Cellectar Biosciences
NOVELOS THERAPEUTICS, INC. (Form: 424B3, Received: 11/21/2006 16:56:20)
Filed pursuant to Rule 424(b)(3)
Registration Nos.   333-133043
333-129744
 
PROSPECTUS
 
34,285,449 shares of common stock
 
NOVELOS THERAPEUTICS, INC.
 

 
This prospectus relates to the resale, from time to time, of up to 34,285,449 shares of our common stock by the stockholders referred to throughout this prospectus as “selling stockholders.” 14,785,697 shares of our common stock offered in this prospectus are currently outstanding, 16,803,469 shares of our common stock are issuable upon exercise of warrants, and up to 2,696,283 shares of our common stock are issuable upon conversion of preferred stock.
 
The selling stockholders will receive all of the proceeds from the sales made under this prospectus. Accordingly, we will receive no part of the proceeds from sales made under this prospectus. We are paying the expenses incurred in registering the shares, but all selling and other expenses incurred by the selling stockholders will be borne by the selling stockholders.
 

 
  Our common stock is quoted on the OTC Electronic Bulletin Board of the National Association of Securities Dealers, Inc. under the symbol “NVLT.OB.” On November 15, 2006, the last reported sale price of our common stock on the OTC Electronic Bulletin Board was $0.65 per share.
 

 
Investing in our common stock involves a high degree of risk.
See risk factors beginning on page 6 of this prospectus.
 

 
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
 
The date of this prospectus is November 21, 2006

1


TABLE OF CONTENTS

   
  Page
 
PROSPECTUS SUMMARY
   
4
 
         
RISK FACTORS
   
6
 
         
FORWARD-LOOKING STATEMENTS
   
16
 
         
USE OF PROCEEDS
   
16
 
         
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
   
17
 
         
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
   
17
 
         
BUSINESS
   
23
 
         
MANAGEMENT
   
31
 
         
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
   
38
 
         
SELLING STOCKHOLDERS
   
40
 
         
DESCRIPTION OF SECURITIES
   
52
 
         
PLANS OF DISTRIBUTION
   
54
 
         
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR
SECURITIES ACT LIABILITIES
   
57
 
         
WHERE YOU CAN FIND MORE INFORMATION
   
58
 
         
LEGAL MATTERS
   
58
 
         
EXPERTS
   
58
 
         
INDEX TO FINANCIAL STATEMENTS
   
F-1
 
         
 

 
2

 
No dealer, salesperson or other person has been authorized to give any information or to make any representations other than those contained in this prospectus in connection with the offer contained in this prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by us.
 
Neither the delivery of this prospectus nor any sale made hereunder shall under any circumstances create an implication that there has been no change in our affairs since the date hereof. This prospectus does not constitute an offer to sell or a solicitation of an offer to buy securities other than those specifically offered hereby or of any securities offered hereby in any jurisdiction where, or to any person to whom, it is unlawful to make such offer or solicitation. The information contained in this prospectus speaks only as of the date of this prospectus unless the information specifically indicates that another date applies.
 
This prospectus has been prepared based on information provided by us and by other sources that we believe are reliable. This prospectus summarizes certain documents and other information in a manner we believe to be accurate, but we refer you to the actual documents, if any, for a more complete understanding of what we discuss in this prospectus. In making a decision to invest in the common stock, you must rely on your own examination of us and the terms of the offering and the common stock, including the merits and risks involved.
 
We are not making any representation to you regarding the legality of an investment in our common stock under any legal investment or similar laws or regulations. You should not consider any information in this prospectus to be legal, business, tax or other advice. You should consult your own attorney, business advisor and tax advisor for legal, business and tax advice regarding an investment in our common stock.
 

 
3

 
PROSPECTUS SUMMARY
 
The following summary highlights certain material aspects of the offering for resale of common stock by the selling stockholders covered by this prospectus but may not contain all of the information that is important to you. You should read this summary together with the more detailed information regarding our company, our common stock and our financial statements and notes to those statements appearing elsewhere in this prospectus, including the “RISK FACTORS” beginning on page 9.
 
Business
 
We were incorporated in June 1996 as AVAM International, Inc. In October 1998, Novelos Therapeutics, Inc., a newly incorporated entity, merged into AVAM, and the name of AVAM was changed to Novelos Therapeutics, Inc. In June 2005, we merged with Common Horizons, Inc., a Nevada Corporation. Following the merger, Common Horizons, Inc. changed its state of incorporation, by-laws, certificate of incorporation and fiscal year to that of Novelos and the surviving company was Novelos Therapeutics, Inc.
 
We are a biotechnology company commercializing oxidized glutathione-based compounds for the treatment of cancer and hepatitis. NOV-002, our lead compound, is currently in Phase 3 development for lung cancer under a Special Protocol Assessment and Fast Track. NOV-002 is also in Phase 2 development for chemotherapy-resistant ovarian cancer and early-stage breast cancer, and is also being developed for acute radiation injury. NOV-205, our second compound, is in Phase 1b development for chronic hepatitis C non-responders. Both compounds have completed clinical trials in humans and have been approved for use in Russia where they were originally developed.
 
NOV-002, our lead compound, acts as a chemoprotectant and an immunomodulator. It is marketed in Russia by ZAO BAM under the trade name Glutoxim®, and has been administered to over 5,000 patients, demonstrating clinical efficacy and excellent safety. The U.S.-based Phase 1/2 clinical trial of NOV-002 for non-small cell lung cancer (NSCLC) has been completed and the treated group demonstrated improved objective tumor response (defined as greater than 50% tumor shrinkage) and higher tolerance of chemotherapy versus the control group. During an End-of-Phase 2 meeting (December 2005), the FDA agreed with us that advancing NOV-002 into a pivotal Phase 3 trial in advanced NSCLC, in combination with first-line chemotherapy, is warranted. In May 2006, we finalized a Special Protocol Assessment with the FDA for a single pivotal Phase 3 trial and obtained Fast Track designation in August 2006. The primary endpoint of this trial is overall survival, and we commenced patient enrollment in November 2006. In a 1996-98 Russian NSCLC trial, NOV-002 increased the one-year survival rate from 17% to 63% when used in combination with chemotherapy. This result represents an 80% improvement over the U.S. survival rate of 35% that results from the current standard of care.
 
NOV-002 is also being developed to treat chemotherapy-resistant ovarian cancer. A U.S. Phase 2 trial is ongoing at Massachusetts General Hospital and Dana-Farber Cancer Institute. In a 1998 Russian review of case studies, NOV-002 sensitized previously platinum-resistant ovarian cancer patients to chemotherapy. In combination with NOV-002, 40% of the women responded favorably (partial or complete response) to the same chemotherapy that had failed previously.
 
NOV-002 is also being developed to treat early-stage breast cancer. These patients are often treated with chemotherapy to minimize or avoid surgical intervention. A planned U.S. Phase 2 trial will evaluate the ability of NOV-002 to enhance the effectiveness of such chemotherapy while diminishing dose-limiting side-effects.
 
NOV-002 is also being developed to treat acute radiation injury.
 
NOV-205, our second compound, acts as a hepatoprotective agent with immunomodulating and anti-inflammatory properties. Russian clinical studies completed in 1999 in hepatitis B and C patients showed that after treatment with NOV-205, viral load was undetectable in a high proportion of patients and serum biochemical markers of liver damage were significantly decreased. Our Investigational New Drug Application for NOV-205 as mono-therapy for chronic hepatitis C has been accepted by the FDA, and a U.S. Phase 1b trial in patients who previously failed treatment with pegylated interferon plus ribavirin is ongoing.
 
4

 
Our intellectual property portfolio includes four U.S. patents (plus a fifth notice of allowance), two European patents and one Japanese issued patent. Overall we have a  total of thirty patent applications filed worldwide, with coverage including composition of matter, method of use and manufacturing. The breadth of the intellectual property will also allow us to expand our pipeline by claiming and commercializing additional compounds that are based on oxidized glutathione.
 
We have devoted substantially all of our efforts towards the research and development of our product candidates. As of September 30, 2006, we have incurred approximately $9.0 million in research and development expense since our inception. We have had no revenue from product sales to date and have funded our operations through the sale of equity securities and debt financings. From our inception through September 30, 2006, we have raised approximately $29.0 million in equity and debt financings. We have never been profitable and have incurred an accumulated deficit of $21.0 million as of September 30, 2006.  
 
The Offering
 
Securities Offered:
 
34,285,449 shares of our common stock including:
·    14,785,697 shares of our common stock currently outstanding,
·    16,803,469 shares of our common stock issuable upon exercise of warrants, and
·    2,696,283 shares of our common stock issuable upon conversion of preferred stock.
     
Use of Proceeds:
 
We will not receive any of the proceeds from the sale by any selling stockholder of common stock or the conversion of preferred stock. However, we will receive proceeds from the exercise of the warrants if they are exercised by the selling stockholders. We intend to use any proceeds for working capital and general corporate purposes.
     
Total Shares of our Common Stock
Outstanding as of  November 1, 2006:
 
 
39,235,272
 
Summary Financial Information
 
The following table provides selected financial and operating data for the years ended December 31, 2005 and 2004 and the nine months ended September 30, 2006 and 2005.   
 
     
Nine Months Ended September 30,
   
Year Ended
December 31,  
 
     
2006  
   
2005  
   
2005  
   
2004   
 
Revenue
 
$
-
 
$
12,584
 
$
12,584
 
$
4,962
 
Costs and expenses
   
6,089,647
   
1,832,393
   
2,578,966
   
630,181
 
Other income (expense)
   
476,523
   
(528,699
)
 
(487,017
)
 
(190,066
)
Net loss
   
(5,613,124
)
 
(2,348,508
)
 
(3,053,399
)
 
(815,285
)
Net loss attributable to common stockholders
   
(5,808,964
)
 
(4,291,885
)
 
(5,194,720
)
 
(952,093
)
Current assets
   
14,293,353
   
5,658,097
   
4,801,925
   
102,571
 
Current liabilities
   
1,107,767
   
695,569
   
217,156
   
4,443,804
 
Total assets
   
14,330,362
   
5,689,413
   
4,938,699
   
108,571
 
 
Our principal executive offices are located at One Gateway Center, Suite 504, Newton, Massachusetts 02458 and our telephone number is (617) 244-1616.
 

 
5

 
RISK FACTORS
 
The following risk factors should be considered carefully in addition to the other information contained in this prospectus:
 
Risks Related to Our Business and Industry
 
We may have difficulty raising needed capital because of our limited operating history and business risks associated with us.
 
We currently generate no revenue from our proposed products or otherwise. We do not know when this will change. We have expended and will continue to expend substantial funds in the research, development and clinical and pre-clinical testing of our drug compounds. We will require additional funds to conduct research and development, establish and conduct clinical and pre-clinical trials, establish commercial-scale manufacturing arrangements and provide for the marketing and distribution of our products. Additional funds may not be available on acceptable terms, if at all. If adequate funding is not available to us, we may have to delay, reduce the scope of or eliminate one or more of our research or development programs or product launches or marketing efforts, which may materially harm our business, financial condition and results of operations.
 
Our long-term capital requirements are expected to depend on many factors, including:
 
·  
the number of potential products and technologies in development;
 
·  
continued progress and cost of our research and development programs;
 
·  
progress with pre-clinical studies and clinical trials;
 
·  
the time and costs involved in obtaining regulatory clearance;
 
·  
costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims;
 
·  
costs of developing sales, marketing and distribution channels and our ability to sell our drugs;
 
·  
costs involved in establishing manufacturing capabilities for clinical trial and commercial quantities of our drugs;
 
·  
competing technological and market developments;
 
·  
market acceptance of our products;
 
·  
costs for recruiting and retaining management, employees and consultants;
 
·  
costs for training physicians;
 
·  
our status as a bulletin-board listed company and the prospects for our stock to be listed on a national exchange; and
 
·  
uncertainty and economic instability resulting from terrorist acts and other acts of violence or war.
 
We may consume available resources more rapidly than currently anticipated, resulting in the need for additional funding. We may seek to raise any necessary additional funds through the issuance of warrants, equity or debt financings or executing collaborative arrangements with corporate partners or other sources, which may be dilutive to existing stockholders or otherwise have a material effect on our current or future business prospects. In addition, in the event that additional funds are obtained through arrangements with collaborative partners or other sources, we may have to relinquish economic and/or proprietary rights to some of our technologies or products under development that we would otherwise seek to develop or commercialize by ourselves. If adequate funds are not available, we may be required to significantly reduce or refocus our development efforts with regard to our drug compounds. Currently, we believe that we have available cash sufficient to meet our working capital requirements into the third quarter of 2007, assuming our expense levels do not exceed our current plan. If we do not generate revenues or raise additional capital, we will not be able to sustain our operations at existing levels beyond that date or earlier if expense levels increase.
 
6

 
The failure to complete development of our therapeutic technology, obtain government approvals, including required U.S. Food and Drug Administration (FDA) approvals, or to comply with ongoing governmental regulations could prevent, delay or limit introduction or sale of proposed products and result in failure to achieve revenues or maintain our ongoing business.
 
Our research and development activities and the manufacture and marketing of our intended products are subject to extensive regulation for safety, efficacy and quality by numerous government authorities in the United States and abroad. Before receiving FDA clearance to market our proposed products, we will have to demonstrate that our products are safe and effective on the patient population and for the diseases that are to be treated. Clinical trials, manufacturing and marketing of drugs are subject to the rigorous testing and approval process of the FDA and equivalent foreign regulatory authorities. The Federal Food, Drug and Cosmetic Act and other federal, state and foreign statutes and regulations govern and influence the testing, manufacturing, labeling, advertising, distribution and promotion of drugs and medical devices. As a result, clinical trials and regulatory approval can take many years to accomplish and require the expenditure of substantial financial, managerial and other resources.
 
In order to be commercially viable, we must successfully research, develop, obtain regulatory approval for, manufacture, introduce, market and distribute our technologies. For each drug utilizing oxidized glutathione-based compounds, including NOV-002 and NOV-205, we must successfully meet a number of critical developmental milestones including:
 
·  
demonstrating benefit from delivery of each specific drug for specific medical indications;
 
·  
demonstrating through pre-clinical and clinical trials that each drug is safe and effective; and
 
·  
demonstrating that we have established a viable Good Manufacturing Process capable of potential scale-up.
 
The time-frame necessary to achieve these developmental milestones may be long and uncertain, and we may not successfully complete these milestones for any of our intended products in development.
 
In addition to the risks previously discussed, our technology is subject to additional developmental risks that include the following:
 
·  
uncertainties arising from the rapidly growing scientific aspects of drug therapies and potential treatments;
 
·  
uncertainties arising as a result of the broad array of alternative potential treatments related to cancer, hepatitis and other diseases; and
 
·  
anticipated expense and time believed to be associated with the development and regulatory approval of treatments for cancer, hepatitis and other diseases.
 
In order to conduct the clinical trials that are necessary to obtain approval by the FDA to market a product, it is necessary to receive clearance from the FDA to conduct such clinical trials. The FDA can halt clinical trials at any time for safety reasons or because we or our clinical investigators do not follow the FDA’s requirements for conducting clinical trials. If we are unable to receive clearance to conduct clinical trials or the trials are halted by the FDA, we would not be able to achieve any revenue from such product, as it is illegal to sell any drug for human consumption in the U.S. without FDA approval.
 
7

 
Data obtained from clinical trials is susceptible to varying interpretations, which could delay, limit or prevent regulatory clearances.
 
Data already obtained, or in the future obtained, from pre-clinical studies and clinical trials does not necessarily predict the results that will be obtained from later pre-clinical studies and clinical trials. Moreover, pre-clinical and clinical data are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. A number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. The failure to adequately demonstrate the safety and effectiveness of an intended product under development could delay or prevent regulatory clearance of the potential drug, resulting in delays to commercialization, and could materially harm our business. Our clinical trials may not demonstrate sufficient levels of safety and efficacy necessary to obtain the requisite regulatory approvals for our drugs, and our proposed drugs may not be approved for marketing.
 
We may encounter delays or rejections based upon additional government regulation from future legislation or administrative action or changes in FDA policy during the period of development, clinical trials and FDA regulatory review. We may encounter similar delays in foreign countries. Sales of our products outside the U.S. would be subject to foreign regulatory approvals that vary from country to country. The time required to obtain approvals from foreign countries may be shorter or longer than that required for FDA approval, and requirements for foreign licensing may differ from FDA requirements. We may be unable to obtain requisite approvals from the FDA and foreign regulatory authorities, and even if obtained, such approvals may not be on a timely basis, or they may not cover the uses that we request.
 
Even if we do ultimately receive FDA approval for any of our products, it will be subject to extensive ongoing regulation. This includes regulations governing manufacturing, labeling, packaging, testing, dispensing, prescription and procurement quotas, record keeping, reporting, handling, shipment and disposal of any such drug. Failure to obtain and maintain required registrations or comply with any applicable regulations could further delay or preclude us from developing and commercializing our drugs and subject us to enforcement action.
 
Our drugs or technology may not gain FDA approval in clinical trials or be effective as a therapeutic agent, which could affect our future profitability and prospects.
 
In order to obtain regulatory approvals, we must demonstrate that each drug is safe and effective for use in humans and functions as a therapeutic against the effects of a disease or other physiological response. To date, studies conducted in Russia involving our NOV-002 and NOV-205 products have shown what we believe to be promising results. In fact, NOV-002 has been approved for use in Russia for general medicinal use as an immunostimulant in combination with chemotherapy and antimicrobial therapy, and specifically for indications such as tuberculosis and psoriasis. NOV-205 has been approved in Russia as a mono-therapy agent for the treatment of hepatitis B and C. Russian regulatory approval is not equivalent to FDA approval. Pivotal Phase 3 studies with a large number of patients, typically required for FDA approval, were not conducted for NOV-002 and NOV-205 in Russia. Further, all of our Russian clinical studies were completed prior to 2000 and may not have been conducted in accordance with current guidelines either in Russia or the United States.
 
A U.S.-based Phase 1/2 clinical study involving 44 non-small cell lung cancer patients provided what we believe to be a favorable outcome. As a result, we have enrolled the first patient in the Phase 3 study of NOV-002 for non-small cell lung cancer in November 2006. We enrolled the first patient in the Phase 2 clinical study for NOV-002 for chemotherapy-resistant ovarian cancer in July 2006 and anticipate completing that study in 2007. We enrolled the first patient in the Phase 1b clinical study for NOV-205 for chronic hepatitis C in September 2006 and we anticipate completing that study in 2007. There can be no assurance that we can demonstrate that these products are safe or effective in advanced clinical trials. We are also not able to give assurances that the results of the tests already conducted can be repeated or that further testing will support our applications for regulatory approval. As a result, our drug and technology research program may be curtailed, redirected or eliminated at any time.
 
8

 
There is no guarantee that we will ever generate substantial revenue or become profitable even if one or more of our drugs are approved for commercialization.
 
We expect to incur increasing operating losses over the next several years as we incur increasing costs for research and development and clinical trials. Our ability to generate revenue and achieve profitability depends upon our ability, alone or with others, to complete the development of our proposed products, obtain the required regulatory approvals and manufacture, market and sell our proposed products. Development is costly and requires significant investment. In addition, if we choose to license or obtain the assignment of rights to additional drugs, the license fees for such drugs may increase our costs.
 
To date, we have not generated any revenue from the commercial sale of our proposed products or any drugs and do not expect to receive such revenue in the near future. Our primary activity to date has been research and development. A substantial portion of the research results and observations on which we rely were performed by third parties at those parties’ sole or shared cost and expense. We cannot be certain as to when or whether to anticipate commercializing and marketing our proposed products in development, and do not expect to generate sufficient revenues from proposed product sales to cover our expenses or achieve profitability in the near future.
 
We rely solely on research and manufacturing facilities at various universities, hospitals, contract research organizations and contract manufacturers for all of our research, development, and manufacturing, which could be materially delayed should we lose access to those facilities.
 
At the present time, we have no research, development or manufacturing facilities of our own. We are entirely dependent on contracting with third parties to use their facilities to conduct research, development and manufacturing. Our inability to have the facilities to conduct research, development and manufacturing may delay or impair our ability to gain FDA approval and commercialization of our drug delivery technology and products.
 
We currently maintain a good working relationship with such contractors. Should the situation change and we are required to relocate these activities on short notice, we do not currently have an alternate facility where we could relocate our research, development and/or manufacturing activities. The cost and time to establish or locate an alternative research, development and manufacturing facility to develop our technology would be substantial and would delay gaining FDA approval and commercializing our products.
 
We are dependent on our collaborative agreements for the development of our technologies and business development, which exposes us to the risk of reliance on the viability of third parties.
 
In conducting our research, development and manufacturing activities, we rely and expect to continue to rely on numerous collaborative agreements with universities, hospitals, governmental agencies, charitable foundations, manufacturers and others. The loss of or failure to perform under any of these arrangements, by any of these entities, may substantially disrupt or delay our research, development and manufacturing activities including our anticipated clinical trials.
 
We may rely on third-party contract research organizations, service providers and suppliers to support development and clinical testing of our products. Failure of any of these contractors to provide the required services in a timely manner or on reasonable commercial terms could materially delay the development and approval of our products, increase our expenses and materially harm our business, financial condition and results of operations.
 
We are exposed to product, clinical and preclinical liability risks that could create a substantial financial burden should we be sued.
 
Our business exposes us to potential product liability and other liability risks that are inherent in the testing, manufacturing and marketing of pharmaceutical products. We cannot assure that such potential claims will not be asserted against us. In addition, the use in our clinical trials of pharmaceutical products that we may develop and then subsequently sell or our potential collaborators may develop and then subsequently sell may cause us to bear a portion of or all product liability risks. A successful liability claim or series of claims brought against us could have a material adverse effect on our business, financial condition and results of operations.
 
9

 
Although we have not received any product liability claims to date, we have an insurance policy of $5,000,000 per occurrence and $5,000,000 in the aggregate to cover such claims should they arise. There can be no assurance that material claims will not arise in the future or that our insurance will be adequate to cover all situations. Moreover, there can be no assurance that such insurance, or additional insurance, if required, will be available in the future or, if available, will be available on commercially reasonable terms. Any product liability claim, if successful, could have a material adverse effect on our business, financial condition and results of operations. Furthermore, our current and potential partners with whom we have collaborative agreements or our future licensees may not be willing to indemnify us against these types of liabilities and may not themselves be sufficiently insured or have a net worth sufficient to satisfy any product liability claims. Claims or losses in excess of any product liability insurance coverage that may be obtained by us could have a material adverse effect on our business, financial condition and results of operations.
 
Acceptance of our products in the marketplace is uncertain and failure to achieve market acceptance will prevent or delay our ability to generate revenues.
 
Our future financial performance will depend, at least in part, upon the introduction and customer acceptance of our proposed products. Even if approved for marketing by the necessary regulatory authorities, our products may not achieve market acceptance. The degree of market acceptance will depend upon a number of factors including:
 
·  
the receipt of regulatory clearance of marketing claims for the uses that we are developing;
 
·  
the establishment and demonstration of the advantages, safety and efficacy of our technologies;
 
·  
pricing and reimbursement policies of government and third-party payers such as insurance companies, health maintenance organizations and other health plan administrators;
 
·  
our ability to attract corporate partners, including pharmaceutical companies, to assist in commercializing our intended products; and
 
·  
our ability to market our products.
 
Physicians, patients, payers or the medical community in general may be unwilling to accept, utilize or recommend any of our products. If we are unable to obtain regulatory approval or commercialize and market our proposed products when planned, we may not achieve any market acceptance or generate revenue.
 
We may face litigation from third parties who claim that our products infringe on their intellectual property rights, particularly because there is often substantial uncertainty about the validity and breadth of medical patents.
 
We may be exposed to future litigation by third parties based on claims that our technologies, products or activities infringe the intellectual property rights of others or that we have misappropriated the trade secrets of others. This risk is exacerbated by the fact that the validity and breadth of claims covered in medical technology patents and the breadth and scope of trade-secret protection involve complex legal and factual questions for which important legal principles are unresolved. Any litigation or claims against us, whether or not valid, could result in substantial costs, could place a significant strain on our financial and managerial resources and could harm our reputation. Most of our license agreements would likely require that we pay the costs associated with defending this type of litigation. In addition, intellectual property litigation or claims could force us to do one or more of the following:
 
·  
cease selling, incorporating or using any of our technologies and/or products that incorporate the challenged intellectual property, which would adversely affect our future revenue;
 
·  
obtain a license from the holder of the infringed intellectual property right, which license may be costly or may not be available on reasonable terms, if at all; or
 
10

 
·  
redesign our products, which would be costly and time-consuming.
 
If we are unable to adequately protect or enforce our rights to intellectual property or secure rights to third-party patents, we may lose valuable rights, experience reduced market share, assuming any, or incur costly litigation to protect such rights.
 
Our ability to obtain licenses to patents, maintain trade secret protection and operate without infringing the proprietary rights of others will be important to our commercializing any products under development. Therefore, any disruption in access to the technology could substantially delay the development of our technology.
 
The patent positions of biotechnology and pharmaceutical companies, including us, that involve licensing agreements, are frequently uncertain and involve complex legal and factual questions. In addition, the coverage claimed in a patent application can be significantly reduced before the patent is issued or in subsequent legal proceedings. Consequently, our patent applications and any issued and licensed patents may not provide protection against competitive technologies or may be held invalid if challenged or circumvented. Our competitors may also independently develop products similar to ours or design around or otherwise circumvent patents issued or licensed to us. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as U.S. law.
 
We also rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. We generally require our employees, consultants, advisors and collaborators to execute appropriate confidentiality and assignment-of-inventions agreements. Our competitors may independently develop substantially equivalent proprietary information and techniques, reverse engineer our information and techniques, or otherwise gain access to our proprietary technology. We may be unable to meaningfully protect our rights in trade secrets, technical know-how and other non-patented technology.
 
Although our trade secrets and technical know-how are important, our continued access to the patents is a significant factor in the development and commercialization of our products. Aside from the general body of scientific knowledge from other drug delivery processes and technology, these patents, to the best of our knowledge and based upon our current scientific data, are the only intellectual property necessary to develop our products, including NOV-002 and NOV-205. We do not believe that we are or will be violating any patents in developing our technology.
 
We may have to resort to litigation to protect our rights for certain intellectual property, or to determine their scope, validity or enforceability. Enforcing or defending our rights is expensive, could cause diversion of our resources and may not prove successful. Any failure to enforce or protect our rights could cause us to lose the ability to exclude others from using our technology to develop or sell competing products.
 
We have limited manufacturing experience and, if our products are approved, we may not be able to manufacture sufficient quantities at an acceptable cost, or may be subject to risk that contract manufacturers could experience shut-downs or delays.
 
We remain in the research and development and clinical and pre-clinical trial phase of product commercialization. Accordingly, if our products are approved for commercial sale, we will need to establish the capability to commercially manufacture our products in accordance with FDA and other regulatory requirements. We have limited experience in establishing, supervising and conducting commercial manufacturing. If we fail to adequately establish, supervise and conduct all aspects of the manufacturing processes, we may not be able to commercialize our products.
 
We presently plan to rely on third-party contractors to manufacture our products. This may expose us to the risk of not being able to directly oversee the production and quality of the manufacturing process. Furthermore, these contractors, whether foreign or domestic, may experience regulatory compliance difficulties, mechanical shutdowns, employee strikes or other unforeseeable acts that may delay production.
 
11

 
Due to our limited marketing, sales and distribution experience, we may be unsuccessful in our efforts to sell our products, enter into relationships with third parties or develop a direct sales organization.
 
We have not yet had to establish marketing, sales or distribution capabilities for our proposed products. Until such time as our products are further along in the regulatory process, we will not devote any meaningful time and resources to this effort. At the appropriate time, we intend to enter into agreements with third parties to sell our products or we may develop our own sales and marketing force. We may be unable to establish or maintain third-party relationships on a commercially reasonable basis, if at all. In addition, these third parties may have similar or more established relationships with our competitors.
 
If we do not enter into relationships with third parties for the sale and marketing of our products, we will need to develop our own sales and marketing capabilities. We have limited experience in developing, training or managing a sales force. If we choose to establish a direct sales force, we may incur substantial additional expenses in developing, training and managing such an organization. We may be unable to build a sales force on a cost-effective basis or at all. Any such direct marketing and sales efforts may prove to be unsuccessful. In addition, we will compete with many other companies that currently have extensive marketing and sales operations. Our marketing and sales efforts may be unable to compete against these other companies. We may be unable to establish a sufficient sales and marketing organization on a timely basis, if at all.
 
We may be unable to engage qualified distributors. Even if engaged, these distributors may:
 
·  
fail to satisfy financial or contractual obligations to us;
 
·  
fail to adequately market our products;
 
·  
cease operations with little or no notice; or
 
·  
offer, design, manufacture or promote competing products.
 
If we fail to develop sales, marketing and distribution channels, we would experience delays in product sales and incur increased costs, which would harm our financial results.
 
If we are unable to convince physicians as to the benefits of our intended products, we may incur delays or additional expense in our attempt to establish market acceptance.
 
Achieving broad use of our products may require physicians to be informed regarding these products and their intended benefits. The time and cost of such an educational process may be substantial. Inability to successfully carry out this physician education process may adversely affect market acceptance of our products. We may be unable to timely educate physicians regarding our intended products in sufficient numbers to achieve our marketing plans or to achieve product acceptance. Any delay in physician education may materially delay or reduce demand for our products. In addition, we may expend significant funds towards physician education before any acceptance or demand for our products is created, if at all.
 
Fluctuations in foreign exchange rates could increase costs to complete international clinical trial activities.
 
We have initiated a portion of our clinical trial activities in Europe. Significant depreciation in the value of the U.S. Dollar against principally the Euro could adversely affect our ability to complete the trials, particularly if we are unable to redirect funding or raise additional funds. Since the timing and amount of foreign-denominated payments are uncertain and dependent on a number of factors, it is difficult to cost-effectively hedge the potential exposure. Therefore, to date, we have not entered into any foreign currency hedges to mitigate the potential exposure.
 
12

 
The market for our products is rapidly changing and competitive, and new therapeutics, new drugs and new treatments which may be developed by others could impair our ability to maintain and grow our business and remain competitive.
 
The pharmaceutical and biotechnology industries are subject to rapid and substantial technological change. Developments by others may render our technologies and intended products noncompetitive or obsolete, or we may be unable to keep pace with technological developments or other market factors. Technological competition from pharmaceutical and biotechnology companies, universities, governmental entities and others diversifying into the field is intense and is expected to increase. Many of these entities have significantly greater research and development capabilities and budgets than we do, as well as substantially more marketing, manufacturing, financial and managerial resources. These entities represent significant competition for us. Acquisitions of, or investments in, competing pharmaceutical or biotechnology companies by large corporations could increase such competitors’ financial, marketing, manufacturing and other resources.
 
We are an early-stage enterprise that operates with limited day-to-day business management, operating as a vehicle to hold certain technology for possible future exploration, and have been and will continue to be engaged in the development of new drugs and therapeutic technologies. As a result, our resources are limited and we may experience management, operational or technical challenges inherent in such activities and novel technologies. Competitors have developed or are in the process of developing technologies that are, or in the future may be, the basis for competition. Some of these technologies may have an entirely different approach or means of accomplishing similar therapeutic effects compared to our technology. Our competitors may develop drugs and drug delivery technologies that are more effective than our intended products and, therefore, present a serious competitive threat to us.
 
The potential widespread acceptance of therapies that are alternatives to ours may limit market acceptance of our products even if commercialized. Many of our targeted diseases and conditions can also be treated by other medication or drug delivery technologies. These treatments may be widely accepted in medical communities and have a longer history of use. The established use of these competitive drugs may limit the potential for our technologies and products to receive widespread acceptance if commercialized.
 
If users of our products are unable to obtain adequate reimbursement from third-party payers, or if new restrictive legislation is adopted, market acceptance of our products may be limited and we may not achieve anticipated revenues.
 
The continuing efforts of government and insurance companies, health maintenance organizations and other payers of healthcare costs to contain or reduce costs of health care may affect our future revenues and profitability, and the future revenues and profitability of our potential customers, suppliers and collaborative partners and the availability of capital. For example, in certain foreign markets, pricing or profitability of prescription pharmaceuticals is subject to government control. In the United States, given recent federal and state government initiatives directed at lowering the total cost of health care, the U.S. Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid systems. While we cannot predict whether any such legislative or regulatory proposals will be adopted, the announcement or adoption of such proposals could materially harm our business, financial condition and results of operations.
 
Our ability to commercialize our products will depend in part on the extent to which appropriate reimbursement levels for the cost of our products and related treatment are obtained by governmental authorities, private health insurers and other organizations, such as health maintenance organizations (“HMO’s”). Third-party payers are increasingly challenging the prices charged for medical drugs and services. Also, the trend toward managed healthcare in the United States and the concurrent growth of organizations such as HMO’s which could control or significantly influence the purchase of healthcare services and drugs, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices for or rejection of our drugs. The cost containment measures that health care payers and providers are instituting and the effect of any healthcare reform could materially harm our ability to operate profitably.
 
13

 
We depend upon key personnel who may terminate their employment with us at any time, and we would need to hire additional qualified personnel.
 
Our success will depend to a significant degree upon the continued services of key management and advisors to us. There can be no assurance that these individuals will continue to provide service to us. In addition, our success will depend on our ability to attract and retain other highly skilled personnel. We may be unable to recruit such personnel on a timely basis, if at all. Our management and other employees may voluntarily terminate their employment with us at any time. The loss of services of key personnel, or the inability to attract and retain additional qualified personnel, could result in delays in development or approval of our products, loss of sales and diversion of management resources.
 
Compliance with changing corporate governance and public disclosure regulations may result in additional expense.
 
Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance, public disclosure and internal controls, including the Sarbanes-Oxley Act of 2002, new SEC regulations and, in the event we seek and are approved for listing on a registered national securities exchange, the stock exchange rules will require an increased amount of management attention and external resources. We intend to continue to invest all reasonably necessary resources to comply with evolving standards, which may result in increased general and administrative expense and a diversion of management time and attention from revenue-generating activities to compliance activities.
 
Risks Related to our Common Stock
 
In the time that our common stock has traded, our stock price has experienced price fluctuations.  
 
There can be no assurance that the market price for our common stock will remain at its current level and a decrease in the market price could result in substantial losses for investors. The market price of our common stock may be significantly affected by one or more of the following factors:
 
·  
announcements or press releases relating to the bio-pharmaceutical sector or to our own business or prospects;
 
·  
regulatory, legislative, or other developments affecting us or the healthcare industry generally;
 
·  
the dilutive effect of conversion of our Series A preferred stock into common stock at conversion rates or the exercise of options and warrants at below-current-market prices;
 
·  
sales by those financing our company through convertible securities and warrants of the underlying common stock, when it is registered with the SEC and may be sold into the public market, immediately upon conversion or exercise; and
 
·  
market conditions specific to bio-pharmaceutical companies, the healthcare industry and the stock market generally.
 
There may be a limited public market for our securities; we may fail to qualify for listing on certain national securities exchanges.
 
We have filed applications for listing of our common stock on Archipelago and AMEX, but these applications were withdrawn primarily because our stock prices did not meet the listing requirements. Although we may reapply, there can be no assurance if and when initial listing criteria will be met or if such applications will be granted, or that the trading of our common stock will be sustained. In the event that our common stock fails to qualify for initial or continued listing on a registered stock exchange or for initial or continued inclusion in the NASDAQ system, trading, if any, in our common stock, would then continue to be conducted on the NASD’s electronic bulletin board in the over-the-counter market and in what are commonly referred to as pink sheets. As a result, an investor may find it more difficult to dispose of or to obtain accurate quotations as to the market value of our common stock, and our common stock would become substantially less attractive for margin loans, for investment by financial institutions, as consideration in future capital raising transactions or other purposes.
 
14

 
Trading of our common stock may be subject to penny-stock rules under the Securities Exchange Act of 1934. Unless exempt, for any transaction involving a penny-stock, the regulations require broker-dealers making a market in our common stock to provide risk disclosure to their customers including regarding the risks associated with our common stock, the suitability for the customer of an investment in our common stock, the duties of the broker-dealer to the customer, information regarding prices for our common stock and any compensation the broker-dealer would receive. The application of these rules may result in fewer market makers in our common stock. Our common stock is presently subject to the rules on penny-stocks, and the liquidity of our common stock could be materially adversely affected so long as we remain subject to such rule.
 
Our executive officers, directors and principal stockholders have substantial holdings, which could delay or prevent a change in corporate control favored by our other stockholders.
 
Our directors, officers and 5% stockholders beneficially own, in the aggregate, approximately 34% of our outstanding voting stock. As a result, they may have the ability to determine our direction and decisions. The interests of our current officers and directors may differ from the interests of other stockholders. Further, our current officers and directors may have the ability to significantly affect the outcome of all corporate actions requiring stockholder approval, including the following actions:
 
·  
the election of directors;
 
·  
the amendment of charter documents;
 
·  
issuance of blank-check preferred or convertible stock, notes or instruments of indebtedness which may have conversion, liquidation and similar features, or effecting other financing arrangements; or
 
·  
the approval of certain mergers and other significant corporate transactions, including a sale of substantially all of our assets, or merger with a publicly-traded shell or other company.
 
Our common stock could be further diluted as the result of the issuance of additional shares of common stock, convertible securities, warrants or options.
 
In the past, we have issued common stock, convertible securities, such as our Series A preferred stock, and warrants in order to raise money. We have also issued options and warrants as compensation for services and incentive compensation for our employees and directors. We have a substantial number of shares of common stock reserved for issuance upon the conversion and exercise of these securities. Our issuance of additional common stock, convertible securities, options and warrants could affect the rights of our stockholders, and could reduce the market price of our common stock.
 
We sold shares of our Series A preferred stock and common stock purchase warrants in violation of certain provisions of our securities purchase agreement and registration rights agreement executed in connection with our private placement of units. While we have received waivers from such investors representing approximately 96% of the outstanding units as of September 30, 2006, other investors who do not waive such rights could sue us seeking damages arising from the breach of such agreements.
 
On May 27, 2005, June 29, 2005, July 29, 2005 and August 9, 2005, we sold units, consisting of shares of our common stock and common stock purchase warrants pursuant to a securities purchase agreement and registration rights agreement.
 
The registration rights agreement required us to file a registration statement on Form SB-2 with the SEC to register the shares of common stock and the shares of common stock issuable upon the exercise of the warrants on or before October 8, 2005. We filed the registration statement with the SEC on November 16, 2005, which became effective on December 15, 2005. We recorded an accrued liability of $8,000 as of September 30, 2006 for payments in connection with this late filing.
 
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The securities purchase agreement also prohibited us from effecting or entering into an agreement to effect any financing involving a variable rate transaction for two years.
 
The use of the prospectus included in the Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 (previously declared effective on April 3, 2006) and the prospectus included in the Registration Statement on Form SB-2 (previously declared effective on April 19, 2006) were suspended on October 24, 2006.
 
On October 24, 2006, we filed a Current Report on Form 8-K which described an error in the financial statements and related notes to financial statements for the quarter ended September 30, 2005 and the year ended December 31, 2005 relating to the accounting and disclosure of the beneficial conversion feature of the Company’s Series A 8% Cumulative Convertible Preferred Stock. On November 1, 2006 we filed amendments to the Annual Report on Form 10-KSB for the year ended December 31, 2005 and the Quarterly Report on Form 10-QSB for the quarter ended September 30, 2005. Following the filing of the Form 8-K on October 24, 2006, we advised the selling stockholders named in two registration statements related to the resale of securities purchased in private placement transactions in 2005 and 2006 that the use of the respective prospectuses had been suspended. We plan to amend these registration statements as soon as practicable to include the restated financial statements. Pursuant to the registration rights associated with these financings, we may become obligated to these selling stockholders in the event that the suspension of the use of the prospectuses exceeds the grace periods specified. The amount of such obligation, if any, will not be determined until later in the fourth quarter of 2006.
 
FORWARD-LOOKING STATEMENTS
 
Except for historical facts, the statements in this prospectus are forward-looking statements. Forward-looking statements are merely our current predictions of future events. These statements are inherently uncertain, and actual events could differ materially from our predictions. Important factors that could cause actual events to vary from our predictions include those discussed under the headings “Risk Factors,” “Management’s Discussion and Analysis or Plan of Operation” and “Business.” We assume no obligation to update our forward-looking statements to reflect new information or developments. We urge readers to review carefully the risk factors described in this prospectus and the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov .
 
WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS WHETHER AS A RESULT OF NEW INFORMATION, NEW EVENTS OR ANY OTHER REASON, OR REFLECT ANY EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS PROSPECTUS OR THE DATE OF ANY APPLICABLE PROSPECTUS SUPPLEMENT THAT INCLUDES FORWARD-LOOKING STATEMENTS.
 
USE OF PROCEEDS
 
The selling stockholders will receive all of the proceeds from the sale of the shares offered for sale by them under this prospectus. We will not receive any proceeds from the resale of shares by the selling stockholders covered by this prospectus. We will receive proceeds from the exercise of warrants. Such proceeds will be used for working capital and general corporate purposes.

16

 
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
Market Information
 
Our common stock has been quoted on the OTC Electronic Bulletin Board of The National Association of Securities Dealers, Inc. under the symbol “NVLT.OB” since June 13, 2005. The following table provides, for the periods indicated, the high and low bid prices for our common stock. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
 
Fiscal Year 2005
 
High
 
Low
 
First Quarter
 
$
N/A
 
$
N/A
 
Second Quarter (beginning June 13, 2005)
   
2.80
   
2.20
 
Third Quarter
   
4.47
   
2.16
 
Fourth Quarter
   
3.65
   
1.53
 

Fiscal Year 2006
 
High
 
Low
 
First Quarter
 
$
2.25
 
$
1.60
 
Second Quarter
   
1.95
   
0.85
 
Third Quarter
   
1.05
   
0.63
 
Fourth Quarter (through November 15, 2006)
   
0.99
   
0.60
 

On November 15, 2006, the closing sale price of our common stock as reported on the OTC Bulletin Board was $0.65 per share. On that date, we had approximately, 179 holders of record of our common stock. This number does not include stockholders for whom shares were held in a “nominee” or “street” name.
 
We have not declared or paid any cash dividends on our common stock and do not anticipate declaring or paying any cash dividends in the foreseeable future. We currently expect to retain future earnings, if any, for the development of our business. Dividends may be paid on our common stock only if and when declared by our board of directors after payment of any accrued dividends on our Series A preferred stock.
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 
Overview
 
We are a biotechnology company, established in 1996, commercializing oxidized glutathione-based compounds for the treatment of cancer and hepatitis.
 
NOV-002, our lead compound currently in Phase 3 development for non-small cell lung cancer (NSCLC), acts as a chemoprotectant and an immunomodulator. In May 2006, we finalized a Special Protocol Assessment (SPA) with the FDA for a single pivotal Phase 3 trial in advanced NSCLC in combination with first-line chemotherapy, and received Fast Track designation in August 2006. The primary endpoint of this trial will be overall survival and patient enrollment commenced in November 2006. NOV-002 is also in Phase 2 development for chemotherapy-resistant ovarian cancer and early-stage breast cancer, and, in addition, is being developed for treatment of acute radiation injury.
 
NOV-205, our second compound, acts as a hepatoprotective agent with immunomodulating and anti-inflammatory properties. Our Investigational New Drug Application for NOV-205 as mono-therapy for chronic hepatitis C has been accepted by the FDA, and a U.S. Phase 1b clinical trial in patients who previously failed treatment with pegylated interferon plus ribavirin is ongoing.
 
Both compounds have completed clinical trials in humans and have been approved for use in Russia where they were originally developed. We own all intellectual property rights worldwide (excluding Russia and other states of the former Soviet Union) related to compounds based on oxidized glutathione, including NOV-002 and NOV-205. Our patent portfolio includes four U.S. issued patents (plus one notice of allowance), two European issued patents and one Japanese issued patent.
 
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We have devoted substantially all of our efforts towards the research and development of our product candidates. As of September 30, 2006, we have incurred approximately $9.3 million in research and development expense since our inception. We have had no revenue from product sales to date and have funded our operations through the sale of equity securities and debt financings. From our inception through September 30, 2006, we have raised approximately $29.0 million in equity and debt financings. We have never been profitable and have incurred an accumulated deficit of $21.0 million as of September 30, 2006.
 
On May 26, 2005, we restructured certain of our indebtedness. We exchanged indebtedness of $3,139,185 for 586,352 shares of our common stock with an aggregate deemed value of $732,940, $318,714 in cash, and forgiveness of debt of $2,087,531. Also on May 26, 2005, holders of $1,100,000 of convertible notes payable exercised their option to convert their notes into 1,760,000 shares of common stock at a price of $0.625 per share. On May 26, 2005, we also revised certain of our royalty obligations. As a result, we issued 2,016,894 shares of our common stock with an aggregate deemed value of $2,521,118.

Following the restructuring of debt, the Company completed a reverse merger with Common Horizons, Inc. (“Common Horizons”), a Nevada-based developer of web portals. In connection with that transaction, all outstanding shares of Novelos (net of shares of treasury stock) were converted into an equal number of shares of common stock of Common Horizons and all outstanding options and warrants to purchase shares of Novelos common stock were converted into an equal number of options and warrants to purchase shares of Common Horizons with the same terms and conditions as the original options and warrants. In connection with the merger all but 4,500,000 shares of outstanding common stock of Common Horizons were canceled. Common Horizons changed its state of incorporation, by-laws, certificate of incorporation and fiscal year to that of Novelos and Novelos became the surviving corporation. The business of Common Horizons, which was insignificant, was abandoned and the business of Novelos was adopted. The transaction was therefore treated as a reverse acquisition recapitalization with Novelos as the acquiring party and Common Horizons as the acquired party for accounting purposes. Accordingly, all historical information in these financial statements is that of the Novelos business. The results of operations of Common Horizons prior to the merger were not material for purposes of pro forma presentation. The 4,500,000 remaining shares of Common Horizons outstanding at the completion of the merger, net of cancellations, were deemed, for accounting purposes, to be an issuance by Novelos. Since Common Horizons had no remaining financial assets or liabilities, the merger with Common Horizons did not have any significant effects on the Company’s assets or liabilities or on the Company’s results of operations subsequent to the date of the merger.

During 2005 and 2006 we completed various private placements of securities. In May through August of 2005 we sold an aggregate of 4,000,000 shares of common stock and warrants to purchase 2,000,000 shares of common stock for net cash proceeds of $3,714,468 and the conversion of $550,000 of convertible debt. In September and October 2005, we sold in a private placement 3,200 shares of Series A preferred stock and warrants to purchase 909,090 shares of common stock for aggregate net proceeds of $2,864,000. The preferred stock was initially convertible into 1,939,393 shares of common stock, and is currently convertible into 2,370,370, shares of common stock due to certain adjustments to the conversion price. On March 7, 2006, we sold 11,154,073 shares of our common stock and warrants to purchase 8,365,542 shares of our common stock for net proceeds of $ 13,847,000.
 
Critical Accounting Policies
 
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates. We review these estimates and assumptions periodically and reflect the effects of revisions in the period that they are determined to be necessary.
 
18

 
We believe that the following accounting policies reflect our more significant judgments and estimates used in the preparation of our financial statements.
 
Accrued Expenses. As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves identifying services that 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 financial statements. Examples of estimated expenses for which we accrue include: contract service fees such as amounts paid to clinical monitors; data management organizations and investigators in conjunction with clinical trials; fees paid to contract manufacturers in conjunction with the production of clinical materials; consulting fees; and professional service fees, such as for lawyers and accountants. 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 that have begun to be incurred, or we over- or underestimate 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 determined based on subjective judgments. We make these judgments based upon the facts and circumstances known to us in accordance with generally accepted accounting principles.
 
Stock-Based Compensation. Commencing on January 1, 2006 we began applying the provisions of SFAS 123R in accounting for stock-based compensation. SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award, the requisite service period (usually the vesting period). Prior to January 1, 2006, we followed Accounting Principles Board (APB), Opinion No. 25, Accounting for Stock Issued to Employees , or APB 25, and related interpretations, in accounting for our stock-based compensation plans, rather than the alternative fair-value method provided for under SFAS No. 123, Accounting for Stock-Based Compensation , or SFAS 123. In the notes to our financial statements, we provide pro-forma disclosures in accordance with SFAS 123. We account for transactions in which services are received from non-employees in exchange for equity instruments based on the fair value of such services received or of the equity instruments issued, whichever is more reliably measured, in accordance with SFAS 123 and the Emerging Issues Task Force (EITF) Issue 96-18, Accounting for Equity Instruments That Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services , or EITF 96-18.
 
Accounting for equity instruments granted or sold by us under APB 25, SFAS 123, SFAS 123R and EITF 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, our expenses may be over- or understated. For equity instruments granted or sold in exchange for the receipt of goods or services, we estimate the fair value of the equity instruments based on consideration of factors that we deem to be relevant at that time. Because shares of our common stock were not publicly traded prior to the corporate restructuring described in Note 3 to the financial statements, market factors historically considered in valuing stock and stock option grants included corresponding values of comparable 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 occurred between the times of such grants; economic trends; and the comparative rights and preferences of the security being granted compared to the rights and preferences of our other outstanding equity.
 
Prior to our corporate restructuring, the fair value of our common stock was determined by our board of directors contemporaneously with the grant. In the absence of a public trading market for our common stock, our board of directors considered numerous objective and subjective factors in determining the fair value of our common stock. At the time of option grants and other stock issuances, our board of directors considered the liquidation preferences, dividend rights, voting control and anti-dilution protection attributable to our then-outstanding convertible preferred stock; the status of private and public financial markets; valuations of comparable private and public companies; the likelihood of achieving a liquidity event such as an initial public offering; our existing financial resources; our anticipated continuing operating losses and increased spending levels required to complete our clinical trials; dilution to common stockholders from anticipated future financings; and a general assessment of future business risks.
 
19

 
Results of Operations
 
Research and development expense . Research and development expense consists of costs incurred in identifying, developing and testing product candidates, which primarily consist of salaries and related expenses for personnel, fees paid to professional service providers for independent monitoring and analysis of our clinical trials, costs of contract research and manufacturing, and costs to secure intellectual property. We currently have two compounds, NOV-002 and NOV-205. However, to date, most of our research and development costs have been associated with our NOV-002 compound.
 
General and administrative expense. General and administrative expense consists primarily of salaries and other related costs for personnel in executive, finance and administrative functions. Other costs include facility costs, insurance, costs for public and investor relations, directors’ fees and professional fees for legal and accounting services.

Nine Months Ended September 30, 2006 and 2005

Research and Development. Research and development expense for the nine months ended September 30, 2006 was $4,200,000 compared to $927,000 for the nine months ended September 30, 2005. The $3,273,000, or 353%, increase in research and development expense was primarily due to increased funding of our clinical, contract manufacturing and non-clinical activities. In particular, activities relating to the commencement of our pivotal Phase 3 clinical trial of NOV-002 for non-small cell lung cancer resulted in increased expenses during the nine months ended September 30, 2006, including an increase of $1,522,000 for contract research and consulting services and an increase of $259,000 in drug manufacturing costs. We also purchased $864,000 of chemotherapy drugs during the third quarter of 2006 to be used in the Phase 3 clinical trial, specifically for European and Eastern European clinical sites. Since we do not anticipate recovering any of the costs of the chemotherapy and we do not have a reliable method for tracking the drugs that have been administered to patients or evaluating any losses associated with spoilage, we recorded the entire amount as an expense in the period purchased. As disclosed in Note 10, we have a commitment to purchase an additional $1.8 million of chemotherapy drugs at specified intervals through March 2008. Additionally, as a result of hiring that occurred during the third quarter of 2005, research and development salaries and related costs also increased $487,000 in the first nine months of 2006 compared to the same period in 2005. Lastly, stock compensation expense increased $76,000 during the first nine months of 2006 compared to the first nine months of 2005 relating to stock option grants principally resulting from the adoption of SFAS 123R in January 2006.

General and Administrative. General and administrative expense for the nine months ended September 30, 2006 was $1,889,000 compared to $905,000 for the nine months ended September 30, 2005. The $984,000, or 109%, increase in general and administrative expense was primarily due to increased costs associated with corporate governance and periodic filing requirements as a public company, increased overhead costs to support the research activities described above, as well as expanded investor relations activities. The total increase includes an increase of $346,000 in compensation and directors’ fees; an increase of $389,000 in public and investor relations costs and public company recordkeeping costs (including a $174,000 increase in non-cash stock compensation related to restricted stock awards); an increase of $190,000 related to professional and consulting fees; and an increase of $30,000 in insurance costs. We also incurred an increase of $171,000 in non-cash stock compensation expense related to stock option grants and an increase of $80,000 in travel and overhead expenses. These increases were offset in 2006 by a $225,000 reduction in accrued registration filing penalties that were recorded in the first nine months of 2005. However, waivers from the associated requirements were received from certain stockholders and the accrual was reduced in the fourth quarter of 2005.

Interest Income. Interest income for the nine months ended September 30, 2006 was $472,000 compared to $10,000 for the nine months ended September 30, 2005. The increase in interest income during the nine months ended September 30, 2006 related to higher average cash balances in 2006, as a result of the financings described in Notes 3 and 5 being placed in interest-bearing accounts.

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Interest Expense. Interest expense for the nine months ended September 30, 2006 was $0 compared to $109,000 for the nine months ended September 30, 2005. The decrease was due to all interest-bearing debt balances being paid off during 2005.

Gain on Forgiveness of Debt. Gain on forgiveness of debt for the nine months ended September 30, 2006 was $0 compared to $2,087,531 for the nine months ended September 30, 2005. On May 26, 2005, we exchanged indebtedness of $3,139,185 for 586,352 shares of our common stock with an aggregate deemed value of $732,940 and $318,714 in cash, which resulted in forgiveness of debt income of $2,087,531.

Restructuring Expense. Restructuring expense for the nine months ended September 30, 2006 was $0 compared to $2,521,118 for the nine months ended September 30, 2005. On May 26, 2005, we revised an arrangement that requires us to pay future royalties, which resulted in the issuance of 2,016,894 shares of our common stock with an aggregate deemed value of $2,521,118.
 
Preferred Stock Dividends and Deemed Dividend. During the nine months ended September 30, 2006 we paid dividends to preferred stockholders of $195,840 . There were no dividends paid to preferred stockholders in the nine months ended September 30, 2005, but during that period we recorded a deemed dividend to preferred stockholders of $1,943,377. This amount represents the value attributed to the beneficial conversion feature of the Series A 8% Cumulative Convertible Preferred Stock issued in September 2005 . There were no deemed dividends in the nine months ended September 30, 2006. The deemed dividends and cash dividends have been included in the calculation of net loss attributable to common stockholders for the respective periods.
 
Years Ended December 31, 2005 and 2004
 
Revenue. Revenue for the year ended December 31, 2005 was $12,584 compared to $4,962 for the year ended December 31, 2004. The 2005 amount represented the recognition of a prior year’s deferred revenue on sales of bulk drug samples to facilitate research activities. This revenue represents recognition of the remaining installment due on bulk drug sample sales. In lieu of cash, we accepted research and development services as final payment.
 
Research and Development. Research and development expense for the year ended December 31, 2005 was $1,136,217 compared to $261,768 for the year ended December 31, 2004. The $874,449, or 334%, increase in research and development expense was primarily due to increased funding of our preclinical, clinical and contract manufacturing activities, an increase in compensation costs due to an increase in headcount, and an increase in stock-based compensation. The private placement transactions, corporate restructuring and issuance of promissory notes during the year ended December 31, 2005 allowed us to engage outside consultants and organizations to further research, develop and test our product candidates.
 
General and Administrative. General and administrative expense for the year ended December 31, 2005 was $1,442,749 compared to $368,413 for the year ended December 31, 2004. The $1,074,336, or 292%, increase in general and administrative expense was primarily due to our periodic filing obligations and increases in professional and consulting fees, public and investor relations and public company recordkeeping. We also incurred additional legal and consulting costs during the year ended December 31, 2005 in translating and filing our European patent applications. As described in Note 3 to our financial statements, we also recorded a $33,000 expense during the year ended December 31, 2005 relating to the late filing of a registration statement associated with our sale of units.
 
Consulting Revenue. Consulting revenue for the year ended December 31, 2005 was $0 compared to $13,374 for the year ended December 31, 2004. Consulting revenue recorded during the year ended December 31, 2004 primarily related to one consulting engagement that ended during the quarter ended June 30, 2004.
 
Interest Income. Interest income for the year ended December 31, 2005 was $49,876 compared to $95 for the year ended December 31, 2004.   The increase in interest income during the year ended December 31, 2005 over the comparable period in 2004 related to higher average cash balances in 2005, as a result of the financings described in Notes 3 and 5 to our financial statements, being placed in interest-bearing accounts.
 
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Interest Expense. Interest expense for the year ended December 31, 2005 was $109,102 compared to $208,741 for the year ended December 31, 2004. The $99,639, or 48%, decrease was due to lower average debt balances during the 2005 period.
 
Gain on Forgiveness of Debt. Gain on forgiveness of debt for the year ended December 31, 2005 was $2,087,531 compared to $0 for the year ended December 31, 2004. On May 26, 2005, we exchanged indebtedness of $3,139,185 for 586,352 shares of our common stock with an aggregate deemed value of $732,940 and $318,714 in cash, which resulted in forgiveness of debt income of $2,087,531.
 
Restructuring Expense. Restructuring expense for the year ended December 31, 2005 was $2,521,118 compared to $0 for the year ended December 31, 2004. On May 26, 2005, we revised an arrangement that requires us to pay future royalties, which resulted in the issuance of 2,016,894 shares of our common stock with an aggregate deemed value of $2,521,118.
 
Preferred Stock Dividends and Deemed Dividend. In the year ended December 31, 2005 we recorded a deemed dividend to preferred stockholders of $2,077,321. This amount represents the value attributed to the beneficial conversion feature of the Series A 8% Cumulative Convertible Preferred Stock issued during that period . In the year ended December 31, 2005, we also paid $64,000 in dividends to preferred stockholders in the form of additional shares of preferred stock. These amounts have been included in the calculation of net loss attributable to common stockholders for the year ended December 31, 2005. There were no dividends or deemed dividends in the year ended December 31, 2004.  

Liquidity and Capital Resources

We have financed our operations since inception through the sale of equity securities and the issuance of debt. As of September 30, 2006, we had $13,922,000 in cash and equivalents, including $2,211,000 of restricted cash that is reserved for research and development activities.
 
During the nine months ended September 30, 2006, cash of approximately $4,206,000 was used in operations, primarily due to a net loss of $5,613,000, offset by non-cash stock-based compensation expense of $462,000, depreciation and amortization of $7,000, a decrease in prepaid expenses of $47,000 and an increase in accounts payable and accrued expenses of $891,000. During the nine months ended September 30, 2006, cash of approximately $2,001,000 was used in investing activities primarily due to the outstanding pledge of $2,058,000 in cash and equivalents associated with a letter of credit agreement with a bank as described in Note 10.
 
During the nine months ended September 30, 2006, cash of approximately $13,652,000 was provided by financing activities. The sale of common stock and warrants generated net proceeds of $13,847,000 after issuance costs, offset by the payment of $196,000 in dividends on the Series A cumulative convertible preferred stock.
 
We believe that our available cash and equivalents will be sufficient to meet our working capital requirements, including operating losses, and capital expenditure requirements into the third quarter of 2007, assuming that our business plan is implemented successfully.
 
We believe that we will need to raise additional capital during 2007 in order to support the pivotal Phase 3 clinical trial for NOV-002 and other research and development activities. Furthermore, we may license or acquire other compounds that will require capital for development. We may seek additional funding through collaborative arrangements and public or private financings. Additional funding may not be available to us on acceptable terms or at all. In addition, the terms of any financing may adversely affect the holdings or the rights of our stockholders. For example, if we raise additional funds by issuing equity securities, further dilution to our existing stockholders may result. If we are unable to obtain funding on a timely basis, we may be required to significantly curtail one or more of our research or development programs. We also could be required to seek funds through arrangements with collaborators or others that may require us to relinquish rights to some of our technologies, product candidates, or products which we would otherwise pursue on our own.
 
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Even if we are able to raise additional funds in a timely manner, our future capital requirements may vary from what we expect and will depend on many factors, including the following:
 
·  
the resources required to successfully complete our clinical trials;
 
·  
the time and costs involved in obtaining regulatory approvals;
 
·  
continued progress in our research and development programs, as well as the magnitude of these programs;
 
·  
the cost of manufacturing activities;
 
·  
the costs involved in preparing, filing, prosecuting, maintaining, and enforcing patent claims;
 
·  
the timing, receipt, and amount of milestone and other payments, if any, from collaborators; and
 
·  
fluctuations in foreign exchange rates.
 
Recently Issued Accounting Pronouncements
 
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), to define fair value, establish a framework for measuring fair value in generally accepted accounting principles and expand disclosures about fair-value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with earlier application allowed. We are currently evaluating the effect of this standard on its future reported financial position and results of operations.
 
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140 (“SFAS 155”), to simplify and make more consistent the accounting for certain financial instruments. SFAS 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , to permit fair-value remeasurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair-value basis. SFAS 155 amends SFAS No. 140, Accounting for the Impairment or Disposal of Long-Lived Assets , to allow a qualifying special-purpose entity to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 applies to all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006, with earlier application allowed. This standard is not expected to have a significant effect on our future reported financial position or results of operations.

BUSINESS  
 
We were incorporated in June 1996 as AVAM International, Inc. In October 1998, Novelos Therapeutics, Inc., a newly incorporated entity, merged into AVAM, and the name of AVAM was changed to Novelos Therapeutics, Inc. In June 2005, we merged with Common Horizons, Inc., a Nevada corporation. Following the merger, Common Horizons, Inc. changed its state of incorporation, by-laws, certificate of incorporation and fiscal year to that of Novelos and the surviving company was Novelos Therapeutics, Inc.
 
We are a biotechnology company commercializing oxidized glutathione-based compounds for the treatment of cancer and hepatitis. NOV-002, our lead compound, is currently in Phase 3 development for lung cancer under a Special Protocol Assessment and Fast Track. NOV-002 is also in Phase 2 development for chemotherapy-resistant ovarian cancer and early-stage breast cancer, and is also being developed for acute radiation injury. NOV-205, our second compound, is in Phase 1b development for chronic hepatitis C non-responders. Both compounds have completed clinical trials in humans and have been approved for use in Russia where they were originally developed.
 
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NOV-002, our lead compound acts as a chemoprotectant and an immunomodulator. It is marketed in Russia by ZAO BAM under the trade name Glutoxim®, and has been administered to over 5,000 patients, demonstrating clinical efficacy and excellent safety. The U.S.-based Phase 1/2 clinical trial of NOV-002 for non-small cell lung cancer (NSCLC) has been completed and the treated group demonstrated improved objective tumor response (defined as greater than 50% tumor shrinkage) and higher tolerance of chemotherapy versus the control group. During an End-of-Phase 2 meeting (December 2005), the FDA agreed with us that advancing NOV-002 into a pivotal Phase 3 trial in advanced NSCLC, in combination with first-line chemotherapy, is warranted. In May 2006, we finalized a Special Protocol Assessment with the FDA for a single Phase 3 pivotal trial and obtained Fast Track designation in August 2006. The primary endpoint of this trial is overall survival, and we commenced patient enrollment in November 2006. In a 1996-98 Russian NSLC trial, NOV-002 increased the one-year survival rate from 17% to 63% when used in combination with chemotherapy. This result represents an 80% improvement over the U.S. survival rate of 35% that results from the current standard of care.
 
NOV-002 is also being developed to treat chemotherapy-resistant ovarian cancer. A U.S. Phase 2 trial is ongoing at Massachusetts General Hospital and Dana-Farber Cancer Institute. In a 1998 Russian review of case studies, NOV-002 sensitized previously platinum-resistant ovarian cancer patients to chemotherapy. In combination with NOV-002, 40% of the women responded favorably (partial or complete response) to the same chemotherapy that had failed previously.
 
NOV-002 is also being developed to treat early-stage breast cancer. These patients are often treated with chemotherapy to minimize or avoid surgical intervention. A planned U.S. Phase 2 trial will evaluate the ability of NOV-002 to enhance the effectiveness of such chemotherapy while diminishing dose-limiting side-effects.
 
NOV-002 is in addition being developed to treat acute radiation injury.
 
NOV-205, our second compound, acts as a hepatoprotective agent with immunomodulating and anti-inflammatory properties. Russian clinical studies completed in 1999 in hepatitis B and C patients showed that after treatment with NOV-205, viral load was undetectable in a high proportion of patients and serum biochemical markers of liver damage were significantly decreased. Our Investigational New Drug Application for NOV-205 as mono-therapy for chronic hepatitis C has been accepted by the FDA, and a U.S. Phase 1b trial in patients who previously failed treatment with pegylated interferon plus ribavirin is ongoing.
 
Our intellectual property portfolio includes four U.S. patents (plus a fifth notice of allowance), two European patents and one Japanese issued patent. Overall, we have a total of thirty patent applications filed worldwide, with coverage including composition of matter, method of use and manufacturing. The breadth of the intellectual property will also allow us to expand our pipeline by claiming and commercializing additional compounds that are based on oxidized glutathione.
 
We have devoted substantially all of our efforts towards the research and development of our product candidates. As of September 30, 2006, we have incurred approximately $9.0 million in research and development expense since our inception. We expect to increase our expenditures on research and development activities over the next 18 months.
 
Business Strategy
 
Our primary objective is to fully exploit our proprietary scientific and intellectual property portfolio in oxidized glutathione-based therapeutics. NOV-002, currently in Phase 3 development in the U.S., has demonstrated an excellent safety and efficacy profile in Russia as an adjunctive treatment to chemotherapy for a number of different cancers. The Russian data is particularly compelling in non-small cell lung cancer and platinum-resistant (i.e., resistant to initial chemotherapy) ovarian cancer, and the current as well as projected unmet medical need in these types of cancer is great. Positive results in a controlled U.S-based Phase 1/2 lung cancer study suggest that the Russian experience can be replicated here. Therefore, we are implementing a focused program in each of these indications designed in hope of gaining FDA approval in the shortest amount of time with a reasonable amount of expense.
 
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We also intend to explore the commercial potential of NOV-002 for treatment of acute radiation injury in the U.S. and abroad to address the growing concern over catastrophic radiation exposure from, for example, a nuclear weapon, a “dirty bomb” or an accident at a nuclear power plant. Significantly, animals treated with NOV-002 demonstrated substantially increased survival rates (two- to three-fold, measured at thirty days post-radiation) compared to the irradiated control animals. In addition, NOV-002 treated animals did not experience severe neutropenia (loss of white blood cells used for fighting off infections) and demonstrated significantly higher bone marrow cell counts than the control (bone marrow is the source of white blood cells). In February 2006, we submitted a proposal to the Department of Health and Human Services (“HHS”) for the use of NOV-002 to treat subjects that may develop Acute Radiation Syndrome (“ARS”) after exposure to high levels of penetrating radiation. In June 2006, HHS notified us that our proposal was within the competitive range for discussion and further evaluation. In October 2006, HHS notified us that NOV-002 was not eligible for procurement under this specific award.
 
NOV-205 has demonstrated the ability to substantially decrease the viral load of patients with either hepatitis B or C as well as to restore normal liver function as evidenced by blood biochemical markers. In the U.S., both hepatitis B and C are relatively large markets, but hepatitis B is reasonably well served. Therefore, we will concentrate clinical development efforts on chronic hepatitis C, which should represent a more direct path to regulatory approval as well as providing patients with an improved therapy regimen. We will seek to out-license the hepatitis B indication in the Far East where the incidence of the disease is very high.
 
For both NOV-002 and NOV-205, we plan to develop the product in the U.S. to the point where initiation of a pivotal trial is possible for strategic indications. At that point, we plan to out-license the drug and indication in Europe and/or Japan and use resources from these arrangements to offset, in part, the expense of the pivotal trials. In addition, we plan to out-license non-strategic indications, like hepatitis B, in markets like the Far East (including China and India).
 
Technology Overview
 
Glutathione is a naturally occurring substance present in nearly all cells of the body. The glutathione pathway consists of oxidized glutathione, the primary component of NOV-002, and associated metabolic enzymes. It is considered to be the most important cellular system for protection against the toxic effects of a variety of cell-damaging molecules. More recently, it has become evident that in addition to this cell protective role, a key function of the glutathione system is to dynamically regulate cell function by reversibly altering the structure of proteins via a process termed glutathionylation. The resulting activation/inhibition of protein function is analogous to the much-studied role of protein phosphorylation as a cellular regulatory mechanism.
 
Thus, changes in the ratio of intracellular reduced and oxidized glutathione can trigger glutathionylation, affecting cell signaling pathways that govern a variety of critical cell functions including gene expression, cell proliferation, growth arrest and apoptosis (programmed cell death). Importantly, it has been shown that oxidized glutathione itself is capable of causing protein glutathionylation leading to changes in cell signaling pathway function. Examples of effects of oxidized glutathione on gene expression include regulation of gene transcription factors such as NFkB and AP-1, which have been shown to have pivotal roles in the regulation of many genes involved in immune and inflammatory responses, including cytokines and growth factors. Findings with NOV-002 in animals and humans (e.g., cell protection; effects on cytokine production and blood cell proliferation; immune system modulation) are consistent with the hypothesis that it may act, at least in part, by such a mechanism.
 
Pharmacological manipulation of reduced and oxidized glutathione (e.g., including protein glutathionylation) can have multiple and parallel effects on cells, with the overall impact on cell function being dependent upon the type of cell and its physiological state (i.e., normal or diseased). In light of this complexity, identification of the precise molecular targets of NOV-002, which account for its clinical effects, is the subject of ongoing study.
 
Products in Development
 
Our current developmental pipeline of drugs is based on oxidized glutathione, a natural metabolite, that has shown excellent safety as well as preclinical and clinical efficacy in numerous cancers, hepatitis B and C, HIV, psoriasis, tuberculosis and certain other diseases. The lead products are believed to act via modulation of critical regulatory molecules that mediate immune function, tumor progression (in combination with chemotherapy), and drug detoxification.
 
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NOV-002
 
NOV-002 is an injectable, small-molecule derivative of a natural metabolite that is being developed in combination with chemotherapy for treatment of lung, ovarian and breast cancer.
 
NOV-002 for Non-Small Cell Lung Cancer
 
In the U.S., NOV-002 is in Phase 3 development for non-small cell lung cancer under a Special Protocol Assessment and Fast Track. NOV-002 is approved in Russia for general medicinal usage as an immunostimulant in combination with chemotherapy and antimicrobial therapy, and specifically for indications such as tuberculosis and psoriasis. Efficacy and excellent safety have been demonstrated in trials with 340 patients in Russia with several types of cancer including: non-small cell lung cancer, colorectal cancer, pancreatic cancer, breast cancer and ovarian cancer. Since the Russian Ministry of Health approval in 1998, NOV-002 has been administered to over 5,000 patients.
 
According to the American Cancer Society, in 2006 about 1.4 million U.S. men and women are expected to be diagnosed with cancer. In 2006 over 550,000 U.S. cancer patients are expected to die, which makes cancer the second leading cause of death in the U.S., exceeded only by deaths related to heart disease. Lung cancer is the leading cause of cancer death in the U.S. It is expected that in 2006, approximately 175,000 people will be diagnosed with lung cancer and more than 160,000 will die as a result. According to Globocan, there were 900,000 cases of lung cancer worldwide and 800,000 resulting deaths in 2002. According to Needham & Company, the pharmaceutical market for treating lung cancer in the U.S. was approximately $800 million in 2003.   Non-small cell lung cancer accounts for more than 80% of lung cancer. Only about 15% of non-small cell lung cancer patients are diagnosed early enough to be eligible for surgery.
 
Platinum-based chemotherapy regimens are standard first-line treatment for advanced non-small cell lung cancer patients, since these patients are not eligible for surgery. Carboplatin and paclitaxel are the most common combination therapy in the U.S., while cisplatin and gemcitabine are more common in Europe. During treatment, patients continue to be subject to serious adverse effects. According to December 2003 Credit Suisse First Boston and UBS reports and Phase 3 clinical trials conducted prior to 1999,   the   one-year survival rate for first-line therapy is typically only about 35%, median survival is approximately 8.5 months and an objective response rate is about 20%. Overall, less than 5% of the patients survive five years. Docetaxel is approved for use as second-line treatment of non-small cell lung cancer. New regimens with existing cytotoxic drugs are expected to provide only incremental improvements in efficacy and/or safety, but are very expensive. Newly emerged targeted biologic therapies, such as Astra Zeneca’s IRESSA®, OSI’s TARCEVA® and Genentech’s AVASTIN®, may offer some limited benefit for certain patients, but overall efficacy has remained low, there are safety concerns and the costs are very high. Thus, there is a lack of effective treatments for non-small cell lung cancer, particularly for late stage patients.
 
NOV-002, unlike any other marketed drug or product in development, appears to increase toleration and efficacy of chemotherapy in that it allows the patient to safely undergo more cycles of chemotherapy (demonstrated in both U.S. and Russian studies), produces a clinical survival benefit (63% and 55% one-year survival in Russian studies versus 35% typical in the U.S.) and demonstrated better tumor shrinkage (69% of the patients treated with NOV-002 plus chemotherapy had 50% or greater tumor shrinkage versus only 33% of the chemotherapy-alone-treated patients). We expect that NOV-002 will be used in combination with first-line chemotherapy treatments and may be complementary to second-line and recently emerging third-line products. Furthermore, we expect that NOV-002 may be used in all disease stages for non-small cell lung cancer and other solid tumors.
 
The Russian preclinical and clinical data set (including clinical safety and efficacy, extensive animal toxicology studies and a comprehensive chemistry and manufacturing package) was accepted by the FDA as the basis of an Investigational New Drug (IND) application, leading to a Novelos-sponsored Phase 1/2 clinical trial in advanced non-small cell lung cancer in late 1999. The aim of the Phase 1/2 clinical study was to demonstrate safety, detect trends towards efficacy, compare routes of administration and support initiation of a Phase 3 study. The FDA advised us in December 2005 that they agreed that advancing NOV-002 into a pivotal Phase 3 study in advanced non-small cell lung cancer, in combination with first-line chemotherapy, is warranted. We finalized a Special Protocol Assessment with the FDA in May 2006 for a single pivotal Phase 3 trial in advanced NSCLC in combination with first-line chemotherapy, and obtained Fast Track designation in August 2006. The primary endpoint of this trial is overall survival, and we commenced enrollment in November 2006.
 
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In the U.S. Phase 1/2 non-small cell lung cancer clinical trial of NOV-002, 44 chemotherapy-naive late-stage lung cancer patients who had not received prior chemotherapy were randomized to one of three groups for six months of treatment:
 
·  
Group A: NOV-002, administered intravenously and intramuscularly, in combination with cytotoxic chemotherapy (carboplatin + paclitaxel).
 
·  
Group B: NOV-002, administered intravenously and subcutaneously, in combination with cytotoxic chemotherapy.
 
·  
Group C: Cytotoxic chemotherapy alone was administered to this control group.
 
Based on the study protocol, the intent-to-treat analysis of the best overall objective tumor response (e.g., complete or partial tumor shrinkage) showed that eleven out of sixteen (69%) NOV-002-treated patients in Group B demonstrated greater than 50% tumor shrinkage versus only five out of fifteen (33%) in the control group (C). Six out of thirteen (46%) patients in Group A demonstrated an objective response. The difference between groups B and C was statistically significant (p=0.044).
 
Further, NOV-002-treated patients better tolerated cytotoxic chemotherapy as evidenced by their ability to receive more cycles of chemotherapy compared to the control group (C). 100% of patients in Group B and 85% in Group A were able to complete four cycles of chemotherapy, while only 50% of control group patients (C) were able to do so. The differences between groups was statistically significant (p=0.004).
 
In St. Petersburg, Russia, a multi-center, randomized, open-label study was conducted to evaluate the safety and efficacy of NOV-002 in patients with advanced non-small cell lung cancer. The overall results of the Russian non-small cell lung cancer study were impressive. NOV-002, used in combination with chemotherapy, dramatically and significantly increased the one-year survival rate (63% treated group vs. 17% control, p<0.05). NOV-002 significantly improved patients’ ability to conduct daily activities and quality of life, increased tolerance to chemotherapy, improved hematologic parameters and improved or normalized kidney/liver toxicity markers. Importantly, no NOV-002-associated adverse effects were observed. In addition, in an independent study in advanced non-small cell lung cancer study of similar design in Moscow, 55% of the patients treated with NOV-002 survived for one year.
 
NOV-002 for Chemotherapy (Platinum)-Resistant Ovarian Cancer
 
According to the American Cancer Society, in 2006 approximately 20,000 U.S. women are expected to be diagnosed with ovarian cancer and 15,000 women are expected to die from it. According to Needham & Company, the pharmaceutical market for treating ovarian cancer was estimated to be $280 million in 2003. There is a lack of effective treatment, particularly in the case of refractory patients (those who do not respond to chemotherapy).  
 
First-line chemotherapy treatment is the same in ovarian cancer as in non-small cell lung cancer. Standard first-line treatment for ovarian cancer patients is carboplatin and paclitaxel chemotherapy combination. Doxorubicin and topotecan alternate as second- and third-line chemotherapy treatments.
 
Refractory ovarian cancer patients have a very poor prognosis because they are faced with inadequate therapeutic options. According to a Lehman Brothers report dated September 2002, response rates from second-line treatments, such as doxorubicin and topotecan, are typically less than 12%. Once a woman’s ovarian cancer is defined as platinum resistant, the chance of having a partial or complete response to further platinum therapy is typically less than 10%, according to Berkenclit, J.Repro. Med., 2005.
 
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In Russia in 1998, twenty ovarian cancer case studies were analyzed. All of these patients were treated for three cycles with platinum-based chemotherapy but continued with progressive disease according to qualitative assessments and Cancer Antigen 125. The patients were then treated with NOV-002 for three to four weeks, followed by three more cycles of the same platinum-based chemotherapy (which they previously failed to respond to) in conjunction with NOV-002. The observed 40% objective response rate across these case studies compares very favorably to current alternatives. Objective response is defined as partial (50% or greater tumor reduction) or complete response; it does not include stabilization of the disease or small reductions in tumor size. An additional 40% of patients in the Russian analysis displayed stable disease.
 
In the U.S., a Phase 2 trial in chemotherapy-resistant ovarian cancer patients is ongoing at Massachusetts General Hospital and Dana-Farber Cancer Institute.
 
NOV-002 for Neoadjuvant Treatment of Breast Cancer
 
We are also developing NOV-002 to treat early-stage breast cancer in combination with chemotherapy. These patients are often treated with chemotherapy to minimize or avoid surgical intervention. A planned U.S. Phase 2 trial will evaluate the ability of NOV-002 to enhance the effectiveness of such chemotherapy while diminishing dose-limiting side-effects.
 
NOV-002 for Treatment of Acute Radiation
 
Significant market opportunity and unmet need exist for a drug that may safely treat the effects of acute radiation injury. In today’s world, there appears to be more concern than ever about an attack by a nuclear weapon, a “dirty bomb” or an attack or accident at a nuclear power plant. The majority of deaths following such an attack do not result from the explosion itself, but from bone marrow suppression, which in turn leads to neutropenia (severe loss of white blood cells, neutrophils, leaving the body defenseless against infections) and depletion of platelets (key clotting factors that stop bleeding). The window of opportunity to treat radiation injury is short, thus the drug would need to be stockpiled at the local level in high risk areas, such as military bases, major population centers and within a 10-50 mile radius of a nuclear power plant facilities.
 
Current post-radiation exposure treatment options are essentially non-existent. Potassium iodide is the only pharmaceutical agent that has been stockpiled in the event of radiation exposure. However, it is effective only in reducing the risk of thyroid cancer, and does not protect the body from acute radiation injury. Similarly, the FDA recently approved pentetate calcium trisodium injection and pentetate zinc trisodium injection, which have already been in use for decades to treat radiation contamination caused by industrial accidents. The goal of treatment with these agents is to help remove the radioactive elements from the body and reduce the risk of the development of illnesses such as cancer that can occur years after exposure, but they do not address acute radiation injury.
 
NOV-002 has been safely administered to several thousand Russian patients since the mid-1990s and to a limited number of subjects in a U.S. Phase 1/2 lung cancer trial. Further, NOV-002 has already demonstrated the ability to restore hematological parameters and boost immune function in cancer patients receiving cytotoxic chemotherapy. In Russian preclinical experiments in 2003, groups of mice and rats were exposed to lethal levels of ionizing radiation. The animals treated with NOV-002 post-exposure demonstrated an increased survival of two- to three-fold (measured at thirty days post-exposure) compared to the irradiated control animals. Moreover, there was a 2.5-fold increase in the number of hematopoietic colony-forming units in the spleens of mice receiving NOV-002 after radiation compared to those receiving radiation alone. In another experiment, two groups of rats were irradiated. The control group received no treatment. The treated group received daily injections of NOV-002. The NOV-002-treated animals did not experience severe neutropenia and demonstrated increased survival.
 
We intend to explore the commercial potential of NOV-002 for radiation protection in the U.S. and abroad to address the growing concern over catastrophic radiation exposure from a nuclear weapon, a “dirty bomb”, or an attack/accident at a nuclear power plant. Meanwhile, we are working with Shriners Hospitals to conduct studies in animal models to confirm and expand upon the positive results in treatment of acute radiation injury with NOV-002 demonstrated in Russian experiments.
 
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NOV-205
 
NOV-205 for Chronic Hepatitis C
 
NOV-205 is a unique, injectable, small-molecule proprietary formulation of oxidized glutathione and inosine. We are developing NOV-205 in the U.S. for the treatment of chronic hepatitis C.
 
According to the World Health Organization, chronic hepatitis C affected 170 million people worldwide in 2003, and up to four million people are newly infected each year. Chronic infection can progress to cirrhosis and end-stage liver disease. While there are varying estimates about the size of the global market for hepatitis C drugs, according to PharmaWeek November 2005 the U.S. market alone was believed to be $800 million in 2004 and the current global market is believed to be in excess of $2 billion per year, growing to $4 billion by 2007 and possibly $10 billion by 2012.   In the U.S., according to the Centers for Disease Control and Prevention, an estimated 3.9 million persons were infected with hepatitis C, and 2.7 million persons in the U.S. had chronic infection in 2003. Further, hepatitis C infections account for approximately 30,000 new infections and 8,000-10,000 deaths each year in the U.S.
 
NOV-205 was approved in Russia by the Ministry of Health in 2001 as mono-therapy for the treatment of hepatitis B and C. The Russian approval of NOV-205 was supported by a Russian New Drug Application, which included studies in hepatitis B and C totaling 90 treated patients. An additional 88 patients were treated in previous anecdotal studies. After relatively short treatment periods (1-2 months) the drug was shown to eliminate the viral load in hepatitis B patients and to decrease viral load below detection in 40-60% of hepatitis C subjects. Importantly, these reductions were largely maintained during 1-3 months of post-treatment follow-up. In addition, NOV-205 improved liver function as evidenced by significant reductions in serum biochemical markers of liver toxicity. No NOV-205-related adverse events were reported among any of the 178 patients treated in these studies.
 
The therapeutic profile of NOV-205 contrasts sharply with those of currently approved therapies in the U.S., which have limited effectiveness, are expensive and have severe side effects, particularly in the case of chronic hepatitis C. For example, pegylated interferon and ribavirin combinations have limitations of safety and tolerability (40-65% of treated patients experience fatigue, depression, fever, headaches, muscle pain, anemia). Furthermore, these drugs are effective in only a fraction of the patient population and are very expensive. Other new products for hepatitis C, beyond variations of ribavirin and interferon (e.g., HCV protease inhibitors), are at early stages of development and could potentially be used in combination with NOV-205.
 
On the basis of the clinical and pre-clinical data package underlying Russian approval of NOV-205 in combination with U.S. chemistry and manufacturing information, Novelos filed an Investigational New Drug Application with the FDA for NOV-205 as mono-therapy in chronic hepatitis C in March 2006. The FDA accepted our Investigational New Drug Application in April 2006, and a U.S. Phase 1b trial in patients who previously failed treatment with pegylated interferon plus ribavirin commenced in September 2006.
 
Preclinical Research Program
 
Our preclinical research program is aimed at (a) gaining a better understanding of the mechanism(s) of action of our oxidized glutathione-based drug products and (b) adding to the Russian non-clinical data information that will be required for ultimate FDA filing of our products. This research is being performed via a network of academic and commercial (i.e., contract research organizations) laboratories.
 
We are engaged in funded research collaboration with the laboratory of Kenneth Tew, Ph.D., D.Sc., Chairman of the Department of Cell and Molecular Pharmacology and Experimental Therapeutics at The Medical University of South Carolina. Dr. Tew is also chairman of our Scientific Advisory Board. The general objectives of this research program are to add to the understanding of NOV-002 and NOV-205 as drug products, particularly with respect to their molecular and cellular mechanism(s) of action and to facilitate: (1) the design and execution of clinical studies, (2) the interactions with the FDA and (3) the interactions with others in the scientific community.
 
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We are also working with Jeffrey Gelfand, M.D., senior advisor for international medical affairs at Partners Healthcare System (Massachusetts General Hospital, Harvard Medical School, Dana-Farber Cancer Institute, Brigham and Women’s Hospital) and director of the Center for Integration of Medicine and Innovative Technology. We have funded Dr. Gelfand’s new laboratory at Shriners Hospitals to conduct studies in animal models to confirm and expand upon the positive results in treatment of acute radiation injury with NOV-002 demonstrated in Russian experiments.
 
We also intend to continue to collaborate, through ZAO BAM, with leading Russian research institutions in Moscow and St. Petersburg, to enhance the basic science of the glutathione pathway, support development of NOV-002 and NOV-205 and develop additional products and product forms. Further, through our other contacts in Russia, we believe we have access to products and technologies developed by other Russian research institutions and scientists.
 
Manufacturing
 
Our proprietary manufacturing process is well-established, simple, inexpensive and scalable. We have used U.S. and Canadian contract manufacturing facilities to support our U.S. development efforts. We do not plan to build manufacturing capability over the next several years. Rather, we plan to continue to employ contract manufacturers.
 
The active pharmaceutical ingredient of NOV-002 is manufactured in the U.S. in compliance with current Good Manufacturing Principles at Synthetech, Inc. (Albany, OR) in a single, very cost effective synthetic step and then lyophilized into a powder at Oregon Freeze Dry, Inc. (Albany, OR). It is then filled, finished and packaged at Hyaluron (Burlington, MA) as a sterile filtered, aseptically processed solution for intravenous, intramuscular and/or subcutaneous use. NOV-002 Clinical Trial Material, API and vials, has successfully completed 36-month stability studies.
 
Similar to NOV-002, NOV-205’s active pharmaceutical ingredient is manufactured in compliance with current Good Manufacturing Principles in a single, very cost effective, synthetic step at Synthetech, Inc. and then lyophilized into a powder at Oregon Freeze Dry, Inc. It is then filled, finished and packaged at Dalton Pharma Services Inc. (Toronto, Canada).
 
Intellectual Property
 
We own all intellectual property rights worldwide (excluding Russia and other states of the former Soviet Union) related to both clinical-stage compounds (i.e., NOV-002 and NOV-205) and other pre-clinical compounds based on oxidized glutathione. We have four issued patents in the U.S., and received a notice of allowance for a fifth U.S. patent in September 2006. We also have two issued patents in Europe and one in Japan. Overall, we have filed over 30 patent applications worldwide.
 
We believe that our breadth of intellectual property will allow us to expand our pipeline by claiming and commercializing additional compounds that are based on oxidized glutathione.
 
Employees
 
As of November 1, 2006, we have seven employees, all of whom are full-time employees. We believe our relationships with our employees are good.
 
Regulation
 
The manufacturing and marketing of NOV-002 and NOV-205 and our related research and development activities are subject to regulation for safety, efficacy and quality by numerous governmental authorities in the United States and other countries. We anticipate that these regulations will apply separately to each drug and compound in our drug therapy technology. We believe that complying with these regulations will involve a considerable level of time, expense and uncertainty.
 
30

 
In the United States, drugs are subject to rigorous federal regulation and, to a lesser extent, state regulation. The Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations govern, among other things, the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of our drugs. Drug development and approval within this regulatory framework is difficult to predict and will take a number of years and involve the expenditure of substantial resources.
 
The steps required before a pharmaceutical agent may be marketed in the United States include:
 
·  
Pre-clinical laboratory tests, in vivo pre-clinical studies, and formulation studies;
 
·  
The submission to the FDA of an Investigational New Drug Application for human clinical testing, which must become effective before human clinical trials can commence;
 
·  
Adequate and well controlled human clinical trials to establish the safety and efficacy of the product;
 
·  
The submission of a New Drug Application or Biologic Drug License Application to the FDA; and
 
·  
FDA approval of the New Drug Application or Biologic Drug License Application prior to any commercial sale or shipment of the product.
 
In addition to obtaining FDA approval for each product, each product manufacturing facility must be registered with and approved by the FDA. Manufacturing facilities are subject to biennial inspections by the FDA and must comply with the FDA’s Good Manufacturing Practices for products, drugs and devices.
 
Whether or not FDA approval has been obtained, approval of a product by regulatory authorities in foreign countries must be obtained prior to the commencement of commercial sales of the drug in such countries. The requirements governing the conduct of clinical trials and drug approvals vary widely from country to country, and the time required for approval may be longer or shorter than that required for FDA approval. Although there are some procedures for unified filings for certain European countries, in general, each country at this time has its own procedures and requirements.
 
LITIGATION
 
We are not a party to any legal proceedings the outcome of which, in the opinion of our management, would have a material adverse effect on our business, financial condition, or results of operations.

PROPERTIES
 
We lease our executive offices in Newton, Massachusetts. Our office consists of approximately 2,200 square feet and is rented for approximately $5,700 per month. This lease expires in August 2007. We believe that our present facilities are adequate to meet our current needs. If new or additional space is required, we believe that adequate facilities are available at competitive prices.
 
MANAGEMENT
 
Directors and Executive Officers
 
Our current directors and executive officers are:
 
N ame
Age
Position
Simyon Palmin
62
Chairman of the Board
Harry S. Palmin
36
President, Chief Executive Officer, Director
George R. Vaughn
52
Chief Financial Officer and Chief Accounting Officer
M. Taylor Burtis
55
Vice President of Regulatory, Quality and Compliance
Christopher J. Pazoles, Ph.D.
55
Vice President of Research and Development
Michael J. Doyle (1) (2) (3)
47
Director
Sim Fass, Ph.D. (1) (2) (3)
63
Director
David B. McWilliams (2) (3)
62
Director
Howard M. Schneider (1) (3)
62
Director
 

(1) Member of the audit committee.
 
(2) Member of the compensation committee.
 
(3) Member of the nominating and corporate governance committee.
 
31

 
Our executive officers are appointed by, and serve at the discretion of, our board of directors. Simyon Palmin is the father of Harry Palmin.
 
Simyon Palmin . Mr. Palmin founded us in 1996. He has served as our chairman of the board and director of Russian relations since 1996. From 1996 to February 2004, he served as our chief executive officer. From 1984 to 1998, Mr. Palmin served as vice president of strategic planning and vice president of new product development of Design Components Inc. Mr. Palmin received a B.S. in naval instrumentation from St. Petersburg Navy Institute, St. Petersburg, Russia and a M.A. in aviation instrumentation from the Institute of Aviation Instrumentation, St. Petersburg, Russia. He also completed studies for a Ph.D. in electrical engineering.
 
Harry S. Palmin . Mr. Palmin has served as our president and a director since 1998 and our chief executive officer since January 2005. From 1998 to September 2005, he served as our acting chief financial officer. From 1996 to 1998, he was a vice president at Lehman Brothers and from 1993 to 1996, he was an associate at Morgan Stanley & Co. Mr. Palmin earned a B.A. in economics and business, magna cum laude , and a M.A. in international economics and finance from the International Business School at Brandeis University. He has also studied at the London School of Economics and the Copenhagen Business School.
 
George R. Vaughn . Mr. Vaughn has served as our chief financial officer and chief accounting officer since September 2005. Since April 2001, Mr. Vaughn has been President of Vaughn & Associates, P.C., a professional services organization he founded in 1995 that provides interim and part-time chief financial officer, outsourced financial management, and tax advisory services for emerging and established businesses, including Novelos. From 1990 to 1995, Mr. Vaughn served as chief financial officer of XRL, Inc. Mr. Vaughn is a certified public accountant and is a member of the American Institute of Certified Public Accountants and the Massachusetts Society of Certified Public Accountants. He holds a B.S. in business administration from Stonehill College.
 
Christopher J. Pazoles, Ph.D . Dr. Pazoles has served as our vice president of research and development since July 2005. From May 2004 to June 2005, he held a senior research and development position at the Abbott Bioresearch Center, a division of Abbott Laboratories. From October 2002 to January 2004, he served as chief operating officer and head of research and development at ALS Therapy Development Foundation. From 1994 to October 2002, Dr. Pazoles served as vice president of research for Phytera, Inc. From 1981 to 1994, he served as a researcher and senior manager with Pfizer. Dr. Pazoles holds a Ph.D. in microbiology from the University of Notre Dame.
 
M. Taylor Burtis . Ms. Burtis has served as our vice president of regulatory, quality and compliance since July 2005. From October 2004 to June 2005, she served as a senior director of regulatory affairs at Therion Biologics. From November 2003 to September 2004, she served as a senior director of regulatory affairs at Antigenics. From May 2000 to October 2003, Ms. Burtis served as an associate director for worldwide regulatory affairs at Wyeth BioPharma. From 1996 to April 2000, she served as a senior manager of regulatory affairs at Genentech. From 1992 to 1996, Ms. Burtis was an FDA consumer safety officer in the Office of Compliance at the Center for Biologics Evaluation and Research. From 1991 to 1992, Ms. Burtis served as a medical research manager at Boston Veterans Administration Center. From 1987 to 1991, she served as a research lab manager at Children’s Hospital, from 1985 to 1987, she served as a laboratory director at Brigham & Women’s Hospital and from 1980 to 1985, she served as a technical specialist international liaison with the American Red Cross. Ms. Burtis earned a B.S. in biology from Framingham State College and a M.B.A. in operations and strategy from Simmons College.
 
32

 
Michael J. Doyle . Mr. Doyle has served as one of our directors since October 2005. Since April 2006, he has served as chief executive officer of Advantedge Healthcare Solutions. From January 2005 to March 2006, he served as chief executive officer of Windward Advisors. From March 2000 to December 2004, Mr. Doyle served as chairman and chief executive officer of Salesnet. From 1989 to 1997, he served as chairman and chief executive officer of Standish Care/Carematrix, a company he founded. He received a B.S. in biology from Tufts University and a M.B.A. with a concentration in finance and health care from the University of Chicago, where he was a Kaiser Fellow.
 
Sim Fass , Ph.D . Dr. Fass has served as one of our directors since February 2005. Dr. Fass served as chief executive officer and chairman of Savient Pharmaceuticals from 1997 to 2004, its president and chief executive officer from 1984 to 1997, and its chief operating officer from 1983 to 1984. From 1980 to 1983, Dr. Fass served as vice president and general manager of Wampole Laboratories. From 1969 to 1980, he held a number of marketing, sales and senior management positions at Pfizer, Inc in both pharmaceuticals and diagnostics. He received a B.S. in biology and chemistry from Yeshiva College and a doctoral degree in developmental biology/biochemistry from the Massachusetts Institute of Technology.
 
David B. McWilliams . Mr. McWilliams has served as one of our directors since March 2004. From February 2004 to December 2004, Mr. McWilliams performed chief executive officer services for us. Since August 2004, Mr. McWilliams has served as chief executive officer of Opexa Therapeutics, Inc. From 1992 to March 2002, he served as president, chief executive officer and a director of Encysive Pharmaceuticals (formerly Texas Biotech). From 1989 to 1992, Mr. McWilliams served as president, chief executive officer and director of Zonagen. From 1984 to 1988, he served as president and chief executive officer of Kallestad Diagnostics. From 1980 to 1984, he served as president of Harleco Diagnostics Division. From 1972 to 1980, he was an executive at Abbott Laboratories, rising to general manager for South Africa. From 1969 to 1972, he was a management consultant at McKinsey & Co. Mr. McWilliams is also a director of Fairway Medical Technologies, Houston Technology Center and Texas Healthcare and Bioscience Institute. Mr. McWilliams received a M.B.A. in finance from the University of Chicago and a B.A. in chemistry, Phi Beta Kappa , from Washington and Jefferson College.
 
Howard M. Schneider . Mr. Schneider has served as one of our directors since February 2005. From January to December 2003, he served as chief executive officer of Metrosoft, Inc., and had been an advisor to such company from July to December 2002. From May 2000 to May 2001, he served as president of Wofex Brokerage, Inc. and from 1965 to 1999, he served as an executive at Bankers Trust Company, holding a variety of positions in the commercial banking and investment banking businesses. Mr. Schneider received a B.A., magna cum laude , in economics from Harvard College and a M.B.A. with distinction from New York University.
 
Employment Agreements
 
On January 31, 2006, we entered into an employment agreement with Harry Palmin effective January 1, 2006, whereby he agreed to serve as our president and chief executive officer for an initial term of two years at an annual salary of $225,000. He is eligible to receive an annual cash bonus at the discretion of the compensation committee and he is entitled to participate in our employee fringe benefit plans or programs generally available to our senior executives. The agreement provides that in the event that we terminate Mr. Palmin without cause or he resigns for good reason (as defined below), we will (i) pay Mr. Palmin his pro rata share of the average of his annual bonus paid during the two fiscal years preceding his termination; (ii) pay Mr. Palmin his base salary for 11 months after the date of termination; (ii) continue to provide him benefits for 11 months after the date of termination; and (iii) fifty percent of his unvested stock options will vest. The agreement also contains a non-compete provision, which prohibits Mr. Palmin from competing with us for one year after termination of his employment with us.

‘‘Cause’’ means (i) gross neglect of duties for which employed; (ii) committing fraud, misappropriation or embezzlement in the performance of duties as our employee; (iii) conviction or guilty or nolo plea of a felony or misdemeanor involving moral turpitude; or (iv) willfully engaging in conduct materially injurious to us or violating a covenant contained in the employment agreement.

33

 
‘‘Good Reason’’ means (i) the failure of our board of directors to elect Mr. Palmin to the offices of president and chief executive officer; (ii) the failure by our stockholders to continue to elect Mr. Palmin to our board of directors; (iii) our failure to pay Mr. Palmin the compensation provided for in the employment agreement, except for across the board cuts applicable to all of our officers on an equal percentage basis; provided that such reduction is approved by our board of directors; (iv) relocation of Mr. Palmin’s principal place of employment to a location beyond 50 miles of Newton, Massachusetts; (v) a reduction of base salary or material reduction in other benefits or any material change by us to Mr. Palmin’s function, duties, authority, or responsibilities, which change would cause Mr. Palmin’s position with us to become one of lesser responsibility, importance, or scope; and (vi) our material breach of any of the other provisions of the employment agreement.

On July 15, 2005, we entered into an employment agreement with Christopher J. Pazoles, Ph.D., whereby he agreed to serve as our vice president of research and development for an initial term of two years. His annual salary is $192,000 for the first year and $195,000 for the second year. Dr. Pazoles is also entitled to a minimum cash bonus of $16,000 at the end of the first year and $25,000 at the end of the second year. Dr. Pazoles’ agreement provides that he is entitled to participate in our employee fringe benefit plans or programs generally available to our senior executives. The agreement further provides that in the event that we terminate Dr. Pazoles without cause or he resigns for good reason (as defined below), we will (i) pay Dr. Pazoles his base salary through the remainder of the term of his employment agreement in monthly installments; (ii) continue to provide him benefits for 12 months after the date of termination; and (iii) pay, on a prorated basis, any minimum bonus or other payments earned.
 
Dr. Pazoles also entered into a nondisclosure and development agreement with us, which prohibits him from competing with us and soliciting our employees or customers during the term of his employment and for two years thereafter. If we terminate his employment without cause, this prohibition will only extend for six months after his termination.
 
“Cause” means Dr. Pazoles (i) has willfully failed, neglected, or refused to perform his duties under the employment agreement; (ii) has been convicted of or pled guilty or no contest to a crime involving a felony; or (iii) has committed any act of dishonesty resulting in material harm to us.
 
“Good Reason” means that Dr. Pazoles has resigned due to our failure to meet any of our material obligations to him under the employment agreement.
 
On March 21, 2006, our board of directors approved a 5% increase in Dr. Pazoles’ base salary. This increase became effective on April 1, 2006.
 
Compensation of Directors and Executive Officers
 
Director Compensation
 
As of January 1, 2006, we pay our non-employee directors a cash fee of $4,000 per quarter. The non-employee directors also receive a fee of $1,000 for any board or committee meeting attended or $500 for each telephonic board or committee meeting in which the director participated. We also pay each non-employee director who serves as the chair of the audit committee an additional annual fee of $5,000 and each non-employee director who serves as the chairman of the compensation and nominating and corporate governance committees an additional annual fee of $3,000. We will also reimburse directors for reasonable out-of-pocket expenses incurred in attending board and committee meetings and undertaking certain matters on our behalf. Directors who are our employees will not receive separate fees for their services as directors. For the year ended December 31, 2005, the chairman of our audit committee was paid $5,000 in fees. No other director received a cash fee during 2005.
 
Non-employee directors also receive stock option grants under our option plan. Commencing January 1, 2006, options to purchase 5,000 shares of our common stock are granted to each non-employee director per quarter at the closing price of our common stock on the last day of the quarter. These options vest on a quarterly basis over a two-year period.
 
34

 
Mr. Schneider and Mr. Fass each received a non-qualified stock option to purchase 100,000 shares of our common stock in February 2005. Michael J. Doyle received a non-qualified stock option to purchase 100,000 shares of our common stock in October 2005. All options were granted at the fair market value on the date of grant.
 
Executive Officer Compensation
 
Summary Compensation: The following table sets forth certain information about the compensation we paid or accrued with respect to our chief executive officer and our most highly compensated officers (other than our chief executive officer) who served as executive officers during the year ended December 31, 2005 and whose annual compensation exceeded $100,000 for the year ended December 31, 2005.
 
Other annual compensation in the form of perquisites and other personal benefits has been omitted as the aggregate amount of those perquisites and other personal benefits was less than $50,000 in the aggregate and constituted less than ten percent of the executive officers’ respective total annual salary and bonus.
 
Summary Compensation Table
 
       
Annual Compensation
 
Long-Term Compensation
 
Name and Principal Position
 
Year
 
Salary
($)
 
Securities Underlying Options
(#)
 
Harry S. Palmin
   
2005
 
$
148,000
 
400,000
 
President, Chief Executive Officer
   
2004
 
$
155,000
(1)
 
330,000
 
Christopher J. Pazoles, Ph.D.
   
2005
 
$
118,500
(2)  
200,000
 
Vice President of Research and Development
   
2004
  $
26,000
   
16,667
 
 

(1)   Mr. H. Palmin earned $155,000; but he forgave $119,167 of this salary.
 
(2)   On March 21, 2006, our board of directors approved a 5% increase in Dr. Pazoles’ base salary. This increase became effective on April 1, 2006.

Option grants in last fiscal year . The following table sets forth certain information about stock options granted during the year ended December 31, 2005 by us to the executive officers named in the summary compensation table.
 
Option grants in last fiscal year

   
Individual Grants
 
Name
 
Number of securities underlying
options granted
 
% of total options granted to employees in fiscal year
 
Exercise or base price ($/share)
 
Expiration date
 
Harry S. Palmin
   
250,000
(1 )
 
14
%
$
0.01
   
1/31/2015
 
     
150,000
(1)
 
8
%
$
0.01
   
3/31/2015
 
Christopher J. Pazoles, Ph.D.
   
200,000
(2 )
 
11
%
$
0.01
   
4/08/2015
 
 

(1)
These shares initially vested over a two-year period. Pursuant to their terms, the shares fully vested upon the completion of a non-bridge loan financing, which occurred in the second quarter of 2005.
   
(2)
These shares vest 25% each six-month period over two years from date of grant.
 
35

 
Fiscal year-end option table. The following table sets forth certain information regarding stock options held as of December 31, 2005 by the executive officers named in the summary compensation table.
 
The value of unexercised in-the-money options is based on a price of $2.00 per share, the fair market value of our stock on December 30, 2005, minus the per-share exercise price, multiplied by the number of shares underlying the option. Actual gains, if any, will depend on the value of the common stock on the date of the sale of the shares.
 
Aggregated option exercises in last fiscal year and fiscal year-end option values
 

   
 
 
 
 
Number of securities underlying
options at fiscal year-end
 
Value of in-the-money options at fiscal year-end
 
Name
 
Shares acquired on exercise (#)
 
Value realized ($)
 
Exercisable (#)
 
Unexercisable (#)
 
Exercisable ($)
 
Unexercisable ($)
 
Harry S. Palmin
   
   
   
734,752
   
2,378
 
$
1,458,878
 
$
3,091
 
Christopher J. Pazoles, Ph.D.
   
   
   
66,667
   
150,000
   
132,667
   
298,500
 
 
Equity compensation plans
 
The following table provides information as of December 31, 2005 regarding shares authorized for issuance under our equity compensation plans, including individual compensation arrangements.
 
The equity compensation plan approved by our stockholders is our 2000 stock option and incentive plan. We issued options to our directors and consultants that were not approved by our stockholders. These options are exercisable within a ten-year period from the date of the grant and vest at various intervals with all options being fully vested within three years of the date of grant. The option price per share is not less than the fair market value of our common stock on the date of grant.
 
Equity compensation plan information
 
Plan category
 
Number of shares to be issued upon exercise of outstanding options, warrants and rights
 
Weighted-average exercise price of outstanding options, warrants and rights
 
Number of shares remaining available for future issuance under equity compensation plans (excluding shares reflected in column (a))
 
   
(a)
 
(b)
 
(c)
 
Equity compensation plans approved by stockholders
   
73,873
 
$
3.16
   
0
 
Equity compensation plans not approved by stockholders
   
2,653,778
 
$
0.53
   
0
 
Total
   
2,727,651
 
$
0.60
   
0
 

 
On May 1, 2006, our board of directors adopted and on July 21, 2006 our stockholders approved, the 2006 Stock Incentive Plan (the “2006 Plan”). A total of 5,000,000 shares of common stock are reserved for issuance under the 2006 Plan for grants of incentive or nonqualified stock options, rights to purchase restricted and unrestricted shares of common stock, stock appreciation rights and performance share grants. A committee of the board of directors determines exercise prices, vesting periods and any performance requirements on the date of grant, subject to the provisions of the 2006 Plan. Options are granted at or above the fair market value of the common stock at the grant date and expire on the tenth anniversary of the grant date. In the nine months ended September 30, 2006, stock options for the purchase of 210,000 shares of common stock were granted under the 2006 Plan.
 
36

 
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
 
At the close of business on November 1, 2006, there were issued and outstanding 39,235,272 shares of our common stock. The following table provides information regarding beneficial ownership of our common stock as of November 1, 2006 by:
 
·  
Each person known by us to be the beneficial owner of more than five percent of our common stock;
 
·  
Each of our directors;
 
·  
Each executive officer named in the summary compensation table; and
 
·  
All of our current directors and executive officers as a group.
 
The address of each executive officer and director is c/o Novelos Therapeutics, Inc., One Gateway Center, Suite 504, Newton, Massachusetts 02458. The persons named in this table have sole voting and investment power with respect to the shares listed, except as otherwise indicated. The inclusion of shares listed as beneficially owned does not constitute an admission of beneficial ownership. Shares included in the “Right to acquire” column consist of shares that may be purchased through the exercise of options and warrants that vest within 60 days of November 1, 2006.

Name and Address of Beneficial Owner
 
Shares Beneficially Owned
 
 
 
Outstanding  
 
Right to Acquire  
 
Total  
 
Percentage  
 
Margie Chassman
445 West 23 rd Street, Apt. 16E
New York, NY 10011
   
4,370,061
   
66,666
   
4,436,727
   
11.3
%
Wood River Trust
c/o Michael C. Doyle, co-trustee
Stewart Management Company
1410 Nemours Building
1007 Orange Street
Wilmington, DE 19801
   
3,850,000
   
0
   
3,850,000
   
9.8
%
Harry S. Palmin
   
265,118
   
737,130
   
1,002,248
   
2.5
%
Simyon Palmin
   
1,738,939
   
487,826
   
2,226,765
   
5.6
%
Christopher J. Pazoles, Ph.D.
   
0
   
166,667
   
166,667
   
*
 
Michael J. Doyle
   
0
   
53,750
   
53,750
   
*
 
David McWilliams
   
0
   
156,528
   
156,528
   
*
 
Sim Fass
   
0
   
103,750
   
103,750
   
*
 
Howard Schneider
   
0
   
103,750
   
103,750
   
*
 
All directors and officers as a group (9 persons)
   
2,004,057
   
1,959,401
   
3,963,458
   
9.6
%
 

*   Less than one percent.

37

 
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
In connection with our private placements of units on May 27, 2005, June 29, 2005, July 29, 2005 and August 9, 2005, we paid Margie Chassman, one of the beneficial owners of in excess of 5% of our common stock, an aggregate of $52,000 as finder’s fees.
 
In connection with our private placement of Series A preferred stock and common stock purchase warrants on September 30, 2005 and October 3, 2005, Ms. Chassman provided a financial enhancement to the investors in the form of an escrow of 2,133,000 share of her common stock, to be drawn upon by the investors if their investment in our equity securities fails to provide a specified yield. We paid Ms. Chassman and her brother $166,000 for providing such financial enhancement.
 
In May 2005, we issued The Oxford Group 2,016,894 shares of our common stock in exchange for its forgiveness of our obligation to pay The Oxford Group an amount not to exceed $20 million, limited to 10% of our earnings before interest and taxes. This obligation resulted from the assignment of the exclusive intellectual property and marketing rights to the oxidized glutathione drug development platform technology, worldwide, excluding Russia and other countries comprising the former Soviet Union in 2000.   The shares were issued to Simyon Palmin, the Chairman of our Board of Directors, Mark Balazovsky, a former director, and to another one of our shareholders. Simyon Palmin is the president of The Oxford Group.  
 
We are obligated to pay The Oxford Group a royalty of 0.8% of our revenue derived from our oxidized glutathione products during the patent life of the products. All or a portion of these payments may be distributed to Simyon Palmin, the Chairman of our Board of Directors, and Mark Balazovsky, a former director.
 
In August 2000, Simyon Palmin loaned us $271,890 and Harry Palmin loaned us $250,041. In May 2005, Simyon Palmin forgave this loan plus accrued interest of $79,618 and Harry Palmin forgave this loan plus accrued interest of $74,505.
 
From October 1996 to October 1998, Simyon Palmin loaned us $99,000. In May 2005, he forgave the accrued interest of $24,362 related to this loan.
 
We were indebted to Simyon Palmin in the principal amount of $300,000 and Harry Palmin in the principal amount of $100,000. In May 2005, Simyon Palmin converted this debt into 480,000 shares of our common stock and Harry Palmin converted this debt into 160,000 shares of our common stock. We also paid Messrs. Palmin an aggregate of $23,976 and $11,250 in accrued interest on the debt during 2005 and 2004, respectively.
 
We acquired our rights to the oxidized glutathione technology from ZAO BAM, a company controlled by one of our former directors, Mark Balazovsky. We are required to pay ZAO BAM a 1.2% royalty on our revenue from the oxidized glutathione products during the patent life of the products and $2 million for each of our products utilizing such technology approved by the FDA 18 months following such approval. Further, if we license any such products to third parties, we are required to pay ZAO BAM 3% of all licensing revenue and an additional 9% of such revenue to the extent it exceeds our developmental costs of the licensed products. However, we are not required to make the 3% and 9% payments if we are paying the 1.2% royalty. ZAO BAM also granted us an exclusive right of first option and right of first refusal with respect to all future developments, discoveries or inventions of ZAO BAM.
 
In January 2005, we entered into an agreement with David Blech (the husband of Margie Chassman), which provided that he or his designees would lend us $500,000 (inclusive of $100,000 previously advanced to us in December 2004 by Ms. Chassman) for operating capital pending our debt restructuring and completion of our private placements of units, and up to an additional $500,000 on the same terms if the private placement was delayed. Mr. Blech did not lend us any money. The two loans, both of which were made by Ms. Chassman, totaled $500,000 and bore interest at 6% per annum. We repaid Ms. Chassman the entire $500,000 out of proceeds of our private placements of units on August 9, 2005. According to the agreement, we also issued the following individuals the following number of shares of our common stock:
 
38

 
Investor
 
Number of Shares
of Common Stock
 
Margie Chassman
   
2,475,000
 
Wood River Trust
   
3,850,000
 
Esther Blech
   
1,225,000
 
Milton Chassman
   
1,225,000
 
Aaron Eiger
   
1,225,000
 
Mark Germain
   
500,000
 
Total
   
10,500,000
 

Wood River Trust is a trust formed for the benefit of Evan Blech, the son of Ms. Chassman and Mr. Blech. The trustees of the trust are Harvey Kesner and Michael C. Doyle (no relation to our director, Michael J. Doyle). Esther Blech is the mother-in-law of Ms. Chassman. Milton Chassman is the brother of Ms. Chassman. These investors have agreed not to publicly sell their shares of common stock until November 20, 2006 and if they sell their shares in a private transaction, the buyer must also agree not to sell their shares publicly until November 20, 2006.
 
In 1990, Mr. Blech founded D. Blech & Company, which, until it ceased doing business in September 1994, was a registered broker-dealer involved in underwriting biotechnology issues. In May 1998, David Blech pled guilty to two counts of criminal securities fraud, and, in September 1999, he was sentenced by the U.S. District Court for the Southern District of New York to five years’ probation, which was completed in September 2004. Mr. Blech also settled administrative charges by the Securities and Exchange Commission in December 2000 arising out of the collapse in 1994 of D. Blech & Co., of which Mr. Blech was president and sole stockholder. The settlement prohibits Mr. Blech from engaging in future violations of the federal securities laws and from association with any broker-dealer. In addition, the District Business Conduct Committee for District No. 10 of NASD Regulation, Inc. reached a decision, dated December 3, 1996, in a matter styled District Business Conduct Committee for District No. 10 v. David Blech, regarding the alleged failure of Mr. Blech to respond to requests by the staff of the NASD for documents and information in connection with seven customer complaints against various registered representatives of D. Blech & Co. The decision found that Mr. Blech failed to respond to such requests in violation of NASD rules and that Mr. Blech should, therefore, be censured, fined $20,000 and barred from associating with any member firm in any capacity. Furthermore, Mr. Blech was discharged in bankruptcy in the United States Bankruptcy Court for the Southern District of New York in March 2000.
 
In November and December 2004, Simyon Palmin loaned us $19,000. In April and June 2005, we repaid the principal amount and Mr. Palmin forgave the interest of $465.
 
In February 2004, we entered into a consulting agreement with David McWilliams, one of our directors, whereby he performed interim chief executive officer services for us. We mutually terminated this consulting agreement in December 2004. As compensation for his services and for joining our board of directors, we granted Mr. McWilliams an option to purchase 152,778 shares of our common stock in April 2004.
 
During various time periods in 2003 and 2004, payroll and associated payroll taxes were accrued for Simyon Palmin and Harry Palmin in the amounts of $207,518 and $152,839, respectively. In May 2005, Messrs. Palmin forgave these amounts.
 
39

 
SELLING STOCKHOLDERS
 
34,285,449 shares are being offered under this prospectus, all of which are being registered for sale for the account of the selling stockholders.
 
2005 Private Placement of Units Consisting of Common Stock and Warrants
 
We completed a private placement of units, each unit initially consisting of 20,000 shares of our common stock and a warrant to purchase 10,000 shares of our common stock (the “units”), to the selling stockholders listed in the table below under the heading “Investors in 2005 Private Placement of Units” on May 27, 2005, June 29, 2005, July 29, 2005 and August 9, 2005. In this private placement, we sold an aggregate of 200 units. Holders of our convertible debt in the amount of $550,000 converted debt into 22 of the 200 units. The registration statement, of which this prospectus is a part, was filed pursuant to the terms of our registration rights agreements with these investors.
 
The selling stockholders listed in the table below under the heading “Investors in 2005 Private Placement of Units” are offering up to 7,296,609 shares of our common stock being registered for resale by this registration statement, of which this prospectus is a part, consisting of:
 
·  
3,980,000 shares of our outstanding common stock obtained in the private placement transactions; and
 
·  
3,316,609 shares of our common stock to be obtained upon exercise of three-year common stock purchase warrants with a current exercise price of $1.35 per share that were issued in the private placement transactions.
 
The selling stockholders listed in the table below under the heading “Placement Agent and Finders Warrants and Shares issued in connection with 2005 Private Placements of Units” are offering up to 628,692 shares of our common stock being registered for resale by this registration statement, of which this prospectus is a part, consisting of:
 
·  
180,736 shares of our common stock to be obtained upon exercise of five-year common stock purchase warrants with a current exercise price of $1.35 per share that were issued as finders’ compensation in connection with the private placement transactions;
 
·  
125,000 shares of our common stock that were issued to vFinance Investments, Inc. and Mercer Capital, Ltd. as partial compensation for their services as placement agents; and
 
·  
322,956 shares of our common stock to be obtained upon exercise of five-year common stock purchase warrants with a current exercise price of $1.35 per share that were issued to vFinance Investments, Inc. and Mercer Capital, Ltd. as partial compensation for their services as placement agents.
 
We received gross proceeds of $4,450,000 and net cash proceeds of $3,715,000 (after deducting finders’ fees and transaction costs) from this private placement.
 
In connection with our private placement completed on March 7, 2006, there was an anti-dilution adjustment to the warrants described above. Such adjustment reduced the exercise price of the warrants to $1.35 and increased the number of five and three year warrants to 3,333,275 and 503,692 respectively.
 
 
2005 Private Placement of Series A Preferred Stock and Warrants
 
We completed a private placement of Series A preferred stock and common stock purchase warrants to the selling stockholders listed in the table below under the heading “Investors in 2005 Private Placement of Series A Preferred Stock” on September 30, 2005 and October 3, 2005. In this private placement, we sold an aggregate of 3,200 shares of our Series A preferred stock and warrants to purchase 969,696 shares of our common stock. The registration statement, of which this prospectus is a part, was filed pursuant to the terms of our subscription agreement with these investors.
 
40

 
The selling stockholders listed in the table below under the heading “Investors in 2005 Private Placement of Series A Preferred Stock” are offering up to 3,665,979 shares of our common stock being registered for resale by this registration statement, of which this prospectus is a part, consisting of:
 
·  
2,696,283 shares of our common stock to be obtained upon conversion of the Series A preferred stock in the private placement; and
 
·  
969,696 shares of our common stock to be obtained upon exercise of five-year common stock purchase warrants with an exercise price of $1.35 per share that were issued in the private placement.
 
We received gross proceeds of $3,200,000 and net proceeds of $2,864,000 (after deducting fees and transaction costs) from this private placement.
 
We agreed to register for resale additional shares of common stock in excess of the 1,939,393 shares that are issuable to certain stockholders upon conversion of the Series A preferred stock to accommodate possible adjustments in the conversion rate contemplated by certain provisions of the preferred stock.
 
In connection with our private placement completed on March 7, 2006, there was an anti-dilution adjustment to the exercise price of our outstanding common stock purchase warrants described above. Such adjustment reduced the exercise price of such warrants from $1.65 to $1.35 per share of common stock. This private placement also resulted in an anti-dilution adjustment to the conversion price of our Series A preferred stock from $1.65 to $1.35.
 
2006 Private Placement
 
We completed a private placement to the selling stockholders listed in the table below under the heading “Investors in 2006 Private Placement” on March 7, 2006. We are filing the registration statement, of which this prospectus is a part, pursuant to the terms of our registration rights agreements with these investors.
 
The selling stockholders listed in the table below under the heading “Investors in 2006 Private Placement” are offering up to 18,643,762 shares of our common stock being registered for resale by this registration statement, of which this prospectus is a part, consisting of:
 
·  
8,186,845 shares of our outstanding common stock obtained in the private placement transaction; and
 
·  
10,456,917 shares of our common stock to be obtained upon exercise of five-year common stock purchase warrants with an exercise price of $2.50 per share that were issued in the private placement transaction.
 
The selling stockholders listed in the table below under the heading “Placement Agent Warrants issued in connection with 2006 Private Placement” are offering up to 836,555 shares of our common stock to be obtained upon exercise of five-year common stock purchase warrants with an exercise price of $2.50 per share that were obtained as partial compensation for their services as placement agents.
 
We received gross proceeds of $15,058,005 and net proceeds of approximately $13,900,000 (after deducting placement agent fees and transaction costs) from this private placement.
 
41

 
Registration Rights
 
2005 Private Placement of Units Consisting of Common Stock and Warrants and 2005 Private Placement of Series A Preferred Stock and Warrants
 
We entered into agreements with investors in our private placement of units completed on May 27, 2005, June 29, 2005, July 29, 2005 and August 9, 2005 and our private placement of Series A preferred stock on September 30, 2005 and October 3, 2005. Pursuant to these agreements, we agreed to file with the SEC a registration statement covering the resale of all our common stock covered by this prospectus pursuant to Rule 415 of the Securities Act. The registration rights agreements executed in connection with our private placement of units required us to file such registration statement on or before October 8, 2005. We filed a registration statement on Form SB-2, of which this prospectus forms a part, on November 16, 2005, with respect to the resale of these shares from time to time. We recorded an accrued liability of $8,000 as of September 30, 2006 for payments in connection with this late filing. The subscription agreements executed in connection with our private placement of Series A preferred stock required us to file such registration statement on or before November 16, 2005.
 
Pursuant to the terms of the registration rights agreements executed in connection with the private placement of units completed on May 27, 2005, June 29, 2005, July 29, 2005 and August 9, 2005, we agreed to cause the registration statement to be declared effective on or before February 5, 2006. The registration statement was declared effective on December 15, 2005. We also agreed to use our best efforts to keep the registration statement effective for two years following its effective date, unless the shares of our common stock covered by this prospectus have been sold or may be sold pursuant to Rule 144(k) of the Securities Act, subject to certain restrictions.
 
Pursuant to the terms of the subscription agreements executed in connection with the private placement of Series A preferred stock completed on September 30, 2005 and October 3, 2005, we agreed to cause the registration to be declared effective on or before January 28, 2006 and January 31, 2006, respectively. The registration statement was declared effective on December 15, 2005. We also agreed to use our best efforts keep the registration statement effective for two years following its effective date.
 
We were required to register for resale the shares of common stock issuable upon conversion of the Series A preferred stock we issued in the private placement transaction completed on September 30, 2005 and October 3, 2005 to cover the shares of our common stock, if any, issuable as a result of adjustments contemplated by certain provisions of the subscription agreements dated September 30, 2005 and October 3, 2005. We are required to amend this registration statement or file an additional registration statement, of which this prospectus is a part, at any time if the remaining number of shares of common stock issuable upon conversion of the Series A preferred stock or exercise of the common stock purchase warrants exceeds 100% of the number of shares of common stock registered by this registration statement, of which this prospectus is a part.
 
2006 Private Placement
 
We entered into agreements with investors in our private placement completed on March 7, 2006. Pursuant to these agreements, we agreed to file with the SEC a registration statement covering the resale of all our common stock covered by this prospectus pursuant to Rule 415 of the Securities Act. The subscription agreements executed in connection with our private placement required us to use our best efforts to file such registration statement by the later of (i) 30 days after the closing (April 6, 2006) or (ii) five (5) business days after we file our Form 10-KSB for the year ended December 31, 2005 with the SEC (but no later than March 31, 2006).
 
Accordingly, we filed a registration statement on Form SB-2, of which this prospectus forms a part, on April 6, 2006, with respect to the resale of these shares from time to time. Pursuant to the terms of the subscription agreements executed in connection with the private placement completed on March 7, 2006, we agreed to use our best efforts to cause the registration statement to be declared effective on or before July 5, 2006. The registration statement was declared effective on April 19, 2006. We also agreed to use our best efforts keep the registration statement effective until the earliest of (i) the second anniversary of the closing (March 7, 2008) or (ii) the date when all of the common stock covered by the registration statement have been sold.
 
42

 
On October 24, 2006, we advised the selling stockholders named in the registration statements related to the resale of securities purchased in the private placement transactions described above, that the use of the prospectuses had been suspended due to the need to restate our financial statements for the quarter ended September 30, 2005 and the year ended December 31, 2005. Pursuant to the registration rights associated with these financings, we may become obligated to the selling stockholders in the event that the suspension of the use of the prospectuses exceeds the grace periods specified. The amount of such obligation, if any, will be determined during the fourth quarter of 2006.
 
Additional Selling Stockholders
 
The selling stockholders listed under the heading “Additional Selling Stockholders” are offering up to 3,213,852 shares of our common stock being registered for resale by this registration statement, of which this prospectus is a part, consisting of:
 
·  
720,000 shares of our common stock issuable upon exercise of five-year common stock purchase warrants, with an exercise price of $0.625 per share, issued in connection with our bridge financing in April 2005;
 
·  
1,760,000 shares of our common stock issued to our former holders of secured promissory notes issued in November 2003 and May 2004 in the aggregate principal amount of $1,100,000, which were converted into equity in May 2005 pursuant to restructuring agreements;
 
·  
163,952 shares of our common stock issued to our former holders of unsecured promissory notes in the aggregate principal amount of $177,000, which were converted into equity in May 2005 pursuant to restructuring agreements;
 
·  
422,400 shares of our common stock issued to three firms, as partial compensation, for consulting services rendered to us pursuant to restructuring agreements dated May 2005; and
 
·  
147,500 shares of our common stock issued to current and former investor relations firms, as partial compensation, pursuant to consulting agreements for services rendered to us.

Selling Stockholders Table
 
Based on the information supplied to us by each selling stockholder, the following table sets forth the approximate number of shares beneficially owned as of November 1, 2006, by each of the selling stockholders and their pledgees, assignees and successors in interest. The “Right to Acquire” column reflects beneficial ownership of shares subject to warrants that may be exercised within 60 days after November 1, 2006. The “Shares Offered” column reflects all of the shares that each selling stockholder may offer under this prospectus. Percentage ownership is based on 39,235,272 shares issued and outstanding as of November 1, 2006. The table assumes that the selling stockholders sell all of the shares.
 
We prepared the table below based on information supplied to us by the selling stockholders. Although we have assumed for purposes of the table that the selling stockholders will sell all of the shares offered by this prospectus, because the selling stockholders may offer from time to time all or some of their shares covered under this prospectus, or in another permitted manner, no assurances can be given as to the actual number of shares that will be resold by the selling stockholders or that will be held by the selling stockholders after completion of the resales.
 
The terms of the common stock purchase warrants provide that the number of shares to be obtained by each of the holders of warrants, upon exercise of our common stock purchase warrants, cannot exceed the number of shares that, when combined with all other shares of our common stock and securities owned by each of them, would result in any one of them owning more than 4.99% of our outstanding common stock at any given point in time.
 
In addition, the selling stockholders may have sold, transferred or otherwise disposed of the common stock and warrants issued in the recently completed private placement in transactions exempt from the registration requirements of the Securities Act since the date the selling stockholders provided the information regarding their securities holdings.
 
43

 
Information concerning the selling stockholders may change from time to time and changed information will be presented in a supplement to this prospectus if and when necessary and required. Except as described above, there are currently no agreements, arrangements or understandings with respect to the resale of any of the shares covered by this prospectus.
 
Certain of the selling stockholders are or were our executive officers. Harry Palmin is our president and chief executive officer and one of our directors. He also served as our acting chief financial officer from 1998 to September 2005. Simyon Palmin is our chairman of the board of directors and director of Russian relations. He also served as our chief executive officer from 1996 to February 2004. Rudy Peselman served as our secretary until May 2005.
 
Except as described above and for the ownership of common stock, none of the selling stockholders had any material relationship with us within the past three years.
 
Selling Stockholders    
 
   
  Beneficial Ownership Prior to Offering
       
  Beneficial Ownership After Offering
 
Name of Beneficial Owner  
  Outstanding  
 
  Right to Acquire  
 
  Total  
   
Shares Offered  
 
  Outstanding  
 
  Right to Acquire  
 
  Percent  
 
Investors in 2005 Private Placement of Units (8)
                                           
Anthony Abenante  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
ALE Industries- Albert Jacobs  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Alpha Capital AG  
   
160,000
   
453,333
   
613,333
 (1)
 
613,333
   
0
   
0
   
*
 
John Wayne Andrews  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Sergey Babchin  
   
771,229
   
33,333
   
804,562
 (2)
 
553,333
   
251,229
   
0
   
*
 
John Barnhardt  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Jerome Belson
   
100,000
   
83,333
   
183,333
   
183,333
   
0
   
0
   
*
 
Andrey Beltov  
   
795,871
   
33,333
   
829,204
 (2)
 
553,333
   
275,871
   
0
   
*
 
Walter Bernheimer  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Family Ltd. Partnership Bernheimer  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Harvey Blitz  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Erno Bodek  
   
160,000
   
133,333
   
293,333
 
 
293,333
   
0
   
0
   
*
 
Gerald Brauser  
   
300,000
   
250,000
   
550,000
   
550,000
   
0
   
0
   
*
 
Richard J. & Joan M. Brown  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Allen O. & Jolaine Cage  
   
60,000
   
50,000
   
110,000
 
110,000
   
0
   
0
   
*
 
Camden International  
   
80,000
   
226,666
   
306,666
 (1)  
306,666
   
0
   
0
   
*
 
Ron Cate  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Margie Chassman  
   
4,370,061
   
66,666
   
4,436,727
   
146,666
   
4,290,061
   
0
   
10.9
 
Simon Clarke  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Leonard Cohen  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Frank A. & Carol A. Consolati  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
 
44

 
     
Beneficial Ownership Prior to Offering
         
Beneficial Ownership After Offering
 
Name of Beneficial Owner    
Outstanding  
   
Right to Acquire
   
Total
   
Shares Offered
   
Outstanding
   
Right to Acquire
   
Percent
 
Harold E. & Connie L. Crowley  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Peter D’Arienzo  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Frank DeCarolis  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Ulrich Eilers  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Richard G. & Kenneth S. Etra  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Chris Everest IRA  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Frank Fila  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Anthony J. Fortunato  
   
27,000
   
16,666
   
43,666
   
36,666
   
7,000
   
0
   
*
 
Eugene Fridman  
   
32,122
   
16,666
   
48,788
   
36,666
   
12,122
   
0
   
*
 
Boris Friedberg  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Vitaliy Gassel  
   
27,498
   
16,666
   
44,164
   
36,666
   
7,498
   
0
   
*
 
Joseph Giamanco  
   
160,000
   
133,332
   
293,332
   
293,332
   
0
   
0
   
*
 
A. George- Gitter, Trust C, GST Exempt  
   
160,000
   
133,333
   
293,333
   
293,333
   
0
   
0
   
*
 
Dennis Glynn  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Anna & Max Goldfarb  
   
64,694
   
50,000
   
114,694
   
110,000
   
4,694
   
0
   
*
 
Klatte Golf, L.P.  
   
80,000
   
66,666
   
146,666
   
146,666
   
0
   
0
   
*
 
Mark Stephen Goodman  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Herbert A. & Lily A. Gordon  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Lawrence Gould  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Russell Green (3)  
   
20,000
   
26,828
   
46,828
 (4)
 
46,828
   
0
   
0
   
*
 
James D. & Karen J. Griffith  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Salvatore Guerrera  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Stuart Hanford  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Colin J. & Gursharn K. Harvey  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Willie Hines  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Jasuns Holdings Ltd.  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Dr. Vincent & Betty L. John  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Robert & Margaret R. Kenwrick  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Gary Kessler  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Michael Koral  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Michael Lane  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Richard Lazarow  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Carlos C. Lee  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Julian Lender  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
 
45

 
 
     
Beneficial Ownership Prior to Offering
       
Beneficial Ownership After Offering
 
Name of Beneficial Owner    
Outstanding  
   
Right to Acquire
   
Total
   
Shares Offered
   
Outstanding
   
Right to Acquire
   
Percent
 
Stolpe Family Limited Partnership  
   
80,000
   
66,666
   
146,666
   
146,666
   
0
   
0
   
*
 
Lev Lisser  
   
95,122
   
70,740
   
165,862
 (5)
 
130,740
   
35,122
   
0
   
*
 
Anna Lisser  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Keith and Patricia Little, FLP.  
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Mark Livshitz  
   
49,154
   
16,666
   
65,820
   
36,666
   
29,154
   
0
   
*
 
Longview Fund LP  
   
120,000
   
340,000
   
460,000
 (1)    
460,000
   
0
   
0
   
*
 
Chris Marley  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Bruce R. Mathias  
   
40,000
   
51,110
   
91,110
 (6)
 
91,110
   
0
   
0
   
*
 
Albert Mazler  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Ronald J. Menello  
   
120,000
   
99,999
   
219,999
   
219,999
   
0
   
0
   
*
 
Robert Mynett  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Derek Neesam  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Dennis A. Noyes  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Francis G. O’Connor  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Richard Olson  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Brian Oregan  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Gerald Ortsman  
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Rick Perlmutter
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Lauren Pozefsky, Irrevocable Trust
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Andrew Richards
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Michael H. Rock
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Joseph Roda
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Dr. Daniel Rosberger
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Joseph C. Roselle (3)
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Philip Rushby
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Albert L. Saphier IRA
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
SCG Capital (3)
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Adam Schacter (3) (7)
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Irwin Schacter (3) (7)
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Steve Schnipper
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Guido Schoeb
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Duncan Scott
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Fred B. & John Sheats & Molis, Joint Tenants
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Isaak Shklyarov
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
 
46

 
 
     
Beneficial Ownership Prior to Offering  
         
Beneficial Ownership After Offering  
 
Name of Beneficial Owner     Outstanding    
Right to Acquire
   
Total
   
Shares Offered
    Outstanding    
Right to Acquire  
   
Percent
 
David M. Solomon
   
40,000
   
33,333
   
73,333
   
73,333
   
0
   
0
   
*
 
Alvin & Sharon Spearman
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Nick Stock
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Ira Stollar
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
David Sukoff
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Sunrise Equity Partners, L.P.
   
160,000
   
133,333
   
293,333
   
293,333
   
0
   
0
   
*
 
Richard & Janet Sygar
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Certified Systems
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Alan & Sheena Taylor
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Andrew Telford
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Owen James Truelove
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Herbert Weisberger
   
20,000
   
16,666
   
36,666
   
36,666
   
0
   
0
   
*
 
Placement Agent and Finders Warrants and Shares issued in connection with 2005 Private Placements of Units (8)  
Jeffrey Auerbach (3)
   
31,997
   
62,398
   
94,395
   
94,395
   
0
   
0
   
*
 
Vince Calicchia (3)
   
7,935
   
17,296
   
25,231
   
25,231
   
0
   
0
   
*
 
vFinance Investments, Inc. (3) (7)
   
28,620
   
65,140
   
93,760
   
93,760
   
0
   
0
   
*
 
Wunderlich Securities, Inc. (7)
   
0
   
11,200
   
11,200
   
11,200
   
0
   
0
   
*
 
Carmelo Troccoli (3)
   
1,625
   
4,192
   
5,817
   
5,817
   
0
   
0
   
*
 
Jonathan Rich (3)
   
2,535
   
5,837
   
8,372
   
8,372
   
0
   
0
   
*
 
David Rich (3)(7)
   
0
   
1,592
   
1,592
   
1,592
   
0