**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM 10-Q**


**(Mark
      One)**


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





**For
      the quarterly period ended September 30, 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**





**Commission
      file number: 000-51531**





**SUNESIS
      PHARMACEUTICALS, INC.**


(Exact
      Name of Registrant as Specified in its Charter)





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





**395
      Oyster Point Boulevard, Suite 400**


**South
      San Francisco, California 94080**


(Address
      of Principal Executive Offices including Zip Code)





**(650)
      266-3500**


(Registrant’s
      Telephone Number, Including Area Code)





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




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


Large
                accelerated filero
            
            Accelerated
                filerxNon-accelerated
                filero
            
            Smaller
                reporting companyo(Do
                not check if a smaller reporting company)





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





The
      registrant had 34,401,535 shares of common stock, $0.0001 par value per share,
      outstanding as of October 31, 2008.















**SUNESIS
      PHARMACEUTICALS, INC.**


**TABLE
      OF CONTENTS**





**Page**
              **No.****PART I.
                FINANCIAL INFORMATION**Item
                1.
            Financial
                Statements:
            2Consolidated
                Balance Sheets as of September 30, 2008 and December 31,
                2007
            2Consolidated
                Statements of Operations for the Three Months and Nine Months Ended
                September 30, 2008 and 2007
            3Consolidated
                Statements of Cash Flows for the Nine Months Ended September 30,
                2008 and
                2007
            4Notes
                to Consolidated Financial Statements
            5Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            15Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            21Item
                4.
            Controls
                and Procedures
            21**PART II.
                OTHER INFORMATION**
            21Item
                1.
            Legal
                Proceedings
            21Item
                1A.
            Risk
                Factors
            21Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            36Item
                3.
            Defaults
                Upon Senior Securities
            37Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            37Item
                5.
            Other
                Information
            37Item
                6.
            Exhibits
            37**Signatures**
            
            38





1




**PART I
      — FINANCIAL INFORMATION**


**Item
      1.**  **Financial
      Statements**


**SUNESIS
      PHARMACEUTICALS, INC.**


**CONSOLIDATED
      BALANCE SHEETS**





**September
                30,**
              **2008**
            
            **December 31,**
              **2007****(Unaudited)**
            
            **(1)****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            8,484,014
            
            $
            11,726,126Marketable
                securities
            
            
            9,782,214
            
            
            35,957,933Prepaids
                and other current assets
            
            
            616,182
            
            
            945,583Total
                current assets
            
            
            18,882,410
            
            
            48,629,642Property
                and equipment, net
            
            
            931,075
            
            
            4,238,498Assets
                held-for-sale
            
            
            1,182,864
            
            
            —Deposits
                and other assets
            
            
            377,798
            
            
            377,798Total
                assets
            
            $
            21,374,147
            
            $
            53,245,938**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable and other accrued liabilities
            
            $
            3,997,919
            
            $
            4,515,426Accrued
                compensation
            
            
            1,189,334
            
            
            2,225,868Deferred
                revenue
            
            
            39,583
            
            
            1,227,031Current
                portion of equipment financing
            
            
            1,560,967
            
            
            953,940Total
                current liabilities
            
            
            6,787,803
            
            
            8,922,265Non-current
                portion of equipment financing
            
            
            —
            
            
            1,352,684Deferred
                rent liabilities
            
            
            1,536,572
            
            
            1,576,734Total
                liabilities
            
            
            8,324,375
            
            
            11,851,683CommitmentsStockholders’
                equity:Preferred
                stock, $0.0001 par value; 5,000,000 shares authorized, no shares
                issued
                and outstanding at September 30, 2008 and December 31,
                2007
            
            
            —
            
            
            —Common
                stock, $0.0001 par value; 100,000,000 shares authorized at
                September 30, 2008 and December 31, 2007; 34,401,535 shares issued
                and
                outstanding at September 30, 2008; 34,364,896 shares issued and
                outstanding at December 31, 2007
            
            
            3,440
            
            
            3,437Additional
                paid-in capital
            
            
            322,314,385
            
            
            320,579,240Deferred
                stock-based compensation
            
            
            —
            
            
            (251,601
            )Accumulated
                other comprehensive (loss) income
            
            
            (3,475
            )
            
            69,262Accumulated
                deficit
            
            
            (309,264,578
            )
            
            (279,006,083
            )Total
                stockholders’ equity
            
            
            13,049,772
            
            
            41,394,255Total
                liabilities and stockholders’ equity
            
            $
            21,374,147
            
            $
            53,245,938







(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.





See
      accompanying notes to consolidated financial statements.





2





**SUNESIS
      PHARMACEUTICALS, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**




**Three months ended September
                30,**
            
            **Nine months ended****September****30,****2008**
            
            **2007**
            
            **2008**
            
            **2007****(Unaudited)**
            
            **(Unaudited)**Revenue:Collaboration
                revenue
            
            $
            10,417
            
            $
            1,830,274
            
            $
            4,904,840
            
            $
            7,366,805License
                revenue
            
            
            500,000
            
            
            —
            
            
            500,000
            
            
            250,000Total
                revenues
            
            
            510,417
            
            
            1,830,274
            
            
            5,404,840
            
            
            7,616,805Operating
                expenses:Research
                and development
            
            
            4,662,556
            
            
            8,787,118
            
            
            21,668,055
            
            
            27,792,058General
                and administrative
            
            
            2,827,797
            
            
            3,408,693
            
            
            9,328,987
            
            
            10,749,034Restructuring
                charges
            
            
            192,225
            
            
            1,217,848
            
            
            5,389,745
            
            
            1,217,848Total
                operating expenses
            
            
            7,682,578
            
            
            13,413,659
            
            
            36,386,787
            
            
            39,758,940Loss
                from operations
            
            
            (7,172,161
            )
            
            (11,583,385
            )
            
            (30,981,947
            )
            
            (32,142,135
            )Interest
                income
            
            
            138,668
            
            
            796,731
            
            
            868,465
            
            
            2,310,285Interest
                expense
            
            
            (40,278
            )
            
            (55,903
            )
            
            (154,084
            )
            
            (152,254
            )Other
                income, net
            
            
            8,599
            
            
            232
            
            
            9,071
            
            
            1,159Net
                loss
            
            $
            (7,065,172
            )
            $
            (10,842,325
            )
            $
            (30,258,495
            )
            $
            (29,982,945
            )Basic
                and diluted loss per share
            
            $
            (0.21
            )
            $
            (0.32
            )
            $
            (0.88
            )
            $
            (0.95
            )Shares
                used in computing basic and diluted loss per share
            
            
            34,401,519
            
            
            34,315,961
            
            
            34,381,335
            
            
            31,667,511





See
      accompanying notes to consolidated financial statements.





3





**SUNESIS
      PHARMACEUTICALS, INC.**


**CONSOLIDATED
      STATEMENT OF CASH FLOWS**





**Nine months ended
                September 30,****2008**
            
            **2007****(Unaudited)****Cash
                flows from operating activities**Net
                loss
            
            $
            (30,258,495
            )
            $
            (29,982,945
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            992,624
            
            
            1,295,834Stock-based
                compensation expense
            
            
            1,571,672
            
            
            2,488,435Non-cash
                restructuring charges
            
            
            1,664,817
            
            
            209,921Gain
                on property and equipment disposal
            
            
            (8,548
            )
            
            —Changes
                in operating assets and liabilities:Prepaids
                and other current assets
            
            
            329,401
            
            
            (106,791
            )Accounts
                payable and other accrued liabilities
            
            
            (517,903
            )
            
            464,926Accrued
                compensation
            
            
            (1,036,534
            )
            
            (133,781
            )Deferred
                rent liabilities
            
            
            (40,161
            )
            
            116,324Deferred
                revenue
            
            
            (1,187,448
            )
            
            (1,701,606
            )Net
                cash used in operating activities
            
            
            (28,490,575
            )
            
            (27,349,683
            )**Cash
                flows from investing activities**Purchases
                of property and equipment
            
            
            (168,275
            )
            
            (1,160,879
            )Purchases
                of marketable securities
            
            
            (22,949,746
            )
            
            (70,733,619
            )Proceeds
                from maturities of marketable securities
            
            
            49,052,728
            
            
            85,249,145Proceeds
                from property and equipment disposal
            
            
            10,870
            
            
            —Net
                cash provided by investing activities
            
            
            25,945,577
            
            
            13,354,647**Cash
                flows from financing activities**Proceeds
                from borrowings under equipment financing
            
            
            —
            
            
            1,179,337Payments
                on property and equipment financing
            
            
            (745,657
            )
            
            (756,681
            )Proceeds
                from issuance of common stock and exercise of options, net of
                repurchases
            
            
            48,543
            
            
            19,908,692Net
                cash (used in) provided by financing activities
            
            
            (697,114
            )
            
            20,331,348Net
                (decrease) increase in cash and cash equivalents
            
            
            (3,242,112
            )
            
            6,336,312Cash
                and cash equivalents at beginning of period
            
            
            11,726,126
            
            
            6,075,449Cash
                and cash equivalents at end of period
            
            $
            8,484,014
            
            $
            12,411,761**Supplemental
                disclosure of cash flow information**Interest
                paid
            
            $
            157,543
            
            $
            152,254Non-cash
                activities:Deferred
                stock-based compensation, net of (reversal)
            
            $
            (28,500
            )
            $
            (76,980
            )





See
      accompanying notes to consolidated financial statements.





4




**SUNESIS
      PHARMACEUTICALS, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**September
      30, 2008**


**(Unaudited)**





**1.**
            **Organization
                and 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 395 Oyster Point Boulevard, Suite 400, South San Francisco, California 94080.
      Sunesis is a biopharmaceutical company focused on the development and
      commercialization of new oncology therapeutics for the treatment of hematologic
      and solid cancers. The Company’s primary activities since incorporation have
      been conducting research and development internally and with corporate
      collaborators, in-licensing pharmaceutical compounds, conducting clinical
      trials, performing business and financial planning, and raising capital. In
      January 2007, the Company formed a wholly-owned subsidiary, Sunesis Europe
      Limited, a United Kingdom corporation.





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





***Need
      to Raise Additional Capital***





The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. The Company has incurred
      significant losses and negative cash flows from operations since its inception.
      At September 30, 2008, the Company had an accumulated deficit of $309.3
      million. The Company needs to raise substantial additional funds to continue
      its
      operations, fund additional clinical trials of voreloxin and bring future
      products to market. Management plans to continue to finance the Company’s
      operations with equity issuances, debt arrangements, some combination of
      technology and product licenses, and, in the long term, product sales and
      royalties. If adequate funds are not available, the Company may be required
      to
      delay, reduce the scope of, or eliminate one or more of its clinical trials,
      partner one or more of its product candidate programs at an earlier stage of
      development than the Company might otherwise choose or conduct additional
      workforce or other expense reductions. Management believes that currently
      available cash, cash equivalents and marketable securities will provide
      sufficient funds to enable the Company to fund its operations to
      approximately the middle of 2009.





***Principles
      of Consolidation***





The
      Company’s consolidated financial statements include a wholly-owned subsidiary,
      Sunesis Europe Limited, a United Kingdom corporation.





***Use
      of Estimates***





The
      preparation of financial statements in conformity with U.S. generally accepted
      accounting principles (“GAAP”) requires management to make estimates and
      assumptions that affect the amounts reported in the Company’s consolidated
      financial statements and accompanying notes. Actual results could differ
      materially from these estimates.





***Clinical
      Trial Accounting***





The
      Company records accruals for estimated clinical trial costs, comprising payments
      for work performed by contract research organizations and participating clinical
      trial sites. These costs will be a significant component of future research
      and
      development expense. The Company accrues costs for activities related to
      clinical trials performed by contract research organizations based on estimates
      of work performed under the contracts. Costs of setting up clinical trial sites
      for participation in trials are expensed immediately. Costs related to patient
      enrollment are accrued as patients are entered in the trial, reduced by an
      initial payment made to the trial site when the first patient is enrolled.
      These
      cost estimates may or may not match the actual costs incurred for services
      performed by the organizations as determined by patient enrollment levels and
      related activities. If the Company has incomplete or inaccurate information,
      it
      may underestimate costs associated with various trials at a given point in
      time.
      Although the Company’s experience in estimating these costs is limited, the
      difference between accrued expenses based on its estimates and actual expenses
      have not been material to date.





5




***Basis
      of Presentation***





The
      accompanying unaudited consolidated financial statements have been prepared
      in
      accordance with GAAP for interim financial information and with the instructions
      to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
      not include all of the information and notes required by GAAP for complete
      financial statements. The financial statements include all adjustments
      (consisting only of normal recurring adjustments) that management believes
      are
      necessary for a fair presentation of the periods presented. These interim
      financial results are not necessarily indicative of results to be expected
      for
      the full fiscal year or any other interim period. The balance sheet at December
      31, 2007 was derived from the audited financial statements at that
      date.





These
      unaudited consolidated financial statements and the notes accompanying them
      should be read in conjunction with the Company’s Annual Report on Form 10-K
      for the year ended December 31, 2007.





***Loss
      Per Share***





Basic
      loss per share is calculated by dividing the loss by the weighted-average number
      of common shares outstanding for the period, less the weighted average number
      of
      unvested common shares subject to repurchase. Diluted loss per common share
      is
      computed by dividing the loss applicable to common stockholders by the
      weighted-average number of common shares outstanding, less the weighted average
      number of unvested common shares subject to repurchase, and dilutive potential
      common shares for the period determined using the treasury-stock method. For
      purposes of this calculation, options to purchase common stock and warrants
      to
      purchase common stock are considered to be potential common shares and are
      only
      included in the calculation of diluted loss per common share when their effect
      is dilutive.


**Three months ended**
              **September****30,**
            
            **Nine months ended**
              **September
                30,****2008**
            
            **2007**
            
            **2008**
            
            **2007****Outstanding
                securities not included in diluted loss per share
                calculation:**Options
                to purchase common stock
            
            
            4,920,708
            
            
            5,036,647
            
            
            4,920,708
            
            
            5,036,647Warrants
                to purchase common stock
            
            
            2,693,237
            
            
            2,693,237
            
            
            2,693,237
            
            
            2,693,237**Total**
            
            
            7,613,945
            
            
            7,729,884
            
            
            7,613,945
            
            
            7,729,884





***Comprehensive
      Loss***





Comprehensive
      loss is comprised of net loss and unrealized gains and losses on marketable
      securities. Comprehensive loss is


as
      follows:





**Three months ended September 30,**
            
            **Nine months ended September
                30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Net
                loss
            
            $
            (7,065,172
            )
            $
            (10,842,325
            )
            $
            (30,258,495
            )
            $
            (29,982,945
            )Change
                in unrealized (loss) gain on marketable securities
            
            
            (14,497
            )
            
            34,228
            
            
            (72,737
            )
            
            53,939**Comprehensive
                loss**
            
            $
            (7,079,669
            )
            $
            (10,808,097
            )
            $
            (30,331,232
            )
            $
            (29,929,006
            )




Accumulated
      other comprehensive income (loss) consists of the following:


**September 30,**
              **2008**
            
            **December 31,**
              **2007**Unrealized
                (loss) gain on marketable securities
            
            $
            (3,475
            )
            $
            69,262





6




***Operating
      lease***





The
      Company entered into a lease agreement for an approximately 5,500 square foot
      laboratory space located at 349 Allerton Avenue, South San Francisco, California
      on October 6, 2008 for a lease term of two years with an option to renew. The
      lease agreement contains rent discounts and rent increase adjustments which
      the
      Company will recognize on straight-line basis.





***Restructuring***





The
      Company has in recent years engaged in, and may in the future engage in,
      restructurings to streamline its operations and extend its financial resources.
      Restructurings require management to utilize significant estimates related
      to
      expenses for severance and related benefit costs, facility-related expenses
      and
      asset-related impairment. For a description of our restructuring actions, see
      Note 4.




***Recent
      Accounting Pronouncements***





In
      February 2008, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Position (FSP) No. 157-2, which delays the effective
      date
      of FASB Statement of Financial Accounting Standards (“SFAS”) No. 157, *Fair
      Value Measurements,* for
      non-financial assets and non-financial liabilities, except for items that are
      recognized or disclosed at a fair value on a recurring basis (items that are
      measured annually). The FSP defers the effective date of SFAS No. 157 for
      non-financial assets and non-financial liabilities until fiscal years beginning
      after November 15, 2008. The Company will adopt FSP No. 157-2 in the first
      quarter of 2009 and currently does not believe the adoption of FSP No. 157-2
      will have a material effect on the Company’s financial position or results of
      operations.





In
      June 2007, FASB ratified the Emerging Issues Task Force (“EITF”) 07-3, *Accounting
      for Nonrefundable Advance Payments for Goods or Services Received for Use in
      Future Research and Development Activities* (“EITF 07-3”). EITF 07-3 requires nonrefundable advance payments for
      goods or services that will be used or rendered for future research and
      development activities to be deferred and capitalized. Such amounts should
      be
      recognized as an expense when the related goods are delivered or services are
      performed. EITF 07-3 is effective for fiscal years beginning after
      December 15, 2007. The Company adopted EITF 07-3 in the first quarter
      of 2008. The adoption of EITF 07-3 did not have a material effect on the
      Company’s financial position or results of operations.





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





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





***In-Licenses***





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





In
      October 2003, the Company entered into an agreement with Dainippon Sumitomo
      Pharma Co., Ltd. (“Dainippon”) to acquire exclusive worldwide development and
      marketing rights for the Company’s lead anti-cancer product candidate, referred
      to as voreloxin (formerly SNS-595). In addition to payments already made as
      of
      December 31, 2007, the Company may in the future make a series of milestone
      payments of up to $8.0 million to Dainippon based on successful development
      and regulatory approval of voreloxin for anti-cancer indications, as well as
      royalty payments based on any future product sales. In return, the Company
      has
      received an exclusive, worldwide license to develop and market
      voreloxin.





***Bristol-Myers
      Squibb Company***





In
      April 2005, the Company entered into an agreement with Bristol-Myers Squibb
      Company (“BMS”) to acquire worldwide development and commercialization rights
      for an anti-cancer product candidate, referred to as SNS-032. Under the terms
      of
      this agreement, the Company may in the future be required to make a series
      of
      milestone payments of up to $29.0 million to BMS based on the successful
      development and approval for the first indication and formulation of SNS-032.
      The Company may also be required to make a series of additional development
      and
      commercialization milestone payments totaling up to $49.0 million to BMS,
      as well as royalty payments based on any future product net sales. The Company
      may, at its election, pay some of the 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 and therapeutic
      licenses to SNS-032 and any future cyclin-dependent kinase (“CDK”) inhibitors
      derived from the related intellectual property. However, based on trial results
      to date in our ongoing Phase 1 clinical trial of SNS-032, we expect that we
      will
      cease further development of SNS-032 after completion of this
      trial.




7




***Out-Licenses***





***SARcode
      Corporation***





In
      March 2006, the Company entered into a license agreement with SARcode
      Corporation (“SARcode”), a privately-held biopharmaceutical company, which
      provides SARcode an exclusive, worldwide license to all of the Company’s
      lymphocyte function-associated antigen-1 (“LFA-1”) patents and related know-how.
      SARcode intends to use the license to develop small molecule drugs to treat
      inflammatory diseases. Pursuant to the license agreement, the Company has
      received two cash payments of $0.5 million each in license fees both in 2007
      and
      in September 2008. The Company recorded these payment as revenue. In addition,
      the Company has received three notes convertible into preferred stock of SARcode
      totaling $1.0 million. The Company did not record these notes receivable from
      SARcode, which are due in 2012, as revenue due to uncertainty of collectibility.
      In addition to the $1.0 million of cash and convertible notes already
      received, the Company may receive up to $30.8 million in development and
      marketing milestone payments, and royalties for the commercialization of a
      licensed compound.





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





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





In
      May 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 is important to regulating the inflammatory response. During the research
      term, the Company applied its proprietary Tethering technology to discover
      novel
      inhibitors of Cathepsin S.





The
      research funding portion of the agreement expired on December 31, 2005. In
      February 2008, the Company received a milestone payment from J&J PRD upon
      its selection of a development candidate from the collaboration.   The
      Company may in the future receive additional research and development milestones
      of up to $24.5 million, as well as royalty payments from J&J PRD based
      on future product sales.





***Biogen
      Idec, Inc.***





In
      August 2004, the Company entered into a research collaboration with Biogen
      Idec, Inc. (“Biogen Idec”) to discover and develop small molecules
      targeting kinases, a family of cell signaling enzymes that play a role in the
      progression of cancer. During the research term, the Company applied its
      proprietary Tethering technology to generate leads that inhibit the oncology
      kinase targets covered by this collaboration. The research funding portion
      of
      the agreement was scheduled to expire in August 2008, but in light of the
      Company’s June 2008 restructuring (see Note 4), the parties agreed to terminate
      the research term on June 30, 2008.





Under
      the
      terms of the collaboration agreement, the Company received a $7.0 million
      upfront non-refundable and non-creditable technology access fee, which was
      recognized as revenue over the research term. During the research term, the
      Company also received quarterly research funding of $1.2 million from
      Biogen Idec, subject to inflation adjustments, which was paid in advance to
      support some of the Company’s scientific personnel. As a result of the June
      termination of the research term, the Company will not receive any further
      research funding and the $0.3 million remaining balance of upfront
      technology access fee was recognized as revenue in the second quarter of 2008.
      Also in the second quarter of 2008, the Company received a $0.5 million
      milestone payment that was recognized as revenue. The Company may in the future
      receive additional pre-commercialization milestone payments of up to
      $60.0 million per target covered by the collaboration and royalty payments
      based on any product sales. The Company retains an option to participate in
      the
      co-development and co-promotion of product candidates for up to two
      collaboration targets.





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





In
      February 2003, the Company and Merck & Co., Inc. (“Merck”)
      entered into a research collaboration to identify and optimize inhibitors of
      beta-secretase (“BACE”), which is believed to be important in the progression of
      Alzheimer’s disease. The research term of the collaboration ended in
      February 2006. Accordingly, the upfront, non-refundable and non-creditable
      technology access fee was recognized as revenue over the 36-month term of the
      agreement. However, the Company retains the right to earn future milestone
      payments of up to $84.3 million, as well as royalty payments depending on
      sales of products which may result from the collaboration.





In
      July 2004, the Company and Merck entered into a second multi-year research
      collaboration to discover novel oral drugs for the treatment of viral
      infections. The Company provided Merck with a series of small molecules
      targeting viral infections. These compounds were derived from Tethering. Under
      the 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 recognized as revenue over the research term. The Company is also
      entitled to receive annual license fees aggregating approximately $1.0 million
      for the Company’s consulting services and ongoing access to Tethering as a means
      of identifying additional compounds for the treatment of viral
      infections. Through September 30, 2008, the Company has received a total
      of approximately $1.0 million in annual license fees of which approximately
      $0.1 million was received in the third quarter of 2008. Annual license fees
      are
      recognized as revenue over a 12-month period when received. In addition, the
      Company may receive payments based on the achievement of development milestones
      of up to $22.1 million and royalty payments based on net sales for any
      products resulting from the collaboration.




8




In
      connection with the four collaboration agreements described above, the Company
      recognized the following revenues in the periods presented, which include the
      amortization of upfront fees received, research funding, and milestones
      earned:








**Three months ended**
              **September
                 30,**
            
            **Nine months ended**
              **September****30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Biogen
                Idec
            
            $
            —
            
            $
            1,749,498
            
            $
            4,310,551
            
            $
            5,827,695J&J
                PRD
            
            
            —
            
            
            —
            
            
            500,000
            
            
            —Merck
            
            
            10,417
            
            
            80,776
            
            
            94,289
            
            
            1,539,110Total
                collaboration revenue
            
            $
            10,417
            
            $
            1,830,274
            
            $
            4,904,840
            
            $
            7,366,805




**4.**
            **Restructurings**





*2008
      Restructuring*





On
      June
      3, 2008, the Company implemented a corporate realignment to focus on the
      development of the Company’s lead oncology product candidate, voreloxin. In
      conjunction with this strategic restructuring, the Company expanded its
      late-stage development leadership team, announced the winding down of its
      internal discovery research activities and reduced its workforce by
      approximately 60 percent. All terminated employees were awarded severance
      payments and continuation of benefits, based on length of service at the
      Company, and career transition assistance. The Company also decided to
      consolidate its remaining employees in one location at leased premises at 395
      Oyster Point Boulevard and is in the process of vacating its former research
      and
      development facility at 341 Oyster Point Boulevard. The Company is currently
      seeking a tenant to sublease the research and development facility.





The
      Company currently estimates total restructuring expenses of approximately $12.1
      million in connection with the 2008 restructuring. However, as a result of
      a
      $0.7 million reversal of restructuring costs incurred in connection
      with the 2007 restructuring discussed below, the Company anticipates net
      restructuring expenses of $11.4 million in 2008. Of this total, approximately
      $3.6 million relates to employee severance and related benefit costs, and $7.8
      million relates to net facility exit costs and asset impairments. In connection
      with the 2008 restructuring, the Company recognized a net $4.9 million
      restructuring charge during the second quarter of 2008, of which approximately
      $3.6 million related to employee severance and related benefit costs, including
      a non-cash portion of approximately $0.4 million related to stock-based
      compensation, and approximately $2.0 million related to asset impairment and
      facility exit costs, partially offset by the $0.7 million reversal of
      restructuring costs incurred in connection with the 2007 restructuring. During
      the third quarter of 2008, the Company recognized a $0.2 million restructuring
      charge, of which approximately $0.1 million related to employee severance and
      related benefit costs and $0.1 million related to facility exit costs in
      connection with the 2008 restructuring. These expenses were included in the
      line
      labeled “Restructuring charges” in the Company’s Consolidated Statements of
      Operations. The Company currently expects to record an additional restructuring
      expense of approximately $6.3 million in the first quarter of 2009. This expense
      is primarily related to the anticipated vacating of the Company’s former
      research and development facility in the first quarter of 2009. The Company
      made
      cash payments totaling $3.1 million for the employee severance and related
      benefits in the second and the third quarter of 2008 and expects to pay the
      remainder by the first quarter of 2009.






The
      following table summarizes the restructuring accrual balances, which are
      included under “Accounts payable and other accrued liabilities” on the Company’s
      Consolidated Balance Sheet, and the utilization by cost type for the 2008
      restructuring:




**Employee**
              **Severance and**
              **Related**
              **Benefits**
            
            **Facilities**
              **Related and**
              **Other Costs**
            
            **Total****Restructuring
                liability at December 31, 2007**
            
            $
            —
            
            $
            —
            
            $
            —2nd
                quarter charges
            
            
            3,537,585
            
            
            2,012,794
            
            
            5,550,3793rd
                quarter charges
            
            
            80,646
            
            
            111,579
            
            
            192,225Cash
                payments
            
            
            (3,062,006
            )
            
            (103,082
            )
            
            (3,165,088
            )Non-cash
                settlements
            
            
            (366,534
            )
            
            (1,728,932
            )
            
            (2,095,466
            )**Restructuring
                liability at September 30, 2008**
            
            $
            189,691
            
            $
            292,359
            
            $
            482,050




9




*2007
      Restructuring*





In
      August 2007, the Company implemented a revised operating plan to focus its
      efforts on generating definitive data from its lead programs while streamlining
      the Company’s operations and extending its financial resources. The
      restructuring plan included a reduction in the Company’s workforce of
      approximately twenty-five percent. All terminated employees were given severance
      payments and continuation of benefits, based on length of service at the
      Company, and career transition assistance. Also, in the third quarter of 2007,
      the Company vacated its leased facilities at 395 Oyster Point Boulevard and
      relocated employees to its main research and development facility at 341 Oyster
      Point Boulevard. As a result of the 2008 restructuring, the Company relocated
      its remaining employees back into 395 Oyster Point Boulevard.





As
      a
      result of the 2007 restructuring, the Company recorded in 2007 total
      restructuring charges of $1.6 million for employee severance and related
      benefit costs, including a non-cash portion related to stock-based compensation
      of approximately $0.1 million, and approximately $0.6 million of 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 first quarter of 2008, the Company recorded an
      additional $0.3 million of restructuring charges on the lease obligation on
      the vacated property. In the second quarter of 2008, the Company reversed a
      previously recorded expense of approximately $0.7 million related to the lease
      obligation on 395 Oyster Point Boulevard after the Company relocated its
      remaining employees back into this facility. Cash payments related to employee
      severance for the 2007 restructuring were all made by December 31,
      2007.




The
      following table summarizes the accrual balances and utilization by cost type
      for
      the 2007 restructuring:




**Employee**
              **Severance and**
              **Related**
              **Benefits**
            
            **Facilities**
              **Related and**
              **Other Costs**
            
            **Total****Restructuring
                liability at December 31, 2007**
            
            $
            41,399
            
            $
            274,834
            
            $
            316,2331st
                quarter charges (reversal)
            
            
            (9,418
            )
            
            330,192
            
            
            320,7742nd
                quarter charges (reversal)
            
            
            —
            
            
            (673,633
            )
            
            (673,633
            )Cash
                payments
            
            
            (227
            )
            
            (197,654
            )
            
            (197,881
            )Adjustments
            
            
            (31,754
            )
            
            266,261
            
            
            234,507**Restructuring
                liability at June 30, 2008**
            
            $
            —
            
            $
            —
            
            $
            —





**5.**
            **Assets
                Held-for-Sale**




As
      a part
      of the 2008 restructuring, the Company implemented a corporate realignment
      to
      focus on the development of the Company’s oncology products and terminated its
      research activities. Due to this realignment, laboratory equipment valued at
      approximately $1.2 million is being held-for-sale as of September 30, 2008.
      The
      Company expects to sell the held-for-sale equipment by June 30,
      2009.





**6.**
            **Equipment
                Financing and Debt
                Facility**





In
      June 2000, the Company entered into an equipment financing agreement with
      General Electric Capital Corporation (“GECC”). Various credit lines have been
      issued under the financing agreement since 2000. As of September 30, 2008,
      the Company had drawn an aggregate of $10.7 million under various credit lines
      under the financing agreement. At September 30, 2008, the outstanding
      balance was $1.6 million. The outstanding balance bears interest at rates
      ranging from 8.70 percent to 10.61 percent per annum and is due in 36 to 48
      monthly payments. The equipment loans are secured by the equipment financed.
      Prior to the sale of the held-for-sale assets, the Company will be required
      to
      pay the entire outstanding balance. As of September 30, 2008, the Company
      was in compliance with all covenants under the GECC agreement. No credit lines
      remain available under this agreement.




**7.**
            **Contingencies**





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





**8.**
            **Stockholders’
                Equity**





On
      May 30, 2007, the Company completed a public offering of 4,750,000 shares
      of its common stock at a public offering price of $4.43 per share. Net cash
      proceeds from this offering were approximately $19.5 million after deducting
      issuance costs of $1.5 million.





10





**9.**
            **Employee
                Benefit Plans**





***Stock
      Option Plans***





**2005
      Equity Incentive Award Plan**





On
      January 1, 2008, the 2005 Equity Incentive Award Plan (“2005 Plan”) was
      increased by 1,082,352 shares pursuant to the 2005 Plan’s evergreen provision.
      Options to purchase 109,000 shares and 701,725 shares of the Company’s common
      stock were granted in the three months and nine months ended September 30,
      2008,
      respectively. As of September 30, 2008, options to purchase an aggregate of
      4,446,581 shares of the Company’s common stock have been granted under the 2005
      Plan. As of September 30, 2008, the total number of shares available for future
      grants under the 2005 Plan was 1,858,029.




**2006
      Employment Commencement Incentive Plan**





On
      January 1, 2008, the Company’s Board of Directors approved an amendment to
      the Company’s 2006 Employment Commencement Incentive Plan (“2006 Plan”) to
      increase the number of shares of common stock reserved for issuance under the
      2006 Plan by an additional 125,000 shares. For the three months ended September
      30, 2008, no options to purchase the Company’s common stock were granted. For
      the nine months ended September 30, 2008, options to purchase 140,000 shares
      of
      the Company’s common stock were granted. As of September 30, 2008, options to
      purchase an aggregate of 553,000 shares of the Company’s common stock have been
      granted under the 2006 Plan. As of September 30, 2008, the total number of
      shares available for future grants under the 2006 Plan was 61,273.




A
      summary of stock option transactions for all of the Company’s stock option plans
      (including its 1998 Stock Plan and 2001 Stock Plan) 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
            
            $
            3.83Options
                granted
            
            
            841,725
            
            $
            1.48Options
                exercised
            
            
            —
            
            
            —Options
                canceled/forfeited/expired
            
            
            (1,020,864
            )
            $
            3.77**Balance
                at September 30, 2008**
            
            
            4,920,708
            
            $
            3.44
            
            
            7.3
            
            $
            4,894**Exercisable
                at September 30, 2008**
            
            
            3,169,698
            
            $
            3.86
            
            
            6.4
            
            $
            4,894







In
      conjunction with the Company’s IPO,
      the
      Company’s
      Board of Directors elected not to issue any additional shares under its 1998
      Stock Plan or its 2001 Stock Plan. However, the Company still had 1,281,560
      options outstanding under these plans as of September 30, 2008.




The
      following table summarizes outstanding and exercisable options for all of the
      Company’s stock option plans as of September 30, 2008:




**Options Outstanding**
            
            **Options Exercisable****Range of Exercise Prices**
            
            **Number**
              **Outstanding**
              **as of 9/30/08**
            
            **Weighted-**
              **Average**
              **Remaining**
              **Contractual**
              **Term**
            
            **Weighted-**
              **Average**
              **Exercise**
              **Price**
            
            **Number**
              **Exercisable**
              **as of 9/30/08**
            
            **Weighted-**
              **Average**
              **Exercise**
              **Price**$0.43
                - $1.30
            
            
            22,711
            
            
            3.2
            
            $
            0.93
            
            
            16,711
            
            $
            0.80$1.44
            
            
            719,503
            
            
            9.8
            
            $
            1.44
            
            
            30,961
            
            $
            1.44$1.55
                - $2.31
            
            
            212,000
            
            
            9.4
            
            $
            1.97
            
            
            30,250
            
            $
            1.99$2.55
            
            
            1,210,934
            
            
            4.1
            
            $
            2.55
            
            
            1,210,934
            
            $
            2.55$2.59
            
            
            695,423
            
            
            9.0
            
            $
            2.59
            
            
            311,155
            
            $
            2.59$2.62
                - $4.85
            
            
            856,536
            
            
            8.2
            
            $
            4.50
            
            
            553,754
            
            $
            4.54$4.93
                - $5.16
            
            
            86,425
            
            
            7.8
            
            $
            5.02
            
            
            70,023
            
            $
            5.04$5.25
            
            
            876,908
            
            
            7.2
            
            $
            5.25
            
            
            727,831
            
            $
            5.25$5.50
                - $7.15
            
            
            189,125
            
            
            7.8
            
            $
            6.14
            
            
            166,936
            
            $
            6.18$9.56
            
            
            51,143
            
            
            6.7
            
            $
            9.56
            
            
            51,143
            
            $
            9.56$0.43
                - $9.56
            
            
            4,920,708
            
            
            7.3
            
            $
            3.44
            
            
            3,169,698
            
            $
            3.86





11





***2005
      Employee Stock Purchase Plan***





On
      January 1, 2008, the share reserve under the Company’s 2005 Employee Stock
      Purchase Plan (“ESPP”) was increased by 100,000 shares pursuant to the ESPP’s
      evergreen provision. At September 30, 2008, there were 260,686 shares of common
      stock reserved for future issuance under the ESPP. For the three months ended
      September 30, 2008, zero shares were issued. For the nine months ended September
      30, 2008, 36,569 shares were issued.





***Employee
      Stock-Based Compensation***





Employee
      stock-based compensation expense related to all of the Company’s share-based
      awards, including stock options granted prior to the Company’s initial public
      offering (“IPO”), which continue to be accounted for under Accounting Principles
      Board Opinion No. 25, *Accounting
      for Stock Issued to Employees,* (“APB
      25”), is as follows for the periods presented:





**Three months ended September
                30,**
            
            **Nine months ended September 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Research
                and development
            
            $
            46,663
            
            $
            320,854
            
            $
            588,123
            
            $
            1,047,218General
                and administrative
            
            
            206,707
            
            
            421,242
            
            
            982,769
            
            
            1,439,237Restructuring
                charges
            
            
            2,462
            
            
            92,765
            
            
            366,533
            
            
            92,765**Stock-based
                compensation**
            
            $
            255,832
            
            $
            834,861
            
            $
            1,937,425
            
            $
            2,579,220




The
      Company determines the fair value of share-based payment awards on the grant
      date using the Black-Scholes option-pricing model (the “Black-Scholes Model”)
      which is affected by the Company’s stock price as well as assumptions regarding
      a number of highly subjective variables. The total estimated grant date fair
      value of stock options that were granted during the three months ended September
      30, 2008 and 2007 was $28,000 and approximately $1.9 million, respectively.
      The
      total estimated grant date fair value of stock options that were granted during
      the nine months ended September 30, 2008 and 2007 was approximately $0.8 million
      and $2.8 million, respectively. The estimated fair value of shares vested during
      each of the three month periods ended September 30, 2008 and 2007 was $0.6
      million and $0.7 million, respectively. The estimated fair value of shares
      vested during each of the nine month periods ended September 30, 2008 and 2007
      was $2.0 million and $2.1 million, respectively. At September 30, 2008, total
      unrecognized estimated compensation cost related to non-vested stock options
      granted prior to that date was $4.7 million and the cost is expected to be
      recognized over a weighted average period of 3.5 years. No options were
      exercised during the three months and nine months ended September 30, 2008.
      The
      total intrinsic value of stock options exercised during the three months and
      nine months ended September 30, 2007 was approximately zero and $0.1 million,
      respectively. For the three months and nine months ended September 30,
      2007, the Company recorded cash received from the exercise of stock options
      of
      approximately $28,000 and $0.2 million, respectively. As it is more likely
      than
      not that all of the stock option related tax benefits will not be realized,
      the
      Company did not record net tax benefits related to the options exercised in
      the
      three months and nine months ended September 30, 2008 and 2007.





For
      the
      three months and nine months ended September 30, 2008, the Company recorded
      approximately $2,000 and $0.4 million in stock-based compensation related to
      the
      incremental fair value on options that were modified in connection with the
      2008
      restructuring to extend the term in which the the optionee could exercise such
      options until the later of (a) the existing expiration date of such options
      and
      (b) June 30, 2009. (See Note 4). For both the three and nine months ended
      September 30, 2007, the Company recorded approximately $0.1 million in
      stock-based compensation expense related to the incremental fair value on
      modification to options resulting from the 2007 restructuring. (See Note
      4).





The
      weighted-average estimated fair value of employee stock options granted during
      the three months ended September 30, 2008 and 2007 was $0.96 and $1.56 per
      share, respectively, using the Black-Scholes Model. The weighted-average
      estimated fair value of employee stock options granted during the nine months
      ended September 30, 2008 and 2007 was $0.90 and $1.78 per share, respectively,
      using the Black-Scholes Model.




12




The
      Company uses the Black-Scholes Model to value its stock options with the
      following assumptions (annualized percentages):




**Three months ended September
                30,**
            
            **Nine months ended September
                30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Volatility
            
            
            71.6
            %
            
            68.5
            %
            
            71.6
            %
            
            80.0
            %Risk-free
                interest rate
            
            
            3.2
            %
            
            4.2
            %
            
            3.3
            %
            
            4.9
            %Dividend
                yield
            
            
            0
            %
            
            0
            %
            
            0
            %
            
            0
            %Expected
                term (years)
            
            
            5.0
            
            
            5.1
            
            
            5.0
            
            
            5.0




The
      weighted-average estimated fair value of purchase rights under the ESPP for
      the
      three months ended September 30, 2008 and 2007 was $0.81 and $2.00 per share,
      respectively. The weighted average estimated fair value of purchase rights
      under
      the ESPP for the nine months ended September 30, 2008 and 2007 was $1.16 and
      $1.93 per share, respectively. The weighted-average estimated fair value of
      purchase rights under the ESPP was calculated using the Black-Scholes Model
      with
      the following assumptions (annualized percentages):





**Three months ended September
                 30,**
            
            **Nine months ended September
                 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Volatility
            
            
            68.5%
                - 71.6
            %
            
            68.5%
                - 80.0
            %
            
            68.5%
                - 71.6
            %
            
            68.5%
                - 80.0
            %Risk-free
                interest rate
            
            
            2.0%
                - 5.1
            %
            
            4.9%
                - 5.1
            %
            
            2.0%
                - 5.1
            %
            
            4.9%
                - 5.1
            %Dividend
                yield
            
            
            0
            %
            
            0
            %
            
            0
            %
            
            0
            %Expected
                term (years)
            
            
            0.5
                - 1.0
            
            
            0.5
                - 1.0
            
            
            0.5
                - 1.0
            
            
            0.5
                - 1.0




The
      total
      estimated fair value of purchase rights outstanding under the ESPP that vested
      during the three months ended September 30, 2008 and 2007 was zero for both
      periods. The total estimated fair value of purchase rights outstanding under
      the
      ESPP that vested during the nine months ended September 30, 2008 and 2007 was
      approximately $0.1 million for both periods.





The
      Company has based its assumptions for volatility and expected term of employee
      stock options on the information available with respect to its peer group in
      the
      same industry. The expected term of the employees’ purchase rights under the
      Company’s ESPP is equal to the purchase period. The risk-free interest rate
      assumption is based upon observed interest rates appropriate for the expected
      life of the Company’s employee stock options and employees’ purchase rights. The
      Company does not anticipate paying any cash dividends in the foreseeable future,
      and therefore uses an expected dividend yield of zero in both models. Statement
      of Financial Accounting Standard No. 123 (revised 2004), *“Share-Based
      Payment* (“FAS
      123R”) *,”* also
      requires forfeitures to be estimated at the time of grant and revised, if
      necessary, in subsequent periods if actual forfeitures differ from those
      estimates. The forfeiture rate is estimated based on the Company’s historical
      option cancellation and forfeiture information. The Company’s stock-based
      compensation expense recognized under FAS 123R in its consolidated financial
      statements reflects estimated forfeiture rates of 9.8% in both the three and
      nine months ended September 30, 2008 and 5.5% in both the three and nine months
      ended September 30, 2007. If factors change and the Company employs different
      assumptions in the application of FAS 123R in future periods, the compensation
      expense that the Company records under FAS 123R may differ significantly from
      what it has recorded in the current period.





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





Prior
      to
      the Company’s IPO in September 2005, certain stock options were granted
      with exercise prices that were below the reassessed fair value of the common
      stock at the date of grant. In accordance with APB 25, deferred stock-based
      compensation was recorded for the difference between the estimated fair value
      of
      the common stock underlying the options and the exercise price of the options.
      The deferred stock-based compensation is being amortized over the related
      vesting terms of the options. For the three months ended September 30, 2008
      and
      2007, the Company recorded amortization of deferred stock-based compensation
      of
      $34,000 and $0.2 million, respectively. For the nine months ended September
      30,
      2008 and 2007, the Company recorded amortization of deferred stock-based
      compensation of $0.2 million and $0.5 million, respectively.





As
      of
      September 30, 2008, the amortization expense for deferred stock-based
      compensation is fully amortized.





13





**10.**
            **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 for measuring fair value based on GAAP
      and clarified the definition of fair value within that framework. SFAS 157
      does
      not require any new fair value measurements in GAAP. SFAS 157 introduced, or
      reiterated, a number of key concepts which form the foundation of the fair
      value
      measurement approach to be utilized for financial reporting purposes. The fair
      value of the Company’s financial instruments reflect the amounts that would be
      received to sell an asset or paid to transfer a liability in an orderly
      transaction between market participants at the measurement date (exit price).
      SFAS 157 also established a fair value hierarchy that prioritizes the use of
      inputs used in valuation techniques into the following three
      levels:




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


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


Level
      3—unobservable inputs.





The
      adoption of SFAS 157 did not have a material effect on the Company’s financial
      condition and results of operations, but SFAS 157 introduced new disclosures
      about how the Company values certain assets 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 quoted prices in active markets (Level
      1)
      or based upon other observable inputs (Level 2). The following table sets forth
      the fair value of the Company’s financial assets that were measured on a
      recurring basis during the nine months ended September 30, 2008 *(in
      thousands):*





**Fair Value Measurements at Reporting Date Using****(Level 1)**
            
            **(Level 2)**
            
            **(Level 3)**
            
            **Total****Description**Cash
                equivalents
            
            $
            —
            
            $
            989
            
            $
            —
            
            $
            989Marketable
                securities
            
            
            5,773
            
            
            4,009
            
            
            —
            
            
            9,782**Total**
            
            $
            5,773
            
            $
            4,998
            
            $
            —
            
            $
            10,771





At
      September 30, 2008, the Company’s cash equivalents and marketable securities
      were classified within Level 1 or Level 2 of the fair value hierarchy. The
      type
      of securities utilizing Level 1 inputs consisted of the Company’s U.S.
      government agency securities. The Company’s Level 2 valuations are based upon
      quoted prices for similar instruments or securities that are under an active
      market with pricing adjustments for yield and number of days to maturity. The
      type of securities utilizing Level 2 inputs consisted of the Company’s corporate
      bonds and commercial papers.




**11.**
            **Guarantees
                and Indemnification**





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





As
      permitted under Delaware law and in accordance with the Company’s Bylaws, the
      Company indemnifies its officers and directors for certain events or
      occurrences, subject to certain limits, while the officer or director is or
      was
      serving at the Company’s request in such capacity. The indemnification
      agreements with the Company’s officers and directors terminate upon termination
      of their employment, but the termination does not affect claims for
      indemnification relating to events occurring prior to the effective date of
      termination. The maximum amount of potential future indemnification is
      unlimited; however, the Company’s officer and director insurance policy reduces
      the Company’s exposure and may enable the Company to recover a portion of
      any future amounts paid. The Company believes that the fair value of these
      indemnification agreements is minimal. In addition, in the ordinary course
      of
      business the Company enters into agreements, such as licensing agreements,
      clinical trial agreements and certain services agreements, containing standard
      indemnifications provisions. The Company believes that the likelihood of an
      adverse judgment related to such indemnification provisions is remote.
      Accordingly, the Company has not recorded any liabilities for any of these
      agreements as of September 30, 2008.




14




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




*The
      following discussion and analysis of our financial condition as of September
      30,
      2008 and results of operations for the three and nine months ended September
      30,
      2008 and 2007 should be read together with our financial statements and related
      notes included elsewhere in this report. This discussion and analysis contains
“
forward-looking statements” within the meaning of Section 27A of the
      Securities Act of 1933, as amended, and Section 21E of the Securities and
      Exchange Act of 1934, as amended, that involve risks, uncertainties and
      assumptions. All statements other than statements of historical facts, are
      “forward-looking statements” for purposes of these provisions, including any
      projections of revenue, expenses or other financial items, cash requirements,
      financing plans, any statement of the plans and objectives of management for
      future operations, any statements concerning proposed new clinical trials or
      licensing or collaborative arrangements, any statements regarding future
      economic conditions or performance, and any statement 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,” “could,”
“seeks,” “plans,” “potential,” or “will” or the negative thereof or other
      comparable terminology. Although we believe that the expectations reflected
      in
      the forward-looking statements contained herein are reasonable, there can be
      no
      assurance that such expectations or any of the forward-looking statements will
      prove to be correct, and actual results could differ materially from those
      projected or assumed in the forward-looking statements. Our actual results
      may differ materially from those anticipated in these forward-looking
      statements as a result of many factors, including but not limited to those
      set
      forth under “Risk Factors” and elsewhere in this report. We urge you not to
      place undue reliance on these forward-looking statements, which speak only
      as of
      the date of this report. All forward-looking statements included in this report
      are based on information available to us on the date of this report, and we
      assume no obligation to update any forward-looking statements contained in
      this
      report.*




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





**Overview**





We
      are a
      biopharmaceutical company focused on the development and commercialization
      of
      new oncology therapeutics for the treatment of hematologic and solid cancers.
      We
      have built a highly experienced cancer drug development organization committed
      to advancing our lead product candidate, voreloxin, in multiple indications
      to
      improve the lives of people with cancer.





From
      our
      incorporation in 1998 through 2001, our operations consisted primarily of
      developing and refining our drug discovery technologies. From 2002 through
      June
      2008, we focused on the discovery and development of novel small molecule drugs.
      On June 3, 2008, we announced a corporate realignment to focus on the
      development of voreloxin. In conjunction with this strategic restructuring,
      we
      expanded our late-stage development leadership team, announced the winding
      down
      of our internal discovery research activities and reduced our workforce by
      approximately 60 percent.





We
      are currently advancing voreloxin through later stage development efforts.
      Voreloxin is a first-in-class naphthyridine analog, a chemical structure closely
      related to that of the quinolone antibacterial agents. We are in the process
      of
      conducting three clinical trials of voreloxin: a Phase 2 clinical trial (known
      as the REVEAL-1 trial) in previously untreated elderly patients with acute
      myeloid leukemia (“AML”), a Phase 1b/2 combination clinical trial
      combining voreloxin with cytarabine in patients with relapsed/refractory AML,
      and a Phase 2 single agent clinical trial in advanced platinum-resistant ovarian
      cancer patients. We have worldwide development and commercialization rights
      to
      voreloxin. In the future, we may enter into partnering arrangements for this
      product candidate to maximize its commercial potential.





We
      also
      have two other proprietary oncology product candidates, SNS-032 and SNS-314,
      completing Phase 1 clinical trials. SNS- 032,
      is a
      selective inhibitor of cyclin-dependent kinases (“CDKs”) 2, 7 and 9 and we have
      been conducting a Phase 1 clinical trial of SNS-032 in patients with
      relapsed/refractory chronic lymphocytic leukemia (“CLL”) or multiple myeloma and
      recently completed dose escalations in both arms. No objective responses have
      been observed to date in either the CLL or multiple myeloma arm. Based on trial
      results to date, we expect that we will cease further development after
      completion of the Phase 1 trial. SNS-314, a potent and selective pan-Aurora
      kinase inhibitor, is being studied in a Phase 1 dose-escalating clinical
      trial in patients with advanced solid tumors. Dose escalation is ongoing.
      Depending upon results from this trial, we will seek a partner to support
      additional development of SNS-314.




15






We had
      developed proprietary methods of discovering drugs in pieces, or fragments.
      Our
      initial fragment-based discovery approach was called “Tethering ® .” The
      Tethering approach to drug discovery formed the basis of several collaborations.
      While we are no longer receiving research funding in any collaboration, as
      of
      September 30, 2008, we had received an aggregate of approximately $85.8 million
      in cash from our collaboration partners in the form of stock purchase proceeds
      and fees. This includes collaborations with Biogen Idec, Inc. (“Biogen Idec”),
      Johnson & Johnson Pharmaceutical Research & Development, L.L.C.
      (“J&J PRD”) and Merck & Co., Inc. (“Merck”). We may in the future
      receive milestones as well as royalty payments based on future sales of products
      resulting from such collaborations.





Prior
      to
      our restructuring announced in June 2008 and the resulting wind down of our
      internal discovery research activities, we had developed further enhancements
      to
      our fragment-based discovery platform that were being used to discover new
      targeted agents. We are also exploring opportunities to monetize our exclusive
      fragment-based drug discovery capabilities, our preclinical programs and/or
      our
      intellectual property portfolio.




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





Since
      our
      inception, we have generated significant losses. As of September 30, 2008,
      we
      had an accumulated deficit of $309.3 million, including a deemed dividend
      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, as we continue to conduct development of, and seek
      regulatory approvals for, voreloxin.





**Critical
      Accounting Policies and Significant Judgments and
      Estimates**





This
      discussion and analysis of our financial condition and results of operations
      is
      based on our financial statements, which have been prepared in accordance with
      accounting principles generally accepted in the United States. The preparation
      of these financial statements requires management to make estimates and
      judgments that affect the reported amounts of assets, liabilities and expenses
      and the disclosure of contingent assets and liabilities at the date of the
      financial statements, as well as revenue and expenses during the reporting
      periods. We evaluate our estimates and judgments on an ongoing basis. We base
      our estimates on historical experience and on various other factors we believe
      are reasonable under the circumstances, the results of which form the basis
      for making judgments about the carrying value of assets and liabilities that
      are
      not readily apparent from other sources. Actual results could therefore differ
      materially from those estimates under different assumptions or
      conditions.





An
      accounting policy is deemed to be critical if it requires an accounting estimate
      to be made based on assumptions about matters that are highly uncertain at
      the
      time the estimate is made, and if different estimates that reasonably could
      have
      been used, or changes in the accounting estimate that are reasonably likely
      to
      occur periodically, could materially change the financial statements. We believe
      there have been no significant changes during the nine months ended September
      30, 2008 to the items that we disclosed as our critical accounting policies
      and
      estimates under Note 1 to our consolidated financial statements included in
      our
      Annual Report on Form 10-K for the year ended December 31,
      2007.




**Recent
      Accounting Pronouncements**





In
      February 2008, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Position (FSP) No. 157-2, which delays the effective
      date
      of FASB Statement of Financial Accounting Standards (“SFAS”) No. 157, *Fair
      Value Measurements,* for
      non-financial assets and non-financial liabilities, except for items that are
      recognized or disclosed at a fair value on a recurring basis (items that are
      measured annually). The FSP defers the effective date of SFAS No. 157 for
      non-financial assets and non-financial liabilities until fiscal years beginning
      after November 15, 2008. We will adopt FSP No. 157-2 in the first quarter of
      2009 and currently does not believe the adoption of FSP No. 157-2 will have
      a
      material effect on our financial position or results of operations.





In
      June 2007, the FASB ratified the Emerging Issues Task Force
      (“EITF”) 07-3, *Accounting
      for Nonrefundable Advance Payments for Goods or Services Received for Use in
      Future Research and Development Activities* (“EITF 07-3”). EITF 07-3 requires nonrefundable advance payments for
      goods or services that will be used or rendered for future research and
      development activities should be deferred and capitalized. Such amounts should
      be recognized as an expense when the related goods are delivered or services
      are
      performed. EITF 07-3 is effective for fiscal years beginning after
      December 15, 2007. We adopted EITF 07-3 in the first quarter of 2008.
      The adoption of EITF 07-3 did not have a material effect on our financial
      position or results of operations.





In
      December 2007, the EITF reached a consensus on EITF 07-1, *Accounting
      for Collaborative Arrangements Related to the Development and Commercialization
      of Intellectual Property* (“EITF 07-1”). EITF 07-1 discusses the appropriate income statement
      presentation and classification for the activities and payments between
      participants in arrangements related to the development and commercialization
      of
      intellectual property. The sufficiency of disclosure related to these
      arrangements is also specified. 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 currently do not believe the adoption of
      EITF 07-1 will have a material impact on our financial position or results
      of operations.




16




**Results
      of Operations**





***Three
      and Nine Months Ended September 30, 2008 and
      2007***





***Revenues***





*Collaboration
      Revenue.* Since
      inception, we have not generated any revenue from sales of commercial products
      and do not expect to generate any product revenue for the foreseeable future.
      To
      date, substantially all of our revenue has consisted of technology access fees,
      research funding and milestone payments we have received in connection with
      our
      collaborations. The research term of all of our collaborations is completed,
      including the research term of our collaboration with Biogen Idec which ended
      June 30, 2008. As a result, we are no longer receiving research funding, and
      our
      personnel are not actively participating in continued development of product
      candidates resulting from such collaborations.




The
      table
      below sets forth our revenue for the three and nine months ended September
      30,
      2008 and 2007 from our collaborations with Biogen Idec, J&J PRD and
      Merck.


**Three months ended September
                 30,**
            
            **Nine months ended September
                 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Biogen
                Idec
            
            $
            —
            
            $
            1,749,498
            
            $
            4,310,551
            
            $
            5,827,695J&J
                PRD
            
            
            —
            
            
            —
            
            
            500,000
            
            
            —Merck
            
            
            10,417
            
            
            80,776
            
            
            94,289
            
            
            1,539,110Total
                collaboration revenue
            
            $
            10,417
            
            $
            1,830,274
            
            $
            4,904,840
            
            $
            7,366,805




Collaboration
      revenue for the three months ended September 30, 2008 decreased to $10,000
      compared to $1.8 million in the same period in 2007. The decrease was primarily
      due to the termination of the research phase of our kinase inhibitor
      collaboration with Biogen Idec in June 2008 and the resulting cessation of
      research revenue from Biogen Idec and a decrease in research revenue from our
      BACE program with Merck. Collaboration revenue for the nine months ended
      September 30, 2008 decreased to $4.9 million compared to $7.4 million in the
      same period in 2007. In addition to the reasons stated above with respect to
      the
      most recent quarter, the decrease was due to (i) lower research revenue from
      Biogen Idec throughout 2008 because fewer Company research personnel were
      working on the collaboration activities and (ii) a $1.0 million payment received
      from Merck in 2007 for the achievement of a preclinical milestone. Partially
      offsetting the decrease in 2008 was a milestone payment from J&J PRD for the
      selection of a compound targeting the Cathepsin S enzyme using our proprietary
      Tethering technology.





We
      expect
      to have no ongoing research funding. As a result, collaboration revenue will
      be
      substantially lower in the next couple of years and may continue to be
      substantially lower in future years, unless and until any products that may
      result from our collaborations advance to a level where significant milestones
      will be payable to us.





*License
      Revenue.*  License
      revenue for the three months ended September 30, 2008 increased to $0.5 million
      compared to zero dollars in the same period in 2007 due to a $0.5 million license fee  pursuant
      to our out-license agreement with SARcode. License
      revenue for the nine months ended September 30, 2008 increased to $0.5 million
      compared to $0.3 million in the same period in 2007 due to increased license
      fees under our out-license
      agreement with SARcode .
      We do
      not expect to receive license revenue from SARcode in the fourth quarter of
      2008. However, based on SARcode’s future achievements using our propietary LFA-1
      patients and related know-how, we may receive future license
      revenue.





***Research
      and Development Expense.*** Most of
      our operating expenses to date have been for research and development
      activities. Past research and development expense 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 voreloxin 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,




17




·
            
            in
                connection with in-licensing activities, and·
            
            in
                the conduct of activities we were required to perform in connection
                with
                our strategic collaborations.





We
      expense all research and development costs as they are incurred.





The
      table
      below sets forth our research and development expense for the three and nine
      months ended September 30, 2008 and 2007 for each of our product candidate
      programs (in thousands):


**Three months ended September
                 30,**
            
            **Nine months ended September 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Voreloxin
            
            $
            3,730
            
            $
            3,693
            
            $
            12,614
            
            $
            9,999SNS-032
            
            
            634
            
            
            952
            
            
            3,042
            
            
            2,858SNS-314
            
            
            299
            
            
            953
            
            
            1,755
            
            
            3,434Discovery
                programs and new technologies
            
            
            —
            
            
            834
            
            
            2,233
            
            
            2,806Other
                kinase inhibitors
            
            
            —
            
            
            2,261
            
            
            2,001
            
            
            8,498Other
                programs
            
            
            —
            
            
            94
            
            
            23
            
            
            197**Total
                Expense**
            
            $
            4,663
            
            $
            8,787
            
            $
            21,668
            
            $
            27,792




Research
      and development expense decreased by $4.1 million, or 47 percent, to $4.7
      million for the three months ended September 30, 2008 from $8.8 million for
      the
      same period in 2007. This decrease is primarily due to (i) a $0.7 million
      and $0.3 million decrease in clinical trial activities related to SNS-314 and
      SNS-032, respectively; and (ii) a $2.3 million and $0.8 million decrease in
      expenses under our other kinase inhibitors and our discovery and new
      technologies programs, respectively.




Research
      and development expense decreased by $6.1 million, or 22 percent, to $21.7
      million for the nine months ended September 30, 2008 from $27.8 million for
      the
      same period in 2007. This decrease is primarily due to (i) a $6.5 million
      decrease in expenses under our other kinase inhibitors program, (ii) a $1.7
      million decrease in clinical trial activity related to SNS-314, (iii) a $0.6
      million decrease in expenses for discovery programs and new technologies, and
      (iv) a $0.1 million decrease in other programs, partially offset by a $2.6
      million increase in voreloxin expenses and $0.2 million of increased expenses,
      particularly in the early months of 2008, on SNS-032 due to increased clinical
      trial activities.





As
      a
      result of our June restructuring and the resulting wind down of our research
      activities, we do not anticipate incurring any significant additional research
      expenses related to the discovery of additional product candidates, the
      development or application of our proprietary fragment-based drug discovery
      methods, or the development of in-house research capabilities. In addition,
      we
      are no longer conducting any research activities in connection with any of
      our
      collaborations.





However,
      we have incurred and expect to continue to incur substantial research and
      development expense to conduct clinical trials primarily on voreloxin, but
      also
      to complete our ongoing Phase 1 clinical trials of SNS-032 and SNS-314. Clinical
      trials are costly, and as we continue to advance voreloxin through preclinical
      and clinical development, we expect our related expenses to remain high. For
      example, we expect to spend approximately $8.0 million over the next twelve
      months (i) to advance our voreloxin program to completion of the current
      Phase 1b/2 combination trial in AML, Phase 2 AML clinical trial in the
      untreated elderly, and Phase 2 clinical trial in ovarian
      cancer,  (ii) to complete our ongoing Phase 1 clinical trial
      in SNS-032, and (iii) to complete the ongoing Phase 1 clinical trial
      for SNS-314. As of the date of this report, due to the risks inherent in the
      clinical trial process and given the early state of development of our programs,
      we are unable to estimate the additional substantial costs we will incur in
      any
      continued development program.





In
      addition, while we are currently focused on trials in voreloxin, SNS-032 and
      SNS-314, we anticipate that we will make determinations as to which programs
      to
      pursue and how much funding to direct to each program on an ongoing basis in
      response to the scientific and clinical success of each product candidate,
      an
      assessment as to the product candidate’s commercial potential and our overall
      financial objectives. This will affect our research and development expense
      going forward. We are currently anticipating that development of voreloxin
      will
      be our highest priority, that we will cease further development of SNS-032
      after
      the completion of the ongoing Phase 1 trial and that SNS-314 will be
      deemphasized in 2009 as we seek a development partner for that product candidate
      depending on our results from the ongoing SNS-314 Phase 1 clinical trial. We
      cannot forecast which product candidates will be subject to future collaborative
      or licensing arrangements, when such arrangements will be secured, if at all,
      and to what degree such arrangements would affect our development plans and
      capital requirements.





Under
      our
      Biogen Idec agreement, we have an option on a target-by-target basis to co-fund
      post-Phase 1 development costs for product candidates directed to up to two
      collaboration targets, which may, at our option, include the Raf kinase target.
      If we exercise our option on one or more product candidates, our research and
      development expense will increase significantly. We expect that research and
      development expense related to co-development activities that we might elect
      to
      co-fund would consist primarily of manufacturing costs for the product
      candidate, clinical trial-related costs, costs for consultants and contract
      research organizations, employee and facilities costs and depreciation of
      equipment.




18




***General
      and Administrative Expense.*** Our
      general and administrative expense consists primarily of salaries and other
      related costs for personnel in finance, human resources, legal, including
      intellectual property management, and general administration, as well as
      non-cash stock-based compensation. Other significant costs include facilities
      costs and fees paid to outside legal advisors and auditors. General and
      administrative expense for the three months ended September 30, 2008 decreased
      by approximately $0.6 million, or 18 percent, to $2.8 million for the three
      months ended September 30, 2008 from $3.4 million for the same period in 2007,
      primarily due to reduced headcount compared to 2007, a decrease in personnel-
      and office-related expenses and a decrease in professional and consulting
      expenses. For the nine months ended September 30, 2008, general and
      administrative expense decreased by approximately $1.4 million, or 13 percent,
      to $9.3 million from $10.7 million for the same period in 2007, primarily due
      to reduced headcount, lower personnel-, office- and facilities- related
      expenses and a decrease in professional and consulting expenses. As a result
      of
      the 2008 restructuring, we expect our general and administrative expenses to
      decrease over the next twelve months due to reduced headcount.





***Restructuring
      Charge.*** For the
      three months ended September 30, 2008, we recorded approximately $0.2 million
      related to the 2008 restructuring, of which $0.1 million is related to employee
      severance and related benefit costs and another $0.1million is related to
      facility exit costs. For the nine months ended September 30, 2008, we recorded
      approximately $5.4 million of restructuring charges, comprised of $5.8 million
      related to the 2008 restructuring, partially offset by a $0.4 million reversal
      of the 2007 restructuring related to Company’s facilities exit costs. For the
      three and nine months ended September 30, 2007, we recorded a $1.2 million
      charge related to the 2007 restructuring. These charges consist of $1.1 million
      in severance and related benefit costs and $0.1 million in leasehold improvement
      write-offs. We currently expect to record additional restructuring expenses
      of
      approximately $6.3 million in the first quarter of 2009.





***Interest
      Income.*** Interest
      income decreased by $0.7 million, or 88 percent, to $0.1 million for the three
      months ended September 30, 2008 from $0.8 million for the same period in
      2007. Interest income decreased by $1.4 million, or 61 percent, to $0.9 million
      for the nine months ended September 30, 2008 from $2.3 million in the same
      period in 2007. The lower interest income for the three and nine months ended
      September 30, 2008 was due to lower average balances of cash, cash equivalents
      and marketable securities during 2008, as well as lower average interest
      rates.




***Interest
      Expense.***Interest
      expense decreased to $40,000 in the three months ended September 30, 2008 from
      $56,000 for the same period in 2007 mainly due to a decrease in outstanding
      debt
      obligation in 2008 compared to 2007. Interest expense increased to $154,000
      in
      the nine months ended September 30, 2008 from $152,000 for the same period
      in
      2007 due to higher interest rates on outstanding debt obligation in
      2008.





**Liquidity
      and Capital Resources**





Since
      our
      inception, we have funded our operations primarily through the issuance of
      common and preferred stock, research funding, technology access fees and
      milestone payments from our collaboration partners, debt financings and research
      grants. As of September 30, 2008, we had cash, cash equivalents and marketable
      securities of $18.3 million and outstanding debt from equipment financing
      of $1.6 million.





***Cash
      Flows***





Net
      cash
      used in operating activities was $28.5 million and $27.3 million for the
      nine months ended September 30, 2008 and 2007, respectively. Net cash used
      in operating activities for the nine months ended September 30, 2008
      resulted primarily from our net loss of $30.3 million and changes in operating
      assets and liabilities of $2.4 million, partially offset by adjustments for
      non-cash items of $4.2 million primarily from depreciation and amortization,
      the
      non-cash portion of restructuring charges, and stock-based compensation expense.
      Net cash used in operating activities for the nine months ended September 30,
      2007 resulted primarily from our net loss of $30.0 million and changes in
      operating assets and liabilities of $1.3 million, partially offset by
      adjustments for non-cash items of $4.0 million primarily from depreciation
      and
      amortization and stock-based compensation expense.





Net
      cash
      provided by investing activities was $25.9 million for the nine months ended
      September 30, 2008, compared to $13.3 million for the nine months ended
      September 30, 2007. The cash provided by investing activities during the
      nine months ended September 30, 2008 was primarily attributable to net
      proceeds from the maturity of marketable securities of $26.1 million, partially
      offset by capital expenditures of $0.2 million. Net cash provided by investing
      activities during the nine months ended September 30, 2007 was related to the
      net proceeds from maturities of marketable securities of $14.5 million,
      partially offset by the purchase of capital equipment totaling $1.2
      million.





Net
      cash
      used in financing activities was $0.7 million for the nine months ended
      September 30, 2008, as compared with $20.3 million in net cash provided by
      financing activities for the nine months ended September 30, 2007. Our
      financing activities for the nine months ended September 30, 2008 consist
      primarily of equipment loan re-payments of $0.7 million. Our financing
      activities for the nine months ended September 30, 2007 consisted primarily
      of
      $19.5 million in net proceeds from a public offering in May 2007, $0.4 million
      of proceeds from common stock issuance under the ESPP and stock option exercises
      and $0.4 million borrowed under equipment loans borrowing net of equipment
      financing repayments.




19




***Credit
      and Loan Arrangements***





In
      June 2000, we entered into an equipment financing agreement with General
      Electric Capital Corporation (“GECC”). Various credit lines have been issued
      under the financing agreement since 2000. As of September 30, 2008, we had
      drawn
      an aggregate of $10.7 million under various credit lines under the financing
      agreement. At September 30, 2008, the outstanding balance was $1.6 million.
      The outstanding balance bears interest at rates ranging from 8.70 percent to
      10.61 percent per annum and is due in 36 to 48 monthly payments. The equipment
      loans are secured by the equipment financed. Prior to the sale of the our
      held-for-sale assets, we will be required to pay the entire outstanding balance.
      No credit lines remain available under this agreement.




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





We
      expect
      to continue to incur substantial operating losses in the future. We will not
      receive any product revenue unless and until a product candidate has been
      approved by the United States Food and Drug Administration (“FDA”) or similar
      regulatory agency in other countries and has been successfully commercialized.
      As of September 30, 2008, our cash, cash equivalents and marketable securities
      totaled $18.3 million. We also have outstanding debt from equipment
      financing of $1.6 million. We believe that our cash, cash equivalents and
      marketable securities will be sufficient to enable us to meet our obligations
      to
      approximately the middle of 2009. We need to raise substantial additional funds
      to continue our operations, fund additional clinical trials of voreloxin and
      bring future products to market. We cannot be certain that we will be able
      to
      raise sufficient funds to complete the development and commercialization of
      voreloxin or that the voreloxin will be successful. Additionally, we plan to
      continue to evaluate in-licensing and acquisition opportunities to gain access
      to new drugs or drug targets that would fit with our strategy. Any such
      transaction would likely increase our funding needs in the
      future.





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





·
            
            the
                rate of progress and cost of our clinical trials 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 a sufficient amount of product revenue to finance our cash
      requirements, which we may never do, we expect to finance future cash needs
      with
      equity issuances, debt arrangements and some combination of technology and
      product licenses of development and/or commercialization rights to one or more
      of our product candidates. We do not know whether additional funding will be
      available on acceptable terms, or at all. If we are not able to secure
      additional funding when needed, we may have to delay, reduce the scope of or
      eliminate one or more of our clinical trials or development programs or conduct
      additional workforce or expense reductions. In addition, we may have to partner
      voreloxin at an earlier stage of development than we might otherwise choose,
      which could lower the economic value of that program to us.





**Off-Balance
      Sheet Arrangements**





Through
      the nine months ended September 30, 2008 and the year ended
      December 31, 2007, we do not have any off-balance sheet arrangements or
      relationships with unconsolidated entities or financial partnerships, such
      as
      entities often referred to as structured finance or variable interest entities,
      which are typically established for the purpose of facilitating off-balance
      sheet arrangements or other contractually narrow or limited
      purposes.




20




**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market Risk**




The
      primary objective of our investment activities is to preserve our capital for
      the purpose of funding operations while at the same time maximizing the income
      we receive from our investments without significantly increasing risk. Our
      exposure to market rate risk for changes in interest rates relates primarily
      to
      our investment portfolio. This means that a change in prevailing interest rates
      may cause the principal amount of the investments to fluctuate. By policy,
      we
      minimize risk by placing our investments with high quality debt security
      issuers, limit the amount of credit exposure to any one issuer, limit duration
      by restricting the term and hold investments to maturity except under rare
      circumstances. To achieve these objectives, our investment policy allows us
      to
      maintain a portfolio of cash equivalents and short-term investments in a variety
      of securities, including commercial paper, money market funds and corporate
      debt
      securities. Our investment policy prohibits investments in derivative
      instruments. We did not hold derivative instruments as of September 30,
      2008, and we have not held derivative instruments in the past. Through our
      money
      managers, we maintain risk management control systems to monitor interest rate
      risk. Our cash and cash equivalents as of September 30, 2008 included
      liquid money market accounts. Our marketable securities as of September 30,
      2008
      included readily marketable debt securities. Due to the short-term nature of
      these instruments, a 1% movement in market interest rates would not have a
      significant impact on the total value of our portfolio as of September 30,
      2008.
      For example, a 1/2 percentage point increase in short-term interest rates would
      reduce the fair market value of our portfolio of September 30, 2008 by
      approximately $7,000.




**Item
                4.**
            **Controls
                and Procedures**




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





We
      maintain disclosure controls 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 our reports under the Securities Exchange Act of
      1934, as amended, is recorded, processed, summarized and reported within the
      time periods specified in the SEC’s rules and forms and that such
      information is accumulated and communicated to our management, including our
      Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
      for timely decisions regarding required disclosure. In designing and evaluating
      the disclosure controls and procedures, management recognizes that any controls
      and procedures, no matter how well designed and operated, can provide only
      reasonable assurance of achieving the desired control objectives, and management
      is required to apply its judgment in evaluating the cost-benefit relationship
      of
      possible controls and procedures.




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





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





There
      have been no changes in our internal control over financial reporting during
      the
      quarter ended September 30, 2008 that have materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.





**PART II.
      OTHER INFORMATION**





**Item
                1.**
            **Legal
                Proceedings**




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





We
      are
      not currently involved in any material legal proceedings.




**Item
                1A.**
            **Risk
                Factors**




Investing
      in our common stock involves a high degree of risk. You should carefully
      consider the risks and uncertainties described below and all information
      contained in this Quarterly 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 may be unable to conduct our business as currently planned
      and our financial condition and operating results could be harmed. In addition,
      the trading price of our common stock could further decline due to the
      occurrence of any of these risks, and you may lose all or part of your
      investment.




21




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





**We
      have marked with an asterisk (*) those risk factors below that reflect
      substantive changes from the risk factors included in our Quarterly Report
      on
      Form 10-Q filed with the Securities and Exchange Commission on August 7,
      2008.**




**Risks
      Related to Our Business**





****
      If we are unable to raise additional capital in the near term, we may not be
      able to continue to operate as a going concern.***





We
      will
      need to raise substantial additional capital to continue our development
      activities and any possible future commercialization activities.





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





·
            fund
                clinical trials and seek regulatory
                approvals;





·
            continue
                and expand our development
                activities;





·
            hire
                additional development personnel;




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





·
            implement
                additional internal systems and infrastructure;
                and





·
            build
                or access manufacturing and commercialization
                capabilities.





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





·
            the
                rate of progress and cost of our clinical trials and other development
                activities;





·
            the
                economic and other terms and timing of any collaboration, licensing
                or
                other arrangements into which we may
                enter;





·
            the
                costs associated with building or accessing 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; and





·
            the
                effect of competing technological and market
                developments.





We
      currently anticipate that our cash, cash equivalents and marketable securities
      will be sufficient to enable us to fund our operations to approximately the
      middle of 2009. Until we can generate a sufficient amount of product revenue
      to
      finance our cash requirements, which we may never do, we expect to finance
      future cash needs primarily through equity issuances, debt arrangements
      and some combination of technology and product licenses of development
      and/or commercialization rights to one or more of our product candidates. We
      do
      not know whether additional funding will be available on acceptable terms,
      or at
      all.





We
      are
      currently continuing to advance our ongoing clinical trials of voreloxin in
      acute myeloid leukemia (“AML”) and ovarian cancer. If we are not able to
      secure additional funding when needed, we may have to delay, reduce the scope
      of
      or eliminate one or more of our clinical trials or scale back our development
      program or conduct additional workforce or other expense reductions. For
      example, in June 2008, we announced that we reduced our workforce by
      approximately sixty percent and implemented a revised operating plan to focus
      our efforts on voreloxin, wind down our internal discovery research activities
      to streamline our operations and extend our financial resources.




22




In
      addition, if we out-license or partner one or more of our product candidate
      programs prior to completion of a Phase 2 trial or at an earlier stage of
      development, this will likely lower the long-term economic value of such program
      or programs to our company. For example, depending upon results from our ongoing
      Phase 1 clinical trial of SNS-314, we plan to continue to seek a development
      partner to support further development of this product candidate. However,
      if we
      retain rights for a longer period with an expectation of improving our economic
      upside, we will not only incur substantial development expenditures, but also
      risk that our clinical trials may not generate data sufficient to support an
      out-license or partnering arrangement.





Our
      failure to raise capital when needed and on acceptable terms would require
      us to
      reduce our operating expenses, delay or reduce the scope of our voreloxin
      development program and limit our ability to continue our operations. Any one
      of
      the foregoing would have a material adverse effect on our business, financial
      condition and results of operations.





***Conditions
      affecting the equity market may make 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 buying
      stock and corporate bonds and economic growth has begun to slow. Factors
      contributing to a slowing economy appear to be reduced credit availability,
      falling house prices and rising prices. If these factors continue to affect
      equity markets, our ability to raise capital may be adversely
      affected.





****
      We have incurred losses since inception and anticipate that we will continue
      to
      incur losses for the foreseeable future. We may not ever achieve or sustain
      profitability.***





We
      are a
      clinical-stage biopharmaceutical company with a limited operating history as
      a
      public company. We are not profitable and have incurred losses in each year
      since our inception in 1998, including a net loss of $30.3 million for the
      nine
      months ended September 30, 2008. Our net loss for the years ended
      December 31, 2007, 2006 and 2005 was $38.8 million,
      $31.2 million, and $27.5 million (excluding a preferred stock deemed
      dividend of $88.1 million), respectively. As of September 30, 2008, we had
      an accumulated deficit of $309.3 million, including the $88.1 million
      preferred stock deemed dividend related to our initial public offering in
      September 2005. We do not currently have any products that have been
      approved for marketing, and we continue to incur substantial development and
      general and administrative expenses related to our operations. We expect to
      continue to incur losses for the foreseeable future, and we expect these losses
      to increase significantly, especially upon commencing pivotal and Phase 3
      clinical trials for voreloxin, as we conduct development of, and seek regulatory
      approvals for, voreloxin, and as we commercialize any approved drugs. Our
      losses, among other things, have caused and will continue to cause our
      stockholders’ equity and working capital to decrease.




Our
      business model had been based in part upon entering into strategic
      collaborations for discovery and/or the development of some of our product
      candidates. To date, we have derived substantially all of our revenue from
      research collaboration agreements. The research phase for all of our
      revenue-generating collaboration agreements is completed. As we have wound
      down
      our internal discovery research capabilities in connection with our June 2008
      restructuring, we do not expect to enter into any new collaboration agreement
      that will result in research revenue for us. We also do not anticipate that
      we
      will generate revenue from the sale of products for the foreseeable future.
      In
      the absence of additional sources of capital which may not be available to
      us on
      acceptable terms, if at all, the development of our current or future product
      candidates may be reduced in scope, delayed or terminated. If our product
      candidates or those of our collaborators fail in clinical trials or do not
      gain
      regulatory approval, or if our future products do not achieve market acceptance,
      we may never become profitable. Even if we achieve profitability in the future,
      we may not be able to sustain profitability in subsequent periods.





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





Our
      product candidates are in the early stages of drug development and are prone
      to
      the risks of failure inherent in the drug development process. We and our
      collaboration partners will need to conduct significant additional preclinical
      studies and clinical trials before we or our collaboration partners can
      demonstrate that our product candidates are safe and effective to the
      satisfaction of the FDA and other regulatory authorities. In our industry,
      it is
      unlikely that the limited number of compounds that we have identified as
      potential product candidates will actually lead to successful product
      development efforts. Failure can occur at any stage of the process, and
      successful preclinical studies and early clinical trials do not ensure that
      later clinical trials will be successful. We terminated two Phase 2 trials
      of voreloxin in small cell and non-small cell lung cancer. We expect that we
      will cease further development of SNS-032 after completion of the ongoing Phase
      1 trial as no responses demonstrating efficacy have been seen to date in either
      arm of the trial. To date, SNS-314 has only been tested in humans in Phase
      1
      trials. None of our product candidates with collaboration parties have completed
      testing in humans. In addition, product candidates in later stage trials may
      fail to show desired efficacy and safety traits despite having progressed
      through initial clinical trials. A number of companies in the pharmaceutical
      industry have suffered significant setbacks in advanced clinical trials, even
      after obtaining promising results in earlier trials.




23




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





·
            delays
                or failures to raise additional
                funding;





·
            limited
                number of, and competition for, suitable patients with particular
                types of
                cancer for enrollment in clinical
                trials;





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





·
            delays
                or failures in obtaining sufficient clinical
                materials;





·
            delays
                or failures in obtaining IRB approval to conduct a clinical trial
                at
                prospective sites; or





·
            delays
                or failures in reaching acceptable clinical trial agreement terms
                or
                clinical trial protocols with prospective
                sites.





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





·
            delays
                or failures to raise additional
                funding;





·
            slower
                than expected rates of patient recruitment and
                enrollment;





·
            failure
                of patients to complete the clinical
                trial;





·
            unforeseen
                safety issues;


·
            lack
                of efficacy during clinical trials;





·
            inability
                or unwillingness of patients or clinical investigators to follow
                our
                clinical trial protocols; and





·
            inability
                to monitor patients adequately during or after
                treatment.





Additionally,
      our clinical trials may be suspended or terminated at any time by the FDA,
      other
      regulatory authorities, ourselves or, in some cases, our collaboration partners.
      Any failure to complete or significant delay in completing, clinical trials
      for
      our product candidates could harm our financial results and the commercial
      prospects for our product candidates.





In
      March
      2008, we informed the FDA of a stability observation in our voreloxin drug
      product. Specifically, visible particles were observed in the finished product.
      We have since identified a process impurity in the active pharmaceutical
      ingredient (“API”) for voreloxin that, when formulated into the packaged vial of
      the voreloxin drug product, can result in the formation of the particles over
      time. Currently, we are implementing plans to eliminate the particles by
      revising our manufacturing process to control the impurity. It will take time
      to
      evaluate whether or not this revised manufacturing process for voreloxin drug
      product will be successful in stopping the formation of these particles. We
      have
      implemented a short-term corrective action for this issue and committed to
      provide an update on the results from our process optimization activities to
      the
      FDA before the end of the year. If the change in manufacturing process does
      not
      adequately control the formation of the visible particles, we will need to
      discuss other possibilities with the FDA, which could possibly include temporary
      clinical hold until the issue has been resolved to their
      satisfaction.





****
      Our clinical trials for our product candidates may not demonstrate safety or
      efficacy or lead to regulatory approval.***





Our
      product candidates are small molecule therapeutics being developed for the
      treatment of certain types of cancer. Many cancer drugs promote cancer cell
      death by inhibiting cell proliferation, and commonly have a narrow dose range
      between efficacy and toxicity, commonly known as a “therapeutic window.” We may
      select doses for use in our clinical trials that may prove to be ineffective
      in
      treating cancer. In addition, if our clinical trials result in unacceptable
      toxicity or lack of efficacy, we may have to terminate clinical trials. Even
      if
      we are able to find a proper dose that balances the toxicity and efficacy of
      one
      or more of our product candidates, we will be required to conduct extensive
      additional clinical trials before we are able to seek the regulatory approvals
      needed to market them. If clinical trials are halted, or if they do not show
      that our product candidates are safe and effective in the indications for which
      we are seeking regulatory approval, our future growth would be limited and
      we
      may not have any other product candidates to develop. Based on trial results
      to
      date in our ongoing clinical trial of SNS-032, we expect that we will cease
      further development after completion of the ongoing Phase 1 trial. No responses
      demonstrating efficacy have been observed in either arm of the
      trial.





24





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





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





We
      may
      encounter delays if we or our collaboration partners are unable to enroll enough
      patients to complete clinical trials. Patient enrollment depends on many
      factors, including the size of the patient population, the nature of the
      protocol, the proximity of patients to clinical sites and the eligibility
      criteria for the trial. Moreover, when one product candidate is evaluated in
      multiple clinical trials simultaneously, patient enrollment in ongoing trials
      can be adversely effected by negative results from completed trials. Our product
      candidates are focused in oncology, which can be a difficult patient population
      to recruit.





***The
      results of preclinical studies and clinical trials may not satisfy the
      requirements of the FDA or other regulatory agencies.***





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





****Our
      approach to developing cancer therapeutics by inhibiting CDKs, Aurora kinases
      and other kinases has not been clinically validated and may not be
      successful.***





SNS-032
      is an inhibitor of CDKs 2, 7 and 9, and SNS-314 is an inhibitor of
      Aurora A, B and C kinases. The therapeutic benefit of inhibiting CDKs
      and/or Aurora kinases in the treatment of human cancer has not been established
      definitively in the clinic. There are also other CDKs and Aurora kinase
      inhibitors in early clinical development, but they have yet to show therapeutic
      benefit or they target other kinases in addition to CDKs and Aurora kinases
      and
      their activity may be associated with inhibition of those other kinases. In
      addition, there are conflicting scientific reports regarding the reliance or
      necessity of CDK2 in the cell cycle. If CDK or Aurora kinase inhibition is
      not
      an effective treatment of human cancer, SNS-032, SNS-314 and any other drug
      candidates from our kinase programs, including the Raf kinase program from
      our
      collaboration with Biogen Idec, may have little or no commercial value. Based
      on
      trial results to date in our ongoing clinical trial of SNS-032, we expect that
      we will cease further development after completion of the ongoing Phase 1 trial.
      No responses demonstrating efficacy have been observed in either arm of the
      trial.





***We
      rely on third parties to manufacture our product candidates and depend on a
      single supplier for the active pharmaceutical ingredients for voreloxin and
      SNS-032. There are a limited number of manufacturers that are capable of
      manufacturing the active ingredient of voreloxin.***





We
      do not
      currently own or operate manufacturing facilities and lack the capability to
      manufacture any of our product candidates on a clinical or commercial scale.
      As
      a result, we rely on third parties to manufacture both the active pharmaceutical
      ingredient, or API, and drug products for our product candidates. The APIs
      are
      classified as toxic substances, limiting the available manufacturers. We believe
      that there are at least five contract manufacturers in North America with
      suitable capabilities for API manufacture, and at least four that can
      manufacture our drug products. We currently have established relationships
      with
      only one manufacturer for API for voreloxin and two manufacturers for the
      finished drug product. If our third-party manufacturer is unable or unwilling
      to
      produce API for voreloxin, we will need to establish a contract with another
      supplier. However, establishing a relationship with an alternative supplier
      would likely delay our ability to produce voreloxin API for six to nine months,
      during which time we will rely on current inventory to supply our drug product
      manufacturing activities. We expect to continue to depend on third-party
      contract manufacturers for all our API and drug products in the foreseeable
      future.




25




Our
      product candidates require precise, high quality manufacturing. A contract
      manufacturer is subject to ongoing periodic unannounced inspection by the FDA
      and corresponding state agencies to ensure strict compliance with current Good
      Manufacturing Practice (“cGMP”), and other applicable government regulations and
      corresponding foreign standards. Our contract manufacturer’s failure to achieve
      and maintain high manufacturing standards in compliance with cGMP regulations
      could result in manufacturing errors resulting in patient injury or death,
      product recalls or withdrawals, delays or interruptions of production or
      failures in product testing or delivery, delay or prevention of filing or
      approval of marketing applications for our products, cost overruns or other
      problems that could seriously harm our business.





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





Any
      performance failure on the part of a contract manufacturer could delay clinical
      development or regulatory approval of our product candidates or
      commercialization of our future products, depriving us of potential product
      revenue and resulting in additional losses. For example, because we rely on
      a
      single supplier for the API for voreloxin and SNS-032, the failure of such
      supplier to have sufficient quantities of the API or to supply API on a timely
      basis or at all would negatively affect us. In addition, our dependence on
      a
      third party for manufacturing may adversely affect our future profit margins.
      Our ability to replace an existing manufacturer may be difficult because the
      number of potential manufacturers is limited and the FDA must approve any
      replacement manufacturer before it can begin manufacturing our product
      candidates for commercial sale. Such approval would require new testing and
      compliance inspections. It may be difficult or impossible for us to identify
      and
      engage a replacement manufacturer on acceptable terms in a timely manner, or
      at
      all.





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





We
      are
      highly dependent on the principal members of our management and clinical staff.
      We expect to expand our clinical development and marketing capabilities by
      increasing expenditures in these areas, hiring additional employees and
      expanding the scope of our current operations. Future growth will require us
      to
      continue to implement and improve our managerial, operational and financial
      systems, expand our facilities and continue to retain, recruit and train
      additional qualified personnel, which may impose a strain on our administrative
      and operational infrastructure. The competition for qualified personnel in
      the
      biopharmaceutical field is intense. We are highly dependent on our continued
      ability to attract, retain and motivate highly-qualified management and clinical
      personnel. Due to our limited resources, we may not be able to effectively
      manage the expansion of our operations or recruit and train additional qualified
      personnel. If we are unable to retain key personnel or manage our growth
      effectively, we may not be able to implement our business plan.





***If
      we are sued for infringing intellectual property rights of third parties,
      litigation will be costly and time consuming and could prevent us from
      developing or commercializing our future products.***





Our
      commercial success depends on not infringing the patents and other proprietary
      rights of third parties and not breaching any collaboration or other agreements
      we have entered into with regard to our technologies and product candidates.
      Numerous third-party U.S- and foreign-issued patents and pending patent
      applications exist in the area of kinases, including CDKs and Aurora and Raf
      kinases. Because patent applications can take several years to issue, there
      may
      be pending applications that may result in issued patents that cover our
      technologies or product candidates. For example, some pending patent
      applications contain broad claims that could represent freedom to operate
      limitations for some of our kinase programs should such applications be issued
      unchanged. In addition, because pending patent applications are not required
      to
      be published generally until at least 18 months after they are filed (or at
      all
      before issuance in the case of U.S. patent applications filed before
      November 29, 2000) there may be claims contained in such unpublished
      applications that we are not even aware of. If a third party asserts that we
      are
      using technology or compounds claimed in issued and unexpired patents owned
      or
      controlled by the third party, we may need to obtain a license, enter into
      litigation to challenge the validity of the patents or incur the risk of
      litigation in the event that a third party asserts that we infringe its
      patents.





If
      a
      third party asserts that we infringe its patents or other proprietary rights,
      we
      could face a number of issues that could seriously harm our competitive
      position, including:







·
            
            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;




26




·
            
            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’s patent or other proprietary rights;·
            
            a
                court order 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 and market products that are more effective, safer
      or
      less expensive than our future products, our commercial opportunities will
      be
      negatively impacted.***





The
      life
      sciences industry is highly competitive, and we face significant competition
      from many pharmaceutical, biopharmaceutical and biotechnology companies that
      are
      researching and marketing products designed to address cancer and other serious
      diseases. We are developing small molecule therapeutics that will compete with
      other drugs and therapies that currently exist or are being developed. Many
      of
      our competitors have significantly greater financial, manufacturing, marketing
      and drug development resources than we do. Large pharmaceutical companies in
      particular have extensive experience in clinical testing and in obtaining
      regulatory approvals for drugs. These companies also have significantly greater
      research capabilities than we do. In addition, many universities and private
      and
      public research institutes are active in cancer research, some of which are
      in
      direct competition with us.





Our
      product candidates will compete with a number of cancer therapeutics that are
      currently marketed or in development that also target proliferating cells but
      at
      different points of the cell cycle or with a different mechanism of action.
      These drugs include irinotecan, doxorubicin, taxanes and other cytotoxics and
      targeted therapies. To compete effectively with these agents, our product
      candidates will need to demonstrate advantages that lead to improved clinical
      efficacy as either a single agent or in combination settings.





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 voreloxin in AML include Genzyme Corporation’s
      clofarabine, Eisai Corporation’s decitabine and ViON Corporation’s cloretazine,
      all of which could change the treatment paradigm of acute leukemia. Each of
      these compounds is further along in clinical development than is voreloxin.
      Liposomal doxorubicin and topotecan are current standards of care in
      platinum-resistant ovarian cancer patients, and we are aware that several of
      our
      competitors have initiated Phase 3 clinical trials for this
      indication.




Further,
      with respect to SNS-032, we believe that several companies, including
      Sanofi-Aventis, Inc., Nerviano Medical Sciences, Cyclacel
      Pharmaceuticals, Inc., Pfizer Inc., Schering AG and others, are
      conducting clinical trials with CDK inhibitors and others are developing other
      compounds that may compete with SNS-032.





With
      respect to SNS-314, Merck and Vertex Pharmaceuticals Incorporated are
      co-developing an Aurora kinase inhibitor and Cyclacel
      Pharmaceuticals, Inc., AstraZeneca International, Astex Therapeutics
      Limited, Millennium Pharmaceuticals, Inc. and Rigel
      Pharmaceuticals, Inc. in conjunction with Merck Serono
      International S.A., Pfizer Inc., Nerviano Medical Sciences, and others are
      also developing Aurora kinase inhibitors. Several other companies have Aurora
      kinase programs for which they are close to filing an investigational new drug
      application (“IND”) with the FDA. Other molecules that may compete with SNS-314
      may include other naturally occurring cell-cycle inhibitor drugs.




27




If
      our
      competitors market products that are more effective, safer or less expensive
      than our future products, if any, or that reach the market sooner than our
      future products, if any, we may not achieve commercial success. In addition,
      the
      biopharmaceutical industry is characterized by rapid change. Products
      developed by our competitors may render our product candidates
      obsolete.




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





We
      do not
      have the ability to independently conduct clinical trials for our product
      candidates. We rely on third parties, such as contract research organizations,
      medical institutions, clinical investigators and contract laboratories, to
      conduct the planned and existing clinical trials of our product candidates.
      If
      the third parties conducting our clinical trials do not perform their
      contractual duties or obligations, do not meet expected deadlines or need to
      be
      replaced, or if the quality or accuracy of the clinical data they obtain is
      compromised due to the failure to adhere to our clinical trial protocols or
      for
      any other reason, we may need to enter into new arrangements with alternative
      third parties and our clinical trials may be extended, delayed or terminated
      or
      may need to be repeated, and we may not be able to obtain regulatory approval
      for or commercialize the product candidate being tested in such
      trials.





***Our
      proprietary rights may not adequately protect our technologies and product
      candidates.***





Our
      commercial success will depend on our ability to obtain patents and maintain
      adequate protection for our technologies and product candidates in the United
      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 and
      approximately 345 pending U.S. and foreign patent applications. We will be
      able
      to protect our proprietary rights from unauthorized use by third parties only
      to
      the extent that our proprietary technologies and future products are covered
      by
      valid and enforceable patents or are effectively maintained as trade
      secrets.





We
      apply
      for patents covering both our technologies and product candidates, as we deem
      appropriate. However, we may fail to apply for patents on important technologies
      or product candidates in a timely fashion, or at all. Our existing patents
      and
      any future patents we obtain may not be sufficiently broad to prevent others
      from practicing our technologies or from developing competing products and
      technologies. In addition, we generally do not exclusively control the patent
      prosecution of subject matter that we license to or from others. Accordingly,
      in
      such cases we are unable to exercise the same degree of control over this
      intellectual property as we would over our own. Moreover, the patent positions
      of biopharmaceutical companies are highly uncertain and involve complex legal
      and factual questions for which important legal principles remain unresolved.
      As
      a result, the validity and enforceability of patents cannot be predicted 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;·
            
            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 or obtainable. However, trade
      secrets are difficult to maintain. While we use reasonable efforts to protect
      our trade secrets, our or our collaboration partners’ employees, consultants,
      contractors or scientific and other advisors, or those of our licensors, may
      unintentionally or willfully disclose our proprietary information to
      competitors. Enforcement of claims that a third party has illegally obtained
      and
      is using trade secrets is expensive, time consuming and uncertain. In addition,
      foreign courts are sometimes less willing than U.S. courts to protect trade
      secrets. If our competitors independently develop equivalent knowledge, methods
      and know-how, we would not be able to assert our trade secrets against them
      and
      our business could be harmed.




28




***The
      composition of matter patents covering voreloxin are due to expire in 2015.
      Even
      if voreloxin is approved by the FDA, we may not be able to recover our
      development costs prior to the expiration of these
      patents.***





The
      composition of our lead product candidate, voreloxin, is covered by U.S. patent
      5,817,669 and its counterpart patents and patent applications in 43 foreign
      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 do not
      know whether patent term extensions and data exclusivity periods will be
      available in the future. Voreloxin must undergo extensive clinical trials before
      it can be approved by the FDA. We do not know when, if ever, voreloxin will
      be
      approved by the FDA. Even if voreloxin is approved by the FDA in the future,
      we
      may not have sufficient time to commercialize voreloxin to enable us to recover
      our development costs prior to the expiration of the U.S. and foreign patents
      covering voreloxin. Our obligation to pay royalties to Dainippon, the company
      from which we licensed voreloxin, may extend beyond the patent expiration,
      which
      would further erode the profitability of this product.





***The
      composition of matter patents covering SNS-032 are due to expire in 2018 in
      the
      United States. Even if SNS-032 is approved by the FDA, we may not be able to
      recover our development costs 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 33 foreign 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 whether patent term extensions and
      data exclusivity periods will be available in the future. SNS-032 must undergo
      extensive clinical trials before it can be approved by the FDA. We do not know
      when, if ever, SNS-032 will be approved by the FDA. Even if SNS-032 is approved
      by the FDA in the future, we may not have sufficient time to commercialize
      SNS-032 to enable us to recover our development costs prior to the expiration
      of
      the U.S. and foreign patents covering SNS-032. Our obligation to pay royalties
      to BMS, the company from which we licensed SNS-032, may extend beyond the patent
      expiration, which would further erode the profitability of this
      product.





***The
      composition of matter patents covering SNS-314 are due to expire in 2025 and
      2029 in the United States. Even if SNS-314 is approved by the FDA, we may not
      be
      able to recover our development costs prior to the expiration of these
      patents.***





The
      composition of our product candidate SNS-314 is covered by a pending U.S.
      utility patent application and its counterpart patent applications in 14 foreign
      jurisdictions, as well as three pending U.S. provisional patent applications.
      If
      a patent issues based on the pending U.S. utility application, it would be
      due
      to expire on or about July 2025, as would most of any issued foreign
      counterparts. If a patent issues based on the earliest of the three pending
      U.S.
      provisional applications, it would be due to expire on or about March 2029,
      as
      would most of any issued foreign counterparts, if such are filed. We do not
      know
      whether patent term extensions and data exclusivity periods will be available
      in
      the future. SNS-314 must undergo extensive clinical trials before it can be
      approved by the FDA. We do not know when, if ever, SNS-314 will be approved
      by
      the FDA. Even if SNS-314 is approved by the FDA in the future, we may not have
      sufficient time to commercialize SNS-314 to enable us to recover our development
      costs prior to the expiration of any U.S. and foreign patents covering
      SNS-314.





***Our
      workforce reductions in August 2007 and June 2008 and any future workforce
      and expense reductions may have an adverse impact on our internal programs,
      our
      ability to hire and retain key personnel and may be distracting to
      management.***





In
      August 2007, we conducted a workforce reduction of approximately twenty
      five percent in order to reduce expenses. In June 2008, we conducted a second
      workforce reduction of approximately sixty percent to focus on the development
      of voreloxin. In conjunction with this strategic restructuring, we wound down
      our internal discovery research activities. In light of our continued need
      for
      funding and expense control, we may be required to implement further workforce
      and expense reductions in the future. Further workforce and expense reductions
      could result in reduced progress on our internal programs. In addition,
      employees, whether or not directly affected by a reduction, may seek future
      employment with our business partners or competitors. Although our employees
      are
      required to sign a confidentiality agreement at the time of hire, the
      confidential nature of certain proprietary information may not be maintained
      in
      the course of any such future employment. Further, we believe that our future
      success will depend in large part upon our ability to attract and retain highly
      skilled personnel. We may have difficulty retaining and attracting such
      personnel as a result of a perceived risk of future workforce and expense
      reductions. In addition, the implementation of expense reduction programs may
      result in the diversion of efforts of our executive management team and other
      key employees, which could adversely affect our business.





***The
      commercial success of products resulting from our collaborations, if any,
      depends in whole or in part on the development and marketing efforts of our
      collaboration partners, over which we have limited control. If our
      collaborations are unsuccessful, our potential to generate future revenue from
      the sale of these products would be significantly
      reduced.***





Our
      dependence on collaboration arrangements subjects our company to a number of
      risks. The commercial success of products resulting from our collaborations,
      if
      any, depends, in whole or in part on our collaboration partners’ ability to
      establish the safety and efficacy of our product candidates, obtain and maintain
      regulatory approvals and achieve market acceptance of a product once
      commercialized. Our collaboration partners may elect to delay or terminate
      development of one or more product candidates, independently develop products
      that compete with ours, or fail to commit sufficient resources to the marketing
      and distribution of products developed through their collaborations with us.
      In
      the event that one or more of our collaboration partners fails to diligently
      develop or commercialize a product candidate covered by one of our collaboration
      agreements, we may have the right to terminate our partner’s rights to such
      product candidate but we will not receive any future revenue from that product
      candidate unless we are able to find another partner or commercialize the
      product candidate on our own, which is likely to result in significant
      additional expense. Business combinations, significant changes in business
      strategy, litigation and/or financial difficulties may also adversely affect
      the
      willingness or ability of one or more of our collaboration partners to complete
      their obligations under our collaboration agreements. If our collaboration
      partners fail to perform in the manner we expect, our potential to generate
      future revenue from the sale of products resulting from our collaborations,
      would be significantly reduced.




29




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





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





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





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





Many
      of
      our employees were previously employed at universities or biotechnology or
      pharmaceutical companies, including our competitors or potential competitors.
      We
      may be subject to claims that we or our employees have inadvertently or
      otherwise used or disclosed trade secrets or other proprietary information
      of
      their former employers. Litigation may be necessary to defend against these
      claims. If we fail in defending such claims, in addition to paying monetary
      damages, we may lose valuable intellectual property rights or personnel. A
      loss
      of key personnel or the work product of current or former personnel could hamper
      or prevent our ability to commercialize our product candidates, which could
      severely harm our business. Even if we are successful in defending against
      these
      claims, litigation could result in substantial costs and be a distraction to
      management.




***We
      currently have limited marketing staff and no sales or distribution
      organization. If we are unable to develop a sales and marketing and distribution
      capability on our own or through collaborations with marketing partners, we
      will
      not be successful in commercializing our future
      products.***





We
      currently have no sales or distribution capabilities and limited marketing
      staff. We intend to establish our own sales and marketing organization with
      technical expertise and supporting distribution capabilities to commercialize
      at
      least some of our future products, if any, which will be expensive and time
      consuming. Any failure or delay in the development of our internal sales,
      marketing and distribution capabilities would adversely impact the
      commercialization of these products. With respect to other future products,
      we
      plan to collaborate with third parties that have direct sales forces and
      established distribution systems. To the extent that we enter into co-promotion
      or other licensing arrangements, our product revenue is likely to be lower
      than
      if we directly marketed or sold our products. In addition, any revenue we
      receive will depend upon the efforts of third parties, which may not be
      successful and are only partially within our control. If we are unable to enter
      into such arrangements on acceptable terms or at all, we may not be able to
      successfully commercialize these future products. If we are not successful
      in
      commercializing our future products, either on our own or through collaborations
      with one or more third parties, our future product revenue will suffer and
      we
      may incur significant additional losses.





***We
      depend on various scientific consultants and advisors for the success and
      continuation of development efforts.***





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




30




***Our
      facilities are located near known earthquake fault zones, and the occurrence
      of
      an earthquake or other catastrophic disaster could cause damage to our
      facilities and equipment, which could require us to cease or curtail
      operations.***





Our
      facilities are located in the San Francisco Bay Area near known earthquake
      fault
      zones and are vulnerable to significant damage from earthquakes. We are also
      vulnerable to damage from other types of disasters, including fires, floods,
      power loss, communications failures and similar events. We are in the process
      of
      designing and implementing a disaster relief plan. However, even if such a
      plan
      were in place, if any disaster were to occur, our ability to operate our
      business at our facilities may be seriously or completely impaired and
      our data could be lost or destroyed.





***Compliance
      with changing regulation of corporate governance and public disclosure may
      result in additional expenses.***





Changing
      laws, regulations and standards relating to corporate governance and public
      disclosure may create uncertainty regarding compliance matters. New or changed
      laws, regulations and standards are subject to varying interpretations in many
      cases. As a result, their application in practice may evolve over time. We
      are
      committed to maintaining high standards of corporate governance and public
      disclosure. Complying with evolving interpretations of new or changed legal
      requirements may cause us to incur higher costs as we revise current practices,
      policies and procedures, and may divert management time and attention from
      potential revenue-generating activities to compliance matters. If our efforts
      to
      comply with new or changed laws, regulations and standards differ from the
      activities intended by regulatory or governing bodies due to ambiguities related
      to practice, our reputation may also be harmed. Further, our board members,
      chief executive officer and chief financial officer could face an increased
      risk
      of personal liability in connection with the performance of their duties. As
      a
      result, we may have difficulty attracting and retaining qualified board members
      and executive officers, which could harm our business.





***Global
      credit and financial market conditions negatively impact the value of our
      current portfolio of cash equivalents or short-term investments and our ability
      to meet our financing objectives.***





Our
      cash
      and cash equivalents are maintained in highly liquid investments with remaining
      maturities of 90 days or less at the time of purchase. Our marketable
      securities consist primarily of investments in readily marketable debt
      securities with remaining maturities of more than 90 days at the time of
      purchase. While as of the date of this filing, we are not aware of any
      downgrades, material losses, or other significant deterioration in the fair
      value of our cash equivalents or marketable securities since September 30,
      2008,
      no assurance can be given that further deterioration in conditions of the global
      credit and financial markets would not negatively impact our current portfolio
      of cash equivalents or marketable securities or our ability to meet our current
      liquidity needs.





**Risks
      Related to Our Industry**





***The
      regulatory approval process is expensive, time consuming and uncertain and
      may
      prevent us or our collaboration partners from obtaining approvals for the
      commercialization of some or all of our product
      candidates.***





The
      research, testing, manufacturing, selling and marketing of product candidates
      are subject to extensive regulation by the FDA and other regulatory authorities
      in the United States and other countries, which regulations differ from country
      to country. Neither we nor our collaboration partners are permitted to market
      our product candidates in the United States until we receive approval of a
      new
      drug application (“NDA”) from the FDA or in any other country without the
      equivalent marketing approval from such country. Neither we nor our
      collaboration partners have received marketing approval for any of our product
      candidates. In addition, failure to comply with FDA and other applicable U.S.
      and foreign regulatory requirements may subject us to administrative 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 to approve pending NDAs,
      supplements to approved NDAs or their foreign equivalents.





Regulatory
      approval of an NDA or NDA supplement or a foreign equivalent is not guaranteed,
      and the approval process is expensive and may take several years. Furthermore,
      the development process for oncology products may take longer than in other
      therapeutic areas. Regulatory authorities have substantial discretion in the
      drug approval process. Despite the time and expense exerted, failure can occur
      at any stage, and we could encounter problems that cause us to abandon clinical
      trials or to repeat or perform additional preclinical studies and clinical
      trials. The number of preclinical studies and clinical trials that will be
      required for marketing approval varies depending on the drug candidate, the
      disease or condition that the drug candidate is designed to address, and the
      regulations applicable to any particular drug candidate. The FDA or a foreign
      regulatory authority can delay, limit or deny approval of a drug candidate
      for
      many reasons, including:





·
            the
                drug candidate may not be deemed safe or
                effective;




31


·
            regulatory
                officials may not find the data from preclinical studies and clinical
                trials sufficient;





·
            the
                FDA or foreign regulatory authority might not approve our or our
                third-party manufacturer’s processes or facilities;
                or





·
            the
                FDA or foreign regulatory authority may change its approval policies
                or
                adopt new regulations.





***We
      may be subject to costly claims related to our clinical trials and may not
      be
      able to obtain adequate insurance.***





Because
      we conduct clinical trials in humans, we face the risk that the use of our
      product candidates will result in adverse side effects. We cannot predict the
      possible harms or side effects that may result from our clinical trials.
      Although we have clinical trial liability insurance for up to $10.0 million
      aggregate, our insurance may be insufficient to cover any such events. We do
      not
      know whether we will be able to continue to obtain clinical trial coverage
      on
      acceptable terms, or at all. We may not have sufficient resources to pay for
      any
      liabilities resulting from a claim excluded from, or beyond the limit of, our
      insurance coverage. There is also a risk that third parties that we have agreed
      to indemnify could incur liability. Any litigation arising from our clinical
      trials, even if we were ultimately successful, would consume substantial amounts
      of our financial and managerial resources and may create adverse
      publicity.





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





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





·
            timing
                of market introduction of competitive
                products;





·
            efficacy
                of our product;





·
            prevalence
                and severity of any side effects;





·
            potential
                advantages or disadvantages over alternative
                treatments;





·
            strength
                of marketing and distribution
                support;





·
            price
                of our future products, both in absolute terms and relative to alternative
                treatments; and




·
            availability
                of reimbursement from health maintenance organizations and other
                third-party payors.





For
      example, the potential toxicity of single and repeated doses of voreloxin has
      been explored in a number of animal studies that suggest the dose-limiting
      toxicities in humans receiving voreloxin may be similar to some of those
      observed with approved cytotoxic agents, including reversible toxicity to bone
      marrow cells, the gastrointestinal system and other systems with rapidly
      dividing cells. In our Phase 1 and Phase 2 clinical trials of
      voreloxin, we have witnessed the following side effects, irrespective of
      causality, ranging from mild to more severe: lowered white blood cell count
      that
      may lead to a serious or possibly life-threatening infection, 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 of breath, diarrhea and intestinal
      blockage. Our ongoing Phase 1 clinical trials of SNS-032 and SNS-314 have
      enrolled only a limited number of patients. We can not yet assess the extent
      and
      type of side effects and/or unacceptable toxicities that these product
      candidates might exhibit in the patient populations and dosing regimens being
      evaluated.





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





***Even
      if we receive regulatory approval for a product candidate, we will be subject
      to
      ongoing FDA and other regulatory obligations and continued regulatory review,
      which may result in significant additional expense and limit our ability to
      commercialize our future products.***





Any
      regulatory approvals that we or our collaboration partners receive for our
      product candidates may also be subject to limitations on the indicated uses
      for
      which the product may be marketed or contain requirements for potentially costly
      post-marketing studies. In addition, even if approved, the labeling, packaging,
      adverse event reporting, storage, advertising, promotion and recordkeeping
      for
      any product will be subject to extensive and ongoing regulatory requirements.
      The subsequent discovery of previously unknown problems with a product,
      including adverse events of unanticipated severity or frequency, may result
      in
      restrictions on the marketing of the product, and could include withdrawal
      of
      the product from the market.




32




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





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





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





***Failure
      to obtain regulatory approval in foreign jurisdictions will prevent us from
      marketing our products abroad.***





We
      intend
      to market our future products in international markets. In order to market
      our
      future products in Canada, the European Union and many other foreign
      jurisdictions, we must obtain separate regulatory approvals. We have had limited
      interactions with foreign regulatory authorities, and the approval procedures
      vary among countries and can involve additional testing at significant cost.
      The
      time required to obtain approval may differ from that required to obtain FDA
      approval. Approval by the FDA does not ensure approval by regulatory authorities
      in other countries, and approval by one foreign regulatory authority does not
      ensure approval by regulatory authorities in other foreign countries or by
      the
      FDA. The foreign regulatory approval process may include all of the risks
      associated with obtaining FDA approval. We may not obtain foreign regulatory
      approvals on a timely basis, if at all. We may not be able to file for
      regulatory approvals and may not receive necessary approvals to commercialize
      our products in any market.




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





We
      intend
      to seek approval to market our future products in both the United States and
      foreign jurisdictions. If we obtain approval in one or more foreign
      jurisdictions, we will be subject to rules and regulations in those
      jurisdictions relating to our product. In some foreign countries, particularly
      in the European Union, prescription drug pricing is subject to governmental
      control. In these countries, pricing negotiations with governmental authorities
      can take considerable time after the receipt of marketing approval for a drug
      candidate. To obtain reimbursement or pricing approval in some countries, we
      may
      be required to conduct a clinical trial that compares the cost-effectiveness
      of
      our future product to other available therapies. If reimbursement of our future
      products is unavailable or limited in scope or amount, or if pricing is set
      at
      unsatisfactory levels, we may be unable to achieve or sustain
      profitability.





***We
      may incur significant costs complying with environmental laws and regulations,
      and failure to comply with these laws and regulations could expose us to
      significant liabilities.***





We
      use
      hazardous chemicals and radioactive and biological materials in our business
      and
      are subject to a variety of federal, state, regional and local laws and
      regulations governing the use, generation, manufacture, storage, handling and
      disposal of these materials. Although we believe our safety procedures for
      handling and disposing of these materials and waste products comply with these
      laws and regulations, we cannot eliminate the risk of accidental injury or
      contamination from the use, storage, handling or disposal of hazardous
      materials. In the event of contamination or injury, we could be held liable
      for
      any resulting damages, and any liability could significantly exceed our
      insurance coverage, which is limited to $0.1 million for pollution cleanup,
      and we are uninsured for third-party contamination injury. In addition, as
      a
      result of the wind down of our research activities and the closure of our former
      research and development facility, we are in the process of extensive hazardous
      waste disposal and decontamination activities. Failure to conduct these
      activities in a timely manner and in accordance with all applicable laws and
      regulations could result in significant liability and/or significant delays
      in
      our ability to sublease our vacated facility.




33




**Risks
      Related to Our Common Stock**





****
      If we sell shares of our common stock in future financings or other
      arrangements, stockholders may experience immediate
      dilution.***




The
      Company needs to raise substantial additional funds to continue its operations,
      fund additional clinical trials of voreloxin and bring future products to
      market. Management plans to continue to finance the Company’s operations with
      some combination of technology and product licenses, equity issuances, debt
      arrangements, and, in the long term, product sales and royalties. These
      arrangements will likely involve the issuance of debt securities, preferred
      stock or common stock and may be at a discount from the current trading price
      of
      our common stock. If we issue additional common or preferred stock or securities
      convertible into common stock, our stockholders will experience
      dilution.





****The
      price of our common stock may continue to be volatile, and the value of an
      investment in our common stock may decline.***





In
      2008,
      our common stock has traded as low as $0.18 and as high as $2.10. Factors that
      could cause continued volatility in the market price of our common stock
      include, but are not limited to:





·
            failure
                to raise additional capital to carry through with our clinical development
                plans and future operations;





·
            results
                from, and any delays in or discontinuance of, our clinical trial
                programs,
                especially our ongoing and planned clinical trials for
                voreloxin;





·
            announcements
                of FDA non-approval of our product candidates, delays in filing regulatory
                documents with the FDA or other regulatory agencies, or delays in
                the
                review process by the FDA or other foreign regulatory
                agencies;





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





·
            announcements
                relating to restructuring and other operational
                changes;





·
            delays
                in the commercialization of our future
                products;





·
            market
                conditions in the pharmaceutical, biopharmaceutical and biotechnology
                sectors;




·
            issuance
                of new or changed securities analysts’ reports or
                recommendations;





·
            actual
                and anticipated fluctuations in our quarterly operating
                results;





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





·
            introduction
                of technological innovations or new products by us or our
                competitors;





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





·
            market
                acceptance of our future products, if
                any;





·
            deviations
                in our operating results from the estimates of
                analysts;





·
            third-party
                healthcare reimbursement policies;





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





·
            litigation
                or public concern about the safety of our product candidates or future
                products, if any;





·
            failure
                to develop or sustain an active and liquid trading market for our
                common
                stock;





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





·
            additions
                or departures of key personnel.




34




In
      addition, the stock markets in general, and the markets for pharmaceutical,
      biopharmaceutical and biotechnology stocks in particular, have experienced
      extreme volatility that has often been unrelated to the operating performance
      of
      the issuer. These broad market fluctuations may adversely affect the trading
      price or liquidity of our common stock. In the past, when the market price
      of a
      stock has been volatile, holders of that stock have sometimes instituted
      securities class action litigation against the issuer. If any of our
      stockholders were to bring such a lawsuit against us, we could incur substantial
      costs defending the lawsuit and the attention of our management would be
      diverted from the operation of our business.





*****  ***If
      we fail to continue to comply with the listing requirements of The NASDAQ Global
      Market, the price of our common stock and our ability to access the capital
      markets could be negatively impacted.***




Our
      common stock is currently listed on The NASDAQ Global Market. Through November
      4, 2008, our stock has traded as low as $0.18 per share and, as of November
      4,
      2008, the closing price of our common stock was $0.72. The listing standards
      of
      The NASDAQ Global Market provide, among other things, that a company may be
      delisted if the bid price of its stock drops below $1.00 for a period of 30
      consecutive business days. Additionally, we must satisfy at least one of the
      following conditions: (i) stockholders’ equity of at least $10 million, (ii)
      total market value of listed securities of at least $50 million or (iii) at
      least $50 million of total assets and $50 million of total revenue. While we
      currently satisfy the stockholders’ equity requirement, we may not continue to
      do so.





Due
      to
      the recent economic crisis and volatility of the stock market, effective on
      October 16, 2008, the NASDAQ implemented a temporary suspension of the minimum
      $1 closing bid price and minimum market value of publicly held securities.
      The
      suspension will remain in effect through January 19, 2009. If we fail to satisfy
      any of the other conditions of listing on The NASDAQ Global Market, or if we
      fail to maintain the minimum bid price condition after January 19, 2009, we
      may
      have delisting proceedings initiated against us which may negatively impact
      the
      price of our common stock and our ability to access the capital markets.




Announcements
      by us of potential or pending NASDAQ delisting actions could further depress
      our
      stock price and market value and, even if we satisfy the market capitalization
      requirement, our stock price will need to trade above $1.00 on a sustained
      basis
      to remain listed. If our stock price drops below $1.00, we may seek to implement
      a reverse stock split. Reverse stock splits frequently result in a loss in
      stockholder value as the actual post-split price is often lower than the
      pre-split price, adjusted for the split.





If
      we
      fail to comply with the listing standards, our common stock listing may be
      moved
      to the NASDAQ Capital Market, which is a lower tier market, or our common stock
      may be delisted and traded on the over-the-counter bulletin board network.
      Moving our listing to the NASDAQ Capital Market could adversely affect the
      liquidity of our common stock and the delisting of our common stock would
      significantly affect the ability of investors to trade our securities and could
      significantly negatively affect the value and liquidity of our common stock.
      In
      addition, the delisting of our common stock could adversely affect our ability
      to raise capital on terms acceptable to us or at all. Delisting from NASDAQ
      could also have other negative results, including the potential loss of
      confidence by suppliers and employees, the loss of institutional investor
      interest and fewer business development opportunities.





***Provisions
      of our charter documents or Delaware law could delay or prevent an acquisition
      of our company, even if the acquisition would be beneficial to our stockholders,
      and could make it more difficult to change
      management.***





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





·
            a
                classified Board of Directors so that not all directors are elected
                at one
                time;





·
            a
                prohibition on stockholder action through written
                consent;





·
            limitations
                on our stockholders’ ability to call special meetings of
                stockholders;





·
            an
                advance notice requirement for stockholder proposals and nominations;
                and





·
            the
                authority of our Board of Directors to issue preferred stock with
                such
                terms as our Board of Directors may
                determine.





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




35




Provisions
      in our charter documents and provisions of Delaware law could limit the price
      that investors are willing to pay in the future for shares of our common
      stock.





***The
      ownership of our common stock is highly concentrated, and your interests may
      conflict with the interests of our existing
      stockholders.***





Our
      executive officers and directors and their affiliates beneficially owned
      approximately 42.0 percent of our outstanding common stock as of
      February 29, 2008. Accordingly, these stockholders, acting as a group, have
      significant influence over the outcome of corporate actions requiring
      stockholder approval, including the election of directors, any merger,
      consolidation or sale of all or substantially 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. The significant concentration of stock ownership may
      adversely affect the trading price of our common stock due to investors’
perception that conflicts of interest may exist or arise.





***We
      have never paid dividends on our capital stock and we do not anticipate paying
      any cash dividends in the foreseeable future.***





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





***We
      are at risk of securities class action litigation.***





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





**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of Proceeds**




There
      were no repurchases of securities or any sales of unregistered equity securities
      during the quarter ended September 30, 2008.





36





**Item
                3.**
            **Defaults
                Upon Senior Securities**




None.





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




None.





**Item
                5.**
            **Other
                Information**




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 Registrant’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 Registrant’s Current Report on Form 8-K filed
                on December 11, 2007).4.1
            
            Reference
                is made to Exhibit 3.1 and
                3.2.




10.69*
            
            Forms
                of Stock Option Grant Notice and Stock Option Agreement for Automatic
                Grants to Outside Directors under the2005
                Equity Incentive Award Plan.10.70*
            
            Consulting
                Agreement, dated August 5, 2008, and First Amendment to Consulting
                Agreement, dated October 1, 2008,by
                and between Registrant and Robert S. McDowell, Ph.D.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.







*
            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.





37





**SIGNATURE**





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




**SUNESIS
                PHARMACEUTICALS, INC.***(Registrant)*Date:
                November 7, 2008
            
            /S/
                ERIC H. BJERKHOLTEric
                H. Bjerkholt
              *Senior
                Vice President, Corporate Development and Finance,*
              *Chief
                Financial Officer*




38




**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 Registrant’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 Registrant’s Current Report on Form 8-K filed
                on December 11, 2007).4.1
            
            Reference
                is made to Exhibit 3.1 and
                3.2.




10.69*
            
            Forms
                of Stock Option Grant Notice and Stock Option Agreement for Automatic
                Grants to Outside Directors under the2005
                Equity Incentive Award Plan.10.70*
            
            Consulting
                Agreement, dated August 5, 2008, and First Amendment to Consulting
                Agreement, dated October 1, 2008,by
                and between Registrant and Robert S. McDowell, Ph.D.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.








*
            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.








39