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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

[ ]

TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 000-26534

VION PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)


Delaware 13-3671221
(State or other jurisdiction of
incorporation or organization)		 (I.R.S. Employer Identification No.)
    
4 Science Park
New Haven, CT 06511		 06511
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (203) 498-4210

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 [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

The number of shares outstanding of the registrant's common stock as of November 5, 2004 was 55,851,300.



VION PHARMACEUTICALS, INC.
TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION


    Page No.
Item 1. Financial Statements   1  
  Condensed Balance Sheets   1  
  Condensed Statements of Operations   2  
  Condensed Statement of Changes in Shareholders' Equity   3  
  Condensed Statements of Cash Flows   4  
  Notes to Condensed Financial Statements   5  
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   6  
Item 3. Quantitative and Qualitative Disclosures About Market Risk   14  
Item 4. Controls and Procedures   14  
  PART II – OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   15  
Item 6. Exhibits   15  
SIGNATURES

In this report, unless the context otherwise requires, the terms "we," "us," "our," "the Company" and "Vion" refer to Vion Pharmaceuticals, Inc., a Delaware corporation.



PART I

FINANCIAL INFORMATION

ITEM 1.    Financial Statements

Vion Pharmaceuticals, Inc.
(A Development Stage Company)

Condensed Balance Sheets
(Unaudited)


(In thousands, except share and per share data) September 30,
2004		 December 31,
2003
             
ASSETS            
             
Current Assets:            
Cash and cash equivalents $ 43,969   $ 1,219  
Short-term investments   —     14,500  
Total cash, cash equivalents and short-term investments   43,969     15,719  
Interest receivable   —     11  
Accounts receivable   47     27  
Prepaid expenses   785     224  
Total current assets   44,801     15,981  
Property and equipment, net   553     370  
Security deposits   25     25  
Total assets $ 45,379   $ 16,376  
             
LIABILITIES AND SHAREHOLDERS' EQUITY            
             
Current Liabilities:            
Accrued payroll and payroll-related expenses $ 361   $ 464  
Accounts payable and accrued expenses   4,283     3,595  
Deferred revenue   18     18  
Total current liabilities   4,662     4,077  
Deferred revenue   364     377  
Total liabilities   5,026     4,454  
             
Shareholders' Equity:            
Preferred stock, $0.01 par value, authorized: 5,000,000 shares; issued and outstanding: none   —     —  
Common stock, $0.01 par value, authorized: 150,000,000 shares; issued and outstanding: 55,432,601 and 39,276,755 shares at September 30, 2004 and December 31, 2003, respectively   554     393  
Additional paid-in-capital   166,342     127,239  
Deficit accumulated during the development stage   (126,543 )    (115,710 ) 
    40,353     11,922  
Total liabilities and shareholders' equity $ 45,379   $ 16,376  

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

1



Vion Pharmaceuticals, Inc.
(A Development Stage Company)

Condensed Statements of Operations
(Unaudited)


  For the Three Months Ended
September 30,		 For the Nine Months Ended
September 30,		 May 1, 1994 (Inception)
throught
September 30, 2004
(In thousands, except per share data) 2004 2003 2004 2003
Revenues:
Contract research grants $ —   $ 14   $ 100   $ 152   $ 2,501  
Research and laboratory support fees   45     74     149     101     5,931  
Technology license fees   5     6     22     12     4,483  
Total revenues   50     94     271     265     12,915  
Operating expenses:
Clinical trials   2,247     1,446     6,081     4,043     33,220  
Other research and development   1,050     1,065     3,169     2,921     65,741  
Total research and development   3,297     2,511     9,250     6,964     98,961  
General and administrative   789     563     2,132     1,919     26,872  
Total operating expenses   4,086     3,074     11,382     8,883     125,833  
Loss from operations   (4,036 )    (2,980 )    (11,111 )    (8,618 )    (112,918 ) 
Interest income   148     32     354     87     5,227  
Interest expense   —     —     —     —     (210 ) 
Other expense, net   (18 )    —     (42 )    —     (87 ) 
Loss before income taxes   (3,906 )    (2,948 )    (10,799 )    (8,531 )    (107,988 ) 
Income tax provision (benefit)   —     27     34     5     (189 ) 
Net loss   (3,906 )    (2,975 )    (10,833 )    (8,536 )    (107,799 ) 
Preferred stock dividends and accretion   —     —     —     —     (18,489 ) 
Loss applicable to common shareholders $ (3,906 )  $ (2,975 )  $ (10,833 )  $ (8,536 )  $ (126,288 ) 
Loss applicable to common shareholders per share $ (0.07 )  $ (0.09 )  $ (0.21 )  $ (0.28 ) 
Weighted-average number of shares of common stock outstanding   55,398     33,631     52,687     30,628  

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

2



Vion Pharmaceuticals, Inc.
(A Development Stage Company)

Condensed Statement of Changes in Shareholders' Equity
(Unaudited)


  Common Stock Additional
Paid-in
Capital		 Accumulated
Other
Comprehensive
Income (Loss)		 Accumulated
Deficit		 Total
Shareholders'
Equity
(In thousands, except share data) Shares Amount
Balance at December 31, 2000   26,167,642   $ 262   $ 100,027   $ 120   $ (77,752 )  $ 22,657  
Public offering – August 2001   2,500,000     25     11,386                 11,411  
Exercise of stock options   191,527     2     777                 779  
Exercise of warrants   4,015     —     14                 14  
Compensation associated with stock option grants               111                 111  
Issuances under employee benefit plans   10,189     —     62                 62  
Change in net unrealized gains and losses                     (126 )          (126 ) 
Net loss                           (13,810 )    (13,810 ) 
Comprehensive loss                                 (13,936 ) 
Balance at December 31, 2001   28,873,373   $ 289   $ 112,377   $ (6 )  $ (91,562 )  $ 21,098  
Exercise of stock options   10,395     —     32                 32  
Issuances under employee benefit plans   25,104     —     38                 38  
Change in net unrealized gains and losses                     6           6  
Net loss                           (12,310 )    (12,310 ) 
Comprehensive loss                                 (12,304 ) 
Balance at December 31, 2002   28,908,872   $ 289   $ 112,447   $ —   $ (103,872 )  $ 8,864  
Private placement – June 2003   3,846,150     38     4,436                 4,474  
Private placement – September 2003   6,475,000     65     10,340                 10,405  
Exercise of stock options   5,552     -     3                 3  
Issuances under employee benefit plans   41,181     1     13                 14  
Net loss                           (11,838 )    (11,838 ) 
Comprehensive loss                                 (11,838 ) 
Balance at December 31, 2003   39,276,755   $ 393   $ 127,239   $ —   $ (115,710 )  $ 11,922  
Private placement – February 2004   13,553,845     136     32,831                 32,967  
Exercise of stock options   26,441     -     67                 67  
Exercise of warrants   2,568,868     25     6,196                 6,221  
Issuance under employee benefit plans   6,692           9                 9  
Net loss                           (10,833 )    (10,833 ) 
Comprehensive loss                                 (10,833 ) 
Balance at September 30, 2004   55,432,601   $ 554   $ 166,342   $ —   $ (126,543 )  $ 40,353  
                                     

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

3



Vion Pharmaceuticals, Inc.
(A Development Stage Company)

Condensed Statements of Cash Flows
(Unaudited)


  For the Nine Months
Ended September 30,		 For The Period From
May 1, 1994
(Inception) through
September 30, 2004
(In thousands) 2004 2003
Cash flows from operating activities:                  
Net loss $ (10,833 )  $ (8,536 )  $ (107,799 ) 
Adjustments to reconcile net loss to net cash used in operating activities-                  
Depreciation and amortization   152     148     2,767  
Loss on equipment disposals   —     8     12  
(Decrease) increase in deferred revenue   (13 )          382  
Purchased research and development   —     —     4,481  
Non-cash compensation   —     —     1,068  
Stock issued for services   —     —     600  
Amortization of financing costs   —     —     346  
Extension/reissuance of placement agent warrants   —     —     168  
Changes in operating assets and liabilities-                  
Receivables and prepaid expenses   (570 )    243     (831 ) 
Other assets   —     —     (22 ) 
Current liabilities   585     1,631     4,609  
Net cash used in operating activities   (10,679 )    (6,506 )    (94,219 ) 
Cash flows from investing activities:                  
Purchases of marketable securities   (61,901 )    —     (321,052 ) 
Maturities of marketable securities   76,401     —     321,052  
Acquisition of equipment   (335 )    (59 )    (2,388 ) 
Net cash provided by (used in) investing activities   14,165     (59 )    (2,388 ) 
Cash flows from financing activities:                  
Initial public offering   —     —     9,696  
Net proceeds from issuances of common stock   33,043     14,849     81,828  
Net proceeds from issuance of preferred stock   —     —     20,716  
Net proceeds from exercise of Class A Warrants   —     —     5,675  
Net proceeds from exercise of Class B Warrants   —     —     17,538  
Net proceeds from exercise of other warrants   6,221     —     6,336  
Repayment of equipment capital leases   —     —     (927 ) 
Other financing activities, net   —     —     (286 ) 
Net cash provided by financing activities   39,264     14,849     140,576  
Change in cash and cash equivalents   42,750     8,284     43,969  
Cash and cash equivalents, beginning of period   1,219     10,131     —  
Cash and cash equivalents, end of period $ 43,969   $ 18,415   $ 43,969  
Supplemental disclosure of cash flow information:                  
Cash paid for interest $ —   $ —   $ 210  
Cash paid for taxes $ 5   $ —   $ 22  

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

4



Vion Pharmaceuticals, Inc.
(A Development Stage Company)

Notes to Condensed Financial Statements
(Unaudited)

1.    The Company

Vion Pharmaceuticals, Inc. (the "Company") is a development stage company engaged in the development of novel therapeutics for the treatment of cancer. The Company, formerly OncoRx, Inc., was incorporated in March 1992 as a Delaware corporation and began operations on May 1, 1994.

2.    Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q. They do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2003 (File No. 000-26534).

3.    Private Placement of Common Stock

In February 2004, the Company completed a private placement of 13,553,845 shares of its common stock at $2.60 per share and warrants to purchase 3,388,463 shares of common stock at $3.25 per share. The net proceeds, net of cash offering costs, were $32.9 million. A warrant to purchase an additional 300,000 shares of common stock at $3.25 per share was issued to the placement agent. All of these warrants expire on February 11, 2009. Beginning May 27, 2005, if the volume weighted-average price of the Company's common stock is at or above $4.875 per share for 20 consecutive trading days, then the warrants shall become callable by the Company upon written notice within 10 trading days of such period.

4.    Warrant Exercises

For the nine months ended September 30, 2004, the Company issued 2,568,868 shares of its common stock upon exercises of warrants issued in connection with private placements in 2003 and 2004, resulting in proceeds of $6.2 million.

5.    Per Share Data – Anti-dilution

As of September 30, 2004, the Company had outstanding warrants to purchase 9,825,670 shares of its common stock at exercise prices between $2.20 and $6.00 per share, and outstanding stock options to purchase 4,616,078 shares of its common stock at exercise prices between $0.36 and $17.88 per share. These warrants and options were excluded from the computation of diluted loss per share because such warrants and options were anti-dilutive in the respective periods presented.

6.    Income Taxes

For the nine months ended September 30, 2004, the Company recorded a provision of $34,000 for minimum state capital taxes. For the nine months ended September 30, 2003, the Company recorded a provision of $5,000 which reflected a provision for minimum state capital taxes of $27,000, net of a state tax benefit of $22,000 for the sale of certain research and development tax credits to the State of Connecticut.

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7.    Stock-Based Compensation

The Company follows Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related interpretations in accounting for stock-based compensation issued to employees rather than the alternative fair value accounting method provided for under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). Under APB 25, no compensation expense is recognized if the terms of the option are fixed and the exercise price of the option granted equals the market price of the underlying stock on the date of grant. For the nine-month periods ended September 30, 2004 and 2003, no stock-based compensation cost is reflected in the Company's reported net loss.

The following tables illustrate the assumptions used and the effect on net loss and net loss per share if the Company had applied the fair value recognition provision of SFAS 123 to employee stock-based compensation. The Company has computed the pro forma disclosures required under SFAS 123, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure" ("SFAS 148"), for all employee stock options granted using the Black-Scholes option pricing model prescribed by SFAS 123.


  For the Three Months
Ended September 30,		 For the Nine Months
Ended September 30,
  2004 2003 2004 2003
Risk-free interest rate   3.90 %    3.16 %    4.07 %    3.16 % 
Expected volatility   77 %    170 %    88 %    170 % 
Expected life (in years)   5.92     5.91     5.90     5.91  
Expected dividend yield   0 %    0 %    0 %    0 % 

  For the Three Months
Ended September 30,		 For the Nine Months
Ended September 30,		 From Inception
(May 1, 1994)
through
September 30,
  2004 2003 2004 2003 2004
                               
Reported net loss $ (3,906 )  $ (2,975 )  $ (10,833 )  $ (8,536 )  $ (126,288 ) 
Add: Stock-based employee compensation expense included in reported net loss   —     —     —     —     768  
Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards   (459 )    (702 )    (1,406 )    (2,383 )    (20,520 ) 
Pro forma net loss   (4,365 )    (3,677 )    (12,239 )    (10,919 )    (146,040 ) 
Pro forma preferred stock dividend and accretion   —     —     —     —     (18,489 ) 
Pro forma loss applicable to common shareholders $ (4,365 )  $ (3,677 )  $ (12,239 )  $ (10,919 )  $ (164,529 ) 
Reported basic and diluted loss applicable to common shareholders per share $ (0.07 )  $ (0.09 )  $ (0.21 )  $ (0.28 ) 
Pro forma basic and diluted loss applicable to common shareholders per share $ (0.08 )  $ (0.11 )  $ (0.23 )  $ (0.36 ) 

ITEM 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q, including without limitation statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations," regarding our financial position, business strategy, and plans and objectives of our management for future operations, are forward-looking statements.

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When used in this Quarterly Report on Form 10-Q, words such as "may," "will," "should," "could," "potential," "seek," "project," "predict," "anticipate," "believe," "estimate," "expect," "intend" and similar expressions, as they relate to us or our management, identify forward-looking statements. Forward-looking statements are based on the beliefs of our management as well as assumptions made by and information currently available to our management. Such statements are subject to certain risk factors which may cause our plans to differ or results to vary from those expected, including our ability to secure external sources of funding to continue operations, the inability to access capital and funding on favorable terms, continued operating losses and the inability to continue operations as a result, our dependence on regulatory approval for our products, delayed or unfavorable results of drug trials, the possibility that favorable results of earlier clinical trials are not predictive of safety and efficacy results in later clinical trials, the need for additional research and testing, and a variety of other risks set forth from time to time in our filings with the U.S. Securities and Exchange Commission including, but not limited to, the detailed discussion of risks attendant to the forward-looking statements included under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K/A for the year ended December 31, 2003. The information contained in this Quarterly Report on Form 10-Q is believed to be current as of the date of filing with the U.S. Securities and Exchange Commission. Except in special circumstances in which a duty to update arises under law when prior disclosure becomes materially misleading in light of subsequent events, we do not intend to update any of these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview

We are a development stage company engaged in the development of novel therapeutics for the treatment of cancer. Our activities to date have consisted primarily of research and product development, obtaining regulatory approval for clinical trials, conducting clinical trials, negotiating and obtaining collaborative agreements, and obtaining financing in support of these activities. Our revenues primarily consist of contract research grants, technology license fees, and research and laboratory support fees. Since inception, we have generated minimal revenues and have incurred substantial operating losses from our activities. We expect to incur substantial operating losses for the next several years due to expenses associated with our activities.

We have five research and development projects, which include two product candidates in clinical trials (CLORETAZINE™ (VNP40101M) and Triapine®), two product development programs in preclinical development (KS119 and heterocyclic hydrazones) and one product development program for which we are seeking a development partner (TAPET®). The following table provides information on clinical trials sponsored by us which were open for patient enrollment as of October 31, 2004.


Product Trial Trial Commencement Date
CLORETAZINE™
(VNP40101M)		 Phase II trial in acute myeloid leukemia and myelodysplastic syndromes March 2004
  Phase I trial in combination with temozolomide in patients with hematologic malignancies October 2004
Triapine® Phase II trial of 24-hour infusion in combination with gemcitabine in pancreatic cancer September 2004

In addition to the above-listed clinical trial for CLORETAZINE™ (VNP40101M), a Phase II trial in primary brain tumors was initiated in May 2004 under an investigator's IND. We provide product for this trial and incur certain costs related to patient enrollment.

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In addition to above-listed clinical trial for Triapine®, the National Cancer Institute (NCI) is also sponsoring several Phase I and Phase II single agent or combination clinical trials of that compound. In January 2004, we announced the first trial to open under NCI sponsorship. We are expected to provide product for the NCI trials.

Our plan of operations for the next 12 months includes the following elements:

•  Conduct Phase II clinical studies of an intravenous formulation of Triapine® in combination with standard chemotherapy treatments;
•  Provide product for Phase I and Phase II clinical studies to be sponsored by the NCI of an intravenous formulation of Triapine® as a single agent and in combination with standard chemotherapy treatments;
•  Provide product for Phase I clinical studies to be sponsored by the NCI of an oral formulation of Triapine®;
•  Conduct Phase I, Phase II and Phase III clinical studies of CLORETAZINE™ (VNP40101M) as a single agent or in combination with standard chemotherapy treatments;
•  Provide product and make payments related to certain patient costs for a Phase II study of CLORETAZINE™ (VNP40101M) in primary brain tumors to be conducted under an investigator's IND;
•  Conduct additional clinical trials of Triapine® and/or CLORETAZINE™ (VNP40101M), depending on the results of the clinical trials already underway;
•  Continue to conduct internal product development studies with respect to our clinical products and other product candidates that we may identify, including heterocyclic hydrazones and KS119;
•  Seek development partners for our TAPET® product development program;
•  Continue to support research and development being performed at Yale University and by other collaborators; and
•  Continue to seek collaborative partnerships, joint ventures, co-promotional agreements or other arrangements with third parties.

Completion of clinical trials may take several years or more and the length of time can vary substantially according to the type, complexity, novelty and intended use of a product candidate. The types of costs incurred during a clinical trial vary depending upon the type of product candidate, the disease treated and the nature of the study.

Given the uncertainties related to pharmaceutical product development, we are currently unable to reliably estimate when, if ever, our product candidates will generate revenue and cash flows. We do not expect to receive net cash inflows from any of our major research and development projects until and unless a product candidate becomes a profitable commercial product.

If we enter into Phase III or registrational clinical trials of a product and achieve successful completion of those trials, of which there can be no certainty, we intend to submit the results to the FDA to support regulatory approval of the product. However, we cannot be certain that any of our products will prove to be safe or effective, will achieve the safety and efficacy needed to enter into Phase III or registrational clinical trials, will receive regulatory approvals, or will be successfully commercialized. Our clinical trials might prove that our product candidates may not be effective in treating the disease or have undesirable or unintended side effects, toxicities or other characteristics that require us to cease further development of the project. The cost to take a product candidate through clinical trials is dependent upon, among other things, the disease indications, the timing, the size and dosing schedule of each clinical trial, the number of patients enrolled in each trial and the speed at which patients are enrolled and treated. We could incur increased product development costs if we experience delays in trial enrollment, the evaluation of clinical trial results or regulatory approvals. Significant delays could allow our competitors to bring products to market before we do

8



and impair our ability to commercialize our product candidates. These uncertainties and variability make it difficult to accurately predict the future cost of or timing to complete our product development projects.

We budget and monitor our research and development costs by category. Significant categories of costs include personnel, clinical, third party research and development services, and laboratory supplies.

Critical Accounting Policies and Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. These estimates form the basis for making judgments about the carrying values of assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates.

We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.

Revenue Recognition

We record revenue from contract research grants as the costs are incurred. We are reimbursed for eligible costs after submission of grant reports. We are subject to grant audits as required by the Department of Health and Human Services. Audits may result in adjustments to the amount of grant revenues recorded and funds received.

We record revenue under technology license agreements related to the following. Actual license fees received may vary from recorded estimated revenues.

•  Nonrefundable upfront license fees for which no further performance obligations exist are recognized as revenue on the earlier of when payments are received or collection is assured;
•  Nonrefundable upfront license fees including guaranteed, time-based payments that require continuing involvement in the form of development or other efforts by us are recognized as revenue ratably over the performance period; and
•  Milestone payments are recognized as revenue when milestones, as defined in the applicable agreement, are achieved.

We record revenue from royalties, if any, based on licensees' sales of our products or technologies. Revenues are recognized as earned in accordance with the contract terms when royalties from licensees can be reliably measured and collectibility is reasonably assured. Royalty estimates are made in advance of amounts collected based on historical and forecasted trends.

We record revenue from laboratory and research support as the services are provided. Actual laboratory and research support fees collected may vary from revenue recognized.

The effect of any change in revenues from contract research grants, technology license agreements, or laboratory and research support would be reflected in revenues in the period such determination was made. Historically, such adjustments have been insignificant.

Research and Development Expenses

We record research and development expenses as incurred. We disclose clinical trials expenses and other research and development expenses as separate components of research and development expense in our statements of operations to provide more meaningful information to our investors. The

9



classification of expenses into these components of research and development expense are based, in part, on estimates of certain costs when incurred. The effect of any change in the clinical trials expenses and other research and development expenses would be reflected in the period such determination was made.

Income Taxes

We provide deferred income taxes for the future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities, and on operating loss and tax credit carryforwards. Except for the sales recorded in 2002 and 2003 of certain research and development tax credits to the State of Connecticut and the provisions recorded in 2003 and 2004 for minimum state capital taxes, we have not recorded a provision or benefit for income taxes in the financial statements due to recurring historical losses and based on judgments regarding the timing of future profitability. Accordingly, we have provided a full valuation allowance for our deferred income tax asset as of September 30, 2004. In the event we were to determine that we would be able to realize deferred income tax assets in the future, an adjustment to increase income in that period of determination would be made.

Stock-Based Compensation

We measure stock-based compensation expense under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and related Interpretations, and provide required disclosures under the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure."

Investments

Our investment securities are classified as available-for-sale and carried at fair market value. Unrealized gains or losses are recorded in other comprehensive income until the securities are sold or otherwise disposed. However, a decline in fair market value below cost that is other than temporary would be accounted for as a realized loss in the period such determination was made.

Recently Enacted Pronouncements

There may be potential new accounting pronouncements or regulatory rulings, which may have an impact on our future financial position and results of operations. On October 13, 2004, the FASB concluded that Statement 123R, "Share-Based Payment - An Amendment of FASB Statements No. 123 and 95", would be effective for public companies for interim or annual periods beginning after June 15, 2005. We will be required to adopt Statement 123R in our financial statements for the quarter ended September 30, 2005. The cumulative effect of adoption, if any, would be measured and recognized on July 1, 2005. The FASB's current plan is to issue a final Statement on or around December 15, 2004. The proposed Statement addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. The proposed Statement would eliminate the ability to account for share-based compensation transactions using APB 25 and generally would require instead that such transactions be accounted for using a fair-value based method. As proposed, companies would be required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. The FASB has tentatively concluded that companies could adopt the new standard in one of two ways: (1) the modified prospective transition method as proposed in the Exposure Draft, or (2) the modified retrospective transition method. We are currently evaluating our option valuation methodologies and assumptions in light of these evolving accounting standards related to employee stock options and employee stock purchase plan.

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Results of Operations

Comparison of the Three-Month Periods Ended September 30, 2004 and 2003

Revenues.    Revenues were $50,000 for the three months ended September 30, 2004, compared to $94,000 for the same period in 2003. The decrease was due primarily to lower revenues from research and laboratory support fees, and lower revenues from contract research grants. All revenues under contract research grants have been fully recognized.

Research and Development Expenses.    Total research and development expenses (which include clinical trials expenses and other research and development expenses) were $3.3 million for the three months ended September 30, 2004, compared to $2.5 million for the same 2003 period. The increase in total research and development expenses was due to higher clinical trials expenses, which increased to $2.2 million for the third quarter of 2004 from $1.4 million for the same 2003 period. The increase in clinical trials expenses was due primarily to (1) higher drug production expense of $156,000 for Triapine and, to a lesser extent, CLORETAZINE™ (VNP40101M), (2) higher clinical consulting fees of $167,000, and (3) higher expense of $1 million for CLORETAZINE™ (VNP40101M) trials due to higher 2004 patient enrollment, partially offset by lower expense of $498,000 for Triapine® trials due primarily to lower 2004 patient enrollment. Other research and development expenses were $1.1 million for each of the three-month periods ended September 30, 2004 and 2003. We expect total research and development expenses to increase over time mainly due to conducting larger clinical trials, including planned commencement of a Phase III clinical trial of CLORETAZINE™ (VNP40101M) before the end of the first quarter of 2005, and additional development of our preclinical products.

General and Administrative Expenses.    General and administrative expenses increased to $789,000 for the three months ended September 30, 2004 from $563,000 for the same 2003 period. The increase was primarily due to employee recruiting fees incurred as we moved into late-stage clinical trials of products.

Interest Income.    Interest income was $148,000 for the three months ended September 30, 2004, as compared to $32,000 for the same 2003 period. The increase was primarily due to higher levels of invested funds in 2004.

Income Taxes.    For the three months ended September 30, 2004, there was no provision recorded for income taxes. For the three months ended September 30, 2003, a provision of $27,000 was recorded for minimum state capital taxes.

Net Loss.    The net loss was $3.9 million, or $0.07 per share, for the three months ended September 30, 2004, compared to a net loss of $3 million, or $0.09 per share, for the same 2003 period. Weighted-average common shares outstanding for the three months ended September 30, 2004 and 2003 were 55.4 million and 33.6 million, respectively.

Comparison of the Nine-Month Periods Ended September 30, 2004 and 2003

Revenues.    Revenues were $271,000 for the nine months ended September 30, 2004, compared to $265,000 for the same period in 2003. The increase was due to higher revenues from research and laboratory support fees and technology license fees, partially offset by lower revenues from contract research grants. All revenues under contract research grants have been fully recognized.

Research and Development Expenses.    Total research and development expenses (which include clinical trials expenses and other research and development expenses) were $9.3 million for the nine months ended September 30, 2004, compared to $7.0 million for the same 2003 period. Clinical trials expenses increased to $6.1 million for the nine months ended September 30, 2004 from $4.0 million for the same 2003 period. The increase in clinical trials expenses was due primarily to (1) higher drug production expense of $800,000 for Triapine and, to a lesser extent, CLORETAZINE™ (VNP40101M), (2) higher clinical consulting fees of $189,000, and (3) higher expense of $1.4 million for CLORETAZINE™ (VNP40101M) trials due to higher 2004 patient enrollment, partially offset by

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lower expense of $480,000 for Triapine® trials due primarily to lower 2004 patient enrollment. Other research and development expenses were $3.2 million for the nine months ended September 30, 2004, compared to $2.9 million for the same 2003 period. The increase was due primarily to higher expenses for lab supplies and consulting fees for preclinical development. We expect total research and development expenses to increase over time mainly due to conducting larger clinical trials, including planned commencement of a Phase III clinical trial of CLORETAZINE™ (VNP40101M) before the end of the first quarter of 2005, and additional development of our preclinical products.

General and Administrative Expenses.    General and administrative expenses were $2.1 million for the nine months ended September 30, 2004, as compared to $1.9 million for the same 2003 period. The increase was primarily due to employee recruiting fees incurred as we moved into late-stage clinical trials of products, as well as expenses associated with our June 2004 annual stockholder meeting, partially offset by lower legal and patent fees.

Interest Income.    Interest income was $354,000 for the nine months ended September 30, 2004, as compared to $87,000 for the same period in 2003. The increase was primarily due to higher levels of invested funds in 2004.

Income Taxes.    For the nine months ended September 30, 2004, a provision of $34,000 was recorded for minimum state capital taxes. For the nine months ended September 30, 2003, a provision of $5,000 was recorded, which reflected a provision of $27,000 for minimum state capital taxes, net of a benefit recognized of $22,000 for the sale of certain research and development tax credits to the State of Connecticut.

Net Loss.    The net loss was $10.8 million, or $0.21 per share, for the nine months ended September 30, 2004, compared to a net loss of $8.5 million, or $0.28 per share, for the same period in 2003. Weighted-average common shares outstanding for the nine months ended September 30, 2004 and 2003 were 52.7 million and 30.6 million, respectively.

Liquidity and Capital Resources

At September 30, 2004, we had cash and cash equivalents of $44.0 million compared to cash, cash equivalents and short-term investments of $15.7 million at December 31, 2003. The increase in 2004 was due primarily to net proceeds of $32.9 million from a private placement of securities in February 2004 and proceeds of $6.2 million from exercises of warrants, described below, offset by cash used of $10.7 million to fund operating activities.

Cash Used in Operating Activities

Cash used in operating activities is primarily a result of our net loss. However, operating cash flows differ from net loss as a result of non-cash charges, changes in operating assets and liabilities, or differences in the timing of cash flows and earnings/expense recognition. Significant components of cash used in operating activities are as follows:

Receivables and prepaid expenses increased $570,000 during the nine months ended September 30, 2004 compared to a decrease of $243,000 for the same 2003 period. The increase in 2004 was primarily due to a deposit of $791,000 made with a clinical research organization in connection with a clinical research agreement, partially offset by a reduction of prepaid insurance expense. The decrease in 2003 was primarily due to a reduction of prepaid insurance expense as the timing of insurance premium payments differs from the recognition of insurance expense.

Current liabilities increased $585,000 during the nine months ended September 30, 2004 compared to an increase of $1.6 million for the same 2003 period. The increases in 2004 and 2003 were primarily due to increases in our clinical trials liability as the timing of payments to clinical vendors differs from the recognition of clinical trials expenses.

Cash Provided by or Used in Investing Activities

Cash provided by or used in investing activities primarily relates to the purchases and maturities of investments and acquisitions of capital equipment. For the nine months ended September 30, 2004,

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purchases of marketable securities totaled $61.9 million and maturities of marketable securities totaled $76.4 million. Cash provided by the maturities of these short-term investments was reinvested during the second quarter of 2004 in U.S. treasury securities classified as cash equivalents. As a result, the short-term investments were reduced to $0. Capital expenditures were $335,000 for the nine months ended September 30, 2004 and $59,000 for the same 2003 period. The increase in 2004 capital expenditures was due primarily to the purchase of laboratory equipment. Capital expenditures for fiscal 2004 are not expected to exceed $500,000.

Cash Provided by Financing Activities

Cash provided by financing activities is primarily related to capital raised, warrant exercise proceeds and proceeds from common stock issuances under our employee stock plans. For the nine months ended September 30, 2004, we received $39.3 million primarily due to net proceeds of $32.9 million from a private placement and proceeds of $6.2 million from exercises of warrants. For the nine months ended September 30, 2003, we received $14.8 million due to net proceeds from a private placement.

In February 2004, we completed a private placement of 13,553,845 shares of our Common Stock at $2.60 per share. The investors also received warrants to purchase 3,388,463 shares of Common Stock at $3.25 per share and the placement agent received a warrant to purchase an additional 300,000 shares of Common Stock at $3.25 per share. All of these warrants expire on February 11, 2009. Net proceeds from the private placement totaling $32.9 million will be used to fund clinical and preclinical product development activities, working capital and general corporate purposes.

In September 2003, we completed a private placement of 6,475,000 shares of our Common Stock at $1.75 per share and warrants to purchase 6,475,000 shares of common stock at $2.50 per share. Net proceeds from this private placement totaled $10.4 million. The warrants expire on September 19, 2008.

In June 2003, we completed a private placement of 3,846,150 shares of our Common Stock at $1.30 per share and warrants to purchase 1,923,075 shares of common stock at $2.20 per share. Net proceeds from this private placement totaled $4.4 million. The warrants expire on June 25, 2008.

For the nine months ended September 30, 2004, we issued 2,568,868 shares of our Common Stock upon exercises of warrants issued in connection with private placements in 2003 and 2004, resulting in proceeds of $6.2 million.

Future Cash Requirements

Based on our current operating plan, we estimate that our existing cash and cash equivalents totaling $44 million at September 30, 2004 will be sufficient to fund our operations into 2006. Our operating plans and cash requirements may vary materially from the foregoing due to the results of preclinical development, clinical trials, product testing, relationships with strategic partners, changes in focus and direction of our preclinical and clinical development programs, competitive and technological advances, the regulatory process in the United States and abroad, and other factors. In the future, we will need to raise substantial capital to complete our product development and clinical trials and to fund operations in 2006 and beyond, however, we cannot assure you that we will be able to raise additional capital, nor can we predict what the terms of any financing might be.

Off-Balance Sheet Financing

We have no off-balance sheet arrangements that have a material current effect or that are reasonably likely to have a material future effect on our financial position or results of operations.

Contractual Obligations

During the first nine months of 2004, there was no significant changes in our reported payments due under contractual obligations at December 31, 2003. Under various agreements with contract research organizations, clinical sites and contract drug manufacturers, we expect to incur costs relating

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to the progress of clinical trials. These costs are expensed as incurred and are based upon patient enrollment, services rendered or other expenses as incurred. In the event of termination, certain agreements provide for cancellation fees to be paid by us and for reimbursement of noncancellable commitments that may have been entered into on our behalf.

Available Information

The following information can be found on our website at http://www.vionpharm.com or may be obtained free of charge by contacting our Investor Relations Department at (203) 498-4210 or by sending an e-mail message to info@vionpharm.com:

•  our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission;
•  our policies related to corporate governance, including the charter for the Nominating and Governance Committee of our Board of Directors, our code of ethics and business conduct applying to our directors, officers and employees, and our code of ethics applying to our chief executive officer and senior financial officials; and
•  the charter of the Audit Committee of our Board of Directors.

ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk, including changes to interest rates associated with our cash equivalents and investments, and foreign currency exchange rates. The following describes the nature of these risks which we do not believe to be material to us.

Our cash equivalents are generally highly liquid investments in U.S treasury securities and money market funds. Investments in fixed rate interest earning instruments carry a degree of interest risk. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. Our investments are held for purposes other than trading and we believe that we currently have no material adverse market risk exposure. The cash equivalents as of September 30, 2004 had maturities of up to 28 days. The weighted-average interest rate on cash equivalents held at September 30, 2004 was approximately 1.5%.

We have a contract with a vendor outside the U.S. that is denominated in a foreign currency. To date, fluctuations in this foreign currency exchange rate have not materially impacted our results of operations. We have no derivative financial instruments. We do not believe we have material exposures to changes in foreign currency exchange rates.

ITEM 4.    Controls and Procedures

(a) Evaluation of disclosure controls and procedures – As of the end of the period covered by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic filings with the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

(b) Changes in internal control over financial reporting – There has been no change in our internal control over financial reporting during the period covered by this quarterly report or in other factors that has materially affected or is reasonably likely to materially affect the Company's internal control.

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PART II

OTHER INFORMATION

ITEM 2.    Unregistered Sales of Equity Securities and Use of Proceeds

During the quarter ended September 30, 2004, we issued 40,714 shares of our Common Stock at $2.50 per share pursuant to an exercise of a warrant issued to an institutional investor in connection with a private placement in September 2003. Net proceeds from the exercise of $101,785 will be used to fund clinical and preclinical product development activities, working capital and general corporate purposes. We have subsequently registered the resale of these shares by the investor pursuant to an effective registration statement on Form S-3.

ITEM 6.    Exhibits

  3.4  Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Vion Pharmaceuticals, Inc. dated as of June 10, 2004.
10.25  Form of Severance Agreement between the Company and Terrence W. Doyle, Ivan King, Howard B. Johnson, Mario Sznol, Bijan Almassian and Ann Lee Cahill(1)
10.48  Vion Pharmaceuticals, Inc. 2003 Stock Option Plan, as amended (through June 2004)
10.49  Form of Stock Option Agreement for Executive Officers
10.50  Amendment to Option Agreements with Mario Sznol
31.1  Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2  Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1  Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2  Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(1) Incorporated by reference to the Company's quarterly report on Form 10-QSB for the quarter ended March 31, 1999.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of New Haven, State of Connecticut on November 9, 2004.

VION PHARMACEUTICALS, INC.
By:   /s/ Howard B. Johnson
Howard B. Johnson
President and Chief Financial Officer

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