# **UNITED STATES**

# **SECURITIES AND EXCHANGE COMMISSION**

## **WashingtonD.C. 20549**

## ** **

# **FORM 10-Q**

# ** **

**x****               ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDEDSEPTEMBER 30, 2007**

 

**or**

 

**o****                  ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THETRANSITION 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)  |       |                                     |

 

**2202620th Ave. SE, Bothell, Washington 98021**

(Address ofPrincipal Executive Offices)

 

**(425) 487-9500**

(Registrant’s telephone number, including areacode)

 

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

 

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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

| Class                           |   | Outstanding at November 5, 2007 |
|---------------------------------|--------|-----------------------------------------------------|
|                            |   |                                                |
| Common Stock, $0.001  par value |   | 36,973,902                                          |

 

 

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**SonusPharmaceuticals, Inc.**

**Index toForm 10-Q**

 
| **Part I.  Financial Information**                                          | ** **                                                                                                            |
|-----------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------|
|                                                                        |                                                                                                                  |   |
| Item 1.                                                                     | Financial  Statements                                                                                                 |   |
|                                                                        |                                                                                                                  |   |
|                                                                        | Balance Sheets as of September 30, 2007  (unaudited) and December 31, 2006                                            |   |
|                                                                        |                                                                                                                  |   |
|                                                                        | Statements of Operations (unaudited) for  the three and nine months ended   September 30, 2007 and September 30, 2006 |   |
|                                                                        |                                                                                                                  |   |
|                                                                        | Statements of  Cash Flows (unaudited) for the nine months ended   September 30, 2007 and September 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 6.                                                                     | Exhibits                                                                                                              |   |
|                                                                        |                                                                                                                  |   |
| Items 1, 2, 3, 4  and 5 are not applicable and therefore have been omitted. |                                                                                                                  |

 

2

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**Part I.****              FinancialInformation**

 

**Item 1.**           Financial Statements

 

**Sonus Pharmaceuticals, Inc.**

**Balance Sheets**

 
| ** **                                                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                        | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                        |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                        |       | $                      | 2,288,397  |                  | $          | 35,771,784 |   |
| Marketable  securities                                                                                                                                                            |       | 38,376,614             |       | 22,506,086            |       |
| Accounts  receivable from related party                                                                                                                                           |       | 4,577,313              |       | 8,043,771             |       |
| Other current  assets                                                                                                                                                             |       | 1,290,883              |       | 524,470               |       |
| Total current assets                                                                                                                                                              |       | 46,533,207             |       | 66,846,111            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Equipment,  furniture and leasehold improvements, net                                                                                                                             |       | 1,352,303              |       | 1,186,174             |       |
| Other assets                                                                                                                                                                      |       | 439,822                |       | 460,717               |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Total assets                                                                                                                                                                      |       | $                      | 48,325,332 |                  | $          | 68,493,002 |   |
|                                                                                                                                                                              |       |                   |       |                  |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                    |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                  |       | $                      | 292,227    |                  | $          | 898,486 |   |
| Accounts payable  to related party                                                                                                                                                |       | 2,630,300              |       | 1,473,050             |       |
| Accrued expenses                                                                                                                                                                  |       | 8,889,180              |       | 11,928,124            |       |
| Deferred revenue  from related party                                                                                                                                              |       | 6,927,174              |       | 5,545,919             |       |
| Other current  liabilities                                                                                                                                                        |       | —                 |       | 64,792                |       |
| Total current  liabilities                                                                                                                                                        |       | 18,738,881             |       | 19,910,371            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Deferred revenue  from related party, less current portion                                                                                                                        | ** ** | **—**             |       | 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; 36,973,902 and 36,853,974  shares issued and outstanding at September 30, 2007 and December 31, 2006,  respectively |       | 156,323,186            |       | 154,780,939           |       |
| Accumulated  deficit                                                                                                                                                              |       | (126,734,778           | )          | (111,738,669          | )          |
| Accumulated  other comprehensive loss                                                                                                                                             |       | (1,957                 | )          | (333                  | )          |
| Total  stockholders’ equity                                                                                                                                                  |       | 29,586,451             |       | 43,041,937            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Total  liabilities and stockholders’ equity                                                                                                                                  |       | $                      | 48,325,332 |                  | $          | 68,493,002 |   |

 

See accompanyingnotes.

 

3

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**Sonus Pharmaceuticals, Inc.**

**Statements of Operations**

**(Unaudited)**

 
| ** **                                                          | ** ** | **Three Months**             | ** ** | **Nine Months**              | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                                          | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                                                          | ** ** | **2007**                          | ** ** | **2006**                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Revenue:                                                            |       |                              |       |                              |       |   |   |   |   |
| Collaboration  revenue from related party                           |       | $                                 | 4,079,400  |                              | $          | 4,931,212 |   | $ | 12,401,452 |   | $ | 16,498,417 |   |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Operating  expenses:                                                |       |                              |       |                              |       |   |   |   |   |
| Research and  development                                           |       | 8,870,645                         |       | 10,281,055                        |       | 23,506,016 |   | 29,640,135 |   |
| General and  administrative                                         |       | 1,562,420                         |       | 1,786,317                         |       | 5,666,542 |   | 5,442,235 |   |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Total operating  expenses                                           |       | 10,433,065                        |       | 12,067,372                        |       | 29,172,558 |   | 35,082,370 |   |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Operating loss                                                      |       | (6,353,665                        | )          | (7,136,160                        | )          | (16,771,106 | ) | (18,583,953 | ) |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Other income  (expense):                                            |       |                              |       |                              |       |   |   |   |   |
| Other income  (expense)                                             |       | (629                              | )          | 3,594                             |       | (34,632 | ) | (44,447 | ) |
| Interest income                                                     |       | 546,705                           |       | 840,384                           |       | 1,810,063 |   | 2,092,362 |   |
| Interest expense                                                    | ** ** | **—**                        |       | (663                              | )          | (434 | ) | (2,496 | ) |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Total other  income, net                                            |       | 546,076                           |       | 843,315                           |       | 1,774,997 |   | 2,045,419 |   |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Net loss                                                            |       | $                                 | (5,807,589 | )                                 | $          | (6,292,845 | ) | $ | (14,996,109 | ) | $ | (16,538,534 | ) |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Basic and  diluted net loss per share                               |       | $                                 | (0.16      | )                                 | $          | (0.17 | ) | $ | (0.41 | ) | $ | (0.49 | ) |
|                                                                |       |                              |       |                              |       |   |   |   |   |
| Shares used in  computation of basic and diluted net loss per share |       | 36,925,165                        |       | 36,793,772                        |       | 36,887,715 |   | 34,036,401 |   |

 

See accompanyingnotes.

 

4

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**Sonus Pharmaceuticals, Inc.**

**Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                             | ** ** | **Nine Months Ended September 30,** | ** **  |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                                             | ** ** | **2007**                                                | ** **  | **2006** | ** ** |
| **Operating  activities:**                                                             |       |                                                    |        |   |   |
| Net loss                                                                               |       | $                                                       | (14,996,109 | ) | $ | (16,538,534 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:           |       |                                                    |        |   |   |
| Depreciation                                                                           |       | 464,646                                                 |        | 442,827 |   |
| Non-cash  stock-based compensation                                                     |       | 1,309,235                                               |        | 1,481,111 |   |
| Accretion of  investments                                                              |       | (361,884                                                | )           | (41,904 | ) |
| Changes in  operating assets and liabilities:                                          |       |                                                    |        |   |   |
| Accounts  receivable from related party                                                |       | 3,466,458                                               |        | (2,615,676 | ) |
| Other current  assets                                                                  |       | (766,413                                                | )           | 102,779 |   |
| Long term  receivable from related party                                               |       | —                                                  |        | 87,500 |   |
| Other long term  assets                                                                |       | 20,895                                                  |        | 23,507 |   |
| Accounts payable                                                                       |       | (606,259                                                | )           | (867,137 | ) |
| Accounts payable  to related party                                                     |       | 1,157,250                                               |        | 866,000 |   |
| Accrued expenses                                                                       |       | (3,038,944                                              | )           | 4,689,409 |   |
| Other current  liabilities                                                             |       | (50,029                                                 | )           | — |   |
| Deferred revenue  from related party                                                   |       | (4,159,439                                              | )           | (4,159,439 | ) |
| Other  liabilities                                                                     |       | —                                                  |        | (232,023 | ) |
| Net cash used in  operating activities                                                 |       | (17,560,593                                             | )           | (16,761,580 | ) |
|                                                                                   |       |                                                    |        |   |   |
| **Investing  activities:**                                                             |       |                                                    |        |   |   |
| Purchases of  capital equipment and leasehold improvements                             |       | (630,775                                                | )           | (676,224 | ) |
| Purchases of  marketable securities                                                    |       | (46,444,749                                             | )           | (16,640,990 | ) |
| Proceeds from  sales of marketable securities                                          |       | 30,465,514                                              |        | — |   |
| Proceeds from  maturities of marketable securities                                     |       | 468,967                                                 |        | — |   |
| Net cash used in  investing activities                                                 |       | (16,141,043                                             | )           | (17,317,214 | ) |
|                                                                                   |       |                                                    |        |   |   |
| **Financing  activities:**                                                             |       |                                                    |        |   |   |
| Proceeds from  issuance of common stock under equity financings, net of issuance costs |       | —                                                  |        | 28,570,451 |   |
| Proceeds from  exercise of common stock warrants                                       |       | 57,440                                                  |        | 301,330 |   |
| Proceeds from  exercise of stock options and other                                     |       | 175,572                                                 |        | 99,211 |   |
| Payments on  lease obligations                                                         |       | (14,763                                                 | )           | (20,300 | ) |
| Net cash  provided by investing activities                                             |       | 218,249                                                 |        | 28,950,692 |   |
|                                                                                   |       |                                                    |        |   |   |
| (Decrease) Increase  in cash and cash equivalents for the period                       |       | (33,483,387                                             | )           | (5,128,102 | ) |
| Cash and cash  equivalents at beginning of period                                      |       | 35,771,784                                              |        | 49,317,845 |   |
|                                                                                   |       |                                                    |        |   |   |
| Total cash and  cash equivalents                                                       |       | $                                                       | 2,288,397   |   | $ | 44,189,743 |   |
|                                                                                   |       |                                                    |        |   |   |
| Supplemental  cash flow information:                                                   |       |                                                    |        |   |   |
| Interest paid                                                                          |       | $                                                       | 434         |   | $ | 2,496 |   |

 

See accompanyingnotes.

 

5

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** **

**SonusPharmaceuticals, Inc.**

**Notes to Financial Statements**

**(Unaudited)**

 

**1.****              Basis ofPresentation**

 

The unaudited financialstatements have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q. Accordingly, they do not include all of the information and footnotesrequired to be presented for complete financial statements. The accompanyingfinancial statements reflect all adjustments (consisting only of normal recurringitems) which are, in the opinion of management, necessary for a fairpresentation of the results for the interim periods presented. The accompanyingBalance Sheet at December 31, 2006 has been derived from the audited financialstatements included in the Company’s Annual Report on Form 10-K for the yearthen ended. The financial statements and related disclosures have been preparedwith the assumption that users of the interim financial information have reador have access to the audited financial statements for the preceding fiscalyear. Accordingly, these financial statements should be read in conjunctionwith the audited financial statements and the related notes thereto included inthe Annual Report on Form 10-K for the year ended December 31, 2006 and filedwith the Securities and Exchange Commission on March 16, 2007.

 

**2.****              Related Party**

 

The Company engages insignificant transactions with Bayer Schering Pharma AG, Germany (“BayerSchering”). Bayer Schering is a related party due to their ownership interestin the Company (10.6% fully diluted) and has been appropriately identified assuch on the face of the financial statements. All amounts disclosed on the faceof the financial statements with related parties are attributable to BayerSchering. Please see Note 3 “Collaboration and License Agreement with BayerSchering Pharma AG” for additional details.

 

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

 

OnOctober 17, 2005, Sonus entered into a Collaboration and License Agreement (the“Agreement”) with Bayer Schering Pharma AG (formerly Schering AG), a Germancorporation, pursuant to which, among other things, it granted Bayer Scheringan exclusive, worldwide license to TOCOSOL® Paclitaxel. At thattime, the parties agreed to a core development program consisting of theinitial pivotal trial in metastatic breast cancer, trials for additionalindications and trials to support launch of TOCOSOL Paclitaxel, and agreed toshare equally in the costs of the core development program. In connection withthe Agreement, the Company and an affiliate of Bayer Schering entered into aSecurities Purchase Agreement whereby the Company sold 3,900,000 shares ofcommon stock for an aggregate of $15.7 million and warrants to purchase 975,000shares of common stock for an aggregate purchase price of $122,000.

 

Duringthe nine month period ended September 30, 2007, the Company recognized revenueof $4.1 million as amortization of the upfront license fee and an additional$8.3 million related to research and development services performed by Sonusprimarily for the Phase 3 trial for TOCOSOL Paclitaxel and relatedmanufacturing costs. As of September 30, 2007, the Company had $6.9 million indeferred revenue related to the unamortized upfront payment (net of theadjustment for warrants issued in connection with the Agreement) as well as$4.6 million in receivables and $2.6 million in payables with Bayer Schering.

 

6

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On October 3, 2007, Sonus received notification fromBayer Schering of its decision to terminate the Agreement in accordance withits terms because the Phase 3 pivotal trial did not meet its primary endpointand the results of the trial do not support, in Bayer Schering’s judgment, asubmission for a New Drug Application with the United States Food and DrugAdministration (“FDA”). The Agreement provides that the termination shall beeffective within thirty days of the date on which written notice was receivedby the Company. In accordance with the terms of the Agreement, all rights toTOCOSOL Paclitaxel have reverted back to Sonus. We have discontinueddevelopment of TOCOSOL Paclitaxel due to results of the Phase 3 study and thetime and cost that would be required to conduct the necessary clinical studiesto continue development, which at a minimum, would include another Phase 3pivotal trial. We believe that these closure activities will be substantiallycomplete by December 31, 2007. Due to the termination of the Agreement by BayerSchering, in October 2007, the Company will recognize $6.9 million of revenuein the fourth quarter of 2007, which represents the balance of the unamortizeddeferred revenue from the upfront license fee. There will also be a final netbilling to Bayer Schering in the fourth quarter of 2007 for accrued expensesrelated primarily to reimbursable Phase 3 activity through the date oftermination and expenses associated with the termination of the Phase 3 trial. AsSonus is still in the process of finalizing these costs, no estimate can beprovided at this time. The Company does not expect recognition of any revenuerelated to the Agreement with Bayer Schering beyond 2007.

 

**4.****             ****Accrued Expenses**

 

Accrued expenses consist of thefollowing:

 
| ** **             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| Clinical trials        |       | $                      | 7,999,195  |                  | $          | 8,497,278 |   |
| Compensation           |       | 226,475                |       | 1,459,128             |       |
| Product  manufacturing |       | 12,330                 |       | 1,617,580             |       |
| Other                  |       | 651,180                |       | 354,138               |       |
|                   |       | $                      | 8,889,180  |                  | $          | 11,928,124 |   |

 

**5.****              Comprehensive Income(Loss)**

** **
| ** **                                                            | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                                   | ** ** | **2006**                                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net loss                                                              |       | $                                                          | (5,807,589 | )                                                         | $          | (6,292,845 | ) | $ | (14,996,109 | ) | $ | (16,538,534 | ) |
| Unrealized gain  (loss) on cash equivalents and marketable securities |       | 19,845                                                     |       | (3,363                                                    | )          | (1,624 | ) | 3,293 |   |
| Comprehensive  loss                                                   |       | $                                                          | (5,787,744 | )                                                         | $          | (6,296,208 | ) | $ | (14,997,733 | ) | $ | (16,535,241 | ) |

 

**6.**              Stockholders’ Equity

** **

***Common Stock Issuances***

 

Duringthe third quarter of 2007, the Company received $59,063 in proceeds fromthe issuance of 54,026 shares of common stock from the issuance of shares underemployee benefit programs. For the nine months ended September 30, 2007, theCompany received $57,440 in proceeds from the issuance of 14,044 shares ofcommon stock from the exercise of common stock warrants, in addition to $175,572in proceeds from the issuance of 105,884 shares of common stock from theissuance of shares under employee benefit programs.

 

7

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***Employee Stock Plans***

 

On May10, 2007, Sonus shareholders approved a new incentive plan entitled the “2007Performance Incentive Plan”. Under the terms of this plan, the Company canissue up to 3,900,000 additional shares of the Company’s common stock throughthe grant of stock options and restricted stock. Employee stock options andrestricted stock vest over a period of time determined by the Board ofDirectors, generally four years, and director stock options are generally fullyvested on the date of grant. Stock options generally are granted at the fairmarket value on the date of grant and expire ten years from the date of grant.

 

TheCompany has an employee stock purchase plan whereby employees may contribute upto 15% of their compensation to purchase shares of the Company’s common stockat 85% of the stock’s fair market value at the lower of the beginning or end ofeach six-month offering period. The Company recognized $8,117 in compensationexpense related to this plan for the nine month period ended September 30, 2007.At September 30, 2007, a total of 76,083 shares remain available for purchaseby employees under the plan.

 

The Company has a 401(k) plan for allemployees under which it provides a specified percentage match on employeecontributions. Currently, the Company match is made in shares of the Company’scommon stock. The Company recognized compensationexpense related to this plan for the three and nine month periods endedSeptember 30, 2007 of $30,150 and $87,462, respectively. AtSeptember 30, 2007, a total of 51,615 shares remain available for futureissuances as matching contributions under the plan.

 

***Stock-Based Compensation***

 

 During the three and nine month periods endedSeptember 30, 2007 and 2006, respectively, the Company recorded stock-basedcompensation cost under the provisions of Statement 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. Thefollowing table summarizes the income statement classification of stock-basedcompensation:

 
| ** **                                        | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                                   | ** ** | **2006**                                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| Stock-based  compensation income (expense):  |       |                                                       |       |                                                      |       |   |   |   |   |
| General &  administrative                     |       | $                                                          | (99,663    | )                                                         | $          | (208,208 | ) | $ | (866,512 | ) | $ | (808,142 | ) |
| Research &  development                       |       | 99,918                                                     |       | (225,313                                                  | )          | (442,723 | ) | (672,969 | ) |
| Total  stock-based compensation income (expense)  |       | $                                                          | 255        |                                                      | $          | (433,521 | ) | $ | (1,309,235 | ) | $ | (1,481,111 | ) |

 

The reversal of expensein the research & development area for the third quarter related to theimpact of a mark to market adjustment for consultant option awards. Theseawards are revalued at the end of each quarter. The significant decline in theCompany’s stock price in the third quarter resulted in a decrease ofapproximately $200,000 in stock compensation expense as compared to the secondquarter of 2007. In addition, the Company’s change in the estimated forfeiturerate based on personnel reductions in the fourth quarter of 2007 resulted in adecrease of approximately $445,000 in stock compensation expense as compared tothe second quarter of 2007. These changes in estimates are based on eventswhich occurred or were triggered in the third quarter 2007 and are beingaccounted for on a prospective basis. The fair value of each stock option usedin the calculations under SFAS 123R is estimated using the Black-Scholes-Mertonoption pricing model. The assumptions used in this model include (1) the stockprice at grant date, (2) the exercise price, (3) an estimated option life of6.6 years and four years as of September 30, 2007 and 2006, respectively, (4)no expected dividends for each period presented, (5) stock price volatilityfactor of 104.0%****and 68.5% as of   September 30, 2007 and 2006, respectively,(6) forfeiture rate of 16.0%****and 13.1%  as of September 30, 2007 and 2006,respectively, and (7) a risk-free interest rate of 4.6%****and4.8% as of September 30, 2007 and 2006, respectively.

 

8

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***Stock Option Activity***

 

Thefollowing is a summary of option activity through September 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                                            |       | 18,450                                            |       | (18,450                          | )          | $ | 4.94 |   |
| March 31, 2007                                           |       | 959,316                                           |       | 4,750,940                        |       | $ | 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                                            |       | 4,770,066                                         |       | 4,795,628                        |       | $ | 4.93 |   |
|                                                     |       |                                              |       |                             |       |   |   |
| Grants                                                   |       | —                                            |       | —                           |       | — |   |
| Exercises                                                |       | —                                            |       | —                           |       | — |   |
| Cancellations                                            |       | 42,768                                            |       | (42,768                          | )          | $ | 5.19 |   |
| September 30,  2007                                      |       | 4,812,834                                         |       | 4,752,860                        |       | $ | 4.93 |   |

 

**7.**              Income Taxes

** **

**EffectiveJanuary 1, 2007, the Company adopted the provisions of the FinancialInterpretation No. 48, “Accounting**for Uncertainty in Income Taxes – aninterpretation of FASB Statement No. 109” (“FIN 48”). FIN 48prescribes a recognition threshold and a measurement attribute for thefinancial statement recognition and measurement of tax positions taken orexpected to be taken in a tax return. At the date of adoption of FIN 48, we hadno unrecognized tax benefits and expected no significant changes inunrecognized tax benefits in the next twelve months. The adoption of thisstatement did not result in a cumulative accounting adjustment and did notimpact our financial position, results of operations or cash flows.**

** **

**Werecognize interest and penalties related to uncertain tax positions in incometax expense when applicable. To date, there have been no interest or penaltiescharged to the Company in relation to the underpayment of income taxes.**

** **

**TheCompany is subject to audit by the IRS and The Washington State Department ofRevenue for all years since inception. As of January 1, 2007, we have recordeda valuation allowance equal to our total net deferred tax assets due to theuncertainty of ultimately realizing tax benefits of approximately $40.6 million.**

 

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**8.**              Subsequent Events

** **

On October 3, 2007, Sonus received notification from Bayer Schering ofits decision to terminate the Agreement in accordance with its terms becausethe Phase 3 pivotal trial did not meet its primary endpoint and the results ofthe trial do not support, in Bayer Schering’s judgment, a submission for a NewDrug Application with the United States Food and Drug Administration (“FDA”). TheAgreement provides that the termination shall be effective within thirty daysof the date on which written notice was received by Sonus. In accordance withthe terms of the Agreement, all rights to TOCOSOL Paclitaxel have reverted backto Sonus. The Company has discontinued development of TOCOSOL Paclitaxel due toresults of the Phase 3 study and the time and cost that would be required toconduct the necessary clinical studies to continue development, which at aminimum, would include another Phase 3 pivotal trial. The Company believes thatthese closure activities will be substantially complete by December 31, 2007.Due to the termination of the Agreement by Bayer Schering, in October 2007, theCompany will recognize $6.9 million of revenue in the fourth quarter of 2007,which represents the balance of the unamortized deferred revenue from theupfront license fee. There will also be a final net billing to Bayer Scheringin the fourth quarter of 2007 for accrued expenses related primarily toreimbursable Phase 3 activity through the date of termination and expensesassociated with the termination of the Phase 3 trial. As the Company is stillin the process of finalizing these costs, no estimate can be provided at thistime. The Company does not expect recognition of any revenue related to theAgreement with Bayer Schering beyond 2007. Any adjustments resulting from thefourth quarter termination will be recorded in the fourth quarter of 2007.

 

On October 22, 2007, Sonusannounced that it had engaged Ferghana Partners Inc. as its advisor to assistit in identifying, evaluating and pursuing alternative strategies to maximizeshareholder value. These alternatives may include a merger or acquisition,among other things.

 

On November 1, 2007, the Company implemented areduction of workforce (“Reduction of Workforce”) pursuant to which the Company’sworkforce was reduced by 16 positions, or approximately 25%, leaving theCompany with 48 employees. The effective date of the Reduction of Workforce isNovember 30, 2007. The Company undertook the Reduction of Workforce in light ofthe outcome of itsPhase 3 Pivotal Trial for TOCOSOL Paclitaxel, which was announced in theCompany's press release on September 204, 2007. These steps were taken in orderto conserve cash and preserve the critical capabilities necessary to pursue thehighest priority development programs.

 

In connection with the Reduction of Workforce, theCompany expects to incur expenses associated with one-time termination benefitsof approximately $1.2 million, including approximately $1.1 million of severancebenefits and $100,000 attributable to the continuation of medial insurancebenefits. It is currently anticipated that these expenses will be incurred inthe fourth quarter of 2007.

 

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**Item 2.****         ****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

 

**Forward-LookingStatements**

 

Thisreport contains certain forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, and we intend that suchforward-looking statements be subject to the safe harbors created thereby.Examples of these forward-looking statements include, but are not limited to:

 

•                  timing and amount of future contractualpayments, product revenue and operating expenses;

•                  progress and preliminary results of clinicaltrials;

•                  our anticipated future capital requirementsand the terms of any capital financing agreements;

•                  anticipated regulatory filings, requirementsand future clinical trials; and

•                  market acceptance of our products and theestimated potential size of these markets.

 

Whilethese forward-looking statements made by us are based on our current beliefsand judgments, they are subject to risks and uncertainties that could causeactual results to vary from the projections in the forward-looking statements.You should consider the risks below carefully in addition to other informationcontained in this report before engaging in any transaction involving shares ofour common stock. If any of these risks occur, they could seriously harm ourbusiness, financial condition or results of operations. In such case, thetrading price of our common stock could decline, and you may lose all orpart of your investment.

 

Thediscussion and analysis set forth in this document contains trend analysis,discussions of regulatory status and other forward-looking statements. Actualresults could differ materially from those projected in the forward-lookingstatement as a result of the following factors, among others:

 

•                  resultsof research and preclinical studies may not be indicative of results in humans;

•                  abilityto build out our product candidate pipeline through internal development,product in-licensing or acquisition activities;

•                  propermanagement of our operations will be critical to the success of the Company;

•                  historyof operating losses and uncertainty of future financial results;

•                  volatilityin the value of our common stock;

•                  continuedlisting on the NASDAQ Global Market (formerly NASDAQ National Market);

•                  dependenceon the development and commercialization of products;

•                  uncertaintyof governmental regulatory requirements and lengthy approval process;

•                  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; and

•                  other factors set forth under “Risk Factors”contained in our Annual Report on Form 10-K for the fiscal year ended December31, 2006 filed on March 16, 2007, Quarterly Reports on Form 10-Q filed on May9, 2007 and August 3, 2007 for the first and second quarters ending March 31,2007****and June 30, 2007, respectively,****and in this Quarterly Report on Form 10-Q.

 

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## **MD&A Overview**

## ** **

InManagement’s Discussion and Analysis of Financial Condition and Results ofOperations we explain the general financial condition and the results ofoperations for our Company, including:

 

•                  an overview of our business;

•                  results of operations and why those resultsare different from the prior year; and

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

 

# **Business Overview**

** **

Sonus Pharmaceuticals is developing novel smallmolecule treatments for patients with cancer. Our objective is to identify opportunities where there is thepossibility for major improvements in patient treatments and where we believewe can mitigate development risk.  Wecurrently have one drug in clinical development and four earlier stageprograms. Our plan is to continue to develop our internal pipeline of clinicalcompound opportunities and to evaluate possible strategic alternatives,including in-licensing, out-licensing and merger and acquisition opportunities,as a means of achieving our business strategies and enhancing stockholdervalue.  On October 22, 2007, we announcedthat we have engaged Ferghana Partners Inc., an international provider ofindependent financial advisory services to firms in the biotechnology,pharmaceuticals, diagnostics and specialty chemicals industries, to assist us.

 

## **ProductCandidates**

## ** **

TOCOSOLPaclitaxel

 

TOCOSOLPaclitaxel is a novel formulation of paclitaxel manufactured in a ready-to-use,injectable vitamin E-based emulsion formulation. The Investigational New DrugApplication (“IND”) for TOCOSOL Paclitaxel was submitted to the FDA in 2000,and Phase 1 testing was initiated shortly thereafter. On September 24, 2007 weannounced that TOCOSOL Paclitaxel failed to meet the primary endpoint in Phase3 clinical testing. We have discontinued development of TOCOSOL Paclitaxel dueto results of the Phase 3 study and the time and cost that would be required toconduct the necessary clinical studies to continue development, which at aminimum, would include another Phase 3 pivotal trial. We believe that theseclosure activities will be substantially complete by December 31, 2007. Basedon the results from the Phase 3 trial, we received a 30 day notice oftermination from Bayer Schering on October 3, 2007, under the terms of theAgreement. In accordance with the terms of the Agreement, all rights to TOCOSOLPaclitaxel have reverted back to us.

 

SN2310

 

SN 2310 is an injectable Emulsion (“SN2310”). This product candidate isa novel camptothecin derivative formulated as an oil-in-water emulsion withSonus’ 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, and ovarian cancers.The active ingredient in SN2310 is SN-38, which is considered to be the activeingredient in irinotecan. Our objective with SN2310 is to provide aready-to-use product that has enhanced anti-tumor activity and improvedtolerability compared with the approved camptothecin-based products. An IND wassubmitted to the FDA for SN2310 in June 2006 and Phase 1 clinical testing wasinitiated in September 2006. As this product candidate is early in clinicaldevelopment, we cannot give any assurance that this compound will be clinicallysuccessful.

 

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PipelineCompounds

 

We continue to invest in the research and developmentof new oncology related product candidates, including those that we believecould extend the application of our technology. We have identified three areasof opportunity where we believe there is the possibility for major improvementsin patient treatments and where we believe we can mitigate development risk:(1) prodrugs of existing small molecules, where the novel prodrug is designedto provide greater patient convenience and improved patient outcome; (2) novelsmall molecules, where an opportunity exists, using known moieties, to improveclinical shortcomings of existing approved compounds; and (3) reformulation,with the aim of improving on the safety or efficacy profile of an existingparenteral drug. We are currently working on four early stage programs withcompounds under development that either use our TOCOSOL technology or other newtechnologies under development.

 

**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 September 30, 2007, sixteen United States patentsand seven patents outside the U.S. have been issued relating to our proprietarytechnologies. Additional patent applications are pending in the United Statesand counterpart filings have been made in selected countries outside theU.S.

 

**Collaboration and LicenseAgreement with Bayer Schering Pharma AG**

 

On October 17, 2005, we entered the Agreement withBayer Schering Pharma AG (formerly Schering AG), a German corporation, pursuantto which, among other things, we granted Bayer Schering an exclusive, worldwidelicense to TOCOSOL Paclitaxel. At that time, the parties agreed to a coredevelopment program consisting of the pivotal trial in metastatic breastcancer, trials for additional indications and trials to support launch of theTOCOSOL Paclitaxel, and agreed to share equally in the costs of the coredevelopment program.

 

On October 3, 2007, we received notification fromBayer Schering of its decision to terminate the Agreement in accordance withits terms because the Phase 3 pivotal trial did not meet its primary endpointand the results of the trial do not support, in Bayer Schering’s judgment, asubmission for a New Drug Application with the United States Food and DrugAdministration (“FDA”). The Agreement provides that the termination shall beeffective within thirty days of the date on which written notice was received byus. In accordance with the terms of the Agreement, all rights to TOCOSOLPaclitaxel have reverted back to us. We have discontinued development ofTOCOSOL Paclitaxel due to results of the Phase 3 study and the time and costthat would be required to conduct the necessary clinical studies to continuedevelopment, which at a minimum, would include another Phase 3 pivotal trial.We believe that these closure activities will be substantially complete byDecember 31, 2007. Due to the termination of the Agreement by Bayer Schering,in October 2007, we will recognize $6.9 million of revenue in the fourthquarter of 2007, which represents the balance of the unamortized deferredrevenue from the upfront license fee. There will also be a final net billing toBayer Schering in the fourth quarter of 2007 for accrued expenses relatedprimarily to reimbursable Phase 3 activity through the date of termination andexpenses associated with the termination of the Phase 3 trial. As we are stillin the process of finalizing these costs, no estimate can be provided at thistime. We do not expect recognition of any revenue related to the Agreement withBayer Schering beyond 2007.

 

**Results ofOperations**

** **

As of September 30, 2007, our accumulated deficit was approximately$126.7 million. We expect to incur substantial additional operating losses overthe next several years. Such losses have been and will continue to principallybe the result of various costs associated with our discovery and research anddevelopment programs. Substantially all of our working capital in recent yearshas resulted from equity

 

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financingsand payments received under corporate partnership agreements. Our ability toachieve a consistent, profitable level of operations depends in largepart on obtaining regulatory approval for future product candidates inaddition to successfully manufacturing and marketing those products if they areapproved. Even if we are successful in the aforementioned activities our operationsmay not be profitable.

 

Ourrevenue was $4.1 million for the three months ended September 30, 2007 ascompared with $4.9 million for the same period in 2006. We had revenue of $12.4million for the nine months ended September 30, 2007 compared with $16.5million for the same period in 2006. Revenue in both periods was fullyattributable to the Agreement with Bayer Schering. We recognized $1.4 millionand $4.1 million in amortization of an upfront license fee received from BayerSchering for the three and nine month periods ended September 30, 2007,respectively and an additional $2.7 million and $8.3 million in research anddevelopment reimbursements for the three month and nine month periods endedSeptember 30, 2007, respectively. Due to the termination of the Agreement byBayer Schering in October 2007, we will recognize $6.9 million of revenue inthe fourth quarter of 2007, which represents the balance of the unamortizeddeferred revenue from the upfront license fee. There will also be a final netbilling to Bayer Schering in the fourth quarter of 2007 for accrued expensesrelated primarily to reimbursable Phase 3 activity through the date oftermination and expenses associated with the termination of the Phase 3 trial. Aswe are still in the process of finalizing these costs, no estimate can beprovided at this time. We do not expect recognition of any revenue related tothe Agreement with Bayer Schering beyond 2007.

 

Ourresearch and development (“R&D”) expenses were $8.9 million for the threemonths ended September 30, 2007 compared with $10.3 million for the same periodin 2006. Our R&D expenses were $23.5 million for the nine months endedSeptember 30, 2007 compared with $29.6 million for the same period in 2006. Thedecrease for both periods was primarily the result of lower spending onclinical trials and drug supply and manufacturing costs related to the Phase 3trial for TOCOSOL Paclitaxel. We expect R&D costs to increase in the fourthquarter of 2007 due to expected costs we will incur for terminating all TOCOSOLPaclitaxel related clinical trials, in addition to costs associated withplanned staff reductions. We expect R&D expenses in 2008 to besignificantly lower than levels experienced in 2007, absent any strategictransaction which could affect R&D expenses.

 

Ourgeneral and administrative (“G&A”) expenses were $1.6 million for the threemonths ended September 30, 2007 compared with $1.8 million for the same periodin 2006. Our G&A expenses were $5.7 million for the nine months ended September30, 2007 compared with $5.4 million for the same period in 2006. Thefluctuations for both periods were primarily related to normal variations inpersonnel and market research type expenses. We expect G&A costs toincrease in the fourth quarter of 2007 due to costs associated with plannedstaff reductions. We expect G&A expenses in 2008 to be lower than levelsexperienced in 2007, absent any strategic transaction which could affectG&A expenses.

 

Weexpect our total operating expenses during the fourth quarter of 2007 toincrease due to expected costs associated with the termination of all TOCOSOLPaclitaxel related clinical trials and planned staff reductions. We estimatethat R&D spending will comprise approximately 80%-90% of the anticipatedspending in 2007. A significant portion ofthe R&D spending will be devoted to the cessation of TOCOSOL Paclitaxelprograms in addition to development activities related to other compounds inour pipeline. These estimates and actual expenses are subject to changedepending on many factors. We expect operating expenses in 2008 to besignificantly lower than levels experienced in 2007, absent any strategictransaction which could affect operating expenses.

 

Ourother income, net, was $546,000 for the three months ended September 30, 2007compared with $843,000 for the same period in 2006. Our other income, net, was$1.8 million for the nine month period ended September 30, 2007 compared with$2.0 million for the same period in 2006. The 

 

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decreasefor both periods was due primarily to lower levels of invested cash in 2007compared to the same periods in 2006.

 

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

 

## **Liquidity andCapital Resources**

## ** **

Wehave historically financed operations with proceeds from equity financings andpayments under corporate partnerships with third parties. At September 30,2007, we had cash, cash equivalents and marketable securities totaling $40.7million compared to $58.3 million at December 31, 2006. The decrease wasprimarily due to the net loss for the nine month period ended September 30,2007 of $15.0 million, in addition to timing of items accrued in 2006 and paidin 2007.

 

Net cash used in operating activities for the ninemonths ended September 30, 2007, and 2006, was $17.6 million and $16.8 million,respectively. Expenditures in all periods were a result of R&D expenses,including clinical trial costs, and G&A expenses in support of ouroperations and product development activities primarily related to TOCOSOLPaclitaxel and to a lesser extent other potential product candidates. Theincrease in net cash used in operating activities from the nine months endedSeptember 30, 2007 to the nine months ended September 30, 2006 was primarilydue timing of invoices and related payments.

 

Netcash used in investing activities for the nine months ended September 30, 2007and 2006 was $16.1 million and $17.3 million, respectively. The net cash usedin investing activities during both nine month periods ended September 30, 2007and 2006 was primarily due to transactions involving marketable securities inthe normal course of business in addition to purchases of fixed assets. Activityrelated to marketable securities relates primarily to the investment of moneyraised in equity financings or received under collaborative agreements. Therelated maturities and sales of those investments provide us with working capitalon an as needed basis. We also initiate shifts between cash equivalentsecurities and marketable securities based on our cash needs and the prevailinginterest rate environment.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2007, and 2006 was$218,000 and $29.0 million, respectively. The net cash provided by financingactivities during the nine month period ended September 30, 2007 was primarilydue to the issuance of common stock under employee benefit plans and theexercise of common stock warrants. The net cash provided by financingactivities during the same period in the prior year was primarily due toproceeds raised in our May 2, 2006 equity financing and the exercise of commonstock warrants.

 

Weexpect that our cash requirements will decrease in 2008 due to the terminationof development of TOCOSOL Paclitaxel and related staff reductions. Under ourcurrent forecasted cash needs, which assume continued development of SN2310 andother earlier stage product candidates, we believe that existing cash, cashequivalents and marketable securities, in addition to final payments from BayerSchering, will be sufficient to fund expected operations through at least thethird quarter of 2009. We will need additional capital in 2009 to support thecontinued development SN2310, other product candidates and to fund continuingoperations. Our future capital requirements depend on many factors including:

 

•                  our ability to obtain and timing of paymentsunder equity or debt financings;

•                  outcome related to strategic activitiescurrently being evaluated;

•                  timing and costs of preclinical development,clinical trials and regulatory approvals;

•                  timing and cost of drug discovery andresearch and development;

 

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•                  entering into new collaborative or productlicense agreements for products in our pipeline; and

•                  costs related to obtaining, defending andenforcing patents.

 

We have contractualobligations in the form of operating leases which expire between 2010 and2017. We signed a new facility lease in November 2006. The new facility leasehas a term of 10 years with a provision for two additional five year renewals. Theestimated commencement date for the new lease is December 2007. The followingtable summarizes our contractual obligations under these agreements as ofSeptember 30, 2007:

 
| **Contractual   Obligations** | ** ** | **Total** | ** ** | **Less than   1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5   years** | ** ** |
|------------------------------------|------------|-----------|------------|---------------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------------|------------|
|                               |       |      |       |                                  |       |               |       |               |       |                                   |       |
| Operating lease  obligations       |       | $         | 25,823,624 |                                  | $          | 1,878,513          |       | $                  | 4,593,821  |                                   | $          | 4,892,136 |   | $ | 14,459,154 |   |
|                                    |            |           |            |                                       |            |                    |            |                    |            |                                        |            |  |  |  |  |  |

 

**Material Changes in Financial Condition**

 
| ** **                 | ** ** | **September 30,   2007** | ** ** | **December 31, 2006** | ** ** |
|----------------------------|------------|------------------------------------|------------|---------------------------------|------------|
|                       |       |                               |       |                            |       |
| Total assets               |       | $                                  | 48,325,332 |                            | $          | 68,493,002 |   |
| Total  liabilities         |       | $                                  | 18,738,881 |                            | $          | 25,451,065 |   |
| Shareholders’  equity |       | $                                  | 29,586,451 |                            | $          | 43,041,937 |   |

 

The decline in assets fromDecember 31, 2006 primarily relates to declines in cash, cash equivalents andmarketable securities used to fund operations and timing of collections ofreceivables. The decline in liabilities from December 31, 2006 relatesprimarily to generally lower accrued liabilities on reduced manufacturingactivity and the reversal of 2007 bonus accruals and lower deferred revenue onnormal amortization. The decline in shareholders equity is primarily due to thenet loss for the year. We expect that the termination of the Agreement withBayer Schering in October 2007 will have a material financial impact in futureperiods as that Agreement was our only source of revenue.

 

**Critical Accounting Policies and Estimates**

 

We previously identifiedcertain policies and estimates as critical to our business operations and theunderstanding of our past or present results of operations in our Annual Reporton Form 10-K for the year ended December 31, 2006 and filed with the Securitiesand 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 because theyrequire significant judgments, assumptions or estimates. Our preparation offinancial statements requires us to make estimates and assumptions that affectthe reported amount of assets and liabilities, disclosure of contingent assetsand liabilities at the date of our financial statements, and the reportedamounts of revenue and expenses during the reporting period.

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

*Interestrate risk:*

 

Themarket risk inherent in our marketable securities portfolio represents thepotential loss arising from adverse changes in interest rates. If market rateshypothetically increase immediately and uniformly by 100 basis points fromlevels at September 30, 2007, the decline in the fair value of the investmentportfolio would not be material. Given the short-term nature of our investmentportfolio, we do not expect our operating results or cash flows to be affectedto any significant degree by a sudden change in market interest rates.

 

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*Foreign currency exchange risk:*

 

Weare exposed to risks associated with foreign currency transactions on certaincontracts denominated in foreign currencies (primarily Euro and Pound Sterlingdenominated contracts) and we have not hedged these amounts. As our unhedgedforeign currency transactions fluctuate, our earnings might be negativelyaffected. Accordingly, changes in the value of the U.S. dollar relative to theEuro/Pound Sterling might have an adverse effect on our reported results ofoperations and financial condition, and fluctuations in exchange rates mightharm our reported results and accounts from period to period. The impact offoreign currency fluctuations related to realized gains and losses during thethree month and nine month periods ended September 30, 2007 and 2006,respectively, was not material.

 

**Item 4. Controls and Procedures**

 

Evaluation of disclosurecontrols and procedures

 

Anevaluation as of the end of the period covered by this report was carried outunder the supervision and participation of management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls 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 matter how well designed and operated, cannotprovide absolute assurance that the objectives of the controls are met, and noevaluation of controls can provide absolute assurance that all controls andinstances of fraud, if any, within a company have been, or will be, detected.

 

Changes in internal controlover financial reporting

 

We have not made any changes to our internal controlover financial reporting (as defined in rule 13a-15(f) and 15d-15(f) under theExchange Act) during the fiscal quarter ended September 30, 2007 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Part II.****          Other Information**

 

**Item 1A. RiskFactors**

 

You should consider the risks below carefully inaddition to other information contained in this report before engaging in anytransaction involving shares of our common stock. Potential risks anduncertainties include, among other things, those factors discussed in thesections entitled “Business”, “Risk Factors” and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” in our Annual Reporton Form 10-K for the year ended December 31, 2006, the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inthis Quarterly Report on Form 10-Q, and as set forth below in this Item 1A.Readers should carefully review those risks, as well as additional risksdescribed in other documents we file from time to time with the Securities andExchange Commission. The following risk factors include material changes to therisk factors previously disclosed in our Form 10-K for the year ended December31, 2006, and are not a complete list of our risk factors. We undertake noobligation 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.

 

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*The success of our potentialproducts in research and preclinical studies does not guarantee that theseresults will be replicated in humans.*

 

Severalof our drug development programs are currently in the research stage or inpreclinical development. Our only product in clinical trials, SN2310, began Phase1 clinical testing in September 2006 and is still in the early stages ofclinical testing. Although our clinical development-stage drug candidate hasshown favorable results in preclinical studies, these results may not bereplicated in our clinical trials. Before we make any products from ourresearch and development programs commercially available, we will need toconduct further research and development, including laboratory testing, animalstudies, clinical studies, and obtain product approval from the appropriateregulatory authorities. These programs may not move beyond their current stagesof development. Even if our research does advance, we will need to engage incertain additional preclinical development efforts to determine whether aproduct is sufficiently safe and effective to enter clinical trials.Consequently, there is no assurance that the results in our research andpreclinical studies are predictive of the results that we may see in ourclinical trials, that they are predictive of whether any resulting productswill be safe and effective in humans, or that the resulting products will beapproved by regulatory authorities.

 

*Our success is dependent on theproper management of our current and future business operations, and theexpenses associated with them given our limited resources.*

 

Ourbusiness strategy requires us to manage our operations to provide for thecontinued development and potential commercialization of our drug candidates.If we are unable to effectively manage our current operations given our limitedresources, we may not be able to implement our business strategy and ourfinancial condition and results of operations may be adversely affected. If weare unable to effectively manage our expenses, we may find it necessary to reduceour expenses through a reduction in our workforce and/or cancellation ofresearch & development programs, which could adversely affect ouroperations.

 

*If we failto develop new products, then we may never realize revenue from productcommercialization.*

 

Most of our attention andresources at this time are directed to the development of SN2310, a novelcamptothecin derivative as well as earlier stage oncology product candidates.Camptothecins are a class of anti-cancer drugs used in the treatment of colorectal,lung, and ovarian cancers. Significant expenditures in additional research anddevelopment, clinical testing, regulatory, manufacturing, and sales andmarketing activities will be necessary in order for us to gain marketingapproval for our product candidates and subsequently commercialize them. Therecan be no assurance that product candidates under development or any futureproducts will be safe and efficacious. If the product candidates underdevelopment are ultimately ineffective in treating cancer, do not receive thenecessary regulatory approvals or do not obtain commercial acceptance, we willincur additional losses, our accumulated deficit will increase and our businesswill be materially adversely affected.

 

Even if we are successful indeveloping our products, there is no assurance that such products will receiveregulatory approval or that a commercially viable market will develop.

 

*We may merge with or acquireother companies or drug candidates, and our failure to receive the anticipatedbenefits in these transactions could harm our business.*

 

Weare actively seeking strategic opportunities, which may include a merger oracquisition, among other things. The success of any merger or acquisitiondepends, in part, on our ability to realize the anticipated synergies, costsavings and growth opportunities from integrating the business of the merged oracquired company with our business. The integration of two independentcompanies is a complex, costly and time-consuming process. The difficulties ofcombining the operations of two companies include, among others:

 

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•                  consolidating research anddevelopment operations;

•                  retaining key employees;

•                  consolidating corporate andadministrative infrastructures;

•                  preserving the research anddevelopment and other important relationships of the companies;

•                  integrating and managing thetechnology of two companies;

•                  using the merged or acquiredcompany’s liquid capital and other assets efficiently to develop the businessof the combined company;

•                  diverting management’sattention from ongoing business concerns; and

•                  coordinating geographicallyseparate organizations.

 

Therecan be no assurance that we will find any attractive strategic opportunities,or that if we find them, that we will be able to consummate a transaction onfavorable terms, or at all. If we do enter into a transaction, there can be noassurance that we will receive all of the anticipated benefits of anytransaction, or that any of the risks described above will not occur. Ourfailure to receive anticipated benefits of and our exposure to inherent risksin, any such transaction could significantly harm our business, financialcondition and operating results.

 

*Failure tosatisfy NASDAQ Global Market listing requirements may result in our commonstock being delisted from The NASDAQ Global Market.*

 

Our common stock iscurrently listed on The NASDAQ Global Market under the symbol “SNUS.”  For continued inclusion on The NASDAQ Global Market, we must maintain, among otherrequirements, stockholders’ equity of at least $10.0 million, a minimum bidprice of $1.00 per share and a market value of our public float of at least$5.0 million; or market capitalization of at least $50 million, a minimum bidprice of $1.00 per share and a market value of our public float of at least$15.0 million. Between September 24, 2007 and November 5, 2007, the closingprice of our common stock, as reported on the NASDAQ Global Market, has tradedin a range of $0.49 and $0.78 per share. On November 5, 2007, we received notice from NASDAQ that we do notcomply with NASDAQ’s continued listing standards because the closing bid priceof our common stock has been below the required minimum bid price of $1.00 for30 consecutive business days.  We haveuntil May 5, 2008 to regain compliance. If we do not regain compliance by May 5, 2008, our common stock will bedelisted if we do not appeal NASDAQ’s determination to delist our commonstock.  Alternatively, we may apply forlisting on The NASDAQ Capital Market if we meet the initial listing standardsfor that market, in which case we would have an additional 180 days to regaincompliance.  In addition, as of September30, 2007, we had stockholders’ equity of approximately $29.6 million. In theevent that we fail to satisfy any of the listing standards on a continuousbasis, our common stock may be removed from listing on The NASDAQ GlobalMarket. If our common stock were delisted from The NASDAQ Global Market, ourcommon stock may be transferred to The NASDAQ Capital Market if we satisfythe listing criteria for The NASDAQ Capital Market or trading of our commonstock, if any, may be conducted in the over-the-counter market in theso-called “pink sheets” or, if available, the National Association ofSecurities Dealer’s “Electronic Bulletin Board.”  Consequently, broker-dealers may be lesswilling or able to sell and/or make a market in our common stock. Additionally,an investor would find it more difficult to dispose of, or to obtain accuratequotations for the price of, our common stock. As a result of a delisting, itmay become more difficult for us to raise funds through the sale of oursecurities.

 

*We may not achieve our projecteddevelopment goals in the time frames we announce and anticipate.*

 

Weset goals for and make public statements regarding the timing of certainaccomplishments, such as the commencement and completion of clinical trials,anticipated regulatory approval dates and time of product launch, which wesometimes refer to as milestones. These milestones may not be achieved, and theactual timing of these events can vary dramatically due to a number of factorssuch as delays or failures in our clinical trials, disagreements with futurecollaborative partners, the uncertainties inherent in the regulatory approvalprocess and manufacturing scale-up and delays in achieving manufacturing ormarketing arrangements sufficient to commercialize our products. There can beno assurance that our clinical trials will be completed, that we will makeregulatory submissions or receive regulatory approvals as planned or that wewill be able to launch any of our products in anticipated timeframes. If wefail to achieve one or more of these milestones as planned, our business will bematerially adversely affected, and the price of our shares will decline.

 

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*We have not yet commercializedany of our drug candidates; our ability to commercialize products is unproven.*

 

Wehave not yet commercialized any of our product candidates. Ourcommercialization of products is subject to several risks, including but notlimited to:

 

•                  the possibility that aproduct is toxic, ineffective or unreliable;

•                  failure to obtain regulatoryapproval for the product;

•                  difficulties inmanufacturing the product on a large scale;

•                  difficulties in planning,coordinating and executing the commercial launch of the product;

•                  difficulties in marketing,distribution or sale of the product;

•                  the possibility of a failureto comply with laws and regulations related to the marketing sale andreimbursement of the product;

•                  competition from superiorproducts; and

•                  third-party patents thatpreclude us from marketing a product.

 

Evenif a product candidate is approved for commercial sale, significant strategicplanning and resources will be necessary to effectively coordinate commerciallaunch of the product in the approved indication or indications, and toeffectively market, distribute and sell the product for use in the approvedindication or indications. We currently have limited marketing and nodistribution capability.

 

*We willneed additional capital in the future to support the continued development ofour product candidates and to fund continuing operations.*

 

We expect that our cashrequirements will decrease in future periods due to the discontinuation ofdevelopment of TOCOSOL Paclitaxel. We believe that existing cash, cashequivalents and marketable securities, in addition to final payments expectedfrom Bayer Schering, will be sufficient to fund operations through at least thethird quarter of 2009. We will need additional capital in 2009 to support thecontinued development SN2310, other product candidates and to fund continuingoperations. Our future capital requirements depend on many factors including:

 

•                  our ability to obtain, and the timing ofpayments under, debt or equity financings;

•                  timing and costs of preclinical development,clinical trials and regulatory approvals;

•                  timing and cost of drug discovery andresearch and development;

•                  entering into new collaborative or productlicense agreements for products in our pipeline; and

•                  costs related to obtaining, defending andenforcing patents.

 

Any future debt or equityfinancing, if available, may result in substantial dilution to existingstockholders, and debt financing, if available, may include restrictivecovenants.

 

*We have ahistory of operating losses which we expect will continue and we may neverbecome profitable.*

 

We have experiencedsignificant accumulated losses since our inception, and expect to incur netlosses for the foreseeable future. These losses have resulted primarily fromexpenses associated with our research and development activities, includingnonclinical and clinical trials, and general and administrative expenses. As ofSeptember 30, 2007, our accumulated deficit totaled $126.7 million. Weanticipate that our operating losses will continue as we further invest inresearch and development for our products. Our results of operations havevaried and will continue to vary significantly and depend on, among otherfactors:

 

•                  ourability to obtain and timing of payments under debt or equity financings;

 

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•                  outcomerelated to strategic activities currently being evaluated;

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

•                  drugdiscovery and research and development;

•                  enteringinto new collaborative or product license agreements for products in our pipeline;and

•                  costsrelated to obtaining, defending and enforcing patents.

 

*Governmental regulatoryrequirements are lengthy and expensive and failure to obtain necessaryapprovals will prevent us from commercializing our product candidates.*

 

We are subject to uncertaingovernmental regulatory requirements and a lengthy approval process for ourproducts prior to any commercial sales of our products. The development andcommercial use of our products are regulated by the FDA, the European MedicinesEvaluation Agency, or EMEA, and comparable regulatory agencies in othercountries. The regulatory approval process for new products is lengthy andexpensive. Before we can submit an application to the FDA and comparableinternational agencies, the product candidate must undergo extensive testing,including animal studies and clinical trials that can take many years andrequire substantial expenditures. Data obtained from such testing may besusceptible to varying interpretations, which could delay, limit or prevent regulatoryapproval. In addition, changes in regulatory policy for product approvalmay cause additional costs in our efforts to secure necessary approvals.

 

Our product candidates aresubject to significant uncertainty because they are in early stages of developmentand are subject to regulatory approval. The results of preclinical and clinicaltesting of our products are uncertain and regulatory approval of our productsmay take longer or be more expensive than anticipated, which could have amaterial adverse effect on our business, financial condition and results ofoperations. We cannot predict if or when any of our products under developmentwill be commercialized, if at all.

 

*Thedevelopment of oncology related pharmaceutical products is extremely competitive,and if we fail to compete effectively, it would negatively impact our business.*

 

Competition in thedevelopment of pharmaceutical products is intense and expected to increase. Wealso believe that other medical and pharmaceutical companies will compete withus in the areas of research and development, acquisition of products andtechnology licenses, and the manufacturing and marketing of our products.Success of products in these fields will be based primarily on:

 

•                        efficacy;

•                        safety;

•                        price;

•                        breadth of approved indications; and

•                        physician, healthcare payor and patient acceptance.

 

Many of our competitors andpotential competitors, including large pharmaceutical, chemical andbiotechnology concerns and universities and other research institutions, havesubstantially greater financial, technical and human resources than we do andhave substantially greater experience in developing products, obtainingregulatory approvals and marketing and manufacturing medical products.Accordingly, these competitors may succeed in obtaining FDA approval fortheir products more rapidly than we do. In addition, other technologies orproducts may be developed that have an entirely different approach thatwould render our technology and products noncompetitive or obsolete. If we failto compete effectively, it would have a material adverse effect on ourbusiness, financial condition and results of operations.

 

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*If we failto secure adequate intellectual property protection or become involved in anintellectual property dispute, it could significantly harm our financialresults and ability to compete.*

 

Our success will depend, inpart, on our ability to obtain and defend patents and protect trade secrets. Asof September 30, 2007, we held sixteen United States patents and seven patents outside the U.S. relating toour proprietary technologies. Additional patent applications are pendingin the United States and counterpart filings have been made in Europe,Canada and key countries in Asia and Latin America. The patent position ofmedical and pharmaceutical companies is highly uncertain and involves complexlegal and factual questions. There can be no assurance that any claims whichare included in pending or future patent applications will be issued, that anyissued patents will provide us with competitive advantages or will not bechallenged by third parties, or that the existing or future patents of thirdparties will not have an adverse effect on our ability to commercialize ourproducts. Furthermore, there can be no assurance that other companies will notindependently develop similar products, duplicate any of our products or designaround patents that may be issued to us. Litigation may be necessaryto enforce any patents issued to us or to determine the scope and validity ofothers’ proprietary rights in court or administrative proceedings. Anylitigation or administrative proceeding could result in substantial costs to usand distraction of our management. An adverse ruling in any litigation oradministrative proceeding could have a material adverse effect on our business,financial condition and results of operations.

 

*If we encounter difficultiesenrolling patients in our clinical trials, our trials could be delayed orotherwise adversely affected.*

 

Clinicaltrials for our drug candidates require that we identify and enroll patientswith the disorder or condition under investigation. We may not be able toenroll a sufficient number of patients to complete our clinical trials in atimely manner.

 

Patient enrollment isaffected by factors including:

 

•                  design of the protocol;

•                  the size of the patientpopulation;

•                  eligibility criteria for thestudy in question;

•                  perceived risks and benefitsof the drug under study;

•                  Institutional ReviewBoards/Ethics Committees approvals to conduct the study;

•                  availability of competingtherapies;

•                  efforts to facilitate timelyenrollment in clinical trials;

•                  the success of our personnelin making the arrangements with potential clinical trial sites necessary forthose sites to begin enrolling patients;

•                  patient referral practicesof physicians;

•                  availability of clinicaltrial sites; and

•                  other clinical trialsseeking to enroll subjects with similar profiles.

 

Ifwe have difficulty enrolling a sufficient number of patients to conduct ourclinical trials as planned, we may need to delay or terminate ongoing orplanned clinical trials, either of which would have a negative effect on ourbusiness.

 

*We may face fluctuations inoperating results.*

 

Ouroperating results may rise or fall significantly from period to period as aresult of many factors, including:

 

•                  the amount of research anddevelopment we engage in;

•                  outcome related to strategicactivities currently being evaluated;

 

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•                  the number of productcandidates we have, their progress in research, preclinical and clinicalstudies and the costs involved in manufacturing them;

•                  our ability to enter intonew strategic relationships;

•                  our ability to maintain ourfacilities to support our operations;

•                  the costs involved inprosecuting, maintaining and enforcing patent claims;

•                  the possibility that othersmay have or obtain patent rights that are superior to ours;

•                  changes in governmentregulation;

•                  changes in the price of ourcommon stock or other variables used as a basis for valuing stock-based awards;

•                  changes in accountingpolicies or principles; and

•                  release of successfulproducts into the market by our competitors.

 

Asa result, we may experience fluctuations in our operating results from quarterto quarter and continue to generate losses. Quarterly comparisons of ourfinancial results may not necessarily be meaningful, and investors should notrely upon such results as an indication of our future performance. In addition,investors may react adversely if our reported operating results are lessfavorable than in a prior period or are less favorable than those anticipatedby investors or the financial community, which may result in a drop in themarket price of our common stock.

 

*The impact of the recall by Bristol-Myers Squibb Pharmaceuticals ofcertain batches of Taxol.*

 

In March 2007, Bristol-MyersSquibb Pharmaceuticals recalled certain batches of Taxol due to potential lackof sterility assurance. At the time of the recall, there had been no reports ofnon-sterile product and no stability failures had been detected. Among therecalled batches were those being used in the reference arm of the Phase 3TOCOSOL Paclitaxel pivotal study. Based on the available information, Sonus hasno reason to believe that the recalled batches had an adverse impact onpatients treated with those batches in the Phase 3 study.

 

The Company plans to returnall of the recalled material to its suppliers in accordance with the recallnotice. While we believe that we will receive a full refund for the returnedmaterial, there can be no assurance that we will receive that refund or that itwill be received in a timely basis.

 

**Item 6. Exhibits**

 

10.1                           Form of the Stock Option Agreement to the2007 Stock Performance Incentive Plan. (1)

 

10.2                           Form of the Restricted Stock PurchaseAgreement to the 2007 Stock Performance Incentive Plan. (1)

 

31.1                           Certificationof President and Chief Executive Officer pursuant to Rule 13a-14(a) or15d-14(a). (1)

 

31.2                           Certificationof Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a). (1)

 

32.1                           Certificationof President and Chief Executive Officer pursuant to Rule 13a-14(b) or15d-14(b). (2)

 

32.2                           Certificationof Chief Financial Officer pursuant to Rule 13a-14(b) or 15d-14(b). (2)

 

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(1)                                  Filedherewith.

(2)                                  Furnishedherewith and not “filed” for purposes of Section 18 of the Securities ExchangeAct of 1934, as amended.

 

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**SIGNATURES**

 

In accordance with therequirements of the Securities Exchange Act, the registrant caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|   | **SONUS PHARMACEUTICALS, INC.** |
|--------|---------------------------------|
|   |                            |   |
| Date:  | November 9, 2007                | By: | /s/ Alan Fuhrman |   |
|   |                            | Alan Fuhrman |
|   |                            | Senior Vice President, |
|   |                            | Chief Financial Officer |
|   |                            | (Principal Financial  Officer) |
|        |                                 |  |  |  |  |

 

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