other companies, such as Cell Therapeutics, are developing new chemical entities that involve paclitaxel conjugated, or chemically bound, to another chemical.

 

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

 

Relative to us, most of our competitors have substantially greater capital resources, research and development staffs, facilities and experience in conducting clinical trials and obtaining regulatory approvals, as well as in manufacturing and marketing pharmaceutical products. Many of our competitors may achieve product commercialization or patent protection earlier than we will.

 

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

 

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

 

We depend on the principal members of our scientific and management staff. The loss of these principal members’ services might significantly delay or prevent the achievement of research, development or business objectives and could materially adversely affect our business, financial condition and results of operations. We do not maintain key person life insurance on any of these principal members. We do not have employment contracts with any of these principal members.

 

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

 

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

 

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

 

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

 

•                                          different regulatory requirements for approval of our product candidates;

 

•                                          dependence on local distributors;

 

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•                                          longer payment cycles and problems in collecting accounts receivable;

 

•                                          adverse changes in trade and tax regulations;

 

•                                          the absence or significant lack of legal protection for intellectual property rights;

 

•                                          political and economic instability; and

 

•                                          currency risks.

 

Risks Relating to Our Industry

 

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

 

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

 

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

 

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

 

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

 

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

 

If third-party payors do not approve our products for reimbursement or fail to reimburse them adequately, sales will suffer as some physicians or their patients will opt for a competing product that is approved for reimbursement or is adequately reimbursed. Even if third-party payors make reimbursement available, these payors’ reimbursement policies may adversely affect the ability of us and our potential collaborators to sell our products on a profitable basis.

 

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

 

In addition, legislation and regulations affecting the pricing of pharmaceuticals may change in ways adverse to us before or after the FDA or other regulatory agencies approve any of our proposed products for marketing. While we cannot predict the likelihood of

 

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any of these legislative or regulatory proposals, if any government or regulatory agencies adopt these proposals they could materially adversely affect our business, financial condition and results of operations.

 

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

 

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

 

Rapid technological change could make our products obsolete.

 

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

 

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

 

Our research and development activities involve the use of hazardous materials, including chemicals and biological materials. We believe that our procedures for handling hazardous materials comply with federal and state regulations. However, there can be no assurance that accidental injury or contamination from these materials will not occur. In the event of an accident, we could be held liable for any damages, which could exceed our available financial resources. This liability could materially adversely affect our business, financial condition and results of operations.

 

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

 

Risks Related to Our Common Stock

 

We expect that our stock price will fluctuate significantly.

 

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

 

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

 

•                                          market conditions in the pharmaceutical and biotechnology sectors;

 

•                                          rumors relating to us or our competitors;

 

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•                                          litigation or public concern about the safety of our potential products;

 

•                                          our quarterly operating results;

 

•                                          deviations in our operating results from the estimates of securities analysts; and

 

•                                          FDA or international regulatory actions.

 

The market price of our common stock may also fluctuate in response to the exercise by us of rights under the terms of our convertible preferred stock. For example, we may elect to automatically convert the preferred stock if our common stock price has exceeded 150% of the conversion price of the preferred stock for at least 20 trading days during a 30-day trading period ending within five trading days prior to the notice of automatic conversion. There is a risk of fluctuation in the price of our common stock between the time when we may first elect to automatically convert the preferred stock and the automatic conversion date. These fluctuations may adversely affect the value of the common stock.

 

Our common stock is junior to our preferred stock with respect to the right to receive payments in the event of a dissolution, liquidation or winding up of Acusphere.

 

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

 

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

 

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

 

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

 

The market price of our common stock could decline as a result of sales by our existing stockholders of shares of common stock in the market, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate. As of May 6, 2005, we have 17,831,954 shares of common stock outstanding and 900,000 shares of convertible preferred stock outstanding that are convertible into approximately 6,559,740 shares of our common stock, plus up to a maximum of approximately 1,959,799 additional shares of our common stock issuable at our option in satisfaction of the maximum dividend make- whole payment on these shares of preferred stock. All of the shares of common stock issuable upon conversion of our preferred stock will be freely tradable without restriction under the federal securities laws unless purchased by our affiliates.

 

Our directors and management will exercise significant control over our company.

 

Our directors and executive officers and their affiliates collectively control approximately 12.0% of our outstanding common stock, excluding unexercised options and warrants. As a result, these stockholders, if they act together, will be able to influence our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control of our company and might affect the market price of our common stock.

 

The terms of our outstanding shares of preferred stock may restrict our ability to raise additional capital or hamper or prevent an acquisition of us.

 

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

 

In addition, without the vote or consent of the holders of at least a majority of the shares of preferred stock we may not effect a consolidation or merger with another entity unless the preferred stock that remains outstanding and its rights, privileges and preferences are unaffected or are converted into or exchanged for preferred stock of the surviving entity having rights, preferences and limitations substantially similar, but no less favorable, to the convertible preferred stock. This provision could hamper a third party’s acquisition of us or discourage a third party from attempting to acquire control of us via a merger.

 

Under some circumstances, the holders of our outstanding shares of preferred stock may be entitled to elect some of the directors of Acusphere.

 

In February 2005 we issued and sold 900,000 shares of our 6.5% convertible exchangeable preferred stock. Cumulative dividends accrue on our preferred stock at an annual rate of $3.25 per share, payable quarterly on the first day of March, June, September and December, commencing June 1, 2005. Any dividends must be declared by our board of directors and must come from funds that are legally available for dividend payments. If we have not paid dividends on the preferred stock in an aggregate amount equal to at least six quarterly dividends whether or not consecutive, we must increase the size of our board of directors by two additional directors. After this time, and for so long as these dividends remain due and unpaid, holders of the preferred stock, voting separately as a class with holders of preferred stock ranking on the same basis as to dividends having like voting rights, will be entitled to elect two additional directors at any meeting of stockholders at which directors are to be elected. These directors will be appointed to classes on the board as determined by our board of directors. These voting rights will terminate when we have declared and either paid or set aside for payment all accrued and unpaid dividends. The terms of office of all directors so elected will terminate immediately upon the termination of these voting rights.

 

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

 

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

 

These provisions include:

 

•                                          a provision allowing us to issue preferred stock with rights senior to those of the common stock without any further vote or action by the holders of the common stock;

 

•                                          the existence of a staggered board of directors in which there are three classes of directors serving staggered three-year terms, thus expanding the time required to change the composition of a majority of directors and potentially discouraging someone from making an acquisition proposal for us;

 

•                                          the by-laws’ requirement that stockholders provide advance notice when nominating our directors;

 

•                                          the inability of stockholders to convene a stockholders’ meeting without the chairperson of the board, the chief executive officer, the president or a majority of the board of directors first calling the meeting; and

 

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•                                          the application of Delaware law prohibiting us from entering into a business combination with the beneficial owner of 15% or more of our outstanding voting stock for a period of three years after the 15% or greater owner first reached that level of stock ownership, unless we meet specified criteria.

 

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

 

We have paid no cash dividends on our common stock to date and, other than cash dividends paid on our preferred stock, we currently intend to retain our future earnings, if any, to fund the development and growth of our businesses. In addition, the terms of any future debt or credit facility may preclude us from paying these dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We have not used derivative financial instruments for speculation or trading purposes. However, we are exposed to market risk related to changes in interest rates. Our current policy is to maintain an investment portfolio consisting mainly of U.S. money market and government-grade securities, directly or through managed funds, with maturities of one year or less. Our cash is deposited in and invested through highly rated financial institutions in North America. Our cash equivalents are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at March 31, 2005, we estimate that the fair value of our investment portfolio would decline by an immaterial amount. We currently have the ability to hold our fixed income investments until maturity, and therefore we do not expect our operating results or cash flows to be affected to any significant degree by the effect of a change in market interest rates on our investments.

 

Effects of Inflation

 

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

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of March 31, 2005 (the “Evaluation Date”), the our management, with the participation of our Chief Executive Officer and our Senior Vice President and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(b) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in ensuring that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, including ensuring that such material information is accumulated and communicated to our management, including our Chief Executive Officer and our Senior Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Internal Control Over Financial Reporting

 

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

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

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

 

The aggregate price of the offering amount registered on our behalf was $52.5 million. In connection with the offering, we paid $3.7 million in underwriting discounts and commissions to the underwriters and incurred an estimated $1.2 million in other offering expenses. None of the underwriting discounts and commissions or offering expenses were incurred or paid to directors or officers of ours or their associates or to persons owning 10 percent or more of our common stock or to any affiliates of ours. After deducting the underwriting discounts and commissions and offering expenses, we received net proceeds from the offering of approximately $47.6 million. The proceeds to us have conformed with our intended use outlined in the prospectus related to the offering.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None

 

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

 

None

 

ITEM 5. OTHER INFORMATION

 

On May 11, 2005, the Company signed an amendment to its Watertown, MA facility lease.  The amendment extends the base term of the original lease from an ending date of December 31, 2011 to an ending date of June 30, 2012 in return for the landlord providing the Company a tenant improvement allowance of up to $270,000 for certain improvements to the facility.   The extension of the lease term will result in additional rent payments by the Company of approximately $1.4 million over the life of the extended lease. The facility improvements will be constructed by the landlord and the improvement allowance will be disbursed in accordance with a work letter entered into by the landlord and the Company on May 11, 2005.  All other terms of the original lease remain in full force and effect.

 

On May 11, 2005, Acusphere entered into a Patent Transfer Agreement with Schering Aktiengesellschaft (“Schering”) under which the Company acquired all right, title and interest in certain ultrasound patents from Schering.  As part of the agreement, Acusphere granted Schering a non-exclusive, royalty-free, worldwide license to certain of the acquired patents in connection with the sale of Schering’s ultrasound product Levovist®.  Acusphere acquired these patents to expand its intellectual property portfolio for ultrasound contrast agents and the use of ultrasound contrast agents generally for drug delivery applications.  In consideration of the transfer and assignment of these patents, the Company agreed to pay Schering a total of $7.0 million, with $1.0 million due in May 2005, $3.0 million due in May 2006, and $3.0 million due in May 2007.

 

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ITEM 6. EXHIBITS

 

Exhibit Number		Exhibit Description
10.1		Amendment to Lease between ARE-500 Arsenal Street, LLC and Acusphere, Inc.
10.2		Patent Transfer agreement dated May 11, 2005 between Schering Aktiengesellschaft and Acusphere, Inc.
31.1		Rule 13a-14(a) / 15d-14(a) Certification
31.2		Rule 13a-14(a) / 15d-14(a) Certification
32.1		Section 1350 Certifications

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on this 12th day of May 2005.

 

 

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

 

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EXHIBIT INDEX

 

Exhibit Number		Exhibit Description
10.1		Amendment to Lease between ARE-500 Arsenal Street, LLC and Acusphere, Inc.
10.2		Patent Transfer agreement dated May 11, 2005 between Schering Aktiengesellschaft and Acusphere, Inc.
31.1		Rule 13a-14(a) / 15d-14(a) Certification
31.2		Rule 13a-14(a) / 15d-14(a) Certification
32.1		Section 1350 Certifications

 

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