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**U.S. SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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** **

**Form 10-K**

** **
| **x**  | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES   EXCHANGE ACT OF 1934**    |
|--------|----------------------------------------------------------------------------------------------------------|
|   |                                                                                                     |
|   | For the fiscal  year ended June 30, 2008                                                            |
|   |                                                                                                     |
|   | OR                                                                                                       |
|   |                                                                                                     |
| **o**  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

For the transitionperiod from         to        

 

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**Commission File Number: 000-31979**

 

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**Array BioPharma Inc.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Delaware**              | ** ** | **84-1460811**                        |
|---------------------------|------------|---------------------------------------|
| (State of  Incorporation) |       | (I.R.S. Employer  Identification No.) |

 

**3200 Walnut Street**

**Boulder, Colorado 80301**

(Address of Principal Executive Offices)

 

**(303) 381-6600**

(Registrant’s Telephone Number, Including Area Code)

 

**Common Stock, Par Value $.001 per Share**

(Securities Registered Pursuant to Section 12(b) of the Act)

 

**The NASDAQ Stock Market LLC (NASDAQ Global Market)**

(Nameof Exchange on Which Registered)

 

**None**

(Securities Registered Pursuant to Section 12(g) of the Act)

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

Yes o No x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or15(d) of the Exchange Act.

Yes o No x

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

Yes x No o

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.
| Large Accelerated Filer o |   | Accelerated Filer x |   | Non-Accelerated Filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes o No x

 

The aggregate market valueof voting stock held by non-affiliates of the registrant as of December 31,2007 (based upon the closing sale price of such shares as of the last tradingday of the year, December 31, 2007, on the NASDAQ Global Market) was$397,452,106. Shares of the Registrant’s common stock held by each executiveofficer and director and by each entity that owns 5% or more of the Registrant’soutstanding common stock have been excluded in that such persons or entitiesmay be deemed to be affiliates. This determination of affiliate status is notnecessarily a conclusive determination for other purposes.

 

Number of sharesoutstanding of the registrant’s class of common stock as of August 7,2008: 47,557,131.

** **

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the registrant’sdefinitive Proxy Statement to be filed with the Securities and ExchangeCommission on Form 14A for the 2008 Annual Meeting of Stockholders areincorporated by reference in Part III of this Annual Report on 10-K to theextent stated therein.

 

 

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**TABLEOF CONTENTS**

 
| ** **        | ** ** | ** **                                                                                                              | ** ** | **Page No.** |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| ** **        | ** ** | ** **                                                                                                              | ** ** | ** **        |
| **PART I**   |       |                                                                                                                    |       | 1                 |
| Item 1.           |       | Business                                                                                                                |       | 1                 |
| Item 1A.          |       | Risk Factors                                                                                                            |       | 16                |
| Item 1B.          |       | Unresolved  Staff Comments                                                                                              |       | 31                |
| Item 2.           |       | Properties                                                                                                              |       | 31                |
| Item 3.           |       | Legal Proceedings                                                                                                       |       | 31                |
| Item 4.           |       | Submission  of Matters to a Vote of Security Holders                                                                    |       | 31                |
|              |       |                                                                                                                    |       |              |
| **PART II**  |       |                                                                                                                    |       | 32                |
| Item 5.           |       | Market for  the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |       | 32                |
| Item 6.           |       | Selected  Financial Data                                                                                                |       | 34                |
| Item 7.           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |       | 34                |
| Item 7A.          |       | Quantitative  and Qualitative Disclosures about Market Risk                                                             |       | 47                |
| Item 8.           |       | Financial  Statements and Supplementary Data                                                                            |       | 48                |
| Item 9.           |       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosures                                  |       | 48                |
| Item 9A.          |       | Controls and  Procedures                                                                                                |       | 48                |
| Item 9B.          |       | Other Information                                                                                                       |       | 49                |
|              |       |                                                                                                                    |       |              |
| **PART III** |       |                                                                                                                    |       | 50                |
| Item 10.          |       | Directors  and Executive Officers of the Registrant                                                                     |       | 50                |
| Item 11.          |       | Executive  Compensation                                                                                                 |       | 50                |
| Item 12.          |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        |       | 50                |
| Item 13.          |       | Certain  Relationships and Related Transactions                                                                         |       | 50                |
| Item 14.          |       | Principal  Accountant Fees and Services                                                                                 |       | 50                |
|              |       |                                                                                                                    |       |              |
| **PART IV**  |       |                                                                                                                    |       | 51                |
| Item 15.          |       | Exhibits  and Financial Statement Schedules                                                                             |       | 51                |
|              |       |                                                                                                                    |       |              |
| **SIGNATURES**    |       | 52                                                                                                                      |

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**PART I**

 

ArrayBioPharma Inc., the Array BioPharma Inc. logo and allother Array names are trademarks of Array BioPharma Inc. inthe United States of America and in other selected countries. All other brandnames or trademarks appearing in this report are the property of theirrespective holders. Unless the context requires otherwise, references in thisreport to “Array,” “we,” “us,” and “our” refer to Array BioPharma Inc.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Annual Report filedon Form 10-K and other documents we file with the Securities and ExchangeCommission contain forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995 that involve significant risksand uncertainties. In addition, we may make forward-looking statements in ourpress releases or in other oral or written communications with thepublic. These forward-looking statements include, but are not limited to,statements concerning our projected timelines for the initiation and completionof preclinical and clinical trials; the potential for the results ofongoing preclinical or clinical trials to support regulatoryapproval or the marketing success of drug candidates; our planswith respect to the timing and scope of the expansion of our clinical andcommercialization capabilities; other statements regarding our future productdevelopment and regulatory strategies, including with respect to specificindications; the ability of third-party contractmanufacturing parties to support our drug development activities; anystatements regarding our future financial performance, results of operations orsufficiency of capital resources to fund our operating requirements; and anyother statements which are other than statements of historical fact.

 

Although we believe theassumptions upon which our forward-looking statements are based currently to bereasonable, our actual results could differ materially from those anticipatedin these forward-looking statements as a result of many factors. These factorsinclude, but are not limited to, our ability to continue to fund andsuccessfully progress internal research and development efforts and to createeffective, commercially viable drugs; our ability to effectively and timelyconduct clinical trials in light of increasing costs and difficulties inlocating appropriate trial sites and in enrolling patients who meet thecriteria for certain clinical trials; our ability to achieve and maintainprofitability; the extent to which the pharmaceutical and biotechnologyindustries are willing to in-license drug candidates for their productpipelines and to collaborate with and fund third parties on their drugdiscovery activities; our ability to out-license our proprietary candidates onfavorable terms; risks associated with our dependence on our collaborators forthe clinical development and commercialization of our out-licensed drugcandidates; the ability of our collaborators and of Array to meet objectivestied to milestones and royalties; our ability to attract and retain experiencedscientists, and management; and the risk factors set forth below under thecaption Item 1A. Risk Factors. We are providing this information as of the dateof this report. We undertake no duty to update any forward-looking statementsto reflect the occurrence of events or circumstances after the date of suchstatements or of anticipated or unanticipated events that alter any assumptionsunderlying such statements.

 

**ITEM 1 - BUSINESS**

 

**OurBusiness**

 

We are abiopharmaceutical company focused on the discovery, development andcommercialization of targeted small molecule drugs aimed at large marketopportunities.  Our proprietary drugdevelopment pipeline includes clinical candidates that are designed to treatpatients afflicted with cancer, inflammatory diseases and pain.  In addition, leading pharmaceutical andbiotechnology companies collaborate with us to discover and develop drugcandidates across a broad range of therapeutic areas.  We currently have six wholly-owned programsin our development pipeline:

 

·                  ARRY-797, a p38inhibitor and pan-cytokine modulator for inflammation and for pain;

·                  ARRY-162, a MEKinhibitor for inflammation;

·                  ARRY-614, ap38/Tie 2 dual inhibitor for cancer and/or inflammation;

·                  ARRY-543, an ErbBfamily (EFGR / ErbB-2) inhibitor for cancer;

·                  ARRY-520, a KSPinhibitor for cancer; and

·                  ARRY-380, anErbB-2 inhibitor for cancer.

 

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We also have a portfolioof drug discovery programs that we believe will generate one to threeInvestigational New Drug, or IND, applications each year. Our drug discoveryefforts have also generated additional early-stage drug candidates that we may chooseto out-license through research partnerships prior to filing an INDapplication.

 

**OurStrategy**

 

We are building a fullyintegrated, commercial-stage biopharmaceutical company that invents, developsand markets safe and effective small molecule drugs to treat patients afflictedwith cancer, inflammatory diseases or pain. We intend to accomplish thisthrough the following strategies:

 

·      Inventing targeted smallmolecule drugs that are either first-in-class or second generation drugs thatdemonstrate a competitive advantage over drugs on the market or in clinicaldevelopment;

·      Partnering select drugsafter establishing proof-of-concept for co-development and commercialization,while retaining the right to commercialize and/or co-promote in the U.S.;

·      Partnering selectearly-stage programs for continued research and co-development in exchange forresearch funding, plus significant milestone payments and royalties;

·      Expanding our clinicaldevelopment organization to provide timely, robust proof of concept, and, inthe longer term, to conduct later-stage development and seek marketing approvalfor important new drugs across multiple therapeutic areas; and

·      Building commercialcapabilities to position our drugs to maximize their overall value.  As our first drug nears approval, we plan tobuild a U.S.-based, therapeutically-focused sales force to commercialize orco-promote our drugs.

 

**BusinessHistory**

 

We have built ourproprietary pipeline of drug development and discovery programs on aninvestment of approximately $240 million from our inception through June 30,2008. Over the past three years, researchand development expenses for proprietary drug discovery have significantlyincreased year over year to support, in particular, our clinical development effortsand were $90.3 million for fiscal 2008, as compared to $57.5 million for fiscal2007 and $33.4 million for fiscal 2006.

 

Additionally, we havereceived a total of $322 million in research funding and in up-front andmilestone payments from our collaboration partners through June 30, 2008.Under our existing collaboration agreements, we have the potential to earn $1.4billion in additional milestone payments if all the discovery and revenueobjectives detailed in these agreements are achieved, as well as to earnroyalties on any resulting product sales from 18 drug development programs.

 

Our three largestexisting collaborators include:

 

·                 AstraZeneca, PLC, which licensed three of our MEKinhibitors for cancer, including AZD6244 (ARRY-886), which is currently inmultiple Phase 2 clinical trials;

·                 Genentech, Inc., which entered into a worldwidestrategic collaboration agreement with us to develop two of our cancer programs– which has been expanded to include two additional cancer programs— all fourof which are in preclinical development; and

·                 Celgene Corporation, which entered into a worldwidestrategic collaboration agreement with us focused on the discovery, developmentand commercialization of novel therapeutics in cancer and inflammation.

 

Through collaborations,we have also invented drug candidates that are currently in clinicaldevelopment, including InterMune, Inc.’s hepatitis C virus NS3/4 proteaseinhibitor, ITMN-191, and Eli Lilly and Company’s (formerly ICOS Corporation)CHK-1 inhibitor, IC83.  Our out-licenseand collaboration agreements with these and our other partners typicallyprovide for up-front payments, research funding, success-based milestonepayments and/or royalties on product sales.

 

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The following chart shows our six most advanced wholly-owned compounds,their stage in the drug development process and our expected future developmentplans.

 
| **Drug  Candidates**               | ** **   | **Current  Development Status** | ** **   | **Expected  Development Plan**                                                    |
|------------------------------------|--------------|---------------------------------|--------------|-----------------------------------------------------------------------------------|
| ** **                         | ** **   | ** **                      | ** **   | ** **                                                                        | ** ** | ** ** |
| ***Inflammation & Pain*** | *** *** | *** ***                    | *** *** | *** ***                                                                      |
| ARRY-797                           |         | P38                             |         | Phase 2 dental pain  trial and Phase 1b 28-day rheumatoid arthritis, or RA, trial |   | Initiate Phase 2 ankylosing  spondylitis trial during the second half of calendar 2008 |
|                               |         |                            |         |                                                                              |   |   |
| ARRY-162                           |         | MEK                             |         | Phase 2 worldwide,  12-week RA trial                                              |   | Receive top-line  results during the second half of calendar 2009 |
|                               |         |                            |         |                                                                              |   |   |
| ARRY-614                           |         | P38/Tie2                        |         | Phase 1 trial with  healthy volunteers                                            |   | Initiate  first-in-patient Phase 1b trial in cancer and/or inflammation during the  first half of calendar 2009 |
| ***Cancer***                       | *** *** | *** ***                    | *** *** | *** ***                                                                      | *** *** | *** *** |
| ARRY-543                           |         | ErbB-2/EGFR                     |         | Phase 1 expansion and  Phase 1b/2 trials in metastatic breast cancer              |   | Initiate combination  studies with Xeloda® (capecitabine) and Taxotere® (docetaxel) in the second  half of calendar 2008 |
|                               |         |                            |         |                                                                              |   |   |
| ARRY-520                           |         | KSP                             |         | Phase 1 expansion trial  and Phase 2 acute myelogenous leukemia, or AML, trials   |   | Initiate Phase 2  multiple myeloma trial in the first half of calendar 2009 |
|                               |         |                            |         |                                                                              |   |   |
| ARRY-380                           |         | ErbB-2                          |         | Phase 1 trial with  cancer patients                                               |   | Initiate Phase 1b  combination trial during the first half of 2009 |
|                               |         |                            |         |                                                                              |   |   |
| ARRY-614                           |         | P38/Tie2                        |         | Phase 1 trial with  healthy volunteers                                            |   | Initiate first-in-patient  Phase 1b trial in cancer and/or inflammation during the first half of  calendar 2009 |

 

**Proprietary Development Programs**

 

*ARRY-797 - Pan-cytokine / p38 Program*

p38is a critical mediator of pain and inflammation, which acts by modulating theproduction of the pro-inflammatory cytokines TNF, IL-6 and IL-1 as well as thepain mediator PGE2. ARRY-797 is a novel, selective, potent inhibitor of p38with unique physical properties. It is highly selective with nanomolar potency,high water solubility and low potential to cross the blood brain barrier. In aPhase 1 clinical trial in healthy volunteers, ARRY-797 demonstrateddose-dependent marked suppression of all three of these cytokines, as measuredin *ex vivo* LPS-stimulated wholeblood samples.  We believe thatinhibition of p38 will modulate cytokine production in various inflammatorydisorders and, as such, ARRY-797 will be evaluated for a variety of painful,inflammatory indications.

 

Ourclinical development activities for ARRY-797 consisted of the following duringfiscal 2008:

 

·      Conducted a Phase 2 trial inacute inflammatory pain using a dental pain model.  ARRY-797 achieved its primary and secondaryendpoints for analgesic effect, was well tolerated, and prevented the rise inC-reactive protein that follows oral surgery.

·      Initiated a second Phase 2acute inflammatory pain trial in 250 patients, in which we compared three dosesof ARRY-797 (200, 400 and 600 mg) with both placebo and with an activecomparator, Celebrex® (celecoxib) (400 mg).

 

Duringfiscal 2009, we plan to initiate the following studies:

 

·                  A 28-day Phase 1study in 30 rheumatoid arthritis, or RA, patients on stable doses ofmethotrexate.

·                  A 12-week Phase 2study in ankylosing spondylitis.

 

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*ARRY-162 - MEK for Inflammation Program*

MEKhas been demonstrated to modulate the biosynthesis of certain pro-inflammatorycytokines, in particular, TNF, IL-1 and IL-6. We believe that the inhibition of MEK will have applications ininflammatory diseases characterized by high levels of these cytokines, such asarthritis, psoriasis and inflammatory bowel disease.  ARRY-162 is a first in class, orally-active,selective MEK inhibitor that is active, either alone, or in combination withother agents, in *in vivo* RAmodels.  In Phase 1 clinical trials,ARRY-162 exhibited significant cytokine inhibition and has been welltolerated.  We believe ARRY-162 is theonly MEK inhibitor currently in development for RA.

 

Our clinical development activities for ARRY-162consisted of the following during fiscal 2008:

 

·                  Reported Phase 1clinical trial results in healthy volunteers in June 2008.  In that trial, ARRY-162 showed no seriousadverse events through 14 days of continuous dosing and significantly inhibitedproduction of the inflammatory cytokines TNF, IL-1 and IL-6, as measured in *ex-vivo*, TPA-stimulated whole bloodsamples.

·                  Reported resultsfrom a Phase 1b trial of ARRY-162 in combination with methotrexate in stable RApatients.  In this study, ARRY-162 showedlinear increases in exposure with increasing dose and no drug / druginteractions between ARRY-162 and methotrexate were observed.  In addition, ARRY-162 suppressed theproduction of inflammatory cytokines, relative to methotrexate alone,suggesting that this combination treatment may be more beneficial for patientswith RA.

·                  Completedlong-term toxicology studies.

·                  Initiated a worldwide Phase 2 trial with ARRY-162 added to methotrexatein 200 patients with RA.

 

Weexpect to receive top-line results on the Phase 2 RA trial during the secondhalf of calendar 2009.

 

*ARRY 614 - p38/Tie2 for Inflammation and CancerProgram*

Asdiscussed above, p38 regulates the production of numerous cytokines, such asTNF, IL-1 and IL-6, the increased production of which can cause inflammationand aberrant tissue proliferation. Tie2 plays an important role inangiogenesis, the growth, differentiation and maintenance of new blood vessels.ARRY-614, an orally active compound that inhibits both p38 and Tie2, has beenshown to block angiogenesis, to inhibit inflammation and to antagonize tumorgrowth, while showing a low side effect profile after prolonged dosing inpreclinical models. We believe this compound will have broad therapeuticbenefits in various cancers and inflammatory diseases.

 

Duringfiscal 2008, we initiateda single and multiple dose escalation study with ARRY-614 in healthy volunteersfor safety, tolerability, exposure and inhibition of mechanism-relatedbiomarkers.

 

Duringfiscal 2009, we plan to initiate first-in-patient trials in either cancer orinflammatory disease.

 

*ARRY-543 - Pan-ErbB - EGFR / ErbB-2 Program*

ErbB-2and EGFR are receptor kinase targets that are over-expressed in a number ofmalignancies, including breast, lung, pancreas, colon and head and neckcancers. ARRY-543 is a novel, orally-active dual inhibitor of ErbB-2 andEGFR.  It behaves as a reversibleATP-competitive inhibitor with nanomolar potency both *in vitro* and in cell-based proliferationassays.

 

Inpreclinical models, ARRY-543 demonstrated significant dose-related tumor growthinhibition when administered orally.  Ithas demonstrated superior activity versus Tykerb® (lapatinib) in most EGFR andErbB-2 *in vivo* models, equivalentactivity to Iressa® (gefitinib)/ Tarceva® (erlotinib) in EGFR models, andenhanced efficacy in certain preclinical models where dual inhibition isrelevant when compared to Herceptin® (trastuzumab), Tarceva and Tykerb.

 

Our clinical development activities for ARRY-543 consisted of thefollowing during fiscal 2008:

 

·                  Presented results from a Phase 1 trial of ARRY-543 at the 2007AACR-NCI-EORTC International Conference on Molecular Targets and CancerTherapeutics and at the San Antonio Breast Cancer Symposium. ARRY-543 producedprolonged stable disease in patients who have previously failed prior

 

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treatments with solid tumors. ARRY-543 waswell-tolerated up to 400 mg twice daily, or BID, dosing. Systemicconcentrations of ARRY-543 increased with escalating doses at all dose levelstested, providing continuous exposure over a 24-hour period. In completedcohorts, sixty percent of patients receiving doses of 200 mg BID and higher hadprolonged stable disease. Based on these results, the BID regimen has beenchosen for Phase 2 studies.

·                  Initiated a Phase 1b expansion cohort at the maximum tolerated dose forARRY-543, with half of the patients with ErbB-2 positive metastatic breast cancer,who had been previously treated with Herceptin, and half of the patients withother ErbB-family expressing cancers.

 

During fiscal 2009, we plan to initiate two Phase 1b studies of ARRY-543in combination with Xeloda® (capecitabine) or Taxotere® (docetaxel).

 

*ARRY-520 - KSP Program*

ARRY-520inhibits kinesin spindle protein, or KSP, which plays an essential role inmitotic spindle formation. Like taxanes and vinca alkaloids, KSP inhibitorsinhibit tumor growth by preventing mitotic spindle formation and cell division.However, unlike taxanes and vinca alkaloids, KSP inhibitors do not demonstratecertain side effects such as peripheral neuropathy and alopecia.

 

ARRY-520has demonstrated efficacy in multiple preclinical cancer models.  ARRY-520 caused marked tumor regression inpreclinical models of human cancer at tolerated doses, and produced completeresponses in two solid tumor models (colon and ovarian) and in leukemia models.

 

Ourclinical development activities for ARRY-520 consisted of the following duringfiscal 2008:

 

·                  Completeda Phase 1 dose escalation trial in advanced cancer patients.

·                  Initiateda Phase 1 expansion trial to evaluate the safety, tolerability and preliminaryefficacy at maximum tolerated dose.

·                  Initiateda Phase 2 trial in acute myelogenous leukemia, or AML.

 

Duringfiscal 2009, we plan to begin a Phase 2 trial in multiple myeloma.

 

*ARRY-380 - ErbB-2 Program*

ErbB-2,also known as HER2, is a receptor kinase target that has been found to beover-expressed in breast cancer and other cancers. Our orally active ErbB-2inhibitor, ARRY-380, has shown efficacy and a mild side effect profile inpreclinical models of human cancer. Recently, Herceptin, theintravenously-dosed protein inhibitor that modulates ErbB-2, has been approved asan adjuvant to surgery in early stage breast cancer patients; it had alreadybeen approved for ErbB2+ metastatic breast cancer. This new indication hassignificantly expanded the number of breast cancer patients eligible for anErbB-2 inhibitor.

 

Duringfiscal 2008, we filed an IND application for ARRY-380 with the U.S. Food andDrug Administration, or the FDA, and initiated a Phase 1 clinical trial inadvanced cancer patients.  During fiscal2009, we plan to complete the Phase 1 trial and initiate Phase 1b combinationtrials.

 

**PartneredDiscovery and Development Programs**

 

Wehave collaborations with leading pharmaceutical and biotechnology companiesunder which we have out-licensed certain of our proprietary drug programs forfurther research, development and commercialization. We also have researchpartnerships with leading pharmaceutical and biotechnology companies, for whichwe design, create and optimize drug candidates, and conduct preclinical testingacross a broad range of therapeutic areas, on targets selected by ourpartners.  In certain of thesepartnerships, we also perform process research and development, clinicaldevelopment and manufacture clinical supplies.

 

Ourdiscovery and development collaborations provide funding for research anddevelopment activities we conduct and, in a number of our current agreements,up-front fees, milestone payments and/or royalties based upon the success ofthe program.  Our largest and mostadvanced collaborations include our agreements with AstraZeneca, Celgene,Genentech, InterMune, Eli Lilly, and VentiRx Pharmaceuticals, Inc.

 

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Informationabout collaborators that comprise 10 percent or more of our total revenue andabout revenue we receive within and outside the U.S. can be found in Note 2 ofthe accompanying Financial Statements included elsewhere in this Annual Report.

 

Below are summaries of our most advanced ongoing partnereddiscovery and development programs.

 

*AstraZeneca- AZD6244 / MEK Program*

We initiated ananti-cancer research program targeting MEK in July 2001, and quicklyidentified AZD6244, an orally active clinical candidate. AZD6244 and othercompounds have shown tumor suppressive or regressive activity in multiplepreclinical models of human cancer, including melanoma, pancreatic, colon,lung, and breast cancers.  Potentialadvantages of MEK inhibitors over current therapies include potential improvedefficacy and reduced side effects.

 

In December 2003, weentered into an out-licensing and collaboration agreement with AstraZeneca todevelop our MEK program solely in the field of oncology. Under the agreement,AstraZeneca acquired exclusive worldwide rights to our clinical developmentcandidate, AZD6244, together with two other compounds we developed during thecollaboration for oncology indications. We retain the rights to allnon-oncology therapeutic indications for MEK compounds not selected by AstraZenecafor development.  In April 2009, weor AstraZeneca may independently undertake research, development andcommercialization of small molecule inhibitors of MEK for any therapeuticindication; however both of us will continue to work exclusively with each otherfor the development and commercialization of AZD6244 and the other twocompounds selected by AstraZeneca in oncology. To date, we have earned $21.5 million in up-front and milestonepayments. The agreement also provides for research funding, which is nowcomplete, and potential additional development milestone payments ofapproximately $75 million and royalties on product sales. AstraZeneca isresponsible for further clinical development and commercialization for AZD6244,and for clinical development and commercialization for the other two compoundsit licensed.

 

Under our collaborationwith AstraZeneca, we conducted Phase 1 clinical testing in 2004.  The trial evaluated tolerability andpharmacokinetics of AZD6244 following oral administration to patients withadvanced cancer.  In addition, the trialexamined patients for indications of biological activity as well aspharmacodynamic and tumor biomarkers. Phase 1 testing showed that AZD6244 inhibited the MEK pathway in tumortissue at the dose that was later selected for the Phase 2 studies and providedprolonged disease stabilization in a number of cancer patients that hadpreviously received numerous othercancer therapies.

 

In June 2006, AstraZeneca initiated a Phase 2study for AZD6244 in malignant melanoma, resulting in a $3 million milestonepayment to us. The trial was a randomized Phase 2 study that compared AZD6244to Temodar® (temozolomide) in the treatment of stage III / IV melanomapatients. AstraZeneca enrolled approximately 180 patients at 40 centersworldwide. AstraZeneca also initiated additional Phase 2 studies for AZD6244 incolorectal, pancreatic and non-small cell lung cancer during 2006.

 

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During fiscal 2008, AstraZeneca reported the followingprogress on the program:

 

## ·                  AstraZenecapresented Phase 1 clinical trial results at the 2008 American Society ofClinical Oncology, or ASCO, annual meeting of a new AZD6244 capsule formulationthat replaces the mix/drink formulation used in all prior trials to date.  The new capsule’s maximum tolerated dose was25 percent lower yet provided, on average, higher exposure than historicalvalues for the mix/drink formulation. The study also reported a completeresponse in one of the patients.

## ·                  AstraZenecaalso presented Phase 2 clinical trial results of AZD6244 at ASCO:

##  

## o                 InPhase 2 trial results comparing AZD6244 to Alimta® (pemetrexed) in 84 non smallcell lung cancer, or NSCLC, patients, neither of these drugs demonstratedsuperior efficacy.

## o                 Phase2 results showed no difference between the two treatment arms in the overallpopulation comparing AZD6244 to Temodar® (temozolomide) in patients withadvanced melanoma.  The safety andtolerability profile for AZD6244 was found to be consistent with that reportedfrom the Phase 1 trial.

## o                 Phase2 results comparing AZD6244 to Xeloda® (capecitabine) in patients withmetastatic colorectal cancer showed that AZD6244 was generally well tolerated,with neither of these drugs demonstrating superior efficacy.

## ·                  AZD6244is also being investigated in a number of studies conducted by the NationalCancer Institute in collaboration with AstraZeneca.

##  

## AstraZenecaalso announced two additional Phase 2 trials of AZD6244 at ASCO. Preclinicaldata suggests that the potential benefit of AZD6244 may be maximized in sometumors when delivered as combination therapy. The two planned trials will beexploring combinations in advanced melanoma and non-small cell lung cancer, orNSCLC patients. Patient enrollment is expected to begin during the firstquarter of calendar 2009.

##  

*InterMune- ITMN-191 / Hepatitis C Virus NS3/4 Protease Program*

From 2002 to 2007,scientists from Array and InterMune have collaborated on the discovery of novelsmall molecule inhibitors of the Hepatitis C Virus, or HCV, NS3/4 protease.During the collaboration, the companies jointly discovered ITMN-191, whichInterMune is now developing in partnership with Roche. Under the terms ofcollaboration agreement, InterMune funded certain drug discovery efforts,preclinical testing, process development and manufacturing in conformity withcurrent Good Manufacturing Practices, or cGMP. InterMune will make milestonepayments to us based on the selection and progress of clinical drug candidates,as well as royalties on sales of any products derived from the collaboration.We received our first milestone payment from InterMune in June 2004.Research funding under this agreement ended June 30, 2007.

 

During 2006, we producedand delivered cGMP clinical supplies of ITMN-191, and InterMune initiated aPhase 1 clinical trial.  We received a$500 thousand milestone payment in February 2007 after the first subjectwas dosed.

 

During 2008, InterMunereported the following progress on the program:

 

·      InterMune advanced ITMN-191 in a Phase 1bmultiple-ascending-dose clinical trial evaluating ITMN-191 as monotherapy inpatients with chronic HCV.

·      InterMune also reported top-line resultsfrom four dose cohorts of treatment-naive patients demonstrating rapid andsignificant reductions in HCV RNA.

 

*EliLilly – IC83 / CHK-1 Program*

We entered into acollaboration agreement with ICOS Corporation in 1999 to create small moleculeCHK-1 inhibitors.  Our scientists andICOS scientists invented IC83, and we received a milestone payment after thefirst patient was dosed with this molecule in a Phase 1 clinical trial in early2007.  The agreement provided researchfunding, which has now ended, and we are entitled to receive additionalmilestone payments based on Eli Lilly’s achievement of clinicalmilestones.  Eli Lilly acquired ICOS in2007.

 

*VentiRx - VTX-2337 & VTX-1463 / Toll-Like Receptor(TLR-8) Program*

In February 2007, weentered into a licensing and collaboration agreement with privately heldbiopharmaceutical company VentiRx, under which we granted VentiRx exclusiveworldwide rights to certain molecules from our toll-like receptor, or TLR,program.  The program contains a numberof compounds targeting TLR’s to activate innate immunity.  VentiRx expects to develop its first twocandidates in cancer and allergy.  Wereceived an equity stake in VentiRx as well

 

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as an up-front payment,potential milestone payments and royalties on product sales.  We retain an option to acquire a 50 percentownership position in each VentiRx clinical oncology products developed underthis agreement.

 

During fiscal 2008,VentiRx reported the following progress on the program:

 

·                  VentiRx filed an IND application on VTX-2337 for the treatment ofcancer, and patients are expected to be enrolled in the Phase I trial during thesecond half of calendar 2008.

·                  VentiRx advanced VTX-1463 into regulated safety assessment testing fortreatment of allergy, with an IND expected to be filed in calendar 2009.

 

During fiscal 2009, wewill continue to collaborate with VentiRx on back-up molecules.

 

*Genentech– Oncology Programs*

We entered into alicensing and collaboration agreement with Genentech in December 2003 todevelop small molecule drugs against multiple therapeutic targets in the fieldof oncology. We initiated this collaboration to advance two of our proprietaryoncology programs into clinical development. These programs included smallmolecule leads we had developed along with additional, related intellectualproperty. Under the agreement, Genentech made an up-front payment, providesresearch funding and paid a milestone to us for nominating a clinical candidateand advancing it into regulated safety assessment testing.  In addition, Genentech has agreed to makeadditional potential development milestone payments and pay us royalties on anyresulting product sales. Genentech is responsible for clinical development andcommercialization of the resulting products.

 

In 2005 and in 2008, weexpanded our collaboration with Genentech to develop clinical candidatesdirected against an additional third and fourth cancer target,respectively.  Under the agreement, wereceive additional research funding, as well as potential research anddevelopment milestone payments and product royalties based on the success ofeach new program.  Genentech has the soleresponsibility for clinical development and commercialization of any resultingproducts.  In July 2008, Genentechextended the agreement for an additional two years of funded research through January 2011and reduced the number of full-time equivalent scientists working on theprogram. Genentech may terminate its agreement with us upon 120 days’ notice.

 

*Celgene– Oncology and Inflammation Programs*

In September 2007,we entered into a worldwide strategic collaboration with Celgene focused on thediscovery, development and commercialization of novel therapeutics in cancerand inflammation. Under the agreement, Celgene made an upfront payment of $40million to us and, in return, we granted Celgene an option to select a limitednumber of drugs developed under the collaboration that are directed to two offour mutually selected discovery targets. We are responsible for all discoveryand clinical development through Phase 1 or Phase 2a. Until this time, Celgenewill have the option to select drugs resulting from up to two of these fourtherapeutic programs and will receive exclusive worldwide rights to thosedrugs, except for limited co-promotional rights in the U.S. Additionally, weare entitled to receive, for each drug, potential milestone payments ofapproximately $200 million, if certain discovery, development and regulatorymilestones are achieved and an additional $300 million if certain commercialmilestones are achieved, as well as royalties on net sales. We will retain allrights to the other programs.  Theagreement may be terminated in whole or in part with respect to individual drugdevelopment programs by Celgene upon six months’ written notice to us and byeither party, following certain cure periods, in the event of a breach by theother party of its obligations under the agreement.

 

**MarketOpportunity**

 

We believe there is atremendous opportunity in creating drugs for debilitating and life-threateningdiseases, especially in cancer, inflammation and pain. The medical community isseeking targeted therapies that treat both the underlying disease as well ascontrol symptoms more effectively and/or more safely than drugs that arecurrently available. We believe future patient care will improve with the useof screening to select targeted therapies for more effective disease treatment.Also, clinical trials aimed at well-defined patient populations may showimproved response rates and may thereby increase the chances for FDA approval.This approach may result in a greater number of marketed drugs each aimed at asmaller subset of patients.

 

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Our proprietary pipelineis primarily directed at drugs that treat cancer, inflammatory disease andpain. The worldwide market for targeted cancer drugs -- the cancer drug market’sfastest growing segment -- is expected to grow from $25 billion in 2007 to$56 billion in 2012. The inflammatory disease market is highly diverse andincludes RA, osteoarthritis, ankylosingspondylitis, asthma, chronic obstructive pulmonary disease, psoriasis,and inflammatory bowel diseases. According to EvaluatePharma®, the worldwidemarkets for injectable targeted RA therapies and for prescription non-steroidalanti-inflammatory drugs, or NSAIDs, and opioids are expected to grow from $17 billionin 2007 to $28 billion in 2012. Additionally, with the safety concerns over the class of painmedications known as COX-2 inhibitors (such as Vioxx® and Celebrex®), newmarkets should emerge for drugs with novel mechanisms to treat chronic painassociated with arthritis and other painful inflammatory disorders.  In addition, there remains a large need toaddress patients with acute or subacute pain, such as post-operative pain.

 

In addition, the drugindustry has an ongoing need to fill clinical development pipelines with newdrugs to drive future revenue growth. Despite increased spending on internalresearch, the industry has been unable to meet this demand. As a result, it hasbecome increasingly reliant on biotech companies to acquire new drugs.  The scarcity of later-stage clinical assetsavailable for in-licensing is driving these companies to enter into licensingdeals at earlier stages, including the preclinical stage.  However, once a drug has entered clinicaldevelopment, companies generally require proof of concept data, which includesboth efficacy and safety, before they will consider licensing a drug candidate.Accordingly, we believe there is an opportunity to license first-in-class drugsat several stages during the drug development process.

 

*InflammationMarket*

Inflammation is a naturalbiologic response to injury or infectious attack to the human body. Unregulatedinflammation results in a broad range of conditions, most of which areclassified by the tissue or organ where the inflammation occurs.  These conditions include RA in the joints,psoriasis in the skin, asthma and chronic obstructive pulmonary disease in thelung, fibrotic disease in the liver and kidney, Crohn’s disease and ulcerativecolitis in the intestine, and atherosclerosis in the arteries. Currently, manyof these patients are treated with injectable protein therapeutics, such asEnbrel®, Remicade®, Humira® and Kineret®, which bind to and/or modulate theactivity of the inflammatory cytokines TNF or IL-1. These injectable proteintherapeutics have significant cost, safety and patient compliance issues.  Other therapies currently on the market,including NSAIDs and opioids, have side effect and efficacy issues.

 

Despite their drawbacks,the worldwide market for injectable targeted therapies for RA and prescriptionNSAIDs and opioids are expected to grow from $17 billion in 2007 to$28 billion in 2012.  We believethere are significant opportunities to create orally active drugs to treat manyof these often-chronic diseases and conditions. We are developing drugs thatmodulate important biological targets in key intracellular pathways thatcontrol inflammation, potentially providing the ability to treat multiplediseases and conditions with a single oral agent as follows:

 

·                 Rheumatoid Arthritis - RA is a debilitating autoimmune disease thataffects more than two million Americans, and as many as one percent of theglobal population. RA hinders the daily activities of its sufferers. The damagethat occurs in RA is a result of the immune system attacking joint tissue,causing painful chronic inflammation, often resulting in irreversibledestruction of cartilage, tendons and bones. Common RA symptoms includeinflammation of the joints, swelling, fatigue, stiffness and pain.Additionally, since RA is a systemic disease, it can have effects in othertissues such as the lungs and eyes.

·                 Ankylosing Spondylitis – Ankylosing spondylitis is a chronicinflammatory disease of joints that causes a significant reduction in qualityof life, health status and working ability for those afflicted with thedisease.  With moderate diagnosis andtreatment rates, it is substantially more prevalent than previously believed,with up to 1.5 million sufferers in the U.S.  Diagnosis of ankylosingspondylitis is often delayed primarily due to the insensitivity of radiographs,coupled with limited availability of therapeutic options and low diseaseawareness.  Treatment options includephysical therapy and NSAIDs. Conventional disease-modifying anti-rheumatic drugs are ineffective foraxial disease.  Recent data showed that70% of ankylosing spondylitis patients progress to having a fusion of the spinewithin 10 to 15 years.  While ankylosingspondylitis has considerable impact at both the individual and community level,it has received little attention due to the difficulty in diagnosing it earlyand the commonly held assumption of a low probability for good clinicaloutcome.  With the recent success ofanti-TNF therapies in treating ankylosing spondylitis, this outcome assumptionhas been challenged, with data showing the ability and efficacy of anti-TNFtherapy, which we believe may expand the market for small molecule cytokinemodulators in the treatment of ankylosing spondylitis.

 

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*PainMarket*

Over 59 million patientsin the U.S. alone are treated for acute pain annually.  The incidence of acute pain typically occursin surgical or trauma/emergency settings. Surgical patients typically experience moderate to severe pain for a fewdays or a few weeks and primarily use analgesics, including opiods and/orNSAIDs, to manage it.   Additionally, theWorld Health Organization estimates that 5 million people suffer moderate tosevere pain associated with cancer worldwide. The market size in the U.S. for acute pain drugs is estimated to be $2.3billion in 2008 and $2.9 billion in 2012 and is expected to grow at a compoundannual growth rate of approximately 1% over the next 10 years.

 

Opioids have been shownto be efficacious in the management of pain. Opioids, however, cause nausea, vomiting, constipation, and respiratoryand psychological side effects.  Additionally,drug abuse is a major concern with the use of opioids.  NSAIDs have demonstrated modest painreduction, but they are less effective than opioids.  Although NSAIDS have a more favorable safetyprofile than opioids, renal toxicity and gastrointestinal bleeding areassociated with their use. Cardiovascular side effects are linked with Cox-2 inhibitors.  This presents an opportunity for a drug withcomparable or better efficacy than NSAIDS, including Cox-2 inhibitors, andopioids.

 

*Cancer Market*

Despitea wide range of available cancer therapies, patient responses remain limitedand variable. As a result, oncologists are increasingly using combinationtherapies and drug dosing regimens tailored for individual tumor types andpatients. Targeted therapies are believed to be more efficacious with fewerside effects than first generation cytotoxic chemotherapy drugs, as they areable to specifically target the underlying mechanisms of the disease byregulating discrete aspects of cellular function affecting cancer cells to agreater extent than normal cells. We believe certain cancers will eventuallybecome chronic diseases, treated with a combination of targeted therapies.  Our research strategy in the cancer market isto build a pipeline of complementary targeted therapies.

 

Accordingto the American Cancer Society, Surveillance Research Study for 2008, there arean estimated 1.4 million new cases of cancer in 2008 and nearly 600 thousandcancer related deaths.  The five-yearrelative survival rate for all cancers diagnosed between 1996 and 2003 was only66 percent.  Earlier diagnosis and theuse of new and/or improved treatments have resulted in improved survivalrates.  The following table showsestimated new cases diagnosed and estimated deaths in the U.S. during 2007 bymajor cancer types of interest to us:

 
| **Type of Cancer** | ** ** | **New Cases** | ** ** | **Deaths** | ** ** |
|------------------------------|------------|--------------------|------------|------------|------------|
| ** **                   | ** ** | ** **         | ** ** | ** ** | ** ** |
| Lung                         |       | 215,020            |       | 161,840    |       |
| Prostate                     |       | 186,320            |       | 28,660     |       |
| Breast                       |       | 184,450            |       | 40,930     |       |
| Colorectal                   |       | 108,070            |       | 49,960     |       |
| Melanoma                     |       | 62,480             |       | 8,420      |       |
| Pancreas                     |       | 37,680             |       | 34,290     |       |
| Multiple Myeloma             |       | 19,920             |       | 10,690     |       |
| Acute Myelogenous Leukemia   |       | 13,290             |       | 8,820      |       |
|                         |       | 827,230            |       | 343,610    |       |

 

Theuse of targeted therapies has the potential to change the focus of cancertreatment away from categorization and treatment modality by organ type andtowards categorization and treatment modalities by level of gene expression inindividual patients, or “personalized medicine.”  It is believed that targeted therapies andpersonalized medicine will result in increased survival with improved qualityof life.  However, a potentialimplication of personalized medicine is smaller market opportunities.

 

Oncology,both in treating cancer itself and palliative therapy, has been a majortherapeutic category for biotechnology companies since the inception of theindustry.  Recently, major pharmaceuticalcompanies have increased their research and development and in-licensinginvestment in this market, particularly the targeted

 

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cancertherapy market.  Targeted therapiescurrently on the market that have been successful include Avastin®, Gleevec®, Herceptin andRituxan®.

 

*Breast Cancer*

BreastCancer is the third most prevalent cancer type in the U.S., with 184 thousandnew cases diagnosed per year. Approximately 25 percent of all breast cancer patients are HER2+.Herceptin is an intravenously-dosed monoclonal antibody currently on the marketfor the treatment of breast cancers that over-express HER2 and is approved forHER2+ adjuvant breast cancer and all lines of HER2+ metastatic breastcancer.  We believe the broad use ofHerceptin in HER2+ breast cancer suggests a high potential value for an orallyactive drug that regulates HER2 and can be conveniently dosed for extendedperiods of time.

 

Tykerb,a small molecule drug that modulates ErbB-2 and EGFR, was approved in March 2007for the treatment of patients with metastatic HER2+ breast cancer patientswhose tumors have failed to respond to Herceptin and chemotherapy in second andthird-line treatment.  Tykerb incombination with Xeloda is currently being used in five percent of all treatedbreast cancer patients, approximately 15 percent of the HER2+subpopulation.  Tykerb’s sales during 2007were $102 million, with 2008 worldwide sales projected to reach $228 million.

 

*Multiple Myeloma*

Multiplemyeloma is a hematological cancer in which malignant plasma cells areoverproduced in the bone marrow.  Normalplasma cells are white blood cells that produce antibodies that fight infectionand disease.  Multiple Myeloma plasmacells replace normal plasma cells and other white blood cells which areimportant to maintaining the immune system.

 

Multiplemyeloma is the second most common hematologic malignancy in the U.S.  It is a disease which primarily afflicts theelderly, with an average onset occurring between the ages of 65 to 70.  The incidence of multiple myeloma in 2007 isestimated to be over 40 thousand in the seven major global markets.  Approximately 11 thousand people die annuallyfrom multiple myeloma in the U.S. alone.

 

*Acute Myeloid Leukemia*

Acutemyelogenous leukemia, or AML, is a fast-growing cancer of the blood and bonemarrow. In acute myelogenous leukemia, the bone marrow makes many unformedcells called blasts. Blasts normally develop into white blood cells that fightinfection. However, the blasts are abnormal in AML. They do not develop andcannot fight infections. The bone marrow may also make abnormal red blood cellsand platelets. The number of abnormal cells (or leukemia cells) grows quickly.They crowd out the normal red blood cells, white blood cells and platelets thebody needs.

 

AMLis the most common type of leukemia. More than 13 thousand new cases occur inthe U.S. each year, mostly in older adults. The average age of a person withAML is 65 years.

 

**Researchand Development for Proprietary Drug Discovery**

 

Our primary researchefforts are centered on the treatment of cancer, inflammatory disease andpain.  Our research focuses on biologicfunctions, or pathways, that have been identified as important in the treatmentof human disease based on human clinical, genetic or preclinical data. Withinthese pathways, we seek to create first-in-class drugs regulating important therapeutictargets to treat patients with serious or life-threatening conditions,primarily in cancer, inflammatory disease and other important diseaseareas.  In addition, we seek to identifyopportunities to improve upon existing therapies or drugs in clinicaldevelopment by creating clinical candidates with superior, or best-in-class,drug characteristics, including efficacy, tolerability or dosing to providesafer, more effective drugs. During fiscal years 2008, 2007 and 2006, we spent$90.3 million, $57.5 million and $33.4 million, respectively, on research anddevelopment for proprietary drug discovery, which consist of costs associated with our proprietary drugprograms for, among other things, salaries and benefits for scientificpersonnel, consulting and outsourced services, laboratory supplies, allocatedfacilities costs and depreciation.

 

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***Drug Discovery and Development Timeline***

* *

The drug developmentprocess is highly uncertain, subject to a number of risks that are beyond ourcontrol and takes many years to complete. The following table outlines each phase in the drug development process.  Completion times are difficult to estimateand can vary greatly based on the drug and indication.  Therefore, the duration times shown in thetable below are estimates only.

 
| **Phase**    | ** ** | **Objective**                                                                                              | ** ** | **Estimated  Duration** |
|--------------|------------|------------------------------------------------------------------------------------------------------------|------------|-------------------------|
| ** **   | ** ** | ** **                                                                                                 | ** ** | ** **              |
| Discovery    |       | Lead identification and  target validation                                                                 |       | 2 to 4 years            |
|         |       |                                                                                                       |       |                    |
| Preclinical  |       | Initial toxicology for  preliminary identification of risks for humans; gather early pharmacokinetic  data |       | 1 to 2 years            |
|         |       |                                                                                                       |       |                    |
| Phase 1      |       | Evaluate safety in  humans; study how the drug works, metabolizes and interacts with other drugs           |       | 1 to 2 years            |
|         |       |                                                                                                       |       |                    |
| Phase 2      |       | Establish effectiveness  of the drug and its optimal dosage; continue safety evaluation                    |       | 2 to 4 years            |
|         |       |                                                                                                       |       |                    |
| Phase 3      |       | Confirm efficacy,  dosage regime and safety profile of the drug; submit New Drug Application               |       | 2 to 4 years            |
|         |       |                                                                                                       |       |                    |
| FDA Approval |       | Approval by the FDA to  sell and market the drug under approved labeling                                   |       | 6 months to 2  years    |

 

Animal and othernon-clinical studies are often conducted during each phase of human clinicalstudies. Proof of concept for a drug candidate generally occurs during Phase 2after safety and efficacy data is established.

 

**OurResearch and Development Technologies and Expertise**

 

We are continuing toimprove our comprehensive research and development capabilities, consisting ofthree integrated areas of expertise:

 

·                  Discovery Research - Biology, Chemistry and Translational Medicine

·                  Process Research, Development andManufacturing

·                  Clinical Development

 

These capabilities aresupported by an integrated information technology system.  Over the next three years, we plan tocontinue building a significant clinical development competency capable ofdelivering robust proof of concept results and to scale process research,development and manufacturing to meet clinical needs, while optimizing ourcurrent discovery capability at approximately its current size.  In the longer term, we plan to build a Phase3 clinical and regulatory product filing capability and therapeutic sales forceto become a fully integrated commercial stage biopharmaceutical company.

 

*Research*

We have a broad drugdiscovery platform with all the necessary capabilities to efficiently inventnew chemical compounds.  We continue toadd to our knowledge breadth, refine our processes, and hire key scientiststhat enhance our current capabilities. We have expanded our translational medicine team, which designs and runsmechanistic studies in cell biology and pharmacology to provide insight intoclinical development strategy, product differentiation, and biomarker supportfor clinical development.  Today, we arerecognized as having one of the premier small molecule drug discoverycapabilities in the biotech industry in its comprehensiveness, scale andexpertise. To date, our average cost to invent a new chemical entity and filean IND application is less than $15 million, compared to estimates of up to$100

 

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million spent by majorpharmaceutical companies.  The discoverygroup has created high quality clinical assets. To date, every wholly-owned, and to our knowledge, every partnered, drugto reach the clinic has been shown to modulate its mechanistic target, asmeasured by an appropriate clinical biomarker.

 

*ProcessResearch, Development, Formulation and Manufacturing*

We have built and continue to enhance our processresearch and development and cGMP manufacturing to accommodate the productivityof our research platform and support of the clinical development plans.  We enhanced our process research, developmentand manufacturing capabilities to include formulations, physical formcharacterization and certain aspects of clinical supply manufacturing duringfiscal 2008.  In parallel, we are growingand improving our abilities to manage the work of contract manufacturingorganizations which we retain to perform certain of these functions.

 

*ClinicalDevelopment*

Our current keycapabilities within clinical development include clinical operations, safetymonitoring, biostatistics, programming and data management, regulatory strategyand program management.  As our pipelinegrows, we expect to continue to invest in building our clinical developmentexpertise and resources. This group leads the development and implementation ofour clinical and regulatory strategies. Our near term focus is on bringing ourdrugs through proof of concept clinical trials.   Our proof of concept strategy is toefficiently conduct studies to demonstrate the value of each program in atherapeutic area so that decisions to continue, modify or cease development ofa program can be made early in the development process.  We believe that our broad developmentpipeline and productive discovery platform provide an incentive to designtrials for each program with high hurdles to demonstrate the potential of thedrug or to “fail early.”

 

The clinical group worksclosely with the discovery and translational medicine groups to select diseaseindications in which our drugs are studied in clinical trials. The clinicalgroup designs, directs and implements all clinical operations, includingidentifying and selecting clinical investigators, recruiting study subjects toparticipate in our clinical trials, biostatistics, data management, drug safetyevaluation, and adverse event reporting. The clinical group also is responsiblefor assuring that our development programs are conducted in compliance withapplicable regulatory requirements. The group also works closely with the crossfunctional project and clinical teams to facilitate the appropriate andefficient development of our diverse product pipeline.

 

*InformationTechnology*

We believe that ourinformation technology capabilities provide a competitive advantage.  We understand the importance of thiscapability to maintain competitiveness in our information-rich environment andto increasing our productivity by capturing, organizing and providingappropriate information to improve decision making.  We accomplished our primary goal of creatinga paperless research environment, which we believe has empowered our scientiststo improve real time decision-making “at the bench top.”  Our goal is to develop a complementarycapability in preclinical, clinical development and regulatory affairs toprovide a similar competitive advantage as our research information technologyplatform provides.  We have begundeployment of a state-of-the-art company-wide information system that organizesand provides access to real-time information, and is customizable to individualneeds.

 

**Competitors**

 

The pharmaceutical andbiotechnology industries are characterized by rapid and continuoustechnological innovation. We compete with companies worldwide that are engagedin the research and discovery, licensing, development and commercialization ofdrug candidates, including large pharmaceutical companies with internaldiscovery and development functions, biotech companies with competing productsin the therapeutic areas we are targeting and contract research organizationsthat perform many of the functions we perform under our collaborations.  In addition, we face competition from otherpharmaceutical and biotechnology companies seeking to out-license drugstargeting the same disease class or condition as our drug candidates based on,among other things, patent position, product efficacy, safety, reliability,availability, patient convenience, price and reimbursement potential.Therefore, we may be unable to enter into collaboration, partnering, orout-licensing agreements on terms that are acceptable to us, or at all. We alsocompete with other clinical trials for patients who are eligible to be enrolledin clinical trials we or our collaborators are conducting, which may limit thenumber patients who meet the criteria for enrollment and delay or prevent us orour collaborators from completing trials when anticipated. Because the timingof entry of a drug in the market presents important competitive advantages, thespeed with which we are able to complete drug development and clinical trials,obtain regulatory approval and

 

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supply commercialquantities of drugs to the market will affect our competitive position.   Someof our competitors have a broader range of capabilities and have greater accessto financial, technical, scientific, regulatory, business development,recruiting and other resources than we do. Their access to greater resourcesmay allow them to develop processes or products that are more effective, saferor less costly, or gain greater market acceptance, than products we develop orfor which they obtain FDA approval more rapidly than we do. We anticipate thatwe will face increased competition in the future as new companies enter themarket and advanced technologies become available.

 

**GovernmentRegulation**

 

Biopharmaceuticalcompanies are subject to substantial regulation by governmental agencies in theU.S. and other countries. Virtually all pharmaceutical products are subject torigorous preclinical and clinical testing and other approval procedures by theFDA and by foreign regulatory agencies. Before a drug product is approved bythe FDA for commercial marketing, three phases of human clinical trials areusually conducted to test the safety and effectiveness of the product.  Phase 1 clinical trials most typicallyinvolve testing the drug on a small number of healthy volunteers to assess thesafety profile of the drug at different dosage levels.  Phase 2 clinical trials, which may alsoenroll a relatively small number of patient volunteers, are designed to furtherevaluate the drug’s safety profile and to provide preliminary data as to thedrug’s effectiveness in humans.  Phase 3clinical trials consist of larger, well-controlled studies that may involveseveral hundred or thousand patient volunteers representing the drug’s targetedpopulation.  During any of these phases,the clinical trial can be placed on clinical hold, or temporarily orpermanently stopped for a variety of reasons, principally for safetyconcerns.  In addition, the failure tocomply with applicable regulatory requirements in the U.S. and in othercountries in which we conduct development activities could result in a varietyof fines and sanctions, such as warning letters, product recalls, productseizures, suspension of operations, fines and civil penalties or criminalprosecution.

 

The approval process istime-consuming and expensive, and there are no assurances that approval will begranted on a timely basis, or at all. Even if regulatory approvals are granted,a marketed product is subject to continual review under federal and state lawsand regulations.  Post-marketingrequirements include reporting adverse events, recordkeeping, and compliancewith cGMP and marketing requirements. Adverse events reported after marketing of a drug can result inadditional restrictions being placed on the use of a drug and, possibly, inwithdrawal of the drug from the market. The FDA may also require labelingchanges to products at any time based on new safety information.

 

If drug candidates wedevelop are approved for commercial marketing by the FDA, they would be subjectto the provisions of the Drug Price Competition and Patent Term Restoration Actof 1984 known as the “Hatch-Waxman Act.” The Hatch-Waxman Act provides companies with marketing exclusivity fornew chemical entities and allows companies to apply to extend patent protectionfor up to five additional years. It also provides a means for approving genericversions of a drug product once the marketing exclusivity period has ended andall relevant patents have expired (or have been successfully challenged anddefeated).  The period of exclusive marketingmay be shortened, however, by a successful patent challenge.

 

All facilities andmanufacturing processes used in the production of Active PharmaceuticalIngredients for clinical use in the U.S. must be operated in conformity withcGMP as established by the FDA. We have a cGMP manufacturing facility, whichallows us to produce cGMP compliant compounds. In our facility, we have thecapacity to produce Active Pharmaceutical Ingredients for Phase 1 and Phase 2clinical testing. We have validated this capability for compliance with FDAregulations and began our first cGMP manufacturing campaign in 2002. Our cGMPfacility is subject to periodic regulatory inspections to ensure compliancewith cGMP requirements. We could also be required to comply with specificrequirements or specifications of our collaborators, which may be morestringent than regulatory requirements. If we fail to comply withapplicable regulations, the FDA could require us to cease ongoing research ordisqualify the data submitted to regulatory authorities. A finding that we hadmaterially violated cGMP requirements could result in additional regulatorysanctions and, in severe cases, could result in a mandated closing of our cGMPfacility, which would materially and adversely affect our business, financialcondition and results of operations.

 

In the course of ourbusiness, we handle, store and dispose of chemicals and biological samples. Weare subject to various federal, state and local laws and regulations relatingto the use, manufacture, storage, handling and disposal of hazardous materialsand waste products. These environmental laws generally impose liability

 

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regardless of the negligenceor fault of a party and may expose us to liability for the conduct of, orconditions caused by, others.

 

Most health careproviders, including research institutions from whom we or our collaboratorsobtain patient information, are subject to privacy rules under the HealthInsurance Portability and Accountability Act of 1996, or HIPAA, the Directive95/46-EC of the European Parliament on the protection of individuals withregard to the processing of personal data as well as individual European Union memberstates implementing additional legislation, and similar legislation in othercountries.  Although our clinicaldevelopment efforts are not directly regulated by these privacy regulations, wecould face substantial criminal penalties if we knowingly receive individuallyidentifiable health information from a health care provider that has notsatisfied HIPAA’s or the European Union Data Protection Directive’s disclosurestandards. In addition, certain privacy laws and genetic testing laws may applydirectly to our operations and/or those of our collaborators and may imposerestrictions on the use and dissemination of individuals’ health information.

 

Our clinical developmentactivities involve the production and use of intermediate and bulk active pharmaceuticalingredients, or API. We typically contract with third party manufacturersto produce API for us. Some of these manufacturers are located outside the U.S.and may obtain ingredients from suppliers in other foreign countries beforeshipping the bulk API to Array in the U.S. Cross-border shipments ofpharmaceutical ingredients and products are subject to regulation in the UnitedStates by the FDA and in foreign countries, including, in the EU, underdirectives adopted by the EU member countries. These regulations generallyimpose notice requirements on us or our third party manufacturers andrequire confirmation that we are registered with the FDA and have an INDapplication, an approved New Drug Application or Biologics License Application.

 

We are subject to otherregulations, including regulations under the Occupational Safety and HealthAct, regulations promulgated by the U.S. Department of Agriculture, andregulations under other federal, state and local laws.

 

**Intellectual Property**

 

Our success depends inpart on our ability to protect our potential drug candidates, otherintellectual property rights and our proprietary software technologies. Toestablish and protect our proprietary technologies and products, we rely on acombination of patent, copyright, trademark and trade secret laws, as well asconfidentiality provisions in our contracts with collaborators.

 

We attempt to protect ourtrade secrets by entering into confidentiality agreements with our employees,third parties and consultants. Our employees also sign agreements requiringthat they assign to us their interests in inventions, original expressions andany corresponding patents and copyrights arising from their work for us.However, it is possible that these agreements may be breached, invalidated orrendered unenforceable, and if so, we may not have an adequate remedyavailable. Despite the measures we have taken to protect our intellectualproperty, parties to our agreements may breach the confidentiality provisionsor infringe or misappropriate our patents, copyrights, trademarks, tradesecrets and other proprietary rights. In addition, third parties mayindependently discover or invent competing technologies or reverse-engineer ourtrade secrets or other technology.

 

Our patent strategy isdesigned to protect inventions, technology and improvements to inventions thatare commercially important to our business. We currently have 16 issued U.S.patents and numerous patent applications on file with the U.S. Patent andTrademark Office and around the world. The source code for our proprietarysoftware programs is protected both as a trade secret and as a copyrightedwork.

 

U.S. patents issued fromapplications filed on or after June 8, 1995, have a term of 20 yearsfrom the application filing date or earlier claimed priority. All of our patentapplications were filed after June 8, 1995. Patents in most othercountries have a term of 20 years from the date of filing of the patentapplication. Because the time from filing patent applications to issuance ofpatents is often several years, this process may result in a period of patentprotection significantly shorter than 20 years, which may adversely affectour ability to exclude competitors from our markets. Our success will depend inpart upon our ability to develop proprietary products and technologies and toobtain patent coverage for these products and technologies. We intend tocontinue to file patent

 

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applications coveringnewly developed products and technologies. We may not, however, commercializethe technology underlying any or all of our existing or future patentapplications.

 

Patents provide somedegree of protection for our proprietary technology. However, the pursuit andassertion of patent rights, particularly in areas like pharmaceuticals andbiotechnology, involve complex legal and factual determinations and, therefore,are characterized by some uncertainty. In addition, the laws governingpatentability and the scope of patent coverage continue to evolve, particularlyin biotechnology. As a result, patents may not be issued from any of our patentapplications or from applications licensed to us. The scope of any of ourpatents, if issued, may not be sufficiently broad to offer meaningfulprotection. In addition, our patents or patents licensed to us, if they areissued, may be successfully challenged, invalidated, circumvented or renderedunenforceable so that our patent rights might not create an effectivecompetitive barrier. Moreover, the laws of some foreign countries may notprotect our proprietary rights to the same extent as do the laws of the U.S.Any patents issued to us or our strategic partners may not provide a legalbasis for establishing an exclusive market for our products or provide us withany competitive advantages. Moreover, the patents held by others may adverselyaffect our ability to do business or to continue to use our technologiesfreely. In view of these factors, our intellectual property positions bear somedegree of uncertainty.

 

**Employees**

 

As of June 30, 2008,we had 386 full-time employees, including 292 scientists, of whom 131 have PhD’sor MD’s. None of our employees are covered by collective bargaining agreements,and we consider our employee relations to be good.

 

**OurCorporate Information**

 

Our principal executiveoffices are located at 3200 Walnut Street, Boulder, Colorado 80301 and ourphone number is (303) 381-6600.  We werefounded in 1998 and became a public company in November 2000.  Our stock is listed on the NASDAQ GlobalMarket under the symbol “ARRY.”

 

**AvailableInformation**

** **

Electronic copies of ourAnnual Reports on Form 10-K, Quarterly Reports on Form 10-Q andCurrent Reports on Form 8-K and other documents we file with or furnish tothe SEC are available free of charge (i) on the “Investor Relations”section of our website at http://www.arraybiopharma.com or (ii) bysending a written request to Investor Relations at our corporate headquarters.Information on our website is not incorporated by reference into this report.

 

**ITEM 1A. RISK FACTORS**

 

In addition to the otherfactors discussed elsewhere in this report and in other reports we file withthe SEC, the following factors could cause our actual results or events todiffer materially from those contained in any forward-looking statements madeby us or on our behalf.  In addition,other risks and uncertainties not presently known to us or that we currentlydeem immaterial may impair our business operations.  If any of the following risks or such otherrisks occur, it could adversely affect our business, operating results andfinancial condition, as well as cause the value of our common stock to decline.

 

**Risks Related to Our Business**

** **

*WeHave a History of Losses and May Not Achieve or Sustain Profitability.*

We are at an early stageof executing our business plan, and we have a limited history of developing andout-licensing our proprietary drug candidates and offering our drug discoverycapabilities. We have incurred significant operating and net losses andnegative cash flows from operations since our inception. As of June 30,2008, we had an accumulated deficit of $285.4 million. We had net losses of $96.3million, $55.4 million and $39.6 million for the fiscal years ended June 30,2008, 2007 and 2006, respectively. We expect to incur additional losses andnegative cash flows in the future, and these losses may continue or increasedue in part to anticipated increases in expenses for research and developmentfor proprietary drug discovery, particularly clinical development, expansion ofour clinical and scientific capabilities, development of commercialcapabilities and

 

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acquisitions ofcomplementary technologies. At the same time, we expect that revenue from thesale of our research tools and services will continue to decline as apercentage of total revenue as we devote more resources to drug discovery andour proprietary drug programs.  As aresult, we may not be able to achieve or maintain profitability. Moreover, ifwe do achieve profitability, the level of any profitability cannot be predictedand may vary significantly.

 

*We May NotReceive Royalty or Milestone Revenue Under Our Collaboration Agreements forSeveral Years, or at All.*

Much of our current revenue is non-recurring in natureand unpredictable as to timing and amount. While several of our out-license andcollaboration agreements provide for royalties on product sales, none of ourdrug candidates have been approved for commercial sale, our drug candidates areat early stages of development and drug development entails a high risk offailure. Consequently, we do not expect to receive any royalty revenue forseveral years, if at all. For the same reasons, we may never realize much ofthe milestone revenue provided for in our out-license and collaborationagreements. Similarly, drugs we select to commercialize ourselves or partnerfor later-stage co-development and commercialization may not generate revenuefor several years, or at all.

 

*Our Drug Candidates Are at Early Stages of Development, andWe May Not Successfully Develop a Drug Candidate That Becomes aCommercially Viable Drug.*

Thedrug discovery and development process is highly uncertain, and we have notdeveloped, and may never develop, a drug candidate that ultimately leads to acommercially viable drug. All of our most advanced drug candidates are in theearly stages of development, in either Phase 1 or Phase 2, and we do not haveany drugs approved for commercial sale. Before a drug product is approved bythe FDA for commercial marketing, it is tested for safety and effectiveness inclinical trials that can take up to six years or longer. Promising results inpreclinical development or clinical trials may not be predictive of resultsobtained in later clinical trials. A number of pharmaceutical companies haveexperienced significant setbacks in advanced clinical trials, even afterobtaining promising results in earlier preclinical and clinical trials. At anytime, the FDA may place a clinical trial on clinical hold, or temporarily orpermanently stop the trial, for a variety of reasons, principally for safetyconcerns.  We or our collaborators mayexperience numerous unforeseen events during, or as a result of, the clinicaldevelopment process that could delay or prevent our drug candidates from beingapproved, including:

* *

·                  Failure to achieve clinical trial results thatindicate a candidate is effective in treating a specified condition or illnessin humans;

·                  Presence of harmful side effects;

·                  Determination by the FDA that the submitted data donot satisfy the criteria for approval;

·                  Lack of commercial viability of the drug;

·                  Failure to acquire, on reasonable terms, intellectualproperty rights necessary for commercialization; and

·                  Existence of therapeutics that are more effective.

 

*We or Our Collaborators May Choose Not to Commercializea Drug Candidate at Any Time During Development, Which Would Reduce orEliminate Our Potential Return on Investment for That Drug.*

At any time, we or our collaborators may decide to discontinue thedevelopment of a drug candidate or not to commercialize a candidate. If weterminate a preclinical program in which we have invested significantresources, we will have expended resources on a program that will not provideany or a full return on our investment and we will have missed the opportunityto have allocated those resources to potentially more productive uses. Even ifone of our drug candidates receives regulatory approval for marketing,physicians or consumers may not find that its effectiveness, ease of use, sideeffect profile, cost or other factors make it effective in treating disease ormore beneficial than or preferable to other drugs on the market. Additionally,third party payors, such as government health plans and health insurance plansor maintenance organizations, may choose not to include our drugs on theirformulary lists for reimbursement. As a result, our drugs may not be used ormay be used only for restricted applications.

 

*WeMay Not Be Successful In Entering Into Additional Out-License Agreementson Favorable Terms.*

We are committingsignificant resources to create our own proprietary drug candidates and tobuild a commercial-stage biopharmaceutical company. In fiscal 2008, weincreased our investment in proprietary research to $90.3 million inresearch and development for proprietary drug discovery expenses, compared to$57.5 million and $33.4 million for fiscal years 2007 and 2006,respectively. Our proprietary drug discovery programs are in their

 

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early stage ofdevelopment and are unproven. To date, we have entered into five out-licensingagreements for the development and commercialization of our drug candidates.Although we have expended, and continue to expend, resources on internalresearch and development for proprietary drug discovery for our proprietaryprograms, we may not be successful in entering into additional out-licensingagreements with favorable terms, including up-front, milestone, royalty and/orlicense payments and the retention of certain valuable commercialization orco-promote rights, as a result of factors, many of which are outside of ourcontrol, and which include:

 

·                  Our ability to create valuable proprietary drug candidates targetinglarge market opportunities;

·                  Research and spending priorities of potential licensing partners;

·                  Willingness of and the resources available to pharmaceutical andbiotechnology companies to in-license drug candidates to fill their clinicalpipelines; or

·                  Our ability or inability to agree with a potential partner on the valueof proprietary drug candidates we are seeking to out-license, or on the relatedterms.

* *

*Our Capital Requirements Could Significantly Increase If WeChoose to Develop More of Our Proprietary Programs Internally.*

We believe thatthe maximum value for certain proprietary drug candidates is best achieved byretaining the rights to develop and commercialize the candidate and not seekinga partner or by waiting until later in the development process to seek apartner to co-develop and commercialize or co-promote a product.  It is difficult to predict which of ourproprietary programs are likely to yield higher returns if we elect to developthem further before seeking a partner or to not seek a partner at all as aresult of many factors, including the competitive position of the product, ourcapital resources, the perceived value among potential partners of the productand other factors outside of our control. Therefore, we may undertake and fund,solely at our expense, further development, clinical trials, manufacturing andmarketing activities for a greater number of proprietary candidates than weplanned. In addition, we may choose not to out-license certain of ourproprietary programs if we are unable to do so on terms that are favorable tous. As a result, our requirements for capital could increase significantly. Wemay be unable to raise additional required capital on favorable terms, or atall, however, or we may be required to substantially reduce our developmentefforts, which would delay, limit or prevent our ability to commercialize andrealize revenue from our drug candidates.

 

*We May Not Out-License Our Proprietary Programs at theMost Appropriate Time to Maximize the Total Value or Return of These Programsto Us.*

A critical aspect of ourbusiness strategy is to out-license drug candidates for late-stage development,co-development and/or commercialization to obtain the highest possible valuewhile also evaluating earlier out-licensing opportunities to maximize ourrisk-adjusted return on our investment in proprietary research. Because thecosts and risk of failure of bringing a drug to market are high, the value ofout-licensing a drug candidate generally increases as it successfullyprogresses through clinical trials. We may choose or be forced to out-license adrug candidate or program on terms that require us to relinquish commercial ormarket rights or at a point in the research and development process that doesnot provide as great a value or return than what might have been obtained if wehad further developed the candidate or program internally. Likewise, we maydecline, or be unable to obtain favorable, early out-licensing opportunities inprograms that do not result in a commercially viable drug, which could leavethe resulting program with little or no value even though significant resourceswere invested in its development.  Ourinability to successfully out-license our programs on favorable terms couldmaterially adversely affect our results of operations and cash flows.

 

*IfWe Fail to Adequately Conduct Clinical Trials, Our Potential Return Could BeReduced or Eliminated.*

Before any of our drugcandidates can be sold commercially, we or our collaborators must conductclinical trials that demonstrate that drug is safe and effective for use inhumans for the indications sought. The results of these clinical trials areused as the basis to obtain regulatory approval from government authoritiessuch as the FDA. Conducting clinical trials is a complex, time-consuming andexpensive process that requires an appropriate number of trial sites andpatients to support the product label claims being sought. The length of time,number of trial sites and number of patients required for clinical trials varysubstantially according to their type, complexity, novelty and the drugcandidate’s intended use, and therefore, we may spend as much as several yearscompleting certain trials. Further, the time within which we can complete ourclinical trials depends in large part on the ability to enroll eligiblepatients that meet the enrollment criteria and who are in proximity to thetrial sites. We and our collaborators also face competition with other clinicaltrials for eligible patients. As a consequence, there may be limitedavailability of eligible patients, which can result in increased developmentcosts, delays in

 

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regulatory approvals andassociated delays in drug candidates reaching the market. Patients may alsosuffer adverse medical events or side effects in the course of our clinicaltrials that may delay or prohibit regulatory approval of our drug candidates.Even if we or our collaborators successfully conduct clinical trials, we or ourcollaborators may not obtain favorable clinical trial results and may not beable to obtain regulatory approval on this basis.

 

In addition, to executeour clinical development plans, we need to accelerate the growth of ourclinical development organization and increase dependence on third-partyclinical trial service providers. We anticipate that we will be required tocontract with clinical sites and enroll patients in a number of new geographiclocations where our experience conducting clinical trials is more limited,including some countries in Eastern Europe and South American, and in India. Weare conducting and plan to conduct further clinical trial activities interritories outside the U.S. through third-party clinical trial serviceproviders.

 

If we or ourcollaborators fail to adequately manage the increasing number, size andcomplexity of clinical trials, the clinical trials and corresponding regulatoryapprovals may be delayed or we or our collaborators may fail to gain approvalfor our drug candidates altogether. If we or our collaborators are unable tomarket and sell our drug candidates or are unable to obtain approvals in thetimeframe needed to execute our product strategies, our business and results ofoperations would be materially adversely affected.

 

*WeExpect That Revenue From Our Funded Research Collaborations Will Decline In theFuture As We Focus More Resources on Our Proprietary Research Programs.*

We expect that revenuefrom our funded research collaborations to discover drug candidates againsttargets our collaborators select will decline. Historically, revenue from these collaborations has partially fundeddevelopment of a drug discovery platform for identifying and developing earlystage drug candidates.  We believe thevalue of the drug candidates we have created for many of our collaboratorsunder these collaboration agreements has exceeded the economic reward providedto us under the agreements.   We intendto continue to implement our partnering strategy, a key component of which, inaddition to potentially obtaining higher milestone and royalty rates, is toout-license later stage candidates and retain commercialization or promotionalrights in parts of the world.  As weimplement this strategy, we expect to make significant investments in our owndrug discovery and development efforts to discover additional candidates forout-licensing and to develop candidates to proof-of-concept and that ourcollaboration revenue will decline as our historical collaborations end.

 

*We Have Limited Clinical Development and CommercializationExperience.*

One ofour business strategies is to develop select drug candidates through laterstage clinical trials before out-licensing them to a pharmaceutical orbiotechnology partner for further clinical development and commercializationand to commercialize select drug candidates ourselves. We have not yetconducted a Phase 3 or later stage clinical trial ourselves, nor have wecommercialized a drug. We have limited experience conducting clinical trialsand obtaining regulatory approvals, and we may not be successful in some or allof these activities. We have no experience as a company in the sales, marketingand distribution of pharmaceutical products and do not currently have a salesand marketing organization. We expect to expend significant amounts to recruitand retain high quality personnel with clinical development experience.Developing commercialization capabilities would be expensive andtime-consuming, could delay any product launch, and we may never be able todevelop this capacity. To the extent we are unable or determine not to developthese resources internally, we may be forced to rely on third-party clinicalinvestigators, or clinical research or marketing organizations, which couldsubject us to costs and to delays that are outside our control. If we areunable to establish adequate capabilities independently or with others, we maybe unable to generate product revenues for certain candidates.

 

*Delays In the Commencement or Completion of Clinical TestingCould Result In Increased Costs to Us and Delay or Limit Our Ability toGenerate Revenues.*

Delaysin the commencement or completion of clinical testing of our products couldsignificantly affect our product development costs and our ability to generaterevenue from these products. We do not know whether planned clinical trialswill begin on time or be completed on schedule, if at all. The commencement andcompletion of clinical trials can be delayed for a number of reasons, includingdelays related to our ability to do the following:

 

·                  Obtain regulatory approval to commence a clinical trial;

 

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·                 Reach agreement on acceptable terms with prospective clinical researchorganizations, or CROs, and trial sites, the terms of which can be subject toextensive negotiation and may vary significantly among different CROs and trialsites;

·                 Manufacture sufficient quantities of a product candidate for use inclinical trials;

·                 Obtain institutional review board, or IRB, approval to conduct aclinical trial at a prospective site;

·                 Recruit and enroll patients to participate in clinical trials, whichcan be impacted by many factors outside our control, including competition fromother clinical trial programs for the same or similar indications; and

·                 Retain patients who have initiated a clinical trial but may be prone towithdraw due to side effects from the therapy, lack of efficacy or personalissues.

 

Clinical trials may alsobe delayed as a result of ambiguous or negative interim results. In addition, aclinical trial may be suspended or terminated by us, the FDA, the IRBoverseeing the clinical trial at issue, any of our clinical trial sites withrespect to that site, or other regulatory authorities due to a number offactors, including:

 

·                  Failure to conduct the clinical trial in accordance with regulatoryrequirements or our clinical protocols;

·                  Inspection of the clinical trial operations or trial sites by the FDAor other regulatory authorities resulting in the imposition of a clinical hold;

·                  Unforeseen safety issues; and

·                  Lack of adequate funding to continue the clinical trial.

 

Additionally, changes inregulatory requirements and guidance may occur and we may need to amendclinical trial protocols to reflect these changes. Amendments may require us toresubmit our clinical trial protocols to IRBs for reexamination, which mayimpact the costs, timing or successful completion of a clinical trial. If weexperience delays in completion of, or if we terminate, any of our clinicaltrials, the commercial prospects for our product candidates may be harmed andour ability to generate product revenues will be delayed and/or reduced. Inaddition, many of the factors that cause, or lead to, a delay in thecommencement or completion of clinical trials may also ultimately lead to thedenial of regulatory approval of a product candidate.

 

*Drug Candidates That We Develop With Our Collaborators or onOur Own May Not Receive Regulatory Approval*

Thedevelopment and commercialization of drug candidates for our collaborators andour own internal drug discovery efforts are subject to regulation.Pharmaceutical products require lengthy and costly testing in animals andhumans and regulatory approval by governmental agencies prior tocommercialization. It takes several years to complete testing, and failure canoccur at any stage of testing. Results attained in preclinical testing andearly clinical trials for any of our drug candidates may not be indicative ofresults that are obtained in later studies, and significant setbacks inadvanced clinical trials may arise, even after promising results in earlierstudies. Clinical trials may not demonstrate sufficient safety and efficacy toobtain the requisite regulatory approvals or result in marketable products. Furthermore,data obtained from preclinical and clinical studies are susceptible to varyinginterpretations that may delay, limit or prevent regulatory approval. Inaddition, the administration of any drug candidate we develop may produceundesirable side effects or safety issues that could result in theinterruption, delay or suspension of clinical trials, or the failure to obtainFDA or other regulatory approval for any or all targeted indications. Based onresults at any stage of testing, we or our collaborators may decide to repeator redesign a trial or discontinue development of a drug candidate.

 

Approval of a drugcandidate as safe and effective for use in humans is never certain, andregulatory agencies may delay or deny approval of drug candidates for commercialization.These agencies may also delay or deny approval based on additional governmentregulation or administrative action, on changes in regulatory policy during theperiod of clinical trials in humans and regulatory review or on the availabilityof alternative treatments. Similar delays and denials may be encountered inforeign countries. None of our collaborators have obtained regulatory approvalto manufacture and sell drug candidates owned by us or identified or developedunder an agreement with us. If we or our collaborators cannot obtain thisapproval, we will not realize milestone or royalty payments based oncommercialization goals for these drug candidates.

 

In light of widelypublicized events concerning the safety of certain drug products, such asVioxx, regulatory authorities, members of Congress, the GovernmentAccountability Office, or the GAO, medical professionals, and the generalpublic have raised concerns about potential drug safety issues. These eventshave resulted in the withdrawal of drug products, revisions to drug labelingthat further limit use of the drug products, and establishment

 

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of risk management plansthat may, for instance, restrict distribution of drug products. Although drugsafety concerns have occurred over time, the increased attention to this issuemay result in a more cautious approach by the FDA. As a result, data fromclinical trials may receive greater scrutiny with respect to safety. Safetyconcerns may result in the FDA or other regulatory authorities terminatingclinical trials before completion or requiring longer or additional clinicaltrials that may result in substantial additional expense and a delay or failurein obtaining approval or approval for a more limited indication than originallysought.

 

*Even If Our Drug Candidates Obtain Regulatory Approval, Weand Our Collaborators Will Be Subject to Ongoing Government Regulation.*

Even if regulatoryauthorities approve any of our drug candidates, the manufacture, labeling,storage, recordkeeping, distribution, marketing and sale of these drugs will besubject to strict and ongoing regulation. Compliance with this regulationconsumes substantial financial and management resources and may expose us andour collaborators to the potential for other adverse circumstances. Forexample, approval for a drug may be conditioned on costly post-marketingfollow-up studies. Based on these studies, if a regulatory authority does notbelieve that the drug demonstrates a clinical benefit to patients, it couldlimit the indications for which a drug may be sold or revoke the drug’smarketing approval. In addition, identification of certain side effects after adrug is on the market may result in the subsequent withdrawal of approval,reformulation of a drug, additional preclinical and clinical trials and changesin labeling or distribution. Any of these events could delay or prevent us fromgenerating revenue from the commercialization of these drugs and cause us toincur significant additional costs.

 

Given the number ofrecent high profile safety events with certain drug products, the FDA mayrequire, as a condition of approval, costly risk management programs withcomponents including safety surveillance, restricted distribution and use,patient education, enhanced labeling, special packaging or labeling, expeditedreporting of certain adverse events, pre-approval of promotional materials, andrestrictions on direct-to-consumer advertising. Furthermore, heightenedCongressional scrutiny on the adequacy of the FDA’s drug approval process andthe agency’s efforts to assure the safety of marketed drugs has resulted in theproposal of new legislation addressing drug safety issues. If enacted, any newlegislation could result in delays or increased costs for manufacturers anddrug sponsors during the period of product development, clinical trials, andregulatory review and approval, as well as increased costs to assure compliancewith any new post-approval regulatory requirements.

 

In addition, themarketing of these drugs by us or our collaborators will be regulated byfederal and state laws pertaining to health care “fraud and abuse,” such as thefederal anti-kickback law prohibiting bribes, kickbacks or other remunerationfor the order, purchase or recommendation of items or services reimbursed byfederal health care programs. Many states have similar laws applicable to itemsor services reimbursed by commercial insurers. Violations of fraud and abuselaws can result in fines and/or imprisonment.

 

*If Our Drug Candidates Do Not Gain Market Acceptance, We May BeUnable to Generate Significant Revenue.*

Even if our drugcandidates are approved for sale, they may not be successful in themarketplace. Market acceptance of any of our drug candidates will depend on anumber of factors including:

 

·                  Demonstration of clinical effectiveness and safety;

·                  Potential advantages of our drug candidates over alternativetreatments;

·                  Ability to offer our drug candidates for sale at competitive prices;

·                  Availability of adequate third-party reimbursement; and

·                  Effectiveness of marketing and distribution methods for the products.

 

If our drug candidates donot gain market acceptance among physicians, patients and others in the medicalcommunity, our ability to generate meaningful revenues from our drug candidateswould be limited.

* *

*If We Need But Are Unable to Obtain Additional Funding toSupport Our Operations, We Could Be Unable to Successfully Execute OurOperating Plan or Be Forced to Reduce Our Operations.*

We have historicallyfunded our operations through revenue from our collaborations, the issuance ofequity securities and debt financing. We used $45.7 million in our operatingactivities in fiscal 2008, while we used $44.5 million and $24.3 million in ouroperating activities in fiscal 2007 and 2006, respectively. In addition, aportion of our cash flow is dedicated to the payment of principal and interest,and possibly to fund increased compensating and restricted cash balances withthe lender, on our existing senior secured credit facility, which provides fora $10

 

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million term loan and a$5 million equipment line, and may be dedicated to the payment of principal andinterest on our credit facility with Deerfield Private Design Fund, L.P. andDeerfield Private Design International Fund, L.P. (who we refer to collectivelyas Deerfield), which provides for an $80 million term loan that at our optionmay be repaid with our common stock. Our debt obligations could thereforerender us more vulnerable to competitive pressures and economic downturns andimposes some restrictions on our operations. Although we anticipate that we will use more cash in our operatingactivities in future periods, we believe that our existing cash, cashequivalents and marketable securities, amounts available on the DeerfieldCredit Facility and anticipated cash flow from existing out-license andcollaboration agreements will be sufficient to support our current operatingplan for at least the next 12 months. However, our current operating planand assumptions could change as a result of many factors, and we could requireadditional funding sooner than anticipated.

 

If we are unable to meetour capital requirements from cash generated by our future operating activitiesand are unable to obtain additional funds when needed, we may be required tocurtail operations significantly or to obtain funds through other arrangementson unattractive terms, which could prevent us from successfully executing ouroperating plan. If we raise additional capital through the sale of equity orconvertible debt securities, the issuance of those securities would result indilution to our stockholders.

 

*Our Collaborators Have Substantial Control and DiscretionOver the Timing and the Continued Development and Marketing of Drug CandidatesWe Create for Them.*

Our collaborators havesignificant discretion in determining the efforts and amount of resources thatthey dedicate to our collaborations. Our collaborators may determine not toproceed with clinical development or commercialization of a particular drugcandidate for a number of reasons that are beyond our control, even undercircumstances where we might have continued such a program. In addition, ourability to generate milestone payments and royalties from our collaboratorsdepends on our collaborators’ abilities to establish the safety and efficacy ofour drug candidates, obtain regulatory approvals and achieve market acceptanceof products developed from our drug candidates. We also depend on ourcollaborators to manufacture clinical scale quantities of some of our drugcandidates and would depend on them in the future for commercial scalemanufacture, distribution and direct sales. Our collaborators may not besuccessful in manufacturing our drug candidates on a commercial scale or insuccessfully commercializing them.

 

We face additional risksin connection with our collaborations, including the following:

 

·                  Collaborators may develop and commercialize, either alone or withothers, products and services that are similar to or competitive with theproducts that are the subject of the collaboration with us;

·                  Collaborators may under fund or not commit sufficient resources to thetesting, marketing, distribution or other development of our drug candidates;

·                  Collaborators may not properly maintain or defend our intellectualproperty rights or they may utilize our proprietary information in such a wayas to invite litigation that could jeopardize or potentially invalidate ourintellectual property or proprietary information or expose us to potentialliability;

·                  Collaborators may encounter conflicts of interest, changes in businessstrategy or other business issues which could adversely affect theirwillingness or ability to fulfill their obligations to us (for example,pharmaceutical and biotechnology companies historically have re-evaluated theirpriorities following mergers and consolidations, which have been common inrecent years in these industries); and

·                  Disputes may arise between us and our collaborators delaying orterminating the research, development or commercialization of our drugcandidates, resulting in significant litigation or arbitration that could betime-consuming and expensive, or causing collaborators to act in their ownself-interest and not in the interest of our stockholders.

 

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*RevenueFrom Collaborations Depends on the Extent to Which the Pharmaceutical andBiotechnology Industries Collaborate With Other Companies for One or MoreAspects of Their Drug Discovery Process.*

Our capabilities include aspects of the drug discoveryprocess that pharmaceutical and biotechnology companies have traditionallyperformed internally. The willingness of these companies to expand or continuedrug discovery collaborations to enhance their research and development processis based on several factors that are beyond our control, any of which couldcause our revenue to decline. These include their ability to hire and retainqualified scientists, the resources available for entering into drug discoverycollaborations and the spending priorities among various types of researchactivities. In addition, our ability to convince these companies to use ourdrug discovery capabilities, rather than develop them internally, depends onmany factors, including our ability to:

 

·                  Develop and implement drug discovery technologies that will result inthe identification of higher-quality drug candidates;

·                  Attract and retain experienced, high caliber scientists;

·                  Achieve timely, high-quality results at an acceptable cost; and

·                  Design, create and manufacture our chemical compounds in quantities, atpurity levels and at costs that are acceptable to our collaborators.

 

The importance of thesefactors varies depending on the company and type of discovery program, and wemay be unable to meet any or all of them in the future. Even if we are able toaddress these factors, these companies may still decide to perform theseactivities internally or retain other companies that provide drug research anddevelopment expertise similar to ours.

 

*Our Research and DevelopmentCapabilities May Not Produce Viable Drug Candidates.*

We have entered into several research and developmentcollaborations under which we provide drug discovery and development servicesto identify drug candidates for our collaborators. We also seek to identify anddevelop drug candidates for our proprietary programs. It is uncertain whetherwe will be able to provide drug discovery more efficiently or create highquality drug candidates that are suitable for our or our collaborators’purposes, which may result in delayed or lost revenue, loss of collaborators orfailure to expand our existing relationships. Our ability to create viable drugcandidates for ourselves and our collaborators depends on many factors,including the implementation of appropriate technologies, the development ofeffective new research tools, the complexity of the chemistry and biology, thelack of predictability in the scientific process and the performance anddecision-making capabilities of our scientists. Our information-driventechnology platform, which we believe allows our scientists to make betterdecisions, may not enable our scientists to make correct decisions or developviable drug candidates.

 

*IfOur Drug Discovery and Development Programs Do Not Progress As Anticipated, OurRevenue and Stock Price Could Be Negatively Impacted.*

We estimate the timing ofa variety of preclinical, clinical, regulatory and other milestones forplanning purposes, including when a drug candidate is expected to enterclinical trials, when a clinical trial will be completed or when an applicationfor regulatory approval will be filed. Some of our estimates are included inthis report. We base our estimates on facts that are currently known to us andon a variety of assumptions, many of which are beyond our control. Delays maybe caused by regulatory or patent issues, interim or final results of on-goingclinical trials, scheduling conflicts with participating clinics and theavailability of patients who meet the criteria for, and the rate of patientenrollment in, clinical trials. If we or our collaborators do not achievemilestones when anticipated, we may not achieve our planned revenue, and ourstock price could decline.  In addition,any delays in obtaining approvals to market and sell drugs may result in theloss of competitive advantages in being on the market sooner than, or inadvance of, competing products, which may reduce the value of these productsand the potential revenue we receive from the eventual sale of these products,either directly or under agreements with our partners.

 

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*We May Not Realize Anticipated Benefits From FutureAcquisitions, Investments and Strategic Partnerships.*

As part of our businessstrategy, we may acquire, invest in or form strategic partnerships withbusinesses with complementary products, services and/or technologies.Acquisitions, investments and strategic partnerships involve numerous risks,including, but not limited to:

 

·                  Difficultiesand increased costs in connection with integration of the personnel,operations, technologies and products of acquired companies;

·                  Diversionof management’s attention from other operational matters;

·                  Potentialloss of key employees;

·                  Potentialloss of key collaborators;

·                  Lackof synergy, or the inability to realize expected synergies, resulting from theacquisition or partnership; and

·                  Impairmentof acquired intangible assets as a result of technological advancements orworse-than-expected clinical results or performance of the acquired company orthe partnered assets.

 

Acquisitions,investments and strategic partnerships are inherently risky and involvesignificant investments in time and resources to effectively manage these risksand integrate an acquired business or create a successful drug with a strategicpartner. Even with investments in time and resources, an acquisition orstrategic partnership may not produce the revenues, earnings or businesssynergies we anticipate. An acquisition or strategic partnership that fails tomeet our expectations could materially and adversely affect our business,financial condition and results of operations.

 

*Because We Rely on a Small Number of Collaborators for aSignificant Portion of Our Revenue, If One or More of Our Major CollaboratorsTerminates or Reduces the Scope of Their Agreement With Us, Our Revenue May SignificantlyDecrease.*

A relatively small number ofcollaborators account for a significant portion of our revenue as outlinedfurther in the section below entitled Management’s Discussion and Analysis ofFinancial Condition and Results of Operations. We expect that revenue from a limited number of collaborators will  continue to account for a large portion ofour revenue in future quarters. In general, our collaborators may terminatetheir contracts with us upon 90 to 120 days’ notice for any reason. Inaddition, some of our major collaborators can determine the amount of productsdelivered and research or development performed under these agreements. As aresult, if any one of our major collaborators cancels, declines to renew orreduces the scope of its contract with us, our revenue may significantlydecrease.

 

*We May Not Be Able to Recruit and Retain theExperienced Scientists and Management We Need to Compete In the Drug Researchand Development Industry.*

Wehave 386 employees as of June 30, 2008, and our future success dependsupon our ability to attract, retain and motivate highly skilled scientists andmanagement. Our ability to achieve our business strategies, includingprogressing drug candidates through later stage development orcommercialization, attracting new collaborators and retaining, renewing andexpanding existing collaborations, depends on our ability to hire and retain highcaliber scientists and other qualified experts, particularly in clinicaldevelopment and commercialization.  Wecompete with pharmaceutical and biotechnology companies, contract researchcompanies and academic and research institutions to recruit personnel and facesignificant competition for qualified personnel, particularly clinicaldevelopment personnel. We may incur greater costs than anticipated, or may notbe successful, in attracting new scientists or management or in retaining ormotivating our existing personnel.

 

Ourfuture success also depends on the personal efforts and abilities of theprincipal members of our senior management and scientific staff to providestrategic direction, manage our operations and maintain a cohesive and stableenvironment. In particular, we rely on the services of Robert E. Conway,our Chief Executive Officer; Dr. Kevin Koch, our President and ChiefScientific Officer; Dr. David L. Snitman, our Chief Operating Officer andVice President, Business Development; Dr. John Yates, our Chief MedicalOfficer, R. Michael Carruthers, our Chief Financial Officer; andJohn R. Moore, our Vice President and General Counsel. We have employmentagreements with all of the above personnel that are terminable upon 30 days’prior notice.

 

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*Our cGMP and Pharmacology Facilities and Practices May Failto Comply with Government Regulations.*

Allfacilities and manufacturing processes used in the production of drug products,including Active Pharmaceutical Ingredients for clinical use in the U.S. mustbe operated in conformity with current Good Manufacturing Practices, or cGMP,as established by the FDA. Similar requirements exist for manufacture of drugproducts for clinical use in other countries. These requirements include, amongother things, quality control, quality assurance and the maintenance of recordsand documentation. If we fail to comply with these requirements, we may not beable to continue the production of our products, and we could be subject tofines and penalties, suspension of production, suspension or delay in productapproval, product seizure or recall, or withdrawal of product approval. Weoperate a clinical-scale manufacturing facility that we believe conforms tocGMP requirements. This facility and our cGMP practices are subject to periodicregulatory inspections to ensure compliance with cGMP requirements. Inaddition, we could be required to comply with specific requirements of ourcollaborators, which may exceed FDA or other applicable regulations. Failure onour part to comply with applicable regulations and specific requirements of ourcollaborators could result in the termination of ongoing research,disqualification of data for submission to regulatory authorities, delays ordenials of new product approvals, warning letters, fines, consent decreesrestricting or suspending manufacturing operations, injunctions, civil penalties,recall or seizure of products, and criminal prosecution. Material violations ofcGMP requirements could result in regulatory sanctions and, in severe cases,could result in a mandated closing of our cGMP facility.

 

Inconnection with our application for commercial approvals and, if any drugcandidate is approved by the FDA or other regulatory agencies for commercialsale, a significant scale-up in manufacturing may require additional validationstudies. If we are unable to successfully increase the manufacturing capacityfor a drug candidate, the regulatory approval or commercial launch of that drugcandidate may be delayed, or there may be a shortage of supply, which couldlimit our ability to commercialize the drug.

 

Inaddition, our pharmacology facility may be subject to the U.S. Department ofAgriculture, or USDA, regulations for certain animal species. Failure on ourpart to comply with applicable regulations and specific requirements of ourcollaborators could result in the termination of ongoing pharmacology research.Material violations of USDA requirements could result in additional regulatorysanctions and, in severe cases, could result in a mandated closing of ourpharmacology facility for certain species.

 

*Our Development, Testing and Manufacture of Drug Candidates May ExposeUs to Product Liability and Other Lawsuits.*

Wedevelop, test and manufacture drug candidates that are generally intended foruse in humans. Our drug discovery and development activities, includingclinical trials we or our collaborators conduct, that result in the futuremanufacture and sale of drugs by us or our collaborators expose us to the riskof liability for personal injury or death to persons using these drugcandidates. We may be required to pay substantial damages or incur legal costsin connection with defending any of these product liability claims, or we maynot receive revenue from expected royalty or milestone payments if thecommercialization of a drug is limited or ceases as a result of such claims. Wehave product liability insurance that contains customary exclusions andprovides coverage up to $10.0 million per occurrence and in the aggregate,which we believe is customary in our industry for our current operations.However, our product liability insurance does not cover every type of productliability claim that we may face or loss we may incur, and may not adequatelycompensate us for the entire amount of covered claims or losses or for the harmto our business reputation. We may be unable to acquire or maintain additionalor maintain our current insurance policies at acceptable costs or at all.

 

*If Our Use of Chemical and Hazardous Materials ViolatesApplicable Laws or Regulations or Causes Personal Injury We May Be Liablefor Damages.*

Ourdrug discovery activities, including the analysis and synthesis of chemicalcompounds, involve the controlled use of chemicals, including flammable,combustible, toxic and radioactive materials that are potentially hazardous.Our use, storage, handling and disposal of these materials is subject tofederal, state and local laws and regulations, including the ResourceConservation and Recovery Act, the Occupational Safety and Health Act and localfire codes, and regulations promulgated by the Department of Transportation,the Drug Enforcement Agency, the Department of Energy, the Colorado Departmentof Public Health and Environment, and the Colorado Department of HumanServices, Alcohol and Drug Abuse Division. We may incur significant costs tocomply with these laws and regulations in the future. In addition, we cannotcompletely eliminate the risk of accidental contamination or injury from thesematerials, which could result in material unanticipated expenses, such assubstantial fines or penalties, remediation costs or damages, or the loss of apermit or other authorization

 

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tooperate or engage in our business. Those expenses could exceed our net worthand limit our ability to raise additional capital.

 

*Our Operations Could Be Interrupted By Damage to OurSpecialized Laboratory Facilities.*

Ouroperations are dependent upon the continued use of our highly specializedlaboratories and equipment in Boulder and Longmont, Colorado. Catastrophicevents, including fires or explosions, could damage our laboratories,equipment, scientific data, work in progress or inventories of chemicalcompounds and may materially interrupt our business. We employ safetyprecautions in our laboratory activities in order to reduce the likelihood ofthe occurrence of these catastrophic events; however, we cannot eliminate thechance that such an event will occur. The availability of laboratory space in theselocations is limited, and rebuilding our facilities could be time consuming andresult in substantial delays in fulfilling our agreements with ourcollaborators. We maintain business interruption insurance in the amount of$18.0 million to cover continuing expenses and lost revenue caused by suchoccurrences. However, this insurance does not compensate us for the loss ofopportunity and potential harm to customer relations that our inability to meetour collaborators’ needs in a timely manner could create.

 

*Due to Our Reliance on Contract ResearchOrganizations and Other Third Parties to Conduct Our Clinical Trials, We AreUnable to Directly Control the Timing, Conduct and Expense of Our ClinicalTrials.*

Werely primarily on third parties to conduct our clinical trials. As a result, wehave had and will continue to have less control over the conduct of ourclinical trials, the timing and completion of the trials, the requiredreporting of adverse events and the management of data developed through the trialthan would be the case if we were relying entirely upon our own staff.Communicating with outside parties can also be challenging, potentially leadingto mistakes as well as difficulties in coordinating activities. Outside partiesmay have staffing difficulties, may undergo changes in priorities or may becomefinancially distressed, adversely affecting their willingness or ability toconduct our trials. We may experience unexpected cost increases that are beyondour control. Problems with the timeliness or quality of the work of a contractresearch organization may lead us to seek to terminate the relationship and usean alternative service provider. However, making this change may be costly andmay delay our trials, and contractual restrictions may make such a changedifficult or impossible. Additionally, it may be impossible to find areplacement organization that can conduct our trials in an acceptable mannerand at an acceptable cost.

 

*Controls We or Our Third Party Service Providers Havein Place to Ensure Compliance With Laws May Not Be Effective to EnsureCompliance With All Applicable Laws and Regulations.*

Thediscovery and development of our products, together with our generaloperations, are subject to extensive regulation in the United States by stateand federal agencies and, as we begin to conduct clinical trials and otheractivities outside the United States, in foreign countries. Due to escalatingcosts and difficulties associated with conducting certain types of clinicaltrials in the United States, we expect that we will be required to conductcertain clinical trials in foreign locations where we have little experience,including countries in eastern Europe, South America and India. We expect thatwe typically will conduct these trials through third party clinical trialservice providers. In addition, we purchase from third party suppliers andmanufacturers that are located outside the United States, principally countriesin Europe, intermediate and bulk active pharmaceutical ingredients, or API,that are used in our development efforts. As a result, we and our contractorsare subject to regulations in the United States and in the foreign countries inwhich the API is sourced and manufactured relating to the cross-border shipmentof pharmaceutical ingredients. Although we have developed and institutedcontrols based on what we believe to be current best practices, we, ouremployees, our consultants or our contractors may not be in compliance with allpotentially applicable U.S. federal and state regulations and/or laws or allpotentially applicable foreign regulations and/or laws. Further, we have alimited ability to monitor and control the activities of third party serviceproviders, suppliers and manufacturers to ensure compliance by such partieswith all applicable regulations and/or laws. We may be subject to directliabilities or be required to indemnify such parties against certainliabilities arising out of any failure by them to comply with such regulationsand/or laws. If we or our employees, consultants or contractors fail to complywith any of these regulations and/or laws a range of actions could result,including, but not limited to, the termination of clinical trials, the failureto approve a product candidate, restrictions on our products or manufacturingprocesses, including withdrawal of our products from the market, significantfines, exclusion from government healthcare programs or other sanctions orlitigation.

 

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**Risks Related To Our Industry**

 

*The Concentration of the Pharmaceutical and BiotechnologyIndustry and Any Further Consolidation Could Reduce the Number of Our PotentialCollaborators.*

There are a limited numberof pharmaceutical and biotechnology companies, and these companies represent asignificant portion of the market for our capabilities. The number of ourpotential collaborators could decline even further through consolidation amongthese companies. If the number of our potential collaborators declines evenfurther, they may be able to negotiate greater rights to the intellectualproperty they license from us, price discounts or other terms that areunfavorable to us.

 

*Capital Market Conditions May Reduce Our BiotechnologyCollaborators’ Ability to Fund Research.*

Traditionally,many unprofitable biotechnology companies have funded their research anddevelopment expenditures through raising capital in the equity markets. Declinesand uncertainties in these markets have severely restricted raising new capitalat times in the past and have affected these companies’ ability to continue toexpand or fund existing research and development efforts. If our current orfuture biotechnology collaborators are unable to raise sufficient capital tofund research and development expenditures, we may not be able to expand ormaintain current revenue.

 

*Health Care Reform and Cost Control Initiatives ByThird-Party Payors Could Reduce the Prices That Can Be Charged for Drugs, WhichCould Limit the Commercial Success of Our Drug Candidates.*

Inthe U.S., there have been and we expect there will continue to be a number oflegislative and regulatory proposals to change the healthcare system in waysthat could significantly affect our business. Federal and state lawmakersregularly propose and, at times, enact legislation that would result insignificant changes to the healthcare system, some of which are intended tocontain or reduce the costs of medical products and services. For instance, theMedicare Prescription Drug Improvement and Modernization Act of 2003, amongother things, added a new Part D prescription drug benefit for Medicarebeneficiaries otherwise without prescription drug coverage. Furthermore, futurelegislation may limit the prices that can be charged for drugs we develop andmay limit our commercial opportunity and reduce any associated revenue andprofits. For example, federal laws require drug manufacturers to pay specifiedrebates for medicines reimbursed by Medicaid and to provide discounts forout-patient medicines purchased by certain public health service entities and “disproportionateshare” hospitals and for purchases by some federal governmental departmentssuch as the Department of Veterans Affairs and the Department of Defense. Insome countries other than the U.S., reimbursement, pricing and profitability ofprescription pharmaceuticals and biopharmaceuticals are subject to governmentcontrol. We are unable to predict what additional legislation or regulation, ifany, relating to the healthcare industry or third-party coverage andreimbursement may be enacted in the future or what effect such legislation orregulation would have on our business.

 

Also,we expect managed care plans will continue to put pressure on the pricing ofpharmaceutical and biopharmaceutical products. Cost control initiatives coulddecrease the price that we, or any potential collaborators, receive for any ofour future products, which could adversely affect our profitability. Theseinitiatives may also have the effect of reducing the resources thatpharmaceutical and biotechnology companies can devote to in-licensing drugcandidates and the research and development of new drugs, which could reduceour resulting revenue. Any cost containment measures or other reforms that areadopted could have a negative impact on our ability to commercializesuccessfully our products or could limit or eliminate our spending ondevelopment of new drugs and affect our profitability.

 

*We or Our Collaborators May Not Obtain FavorableReimbursement Rates for Our Drug Candidates.*

Thecommercial success of our drug candidates will depend on the availability andadequacy of coverage and reimbursement from third-party payors, includinggovernment and private insurance plans. Third-party payors are increasinglychallenging the prices charged for pharmaceuticals and other medical products.Our products may be considered less cost-effective than existing products, and,as such, coverage and reimbursement to the patient may not be available or besufficient to allow the sale of our products on a competitive basis.

 

Inaddition, the market for our drug candidates will depend significantly onaccess to third-party payors’ drug formularies, or lists of medications forwhich third-party payors provide coverage and reimbursement. Industrycompetition to be included in such formularies can result in downward pricingpressures on pharmaceutical companies. As such, we cannot provide assurances thatour products will be placed on third-party payors’

 

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formularies.To the extent that our products are listed on third-party payors’ formularies,we or our collaborators may not be able to negotiate favorable reimbursementrates for our products. If we or our collaborators fail to obtain an adequatelevel of reimbursement for our products by third-party payors, sales of thedrugs would be adversely affected or there may be no commercially viable marketfor the products.

 

*The Drug Research and Development Industry Has a History ofPatent and Other Intellectual Property Litigation, and We May Be InvolvedIn Costly Intellectual Property Lawsuits.*

Thedrug research and development industry has a history of patent and otherintellectual property litigation, and we believe these lawsuits are likely tocontinue. Legal proceedings relating to intellectual property would beexpensive, take significant time and divert management’s attention from otherbusiness concerns. Because we produce drug candidates for a broad range oftherapeutic areas and provide many different capabilities in this industry, weface potential patent infringement suits by companies that control patents forsimilar drug candidates or capabilities or other suits alleging infringement oftheir intellectual property rights. There could be issued patents of which weare not aware that our products infringe or patents that we believe we do notinfringe that we are ultimately found to infringe. Moreover, patentapplications are in many cases maintained in secrecy for eighteen months afterfiling or even until patents are issued. The publication of discoveries in thescientific or patent literature frequently occurs substantially later than thedate on which the underlying discoveries were made and patent applications werefiled. Because patent applications can take many years to issue, there may becurrently pending applications of which we are unaware that may later result inissued patents that we infringe with our products. In addition, technologycreated under our research and development collaborations may infringe theintellectual property rights of third parties, in which case we may not receivemilestone or royalty revenue from those collaborations.

 

Ifwe do not prevail in an infringement lawsuit brought against us, we might haveto pay substantial damages, including triple damages, and we could be requiredto stop the infringing activity or obtain a license to use the patentedtechnology or redesign our products so as not to infringe the patent. We maynot be able to enter into licensing arrangements at a reasonable cost oreffectively redesign our products. Any inability to secure licenses oralternative technology could delay the introduction of our products or preventus from manufacturing or selling products.

 

*The Intellectual Property Rights We Rely on to Protect OurProprietary Drug Candidates and the Technology Underlying Our Tools andTechniques May Be Inadequate to Prevent Third Parties From Using OurTechnology or Developing Competing Capabilities or to Protect Our Interests InOur Proprietary Drug Candidates.*

Oursuccess depends in part on our ability to protect patents and maintain thesecrecy of proprietary processes and other technologies we develop for thetesting and synthesis of chemical compounds in the drug discovery process. Wecurrently have 16 issued U.S. patents and numerous patent applications on filewith the U.S. Patent and Trademark Office and around the world.

 

Anypatents that we may own or license now or in the future may not affordmeaningful protection for our drug candidates or our technology and tools. Inorder to protect or enforce our intellectual property rights, we may have toinitiate legal proceedings against third parties. Our efforts to enforce andmaintain our intellectual property rights may not be successful and may resultin substantial costs and diversion of management time. In addition, othercompanies may challenge our patents and, as a result, these patents could benarrowed, invalidated or rendered unenforceable, or we may be forced to stopusing the technology covered by these patents or to license the technology fromthird parties. In addition, current and future patent applications on which wedepend may not result in the issuance of patents in the U.S. or foreigncountries. Even if our rights are valid, enforceable and broad in scope,competitors may develop drug candidates or other products based on similarresearch or technology that is not covered by our patents.

 

Patentapplications relating to or affecting our business may have been filed by anumber of pharmaceutical and biopharmaceutical companies and academicinstitutions. A number of the technologies in these applications or patents mayconflict with our technologies, patents or patent applications, which couldreduce the scope of patent protection we could otherwise obtain. We could alsobecome involved in interference proceedings in connection with one or more ofour patents or patent applications to determine priority of inventions. Wecannot be certain that we are the first creator of inventions covered bypending patent applications, or that we were the first to file patentapplications for any such inventions.

 

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Drugcandidates we develop that are approved for commercial marketing by the FDAwould be eligible for market exclusivity for varying time periods during whichgeneric versions of a drug may not be marketed, and we could apply to extendpatent protection for up to five additional years under the provisions of theDrug Price Competition and Patent Term Restoration Act of 1984, known as the “Hatch-WaxmanAct.” The Hatch-Waxman Act provides a means for approving generic versions of adrug once the marketing exclusivity period has ended and all relevant patentshave expired. The period of exclusive marketing, however, may be shortened if apatent is successfully challenged and defeated, which could reduce the amountof royalties we receive on the product.

 

*Agreements We Have With Our Employees, Consultants andCollaborators May Not Afford Adequate Protection for Our Trade Secrets,Confidential Information and Other Proprietary Information.*

Inaddition to patent protection, we also rely on copyright and trademarkprotection, trade secrets, know-how, continuing technological innovation andlicensing opportunities. In an effort to maintain the confidentiality andownership of our trade secrets and proprietary information, we require ouremployees, consultants and advisors to execute confidentiality and proprietaryinformation agreements. However, these agreements may not provide us withadequate protection against improper use or disclosure of confidentialinformation and there may not be adequate remedies in the event of unauthorizeduse or disclosure. Furthermore, we may from time to time hire scientificpersonnel formerly employed by other companies involved in one or more areassimilar to the activities we conduct. In some situations, our confidentialityand proprietary information agreements may conflict with, or be subject to, therights of third parties with whom our employees, consultants or advisors haveprior employment or consulting relationships. Although we require our employeesand consultants to maintain the confidentiality of all proprietary informationof their previous employers, these individuals, or we, may be subject toallegations of trade secret misappropriation or other similar claims as aresult of their prior affiliations. Finally, others may independently developsubstantially equivalent proprietary information and techniques or otherwisegain access to our trade secrets. Our failure or inability to protect ourproprietary information and techniques may inhibit or limit our ability tocompete effectively, or exclude certain competitors from the market.

 

*The Drug Research and Development Industry Is HighlyCompetitive, and We Compete With Some Companies That Offer a Broader Range ofCapabilities and Have Better Access to Resources Than We Do.*

Thepharmaceutical and biotechnology industries are characterized by rapid andcontinuous technological innovation. We compete with many companies worldwidethat are engaged in the research and discovery, licensing, development andcommercialization of drug candidates. Some of our competitors have a broader range of capabilities and havegreater access to financial, technical, scientific, regulatory, businessdevelopment, recruiting and other resources than we do. Their access to greaterresources may allow them to develop processes or products that are moreeffective, safer or less costly, or gain greater market acceptance, thanproducts we develop or for which they obtain FDA approval more rapidly than wedo. We anticipate that we will face increased competition in the future as newcompanies enter the market and advanced technologies become available.

 

*We Face Potential Liability Related to the Privacy of HealthInformation We Obtain From Research Institutions.*

Mosthealth care providers, including research institutions from which we or ourcollaborators obtain patient information, are subject to privacy regulationspromulgated under the Health Insurance Portability and Accountability Act of1996, or HIPAA. Our clinical research efforts are not directly regulated byHIPAA. However, conduct by a person that may not be prosecuted directly underHIPAA’s criminal provisions could potentially be prosecuted under aiding andabetting or conspiracy laws. Consequently, depending on the facts andcircumstances, we could face substantial criminal penalties if we receiveindividually identifiable health information from a health care provider orresearch institution that has not satisfied HIPAA’s disclosure standards. Inaddition, international data protection laws including the European Union DataProtection Directive and member state implementing legislation, may apply tosome or all of the clinical data obtained outside of the U.S.  Furthermore, certain privacy laws and genetictesting laws may apply directly to our operations and/or those of ourcollaborators and may impose restrictions on our use and dissemination ofindividuals’ health information. Moreover, patients about whom we or ourcollaborators obtain information, as well as the providers who share thisinformation with us, may have contractual rights that limit our ability to useand disclose the information. Claims that we have violated individuals’ privacyrights or breached our contractual obligations, even if we are not foundliable, could be expensive and time-consuming to defend and could result in adversepublicity that could harm our business.

 

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**Risks Related To Our Stock**

 

*Our Officers and Directors Have Significant Control Over Usand Their Interests May Differ From Those of Our Stockholders.*

Asof June 30, 2008, our directors and officers beneficially owned orcontrolled approximately 11.4% of our common stock. Individually and in theaggregate, these stockholders significantly influence our management, affairsand all matters requiring stockholder approval. These stockholders may votetheir shares in a way with which other stockholders do not agree. Inparticular, this concentration of ownership may have the effect of delaying,deferring or preventing an acquisition of us or entrenching management and mayadversely affect the market price of our common stock.

 

*Our Quarterly Operating Results Could FluctuateSignificantly, Which Could Cause Our Stock Price to Decline.*

Ourquarterly operating results have fluctuated in the past and are likely tofluctuate in the future. Entering into licensing or drug discoverycollaborations typically involves significant technical evaluation and/orcommitment of capital by our collaborators. Accordingly, negotiation can belengthy and is subject to a number of significant risks, includingcollaborators’ budgetary constraints and internal acceptance reviews. Inaddition, a significant portion of our revenue is attributable to up-frontpayments and milestones that are non-recurring. Further, some of our collaborators can influence when we deliverproducts and perform services, and therefore receive revenue, under theircontracts with us. Due to these factors, our operating results could fluctuatesignificantly from quarter to quarter. In addition, we may experiencesignificant fluctuations in quarterly operating results due to factors such asgeneral and industry-specific economic conditions that may affect the researchand development expenditures of pharmaceutical and biotechnology companies.

 

Dueto the possibility of fluctuations in our revenue and expenses, we believe thatquarter-to-quarter comparisons of our operating results are not a goodindication of our future performance. Our operating results in some quartersmay not meet the expectations of stock market analysts and investors. If we donot meet analysts’ and/or investors’ expectations, our stock price coulddecline.

 

*Because Our Stock Price May Be Volatile, Our StockPrice Could Experience Substantial Declines.*

Themarket price of our common stock has historically experienced and may continueto experience volatility.  The high andlow closing bids for our common stock were $4.66 and $12.91, respectively, infiscal 2008; $14.40 and $7.55, respectively, in fiscal 2007; and $9.67 and$5.99, respectively, in fiscal 2006. Our quarterly operating results, thesuccess or failure of our internal drug discovery efforts, changes in generalconditions in the economy or the financial markets and other developmentsaffecting our collaborators, our competitors or us could cause the market priceof our common stock to fluctuate substantially. This volatility coupled withmarket declines in our industry over the past several years have affected themarket prices of securities issued by many companies, often for reasonsunrelated to their operating performance, and may adversely affect the price ofour common stock. In the past, securities class action litigation has oftenbeen instituted following periods of volatility in the market price of acompany’s securities. A securities class action suit against us could result inpotential liabilities, substantial costs and the diversion of management’sattention and resources, regardless of whether we win or lose.

 

*Because We Do Not Intend to Pay Dividends, Stockholders WillBenefit From An Investment In Our Common Stock Only If It Appreciates In Value.*

Wehave never declared or paid any cash dividends on our common stock and arerestricted in our ability to do so under our current credit agreement. Wecurrently intend to retain our future earnings, if any, to finance theexpansion of our business and do not expect to pay any cash dividends in theforeseeable future. As a result, the success of an investment in our commonstock will depend entirely upon any future appreciation. There is no guaranteethat our common stock will appreciate in value or even maintain the price atwhich stockholders have purchased their shares.

 

*The Ability of Our Stockholders to Control Our Policies andEffect a Change of Control of Our Company Is Limited, Which May Not Be Inthe Best Interests of Our Stockholders.*

Thereare provisions in our certificate of incorporation and bylaws that maydiscourage a third party from making a proposal to acquire us, even if some ofour stockholders might consider the proposal to be in their best interests.These include the following provisions in our certificate of incorporation:

 

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·                  Our certificate of incorporation provides for threeclasses of directors with the term of office of one class expiring each year,commonly referred to as a “staggered board.” By preventing stockholders fromvoting on the election of more than one class of directors at any annualmeeting of stockholders, this provision may have the effect of keeping thecurrent members of our Board of Directors in control for a longer period oftime than stockholders may desire; and

·                  Our certificate of incorporation authorizes our Boardof Directors to issue shares of preferred stock without stockholder approvaland to establish the preferences and rights of any preferred stock issued,which would allow the board to issue one or more classes or series of preferredstock that could discourage or delay a tender offer or change in control.

 

Inaddition, our Board of Directors approved a Rights Agreement on August 2,2001, which could prevent or deter a potential unsolicited takeover of us bycausing substantial dilution of an acquirer of 15% or more of our outstandingcommon stock. We are also subject to the business combination provisions of Section 203of the Delaware General Corporation Law, which, in general, imposesrestrictions upon acquirers of 15% or more of our stock. As a result, it isdifficult for a third party to acquire control of us without the approval ofthe Board of Directors and, therefore, mergers and acquisitions of us that ourstockholders may consider in their best interests may not occur.

 

**ITEM 1B.UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2.PROPERTIES**

 

Weare headquartered in Boulder, Colorado, where we lease 150 thousand square feetof office and laboratory space under a lease that expires in July 2016.We lease 78 thousand square feet of laboratory space in Longmont, Coloradounder a lease that expires in August 2016. We lease 20 thousandsquare feet of office space in Morrisville, North Carolina under a lease thatexpires in November 2013. We have options to extend each of the leasesfor up to two terms of five years each. In addition, we leasefive thousand square feet of storage space in Boulder, Colorado under a leasethat expires in March 2010.

 

**ITEM 3. LEGAL PROCEEDINGS**

 

Wemay be involved, from time to time, in various claims and legal proceedings arisingin the ordinary course of our business. We are not currently a party to anysuch claims or proceedings that, if decided adversely to us, would eitherindividually or in the aggregate have a material adverse effect on ourbusiness, financial condition or results of operations.

 

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

###  

No matters were submitted to a vote of our security holders, throughsolicitation of proxies or otherwise, during the fourth quarter ended June 30,2008.

 

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**PART II**

###### ** **

###### **ITEM 5. MARKET FOR THEREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES**

######  

**Common Stock Sales Prices**

 

Thefollowing table sets forth, for the periods indicated, the range of the closinghigh and low sales prices for our common stock as reported by the NASDAQ GlobalMarket.

 
| **Fiscal Year Ended June 30, 2008** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|---------|------------|
|                                                         |       |     |       |    |       |
| First Quarter                                                |       | $        | 12.91      |    | $          | 9.72 |   |
| Second Quarter                                               |       | $        | 12.25      |    | $          | 7.96 |   |
| Third Quarter                                                |       | $        | 8.57       |    | $          | 5.30 |   |
| Fourth Quarter                                               |       | $        | 7.16       |    | $          | 4.66 |   |

 
| **Fiscal Year Ended June 30, 2007** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|---------|------------|
|                                                         |       |     |       |    |       |
| First Quarter                                                |       | $        | 8.72       |    | $          | 7.55 |   |
| Second Quarter                                               |       | $        | 13.57      |    | $          | 8.30 |   |
| Third Quarter                                                |       | $        | 13.92      |    | $          | 11.42 |   |
| Fourth Quarter                                               |       | $        | 14.40      |    | $          | 11.04 |   |

 

Asof August 7, 2008, there were approximately 73 holders of record of ourcommon stock. This does not include the number of persons whose stock is innominee or “street name” accounts through brokers.

 

**Dividends**

 

Wehave never declared or paid any cash dividends on our common stock and we donot intend to pay any cash dividends in the foreseeable future. In addition,the terms of our loan agreements restrict our ability to pay cash dividends toour stockholders. We currently intend to retain all available funds and anyfuture earnings for use in the operations of our business and to fund futuregrowth.

 

**StockPerformance Graph**

 

Thisstock performance graph shall not be deemed “filed” for purposes of Section 18of the Securities Exchange Act of 1934, as amended or the Exchange Act, orotherwise subject to the liabilities under that Section and shall not bedeemed to be incorporated by reference into any filing of ours under theSecurities Act of 1933, as amended, or the Exchange Act.

 

Thefollowing graph compares the cumulative total stockholder return for our commonstock, the NASDAQ Global Markets’ Composite (U.S. companies) Index, the NASDAQPharmaceutical Index and the NASDAQ Biotechnology Index for the five yearperiod ended June 30, 2008. The graph assumes that $100 was invested on June 30,2003 in the common stock of Array, the NASDAQ Composite Index, the NASDAQPharmaceutical Index and the NASDAQ Biotechnology Index. It also assumes thatall dividends were reinvested.

 

Thestock price performance on the following graph is not necessarily indicative offuture stock price performance.

 

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**COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURNS**

Among Array BioPharma Inc., the NASDAQ Composite Index,

the NASDAQ Pharmaceutical Index and the NASDAQ Biotechnology Index

 

 
| ** ** | ** ** | **Array BioPharma  Inc.** | ** ** | **NASDAQ  Composite Index** | ** ** | **NASDAQ  Pharmaceutical  Index** | ** ** | **NASDAQ  Biotechnology  Index** | ** ** |
|------------|------------|--------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| ** ** | ** ** | ** **                     | ** ** | ** **                       | ** ** | ** **                        | ** ** | ** **                       | ** ** |
| 6/30/2003  |       | $                              | 100.00     |                             | $          | 100.00                            |       | $                                | 100.00     |   | $ | 100.00 |   |
| 9/30/2003  |       | $                              | 176.04     |                             | $          | 109.81                            |       | $                                | 104.76     |   | $ | 104.99 |   |
| 12/31/2003 |       | $                              | 181.79     |                             | $          | 122.79                            |       | $                                | 105.12     |   | $ | 106.31 |   |
| 3/31/2004  |       | $                              | 287.54     |                             | $          | 124.75                            |       | $                                | 110.19     |   | $ | 113.28 |   |
| 6/30/2004  |       | $                              | 253.99     |                             | $          | 129.09                            |       | $                                | 109.95     |   | $ | 113.33 |   |
| 9/30/2004  |       | $                              | 223.32     |                             | $          | 121.22                            |       | $                                | 108.95     |   | $ | 108.94 |   |
| 12/31/2004 |       | $                              | 304.15     |                             | $          | 138.87                            |       | $                                | 117.86     |   | $ | 119.50 |   |
| 3/31/2005  |       | $                              | 223.96     |                             | $          | 126.45                            |       | $                                | 103.86     |   | $ | 105.48 |   |
| 6/30/2005  |       | $                              | 201.28     |                             | $          | 127.97                            |       | $                                | 102.44     |   | $ | 111.71 |   |
| 9/30/2005  |       | $                              | 229.39     |                             | $          | 134.33                            |       | $                                | 120.35     |   | $ | 132.42 |   |
| 12/31/2005 |       | $                              | 223.96     |                             | $          | 136.72                            |       | $                                | 118.83     |   | $ | 137.08 |   |
| 3/31/2006  |       | $                              | 292.01     |                             | $          | 148.01                            |       | $                                | 124.38     |   | $ | 142.20 |   |
| 6/30/2006  |       | $                              | 274.76     |                             | $          | 136.00                            |       | $                                | 113.55     |   | $ | 127.27 |   |
| 9/30/2006  |       | $                              | 272.20     |                             | $          | 142.29                            |       | $                                | 116.70     |   | $ | 132.72 |   |
| 12/31/2006 |       | $                              | 412.78     |                             | $          | 153.83                            |       | $                                | 120.86     |   | $ | 135.88 |   |
| 3/31/2007  |       | $                              | 405.75     |                             | $          | 153.87                            |       | $                                | 114.39     |   | $ | 131.94 |   |
| 6/30/2007  |       | $                              | 372.84     |                             | $          | 164.15                            |       | $                                | 116.30     |   | $ | 136.97 |   |
| 9/30/2007  |       | $                              | 358.79     |                             | $          | 171.17                            |       | $                                | 122.68     |   | $ | 145.26 |   |
| 12/31/2007 |       | $                              | 269.01     |                             | $          | 162.09                            |       | $                                | 112.12     |   | $ | 136.85 |   |
| 3/31/2008  |       | $                              | 223.96     |                             | $          | 141.25                            |       | $                                | 107.98     |   | $ | 132.05 |   |
| 6/30/2008  |       | $                              | 150.16     |                             | $          | 142.67                            |       | $                                | 111.49     |   | $ | 133.91 |   |

 

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**ITEM 6. SELECTED FINANCIAL DATA**

 

Thefollowing selected financial data is derived from our audited financialstatements. These historical results do not necessarily indicate futureresults. When you read this data, it is important that you also read ourfinancial statements and related notes, as well as the section entitledManagement’s Discussion and Analysis of Financial Condition and Results ofOperations appearing elsewhere in this Annual Report on Form 10-K.  Amounts are in thousands except per sharedata:

 
| ** **                                                            | ** ** | **Years Ended June 30,** | ** **    |
|-----------------------------------------------------------------------|------------|-----------------------------------------|---------------|
| ** **                                                            | ** ** | **2008**                                | ** **    | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                            | ** ** | ** **                              | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenue**                                                           |       |                                    |          |   |   |   |   |   |   |   |   |
| Collaboration revenue                                                 |       | $                                       | 21,513   |   | $ | 30,106  |   | $ | 37,738  |   | $ | 34,343  |   | $ | 28,186  |   |
| License and milestone revenue                                         |       | 7,295                              |          | 6,864  |   | 7,265  |   | 11,162  |   | 6,645  |   |
| Total revenue                                                         |       | 28,808                             |          | 36,970  |   | 45,003  |   | 45,505  |   | 34,831  |   |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| **Operating expenses**                                                |       |                                    |          |   |   |   |   |   |   |   |   |
| Cost of revenue                                                       |       | 21,364                             |          | 24,936  |   | 39,611  |   | 38,048  |   | 37,257  |   |
| Research and development for proprietary  drug discovery              |       | 90,347                             |          | 57,464  |   | 33,382  |   | 22,871  |   | 15,905  |   |
| General and administrative                                            |       | 15,591                             |          | 13,644  |   | 13,683  |   | 9,372  |   | 8,016  |   |
| Total operating expenses                                              |       | 127,302                            |          | 96,044  |   | 86,676  |   | 70,291  |   | 61,178  |   |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| **Loss from operations**                                              |       | (98,494)                                |          | (59,074) |   | (41,673) |   | (24,786) |   | (26,347) |   |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| **Other income (expense)**                                            |       |                                    |          |   |   |   |   |   |   |   |   |
| Impairment of marketable securities                                   |       | (1,872)                                 |          |       - |   |       - |   |       - |   |       - |   |
| Interest income                                                       |       | 6,064                              |          | 4,610  |   | 2,729  |   | 1,542  |   | 381  |   |
| Interest expense                                                      |       | (1,986)                                 |          | (979) |   | (670) |   |       - |   |       - |   |
| Total other income (expense)                                          |       | 2,206                              |          | 3,631  |   | 2,059  |   | 1,542  |   | 381  |   |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| **Net loss**                                                          |       | $                                       | (96,288)      |   | $ | (55,443) |   | $ | (39,614) |   | $ | (23,244) |   | $ | (25,966) |   |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| **Weighted average shares outstanding - basic  and diluted**          |       | 47,309                             |          | 40,717  |   | 38,759  |   | 34,043  |   | 28,511  |   |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| **Net loss per share - basic and diluted**                            |       | $                                       | (2.04)        |   | $ | (1.36) |   | $ | (1.02) |   | $ | (0.68) |   | $ | (0.91) |   |
| ** **                                                            | ** ** | ** **                              | ** **    |
|                                                                       | ** ** | **June 30,**                       | ** **    |
| ** **                                                            | ** ** | **2008**                                | ** **    | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                  |       |                                    |          |   |   |   |   |   |   |   |   |
| Cash and cash equivalents, marketable  securities and restricted cash |       | $                                       | 125,531  |   | $ | 141,331  |   | $ | 70,100  |   | $ | 92,726  |   | $ | 37,446  |   |
| Working capital                                                       |       | $                                       | 66,346   |   | $ | 120,827  |   | $ | 56,056  |   | $ | 80,522  |   | $ | 24,652  |   |
| Total assets                                                          |       | $                                       | 163,077  |   | $ | 174,974  |   | $ | 102,173  |   | $ | 127,952  |   | $ | 77,764  |   |
| Long-term debt, net of discount                                       |       | $                                       | 35,355   |   | $ | 15,000  |   | $ | 14,150  |   | $ | 10,000  |   | $ |    - |   |
| Total stockholders’ equity                                       |       | $                                       | 38,027   |   | $ | 107,701  |   | $ | 68,639  |   | $ | 99,414  |   | $ | 54,493  |   |

 

**ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

TheManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995, including statements aboutour expectations related to the progress and success of our internalproprietary drug discovery activities, realizing new revenue streams andobtaining future out-licensing collaboration agreements that include up-frontmilestone and/or royalty payments, our ability to realize such up-frontmilestone and royalty payments under our existing or any future agreements,future research and development spending, our working capital

 

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requirementsand our future headcount requirements. In some cases, forward-lookingstatements can be identified by the use of terminology such as “may,” “will,” “expects,”“intends,” “plans,” “anticipates,” “estimates,” “potential,” or “continue,” orthe negative thereof or other comparable terminology. These statements arebased on current expectations and projections about our industry andassumptions made by management and are not guarantees of future performance.Although we believe that the expectations reflected in the forward-lookingstatements contained herein are reasonable, these expectations or any of theforward-looking statements could prove to be incorrect, and actual resultscould differ materially from those projected or assumed in the forward-lookingstatements. Our future financial condition, as well as any forward-lookingstatements are subject to significant risks and uncertainties, including butnot limited to the factors set forth under the heading “Risk Factors” in Item1A of this Annual Report on Form 10-K. All forward looking statements andreasons why results may differ included in this Annual Report on Form 10-Kare made as of the date hereof, and, unless required by law, we undertake noobligation to update any forward-looking statements or reasons why actualresults may differ in this Annual Report on Form 10-K.

 

Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with the financial statements and notes to thosestatements included elsewhere in this report.

 

**Overview**

 

Weare a biopharmaceutical company focused on the discovery, development andcommercialization of targeted small molecule drugs aimed at large marketopportunities.  Our proprietary drugdevelopment pipeline includes clinical candidates that are designed to treatpatients afflicted with cancer, inflammatory diseases and pain.  In addition, leading pharmaceutical andbiotechnology companies collaborate with us to discover and develop drugcandidates across a broad range of therapeutic areas.  Our six most advanced, wholly-owned programsin our development pipeline are as follows:

 

·                  ARRY-797, a p38inhibitor and pan-cytokine modulator for inflammation and for pain;

·                  ARRY-162, a MEKinhibitor for inflammation;

·                  ARRY-614, a p38/Tie 2dual inhibitor for cancer and/or inflammation;

·                  ARRY-543, an ErbBfamily (EFGR / ErbB-2) inhibitor for cancer;

·                  ARRY-520, a KSPinhibitor for cancer; and

·                  ARRY-380, an ErbB-2inhibitor for cancer.

 

Wealso have a portfolio of discovery programs that we believe will generate oneto three IND applications each year. Our discovery efforts have also generatedadditional early-stage drug candidates that we may choose to out-licensethrough research partnerships prior to filing an IND application.

 

Wehave built our proprietary pipeline of research and development programs on aninvestment of approximately $240 million from our inception through June 30,2008. Over the past three years, research and development expenses havesignificantly increased year over year to support our clinical developmentefforts and were $90.3 million for fiscal 2008, compared to $57.5 million forfiscal 2007 and $33.4 million for fiscal 2006.

 

Additionally,we have received a total of $322 million in research funding and in up-frontand milestone payments from our collaboration partners through June 30,2008. Under our existing collaboration agreements, we have the potential toearn $1.4 billion additional milestone payments if we achieve all the drugdiscovery objectives detailed in these agreements, as well as the potential toearn royalties on any resulting product sales from 18 drug developmentprograms.

 

Ourlargest existing collaborators include:

 

·      AstraZeneca, which licensed three of our MEKinhibitors for cancer, including AZD6244 (ARRY-886), which is currently inmultiple Phase 2 clinical trials;

·      Genentech, which entered into a worldwidestrategic collaboration agreement with us to develop two of our cancer programs– which has been expanded to include two additional cancer programs – all fourof which are in preclinical development; and

·      Celgene, which entered into a worldwidestrategic collaboration agreement with us focused on the discovery, developmentand commercialization of novel therapeutics in cancer and inflammation.

 

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Wehave incurred net losses since inception and expect to incur losses in the nearfuture as we continue to invest in our proprietary drug discovery programs. Asof June 30, 2008, we had an accumulated deficit of $285.4 million.

 

Ourfiscal year ends on June 30 each year. When we refer to a fiscal year, weare referring to the year in which the fiscal year ends. Therefore, fiscal 2008refers to the fiscal year ended June 30, 2008.

 

**Business Development and Collaborator Concentrations**

 

Wecurrently license or partner certain of our compounds and/or programs and enterinto collaborations directly with pharmaceutical and biotechnology companiesthrough opportunities identified by our business development group, seniormanagement, scientists and customer referrals. In addition, we license ourcompounds and enter into collaborations in Japan through an agent.

 

Thecollaborators that contributed in excess of 10% of our revenue in each of the lastthree fiscal years is as follows:

 
| ** **  | ** ** | **Years Ended June 30,** | ** ** |
|-------------|------------|-----------------------------------------|------------|
| ** **  | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **  | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Genentech   |       | 54.1%                                   |       | 41.8% |   | 34.8% |   |
| Celgene     |       | 14.9%                                   |       | 0.0% |   | 0.0% |   |
| Ono         |       | 14.2%                                   |       | 13.0% |   | 6.9% |   |
| VentiRx     |       | 13.7%                                   |       | 4.0% |   | 0.0% |   |
| InterMune   |       | 1.0%                                    |       | 21.0% |   | 24.0% |   |
| AstraZeneca |       | 0.0%                                    |       | 13.5% |   | 15.8% |   |
|        |       | 97.9%                                   |       | 93.3% |   | 81.5% |   |

 

Ingeneral, certain of our collaborators may terminate their collaborationagreements with 90 to 120 days’ prior notice. Our agreement with Genentech can be terminated with 120 days’notice.  Celgene may terminate itsagreement with us with six months notice. Our agreement with Ono ended in April 2008.

 

Thefollowing table details the countries from which we derive in excess of 10% ofour revenue in each of the last three fiscal years based on the country inwhich collaborators are located or the ship-to destination for compounds:

 
| ** ** | ** ** | **Years Ended June 30,** | ** ** |
|------------|------------|-----------------------------------------|------------|
| ** ** | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|       |       |                                    |       |   |   |   |   |
| U.S.       |       | 84.7%                                   |       | 69.5% |   | 68.8% |   |
| Japan      |       | 14.3%                                   |       | 16.0% |   | 14.0% |   |
| Sweden     |       | 0.0%                                    |       | 13.6% |   | 16.0% |   |
|       |       | 99.0%                                   |       | 99.1% |   | 98.8% |   |

 

Allof our collaboration agreements are denominated in U.S. dollars.

 

**Critical Accounting Policies and Estimates**

 

Management’sdiscussion and analysis of its financial condition and results of operationsare based upon our accompanying Financial Statements which have been preparedin accordance with accounting principles generally accepted in the U.S.  The preparation of these financial statementsrequires us to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenue and expenses as well as the disclosure ofcontingent assets and liabilites. We regularly review our estimates andassumptions. These estimates and assumptions, which are based upon historical

 

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experienceand on various other factors believed to be reasonable under the circumstances,form the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Reported amountsand disclosures may have been different had management used different estimatesand assumptions or if different conditions had occurred in the periodspresented.

 

Belowis a discussion of the policies and estimates that we believe involve a highdegree of judgment and complexity.

 

*Revenue Recognition*

Most of our revenue isderived from designing, creating, optimizing, evaluating and developing drugcandidates for our collaborators. Our agreements with our collaborationpartners include fees based on contracted annual rates for full time equivalentemployees working on a project, and may also include non-refundable license andup-front fees, non-refundable milestone payments that are triggered uponachievement of specific research or development goals, and future royalties onsales of products that result from the collaboration. A small portion of ourrevenue comes from fixed fee agreements or from sales of compounds on aper-compound basis.  We report revenuefor lead generation and lead optimization research, custom synthesis and processresearch, the development and sale of chemical compounds and the co-developmentof proprietary drug candidates we out-license, as collaboration revenue.License and milestone revenue is combined and reported separately fromcollaboration revenue.

 

Arrangementsthat include multiple elements are evaluated under Emerging Issues Task Force (“EITF”)Issue No. 00-21 *Revenue Arrangementswith Multiple Deliverables*(“EITF 00-21”), to determine whether theelement has value to the customer on a stand-alone basis and whether reliableevidence of fair value for the delivered elements exists. Deliverables in anarrangement that do not meet the separation criteria of EITF 00-21 are treatedas a single unit of accounting, generally applying applicable revenue recognitionguidance for the final deliverable to the combined unit of accounting asdefined in Staff Accounting Bulletin No. 104 *Revenue Recognition* (“SAB 104”). SAB 104 in turn establishedfour criteria, each of which must be met, in order to recognize revenue relatedto the performance of services or the shipment of products.  Revenue is recognized when (a) persuasiveevidence of an arrangement exists, (b) products are delivered or servicesare rendered, (c) the sales price is fixed or determinable and (d) collectabilityis reasonably assured.

 

Werecognize revenue from non-refundable up-front payments and license fees on astraight-line basis over the term of performance under the agreement, which isgenerally the research term specified in the agreement. These advance paymentsare deferred and recorded as advance payments from collaborators upon receipt,pending recognition, and are classified as a short-term or long-term liabilityon our balance sheet. When the performance period is not specifically identifiablefrom the agreement, we estimate the performance period based upon provisionscontained within the agreement, such as the duration of the research term, thespecific number of full time equivalent scientists working a defined number ofhours per year at a stated price under the agreement, the existence orlikelihood of development commitments, and other significant commitments ofours.

 

Similarlyto advance payments, for agreements that provide for milestone payments, aportion of each milestone payment is recognized as revenue when the specificmilestone is achieved based on the applicable percentage of the estimatedresearch term that has elapsed to the total estimated research term. Revenuerecognition related to non-refundable license fees and up-front payments and tomilestone payments could be accelerated in the event of early termination ofprograms.

 

Revenuefrom sales of compounds in our Lead Generation Library and Optimer buildingblocks is generally recognized as the compounds are shipped. We recognizerevenue based on contracted annual rates for full time equivalent employeesworking on a project on a monthly basis as work is performed.

 

Wedetermined that the performance period applicable to our agreement with CelgeneCorporation is seven years ending September 2014; and we determined theperformance period for our agreement with VentiRx to be one year. Each of theseperiods coincides with the research terms specified in each agreement. Weperiodically review the expected performance periods under each of ouragreements that provide for non-refundable up-front payments and licensefees.  To date, there has not been asignificant change in an estimate or assumption of the expected period ofperformance that has had a material effect on the timing or amount of revenuerecognized.

 

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InFebruary 2007, we entered into a collaboration and licensing agreementwith VentiRx in which we received a non-refundable cash technology access feeand shares of preferred stock valued at $1.5 million based on the price atwhich such preferred stock was sold to investors in a private offering.  Both the technology access fee and the valueof the preferred stock were recorded as advance payments from collaborators anddeferred revenue, and were recognized as revenue on a straight-line basis overthe estimated one-year research term. The preferred stock has been recorded in Other Long-term Assets in theaccompanying Balance Sheets.

 

*Cost of Revenue and Research andDevelopment for Proprietary Drug Discovery*

Costof revenue represents research and development conducted for our collaboratorsand the cost of chemical compounds sold. These costs consist mainly ofcompensation, associated fringe benefits, share-based compensation and othercollaboration-related costs, including supplies, small tools, facilities,depreciation, recruiting and relocation and other direct and indirect chemicalhandling and laboratory support costs. We allocate these costs between Cost ofRevenue and Research and Development for Proprietary Drug Discovery based uponthe respective time spent on each by our scientists on development conductedfor our collaborators and for our internal proprietary programs, respectively.

 

Whereour collaboration agreements provide for us to conduct development of drugcandidates, and for which our partner has an option to obtain the right toconduct further development and to commercialize a product, we attribute aportion of our research and development costs to Cost of Revenue based on thepercentage of total compounds under the agreement that may be selected by thepartner.  For example, we granted toCelgene an option to select up to two of four drugs developed under thecollaboration. Accordingly, we report costs associated with the Celgenecollaboration as follows:  50% to cost ofrevenue, with the remaining 50% to research and development for proprietarydrug discovery.  See the furtherdiscussion on this transaction in Note 6 to the accompanying FinancialStatements.

 

*Investments in Marketable Securities*

Ourinvestments in marketable securities include domestic public corporate debtsecurities, commercial paper issued by domestic public companies, obligationsof U.S. federal government agencies and auction rate securities, or ARS. Marketablesecurities are classified as short-term or long-term based on the nature ofthese securities and the availability of these securities to meet currentoperating requirements. The specific identification method is used to determinethe cost of securities disposed of, with realized gains and losses reflected inInterest Income or Interest Expense, as appropriate in the accompanyingFinancial Statements.  Temporaryimpairments are recognized in Accumulated Other Comprehensive Loss in the accompanyingBalance Sheets and other-than-temporary impairments are recognized inImpairments of Marketable Securities in the accompanying Statements of Operationsand Comprehensive Loss.  All of ourinvestments in marketable securities are held in our name at a limited numberof financial institutions.

 

Includedwithin long-term marketable securities are our investments in ARS. During thefiscal year ended June 30, 2008 and subsequent thereto, auctions for allof our ARS, amounting to seven securities with a par value of$32.9 million, were unsuccessful. We recorded an other-than-temporaryimpairment of $1.9 million on two of our ARS, primarily as a result of thecontinuous decline and magnitude of the fair value discount from par value,which is due in part to the relative weakness in the performance of theunderlying trust assets.  Accordingly,the other-than-temporary impairment is recorded in Impairment of MarketableSecurities in the accompanying Statements of Operations and Comprehensive Loss.

 

Webelieve that impairment in the other five ARS in the portfolio, amounting to$1.9 million, is temporary, primarily because of stronger performance of theunderlying trust assets, the relatively smaller discount of fair value from parvalue, and because these securities have not incurred significant continuousdeclines in fair value during recent periods. Accordingly, the temporaryimpairment is recorded in Accumulated Other Comprehensive Loss in theaccompanying Balance Sheets as of June 30, 2008.

 

Whilewe now earn a higher contractual interest rate on these ARS investments, theinvestments are not currently liquid. In the event we need to access thesefunds, we will not be able to do so until auctions of these investments aresuccessful, the original issuers retire these securities or a secondary marketdevelops for these securities.  Therefore, they are classified as Marketable Securities – Long Term inthe accompanying Balance Sheets as of June 30, 2008.

 

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*Preclinical Study and Clinical Trial Outsourcing Accruals*

Substantial portions of ourpreclinical studies and all of our clinical trials have been performed bythird-party medical centers or contract research organizations, which we referto collectively as CROs.  Some CROs billmonthly for services performed, while others bill based upon milestoneachievement.  We accrue expenses eachmonth for agreements involving significant costs and that bill based onmilestone achievement. For preclinical studies, accruals are based upon the estimatedpercentage of work completed and the contract milestones remaining.  For costs for clinical study activitiesperformed by CROs, accruals are estimated based upon the estimated workcompleted on each study and, for clinical trial expenses, accruals are basedupon the number of patients enrolled and the expected duration of the study forwhich they will be enrolled.  We monitorpatient enrollment and related activities to the extent possible throughinternal reviews, correspondence with the CROs, clinical site visits, andreview of contractual terms.  Ourestimates are highly dependant upon the timeliness and accuracy of the dataprovided by our CROs regarding the status of each program and total programspending. We periodically evaluate our estimates to determine if adjustmentsare necessary or appropriate based on information we receive concerningchanging circumstances, conditions or events that may affect suchestimates.  No material adjustments topreclinical study and clinical trial expenses have been recognized to date.

 

*Income Taxes*

Weestimate our actual current tax expense together with our temporary differencesresulting from differing treatment of items for tax and accounting purposes.These temporary differences result in deferred tax assets and/or liabilities.We must then assess the likelihood that our deferred tax assets will berecovered from future taxable income and to the extent that we believe that itis more likely than not we will not recover these deferred assets, we mustestablish a valuation allowance against these tax assets. Significantmanagement judgment is required in determining our provision for income taxes,our deferred tax assets and liabilities and any valuation allowance against ourdeferred tax assets. To the extent that we believe a valuation allowance isrequired, we must include and expense the tax effect of the allowance withinthe tax provision in our statement of operations.

 

**Results of Operations**

 

*Revenue*

Collaboration revenueconsists of revenue for lead generation and lead optimization research, customsynthesis and process research, the development and sale of chemical compoundsand the co-development of proprietary drug candidates we out-license. Licenseand milestone revenue is combined and reported separately from CollaborationRevenue.

 

Asummary of our revenue follows (amounts in thousands):

 
| ** **                    | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                    | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                    | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Collaboration revenue         |       | $                                       | 21,513     |                                    | $          | 30,106                                  |       | $ | 37,738 |   | $ | (8,593) |   | (28.5%) |   | $ | (7,632) |   | (20.2%) |   |
| License and milestone revenue |       | 7,295                                   |       | 6,864                                   |       | 7,265                                   |       | 431  |   | 6.3% |   | (401) |   | (5.5%) |   |
| Total revenue                 |       | $                                       | 28,808     |                                    | $          | 36,970                                  |       | $ | 45,003 |   | $ | (8,162) |   | (22.1%) |   | $ | (8,033) |   | (17.8%) |   |

 

*Fiscal 2008 as compared to Fiscal 2007* – Collaboration revenue decreased by $8.6million due to the expiration of collaborations with InterMune and Takeda in June andMarch of 2007, respectively, as well as the expiration of ourcollaboration with Ono during the fourth quarter of fiscal 2008.  Additionally, collaboration revenue from thesale of Optimer building blocks decreased by approximately $300 thousandcompared to fiscal 2007.  Partiallyoffsetting these decreases was increased revenue of approximately $960 thousandfrom our collaborations with VentiRx and Genentech.  Collaboration revenue is expected to furtherdecline in fiscal 2009 as we continue to focus on our own discovery anddevelopment programs.

 

Licenseand milestone revenue increased by approximately $431 thousand due to increasedrevenue of $5.4 million from our collaborations with Celgene and VentiRx.  Largely offsetting this increase was the fullrecognition of two milestone payments totaling $5.0 million from AstraZenecaduring fiscal 2007 as discussed below.

 

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*Fiscal 2007 as compared to Fiscal 2006* - Collaboration revenue declined by $10.2million due to the expiration of collaborations with AstraZeneca, Roche and EliLilly during fiscal 2006 as well as the research portions of collaborationswith InterMune and Takeda that expired in fiscal 2007.  Additionally, collaboration revenue from thesale of Optimer building blocks and Lead Generation Libraries decreased by $1.0million during these same periods. Partially offsetting these decreases was increased revenue of $3.6million from our collaborations with Genentech and Ono, as well as theinitiation of a new research agreement with VentiRx.

 

Licenseand milestone revenue declined by $6.7 million during fiscal 2007 becausepreviously received license and milestone payments from AstraZeneca andGenentech had been fully recognized as revenue as of June 30, 2006.  This decrease was partially offset by therecognition of two milestone payments totaling $5.0 million from AstraZenecaduring fiscal 2007 for the advancement of AZD6244 into Phase 2 clinical trialsand ARRY-704 into Phase 1 clinical trials. Additional license and milestone revenue of $1.3 million was recognizedin fiscal 2007 from VentiRx, InterMune and Eli Lilly.

 

*Cost of Revenue*

Costof revenue represents research and development conducted for our collaboratorsand the cost of chemical compounds sold from our inventory. These costs consistmainly of compensation, associated fringe benefits and othercollaboration-related costs, including supplies, small tools, facilities,depreciation, recruiting and relocation and other direct and indirect chemicalhandling and laboratory support costs. Fine chemicals consumed as well as anyrequired inventory reserve adjustments are also recorded as cost of revenue.

 

Asummary of our cost of revenue follows (amounts in thousands):

 
| ** **                                        | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** |
|---------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| ** **                                        | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |
| ** **                                        | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenue                                   |       | $                                       | 21,364     |                                    | $          | 24,936                                  |   | $ | 39,611 |   | $ | (3,572 | ) | (14.3%) |   | $ | (14,675 | ) | (37.0%) |
| Cost of revenue as a percentage of total  revenue |       | 74.2%                                   |       | 67.4%                                   |       | 88.0%                                   |   |   |   |   |   |   |   |   |
|                                                   |            |                                         |            |                                         |            |                                         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Fiscal 2008 as compared to Fiscal 2007* – Cost of revenue for fiscal 2008 decreased14.3% from fiscal 2007 as a result of a reduction in the number of scientistsworking on external collaborations that expired in the prior fiscal year.  These scientific resources were shifted toour proprietary drug research and the Celgene collaboration upon expiration ofthese external collaborations.  Half ofthe research-related costs of the Celgene program is charged to Cost of Revenue,as discussed further in Note 6 to the accompanying Financial Statements.  We expect an additional decline in futureperiods as a result of the expiration of our collaboration with Ono during thefourth quarter of fiscal 2008.

 

DuringJuly and August 2006, we terminated our prior facilities leases andexecuted new lease agreements with a new landlord.  As a result of this transaction, we reverseda $1.6 million deferred rent liability balance and reduced our rent expense bythe same amount.  Because we allocaterent expense, the reduction in rent expense resulted in a decrease to cost ofrevenue of approximately $600 thousand for fiscal 2008.

 

*Fiscal 2007 as compared to Fiscal 2006 -*Cost of revenue for fiscal 2007 decreased by37.0% from fiscal 2006, primarily reflecting a decrease in collaborationrelated services as a greater percentage of our resources were focused onadvancing our proprietary drug discovery programs.  Cost of revenue as a percentage of totalrevenue decreased to 67.4% for the 2007 fiscal year compared with 88.0% for theprior fiscal year. These decreases were largely the result of increased averagepricing received from collaborations for full-time equivalent scientists duringfiscal 2007 resulting in fewer scientific resources used in generating the sameapproximate level of collaboration revenue. Additionally, share-based compensationexpense charged to cost of revenue for 2007 fiscal year decreased byapproximately $960 thousand due to options that became fully vested in theprior fiscal year.

 

OnJune 22, 2006, we assigned options we owned to purchase our Boulder andLongmont, Colorado facilities to BioMed Realty L.P., which purchased thosefacilities in July and August 2006. We entered into new lease

 

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agreementsfor these facilities with BioMed over a ten-year lease term and beganamortizing our leasehold improvement costs for these facilities over a ten-yearlife. Prior to completing these transactions, we had determined that we were reasonablyassured during fiscal 2006 that we would be vacating our Boulder facility atthe end of the initial lease term in March 2008 and therefore amortizedthe cost of leasehold improvements for that facility over an approximatetwo-year life. We determined the lease terms under our new facilities leases tobe the fixed, non-cancelable ten-year term because we concluded that theexercise of optional extension periods available under the leases was notreasonably assured.

 

Thisconclusion was based on our experience with prior lease facilities andmanagement’s determination that it was unable to predict in the early years ofa long-term lease whether it would remain in the facilities beyond the initiallease term as a result of changing business, economic or other conditions. Thechange in the amortization period from two to 10 years resulted in a decreaseof approximately $775 thousand in amortized leasehold improvement costs chargedto cost of revenue for fiscal 2007 as compared to the prior fiscal year.

 

*Research and Development Expenses for Proprietary DrugDiscovery*

Our research and developmentexpenses for proprietary drug discovery include costs associated with ourproprietary drug programs for scientific personnel, supplies, equipment,consultants, sponsored research, allocated facility costs, costs related topreclinical and clinical trials, and share-based compensation. We manage ourproprietary programs based on scientific data and achievement of research plangoals. Our scientists record their time to specific projects when possible.

 

However,many activities simultaneously benefit multiple projects and cannot be readilyattributed to a specific project. Accordingly, the accurate assignment of timeand costs to a specific project is difficult and may not give a true indicationof the actual costs of a particular project. As a result, we do not reportcosts on a program basis. The following table shows our research anddevelopment expenses by categories of costs for the periods presented (amounts inthousands):

 
| ** **                                                     | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| ** **                                                     | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |
| ** **                                                     | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries, benefits and share-based                             |       |                                    |       |                                    |       |                                    |   |   |   |   |   |   |   |   |
| compensation                                                   |       | $                                       | 33,304     |                                    | $          | 21,805                                  |   | $ | 12,394 |   | $ | 11,499 |   | 52.7% |   | $ | 9,411 |   | 75.9% |
| Outsourced services and consulting                             |       | 34,570                                  |       | 19,953                                  |       | 7,921                                   |   | 14,617 |   | 73.3% |   | 12,032 |   | 151.9% |
| Laboratory supplies                                            |       | 10,521                                  |       | 6,878                                   |       | 5,538                                   |   | 3,643 |   | 53.0% |   | 1,340 |   | 24.2% |
| Facilities and depreciation                                    |       | 10,148                                  |       | 7,910                                   |       | 7,063                                   |   | 2,238 |   | 28.3% |   | 847 |   | 12.0% |
| Other                                                          |       | 1,804                                   |       | 918                                     |       | 466                                     |   | 886 |   | 96.5% |   | 452 |   | 97.0% |
| Total research and development for  proprietary drug discovery |       | $                                       | 90,347     |                                    | $          | 57,464                                  |   | $ | 33,382 |   | $ | 32,883 |   | 57.2% |   | $ | 24,082 |   | 72.1% |

 

*Fiscal 2008 as compared to Fiscal 2007* – Research and development expensesincreased 57.2% over the prior fiscal year as a result of the deployment ofexisting scientific personnel previously engaged in our external collaborationsto advance our proprietary research. In addition, we expanded our clinicaldevelopment group and moved into more advanced clinical trials and increasedthe amount of outsourced pharmacology to advance our proprietary developmentcompounds.  The most significantincreases resulted in the advancement of the following programs:

 

1.               ARRY-797, a p38inhibitor and pan-cytokine modulator for inflammation and for pain;

2.               ARRY-162, a MEKinhibitor for inflammation;

3.               ARRY-614, a p38/Tie 2dual inhibitor for cancer and/or inflammation;

4.               ARRY-543, an ErbBfamily (EFGR / ErbB-2) inhibitor for cancer;

5.               ARRY-520, a KSPinhibitor for cancer; and

6.               ARRY-380, an ErbB-2inhibitor for cancer.

 

Duringfiscal 2008, we expensed $3.3 million of share-based compensation expense ascompared to $1.7 million for fiscal 2007. We expect that research and development for proprietary drug discoveryspending will continue to

 

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increasein fiscal 2009 as we focus more resources on our proprietary drug discovery anddevelopment programs and advancing our programs through clinical development.

 

*Fiscal 2007 as compared to Fiscal 2006**-***Research and development for proprietary drugdiscovery expenses increased 72.1% over the prior fiscal year as a result ofincreases in the number of scientists devoted to proprietary programs,reflecting both increased headcount as well as a shift of existing scientificresources from collaborative projects to internal proprietary discovery. The mostsignificant increase in costs came from outsourced pharmacology studies andclinical trial related expenses supporting the advancement of our ErbB-2/EGFR,MEK for inflammation, ErbB-2, P38/Tie2 and other programs. During fiscal 2007we expensed $1.7 million of share-based compensation expense to research anddevelopment for proprietary drug discovery expenses compared to $1.3 millionfor the prior fiscal year.

 

Theseincreases were partially offset by reductions in leasehold improvementamortization and rent expense allocated to research and development forproprietary drug discovery expenses as described in Cost of Revenue above. Thechange in estimated useful life of our leasehold improvements resulted in areduction of amortization of leasehold improvement costs charged to researchand development for proprietary drug discovery expenses for the 2007 fiscalyear of approximately $900 thousand. Additionally, the reversal of the prioryear deferred rent balance resulted in a reduction to rent expense allocated toresearch and development for proprietary drug discovery expenses for the 2007fiscal year of approximately $850 thousand.

 

Asdiscussed in the section above entitled Business – Proprietary DevelopmentPrograms, we have multiple programs in different phases of preclinical andclinical development.  We anticipate thatwe will make determinations as to which research programs to pursue and howmuch funding to direct to each program on an ongoing basis in response to thescientific and clinical success of each drug candidate. The lengthy process ofdeveloping and testing a drug candidate, seeking regulatory approvals, andsubsequent compliance with applicable regulations, require the expenditure ofsubstantial resources that generally increase as the candidate moves throughthe development process.

 

Althoughwe expect our research and development costs to increase as we progress ourprograms through later-stage development, the scope and magnitude of futureresearch and development expenses are difficult to predict given the number ofstudies that will need to be conducted for any of our potential products, aswell as our limited capital resources. The successful development andcommercialization of drugs resulting from our proprietary programs is highly uncertainand subject to a number of risks that are beyond our control. The duration andcost of discovery, preclinical, non-clinical and clinical trials may varysignificantly based on the type, complexity and novelty of a product and aredifficult to predict. The FDA and comparable agencies in foreign countriesimpose substantial requirements on the introduction of therapeuticpharmaceutical products, typically requiring lengthy and detailed laboratoryand clinical testing procedures, sampling activities and other costly andtime-consuming procedures. Data obtained from preclinical, non-clinical andclinical activities at any step in the testing process may be adverse and leadto discontinuation or redirection of development activity or be susceptible to varyinginterpretations, which could delay, limit or prevent regulatory approval.Consequently, accurate and meaningful estimates of the ultimate costs to bringour drug candidates to market are not available. Given the uncertaintiesrelated to development, we are currently unable to reliably estimate when, ifever, our drug candidates will generate revenue and net cash inflows.

 

*General and Administrative Expenses*

Generaland administrative expenses consist mainly of compensation and associatedfringe benefits not included in cost of revenue or research and development forproprietary drug discovery expenses and include other management, businessdevelopment, accounting, information technology and administration costs,including patent prosecution, recruiting and relocation, consulting andprofessional services, travel and meals, sales commissions, facilities,depreciation and other office expenses.

 

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A summary of our general andadministrative expenses follows (amounts in thousands):

 
| ** **                 | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** |
|----------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| ** **                 | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |
| ** **                 | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative |       | $                                       | 15,591     |                                    | $          | 13,644                                  |   | $ | 13,683  |   | $ | 1,947 |   | 14.3% |   | $ | (39 | ) | (0.3%) |
|                            |            |                                         |            |                                         |            |                                         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Fiscal 2008 as compared to Fiscal 2007* - General and administrative expensesincreased by approximately $1.9 million during the 2008 fiscal year over theprior fiscal year primarily due to increased compensation and benefit expensesof $1.0 million associated with the addition of general and administrativepersonnel. Audit, legal and other consulting expenses increased byapproximately $750 thousand as a result of increased legal and audit fees forgeneral corporate matters and strategic consulting. Other general andadministrative expenses associated with increased personnel, such as travel andoffice related costs make up the remaining increase of approximately $190thousand.

 

*Fiscal 2007 as compared to Fiscal 2006* - General and administrative expensesdecreased by approximately $145 thousand during the 2007 fiscal year over theprior fiscal year primarily as a result of decreased share-based compensationexpense of approximately $790 thousand recognized upon the vesting of optionshares in the prior fiscal year. As described in Cost of Revenue above, thechange in estimated useful life of our leasehold improvements resulted in areduction of amortization of leasehold improvement costs charged to general andadministrative expenses for the 2007 fiscal year of approximately $90 thousandand the reversal of the prior year deferred rent balance resulted in areduction to rent expense allocated to general and administrative expenses forthe 2007 fiscal year of approximately $150 thousand. Partially offsetting allthese decreases in general and administrative expenses were increases inpatent and patent application costs of approximately $830 thousand for the 2007fiscal year associated with the advancement of our propriety drug developmentprograms. The remaining increase in general and administrative expenses of $55thousand from the prior year was attributable to increases in compensation andbenefit expenses.

 

*Other Income (Expense)*

A summary of our otherincome (expense) follows (amounts in thousands):

 
| ** **                          | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** |
|-------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| ** **                          | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |
| ** **                          | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Impairment of marketable securities |       | $                                       | (1,872     | )                                       | $          | -                                       |   | $ | - |   |   | $ | (1,872 | ) | 0.0% |   | $ | -   |   | 0.0% |
| Interest income                     |       | 6,064                                   |       | 4,610                                   |       | 2,729                                   |   |   | 1,454 |   | 31.5% |   | 1,881 |   | 68.9% |
| Interest expense                    |       | (1,986                                  | )          | (979                                    | )          | (670                                    | ) |   | (1,007 | ) | 102.9% |   | (309 | ) | 46.1% |
| Total other income                  |       | $                                       | 2,206      |                                    | $          | 3,631                                   |   | $ | 2,059 |   |   | $ | (1,425 | ) | (39.2%) |   | $ | 1,572 |   | 76.3% |

 

*Fiscal 2008 as compared to Fiscal 2007* – Other income and expense, net in fiscal2008 includes an other-than-temporary impairment of certain ARS. Interestincome increased in fiscal 2008 compared to fiscal 2007 primarily due to highereffective interest rates and higher average cash, cash equivalent andinvestment balances.  Interest expenseincreased in fiscal 2008 compared to fiscal 2007 due to increased borrowingsand higher effective interest rates related to our long-term borrowings.  We expect interest expense to increase as aresult of our Credit Facility entered into in April 2008 with Deerfield.

 

*Fiscal 2007 as compared to Fiscal 2006 -*Interest income increased in fiscal 2007compared to fiscal 2006 primarily due to higher effective interest rates andhigher average cash, cash equivalent and investment balances.  Interest expense increased in fiscal 2007compared to fiscal 2006 due to increased borrowings and higher effectiveinterest rates related to our long-term borrowings.

 

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**Liquidity and Capital Resources**

 

Wehave historically funded our operations through revenue from our collaborationsand the issuance of debt and of equity securities.

 

Ourfuture capital requirements will depend on a number of factors, including therate at which we invest in proprietary research, the growth of our clinicaldevelopment capabilities, the growth or decline of our collaboration businessand the amount of collaboration research funding we receive, the timing ofmilestone and royalty payments, if any, from our collaboration and out-licensedprograms, our capital spending on new facilities and equipment, the number andsize of Phase 2 and Phase 3 clinical trials we decide to run, expensesassociated with unforeseen litigation, regulatory changes, competition andtechnological developments, general economic and market conditions and theextent to which we acquire or invest in other businesses, products andtechnologies.

 

Inaddition, our future capital requirements may be impacted if we do not receivepotential milestone or royalty payments under our existing or futurecollaboration agreements. Our ability to realize these payments is subject to anumber of risks, many of which are beyond our control and include thefollowing: the drug development process is risky and highly uncertain, and weor our collaborators may not be successful in commercializing drug candidateswe create; our collaborators have substantial control and discretion over thetiming and continued development and marketing of drug candidates we create;the sale and manufacture of drug candidates we develop may not obtainregulatory approval; and, if regulatory approval is received, drugs we developwill remain subject to regulation or may not gain market acceptance, whichcould delay or prevent us from generating milestone, royalty revenue or productrevenue from the commercialization of these drugs.

 

Webelieve that our existing cash, cash equivalents, marketable securities, creditfacilities and anticipated cash flow from existing collaboration agreementswill be sufficient to support our current operating plan for at least the next12 months. This estimate of our future capital requirements is aforward-looking statement that is based on assumptions that may prove to bewrong and that involve substantial risks and uncertainties. Our actual futurecapital requirements could vary as a result of a number of factors, including:

 

·                  The progress of our research and developmentactivities;

·                  Our ability to enter into agreements toout-license and co-develop our proprietary drug candidates, and the timing ofthose agreements in each candidate’s development stage;

·                  The number and scope of our research anddevelopment programs;

·                  The progress of our preclinical and clinicaldevelopment activities;

·                  The number and scope of phase 2 and phase 3studies we may decide to run;

·                  The progress of the development efforts ofour collaborators;

·                  The availability of resources for revenuegenerating collaborations as we devote more resources to our proprietaryprograms;

·                  Our ability to establish and maintain currentand new collaboration agreements;

·                  The ability of our collaborators to fundresearch and development programs;

·                  The costs involved in enforcing patent claimsand other intellectual property rights;

·                  The costs and timing of regulatory approvals;and

·                  The costs of establishing clinicaldevelopment and distribution or commercialization capabilities.

 

Untilwe can generate sufficient levels of cash from our operations, which we do notexpect to achieve in the foreseeable future, we expect to continue to utilizeour existing cash, cash equivalents and marketable securities that wereprimarily generated from the proceeds of our credit facilities and equityofferings and from our collaborations. In addition, we may finance future cashneeds through the sale of equity securities, strategic collaboration agreementsand debt financing. We cannot assure that we will be successful in obtainingnew or in retaining existing out-license or collaboration agreements, insecuring agreements for the co-development of our proprietary drug candidates,or in receiving milestone and/or royalty payments under those agreements, thatour existing cash, cash equivalents and marketable securities resources will beadequate or that additional financing will be available when needed or that, ifavailable, this financing will be obtained on terms favorable to us or ourstockholders. Insufficient funds may require us to delay, scale back oreliminate some or all of our research or development programs or to relinquishgreater or all rights to product candidates at an earlier stage of

 

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developmentor on less favorable terms than we would otherwise choose, or may adverselyaffect our ability to operate as a going concern. If we raise additional fundsby issuing equity securities, substantial dilution to existing stockholders mayresult.

 

Thefollowing discussion highlights our cash flow activities during the fiscalyears ended June 30, 2008, 2007 and 2006.

 

*Cash, Cash Equivalents and Marketable Securities*

Weconsider short-term, highly liquid financial instruments that are readilyconvertible to cash and have maturities of 90 days or less from the date ofpurchase to be cash equivalents.

 

Marketablesecurities classified as short-term consist of various financial instrumentssuch as commercial paper, U.S. government agency obligations and corporatenotes and bonds with high credit quality with maturities of greater than 90days when purchased.  Marketable securitiesclassified as long-term consist of our investments in ARS.

 

Followingis a summary of our cash, cash equivalents and marketable securities (amountsin thousands):

 
| ** **                          | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** |
|-------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| ** **                          | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |
| ** **                          | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents          |       | $                                       | 56,448     |                                    | $          | 10,670                                  |   | $ | 15,568 |   | $ | 45,778 |   |   | 429.0% |   | $ | (4,898 | ) | (31.5%) |
| Marketable  securities - short-term |       | 39,243                                  |       | 130,661                                 |       | 54,532                                  |   | (91,418 | ) |   | (70.0%) |   | 76,129 |   | 139.6% |
| Marketable securities  - long-term  |       | 29,840                                  |       | -                                       |       | -                                       |   | 29,840 |   |   | 0.0% |   | -   |   | 0.0% |
| Total                               |       | $                                       | 125,531    |                                    | $          | 141,331                                 |   | $ | 70,100 |   | $ | (15,800 | ) |   | (11.2%) |   | $ | 71,231 |   | 101.6% |

 

*Cash Flow Activities*

Followingis a summary of our cash flow activities (amounts in thousands):

 
| ** **                         | ** ** | **Years Ended June 30,** | ** ** | **Change 2008 vs. 2007** | ** ** | **Change 2007 vs. 2006** |
|------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| ** **                         | ** ** | **2008**                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |
| ** **                         | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows  provided by (used in): |       |                                    |       |                                    |       |                                    |   |   |   |   |   |   |   |   |
| Operating  activities              |       | $                                       | (45,736    | )                                       | $          | (44,523                                 | ) | $ | (24,298 | ) |   | $ | (2,213 | ) | 5.0 | % |   | $ | (20,225 | ) | 83.2 | % |
| Investing  activities              |       | 50,726                                  |       | (50,663                                 | )          | 20,613                                  |   |   | 101,389 |   | * |   |   | (71,276 | ) | * |   |
| Financing  activities              |       | 40,788                                  |       | 90,288                                  |       | 6,824                                   |   |   | (48,500 | ) | (53.7 | %) |   | 83,464 |   | * |   |
| Total                              |       | $                                       | 45,778     |                                    | $          | (4,898                                  | ) | $ | 3,139 |   |   | $ | 50,676 |   | * |   |   | $ | (8,037 | ) | * |   |

 

* Percentage calculationexcluded as we have determined that it was not meaningful

 

*Fiscal 2008 as compared to Fiscal 2007* – Net cash used in operating activities forfiscal year 2008 was $45.7 million, compared to $44.5 million for fiscal2007.  During fiscal year 2008, our netloss of $96.3 million was reduced by non-cash charges of $6.1 million fordepreciation and amortization expense, $6.2 million for share-basedcompensation expense, a $1.9 million other-than temporary impairment chargerelated to certain ARS and $944 thousand of amortization of debt discount.Changes in operating assets and liabilities included an increase of $32.6million of deferred revenue primarily from Celgene, an increase of $7.6 millionin accrued outsourcing costs due to increased obligations for outsourcedpharmacology and clinical trial expenses, a decrease of $2.6 million related toamortization or deferred rent, a decrease in accounts payable of $1.7 millionresulting from lower capital expenditures during the last quarter of 2008relative to 2007, an increase in prepaid expenses and other current assets of $818thousand resulting from increased equipment deposits, sales tax refunds andprepaid interest, an increase in accrued compensation and benefits of $961thousand associated with increased employment and $544 thousand of changes inother current liabilities and accrued expenses.

 

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Netcash provided by (used in) investing activities was $50.7 million and $(50.7)million in fiscal 2008 and 2007, respectively. During fiscal 2008, we invested$8.2 million in property and equipment, primarily in lab equipment andfacilities for research and development and various computer equipment hardwareand software associated with new employees. Purchases of marketable securitiesused $71.6 million in cash, and proceeds from sales and maturities ofmarketable securities provided $130.5 million.

 

Netcash provided by financing activities was $40.8 million and $90.3 million infiscal 2008 and 2007, respectively. During fiscal 2008, we received proceeds of $40 million in connectionwith our $80 million convertible debt facility in June of 2008 and paid$1.0 million of transaction fees. We also received proceeds of $1.8 millionfrom exercises of employee stock options and purchases of stock by employeesunder our ESPP.

 

*Fiscal 2007 as compared to Fiscal 2006 -*****Net cash used in operating activities for fiscal year 2007 was $44.5million, compared to $24.3 million for fiscal 2006.  During fiscal year 2007, our net loss of$55.4 million was reduced by non-cash charges of $11.1 million, primarilyassociated with depreciation and amortization expense and, share-based compensationexpense.  For fiscal year 2007, our netoperating assets and liabilities excluding cash decreased by $270 thousand.  Accounts payable and assured outstanding increasedby $3.9 million due to increased obligations for outsourced pharmacology andclinical trial expenses, fine chemicals, and facilities improvements. Accruedcompensation and benefits increased by $772 thousand, half of which was due toincreased amounts reserved for fiscal year 2007 employee bonuses with theremainder due to increased vacation reserves as well as increased 401(k),deferred compensation and ESPP payroll withholdings attributable to our largeremployee base.  Deferred rent liabilitiesdecreased by $4 million due to the BioMed facilities transaction.  Deferred revenues decreased by approximately$2 million as we concluded collaboration programs with InterMune and Takeda.  Other operating assets and liabilitiesincreased by $1 million making up the remainder of the change.

 

Netcash provided by (used in) investing activities was $(50.7) million and $20.6million for fiscal year 2007 and 2006, respectively.  During fiscal year 2007, we received netproceeds of $32.3 million from BioMed related to the assignment of purchaseoptions of our Boulder and Longmont, Colorado facilities.  We invested $7.1 million in property andequipment, primarily in lab equipment for drug metabolism, analytical researchand development operations, process chemistry and biology, as well as inimprovements to our facilities, and various computer hardware andsoftware.   Purchases of marketablesecurities used $144.9 million of cash while proceeds from the sale andmaturity of marketable securities provided $69.2 million of cash.

 

Financingactivities provided $90.3 million of cash consisting of $85.2 million in netproceeds from our public common stock offering, $4.2 million of cash resultingfrom the exercise of stock options under our stock option plan and purchases ofstock under our ESPP, and approximately $850 thousand of proceeds received fromthe issuance of long-term debt used to finance purchases of capital equipment.

 

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**Obligations and Commitments**

 

Thefollowing table shows our contractual obligations and commitments as of June 30,2008 (amounts in thousands):

 
| ** **                                | ** ** | **Less Than  1 Year** | ** **    | **1 to 3  Years** | ** ** | **4 to 5  Years** | ** ** | **Over 5 Years** | ** **    | **Total**  | ** ** |
|-------------------------------------------|------------|---------------------------------|---------------|-----------------------------|------------|-----------------------------|------------|----------------------------|---------------|------------|------------|
| ** **                                | ** ** | ** **                      | ** **    | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** **    | ** ** | ** ** |
| Debt obligations (1)                      |       | $                               | -   |                        | $          | 15,000                      |       | $                          | -   |       | $          | 40,000 |   | $ | 55,000 |   |
| Interest on debt obligations (3) (4) |       | 2,096                           |          | 3,688                       |       | 1,603                       |       | 40,977                     |          | 48,364     |       |
| Operating lease commitments (2)           |       | 7,643                           |          | 15,969                      |       | 16,462                      |       | 24,954                     |          | 65,028     |       |
| Purchase obligations (2)                  |       | 13,908                          |          | 8,003                       |       | 1,314                       |       | -                |          | 23,225     |       |
| Total                                     |       | $                               | 23,647        |                        | $          | 42,660                      |       | $                          | 19,379        |       | $          | 105,931 |   | $ | 191,617 |   |

 

(1)                    Reflected in the accompanying Balance Sheets

 

(2)                    Not reflected in the accompanying BalanceSheets

 

(3)                    Intereston the variable debt obligations was calculated at 3.25%, the interest rate ineffect as of June 30, 2008.

 

(4)                    Includes $1.2 million of interest accrued forin the accompanying Balance Sheets.  Theremaining amounts are not reflected in the accompanying Balance Sheets.

 

Weare obligated under non-cancelable operating leases for all of our facilitiesand under certain equipment leases. Original lease terms for our facilities ineffect as of June 30, 2008 were five to ten years and generally require usto pay the real estate taxes, insurance and other operating costs. Equipmentlease terms generally range from three to five years.

 

Totaloperating lease obligations under the Boulder Lease amount to $52.0 millionover the lease term, and account for $42.5 million of operating leaseobligations within the above table. Total operating lease obligations under the Longmont lease are $24.2million over the lease term, and account for $20.0 million of operating leaseobligations within the above table.

 

Purchaseobligations totaling $19.2 million were primarily for outsourced clinical andpharmacology services. Additional purchase obligations of $4.0 million wereprimarily for software to support the advancement of clinical trials,facilities improvements and lab supplies.

 

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

##  

Marketrisk represents the risk of loss that may impact our financial position,results of operations or cash flows due to adverse changes in financial andcommodity market prices, the liquidity of our ARS, and interest rates. All ofour collaboration agreements and nearly all purchase orders are denominated inU.S. dollars. As a result, historically and as of June 30, 2008, we havehad little or no exposure to market risk from changes in foreign currency orexchange rates.

 

Ourexposure to market risk for changes in interest rates relates primarily to ourinvestments in marketable securities. The investment portfolio is comprisedprimarily of readily marketable, high-quality securities diversified andstructured to minimize market risks while providing a reasonable return on investedfunds. As of June 30, 2008, $29.1 million of our investment portfolio isinvested in ARS that are not marketable. We target our average portfolio maturity at one year or less.Nevertheless, the securities held in our investment portfolio are subject tochanges in market value in response to changes in interest rates and liquidity.In addition, a significant change in market interest rates could have amaterial impact on interest income earned from our investment portfolio.

 

Giventhe current balance of $125.5 million of investments classified as cash andcash equivalents, and short-term and long-term marketable securities availablefor sale, a theoretical 100 basis point change in interest rates and securityprices would impact our net income (loss) positively or negatively byapproximately $1.3 million.

 

Ourlong-term marketable securities investment portfolio includes ARS. During thefiscal year ended June 30, 2008 and subsequent thereto, auctions for allof our ARS, amounting to seven securities with a par value of$32.9 million, were unsuccessful. We recorded an other-than-temporaryimpairment of $1.9 million on two of our ARS, primarily due the continuousdecline and magnitude of the fair value discount from par value, which is duein

 

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partto the relative weakness in the performance of the underlying trust assets. Webelieve that impairment in the other five ARS in the portfolio, amounting to$1.9 million, is temporary, primarily because of stronger performance of theunderlying trust assets, the relatively smaller discount of fair value from parvalue, and because these securities have not incurred significant continuousdeclines in fair value during recent periods. If credit market liquidityconditions deteriorate further, we may be required to record additionaltemporary or other-than-temporary impairments of our ARS, which could adverselyaffect our financial condition, cash flow and reported earnings. In the eventwe need to access any of our ARS, we will not be able to do so until auctionsof these investments are successful, the original issuers retire thesesecurities or a secondary market develops for these securities.

 

Weare also impacted by adverse changes in interest rates relating tovariable-rate borrowings under our senior secured Credit Facility with ComericaBank. We pay interest on advances under our loan agreement at one of threevariable rates, which are adjusted periodically for changes in the underlyingprevailing rate. Changes in prevailing interest rates will affect the fairvalue of our debt, and will impact future results of operations and cash flows.As of June 30, 2008, we had $55.9 million of long-term debt outstanding,exclusive of the debt discount of $20.5 million, of which $15.0 million isunder our variable rate term loan and equipment advance facilities.  The variable rate is adjusted based onchanges in the bank’s prime lending rate. The interest rate on the remainder ofour long-term debt is fixed.  Assumingconstant debt levels, a theoretical change of 100 basis points on our currentinterest rate of 3.25% as of June 30, 2008 would result in a change in ourannual interest expense of approximately $150 thousand.

 

Historically,and as of June 30, 2008, we have not used derivative instruments orengaged in hedging activities.

 

**ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

Thefinancial statements required by this item are located in Item 15 beginning on page F-1of this Annual Report on Form 10-K and are incorporated herein byreference.

 

**ITEM9.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES**

 

None.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

Asof the end of the period covered by this Annual Report on Form 10-K, underthe supervision of our Chief Executive Officer and our Chief Financial Officer,we evaluated the effectiveness of our disclosure controls and procedures, assuch term is defined in Rule 13a-15(e) and Rule 15d-15(e) underthe Securities Exchange Act of 1934. Based on this evaluation, our ChiefExecutive Officer and our Chief Financial Officer have concluded that ourdisclosure controls and procedures are effective to ensure that information weare required to disclose in reports that we file or submit under the SecuritiesExchange Act of 1934: (1) is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rules andforms, and (2) is accumulated and communicated to our management,including our Chief Executive Officer and our Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosure. Ourdisclosure controls and procedures include components of our internal controlover financial reporting. Management’s assessment of the effectiveness of ourinternal control over financial reporting set forth below is expressed at thelevel of reasonable assurance because a control system, no matter how welldesigned and operated, can provide only reasonable, but not absolute, assurancethat the control system’s objectives will be met.

 

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**Evaluation of Internal Control over Financial Reporting**

 

Pursuant to Section 404of the Sarbanes-Oxley Act of 2002, we have included a report on management’sassessment of the design and effectiveness of its internal control overfinancial reporting as part of this Annual Report on Form 10-K for thefiscal year ended June 30, 2008. Our independent registered publicaccounting firm also audited and reported on the effectiveness of internalcontrol over financial reporting. Management’s report and the independentregistered public accounting firm’s attestation report are included under thecaptions entitled “Management’s Report on Internal Control Over FinancialReporting” and “Report of Independent Registered Public Accounting Firm onInternal Control Over Financial Reporting” in Item 15 of this AnnualReport on Form 10-K and are incorporated herein by reference.

 

Basedon their evaluation as of June 30, 2008, our principal executive officerand our principal financial officer have concluded that our disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act) are effective.

 

**Changes in Internal Control over Financial Reporting**

 

Therehas been no change in our internal control over financial reporting during thefourth quarter of our fiscal year ended June 30, 2008 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**ITEM 9B. OTHER INFORMATION**

 

None.

 

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** **

**PART III**

###### ** **

###### **ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

######  

Theinformation required by this item is incorporated by reference from theinformation under the captions “Proposal 1-Election of Directors,” “ExecutiveOfficers” and “Section 16(a) Beneficial Ownership ReportingCompliance” contained in the Proxy Statement of Array BioPharma Inc. relatingto the annual meeting of stockholders to be held on October 30, 2008.

 

**Code of Ethics**

 

We have adopted a Code of Business Conduct that applies to all of ourdirectors, officers and employees, including our principal executive officer,principal financial officer and principal accounting officer. The Code ofBusiness Conduct is posted under the Investor Relations portion of our websiteat www.arraybiopharma.com.

 

We intend to satisfy the disclosure requirement of Form 8-Kregarding amendments to or waivers from a provision of our Code of BusinessConduct by posting such information on our website at www.arraybiopharma.comand, to the extent required by the NASDAQ Global Market, by filing a currentreport on Form 8-K with the SEC, disclosing such information.

 

**ITEM 11.EXECUTIVE COMPENSATION**

 

Theinformation required by this item is incorporated by reference from theinformation under the caption “Executive Compensation” contained in the ProxyStatement of Array BioPharma Inc. relating to the annual meeting ofstockholders to be held on October 30, 2008.

 

###### **ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND RELATED STOCKHOLDER MATTERS**

######  

Theinformation required by this item is incorporated by reference from the informationunder the captions “Principal Stockholders” and “Proposal 2 – Approval ofAmendment to Employee Stock Purchase Plan” contained in the Proxy Statement ofArray BioPharma Inc. relating to the annual meeting of stockholders to be heldon October 30, 2008.

 

###### **ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTORINDEPENDENCE**

######  

Theinformation required by this item is incorporated by reference from theinformation under the captions “Certain Relationships and Transactions” and “Proposal1 – Election of Directors – Meetings of the Board of Directors and Committeesof the Board of Directors” contained in the Proxy Statement of Array BioPharmaInc. relating to the annual meeting of stockholders to be held on October 30,2008.

 

###### **ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

######  

Theinformation required by this item is incorporated by reference from theinformation under the caption “Fees Billed by the Principal Accountant”contained in the Proxy Statement of Array BioPharma Inc. relating to the annualmeeting of stockholders to be held on October 30, 2008.

 

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** **

**PART IV**

###### ** **

###### **ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

######  

The following documents arefiled as part of this Report on Form 10-K:

 

1.               *Financial Statements*

 

Reference is made to the Index to the FinancialStatements is set forth on page F-1 of this Annual Report on Form 10-K.

 

2.               *Financial Statement Schedules*

 

All schedules have been omitted as the requiredinformation is either not required, not applicable, or otherwise included inthe Financial Statements and notes thereto.

 

3.               *Exhibits*

 

Reference is made to the Exhibit Index that isset forth after the Financial Statements referenced above in this Annual Reporton Form 10-K.

 

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, as amended, the Registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized, in the Cityof Boulder, State of Colorado, on August 15, 2008.

 
|   | ARRAY  BIOPHARMA INC. |
|--------|-----------------------|
|   |                  |
|   |                  |
|   | By:                   | /s/  ROBERT E. CONWAY |
|   |                  | Robert  E. Conway |
|   |                  | Chief  Executive Officer |

 

 
| **SIGNATURE**              | ** ** | **TITLE**                                    | ** ** | **DATE**        |
|----------------------------|------------|----------------------------------------------|------------|-----------------|
|                       |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ ROBERT E. CONWAY       |       | Chief Executive Officer and Director         |       | August 15, 2008 |
| Robert E. Conway           |       | (Principal Executive Officer)                |       |            |
|                       |       |                                         |       |            |
| /s/ KYLE A. LEFKOFF        |       | Chairman of the Board of Directors           |       | August 15, 2008 |
| Kyle A. Lefkoff            |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ R. MICHAEL CARRUTHERS  |       | Chief Financial Officer                      |       | August 15, 2008 |
| R. Michael Carruthers      |       | (Principal Financial And Accounting Officer) |       |            |
|                       |       |                                         |       |            |
| /s/ FRANCIS J. BULLOCK     |       | Director                                     |       | August 15, 2008 |
| Francis J. Bullock, Ph.D.  |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ MARVIN H. CARUTHERS    |       | Director                                     |       | August 15, 2008 |
| Marvin H. Caruthers, Ph.D. |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ KEVIN KOCH             |       | Director                                     |       | August 15, 2008 |
| Kevin Koch, Ph.D.          |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ DAVID L. SNITMAN       |       | Director                                     |       | August 15, 2008 |
| David L. Snitman, Ph.D.    |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ GIL J. VAN LUNSEN      |       | Director                                     |       | August 15, 2008 |
| Gil J. Van Lunsen          |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ DOUGLAS E. WILLIAMS    |       | Director                                     |       | August 15, 2008 |
| Douglas E. Williams, Ph.D. |       |                                         |       |            |
|                       |       |                                         |       |            |
| /s/ JOHN L. ZABRISKIE      |       | Director                                     |       | August 15, 2008 |
| John L. Zabriskie, Ph.D.   |       |                                         |       |            |

 

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**INDEX TO THEFINANCIAL STATEMENTS**

 
| **Description**                                                                                        | ** ** | **Page No.** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------|
|                                                                                                   |       |              |
| Management’s Report on Internal  Control Over Financial Reporting                                 |       | F-2               |
|                                                                                                   |       |              |
| Report of Independent  Registered Public Accounting Firm on Internal Control Over Financial  Reporting |       | F-3               |
|                                                                                                   |       |              |
| Report of Independent  Registered Public Accounting Firm                                               |       | F-4               |
|                                                                                                   |       |              |
| Balance Sheets as of June 30, 2008 and 2007                                                       |       | F-5               |
|                                                                                                   |       |              |
| Statements of Operations and  Comprehensive Loss for the years endedJune 30, 2008, 2007 and 2006  |       | F-6               |
|                                                                                                   |       |              |
| Statements of Stockholders’  Equity for the years ended June 30, 2008, 2007 and 2006         |       | F-7               |
|                                                                                                   |       |              |
| Statements of Cash Flows for the years  ended June 30, 2008, 2007 and 2006                        |       | F-8               |
|                                                                                                   |       |              |
| Notes to the Financial  Statements                                                                     |       | F-9               |

 

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**MANAGEMENT’SREPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and15d-15(f). Our internal control over financial reporting is a process designedto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.

 

Allinternal control systems, no matter how well designed, have inherentlimitations. Therefore even those systems determined to be effective canprovide only reasonable assurance with respect to financial statementpreparation and presentation. Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.Projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we conducted an evaluationof the effectiveness of our internal control over financial reporting as of June 30,2008 based on the framework set forth in Internal Control – IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). Based on that evaluation, our management concluded that, asof June 30, 2008, our internal control over financial reporting waseffective.

 

KPMGLLP, our independent registered public accounting firm, has issued anattestation report on management’s assessment of the effectiveness of ourinternal control over financial reporting as of June 30, 2008, as statedin their report, which is included elsewhere herein.

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

TheBoard of Directors and Stockholders

ArrayBioPharma Inc.:

 

Wehave audited Array BioPharma Inc.’s internal control over financial reportingas of June 30, 2008, based on criteria established in*Internal Control – Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). Array BioPharma Inc.’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting, included in theaccompanying *Management’s Report on InternalControl over Financial Reporting*. Our responsibility is to expressan opinion on the Company’s internal control over financial reporting based onour audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, assessing the risk that a material weaknessexists, and testing and evaluating the design and operating effectiveness of internalcontrol based on the assessed risk. Our audit also included performing suchother procedures as we considered necessary in the circumstances. We believethat our audit provides a reasonable basis for our opinion.

 

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

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Inour opinion, Array BioPharma Inc. maintained, in all material respects,effective internal control over financial reporting as of June 30, 2008,based on criteria established in *InternalControl – Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the balance sheets of Array BioPharmaInc. as of June 30, 2008 and 2007, and the related statements ofoperations and comprehensive loss, stockholders’ equity, and cash flows foreach of the years in the three-year period ended June 30, 2008, and ourreport dated August 15, 2008 expressed an unqualified opinion on thosefinancial statements.

 

 
|                  | /s/     KPMG  LLP |   |
|-----------------------|--------------------------------------------|--------|
|                  |                                       |
| Boulder,  Colorado    |                                       |
| August 15,  2008 |                                       |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

TheBoard of Directors and Stockholders

ArrayBioPharma Inc.:

 

Wehave audited the accompanying balance sheets of Array BioPharma Inc. as of June 30,2008 and 2007, and the related statements of operations and comprehensive loss,stockholders’ equity, and cash flows for each of the years in the three-yearperiod ended June 30, 2008. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Array BioPharma Inc. as of June 30,2008 and 2007, and the results of its operations and its cash flows for each ofthe years in the three-year period ended June 30, 2008, in conformity withU.S. generally accepted accounting principles.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), Array BioPharma Inc.’s internalcontrol over financial reporting as of June 30, 2008, based on thecriteria established in *Internal Control –Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated August 15,2008 expressed an unqualified opinion on the effectiveness of the Company’sinternal control over financial reporting.

 

 
|                  | /s/     KPMG  LLP |   |
|-----------------------|--------------------------------------------|--------|
|                  |                                       |
| Boulder,  Colorado    |                                       |
| August 15,  2008 |                                       |

 

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**ARRAY BIOPHARMA INC.**

**Balance Sheets**

**(Amountsin Thousands, Except Share and Per Share Amounts)**

 
| ** **                                                                                                                                                                               | ** ** | **June 30,**                                       | ** **    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|---------------|
| ** **                                                                                                                                                                               | ** ** | **2008**                                                | ** **    | **2007** | ** ** |
|                                                                                                                                                                                     |       |                                                    |          |   |   |
| **ASSETS**                                                                                                                                                                               |       |                                                    |          |   |   |
| **Current assets**                                                                                                                                                                       |       |                                                    |          |   |   |
| Cash and cash equivalents                                                                                                                                                                |       | $                                                       | 56,448   |   | $ | 10,670  |   |
| Marketable securities                                                                                                                                                                    |       | 39,243                                             |          | 130,661  |   |
| Prepaid expenses and other current assets                                                                                                                                                |       | 5,062                                              |          | 4,066  |   |
| Total current assets                                                                                                                                                                     |       | 100,753                                            |          | 145,397  |   |
|                                                                                                                                                                                     |       |                                                    |          |   |   |
| **Long-term assets**                                                                                                                                                                     |       |                                                    |          |   |   |
| Marketable securities                                                                                                                                                                    |       | 29,840                                             |          |          - |   |
| Property and equipment, net                                                                                                                                                              |       | 30,160                                             |          | 28,077  |   |
| Other long-term assets                                                                                                                                                                   |       | 2,324                                              |          | 1,500  |   |
| Total long-term assets                                                                                                                                                                   |       | 62,324                                             |          | 29,577  |   |
| Total assets                                                                                                                                                                             |       | $                                                       | 163,077  |   | $ | 174,974  |   |
|                                                                                                                                                                                     |       |                                                    |          |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                            |       |                                                    |          |   |   |
| **Current liabilities**                                                                                                                                                                  |       |                                                    |          |   |   |
| Accounts payable                                                                                                                                                                         |       | $                                                       | 4,661    |   | $ | 6,398  |   |
| Accrued outsourcing costs                                                                                                                                                                |       | 11,280                                             |          | 3,681  |   |
| Accrued compensation and benefits                                                                                                                                                        |       | 7,503                                              |          | 6,542  |   |
| Other accrued expenses                                                                                                                                                                   |       | 2,251                                              |          | 1,888  |   |
| Deferred rent                                                                                                                                                                            |       | 2,718                                              |          | 2,728  |   |
| Deferred revenue                                                                                                                                                                         |       | 5,994                                              |          | 3,333  |   |
| Total current liabilities                                                                                                                                                                |       | 34,407                                             |          | 24,570  |   |
|                                                                                                                                                                                     |       |                                                    |          |   |   |
| **Long-term liabilities**                                                                                                                                                                |       |                                                    |          |   |   |
| Deferred rent                                                                                                                                                                            |       | 24,537                                             |          | 27,146  |   |
| Deferred revenue                                                                                                                                                                         |       | 30,000                                             |          | 29  |   |
| Long-term debt, net of discount of $20,543  as of June 30, 2008                                                                                                                     |       | 35,355                                             |          | 15,000  |   |
| Other long-term liability                                                                                                                                                                |       | 751                                                |          | 528  |   |
| Total long-term liabilities                                                                                                                                                              |       | 90,643                                             |          | 42,703  |   |
| Total liabilities                                                                                                                                                                        |       | 125,050                                            |          | 67,273  |   |
|                                                                                                                                                                                     |       |                                                    |          |   |   |
| **Commitments and contingencies**                                                                                                                                                        |       |                                                    |          |   |   |
|                                                                                                                                                                                     |       |                                                    |          |   |   |
| **Stockholders’ equity**                                                                                                                                                            |       |                                                    |          |   |   |
| Preferred stock, $0.001 par value;  10,000,000 shares authorized, no shares issued or outstanding                                                                                        |       |          - |          |          - |   |
| Common stock, $0.001 par value; 120,000,000  and 60,000,000 shares authorized; 47,544,503 and 47,076,172 shares issued and  outstanding, as of June 30, 2008 and 2007, respectively |       | 48                                                 |          | 47  |   |
| Additional paid-in capital                                                                                                                                                               |       | 304,713                                            |          | 296,767  |   |
| Warrants                                                                                                                                                                                 |       | 20,589                                             |          |          - |   |
| Accumulated other comprehensive loss                                                                                                                                                     |       | (1,937)                                                 |          | (15) |   |
| Accumulated deficit                                                                                                                                                                      |       | (285,386)                                               |          | (189,098) |   |
| Total stockholders’ equity                                                                                                                                                          |       | 38,027                                             |          | 107,701  |   |
| Total liabilities and stockholders’ equity                                                                                                                                          |       | $                                                       | 163,077  |   | $ | 174,974  |   |

 

*The accompanying notes are an integral partof these financial statements.*

 

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**ARRAY BIOPHARMA INC.**

**Statements of Operations and Comprehensive Loss**

**(Amountsin Thousands, Except Per Share Data)**

 

 
| ** **                                                   | ** ** | **Years Ended June 30,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                | ** ** | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                   | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenue**                                                  |       |                                    |       |   |   |   |   |   |
| Collaboration revenue                                        |       | $                                       | 21,513     |   |   | $ | 30,106 |   | $ | 37,738 |   |
| License and milestone revenue                                |       | 7,295                                   |       |   | 6,864 |   | 7,265 |   |
| Total revenue                                                |       | 28,808                                  |       |   | 36,970 |   | 45,003 |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Operating expenses**                                       |       |                                    |       |   |   |   |   |   |
| Cost of revenue                                              |       | 21,364                                  |       |   | 24,936 |   | 39,611 |   |
| Research and development for proprietary  drug discovery     |       | 90,347                                  |       |   | 57,464 |   | 33,382 |   |
| General and administrative                                   |       | 15,591                                  |       |   | 13,644 |   | 13,683 |   |
| Total operating expenses                                     |       | 127,302                                 |       |   | 96,044 |   | 86,676 |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Loss from operations**                                     |       | (98,494)                                |       |   | (59,074) |   | (41,673) |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Other income (expense)**                                   |       |                                    |       |   |   |   |   |   |
| Impairment of marketable securities                          |       | (1,872)                                 |       |   |         - |   |         - |   |
| Interest income                                              |       | 6,064                                   |       |   | 4,610 |   | 2,729 |   |
| Interest expense                                             |       | (1,986)                                 |       |   | (979) |   | (670) |   |
| Total other income                                           |       | 2,206                                   |       |   | 3,631 |   | 2,059 |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Net loss**                                                 |       | $                                       | (96,288)   |   |   | $ | (55,443) |   | $ | (39,614) |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| Change in unrealized loss on marketable  securities          |       | (1,922)                                 |       |   | 256 |   | 8 |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Comprehensive loss**                                       |       | $                                       | (98,210)   |   |   | $ | (55,187) |   | $ | (39,606) |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Weighted average shares outstanding - basic  and diluted** |       | 47,309                                  |       |   | 40,717 |   | 38,759 |   |
|                                                         |       |                                    |       |   |   |   |   |   |
| **Net loss per share - basic and diluted**                   |       | $                                       | (2.04)     |   |   | $ | (1.36) |   | $ | (1.02) |   |

 

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

 

F-6

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Table of Contents

 

**ARRAYBIOPHARMA INC.**

**Statementsof Stockholders’ Equity**

**(Amountsin Thousands)**

** **
| ** **                                                                     | ** ** | ** **               | ** ** | ** **            | ** **          | ** **                | ** ** | ** **    | ** ** | ** **                | ** ** | ** **      | ** ** | **Accumulated**           | ** ** | ** **                      | ** ** | ** **    | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|---------------------|---------------------------|------------|---------------|------------|---------------------------|------------|-----------------|------------|---------------------------|------------|---------------------------------|------------|---------------|------------|
| ** **                                                                     | ** ** | ** **               | ** ** | ** **            | ** **          | ** **                | ** ** | ** **    | ** ** | **Additional**            | ** ** | ** **      | ** ** | **Other**                 | ** ** | ** **                      | ** ** | ** **    | ** ** |
| ** **                                                                     | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** **          | **Paid-in**               | ** ** | ** **    | ** ** | **Comprehensive**         | ** ** | **Accumulated** | ** ** | ** **                | ** ** |
| ** **                                                                     | ** ** | **Shares**               | ** ** | **Amounts**           | ** **          | **Shares**                | ** ** | **Amounts**   | ** ** | **Capital**               | ** ** | **Warrants**    | ** ** | **Income (Loss)**    | ** ** | **Deficit**                     | ** ** | **Total**     | ** ** |
|                                                                           |       |                     |       |                  |                |                      |       |          |       |                      |       |            |       |                      |       |                            |       |          |       |
| **Balance  as of June 30, 2005**                                          |       | -                        |       | $                     | -    |                      | 38,466     |          | $          | 38                        |       | $               | 193,697    |                      | $          |    -             |       | $             | (279)      |   | $ | (94,041) |   | $ | 99,415  |   |
| Issuance of  common stock under stock option and employee stock purchase plans |       | -                        |       | -                     |                | 658                       |       | 1             |       | 2,672                     |       | -               |       | -     |       | -      |       | 2,673    |       |
| Share-based  compensation expense                                              |       | -                        |       | -                     |                | -     |       | -   |       | 6,157                     |       | -               |       | -     |       | -      |       | 6,157    |       |
| Change in  unrealized gain (loss) on marketable securities                     |       | -                        |       | -                     |                | -     |       | -   |       | -                         |       | -               |       | 8                         |       | -      |       | 8        |       |
| Net loss                                                                       |       | -                        |       | -                     |                | -     |       | -   |       | -                         |       | -               |       | -     |       | (39,614)                        |       | (39,614)      |       |
|                                                                           |       |                     |       |                  |                |                      |       |          |       |                      |       |            |       |                      |       |                            |       |          |       |
| **Balance  as of June 30, 2006**                                          |       | -                        |       | -                     |                | 39,124                    |       | 39            |       | 202,526                   |       | -               |       | (271)                     |       | (133,655)                       |       | 68,639   |       |
| Issuance of  common stock for cash -                                           |       |                     |       |                  |                |                      |       |          |       |                      |       |            |       |                      |       |                            |       |          |       |
| public offering,  net of offering costs of $5,764                              |       | -                        |       | -                     |                | 7,000                     |       | 7             |       | 85,236                    |       | -               |       | -     |       | -      |       | 85,243   |       |
| Issuance of  common stock under stock option and employee stock purchase plans |       | -                        |       | -                     |                | 952                       |       | 1             |       | 4,194                     |       | -               |       | -     |       | -      |       | 4,195    |       |
| Share-based  compensation expense                                              |       | -                        |       | -                     |                | -     |       | -   |       | 4,811                     |       | -               |       | -     |       | -      |       | 4,811    |       |
| Change in  unrealized gain (loss) on marketable securities                     |       | -                        |       | -                     |                | -     |       | -   |       | -     |       | -               |       | 256                  |       | -      |       | 256      |       |
| Net loss                                                                       |       | -                        |       | -                     |                | -     |       | -   |       | -     |       | -               |       | -     |       | (55,443)                        |       | (55,443)      |       |
|                                                                           |       |                     |       |                  |                |                      |       |          |       |                      |       |            |       |                      |       |                            |       |          |       |
| **Balance  as of June 30, 2007**                                          |       | -                        |       | -                     |                | 47,076                    |       | 47            |       | 296,767                   |       | -               |       | (15)                      |       | (189,098)                       |       | 107,701  |       |
| Issuance of  common stock under stock option and employee stock purchase plans |       | -                        |       | -                     |                | 469                       |       | 1             |       | 1,787                     |       | -               |       | -     |       | -      |       | 1,788    |       |
| Share-based  compensation expense                                              |       | -                        |       | -                     |                | -     |       | -   |       | 6,159                     |       | -               |       | -     |       | -      |       | 6,159    |       |
| Issuance of  common stock warrants                                             |       | -                        |       | -                     |                | -     |       | -   |       | -     |       | 20,589          |       | -     |       | -      |       | 20,589   |       |
| Change in  unrealized gain (loss) on marketable securities                     |       | -                        |       | -                     |                | -     |       | -   |       | -     |       | -               |       | (1,922)                   |       | -      |       | (1,922)       |       |
| Net loss                                                                       |       | -                        |       | -                     |                | -     |       | -   |       | -     |       | -               |       | -     |       | (96,288)                        |       | (96,288)      |       |
|                                                                           |       |                     |       |                  |                |                      |       |          |       |                      |       |            |       |                      |       |                            |       |          |       |
| **Balance  as of June 30, 2008**                                          |       | -                        |       | $                     | -    |                      | 47,545     |          | $          | 48                        |       | $               | 304,713    |                      | $          | 20,589                          |       | $             | (1,937)    |   | $ | (285,386) |   | $ | 38,027  |   |
|                                                                                |            |                          |            |                       |                     |                           |            |               |            |                           |            |                 |            |                           |            |                                 |            |               |            |  |  |  |  |  |  |  |  |  |

 

*The accompanying notes are an integral part of these financialstatements.*

 

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Table of Contents

 

**ARRAY BIOPHARMA INC.**

**Statements of Cash Flows**

**(Amounts in Thousands)**

 
| ** **                                                                                        | ** ** | **Years Ended June 30,**                       | ** **   |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|--------------|
| ** **                                                                                        | ** ** | **2008**                                                      | ** **   | **2007** | ** ** | **2006** | ** ** |
|                                                                                              |       |                                                          |         |   |   |   |   |
| **Cash flows from operating activities**                                                          |       |                                                          |         |   |   |   |   |
| Net loss                                                                                          |       | $                                                             | (96,288)     |   | $ | (55,443) |   | $ | (39,614) |   |
| Adjustments to reconcile net loss to net  cash used in operating activities:                      |       |                                                          |         |   |   |   |   |
| Depreciation and amortization expense                                                             |       | 6,103                                                    |         | 6,379  |   | 9,033  |   |
| Interest expense for the amortization of  the debt discount                                       |       | 944                                                      |         |           - |   |           - |   |
| Share-based compensation expense                                                                  |       | 6,159                                                    |         | 4,811  |   | 6,157  |   |
| Impairment of marketable securities                                                               |       | 1,872                                                    |         |           - |   |           - |   |
| Loss on disposal of property and equipment                                                        |       |           - |         |           - |   | 106  |   |
| Changes in operating assets and liabilities:                                                      |       |                                                          |         |   |   |   |   |
| Prepaid expenses and other current assets                                                         |       | (818)                                                         |         | 616  |   | (826) |   |
| Accounts payable                                                                                  |       | (1,737)                                                       |         | 1,138  |   | 2,007  |   |
| Accrued outsourcing costs                                                                         |       | 7,599                                                    |         | 2,729  |   | 496  |   |
| Accrued compensation and benefits                                                                 |       | 961                                                      |         | 772  |   | 1,449  |   |
| Other accrued expenses                                                                            |       | (544)                                                         |         | 376  |   | 405  |   |
| Deferred rent liabilites                                                                          |       | (2,619)                                                       |         | (3,964) |   | (88) |   |
| Deferred revenue                                                                                  |       | 32,632                                                   |         | (2,016) |   | (3,758) |   |
| Other liabilities                                                                                 |       |           - |         | 79  |   | 335  |   |
| Net cash used in operating activities                                                             |       | (45,736)                                                      |         | (44,523) |   | (24,298) |   |
|                                                                                              |       |                                                          |         |   |   |   |   |
| **Cash flows from investing activities**                                                          |       |                                                          |         |   |   |   |   |
| Purchases of property and equiment                                                                |       | (8,186)                                                       |         | (7,148) |   | (5,180) |   |
| Proceeds from sales of property and  equipment                                                    |       |           - |         |           - |   | 39  |   |
| Purchases of marketable securities                                                                |       | (71,593)                                                      |         | (144,940) |   | (67,151) |   |
| Proceeds from sales and maturities of  marketable securities                                      |       | 130,505                                                  |         | 69,150  |   | 90,925  |   |
| Net proceeds from assignment of facility  purchase options                                        |       |           - |         | 32,275  |   |           - |   |
| Decrease in restricted cash                                                                       |       |           - |         |           - |   | 1,980  |   |
| Net cash provided by (used in) investing  activities                                              |       | 50,726                                                   |         | (50,663) |   | 20,613  |   |
|                                                                                              |       |                                                          |         |   |   |   |   |
| **Cash flows from financing activities**                                                          |       |                                                          |         |   |   |   |   |
| Proceeds from sale of common stock, net of  issuance costs                                        |       |           - |         | 85,243  |   |           - |   |
| Proceeds from exercise of stock options and  shares issued under the employee stock purchase plan |       | 1,788                                                    |         | 4,195  |   | 2,674  |   |
| Proceeds from the issuance of long-term  debt                                                     |       | 40,000                                                   |         | 850  |   | 4,150  |   |
| Payment of transaction fee                                                                        |       | (1,000)                                                       |         |           - |   |           - |   |
| Net cash provided by financing activities                                                         |       | 40,788                                                   |         | 90,288  |   | 6,824  |   |
|                                                                                              |       |                                                          |         |   |   |   |   |
| **Net increase (decrease) in cash and cash  equivalents**                                         |       | 45,778                                                   |         | (4,898) |   | 3,139  |   |
| Cash and cash equivalents as of beginning  of year                                                |       | 10,670                                                   |         | 15,568  |   | 12,429  |   |
| **Cash and cash equivalents as of end of year**                                                   |       | $                                                             | 56,448  |   | $ | 10,670  |   | $ | 15,568  |   |
|                                                                                              |       |                                                          |         |   |   |   |   |
| **Supplemental disclosure of cash flow  information**                                             |       |                                                          |         |   |   |   |   |
| Cash paid for interest                                                                            |       | $                                                             | 1,806   |   | $ | 969  |   | $ | 599  |   |
|                                                                                              |       |                                                          |         |   |   |   |   |
| **Supplemental disclosure of non-cash  information**                                              |       |                                                          |         |   |   |   |   |
| Property and equipment included in accounts  payable                                              |       | $                                                             | 168     |   | $ | 1,120  |   | $ |        - |   |

 

*The accompanying notes are an integral partof these financial statements.*

 

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Table of Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

**NOTE 1 - OVERVIEW AND SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

**Organization**

 

ArrayBioPharma Inc. (“the Company”) is a biopharmaceutical company focused on thediscovery, development and commercialization of targeted small molecule drugsto treat patients afflicted with cancer, inflammatory diseases and pain.  The Company’s proprietary drug developmentpipeline includes clinical candidates that are designed to regulatetherapeutically important target proteins. In addition, leading pharmaceuticaland biotechnology companies partner with the Company to discover and developdrug candidates across a broad range of therapeutic areas.

 

**Basis of Presentation**

 

Certainfinancial statement amounts have been reclassified to conform to the currentyear presentation.

 

**Use of Estimates**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States (“U.S.”) requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenue and expenses duringthe reporting period. Although management bases these estimates on historicaldata and other assumptions believed to be reasonable under the circumstances,actual results could differ significantly from these estimates.

 

TheCompany believes the accounting estimates having the most significant impact onits financial statements relate to (i) estimating the fair value of theCompany’s auction rate securities (“ARS”), (ii) estimating accruedoutsourcing costs for clinical trials and pre-clinical testing and (iii) forecastingfuture taxable income for determining whether deferred tax valuation allowancesare necessary.

 

**Fair Value of Financial Instruments**

 

The Company’s financial instruments mainly consist of cash and cashequivalents, marketable securities, long-term investments, trade receivablesand payables, accrued expenses, long-term debt and warrants.  The carrying amounts of the Company’s cashequivalents, trade receivables and payables and accrued expenses approximatetheir fair value due to the short-term nature of these instruments. 

 

We periodically review the realizability of each short-term andlong-term marketable security and each long-term investment when impairmentindicators exist with respect to the investment. If an other-than-temporaryimpairment of the value of the investments is deemed to exist, the carryingvalue of the investment is written down to its estimated fair value. See Note 3for further information.

 

The carrying value of the long-term debt with variable interest ratesapproximates its fair value because the interest rates approximate the currentmarket rates.  

 

The fair value of the Company’s long-term debt with fixed interestrates is estimated by discounting the projected cash flows using the rate atwhich similar debt could currently be borrowed. The fair value of the Company’swarrants was determined using the Black-Scholes option pricing model.  However, considerable judgment is required ininterpreting market data to develop estimates of fair value. Accordingly, thefair value estimates disclosed in Note 7 are not necessarily indicative of theamount that the Company or holders of the instruments could realize in acurrent market exchange. The use of different assumptions and/or estimationmethodologies may have a material effect on the estimated fair value.

 

**Cash and Cash Equivalents**

 

Cashequivalents consist of short-term, highly liquid financial instruments that arereadily convertible to cash and have maturities of 90 days or less from thedate of purchase and may consist of money market funds, taxable commercialpaper, U.S. government agency obligations and corporate notes and bonds withhigh credit quality.

 

**Marketable Securities**

 

TheCompany has designated the marketable securities held by the Company as of June 30,2008 and 2007 as available-for-sale securities for purposes of Statement ofFinancial Accounting Standards (“SFAS”) No. 115 *Accounting for Certain Investments in Debt and Equity Securities (“*SFAS115”)*.* Marketable securities thatare readily available for use in current operations are classified asshort-term  available for sale securitiesand are reported as a component of current assets in the accompanying BalanceSheets. Marketable securities that are not considered available for use in currentoperations are classified as long-term available-for-sale securities and arereported as a component of long term assets in the accompanying Balance Sheets.

 

TheCompany concluded that certain of its investments in ARS are not available foruse in current operations due to unsuccessful auctions and therefore hasreported them as a component of long-term assets in the accompanying BalanceSheets.  Securities that are classifiedas available-for-sale are carried at fair value, including accrued interest,with temporary unrealized gains and losses reported as a component ofStockholders’ Equity until their disposition.

 

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Table of Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

Theamortized cost of debt securities in this category is adjusted for amortizationof premiums and accretion of discounts to maturity. Such amortization is includedin interest income. Realized gains and losses are reported in Interest Incomeor Interest Expense in the accompanying Statements of Operations andComprehensive Loss as incurred.  Declinesin value judged to be other-than-temporary on securities available-for-sale arereported in Impairment of Marketable Securities in the accompanying Statementsof Operations and Comprehensive Loss as incurred.  Declines in value considered to be temporaryon securities available for sale are reported in Accumulated OtherComprehensive Loss in the accompanying Balance Sheets.  The cost of securities sold is based on thespecific identification method.  See Note3 for additional information about the Company’s investments in ARS that arenot considered available for use in current operations.

 

TheCompany’s investment policy limits the concentration of its investments in anysingle instrument to a maximum of five percent of the total portfolio. All ofthe Company’s securities at the purchase date must be readily marketable andhave high quality debt ratings from either Moody’s or Standard &Poors.

 

**Property and Equipment**

 

Propertyand equipment are stated at historical cost less accumulated depreciation andamortization. Additions, improvements and major renewals are capitalized.Maintenance, repairs and minor renewals are expensed as incurred.

 

Depreciationand amortization are computed on the straight-line method based on thefollowing estimated useful lives:

 
| Furniture and fixtures         |   | 7 years |
|--------------------------------|--------|---------|
| Equipment                      |   | 5 years |
| Computer hardware and software |   | 3 years |

 

TheCompany depreciates leasehold improvements associated with operating leases ona straight-line basis over the shorter of the expected useful life of theimprovements or the reasonably assured term of the leases.

 

Thecarrying value for property and equipment is reviewed for impairment whenevents or changes in circumstances indicate the book value of the assets maynot be recoverable. An impairment loss would be recognized when estimatedundiscounted future cash flows from the use of the asset and its eventualdisposition is less than its carrying amount.

 

**Equity Investment**

 

TheCompany may enter into collaboration and licensing agreements in which itreceives an equity interest in consideration for all or a portion of up-front,license or other fees under the terms of the agreement. The Company reports thevalue of equity securities received from non-publicly traded companies in whichit does not exercise a significant controlling interest as other long termassets, at cost. The Company monitors its investment for impairment at leastannually and makes appropriate reductions in the carrying value if it isdetermined that an impairment has occurred, based primarily on the financialcondition and near term prospects of the issuer.

 

**Preclinical Study and ClinicalTrial Accruals**

 

Substantialportions of the Company’s preclinical studies and all of the Company’s clinicaltrials have been performed by third-party laboratories, medical centers,contract research organizations, and other vendors (collectively CROs).  These CROs bill monthly for servicesperformed or based upon milestone achievement. The Company accrues for each of the significant agreements it has withCROs.  For preclinical studies, expensesare accrued based upon the percentage of work completed and the contractmilestones remaining.  For clinicalstudies, expenses are accrued based upon the number of patients enrolled andthe duration of the study.  The Companymonitors patient enrollment, the progress of clinical studies and relatedactivities to the extent possible through internal reviews of data reported toit by the CROs, correspondence with the CROs and clinical site visits.  The Company’s estimates depend on thetimelines and accuracy of the data provided by its CROs regarding the

 

F-10

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Table of Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

statusof each program and total program spending. The Company periodically evaluatesits estimates to determine if adjustments are necessary or appropriate based oninformation it receives concerning changing circumstances, conditions or eventsthat may affect such estimates.

 

**Deferred Revenue**

 

TheCompany records amounts received, but not earned, as deferred revenue. Theseamounts are classified based on their maturity in the accompanying BalanceSheets.

 

**Income Taxes**

 

TheCompany provides for income taxes using the liability method in accordance withSFAS No. 109 *Accounting for IncomeTaxes* (“SFAS 109”) and Financial Accounting Standards Board (“FASB”)Interpretation No. 48 *Accounting forUncertainties in Income Taxes, an interpretation of SFAS No. 109,Accounting for Income Taxes* (“FIN 48”). The Company recognizes theamount of income taxes payable or refundable for the year as well as deferredtax assets and liabilities. Deferred tax assets and liabilities are determinedbased on the difference between the financial statement and tax basis of assetsand liabilities using enacted tax rates in effect for the year that thedifferences are expected to effect current taxable income. Valuation allowancesare recorded to reduce the amount of deferred tax assets when, based uponavailable objective evidence including historical taxable income, the expectedreversal of temporary differences, and projections of future taxable income,management cannot conclude it is more likely than not that some or all of thedeferred tax assets will be realized.

 

**Operating Leases**

 

TheCompany has negotiated certain rent holidays, landlord/tenant incentives andescalations in the base price of rent payments over the initial term of itsoperating leases. The initial term includes the “build-out” period of leases,where no rent payments are typically due under the terms of the lease. TheCompany recognizes rent holidays and rent escalations on a straight-line basisover the lease term. The landlord/tenant incentives are recorded as an increaseto Deferred Rent in the accompanying Balance Sheets and amortized on astraight-line basis over the initial lease term.  Deferred Rent balances are classified asshort-term or long-term in the accompanying Balance Sheets based upon whenrecognition of the liability is expected to occur.

 

**Share-Based Compensation**

 

TheCompany uses the fair value method of accounting for share-based compensationarrangements in accordance with SFAS No. 123 (revised 2004) *Share-Based Payments* (“SFAS 123(R)”). TheCompany adopted SFAS 123(R) on July 1, 2005 using the modifiedprospective method of transition. Under this method, compensation expenserecognized beginning with the effective date of adoption of SFAS 123(R) includes(i) compensation cost for all share-based payments granted prior to, butnot yet vested as of, July 1, 2005 based on the grant date fair valueestimated in accordance with the original provisions of SFAS 123; and (ii) compensationcost for all share-based payments granted on or after July 1, 2005 basedon the grant date fair value estimated in accordance with the provisions ofSFAS 123(R). Share-based compensation arrangements covered by SFAS 123(R) includestock options granted under the Company’s Amended and Restated Stock Option andIncentive Plan (the “Option Plan”) and purchases of common stock by itsemployees at a discount to the market price during offering periods under theCompany’s Employee Stock Purchase Plan (the “ESPP”).

 

UnderSFAS 123(R), the estimated fair value of share-based compensation under theOption Plan and the ESPP, is recognized as compensation expense. The estimatedfair value of stock options is expensed on a straight-line basis over thevesting term. Compensation expense for stock options is reduced for estimatedforfeitures, which are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. Compensation expense for purchases under the ESPP is recognizedbased on the estimated fair value of the common stock during each offeringperiod and the percentage of the purchase discount. See Note 12 below for moreinformation on the impact of the Company’s share-based compensation plans onthe Company’s financial statements.

 

F-11

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**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

**Revenue Recognition**

 

Most of the Company’s revenue is derived fromdesigning, creating, optimizing, evaluating and developing drug candidates forthe Company’s collaborators. The Company’s agreements with collaborationpartners include fees based on contracted annual rates for full time equivalentemployees working on a project, and may also include non-refundable license andup-front fees, non-refundable milestone payments that are triggered uponachievement of specific research or development goals, and future royalties onsales of products that result from the collaboration. A small portion of theCompany’s revenue comes from fixed fee agreements or from sales of compounds ona per-compound basis. The Company reports revenue for lead generation and leadoptimization research, custom synthesis and process research, the developmentand sale of chemical compounds and the co-development of proprietary drugcandidates the Company out-licenses, as collaboration revenue. License andmilestone revenue is combined and reported separately from collaboration revenue.

 

Arrangements that include multiple elements areevaluated under Emerging Issues Task Force (“EITF”) Issue No. 00-21 *Revenue Arrangements with Multiple Deliverables*(“EITF00-21”), to determine whether the element has value to the customer on astand-alone basis and whether reliable evidence of fair value for the deliveredelements exists. Deliverables in an arrangement that do not meet the separationcriteria of EITF 00-21 are treated as a single unit of accounting, generallyapplying applicable revenue recognition guidance for the final deliverable tothe combined unit of accounting as defined in Staff Accounting Bulletin No. 104*Revenue Recognition* (“SAB 104”).SAB 104 in turn established four criteria, each of which must be met, in orderto recognize revenue related to the performance of services or the shipment ofproducts. Revenue is recognized when (a) persuasive evidence of anarrangement exists, (b) products are delivered or services are rendered, (c) thesales price is fixed or determinable and (d) collectability is reasonablyassured.

 

The Company recognizes revenue from non-refundableup-front payments and license fees on a straight-line basis over the term ofperformance under the agreement, which is generally the research term specifiedin the agreement. These advance payments are deferred and recorded as advancepayments from collaborators upon receipt, pending recognition, and areclassified as a short-term or long-term liability on the accompanying BalanceSheets. When the performance period is not specifically identifiable from theagreement, the Company estimates the performance period based upon provisionscontained within the agreement, such as the duration of the research term, thespecific number of full time equivalent scientists working a defined number ofhours per year at a stated price under the agreement, the existence orlikelihood of development commitments, and other significant commitments of theCompany.

 

Similarly to advance payments, for agreements thatprovide for milestone payments, a portion of each milestone payment isrecognized as revenue when the specific milestone is achieved based on theapplicable percentage of the estimated research term that has elapsed to thetotal estimated research term. Revenue recognition related to non-refundablelicense fees and up-front payments and to milestone payments could beaccelerated in the event of early termination of programs.

 

Revenue from sales of compounds in the Company’sLead Generation Library and Optimer building blocks is generally recognized asthe compounds are shipped. The Company recognizes revenue based on contractedannual rates for full time equivalent employees working on a project on amonthly basis as work is performed.

 

**Cost of Revenue**

 

Cost of revenue represents research and developmentconducted for the Company’s collaborators and the cost of chemical compoundssold. These costs consist mainly of compensation, associated fringe benefits,share-based compensation and other collaboration-related costs, including supplies,small tools, facilities, depreciation, recruiting and relocation and otherdirect and indirect chemical handling and laboratory support costs. The Companyallocates these costs between Cost of Revenue and Research and Development forProprietary Drug

 

F-12

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

Discoverybased upon the respective time spent on each by its scientists on developmentconducted for its collaborators and for its internal proprietary programs,respectively.

 

Where the Company’s collaboration agreements providefor it to conduct development of drug candidates, and for which the Company’spartner has an option to obtain the right to conduct further development and tocommercialize a product, the Company attributes a portion of its research anddevelopment costs to Cost of Revenue based on the percentage of total compoundsunder the agreement that may be selected by the partner. For example, asdescribed further in Note 6, the Company granted to Celgene an option to selectup to two of four drugs developed under the collaboration. Accordingly, theCompany reports costs associated with the Celgene collaboration asfollows:  50% to cost of revenue, withthe remaining 50% to research and development for proprietary drug discovery.

 

**Research and Development for Proprietary Drug DiscoveryCosts**

 

Research and development for proprietary drugdiscovery costs are expensed as incurred, and consist of direct and indirectinternal costs related to specific projects, as well as fees paid to otherentities that conduct research activities on the Company’s behalf.

 

**Net Loss per Share**

 

Basic net loss per share is computed by dividing netloss for the period by the weighted average number of common shares outstandingduring the period. Diluted net loss per share reflects the additional dilutionfrom potential issuances of common stock, such as stock issuable pursuant tothe exercise of stock options, warrants or stock issued in payment of long-termdebt. The treasury stock method is used to calculate the potential dilutiveeffect of these common stock equivalents. Potentially dilutive shares areexcluded from the computation of diluted loss per share when their effect isanti-dilutive. As a result of the Company’s net losses for the fiscal yearsended June 30, 2008, 2007 and 2006, all potentially dilutive securitieswere anti-dilutive and therefore have been excluded from the computation ofdiluted loss per share.

 

**Comprehensive Income (Loss)**

 

The Company’s comprehensive income (loss) consistsof net income (loss), and unrealized gains and temporary losses on investmentsin available-for-sale marketable securities. The Company had no other sourcesof comprehensive income (loss) for the fiscal years presented.

 

**Recently Issued Accounting Pronouncements**

 

In May 2008, the FASB issued FASB StaffPosition (“FSP”) APB 14-1 *Accounting forConvertible Debt Instruments That May Be Settled in Cash upon Conversion(Including Partial Cash Settlement*(“FSP APB 14-1”)*.* FSP APB 14-1 clarifies that convertibledebt instruments that may be settled in cash upon either mandatory or optionalconversion (including partial cash settlement) are not addressed by paragraph12 of Accounting Principles Board (“APB”) Opinion No. 14 *Accounting for Convertible Debt and Debt issued withStock Purchase Warrants*. Additionally, FSP APB 14-1 specifies thatissuers of such instruments should separately account for the liability andequity components in a manner that will reflect the entity’s nonconvertibledebt borrowing rate when interest cost is recognized in subsequent periods. FSPAPB 14-1 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008, and interim periods within those fiscalyears. The Company will adopt FSP APB 14-1 beginning in the first quarter offiscal 2009, and this standard must be applied on a retrospective basis. TheCompany is evaluating the impact the adoption of FSP APB 14-1 will have on theCompany’s financial position and results of operations.

 

In December 2007, the EITF Board ratified EITFIssue No. 07-1 *Accounting for CollaborativeArrangements Related to the Development and Commercialization of IntellectualProperty*(“EITF 07-1”). EITF 07-1 will require the Company todisclose the nature and purpose of its collaborative arrangements in the annualfinancial statements, its rights and obligations under the collaborativearrangements, the stage of the underlying endeavor’s life cycle, the Company’saccounting policies for the arrangements and the statement of operationsclassification and amount of significant financial statement amounts related tothe collaborative arrangements.

 

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** **

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

EITF 07-1 will be effective for the Companybeginning in July 2008 and will require the Company to apply this Issue asa change in accounting principle through retrospective application to prior periodsfor collaborative arrangements existing as of the effective date. The Companydoes not expect the adoption of EITF 07-1 to have a material impact on itsresults of operations, cash flows and financial condition.

 

In September 2006, the FASB issued SFAS No. 157*Fair Value Measurements*(“SFAS157”). SFAS 157 establishes a single definition of fair value and a frameworkfor measuring fair value, sets out a fair value hierarchy to be used toclassify the source of information used in fair value measurements, andrequires new disclosures of assets and liabilities measured at fair value basedon their level in the hierarchy. This statement applies under other accountingpronouncements that require or permit fair value measurements. In February 2008,the FASB issued FSPs No. 157-1 and No. 157-2, which, respectively,removed leasing transactions from the scope of SFAS 157 and deferred for oneyear the effective date for SFAS 157 as it applies to certain non-financialassets and liabilities. The deferral provided by FSP No. 157-2 applies tosuch items as non-financial assets and liabilities initially measured at fairvalue in a business combination (but not measured at fair value in subsequentperiods) and non-financial long-lived asset groups measured at fair value foran impairment assessment. SFAS 157 will be effective for the Company beginningin July 2008 when the Company will become subject to the new disclosurerequirements (excluding the items covered in FSP 157-2) with respect to theCompany’s fair value measurements of (a) non-financial assets andliabilities that are recognized or disclosed at fair value in the Company’sfinancial statements on a recurring basis (at least annually) and (b) allfinancial assets and liabilities.  The Company is currently evaluating theeffect the adoption of SFAS 157 will have on its operations and financialcondition.

 

In February 2007, the FASB issued SFAS No. 159*The Fair Value Option for Financial Assetsand Financial Liabilities – including an amendment of FASB Statement No. 115*(“SFAS 159”). SFAS 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value that are notcurrently required to be measured at fair value, with unrealized gains andlosses related to these financial instruments reported in earnings at eachsubsequent reporting date. The decision about whether to elect the fair valueoption is generally: (i) applied instrument by instrument; (ii) irrevocable(unless a new election date occurs, as discussed in SFAS 157); and (iii) appliedonly to an entire instrument and not to only specified risks, specific cashflows, or portions of that instrument. Under SFAS 159, financialinstruments for which the fair value option is elected, must be valued inaccordance with SFAS 159 (as described above) and must be marked to marketeach period through the income statement. SFAS 159 will be effective for theCompany beginning in July 2008. The Company is currently evaluating theeffect the adoption of SFAS 159 will have on its operations and financialcondition.

 

**NOTE 2 – SEGMENTS, GEOGRAPHIC INFORMATION ANDSIGNIFICANT COLLABORATORS**

 

**Segments**

 

All operations of the Company are considered to bein one operating segment and, accordingly, no segment disclosures have beenpresented. The physical location of all of the Company’s equipment, leaseholdimprovements and other fixed assets is within the U.S.

 

F-14

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Table of Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

**Geographic Information**

 

The following table details revenue fromcollaborators by geographic area based on the country in which collaboratorsare located or the ship-to destination for compounds (amounts in thousands):

 
| ** **    | ** ** | **Years Ended June 30,** | ** **         |
|---------------|------------|-----------------------------------------|--------------------|
| ** **    | ** ** | **2008**                                | ** **         | **2007** | ** ** | **2006** | ** ** |
| ** **    | ** ** | ** **                              | ** **         | ** ** | ** ** | ** ** | ** ** |
| North America |       | $                                       | 24,454   |   | $ | 25,693   |   | $ | 30,969  |   |
| Europe        |       | 230                           |               | 5,365   |   | 7,653  |   |
| Asia Pacific  |       | 4,124                         |               | 5,912   |   | 6,381  |   |
|          |       | $                                       | 28,808   |   | $ | 36,970   |   | $ | 45,003  |   |

 

**Significant Collaborators**

 

TheCompany had four, four and three collaborators that contributed greater than10% of the total revenue for each of the fiscal years ended June 30, 2008,2007 and 2006, respectively. The revenue from these collaborators as apercentage of total revenue was as follows:

 
| ** **                         | ** ** | **Years Ended June 30,** |
|------------------------------------|------------|-----------------------------------------|
| ** **                         | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** |
| ** **                         | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Genentech, Inc.               |       | 54.1                                    | %  |   | 41.8 | %  |   | 34.8 | %  |
| Celgene Corporation                |       | 14.9                                    | %  |   | 0.0 | %  |   | 0.0 | %  |
| Ono Pharmaceutical Co., Ltd.       |       | 14.2                                    | %  |   | 13.0 | %  |   | 6.9 | %  |
| VentiRx Pharmaceuticals, Inc. |       | 13.7                                    | %  |   | 4.0 | %  |   | 0.0 | %  |
| InterMune, Inc.               |       | 1.0                                     | %  |   | 21.0 | %  |   | 24.0 | %  |
| AstraZeneca AB                     |       | 0.0                                     | %  |   | 13.5 | %  |   | 15.8 | %  |
|                               |       | 97.9                                    | %  |   | 93.3 | %  |   | 81.5 | %  |

 

The loss of one or more of its significantcollaborators could have a material adverse effect on the Company’s business,operating results or financial condition. The Company does not requirecollateral, though most pay in advance, from its collaborators. Although theCompany is impacted by economic conditions in the biotechnology andpharmaceutical sectors, management does not believe significant credit riskexists as of June 30, 2008.

 

**NOTE 3 - MARKETABLE SECURITIES**

 

The Company’s investments in marketable securitiesinclude domestic public corporate debt securities, commercial paper issued bydomestic public companies, obligations of U.S. federal government agencies andARS. Investments are classified as short-term or long-term based on the natureof these securities and the availability of these securities to meet currentoperating requirements. All of these investments are held in the name of theCompany at a limited number of financial institutions. The Company’sinvestments in marketable securities were all classified as available-for-saleas of June 30, 2008 and 2007.

 

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** **

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

Marketablesecurities consisted of the following as of June 30, 2008 (amounts inthousands):

 
| ** **                                | ** ** | ** **         | ** **         | **Gross**                             | ** ** | **Gross**                                         | ** ** | ** **   | ** **                            |
|-------------------------------------------|------------|--------------------|--------------------|---------------------------------------|------------|---------------------------------------------------|------------|--------------|---------------------------------------|
| ** **                                | ** ** | **Amortized**      | ** **         | **Unrealized**                        | ** ** | **Unrealized**                                    | ** ** | **Fair**     | ** **                            |
| ** **                                | ** ** | **Cost**           | ** **         | **Gains**                             | ** ** | **Losses**                                        | ** ** | **Value**    | ** **                            |
| ** **                                | ** ** | ** **         | ** **         | ** **                            | ** ** | ** **                                        | ** ** | ** **   | ** **                            |
| Short-term available-for-sale securities: | ** ** | ** **         | ** **         | ** **                            | ** ** | ** **                                        | ** ** | ** **   | ** **                            |
| Corporate commercial paper securities     |       | $                  | 9,457    |                                  | $          | 9                                       |       | $            | -       |   | $ | 9,466  |   |
| U.S. Government agency securities         |       | 23,801   |               | 1                           |       | (4)                                     |       | 23,798  |                                  |
| Corporate debt securities and other       |       | 5,983    |               | -                           |       | (4)                                     |       | 5,979   |                                  |
| Sub-total                                 |       | 39,241   |               | 10                          |       | (8)                                     |       | 39,243  |                                  |
|                                      |       |               |               |                                  |       |                                              |       |         |                                  |
| Long-term available-for-sale securities:  |       |               |               |                                  |       |                                              |       |         |                                  |
| Auction rate securities                   |       | 31,028   |               | -       |       | (1,939)                                 |       | 29,089  |                                  |
| Mutual fund securities                    |       | 751      |               | -       |       | -         |       | 751     |                                  |
| Sub-total                                 |       | 31,779   |               | -       |       | (1,939)                                 |       | 29,840  |                                  |
|                                      |       |               |               |                                  |       |                                              |       |         |                                  |
| Total                                     |       | $                  | 71,020   |                                  | $          | 10                                      |       | $            | (1,947)                          |   | $ | 69,083  |   |

 

Marketablesecurities consisted of the following as of June 30, 2007 (amounts inthousands):

 
| ** **                                | ** ** | ** **          | ** **          | **Gross**                       | ** ** | **Gross**                                   | ** ** | ** **          | ** **       |
|-------------------------------------------|------------|---------------------|---------------------|---------------------------------|------------|---------------------------------------------|------------|---------------------|------------------|
| ** **                                | ** ** | **Amortized**       | ** **          | **Unrealized**                  | ** ** | **Unrealized**                              | ** ** | **Fair**            | ** **       |
| ** **                                | ** ** | **Cost**            | ** **          | **Gains**                       | ** ** | **Losses**                                  | ** ** | **Value**           | ** **       |
| ** **                                | ** ** | ** **          | ** **          | ** **                      | ** ** | ** **                                  | ** ** | ** **          | ** **       |
| Short term available-for-sale securities: | ** ** | ** **          | ** **          | ** **                      | ** ** | ** **                                  | ** ** | ** **          | ** **       |
| U.S. Government agency securities         |       | $                   | 12,520    |                            | $          | -                  |       | $                   | (15)   |   | $ | 12,505   |
| Auction rate securities                   |       | 118,156   |                | -      |       | -        |       | 118,156   |
| Total                                     |       | $                   | 130,676   |                            | $          | -                  |       | $                   | (15)   |   | $ | 130,661   |
|                                           |            |                     |                     |                                 |            |                                             |            |                     |                  |  |  |  |  |

 

Marketablesecurities in an unrealized loss position for more than twelve months as of June 30,2008 and 2007 were as follows (amounts in thousands):

 
| ** **                            | ** ** | **Less Than 12 Months** | ** **        | **Greater Than 12 Months** | ** ** | **Total**         | ** ** |
|---------------------------------------|------------|----------------------------------------|-------------------|-------------------------------------------|------------|-------------------|------------|
| ** **                            | ** ** | ** **                             | ** **        | **Gross**                                 | ** ** | ** **        | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                            | ** ** | **Fair**                               | ** **        | **Unrealized**                            | ** ** | **Fair**          | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                            | ** ** | **Value**                              | ** **        | **Losses**                                | ** ** | **Value**         | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| ** **                            | ** ** | ** **                             | ** **        | ** **                                | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balances as of June 30, 2008** |       |                                   |              |                                      |       |              |       |   |   |   |   |   |   |
| Auction rate securities               |       | $                                      | 4,760   |                                      | $          | (233)   |       | $ | 24,329   |   | $ | (1,706)   |   | $ | 29,089  |   | $ | (1,939)  |   |
|                                  |       |                                   |              |                                      |       |              |       |   |   |   |   |   |   |
| **Balances as of June 30, 2007** |       |                                   |              |                                      |       |              |       |   |   |   |   |   |   |
| U.S. Government agency securities     |       | $                                      | -       |                                      | $          | -       |       | $ | 10,384   |   | $ | (15)   |   | $ | 10,384  |   | $ | (15)  |   |

 

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** **

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

Theamortized cost and estimated fair value of available-for-sale securities bycontractual maturity as of June 30, 2008 is as follows (amounts inthousands):

 
| ** **                       | ** ** | **Amortized**      | ** **         | **Fair**     | ** ** |
|----------------------------------|------------|--------------------|--------------------|--------------|------------|
| ** **                       | ** ** | **Cost**           | ** **         | **Value**    | ** ** |
| ** **                       | ** ** | ** **         | ** **         | ** **   | ** ** |
| Due in one year or less          |       | $                  | 39,241   |         | $          | 39,243  |   |
| Due in one year to three years   |       | 463      |               | 463     |       |
| Due in four years to eight years |       | 288      |               | 288     |       |
| Due after 10 years or more       |       | 31,028   |               | 29,089  |       |
|                             |       | $                  | 71,020   |         | $          | 69,083  |   |

 

Included within long-term marketable securitiesinvestment portfolio are ARS. During the fiscal year ended June 30, 2008and subsequent thereto, auctions for all of the ARS, amounting to sevensecurities with a par value of $32.9 million, were unsuccessful, whichresulted in the interest rate on these investments increasing to LIBOR plus additionalbasis points as stipulated in the auction rate agreements, ranging from 150 to350 additional basis points as of June 30, 2008. While the Company nowearns a higher contractual interest rate on these investments, the investmentsare not currently liquid. In the event the Company needs to access these funds,it will not be able to do so until auctions of these investments aresuccessful, the original issuers retire these securities or a secondary marketdevelops for these securities. Auctions generally are scheduled to occur atregular intervals of approximately 28 days.

 

Since there is currently no active market data forthe Company’s ARS, the Company developed its own assumptions to determine thefair values for these securities. Fair value for this purpose is defined as anexit price between willing market participants. The Company considered theunderlying structure and assets of each ARS, the coupon interest rates, and thecurrent interest rate market environment. The Company also considered thevaluations prepared by its third party investment advisor who maintains custodyof these securities and conducts the related auctions. The Company used adiscounted cash flow method to estimate fair values. The most significantunobservable inputs used in this method are estimates of the amount of timeuntil a liquidity event will occur and the discount rate, which incorporatesestimates of credit risk and a liquidity premium. While the Company believesthat the estimates used are reasonable, a change in any of these factors wouldresult in different fair value estimates for the ARS, and could result inadditional temporary or other-than-temporary impairment.

 

Based on its analysis and estimates, the Companyrecorded an other-than-temporary impairment of $1.9 million on two of its ARS,primarily due to the continuous decline and magnitude of the fair valuediscount from par value, which is due in part to the relative weakness in theperformance of the underlying trust assets. The Company believes that impairmentin the other five ARS in the portfolio, amounting to $1.9 million, istemporary, primarily because of stronger performance of the underlying trustassets, the relatively smaller discount of fair value from par value, andbecause these securities have not incurred significant continuous declines infair value during recent periods. Accordingly, the temporary impairment isrecorded in other comprehensive loss as of June 30, 2008.

 

While the Company expects cash will be used inoperations for the fiscal year ending June 30, 2009, management currentlybelieves that it has sufficient cash, non-auction rate instruments and accessto sources of cash sufficient to fund its operations over the next 12-monthperiod such that if these ARS are not convertible to cash, management will notbe compelled to liquidate these securities at a loss, or at all.

 

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** **

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

**NOTE 4 –PROPERTY AND EQUIPMENT, NET**

 

Property and Equipment, Net in the accompanyingBalance Sheets consists of the following (amounts in thousands):

 
| ** **                                       | ** ** | **June 30,**  | ** **         |
|--------------------------------------------------|------------|--------------------|--------------------|
| ** **                                       | ** ** | **2008**           | ** **         | **2007** | ** ** |
| ** **                                       | ** ** | ** **         | ** **         | ** ** | ** ** |
| Furniture and fixtures                           |       | $                  | 3,162    |   | $ | 1,877  |   |
| Equipment                                        |       | 37,846   |               | 35,191  |   |
| Computer hardware and software                   |       | 10,208   |               | 8,893  |   |
| Leasehold improvements                           |       | 29,662   |               | 27,003  |   |
| **Property and equipment, gross**                |       | 80,878   |               | 72,964  |   |
| Less: Accumulated depreciation and  amortization |       | (50,718)      |               | (44,887) |   |
| **Property and equipment, net**                  |       | $                  | 30,160   |   | $ | 28,077  |   |

 

Depreciation and amortization expense was $6.1million, $6.4 million and $9.0 million for the years ended June 30, 2008,2007, and 2006, respectively.

 

**Leasehold Improvements**

 

During 2002, the Company entered into a buildinglease for its Longmont, Colorado facility and modified an existing lease forits Boulder, Colorado facility, and in this process obtained options to extendall significant building leases up to, and beyond, 15 years. Due to the highcost to replace and the limited availability of laboratory facilities, theCompany concluded that the exercise of a portion of its options to extend itslease terms to at least 15 years was reasonably assured and therefore amortizedits leasehold improvements over this period of time.

 

During the last quarter of fiscal 2005, the Companyreassessed its facility requirements, and began to consider the possibility ofconsolidating operations in one of its existing locations, or a new location.At that time the Company was no longer reasonably assured that it would remainin its Boulder, Colorado location beyond the initial lease term, which wouldend in March 2008, but was reasonably assured that it would exercise itslease extensions and lease its Longmont, Colorado facility for at least 13 moreyears. Therefore, as of June 2005, the Company began amortizing itsBoulder leasehold improvements over an accelerated period of 34 months representingthe remaining initial lease term, which resulted in an additional expense of$1.6 million for fiscal year 2006.

 

On June 22, 2006, the Company executed a seriesof agreements involving the assignment of facility purchase options that itowned and the subsequent signing of lease agreements for these same facilitiesover a ten-year lease term with a new landlord. Therefore, beginning in June 2006,the Company began amortizing its new leasehold improvements over the newten-year lease terms for both the Boulder and Longmont, Colorado facilities.

 

**NOTE 5 – EQUITY INVESTMENT**

 

In February 2007, the Company entered into acollaboration and licensing agreement with VentiRx Pharmaceuticals, Inc.in which the Company received a non-refundable cash technology access fee andshares of preferred stock valued at $1.5 million based on the price at whichsuch preferred stock was sold to investors in a private offering. Both thetechnology access fee and the value of the preferred stock were recorded asadvance payments from collaborators and deferred revenue, and the deferredrevenue was recognized as revenue on a straight-line basis over the contractualone-year research term. The preferred stock has been recorded as a long-termasset in Other Long-term Assets in the accompanying Balance Sheets.

 

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For theFiscal Years Ended June 30, 2008, 2007 and 2006**

 

**NOTE 6 – DEFERRED REVENUE**

 

On September 21, 2007, the Company entered intoa Drug Discovery and Development Agreement with Celgene Corporation (“Celgene”).Under the agreement, Celgene made an up-front payment of $40 million to theCompany, and, in return, the Company granted to Celgene an option to selectdrugs developed under the collaboration that are directed to two of fourmutually selected discovery targets.  The Company is responsible for alldiscovery and clinical development through Phase 1 or Phase 2a. At that time,Celgene will have the option to select drugs resulting from up to two of thesefour therapeutic programs and will receive exclusive worldwide rights to thosedrugs, except for the Company’s limited co-promotional rights in the U.S. Additionally, the Company is entitled to receive, for each drug, potentialmilestone payments of $200 million if certain discovery, development andregulatory milestones are achieved, and an additional $300 million if certain commercialmilestones are achieved, as well as royalties on net sales. The Company willretain all rights to the programs not selected by Celgene. The agreement may beterminated in whole or in part with respect to individual drug developmentprograms by Celgene upon six months written notice to the Company and by eitherparty, following certain cure periods, in the event of a breach by the otherparty of its obligations under the agreement.

 

**NOTE 7 – LONG-TERM DEBT**

 

Long-termDebt in the accompanying Balance Sheets consists of the following (amounts inthousands):

 
| ** **                                     | ** ** | **June 30,**               | ** **   |
|------------------------------------------------|------------|---------------------------------|--------------|
| ** **                                     | ** ** | **2008**                        | ** **   | **2007** | ** ** |
| ** **                                     | ** ** | ** **                      | ** **   | ** ** | ** ** |
| Credit facility                                |       | $                               | 40,898  |   | $ | -     |   |
| Term loan                                      |       | 10,000                     |         | 10,000 |   |
| Equipment line of credit                       |       | 5,000                      |         | 5,000 |   |
| **Long-term debt, gross**                      |       | 55,898                     |         | 15,000 |   |
| Less: Unamortized discount on credit  facility |       | (20,543)                        |         | - |   |
| **Long-term debt, net**                        |       | 35,355                     |         | 15,000 |   |
| Less: Current portion                          |       | -      |         | -     |   |
| **Long-term debt**                             |       | $                               | 35,355  |   | $ | 15,000  |   |

 

**Credit Facility**

 

In April 2008, the Company entered into asix-year loan (“Credit Facility”) with, and issued warrants to purchase commonstock to, Deerfield Private Design Fund, L.P. and Deerfield Private DesignInternational Fund, L.P. (collectively “Deerfield”) a health care investmentfund. The Company may borrow a total of $80 million under the Credit Facilityin two $40 million payments in June 2008 and December 2008. TheCompany pays simple interest quarterly from the agreement date, at a 2.0%annual rate, on the total Credit Facility of $80 million. In addition, interestis compounded quarterly, at a 6.5% annual rate, on the total Credit Facility of$80 million, and is added to the outstanding principal loan balance throughrepayment. The outstanding principal and interest is due on or before April 2014,and, at the Company’s option, can be repaid at any time with shares of theCompany’s common stock, with certain restrictions, or in cash. A 2.5%transaction fee of the amounts borrowed is payable to Deerfield at the time theCompany borrows under the facility.

 

As of June 30, 2008, the Company has borrowed$40 million and has paid a transaction fee of $1 million. Other direct issuancecosts in connection with the transaction were not significant and were expensedas incurred. The Company recognized a total of $1.2 million in interest expenseduring the fiscal year ended June 30, 2008. The Credit Facility is securedby a second priority security interest in the Company’s assets, includingaccounts receivable, equipment, inventory, investment property and generalintangible assets, excluding copyrights, patents, trademarks, service marks andcertain intangible assets related to these exclusions.

 

F-19

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

The Facility Agreement with Deerfield (the “FacilityAgreement”) contains representations and warranties and affirmative and negativecovenants that are customary for credit facilities of this type. The FacilityAgreement could restrict the Company’s ability to, among other things, sellcertain assets, engage in a merger or change in control transaction, incurdebt, pay cash dividends and make investments. The Facility Agreement alsocontains events of default that are customary for credit facilities of thistype, including payment defaults, covenant defaults, insolvency type defaultsand events of default relating to liens, judgments, material misrepresentationsand the occurrence of certain material adverse events.

 

If the Company’s total cash and cash equivalents andmarketable securities at the end of a fiscal quarter fall below $40 million,the loans and accrued interest thereon become immediately due and payable. TheCompany may elect to repay the outstanding principal and accrued interest byissuance of registered shares of the Company’s common stock. The maximum numberof shares that may be issued for repayment at any given share payment date issubject to a limitation equal to not less than one percent and not more thanfour percent of shares outstanding. Shares issued for repayment are valued forthis purpose between 92% and 95% of the weighted average volume share price on theshare payment date.

 

Additionally, inconsideration for providing the Credit Facility, the Company issued warrants toDeerfield to purchase 6,000,000 shares of common stock at a price of $7.54 pershare, which may be exercised at any time on, or prior to, April 29, 2014.Pursuant to Accounting Principles Board Opinion No. 14 *Accounting for Convertible Debt and Debt issued withStock Purchase Warrants*, the Company allocated the total proceeds of$80 million between the convertible debt and the warrants based upon theirrelative estimated fair values. 

 

The Company estimated thatthe fair value of the first tranche of the Deerfield debt is $30.9 million asof the agreement date.  As of June 30,2008, the Company believes that there has not been a change from the fair valuestated above.

 

The Company valued thewarrants using the Black-Scholes option pricing model using the followingassumptions:

 

·                 Arisk-free interest rate of 3.3%;

·                 Volatilityof 63.9%;

·                 Expectedlife of six years; and

·                 Azero dividend yield.

 

The warrants of $20.5million were recognized as equity under EITF 00-19 *Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock*andare reported within Stockholders’ Equity in the accompanying Balance Sheet. Thefair value of the warrants has been recognized as debt discount in theaccompanying Balance Sheets and will be amortized to interest expense over thesix year term of the Credit Facility.

 

There was approximately $46thousand of interest amortization expense recognized during the fiscal yearended June 30, 2008 and as of June 30, 2008 the warrants have notbeen exercised.

 

**Term Loan and Equipment Line of Credit**

 

The Company entered into a Loan and SecurityAgreement (“Loan and Security Agreement”) with Comerica Bank dated June 28,2005, as amended on July 7, 2006 and on June 6, 2008. The Loan andSecurity Agreement provides for a term loan, equipment advances and a revolvingline of credit, all of which are secured by a first priority security interestin the Company’s assets, other than its intellectual property. The full $10million term loan was advanced to the Company on June 30, 2005, andcurrently has an interest rate of 3.25% per annum and a maturity date of June 28,2010. Up to $5 million in equipment advances were available to the Companythrough December 28, 2006 to finance the purchase of equipment,capitalized software and tenant improvements. As of June 30, 2008, theCompany had received $5 million of equipment advances, which currently have aninterest rate of 3.25% per annum and a maturity date of June 28, 2010.Revolving lines of credit totaling $6.9 million support outstanding standbyletters of credit that have been issued in relation to the Company’s facilitiesleases. These standby letters of credit expire on January 31, 2014 and August 31,2016, respectively.

 

The outstanding balances under the term loan, theequipment advances and the revolving line of credit bear interest on a monthlybasis at one of the following interest rates elected by the Company from timeto time:

 

F-20

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June 30, 2008, 2007 and 2006**

 

·                 Arate equal to 1.75% below the Prime “Base Rate” as quoted by the Bank from timeto time; or

·                 Arate equal to 1.00% above the Bank’s LIBOR rate, which would remain in effectduring the relevant LIBOR period; or

·                 Arate equal to 1.25% above the Bank’s Cost of Funds rate, which would remain ineffect during the relevant Cost of Funds period.

 

Should the Company maintain less than $10 million atthe Bank at any time during any interest rate period, the interest rate theCompany pays will be 0.50% higher than shown above. Interest is payable monthlyon the outstanding borrowings.

 

If the Company’s total cash, cash equivalents andmarketable securities, including those invested at the Bank, falls below $40million, between $30 million and $25 million, or below $25 million, the minimumrequired balance maintained at the Bank is $2 million, $8.5 million and $17million, respectively. If the Company’s total cash, cash equivalents andmarketable securities, including those invested at the Bank, falls below $20million, the loans become due.

 

The Loan and Security Agreement containsrepresentations and warranties and affirmative and negative covenants that arecustomary for credit facilities of this type. The Loan and Security Agreementcould restrict the Company’s ability to, among other things, sell certainassets, engage in a merger or change in control transaction, incur debt, paycash dividends and make investments. The Loan and Security Agreement also containsevents of default that are customary for credit facilities of this type,including payment defaults, covenant defaults, insolvency type defaults andevents of default relating to liens, judgments, material misrepresentations andthe occurrence of certain material adverse events.

 

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

**CommitmentSchedule**

 

Asummary of the Company’s commitments under its Facility Agreement withDeerfield and its Loan and Security Agreement with Comerica Bank is as follows(amounts in thousands):

 

| 2009       |   | $      | -      |   |
|------------|--------|--------|--------|--------|
| 2010       |   | 15,000 |   |
| 2011       |   | -      |   |
| 2012       |   | -      |   |
| 2013       |   | -      |   |
| Thereafter |   | 40,898 |   |
|       |   | $      | 55,898 |   |

 

**NOTE 8 - INCOME TAXES**

 

TheCompany has incurred net losses since inception.  The Company has not incurred any currentincome tax provision or benefit for the fiscal years ending June 30, 2008,2007 and 2006.

 

Areconciliation of income taxes at the statutory federal income tax rate to netincome taxes included in the accompanying statements of operations is asfollows:

 
| ** **                                             | ** ** | **Years Ended June 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                             | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. federal income tax expense at the statutory  rate |       | 34.0%                                   |       | 34.0% |   | 34.0% |   |
| Available research and experimentation tax credits     |       | 4.4%                                    |       | 4.5% |   | 4.0% |   |
| Stock-based compensation                               |       | (1.3%)                                  |       | 0.0% |   | (5.3%) |   |
| Effect of other permanent differences                  |       | 0.0%                                    |       | (0.9%) |   | 0.6% |   |
| State income taxes, net of federal taxes               |       | 2.9%                                    |       | 3.0% |   | 2.6% |   |
| Valuation allowance                                    |       | (40.0%)                                 |       | (40.6%) |   | (35.9%) |   |
| Total                                                  |       | 0.0%                                    |       | 0.0% |   | 0.0% |   |

 

Deferredtax assets and liabilities reflect the net tax effects of net operating losses,credit carryforwards and temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes and amounts used forincome tax purposes. The components of the Company’s deferred tax assets andliabilities are as follows (amounts in thousands):

 

F-22

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 
| ** **                                                            | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                            | ** ** | **2008**          | ** ** | **2007** | ** ** |
| ** **                                                            | ** ** | ** **        | ** ** | ** ** | ** ** |
| Net operating  loss carryforwards                                     |       | $                 | 78,823     |   | $ | 47,018 |   |
| Research and  experimentation credit carryforwards                    |       | 11,931            |       | 7,992 |   |
| Deferred revenue                                                      |       | 11                |       | 29 |   |
| Deferred rent                                                         |       | 10,100            |       | 11,088 |   |
| Inventory  reserve                                                    |       | 862               |       | 753 |   |
| Accrued benefits                                                      |       | 2,160             |       | 1,960 |   |
| Depreciation of  equipment, leasehold improvements and other property |       | 2,059             |       | 1,580 |   |
| Other                                                                 |       | 3,564             |       | 1,357 |   |
| **Deferred  tax assets, gross**                                       |       | 109,510           |       | 71,777 |   |
| Valuation  allowance                                                  |       | (109,510)         |       | (71,777) |   |
| **Deferred  tax assets, net**                                         |       | $                 | -          |   | $ | - |   |

 

Basedupon the level of historical taxable loss and projections of future taxableloss over the periods in which the deferred tax assets are deductible,management believes it is more likely than not that the Company will notrealize the benefits of these deductible differences, and accordingly hasestablished a full valuation allowance as of June 30, 2008 and 2007.

 

Futurerealization is dependent on the future earnings of the Company, if any, thetiming and amount of which are uncertain as of June 30, 2008. In thefuture, should management conclude that it is more likely than not that thedeferred tax assets are, in fact, at least in part, realizable, the valuationallowance would be reduced to the extent of such realization and recognized asa deferred income tax benefit in the Company’s Statement of Operations andComprehensive Loss.

 

Excesstax benefits from employee stock option exercises are included in the deferredtax asset balances as of June 30, 2008 and 2007 as a component of theCompany’s net operating loss carryforwards. The entire balance is offset by a valuation allowance.  As a result of SFAS 123(R), the deferred taxasset balances as of June 30, 2008 and 2007 do not include excess taxbenefits from stock option exercises of approximately $4.3 million and $4.2million, respectively.  Equity will beincreased if and when such excess tax benefits are ultimately realized.

 

Fortax purposes, in fiscal year 2006, the Company recognized approximately $32million as a taxable gain and created a deferred tax asset from the facilitiespurchase options that it assigned to a third-party. See Note 9 to the FinancialStatements for a further description of these transactions.

 

As of June 30,2008, the Company had available total net operating loss carryforwards ofapproximately $224.5 million, which expire in the years 2019 through 2028, andfederal research and experimentation credit carryforwards of $11.9 million,which expire in the years 2020 through 2028.

 

TheTax Reform Act of 1986 contains provisions, among others, that limit theutilization of net operating loss and tax credit carryforwards if there hasbeen a “change of ownership” as described in Section 382 of the InternalRevenue Code. Such a change of ownership may limit the Company’s utilization ofits net operating loss and tax credit carryforwards, and could be triggered bysubsequent sales of securities by the Company or its stockholders.

 

EffectiveJuly 1, 2007, the Company adopted FIN 48. This interpretation prescribes a comprehensive model for recognizing,measuring, presenting and disclosing uncertain tax positions taken or expectedto be taken on a tax return.  Under FIN48, tax positions must initially be recognized in the financial statements whenit is more likely than not the position will be sustained upon examination bythe tax authorities. Such tax positions must initially and subsequently bemeasured as the largest amount of tax benefit that has a greater than 50%likelihood of being realized upon ultimate settlement with the tax authorityassuming full knowledge of the position and relevant 

 

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

facts.Additionally, FIN No. 48 provides guidance on the recognition of interestand penalties related to income taxes.

 

Thecumulative effect of adopting FIN 48 has been recorded net in deferred taxassets, which resulted in no FIN 48 liability on the balance sheet. The totalamount of unrecognized tax benefits as of June 30, 2008 is as follows(amounts in thousands):

 
| **Balance  as of July 1, 2007**                          |   | $   | 298    |   |
|---------------------------------------------------------------|--------|-----|--------|--------|
| Additions based  on tax positions related to the current year |   | 699 |   |
| Additions for  tax positions of prior years                   |   | -   |   |
| Reductions for  tax positions of prior years                  |   | -   |   |
| Settlements                                                   |   | -   |   |
| **Balance  as of June 30, 2008**                         |   | $   | 997    |   |

 

There are open statutes of limitations for taxingauthorities in federal and state jurisdictions to audit the Company’s taxreturns from inception of the Company. The Company’s policy is to account forincome tax related interest and penalties in income tax expense in thestatement of operations. There have been no income tax related interest orpenalties assessed or recorded. Because the Company has provided a fullvaluation allowance on all of its deferred tax assets, the adoption of FIN 48had no impact on the Company’s effective tax rate.

 

**NOTE 9 – COMMITMENTS ANDCONTINGENCIES**

 

**Operating Leases**

 

The Company leases facilities and equipment undervarious non-cancelable operating leases that expire through 2016. In additionto minimum lease payments, the Company is contractually obligated under certainof its lease agreements to pay certain operating expenses during the term ofthe leases, such as maintenance, taxes and insurance.

 

As of June 30,2008, future minimum rental commitments, by fiscal year and in the aggregate,for the Company’s operating leases are as follows (amounts in thousands):

 

| 2009       |   | $      | 7,643  |   |
|------------|--------|--------|--------|--------|
| 2010       |   | 7,939  |   |
| 2011       |   | 8,030  |   |
| 2012       |   | 8,150  |   |
| 2013       |   | 8,312  |   |
| Thereafter |   | 24,954 |   |
|       |   | $      | 65,028 |   |

 

Rentexpense under these agreements, net of deferred credits, was $4.5 million, $3.2million and $4.7 million for the years ended June 30, 2008, 2007, and2006, respectively. Deferred rent credits recognized for the years ended June 30,2008, 2007 and 2006 were approximately $2.6 million, $4.0 million and $88thousand, respectively.

 

*Colorado Facility Lease Agreements*

Duringthe first quarter of fiscal 2007, the Company entered into a series ofagreements involving the acquisition and assignment of options to purchase thefacilities that the Company occupied in Boulder and Longmont, Colorado toBioMed Reality L.P. (“BioMed”).  TheCompany assigned options to purchase these facilities to BioMed, and BioMedpurchased both facilities and subsequently leased them back to the Company.

 

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

On July 7,2006, the Company entered into a 10-year lease agreement with BioMed for theBoulder facility with total obligations under the lease amounting to $52.0million over the lease term.

 

On August 9,2006, the Company entered into a 10-year lease agreement with BioMed for theLongmont facility with total obligations under the lease amounting to $24.2million over the lease term.

 

Asconsideration for the assignment of the options, BioMed paid the Company $32.3million in cash.  The Company haddeferred rent liabilities under the previous leases of $1.6 million, which werereversed in the first quarter of fiscal 2007. The consideration received fromBioMed was recorded as a deferred rent liability and, along with the facilities’annual rent increases, is being recognized on a straight-line basis as areduction to rent expense over the related 10-year term of the new leases.

 

**Legal Proceedings**

 

Fromtime to time, the Company may be involved in claims or lawsuits that arise inthe ordinary course of business. Accruals for claims or lawsuits are providedto the extent that losses are deemed both probable and estimable. Although theultimate outcome of these claims or lawsuits cannot be ascertained, on thebasis of present information and advice received from counsel, it is management’sopinion that the disposition or ultimate determination of such claims orlawsuits will not have a material adverse effect on the Company.

 

**NOTE 10 – NET LOSS PER SHARE**

 

As aresult of the Company’s net losses for the fiscal years ended June 30,2008, 2007 and 2006, all potentially dilutive securities were anti-dilutive andtherefore have been excluded from the computation of diluted loss per share.The number of potentially dilutive common stock equivalents excluded from thediluted loss per share calculations was 10,596,711 shares, 6,531,344 shares and1,486,695 shares for the fiscal years ended June 30, 2008, 2007 and 2006,respectively.

 

**NOTE 11 - COMMON STOCK AND STOCKHOLDER RIGHTS PLAN**

 

**Preferred Stock and the Stockholder Rights Plan**

 

In August 2001,the Company adopted a Stockholder Rights Plan designed to ensure that theCompany’s stockholders receive fair and equal treatment in the event of anunsolicited attempt to take control of the Company and to deter coercive orunfair tactics by potential acquirers. The Stockholder Rights Plan imposes asignificant penalty upon any person or group that acquires 15% or more of theCompany’s outstanding common stock without the approval of the Company’s Boardof Directors. Under the Stockholder Rights Plan, a dividend of one PreferredStock Purchase Right was declared for each common share held of record as ofthe close of business on August 27, 2001.

 

Eachright entitles the holder to purchase 1/100th of a share of Series AJunior Participating Preferred Stock for an exercise price of $70.00 per share.The rights generally will not become exercisable unless an acquiring entity accumulatesor initiates a tender offer to purchase 15% or more of the Company’s commonstock. In that event, each right will entitle the holder, other than theunapproved acquirer and its affiliates, to purchase upon the payment of theexercise price a number of shares of the Company’s common stock having a valueof two times the exercise price. If the Company is not the surviving entity ina merger or stock exchange, or 50% or more of the Company’s assets or earningpower are sold in one or more related transactions, each right would entitlethe holder thereof to purchase for the exercise price a number of shares ofcommon stock of the acquiring company having a value of two times the exerciseprice. The rights expire on August 2, 2011.

 

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

**Common Stock**

 

In May 2007,the Company completed a public offering of 7,000,000 shares of the Company’scommon stock under an effective registration statement, at a price to thepublic of $13.00 per share, for gross proceeds of $91 million. The Companyreceived approximately $85.2 million in net proceeds after deductingunderwriting fees of $5.5 million and offering expenses of approximately $300thousand.

 

**Reserved Shares**

 

As of June 30,2008,****common stock reserved forfuture issuance is as follows:

 
| Outstanding common  stock options                                        |   | 8,386,583  |   |
|--------------------------------------------------------------------------|--------|------------|--------|
| Common stock  reserved for warrants                                      |   | 6,000,000  |   |
| Common stock  authorized for grant under our stock option plan           |   | 5,683,890  |   |
| Common stock  available for grant under the Employee Stock Purchase Plan |   | 209,158    |   |
| **Total**                                                                |   | 20,279,631 |   |

 

**NOTE 12 – EMPLOYEE COMPENSATION PLANS**

 

**Employee Savings Plan**

 

TheCompany has a 401(k) plan that allows participants to contribute from 1%to 60% of their salary, subject to eligibility requirements and annual IRSlimits. The Company matches up to 4% of employee contributions on adiscretionary basis as determined by the Company’s Board of Directors. Companycontributions are fully vested after four years of employment.  During fiscal year 2008, 2007 and 2006, theCompany paid matching contributions of approximately $1.2 million, $1.0 millionand $932 thousand, respectively.

 

**Employee Stock Purchase Plan**

 

TheESPP, as amended, was adopted effective upon the closing of the Company’sinitial public offering in November 2000. The ESPP allows qualified employees (as defined in the ESPP) to purchaseshares of the Company’s common stock at a price equal to 85% of the lower ofthe closing price at the beginning of the offering period or the closing priceat the end of the offering period. Each January 1, a new 12-month offeringperiod begins ending on December 31 of that year. Within this offeringperiod, the Company has two purchase periods: a 12-month period beginingJanuary 1 and a six-month period beginning July 1. However, if the closingstock price on July 1 is lower than the closing stock price on thepreceding January 1, then the original 12-month offering period, andcorresponding purchase period, terminate and the purchase rights under theoriginal offering period roll forward into a new six-month offering period, andcorresponding purchase period, that begin July 1 and end on December 31.

 

TheCompany issued 144,626 shares, 146,191 shares and 108,588 shares of commonstock during the fiscal years ended June 30, 2008, 2007 and 2006,respectively pursuant to the ESPP at an average price per share of $7.16, $6.04and $5.38, respectively. Compensation expense related to the Company’s ESPP was$655 thousand, $375 thousand and $339 thousand for the fiscal years ended June 30,2008, 2007 and 2006, respectively.

 

As of June 30,2008, the Company had authorized a total of 1.65 million shares for issuanceunder the ESPP, and the Company had 209,158 shares available for issuance.

 

### **Stock Option and Incentive Plan**

###  

*Overview*

In September 2000,the Company’s Board of Directors approved the Amended and Restated Stock Optionand Incentive Plan (the “Option Plan”), which is the successor equity incentiveplan to the Company’s 1998 Stock 

 

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

OptionPlan (the “1998 Plan”), initially adopted by the Board of Directors in July 1998.Upon the closing of the Company’s initial public offering in 2000, the OptionPlan became effective and no additional grants were made under the 1998 Plan. Atotal of 14.6 million shares of common stock have been reserved for issuanceunder the Option Plan to eligible employees, consultants and directors of theCompany. In addition, the Option Plan provides for the reservation ofadditional authorized shares on any given day in an amount equal to thedifference between:

 

(i)    25% of theCompany’s issued and outstanding shares of common stock, on a fully diluted andas-converted basis; and

 

(ii)   The number ofoutstanding shares relating to awards under the Option Plan plus the number ofshares available for future grants of awards under the Option Plan on thatdate.

 

As of June 30,2008, there were 5,683,890 shares authorized and available for future issuanceunder the Option Plan.

 

TheOption Plan provides for awards of both non-statutory stock options andincentive stock options within the meaning of Section 422 of the InternalRevenue Code of 1986, as amended and other incentive awards and rights topurchase shares of the Company’s common stock.

 

TheOption Plan is administered by the Compensation Committee of the Board ofDirectors, which has the authority to select the individuals to whom awardswill be granted, the number of shares, vesting exercise price and term of eachoption grant. Generally, options have a four-year annual vesting term, anexercise price equal to the market value of the underlying shares at the grantdate and a ten-year life from the date of grant (a five-year life for incentivestock options granted to holders of more than 10% of the Company’s stock).

 

TheCompany has entered into employment agreements with the Company’s executive officers.Under these agreements, if a participating executive’s employment is terminatedwithout cause or upon a change in control, then the executive is entitled toaccelerated vesting of unvested stock options as provided in their agreement.

 

**Accounting for Stock Options**

 

*Fair Value Assumptions*

TheCompany uses the Black-Scholes option pricing model to estimate the fair valuesof stock options under SFAS 123(R) using the following assumptions andweighted average fair values:

 
| ** **                             | ** ** | **Years  Ended June 30,** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **2008**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                   |       |                           |       |   |   |   |   |
| Risk-free interest rate                |       | 2.8% - 4.5%                    |       | 4.6% - 4.7% |   | 4.2% - 5.0% |   |
| Expected option term in years          |       | 6.25                           |       | 6.25 |   | 6.33 |   |
| Expected volatility                    |       | 64.9% - 65.1%                  |       | 66.6% - 72.7% |   | 74.0% - 77.9% |   |
| Dividend yield                         |       | 0.0%                           |       | 0.0% |   | 0.0% |   |
| Weighted-average grant date fair value |       | $                              | 5.26       |   | $ | 7.42 |   | $ | 4.71 |   |
|                                        |            |                                |            |  |  |  |  |  |  |  |

 

Up tothe fourth quarter of fiscal 2006, the Company calculated the expected life ofstock options using the “simplified” method as permitted by SEC StaffAccounting Bulletin No. 107. Beginning in the fourth quarter of 2006 andthereafter, the Company estimates the expected life of stock options based uponhistorical exercises and post-vesting termination behavior. The Companyestimates expected volatility using daily historical trading data of the Company’scommon stock, primarily because this method is recognized as a valid methodused to predict future volatility and management has not identified a moreappropriate method. Therisk-free interest rates are determined by reference to Treasury note constantmaturities published by the Federal Reserve that 

 

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**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

approximatethe expected option term. The Company has never paid dividends and currentlyhas no plans to do so.

 

Asrequired by SFAS 123(R), stock-based compensation expense is recognized net ofestimated pre-vesting forfeitures, which results in recognition of expense onoptions that are ultimately expected to vest over the expected option term.Forfeitures were estimated using actual historical forfeiture experience.

 

Although the estimated fair values ofemployee stock options are determined in accordance with valuationmethodologies permitted under SFAS 123(R) as outlined above, theseestimates are affected by the Company’s stock prices, as well as assumptionsregarding a number of highly complex and subjective variables. These variablesinclude, but are not limited to, the Company’s stock price volatility over the expectedterms of the awards, estimates of the expected option terms, including actualand expected employee option exercise behaviors, and estimates of pre-vestingforfeitures. Because changes in any of these assumptions can materially affectthe estimated value, the valuation models used may not provide the same measureof fair value that is indicative of the fair value observed in a willingbuyer/willing seller market transaction.

 

*Summary of Activity*

Asummary of option activity under the Option Plan as of June 30, 2008 andfor the three years then ended is as follows:

 
| ** **                                      | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|-------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                      | ** ** | ** **      | ** ** | **Average**  | ** ** |
| ** **                                      | ** ** | **Number  of**  | ** ** | **Exercise** | ** ** |
| ** **                                      | ** ** | **Shares**      | ** ** | **Price**    | ** ** |
| Outstanding balance as of June 30, 2005    |       | 6,634,541  |       | $            | 6.46       |   |
| Grants                                          |       | 1,936,100  |       | $            | 6.58       |   |
| Exercises                                       |       | (572,995)       |       | $            | 3.89       |   |
| Cancellations/expirations                       |       | (402,154)       |       | $            | 7.40       |   |
| Outstanding balance as of June 30, 2006    |       | 7,595,492  |       | $            | 6.63       |   |
| Grants                                          |       | 1,276,890  |       | $            | 11.18      |   |
| Exercises                                       |       | (805,487)       |       | $            | 4.11       |   |
| Cancellations/expirations                       |       | (250,944)       |       | $            | 9.37       |   |
| Outstanding balance as of June 30, 2007    |       | 7,815,951  |       | $            | 7.54       |   |
| Grants                                          |       | 1,076,900  |       | $            | 8.53       |   |
| Exercises                                       |       | (328,781)       |       | $            | 2.42       |   |
| Cancellations/expirations                       |       | (177,487)       |       | $            | 10.37      |   |
| Outstanding balance as of June 30, 2008    |       | 8,386,583  |       | $            | 7.81       |   |
|                                            |       |            |       |         |       |
| Vested and exercisable as of June 30, 2008 |       | 5,600,976  |       | $            | 7.39       |   |

 

F-28

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

Thetotal pre-tax intrinsic value, or the difference between the exercise price andthe market price on the date of exercise, of stock options exercised during theyear ended June 30, 2008 was $2.5 million.

 

Thefollowing table summarizes significant ranges for options outstanding andcurrently exercisable as of June 30, 2008:

 
| ** **          | ** ** | **Stock  Options Outstanding** | ** ** | **Stock  Options Exercisable** | ** ** |
|---------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **          | ** ** | ** **                     | ** ** | **Weighted**                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | ** **                     | ** ** | **Average**                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | ** **                     | ** ** | **Remaining**                  | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Number**                     | ** ** | **Contract**                   | ** ** | **Average** | ** ** | **Aggregate** | ** ** | **Number** | ** ** | **Average** | ** ** | **Aggregate** | ** ** |
| ** **          | ** ** | **of  Options**                | ** ** | **Term  in**                   | ** ** | **Exercise** | ** ** | **Intrinsic** | ** ** | **of  Options** | ** ** | **Exercise** | ** ** | **Intrinsic** | ** ** |
| **Exercise  Price** | ** ** | **Outstanding**                | ** ** | **Years**                      | ** ** | **Price** | ** ** | **Value** | ** ** | **Exercisable** | ** ** | **Price** | ** ** | **Value** | ** ** |
| ** **          | ** ** | ** **                     | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $0.24 - $0.60       |       | 531,560                        |       | 1.6                            |       | $ | 0.55 |   | $ | 2,205,748 |   | 531,560 |   | $ | 0.55 |   | $ | 2,205,748 |   |
| $2.44 - $4.08       |       | 523,988                        |       | 4.5                            |       | $ | 3.27 |   | 750,942 |   | 522,801 |   | $ | 3.27 |   | 749,132 |   |
| $4.46 - $5.69       |       | 244,673                        |       | 8.2                            |       | $ | 5.12 |   | 2,451 |   | 73,573 |   | $ | 4.99 |   | 2,451 |   |
| $5.75 - $7.10       |       | 2,205,468                      |       | 7.3                            |       | $ | 6.52 |   | - |   | 1,042,598 |   | $ | 6.53 |   | - |   |
| $7.18 - $8.48       |       | 1,463,682                      |       | 5.8                            |       | $ | 8.17 |   | - |   | 1,073,351 |   | $ | 8.13 |   | - |   |
| $8.60 - $9.84       |       | 1,610,762                      |       | 4.0                            |       | $ | 9.03 |   | - |   | 1,557,162 |   | $ | 9.04 |   | - |   |
| $10.07 - $11.29     |       | 904,800                        |       | 6.4                            |       | $ | 10.80 |   | - |   | 461,000 |   | $ | 10.86 |   | - |   |
| $11.67 - $12.82     |       | 681,050                        |       | 8.6                            |       | $ | 12.57 |   | - |   | 181,750 |   | $ | 12.53 |   | - |   |
| $12.92 - $14.28     |       | 220,600                        |       | 5.4                            |       | $ | 13.67 |   | - |   | 157,181 |   | $ | 13.70 |   | - |   |
|                |       | 8,386,583                      |       | 5.9                            |       | $ | 7.81 |   | $ | 2,959,141 |   | 5,600,976 |   | $ | 7.39 |   | $ | 2,957,331 |   |

 

TheCompany had 4,828,253 and 4,541,392 outstanding options exercisable at anaggregate average exercise price of $7.05 and $6.63 as of June 30, 2007and 2006, respectively. Shares authorized and available for grant under theOption Plan as of June 30, 2008 were 5,683,890.

 

Theaggregate intrinsic value in the preceding table represents the total pretaxintrinsic value for stock options with an exercise price less than the Company’sclosing stock price of $4.70 as of June 30, 2008, the last trading day ofthe fiscal year, that would have been received by the option holders had theyexercised their options as of that date. The total number of in-the-money stockoptions exercisable as of June 30, 2008 was 1,065,762.

 

*Share-Based Compensation Expense*

Stock-basedcompensation expense recognized under SFAS 123(R) was $6.2 million ($0.13per share); $4.8 million ($0.12 per share) and $6.2 million ($0.16 per share)for the fiscal years ended June 30, 2008, 2007 and 2006, respectively,substantially all of which was related to the Company’s Option Plan and theESPP.

 

Thefollowing table summarizes stock-based compensation expense recorded under SFAS123(R) for the fiscal years ended June 30, 2008, 2007 and 2006 andits allocation within the accompanying Statements of Operations andComprehensive Loss (amounts in thousands):

 
| ** **                                               | ** ** | **Years  Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                               | ** ** | **2008**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                     |       |                           |       |   |   |   |   |
| Cost of revenue                                          |       | $                              | 1,259      |   | $ | 1,127 |   | $ | 2,089 |   |
| Research and  development for proprietary drug discovery |       | 3,295                          |       | 1,748 |   | 1,341 |   |
| General and administrative                               |       | 1,605                          |       | 1,936 |   | 2,727 |   |
| Total                                                    |       | $                              | 6,159      |   | $ | 4,811 |   | $ | 6,157 |   |

 

F-29

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Tableof Contents

 

**ARRAY BIOPHARMA INC.**

**Notes to the Financial Statements**

**For the Fiscal Years Ended June30, 2008, 2007 and 2006**

 

TheCompany did not recognize a tax benefit from share-based compensation expensebecause the Company has concluded that it is not more likely than not that therelated deferred tax assets, which have been reduced by a full valuationallowance, will be realized.

 

As of June 30,2008, there was approximately $11.6 million of total unrecognized compensationexpense (including the impact of expected forfeitures as required under SFAS123(R)) related to unvested share-based compensation arrangements granted underthe Option Plan.  That expense isexpected to be recognized over a weighted-average period of 1.6 years. Cashreceived from stock options exercised and purchases under the ESPP during theyears ended June 30, 2008 and 2007 was $1.8 million and $4.2 million,respectively.

 

**NOTE 13 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED - SEEACCOMPANYING ACCOUNTANTS’ REPORT)**

 

Thetables below summarize the Company’s unaudited quarterly operating results forthe fiscal years ended June 30, 2008 and 2007 (amounts in thousands,except per share data):

 
| ** **                                                   | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|--------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **Fiscal Year Ended June 30, 2008** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                                         |       |        |       |        |       |        |       |        |       |
| Revenue                                                      |       | $           | 6,593      |        | $          | 8,418       |       | $           | 7,711      |   | $ | 6,086 |   |
| Research and development for proprietary drug  discovery     |       | $           | 17,619     |        | $          | 20,548      |       | $           | 23,830     |   | $ | 28,350 |   |
| Total operating expenses                                     |       | $           | 27,309     |        | $          | 30,618      |       | $           | 33,292     |   | $ | 36,083 |   |
| Net loss                                                     |       | $           | (19,054)   |        | $          | (20,387)    |       | $           | (24,410)   |   | $ | (32,437) |   |
|                                                         |       |        |       |        |       |        |       |        |       |
| Weighted average shares outstanding - basic and  diluted     |       | 47,109      |       | 47,174      |       | 47,428      |       | 47,529      |       |
|                                                         |       |        |       |        |       |        |       |        |       |
| Net loss per share - basic and diluted                       |       | $           | (0.40)     |        | $          | (0.43)      |       | $           | (0.51)     |   | $ | (0.68) |   |
|                                                         |       |        |       |        |       |        |       |        |       |   |   |   |   |
| ** **                                                   | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
| **Fiscal Year Ended June 30, 2007** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                                         |       |        |       |        |       |        |       |        |       |
| Revenue                                                      |       | $           | 11,026     |        | $          | 7,558       |       | $           | 10,380     |   | $ | 8,006 |   |
| Research and development for proprietary drug  discovery     |       | $           | 10,853     |        | $          | 14,785      |       | $           | 15,738     |   | $ | 16,088 |   |
| Total operating expenses                                     |       | $           | 20,089     |        | $          | 24,286      |       | $           | 25,172     |   | $ | 26,497 |   |
| Net loss                                                     |       | $           | (8,231)    |        | $          | (15,872)    |       | $           | (14,089)   |   | $ | (17,251) |   |
|                                                         |       |        |       |        |       |        |       |        |       |
| Weighted average shares outstanding - basic and  diluted     |       | 39,148      |       | 39,471      |       | 39,959      |       | 44,283      |       |
|                                                         |       |        |       |        |       |        |       |        |       |
| Net loss per share - basic and diluted                       |       | $           | (0.21)     |        | $          | (0.40)      |       | $           | (0.35)     |   | $ | (0.39) |   |

 

The Net Loss Per Share amounts above may not sumexactly to the annual amounts presented in the Company’s accompanyingStatements of Operations and Comprehensive Loss due to rounding.

 

F-30

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Tableof Contents

 
| **EXHIBIT INDEX** |
|-------------------|
| ** **        | ** ** | ** ** | ** ** | ** ** |
| **Exhibit**       | ** ** | **Footnote** | ** ** | ** ** |
| **No.**           | ** ** | **Ref.** | ** ** | **Description** |
| 3.1               |   | (1) |   | Amended and  Restated Certificate of Incorporation of Array BioPharma Inc. |
| 3.2               |   | (18) |   | Amendment to  Amended and Restated Certificate of Incorporation of Array BioPharma Inc. |
| 3.3               |   | (1) |   | Amended and  Restated Bylaws of Array BioPharma Inc. |
| 3.4               |   | (3) |   | Certificate of  Designation of the Series A Junior Participating Preferred Stock |
| 4.1               |   | (1) |   | Specimen  certificate representing the common stock |
| 4.2               |   | (19) |   | Form of  Warrant to purchase shares of the Registrant’s common stock dated  April 20, 2008 issued to Deerfield Private Design Fund, L.P. and  Deerfield Private Design International, L.P.** |
| 4.3               |   | (19) |   | Registration  Rights Agreement dated April 29, 2008 between the Registrant and  Deerfield Private Design Fund, L.P. and Deerfield Private Design  International, L.P. |
| 10.1              |   | (1) |   | Preferred and  Common Stock Purchase Agreement between Registrant and the parties whose  signatures appear on the signature pages thereto dated May 18, 1998 |
| 10.2              |   | (1) |   | Amendment to  Preferred and Common Stock Purchase Agreement dated August 7, 1998 |
| 10.3              |   | (1) |   | Series B  Preferred Stock Purchase Agreement between Registrant and the parties whose  signatures appear on the signature pages thereto dated November 16,  1999 |
| 10.4              |   | (1) |   | Series C  Preferred Stock Purchase Agreement between Registrant and the parties whose  signatures appear on the signature pages thereto dated August 31,  2000 |
| 10.5              |   | (1) |   | Amended and  Restated Investor Rights Agreement between Registrant and the parties whose  signatures appear on the signature pages thereto dated November 16,  1999 |
| 10.6              |   | (1) |   | Amendment  No. 1 to Amended and Restated Investor Rights Agreement between Registrant  and the parties whose signatures appear on the signature pages thereto  dated August 31, 2000 |
| 10.7              |   | (1) |   | 1998 Stock  Option Plan effective July 1, 1998, as amended* |
| 10.8              |   | (7) |   | Amended and  Restated Array BioPharma Inc. Stock Option and Incentive Plan, as amended* |
| 10.9              |   | (17) |   | Form of  Incentive Stock Option Agreement, as amended* |
| 10.10             |   | (17) |   | Form of  Nonqualified Stock Option Agreement, as amended* |
| 10.11             |   | (7) |   | Array BioPharma  Inc. Employee Stock Purchase Plan, as amended on November 17, 2000 and  on September 12, 2002* |
| 10.12             |   | (9) |   | Amendment dated  April 29, 2004 to Array BioPharma Inc. Employee Stock Purchase Plan* |
| 10.13             |   | (12) |   | Amendment dated  December 9, 2005 to the Array BioPharma Inc. Employee Stock Purchase  Plan=* |
| 10.14             |   | (14) |   | Employment  Agreement by and between Registrant and Robert E. Conway dated March 1,  2006* |
| 10.15             |   | (6) |   | Form of  Employment Agreement dated September 1, 2002 by and between Registrant  and each of David L. Snitman, Kevin Koch and R. Michael Carruthers. * |
| 10.16             |   | (5) |   | Employment Agreement  effective as of March 2002 between Registrant and John Moore* |
| 10.17             |   | (16) |   | Employment  Agreement effective as of May 14, 2007 between the Registrant and John  Yates* |
| 10.18             |   | (13) |   | Description of  performance bonus program* |
| 10.19             |   | (10) |   | Amended and Restated  Deferred Compensation Plan of Array BioPharma Inc. dated December 20,  2004* |
| 10.20             |   | (12) |   | First Amendment  to the Amended and Restated Deferred Compensation Plan of Array BioPharma  Inc. * |
| 10.21             |   | (2) |   | Rights  Agreement, dated August 2, 2001, between the Registrant and  Computershare Trust Company, Inc., as Rights Agent |
| 10.23             |   | (4) |   | Research  Agreement between Registrant and Amgen Inc. dated as of November 1, 2001** |
| 10.24             |   | (3) |   | Lead Generation  Collaboration Agreement by and between Registrant and Takeda Chemical  Industries, Ltd., dated July 18, 2001** |
| 10.25             |   | (8) |   | Collaboration  and License Agreement by and between Registrant and AstraZeneca AB, dated  December 18, 2003** |

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Tableof Contents

 
| 10.26            |   | (8)    |   | Collaboration  and License Agreement by and between Registrant and Genentech, Inc.,  dated December 22, 2003**                                                                                                                                                                                                                                                                                                                          |
|------------------|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.27            |   | (12)   |   | Amendment  No. 2, dated October 1, 2005, to the Collaboration and License  Agreement by and between Registrant and Genentech, Inc.**                                                                                                                                                                                                                                                                                               |
| 10.28            |   | (11)   |   | Drug Discovery  Collaboration Agreement by and between Registrant and InterMune, Inc.,  dated September 13, 2002 along with Amendment No. 1 dated  May 8, 2003, Amendment No. 2 dated January 7, 2004, Amendment  No. 3 dated September 10, 2004, Amendment No. 4 dated  December 7, 2004, Amendment No. 4A dated March 10, 2005 and  Amendment No. 5 dated June 30, 2005** |
| 10.29            |   | (17)   |   | Amendment  No. 6 dated February 3, 2006 to the Drug Discovery Collaboration  Agreement by and between Registrant and InterMune, Inc., dated  September 13, 2002**                                                                                                                                                                                                                                                             |
| 10.30            |   | (17)   |   | Amendment  No. 7 dated June 28, 2006 to the Drug Discovery Collaboration  Agreement by and between Registrant and InterMune, Inc., dated  September 13, 2002**                                                                                                                                                                                                                                                                |
| 10.31            |   | (15)   |   | Exercise of  Option to Extend Funding of Research FTEs dated August 31, 2006 to the  Drug Discovery Collaboration Agreement by and between Registrant and  InterMune, Inc., dated September 13, 2002                                                                                                                                                                                                                               |
| 10.32            |   | (12)   |   | Drug Discovery  Agreement by and between Registrant and Ono Pharmaceutical Co., Ltd., dated  November 1, 2005.**                                                                                                                                                                                                                                                                                                                             |
| 10.33            |   | (20)   |   | Drug Discovery  and Development Agreement by and between Registrant and Celgene Corporation  dated September 21, 2007**                                                                                                                                                                                                                                                                                                                      |
| 10.34            |   | (11)   |   | Loan and  Security agreement by and between Registrant and Comerica Bank dated  June 28, 2005                                                                                                                                                                                                                                                                                                                                                |
| 10.35            |   | (12)   |   | First Amendment  to Loan and Security agreement by and between Registrant and Comerica Bank  dated December 19, 2005.                                                                                                                                                                                                                                                                                                                        |
| 10.36            |   | (15)   |   | Second Amendment  to Loan and Security Agreement between the Registrant and Comerica Bank dated  July 7, 2006                                                                                                                                                                                                                                                                                                                                |
| 10.37            |   | (19)   |   | Facility  Agreement dated April 29, 2008 between the Registrant and Deerfield  Private Design Fund, L.P. and Deerfield Private Design International, L.P.**                                                                                                                                                                                                                                                                                  |
| 10.38            |   | (19)   |   | Security  Agreement dated April 29, 2008 between the Registrant and Deerfield  Private Design Fund, L.P. and Deerfield Private Design International, L.P.                                                                                                                                                                                                                                                                                    |
| 10.39            |   | (15)   |   | Facilities Lease  and Assignment dated July 7, 2006 between the Registrant and BioMed  Realty L.P.                                                                                                                                                                                                                                                                                                                                           |
| 10.40            |   | (15)   |   | Facilities Lease  and Assignment dated August 9, 2006 between the Registrant and BioMed  Realty L.P.                                                                                                                                                                                                                                                                                                                                         |
|   23.1 |   |   |   | Consent of KPMG  LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                                               |
|   23.2 |   |   |   | Consent of KPMG  LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                                               |
|   31.1 |   |   |   | Certification of  Robert E. Conway pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                                                                                                |
|   31.2 |   |   |   | Certification of  R. Michael Carruthers pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                                                                                                                                                                                                                                                                                                           |
|   32.0 |   |   |   | Certifications  of Robert E. Conway and R. Michael Carruthers pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                     |

 

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| (1)    |   | Incorporated  herein by reference to the Registrant’s registration statement on  Form S-1 (File No. 333-45922)                               |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                        |
| (2)    |   | Incorporated  herein by reference to the Current Report on Form 8-K as of August 3,  2001(File No. 000-31979)                                |
|   |   |                                                                                                                                                        |
| (3)    |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended September 30, 2001 (File No. 000-31979) |
|   |   |                                                                                                                                                        |
| (4)    |   | Incorporated  herein by reference to the Current Report on Form 8-K/A as of  February 6, 2002 (File No. 000-31979)                           |
|   |   |                                                                                                                                                        |
| (5)    |   | Incorporated  herein by reference to the Annual Report on Form 10-K for the fiscal  year ended June 30, 2002 (File No. 000-31979)            |
|   |   |                                                                                                                                                        |
| (6)    |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended September 30, 2002 (File No. 000-31979) |

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Tableof Contents

 
| (7)    |   | Incorporated  herein by reference to the Registrant’s definitive proxy statement on  Schedule 14A dated October 1, 2002, with respect to the annual meeting  of stockholders held on October 31, 2002 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                 |
| (8)    |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended December 31, 2003 (File No. 000-31979)                                                           |
|   |   |                                                                                                                                                                                                                 |
| (9)    |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended March 31, 2004 (File No. 000-31979)                                                              |
|   |   |                                                                                                                                                                                                                 |
| (10)   |   | Incorporated  herein by reference to the Current Report on Form 8-K as of  December 20, 2004 (File No. 000-31979)                                                                                     |
|   |   |                                                                                                                                                                                                                 |
| (11)   |   | Incorporated  herein by reference to the Annual Report on Form 10-K for the fiscal  year ended June 30, 2005 (File No. 000-31979)                                                                     |
|   |   |                                                                                                                                                                                                                 |
| (12)   |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended December 31, 2005 (File No. 000-31979)                                                           |
|   |   |                                                                                                                                                                                                                 |
| (13)   |   | Incorporated  herein by reference to the Current Report on Form 8-K as of  October 2, 2007 (File No. 000-31979)                                                                                       |
|   |   |                                                                                                                                                                                                                 |
| (14)   |   | Incorporated  herein by reference to the Current Report on Form 8-K as of  March 1, 2006 (File No. 000-31979)                                                                                         |
|   |   |                                                                                                                                                                                                                 |
| (15)   |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended September 30, 2006 (File No. 000-31979)                                                          |
|   |   |                                                                                                                                                                                                                 |
| (16)   |   | Incorporated  herein by reference to the Current Report on Form 8-K as of May 15,  2007 (File No. 000-31979)                                                                                          |
|   |   |                                                                                                                                                                                                                 |
| (17)   |   | Incorporated  herein by reference to the Registrant’s Annual Report on Form 10-K for  the fiscal year ended June 30, 2006 (File No. 000-31979)                                                   |
|   |   |                                                                                                                                                                                                                 |
| (18)   |   | Incorporated  herein by reference to the Current Report on Form 8-K as of  November 1, 2007 (File No. 000-31979)                                                                                      |
|   |   |                                                                                                                                                                                                                 |
| (19)   |   | Incorporated  herein by reference to the Current Report on Form 8-K as of May 5,  2008 (File No. 000-31979)                                                                                           |
|   |   |                                                                                                                                                                                                                 |
| (20)   |   | Incorporated  herein by reference to the Quarterly Report on Form 10-Q for the fiscal  quarter ended September 30, 2007 (File No. 000-31979)                                                          |
|   |   |                                                                                                                                                                                                                 |
| *      |   | Management  contract or compensatory plan.                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                 |
| **     |   | Confidential  treatment of redacted portions of this exhibit has been granted.                                                                                                                                       |

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