SGXP Sgx Pharmaceuticals (MM)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number 000-51745

 

 

10505 Roselle Street

San Diego, CA 92121

(Address of principal executive offices, including zip code)

 

(858) 558-4850

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes  o      No  þ

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes  o      No  þ

 

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant computed by reference to the price at which the common stock was last sold as of the last business day of the Registrant’s most recently completed second fiscal quarter was $36,098,501. Shares of common stock held by each officer and director and by each person who owns 10 percent or more of the outstanding common stock have been excluded because these persons may be considered affiliates. The determination of affiliate status for purposes of this calculation is not necessarily a conclusive determination for other purposes.

 

As of March 14, 2008, the Registrant had 20,511,868 shares of Common Stock, $0.001 par value, issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive Proxy Statement for our 2008 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.

 

 

SGX PHARMACEUTICALS, INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007

TABLE OF CONTENTS

 

Cautionary Note Regarding Forward-Looking Statements

 

This annual report on Form 10-K contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance and are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. In some cases, you can identify forward-looking statements by terms such as “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “targets,” “seek,” or “continue,” the negative of these terms or other variations of such terms. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements are only predictions based upon assumptions made that are believed to be reasonable at the time, and are subject to risk and uncertainties. Therefore, actual events or results may differ materially and adversely from those expressed in any forward-looking statement. In evaluating these statements, you should specifically consider the risks described under the caption “Risks Factors” in Item 1A of this Form 10-K and elsewhere in this Form 10-K. These factors may cause our actual results to differ materially from any forward-looking statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

The table below summarizes the status of our clinical and preclinical development programs and our drug discovery portfolio:

 

 

 

 

MET Development Program

 

Our MET program is focused on the development of compounds that inhibit both wild-type and activated mutant forms of the protein target, MET. MET is a cellular signaling enzyme known as a receptor tyrosine kinase, which has been implicated in a wide range of cancers. Extensive laboratory studies of MET have yielded a growing body of evidence suggesting that uncontrolled stimulation/activation of MET plays a key role in various effects associated with cancer, including uncontrolled cellular growth and replication, increased cell movement and invasion, and an increased ability of cancer cells to metastasize, or spread beyond the organ of origin. Other observations have implicated MET in increased angiogenesis, a process by which tumors recruit new blood vessels to supply their increasing nutritional needs. Studies of tumors in humans have associated MET with more aggressive forms of cancer, such as lung and renal cancers, and activating MET mutations have been observed in a wide range of cancer types.

 

Conservative estimates based on scientific publications suggest that in the US more than 130,000 new cancers diagnosed during 2007 have the potential to respond to therapy with a MET inhibitor. Such cancers exhibit unusually high levels of MET activation or signaling and are, therefore, thought to be dependent on MET for their uncontrolled growth and proliferation. MET inhibitors have potential applications in both single-agent therapy and in combination with other anti-cancer agents. In some of the estimated 130,000 cancer patients newly diagnosed with MET-dependent tumors in 2007, our current scientific understanding suggests that single-agent treatment with a MET inhibitor may prove sufficient to control tumor growth (e.g., those patients with hereditary papillary renal cell carcinoma). In the majority of cases, however, growth of the cancer is thought to be driven by multiple DNA abnormalities and the appropriate role for a MET inhibitor is more likely to be in combination with other anti-cancer agents. Combination use of MET inhibitors may prove to be particularly significant in the setting of emerging resistance to standard-of-care drug regimens. Two examples provide evidence for this opportunity. First, a recently published scientific study demonstrated that non-small cell lung (NSCL) cancer cells resistant to treatment with an epidermal growth factor receptor (EGFR) inhibitor displayed MET gene amplification (i.e., an increased number of copies of the MET gene). Inhibition of MET activity in these cells in vitro restored their sensitivity to the EGFR inhibitor, suggesting that a MET inhibitor could be combined with either Tarceva ^® (erlotinib) or Iressa ^® (gefitinib) for treatment of drug resistant NSCL cancer. Second, increased MET protein signaling has also been observed in pancreatic cancer cells resistant to gemcitabine. Both EGFR resistance and gemcitabine resistance are accompanied by changes in the behavior of tumor cells that increase the likelihood of cell movement and cell invasion of surrounding tissues, both of which are thought to be controlled by MET.

We have identified a number of low molecular weight, selective MET inhibitors, including SGX523 and SGX126, which have demonstrated potency in cell based assays, oral bioavailability in multiple animal species and potent anti-tumor effects in multiple in vivo mouse models of human cancer.

 

SGX523

 

SGX523 is an internally developed, small molecule inhibitor of MET. In January 2008, we initiated two parallel, multi-center Phase I clinical trials to establish the safety and tolerability of an oral, twice daily dosing of SGX523 in patients with solid tumor cancers. The first trial has been designed to examine twice daily, oral dosing on a continuous 28-day cycle and the second trial has been designed to examine interrupted dosing (a repeating 21 day cycle of 14 days on therapy followed by 7 days off).

 

In both trials we have observed dose limiting toxicity (DLT) earlier than anticipated. The toxicity is of a nature that was not anticipated based on the preclinical profile of SGX523. In the continuous dosing trial, patients are continuing to be treated at a lower dose level, and we are evaluating the safety and efficacy of treatment at that dose level. The interrupted dosing trial started at a higher dose than the continuous dosing trial. No patients are currently receiving treatment in the interrupted dosing trial.

 

With this early identification of DLT, we are reassessing the clinical profile of SGX523 and its future development path is uncertain. We may consider exploring alternate dosing levels and/or schedules in both trials to seek to identify a safe and efficacious dose.

 

SGX126

 

In November 2007, we announced the nomination of a second MET development candidate, SGX126, for IND-enabling preclinical development, to broaden our MET program. SGX126 is an internally developed, orally bioavailable small molecule inhibitor of MET, with potent in vitro and in vivo activity. Pending successful completion of IND-enabling studies, we are targeting filing an IND for SGX126 in the fourth quarter of 2008. We are assessing whether to conduct any supplemental preclinical studies of SGX126 in light of the recent developments in our SGX523 clinical studies.

 

BCR-ABL Development Program

 

Our BCR-ABL development program is focused on a compound that inhibits both wild-type and drug-resistant mutant forms of the BCR-ABL kinase, the target for second-line treatment of Chronic Myelogenous Leukemia.

 

Chronic Myelogenous Leukemia (CML)

 

CML is a bone marrow cancer characterized by rapid and abnormal growth of white blood cells. The disease has an incidence of between 1 and 2 new patients per 100,000 individuals in the general population. In the US, this represents approximately 4,600 new patients a year. CML accounts for approximately 20 percent of adult leukemias in the US. All patients with CML possess an abnormal chromosome, known as the Philadelphia chromosome, in their leukemia cells.

 

Prior to the introduction of Gleevec ^® (imatinib mesylate), a large majority of CML patients failed other treatments and inevitably succumbed to their disease. In 2001, Gleevec was approved by the FDA and has become the standard of care for patients with CML.

 

Gleevec works by targeting leukemic cells and inhibiting the activity of the BCR-ABL tyrosine kinase protein, the enzyme responsible for their uncontrolled growth. Data from a five-year clinical study of Gleevec published in the New England Journal of Medicine documents the life-saving impact of this therapy for CML patients. Specifically, this study demonstrated that following five years of continuous daily therapy, 83% of patients remained in clinical remission with an overall survival rate of 89%. This level of efficacy contributes to the clinical and commercial success of Gleevec, which had sales of approximately $3.1 billion in 2007, and the market is anticipated to continue to increase. Not all patients will, however, benefit indefinitely from single agent treatment with Gleevec. Over time, drug resistance emerges, with approximately 17% of patients relapsing within five years, and 4% of patients intolerant of Gleevec or discontinuing therapy due to adverse events. The New England Journal

of Medicine publication further documented that 31% of patients receiving Gleevec failed to eliminate leukemic cells from their bone marrow within 12 months of commencing therapy. These patients are at significantly higher risk of relapse versus those patients who do eliminate leukemic cells from the bone marrow in this time. In approximately two-thirds of cases, patient relapse has been linked to the emergence of mutant forms of BCR-ABL that are not inhibited by Gleevec. A large number of drug-resistant BCR-ABL mutants have been described, and the single mutant that has proved the most challenging is known as the T315I mutant. None of the currently approved BCR-ABL inhibitors, including Gleevec and Tasigna ^® (nilotinib), both marketed by Novartis Pharmaceuticals Corporation, and Sprycel ^® (dasatinib), marketed by Bristol Meyers Squibb Corporation, inhibit the T315I mutant form of BCR-ABL. Although there are a number of compounds being developed to address this mutant, to our knowledge there is no oral drug presently on the market that inhibits the T315I mutant form of BCR-ABL.

 

SGX393 — Relapsed/Refractory CML

 

The goal of this program is to develop an oral therapy for the second-line treatment of CML, that is patients that relapse while on Gleevec and those intolerant of Gleevec. Our development candidate, SGX393, is currently in IND-enabling preclinical development. SGX393 is an internally developed, potent, selective, orally bioavailable small molecule that inhibits wild-type BCR-ABL and many drug-resistant mutant forms of BCR-ABL, including the T315I mutant. Pending successful completion of IND-enabling activities, including formulation studies, we are targeting filing an IND application for SGX393 in the second quarter of 2008.

 

At present, we plan to conduct a Phase I dose escalation trial in relapsed/refractory CML patients to assess safety and tolerability and establish the maximum tolerated dose (MTD) or biologically effective dose (BED; i.e., the dose at which BCR-ABL enzyme activity is reduced by more than 90%) followed by administration of SGX393 to a cohort of pre-qualified CML patients possessing the T315I mutation. Subsequent clinical trials will be designed once the results of the initial trial are available, but they likely would involve pre-qualified CML patients bearing the T315I mutation, other relapsed/refractory CML patients and those intolerant of Gleevec.

 

SGX393 initially fell within the purview of our collaboration with the Novartis Institute for Biomedical Research (Novartis). We obtained the right to further develop and commercialize SGX393 following an amendment to our agreement with Novartis that was signed in September 2007, and it is subject to a reacquisition right of Novartis which may be exercisable at a future date.

 

Oncology Drug Discovery Portfolio

 

The SGX drug discovery technologies are being applied to a broad portfolio of oncology targets, including JAK2, RAS, and three undisclosed tyrosine kinases. During 2008, our objective is to nominate two new development candidates, which could lead to IND submission in 2009.

 

BCR-ABL

 

We have been collaborating with Novartis under a license and collaboration agreement that we entered into in March 2006, to discover, develop and commercialize oral BCR-ABL inhibitors for the front-line treatment of CML. The research term of this agreement concluded in late March 2008. Novartis remains responsible for the further preclinical and clinical development of the BCR-ABL inhibitors identified under the collaboration, other than SGX393. A number of compounds discovered within the collaboration are now undergoing further evaluation at Novartis. At this time, an IND for a drug candidate under the collaboration is not anticipated in 2008.

 

JAK2

 

JAK2 is a non-receptor tyrosine kinase involved in cytokine-induced signaling and growth regulation, survival, and differentiation of cells. Enhanced JAK2 activation has been implicated in various blood disorders. A particular JAK2 mutation, V617F, has been strongly correlated with a group of blood diseases known as myeloproliferative disorders (MPDs), such as Polycythemia Vera, Essential Thrombocythemia, and Chronic Idiopathic Myelofibrosis. We have identified JAK2 inhibitors that have good potency against both wild-type and mutant JAK2 in cell-based assays. Oral bioavailability and selectivity versus JAK3 have also been demonstrated, and current studies are aimed at optimizing the potency and drug-like properties of these compounds. This program is in the lead optimization

stage. Lead optimization is the stage at which lead compounds are further modified to improve their potency, specificity, in vivo efficacy and safety.

 

RAS

 

RAS is a protein that regulates cell growth. RAS activating mutations, which result in a cancer causing form of RAS, have been found in 20-30% of all cancers. As a result, RAS has been implicated in a large number of diseases. However, RAS has proven a challenging target for the pharmaceutical industry and thus far, to our knowledge, there are currently no drugs on the market that directly target RAS. Applying our FAST platform, we have taken a novel approach to the modulation of RAS activity and we have identified inhibitors that have demonstrated cell-based activity. Our RAS program is currently in the lead identification stage. Lead identification is the stage at which compounds are identified and further characterized in preparation for the lead optimization stage.

 

Additional Drug Discovery Targets

 

In addition to BCR-ABL, JAK2 and RAS, we are pursuing lead identification/lead optimization for three additional undisclosed oncology targets, all of which are tyrosine kinases. Like MET, BCR-ABL, JAK2, and RAS, these targets have been chosen on the basis of their potential roles in human cancers. In each case, we believe there is strong scientific evidence that DNA abnormalities activate the target protein and in turn contribute to uncontrolled cellular growth and replication, both of which are associated with cancer. Our structural biology technologies are used to support all aspects of SGX drug discovery, including assessment of target suitabilitiy, X-ray crystallographic screening, lead identification, and lead optimization.

 

Our Drug Discovery Platform

 

FAST is our proprietary approach to drug discovery that uses X-ray crystallography and complementary biophysical and biochemical methods, combined with medicinal and computational chemistry for the rapid discovery and optimization of novel, potent and selective small molecule inhibitors of drug targets with good drug-like properties. Through the application of FAST, we are building a pipeline of oncology drug candidates. FAST addresses many of the limitations of traditional approaches to identify and optimize lead compounds, making it an attractive technology for a broad range of drug discovery targets, particularly those that have not yielded promising leads from high-throughput screening. Unlike traditional lead discovery approaches, which require ultra high-throughput screening of very large numbers of compounds, FAST focuses on a much smaller number of diverse, low molecular weight, water-soluble fragments, or scaffolds, as starting points for optimization. Rapid synthesis and optimization using protein structure-guided design enables the delivery of novel, potent and selective modulators of drug targets.

 

FAST encompasses the integration of the following technologies:

 

 

Supporting FAST is an extensive X-ray crystallography platform. We have invested significant resources in the development and optimization of the technologies required to produce large numbers of protein variants and to evaluate their ability to provide high quality protein crystals. We have developed customized, robotic technologies for setup, storage, retrieval and imaging of protein crystallization experiments and our current instrumentation supports in excess of 40,000 crystallization experiments per day. We generate protein structures through our

proprietary beamline facility, housed at the Advanced Photon Source at the Argonne National Laboratory, a national synchrotron-radiation facility funded by the U.S. Department of Energy, Office of Science, and Office of Basic Energy Sciences, located in Argonne, Illinois. This facility produces an extremely intense, highly focused X-ray beam to generate high-resolution data from approximately 50 crystals per day. This platform allows very rapid screening of our scaffold library, typically within 3-5 days.

 

Collaborations, Commercial Agreements and Grants

 

Since our inception, we have entered into multiple revenue-generating collaborations, commercial agreements and grants based upon FAST and related technologies with pharmaceutical and biotechnology companies, as well as government and other agencies. We generated aggregate revenues from collaborations, commercial agreements and grants of approximately $84.2 million for the three years of 2007, 2006, and 2005. Our active agreements include:

 

 

License and Collaboration Agreement

 

Novartis Institutes for Biomedical Research, Inc.

 

In March 2006, we entered into a License and Collaboration Agreement with Novartis Institutes for Biomedical Research, Inc., (“Novartis”) focused on the development and commercialization of BCR-ABL inhibitors for the treatment of CML. Under the agreement, the parties are collaborating to develop one or more BCR-ABL inhibitors and Novartis will have exclusive worldwide rights to such compounds, subject to our commercialization option in the United States and Canada. Pursuant to an amendment to our agreement with Novartis signed in September 2007, we have the right, but not the obligation, to develop and commercialize SGX393 outside of the collaboration, subject to a reacquisition right of Novartis that may be exercisable at a future date. We have also granted Novartis rights to include certain compounds that we do not pursue under the collaboration in Novartis’ screening library and we will be entitled to receive royalties on sales of products based on those compounds. The research term under this agreement concluded in late March 2008 and Novartis remains responsible for further development of BCR-ABL inhibitors identified pursuant to the collaboration, other than SGX393.

 

Under the terms of the agreement, we received $25.0 million of upfront payments, including $5.0 million for the purchase by Novartis Pharma AG of shares of our common stock. We were also entitled to receive research funding over the first two years of the collaboration of $9.1 million. With payments for achievement of specified development, regulatory and commercial milestones, including $9.5 million for events up to and including commencement of the first Phase I clinical trial, total payments to us could exceed $515 million. To date, under the collaboration, we have not received any milestone payments. At this time, an IND for a drug candidate under the collaboration is not anticipated in 2008.

 

Novartis is responsible for funding 100% of the development costs of product candidates from the collaboration, other than SGX393. The research and development activities of the parties are overseen by committees with equal representation of the parties, with Novartis having the right to make the final decision on certain matters. We are also eligible to receive royalties based on net sales. In addition, we retain an option to co-commercialize in the

United States and Canada oncology products developed under the agreement through a sales force trained and funded by Novartis.

 

While the research term of the agreement ended in late March 2008, the agreement will continue until the expiration of all of Novartis’ royalty payment obligations, unless the agreement is terminated earlier by either party. Novartis and we each have the right to terminate the agreement early if the other party commits an uncured material breach of its obligations. If Novartis terminates the agreement for material breach by us, Novartis’ licenses under the agreement will continue subject to certain milestone and royalty payment obligations. If we terminate the agreement for material breach by Novartis, all rights to compounds developed under the collaboration will revert to us. Further, Novartis may terminate the agreement without cause if it reasonably determines that further development of compounds or products from the collaboration is not viable, in which event all rights to the compounds and products revert to us. In the event of a change in control of our company, in certain circumstances Novartis may terminate only the joint committees and co-commercialization option, with all other provisions of the agreement remaining in effect, including Novartis’ licenses and its obligations to make milestone and royalty payments.

 

Cystic Fibrosis Foundation Therapeutics, Inc.

 

In July 2005, we entered into a drug discovery collaboration agreement with Cystic Fibrosis Foundation Therapeutics, Inc., or CFFT, the drug discovery and development arm of the Cystic Fibrosis Foundation. Under the collaboration, we are continuing our structural biology work and have employed our proprietary FAST lead generation technology with the objective of generating novel small molecule therapies that function as “correctors” of the F508 deletion mutation found in the cystic fibrosis transmembrane conductance regulator, or CFTR. No such correctors have yet been identified. The F508 deletion mutation is the most commonly observed mutation in patients with cystic fibrosis. Individuals with the mutation fail to transport the CFTR protein to the cell surface, resulting in impaired function of the lung epithelium. Correctors of the mutant protein are expected to increase the amount of the mutant protein that is transported to the cell surface, resulting in more rapid clearing of lung infections and improved lung function. The research term of this collaboration agreement continues until July 2008. Our drug discovery agreement with CFFT may be terminated earlier by either party in the event of a material breach by the other party, subject to prior notice and the opportunity to cure. In addition, CFFT has the right to terminate the drug discovery agreement at any time upon 60 days notice.

 

NIH Cooperative Agreement Award

 

In July 2005, we received a $48.5 million National Institutes of Health Cooperative Agreement Award from the National Institute of General Medical Sciences, or NIGMS. The award is part of the NIH Protein Structure Initiative, which aims to facilitate discovery of three dimensional structures of proteins to help reveal their role in disease and aid in the design of new medicines. The award provides five years of funding for a consortium administered by us. We anticipate retaining approximately 50% of the funding under the award, with the remainder being distributed to academic collaborators.

 

Eli Lilly & Company

 

In April 2003, we entered into a research and technology agreement with Eli Lilly, which was extended in April 2005. Within this agreement, we apply our target-to-structure technology to key Eli Lilly drug targets to determine their three-dimensional structures. Our researchers subsequently generate data on Eli Lilly compounds that bind to the drug targets, providing input for their lead generation and optimization efforts. In parallel with the first two years of research under the agreement, we conducted a comprehensive program of technology transfer involving installation of components of our technology in a high-throughput structural biology facility for Eli Lilly, which includes modular automation systems and process technology we developed for protein engineering, crystallization and structure determination.

 

In December 2007, the research term of this agreement was extended until June 2010. The general terms of this commercial agreement continue until the later of the expiration of the last to expire of the patent rights covering technology developed under the agreement or April 2018, unless the agreement is earlier terminated. Either party may terminate the agreement in the event of material breach by the other party, subject to prior notice and the

opportunity to cure. In addition, Eli Lilly may terminate the agreement if certain of our key employees leave our employment and significantly curtail participation in the project, or in the event we are acquired by one of the top 25 pharmaceutical companies ranked by worldwide sales.

 

In December 2003, we also expanded our research and technology agreement with Eli Lilly to provide Eli Lilly with long-term access to our beamline facility at the Advanced Photon Source in Argonne, Illinois, to support Eli Lilly drug discovery programs. Under the terms of our beamline services agreement with Eli Lilly, we generate crystal structure data on Eli Lilly drug targets and compounds in exchange for upfront access fees and maintenance fees paid by Eli Lilly. Eli Lilly also has the option to extend the term of its access to our beamline facility in the future for additional payments. The term of this beamline agreement continues until January 2012, unless Eli Lilly exercises its option to extend the term of its access to our beamline facility or the agreement is earlier terminated. Either party may terminate the agreement in the event of a material breach by the other party, subject to prior notice and the opportunity to cure. In addition, Eli Lilly may terminate the agreement at any time, subject to prior notice.

 

Our Strategy

 

Our goal is to create a leading biotechnology company that discovers, develops and commercializes novel cancer drugs. Key elements of our strategy are to:

 

 

Intellectual Property

 

We seek to protect our novel lead compounds, and proprietary technologies by filing appropriate patent applications. We have over 100 U.S. and foreign pending patent applications covering compositions of matter, drug discovery methods, protein structures and elements of our high-throughput structure determination platform. We intend to continue to file patent applications on lead series and drug discovery methods, to support our drug discovery platform. We currently have two issued U.S. patents directed to aspects of our high-throughput structure determination platform.

There can be no assurance that any of our patent applications will issue in any jurisdiction. Moreover, we cannot predict the breadth of claims that may be allowed or the actual enforceable scope of our patents. In the United States, we may lose our patent rights if we were not the first to invent the subject matter covered by each of our issued patents or pending patent applications. Outside of the United States we will not be able to obtain patent rights if we were not the first to file patent applications on the subject matter covered in our pending patent applications. We cannot be certain that our patents will be found valid and enforceable, or that we will not be found to infringe issued patent claims of any third party or that third parties will be found to infringe any of our issued patent claims.

 

Although we have taken steps to protect our trade secrets and unpatented know-how, including entering into confidentiality agreements with third parties, and confidential information and inventions agreements with employees, consultants and advisors, third parties may still obtain this information or we may be unable to protect our rights. Enforcing a claim that a third party illegally obtained and is using our trade secrets or unpatented know-how is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States may be less willing to protect trade secret information. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how, and we would not be able to prevent their use.

 

Third Party Intellectual Property

 

Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the field of small molecule kinase inhibitors and fields in which we and our collaborators are developing products. Because patent applications are not published until 18 months after the first filing in the United States and can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates or proprietary technologies may infringe.

 

We may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that our product candidates and/or proprietary technologies infringe their intellectual property rights. If one of these patents was found to cover our product candidates, proprietary technologies or their uses, we or our collaborators could be required to pay damages and could be restricted from commercializing our product candidates or using our proprietary technologies unless we or they obtain a license to the patent. A license may not be available to us or our collaborators on acceptable terms, if at all. In addition, during litigation, the patent holder could obtain a preliminary injunction or other equitable right, which could prohibit us from making, using or selling our products, technologies or methods.

 

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and biopharmaceutical industries generally. If a third party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including but not limited to:

 

 

We have not conducted an extensive search of patents issued to third parties, and no assurance can be given that such patents do not exist, have not been filed, or could not be filed or issued, which contain claims covering our product candidates. Because of the number of patents issued and patent applications filed in our technical areas or

fields, we believe there is a significant risk that third parties may allege they have patent rights encompassing our product candidates.

 

Sales and Marketing

 

We currently do not have sales and marketing capabilities and we have no plans to develop such capabilities in the near future. If we do advance any of our product candidates through clinical development, we will need to build a sales and marketing infrastructure, either on our own or in collaboration with other organizations. Under our license and collaboration agreement with Novartis, we retain an option to co-commercialize in the United States and Canada oncology products developed under the agreement through a sales force trained and funded by Novartis. For other programs, we may pursue strategic collaborations, as appropriate, to commercialize our product candidates on a world-wide basis.

 

Competition

 

We operate in highly competitive segments of the biotechnology and biopharmaceutical markets. We face competition from many different sources, including commercial pharmaceutical and biotechnology enterprises, academic institutions, government agencies, and private and public research institutions. There is also intense competition for fragment-based lead discovery collaborations. Many of our competitors have significantly greater financial, product development, manufacturing and marketing resources than us. Large pharmaceutical companies have extensive experience in clinical testing and obtaining regulatory approval for drugs. These companies also have significantly greater research capabilities than us. In addition, many universities and private and public research institutes are active in cancer research, some in direct competition with us. We also compete with these organizations to recruit scientists and clinical development personnel. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies.

 

Each cancer indication for which we are developing products has a number of established therapies with which our candidates will compete. Most major pharmaceutical companies and many biotechnology companies are aggressively pursuing new cancer development programs, including both therapies with traditional, as well as novel, mechanisms of action.

 

We are aware of competitive products and technologies in each of the markets we target. The competitive products include approved and marketed products as well as products in development.

 

We expect that any MET inhibitor that we may potentially develop for treatment of cancers, to compete with: XL880 and XL184, under development by Exelixis, Inc.; ARQ197, under development by Arqule, Inc.; PF02341066, under development by Pfizer, Inc.; MP470, under development by SuperGen, Inc.; MGCD265, under development by Methylgene Inc.; and inhibitors under development by Merck & Co. Other potential competing products are in clinical trials and preclinical development.

 

We expect that any BCR-ABL inhibitor that we may potentially develop for treatment of CML to compete with: Gleevec ^® (imatinib), marketed by Novartis, Inc.; Tasigna ^® (nilotinib), marketed by Novartis, Inc.; Sprycel ^® (dasatinib), marketed by Bristol Myers Squibb, Inc.; MK0457, under development by Merck and Co.; SKI-606, under development by Wyeth, Inc.; INNO-406, under development by Innovive Pharmaceuticals, Inc.; homoharringtonine, under development by ChemGenex, Inc.; KW-2449, under development by Kyowa Pharma, Inc.; XL228, under development by Exelixis, Inc.; and AP24534, under development by ARIAD Pharmaceuticals, Inc. Other potential competing products are in clinical trials and preclinical development.

 

In each of our development programs addressing indications for which there are therapies available, we intend to complete clinical trials designed to evaluate the potential advantages of our drug candidates as compared to or in conjunction with the current standard of care. Key differentiating elements affecting the success of all of our drug candidates are likely to be their efficacy, safety and side-effect profile compared to commonly used therapies.

 

Significant competitors in the area of fragment-based drug discovery include Astex Therapeutics Limited, Plexxikon Inc., Evotec AG, Vernalis Plc., Sunesis Pharmaceuticals, Inc., and Active Site, Inc. In addition, many large pharmaceutical companies are exploring the internal development of fragment-based drug discovery methods.

Government Regulation and Product Approvals

 

The clinical development, manufacturing and future marketing of our products are subject to regulation by various authorities in the United States, the E.U., and other countries. The Federal Food, Drug, and Cosmetic Act, or FD&C Act, and the Public Health Service Act in the United States, and numerous directives, regulations, local laws, and guidelines in the E.U. govern the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of pharmaceutical products. Product development and approval within these regulatory frameworks takes a number of years, and involves the expenditure of substantial resources.

 

Regulatory approval to conduct clinical trials will be required in any territories in which we, or our licensors, seek to test our development product candidates. Prior to human testing, such approval requires evaluation of product candidate quality as well as animal data relating to safety and, where relevant, efficacy. In general, new chemical entities are tested in animals to determine whether the product candidate is reasonably safe for initial human testing. Clinical trials for new products are typically conducted in three sequential phases that may overlap. Within oncology, Phase I trials typically involve the initial introduction of the pharmaceutical into patients with advanced malignancy and the emphasis is on testing for safety, dosage tolerance, metabolism, distribution, excretion and clinical pharmacology. Phase II trials involve the evaluation of effectiveness of the drug for a particular indication in patients with the disease under study, and to determine the common short-term side effects and risks associated with the drug. Phase II trials are typically closely monitored and conducted in a relatively small number of patients, usually involving no more than fifty to one hundred subjects. Phase III trials are generally expanded, well-controlled clinical trials. They are performed after preliminary evidence suggesting effectiveness of the drug has been obtained, and are intended to gather the additional information about safety and effectiveness needed to evaluate the overall risk-benefit relationship of the drug and to provide an adequate basis for product labeling.

 

In the United States an IND must be submitted to the FDA prior to the initiation of human studies. Absent an objection from the FDA, the application will become effective 30 days following receipt by the FDA. Prior regulatory approval to initiate human studies is also required in member states of the E.U. Additional requirements designed to protect the rights of participating patients also exist. Approval by an appropriately constituted Institutional Review Boards (IRB) in the United States or an equivalent Ethics Committee in other territories (EC) is also required prior to the commencement of any clinical trial. The ongoing conduct of the study is monitored on a periodic basis by the sponsor, institutional committees, as well as regulatory authorities. The submission of relevant safety data on both an episodic and periodic basis to such parties is required, as well as well-defined processes to support this activity. Authorities could demand discontinuation of studies at any time if significant safety issues arise. In all cases, it is our responsibility to ensure that we conduct our business in accordance with the regulations of each relevant territory.

 

In order to gain marketing approval, we must submit a dossier to the relevant authority for review, which is known in the United States as a new drug application (NDA) and in the E.U. as a marketing authorization application (MAA). The format of a marketing application has recently been standardized and includes information specified by each authority, and requires information on the quality of the chemistry, manufacturing and pharmaceutical aspects of the product, as well as non-clinical and clinical data. Failure to adequately demonstrate the quality, safety and efficacy of a therapeutic drug under development would delay or prevent regulatory approval of the product. There can be no assurance that if clinical trials are completed, either we or our collaborative partners will submit applications for required authorizations to manufacture or market potential products, including a marketing authorization application or an NDA, or that any such application will be reviewed and approved by appropriate regulatory authorities in a timely manner, if at all.

 

In general, the competent regulatory authority may approve a product if the data is considered to be of a high quality and supportive of the indication requested. Quality of data is usually determined through regulatory audits of the various components of the dossier, and may include site visits to clinical trial sites and manufacturing facilities. In some circumstances, additional data or clinical trials may be requested during the review and may delay marketing approval and involve unbudgeted costs. Regulatory authorities may find data to be of an unacceptable quality or not supportive of the indication sought; in these circumstances, regulatory approval to market products may be denied or deferred.

As a condition of marketing approval, competent regulatory authorities also require post-marketing surveillance to monitor adverse effects, and may also request other additional studies as deemed appropriate. After approval for the initial indication, further clinical studies are usually necessary to gain approval for additional indications. The terms of any approval, including labeling content, may be more restrictive than expected and could affect product marketability.

 

The FDA has implemented special programs to facilitate the development and to expedite the review of drugs intended to treat serious and life-threatening conditions so that this type of product can be approved and reach the market quickly. A drug that demonstrates a meaningful therapeutic advantage over existing treatments or shows the potential to address an unmet medical need in a serious or life-threatening condition may be considered for expedited approval. In some cases, where approval is granted on the basis of a surrogate measure of benefit, further clinical trials (as post-approval commitments) are generally required to further define the safety and efficacy of the product. If such clinical trials fail to confirm the early benefits seen during the accelerated approval process, the FDA may withdraw approval. A similar set of mechanisms exist within the E.U.

 

The United States and the E.U. may grant orphan drug designation to drugs intended to treat a “rare disease or condition,” which, in the United States, is generally a disease or condition that affects fewer than 200,000 individuals nationwide. In the E.U., orphan drug designation can be granted if:

 

 

The designation of an orphan drug status provides the company with a limited period of market exclusivity for the indication of interest (seven years in the United States, and ten years in the E.U.). Orphan drug designation does not prevent competitors from developing or marketing different drugs for an orphan indication or the same drug for a different indication.

 

Throughout the period of active marketing of any medicinal product, the company retains the responsibility to periodically and systematically review the safety profile of the marketed product. This requires an active pharmacovigilance program, and the company is required to report certain adverse events, safety trends, relevant literature reports and similar data to the competent regulatory authority. Similarly, the advertising and promotion of pharmaceutical products is also closely regulated and monitored by regulatory agencies. Moreover, quality control and manufacturing procedures must continue to conform to current Good Manufacturing Practices (cGMPs) after approval, and the FDA periodically inspects manufacturing facilities to assess cGMP compliance. Accordingly, manufacturers must continue to expend resources on production, quality control and quality assurance to maintain compliance with GMP and other regulatory requirements.

 

Failure to comply with applicable regulatory requirements after obtaining regulatory approval can, among other things, result in suspension of regulatory approval, and possible civil and criminal sanctions. Renewals of the license in Europe may require additional data, which may result in an approval being withdrawn. In the United States and the E.U., regulators have the authority to revoke, suspend or withdraw approvals of previously approved products, to prevent companies and individuals from participating in the drug-approval process, to request recalls, to seize violative products, to obtain injunctions to close manufacturing plants not operating in conformity with regulatory requirements and to stop shipments of violative products. In addition, changes in regulation could harm our financial condition and results of operation.

Employees

 

As of December 31, 2007, we had 123 full-time employees, including 44 who hold Ph.D. and/or M.D. degrees. We had 105 full-time employees engaged in research and development, and our remaining employees are management or administrative staff. None of our employees are subject to a collective bargaining agreement. We believe that we have good relations with our employees.

 

testing. For example, in our SGX523 clinical trials we observed toxicity in patients that was not anticipated from the preclinical studies. Companies frequently suffer significant setbacks in clinical trials, even after preclinical and earlier clinical trials have shown promising results. If negative preclinical results are seen in one compound from a particular chemical series, there may be an increased likelihood that additional compounds from that series will demonstrate the same or similar negative results. There is typically an extremely high rate of attrition from the failure of drug candidates proceeding through clinical trials.

 

Since SGX523 has demonstrated dose limiting toxicities at lower doses than anticipated, its future clinical development is uncertain. If any product candidate fails to demonstrate sufficient safety and efficacy in any clinical trial we are able to undertake, we would experience potentially significant delays in, or be required to abandon, development of that product candidate which may cause our stock price to decline and may materially and adversely affect our business.

 

Part of our strategy is to select drug discovery and development targets for which there is strong scientific evidence that DNA abnormalities activate the target protein and to design and execute initial clinical trials involving patients who are selected on the basis of strong scientific evidence of the requisite activating DNA abnormality. Our goal from this strategy is to potentially decrease the time required to conduct the clinical trial, reduce the number of patients enrolled in the clinical trial, and reduce the cost of the clinical trial as compared to conventional more inclusive large-scale clinical trials. However, there is no guarantee that this strategy will be successful and that we will be able to decrease the time required to conduct clinical trials or reduce the number of patients or costs of such trials.

 

Delays in the commencement or completion of clinical testing could result in increased costs to us and delay our ability to generate significant revenues.

 

Delays in the commencement or completion of clinical testing of SGX523 or any other product candidate we advance into clinical studies could significantly impact our product development costs and delay our ability to generate significant revenues. While the Phase 1 clinical trials for SGX523 commenced on schedule, we have experienced a setback in the clinical trials and we do not know whether they will be completed on schedule, or at all, or if any other clinical trials that we may plan in the future will begin on time or be completed on schedule, if at all. The commencement of clinical trials can be delayed for a variety of reasons, including delays in:

 

 

In addition, once a clinical trial has begun, patient recruitment and enrollment may be slower than we anticipate for a number of reasons including unexpected safety issues or patient availability. For instance, for SGX393 or any other BCR-ABL product candidate that may be selected for clinical development, we may have difficulty in recruiting a sufficient number of patients on an acceptable timeline due to the competing product candidates in clinical development and the relatively small number of patients available in the initial indication which we would expect to target. Patient enrollment may also slow as a result of safety issues that emerge during the trial, the relatively small number of patients and the significant health issues of patients suffering from the indication we are targeting. Further a clinical trial may be suspended or terminated by us, our data and safety monitoring board, our collaborators, the FDA or other regulatory authorities due to a number of factors, including:

 

 

 

If we experience delays in the completion of, or termination of, any clinical trial of SGX523, SGX393, or any other product candidate we advance into clinical trials, the commercial prospects for product candidates we may develop will be harmed, and our ability to generate product revenues from any product candidate we may develop will be delayed. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval of a product candidate. Even if we are able to ultimately commercialize product candidates, other therapies for the same indications may have been introduced to the market during the period we have been delayed and such therapies may have established a competitive advantage over our products.

 

Any product candidate we advance into clinical trials may cause undesirable side effects that could delay or prevent its regulatory approval or commercialization.

 

Undesirable side effects caused by SGX523 such as those we have observed in our Phase 1 clinical trials or any other product candidate we advance into clinical trials could interrupt, delay or halt clinical trials and could result in the denial of regulatory approval by the FDA or other regulatory authorities for any or all targeted indications. This, in turn, could inhibit or prevent us from partnering or commercializing SGX523 or any other product candidates we advance into clinical trials and our business would be materially adversely affected. In addition, if any product candidate receives marketing approval and we or others later identify undesirable side effects caused by the product:

 

 

Any one or a combination of these events could prevent us from achieving or maintaining market acceptance of the affected product or could substantially increase the costs and expenses of commercializing the product, which in turn could delay or prevent us from generating significant revenues from the sale of the product.

 

We have limited manufacturing experience. We primarily rely on third parties to provide sufficient quantities of our product candidates to conduct preclinical and clinical studies. We have no control over our manufacturers’ and suppliers’ compliance with manufacturing regulations, and their failure to comply could result in an interruption in the supply of our product candidates.

 

To date, our product candidates have been manufactured in relatively small quantities for preclinical and clinical trials. We have no experience in manufacturing any of our product candidates and have contracted with third party manufacturers to provide material for preclinical studies and clinical trials and to assist in the development and optimization of our manufacturing processes and methods. We currently rely on a single manufacturer for SGX523 and SGX126 and another single manufacturer for SGX393. Our ability to conduct clinical trials and commercialize our product candidates will depend on the ability of such third parties to manufacture our product candidates on the timeline we have set and in accordance with cGMP and other regulatory requirements, and for clinical studies beyond the Phase 1 studies, to manufacture on a large scale and at a competitive cost. Significant scale-up of manufacturing which will be required for large scale clinical studies may require additional validation studies, which the FDA must review and approve. If we are not able to obtain contract cGMP manufacturing on commercially reasonable terms, obtain or develop the necessary materials and technologies for manufacturing, or obtain intellectual property rights necessary for manufacturing, we may not be able to conduct or complete clinical trials or commercialize our product candidates. There can be no assurance that we will be able to obtain such requisite terms, materials, technologies and intellectual property necessary to successfully manufacture our product candidates for clinical trials or commercialization. Our product candidates require precise, high-quality

manufacturing. The failure to achieve and maintain these high manufacturing standards, including the incidence of manufacturing errors or the failure to maintain consistent standards across different batches, could result in delays in commencement of clinical studies, patient injury or death, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously hurt our business. For SGX393 we have not yet determined the appropriate formulation for clinical studies and there is no guarantee that we will successfully determine an appropriate formulation to move the product candidate into clinical studies.

 

The facilities used by our contract manufacturers must undergo inspections by the FDA for compliance with cGMP regulations before our product candidates produced there can receive marketing approval. If these facilities do not receive a satisfactory cGMP inspection result in connection with the manufacture of our product candidates, we may need to conduct additional validation studies, or find alternative manufacturing facilities, either of which would result in significant cost to us as well as a delay of up to several years in obtaining approval for any affected product candidate. In addition, after approval of a product candidate for commercial use our contract manufacturers, and any alternative contract manufacturer we may utilize, will be subject to ongoing periodic inspection by the FDA and corresponding state and foreign agencies for compliance with cGMP regulations, similar foreign regulations and other regulatory standards. We do not have control over our contract manufacturers’ compliance with these regulations and standards. Any failure by our third-party manufacturers or suppliers to comply with applicable regulations could result in sanctions being imposed on them (including fines, injunctions and civil penalties), failure of regulatory authorities to grant marketing approval of our product candidates, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of product candidates or products, operating restrictions and criminal prosecution.

 

Materials necessary to manufacture our product candidates currently under development may not be available on commercially reasonable terms, or at all, which may delay our development and commercialization of these drugs.

 

Some of the materials necessary for the manufacture of our product candidates currently under development may, from time to time, be available either in limited quantities, or from a limited number of manufacturers, or both. We and/or our collaborators need to obtain these materials for our clinical trials and, potentially, for commercial distribution when and if we obtain marketing approval for these compounds. Suppliers may not sell us these materials at the time we need them or on commercially reasonable terms. If we are unable to obtain the materials needed for the conduct of our clinical trials, product testing and potential regulatory approval could be delayed, adversely impacting our ability to develop the product candidates. If it becomes necessary to change suppliers for any of these materials or if any of our suppliers experience a shutdown or disruption in the facilities used to produce these materials, due to technical, regulatory or other problems, it could significantly hinder or prevent manufacture of our drug candidates and any resulting products.

 

The success of our BCR-ABL inhibitor program depends heavily on the activities of Novartis. If Novartis is unable to identify any development candidates or is unwilling to further develop or commercialize development candidates that may be identified under the collaboration, or experiences significant delays in doing so, our business may be harmed.

 

As the research term of our collaboration with Novartis ended in late March 2008 and Novartis is responsible for the further discovery and development of drug candidates identified under the collaboration, other than SGX393, the future success of our BCR-ABL program for the treatment of front-line CML will depend in large part on the activities of Novartis with respect to compounds and potential drug candidates licensed to Novartis under the collaboration agreement. To date, the nomination of a development candidate has taken longer than anticipated, and we may experience further delays in the collaboration’s progress. It is possible that we and Novartis may never select a development candidate or commence clinical trials. We do not have a significant history of working together with Novartis and cannot predict the progress and success of the collaboration. While Novartis is subject to certain diligence obligations under the collaboration agreement, we cannot guarantee that Novartis will not reduce or curtail its efforts to discover and develop product candidates under the collaboration, because of changes in its research and development budget, its internal development priorities, the success or failure of its other product candidates or other factors affecting its business or operations. For example, Novartis markets Gleevec ^® (imatinib mesylate) and has other drug candidates under development that could compete with any BCR-ABL inhibitor that

may be developed under our collaboration with Novartis. It is possible that Novartis may devote greater resources to its other competing programs, or may not pursue as aggressively our BCR-ABL program or market as aggressively any BCR-ABL product that may result from our collaboration.

 

Any product candidates we advance into clinical trials are subject to extensive regulation, compliance with which can be costly and time consuming, cause unanticipated delays or prevent the receipt of the required approvals to commercialize our product candidates.

 

The clinical development, manufacturing, labeling, storage, record-keeping, advertising, promotion, export, marketing and distribution of any other product candidates we advance into clinical trials are subject to extensive regulation by the FDA in the United States and by comparable governmental authorities in foreign markets. In the United States, neither we nor our collaborators are permitted to market our product candidates until we or our collaborators receive approval of an NDA from the FDA. The process of obtaining NDA approval is expensive, often takes many years, and can vary substantially based upon the type, complexity and novelty of the products involved. Approval policies or regulations may change. In addition, as a company, we have not previously filed an NDA with the FDA. This lack of experience may impede our ability to obtain FDA approval in a timely manner, if at all, for our product candidates for which development and commercialization is our responsibility. Despite the time and expense invested, regulatory approval is never guaranteed. The FDA or any of the applicable European, Canadian or other regulatory bodies can delay, limit or deny approval of a product candidate for many reasons, including:

 

 

In addition, while we may seek to take advantage of various regulatory processes intended to accelerate drug development and approval for SGX393 , there is no guarantee that the FDA will review or accept an NDA under the accelerated approval regulations, based on our clinical trial design, the results of any clinical trials we may conduct or other factors.

 

Also, recent events implicating questions about the safety of marketed drugs, including those pertaining to the lack of adequate labeling, may result in increased cautiousness by the FDA in reviewing new drugs based on safety, efficacy or other regulatory considerations and may result in significant delays in obtaining regulatory approvals. Any delay in obtaining, or inability to obtain, applicable regulatory approvals would prevent us from commercializing our product candidates.

 

We have limited clinical development and commercialization experience.

 

We have very limited experience conducting clinical trials and have never obtained regulatory approvals for any drug. To date, we have filed only one IND application, initiated two Phase 1 clinical trials, and one Phase 2/3 clinical trial (which was ultimately suspended and terminated). We have not filed an NDA or commercialized a drug. We have no experience as a company in the sale, marketing or distribution of pharmaceutical products and do not currently have a sales and marketing organization. Developing commercialization capabilities will be expensive and time-consuming, could delay any product launch, and we may not be able to develop a successful commercial organization. To the extent we are unable or determine not to acquire these resources internally, we would be forced to rely on third-party clinical investigators, clinical research or marketing organizations. If we were unable to establish adequate capabilities independently or with others, our drug development and commercialization efforts could fail and we may be unable to generate product revenues.

We rely on third parties to conduct our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain regulatory approval for or commercialize our product candidates.

 

We rely on third parties, such as medical institutions, clinical investigators and contract laboratories, to conduct our SGX523 clinical trials and any other future clinical trials. We may not be able to control the amount and timing of resources that third parties devote to any clinical trials we may commence or the quality or timeliness of the services performed by such third parties. In any of our clinical trials, in the event that we are unable to maintain our relationship with any clinical trial sites, or elect to terminate the participation of any clinical trial sites, we may experience the loss of follow-up information on patients enrolled in such clinical trial unless we are able to transfer the care of those patients to another qualified clinical trial site. In addition, principal investigators for our clinical trials may serve as scientific advisors or consultants to us from time to time and receive cash or equity compensation in connection with such services. If these relationships and any related compensation result in perceived or actual conflicts of interest, the integrity of the data generated at the applicable clinical trial site may be jeopardized. If these third parties do not successfully carry out their contractual duties or obligations or meet expected deadlines in connection with any future clinical trials, or if the quality or accuracy of the clinical data is compromised due to the failure to adhere to clinical protocols or for other reasons, our clinical trials may be extended, delayed or terminated, our reputation in the industry and in the investment community may be significantly damaged, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates.

 

Even if any product candidate we advance into clinical trials receives regulatory approval, our product candidates may still face future development and regulatory difficulties.

 

If any product candidate we advance into clinical trials receives U.S. regulatory approval, the FDA may still impose significant restrictions on the indicated uses or marketing of the product candidate or impose ongoing requirements for potentially costly post-approval studies. In addition, regulatory agencies subject a product, its manufacturer and the manufacturer’s facilities to continual review and periodic inspections. If a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product, our collaborators or us, including requiring withdrawal of the product from the market. Our product candidates will also be subject to ongoing FDA requirements for the labeling, packaging, storage, advertising, promotion, record-keeping and submission of safety and other post-market information on the drug. If our product candidates fail to comply with applicable regulatory requirements, a regulatory agency may:

 

 

Moreover, in order to market any products outside of the United States, we and our collaborators must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process in other countries may include all of the risks described above regarding FDA approval in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailed above regarding FDA approval in the United

States. As described above, such effects include the risk that our product candidates may not be approved for all indications requested, which could limit the uses of our product candidates and adversely impact potential royalties and product sales, and that such approval may be subject to limitations on the indicated uses for which the product may be marketed or require costly, post-marketing follow-up studies. If we or our collaborators fail to comply with applicable domestic or foreign regulatory requirements, we and our collaborators may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.

 

We are dependent on our collaborations, and events involving these collaborations or any future collaborations could prevent us from developing or commercializing product candidates.

 

The success of our current business strategy and our near and long-term viability will depend in part on our ability to successfully maintain our existing collaborations and establish new strategic collaborations. Since we do not currently possess the resources necessary to independently develop and commercialize all of the product candidates that we have discovered and that may be discovered through our drug discovery platform, we may need to enter into additional collaborative agreements to assist in the development and commercialization of some of these product candidates or in certain markets for a particular product candidate. Establishing strategic collaborations is difficult and time-consuming. Potential collaborators may reject collaborations based upon their assessment of our financial, regulatory or intellectual property position or the safety or efficacy profiles of product candidates. And our discussions with potential collaborators may not lead to the establishment of new collaborations on acceptable terms. In addition, if as a result of our financial condition or other factors we enter into a strategic collaboration while a drug candidate program is in early preclinical development, we may not generate as much near- or longer-term revenue from such program as we could have generated if we had the resources to further independently develop such program.

 

We have entered into drug discovery collaborations, such as those with Novartis and the Cystic Fibrosis Foundation. In each case, our collaborators have agreed to finance the clinical trials for product candidates resulting from these collaborations and, if they are approved, manufacture and market them. Accordingly, we are dependent on our collaborators to gain regulatory approval of, and to commercialize, product candidates resulting from most of our collaborations. Depending upon the success of our collaboration with Novartis, we may derive a substantial portion of our near-term revenues from Novartis. However, it has taken longer than anticipated to identify a development candidate under this collaboration and there is no guarantee that a development candidate will be identified. No further research funding will be received under the collaboration as a result of the conclusion of the research term of the collaboration in late March 2008. At this time, an IND for a development candidate under the collaboration is not anticipated in 2008 and it is possible that an IND may never be filed. While Novartis is subject to certain diligence obligations under the collaboration agreement, we cannot guarantee that Novartis will not reduce or curtail its efforts to develop product candidates that may be identified under the collaboration, because of changes in its research and development budget, its internal development priorities, the success or failure of its other product candidates or other factors affecting its business or operations. If no development candidates are identified under the collaboration or Novartis determines that the further development of compounds being developed under the collaboration is not viable for competitive, safety or efficacy reasons, our business may be materially and adversely affected.

 

We have limited control over the amount and timing of resources that our current collaborators or any future collaborators (including collaborators resulting from a change of control) devote to our programs or potential products. In some instances, our collaborators, such as Novartis, may have competing internal programs or programs with other parties, and such collaborators may devote greater resources to their internal or other programs than to our collaboration and any product candidates developed under our collaboration. Our collaborators may prioritize other drug development opportunities that they believe may have a higher likelihood of obtaining regulatory approval or may potentially generate a greater return on investment. These collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our collaborators may not develop products that arise out of our collaborative arrangements, such as SGX393, or devote sufficient resources to the development, manufacture, marketing or sale of these products. Moreover, in the event of termination of a collaboration agreement, termination negotiations may result in less favorable terms than we would otherwise choose.

We and our present and future collaborators may fail to develop or effectively commercialize products covered by our present and future collaborations for a variety of reasons, including:

 

 

If we or our collaborators are unable to develop or commercialize products as a result of the occurrence of any one or a combination of these events, our business may be seriously harmed.

 

Conflicts may arise between us and our collaborators that could delay or prevent the development or commercialization of our product candidates.

 

Conflicts may arise between our collaborators and us, such as conflicts concerning which compounds, if any, to select for pre-clinical or clinical development, the interpretation of clinical data, the achievement of milestones, the interpretation of financial provisions, the exercise of reacquisition or other rights or the ownership of intellectual property developed during the collaboration. If any conflicts arise with existing or future collaborators, they may act in their self-interest, which may be adverse to our best interests. Any such disagreement between us and a collaborator could result in one or more of the following, each of which could delay or prevent the development or commercialization of our product candidates, and in turn prevent us from generating sufficient revenues to achieve or maintain profitability:

 

 

If we fail to establish new collaborations and other commercial agreements, we may have to reduce or limit our internal drug discovery and development efforts and our business may be adversely affected.

 

Revenue generation utilizing compounds identified by us from the application of our technologies, such as SGX523, and our FAST drug discovery platform and related technologies, is important to us to provide us with funds for reinvestment in our internal drug discovery and development programs. If we fail to enter into a collaboration or out-licensing agreement on SGX523 or SGX126 or establish other collaborations, commercial agreements or out-licensing arrangements on acceptable terms, we may not generate sufficient revenue to support our internal discovery and development efforts. In addition, since our existing collaborations and commercial

agreements are generally not long-term contracts, we cannot be sure we will be able to continue to derive comparable revenues from these or other collaborations or commercial agreements in the future. Even if we successfully establish collaborations, these relationships may never result in the successful development or commercialization of any product candidates or the generation of sales or royalty revenue. Under our commercial arrangements with other pharmaceutical and biotechnology companies, such as under all of our beamline services agreements, we are providing specific services for fees without any interest in future product sales or profits. While we believe these commercial arrangements help to offset the expenses associated with our drug discovery efforts, they may force us to divert valuable resources from our own discovery efforts in order to fulfill our contractual obligations.

 

Our drug discovery efforts are dependent on continued access to and use of our beamline facility, which is subject to various governmental regulations and policies and a user agreement with the University of Chicago and the U.S. Department of Energy. If we are unable to continue the use of our beamline facility, we may be required to delay, reduce the scope of or abandon some of our drug discovery efforts, and may fail to perform under our collaborations, commercial agreements and grants, which would result in a material reduction in our revenue.

 

We generate protein structures through our beamline facility, housed at the Advanced Photon Source at the Argonne National Laboratory, a national synchrotron-radiation facility funded by the U.S. Department of Energy, Office of Science, and Office of Basic Energy Sciences, located in Argonne, Illinois. Accordingly, our access to and use of the facility is subject to various government regulations and policies. In addition, our access to the beamline facility is subject to a user agreement with the University of Chicago and the U.S. Department of Energy with an initial five year term expiring in January 1, 2009. Although the term of our user agreement automatically renews for successive one-year periods, the University of Chicago may terminate the agreement and our access to the beamline facility by providing 60 days’ notice prior to the beginning of each renewal period. In addition, the University of Chicago may terminate the agreement for our breach, subject to our ability to cure the breach within 30 days. In the event our access to or use of the facility is restricted or terminated, we would be forced to seek access to alternate beamline facilities. There are currently only a very small number of alternate beamline facilities worldwide, which we believe are comparable to ours. To obtain equivalent access at a single alternate beamline facility would likely require us building out a new beamline at such facility which could take over two years and would involve significant expense. However, we cannot be certain that we would be able to obtain equivalent access to such a facility on acceptable terms or at all. In the interim period, we would have to obtain beamline access at a combination of facilities, and there is no guarantee that we would be able to obtain sufficient access time on acceptable terms or at all. If alternate beamline facilities are not available, we may be required to delay, reduce the scope of or abandon some of our early drug discovery efforts. We may also be deemed to be in breach of certain of our commercial agreements. Even if alternate beamline facilities are available, we cannot be certain that the quality of or access to the alternate facilities will be adequate and comparable to those of our current facility. Failure to maintain adequate access to and use of beamline facilities may materially adversely affect our ability to pursue our own discovery efforts and perform under our collaborations, commercial agreements and grants, which are our current primary source of revenue.

 

If our competitors develop treatments for cancer indications we target that are approved more quickly, marketed more effectively or demonstrated to be more effective or safer than our current or future product candidates, our ability to generate product revenue will be reduced or eliminated.

 

Most cancer indications for which we are developing products have a number of established therapies with which our product candidates will compete. Most major pharmaceutical companies and many biotechnology companies are aggressively pursuing new cancer development programs, including both therapies with traditional as well as novel mechanisms of action. In addition to programs that specifically compete with ours, our product candidates could be adversely affected by new approaches to the treatment of cancer.

 

We are aware of competitive products in each of the markets we target. These competitive products include approved and marketed products as well as products in development. With respect to SGX523, we are aware of a number of companies working in the area of small molecule inhibitors of MET, which are at varying stages of

preclinical or clinical development, including Exelixis, Inc., Arqule, Inc., Pfizer, Inc., SuperGen, Inc., Methylgene Inc., and Merck and Co. Ltd. We are also aware of a number of companies working in the area of biological agents that interfere with MET, which are at varying stages of preclinical or clinical development, including Amgen, Inc., Schering Plough Corporation, Takeda Pharmaceutical Company Limited, Genentech, Inc. and Astra Zeneca Ltd.

 

With respect to our BCR-ABL inhibitors, we are aware of a number of companies working in this area which are at varying stages of preclinical or clinical development, including Bristol Myers Squibb, Inc., Merck and Co., Wyeth, Inc., Innovive Pharmaceuticals, Inc., ChemGenex, Inc., Kyowa Hakko Kogyo Pharma, Inc., Exelixis, Inc., Ariad Pharmaceuticals, Inc., Kinex Pharmaceuticals, Inc., Pfizer, Inc., and Deciphera Pharmaceuticals, Inc.

 

Significant competitors in the area of fragment-based drug discovery include Astex Therapeutics Limited, Plexxikon Inc., Evotec AG, Vernalis Plc., Sunesis Pharmaceuticals, Inc., and Active Site, Inc. In addition, many large pharmaceutical companies are exploring the internal development of fragment-based drug discovery methods.

 

Many of our competitors have significantly greater financial, product development, manufacturing and marketing resources than us. Large pharmaceutical companies have extensive experience in clinical testing and obtaining regulatory approval for drugs. These companies also have significantly greater research capabilities than us. In addition, many universities and private and public research institutes are active in cancer research, some in direct competition with us. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies.

 

Our competitors may succeed in developing products for the treatment of diseases in oncology therapeutic areas in which our drug discovery programs are focused that are more effective, better tolerated or less costly than any which we may offer or develop. Our competitors may succeed in obtaining approvals from the FDA and foreign regulatory authorities for their product candidates sooner than we do for ours. We will also face competition from these third parties in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, and in acquiring and in-licensing technologies and products complementary to our programs or advantageous to our business.

 

We have limited experience in identifying, acquiring or in-licensing, and integrating third parties’ products, businesses and technologies into our current infrastructure. If we determine that future acquisition, in-licensing or other strategic opportunities are desirable and do not successfully execute on and integrate such targets, we may incur costs and disruptions to our business.

 

An important part of our business strategy is to continue to develop a broad pipeline of product candidates. These efforts may include potential licensing and acquisition transactions. Although we are not currently a party to any in-licensing agreements or commitments, we may, seek to expand our product pipeline and technologies, at the appropriate time and as resources allow, by acquiring or in-licensing products, or combining with businesses that we believe are a strategic fit with our business and complement our existing internal drug development efforts and product candidates, research programs and technologies. Future transactions, however, may entail numerous operational and financial risks including:

 

 

Finally, we may devote resources to potential in-licensing opportunities or strategic transactions that are never completed or fail to realize the anticipated benefits of such efforts.

 

If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to market and sell any products we may develop, we may not be able to generate product revenue.

 

We do not currently have a sales organization for the sales, marketing and distribution of pharmaceutical products. In order to commercialize any products, we must build our sales, marketing, distribution, managerial and other non-technical capabilities or make arrangements with third parties to perform these services. In North America, we currently expect to commercialize any BCR-ABL product candidates that may result from our collaboration with Novartis, and certain other potential product candidates for other indications that are of strategic interest to us, and plan to establish internal sales and marketing capabilities for those product candidates. We plan to seek third party partners for indications and in territories, such as outside North America, which may require more extensive sales and marketing capabilities. The establishment and development of our own sales force to market any products we may develop in North America will be expensive and time consuming and could delay any product launch, and we cannot be certain that we would be able to successfully develop this capacity. If we are unable to establish our sales and marketing capability or any other non-technical capabilities necessary to commercialize any products we may develop, we will need to contract with third parties to market and sell any products we may develop in North America. If we are unable to establish adequate sales, marketing and distribution capabilities, whether independently or with third parties, we may not be able to generate product revenue and may not become profitable.

 

The commercial success of any product that we may develop depends upon market acceptance among physicians, patients, health care payors and the medical community.

 

Even if any product we may develop obtains regulatory approval, our products, if any, may not gain market acceptance among physicians, patients, health care payors and the medical community. The degree of market acceptance of any of our approved products will depend on a number of factors, including:

 

 

If any of our product candidates is approved, but does not achieve an adequate level of acceptance by physicians, healthcare payors and patients, we may not generate sufficient revenue from these products and we may not become profitable.

 

We are subject to uncertainty relating to health care reform measures and reimbursement policies which, if not favorable to our product candidates, could hinder or prevent our product candidates’ commercial success.

 

The continuing efforts of the government, insurance companies, managed care organizations and other payors of health care costs to contain or reduce costs of health care may adversely affect one or more of the following:

 

 

In certain foreign markets, the pricing of prescription drugs is subject to government control and reimbursement may in some cases be unavailable. In the United States, given recent federal and state government initiatives directed at lowering the total cost of health care, Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription drugs and the reform of the Medicare and Medicaid systems. For example, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 provided a new Medicare prescription drug benefit beginning in 2006 and mandated other reforms in the Medicare and Medicaid systems that have been subject to various amendments and modifications over the past several years. We are not yet able to assess the full impact of this legislation and it is possible that the new Medicare prescription drug benefit, which will be managed by private health insurers and other managed care organizations, will result in decreased reimbursement for prescription drugs, which may further exacerbate industry-wide pressure to reduce prescription drug prices. In addition, because we are approaching an election year, there may be significant healthcare reform and other measures that may adversely impact our business. This could harm our ability to market our products and generate revenues. It is also possible that other proposals having a similar effect will be adopted.

 

Our ability to commercialize successfully any product candidates we advance into clinical trials will depend in part on the extent to which governmental authorities, private health insurers and other organizations establish appropriate coverage and reimbursement levels for the cost of our products and related treatments. Third party payors are increasingly challenging the prices charged for medical products and services. Also, the trend toward managed health care in the United States, which could significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care or reduce government insurance programs, may result in lower prices for our product candidates or exclusion of our product candidates from coverage and reimbursement programs. The cost containment measures that health care payors and providers are instituting and the effect of any health care reform could significantly reduce our revenues from the sale of any approved product.

 

We may need to increase or decrease the size of our organization, and we may experience difficulties in managing those organizational changes.

 

Since we were incorporated in 1998, we have increased the number of our full-time employees to 123 as of December 31, 2007. In the future, we may need to expand our managerial, operational, financial and other resources in order to manage and fund our operations, continue our research and development and collaborative activities, progress our product candidates through preclinical studies and clinical trials, and eventually commercialize any product candidates for which we are able to obtain regulatory approval. It is possible that our management and scientific personnel, systems and facilities currently in place may not be adequate to support this potential future growth. Our need to effectively manage our operations, potential future growth and various projects requires that we manage our internal research and development efforts effectively while carrying out our contractual obligations to collaborators and third parties, continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. We may be unable to successfully implement these tasks on a larger scale and, accordingly, may not achieve our research, development and commercialization goals.

 

Alternatively, we may need to decrease the number of our full-time employees in the future in response to adverse business events. Reducing our workforce may lead to additional unanticipated attrition. If our future staffing is inadequate because of additional unanticipated attrition or because we failed to retain the staffing level required to accomplish our business objectives we may be delayed or unable to continue the development or of our product candidates, which could impede our ability to generate revenues and achieve or maintain profitability.

 

If we fail to attract and keep key management and scientific personnel, we may be unable to successfully develop or commercialize our product candidates.

 

We will need to expand and effectively manage our managerial, operational, financial and other resources in order to successfully pursue our research, development and commercialization efforts for any future product candidates.

 

Our success depends on our continued ability to attract, retain and motivate highly qualified management and chemists, biologists, and preclinical and clinical personnel. The loss of the services of any of our senior management, particularly Michael Grey, our President and Chief Executive Officer, or Stephen Burley, our Senior

Vice President and Chief Scientific Officer and Senior Vice President, Research, could have an adverse effect on our business. We do not maintain “key man” insurance policies on the lives of these individuals or the lives of any of our other employees. We employ these individuals on an at-will basis and their employment can be terminated by us or them at any time, for any reason and with or without notice. We have scientific and clinical advisors who assist us in formulating our research, development and clinical strategies. These advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability to us. In addition, our advisors may have arrangements with other companies to assist those companies in developing products or technologies that may compete with ours.

 

We may not be able to attract or retain qualified management and scientific personnel in the future due to the intense competition for qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in the San Diego, California area. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede significantly the achievement of our research and development objectives, our ability to raise additional capital and our ability to implement our business strategy. In particular, if we lose any members of our senior management team, we may not be able to find suitable replacements and our business may be harmed as a result.

 

Earthquake or fire damage to our facilities, systems failures or other adverse events affecting our facilities could delay our research and development efforts and adversely affect our business.

 

Our headquarters and research and development facilities in San Diego are located in a seismic zone, and there is the possibility of an earthquake, which could be disruptive to our operations and result in delays in our research and development efforts. In addition, while our facilities were not adversely impacted by the wildfires in recent years, there is the possibility of future fires in the area. Our internal computer systems are also vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, and telecommunications and electrical failures. In the event of an earthquake or fire or any systems failure, if our facilities, the equipment in our facilities or our computer or other systems are significantly damaged, destroyed or disrupted for any reason, we may not be able to rebuild or relocate our facilities, replace any damaged equipment or repair any systems failures in a timely manner and our business, financial condition, and results of operations could be materially and adversely affected. We do not have insurance for damages resulting from earthquakes. While we do have fire insurance for our property and equipment located in San Diego, any damage sustained in a fire could cause a delay in our research and development efforts and our results of operations could be materially and adversely affected.

 

Risks Relating to our Finances and Capital Requirements

 

We will need substantial additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our research and development programs or commercialization efforts.

 

Historically, we have funded our operations through a combination of proceeds from offerings of our equity securities, collaborations, commercial agreements, grant revenue, and debt financing. As part of our business strategy, we expect to continue to establish new collaborations and commercial agreements. We believe that our existing cash, cash equivalents and short-term investments, together with interest thereon and cash from existing and new collaborations, commercial agreements and grants, will be sufficient to meet projected operating requirements into the second half of 2009. Because we do not anticipate that we will generate significant continuing revenues for several years, if at all, we will need to raise substantial additional capital to finance our operations in the future. Our additional funding requirements will depend on, and could increase significantly as a result of, many factors, including the:

 

 

 

We expect to continue to finance our future cash needs through the sale of equity securities, strategic collaboration agreements and debt financing. However, we may not be successful in obtaining additional collaboration agreements or commercial agreements, or in receiving milestone or royalty payments under existing agreements. In addition, we cannot be sure that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. Failure to obtain adequate financing may also adversely affect our ability to operate as a going concern.

 

If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our research and development programs or our commercialization efforts.

 

We expect our net operating losses to continue for at least several years, and we are unable to predict the extent of future losses or when we will become profitable, if ever.

 

We have incurred substantial net operating losses since our inception. For the year ended December 31, 2007 and 2006, we had a net loss attributable to common stockholders of $16.0 million and $28.1 million, respectively. As of December 31, 2007, we had an accumulated deficit of approximately $179.7 million. We expect our annual net operating losses to continue over the next several years as we conduct our research and development activities, and incur preclinical and clinical development costs. Because of the numerous risks and uncertainties associated with our research and development efforts and other factors, we are unable to predict the extent of any future losses or when we will become profitable, if ever. We will need to commence clinical trials, obtain regulatory approval and successfully commercialize a product candidate or product candidates before we can generate revenues which would have the potential to lead to profitability.

 

We currently lack a significant continuing revenue source and may not become profitable.

 

Our ability to become profitable depends upon our ability to generate significant continuing revenues. To obtain significant continuing revenues, we must succeed, either alone or with others, in developing, obtaining regulatory approval for, and manufacturing and marketing product candidates with significant market potential. However, we cannot guarantee when, if ever, products resulting from our MET, BCR-ABL or other oncology programs will generate product sales, or that any such sales will be sufficient to allow us to become profitable. We had revenues from collaborations, commercial agreements and grants totaling $34.7 million and $27.8 million for years ended December 31, 2007 and 2006, respectively. Though we anticipate that our collaborations, commercial agreements and grants will continue to be our primary sources of revenues for the next several years, these revenues alone will not be sufficient to lead to profitability.

 

Our ability to generate continuing revenues depends on a number of factors, including:

 

 

If we are unable to generate significant continuing revenues, we will not become profitable, and we may be unable to continue our operations.

 

Raising additional funds by issuing securities or through licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.

 

We may raise additional funds through public or private equity offerings, debt financings or licensing arrangements. To the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership will be diluted. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on additional borrowing, specific restrictions on the use of our assets as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments. In addition, if we raise additional funds through licensing arrangements, as we did in our recent collaboration with Novartis, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

 

Our quarterly operating results may fluctuate significantly.

 

We expect our operating results to be subject to quarterly fluctuations. The revenues we generate, if any, and our operating results will be affected by numerous factors, including:

 

 

Quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

 

We may incur substantial liabilities from any product liability claims if our insurance coverage for those claims is inadequate.

 

We face an inherent risk of product liability exposure related to the testing of our product candidates in human clinical trials, and will face an even greater risk if we sell our product candidates commercially. An individual may bring a liability claim against us if one of our product candidates causes, or merely appears to have caused, an injury. If we cannot successfully defend ourselves against the product liability claim, we will incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in any one or a combination of the following:

 

 

We have product liability insurance that covers our Phase 1 clinical trials of SGX 523. We intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for any of our product candidates. However, insurance coverage is increasingly expensive. We may not be able to maintain

insurance coverage at a reasonable cost, and we may not be able to obtain insurance coverage that will be adequate to satisfy any liability that may arise.

 

We use biological and hazardous materials, and any claims relating to improper handling, storage or disposal of these materials could be time consuming or costly.

 

We use hazardous materials, including chemicals, biological agents and radioactive isotopes and compounds, which could be dangerous to human health and safety or the environment. Our operations also produce hazardous waste products. Federal, state and local laws and regulations govern the use, generation, manufacture, storage, handling and disposal of these materials and wastes. Compliance with applicable environmental laws and regulations may be expensive, and current or future environmental laws and regulations may impair our drug development efforts.

 

In addition, we cannot entirely eliminate the risk of accidental injury or contamination from these materials or wastes. If one of our employees was accidentally injured from the use, storage, handling or disposal of these materials or wastes, the medical costs related to his or her treatment would be covered by our workers’ compensation insurance policy. However, we do not carry specific biological or hazardous waste insurance coverage and our property and casualty and general liability insurance policies specifically exclude coverage for damages and fines arising from biological or hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our clinical trials or regulatory approvals could be suspended.

 

Negative conditions in the global credit markets may impair the liquidity of a portion of our investment portfolio.

 

Our investment securities consist of government agency securities, corporate debt securities and auction rate securities (ARS). As of December 31, 2007, our short-term investments included $1.5 million of an AAA/Aaa rated ARS which experienced failed auctions due to market uncertainties at the time its interest rate was to reset. The recent negative conditions in the global credit markets have prevented some investors from liquidating their holdings, including their holdings of auction rate securities. As a result, our ARS has experienced a decline in value. In the event we need to access these funds, we will not be able to do so without a loss of principal, until a future auction on this investment is successful, the security is redeemed by the issuer or the security matures. As of December 31, 2007, the fair value of our ARS was reduced by $0.5 million, from $1.5 million to $1.0 million at December 31, 2007, reflecting the change in fair market value. Although the ARS continues to pay interest according to its stated terms, based on valuation models and an analysis of other-than-temporary impairment factors, a realized loss of approximately $0.5 million was recognized in the fourth quarter of 2007, reflecting an other-than-temporary decline in value. If the credit ratings of the ARS issuer deteriorate or if uncertainties in these markets continue and any decline in market value is determined to be other-than-temporary, we would be required to adjust the fair value of the investment through an additional impairment charge, which could negatively affect the Company’s financial condition. There is no guarantee that we will be able to liquidate our ARS or that we will not incur further realized losses.

 

Risks Relating to our Intellectual Property

 

Our success depends upon our ability to protect our intellectual property and our proprietary technologies.

 

Our commercial success depends on obtaining and maintaining patent protection and trade secret protection for our product candidates, proprietary technologies and their uses, as well as successfully defending these patents against third party challenges. There can be no assurance that our patent applications will result in patents being issued or that issued patents will afford protection against competitors with similar technology, nor can there be any assurance that the patents issued will not be infringed, designed around, or invalidated by third parties. Even issued patents may later be found unenforceable, or be modified or revoked in proceedings instituted by third parties before various patent offices or in courts.

The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. Changes in either the patent laws or in the interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our patents or in third party patents.

 

The degree of future protection for our proprietary rights is uncertain. Only limited protection may be available and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example:

 

 

Patent applications in the U.S. are maintained in confidence for up to 18 months after their filing. Consequently, we cannot be certain that we were the first to invent, or the first to file, patent applications on our compounds or drug candidates. We may not have identified all U.S. and foreign patents or published applications that may affect our business by blocking our ability to commercialize any drugs for which we are able to successfully develop and obtain regulatory approval.

 

Proprietary trade secrets and unpatented know-how are also very important to our business. Although we have taken steps to protect our trade secrets and unpatented know-how, including entering into confidentiality agreements with third parties, and confidential information and inventions agreements with employees, consultants and advisors, third parties may still obtain this information or we may be unable to protect our rights. Enforcing a claim that a third party illegally obtained and is using our trade secrets or unpatented know-how is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States may be less willing to protect trade secret information. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how, and we would not be able to prevent their use.

 

If we are sued for infringing intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.

 

Our commercial success also depends upon our ability and the ability of our collaborators to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields in which we and our collaborators are developing products. Because patent applications can take many years to issue, there may be currently pending applications which may later result in issued patents that our product candidates or proprietary technologies may infringe.

 

We may be exposed to, or threatened with, future litigation by third parties having patent, trademark or other intellectual property rights alleging that we are infringing their intellectual property rights. If one of these patents was found to cover our product candidates, research methods, proprietary technologies or their uses, or one of these trademarks was found to be infringed, we or our collaborators could be required to pay damages and could be unable to commercialize our product candidates or use our proprietary technologies unless we or they obtain a license to the patent or trademark, as applicable. A license may not be available to us or our collaborators on acceptable terms, if at all. In addition, during litigation, the patent or trademark holder could obtain a preliminary injunction or other

equitable right which could prohibit us from making, using or selling our products, technologies or methods. In addition, we or our collaborators could be required to designate a different trademark name for our products, which could result in a delay in selling those products.

 

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and biopharmaceutical industries generally. If a third party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including, but not limited to:

 

 

There can be no assurance that third party patents containing claims covering our product candidates, technology or methods do not exist, have not been filed, or could not be filed or issued. Because of the number of patents issued and patent applications filed in our areas or fields of interest, particularly in the area of protein kinase inhibitors, we believe there is a significant risk that third parties may allege they have patent rights encompassing our product candidates, technology or methods. In addition, we have not conducted an extensive search of third party trademarks, so no assurance can be given that such third party trademarks do not exist, have not been filed, could not be filed or issued, or could not exist under common trademark law. If there is uncertainty with respect to our intellectual property rights related to our product candidates, technologies or methods, we may have difficulty entering into collaboration or licensing arrangements with third parties with respect to such product candidates, technologies or methods.

 

Other product candidates that we may develop, either internally or in collaboration with others, could be subject to similar risks and uncertainties.

 

Risks Relating to the Securities Markets and Ownership of our Common Stock

 

Market volatility may affect our stock price.

 

Until our initial public offering in February 2006, there was no market for our common stock, and despite our initial public offering, an active public market for these shares may not develop or be sustained. We have had relatively low volume of trading in our stock since our initial public offering and we do not know if the trading volume of our common stock will increase in the future. In addition, the market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:

 

 

 

In addition, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price, such as the decline in our stock price following the announcement in August 2006 of the termination of our Phase II/III clinical trial for Troxatyl. Any such litigation brought against us could result in substantial costs and a diversion of management’s attention and resources, which could hurt our business, operating results and financial condition.

 

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

 

Provisions in our amended and restated certificate of incorporation and bylaws may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders, and the ability of our board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which, subject to certain exceptions, prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirors to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

 

We may incur increased costs as a result of changes in laws and regulations relating to corporate governance matters.

 

Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted by the Securities and Exchange Commission and by the Nasdaq Stock Market, have resulted in and will continue to result in increased costs to us as we respond to their requirements. These laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these requirements could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to these laws and regulations and cannot predict or estimate the amount or timing of additional costs we may incur to respond to their requirements.

 

If our executive officers, directors and largest stockholders choose to act together, they may be able to control our operations and act in a manner that advances their best interests and not necessarily those of other stockholders.

 

Our executive officers, directors and holders of 5% or more of our outstanding common stock beneficially own approximately 62% of our common stock. As a result, these stockholders, acting together, are able to control all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders, and they may act in a manner that advances their best interests

and not necessarily those of other stockholders. These stockholders also may not act together and disputes may arise among these stockholders with respect to matters that require stockholder approval. Any disagreements among our significant stockholders, including among significant stockholders that are affiliated with members of our Board of Directors, may also make it more difficult for us to obtain stockholder approval of certain matters and may lead to distraction of management or have other adverse impact on our operations.

 

 

 

 

PART II

 

 

The closing price for our common stock as reported by the Nasdaq Global Market on March 24, 2008 was $4.04 per share. As of March 14, 2008, there were approximately 118 stockholders of record of our common stock.

 

Dividends

 

We have never declared or paid any cash dividends on our capital stock. The payment of dividends by us on our common stock is limited by our debt agreements. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business. We do not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to dividend policy will be made at the discretion of our board of directors.

 

Recent Sales of Unregistered Securities

 

There were no unregistered sales of equity securities during the year ended December 31, 2007.

Performance Measurement Comparison(1)

 

The following graph shows the total stockholder return of an investment of $100 in cash on February 1, 2006 in (i) the Company’s common stock, (ii) the Nasdaq Composite Index (the “Nasdaq”) and (iii) the NASDAQ Biotechnology Index (the “NBI”). All values assume reinvestment of the full amount of all dividends.

 

Comparison of Cumulative Total Return on Investment since our Initial Public Offering on February 1, 2006:

 

COMPARISON OF 23 MONTH CUMULATIVE TOTAL RETURN*
Among SGX Pharmaceuticals, Inc., The NASDAQ Composite Index
And The NASDAQ Biotechnology Index

 

 

 

You should read the following selected consolidated financial and operating information for SGX Pharmaceuticals, Inc. together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.

 

The consolidated statements of operations data for the years ended December 31, 2007, 2006 and 2005, and the consolidated balance sheet data as of December 31, 2007 and 2006 are derived from the audited consolidated financial statements included elsewhere in this report. The consolidated statements of operations data for the years ended December 31, 2004 and 2003, and the consolidated balance sheet data as of December 31, 2005, 2004 and 2003 are derived from audited consolidated financial statements not included in this report. Historical results for any prior period are not necessarily indicative of the results to be expected for any future period.

 

 

 

The following discussion and analysis should be read in conjunction with our Consolidated financial statements and related notes included elsewhere in this report. This discussion and other parts of this report may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under “Risk Factors” in Item 1A of Part I of this report and elsewhere in this report.

 

Overview

 

We are a biotechnology company focused on the discovery, development and commercialization of novel, targeted therapeutics directed at addressing unmet medical needs in oncology. Our most advanced drug development programs target the c-MET receptor tyrosine kinase (or MET), an enzyme implicated in a broad array of solid and blood tumors, and the BCR-ABL tyrosine kinase enzyme, for treatment of Chronic Myelogenous Leukemia, or CML, a cancer of the bone marrow. Our earlier stage drug discovery and development activities are focused on a portfolio of other protein and enzyme targets that have been implicated in human cancers.

 

We generated approximately $34.7 million, $27.8 million, and $21.6 million in revenues from collaborations, commercial agreements and grants during the years ended December 31, 2007, 2006 and 2005, respectively. We have incurred significant losses since our inception in 1998, as we have devoted substantially all of our efforts to research and development activities. As of December 31, 2007, our accumulated deficit was approximately $179.7 million. We expect to incur substantial and possibly increasing losses for the next several years as we develop and expand our oncology pipeline.

 

We were incorporated in Delaware in July 1998. To date, we have not generated any revenues from the sale of therapeutic drugs. We have financed our operations and internal growth through private placements of our equity securities, our initial public offering, our collaboration, commercial agreement and grant revenue and debt financings.

 

Financial Operations Overview

 

Collaboration, Commercial Agreement and Grant Revenue

 

Collaboration, commercial agreement and grant revenue has primarily been a result of various contractual agreements with pharmaceutical companies and biotechnology companies, as well as government and other agencies. We also periodically receive non-refundable payments for achieving certain milestones during the term of our agreements.

 

Research and Development Expense

 

Research and development expense consists primarily of costs associated with our internal research programs and certain clinical trial costs, compensation, including stock-based, and other expenses related to research and development personnel, facilities costs and depreciation. We charge all research and development expenses to operations as they are incurred.

 

Our research activities are focused on building an internal oncology pipeline and generating lead compounds for ourselves and our potential partners through application of our FAST drug discovery platform and related technologies. Our most advanced programs are focused on compounds that inhibit MET and BCR-ABL.

 

We incurred $3.6 million, $2.8 million, and $1.9 million of internal research expenses in connection with our NIH grants in 2007, 2006 and 2005, respectively. We also incurred $3.7 million, $5.1 million, and $5.1 million of expenses to subcontractors in connection with our research under NIH grants in 2007, 2006, and 2005, respectively.

 

We incurred $11.3 million and $3.3 million in expenses related to the research and development of our MET and BCR-ABL programs, respectively, during 2007. We incurred $0.6 million, $9.5 million, and $6.5 million of expenses related to the development of Troxatyl in 2007, 2006 and 2005 respectively, for a total of $22.1 million cumulatively expended on Troxatyl, a drug development program which we discontinued in 2006.

All other research and development expenses are for various programs in the preclinical and research and discovery stages. For these preclinical programs, we use our internal resources, including our employees and discovery infrastructure, across several projects, and many of our costs are not attributable to a specific project but are directed to broadly applicable research projects. Accordingly, we do not account for our internal research costs on a project basis. Research and development expense also includes stock-based compensation expense associated with employees performing research and development activities.

 

We anticipate that our existing level of expenditures will support our planned research and development activities. However, drug discovery and development outcomes and timelines and associated costs are uncertain and therefore vary widely. We anticipate that we will make determinations as to which research and development projects to pursue and how much funding to direct toward each project on an on-going basis in response to the scientific and clinical success in each program.

 

General and Administrative Expense

 

General and administrative expense consists primarily of compensation, including stock-based, and other expenses related to our corporate administrative employees, legal fees and other professional services expenses. We anticipate that we will maintain our existing level of general and administrative expenditures. However, we will make determinations as to the necessary levels of general and administrative expenditures on an on-going basis relative to our research and development activities and regulatory obligations.

 

Interest Income

 

Interest income consists of interest earned on our cash and cash equivalents and short-term investments.

 

Interest Expense

 

Interest expense in 2007 and 2006 includes interest charges associated with the line of credit and equipment financing facility which we entered into with Silicon Valley Bank and Oxford Finance Corporation in September 2005. Interest expense in 2005 represents interest on our debt and secured promissory notes in an aggregate principal amount of $13.4 million that we issued in two tranches in a secured bridge financing in July and September 2004, which were converted into redeemable convertible preferred stock in April 2005.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those estimates. While our significant accounting policies are described in more detail in Note 1 of the Notes to Consolidated Financial Statements included elsewhere in this report, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements:

 

Revenue Recognition

 

Our collaboration agreements and commercial agreements contain multiple elements, including non-refundable upfront fees, payments for reimbursement of research costs, payments for ongoing research, payments associated with achieving specific milestones and, in the case of our collaboration agreements, development milestones and royalties based on specified percentages of net product sales, if any. We apply the revenue recognition criteria outlined in Staff Accounting Bulletin No. 104, Revenue Recognition and Emerging Issues Task Force Issue 00-21, Revenue Arrangements with Multiple Deliverables , or EITF 00-21. In applying these revenue recognition criteria, we consider a variety of factors in determining the appropriate method of revenue recognition under these arrangements, such as whether the elements are separable, whether there are determinable fair values and whether there is a unique earnings process associated with each element of a contract.

Cash received in advance of services being performed is recorded as deferred revenue and recognized as revenue as services are performed over the applicable term of the agreement.

 

When a payment is specifically tied to a separate earnings process, revenues are recognized when the specific performance obligation associated with the payment is completed. Performance obligations typically consist of significant and substantive milestones pursuant to the related agreement. Revenues from milestone payments may be considered separable from funding for research services because of the uncertainty surrounding the achievement of milestones for products in early stages of development. Accordingly, these payments could be recognized as revenue if and when the performance milestone is achieved if they represent a separate earnings process as described in EITF 00-21.

 

In connection with certain research collaborations and commercial agreements, revenues are recognized from non-refundable upfront fees, which we do not believe are specifically tied to a separate earnings process, ratably over the term of the agreement. Research services provided under some of our collaboration agreements and commercial agreements are on a fixed fee basis. Revenues associated with long-term fixed fee contracts are recognized based on the performance requirements of the agreements and as services are performed.

 

Revenues derived from reimbursement of direct out-of-pocket expenses for research costs associated with grants are recorded in compliance with EITF Issue 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent , and EITF Issue 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred. According to the criteria established by these EITF Issues, in transactions where we act as a principal, with discretion to choose suppliers, bear credit risk and perform part of the services required in the transaction, we record revenue for the gross amount of the reimbursement. The costs associated with these reimbursements are reflected as a component of research and development expense in the statements of operations.

 

None of the payments that we have received from collaborators to date, whether recognized as revenue or deferred, is refundable even if the related program is not successful.

 

Stock-Based Compensation Expense

 

In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based Payment , which requires companies to expense the estimated fair value of employee stock options and similar awards. This statement is a revision to SFAS No. 123, Accounting for Stock-Based Compensation , and supersedes Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees , and amends FASB Statement No. 95, Statement of Cash Flows. The accounting provisions of SFAS No. 123R became effective for us at the beginning of the first quarter of 2006.

 

We grant options to purchase our common stock to our employees and directors under our stock option plans. Eligible employees can also purchase shares of our common stock under the employee stock purchase plan at the lower of: (i) 85% of the fair market value on the first day of a two-year offering period; or (ii) 85% of the fair market value on the last date of each six-month purchase period within the two-year offering period. The benefits provided under these plans are stock-based payments subject to the provisions of SFAS 123R. Effective January 1, 2006, we began to use the fair value method to apply the provisions of SFAS 123R with a modified prospective application which provides for certain changes to the method for valuing stock-based compensation. The valuation provisions of SFAS 123R apply to new awards and to awards that were outstanding on January 1, 2006 and subsequently modified or cancelled. Under the modified prospective application, prior periods are not revised for comparative purposes. Prior to adopting the provisions of SFAS 123R, we recorded estimated compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to APB Opinion 25. Stock-based compensation expense recognized under SFAS 123R for the years ended December 31, 2007 and 2006 was $3.3 million and $4.4 million, respectively (excluding stock-based compensation expense for share based awards to non-employees). At December 31, 2007, total unrecognized estimated compensation expense related to non-vested stock options granted prior to that date was $2.6 million, which is expected to be recognized over a weighted average period of 2.45 years. Total stock options granted during the year ended December 31, 2007 and 2006 represented 4.1% and 5.0% of total outstanding shares as of the end of 2007 and 2006, respectively.

Both prior and subsequent to the adoption of SFAS 123R, we estimated the value of stock-based awards on the date of grant using the Black-Scholes option pricing model. Prior to the adoption of SFAS 123R, the value of each stock-based award was estimated on the date of grant using the Black-Scholes model for the pro forma information required to be disclosed under SFAS 123. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, risk-free interest rate and the expected term of the awards.

 

For purposes of estimating the fair value of stock options granted during the years ended December 31, 2007 and 2006 using the Black-Scholes model, we have made a subjective estimate regarding our stock price volatility (weighted average of 73%). Expected volatility is based on average volatilities of the common stock of comparable publicly traded companies using a blend of historical, implied and average of historical and implied volatilities for this peer group of 10 companies, consistent with the guidance in SFAS 123R and Staff Accounting Bulletin No. 107, Share Based Payment or SAB 107. If our stock price volatility assumption were increased to 78%, the weighted average estimated fair value of stock options granted during the year ended December 31, 2007 and 2006 would increase by $0.11 per share, or 4.1%, from $2.69 to $2.80 and $0.49 per share, or 11%, from $4.36 to $4.85, respectively.

 

As permitted by SAB 107, we utilize the “shortcut approach” to estimate an option’s expected term, which represents the period of time that an option granted is expected to be outstanding. The expected term of options granted is derived from the average midpoint between vesting and the contractual term.

 

The risk-free interest rate for the expected term of the option is based on the average U.S. Treasury yield curve on the first day of each month for which the option is granted for the expected term (weighted average of 4.6% and 4.7% for the years ended December 31, 2007 and 2006, respectively) which, if increased to 6.00%, would increase the weighted average estimated fair value of stock options granted during the years ended December 31, 2007 and 2006 by $0.05 per share, or 1.9% and $0.10 per share, or 2.4%, respectively.

 

We are required to assume a dividend yield as an input to the Black-Scholes model. The dividend yield assumption is based on our history. As we have never issued dividends and as we do not anticipate paying dividends in the foreseeable future, we have utilized a dividend yield of 0.0% for the years ended December 31, 2007 and 2006.

 

Prior to 2006, stock-based compensation expense for stock options granted to employees and directors had been determined as the difference between the exercise price and the fair value of our common stock on the date of grant, as estimated by us for financial reporting purposes, on the date those options were granted. It also included stock-based compensation for options granted to consultants that has been determined in accordance with Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation , or SFAS 123, and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods and Services , as the fair value of the equity instruments issued and is periodically revalued as the options vest. Stock-based compensation expense depends on the amount of stock options and other equity compensation awards we grant to our employees, consultants and directors and the exercise price of those options.

 

Deferred stock compensation, which is a non-cash charge, results from employee stock option grants at exercise prices that, for financial reporting purposes, are deemed to be below the estimated fair value of the underlying common stock on the date of grant. Given the absence of an active market for our common stock through 2005, our board of directors considered, among other factors, the liquidation preferences, anti-dilution protection and voting preferences of the preferred stock over the common stock in determining the estimated fair value of the common stock for purposes of establishing the exercise prices for stock option grants.

 

As a result of initiating our initial public offering, we revised our estimate of the fair value of our common stock for the year ended December 31, 2005 for financial reporting purposes. This was done retrospectively by management and we did not obtain contemporaneous valuations from an independent valuation specialist. In reassessing the value of our common stock in 2005, we considered the price we received in April 2005 for our Series B preferred stock and then steadily increased the estimated fair value to $14.06 per common share up to the

time of our initial public offering based on an assessment of market considerations, including discussions with the underwriters who managed the initial public offering, and other factors. Furthermore, we believe this valuation approach is consistent with valuation methodologies applied to other similar companies for financial reporting purposes pursuing an initial public offering.

 

For stock option and restricted stock grants to employees and non-employee directors prior to December 31, 2005, we recorded deferred stock compensation, net of forfeitures, totaling $13.6 million in 2005 which represents the difference between the revised fair value for financial reporting purposes of our common stock and the option exercise price at the date of grant. We also recorded deferred stock compensation of $1.7 million for the issuance of equity instruments to former employees and consultants in 2005. Deferred compensation was to be amortized to expense over the vesting period of the related options using an accelerated method. As a result of the adoption of SFAS 123R on January 1, 2006, these deferred compensation amounts, totaling $5.1 million, were reversed out of deferred compensation against additional paid-in capital and the expense will be taken in accordance with SFAS 123R for all remaining unvested grants.

 

Accrued Expenses

 

As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves identifying services which have been performed on our behalf, and estimating the level of service performed and the associated costs incurred for such service as of each balance sheet date in our financial statements. Examples of estimated expenses for which we accrue include contract service fees paid to contract manufacturers in conjunction with the production of clinical drug supplies and to contract research organizations, particularly in conjunction with the conduct of our clinical trials. In connection with such service fees, our estimates are most affected by our understanding of the status and timing of services provided relative to the actual levels of services incurred by such service providers. The majority of our service providers invoice us monthly in arrears for services performed. The date on which certain services commence, the level of services performed on or before a given date and the cost of such services are often determined based on subjective judgments. We make these judgments based upon the facts and circumstances known to us in accordance with United States generally accepted accounting principles.

 

Deferred Tax Asset Valuation Allowance

 

Our estimate for the valuation allowance for deferred tax assets requires us to make significant estimates and judgments about our future operating results. Our ability to realize the deferred tax assets depends on our future taxable income as well as limitations on utilization. A deferred tax asset must be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized prior to its expiration. The projections of our operating results on which the establishment of a valuation allowance is based involve significant estimates regarding future demand for our products, competitive conditions, product development efforts, approvals of regulatory agencies and product cost. We have recorded a full valuation allowance on our net deferred tax assets as of December 31, 2007 and 2006 due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future. These deferred tax assets primarily consist of certain net operating loss carry-forwards and research and development tax credits.

 

with the Novartis collaboration, is comprised of an increase of $1.7 million related to the amortization into revenue of the $20 million upfront payment received in 2006, $0.8 million increase in research services, which concluded in March 2008, and a decrease of $0.7 million related to reimbursement of out of pocket expenditures. Revenue related to our beamline services increased by approximately $0.5 million during 2007, as a result of an increased customer base combined with an increase in rates over prior year.

 

Research and Development Expense.   Research and development expense decreased to $42.2 million for the year ended December 31, 2007 from $46.9 million for the year ended December 31, 2006. The decrease of $4.7 million, or 10%, was primarily attributable to a $1.4 million decrease in depreciation expense, $1.4 million decrease in the use of outside services in connection with our MET and BCR-ABL programs, $1.3 million decrease in grant subcontractor expense, $0.4 million decrease in stock-based compensation expense and a $0.2 million decrease in external development costs. We anticipate that our existing level of expenditures will support our planned research and development activities in 2008. However, drug discovery and development outcomes, timelines and associated costs are uncertain and therefore vary widely. We anticipate that we will make determinations as to which research and development projects to pursue and how much funding to direct toward each project on an on-going basis in response to the scientific and clinical success of each program.

 

General and Administrative.   General and administrative expense decreased to $8.6 million for the year ended December 31, 2007 from $9.6 million for the year ended December 31, 2006. The decrease of $1.0 million, or 10%, was primarily attributable to a decrease of $0.8 million in stock-based compensation expense, $0.3 million decrease in consulting expense, and $0.3 million decrease in legal and professional fees offset by an increase of $0.3 million in license and patent services and a $0.2 million increase in facilities and utilities expense. We anticipate that we will maintain our existing level of general and administrative expenditures in 2008. However, we will make determinations as to the necessary levels of general and administrative expenditures on an on-going basis relative to our research and development activities and regulatory obligations.

 

Interest Income.   Interest income decreased to $1.0 million for the year ended December 31, 2007 from $1.8 million for the year ended December 31, 2006. The decrease of $0.8 million, or 44%, was due primarily to a realized loss of $0.5 million on a short-term investment in 2007 and lower cash balances during the majority of 2007 compared to 2006. Consistent with our investment policy guidelines, we purchased an auction rate security (ARS) during 2007. This security had an AAA/Aaa credit rating at the time of purchase, which remains unchanged. With the liquidity issues experienced in global credit and capital markets, the ARS held by us at December 31, 2007 has experienced multiple failed auctions. The estimated market value of this ARS at December 31, 2007 was $1.0 million, which reflects a $0.5 million adjustment to the par value of $1.5 million. Although the ARS continues to pay interest according to its stated terms, based on uncertainties surrounding this investment, continued failure of auctions and a downward trend on bid quotes through December 31, 2007, we recorded an impairment charge of $0.5 million in the fourth quarter of 2007, reflecting an other-than-temporary decline in value.

 

Interest Expense.   Interest expense decreased to $0.8 million for the year ended December 31, 2007 from $1.1 million for the year ended December 31, 2006, due to the decrease in our debt obligations.

 

Year Ended December 31, 2006 Compared to 2005

 

Collaboration, Commercial Agreement and Grant Revenue.   Collaboration, commercial agreement and grant revenue increased to $27.8 million for the year ended December 31, 2006 from $21.6 million for the year ended December 31, 2005. The increase of $6.1 million, or 28%, was primarily due to the amortization into revenue of the $20 million upfront payment received from Novartis (approximately $3.8 million), the initiation of the research services (approximately $3.4 million) and reimbursement of out of pocket expenses (approximately $1.6 million), both in connection with the collaboration with Novartis, increased research grant efforts (approximately $0.8 million) and the increase in the level of research services performed in connection with the Cystic Fibrosis Foundation Therapeutics, Inc. (approximately $0.9 million). These additional revenues were offset by a reduction in revenues due to the conclusion of research services in 2006 which were ongoing in 2005.

 

Research and Development Expense.   Research and development expense increased to $46.9 million for the year ended December 31, 2006 from $37.9 million for the year ended December 31, 2005. The increase of $9.0 million, or 24%, was primarily attributable to $3.7 million of additional clinical development costs for

Troxatyl, $2.1 million related to increased laboratory supply usage, $1.7 million related to an increased use of outside services, $2.2 million related to additional headcount and salaries, and $1.1 million related to additional facilities costs, offset by a $2.0 million net reduction in stock-based compensation expense.

 

General and Administrative.   General and administrative expense decreased to $9.6 million for the year ended December 31, 2006 from $11.8 million for the year ended December 31, 2005. The decrease of $2.2 million, or 19%, was primarily attributable to a decrease of $3.6 million in stock-based compensation expense offset by an increase of $0.5 million in legal and other professional services and a $0.5 million increase in accrued salaries and related costs.

 

Interest Income.   Interest income increased to $1.8 million for the year ended December 31, 2006 from $284,000 for the year ended December 31, 2005. The increase of $1.5 million, or 536%, was due primarily to higher cash and cash equivalent balances. The higher cash balances are the result of the proceeds received from our initial public offering in February 2006 and the Novartis agreement in March 2006.

 

Interest Expense.   Interest expense (excluding interest expense associated with our bridge notes issued in July and September 2004) increased to $1.1 million for the year ended December 31, 2006 from $422,000 for the year ended December 31, 2005. We did not receive any funds under the line of credit and equipment financing agreements with Silicon Valley Bank and Oxford Finance Corporation until September 2005. We also received funds under these arrangements in December 2005 and December 2006. Accordingly, the increase in interest expense was due to the higher debt levels in 2006 compared to 2005 (excluding indebtedness under our bridge notes issued in July and September 2004).

 

Interest Expense Associated with Bridge Notes.   We recorded interest expense of $1.2 million during the year ended December 31, 2005 related to the bridge notes issued in July and September 2004. We did not record any interest expense during the year ended December 31, 2006 related to these bridge notes as the notes were converted into preferred stock in April 2005.

 

under this line of credit and equipment financing agreement of approximately $1.1 million, and issued the lenders warrants to purchase an aggregate of 5,771 shares of our common stock at an exercise price of $9.42 per share.

 

As of December 31, 2007, an aggregate of approximately $4.2 million was outstanding under our line of credit and equipment financing agreement with Silicon Valley Bank and Oxford Finance Corporation entered into in 2005 and other lines of credit entered into prior to 2005. The debt agreements subject us to certain financial and non-financial covenants. As of December 31, 2007, we were in compliance with these covenants. These obligations are secured by our assets, excluding intellectual property, and are due in monthly installments through 2010. They bear interest at effective rates ranging from approximately 9.71% to 11.03% and are subject to prepayment fees of up to 4% of the outstanding principal balance as of the prepayment date. We made principal payments on our debt of approximately $3.5 million, $3.5 million, and $3.0 million for the years ended December 31, 2007, 2006, and 2005, respectively.

 

In March 2006, we entered into a license and collaboration agreement with Novartis to develop and commercialize BCR-ABL inhibitors for the treatment of CML. In connection with the license and collaboration agreement, Novartis paid us a non-refundable, non-creditable license fee of $20.0 million, which was received in May 2006. As of December 31, 2007, we had $10.8 million in deferred revenue related to the license fee, which will be amortized into revenue through the end of the research term, which ended in late March 2008.

 

In addition, Novartis Pharma AG purchased 637,755 shares of our common stock for $5.0 million in March 2006.

 

Cash Flows

 

Our cash flows for 2008 and beyond will depend on a variety of factors, some of which are discussed below.

 

As of December 31, 2007, cash and cash equivalents and short-term investments totaled approximately $39.0 million compared to $33.9 million at December 31, 2006, an increase of $5.1 million. The increase resulted primarily from the $23.2 million in net proceeds received from our private placement in November 2007, partially offset by net cash used to fund ongoing operations.

 

Net cash used in operating activities during 2007 was $14.3 million compared to $5.9 million in 2006. This increase is primarily due to the amortization of up-front fees received from Novartis during 2006 into revenue in 2007, offset by a decrease in our net loss. Net cash used in operating activities during 2006 was $5.9 million compared to $11.8 million in 2005. This decrease is primarily due to the receipt of up-front fees received from Novartis of $20.0 million during 2006 offset by a decrease in non-cash share-based compensation.

 

Net cash provided by investing activities was $4.1 million for 2007, and net cash used in investing activities was $7.5 million for 2006 and $1.3 million for 2005. These fluctuations resulted primarily from timing differences in investment purchases, sales and maturities and the fluctuations in our portfolio mix between cash equivalents and short-term investment holdings. We expect similar fluctuations to continue in future periods. Capital equipment purchases for 2007, 2006, and 2005 were $0.4 million, $1.5 million, and $1.3 million, respectively.

 

Net cash provided by financing activities during 2007 was $20.3 million compared to $23.5 million in 2006 and $19.4 million in 2005. In November 2007, we completed a private placement of shares of our common stock and warrants to purchase shares of our common stock pursuant to a securities purchase agreement. We received net proceeds after offering expenses of approximately $23.2 million from this transaction. During 2006, we received net proceeds of $25.6 million from the issuance of common stock in connection with our initial public offering ($20.6 million) and our collaboration agreement with Novartis ($5.0 million) and $1.1 million of proceeds from our line of credit and equipment financings. During 2005, we received net proceeds of $13.4 million from the issuance of preferred and common stock and $8.9 million in connection with proceeds from our line of credit and equipment financings. Principal payments on debt were $3.5 million, $3.5 million and $3.0 million in 2007, 2006 and 2005, respectively.

 

In June 2007, we provided notice of termination of our license agreement with Shire Biochem Inc. (“Shire”) for Troxatyl. This termination became effective in September 2007. We do not expect to incur any future costs related to Troxatyl.

We are unable to estimate with certainty the costs we will incur in the preclinical and clinical development of product candidates we may develop. We expect our cash outflow to increase as we advance product candidates through preclinical and clinical development if such development is not funded by a collaborator, such as Novartis in the case of the BCR-ABL compounds other than SGX393. We are funding the preclinical and any clinical development of SGX393. We are also currently funding the clinical development of SGX523. We expect to continue to expand our research and development activities relating to the clinical development and preclinical research of treatments in the oncology area, including programs focused on MET, BCR-ABL, and other oncology targets. We anticipate that we will make determinations as to which research and development projects to pursue, which to license to or partner with a third party, and how much funding to direct toward each project on an on-going basis in response to the scientific and clinical success of each product candidate and the potential terms associated with any particular licensing or partnering opportunity.

 

Funding Requirements

 

Our future capital uses and requirements depend on numerous factors, including but not limited to the following:

 

 

Historically, we have funded our operations through a combination of proceeds from offerings of our equity securities, collaborations, commercial agreements, grant revenue, and debt financing. As part of our business strategy, we expect to continue to establish new collaborations and commercial agreements. We believe that our existing cash, cash equivalents and short-term investments, together with interest thereon and cash from existing and new collaborations, commercial agreements and grants, will be sufficient to meet projected operating requirements into the second half of 2009. We expect to continue to finance our future cash needs through the sale of equity securities, strategic collaboration agreements and debt financing. However, we may not be successful in obtaining additional collaboration agreements or commercial agreements, or in receiving milestone or royalty payments under existing agreements. In addition, we cannot be sure that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. Failure to obtain adequate financing may also adversely affect our ability to operate as a going concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

 

Off-Balance Sheet Arrangements

 

As of December 31, 2007 and 2006, we have not invested in any variable interest entities. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties other than as described in the Notes to Financial Statements included elsewhere in this report.

 

 

Income Taxes

 

As of December 31, 2007, we had federal and California net operating loss carryforwards of approximately $124.2 million and $95.9 million, respectively, which begin to expire in 2019 and 2009, respectively, if not utilized. We also had federal and California research and development tax credit carryforwards totaling approximately $4.8 million and $3.2 million, respectively. The federal research and development tax credit carryforward will begin to expire in 2019, unless previously utilized and the California research and development tax credit will carry forward indefinitely until utilized.

 

Pursuant to Internal Revenue Code Sections 382 and 383, and similar state provisions, use of our net operating loss and tax credit carryforwards may be limited as a result of certain cumulative changes in our stock ownership. The annual limitations may result in the expiration of net operating losses and credits prior to utilization.

 

At December 31, 2007 and 2006, we had deferred tax assets of $10.8 million and $61.2 million, respectively. We did not record a benefit for the deferred tax assets because realization of the deferred tax assets was uncertain and, accordingly, a valuation allowance has been provided to completely offset the deferred tax assets.

 

Recently Issued Accounting Pronouncements

 

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”) , which clarifies the accounting for uncertainty in income taxes. FIN 48 requires that the Company recognize the impact of a tax position in its financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 were effective as of January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to retained earnings as of that date. The adoption of FIN 48 did not have a material impact on our consolidated financial statements.

 

As a result of the adoption of FIN 48, we have not recorded any changes to retained earnings on January 1, 2007, because we had no unrecognized tax benefits that, if recognized, would affect our effective income tax rate in future periods. At December 31, 2007, we had no unrecognized tax benefits. Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrued interest or penalties at either January 1, 2007 or December 31, 2007. All of our tax years remain subject to future examination by the major tax jurisdictions in which it is subject to tax.

 

We have not completed a study to assess whether a change in control has occurred, or whether there have been multiple changes of control since our formation, due to the significant complexity and cost associated with such study and the possibility that there could be additional changes in the future. If we experienced a greater than

50 percent change or shift in ownership over a 3-year time frame since its formation, utilization of its net operating losses or research and development credit carry forwards would be subject to an annual limitation under Sections 382 and 383. The annual limitation generally is determined by multiplying the value of our stock at the time of the ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Any limitation may result in expiration of a portion of the NOL or R&D credit carry forwards before utilization. Further, until a study is completed and any limitation known, no amounts are being presented as a deferred tax asset as these items represent an uncertain tax position under FIN 48.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies only to fair value measurements that are already required or permitted by other accounting standards. Accordingly, this SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after December 15, 2007. We do not currently expect the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. Under SFAS No. 159, a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees and issued debt. Other eligible items include firm commitments for financial instruments that otherwise would not be recognized at inception and non-cash warranty obligations where a warrantor is permitted to pay a third party to provide the warranty goods or services. If the use of fair value is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred. The fair value election is irrevocable and generally made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of SFAS No. 159, changes in fair value are recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and is required to be adopted by us in the first quarter of fiscal 2008. We do not currently expect the adoption of SFAS No. 159 to have a material impact on our consolidated financial statements.

 

In June 2007, the FASB ratified the consensus reached by the EITF on EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities, or EITF 07-3. EITF Issue No. 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed or such time when the entity does not expect the goods to be delivered or services to be performed. EITF No. 07-3 is effective, on a prospective basis, for fiscal years beginning after December 15, 2007. We do not currently expect the adoption of EITF No. 07-3 to have a material impact on our consolidated financial statements.

 

In November 2007, the EITF issued EITF Issue No. 07-1, Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property, or EITF 07-1. Companies may enter into arrangements with other companies to jointly develop, manufacture, distribute, and market a product. Often the activities associated with these arrangements are conducted by the collaborators without the creation of a separate legal entity (that is, the arrangement is operated as a “virtual joint venture”). The arrangements generally provide that the collaborators will share, based on contractually defined calculations, the profits or losses from the associated activities. Periodically, the collaborators share financial information related to product revenues generated (if any) and costs incurred that may trigger a sharing payment for the combined profits or losses. The consensus requires collaborators in such an arrangement to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. EITF No. 07-1 is effective for collaborative arrangements in place at the beginning of the annual period beginning after December 15, 2008.

We do not currently expect the adoption of EITF No. 07-1 to have a material impact on our consolidated financial statements.

 

 

 

The Board of Directors and Stockholders

SGX Pharmaceuticals, Inc.

 

We have audited the accompanying consolidated balance sheets of SGX Pharmaceuticals, Inc. as of December 31, 2007 and 2006 and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SGX Pharmaceuticals, Inc., at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

 

As discussed in Note 1 to the consolidated financial statements, SGX Pharmaceuticals, Inc. changed its method of accounting for share based payments in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004) effective January 1, 2006.

 

 

San Diego, California

March 24, 2008

SGX Pharmaceuticals, Inc.

 

Consolidated Balance Sheets

 

 

See accompanying notes.

 

See accompanying notes.

 

See accompanying notes.