# **U.S. SECURITIES AND EXCHANGE COMMISSION**

## **Washington D.C. 20549**

# **FORM 10-Q**

| **x**                                                                                                                                                                                                                                                                                                   | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                              | ** ** | ** **                                                                                    |
| **FOR THE  QUARTERLY PERIOD ENDED JUNE 30, 2007**                                                                                                                                                                                                                                                       |
| ** **                                                                                                                                                                                                                                                                                              |
| **or**                                                                                                                                                                                                                                                                                                  |
|                                                                                                                                                                                                                                                                                                    |
| **o**                                                                                                                                                                                                                                                                                                   | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                                              | ** ** | ** **                                                                                    |
| **FOR THE  TRANSITION PERIOD FROM                         TO                      .** |

 

**Commissionfile number 0-26866**

**SonusPharmaceuticals, Inc.**

(Exact Name ofRegistrant as Specified in Its Charter)

| **Delaware**                                                                    |       | **95-4343413**                           |
|---------------------------------------------------------------------------------|------------|------------------------------------------|
| (State or Other  Jurisdiction of                                                |       | (I.R.S. Employer  Identification Number) |
| Incorporation or  Organization)                                                 |       |                                     |
| ** **                                                                      |       |                                     |
| **22026  20th Ave. SE, Bothell, Washington 98021**                              |
| (Address of  Principal Executive Offices)                                       |
| ** **                                                                      |
| **(425)  487-9500**                                                             |
| (Registrant’s  telephone number, including area code)                      |
| ** **                                                                      |
| Securities  registered pursuant to Section 12(b) of the Act:          |
| ** **                                                                      |       | ** **                               |
| **Title of Each Class**                                                         | ** ** | **Name of Exchange on Which Registered** |
| Common Stock,  par value $0.001 per share                                       |       | The NASDAQ Stock  Market, LLC            |
| Series A  Junior Participating Preferred Stock, par value $0.001 per share |       | The NASDAQ Stock  Market, LLC            |
|                                                                            |
| Securities  registered pursuant to Section 12(g) of the Act:          |
| **None**                                                                        |

 

Indicate by check whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

| Large accelerated filero | Accelerated  filer x | Non-accelerated filer o |
|--------------------------|----------------------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Exchange Act Rule12b-2). Yeso  No x

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

| Class                          | ** ** | **Outstanding at July 30, 2007** |
|--------------------------------|------------|----------------------------------|
| Common Stock,  $.001 par value |       | 36,925,351                       |

 

 

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**Sonus Pharmaceuticals, Inc.**

**Index toForm 10-Q**
| **Part I. Financial  Information**                                        |                                                                                                      |
|---------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|                                                                      |                                                                                                      |   |
| Item  1                                                                   | Financial  Statements                                                                                     |   |
|                                                                      |                                                                                                      |   |
|                                                                      | Balance Sheets as of June 30, 2007 (unaudited) and  December 31, 2006                                     |   |
|                                                                      |                                                                                                      |   |
|                                                                      | Statements  of Operations (unaudited) for the three and six months ended June 30, 2007  and June 30, 2006 |   |
|                                                                      |                                                                                                      |   |
|                                                                      | Statements of Cash Flows (unaudited) for the six  months ended June 30, 2007 and June 30, 2006            |   |
|                                                                      |                                                                                                      |   |
|                                                                      | Notes  to Financial Statements (unaudited)                                                                |   |
|                                                                      |                                                                                                      |   |
| Item 2.                                                                   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations               |   |
|                                                                      |                                                                                                      |   |
| Item 3.                                                                   | Quantitative and Qualitative Disclosures About Market  Risk                                               |   |
|                                                                      |                                                                                                      |   |
| Item 4.                                                                   | Controls and Procedures                                                                                   |   |
| ** **                                                                |                                                                                                      |
| **Part  II. Other Information**                                           |                                                                                                      |
|                                                                      |                                                                                                      |   |
| Item  1A.                                                                 | Risk Factors                                                                                              |   |
|                                                                      |                                                                                                      |   |
| Item 4.                                                                   | Submission of Matters to a Vote of Security Holders                                                       |   |
|                                                                      |                                                                                                      |   |
| Item 6.                                                                   | Exhibits                                                                                                  |   |
|                                                                      |                                                                                                      |
| Items 1, 2, 3,  and 5 are not applicable and therefore have been omitted. |                                                                                                      |

 

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**Part I.     Financial Information**

**Item 1.    Financial Statements**

**SonusPharmaceuticals, Inc.**

**BalanceSheets**
| ** **                                                                                                                                                                   | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                   |       |                    |       |                        |       |
| Current assets:                                                                                                                                                              |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                   |       | $                       | 2,545,037  |                        | $          | 35,771,784 |   |
| Marketable  securities                                                                                                                                                       |       | 41,706,321              |       | 22,506,086                  |       |
| Accounts  receivable from related party                                                                                                                                      |       | 5,549,093               |       | 8,043,771                   |       |
| Other current  assets                                                                                                                                                        |       | 1,073,065               |       | 524,470                     |       |
| Total current  assets                                                                                                                                                        |       | 50,873,516              |       | 66,846,111                  |       |
|                                                                                                                                                                         |       |                    |       |                        |       |
| Equipment, furniture  and leasehold improvements, net                                                                                                                        |       | 1,321,339               |       | 1,186,174                   |       |
| Other assets                                                                                                                                                                 |       | 445,046                 |       | 460,717                     |       |
|                                                                                                                                                                         |       |                    |       |                        |       |
| Total assets                                                                                                                                                                 |       | $                       | 52,639,901 |                        | $          | 68,493,002 |   |
|                                                                                                                                                                         |       |                    |       |                        |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                               |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                         |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                             |       | $                       | 141,371    |                        | $          | 898,486 |   |
| Accounts payable  to related party                                                                                                                                           |       | 1,770,300               |       | 1,473,050                   |       |
| Accrued expenses                                                                                                                                                             |       | 7,099,188               |       | 11,928,124                  |       |
| Deferred revenue  from related party                                                                                                                                         |       | 5,545,919               |       | 5,545,919                   |       |
| Other current  liabilities                                                                                                                                                   |       | —                  |       | 64,792                      |       |
| Total current  liabilities                                                                                                                                                   |       | 14,556,778              |       | 19,910,371                  |       |
|                                                                                                                                                                         |       |                    |       |                        |       |
| Deferred revenue from  related party, less current portion                                                                                                                   |       | 2,767,735               |       | 5,540,694                   |       |
|                                                                                                                                                                         |       |                    |       |                        |       |
| Commitments and  contingencies                                                                                                                                               |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                   |       |                    |       |                        |       |
| Preferred stock;  $.001 par value; 5,000,000 authorized; no shares issued or outstanding                                                                                     |       | **—**              |       | —                      |       |
| Common stock;  $.001 par value; 75,000,000 shares authorized; 36,919,876 and 30,565,746  shares issued and outstanding at June 30, 2007 and December 31, 2006,  respectively |       | 156,264,378             |       | 154,780,939                 |       |
| Accumulated  deficit                                                                                                                                                         |       | (120,927,188            | )          | (111,738,669                | )          |
| Accumulated  other comprehensive loss                                                                                                                                        |       | (21,802                 | )          | (333                        | )          |
| Total  stockholders’ equity                                                                                                                                             |       | 35,315,388              |       | 43,041,937                  |       |
|                                                                                                                                                                         |       |                    |       |                        |       |
| Total liabilities and stockholders’ equity                                                                                                                              |       | $                       | 52,639,901 |                        | $          | 68,493,002 |   |

 

See accompanyingnotes.

3

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**SonusPharmaceuticals, Inc.**

**Statementsof Operations**

**(Unaudited)**
| ** **                                                                | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                                                  |       |                                            |       |                                          |       |   |   |   |   |
| Collaboration revenue from related party                                  |       | $                                               | 3,271,018  |                                          | $          | 7,513,588 |   | $ | 8,322,052 |   | $ | 11,567,205 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Operating  expenses:                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Research and development                                                  |       | 7,695,972                                       |       | 11,248,579                                    |       | 14,635,370 |   | 19,359,080 |   |
| General and administrative                                                |       | 2,128,522                                       |       | 1,887,596                                     |       | 4,104,121 |   | 3,655,918 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Total operating  expenses                                                 |       | 9,824,494                                       |       | 13,136,175                                    |       | 18,739,491 |   | 23,014,998 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Operating loss                                                            |       | (6,553,476                                      | )          | (5,622,587                                    | )          | (10,417,439 | ) | (11,447,793 | ) |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Other income  (expense):                                                  |       |                                            |       |                                          |       |   |   |   |   |
| Other income (expense)                                                    |       | 949                                             |       | (48,041                                       | )          | (34,004 | ) | (48,041 | ) |
| Interest income                                                           |       | 589,485                                         |       | 736,039                                       |       | 1,263,358 |   | 1,251,979 |   |
| Interest expense                                                          |       | (125                                            | )          | (833                                          | )          | (434 | ) | (1,833 | ) |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Total other income, net                                                   |       | 590,309                                         |       | 687,165                                       |       | 1,228,920 |   | 1,202,105 |   |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Net loss                                                                  |       | $                                               | (5,963,167 | )                                             | $          | (4,935,422 | ) | $ | (9,188,519 | ) | $ | (10,245,688 | ) |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
|  Basic and diluted net loss per share                                |       | $                                               | (0.16      | )                                             | $          | (0.14 | ) | $ | (0.25 | ) | $ | (0.31 | ) |
|                                                                      |       |                                            |       |                                          |       |   |   |   |   |
|  Shares used in computation of basic and  diluted net loss per share |       | 36,883,944                                      |       | 34,694,553                                    |       | 36,868,990 |   | 32,657,715 |   |

 

See accompanyingnotes.

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**SonusPharmaceuticals, Inc.**

**Statementsof Cash Flows**

**(Unaudited)**
| ** **                                                                             | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| **Operating  activities:**                                                             |       |                                              |       |   |   |
| Net loss                                                                               |       | $                                                 | (9,188,519 | ) | $ | (10,245,688 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:           |       |                                              |       |   |   |
| Depreciation                                                                           |       | 302,288                                           |       | 281,288 |   |
| Non-cash stock-based compensation                                                      |       | 1,309,490                                         |       | 1,047,590 |   |
| Amortization/(accretion) of investments                                                |       | (322,799                                          | )          | 6,656 |   |
| Changes in  operating assets and liabilities:                                          |       |                                              |       |   |   |
| Accounts receivable from related party                                                 |       | 2,494,678                                         |       | (2,631,498 | ) |
| Other current assets                                                                   |       | (548,595                                          | )          | 189,614 |   |
| Long term receivable from related party                                                |       | —                                            |       | 87,500 |   |
| Other long term assets                                                                 |       | 15,671                                            |       | 15,671 |   |
| Accounts payable                                                                       |       | (757,115                                          | )          | 128,732 |   |
| Accounts payable to related party                                                      |       | 297,250                                           |       | 188,000 |   |
| Accrued expenses                                                                       |       | (4,828,936                                        | )          | 2,932,667 |   |
| Other current liabilities                                                              |       | (50,029                                           | )          | — |   |
| Deferred revenue from related party                                                    |       | (2,772,959                                        | )          | (2,772,959 | ) |
| Other liabilities                                                                      |       | —                                            |       | (32,016 | ) |
| Net cash used in  operating activities                                                 |       | (14,049,575                                       | )          | (10,804,443 | ) |
|                                                                                   |       |                                              |       |   |   |
| **Investing  activities:**                                                             |       |                                              |       |   |   |
| Purchases of  capital equipment and leasehold improvements                             |       | (437,453                                          | )          | (384,345 | ) |
| Purchases of marketable  securities                                                    |       | (38,690,506                                       | )          | — |   |
| Proceeds from  sales of marketable securities                                          |       | 19,510,014                                        |       | — |   |
| Proceeds from  maturities of marketable securities                                     |       | 281,587                                           |       | — |   |
| Net cash used in  investing activities                                                 |       | (19,336,358                                       | )          | (384,345 | ) |
|                                                                                   |       |                                              |       |   |   |
| **Financing  activities:**                                                             |       |                                              |       |   |   |
| Proceeds from  issuance of common stock under equity financings, net of issuance costs |       | —                                            |       | 28,559,245 |   |
| Proceeds from  exercise of common stock warrants                                       |       | 57,440                                            |       | 301,330 |   |
| Proceeds from  exercise of stock options and other                                     |       | 116,509                                           |       | 72,850 |   |
| Payments on  lease obligations                                                         |       | (14,763                                           | )          | (13,364 | ) |
| Net cash  provided by investing activities                                             |       | 159,186                                           |       | 28,920,061 |   |
|                                                                                   |       |                                              |       |   |   |
| (Decrease)  Increase in cash and cash equivalents for the period                       |       | (33,226,747                                       | )          | 17,731,273 |   |
| Cash and cash  equivalents at beginning of period                                      |       | 35,771,784                                        |       | 49,317,845 |   |
|                                                                                   |       |                                              |       |   |   |
| Total cash and  cash equivalents                                                       |       | $                                                 | 2,545,037  |   | $ | 67,049,118 |   |
|                                                                                   |       |                                              |       |   |   |
| Supplemental  cash flow information:                                                   |       |                                              |       |   |   |
| Interest paid                                                                          |       | $                                                 | 434        |   | $ | 1,833 |   |

 

See accompanyingnotes.

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**SonusPharmaceuticals, Inc.**

**Notes toFinancial Statements**

**(Unaudited)**

**1.****     Basisof Presentation**

The unaudited financial statements have been preparedin accordance with generally accepted accounting principles for interimfinancial information and with the instructions to Form 10-Q.  Accordingly, they do not include all of theinformation and footnotes required to be presented for complete financialstatements.  The accompanying financialstatements reflect all adjustments (consisting only of normal recurring items)which are, in the opinion of management, necessary for a fair presentation ofthe results for the interim periods presented. The accompanying Balance Sheet at December 31, 2006 has been derivedfrom the audited financial statements included in the Company’s Annual Reporton Form 10-K for the year then ended. The financial statements and related disclosures have been prepared withthe assumption that users of the interim financial information have read orhave access to the audited financial statements for the preceding fiscalyear.  Accordingly, these financialstatements should be read in conjunction with the audited financial statementsand the related notes thereto included in the Annual Report on Form 10-K forthe year ended December 31, 2006 and filed with the Securities and ExchangeCommission on March 16, 2007.

**2.****     RelatedParty**

The Company engages in significant transactions withBayer Schering Pharma AG, Germany (“Bayer Schering”).  Bayer Schering is a related party due totheir ownership interest in the Company (10.6% fully diluted) and has beenappropriately identified as such on the face of the financial statements.  All amounts disclosed on the face of thefinancial statements with related parties are attributable to BayerSchering.  Please see Note 3 “Collaborationand License Agreement with Bayer Schering Pharma AG” for additional details.

**3.****     Collaborationand License Agreement with Bayer Schering Pharma AG**

On October 17, 2005, the Company entered into aCollaboration and License Agreement with Schering AG, pursuant to which, amongother things, Sonus granted Schering AG an exclusive, worldwide license toTOCOSOL Paclitaxel.  Schering AG paid Sonus an upfront license fee of $20million and pays Sonus for 50% of eligible research and development costsincurred by Sonus related to TOCOSOL Paclitaxel (in certain cases thereimbursement rate is 100%).

In 2006, a wholly owned subsidiary of Bayer AG,acquired Schering AG. The company was renamed Bayer Schering Pharma AG,Germany.  We are not aware of anymaterial effect the acquisition has had on Sonus’ business, financial conditionor results of operations but there can be no assurance that the acquisitionwill not have a material effect in the future. The ongoing relationship with Bayer Schering is just as dependent on thedata from our Phase 3 trial for TOCOSOL Paclitaxel, as was the case with ScheringAG.

Bayer Schering may additionally pay Sonus (i) productmilestone payments of up to $132 million upon the achievement of certain U.S.,European Union and Japanese clinical and regulatory milestones, (ii) salesmilestone payments of up to $35 million upon the achievement of certain annualworldwide net sales, and (iii) upon commercialization, royalties rangingbetween 15-30% of annual net sales in the U.S., with the exact percentage to bedetermined based on the achievement of certain annual net sales thresholds, and

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royalties equal to 15% of the annual net sales outside the U.S. The parties have agreed to a U.S. development program consisting of the ongoinginitial pivotal Phase 3 trial in metastatic breast cancer and may agree toother trials to support launch of TOCOSOL Paclitaxel. Sonus has retained anoption for co-promotion rights in the U.S. and also granted Bayer Schering theright of first negotiation on TOCOSOL Camptothecin, which is currently in earlystage clinical development.  Inconnection with the Collaboration and Licensing Agreement, the Company and anaffiliate of Bayer Schering entered into a Securities Purchase Agreementwhereby the Company sold 3,900,000 shares of common stock for an aggregate of$15.7 million and warrants to purchase 975,000 shares of common stock for anaggregate purchase price of $122,000.

During the six month period ended June 30, 2007, theCompany recognized revenue of $2.8 million as amortization of the upfrontlicense fee and an additional $5.5 million related to research and developmentservices performed by Sonus primarily for the Phase 3 trial for TOCOSOLPaclitaxel and related manufacturing costs. The Company expects to recognize revenue related to amortization of theupfront fee and cost reimbursements through the end of the development periodwhich is currently estimated to continue through the end of 2008.  As the clinical development program forTOCOSOL Paclitaxel is still being finalized in collaboration with BayerSchering, we cannot estimate the total costs or expected reimbursements at thistime.  Finalization of these plans willlikely occur after we have independently reviewed data from our ongoing Phase 3trial, which we expect by the end of third quarter of 2007.

As of June 30, 2007, the Company had $8.3 million indeferred revenue related to the unamortized upfront payment (net of theadjustment for warrants issued in connection with the agreement) as well as$5.5 million in receivables and $1.8 million in payables with Bayer Schering onits balance sheet.

**4.     Accrued Expenses**

Accrued expenses consist of the following:
|                        | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Clinical trials        |       | $                       | 5,811,548  |                        | $          | 8,497,278 |   |
| Compensation           |       | 789,363                 |       | 1,459,128                   |       |
| Product  manufacturing |       | 84,830                  |       | 1,617,580                   |       |
| Other                  |       | 413,447                 |       | 354,138                     |       |
|                   |       | $                       | 7,099,188  |                        | $          | 11,928,124 |   |

 

**5.****     ComprehensiveIncome (Loss)**
|                                                                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net loss                                                              |       | $                                                   | (5,963,167 | )                                                 | $          | (4,935,422 | ) | $ | (9,188,519 | ) | $ | (10,245,688 | ) |
| Unrealized gain  (loss) on cash equivalents and marketable securities |       | (12,672                                             | )          | 4,239                                             |       | (21,469 | ) | 6,656 |   |
| Comprehensive loss                                                    |       | $                                                   | (5,975,839 | )                                                 | $          | (4,931,183 | ) | $ | (9,209,988 | ) | $ | (10,239,032 | ) |

 

**6.****    ****Stockholders’ Equity**

***Common Stock Issuances***

During the second quarter of2007, the Company received $57,440 in proceeds from the issuance of14,044 shares of common stock from the exercise of common stock warrants, inaddition to $88,110 in proceeds from the issuance of 46,212 shares of commonstock from the issuance of shares under employee 

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benefit programs.  For the sixmonths ended June 30, 2007, the Company received $57,440 in proceeds from theissuance of 14,044 shares of common stock from the exercise of common stockwarrants, in addition to $116,509 in proceeds from the issuance of 51,858shares of common stock from the issuance of shares under employee benefitprograms.

***Employee Stock Plans***

On May 10, 2007, Sonus shareholders approved a newincentive plan titled, “2007 Performance Incentive Plan”. Under the terms ofthis plan, the Company can issue up to 3,900,000 additional shares of theCompany’s common stock.  Employee stockoptions vest over a period of time determined by the Board of Directors,generally four years, and director stock options are generally fully vested onthe date of grant.  Stock optionsgenerally are granted at the fair market value on the date of grant and expireten years from the date of grant.

The Company has an employee stock purchase planwhereby employees may contribute up to 15% of their compensation to purchaseshares of the Company’s common stock at 85% of the stock’s fair market value atthe lower of the beginning or end of each six-month offering period.  The Company recognized $8,117 in compensationexpense related to this plan for the six month period ended June 30, 2007.  At June 30, 2007, a total of 76,083 sharesremain available for purchase by employees under the plan.

The Company has a 401(k) plan for all employees under which it providesa specified percentage match on employee contributions. Currently, the Companymatch is made in shares of the Company’s common stock. The Company recognizedcompensation expense related to this plan for the three and six month periodsended June 30, 2007 of $28,913 and $57,312, respectively.  AtJune 30, 2007, a total of 5,641 shares remain available for future issuances asmatching contributions under the plan. During the third quarter of 2007, the Company’s filed a registrationstatement under Form S-8 for an additional 100,000 shares for use in theCompany’s 401(k) plan.

***Stock-Based Compensation***

Duringthe three and six month periods ended June 30, 2007 and 2006, respectively, theCompany recorded stock-based compensation cost under the provisions ofStatement of Accounting Standard 123 (revised 2004), “Share Based Payment,” or(“SFAS 123R”).  The fair value of stockbased awards is determined using the Black-Scholes-Merton pricing model.  The following table summarizes the incomestatement classification of stock-based compensation:
|                                         | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Stock-based  compensation expense:      |       |                                                |       |                                              |       |   |   |   |   |
| General & administrative            |       | $                                                   | (480,688   | )                                                 | $          | (413,799 | ) | $ | (766,849 | ) | $ | (599,934 | ) |
| Research & development              |       | (333,653                                            | )          | (249,188                                          | )          | (542,641 | ) | (447,656 | ) |
| Total stock-based  compensation expense |       | $                                                   | (814,341   | )                                                 | $          | (662,987 | ) | $ | (1,309,490 | ) | $ | (1,047,590 | ) |

 

The fair value of each stock option used in thecalculations under SFAS 123R is estimated using the Black-Scholes-Merton optionpricing model.  The assumptions used inthis model include (1) the stock price at grant date, (2) the exercise price,(3) an estimated option life of four years, (4) no expected dividends for eachperiod presented, (5) stock price volatility factor of 56.7%****and 71.5% as of June 30, 2007 and 2006, respectively, (6)forfeiture rate of 4.96%****and13.19%  as of June 30, 2007 and 2006,respectively, and (7) a risk-free interest rate of 4.58%****and4.99% as of June 30, 2007 and 2006, respectively.

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***Stock Option Activity***

The following is a summary of option activitythrough June 30, 2007:
|                                                          | ** ** | ** **                                        | ** ** | **Options Outstanding**     | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **Shares   Available   for Grant** | ** ** | **Number of   Shares** | ** ** | **Weighted-  Average   Exercise Price** | ** ** |
|                                                     |       |                                              |       |                             |       |   |   |
| December 31,  2006                                       |       | 953,366                                           |       | 4,756,890                        |       | $ | 4.90 |   |
| Grants                                                   |       | (12,500                                           | )          | 12,500                           |       | $ | 5.03 |   |
| Exercises                                                |       | —                                            |       | —                           |       | — |   |
| Cancellations                                            |       | 8,450                                             |       | (8,450                           | )          | $ | 5.48 |   |
| March 31, 2007                                           |       | 949,316                                           |       | 4,760,940                        |       | $ | 4.90 |   |
|                                                     |       |                                              |       |                             |       |   |   |
| Grants                                                   |       | (89,250                                           | )          | 89,250                           |       | $ | 5.36 |   |
| Exercises                                                |       | —                                            |       | (35,937                          | )          | $ | 1.17 |   |
| Cancellations                                            |       | —                                            |       | (8,625                           | )          | $ | 6.25 |   |
| Additional  shares approved by shareholders for issuance |       | 3,900,000                                         |       | —                           |       | — |   |
| June 30, 2007                                            |       | 4,760,066                                         |       | 4,805,628                        |       | $ | 4.93 |   |

 

**7.     Income Taxes**

Effective January 1, 2007, the Company adopted theprovisions of the Financial Interpretation No. 48, “Accounting**for Uncertainty in Income Taxes – an interpretation of FASBStatement No. 109” (“FIN 48”). FIN 48 prescribes a recognitionthreshold and a measurement attribute for the financial statement recognitionand measurement of tax positions taken or expected to be taken in a taxreturn.  At the date of adoption of FIN48, we had no unrecognized tax benefits and expected no significant changes inunrecognized tax benefits in the next twelve months.  The adoption of this statement did not resultin a cumulative accounting adjustment and did not impact our financial position,results of operations or cash flows.

We recognize interest and penalties related touncertain tax positions in income tax expense when applicable.  To date, there have been no interest orpenalties charged to the Company in relation to the underpayment of incometaxes.

The Company is subject to audit by the IRS and TheWashington State Department of Revenue for all years since inception.  As of January 1, 2007, we have recorded avaluation allowance equal to our total net deferred tax assets due to theuncertainty of ultimately realizing tax benefits of approximately $40.6million.

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**Item 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL**

**CONDITIONAND RESULTS OF OPERATIONS**

**Forward-LookingStatements**

This report contains certainforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, and we intend that such forward-lookingstatements be subject to the safe harbors created thereby. Examples of theseforward-looking statements include, but are not limited to:

·      timingand amount of future contractual payments, product revenue and operatingexpenses;

·      progressand preliminary results of clinical trials;

·      ouranticipated future capital requirements and the terms of any capital financingagreements;

·      anticipatedregulatory filings, requirements and future clinical trials; and

·      marketacceptance of our products and the estimated potential size of these markets.

While these forward-lookingstatements made by us are based on our current beliefs and judgments, they aresubject to risks and uncertainties that could cause actual results to vary fromthe projections in the forward-looking statements. You should consider therisks below carefully in addition to other information contained in this reportbefore engaging in any transaction involving shares of our common stock. If anyof these risks occur, they could seriously harm our business, financialcondition or results of operations. In such case, the trading price of ourcommon stock could decline, and you may lose all or part of yourinvestment.

The discussion and analysisset forth in this document contains trend analysis, discussions of regulatorystatus and other forward-looking statements. Actual results could differmaterially from those projected in the forward-looking statement as a result ofthe following factors, among others:

·      uncertaintyof governmental regulatory requirements and lengthy approval process;

·      futurecapital requirements and uncertainty of payments under corporate partnershipsor additional funding through either debt or equity financings;

·      dependenceon the development and commercialization of products;

·      futureprospects heavily dependent on results of the Phase 3 trial for TOCOSOLPaclitaxel and subsequent commercialization should the product be approved bythe FDA;

·      historyof operating losses and uncertainty of future financial results;

·      dependenceon third parties for funding, clinical development, regulatory approvals,manufacturing and distribution;

·      dependenceon key employees;

·      uncertaintyof U.S. or international legislative or administrative actions;

·      competitionand risk of competitive new products;

·      limitedmanufacturing experience and dependence on a limited number of contractmanufacturers and suppliers;

·      abilityto obtain and defend patents, protect trade secrets and avoid infringingpatents held by third parties;

·      limitationson third-party reimbursement for medical and pharmaceutical products;

·      acceptanceof our products by the medical community;

·      potentialfor product liability issues and related litigation;

·      potentialfor claims arising from the use of hazardous materials in our business;

·      volatilityin the value of our common stock;

·      continuedlisting on the NASDAQ Global Market (formerly NASDAQ National Market); and

·      otherfactors set forth under “Risk Factors” contained in our Annual Report on Form10-K for the fiscal year ended December 31, 2006 filed on March 16, 2007,Quarterly Report on Form 10-Q filed on May 9, 2007 for the first quarter endingMarch 31, 2007 and in this Quarterly Report on Form 10-Q.

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**MD&AOverview**

In Management’s Discussionand Analysis of Financial Condition and Results of Operations we explain thegeneral financial condition and the results of operations for our Company,including:

·      an overview of our business;

·      results of operations and why those results are different from theprior year; and

·      capital resources we currently have andpossible sources of additional funding for future capital requirements.

**Business Overview**

Sonus Pharmaceuticals is focused on the development ofcancer drugs that are designed to provide better efficacy, safety,tolerability, and ease of use. Our business strategy is as follows:

·      develop proprietaryformulations of cancer drugs utilizing our TOCOSOL® technology;

·      develop novel formulationsof oncology drugs; and

·      identifyand acquire products/technologies that are complementary to our focus inoncology in order to broaden our business and market opportunities.

**Proprietary TOCOSOL technology**

Our novel vitamin E-based emulsion technology has beendesigned to address the limitations of existing cancer drugs. The technologyuses vitamin E (tocopherol) oil and tocopherol derivatives to solubilize andformulate drugs with the goal of enhancing their efficacy, safety andadministration. Drug products formulated with our TOCOSOL technology areready-to-use, requiring no dilution or reconstitution.

TOCOSOL Paclitaxel

Our lead oncology product candidate, TOCOSOLPaclitaxel, is currently in late stage Phase 3 clinical testing withindependently reviewed objective response rate data expected by the end of thethird quarter 2007.  TOCOSOL Paclitaxelis a novel, nanodroplet formulation of paclitaxel and is manufactured in aready-to-use, injectable emulsion formulation. Paclitaxel is one of the world’s most widely prescribed anti-cancerdrugs and a member of the taxane family of chemotherapy agents.  Paclitaxel is also the active ingredient inTaxol®,which is approved in the U.S. for the treatment of breast, ovarian andnon-small cell lung cancers, and Kaposi’s sarcoma. We believe that data fromour Phase 2 clinical trials conducted to-date suggest that TOCOSOL Paclitaxel:

·      eliminatesthe need for cremaphor, which is used in Taxol and generic paclitaxel and hasknown toxicities;

·      comparesfavorably with approved taxane products and other new paclitaxel formulationsunder development (safety and efficacy remain to be proven in Phase 3 testingof TOCOSOL Paclitaxel, which is currently underway);

·      offersthe convenience of a ready-to-use formulation that does not require preparationprior to administration;

·      can beadministered to patients by a short 15-minute infusion, compared to the one- tothree-hour infusion that is typically required with Taxotere® andTaxol or generic versions of paclitaxel;

·      doesnot require any special intravenous (i.v.) tubing or filters; and

·      can beadministered in small volumes of 15 to 35 milliliters compared to volumes ofseveral hundred milliliters of i.v. solution that are required for dosing ofTaxol or Taxotere.

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We initiated Phase 2astudies for TOCOSOL Paclitaxel in March 2002 to evaluate the safety andefficacy of TOCOSOL Paclitaxel in ovarian, non-small cell lung and bladdercancers using weekly dosing of the product. These were single agent, open labelstudies that enrolled taxane naïve patients who had progressive disease despiteprior treatment with a standard chemotherapy regimen. Patient enrollment in thePhase 2a clinical trials was completed in the second quarter of 2003.  Data review, confirmation and analysis arenow complete, and databases have been locked. A total of 122 patients in theovarian, non-small cell lung and bladder cancer studies were evaluable forsafety, and 85 were treated at the maximum tolerated dose and thus wereevaluable for objective response, which means that the patients received themaximum tolerated dose for at least eight weekly cycles of TOCOSOL Paclitaxeland underwent CT scans to determine anti-tumor responses according to RECISTcriteria. Patients were also evaluated for time to disease progression andoverall survival.  Final analyses of alldata are now complete, and best response rates and survival data are presentedin the tables below.
|                        | ** ** | **No.**                 | ** ** | **No.  Patients at   Maximum** | ** ** | ** **          | ** ** | **Objective Response Rates (ORR)*** | ** ** |
|------------------------|------------|-------------------------|------------|------------------------------------------|------------|---------------------|------------|----------------------------------------------------|------------|
| **Cancer   Type** | ** ** | **Patients  Evaluable** | ** ** | **Tolerated   Dose**                | ** ** | **Stable  Disease** | ** ** | **Partial   Response**                        | ** ** | **Complete   Response** | ** ** | **Total   ORR** | ** ** | **%  ORR** | ** ** | **95%   CI** | ** ** |
| Ovarian                |       | 52                      |       | 39                                       |       | 12                  |       | 15                                                 |       | 2 |   | 17 |   | 44 | % | (28%  -60%) |   |
| NSCL                   |       | 43                      |       | 31                                       |       | 14                  |       | 3                                                  |       | 3 |   | 6 |   | 19 | % | (7%  -37%) |   |
| Bladder                |       | 27                      |       | 15                                       |       | 4                   |       | 4                                                  |       | 2 |   | 6 |   | 40 | % | (16% - 68%) |   |

 
| Cancer  Type | ** ** | **Median  Survival  (wks)** | ** ** | **95% CI  (wks)**      | ** ** |
|--------------|------------|-----------------------------|------------|-----------------------------|------------|
| Ovarian      |       | 74.0                        |       | (49.3-110.0)                |       |
| NSCL         |       | 27.9                        |       | (19.7-58.4)                 |       |
| Bladder      |       | 93.1                        |       | (30.7 – not estimable) |       |

 

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*Per protocol, the % ORR is determined for thepatients treated at the maximum tolerated dose (MTD).

In September 2004, weinitiated a Phase 2b study of TOCOSOL Paclitaxel for first line treatment ofwomen with metastatic breast cancer. Enrollment in this study was closed inOctober 2004 with 47 patients randomized. The investigators reported an overallobjective response rate of 53%, (95% Confidence Interval 38% - 68%). Review ofall radiographic images by an independent radiologist who had no informationabout individual patients’ treatment or non-radiographic response assessmentsreported a confirmed objective response rate of 49%, (95% Confidence Interval34% - 64%).

In addition to beingassessed for anti-tumor efficacy, patients were also monitored for adverseevents in all TOCOSOL Paclitaxel clinical studies. The most significant adverseevents expected with taxanes are neutropenia and peripheral neuropathy. Among232 patients treated in the Phase 2 clinical trials, the incidence of at least oneepisode of Grade 4 neutropenia (absolute neutrophil count <500 cells/mm3)during treatment was 18%. However, only 2% of patients had febrile neutropenia,and there was one septic death. No peripheral neuropathy was observed in 56% ofpatients, Grade 3 peripheral neuropathy was reported in only 10% of patientscumulatively, and no patients experienced Grade 4 peripheral neuropathy. Webelieve these adverse event rates compare favorably to the reported neutropeniaand peripheral neuropathy experienced when Taxol is administered with theapproved dosing regimen of 175 mg/m2 everythree weeks. Dose reductions or treatment delays due to toxicity from TOCOSOLPaclitaxel did not limit long-term treatment in most patients. A majority ofpatients in our Phase 2 studies were administered antihistamines prior to theinfusion of TOCOSOL Paclitaxel. Paclitaxel-mediated infusion-relatedtoxicities, sometimes called “hypersensitivity reactions” were generally mildand were reported following approximately 11% of all doses. Investigators havereported that infusion-related toxicities associated with our product could beameliorated by temporary (a few minutes) interruption of infusion andrestarting the infusion at a slower rate. Overall, we believe that TOCOSOLPaclitaxel appears to be well tolerated over multiple treatment cycles.

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The results of the Phase 2 clinical trials may ormay not be indicative of the final results from our Phase 3 pivotal studythat was initiated in September 2005 and closed enrollment in November2006.

The manufacturing process for TOCOSOL Paclitaxel hasbeen successfully scaled to support commercialization. In March 2005,Sonus met with the U.S. Food and Drug Administration (“FDA”) to discuss theChemistry, Manufacturing and Controls (“CMC”) data for TOCOSOL Paclitaxel. TheFDA did not identify any issues with the manufacture and control of the drugproduct that would preclude Sonus from using TOCOSOL Paclitaxel in the Phase 3trial, nor Bayer Schering from submitting the intended New Drug Application(NDA) based on the results of that trial.

Our objective is to work with Bayer Schering toadvance clinical development, gain marketing approval and maximize thecommercial opportunity for TOCOSOL Paclitaxel. Our strategy for productapproval includes the following:

·      *U.S. Development.*In collaboration with our partner, we will seek initial approval ofTOCOSOL Paclitaxel with a 505(b)(2) NDA submission, which will rely on theFDA’s previous findings of safety and efficacy for Taxol (the reference paclitaxelproduct), supplemented by data supporting TOCOSOL Paclitaxel’s safety andefficacy. We are conducting a single Phase 3 clinical trial as the basisfor submission of a NDA for TOCOSOL Paclitaxel under the505(b)(2) regulatory mechanism. The FDA and Sonus finalized the studydesign and plans for conducting and analyzing the results of the Phase 3 trialunder a Special Protocol Assessment (“SPA”) in June 2005. The Phase 3study is comparing the safety and efficacy of TOCOSOL Paclitaxel administeredweekly with Taxol administered weekly. The clinical trial protocol and Statistical Analysis Plan approved underthe SPA provide for sequential superiority analyses for efficacy of TOCOSOLPaclitaxel compared to Taxol, provided that we first demonstrate a non-inferiorobjective response rate; however, there can be no assurance that the Phase 3clinical trial data will demonstrate that TOCOSOL Paclitaxel has efficacy thatis non-inferior or superior to Taxol. Enrollment in the Phase 3 study was closed in November 2006 with 821patients randomized.

·      The FDA hasindicated to Sonus that a NDA approval will require either(a) demonstration of superior efficacy of TOCOSOL Paclitaxel compared toTaxol; or (b) demonstration of non-inferior efficacy as compared to Taxol andeither (i) a change of the approved label for Taxol to include a weeklydosing schedule or (ii) availability of reviewable data from a trialdemonstrating superior efficacy of Taxol using a weekly dosing schedule ascompared to that of Taxol using the currently approved three-weekly dosingschedule.

Wehave an agreement with the Cancer and Leukemia Group B Foundation (“CALGB”)giving us the right to use data from the CALGB Study 9840, a Phase 3 trialcomparing weekly dosing of Taxol to three-weekly dosing of Taxol in patientswith metastatic breast cancer. In the event that TOCOSOL Paclitaxel does notachieve superior efficacy over Taxol in the Phase 3 trial or the approved labelfor Taxol is not changed to include a weekly dosing schedule, our partner andwe plan to submit the CALGB 9840 data to the FDA as part of the TOCOSOLPaclitaxel NDA to support weekly dosing of Taxol as an appropriate referencearm in the ongoing pivotal Phase 3 trial. Based on the summary presentation ofCALGB 9840 at the American Society of Clinical Oncology (ASCO) 2004 annualmeeting, our analysis of the data set and discussions with the FDA, we believethat the data from this study should fulfill the FDA’s requirement to submit areviewable data set that compares weekly dosing of Taxol to three-weekly dosingof Taxol, and demonstrate the weekly regimen to be superior to the everythree-weekly regimen. While there can be no assurance that the data obtainedfrom this study will be sufficient to support the TOCOSOL Paclitaxel NDA, Sonus’preliminary analysis of the CALGB 9840 data confirm the conclusions presentedin the abstract at ASCO 2004. If the FDA does not accept the CALGB Study 9840data or an appropriate alternative data set as support for a weekly reference 

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arm,substantial additional costs and time may be required before the NDA approvalfor TOCOSOL Paclitaxel.  We do notcurrently have sufficient capital resources to fund such substantial additionalcosts.

Weare collaborating with Bayer Schering on the preparation of the NDA.  Bayer Schering is responsible for submissionof the NDA.  We currently believe that Bayer Schering will submit the NDA in thesecond quarter of 2008.  This is only anestimate as the submission date is outside of our direct control and is subjectto change.

·      *Ex-U.S. development.*Under our collaboration agreement, BayerSchering is responsible for development of TOCOSOL Paclitaxel outside theUnited States.  Bayer Schering initiateda Phase 1 study in Japan in the third quarter of 2006, subsequent to theacceptance of the Japanese IND.  Safetyresults from this Phase 1 study will also be included in the U.S. regulatorysubmissions for TOCOSOL Paclitaxel. Bayer Schering has also met with regulatory authorities in Europe andreceived clarification on the requirements for gaining approval of TOCOSOLPaclitaxel in that market. We believe that, in principle, the Phase 3 clinicalstudy currently being conducted by Sonus could suffice as a pivotal trial for asubmission in Europe.

·      *New indications for taxanes.*In conjunction with BayerSchering, we may pursue clinical development of TOCOSOL Paclitaxel for thetreatment of other types of cancer, including indications for which Taxol hasbeen approved as well as for diseases for which Taxol is used but not approved.In October 2003, we announced that we were granted Fast Track designationby the FDA for the development of TOCOSOL Paclitaxel for inoperable ormetastatic urothelial transitional cell cancers (mostly urinary bladdercancers). In December 2004, the FDA granted an Orphan Drug designation toTOCOSOL Paclitaxel for the treatment of non-superficial urothelial cancer. Weinitiated a Phase 2b study in bladder cancer in the U.S. during the fourthquarter of 2003, and in Spain and the U.K. during 2005, using weekly dosing ofTOCOSOL Paclitaxel. Enrollment in this trial was completed in September 2006and we expect to have preliminary data by late-2007.  At this time, there are no plans forcontinued development in this indication. Continued development in thisindication would be dependent on many factors, including the clinical andcommercial potential compared to other opportunities in our pipeline andagreement with Bayer Schering to jointly develop TOCOSOL Paclitaxel for use inthis indication.  

The scope, timing and costs of the clinical trials to be conductedunder all of the above regulatory strategies are difficult to determine withaccuracy. We are conducting a single pivotal Phase 3 trial in metastatic breastcancer, an indication where paclitaxel is approved, with a primary endpoint ofobjective response rate and secondary endpoints of progression-free survivaland overall survival durations. Our partner expects to submit the NDA with dataon the primary endpoint, potentially followed by supplemental submissions forthe secondary endpoints when data are mature. Our current estimate for theexternal cost of the pivotal Phase 3 trial is approximately $50 million. This estimateis our external direct cost only and does not include any internal costs bySonus or Bayer Schering. Under our Collaboration and License Agreement withBayer Schering, Bayer Schering will fund 50% of these costs (in certain casesthe reimbursement rate is 100%). In addition, it is anticipated that we willcollaborate with Bayer Schering on additional studies of TOCOSOL Paclitaxel.Under the terms of our agreement, we are obligated to fund 50% of the costs ofany additional studies conducted by Bayer Schering in support of regulatorysubmission activities for the U.S. market. The exact cost and timing of thesestudies is not yet determined. Finalization of these plans will likely occurafter we have independently reviewed objective response rate data from ourongoing Phase 3 trial, which we expect by the end of the third quarter of 2007.The current ongoing Phase 3 trial will constitute the bulk of the Company’sclinical trial spending in 2007. Approximately three quarters of the cost of the Phase 3 trial has beenincurred as of June 30, 2007. However, future costs may vary significantlydepending upon regulatory and other matters that are not within our control andthere can be no assurance that such amount will be sufficient to complete thestudy.  Development costs in support ofex-US

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commercialization are borne by Bayer Schering.  There can be no assurance that the results ofany or all of the anticipated clinical trials will be successful or willsupport product approval.

TOCOSOL Camptothecin

Oursecond oncology drug candidate is TOCOSOL Camptothecin InjectableEmulsion.  This product candidate is anovel camptothecin derivative formulated as an oil-in-water emulsion with Sonus’proprietary TOCOSOL technology. Camptothecins are an important class ofanti-cancer drugs introduced in recent years; however, the marketedcamptothecin analogs, irinotecan (Camptosar®) and topotecan (Hycamtin®), havedemonstrated limitations that may reduce their clinical utility. Irinotecan andtopotecan are used in the treatment of colorectal, lung, ovarian and cervicalcancers. The active ingredient in TOCOSOL Camptothecin is SN-38 (formulated asa prodrug), which is the active ingredient in irinotecan.  Our objective with TOCOSOL Camptothecin is toprovide a ready-to-use product that has enhanced anti-tumor activity andimproved tolerability compared with the approved camptothecin-based products.An IND was submitted to the FDA for TOCOSOL Camptothecin in June 2006 and Phase1 clinical testing was initiated in September 2006. As this product candidateis very early in clinical development, we cannot give any assurance that thiscompound will be clinically successful.

**Research and DevelopmentPipeline**

We continue to invest in the research and development of new oncologyrelated product candidates, including those that we believe could extend theapplication of our technology. In addition to our internal research anddevelopment efforts, we may also consider acquisitions of other products,development candidates or technologies to expand our pipeline and capabilities.

**ProprietaryTechnology**

We consider the protectionof our technology to be important to our business. In addition to seeking U.S.patent protection for our inventions, we are also seeking patent protection inother selected countries in order to broadly protect our proprietary rights. Wealso rely upon trade secrets, know-how, continuing technological innovationsand licensing opportunities to develop and maintain our competitive position.

Oursuccess will depend, in part, on our ability to obtain and defend patents andprotect trade secrets. As of June 30, 2007, ten United States patents and fivepatents outside the U.S. have been issued pertaining to our proprietary TOCOSOLtechnology. Additional patent applications are pending in the United States andcounterpart filings have been made in selected countries outside the U.S.

***Collaboration andLicense Agreement with Bayer Schering Pharma AG***

On October 17, 2005, weentered into a Collaboration and License Agreement with Schering AG, pursuantto which, among other things, we granted Schering AG an exclusive, worldwidelicense to TOCOSOL Paclitaxel.  Schering AG paid us an upfront license feeof $20 million and pays us for 50% of eligible research and development costsincurred by us related to TOCOSOL Paclitaxel (in certain cases thereimbursement rate is 100%).

In 2006, a wholly owned subsidiary of Bayer AG, a German corporation,acquired Schering AG. The company was renamed Bayer Schering Pharma AG, Germany(“Bayer Schering”).  We are not aware ofany material effect the acquisition has had on our business, financialcondition or results of operations but there can be no assurance that theacquisition will not have a material effect in the future.  The ongoing relationship with Bayer Scheringis just as dependent on the data from our Phase 3 trial for TOCOSOL Paclitaxel,as was the case with Schering AG.

Bayer Schering mayadditionally pay us (i) product milestone payments of up to $132 million uponthe achievement of certain U.S., European Union and Japanese clinical andregulatory milestones,

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(ii) sales milestone payments of up to $35 millionupon the achievement of certain annual worldwide net sales, and (iii) uponcommercialization, royalties ranging between 15-30% of annual net sales in theU.S., with the exact percentage to be determined based on the achievement ofcertain annual net sales thresholds, and royalties equal to 15% of the annualnet sales outside the U.S.  The parties have agreed to a U.S. developmentprogram consisting of the ongoing initial pivotal Phase 3 trial in metastaticbreast cancer and may agree to other trials to support launch of TOCOSOLPaclitaxel. We have retained an option for co-promotion rights in the U.S. andalso granted Bayer Schering the right of first negotiation on TOCOSOLCamptothecin, which is currently in early stage clinical development.  In connection with the Collaboration andLicensing Agreement, the Company and an affiliate of Bayer Schering enteredinto a Securities Purchase Agreement whereby the Company sold 3,900,000 sharesof common stock for an aggregate of $15.7 million and warrants to purchase975,000 shares of common stock for an aggregate purchase price of $122,000.

On March 2, 2006, in accordance with the Collaboration and LicenseAgreement with Bayer Schering, Bayer Schering exercised their right to assumeresponsibility for the manufacturing of TOCOSOL Paclitaxel.  In June 2006, we entered into a clinicalsupply agreement with Bayer Schering to provide clinical supplies of TOCOSOLPaclitaxel to Bayer Schering until such time as Bayer Schering establishesmanufacturing capability for the product.

**Results of Operations**

As of June 30, 2007, our accumulated deficit was approximately $120.9million. We expect to incur substantial additional operating losses over thenext several years.  Such losses havebeen and will continue to principally be the result of various costs associatedwith our discovery and research and development programs.  Substantially all of our working capital inrecent years has resulted from equity financings and payments received undercorporate partnership agreements.  Ourability to achieve a consistent, profitable level of operations depends inlarge part on obtaining regulatory approval for TOCOSOL Paclitaxel as wellas future product candidates in addition to successfully manufacturing andmarketing those products once they are approved.  Even if we are successful in theaforementioned activities our operations may not be profitable.  In addition, payments under corporatepartnerships and licensing arrangements are subject to significant fluctuationsin both timing and amount.  Therefore,our operating results for any period may fluctuate significantly andmay not be comparable to the operating results for any other period.

Ourrevenue was $3.3 million for the three months ended June 30, 2007 as comparedwith $7.5 million for the same period in 2006. We had revenue of $8.3 million for the six months ended June 30, 2007compared with $11.6 million for the same period in 2006.  Revenue in the both periods was fullyattributable to the collaboration agreement with Bayer Schering.  We recognized $1.4 million and $2.8 millionin amortization of an upfront license fee received from Bayer Schering AG forthe three and six month periods ended June 30, 2007, respectively and anadditional $1.9 million and $5.5 million in research and developmentreimbursements for the three month and six month periods ended June 30, 2007,respectively.  Amortization of the $20million upfront fee, net of a $2.3 million adjustment related to the excessfair value of warrants issued to Bayer Schering in connection with the licensearrangement,will continueuntil the end of the development period for TOCOSOL Paclitaxel, which iscurrently estimated to conclude at the end of 2008.  The estimated development period representsthe currently estimated date for FDA approval assuming no further research isrequired and the results of the Phase 3 trial successfully meet itsendpoints.  This estimate is subject tochange as facts and circumstances surrounding our Phase 3 trial for TOCOSOLPaclitaxel change. The license arrangement also includes reimbursement of 50%of research and development costs during this time.  We expect revenue during the remainder of 2007to decline as reimbursements associated with the Phase 3 trial begin to winddown and Bayer Schering takes over full manufacturing of TOCOSOLPaclitaxel.  These reimbursementsconstitute the majority of our revenue.

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Ourresearch and development (R&D) expenses were $7.7 million for the threemonths ended June 30, 2007 compared with $11.2 million for the same period in2006.  Our R&D expenses were $14.6million for the six months ended June 30, 2007 compared with $19.4 million forthe same period in 2006.  The decreasefor both periods was primarily the result of lower spending on clinical trialsand drug supply and manufacturing costs as the Phase 3 trial for TOCOSOLPaclitaxel begins to wind down.  Althoughwe expect to continue expanding development activities of other productcandidates in our pipeline, we expect R&D expenses during the remainder of2007 to decrease as a result of reduced spending related to the Phase 3 trialfor TOCOSOL Paclitaxel as the trial progresses, in addition to reduced spendingfor the non-Phase 3 clinical development of TOCOSOL Paclitaxel, pending receiptof independently reviewed objective response rate data from the Phase 3 trialcurrently expected by the end of the third quarter of 2007.

Ourgeneral and administrative (G&A) expenses were $2.1 million for the threemonths ended June 30, 2007 compared with $1.9 million for the same period in2006.  Our G&A expenses were $4.1million for the six months ended June 30, 2007 compared with $3.7 million forthe same period in 2006.  The increasefor both periods was primarily the result of higher spending associated withpersonnel related costs as we expand operations.  We expect G&A expenses during 2007 toremain generally in line with levels experienced during the first six months of2007.

Weexpect our total operating expenses during the remainder of 2007 to decrease asspending related to the Phase 3 trial for TOCOSOL Paclitaxel begins to winddown and additional clinical development of TOCOSOL Paclitaxel has been scaledback pending receipt of independently reviewed objective response rate datafrom the Phase 3 trial.  We estimate thatR&D spending will comprise approximately 80%-90% of the anticipatedspending in 2007.  A significant portion of the R&D spending willbe devoted to the****Phase 3 clinical trial forTOCOSOL Paclitaxel in addition to development activities related to othercompounds in our pipeline.  Theseestimates and actual expenses are subject to change depending on many factors,including unforeseen expansion of study size or duration, complications inconducting or completing studies when the study begins, changes in FDArequirements, increased material costs and other factors.

Ourother income, net, was $590,000 for the three months ended June 30, 2007compared with $687,000 for the same period in 2006.  Our other income, net, was $1.2 million forboth six month periods ended June 30, 2007 and 2006.  The decrease for the three month period endedJune 30, 2007 was due primarily to higher levels of invested cash in the sameperiod in 2006.

TheCompany had no income tax expense for the three and six month periods endedJune 30, 2007 or 2006 as it had incurred pretax losses.

## **Liquidity and Capital Resources**

Wehave historically financed operations with proceeds from equity financings andpayments under corporate partnerships with third parties.  At June 30, 2007, we had cash, cashequivalents and marketable securities totaling $44.3 million compared to $58.3million at December 31, 2006.  Thedecrease was primarily due to timing of payments accrued in 2006 and paid in2007, in addition to the net loss for the six month period ended June 30, 2007of $9.2 million.  These decreases wereoffset in part by $6.6 million in payments received from Bayer Schering underthe collaboration agreement.

Net cash used in operatingactivities for the six months ended June 30, 2007, and 2006, was $14.0 millionand $10.8 million, respectively. Expenditures in all periods were a result of R&D expenses, includingclinical trial costs, and G&A expenses in support of our operations andproduct development activities primarily related to TOCOSOL Paclitaxel and to alesser extent other potential product candidates.  The increase in net cash used in operating activitiesfrom the six months ended June 30, 2007 to the six months ended June 30, 2006was primarily due timing of invoices and related payments.

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Net cash used in investing activities forthe six months ended June 30, 2007 and 2006 was $19.3 million and $384,000,respectively.** **Thenet cash used in investing activities during the six month period ended June30, 2007 was primarily due to purchases of marketable securities in the normalcourse of business.  The net cash used ininvesting activities during the same period in the prior year was due topurchases of property and equipment. Activity related to marketable securities relates primarily to theinvestment of money raised in equity financings or received under collaborativeagreements.  The related maturities andsales of those investments provide us with working capital on an as neededbasis.   We also initiate shifts betweencash equivalent securities and marketable securities based on our cash needsand the prevailing interest rate environment.

Net cash provided by financing activities for the six months ended June30, 2007, and 2006 was $159,000 and $28.9 million, respectively.** **The net cashprovided by financing activities during the six month period ended June 30,2007 was primarily due to the issuance of common stock under employee benefitplans and the exercise of common stock warrants.  The net cash provided by financing activitiesduring the same period in the prior year was primarily due to proceeds raisedin the May 2, 2006 registered direct equity financing and the exercise of commonstock warrants.

Weexpect that our cash requirements will continue to increase in future periodsdue to the development and commercialization costs associated with TOCOSOLPaclitaxel and other product candidates. Under our current forecasted cash needs,which assume continued development of TOCOSOL Paclitaxel as well as otherproduct candidates, we believe that existing cash, cash equivalents andmarketable securities, in addition to payments pending and cost sharingarrangements under our agreement with Bayer Schering, will be sufficient tofund operations through the second quarter of 2008. In addition to thesupportive trials Sonus plans to conduct, it is anticipated that we willcollaborate with Bayer Schering on additional studies. Under the terms of theCollaboration and License Agreement with Bayer Schering, we are also obligatedto fund 50% of the costs of certain studies conducted by Bayer Schering for theU.S. The exact cost and timing of these studies is not yet known. In addition,the scope, timing and costs of the Phase 3 clinical trial are difficult todetermine with accuracy and these costs may vary significantly dependingupon regulatory and other matters that are not within our control. Our currentestimate for the total external cost of the Phase 3 clinical trial isapproximately $50 million, approximately three quarters of which has beenincurred through June 30, 2007. We will need additional capital in 2008 tosupport the continued development and commercialization of TOCOSOL Paclitaxel,our obligations under the Collaboration and License Agreement with BayerSchering, the development of other product candidates and to fund continuingoperations. Should our clinical data support an NDA submission based on theprimary endpoint of objective response rate, we anticipate that the NDA, thecontents of which are being developed in collaboration with Bayer Schering,will be submitted by Bayer Schering in the second quarter of 2008. Our futurecapital requirements depend on many factors including:

·                  ourability to obtain and timing of payments under corporate partner agreementsand/or debt or equity financings;

·                  timingand costs of preclinical development, clinical trials and regulatory approvals;

·                  timingand results from our Phase 3 trial for TOCOSOL Paclitaxel;

·                  timingand amount of costs to support our obligations under the Collaboration andLicense Agreement with Bayer Schering;

·                  timingand cost of drug discovery and research and development;

·                  enteringinto new collaborative or product license agreements for products in ourpipeline;

·                  timingand costs of technology transfer associated with manufacturing and supplyagreements; and

·                  costsrelated to obtaining, defending and enforcing patents.

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We have contractual obligations in the form of operating leasesand leasehold financing arrangements, which expire in 2007. The Company alsosigned a new facility lease in November 2006. The new facility lease has a term of 10 years with a provision for twoadditional five year renewals.  Theestimated commencement date for the new lease is November 2007. The followingtable summarizes our contractual obligations under these agreements, includinginterest as of June 30, 2007:
| Contractual  Obligations     | ** ** | **Total**  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
|------------------------------|------------|------------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|
|                         |       |       |       |                            |       |               |       |               |       |                             |       |
| Lease financing  obligations |       | $          | 2,533      |                            | $          | 2,533              |       | $                  | —     |                             | $          | — |   | $ | — |   |
| Operating lease  obligations |       | 25,611,311 |       | 1,701,228                       |       | 4,494,156          |       | 4,784,637          |       | 14,631,290                       |       |
| Total                        |       | $          | 25,613,844 |                            | $          | 1,703,761          |       | $                  | 4,494,156  |                             | $          | 4,784,637 |   | $ | 14,631,290 |   |

 

Underthe Collaboration and License Agreement with Bayer Schering, we are obligatedto fund 50% of the costs of certain studies conducted by Bayer Schering. Asthese additional studies have not yet been finalized, no dollar amounts havebeen disclosed above.

**MaterialChanges in Financial Condition**
|                           | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                      |       |                        |       |                            |       |
| Total assets              |       | $                           | 52,639,901 |                            | $          | 68,493,002 |   |
| Total  liabilities        |       | $                           | 17,324,513 |                            | $          | 25,451,065 |   |
| Shareholders’ equity |       | $                           | 35,315,388 |                            | $          | 43,041,937 |   |

 

The decline in assets from December 31, 2006 primarily relates todeclines in cash and investments used to fund operations and timing ofcollections of receivables.  The declinein liabilities from December 31, 2006 primarily relates to lower accruals onthe Phase 3 trial for TOCOSOL Paclitaxel as it begins to wind down, lowerTOCOSOL Paclitaxel manufacturing activity as responsibility for manufacturinghas been assumed by Bayer Schering and lower accruals for compensation due totiming of annual incentive payments.  Thedecline in shareholders equity is primarily due to the net loss for the year.

**CriticalAccounting Policies and Estimates**

We previously identified certain policies and estimates as critical toour business operations and the understanding of our past or present results ofoperations in our Annual Report on Form 10-K for the year ended December 31,2006 and filed with the Securities and Exchange Commission on March 16,2007.  These policies and estimates areconsidered critical because they had a material impact, or they have thepotential to have a material impact, on our financial statements and becausethey require significant judgments, assumptions or estimates.  Our preparation of financial statementsrequires us to make estimates and assumptions that affect the reported amountof assets and liabilities, disclosure of contingent assets and liabilities atthe date of our financial statements, and the reported amounts of revenue andexpenses during the reporting period.  Nopolicies or estimates have materially changed or arisen subsequent to thosepreviously disclosed.

**Item3. Quantitative and Qualitative Disclosures About Market Risk**

*Interest rate risk:*

The market risk inherent in our marketablesecurities portfolio represents the potential loss arising from adverse changesin interest rates. If market rates hypothetically increase immediately anduniformly by 100 basis points from levels at June 30, 2007, the decline in thefair value of the investment portfolio would not be material. Given theshort-term nature of our investment portfolio, we do not expect our operatingresults or cash flows to be affected to any significant degree by a suddenchange in market interest rates.

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*Foreigncurrency exchange risk:*

We are exposed to risksassociated with foreign currency transactions on certain contracts denominatedin foreign currencies (primarily Euro and Pound Sterling denominated contracts)and we have not hedged these amounts. As our unhedged foreign currencytransactions fluctuate, our earnings might be negatively affected. Accordingly,changes in the value of the U.S. dollar relative to the Euro/Pound Sterlingmight have an adverse effect on our reported results of operations andfinancial condition, and fluctuations in exchange rates might harm our reportedresults and accounts from period to period. The impact of foreign currency fluctuations related to realized gainsand losses during the three month and six month periods ended June 30, 2007 and2006, respectively, was not material.

**Item4. Controls and Procedures**

Evaluation of disclosure controls and procedures

An evaluation as of the end of the periodcovered by this report was carried out under the supervision and participationof management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures.  Based upon theevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective in timely alertingthem to material information required to be included in our periodic SECfilings.  A controls system, no matterhow well designed and operated, cannot provide absolute assurance that theobjectives of the controls are met, and no evaluation of controls can provideabsolute assurance that all controls and instances of fraud, if any, within acompany have been, or will be, detected.

Changes in internal control over financial reporting

We have not made any changesto our internal control over financial reporting (as defined in rule 13a-15(f)and 15d-15(f) under the Exchange Act) during the fiscal quarter ended June 30,2007 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

**Part II.     OtherInformation**

**Item1A.  Risk Factors**

You should consider therisks below carefully in addition to other information contained in this reportbefore engaging in any transaction involving shares of our common stock.  Potential risks and uncertainties include,among other things, those factors discussed in the sections entitled “Business”,“Risk Factors” and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” in our Annual Report on Form 10-K for the year endedDecember 31, 2006, the section entitled “Management’s Discussion and Analysisof Financial Condition and Results of Operations” in this Quarterly Report onForm 10-Q, and as set forth below in this Item 1A. Readers should carefullyreview those risks, as well as additional risks described in other documents wefile from time to time with the Securities and Exchange Commission. Weundertake no obligation to publicly release the results of any revisions to anyforward-looking statements to reflect anticipated or unanticipated events orcircumstances occurring after the date of such statements. The following riskfactors include material changes to the risk factors previously disclosed inour Form 10-K filed for the year ended December 31, 2006, but are not acomplete list of all of our risk factors.

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*The acquisition of Schering AG byBayer AG may affect our relationship with the combined company.*

We executed an agreementwith Schering AG for TOCOSOL Paclitaxel in October 2005. Under theCollaboration and License Agreement, Schering AG has a worldwide exclusivelicense to market and promote TOCOSOL Paclitaxel and is responsible forclinical development and regulatory activities outside of the U.S.  In2006, a wholly owned subsidiary of Bayer AG, a German corporation, acquiredSchering AG. The company was renamed Bayer Schering Pharma AG, Germany (“BayerSchering”).  We are not aware of anymaterial effect the acquisition has had on our business, financial condition orresults of operations but there can be no assurance that the acquisition willnot have a material effect in the future. The ongoing relationship with Bayer Schering is just as dependent on thedata from our Phase 3 trial for TOCOSOL Paclitaxel, as was the case withSchering AG.

*The impact of the recall byBristol-Myers Squibb Pharmaceuticals of certain batches of Taxol.*

In March 2007, Bristol-Myers Squibb Pharmaceuticals recalled certainbatches of Taxol due to potential lack of sterility assurance.  At the time of the recall, there had been noreports of non-sterile product and no stability failures had beendetected.  Among the recalled batcheswere those being used in the reference arm of the ongoing Phase 3 TOCOSOLPaclitaxel pivotal study.  Based on theavailable information, Sonus has no reason to believe that the recalled batcheshad an adverse impact on patients treated with those batches in the Phase 3study.  To continue the Phase 3 studywithout interruption, Sonus obtained generic paclitaxel products, as permittedin the Phase 3 protocol, allowing patients to continue treatment in thereference arm.  The generic paclitaxelproducts obtained meet the product specifications of Taxol.  Use of generic paclitaxel products in thePhase 3 study has been discussed with the FDA, and the change from Taxol togeneric paclitaxel products will require additional product data related togeneric paclitaxel products in the NDA. We are in the process of receiving the required information.  However, there can be no assurance that theuse of generic paclitaxel products will not have an impact on the outcome ofour NDA review.

The Company plans to return all of the recalled material to itssuppliers in accordance with the recall notice. While we believe that we will receive a full refund for the returnedmaterial, there can be no assurance that we will receive that refund on atimely basis.

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

Our Annual Meeting of Stockholders was held on May10, 2007.  At the Annual Meeting, therewere three matters submitted to a vote of security holders.  Proxies were solicited pursuant to Regulation14A of the Securities Exchange Act of 1934. There was no solicitation in opposition to management’s nominees aslisted in the proxy statement.

Each director nominated and all other proposals submitted toa vote passed and the voting outcome of each proposal was as follows:

1.     Electionof the following five (5) directors to serve until the next annual meeting ofstockholders or until their successors are elected and have qualified to serveas directors:
| Nominee               | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-----------------------|------------|------------|------------|--------------|------------|
| Michelle Burris       |       | 26,797,985 |       | 1,179,137    |       |
| George W. Dunbar, Jr. |       | 26,484,048 |       | 1,493,074    |       |
| Robert E. Ivy         |       | 26,802,105 |       | 1,175,017    |       |
| Michael A. Martino    |       | 26,794,555 |       | 1,182,567    |       |
| Dwight  Winstead      |       | 26,482,948 |       | 1,494,174    |       |

 

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| 2.     | Approval of the Company’s 2007  Stock Incentive Plan: |               |
|--------|------------------------------------------------------------|--------------------|
|   |                                                       |               |
|   | For: 10,124,830                                            | Against: 3,081,114 | Abstain: 46,170 |
|        |                                                            |                    |  |  |

 
| 3.           Ratification of Ernst & Young LLP as  independent auditors of the Company for the fiscal year ending December 31,  2007: |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                        |
|                                                                                                                                                                                        | For: 27,750,214 | Against: 164,998 | Abstain: 61,910 |

 

**Item6.  Exhibits**
|        | 10.1   | Sonus Pharmaceuticals, Inc. 2007 Performance  Incentive Plan (incorporated by reference to Appendix A to the Company’s  Definitive Proxy Statement on Schedule 14A, as filed with the Commission  on April 3, 2007). |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                |
|   | 31.1   | Certification of President and Chief Executive  Officer pursuant to Rule 13a-14(a) or 15d-14(a).                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                |
|   | 31.2   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or 15d-14(a).                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                |
|   | 32.1   | Certification of President and Chief Executive  Officer pursuant to Rule 13a-14(b) or 15d-14(b).                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                |
|   | 32.2   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(b) or 15d-14(b).                                                                                                                                                  |

** **

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**SIGNATURES**

In accordance withthe requirements of the Securities Exchange Act, the registrant caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|                                              | **SONUS PHARMACEUTICALS, INC.** |
|----------------------------------------------|---------------------------------|
| ** **                                   |                            |   |
| Date:     August 3, 2007 | By:                             | /s/ Alan Fuhrman |   |
|                                         |                            | Alan Fuhrman |
|                                         |                            | Senior Vice  President, |
|                                         |                            | Chief Financial  Officer |
|                                         |                            | (Principal  Financial Officer) |
|                                              |                                 |  |  |

 

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