**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**(Mark One)**
| **x** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|--------------------------------------------------------------------------------------------------------|

 

**For thequarterly period ended March 31, 2008**

 

**OR**

 
| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|---------------------------------------------------------------------------------------------------------|

 

**For the transition period from                    to                    **

 

**Commissionfile number: 000-51531**

 

 

**SUNESISPHARMACEUTICALS, INC.**

(Exact Name of Registrantas Specified in its Charter)

 

| **Delaware**                                                    | ** ** | **94-3295878**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or Other  Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer  Identification Number) |

 

**341Oyster Point Boulevard**

**SouthSan Francisco, California 94080**

(Address of PrincipalExecutive Offices including Zip Code)

 

**(650)266-3500**

(Registrant’s TelephoneNumber, Including Area Code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file reports), and (2) hasbeen subject to such filing requirements for the past 90 days. YES x   NO o

 

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

 

| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in ExchangeAct Rule 12b-2). Yes o No x

 

The registrant had 34,364,906 shares of common stock,$0.0001 par value per share, outstanding as of April 30, 2008.

 

 

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**SUNESISPHARMACEUTICALS, INC.**

**TABLE OFCONTENTS**

 
| ** **                              | **Page********No.**                                                                             |
|-----------------------------------------|-------------------------------------------------------------------------------------------------|
|                                    |                                                                                            |
| **PART I. FINANCIAL  INFORMATION** | 3                                                                                               |
|                                    |                                                                                            |   |
| Item 1.                                 | Financial Statements:                                                                           | 3 |
|                                    |                                                                                            |   |
|                                    | Consolidated Balance  Sheets as of March 31, 2008 and December 31, 2007               | 3 |
|                                    |                                                                                            |   |
|                                    | Consolidated  Statements of Operations for the Three Months Ended March 31, 2008 and  2007 | 4 |
|                                    |                                                                                            |   |
|                                    | Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2008 and  2007 | 5 |
|                                    |                                                                                            |   |
|                                    | Notes to  Consolidated Financial Statements                                                     | 6 |
|                                    |                                                                                            |   |
| Item 2.                                 | Management’s Discussion  and Analysis of Financial Condition and Results of Operations     | 15 |
|                                    |                                                                                            |   |
| Item 3.                                 | Quantitative  and Qualitative Disclosures About Market Risk                                     | 20 |
|                                    |                                                                                            |   |
| Item 4.                                 | Controls and Procedures                                                                         | 21 |
|                                    |                                                                                            |   |
| **PART II. OTHER  INFORMATION**    | 21                                                                                              |
|                                    |                                                                                            |   |
| Item 1.                                 | Legal Proceedings                                                                               | 21 |
|                                    |                                                                                            |   |
| Item 1A.                                | Risk  Factors                                                                                   | 21 |
|                                    |                                                                                            |   |
| Item 2.                                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                    | 36 |
|                                    |                                                                                            |   |
| Item 3.                                 | Defaults Upon  Senior Securities                                                                | 36 |
|                                    |                                                                                            |   |
| Item 4.                                 | Submission of  Matters to a Vote of Security Holders                                            | 36 |
|                                    |                                                                                            |   |
| Item 5.                                 | Other Information                                                                               | 36 |
|                                    |                                                                                            |   |
| Item 6.                                 | Exhibits                                                                                        | 36 |
|                                    |                                                                                            |   |
| **Signatures**                          |                                                                                            | 37 |

 

2

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** **

**PART I — FINANCIAL INFORMATION**

 

**Item 1.**   **FinancialStatements**

 

**SUNESIS PHARMACEUTICALS, INC.**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                | ** ** | **March 31,   2008** | ** ** | **December 31,   2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                | ** ** | **(Unaudited)**                | ** ** | **(1)**                           | ** ** |
| **ASSETS**                                                                                                                                                                |       |                           |       |                              |       |
| Current assets:                                                                                                                                                           |       |                           |       |                              |       |
| Cash and cash equivalents                                                                                                                                                 |       | $                              | 6,235,762  |                              | $          | 11,726,126 |   |
| Marketable securities                                                                                                                                                     |       | 30,581,908                     |       | 35,957,933                        |       |
| Prepaids and other current assets                                                                                                                                         |       | 1,463,390                      |       | 945,583                           |       |
| Total current assets                                                                                                                                                      |       | 38,281,060                     |       | 48,629,642                        |       |
|                                                                                                                                                                      |       |                           |       |                              |       |
| Property and equipment, net                                                                                                                                               |       | 3,971,051                      |       | 4,238,498                         |       |
| Deposits and other assets                                                                                                                                                 |       | 377,798                        |       | 377,798                           |       |
| Total assets                                                                                                                                                              |       | $                              | 42,629,909 |                              | $          | 53,245,938 |   |
| ** **                                                                                                                                                                |       |                           |       |                              |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                            |       |                           |       |                              |       |
| Current liabilities:                                                                                                                                                      |       |                           |       |                              |       |
| Accounts payable and other accrued  liabilities                                                                                                                           |       | $                              | 4,475,117  |                              | $          | 4,515,426 |   |
| Accrued compensation                                                                                                                                                      |       | 1,405,065                      |       | 2,225,868                         |       |
| Current portion of deferred revenue                                                                                                                                       |       | 752,032                        |       | 1,227,031                         |       |
| Current portion of equipment financing                                                                                                                                    |       | 885,286                        |       | 953,940                           |       |
| Total current liabilities                                                                                                                                                 |       | 7,517,500                      |       | 8,922,265                         |       |
|                                                                                                                                                                      |       |                           |       |                              |       |
| Non-current portion of equipment financing                                                                                                                                |       | 1,164,819                      |       | 1,352,684                         |       |
| Deferred rent liabilities                                                                                                                                                 |       | 1,472,418                      |       | 1,576,734                         |       |
| Total liabilities                                                                                                                                                         |       | 10,154,737                     |       | 11,851,683                        |       |
| Commitments                                                                                                                                                               |       |                           |       |                              |       |
| Stockholders’ equity:                                                                                                                                                |       |                           |       |                              |       |
| Preferred stock, $0.0001 par value;  5,000,000 shares authorized, no shares issued and outstanding at  March 31, 2008 and December 31, 2007                     |       | —                         |       | —                            |       |
| Common stock, $0.0001 par value;  100,000,000 shares authorized, 34,364,896 shares issued and outstanding  at March 31, 2008 and at December 31, 2007 |       | 3,437                          |       | 3,437                             |       |
| Additional paid-in capital                                                                                                                                                |       | 321,116,162                    |       | 320,579,240                       |       |
| Deferred stock-based compensation                                                                                                                                         |       | (134,619                       | )          | (251,601                          | )          |
| Accumulated other comprehensive income                                                                                                                                    |       | 121,180                        |       | 69,262                            |       |
| Accumulated deficit                                                                                                                                                       |       | (288,630,988                   | )          | (279,006,083                      | )          |
| Total stockholders’ equity                                                                                                                                           |       | 32,475,172                     |       | 41,394,255                        |       |
|                                                                                                                                                                      |       |                           |       |                              |       |
| Total liabilities and stockholders’ equity                                                                                                                           |       | $                              | 42,629,909 |                              | $          | 53,245,938 |   |

 

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| (1) | The consolidated balance  sheet at December 31, 2007 has been derived from the audited financial  statements at that date included in the Company’s Form 10-K for the year  ended December 31, 2007. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**SUNESIS PHARMACEUTICALS, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                 | ** ** | **Three months ended   March 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| ** **                                                 | ** ** | **(Unaudited)**                                        | ** ** |
| Revenue:                                                   |       |                                                   |       |   |   |
| Collaboration revenue                                      |       | $                                                      | 537,500    |   | $ | 229,167 |   |
| Collaboration revenue from related party                   |       | 1,765,683                                              |       | 2,037,099 |   |
| License revenue                                            |       | —                                                 |       | 250,000 |   |
| Total revenues                                             |       | 2,303,183                                              |       | 2,516,266 |   |
|                                                       |       |                                                   |       |   |   |
| Operating expenses:                                        |       |                                                   |       |   |   |
| Research and development                                   |       | 8,742,895                                              |       | 9,307,478 |   |
| General and administrative                                 |       | 3,266,129                                              |       | 3,296,147 |   |
| Restructuring charges                                      |       | 320,774                                                |       | — |   |
| Total operating expenses                                   |       | 12,329,798                                             |       | 12,603,625 |   |
|                                                       |       |                                                   |       |   |   |
| Loss from operations                                       |       | (10,026,615                                            | )          | (10,087,359 | ) |
|                                                       |       |                                                   |       |   |   |
| Interest income                                            |       | 460,412                                                |       | 769,626 |   |
| Interest expense                                           |       | (59,373                                                | )          | (52,043 | ) |
| Other income, net                                          |       | 671                                                    |       | 739 |   |
| Net loss                                                   |       | $                                                      | (9,624,905 | ) | $ | (9,369,037 | ) |
|                                                       |       |                                                   |       |   |   |
| Basic and diluted loss per share                           |       | $                                                      | (0.28      | ) | $ | (0.32 | ) |
|                                                       |       |                                                   |       |   |   |
| Shares used in computing basic and diluted  loss per share |       | 34,364,896                                             |       | 29,457,247 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

4

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**SUNESIS PHARMACEUTICALS, INC.**

**CONSOLIDATED STATEMENT OF CASH FLOWS**

 
| ** **                                                                          | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                                                          | ** ** | **(Unaudited)**                                      | ** ** |
| **Cash  flows from operating activities**                                           |       |                                                 |       |   |   |
| Net loss                                                                            |       | $                                                    | (9,624,905 | ) | $ | (9,369,037 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:        |       |                                                 |       |   |   |
| Depreciation and amortization                                                       |       | 436,549                                              |       | 427,892 |   |
| Stock-based compensation expense                                                    |       | 653,904                                              |       | 848,203 |   |
| Non-cash restructuring charges                                                      |       | 11,561                                               |       | — |   |
| Changes in operating assets and  liabilities:                                       |       |                                                 |       |   |   |
| Prepaids and other current assets                                                   |       | (517,807                                             | )          | (385,497 | ) |
| Accounts payable and other accrued  liabilities                                     |       | (40,311                                              | )          | 309,314 |   |
| Accrued compensation                                                                |       | (820,803                                             | )          | (714,488 | ) |
| Deferred rent liabilities                                                           |       | (104,316                                             | )          | 13,911 |   |
| Deferred revenue                                                                    |       | (474,999                                             | )          | (666,666 | ) |
| Net cash used in operating activities                                               |       | (10,481,127                                          | )          | (9,536,368 | ) |
|                                                                                |       |                                                 |       |   |   |
| **Cash  flows from investing activities**                                           |       |                                                 |       |   |   |
| Purchases of property and equipment                                                 |       | (180,663                                             | )          | (523,514 | ) |
| Purchases of marketable securities                                                  |       | (14,320,299                                          | )          | (17,017,531 | ) |
| Proceeds from maturities of marketable  securities                                  |       | 19,748,244                                           |       | 31,937,077 |   |
| Net cash provided by investing activities                                           |       | 5,247,282                                            |       | 14,396,032 |   |
|                                                                                |       |                                                 |       |   |   |
| **Cash  flows from financing activities**                                           |       |                                                 |       |   |   |
| Proceeds from borrowings under equipment  financing                                 |       | —                                               |       | 252,533 |   |
| Payments on equipment financing                                                     |       | (256,519                                             | )          | (254,282 | ) |
| Proceeds from issuance of common stock and  exercise of options, net of repurchases |       | —                                               |       | 72,472 |   |
| Net cash (used in) provided by financing  activities                                |       | (256,519                                             | )          | 70,723 |   |
|                                                                                |       |                                                 |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                               |       | (5,490,364                                           | )          | 4,930,387 |   |
| Cash and cash equivalents at beginning of  period                                   |       | 11,726,126                                           |       | 6,075,449 |   |
| Cash and cash equivalents at end of period                                          |       | $                                                    | 6,235,762  |   | $ | 11,005,836 |   |
|                                                                                |       |                                                 |       |   |   |
| **Supplemental  disclosure of cash flow information**                               |       |                                                 |       |   |   |
| Interest paid                                                                       |       | $                                                    | 58,870     |   | $ | 52,043 |   |
| Non-cash activities:                                                                |       |                                                 |       |   |   |
| Deferred stock-based compensation, net of  (reversal)                               |       | $                                                    | (11,238    | ) | $ | (2,533 | ) |

 

Seeaccompanying notes to consolidated financial statements.

 

5

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**SUNESIS PHARMACEUTICALS, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**MARCH 31, 2008**

**(Unaudited)**

 

**1.**   **Organizationand Summary of Significant Accounting Policies**

 

***Organization***

 

Sunesis Pharmaceuticals, Inc.(“Sunesis” or the “Company”) was incorporated in the state of Delaware on February 10,1998 and its facilities are headquartered at 341 Oyster Point Boulevard, SouthSan Francisco, California 94080. Sunesis is a clinical-stage biopharmaceuticalcompany focused on the discovery, development, and commercialization of novelsmall molecule therapeutics for oncology and other serious diseases. TheCompany’s primary activities since incorporation have been conducting researchand development internally and through corporate collaborators, in-licensingpharmaceutical compounds, conducting clinical trials, performing business andfinancial planning, and raising capital. In January 2007, the Companyformed a wholly-owned subsidiary, Sunesis Europe Limited, a United Kingdomcorporation.

 

Sunesis, Tethering and theCompany’s logo are registered trademarks of the Company.  All other trademarks, trade names and servicemarks appearing in this Quarterly Report on Form 10-Q are the property oftheir respective owners.

 

***Need to Raise Additional Capital***

 

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern. The Company has incurred significant lossesand negative cash flows from operations since its inception. At March 31,2008, the Company had an accumulated deficit of $288.6 million. Managementbelieves that currently available cash, cash equivalents and marketablesecurities, together with amounts available to be borrowed under existingfinancing agreements (see Note 5), and revenue generated from our currentcollaboration with Biogen Idec, Inc. (“Biogen Idec”) will providesufficient funds to enable the Company to meet its obligations throughapproximately the middle of 2009. Management plans to continue to finance theCompany’s operations with a combination of equity issuances, debt arrangements,and revenues from collaborations with pharmaceutical companies, technologylicenses, and, in the long term, product sales and royalties. If adequate fundsare not available, the Company may be required to delay, reduce the scope of,or eliminate one or more of its development programs or obtain funds throughcollaborative arrangements with others that may require the Company torelinquish rights to certain of its technologies, product candidates, orproducts that the Company would otherwise seek to develop or commercializeitself.

 

***Principles of Consolidation***

 

The Company’s consolidated financial statementsinclude a wholly-owned subsidiary, Sunesis Europe Limited, a United Kingdomcorporation.

 

***Use of Estimates***

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe amounts reported in the Company’s consolidated financial statements andaccompanying notes. Actual results could differ materially from theseestimates.

 

***Clinical Trial Accounting***

 

The Company records accrualsfor estimated clinical trial costs, comprising payments for work performed bycontract research organizations and participating clinical trial sites. Thesecosts may be a significant component of future research and developmentexpense. The Company accrues costs for clinical trials performed by contractresearch organizations based on estimates of work performed under thecontracts. Costs of setting up clinical trial sites for participation in trialsare expensed immediately. Costs related to patient enrollment are accrued aspatients are entered in the trial, reduced by an initial payment made to thehospital when the first patient is enrolled. These cost estimates may or maynot match the actual costs incurred for services performed by the organizationsas determined by patient enrollment levels and related activities. If theCompany has incomplete or inaccurate information, it may underestimate costsassociated with various trials at a given point in time. Although the Company’sexperience in estimating these costs is limited, the difference between accruedexpenses based on its estimates and actual expenses have not been material todate.

 

6

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***Basis of Presentation***

 

The accompanying unauditedconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States (“GAAP”) forinterim financial information and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the information andnotes required by GAAP for complete financial statements. The financialstatements include all adjustments (consisting only of normal recurringadjustments) that management believes are necessary for a fair presentation ofthe periods presented. The balance sheet at December 31, 2007 was derivedfrom the audited financial statements at that date. These interim financialresults are not necessarily indicative of results to be expected for the fullfiscal year or any other interim period.

 

These unaudited consolidatedfinancial statements and the notes accompanying them should be read inconjunction with the Company’s Annual Report on Form 10-K for the yearended December 31, 2007.

 

***Loss Per Share***

 

Basic loss per share iscalculated by dividing the loss by the weighted-average number of common sharesoutstanding for the period, less the weighted average unvested common sharessubject to repurchase. Diluted loss per common share is computed by dividingthe loss applicable to common stockholders by the weighted-average number ofcommon shares outstanding, less the weighted average unvested common sharessubject to repurchase, and dilutive potential common shares for the perioddetermined using the treasury-stock method. For purposes of this calculation,preferred stock, options to purchase common stock, and warrants to purchasecommon stock are considered to be potential common shares and are only includedin the calculation of diluted loss per common share when their effect isdilutive.

 
| ** **                                                                       | ** ** | **Three months ended   March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| **Outstanding securities not included in  diluted loss per share calculations:** |       |                                                   |       |   |   |
| Options to purchase common stock                                                 |       | 5,002,098                                              |       | 3,965,988 |   |
| Warrants to purchase common stock                                                |       | 2,693,237                                              |       | 2,693,237 |   |
| **Total**                                                                        |       | 7,695,335                                              |       | 6,659,225 |   |

 

***Comprehensive Loss***

 

Comprehensive loss iscomprised of net loss and unrealized gains on marketable securities.Comprehensive loss is as follows:

 
| ** **                                          | ** ** | **Three months ended   March 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Net loss                                            |       | $                                                      | (9,624,905 | ) | $ | (9,369,037 | ) |
| Change in unrealized gain on marketable  securities |       | 51,918                                                 |       | 7,504 |   |
| **Comprehensive loss**                              |       | $                                                      | (9,572,987 | ) | $ | (9,361,533 | ) |

 

Accumulated othercomprehensive income consists of the following:

 
| ** **                               | ** ** | **March 31,  2008** | ** ** | **December 31,   2007** | ** ** |
|------------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| Unrealized gain on marketable securities |       | $                        | 121,180    |                              | $          | 69,262 |   |
|                                          |            |                          |            |                                   |            |  |  |

 

7

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**Recent Accounting Pronouncements**

 

In February 2007, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(“SFAS No. 159”). SFAS No. 159 allows entities to choose, at specifiedelection dates, to measure eligible financial assets and liabilities at fairvalue in situations in which they are not otherwise required to be measured atfair value. If a company elects the fair value option for an eligible item,changes in that item’s fair value in subsequent reporting periods must berecognized in current earnings. SFAS No. 159 also establishes presentationand disclosure requirements designed to draw comparison between entities thatelect different measurement attributes for similar assets and liabilities. SFASNo. 159 is effective for fiscal years beginning after November 15,2007.  The Company chose not to elect thefair value option for its financial assets and liabilities existing at January 1,2008, and did not elect the fair value option for financial assets andliabilities for transactions occurring in the three months ended March 31,2008. Therefore, the adoption of SFAS No. 159 had no impact on the Company’sconsolidated financial statements.

 

In June 2007, the FASBratified the Emerging Issues Task Force (“EITF”) 07-3, *Accounting for Nonrefundable Advance Payments forGoods or Services Received for Use in Future Research and DevelopmentActivities* (“EITF 07-3”). EITF 07-3 requires nonrefundableadvance payments for goods or services that will be used or rendered for futureresearch and development activities to be deferred and capitalized. Suchamounts should be recognized as an expense when the related goods are deliveredor services are performed. EITF 07-3 is effective for fiscal years beginningafter December 15, 2007.  TheCompany adopted EITF 07-3 in the first quarter of 2008.  The adoption of EITF 07-3 did not have amaterial effect on the company’s financial position or results of operations.

 

In December 2007, theEITF reached a consensus on EITF 07-1, *Accountingfor Collaborative Arrangements Related to the Development and Commercializationof Intellectual Property* (“EITF 07-1”). EITF 07-1discusses the appropriate income statement presentation and classification forthe activities and payments between participants in arrangements related to thedevelopment and commercialization of intellectual property. The sufficiency ofdisclosure related to these arrangements is also specified. EITF 07-1 iseffective for fiscal years beginning after December 15, 2008. The Companywill adopt EITF 07-1 in the first quarter of 2009 and currently does notbelieve the adoption of EITF 07-1 will have a material impact on itsfinancial position or results of operations.

 

**2. **   **License Agreements**

 

***In-Licenses***

 

***Dainippon Sumitomo Pharma Co., Ltd.***

 

In October 2003, theCompany entered into an agreement with Dainippon Sumitomo Pharma Co., Ltd. (“Dainippon”)to acquire exclusive worldwide development and marketing rights for Dainippon’santi-cancer compound, referred to as SNS-595.

 

Inaddition to payments already made as of December 31, 2007, the Company mayin the future make a series of milestone payments of up to $8.0 million toDainippon based on successful development and regulatory approval of SNS-595for cancer indications, as well as royalty payments based on any future productsales. In return, the Company has received an exclusive, worldwide license todevelop and market SNS-595.

 

***Bristol-Myers Squibb Company***

 

InApril 2005, the Company entered into an agreement with Bristol-MyersSquibb Company (“BMS”) to acquire worldwide development and commercializationrights for BMS’ anti-cancer compound, referred to as SNS-032.

 

Underthe terms of this agreement, the Company may in the future be required to makea series of milestone payments of up to $29.0 million in cash and equity to BMSbased on the successful development and approval for the first indication andformulation of SNS-032. In addition, the Company may be required to make a seriesof development and commercialization milestone payments totaling up to$49.0 million in cash and equity to BMS, as well as royalty payments basedon any future product net sales. The Company may, at its election, pay some ofthe initial milestone payments in equity or a mixture of cash and equity,rather than entirely in cash.  In return,the Company received worldwide exclusive and non-exclusive diagnostic andtherapeutic licenses to SNS-032 and any future cyclin-dependent kinase (“CDK”)inhibitors derived from the related intellectual property.

 

8

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***Out-Licenses***

 

***The University of California, SanFrancisco***

 

InAugust 2005, and as amended in April 2006, the Company entered intoresearch and license agreements with the University of California, SanFrancisco (“UCSF”) that allow UCSF a limited license to use Tethering, theCompany’s proprietary fragment-based drug discovery approach, for academicpurposes. UCSF intends to leverage Tethering to identify novel, small moleculedrug candidates. In return, the Company received an exclusive royalty-freelicense to any improvements to Tethering or fragment libraries that emerge fromUCSF’s research. In the event that any small molecules are discovered usingTethering, the Company will have a right of first negotiation to in-license thecompounds. UCSF is precluded from utilizing the technology for commercialpurposes and from conducting research in the kinase field or any other drugtarget on which the Company is currently interested. The research at UCSF isbeing conducted by Dr. James Wells. Dr. Wells was a founder of theCompany and is a member of the Company’s Board of Directors.

 

***SARcode Corporation***

 

In March 2006,the Company entered into a license agreement with SARcode Corporation (“SARcode”),a privately-held biopharmaceutical company, that provides SARcode an exclusive,worldwide license to all of the Company’s lymphocyte function-associatedantigen-1 (“LFA-1”)  patents and relatedknow-how. SARcode intends to use the license to develop small molecule drugs totreat inflammatory diseases. The Company had discontinued its LFA-1 antagonistprogram, which is outside of its strategic focus.

 

Pursuant tothe license agreement, in 2007 the Company received a $0.5 million licensefee, which the Company recorded as revenue, and two notes convertible intopreferred stock of SARcode, one in the amount of $0.3 million and theother in the amount of $0.4 million. The Company did not record these twonotes receivable from SARcode, which are due in 2012, as revenue due touncertainty of collectibility. In addition to the $0.5 million of cash andthe convertible notes already received, the Company may receive up to$0.4 million in convertible notes, $31.3 million in development andmarketing milestone payments, and royalties for the commercialization of alicensed compound.

 

**3. **   **Strategic Collaborations**

 

***Johnson & JohnsonPharmaceutical Research & Development, L.L.C.***

 

InMay 2002, the Company entered into a research collaboration with Johnson &Johnson Pharmaceutical Research & Development, L.L.C (“J&J PRD”)to discover small molecule inhibitors of Cathepsin S, an enzyme that isimportant to regulating the inflammatory response. During the research term ofthis collaboration, the Company applied its proprietary Tethering technology todiscover novel inhibitors of Cathepsin S.

 

Theresearch funding portion of the agreement expired on December 31, 2005.Costs associated with research and development activities attributable to thisagreement approximated the research funding recognized. The Company may in thefuture receive research and development milestones of up to $24.5 millionas well as royalty payments from J&J PRD based on future product sales.  In February 2008, the Company received amilestone payment from J&J PRD upon its selection of a developmentcandidate from the collaboration.

 

***Biogen Idec, Inc. - RelatedParty***

 

InAugust 2004, the Company entered into a research collaboration with BiogenIdec, Inc. (“Biogen Idec”) to discover and develop small moleculestargeting kinases, a family of cell signaling enzymes that play a role in theprogression of cancer. The Company applies its proprietary Tethering technologyto generate novel, small molecule leads that inhibit the oncology kinasetargets that are covered by this collaboration. This collaboration is still inthe research phase and involves active participation by the Company’spersonnel. This collaboration has a four-year research term, which, if notextended, expires in August 2008.

 

Underthe terms of the collaboration agreement, the Company received a $7.0 millionupfront non-refundable and non-creditable technology access fee, which is beingrecognized as revenue over an initial four-year research term. In the eventthat Biogen Idec decides to exercise its option to extend the initial four-yearresearch term for one additional year, Biogen Idec is required to pay to theCompany an additional technology access fee as specified in the agreement. Inaddition, the Company receives quarterly research funding of $1.2 millionfrom Biogen Idec, subject to inflation adjustments, which is paid in advance tosupport some of the Company’s scientific personnel, and the Company may in thefuture receive pre-commercialization milestone payments of up to$60.5 million and royalty payments based on any product sales. The Companyretains an option to participate in the co-development and co-promotion ofproduct candidates for up to two targets that may emerge from this collaboration.

 

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*** ***

***Merck & Co., Inc.***

 

InFebruary 2003, the Company and Merck & Co., Inc. (“Merck”)entered into a research collaboration to identify and optimize inhibitors ofbeta-secretase (“BACE”), which is believed to be important in the progressionof Alzheimer’s disease. This collaboration had an initial three-year researchterm and a one-year option period. The research term of the collaboration endedin February 2006. Accordingly, the upfront, non-refundable and non-creditabletechnology access fee was recognized as revenue over the 36-month term of theagreement ending February 2006. However, the Company retains the right toearn future milestone payments of up to $84.3 million, as well asroyalty payments depending on product sales.

 

InJuly 2004, the Company and Merck entered into a multi-year researchcollaboration to discover novel oral drugs for the treatment of viralinfections. The Company provided Merck with a series of small moleculecompounds targeting viral infections. These compounds were derived fromTethering. Merck agreed to be responsible for advancing these compounds intolead optimization, preclinical development, and clinical studies. Merck isobligated to pay annual license fees for the Company’s consulting services andongoing access to Tethering as a means of identifying additional compounds forthe treatment of viral infections.

 

Underthe terms of the anti-viral agreement, the Company received an upfront,non-refundable and non-creditable technology access fee of $2.3 million,which was being recognized as revenue over an initial three-year research term.The Company is also entitled to receive annual license fees aggregatingapproximately $1.0 million. Through March 31, 2008, the Company hasreceived approximately $1.0 million in annual license fees. In addition, theCompany may receive payments based on the achievement of development milestonesof up to $22.1 million. In addition, the Company is entitled to receiveroyalty payments based on net sales for any products resulting from thecollaboration. Merck receives an exclusive worldwide license to any productsresulting from the collaboration.

 

Inconnection with the above collaboration agreements, the Company recognized thefollowing revenues in the periods presented, which include the amortization ofupfront fees received, research funding, and milestones earned:

 
| ** **                       | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Biogen Idec – related party |       | $                                                | 1,765,683  |   | $ | 2,037,099 |   |
| J&J PRD                      |       | 500,000                                          |       | — |   |
| Merck                            |       | 37,500                                           |       | 229,167 |   |
| **Total collaboration revenue**  |       | $                                                | 2,303,183  |   | $ | 2,266,266 |   |

 

TheCompany considers Biogen Idec to be a related party because Biogen Idec ownedapproximately 8.5 percent of the Company’s common stock as of March 31,2008 and approximately 10 percent of the Company’s common stock as of March 31,2007.

 

**4.**** ****2007 Restructuring Plan**

 

During August 2007,the Company implemented a revised operating plan to focus its efforts ongenerating definitive data from its lead programs while streamlining theCompany’s operations and extending its financial resources. The restructuringplan included an immediate reduction in the Company’s workforce ofapproximately twenty-five percent, or 35 employees, to 108 employees. Allemployees were given severance payments, based on length of service at theCompany, and career transition assistance. Also in the third quarter of 2007,the Company completed its consolidation of leased facilities, vacating oneproperty and relocating employees to its main location. The Company iscurrently seeking a tenant to sublease the vacated property.

 

As a result ofthe restructuring plan, in 2007 the Company recorded total restructuringcharges of $1.6 million for employee severance and related benefit costs,including a non-cash portion related to stock-based compensation ofapproximately $0.1 million and facilities exit costs, of which$0.3 million was related to the impairment of leasehold improvements and$0.3 million on the lease obligation on the vacated property. In the firstquarter of 2008, the Company recorded an additional $0.3 million ofrestructuring charges on the lease obligation on the vacated property.  The lease obligation charge is calculatedusing discounted cash flow based on an estimated timeframe in which the spacecan be subleased. Cash payments related to employee severance were all made by December 31,2007.

 

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The followingtable summarizes the accrual balances and utilization by cost type for therestructuring plan:

 
| ** **                                             | ** ** | **Employee   Severance and   Related   Benefits** | ** ** | **Facilities   Related and   Other Costs** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|-----------|------------|
| **Restructuring liability at  December 31, 2007** |       | $                                                                     | 41,399     |                                                           | $          | 274,834   |       | $ | 316,233 |   |
| 1st quarter charges (reversal)                         |       | (9,418                                                                | )          | 330,192                                                        |       | 320,774   |       |
| Cash payments                                          |       | (227                                                                  | )          | (100,264                                                       | )          | (100,491  | )          |
| Adjustments                                            |       | (31,754                                                               | )          | 120,833                                                        |       | 89,079    |       |
| **Restructuring liability at March 31,  2008**    |       | $                                                                     | —     |                                                           | $          | 625,595   |       | $ | 625,595 |   |

 

**5.**   **EquipmentFinancing and Debt Facility**

 

InJune 2000, the Company entered into an equipment financing agreement withGeneral Electric Capital Corporation (“GECC”). Various credit lines have beenissued under the financing agreement since 2000. The Company’s prior $2.6million credit line expired in March 2008. A new $0.7 million credit lineis available through June 2008.  Asof March 31, 2008, the Company had drawn an aggregate of $10.7 millionunder various credit lines under the financing agreement.  At March 31, 2008, the outstandingbalance was $2.1 million, which bears interest at rates ranging from 7.53percent to 10.61 percent per annum and is due in 36 to 48 monthly payments. Theequipment loans are secured by the equipment financed.  As of March 31, 2008, the Company was incompliance with all covenants in the GECC agreement.

 

****6****.  **Contingencies**

 

The Company is not currently involved in anymaterial legal proceedings. From time to time, we may become involved in legalproceedings arising in the ordinary course of the Company’s business.

 

**7.**   **Stockholders’Equity**

 

OnMay 30, 2007, the Company completed a public offering of 4,750,000 sharesof its common stock at a public offering price of $4.43 per share. Net cashproceeds from this offering were approximately $19.5 million after deductingissuance cost of $1.5 million.

 

**8.**   **EmployeeBenefit Plans**

 

***Stock Option Plans***

 

**2005 Equity Incentive Award Plan**

 

OnJanuary 1, 2008, the 2005 Equity Incentive Award Plan (“2005 Plan”) wasincreased by 1,082,352 shares pursuant to the 2005 Plan’s evergreenprovision.  Options to purchase 10,000shares of the Company’s common stock were granted in the three months ended March 31,2008 and, as of March 31, 2008, options to purchase an aggregate of3,754,856 shares of the Company’s common stock have been granted under the 2005Plan.  As of March 31, 2008, the total numberof shares available for future grants under the 2005 Plan was 1,692,610.

 

  **2006 Employment Commencement Incentive Plan**

 

OnJanuary 1, 2008, the Company’s Board of Directors approved an amendment tothe Company’s 2006 Employment Commencement Incentive Plan (“2006 Plan”) toincrease the number of shares of common stock reserved for issuance under the2006 Plan by an additional 125,000 shares. No options were granted under the 2006 Plan in the three months ended March 31,2008.  As of March 31, 2008, thetotal number of shares available for future grants under the 2006 Plan was145,334.

 

**2005 Employee Stock Purchase Plan**

 

OnJanuary 1, 2008, the share reserve under the Company’s 2005 Employee StockPurchase Plan (“ESPP”) was increased by 100,000 shares pursuant to the ESPP’severgreen provision.  At March 31,2008, there were 297,255 shares of common stock reserved for future issuanceunder the ESPP.   For the three monthsended March 31, 2008, no ESPP shares were issued.

 

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Asummary of stock option transactions for all of the Company’s stock optionplans since December 31, 2007 follows:

 
| ** **                                | ** ** | **Number   of Shares** | ** ** | **Weighted Average   Exercise Price** | ** ** | **Weighted   Average   Remaining   Contractual   Term (years)** | ** ** | **Aggregate   Intrinsic   Value** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **Outstanding at December 31, 2007** |       | 5,099,847                        |       | $                                                    | 3.83       |                                                                                     |       |                                        |       |   |
| Options granted                           |       | 10,000                           |       | $                                                    | 1.40       |                                                                                     |       |                                        |       |   |
| Options exercised                         |       | —                           |       | —                                               |       |                                                                                     |       |                                        |       |
| Options canceled/forfeited/expired        |       | (107,749                         | )          | $                                                    | 4.89       |                                                                                     |       |                                        |       |   |
| **Balance at March 31, 2008**        |       | 5,002,098                        |       | $                                                    | 3.80       |                                                                                     | 7.6        |                                        | $          | 14,012 |   |
| **Exercisable at March 31, 2008**    |       | 2,659,448                        |       | $                                                    | 3.82       |                                                                                     | 6.4        |                                        | $          | 12,512 |   |

 

Thefollowing table summarizes outstanding and exercisable options for all of theCompany’s stock option plans as of March 31, 2008:

 
| ** **                                  | ** ** | **Options Outstanding**                           | ** ** | **Options Exercisable**                                           | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number   Outstanding  as of 3/31/08** | ** ** | **Weighted-  Average   Remaining   Contractual   Term** | ** ** | **Weighted-  Average   Exercise   Price** | ** ** | **Number   Exercisable   as of 3/31/08** | ** ** | **Weighted-  Average   Exercise   Price** | ** ** |
| $0.43 -  $2.31                              |       | 137,711                                                |       | 8.6                                                                    |       | $ | 1.98 |   | 16,961 |   | $ | 0.82 |   |
| $2.55                                       |       | 1,275,164                                              |       | 4.6                                                                    |       | $ | 2.55 |   | 1,265,579 |   | $ | 2.55 |   |
| $2.59                                       |       | 1,116,623                                              |       | 9.5                                                                    |       | $ | 2.59 |   | 140,754 |   | $ | 2.59 |   |
| $2.62 -  $4.74                              |       | 475,633                                                |       | 8.8                                                                    |       | $ | 4.07 |   | 151,416 |   | $ | 4.10 |   |
| $4.85                                       |       | 622,752                                                |       | 8.5                                                                    |       | $ | 4.85 |   | 232,000 |   | $ | 4.85 |   |
| $4.93 -  $5.16                              |       | 109,174                                                |       | 8.4                                                                    |       | $ | 5.03 |   | 47,265 |   | $ | 5.04 |   |
| $5.25                                       |       | 1,008,270                                              |       | 7.7                                                                    |       | $ | 5.25 |   | 623,773 |   | $ | 5.25 |   |
| $5.50 -  $6.40                              |       | 176,716                                                |       | 8.3                                                                    |       | $ | 6.07 |   | 117,870 |   | $ | 6.09 |   |
| $7.15                                       |       | 22,400                                                 |       | 8.0                                                                    |       | $ | 7.15 |   | 11,200 |   | $ | 7.15 |   |
| $9.56                                       |       | 57,655                                                 |       | 7.2                                                                    |       | $ | 9.56 |   | 52,630 |   | $ | 9.56 |   |
| $0.43 -  $9.56                              |       | 5,002,098                                              |       | 7.6                                                                    |       | $ | 3.80 |   | 2,659,448 |   | $ | 3.82 |   |

 

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***Employee Stock-Based Compensation***

 

Employeestock-based compensation expense related to all of the Company’s share-basedawards, including stock options granted prior to the Company’s initial publicoffering (“IPO”), which continue to be accounted for under AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees,* (“APB 25”),is as follows for the periods presented:

 
| ** **                   | ** ** | **Three months ended   March 31,** | ** ** |
|------------------------------|------------|--------------------------------------------------------|------------|
| ** **                   | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Research and development     |       | $                                                      | 270,178    |   | $ | 364,893 |   |
| General and administrative   |       | 383,726                                                |       | 481,691 |   |
| **Stock-based compensation** |       | $                                                      | 653,904    |   | $ | 846,584 |   |

 

TheCompany determines the fair value of share-based payment awards on the grantdate using the Black-Scholes option-pricing model (the “Black-Scholes Model”)which is affected by the Company’s stock price as well as assumptions regardinga number of highly subjective variables. The total estimated grant date fairvalue of stock options that were granted during the three months ended March 31,2008 and 2007 was approximately none and $0.2 million, respectively. Theestimated fair value of shares vested during each of the three month periodsended March 31, 2008 and 2007 were $0.6 million. At March 31, 2008,total unrecognized estimated compensation cost related to non-vested stockoptions granted prior to that date was $5.6 million and the cost is expected tobe recognized over a weighted average period of 3.3 years. No options wereexercised during the three months ended March 31, 2008.  The total intrinsic value of stock optionsexercised during the three months ended March 31, 2007 was approximately$0.1 million.  For the three months endedMarch 31, 2007, the Company recorded cash received from the exercise ofstock options of approximately $0.1 million. As it is more likely than not thatall of the stock option related tax benefits will not be realized, the Companydid not record net tax benefits related to the options exercised in the threemonths ended March 31, 2008 and 2007.

 

Theweighted-average estimated fair value of employee stock options granted duringthe three months ended March 31, 2008 and 2007 was $0.85 and $2.68 pershare, respectively, using the Black-Scholes Model.

 

TheCompany uses the Black-Scholes Model to value its stock options with thefollowing assumptions (annualized percentages):

 
| ** **              | ** ** | **Three months ended   March 31,** | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Volatility              |       | 71.6                                                   | %          | 68.5 | % |
| Risk-free interest rate |       | 2.7                                                    | %          | 4.7 | % |
| Dividend yield          |       | 0                                                      | %          | 0 | % |
| Expected term (years)   |       | 5.0                                                    |       | 5.1 |   |

 

Theweighted-average estimated fair value of purchase rights under the ESPP for thethree months ended March 31, 2008 and 2007 was $1.36 and $2.03 per share,respectively, using the Black-Scholes Model with the following assumptions(annualized percentages):

 
| ** **              | ** ** | **Three months ended   March 31,** | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Volatility              |       | 68.5% - 71.6%                                          |       | 80.0% |   |
| Risk-free interest rate |       | 3.2% - 5.1%                                            |       | 4.9% - 5.1% |   |
| Dividend yield          |       | 0%                                                     |       | 0% |   |
| Expected term (years)   |       | 0.5 - 1.0                                              |       | 0.5 - 1.0 |   |

 

Thetotal estimated fair value of purchase rights outstanding under the ESPP thatvested during the three months ended March 31, 2008 and 2007 wasapproximately none and $0.1 million, respectively.

 

TheCompany has based its assumptions for volatility and expected term of employeestock options on the information available with respect to its peer group inthe same industry. The expected term of the employees’ purchase rights underthe Company’s ESPP is 

 

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equal to the purchase period. The risk-free interest rate assumption isbased upon observed interest rates appropriate for the expected life of theCompany’s employee stock options and employees’ purchase rights. The Companydoes not anticipate paying any cash dividends in the foreseeable future, andtherefore uses an expected dividend yield of zero in both models.  Statement of Financial Accounting Standard No. 123(revised 2004) (“FAS 123R”), *“Share-Based Payment,”*alsorequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. The forfeiture rate is estimated based on the Company’s historicaloption cancellation and forfeiture information. The Company’s stock-basedcompensation expense recognized under FAS 123R in its consolidated financialstatements reflects estimated forfeiture rates of 7.2% and 5.0% in the threemonths ended March 31, 2008 and 2007, respectively. If factors change andthe Company employs different assumptions in the application of FAS 123R infuture periods, the compensation expense that the Company records under FAS123R may differ significantly from what it has recorded in the current period.

 

**Stock-Based Compensation for Options Granted Prior to the IPO**

 

Priorto the Company’s IPO in September 2005, certain stock options were grantedwith exercise prices that were below the reassessed fair value of the commonstock at the date of grant. In accordance with APB 25, deferred stock-basedcompensation was recorded for the difference between the estimated fair valueof the common stock underlying the options and the exercise price of theoptions. The deferred stock-based compensation is being amortized over therelated vesting terms of the options. For the three months ended March 31, 2008 and 2007, the Companyrecorded amortization of deferred stock-based compensation of $0.1 million and$0.2 million, respectively.

 

Asof March 31, 2008, the expected future amortization expense for deferredstock-based compensation is $0.1 million and is expected to be fully amortizedby December 31, 2008.

 

**9.   Fair Value Measurements**

 

As of January 1, 2008, the Company adopted FASB Statement No. 157,*Fair Value Measurements* (“SFAS 157”).  SFAS 157 established a framework formeasuring fair value based on GAAP and clarified the definition of fair valuewithin that framework. SFAS 157 does not require any new fair valuemeasurements in GAAP. SFAS 157 introduced, or reiterated, a number of keyconcepts which form the foundation of the fair value measurement approach to beutilized for financial reporting purposes. The fair value of the Company’sfinancial instruments reflect the amounts that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date (exit price). SFAS 157 also established afair value hierarchy that prioritizes the use of inputs used in valuation techniquesinto the following three levels:

 

Level 1—quoted prices in active markets for identical assets andliabilities.

Level 2—observable inputs other than quoted prices in active marketsfor identical assets and liabilities.

Level 3—unobservable inputs.

 

The adoption of SFAS 157 did not have amaterial effect on the Company’s financial condition and results of operations,but SFAS 157 introduced new disclosures about how the Company values certainassets and liabilities, focusing on the inputs used to measure fair value,particularly in instances where the measurement uses significant unobservable(Level 3) inputs. The Company’s financial instruments are valued using quotedprices in active markets (Level 1) or based upon other observable inputs (Level2).  The following table sets forth thefair value of the Company’s financial assets that were measured on a recurringbasis during the three months ended March 31, 2008 *(inthousands)*.

 
| ** **              | ** ** | **Fair Value Measurements at Reporting Date Using** | ** ** |
|-------------------------|------------|-----------------------------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | **(Level 1)**                                                                | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Total** | ** ** |
| **Description**         |       |                                                                              |       |   |   |   |   |   |   |
| Marketable securities   |       | $                                                                                 | 771        |   | $ | 29,811 |   | $ | — |   | $ | 30,582 |   |
| **Total**               |       | $                                                                                 | 771        |   | $ | 29,811 |   | $ | — |   | $ | 30,582 |   |

 

As of the three months ended March 31, 2008,the Company’s marketable securities were classified within Level 1 or Level 2of the fair value hierarchy.  The type ofsecurities utilizing Level 1 inputs consisted of the Company’s U.S. Government Agency.  The Company’s Level 2 valuations are basedupon quoted prices for similar instruments or securities that are under anactive market with pricing adjustments for yield and number of days tomaturity.  The type of securitiesutilizing Level 2 inputs consisted of the Company’s Corporate Bonds and CommercialPapers.

 

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**10.**   **Guaranteesand Indemnification**

 

In November 2002, theFASB issued Interpretation No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, including IndirectGuarantees of Indebtedness of Others* (“FIN 45”). FIN 45 requiresthat upon issuance of a guarantee, the guarantor must recognize a liability forthe fair value of the obligations it assumes under that guarantee.

 

As permitted under Delawarelaw and in accordance with the Company’s Bylaws, the Company indemnifies itsofficers and directors for certain events or occurrences, subject to certainlimits, while the officer or director is or was serving at the Company’srequest in such capacity. The indemnification agreements with the Company’sofficers and directors terminate upon termination of their employment, but thetermination does not affect claims for indemnification relating to eventsoccurring prior to the effective date of termination. The maximum amount ofpotential future indemnification is unlimited; however, the Company’s officerand director insurance policy reduces the Company’s exposure andmay enable the Company to recover a portion of any future amounts paid.The Company believes that the fair value of these indemnification agreements isminimal. In addition, in the ordinary course of business the Company entersinto agreements, such as licensing agreements, clinical trial agreements andcertain services agreements, containing standard indemnifications provisions.The Company believes that the likelihood of an adverse judgment related to suchindemnification provisions is remote. Accordingly, the Company has not recordedany liabilities for any of these agreements as of March 31, 2008.

 

**Item 2.**     **Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*Thefollowing discussion and analysis of our financial condition as of March 31,2008 and results of operations for the three months ended March 31, 2008and 2007 should be read together with our financial statements and relatednotes included elsewhere in this report. This discussion and analysis contains “forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities andExchange Act of 1934, as amended, that involve risks, uncertainties andassumptions. All statements other than statements of historical facts, are “forward-lookingstatements” for purposes of these provisions, including any projections ofrevenue, expenses or other financial items, any statement of the plans andobjectives of management for future operations, any statements concerningproposed new clinical trials or licensing or collaborative arrangements, anystatements regarding future economic conditions or performance, and anystatement of assumptions underlying any of the foregoing. In some cases,forward-looking statements can be identified by the use of terminology such as “anticipates,”“believe,” “continue,” “estimates,” “expects,” “intend,” “look forward,” “may,”“plans,” “potential,” or “will” or the negative thereof or other comparableterminology. Although we believe that the expectations reflected in theforward-looking statements contained herein are reasonable, there can be noassurance that such expectations or any of the forward-looking statements willprove to be correct, and actual results could differ materially from thoseprojected or assumed in the forward-looking statements.  Our actual results may differ materiallyfrom those anticipated in these forward-looking statements as a result of manyfactors, including but not limited to those set forth under “Risk Factors” andelsewhere in this report. We urge you not to place undue reliance on theseforward-looking statements, which speak only as of the date of this report. Allforward-looking statements included in this report are based on informationavailable to us on the date of this report, and we assume no obligation toupdate any forward-looking statements contained in this report.*

 

*In this report, “Sunesis,” the “Company,”“we,” “us,” and “our” refer to Sunesis Pharmaceuticals, Inc. and itswholly-owned subsidiary, except where it is made clear that the term means onlythe parent company.*

 

**Overview**

 

We are a clinical-stage biopharmaceutical company focused on thediscovery, development and commercialization of novel small moleculetherapeutics for use in oncology and other serious diseases. We have built ourproduct candidate portfolio through internal discovery and the in-licensing ofnovel cancer therapeutics. We are advancing product candidates through in-houseresearch and development efforts and strategic collaborations with leadingpharmaceutical and biopharmaceutical companies and academic institutions.

 

From our incorporation in 1998 through 2001, our operations consisted primarilyof developing and refining our drug discovery technologies. Since 2002, we havefocused on the discovery and development of novel small molecule drugs. In August 2007,we announced a reduction in our workforce and implemented a revised operating planto streamline our operations and extended our financial resources. Ourreorganization was completed by the end of 2007.

 

 We are currentlyadvancing three proprietary oncology product candidates, SNS-595, SNS-032 andSNS-314, through in-house research and development efforts. Our lead productcandidate, SNS-595, is a novel naphthyridine analog. With SNS-595, we arecurrently conducting one Phase 2 single agent clinical trial in advancedplatinum-resistant ovarian cancer patients and one Phase 1b 

 

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combination clinical trial with cytarabine in patients with refractoryor relapsed acute myeloid leukemia (“AML”). A Phase 1 single agent studyin advanced acute leukemias is continuing to treat patients, but enrollment wascompleted in 2007. In addition, we are planning to initiate a Phase 2single agent trial in elderly patients with previously untreated AML in thefirst half of this year.

 

Our second product candidate, SNS-032, is a potent and selective inhibitorof cyclin-dependent kinases (“CDKs”) 2, 7 and 9. We currently are conducting aPhase 1 clinical trial with SNS-032 in patients with relapsed orrefractory chronic lymphocytic leukemia (“CLL”) or multiple myeloma. We arealso developing SNS-314, a potent and selective inhibitor of the Aurora A, Band C kinase enzymes. SNS-314 is being studied in a Phase 1dose-escalating clinical trial in patients with advanced solid tumors.

 

We have worldwide development and commercialization rights to SNS-595,SNS-032 (for diagnostic and therapeutic applications) and SNS-314. In thefuture, we plan to enter into collaborations for one or more of these productcandidates in order to maximize the commercial potential of these programs.

 

We have developed proprietary methods of discovering drugs in pieces,or fragments. Our initial fragment-based discovery approach was called “Tethering®.”We have combined Tethering with other drug discovery tools, such asstructure-based design and medicinal chemistry, to discover and develop noveltherapeutics for major diseases. We have an ongoing strategic collaborationwith Biogen Idec, Inc. (“Biogen Idec”) to discover and develop smallmolecules that inhibit certain oncology and immunology kinase targets. Theresearch phase of this collaboration, which involves active participation byour personnel, expires in August 2008. The Tethering approach to drugdiscovery formed the basis of our three other ongoing collaborations, one withJohnson & Johnson Pharmaceutical Research & Development, L.L.C. (“J&JPRD”) and two with Merck & Co., Inc. (“Merck”). In thosethree collaborations, we are no longer receiving research funding, and ourpersonnel are not actively participating in continued development. We havedeveloped further enhancements to our fragment-based discovery platform thatare currently being used to discover new targeted agents and that could formthe basis of future discovery collaborations. As of March 31, 2008, we hadreceived an aggregate of approximately $83.4 million in cash from ourcurrent and former collaboration partners in the form of stock purchaseproceeds and fees.

 

We also have an ongoing research collaboration with the MultipleMyeloma Research Consortium (“MMRC”) to evaluate the nonclinical activity ofSNS-032 in multiple myeloma-relevant models and in primary disease tissue. Thiscollaboration is being performed by investigators at leading academic researchinstitutions including University Health Network (Princess Margaret Hospital),Dana-Farber Cancer Institute, H. Lee Moffitt Cancer Center & ResearchInstitute, Mayo Clinic Cancer Center and Emory University. We believe that thisand our other research arrangements with investigators at academic institutionshelp us to leverage and expand our internal research and developmentcapabilities.

 

In addition, we have licensed worldwide rights to all of our LFA-1patents and related know-how to SARcode Corporation.

 

Since our inception, we have generated significant losses. As of March 31,2008, we had an accumulated deficit of $288.6 million, including a deemeddividend of $88.1 million recorded in conjunction with our IPO in September 2005.We expect our significant net losses to continue for the foreseeable future, aswe continue our research activities and conduct development of, and seekregulatory approvals for, our product candidates.

 

**CriticalAccounting Policies and Significant Judgments and Estimates**

 

This discussion and analysisof our financial condition and results of operations is based on our financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires management to make estimates and judgments that affect thereported amounts of assets, liabilities and expenses and the disclosure ofcontingent assets and liabilities at the date of the financial statements, aswell as revenue and expenses during the reporting periods. We evaluate ourestimates and judgments on an ongoing basis. We base our estimates onhistorical experience and on various other factors we believe are reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying value of assets and liabilities that are notreadily apparent from other sources. Actual results could therefore differmaterially from those estimates under different assumptions or conditions.

 

An accounting policy isdeemed to be critical if it requires an accounting estimate to be made based onassumptions about matters that are highly uncertain at the time the estimate ismade, and if different estimates that reasonably could have been used, orchanges in the accounting estimate that are reasonably likely to occurperiodically, could materially change the financial statements. We believethere have been no significant changes during the three months ended March 31,2008 to the items that we disclosed as our critical accounting policies andestimates under Note 1 to our consolidated financial statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2007.

 

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**RecentAccounting Pronouncements**

 

InFebruary 2007, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities* (“SFAS No. 159”).  SFAS No. 159 allows entities to choose,at specified election dates, to measure eligible financial assets andliabilities at fair value in situations in which they are not otherwiserequired to be measured at fair value. If a company elects the fair value option for an eligible item, changesin that item’s fair value in subsequent reporting periods must be recognized incurrent earnings. SFAS No. 159 also establishes presentation anddisclosure requirements designed to draw comparison between entities that electdifferent measurement attributes for similar assets and liabilities. SFAS No. 159is effective for fiscal years beginning after November 15, 2007.   We chose not to elect the fair value optionfor our financial assets and liabilities existing at January 1, 2008, anddid not elect the fair value option on financial assets and liabilities fortransactions occurring in the three months ended March 31, 2008.Therefore, the adoption of SFAS No. 159 had no impact on our consolidatedfinancial statements.

 

In June 2007, the FASB ratified the Emerging Issues Task Force (“EITF”) 07-3,*Accounting for Nonrefundable AdvancePayments for Goods or Services Received for Use in Future Research andDevelopment Activities* (“EITF 07-3”). EITF 07-3 requiresnonrefundable advance payments for goods or services that will be used orrendered for future research and development activities should be deferred andcapitalized. Such amounts should be recognized as an expense when the relatedgoods are delivered or services are performed. EITF 07-3 is effective forfiscal years beginning after December 15, 2007. We adopted EITF 07-3in the first quarter of 2008.  Theadoption of EITF 07-3 did not have a material effect on our financialposition or results of operations.

 

In December 2007, the EITF reached a consensus on EITF 07-1, *Accounting for Collaborative Arrangements Related tothe Development and Commercialization of Intellectual Property* (“EITF 07-1”).EITF 07-1 discusses the appropriate income statement presentation andclassification for the activities and payments between participants inarrangements related to the development and commercialization of intellectualproperty. The sufficiency of disclosure related to these arrangements is alsospecified. EITF 07-1 is effective for fiscal years beginning after December 15,2008. We will adopt EITF 07-1 in the first quarter of 2009 and currentlydo not believe the adoption of EITF 07-1 will have a material impact onour financial position or results of operations.

 

**Results ofOperations**

 

***Three Months Ended March 31, 2008 and 2007***

 

***Collaboration Revenue.*** Since inception, we have not generated any revenue from sales ofcommercial products and do not expect to generate any product revenue for theforeseeable future. To date, substantially all of our revenue has consisted ofcollaboration revenue.  As of April 30,2008 we had four ongoing strategic collaborations, only one of which currentlyinvolves research funding and active participation by our personnel.  Each of these collaborations included atechnology access fee, research funding, milestone payments and royalties uponsales of future products that may result from the collaboration. The tablebelow sets forth our revenue for the three months ended March 31, 2008 and2007 from each of our current collaborations.

 
| ** **                       | ** ** | **Three months ended   March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Biogen Idec – related party |       | $                                                      | 1,765,683  |   | $ | 2,037,099 |   |
| J&J PRD                      |       | 500,000                                                |       | — |   |
| Merck                            |       | 37,500                                                 |       | 229,167 |   |
| **Total collaboration revenue**  |       | $                                                      | 2,303,183  |   | $ | 2,266,266 |   |

 

The research phase, andresearch funding, from the Biogen Idec collaboration expires in August 2008.  The research phases from each of the othercollaborations are completed.

 

Collaboration revenue forthe three months ended March 31, 2008 was comparable to the same period in2007 primarily due to the receipt of a milestone payment from J&J PRD inthe first quarter of 2008, offset by decreased collaboration revenue from bothBiogen Idec and Merck.

 

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In the absence of any newcollaborations, we expect to have no research funding after August 2008,in which case our overall collaboration revenue will be substantially lower infuture years, unless and until any products that may result from thecollaborations advance to a level where significant milestones will be payableto us.

 

***Research and Development Expense.***  Mostof our operating expenses to date have been for research and developmentactivities.  Research and developmentexpense primarily represents costs incurred:

 
| · |   | in the  discovery and development of novel small-molecule therapeutics and the  advancement of product candidates towards clinical trials, including the  Phase 1 and Phase 2 clinical trial costs for SNS-595 and the  Phase 1 clinical trial costs for SNS-032 and SNS-314, |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                         |
| · |   | in the  development of our proprietary fragment-based Tethering drug discovery  approach and other novel fragment-based drug discovery methods,                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                         |
| · |   | in the  development of in-house research, preclinical study and development  capabilities,                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                         |
| · |   | in  connection with in-licensing activities, and                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                         |
| · |   | in the  conduct of activities we are required to perform in connection with our  strategic collaborations.                                                                                                                                                                                   |

 

We expense all research anddevelopment costs as they are incurred.

 

The table below sets forthour research and development expense for the three months ended March 31,2008 and 2007 for each of our product candidate programs:

 
| ** **                              | ** ** | **Three months ended   March 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                | ** ** |
| SNS-595                                 |       | $                                                      | 4,485      |   | $ | 3,025 |   |
| SNS-032                                 |       | 1,238                                                  |       | 862 |   |
| SNS-314                                 |       | 804                                                    |       | 1,330 |   |
| Discovery programs and new technologies |       | 1,159                                                  |       | 878 |   |
| Other kinase inhibitors                 |       | 1,037                                                  |       | 3,185 |   |
| Other programs                          |       | 20                                                     |       | 27 |   |
| **Total Expense**                       |       | $                                                      | 8,743      |   | $ | 9,307 |   |

 

Research and developmentexpense decreased by $0.6 million, or 6 percent, to $8.7 million for the threemonths ended March 31, 2008 from $9.3 million for the same period in 2007.This decrease is primarily due to (i) a $0.5 million decrease in clinicaltrial activity related to SNS-314 and (ii) a $2.2 million decrease inexpenses under our other kinase inhibitors program, partially offset by (iii) a$1.5 million increase in SNS-595 expenses and a $0.3 million increase in SNS-032expenses due to increased clinical trial activities, and (iv) a $0.3million increase in expenses for discovery programs and new technologies due toincreased work on our proprietary technologies and discovery programs.

 

Under our Biogen Idec agreement, we have anoption on a target-by-target basis to co-fund post-Phase 1 developmentcosts for product candidates directed to up to two collaboration targets, whichmay, at our option, include the Raf kinase target. If we exercise our option onone or more product candidates, our research and development expense willincrease significantly. We expect that research and development expense relatedto co-development activities that we might elect to co-fund would consistprimarily of manufacturing costs for the product candidate, clinicaltrial-related costs, costs for consultants and contract research organizations,employee and facilities costs and depreciation of equipment.

 

We have incurred and expect to continue toincur substantial research and development expense to conduct clinical trialson SNS-595, SNS-032 and SNS-314. Clinical trials are costly, and as we continueto advance our product candidates through preclinical and clinical development,we expect our related expenses to remain high. For example, we expect to spendat least $10.0 million (i) to advance our SNS-595 program tocompletion of the current Phase 2 clinical trial in ovarian cancer, thecurrent Phase 1b combination trial in AML and the planned Phase 2 AMLclinical trial in the untreated elderly, (ii) to advance our SNS-032program to completion of our ongoing Phase 1 clinical trial, and (iii) tocomplete the ongoing Phase 1 clinical trial for SNS-314. As of the date ofthis report, due to the risks inherent in the clinical trial 

 

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process andgiven the early state of development of our programs, we are unable to estimatethe additional substantial costs we will incur in any continued development ofour product candidates for potential commercialization.

 

In addition, while we are currently focusedon advancing SNS-595, SNS-032 and SNS-314 through clinical development, weanticipate that we will make determinations as to which programs to pursue andhow much funding to direct to each program on an ongoing basis in response tothe scientific and clinical success of each product candidate, an assessment asto the product candidate’s commercial potential and our overall financialobjectives. This will affect our research and development expense goingforward. We also cannot forecast which product candidates will be subject tofuture collaborative or licensing arrangements, when such arrangements will besecured, if at all, and to what degree such arrangements would affect ourdevelopment plans and capital requirements.

 

***General and Administrative Expense.*** Our general and administrative expenseconsists primarily of salaries and other related costs for personnel infinance, human resources, facilities management, legal, including intellectualproperty management, and general administration, as well as non-cashstock-based compensation. Other significant costs include facilities costs andfees paid to outside legal advisors and auditors. General and administrativeexpense for the three months ended March 31, 2008 was comparable to thesame period in 2007.  While there was a$0.2 million increase in professional service expenses resulting from increasedpatent prosecution fees, audit, legal and tax preparation fees, this was offsetby a $0.2 million decrease in personnel expenses due to a decrease in the useof temporary services.

 

 ***Restructuring Charge.***For the three months ended March 31, 2008, we recorded an additional $0.3million restructuring charge related to the Company’s facilities costs on vacatedproperty.  No such charges were recordedin the three months ended March 31, 2007.

 

***Interest Income.*** Interest income decreased by $0.3 million to $0.5 million for thethree months ended March 31, 2008, from $0.8 million for the same periodin 2007 due to lower average balances of cash, cash equivalents andmarketable securities during 2008 as well as lower average interest ratesearned.

 

***Interest Expense.*** Interest expense remained relatively consistent at $59,000 for thethree months ended March 31, 2008 compared to $52,000 for the same periodin 2007.

 

**Liquidityand Capital Resources**

 

Since our inception, we havefunded our operations primarily through the issuance of common and preferredstock, research funding, technology access fees and milestone payments from ourcollaboration partners, debt financings and research grants. As of March 31,2008, we had cash, cash equivalents and marketable securities of$36.8 million and an outstanding equipment financing of $2.1 million.

 

***Cash Flows***

 

Net cash used in operatingactivities was $10.5 million and $9.5 million for the three months ended March 31,2008 and 2007, respectively. Net cash used in operating activities for thethree months ended March 31, 2008 resulted primarily from our net loss of$9.6 million and changes in operating assets and liabilities of $2.0 million,partially offset by adjustment for non-cash items of $1.1 million primarilyfrom depreciation and amortization and stock-based compensation expense.  Net cash used in operating activities for thethree months ended March 31, 2007 resulted primarily from our net loss of$9.4 million and changes in operating assets and liabilities of $1.4 million,partially offset by adjustment for non-cash items of $1.3 million primarilyfrom depreciation and amortization and stock-based compensation expense.

 

Net cash provided byinvesting activities was $5.2 million for the three months ended March 31,2008, compared to $14.4 million for the three months ended March 31, 2007.The cash provided by investing activities during the three months ended March 31,2008 was primarily attributable to net proceeds from the maturity of marketablesecurities of $5.4 million, partially offset by capital expenditures of $0.2million.  Net cash provided by investingactivities during the three months ended March 31, 2007 was related to thenet proceeds from maturities of marketable securities of $14.9 million,partially offset by the purchase of capital equipment totaling $0.5 million.

 

Net cash used in financingactivities was $0.3 million for the three months ended March 31, 2008, ascompared with $0.1 million in net cash provided by financing activities for thethree months ended March 31, 2007. Our financing activities for the threemonths ended March 31, 2008 consist of equipment loan re-payments of $0.3million. Our financing activities for the three months ended March 31,2007 consist of the receipt of $0.1 million in proceeds from stock optionexercises and proceeds from equipment loan borrowing of $0.3 million, partiallyoffset by equipment loan re-payments of $0.3 million.

 

***Credit and Loan Arrangements***

 

In June 2000, weentered into an equipment financing agreement with General Electric CapitalCorporation (“GECC”). Various credit lines have been issued under the financingagreement since 2000. Our prior $2.6 million credit line expired in March 2008.A new $0.7 million 

 

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credit line is available through June 2008.  As of March 31, 2008, we had drawn anaggregate of $10.7 million under various credit lines under the financingagreement.   At March 31, 2008, theoutstanding balance was $2.1 million, which bears interest at rates rangingfrom 7.53 percent to 10.61 percent per annum and is due in 36 to 48 monthlypayments. The equipment loans are secured by the equipment financed.  As of March 31, 2008, we were incompliance with all covenants in the GECC agreement.

 

***Operating Capital and Capital Expenditure Requirements***

 

We expect to continue toincur substantial operating losses in the future. We will not receive anyproduct revenue unless and until a product candidate has been approved by theUnited States Food and Drug Administration (“FDA”) or similar regulatory agencyin other countries and has been successfully commercialized. As of March 31,2008, our cash, cash equivalents and marketable securities totaled $36.8million. We currently anticipate that our cash, cash equivalents, marketablesecurities and available credit facilities, together with revenue generatedfrom our collaborations, will be sufficient to fund our operations throughapproximately the middle of 2009. However, we will need to raise substantialadditional funds to continue our operations and bring future products tomarket. We cannot be certain that any of our programs will be successful orthat we will be able to raise sufficient funds to complete the development andcommercialization of any of our product candidates currently in development,should they succeed. Additionally, we plan to continue to evaluate in-licensingand acquisition opportunities to gain access to new drugs or drug targets thatwould fit with our strategy. Any such transaction would likely increase ourfunding needs in the future.

 

Our future fundingrequirements will depend on many factors, including but not limited to:

 
| · |   | the rate of progress and  cost of our clinical trials, preclinical studies and other discovery and  research and development activities; |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                     |
| · |   | the costs associated with  establishing manufacturing and commercialization capabilities;                                                |
|   |   |                                                                                                                                     |
| · |   | the costs of acquiring or  investing in businesses, product candidates and technologies;                                                 |
|   |   |                                                                                                                                     |
| · |   | the costs of filing,  prosecuting, defending and enforcing any patent claims and other intellectual  property rights;                    |
|   |   |                                                                                                                                     |
| · |   | the costs and timing of  seeking and obtaining FDA and other regulatory approvals;                                                       |
|   |   |                                                                                                                                     |
| · |   | the effect of competing  technological and market developments; and                                                                 |
|   |   |                                                                                                                                     |
| · |   | the economic and other  terms and timing of any collaboration, licensing or other arrangements into  which we may enter.                 |

 

Until we can generate asufficient amount of product revenue to finance our cash requirements, which wemay never do, we expect to finance future cash needs primarily through publicor private equity offerings, debt financings or strategic collaborations. We donot know whether additional funding will be available on acceptable terms, orat all. If we are not able to secure additional funding when needed, we mayhave to delay, reduce the scope of or eliminate one or more of our clinical trialsor research and development programs or conduct additional workforcereductions. In addition, we may have to partner one or more of our productcandidate programs at an earlier stage of development, which would lower theeconomic value of those programs to us.

 

**Off-BalanceSheet Arrangements**

 

Through the three monthsended March 31, 2008 and the year ended December 31, 2007, we do nothave any off-balance sheet arrangements or relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or variable interest entities, which are typicallyestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes.

 

**Item 3.**   **Quantitativeand Qualitative Disclosures About Market Risk**

 

The primary objective of our investmentactivities is to preserve our capital for the purpose of funding operationswhile at the same time maximizing the income we receive from our investmentswithout significantly increasing risk. Our exposure to market rate risk forchanges in interest rates relates primarily to our investment portfolio. Thismeans that a change in prevailing interest rates may cause the principal amountof the investments to fluctuate. By policy, we minimize risk by placing ourinvestments with high quality debt security issuers, limit the amount of creditexposure to any one issuer, limit duration by restricting the term and holdinvestments to maturity except under rare circumstances. To achieve theseobjectives, our investment policy allows us to maintain a portfolio of cashequivalents and short-term

 

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investments ina variety of securities, including commercial paper, money market funds andcorporate debt securities. Our investment policy prohibits investments inderivative instruments. We did not hold derivative instruments as of March 31,2008, and we have not held derivative instruments in the past. Through ourmoney managers, we maintain risk management control systems to monitor interestrate risk. Our cash and cash equivalents as of March 31, 2008 includedliquid money market accounts. Our marketable securities as of March 31,2008 included readily marketable debt securities. Due to the short-term natureof these instruments, a 1% movement in market interest rates would not have asignificant impact on the total value of our portfolio as of March 31,2008. For example, a 1/2 percentage point increasein short-term interest rates would reduce the fair market value of ourportfolio of March 31, 2008 by approximately $36,000.

 

**Item 4.**   **Controlsand Procedures**

 

***Evaluation of Disclosure Controls and Procedures***

 

We maintain disclosurecontrols and procedures, as such term is defined in SEC Exchange Act Rule 13a-15(e),that are designed to ensure that information required to be disclosed in ourSecurities Exchange Act of 1934, as amended, reports is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow for timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

 

As required by SEC ExchangeAct Rule 13a-15(b), we carried out an evaluation, under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures as of the end of the periodcovered by this Form 10-Q. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this report onForm 10-Q.

 

***Changes in Internal Control over Financial Reporting***

 

There have been no changesin our internal control over financial reporting during the quarter ended March 31,2008 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

**Item 1.**   **LegalProceedings**

 

From time to time, we may be involved inroutine legal proceedings, as well as demands, claims and threatenedlitigation, that arise in the normal course of our business. The ultimateoutcome of any litigation is uncertain and unfavorable outcomes could have anegative impact on our results of operations and financial condition.Regardless of outcome, litigation can have an adverse impact on us because ofthe defense costs, diversion of management resources and other factors.

 

We are not currently involved in any materiallegal proceedings.

 

**Item 1A.**   **RiskFactors**

 

Investing inour common stock involves a high degree of risk. You should carefully considerthe risks and uncertainties described below and all information contained inthis report on Form 10-Q before you decide to purchase our common stock.If any of the possible adverse events described below actually occurs, we maybe unable to conduct our business as currently planned and our financialcondition and operating results could be harmed. In addition, the trading priceof our common stock could decline due to the occurrence of any of these risks,and you may lose all or part of your investment.

 

Please see the languageregarding forward-looking statements in “Managements’ Discussion and Analysis ofFinancial Condition and Results of Operations.”

 

**We have marked with an asterisk(*) those risk factors below that reflect substantive changes from the riskfactors included in our Annual Report on Form 10-K filed with theSecurities and Exchange Commission on March 17, 2008.**

 

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**Risks Related to Our Business**

 

***If we are unable to raise additionalcapital in the near term, we may not be able to continue to operate as a goingconcern.***

 

We are advancing multiple product candidates through discovery anddevelopment. We will need to raise substantial additional capital to continueour discovery, development and commercialization activities.

 

We will need to raise substantial additional capital in the near term to:

 

·                  fundclinical trials and seek regulatory approvals;

 

·                  continueour research and expand our development activities;

 

·                  hireadditional development personnel;

 

·                  maintain,defend and expand the scope of our intellectual property portfolio;

 

·                  implementadditional internal systems and infrastructure;

 

·                  pursuethe development of additional product candidates; and

 

·                  buildor access manufacturing and commercialization capabilities.

 

Our future funding requirements will depend on many factors, includingbut not limited to:

 

·                  therate of progress and cost of our clinical trials, preclinical studies and otherdiscovery and research and development activities;

 

·                  theeconomic and other terms and timing of any collaboration, licensing or otherarrangements into which we may enter;

 

·                  thecosts associated with building or accessing manufacturing and commercializationcapabilities;

 

·                  thecosts of acquiring or investing in businesses, product candidates andtechnologies;

 

·                  thecosts of filing, prosecuting, defending and enforcing any patent claims andother intellectual property rights;

 

·                  thecosts and timing of seeking and obtaining FDA and other regulatory approvals;and

 

·                  theeffect of competing technological and market developments.

 

We currently anticipate that our cash, cash equivalents and marketablesecurities, together with revenues generated from our collaborations andavailable credit facilities, will be sufficient to fund our operations throughapproximately the middle of 2009. Until we can generate a sufficient amount ofproduct revenue to finance our cash requirements, which we may never do, weexpect to finance future cash needs primarily through public or private equityofferings, out-licensing development and/or commercialization rights to one ormore of our product candidates, debt financings or strategic collaborations. Wedo not know whether additional funding will be available on acceptable terms,or at all.

 

Over the next fifteen months we expect to continue to advance ourongoing clinical trials of SNS-595 in ovarian cancer and acute myeloid leukemia(“AML”), SNS-032 in chronic lymphocytic leukemia or multiple myeloma andSNS-314 in solid tumors. If we are not able to secure additional funding whenneeded, we may have to delay, reduce the scope of or eliminate one or more ofour clinical trials or research and development programs or conduct additionalworkforce reductions. For example, in August 2007, we announced that wereduced our workforce by approximately twenty-five percent and implemented arevised operating plan to focus our efforts on generating definitive data fromour lead programs while streamlining our operations and extending our financialresources.

 

In addition, if we out-license or partner one or more of our productcandidate programs prior to completion of a Phase 2 trial or at an earlierstage of development, this will likely lower the long-term economic value ofsuch program or programs to our company. However, if we retain rights for alonger period with an expectation of improving our economic upside, we will notonly incur substantial development expenditures, but also risk that ourclinical trials may not generate data sufficient to support an out-license orpartnering arrangement.

 

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***Conditions affecting the equity market maymake it more difficult and costly to raise additional capital.***

 

Currently,there is turmoil in the U.S. economy in part due to tightening credit markets.Banks have tightened their lending standards, investors are balking at buyingnew corporate bonds and economic growth appears to have begun to slow. Factorscontributing to a slowing economy appear to be reduced credit availability,falling house prices and rising energy and food prices. If these factors affectequity markets, our ability to raise capital may be adversely affected.

 

**** We have incurred losses since inceptionand anticipate that we will continue to incur losses for the foreseeablefuture. We may not ever achieve or sustain profitability.***

 

We are a clinical-stage biopharmaceutical company with a limitedoperating history as a public company. We are not profitable and have incurredlosses in each year since our inception in 1998, including a net loss of $9.6million for the three months ended March 31, 2008. Our net loss for theyears ended December 31, 2007, 2006 and 2005 was $38.8 million,$31.2 million, and $27.5 million (excluding a preferred stock deemeddividend of $88.1 million), respectively. As of March 31, 2008, wehad an accumulated deficit of $288.6 million, including the$88.1 million preferred stock deemed dividend related to our initialpublic offering in September 2005. We do not currently have any products that have been approved formarketing, and we continue to incur substantial research and development andgeneral and administrative expenses related to our operations. We expect tocontinue to incur losses for the foreseeable future, and we expect these lossesto increase significantly, especially upon commencing Phase 3 clinicaltrials, as we continue our research activities and conduct development of, andseek regulatory approvals for, our product candidates, and commercialize anyapproved drugs. Our losses, among other things, have caused and will continueto cause our stockholders’ equity and working capital to decrease. To date, wehave derived substantially all of our revenue from collaboration agreements.The research phases for all but one of our revenue-generating collaborationagreements is completed, and the research phase of that agreement with BiogenIdec, if not extended, will end in August 2008. We can offer no assurancethat we will enter into a new collaboration agreement in the near future thatwill result in revenue for us. We also do not anticipate that we will generaterevenue from the sale of products for the foreseeable future. If our productcandidates or those of our collaborators fail in clinical trials or do not gainregulatory approval, or if our future products do not achieve marketacceptance, we may never become profitable. Even if we achieve profitability inthe future, we may not be able to sustain profitability in subsequent periods.

 

***If we fail to enter into newstrategic collaborations, we may have to reduce the scope of, or delay, ourinternal product candidate development programs.***

 

Our business model has been based in part upon entering into strategiccollaborations for discovery and/or the development of some of our productcandidates. The research phase of our strategic collaboration with Biogen Idec,the only one for which we currently receive research funding, expires in August 2008unless renewed. In the absence of additional sources of capital which may notbe available to us on acceptable terms, the development of our current orfuture product candidates may be reduced in scope, delayed or terminated.

 

**** There is a high risk that our drug discovery and development activitiescould be halted or significantly delayed for various reasons.***

 

Our product candidates are in the early stages of drug discovery ordevelopment and are prone to the risks of failure inherent in drug development.We and our collaboration partners will need to conduct significant additionalpreclinical studies and clinical trials before we or our collaboration partnerscan demonstrate that our product candidates are safe and effective to thesatisfaction of the FDA and other regulatory authorities. In our industry, itis unlikely that the limited number of compounds that we have identified aspotential product candidates will actually lead to successful productdevelopment efforts. Failure can occur at any stage of the process, andsuccessful preclinical studies and early clinical trials do not ensure thatlater clinical trials will be successful. We terminated two Phase 2 trialsof SNS-595 in small cell and non-small cell lung cancer. To date, SNS-032 andSNS-314 have only been tested in humans in Phase 1 trials. None of our productcandidates with collaboration parties have been tested in humans. In addition,product candidates in later stage trials may fail to show desired efficacy andsafety traits despite having progressed through initial clinical trials. Anumber of companies in the pharmaceutical industry have suffered significantsetbacks in advanced clinical trials, even after obtaining promising results inearlier trials.

 

We do not know whether our ongoing clinical trials or any other futureclinical trials with any of our product candidates will be completed onschedule, or at all, or whether our ongoing or planned clinical trials willbegin on time. The commencement of our planned clinical trials could besubstantially delayed or prevented by several factors, including:

 

·                  limitednumber of, and competition for, suitable patients with particular types ofcancer for enrollment in clinical trials;

 

·                  delaysor failures in obtaining regulatory approval to commence a clinical trial;

 

·                  delaysor failures in obtaining sufficient clinical materials.

 

·                  delaysor failures in obtaining IRB approval to conduct a clinical trial at prospectivesites;

 

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·                  delaysor failures in reaching acceptable clinical trial agreement terms or clinicaltrial protocols with prospective sites; or

 

The completion of our clinical trials could also be substantiallydelayed or prevented by several factors, including:

 

·                  slowerthan expected rates of patient recruitment and enrollment;

 

·                  failureof patients to complete the clinical trial;

 

·                  unforeseensafety issues;

 

·                  lackof efficacy during clinical trials;

 

·                  inabilityor unwillingness of patients or clinical investigators to follow our clinicaltrial protocols; and

 

·                  inabilityto monitor patients adequately during or after treatment.

 

For example, due to potential complications from treatment in ourPhase 1 clinical trial of SNS-032, we have provided patients enrolling inthis clinical trial with in-patient hospital care. In addition to increasingcosts to perform this clinical trial, we believe that this has resulted indifficulty in recruiting patients. Additionally, our clinical trials may besuspended or terminated at any time by the FDA, other regulatory authorities,ourselves or, in some cases, our collaboration partners. Any failure tocomplete, or significant delay in completing, clinical trials for our productcandidates could harm our financial results and the commercial prospects forour product candidates.

 

Recently, we informed the FDA of a stability observation in our SNS-595drug product.  Specifically, visiblearticles were observed in the finished product. We have since identified an impurity in the active pharmaceutical ingredient(“API”) for SNS-595 that appears to react with the plastic stoppers in thepackaged vial of the SNS-595 drug product, resulting in the formation of theparticles.  Currently, we areimplementing plans to eliminate the particles by revising our manufacturingprocess.  It will take time to evaluatewhether or not this revised manufacturing process for SNS-595 drug product willbe successful in removing these particles. We have proposed a short-term corrective action for this issue to theFDA and they have given us nine months in which to report to them results fromour process optimization activities.  Ifduring this time we are not successful in removing the particles from theSNS-595 drug product or providing evidence of an improved process or approachto FDA satisfaction, the FDA may place all of our current clinical trialstesting SNS-595 on clinical hold and we could not resume testing until thisissue was resolved to their satisfaction.

 

**** Our clinical trials for our leadproduct candidates, SNS-595, SNS-032 and SNS-314, may not demonstrate safety orefficacy or lead to regulatory approval.***

 

Our lead product candidates, SNS-595, SNS-032 and SNS-314, are smallmolecule therapeutics being developed for the treatment of certain types ofcancer. Many cancer drugs promote cancer cell death by inhibiting cellproliferation, and commonly have a narrow dose range between efficacy andtoxicity, commonly known as a “therapeutic window.” We may select a dose foruse in future clinical trials that may prove to be ineffective in treatingcancer. If our clinical trials result in unacceptable toxicity or lack ofefficacy, we may have to terminate further clinical trials. Even if we are ableto find a proper dose that balances the toxicity and efficacy of one or more ofour product candidates, we will be required to conduct extensive additionalclinical trials before we are able to seek the regulatory approvals needed tomarket them. If clinical trials of SNS-595, SNS-032 and/or SNS-314 are halted,or if they do not show that these product candidates are safe and effective inthe indications for which we are seeking regulatory approval, our future growthwould be limited and we may not have any other product candidates to develop.

 

Furthermore, our development strategy to date for SNS-032 and SNS-314has been to first test the efficacy and toxicity of each product candidate as asingle agent. We may determine that one or both of these product candidates aremore effective and/or less toxic in combination with another approved cancerdrug. While we are currently conducting a Phase 1b clinical trial ofSNS-595, studying escalating doses of SNS-595 in combination with cytarabine inacute leukemias, it is possible that when therapeutic levels of SNS-595 areachieved the toxicity of the combined regimen may be not tolerated in patients.Likewise, each of our product candidates may only receive FDA and foreignapprovals, if at all, in combination with another cancer drug.

 

In addition to the risks described above, we are aware of risks thatare specific to SNS-032. In previous Phase 1 clinical trials of SNS-032,significant safety risks were observed in patients who were administered SNS-032on either a one-hour or a 24-hour infusion once every three weeks. For example,increases in certain phases of the cardiac cycle, known as the QT interval, orthe corrected QT interval, or QTc, on the electrocardiograms of patients wereobserved in patients receiving the 24-hour infusion regimen. Increased QTintervals may be associated with increased risk for cardiac rhythmabnormalities, some of which can be serious, life-threatening events. Inaddition, pronounced, rapidly reversible decreases in white blood cells wereobserved following infusion under the one-hour infusion regimen, most likelyassociated with higher peak drug levels in this regimen. Further, some patientsalso experienced reversible liver toxicity, which limited the amount of drug that

 

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could be administered tothose patients. Two of these planned clinical trials were discontinued prior tocompletion and prior to determination of a maximum tolerated dose by the formersponsor, BMS, we believe because of a change in priorities within BMS’portfolio. We will not receive regulatory approval for SNS-032 unless we areable to deliver therapeutically active doses of SNS-032 while keepingtoxicities at acceptable levels. In a Phase 1 clinical trial of SNS-032 inpatients with advanced solid tumors, we delivered the drug on a daily basis ina one-hour infusion for five consecutive days. However, this dose and regimendid not allow us to achieve expected efficacious exposure without dose-limitingtoxicity, and therefore we decided not to advance SNS-032 at that time as asingle-agent therapeutic in that patient population.

 

In our ongoing Phase 1 clinical trial of SNS-032, we are awarethat SNS-032 has the potential to kill a large number of cancer cells rapidlyand all at once and the contents of those cells may be released into a patient’sbloodstream. This may result in a higher risk of a severe complication calledtumor lysis syndrome. We have seen biochemical evidence of tumor lysis occurringin some of our patients in our Phase 1 study. When tumor lysis syndrome occurs, some chemicals in a patient’s blood,such as potassium, uric acid and phosphate levels will rise, whereas someothers like calcium may decline. Tumor lysis syndrome, if severe enough, mayresult in kidney failure and, without treatment, can be life-threatening. Thissevere complication has a higher risk of occurring early in the course oftreatment and we are taking measures to prevent, monitor and treat thiscomplication, which may not be effective, when it occurs.

 

In addition, in clinical trials to date SNS-032 has demonstratedvariable pharmacokinetics (“PK”), which is the measure of the concentration ofdrug in the bloodstream over time. The PK variability results in differences indrug exposure between patients, and in some cases in the same patient, who areadministered the same dose of SNS-032. Dose levels in Phase 2 clinicaltrials will be selected primarily based on safety criteria. Because of theobserved PK variability between and among patients, we believe that there is arisk that some patients may receive sub-therapeutic exposure, limiting theopportunity to show activity and efficacy for SNS-032. As with other productcandidates in the biotechnology industry at this stage of development, even ifwe are able to find adequate doses and schedules from our planned Phase 2clinical trials, we will be required to conduct extensive additional clinicaltrials before we are able to seek regulatory approval to market SNS-032.

 

***The failure to enroll patients forclinical trials may cause delays in developing our product candidates.***

 

We may encounter delays if we or our collaboration partners are unableto enroll enough patients to complete clinical trials. Patient enrollmentdepends on many factors, including, the size of the patient population, thenature of the protocol, the proximity of patients to clinical sites and theeligibility criteria for the trial. Moreover, when one product candidate isevaluated in multiple clinical trials simultaneously, patient enrollment inongoing trials can be adversely effected by negative results from completedtrials. Our product candidates are focused in oncology, which can be adifficult patient population to recruit.

 

***The results of preclinical studiesand clinical trials may not satisfy the requirements of the FDA or otherregulatory agencies.***

 

Prior to receiving approval to commercialize any of our productcandidates in the United States or abroad, we and our collaboration partners mustdemonstrate with substantial evidence from well-controlled clinical trials, tothe satisfaction of the FDA and other regulatory authorities, that such productcandidates are safe and effective for their intended uses. The results frompreclinical studies and clinical trials can be interpreted in different ways.Even if we and our collaboration partners believe the preclinical or clinicaldata for our product candidates are promising, such data may not be sufficientto support approval by the FDA and other regulatory authorities. Administeringany of our product candidates to humans may produce undesirable side effects,which could interrupt, delay or halt clinical trials of our product candidatesand result in the FDA or other regulatory authorities denying approval of ourproduct candidates for any or all targeted indications.

 

***Our approach to developing cancertherapeutics by inhibiting CDKs, Aurora kinases and Raf kinases has not beenclinically validated and may not be successful.***

 

We have programs to develop small molecule inhibitors of CDKs, Aurorakinases and Raf kinases for the treatment of cancer. SNS-032 is an inhibitor ofCDKs 2, 7 and 9, and SNS-314 is an inhibitor of Aurora A, B and Ckinases. The therapeutic benefit of inhibiting CDKs, Aurora kinases and/or Rafkinases in the treatment of human cancer has not been established definitivelyin the clinic. There are also other CDKs and Aurora kinase inhibitors in earlyclinical development, but they have yet to show therapeutic benefit or they targetother kinases in addition to CDKs and Aurora kinases and their activity may beassociated with inhibition of those other kinases. In addition, there areconflicting scientific reports regarding the reliance or necessity of CDK2 inthe cell cycle. If CDK, Aurora kinase or Raf kinase inhibition is not aneffective treatment of human cancer, SNS-032, SNS-314 and any other drugcandidates from these kinase programs may have little or no commercial value.

 

***We rely on third parties tomanufacture our product candidates, including SNS-595, SNS-032 and SNS-314, anddepend on a single supplier for the active pharmaceutical ingredients forSNS-595 and SNS-032. There are a limited number of manufacturers that arecapable of manufacturing the active ingredient of SNS-595.***

 

We do not currently own or operate manufacturing facilities and lackthe capability to manufacture any of our product candidates on a clinical orcommercial scale. As a result, we rely on third parties to manufacture both theAPI and drug products for SNS-595, SNS-032 and 

 

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SNS-314. The APIs areclassified as toxic substances, limiting the available manufacturers. Webelieve that there are at least five contract manufacturers in North Americawith suitable capabilities for API manufacture, and at least four that canmanufacture our drug products. We currently have established relationships withonly one manufacturer for API for SNS-595 and two manufacturers for thefinished drug product. If our third-party manufacturer is unable or unwillingto produce API for SNS-595, we will need to establish a contract with anothersupplier. However, establishing a relationship with an alternative supplierwould likely delay our ability to produce SNS-595 API for six to nine months,during which time we will rely on current inventory to supply our drug productmanufacturing activities. We expect to continue to depend on third-partycontract manufacturers for all our API and drug products in the foreseeablefuture.

 

Our product candidates require precise, high quality manufacturing. Acontract manufacturer is subject to ongoing periodic unannounced inspection bythe FDA and corresponding state agencies to ensure strict compliance with currentGood Manufacturing Practice (“cGMP”), and other applicable governmentregulations and corresponding foreign standards. Our contract manufacturer’sfailure to achieve and maintain high manufacturing standards in compliance withcGMP regulations could result in manufacturing errors resulting in patientinjury or death, product recalls or withdrawals, delays or interruptions ofproduction or failures in product testing or delivery, delay or prevention offiling or approval of marketing applications for our products, cost overruns orother problems that could seriously harm our business.

 

To date, our product candidates have been manufactured in smallquantities for preclinical studies and clinical trials. Prior to one of ourproduct candidates being approved for commercial sale, we will need tomanufacture that product in larger quantities. Significant scale-up ofmanufacturing will be accompanied by significant validation studies, which willbe reviewed by the FDA prior to approval. If we are unable to successfullyincrease the manufacturing capacity for a product candidate, the regulatoryapproval or commercial launch may be delayed or there may be a shortage incommercial supply.

 

Any performance failure on the part of a contract manufacturer coulddelay clinical development or regulatory approval of our product candidates orcommercialization of our future products, depriving us of potential productrevenue and resulting in additional losses. For example, because we rely on asingle supplier for the API for SNS-595 and SNS-032, the failure of suchsupplier to have sufficient quantities of the API or to supply API on a timelybasis or at all would negatively affect us. In addition, our dependence on athird party for manufacturing may adversely affect our future profit margins.Our ability to replace an existing manufacturer may be difficult because thenumber of potential manufacturers is limited and the FDA must approve anyreplacement manufacturer before it can begin manufacturing our productcandidates for commercial sale. Such approval would require new testing andcompliance inspections. It may be difficult or impossible for us to identifyand engage a replacement manufacturer on acceptable terms in a timely manner,or at all.

 

***We expect to expand our clinicaldevelopment and marketing capabilities, and any difficulties hiring orretaining key personnel or managing this growth could disrupt our operations.***

 

We are highly dependent on the principal members of our management andtechnical staff. We expect to expand our clinical development and marketingcapabilities by increasing expenditures in these areas, hiring additionalemployees and expanding the scope of our current operations. Future growth willrequire us to continue to implement and improve our managerial, operational andfinancial systems, expand our facilities and continue to retain, recruit andtrain additional qualified personnel, which may impose a strain on ouradministrative and operational infrastructure. The competition for qualifiedpersonnel in the biopharmaceutical field is intense. We are highly dependent onour continued ability to attract, retain and motivate highly-qualifiedmanagement, clinical and scientific personnel. Due to our limited resources, wemay not be able to effectively manage the expansion of our operations orrecruit and train additional qualified personnel. If we are unable to retainkey personnel or manage our growth effectively, we may not be able to implementour business plan.

 

***If we are sued for infringingintellectual property rights of third parties, litigation will be costly andtime consuming and could prevent us from developing or commercializing ourfuture products.***

 

Our commercial success depends on not infringing the patents and otherproprietary rights of third parties and not breaching any collaboration orother agreements we have entered into with regard to our technologies andproduct candidates. Numerous third-party U.S.- and foreign-issued patents andpending patent applications exist in the area of kinases, including CDKs and Auroraand Raf kinases. Because patent applications can take several years to issue,there may be pending applications that may result in issued patents that coverour technologies or product candidates. For example, some pending patentapplications contain broad claims that could represent freedom to operatelimitations for some of our kinase programs should they be issued unchanged. Inaddition, because pending patent applications are not required to be publishedgenerally until at least 18 months after they are filed (or at all beforeissuance in the case of U.S. patent applications filed before November 29,2000) there may be claims contained therein that we are not even aware of. If athird party asserts that we are using technology or compounds claimed in issuedand unexpired patents owned or controlled by the third party, we may need toobtain a license, enter into litigation to challenge the validity of thepatents or incur the risk of litigation in the event that a third party assertsthat we infringe its patents.

 

If a third party asserts that we infringe its patents or otherproprietary rights, we could face a number of issues that could seriously harmour competitive position, including:

 

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| · |   | infringement  and other intellectual property claims, which would be costly and time  consuming to litigate, whether or not the claims have merit, and which could  delay the regulatory approval process and divert management’s attention from  our business; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                 |
| · |   | substantial  damages for past infringement, which we may have to pay if a court determines  that our product candidates or technologies infringe a third party patent or  other proprietary rights;                                                                  |
|   |   |                                                                                                                                                                                                                                                                 |
| · |   | a  court prohibiting us from selling or licensing our product candidates or  technologies unless a third party licenses relevant patent or other  proprietary rights to us, which it is not required to do; and                                                      |
|   |   |                                                                                                                                                                                                                                                                 |
| · |   | if  a license is available from a third party, we may have to pay substantial  royalties or grant cross licenses to our patents or other proprietary rights.                                                                                                         |

 

***If our competitors develop andmarket products that are more effective, safer or less expensive than ourfuture products, our commercial opportunities will be negatively impacted.***

 

The life sciences industry is highly competitive, and we facesignificant competition from many pharmaceutical, biopharmaceutical andbiotechnology companies that are researching and marketing products designed toaddress cancer and other serious diseases. We are developing small moleculetherapeutics that will compete with other drugs and therapies that currentlyexist or are being developed. Many of our competitors have significantlygreater financial, manufacturing, marketing and drug development resources thanwe do. Large pharmaceutical companies in particular have extensive experiencein clinical testing and in obtaining regulatory approvals for drugs. Thesecompanies also have significantly greater research capabilities than we do. Inaddition, many universities and private and public research institutes areactive in cancer, Alzheimer’s and inflammation research, some of which are indirect competition with us.

 

Our product candidates will compete with a number of cancertherapeutics that are currently marketed or in development that also targetproliferating cells but at different points of the cell cycle or with adifferent mechanism of action. These drugs include irinotecan, doxorubicin,taxanes and other cytotoxics and targeted therapies. To compete effectively withthese agents, our product candidates will need to demonstrate advantages thatlead to improved clinical efficacy as either a single agent or in combinationsettings.

 

We believe that our ability to successfully compete will depend on,among other things:

 
| · |   | our  ability to develop novel compounds with attractive pharmaceutical properties  and to secure, protect and maintain intellectual property rights based on our  innovations; |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                           |
| · |   | the  efficacy, safety and reliability of our product candidates;                                                                                                               |
|   |   |                                                                                                                                                                           |
| · |   | the  speed at which we develop our product candidates;                                                                                                                         |
|   |   |                                                                                                                                                                           |
| · |   | our  ability to design and successfully execute appropriate clinical trials;                                                                                                   |
|   |   |                                                                                                                                                                           |
| · |   | our  ability to maintain a good relationship with regulatory authorities;                                                                                                      |
|   |   |                                                                                                                                                                           |
| · |   | our  ability to obtain, and the timing and scope of, regulatory approvals;                                                                                                     |
|   |   |                                                                                                                                                                           |
| · |   | our  ability to manufacture and sell commercial quantities of future products to  the market; and                                                                              |
|   |   |                                                                                                                                                                           |
| · |   | acceptance  of future products by physicians and other healthcare providers.                                                                                                   |

 

Some of the current key competitors to SNS-595 in AML include GenzymeCorporation’s clofarabine, MGI Pharma’s decitabine and ViON Corporation’scloretazine, all of which could change the treatment paradigm of acuteleukemia. Each of these compounds is further along in clinical development thanis SNS-595. Liposomal doxorubicin and topotecan are current standards of carein platinum-resistant ovarian cancer patients, and we are aware that several ofour competitors have initiated Phase 3 clinical trials for this indication.

 

Further, with respect to SNS-032, we believe that several companies,including Aventis Pharmaceuticals, Inc., AstraZeneca International,Cyclacel Pharmaceuticals, Inc., Pfizer Inc., F. Hoffman-LaRoche Ltd., Schering AG and others, are conducting clinical trials withCDK inhibitors and others are developing other compounds that may compete withSNS-032.

 

With respect to SNS-314, Merck and Vertex Pharmaceuticals Incorporatedare co-developing an Aurora kinase inhibitor and Cyclacel Pharmaceuticals, Inc.,AstraZeneca International, Astex Therapeutics Limited, MillenniumPharmaceuticals, Inc. and Rigel Pharmaceuticals, Inc. in conjunctionwith Merck Serono International S.A., and others are also developingAurora kinase inhibitors. Several 

 

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other companies have Aurorakinase programs for which they are close to filing an investigational new drug (“IND”)with the FDA. Other molecules that may compete with SNS-314 may include othernaturally occurring cell-cycle inhibitor drugs.

 

If our competitors market products that are more effective, safer orless expensive than our future products, if any, or that reach the marketsooner than our future products, if any, we may not achieve commercial success.In addition, the biopharmaceutical industry is characterized by rapidtechnological change. Because our research approach integrates manytechnologies, it may be difficult for us to stay abreast of the rapid changesin each technology. If we fail to stay at the forefront of technologicalchange, we may be unable to compete effectively. Technological advances orproducts developed by our competitors may render our technologies or productcandidates obsolete.

 

***Our proprietary fragment-based drugdiscovery approaches are experimental and may not discover any therapeuticcompounds of commercial value.***

 

The initial fragment-based proprietary drug discovery approach wedeveloped is called “Tethering.” Tethering is a process whereby a targetprotein known to be involved in a disease process is engineered to facilitatethe binding of small drug fragments. Once a small fragment is identified, thefragment is built out using the target protein’s surface as a template to makea new full-size therapeutic compound. We have developed further enhancements toour fragment-based drug discovery platform that are currently being utilized todiscover new targeted agents. Our drug discovery approaches are unproven andmay not identify any therapeutic compounds of commercial value.

 

***We rely on third parties to conductour clinical trials for SNS-595, SNS-032, and SNS-314. If these third partiesdo not successfully carry out their contractual duties or meet expecteddeadlines, we may be unable to obtain regulatory approval for or commercializeour product candidates.***

 

We do not have the ability to independently conduct clinical trials forSNS-595, SNS-032, SNS-314 or any other product candidate. We rely on thirdparties, such as contract research organizations, medical institutions,clinical investigators and contract laboratories, to conduct the planned andexisting clinical trials of our product candidates. If the third partiesconducting our clinical trials do not perform their contractual duties orobligations, do not meet expected deadlines or need to be replaced, or if thequality or accuracy of the clinical data they obtain is compromised due to thefailure to adhere to our clinical trial protocols or for any other reason, wemay need to enter into new arrangements with alternative third parties and ourclinical trials may be extended, delayed or terminated or may need to berepeated, and we may not be able to obtain regulatory approval for orcommercialize the product candidate being tested in such trials.

 

***Our proprietary rights may notadequately protect our technologies and product candidates.***

 

Our commercial success will depend on our ability to obtain patents andmaintain adequate protection for our technologies and product candidates in theUnited States and other countries. As of December 31, 2007, we owned,co-owned or had rights to approximately 220 issued U.S. and foreign patents andapproximately 345 pending U.S. and foreign patent applications. We will be ableto protect our proprietary rights from unauthorized use by third parties onlyto the extent that our proprietary technologies and future products are coveredby valid and enforceable patents or are effectively maintained as tradesecrets.

 

We apply for patents covering both our technologies and productcandidates, as we deem appropriate. However, we may fail to apply for patentson important technologies or product candidates in a timely fashion, or at all.Our existing patents and any future patents we obtain may not be sufficientlybroad to prevent others from practicing our technologies or from developingcompeting products and technologies. In addition, we generally do notexclusively control the patent prosecution of subject matter that we license toand from others. Accordingly, we are unable to exercise the same degree of controlover this intellectual property as we would over our own. Moreover, the patentpositions of biopharmaceutical companies are highly uncertain and involvecomplex legal and factual questions for which important legal principles remainunresolved. As a result, the validity and enforceability of patents cannot bepredicted with certainty. In addition, we do not know whether:

 
| · |   | we,  our licensors or our collaboration partners were the first to make the  inventions covered by each of our issued patents and pending patent  applications;   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                              |
| · |   | we,  our licensors or our collaboration partners were the first to file patent  applications for these inventions;                                                |
|   |   |                                                                                                                                                              |
| · |   | others  will independently develop similar or alternative technologies or duplicate  any of our technologies;                                                     |
|   |   |                                                                                                                                                              |
| · |   | any  of our or our licensors’ pending patent applications will result in issued  patents;                                                                    |
|   |   |                                                                                                                                                              |
| · |   | any  of our, our licensors’ or our collaboration partners’ patents will be valid  or enforceable;                                                       |
|   |   |                                                                                                                                                              |
| · |   | any  patents issued to us, our licensors or our collaboration partners will  provide us with any competitive advantages, or will be challenged by third  parties; |

 

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| · |   | we  will develop additional proprietary technologies that are patentable; or |
|--------|--------|------------------------------------------------------------------------------|
|   |   |                                                                         |
| · |   | the  patents of others will have an adverse effect on our business.          |

 

We also rely on trade secrets to protect some of our technology,especially where we do not believe patent protection is appropriate orobtainable. However, trade secrets are difficult to maintain. While we usereasonable efforts to protect our trade secrets, our or our collaborationpartners’ employees, consultants, contractors or scientific and other advisors,or those of our licensors, may unintentionally or willfully disclose our proprietaryinformation to competitors. Enforcement of claims that a third party hasillegally obtained and is using trade secrets is expensive, time consuming anduncertain. In addition, foreign courts are sometimes less willing than U.S.courts to protect trade secrets. If our competitors independently developequivalent knowledge, methods and know-how, we would not be able to assert ourtrade secrets against them and our business could be harmed.

 

***The composition of matter patentscovering SNS-595 are due to expire in 2015. Even if SNS-595 is approved by theFDA, we may not be able to recover our development costs prior to theexpiration of these patents.***

 

The composition of our lead product candidate, SNS-595, is covered byU.S. patent 5,817,669 and its counterpart patents and patent applications in 43foreign jurisdictions. U.S. patent 5,817,669 is due to expire in October 2015,and most of its foreign counterparts are due to expire in June 2015. We donot know whether patent term extensions and data exclusivity periods will beavailable in the future. SNS-595 must undergo extensive clinical trials beforeit can be approved by the FDA. We do not know when, if ever, SNS-595 will beapproved by the FDA. Even if SNS-595 is approved by the FDA in the future, wemay not have sufficient time to commercialize SNS-595 to enable us to recoverour development costs prior to the expiration of the U.S. and foreign patentscovering SNS-595. Our obligation to pay royalties to Dainippon, the companyfrom which we licensed SNS-595, may extend beyond the patent expiration, whichwill further erode the profitability of this product.

 

***The composition of matter patentscovering SNS-032 are due to expire in 2018 in the United States. Even ifSNS-032 is approved by the FDA, we may not be able to recover our developmentcosts prior to the expiration of these patents.***

 

The composition of our product candidate SNS-032 is covered by U.S.patent 6,515,004 and its counterpart patents and patent applications in 33foreign jurisdictions. U.S. patent 6,515,004 is due to expire in October 2018,and most of its foreign counterparts are due to expire in May 2021(although some expire as early as November 2018). We do not know whetherpatent term extensions and data exclusivity periods will be available in thefuture. SNS-032 must undergo extensive clinical trials before it can beapproved by the FDA. We do not know when, if ever, SNS-032 will be approved bythe FDA. Even if SNS-032 is approved by the FDA in the future, we may not havesufficient time to commercialize SNS-032 to enable us to recover ourdevelopment costs prior to the expiration of the U.S. and foreign patentscovering SNS-032. Our obligation to pay royalties to BMS, the company fromwhich we licensed SNS-032, may extend beyond the patent expiration, which willfurther erode the profitability of this product.

 

***The composition of matter patentscovering SNS-314 are due to expire in 2025 in the United States. Even ifSNS-314 is approved by the FDA, we may not be able to recover our developmentcosts prior to the expiration of these patents.***

 

The composition of our product candidate SNS-314 is covered by apending U.S. patent application and its counterpart patents and patentapplications in 14 foreign jurisdictions. If a patent issues based on thepending U.S. application, it would be due to expire on or about July 2025,along with most of its foreign counterparts. We do not know whether patent termextensions and data exclusivity periods will be available in the future.SNS-314 must undergo extensive clinical trials before it can be approved by theFDA. We do not know when, if ever, SNS-314 will be approved by the FDA. Even ifSNS-314 is approved by the FDA in the future, we may not have sufficient timeto commercialize SNS-314 to enable us to recover our development costs prior tothe expiration of any U.S. and foreign patents covering SNS-314.

 

***Our workforce reduction announced inAugust 2007 and any future workforce and expense reductions may have anadverse impact on our internal programs, our ability to hire and retain keypersonnel and may be distracting to management.***

 

In August 2007, we announced a workforce reduction of 35 employeesin order to reduce expenses. In light of our continued need for funding andexpense control, we may be required to implement further workforce and expensereductions in the future. Further workforce and expense reductions could resultin reduced progress on our internal programs. In addition, employees, whetheror not directly affected by a reduction, may seek future employment with ourbusiness partners or competitors. Although our employees are required to sign aconfidentiality agreement at the time of hire, the confidential nature ofcertain proprietary information may not be maintained in the course of any suchfuture employment. Further, we believe that our future success will depend inlarge part upon our ability to attract and retain highly skilled personnel. Wemay have difficulty retaining and attracting such personnel as a result of aperceived risk of future workforce and expense reductions. In addition, theimplementation of expense reduction programs may result in the diversion ofefforts of our executive management team and other key employees, which couldadversely affect our business.

 

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***The commercial success of productsresulting from our collaborations, if any, depends in whole or in part on thedevelopment and marketing efforts of our collaboration partners, over which wehave limited control. If our collaborations are unsuccessful, our potential togenerate future revenue from the sale of these products would be significantlyreduced.***

 

Our dependence on collaboration arrangements subjects our company to anumber of risks. The commercial success of products resulting from ourcollaborations, if any, depends, in whole or in part on our collaborationpartners’ ability to establish the safety and efficacy of our productcandidates, obtain and maintain regulatory approvals and achieve marketacceptance of a product once commercialized. Our collaboration partners mayelect to delay or terminate development of one or more product candidates,independently develop products that compete with ours, or fail to commitsufficient resources to the marketing and distribution of products developedthrough their collaborations with us. In the event that one or more of ourcollaboration partners fails to diligently develop or commercialize a productcandidate covered by one of our collaboration agreements, we may have the rightto terminate our partner’s rights to such product candidate but we will notreceive any future revenue from that product candidate unless we are able tofind another partner or commercialize the product candidate on our own, which islikely to result in significant additional expense. Business combinations,significant changes in business strategy, litigation and/or financialdifficulties may also adversely affect the willingness or ability of one ormore of our collaboration partners to complete their obligations under ourcollaboration agreements. If our collaboration partners fail to perform in themanner we expect, our potential to generate future revenue from the sale ofproducts resulting from our collaborations, would be significantly reduced.

 

***If conflicts of interest arisebetween our collaboration partners and us, any of them may act in their selfinterest, which may be adverse to our interests.***

 

If a conflict of interest arises between us and one or more of ourcollaboration partners, they may act in their own self interest or otherwise ina way that is not in the interest of our company or our stockholders. Some ofour collaboration partners are conducting, and future collaboration partners,if any, may conduct, multiple product development efforts within the diseasearea that is the subject of collaboration with our company. In some of ourcollaborations, we have agreed not to conduct, independently or with any thirdparty, any research that is competitive with the research conducted under ourcollaborations. Our collaboration partners, however, may develop, either aloneor with others, products in related fields that are competitive with theproduct candidates that are the subject of these collaborations. Competingproducts, either developed by our collaboration partners or to which ourcollaboration partners have rights, may result in their withdrawal of supportfor our product candidates.

 

If one or more of our collaboration partners were to breach orterminate their collaboration agreements with us or otherwise fail to performtheir obligations thereunder in a timely manner, the preclinical or clinicaldevelopment or commercialization of the affected product candidates or researchprograms could be delayed or terminated. We do not know whether our current orany future collaboration partners will pursue alternative technologies ordevelop alternative product candidates, either on their own or in collaborationwith others, including our competitors, as a means for developing treatmentsfor the diseases targeted by collaboration agreements with our company.

 

***We may be subject to damagesresulting from claims that we or our employees have wrongfully used ordisclosed alleged trade secrets of our employees’ former employers.***

 

Many of our employees were previously employed at universities orbiotechnology or pharmaceutical companies, including our competitors orpotential competitors. We may be subject to claims that we or our employeeshave inadvertently or otherwise used or disclosed trade secrets or otherproprietary information of their former employers. Litigation may be necessaryto defend against these claims. If we fail in defending such claims, inaddition to paying monetary damages, we may lose valuable intellectual propertyrights or personnel. A loss of key research personnel or their work productcould hamper or prevent our ability to commercialize our product candidates,which could severely harm our business. Even if we are successful in defendingagainst these claims, litigation could result in substantial costs and be adistraction to management.

 

***We currently have limited marketingstaff and no sales or distribution organization. If we are unable to develop asales and marketing and distribution capability on our own or throughcollaborations with marketing partners, we will not be successful incommercializing our future products.***

 

We currently have no sales or distribution capabilities and limitedmarketing staff. We intend to establish our own sales and marketing organizationwith technical expertise and supporting distribution capabilities tocommercialize at least some of our future products, if any, which will beexpensive and time consuming. Any failure or delay in the development of ourinternal sales, marketing and distribution capabilities would adversely impactthe commercialization of these products. With respect to other future products,we plan to collaborate with third parties that have direct sales forces andestablished distribution systems. To the extent that we enter into co-promotionor other licensing arrangements, our product revenue is likely to be lower thanif we directly marketed or sold our products. In addition, any revenue wereceive will depend upon the efforts of third parties, which may not besuccessful and are only partially within our control. If we are unable to enterinto such arrangements on acceptable terms or at all, we may not be able tosuccessfully commercialize these future products. If we are not successful incommercializing our future products, either on our own or throughcollaborations with one or more third parties, our future product revenue willsuffer and we may incur significant additional losses.

 

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***We depend on various scientificconsultants and advisors for the success and continuation of our research anddevelopment efforts.***

 

We work extensively with various scientific consultants and advisors.The potential success of our drug discovery and development programs depends,in part, on continued collaborations with certain of these consultants andadvisors. We rely on certain of these consultants and advisors for expertise inour research, regulatory and clinical efforts. Our scientific consultants andadvisors are not our employees and may have commitments and obligations toother entities that may limit their availability to us. We do not know if wewill be able to maintain such relationships or that such scientific consultantsand advisors will not enter into other arrangements with competitors, any ofwhich could have a detrimental impact on our research and developmentobjectives and our business.

 

***Our facilities are located nearknown earthquake fault zones, and the occurrence of an earthquake or othercatastrophic disaster could cause damage to our facilities and equipment, whichcould require us to cease or curtail operations.***

 

Our facilities are located in the San Francisco Bay Area near knownearthquake fault zones and are vulnerable to significant damage fromearthquakes. We are also vulnerable to damage from other types of disasters,including fires, floods, power loss, communications failures and similarevents. We are in the process of designing and implementing a disaster reliefplan. However, even if such a plan were in place, if any disaster were tooccur, our ability to operate our business at our facilities may be seriouslyor completely impaired and our research could be lost or destroyed. Inaddition, the unique nature of our research activities and of much of ourequipment could make it difficult for us to recover from a disaster.

 

***Compliance with changing regulationof corporate governance and public disclosure may result in additionalexpenses.***

 

Changing laws, regulations and standards relating to corporategovernance and public disclosure may create uncertainty regarding compliancematters. New or changed laws, regulations and standards are subject to varyinginterpretations in many cases. As a result, their application in practice mayevolve over time. We are committed to maintaining high standards of corporategovernance and public disclosure. Complying with evolving interpretations ofnew or changed legal requirements may cause us to incur higher costs as werevise current practices, policies and procedures, and may divert managementtime and attention from potential revenue-generating activities to compliancematters. If our efforts to comply with new or changed laws, regulations andstandards differ from the activities intended by regulatory or governing bodiesdue to ambiguities related to practice, our reputation may also be harmed.Further, our board members, chief executive officer and chief financial officercould face an increased risk of personal liability in connection with theperformance of their duties. As a result, we may have difficulty attracting andretaining qualified board members and executive officers, which could harm ourbusiness.

 

***Global credit and financial marketconditions negatively impact the value of our current portfolio of cashequivalents or short-term investments and our ability to meet our financingobjectives.***

 

Our cash and cash equivalents are maintained in highly liquidinvestments with remaining maturities of 90 days or less at the time ofpurchase. Our marketable securities consist primarily of investments in readilymarketable debt securities with remaining maturities of more than 90 daysat the time of purchase. While as of the date of this filing, we are not awareof any downgrades, material losses, or other significant deterioration in thefair value of our cash equivalents or marketable securities since March 31,2008, no assurance can be given that further deterioration in conditions of theglobal credit and financial markets would not negatively impact our currentportfolio of cash equivalents or marketable securities or our ability to meetour current liquidity needs.

 

 **Risks Related to Our Industry**

 

***The regulatory approval process isexpensive, time consuming and uncertain and may prevent us or our collaborationpartners from obtaining approvals for the commercialization of some or all ofour product candidates.***

 

The research, testing, manufacturing, selling and marketing of productcandidates are subject to extensive regulation by the FDA and other regulatoryauthorities in the United States and other countries, which regulations differfrom country to country. Neither we nor our collaboration partners arepermitted to market our product candidates in the United States until wereceive approval of an new drug application (“NDA”) from the FDA or in anyother country without the equivalent marketing approval from such country.Neither we nor our collaboration partners have received marketing approval forany of our product candidates. In addition, failure to comply with FDA andother applicable U.S. and foreign regulatory requirements may subject us toadministrative or judicially imposed sanctions, including warning letters,civil and criminal penalties, injunctions, product seizure or detention,product recalls, total or partial suspension of production, and refusal toapprove pending NDAs, supplements to approved NDAs or their foreignequivalents.

 

Regulatory approval of an NDA or NDA supplement or a foreign equivalentis not guaranteed, and the approval process is expensive and may take severalyears. Furthermore, the development process for oncology products may takelonger than in other therapeutic areas. Regulatory authorities have substantialdiscretion in the drug approval process. Despite the time and expense exerted,failure can occur at any stage, and we could encounter problems that cause usto abandon clinical trials or to repeat or perform additional preclinicalstudies and clinical 

 

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trials. The number ofpreclinical studies and clinical trials that will be required for marketingapproval varies depending on the drug candidate, the disease or condition thatthe drug candidate is designed to address, and the regulations applicable toany particular drug candidate. The FDA or a foreign regulatory authority candelay, limit or deny approval of a drug candidate for many reasons, including:

 

·                  thedrug candidate may not be deemed safe or effective;

 

·                  regulatoryofficials may not find the data from preclinical studies and clinical trialssufficient;

 

·                  theFDA or foreign regulatory authority might not approve our or our third-partymanufacturer’s processes or facilities; or

 

·                  theFDA or foreign regulatory authority may change its approval policies or adoptnew regulations.

 

***We may be subject to costly claimsrelated to our clinical trials and may not be able to obtain adequateinsurance.***

 

Because we conduct clinical trials in humans, we face the risk that theuse of our product candidates will result in adverse side effects. We cannotpredict the possible harms or side effects that may result from our clinicaltrials. Although we have clinical trial liability insurance for up to$10.0 million aggregate, our insurance may be insufficient to cover anysuch events. We do not know whether we will be able to continue to obtainclinical trial coverage on acceptable terms, or at all. We may not havesufficient resources to pay for any liabilities resulting from a claim excludedfrom, or beyond the limit of, our insurance coverage. There is also a risk thatthird parties that we have agreed to indemnify could incur liability. Anylitigation arising from our clinical trials, even if we were ultimatelysuccessful, would consume substantial amounts of our financial and managerialresources and may create adverse publicity.

 

***Even if we receive regulatoryapproval to market our product candidates, the market may not be receptive toour products.***

 

Even if our product candidates obtain regulatory approval, resultingproducts, if any, may not gain market acceptance among physicians, patients,healthcare payors and/or the medical community. We believe that the degree ofmarket acceptance will depend on a number of factors, including:

 

·                  timingof market introduction of competitive products;

 

·                  efficacyof our product;

 

·                  prevalenceand severity of any side effects;

 

·                  potentialadvantages or disadvantages over alternative treatments;

 

·                  strengthof marketing and distribution support;

 

·                  priceof our future products, both in absolute terms and relative to alternativetreatments; and

 

·                  availabilityof reimbursement from health maintenance organizations and other third-partypayors.

 

For example, the potential toxicity of single and repeated doses ofSNS-595 has been explored in a number of animal studies that suggest themechanism-based dose-limiting toxicities in humans receiving SNS-595 may besimilar to some of those observed in approved cytotoxic agents, includingreversible toxicity to bone marrow cells, the gastrointestinal system and othersystems with rapidly dividing cells. In our Phase 1 and Phase 2clinical trials of SNS-595, we have witnessed the following side effects,irrespective of causality, ranging from mild to more severe: lowered whiteblood cell count that may lead to a serious or possibly life-threateninginfection, hair loss, mouth sores, fatigue, nausea with or without vomiting,lowered platelet count, which may lead to an increase in bruising or bleeding,lowered red blood cell count (anemia), weakness, tiredness, shortness ofbreath, diarrhea and intestinal blockage. Our ongoing Phase 1 clinicaltrials of SNS-032 and SNS-314 have a limited number of patients enrolled thusfar. We can not yet assess the extent and type of side effects and/orunacceptable toxicities that these product candidates might exhibit in thepatient populations and dosing regimens being evaluated.

 

If our future products fail to achieve market acceptance, due tounacceptable side effects or any other reasons, we may not be able to generatesignificant revenue or to achieve or sustain profitability.

 

***Even if we receive regulatoryapproval for a product candidate, we will be subject to ongoing FDA and otherregulatory obligations and continued regulatory review, which may result insignificant additional expense and limit our ability to commercialize ourfuture products.***

 

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Any regulatory approvals that we or our collaboration partners receivefor our product candidates may also be subject to limitations on the indicateduses for which the product may be marketed or contain requirements forpotentially costly post-marketing studies. In addition, even if approved, thelabeling, packaging, adverse event reporting, storage, advertising, promotionand recordkeeping for any product will be subject to extensive and ongoingregulatory requirements. The subsequent discovery of previously unknownproblems with a product, including adverse events of unanticipated severity orfrequency, may result in restrictions on the marketing of the product, andcould include withdrawal of the product from the market.

 

Regulatory policies may change and additional government regulationsmay be enacted that could prevent or delay regulatory approval of our productcandidates. We cannot predict the likelihood, nature or extent of governmentregulation that may arise from future legislation or administrative action,either in the United States or abroad. If we are not able to maintainregulatory compliance, we might not be permitted to market our future productsand we may not achieve or sustain profitability.

 

***The coverage and reimbursementstatus of newly approved drugs is uncertain, and failure to obtain adequatecoverage and reimbursement could limit our ability to market any futureproducts we may develop and decrease our ability to generate revenue.***

 

There is significant uncertainty related to the third party coverageand reimbursement of newly approved drugs both nationally and internationally.The commercial success of our future products in both domestic andinternational markets depends on whether third-party coverage and reimbursementis available for the ordering of our future products by the medical professionfor use by their patients. Medicare, Medicaid, health maintenance organizationsand other third-party payors are increasingly attempting to manage healthcarecosts by limiting both coverage and the level of reimbursement of new drugsand, as a result, they may not cover or provide adequate payment for our futureproducts. These payors may not view our future products as cost-effective, andreimbursement may not be available to consumers or may not be sufficient toallow our future products to be marketed on a competitive basis. Likewise, legislativeor regulatory efforts to control or reduce healthcare costs or reformgovernment healthcare programs could result in lower prices or rejection of ourfuture products. Changes in coverage and reimbursement policies or healthcarecost containment initiatives that limit or restrict reimbursement for ourfuture products may reduce any future product revenue.

 

***Failure to obtain regulatoryapproval in foreign jurisdictions will prevent us from marketing our productsabroad.***

 

We intend to market our future products in international markets. Inorder to market our future products in Canada, the European Union and manyother foreign jurisdictions, we must obtain separate regulatory approvals. Wehave had limited interactions with foreign regulatory authorities, and theapproval procedures vary among countries and can involve additional testing atsignificant cost. The time required to obtain approval may differ from thatrequired to obtain FDA approval. Approval by the FDA does not ensure approvalby regulatory authorities in other countries, and approval by one foreignregulatory authority does not ensure approval by regulatory authorities inother foreign countries or by the FDA. The foreign regulatory approval processmay include all of the risks associated with obtaining FDA approval. We may notobtain foreign regulatory approvals on a timely basis, if at all. We may not beable to file for regulatory approvals and may not receive necessary approvalsto commercialize our products in any market.

 

***Foreign governments often imposestrict price controls, which may adversely affect our future profitability.***

 

We intend to seek approval to market our future products in both theUnited States and foreign jurisdictions. If we obtain approval in one or moreforeign jurisdictions, we will be subject to rules and regulations inthose jurisdictions relating to our product. In some foreign countries,particularly in the European Union, prescription drug pricing is subject togovernmental control. In these countries, pricing negotiations withgovernmental authorities can take considerable time after the receipt ofmarketing approval for a drug candidate. To obtain reimbursement or pricingapproval in some countries, we may be required to conduct a clinical trial thatcompares the cost-effectiveness of our future product to other availabletherapies. If reimbursement of our future products is unavailable or limited inscope or amount, or if pricing is set at unsatisfactory levels, we may beunable to achieve or sustain profitability.

 

***We may incur significant costscomplying with environmental laws and regulations, and failure to comply withthese laws and regulations could expose us to significant liabilities.***

 

We use hazardous chemicals and radioactive and biological materials inour business and are subject to a variety of federal, state, regional and locallaws and regulations governing the use, generation, manufacture, storage,handling and disposal of these materials. Although we believe our safetyprocedures for handling and disposing of these materials and waste productscomply with these laws and regulations, we cannot eliminate the risk ofaccidental injury or contamination from the use, storage, handling or disposalof hazardous materials. In the event of contamination or injury, we could beheld liable for any resulting damages, and any liability could significantlyexceed our insurance coverage, which is limited to $0.1 million forpollution cleanup, and we are uninsured for third-party contamination injury.

 

**Risks Related to Our Common Stock**

 

***If we sell shares of our commonstock in future financings, stockholders may experience immediate dilution.***

 

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We may from time to time issue additional shares of common stock at adiscount from the current trading price of our common stock. As a result, ourstockholders would experience immediate dilution upon the purchase of anyshares of our common stock sold at such discount.

 

In addition, as opportunities present themselves in the future, we mayenter into financing or similar arrangements, including the issuance of debtsecurities, preferred stock or common stock. If we issue additional common orpreferred stock or securities convertible into common stock, our stockholders couldexperience dilution.

 

***The price of our common stock maycontinue to be volatile, and the value of an investment in our common stock maydecline.***

 

We sold shares of common stock in our IPO in September 2005 at aprice of $7.00 per share, and through May 8, 2008, our stock hassubsequently traded as low as $1.00 per share. An active and liquid tradingmarket for our common stock may not develop or be sustained. Factors that couldcause volatility in the market price of our common stock include, but are notlimited to:

 

·                  failureto raise additional capital to carry through with our clinical developmentplans;

 

·                  resultsfrom, and any delays in or discontinuance of, our clinical trial programs,including our ongoing and planned clinical trials for SNS-595, SNS-032 andSNS-314;

 

·                  announcementsof FDA non-approval of our product candidates, including SNS-595, SNS-032 orSNS-314, delays in filing regulatory documents with the FDA or other regulatoryagencies, or delays in the review process by the FDA or other foreignregulatory agencies;

 

·                  announcementsrelating to our ongoing collaborations with Biogen Idec, Johnson &Johnson PRD and Merck;

 

·                  failureor discontinuation of any of our research programs;

 

·                  delaysin the commercialization of our future products;

 

·                  marketconditions in the pharmaceutical, biopharmaceutical and biotechnology sectors;

 

·                  issuanceof new or changed securities analysts’ reports or recommendations;

 

·                  actualand anticipated fluctuations in our quarterly operating results;

 

·                  developmentsor disputes concerning our intellectual property or other proprietary rights;

 

·                  introductionof technological innovations or new products by us or our competitors;

 

·                  issuesin manufacturing our product candidates or future products, if any;

 

·                  marketacceptance of our future products, if any;

 

·                  deviationsin our operating results from the estimates of analysts;

 

·                  third-partyhealthcare reimbursement policies;

 

·                  FDAor other U.S. or foreign regulatory actions affecting us or our industry;

 

·                  litigationor public concern about the safety of our product candidates or futureproducts, if any;

 

·                  salesof our common stock by our officers, directors or significant stockholders; and

 

·                  additionsor departures of key personnel.

 

In addition, the stock markets in general, and the markets forpharmaceutical, biopharmaceutical and biotechnology stocks in particular, haveexperienced extreme volatility that has often been unrelated to the operatingperformance of the issuer. These broad market fluctuations may adversely affectthe trading price or liquidity of our common stock. In the past, when themarket price of a stock has been volatile, holders of that stock have sometimesinstituted securities class action litigation against the issuer. If any of ourstockholders were to bring such a lawsuit against us, we could incursubstantial costs defending the lawsuit and the attention of our managementwould be diverted from the operation of our business.

 

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***Provisions of our charter documentsor Delaware law could delay or prevent an acquisition of our company, even ifthe acquisition would be beneficial to our stockholders, and could make it moredifficult to change management.***

 

Provisions of our amended and restated certificate of incorporation andamended and restated bylaws may discourage, delay or prevent a merger,acquisition or other change in control that stockholders may considerfavorable, including transactions in which stockholders might otherwise receivea premium for their shares. In addition, these provisions may frustrate orprevent any attempt by our stockholders to replace or remove our currentmanagement by making it more difficult to replace or remove our board ofdirectors. These provisions include:

 

·                  aclassified Board of Directors so that not all directors are elected at onetime;

 

·                  aprohibition on stockholder action through written consent;

 

·                  limitationson our stockholders’ ability to call special meetings of stockholders;

 

·                  anadvance notice requirement for stockholder proposals and nominations; and

 

·                  theauthority of our Board of Directors to issue preferred stock with such terms asour Board of Directors may determine.

 

In addition, Delaware law prohibits a publicly held Delaware corporationfrom engaging in a business combination with an interested stockholder,generally a person who, together with its affiliates, owns or within the lastthree years has owned 15% of our voting stock, for a period of three yearsafter the date of the transaction in which the person became an interestedstockholder, unless the business combination is approved in a prescribedmanner. Accordingly, Delaware law may discourage, delay or prevent a change incontrol of our company.

 

Provisions in our charter documents and provisions of Delaware lawcould limit the price that investors are willing to pay in the future forshares of our common stock.

 

***The ownership of our common stock ishighly concentrated, and your interests may conflict with the interests of ourexisting stockholders.***

 

Our executive officers and directors and their affiliates beneficiallyowned approximately 42.0 percent of our outstanding common stock as of February 29,2008. Accordingly, these stockholders, acting as a group, have significant influenceover the outcome of corporate actions requiring stockholder approval, includingthe election of directors, any merger, consolidation or sale of all orsubstantially all of our assets or any other significant corporate transaction.These stockholders could delay or prevent a change of control of our company,even if such a change of control would benefit our other stockholders. Thesignificant concentration of stock ownership may adversely affect the tradingprice of our common stock due to investors’ perception that conflicts ofinterest may exist or arise.

 

***We have never paid dividends on ourcapital stock and we do not anticipate paying any cash dividends in theforeseeable future.***

 

We have never declared or paid cash dividends on our capital stock. Wedo not anticipate paying any cash dividends on our capital stock in theforeseeable future. We currently intend to retain all available funds and anyfuture earnings to fund the development and growth of our business. As aresult, capital appreciation, if any, of our common stock will be ourstockholders’ sole source of gain for the foreseeable future.

 

***We are at risk of securities classaction litigation.***

 

In the past, securities class action litigation has often been broughtagainst a company following a decline in the market price of its securities.This risk is especially relevant for us because biotechnology companies haveexperienced greater than average stock price volatility in recent years. If wefaced such litigation, it could result in substantial costs and a diversion ofmanagement’s attention and resources, which could harm our business.

 

***Changes in financial accountingstandards related to share-based payments are expected to continue to have aneffect on our reported results.***

 

On January 1, 2006, we adopted Statement of Financial AccountingStandards No. FAS 123 (revised 2004) (FAS 123R), “*Share-Based Payment*,” which requires thatwe record compensation expense in the statement of operations for share-basedpayments, such as employee stock options, using the fair value method. Theadoption of this standard is expected to continue to have an effect on ourreported results of operations, although it will not affect our cash flows, andcould adversely impact our ability to provide accurate guidance on our futurereported financial results due to the variability of the factors used toestimate the values of share-based payments. If factors change and we employdifferent assumptions or different valuation methods in the application of FAS 123Rin future periods, the compensation expense 

 

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that we record underFAS 123R may differ significantly from what we have recorded in thecurrent period, which could negatively affect our stock price and our stockprice volatility.

 

**Item 2.**   **UnregisteredSales of Equity Securities and Use of Proceeds**

 

There were no repurchases ofsecurities or any sales of unregistered equity securities during the quarterended March 31, 2008.

 

**Item 3.**   **DefaultsUpon Senior Securities**

 

None.

 

**Item 4.**   **Submissionof Matters to a Vote of Security Holders**

 

None.

 

**Item 5.**   **OtherInformation**

 

None.

 

**Item 6.**   **Exhibits**

 
| **Exhibit**** ****Number** |   | **Description**                                                                                                                                                                                                       |
|---------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                            |   |                                                                                                                                                                                                                  |
| 3.1                             |   | Amended and Restated  Certificate of Incorporation of the Registrant (Delaware) (incorporated by  reference to Exhibit 3.1 to the Company’s Annual Report on  Form 10-K/A filed on May 23, 2007). |
|                            |   |                                                                                                                                                                                                                  |
| 3.2                             |   | Amended and Restated  Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to  the Company’s Annual Report on Form 10K-A on Form S-1 filed on  May 23, 2007).                  |
|                            |   |                                                                                                                                                                                                                  |
| 4.1                             |   | Reference is made to  Exhibit 3.1 and 3.2.                                                                                                                                                                       |
|                            |   |                                                                                                                                                                                                                  |
| 10.55*                          |   | Sunesis  Pharmaceuticals, Inc. 2008 Bonus Program (incorporated by reference to  Exhibit 10.55 to the Registrant’s Current Report on Form 8-K filed  on March 11, 2008).                     |
|                            |   |                                                                                                                                                                                                                  |
| 31.1                            |   | Certification of Chief  Executive Officer as required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                |
|                            |   |                                                                                                                                                                                                                  |
| 31.2                            |   | Certification of Chief  Financial Officer as required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                |
|                            |   |                                                                                                                                                                                                                  |
| 32.1#                           |   | Certification of Chief  Executive Officer as required by Rule 13a-14(b) of the Securities  Exchange Act of 1934, as amended.                                                                                |
|                            |   |                                                                                                                                                                                                                  |
| 32.2#                           |   | Certification of Chief  Financial Officer as required by Rule 13a-14(b) of the Securities  Exchange Act of 1934, as amended.                                                                                |

 

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| *      | Management  contract, compensating plan or arrangement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| #      | In  accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC  Release Nos. 33-8238 and 34-47986, Final Rule; Management’s Reports on  Internal Control over Financial Reporting and Certification of Disclosure in  Exchange Act Periodic Reports, the Certifications furnished in  Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q  and will not be filed for purposes of Section 18 of the Exchange Act.  Such certifications will not be deemed incorporated by reference into any  filing under the Securities Act or the Exchange Act, except to the extent  that the registrant specifically incorporates it by reference.

  |

 

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**SIGNATURE**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                               |   | **SUNESIS PHARMACEUTICALS, INC.**                                                                   |
|------------------------------------|--------|----------------------------------------------------------------------------------------------------------|
|                               |   | *(Registrant)*                                                                                           |
|                               |   | * *                                                                                                 |
|  Date:  May 9, 2008 |   | /S/  ERIC H. BJERKHOLT                                                                                   |
|                               |   | Eric  H. Bjerkholt

*Senior Vice President, Corporate Development and Finance,  Chief Financial Officer* |

 

**Exhibit Index**

 
| **Exhibit**** ****Number** | ** ** | **Description**                                                                                                                                                                                                       |
|---------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                            |       |                                                                                                                                                                                                                  |
| 3.1                             |       | Amended and Restated  Certificate of Incorporation of the Registrant (Delaware) (incorporated by  reference to Exhibit 3.1 to the Company’s Annual Report on  Form 10-K/A filed on May 23, 2007). |
|                            |       |                                                                                                                                                                                                                  |
| 3.2                             |       | Amended and Restated  Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to  the Company’s Annual Report on Form 10K-A on Form S-1 filed on  May 23, 2007).                  |
|                            |       |                                                                                                                                                                                                                  |
| 4.1                             |       | Reference is made to  Exhibit 3.1 and 3.2.                                                                                                                                                                       |
|                            |       |                                                                                                                                                                                                                  |
| 10.55*                          |       | Sunesis  Pharmaceuticals, Inc. 2008 Bonus Program (incorporated by reference to  the Registrant’s Current Report on Form 8-K filed on March 11,  2008).                                           |
|                            |       |                                                                                                                                                                                                                  |
| 31.1                            |       | Certification of Chief  Executive Officer as required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                |
|                            |       |                                                                                                                                                                                                                  |
| 31.2                            |       | Certification of Chief  Financial Officer as required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                |
|                            |       |                                                                                                                                                                                                                  |
| 32.1#                           |       | Certification of Chief  Executive Officer as required by Rule 13a-14(b) of the Securities  Exchange Act of 1934, as amended.                                                                                |
|                            |       |                                                                                                                                                                                                                  |
| 32.2#                           |       | Certification of Chief  Financial Officer as required by Rule 13a-14(b) of the Securities  Exchange Act of 1934, as amended.                                                                                |

 

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| *      | Management  contract, compensating plan or arrangement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| #      | In  accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC  Release Nos. 33-8238 and 34-47986, Final Rule; Management’s Reports on  Internal Control over Financial Reporting and Certification of Disclosure in  Exchange Act Periodic Reports, the Certifications furnished in  Exhibits 32.1 and 32.2 hereto are deemed to accompany this  Form 10-Q and will not be filed for purposes of Section 18 of the  Exchange Act. Such certifications will not be deemed incorporated by  reference into any filing under the Securities Act or the Exchange Act,  except to the extent that the registrant specifically incorporates it by  reference.

  |

 

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