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 March 31, 2009





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 ý   No o




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).   Yes o   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 filer o
              
              Accelerated
      filer oNon-accelerated
      filer o
              
              Smaller
      reporting company ý(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  ý





The
registrant had 34,409,768 shares of common stock, $0.0001 par value per share,
outstanding as of April 30, 2009.





SUNESIS
PHARMACEUTICALS, INC.


TABLE
OF CONTENTS





Page
                  No.PART I.
      FINANCIAL INFORMATION
                3Item
      1.
                Financial
      Statements:
                3Condensed
      Consolidated Balance Sheets as of March 31, 2009 and
      December 31, 2008
                3Condensed
      Consolidated Statements of Operations for the Three Months Ended
      March 31, 2009 and 2008
                4Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended
      March 31, 2009 and 2008
                5Notes
      to Condensed Consolidated Financial Statements
                6Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                17Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                24Item
      4T.
                Controls
      and Procedures
                24PART II.
      OTHER INFORMATION
                25Item
      1.
                Legal
      Proceedings
                25Item
      1A.
                Risk
      Factors
                25Item
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                41Item
      3.
                Defaults
      Upon Senior Securities
                41Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                41Item
      5.
                Other
      Information
                41Item
      6.
                Exhibits
                41Signatures
                
                42


2


PART I
— FINANCIAL INFORMATION





Item 1.   Financial
Statements





SUNESIS
PHARMACEUTICALS, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS





March 31,
                    2009
                  
                  
                  December 31,
                    2008(Unaudited)
                  
                  
                  (1)ASSETSCurrent
      assets:Cash
      and cash equivalents
                  
                  $
                  4,280,363
                  
                  
                  $
                  6,296,942Marketable
      securities
                  
                  
                  —
                  
                  
                  
                  4,321,844Prepaids
      and other current assets
                  
                  
                  763,074
                  
                  
                  
                  934,429Total
      current assets
                  
                  
                  5,043,437
                  
                  
                  
                  11,553,215Property
      and equipment, net
                  
                  
                  501,751
                  
                  
                  
                  612,241Assets
      held-for-sale
                  
                  
                  50,427
                  
                  
                  
                  470,547Deposits
      and other assets
                  
                  
                  96,824
                  
                  
                  
                  147,826Total
      assets
                  
                  $
                  5,692,439
                  
                  
                  $
                  12,783,829LIABILITIES
      AND STOCKHOLDERS’ (DEFICIT) EQUITYCurrent
      liabilities:Accounts
      payable and other accrued liabilities
                  
                  $
                  1,994,735
                  
                  
                  $
                  2,150,980Accrued
      clinical expense
                  
                  
                  1,794,154
                  
                  
                  
                  1,865,773Accrued
      compensation
                  
                  
                  845,649
                  
                  
                  
                  537,215Accrued
      restructuring charges
                  
                  
                  621,149
                  
                  
                  
                  191,170Current
      portion of deferred rent
                  
                  
                  —
                  
                  
                  
                  1,409,513Current
      portion of deferred revenue
                  
                  
                  1,814,583
                  
                  
                  
                  27,083Total
      current liabilities
                  
                  
                  7,070,270
                  
                  
                  
                  6,181,734Non-current
      portion of deferred rent
                  
                  
                  116,339
                  
                  
                  
                  110,919CommitmentsStockholders’
      (deficit) equity:Preferred
      stock, $0.0001 par value; 5,000,000 shares authorized, no shares issued
      and outstanding as of March 31, 2009 and December 31,
      2008
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, $0.0001 par value; 100,000,000 shares authorized,
      34,409,768 shares issued and outstanding as of March 31, 2009 and
      December 31, 2008
                  
                  
                  3,441
                  
                  
                  
                  3,441Additional
      paid-in capital
                  
                  
                  323,057,535
                  
                  
                  
                  322,671,604Accumulated
      other comprehensive income
                  
                  
                  —
                  
                  
                  
                  7,841Accumulated
      deficit
                  
                  
                  (324,555,146
                  )
                  
                  
                  (316,191,710
                  )Total
      stockholders’ (deficit) equity
                  
                  
                  (1,494,170
                  )
                  
                  
                  6,491,176Total
      liabilities and stockholders’ (deficit) equity
                  
                  $
                  5,692,439
                  
                  
                  $
                  12,783,829





(1)
            The
      condensed consolidated balance sheet as of December 31, 2008 has been
      derived from the audited financial statements at that date included in the
      Company’s Annual Report on Form 10-K for the year ended
      December 31, 2008.





See
accompanying notes to condensed consolidated financial
statements.


3


SUNESIS
PHARMACEUTICALS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS





Three months ended
                  March 31,2009
                
                
                2008(Unaudited)Revenue:Collaboration
      revenue
                
                $
                12,500
                
                
                $
                537,500Collaboration
      revenue from related party (Note 3)
                
                
                —
                
                
                
                1,765,683License
      and other revenue
                
                
                211,547
                
                
                
                —Total
      revenues
                
                
                224,047
                
                
                
                2,303,183Operating
      expenses:Research
      and development
                
                
                4,264,152
                
                
                
                8,742,895General
      and administrative
                
                
                2,355,012
                
                
                
                3,266,129Restructuring
      charges
                
                
                1,862,861
                
                
                
                320,774Total
      operating expenses
                
                
                8,482,025
                
                
                
                12,329,798Loss
      from operations
                
                
                (8,257,978
                )
                
                
                (10,026,615
                )Interest
      income
                
                
                12,812
                
                
                
                460,412Interest
      expense
                
                
                (612
                )
                
                
                (59,373
                )Other
      income (expense), net
                
                
                (117,658
                )
                
                
                671Net
      loss
                
                $
                (8,363,436
                )
                
                $
                (9,624,905
                )Basic
      and diluted loss per share
                
                $
                (0.24
                )
                
                $
                (0.28
                )Shares
      used in computing basic and diluted loss per share
                
                
                34,409,768
                
                
                
                34,364,896





See
accompanying notes to condensed consolidated financial
statements.


4


SUNESIS
PHARMACEUTICALS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS





Three months ended March 31,2009
                  
                  
                  2008(Unaudited)Cash
      flows from operating activitiesNet
      loss
                  
                  $
                  (8,363,436
                  )
                  
                  $
                  (9,624,905
                  )Adjustments
      to reconcile loss to net cash used in operating
activities:Depreciation
      and amortization
                  
                  
                  110,490
                  
                  
                  
                  436,549Stock-based
      compensation expense
                  
                  
                  385,931
                  
                  
                  
                  653,904Non-cash
      restructuring (credits) charges, net
                  
                  
                  (1,396,287
                  )
                  
                  
                  11,561Loss
      on sale of held-for-sale assets
                  
                  
                  118,411
                  
                  
                  
                  —Changes
      in operating assets and liabilities:Prepaids
      and other current assets
                  
                  
                  171,355
                  
                  
                  
                  (517,807
                  )Deposits
      and other assets
                  
                  
                  51,002
                  
                  
                  
                  —Accounts
      payable and other accrued liabilities
                  
                  
                  (156,245
                  )
                  
                  
                  (667,317
                  )Accrued
      clinical expense
                  
                  
                  (71,619
                  )
                  
                  
                  317,644Accrued
      compensation
                  
                  
                  308,434
                  
                  
                  
                  (820,803
                  )Accrued
      restructuring
                  
                  
                  429,979
                  
                  
                  
                  309,362Deferred
      rent
                  
                  
                  5,420
                  
                  
                  
                  (104,316
                  )Deferred
      revenue
                  
                  
                  1,787,500
                  
                  
                  
                  (474,999
                  )Net
      cash used in operating activities
                  
                  
                  (6,619,065
                  )
                  
                  
                  (10,481,127
                  )Cash
      flows from investing activitiesProceeds
      from sale of held-for-sale assets
                  
                  
                  288,483
                  
                  
                  
                  —Purchases
      of property and equipment
                  
                  
                  —
                  
                  
                  
                  (180,663
                  )Purchases
      of marketable securities
                  
                  
                  —
                  
                  
                  
                  (14,320,299
                  )Proceeds
      from maturities of marketable securities
                  
                  
                  4,314,003
                  
                  
                  
                  19,748,244Net
      cash provided by investing activities
                  
                  
                  4,602,486
                  
                  
                  
                  5,247,282Cash
      flows from financing activitiesPayments
      on borrowing under equipment financing
                  
                  
                  —
                  
                  
                  
                  (256,519
                  )Net
      cash used in financing activities
                  
                  
                  —
                  
                  
                  
                  (256,519
                  )Net
      decrease in cash and cash equivalents
                  
                  
                  (2,016,579
                  )
                  
                  
                  (5,490,364
                  )Cash
      and cash equivalents at beginning of period
                  
                  
                  6,296,942
                  
                  
                  
                  11,726,126Cash
      and cash equivalents at end of period
                  
                  $
                  4,280,363
                  
                  
                  $
                  6,235,762Supplemental
      disclosure of cash flow informationInterest
      paid
                  
                  $
                  612
                  
                  
                  $
                  58,870Non-cash
      activities:Deferred
      stock-based compensation, net of (reversal)
                  
                  $
                  —
                  
                  
                  $
                  (11,238
                  )





See
accompanying notes to condensed consolidated financial
statements.


5


SUNESIS
PHARMACEUTICALS, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2009


(Unaudited)





1.   Organization and Summary of
Significant Accounting Policies





Organization





Sunesis
Pharmaceuticals, Inc. (the “Company” or “Sunesis”) was incorporated in the
state of Delaware on February 10, 1998, and its facilities are located in
South San Francisco, California. Sunesis is a biopharmaceutical company focused
on the development and commercialization of new oncology therapeutics for the
treatment of hematologic and solid tumor cancers. The Company’s primary
activities since incorporation have been conducting research and development
internally and through corporate collaborators, in-licensing pharmaceutical
compounds, conducting clinical trials, performing business and financial
planning, and raising capital.





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 condensed 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. As of March 31, 2009, the Company had an accumulated
deficit of $324.6 million. The Company needs to raise substantial
additional funds to continue operations, fund additional clinical trials of
voreloxin and bring future products to market. Management plans to finance
the Company’s operations with equity issuances, including the initial closing
and potential additional closings of the sale of units and common stock
described in Notes 7 and 10, debt arrangements, a possible partnership or
license of development and/or commercialization rights to voreloxin and, in the
long term, product sales and royalties. Management believes that currently
available cash, cash equivalents and marketable securities, together with the
net proceeds from the initial closing of the Private Placement described in Note
10, will be sufficient to fund the Company’s operations through at least
December 31, 2009.





Principles
of Consolidation





The
Company’s condensed 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 generally accepted
accounting principles in the United States, or GAAP, requires management to make
estimates and assumptions that affect the amounts reported in the Company’s
condensed consolidated financial statements and accompanying notes. Actual
results could differ materially from these estimates. Significant estimates,
assumptions and judgments made by management include those related to revenue
recognition, clinical trial accounting and stock-based
compensation.





Basis
of Presentation





The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with GAAP for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 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. The
balance sheet as of December 31, 2008 was derived from the audited
financial statements as of that date. These interim financial results are not
necessarily indicative of results to be expected for the full year or any other
interim period.





Certain
prior period liabilities in the condensed consolidated balance sheets and
statements of cash flows have been reclassified to conform to the current year
presentation.


6


These
unaudited condensed 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, 2008.





Loss
per Share





Basic
loss per share is calculated by dividing net 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 share is computed
by dividing net loss 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 and
warrants to purchase stock are considered to be potential common shares and are
only included in the calculation of diluted loss per share when their effect is
dilutive.





The
following table sets forth the computation of basic and diluted loss per
share:





Three months ended
                    March 31,2009
                  
                  
                  2008Historical
      numerator:Net
      Loss
                  
                  $
                  (8,363,436
                  )
                  
                  $
                  (9,624,905
                  )Denominator:Weighted-average
      common shares outstanding
                  
                  
                  34,409,768
                  
                  
                  
                  34,364,896Basic
      and diluted net loss per share
                  
                  $
                  (0.24
                  )
                  
                  $
                  (0.28
                  )Outstanding
      securities not included in diluted loss per share
      calculations:Options
      to purchase common stock
                  
                  
                  4,474,764
                  
                  
                  
                  5,002,098Warrants
      to purchase common stock
                  
                  
                  2,660,845
                  
                  
                  
                  2,693,2377,135,609
                  
                  
                  
                  7,695,335





Comprehensive
Loss





Comprehensive
loss is comprised of net loss and unrealized gains or losses on marketable
securities. Comprehensive loss for the periods presented is as
follows:





Three months ended
                    March 31,2009
                  
                  
                  2008Net
      loss
                  
                  $
                  (8,363,436
                  )
                  
                  $
                  (9,624,905
                  )Change
      in unrealized gain or loss on marketable securities
                  
                  
                  (7,841
                  )
                  
                  
                  51,918Comprehensive
      loss
                  
                  $
                  (8,371,277
                  )
                  
                  $
                  (9,572,987
                  )





Accumulated
other comprehensive income (loss) consists entirely of unrealized gains or
losses on marketable securities as of each balance sheet date
presented.





Recent
Accounting Pronouncements





Effective
January 1, 2009, the Company adopted EITF Issue No. 07-1, Accounting for Collaborative
Arrangements, or EITF 07-1. EITF 07-1 requires participants in a
collaborative arrangement (sometimes referred to as a “virtual joint venture”)
to present the results of activities for which they act as the principal on a
gross basis and to report any payments received from (made to) other
collaborators based on other applicable GAAP or, in the absence of other
applicable GAAP, based on analogy to authoritative literature or a reasonable,
rational, and consistently applied accounting policy election. EITF 07-1 also
requires significant disclosures related to collaborative arrangements. The
adoption did not have a material impact on the Company’s consolidated financial
position or results of operations.


7


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., or Dainippon, to acquire exclusive worldwide development and
marketing rights for the Company’s lead anti-cancer product candidate,
voreloxin. The Company may in the future make a series of milestone payments of
up to $7.5 million to Dainippon for starting Phase 3 clinical testing, for
filing new drug applications, or NDAs, and for receiving regulatory approval in
the United States, Europe and Japan for cancer treatment. If voreloxin is
approved for a non-cancer indication, additional milestone payments become
payable to Dainippon.




The
agreement also provides for royalty payments to Dainippon at rates that are
based on total annual net sales. Under the agreement, the Company may reduce its
royalty payments to Dainippon if a third party markets a competitive product and
the Company must pay royalties for third-party intellectual property rights
necessary to commercialize voreloxin. Royalty obligations under the agreement
continue on a country-by-country and product-by-product basis until the later of
the date on which no valid patent claims relating to a product exist or
10 years from the date of the first sale of the product.





Bristol-Myers
Squibb Company





In April
2005, the Company entered into a license agreement with Bristol-Myers Squibb
Company, or BMS, in which the Company obtained worldwide exclusive and
non-exclusive diagnostic and therapeutic licenses to SNS-032, a selective
inhibitor of cyclin-dependent kinases, or CDKs, 2, 7 and 9, and any future CDK
inhibitors derived from the related intellectual property.  At that
time, the Company paid BMS an $8.0 million upfront payment through the
issuance of shares of the Company’s Series C-2 preferred stock, which
converted into 879,094 shares of common stock upon the Company’s initial public
offering in September 2005.  In addition, in February 2006, as
consideration for a $2.0 million milestone payment due pursuant to the license
agreement for initiating a Phase 1 clinical trial of SNS-032, the Company
issued an aggregate of 404,040 shares of the Company’s common stock to
BMS.




Based on
results in the Company’s Phase 1 clinical trial of SNS-032 and the progress
made with voreloxin, the Company discontinued development of
SNS-032.  As a result, the Company terminated the license agreement
and returned SNS-032 to BMS on March 18, 2009.





Out-License





SARcode
Corporation





In March
2006, the Company entered into a license agreement with
SARcode Corporation, or SARcode, a privately-held biopharmaceutical
company, granting SARcode an exclusive, worldwide license to all of the
Company’s lymphocyte function-associated antigen-1, or LFA-1, patents and
related know-how.  SARcode is developing a small molecule LFA-1
inhibitor, SAR1118, for T-cell mediated ophthalmic diseases.  The
Company had previously discontinued its LFA-1 antagonist program when it
narrowed the focus of its research and development efforts to oncology
exclusively.




Pursuant
to the license agreement, the Company received a total of $1.0 million in
license fees, $0.5 million in 2007 and $0.5 million in September 2008, which
were recorded as revenue upon receipt.  In addition, the Company
received three secured notes, with a total principal amount of $1.0
million, which are due in 2012 and are convertible into the preferred stock of
SARcode at the Company’s option. The Company has yet to record these notes
receivable from SARcode as revenue due to uncertainty of
collectibility.




In
March 2009, SARcode acquired the Company’s interest in all of its LFA-1 patents
and related know-how for a total cash consideration of $2.0 million. Of this
amount, $1.8 million was received in March 2009 and was recorded as deferred
revenue. The remaining $0.2 million was received in April 2009 upon delivery to
SARcode of all records related to LFA-1; the entire $2.0 million will be
recorded as revenue in the second quarter of 2009.  In connection with
the sale, the license agreement was terminated. Sunesis continues to hold
the three secured convertible notes with a total principal amount of $1.0
million.


8


3.   Strategic
Collaborations





Biogen
Idec, Inc.




In August
2004, the Company entered into a collaboration agreement with Biogen Idec, Inc.,
or Biogen Idec, to discover, develop and commercialize small molecule inhibitors
of Raf kinase and up to five additional targets that play a role in oncology and
immunology indications or in the regulation of the human immune
system. Under the terms of the collaboration agreement, during the research
term, the Company applied its proprietary Tethering technology to generate small
molecule leads, and received research funding of approximately $1.2 million per
quarter, which was paid in advance to support some of its scientific
personnel.  In connection with the Company’s June 2008 restructuring,
the parties agreed to terminate the research term on June 30, 2008 and the
Company no longer receives research funding from Biogen Idec.  The
Company received a $7.0 million upfront technology access fee from Biogen Idec
and had received a total of $1.5 million in milestone payments for meeting
certain preclinical milestones through March 31, 2009, including a $0.5 million
milestone received in June 2008. In 2006, Biogen Idec made a $14.0 million
equity investment to purchase the Company’s Series C-2 preferred
stock. Biogen Idec’s equity ownership was 8.5% of the Company’s common
shares outstanding as of March 31, 2009 and December 31, 2008.




The
Company may in the future receive pre-commercialization milestone payments of up
to $60.0 million per target, as well as royalty payments depending on product
sales.  Royalty payments may be increased if the Company exercises its
option to co-develop and co-promote product candidates for up to two targets
worldwide (excluding Japan) and may be reduced if Biogen Idec is required to
in-license additional intellectual property related to certain technology
jointly developed under the collaboration agreement in order to commercialize a
collaboration product.





Johnson &
Johnson Pharmaceutical Research & Development LLC




In May
2002, the Company entered into a collaboration agreement with
Johnson & Johnson Pharmaceutical Research & Development LLC, or
J&JPRD, to discover, develop and commercialize small molecule inhibitors of
Cathepsin S, an enzyme that is important in regulating an inflammatory
response.





The
Company granted J&JPRD a worldwide non-exclusive license to its
intellectual property relating to Tethering on Cathepsin S and an exclusive
license under the collaboration intellectual property for the commercialization
of small molecule products arising from the collaboration. Under the agreement,
J&JPRD is required to pay milestones upon achievement of certain research
and development milestones that could total up to $24.0 million, as well as
royalty payments depending on product sales. To date, J&JPRD has made
milestone payments totaling $1.3 million, including a $0.5 million
milestone in February 2008 when J&JPRD selected a Cathepsin S inhibitor from
the collaboration as a development candidate.  The Company has
received payments totaling $7.3 million under this collaboration as of
March 31, 2009.





In the
first quarter of 2009, J&JPRD informed the Company that it had
ceased development of the previously selected Cathepsin S inhibitor and the
parties initiated discussions regarding a proposed mutual termination of this
agreement.  As a result, the Company does not expect to receive any
additional revenues from J&JPRD under this agreement.




Merck & Co., Inc.




In
February 2003, the Company entered into a license and collaboration agreement
with Merck & Co., Inc., or Merck, to discover, develop
and commercialize small molecule inhibitors of beta-secretase, or BACE, an
enzyme that is believed to be connected to the progression of Alzheimer’s
disease.  The Company has received payments totaling $19.0 million under
this collaboration as of March 31, 2009. The Company retains the right to
earn future milestone payments of up to $46.3 million for BACE and
$38.0 million for all other indications, as well as royalty payments on
annual net sales of any compound that may result from the collaboration. No
milestones were received from Merck in 2008 or the first quarter of
2009.




In July
2004, the Company licensed to Merck a series of small molecule compounds derived
from Tethering that target viral infections. Merck agreed to be responsible for
advancing these compounds into lead optimization, preclinical development, and
clinical studies. Merck will receive an exclusive worldwide license to any
products resulting from the collaboration.  The Company has received
$3.3 million under this collaboration as of March 31, 2009, including an
upfront, non-refundable and non-creditable technology access fee of
$2.3 million and license fees aggregating
$1.0 million.


9


The
Company is entitled to receive additional payments of up to $22.1 million based
on the achievement of development milestones as well as royalty payments based
on net sales for any products resulting from the collaboration. To date, the
Company has not received any development milestone payments under the agreement
and does not expect to receive any future milestone or royalty payments related
to the agreement.




In
connection with the above collaboration agreements, the Company recognized the
following revenues in the three month periods ended March 31, 2009 and
2008, including the amortization of upfront fees received, research funding, and
milestones earned:





Three months ended
                    March 31,2009
                  
                  
                  2008Biogen
      Idec
                  
                  $
                  —
                  
                  
                  $
                  1,765,683J&J
      PRD
                  
                  
                  —
                  
                  
                  
                  500,000Merck
                  
                  
                  12,500
                  
                  
                  
                  37,500Total
      collaboration revenue
                  
                  $
                  12,500
                  
                  
                  $
                  2,303,183





4.
  Restructurings





2009
Restructuring





On March
30, 2009, the Compensation Committee of the Company’s Board of Directors,
in conjunction with the anticipated closing of the initial closing of the
private placement (see Notes 7 and 10), committed to a restructuring plan
for an immediate reduction in force affecting six employees, including two
executives (the “2009 Restructuring”). Employees were notified on March 31,
2009. All terminated employees were awarded severance payments and continuation
of benefits based on length of service at the Company.





As a
result of the 2009 Restructuring, the Company recorded a restructuring charge of
$0.6 million in the first quarter of 2009 for employee severance and related
benefit costs, which is included on a separate line in the condensed
consolidated statement of operations. The severance payments will be made during
the second quarter of 2009. Other personnel-related expenses such as employee
benefits will be substantially paid over the remainder of 2009.  No
further charges are expected related to this restructuring.





The
following table summarizes the changes in the 2009 Restructuring liabilities,
for which balances are included under “Accrued restructuring charges” in the
Company’s condensed consolidated balance sheets:




Employee
                        Severance and
                        Related
                        Benefits2009
      Restructuring liabilities as of December 31, 2008
                      
                      $
                      —Charges
      in period
                      
                      
                      603,189Cash
      payments in period
                      
                      
                      —2009
      Restructuring liabilities as of March 31, 2009
                      
                      $
                      603,189





2008
Restructuring




In June
2008, the Company implemented a corporate realignment to focus on the
development of voreloxin. In conjunction with this restructuring (the “2008
Restructuring”), the Company expanded its late-stage development leadership
team, ceased its internal discovery research activities and reduced its
workforce by approximately 60%. 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 consolidated its remaining
employees into the leased office premises at 395 Oyster Point Boulevard
(previously vacated in connection with the 2007 Restructuring, discussed below)
and a small leased laboratory facility at 349 Allerton Avenue, both in South San
Francisco.


10


On
January 15, 2009, the Company entered into an Agreement for Termination of Lease
and Voluntary Surrender of Premises with ARE-Technology Center, SSF, LLC, or
Alexandria, with respect to a leased facility located at 341 Oyster Point
Boulevard, South San Francisco, which formerly served as the Company’s
headquarters and research and development facility. Pursuant to the terms
of the Termination Agreement, the Company was required to vacate the premises by
February 28, 2009, and agreed to pay an aggregate fee of $2.2 million in
consideration of early termination of the Lease Agreement. Under the
original Lease Agreement, the Company was required to pay Alexandria base rents
and operating expenses of $15.7 million between 2009 and 2013. The $2.2
million termination fee was paid in January 2009. In addition, the Company
paid a commission of $0.4 million in January 2009 to a third party for
negotiation of the lease termination.





In the
first quarter of 2009, the Company recorded net restructuring charges of $1.3
million for these lease termination activities related to the 2008
Restructuring, which are included on a separate line in the condensed
consolidated statement of operations. The net charge included the $2.2 million
early termination fee and $0.5 million for the third-party commission and other
facility closure expenses, partially offset by the reversal of $1.4 million in
non-cash deferred rent on this facility.





The
following table summarizes the changes in 2008 Restructuring liabilities, for
which balances are included under “Accrued restructuring charges” in the
Company’s condensed consolidated balance sheets:




Employee
                        Severance and
                        Related
                        Benefits
                      
                      
                      Facilities
                        Related and
                        Other Costs
                      
                      
                      Total2008
      Restructuring liabilities as of December 31, 2008
                      
                      $
                      62,420
                      
                      
                      $
                      128,750
                      
                      
                      $
                      191,170Charges
      in period
                      
                      
                      —
                      
                      
                      
                      2,583,866
                      
                      
                      
                      2,583,866Cash
      payments in period
                      
                      
                      (61,951
                      )
                      
                      
                      (2,695,125
                      )
                      
                      
                      (2,757,076
                      )2008
      Restructuring liabilities as of March 31, 2009
                      
                      $
                      469
                      
                      
                      $
                      17,491
                      
                      
                      $
                      17,960




As of
March 31, 2009, a total of $3.5 million has been incurred for the employee
severance and related benefit costs, consisting of $3.2 million of severance and
other benefit costs, and $0.3 million of non-cash stock-based compensation. A
total of $3.6 million has been incurred through March 31, 2009 related to
facility exit costs, consisting of $2.2 million of lease termination fees, $1.6
million of asset impairments, $0.4 million of third-party commission and $0.8
million of other facility closure expenses, partially offset by the reversal of
$1.4 million of deferred rent. No further charges are expected related to the
2008 Restructuring.





As part
of the 2008 Restructuring, the Company implemented a corporate realignment to
focus on the development of voreloxin.  Due to the resulting
termination of research activities, it was determined that laboratory equipment
with a net book value of $1.2 million would be sold, and, accordingly, this
equipment was recorded as held-for-sale.  Held-for-sale equipment with
a net book value of $0.4 million was sold in the first quarter of 2009 for net
proceeds of $0.3 million.  The $0.1 million loss on the sale has been
included in “Other income (expense), net” in the Company’s condensed
consolidated statement of operations.  As of March 31, 2009, the
remaining held-for-sale equipment was valued at $50,000.  The Company
expects to sell the remaining held-for-sale equipment by the end of
2009.





2007
Restructuring





In August
2007, the Company implemented a restructuring plan (the “2007 Restructuring”),
which included a 25% reduction in the Company’s workforce and the relocation of
employees occupying leased office facilities at 395 Oyster Point Boulevard to
its main research and development facility at 341 Oyster Point Boulevard. In the
first quarter of 2008, the Company recorded $0.3 million of restructuring
charges related to the lease obligation for the vacated office facilities at 395
Oyster Point Boulevard. There were no remaining 2007 Restructuring
liabilities as of December 31, 2008.





5.   Equipment Financing and Debt
Facility





In June
2000, the Company entered into an equipment financing agreement with General
Electric Capital Corporation, or GECC. Various credit lines were issued under
the financing agreement. In 2008, the interest rates on the debt balance ranged
from 7.53% to 10.61% per annum, and the borrowings were due in 36 to
48 monthly payments. In November 2008, the outstanding balance of
approximately $1.5 million was fully paid off prior to the sale of the Company’s
held-for-sale assets. No credit lines remain available under this
agreement.


11





6.  Contingencies





From time
to time, the Company may be involved in legal proceedings, as well as demands,
claims and threatened litigation, which arise in the normal course of its
business or otherwise. The ultimate outcome of any litigation is uncertain and
unfavorable outcomes could have a negative impact on the Company’s results of
operations and financial condition. Regardless of outcome, litigation can have
an adverse impact on the Company because of the defense costs, diversion of
management resources and other factors.  The Company is not currently
involved in any material legal proceedings.





7.   Stockholders’
Equity





Private
Placement




On March
31, 2009, the Company entered into a securities purchase agreement
with accredited investors, including certain members of
management, providing for a private placement of up to $43.5 million of the
Company’s securities, or the Private Placement. The Private Placement
contemplates the sale of up to $15.0 million of units consisting of Series A
preferred stock and warrants to purchase common stock, and up to $28.5 million
in common stock in three closings. The initial closing for $10.0 million of
units occurred on April 3, 2009, resulting in net proceeds of approximately $8.8
million (see Note 10).  Subject to the approval of the Company’s
stockholders, an additional $5.0 million of units may be sold in the second
closing, which closing may occur at the Company’s election or at the election of
the holders of a majority of the Series A preferred stock issued in the Private
Placement.  The Company may elect to hold the second closing if the
achievement of a specified milestone with respect to voreloxin has occurred and
the Company’s common stock is trading above a specified floor price. If the
Company has not delivered notice to the investors in the Private Placement of
the Company’s election to complete the second closing, or if the conditions for
the second closing have not been met, the investors may elect to purchase the
units in the second closing by delivering notice to the Company of their
election.  Notice of an election to complete the second closing,
either by the Company or the investors in the Private Placement, must be
delivered on or before the earliest to occur of December 31, 2009, the common
equity closing described below or the occurrence of a qualifying alternative
common stock financing.   If the second closing occurs, it will
besubject to the
satisfaction of customary closing conditions.  Subject to the approval
of the Company’s stockholders, the remaining tranche of up to $28.5 million of
common stock may be sold in the common equity closing. The common equity
closing may be completed at the Company’s election prior to the earlier of
December 31, 2010 and a qualifying alternative common stock financing, or upon
the election of the holders of a majority of the Series A preferred stock issued
in the Private Placement prior to a date determined with reference to the
Company’s cash balance dropping below $4.0 million at certain future
dates.  If the Company elects to hold the common equity closing, it
will be subject to the approval of the purchasers holding a majority of the
Series A preferred stock issued in the Private Placement and subject to a
condition that the Company sells at least $28.5 million of common stock in the
common equity closing.





In
connection with the initial closing for $10.0 million of units, the Company
issued approximately 2.9 million shares of Series A preferred stock, which
is initially convertible into approximately 29.0 million shares of common
stock, and warrants to purchase approximately 29.0 million shares of common
stock (see Note 10).  In the second closing, if completed, the Company
would issue approximately 1.45 million shares of Series A preferred stock,
which would be convertible into approximately 14.5 million shares of common
stock, and warrants to purchase approximately 14.5 million shares of common
stock.  The per unit purchase price for a share of Series A preferred
stock and a warrant to purchase 10 shares of common stock is $3.45 for both the
first and second closings.  The warrants issued at the first closing
and issuable in the second closing, if completed, have an exercise price of
$0.22 per share and a term of seven years from issuance.  In the
common equity closing, if completed, the Company would issue approximately
103.6 million shares of common stock at a purchase price of $0.275 per
share.





As
of the initial closing, certain of the investors have the right
to designate three of eight members of the Company’s Board of
Directors.  Following the second closing, if completed, the investors
would have the right to designate five of nine members of the Board of
Directors.  In conjunction with the initial closing of the Private
Placement, the investors received a number of additional rights as a result of
their convertible preferred stock ownership, including the right to approve any
sale of the Company, any issuance of debt or preferred stock and, unless certain
conditions are met, any issuance of common stock, other than the second closing
and the common stock closing described above.  Upon any liquidation,
dissolution or winding up of the Company, whether voluntary or involuntary, the
holders of the Series A preferred stock have a right to receive proceeds equal
to $10.35 (i.e. three times the purchase price of each unit) for each share of
Series A preferred stock held, plus all declared and unpaid dividends, in
preference to the holders of common stock. A change in control, as defined in
the securities purchase agreement, shall be deemed a liquidation, and includes a
consolidation or merger with or into any other corporation, or the sale,
exclusive license or exclusive partnering of the majority of the Company’s
assets.


12


Stock
Option Plans





The
Company generally grants options (i) to new employees, 25% of which becomes
exercisable on the first anniversary of the vesting commencement date,
and  1/48th becomes
exercisable each month over the remainder of the four-year vesting period,
(ii) to existing employees, 1/48th of
which becomes exercisable each month following the date of grant over a period
of four years, (iii) to new non-employee members of the Board of Directors, 50%
of which becomes exercisable on each of the first and second anniversary of the
vesting commencement date, and (iv) to continuing non-employee members of the
Board of Directors, 1/12th of
which becomes exercisable each month following the date of grant over a period
of one year.




2005
Equity Incentive Award Plan





On
January 1, 2009, the number of shares of stock reserved for future issuance
under the 2005 Equity Incentive Award Plan, or 2005 Plan, was increased by
1,082,352 shares pursuant to the 2005 Plan’s evergreen provision.  No
options were granted under the 2005 Plan in the three months ended
March 31, 2009.  Options to purchase an aggregate of 4,481,748
shares of the Company’s common stock had been granted and 3,379,659 shares were
available for future grants under the 2005 Plan as of March 31,
2009.





2006
Employment Commencement Incentive Plan





The
Company’s Board of Directors approved an amendment to the Company’s 2006
Employment Commencement Incentive Plan, or 2006 Plan, to increase the number of
shares of common stock reserved for issuance under the 2006 Plan by an
additional 100,000 shares, effective January 1, 2009.  No options
were granted under the 2006 Plan in the three months ended March 31,
2009.  Options to purchase an aggregate of 553,000 shares of the
Company’s common stock had been granted and 167,939 shares were available for
future grants under the 2006 Plan as of March 31, 2009





2005
Employee Stock Purchase Plan





No ESPP
shares were issued in the three months ended March 31, 2009. There were
252,453 shares of common stock reserved for future issuance under the ESPP as of
March 31, 2009.





8.   Stock-Based
Compensation





Overview





Employee
stock-based compensation expense has been calculated based on awards ultimately
expected to vest, reduced for estimated forfeitures. Statement of Financial
Accounting Standards No. 123 (revised 2004), Share-Based Payment,or SFAS 123R,
requires forfeitures to be estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates. Employee stock-based compensation expense related to all of the
Company’s stock-based awards, including stock options granted prior to the
Company’s initial public offering, which continue to be accounted for under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees,or APB 25, is as
follows:





Three months ended
                      March 31,2009
                    
                    
                    2008Research
      and development
                    
                    $
                    100,812
                    
                    
                    $
                    270,178General
      and administrative
                    
                    
                    285,119
                    
                    
                    
                    383,726Total
      stock-based compensation
                    
                    $
                    385,931
                    
                    
                    $
                    653,904





Fair
Value of Awards





The
Company determines the fair value of share-based payment awards on the grant
date using the Black-Scholes option-pricing model, or Black-Scholes model, which
is affected by the Company’s stock price as well as assumptions regarding a
number of highly subjective variables.





There
were no stock options granted during the three months ended March 31, 2009.
The total estimated grant date fair value of stock options that were granted
during the three months ended March 31, 2008 was zero. The weighted-average
estimated fair value of employee stock options granted was $0.85 per share for
the three months ended March 31, 2008, using the Black-Scholes model with
the following annualized assumptions:


13




Three months ended
                          March 31,2008Expected
      volatility
                        
                        
                        71.6
                        %Risk-free
      interest rate
                        
                        
                        2.7
                        %Dividend
      yield
                        
                        
                        0
                        %Expected
      term (years)
                        
                        
                        5.0





The
estimated fair value of stock options vested during the three month periods
ended March 31, 2009 and 2008 was $0.5 million and $0.6 million,
respectively.





The
weighted-average estimated fair value of purchase rights under the ESPP was
$0.28 and $1.36 per share for the three months ended March 31, 2009 and
2008, respectively, using the Black-Scholes model with the following annualized
assumptions:





Three months ended
                        March 31,2009
                      
                      
                      2008Expected
      volatility
                      
                      
                      93.4%
                      
                      
                      
                      68.5% - 71.6%Risk-free
      interest rate
                      
                      
                      0.4% - 5.1%
                      
                      
                      
                      3.2% - 5.1%Dividend
      yield
                      
                      
                      0%
                      
                      
                      
                      0%Expected
      term (years)
                      
                      
                      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 March 31, 2009 and 2008 was immaterial in
both periods.





The
Company has based its assumptions for expected volatility and expected term of
employee stock options on the information available with respect to its mature
peer group in the same industry. The expected term of the employees’ purchase
rights under the 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 for
the Black-Scholes model.  The post-vesting forfeiture rate is derived
from the Company’s historical option cancellation information.





Option
Plan Activity





The
following table summarizes stock option transactions for the Company’s stock
option plans in the three months ended March 31, 2009:




Number
                            of Shares
                          
                          
                          Weighted Average
                            Exercise Price
                          
                          
                          Weighted
                            Average
                            Remaining
                            Contractual
                            Term (years)
                          
                          
                          Aggregate
                            Intrinsic
                            ValueOutstanding
      as of December 31, 2008
                          
                          
                          4,650,955
                          
                          
                          $
                          3.44Options
      granted
                          
                          
                          —
                          
                          
                          
                          —Options
      exercised
                          
                          
                          —
                          
                          
                          
                          —Options
      canceled/forfeited/expired
                          
                          
                          (176,191
                          )
                          
                          
                          2.52Balance
      as of March 31, 2009
                          
                          
                          4,474,764
                          
                          
                          
                          3.48
                          
                          
                          
                          6.99
                          
                          
                          $
                          —Exercisable
      as of March 31, 2009
                          
                          
                          3,141,226
                          
                          
                          $
                          3.87
                          
                          
                          
                          6.31
                          
                          
                          $
                          —





The
aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (i.e., the difference between the Company’s closing stock
price on the last trading day of the first quarter of 2009 and the exercise
price, multiplied by the number of in-the-money options) that would have been
received by option holders if they all exercised their options on March 31,
2009.




There
were no options exercised during each of the three months ended March 31, 2009
and 2008; therefore, the intrinsic value for options exercised during these
periods is zero. As the Company believes it is more likely than not that no
stock option related tax benefits will be realized, the Company does not record
any net tax benefits related to exercised options.


14





The
following table summarizes outstanding and exercisable options for the Company’s
stock option plans as of March 31, 2009:





Options Outstanding
                                  
                                  Options ExercisableRange of Exercise Prices
                                  
                                  Number
                                    Outstanding
                                    as of 3/31/09
                                  
                                  Weighted-
                                    Average
                                    Remaining
                                    Contractual
                                    Term
                                  
                                  Weighted-
                                    Average
                                    Exercise
                                    Price
                                  
                                  Number
                                    Exercisable
                                    as of 3/31/09
                                  
                                  Weighted-
                                    Average
                                    Exercise
                                    Price$0.32
      - $1.30
                                  
                                  55,211
                                  
                                  6.77
                                  
                                  $
                                  0.78
                                  
                                  18,461
                                  
                                  $
                                  0.85$1.44
                                  
                                  622,475
                                  
                                  9.25
                                  
                                  
                                  1.44
                                  
                                  88,881
                                  
                                  
                                  1.44$1.55
      - $2.31
                                  
                                  207,833
                                  
                                  8.89
                                  
                                  
                                  1.98
                                  
                                  90,958
                                  
                                  
                                  1.96$2.55
                                  
                                  947,806
                                  
                                  3.71
                                  
                                  
                                  2.55
                                  
                                  947,806
                                  
                                  
                                  2.55$2.59
                                  
                                  674,023
                                  
                                  8.45
                                  
                                  
                                  2.59
                                  
                                  366,673
                                  
                                  
                                  2.59$2.62
      - $4.74
                                  
                                  368,351
                                  
                                  7.90
                                  
                                  
                                  4.07
                                  
                                  248,805
                                  
                                  
                                  4.09$4.85
                                  
                                  447,634
                                  
                                  7.54
                                  
                                  
                                  4.85
                                  
                                  340,835
                                  
                                  
                                  4.85$4.93
      - $5.16
                                  
                                  78,551
                                  
                                  7.40
                                  
                                  
                                  5.01
                                  
                                  67,429
                                  
                                  
                                  5.02$5.25
                                  
                                  845,453
                                  
                                  6.67
                                  
                                  
                                  5.25
                                  
                                  760,265
                                  
                                  
                                  5.25$5.50
      - $9.56
                                  
                                  227,427
                                  
                                  7.03
                                  
                                  
                                  6.85
                                  
                                  211,113
                                  
                                  
                                  6.93$0.32 - $9.56
                                  
                                  4,474,764
                                  
                                  6.99
                                  
                                  $
                                  3.48
                                  
                                  3,141,226
                                  
                                  $
                                  3.87





Total
estimated unrecognized stock-based compensation cost related to unvested stock
options was $3.3 million as of March 31, 2009, which is expected to be
recognized over the respective vesting terms of each award through 2011. The
weighted average term of the unrecognized stock-based compensation expense is
3.1 years.





9.   Fair
Value Measurements





In
September 2006, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 157, Fair Value Measurements, or
SFAS 157. SFAS 157 established a framework for measuring fair value, and
expanded disclosure requirements about such fair value
measurements.  The Company adopted SFAS 157 on a prospective basis for
its financial assets and liabilities on January 1, 2008.  In
accordance with Statement of Financial Position No. 157-2, issued by the FASB in
February 2008, the Company adopted FAS 157 for non-financial assets and
non-financial liabilities on January 1, 2009.





Under
SFAS 157, 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
(i.e., the exit price). SFAS 157 also establishes 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.





All of
the Company’s financial instruments held at any time since January 1, 2008 have
been valued using quoted prices in active markets (Level 1) or based upon other
observable inputs (Level 2).  As of March 31, 2009, the Company held
no financial assets (i.e.,marketable securities)
that were measured on a recurring basis during the three months ended
March 31, 2009.  As of December 31, 2008, the fair value of the
Company’s financial assets that were measured on a recurring basis during the
year ended December 31, 2008 were as follows:


Fair Value Measurements at Reporting Date Using(Level 1)
                      
                      
                      (Level 2)
                      
                      
                      (Level 3)
                      
                      
                      TotalDescriptionCash
      equivalents and money market funds
                      
                      $
                      6,185,866
                      
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      6,185,866Marketable
      securities
                      
                      
                      —
                      
                      
                      
                      4,321,844
                      
                      
                      
                      —
                      
                      
                      
                      4,321,844Total
                      
                      $
                      6,185,866
                      
                      
                      $
                      4,321,844
                      
                      
                      $
                      —
                      
                      
                      $
                      10,507,710





As of
December 31, 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 money market
funds. 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 U.S. government agency
securities, corporate bonds and commercial papers.


15


10.
Subsequent Events





On April
3, 2009, $10.0 million of units were sold in the initial closing of the Private
Placement (see Note 7). In the initial closing for $10.0 million of units, the
Company issued 2,898,544 shares of Series A preferred stock, which are initially
convertible into 28,985,440 shares of common stock, and warrants to purchase
28,985,440 shares of common stock. The warrants issued at the initial closing
have an exercise price of $0.22 per share and a term of seven years from
issuance. The net proceeds, after deducting placement agent fees and other
estimated offering expenses payable by the Company, were approximately $8.8
million. The terms and conditions of the convertibility of the Series A
preferred stock are discussed in greater detail in Note 7. The Company
expects all net proceeds received from the initial closing of the Private
Placement to be used for working capital and other general corporate
purposes.


16


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 March 31,
2009 and results of operations for the three months ended March 31, 2009 and
2008 should be read together with our condensed consolidated 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, which 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 tumor cancers.  We have
built a highly experienced cancer drug development organization committed to
advancing our lead product candidate, voreloxin, in multiple indications to
improve lives of people with cancer.




From our
incorporation in 1998 through 2001, our operations consisted primarily of
developing and refining our proprietary methods of discovering drugs in pieces,
or fragments. From 2002 through June 2008, we focused on the discovery,
in-licensing and development of novel small molecule drugs. In June 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 team, announced the winding down of our
internal discovery research activities, ceased development of an enhanced
fragment-based discovery platform, and reduced our workforce by approximately
60%.




We are
currently advancing voreloxin through Phase 2 development. Voreloxin is a
first-in-class anti-cancer quinolone derivative, or AQD — a class of
compounds that has not been used previously for the treatment of cancer.
Quinolone derivatives have been shown to mediate antitumor activity by targeting
mammalian topoisomerase II, an enzyme critical for cell replication, and have
demonstrated promising preclinical antitumor activity.  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, or AML, a Phase 1b/2 clinical trial
combining voreloxin with cytarabine for the treatment of patients with
relapsed/refractory AML, and a Phase 2 single agent clinical trial in
platinum-resistant ovarian cancer patients. We have worldwide development and
commercialization rights to voreloxin. We may enter into partnering arrangements
for this product candidate to maximize its commercial potential.





We have
taken a number of important steps to focus our resources and efforts on the
advancement of voreloxin.  We have discontinued development of our
product candidate, SNS-032, a selective inhibitor of cyclin-dependent kinases,
or CDKs, 2, 7 and 9, which we had in-licensed from BMS.  In March
2009, the license agreement was terminated and SNS-032 was returned to
BMS.  In addition, we recently completed enrollment in a Phase 1 trial
of SNS-314, a potent and selective pan-Aurora kinase inhibitor discovered
internally at Sunesis, in patients with advanced solid tumors.  A
maximum tolerated dose was not established in that trial, and no responses were
observed.  We currently have no plans to conduct further development
activities on SNS-314 on our own, but we plan to seek a partner to support
further development of SNS-314 in the future.


17


On March
31, 2009, we entered into a securities purchase agreement with accredited
investors, including certain members of management, providing for a private
placement of up to $43.5 million of our securities, or the Private Placement.
The Private Placement contemplates the sale of up to $15.0 million of units
consisting of Series A preferred stock and warrants to purchase common stock,
and up to $28.5 million of common stock in three closings.  $10.0
million of units were sold in the initial closing, which occurred on April 3,
2009, resulting in net proceeds of  approximately $8.8
million.  An additional $5.0 million of units may be sold in the
second closing, which may occur at our election or at the election of the
holders of a majority of the Series A preferred stock issued in the Private
Placement, subject to conditions described in ‘Sources of Liquidity’
below.  The remaining tranche of up to $28.5 million of common stock
may be sold in a common equity closing, again subject to conditions described
below.





In March
2009, we announced that we sold our interest in all of our lymphocyte
function-associated antigen-1, or LFA-1, patents and related know-how to
SARcode Corporation, or SARcode, for a total cash consideration of $2.0 million,
of which $1.8 million was received in March 2009 and $0.2 million was received
in April 2009. The entire $2.0 million will be recorded as revenue in the
second quarter of 2009. SARcode has been the exclusive licensee of those assets
since March 2006 and is developing a small molecule LFA-1 inhibitor,
SAR1118, for T-cell mediated ophthalmic diseases.




Our
fragment-based discovery approach, known as Tethering, formed the basis of
several strategic research and development collaborations entered into between
2002 and 2004, including collaborations with Biogen Idec, J&JPRD and Merck.
We are no longer receiving research funding in any of our current
collaborations.  In the first quarter of 2009, J&JPRD
informed us that it has ceased development of the previously selected Cathepsin
S inhibitor and the parties initiated discussions regarding a proposed mutual
termination of the collaboration agreement. As a result, we do not
expect to receive any additional revenues from J&JPRD under the
collaboration agreement. We may in the future receive milestones as well as
royalty payments based on future sales of products, if any, resulting from the
Biogen Idec or Merck collaborations.





We have
incurred significant losses in each year since our inception. As of March 31,
2009, we had an accumulated deficit of $324.6 million. 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
GAAP. 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 as of 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 three months ended March 31,
2009 to the items that we disclosed as our critical accounting policies and
estimates in our management’s discussion and analysis of financial condition and
results of operations included in our Annual Report on Form 10-K for the
year ended December 31, 2008.





Recent
Accounting Pronouncements





Effective
January 1, 2009, we adopted EITF Issue No. 07-1, Accounting for Collaborative
Arrangements, or EITF 07-1. EITF 07-1 requires participants in a
collaborative arrangement (sometimes referred to as a “virtual joint venture”)
to present the results of activities for which they act as the principal on a
gross basis and to report any payments received from (made to) other
collaborators based on other applicable GAAP or, in the absence of other
applicable GAAP, based on analogy to authoritative literature or a reasonable,
rational, and consistently applied accounting policy election. EITF 07-1 also
requires significant disclosures related to collaborative arrangements. The
adoption did not have a material impact on our consolidated financial position
or results of operations.


18





Results
of Operations





Revenue





We have
not generated any revenue from sales of commercial products and do not expect to
generate any product revenue or any other significant revenue for the
foreseeable future.





Collaboration Revenue.In
the past we have generated revenue primarily through payments received in
connection with our collaborations, consisting principally of research funding
and milestones paid by our collaborators, substantially offsetting our related
research and development expenses. However, we are no longer conducting any
research activities or receiving research funding in connection with any of our
collaborations.





We are
entitled to receive milestone payments under our collaborations with Biogen Idec
and Merck upon achievement of certain milestones by them. Additionally, we
are entitled to receive royalty payments based on future sales of products, if
any, resulting from these collaborations, although we do not expect to generate
any royalty revenue from these collaborations in the foreseeable future, if at
all. In addition, in the first quarter of 2009, J&JPRD informed us that it
has ceased development of the previously selected Cathepsin S inhibitor and we
have initiated discussions regarding a proposed mutual termination of our
collaboration agreement. As a result, we do not expect to receive any
milestone or royalty revenue from J&JPRD in the future.





Collaboration
revenue was $12,500 for the three months ended March 31, 2009 as compared
to $2.3 million for the same period in 2008, which included
$1.8 million from Biogen Idec, a related party, and a $0.5 million
milestone payment from J&JPRD. The decrease in collaboration revenue from
Biogen Idec resulted from the termination of the research phase of this
collaboration in June 2008.  We expect that we will have
substantially lower collaboration revenue in 2009 and in future years unless,
and until, any products that may result from the collaborations advance to a
level where significant milestones will be payable to us.





License and Other Revenue.
  Under our March 2006 license agreement with SARcode, we received a
series of three secured notes, with a total principal value of $1.0 million,
which are due in 2012 and are convertible into preferred stock of SARcode at our
option. We have not recorded these notes as revenue due to uncertainty of
collectibility. In March 2009, we announced that we sold to SARcode our interest
in all of the patents and related know-how that had been the subject of the
license agreement for a total cash consideration of $2.0 million. Of this
amount, $1.8 million was received in March 2009 and recorded as deferred
revenue. The remaining $0.2 million was received in April 2009. As all
deliverables under the agreement were completed in April 2009, the entire $2.0
million will be recorded as revenue in the second quarter of 2009. In connection
with the sale, the license agreement was terminated and we will not receive any
future license fees, milestones or royalties under that license.





License
and other revenue was $0.2 million for the three months ended March 31,
2009 as compared to zero for the same period in 2008. The revenue in the 2009
period related to the sale of compound libraries that are not core to our
ongoing development plans.





Research
and Development Expense





Most of
our operating expenses to date have been for research and development
activities, and include 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,
 •
                in connection with in-licensing
      activities, and
 •
                in the conduct of activities we
      are required to perform in connection with our strategic
      collaborations.




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


19


The table
below sets forth our research and development expense by program for the three
months ended March 31, 2009 and March 31, 2008:





Three months ended
                      March 31,2009
                    
                    
                    2008(in thousands)Voreloxin
                    
                    $
                    4,073
                    
                    
                    $
                    4,485SNS-032
                    
                    
                    51
                    
                    
                    
                    1,238SNS-314
                    
                    
                    140
                    
                    
                    
                    804Discovery
      programs and new technologies
                    
                    
                    —
                    
                    
                    
                    1,179Other
      kinase inhibitors
                    
                    
                    —
                    
                    
                    
                    1,037Total
      research and development expense
                    
                    $
                    4,264
                    
                    
                    $
                    8,743





As a
result of our 2008 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 of voreloxin.  Clinical
trials are costly, and as we continue to advance voreloxin through clinical
development, we expect our related expenses to remain high. For example, we
expect to spend at least $11.0 million over the next 12 months to advance
our voreloxin program to completion of the current Phase 1b/2 combination
trial in AML, Phase 2 AML clinical trial in the previously untreated elderly and
Phase 2 clinical trial in ovarian cancer.  Due to the risks inherent
in the clinical trial process and given the early state of development, we are
unable to estimate the additional substantial costs we will incur in the
voreloxin development program.





In
addition, we are currently focused on trials of voreloxin in targeted
indications and patient populations.  Based on results of
translational research, clinical results, regulatory and competitive concerns
and our overall financial resources, we anticipate that we will make
determinations as to which indications to pursue and patient populations to
treat and how much funding to direct to each indication on an ongoing basis.
This will affect our research and development expense going
forward.




We are
currently anticipating that development of voreloxin will be our highest
priority.  If we engage a development or commercialization partner on
our voreloxin program, or if, in the future, we acquire additional product
candidates, our research and development expenses could be significantly
affected.  We cannot predict whether future collaborative or licensing
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 the right to participate in the co-development
and co-promotion of product candidates for up to two targets including, at our
option, the Raf kinase target, on a worldwide basis (excluding Japan). If we
were to exercise our option on one or more product candidates, our research and
development expense would increase significantly.





Research
and development expense was $4.3 million for the three months ended
March 31, 2009 as compared to $8.7 million for the same period in 2008. The
decrease of $4.4 million was primarily due to reduced research staffing as a
result of our 2008 Restructuring, which resulted in a $2.2 million decrease
in headcount-related expenses, and decreases in allocated facility costs of $1.0
million, lab costs of $0.4 million and clinical expenses of $0.4 million. We
expect that we will continue to incur significant expenses related to the
development of voreloxin in 2009 and future years; however, overall research and
development expenses are expected to be lower in 2009 as compared to 2008 as a
result of the reduction in research efforts and related staffing.





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 independent
auditors.





General
and administrative expense was $2.4 million for the three months ended
March 31, 2009 as compared to $3.3 million for the same period in 2008. The
decrease of $0.9 million was primarily due to reduced administrative headcount
as a result of our 2008 Restructuring, which resulted in a $0.6 million
decrease in headcount-related expenses, and a $0.3 million decrease in costs for
professional services.  We expect general and administrative expenses
to be lower in 2009 as compared to 2008 as a result of the reduction in
administrative headcount in connection with our 2009
Restructuring.


20


Restructuring
Charge





For the
three months ended March 31, 2009, we recorded net restructuring charges of
$1.3 million for lease termination activities related to the 2008 Restructuring
and a restructuring charge of $0.6 million for employee severance and related
benefit costs related to the 2009 Restructuring. The net charge for lease
termination activities includes $2.2 million for early lease termination fees
paid to the landlord and $0.5 million for third party commission and other
facility closure expenses, partially offset by the reversal of $1.4 million in
non-cash deferred rent on this facility.





For the
three months ended March 31, 2008, we recorded a charge of $0.3 million for
facilities costs on vacated property related to the 2007
Restructuring.





Interest
Income





Interest
income was $13,000 for the three months ended March 31, 2009, as compared
to $460,000 for the same period in 2008. The decrease was primarily due to lower
average balances of cash, cash equivalents and marketable securities and lower
average interest rates during the three months ended March 31,
2009.





Interest
Expense





Interest
expense was $1,000 for the three months ended March 31, 2009, as compared
to $59,000 for the same period in 2008. The decrease in expense resulted from
the full payment of the outstanding balance under our equipment financing
agreement with General Electric Capital Corporation in November
2008.





Other
income (expense), net





Other
expense, net was $118,000 for the three months ended March 31, 2009, as
compared to other income, net of $1,000 for the same period in 2008. The expense
in the 2009 period was comprised of losses on the sale of held-for-sale
assets.


21


Liquidity
and Capital Resources





Sources
of Liquidity





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; research grants; loans from
Biogen Idec and other debt financings.




Our cash,
cash equivalents and marketable securities totaled $4.3 million as of March
31, 2009, as compared to $10.6 million as of December 31, 2008.  The
decrease of $6.3 million was primarily due to $6.6 million of net cash used in
operating activities as described below.  No debt was outstanding at
either balance sheet date.





On March
31, 2009, we entered into a securities purchase agreement with accredited
investors, including certain members of management, providing for a Private
Placement of up to $43.5 million of our securities. The Private Placement
contemplates the sale of up to $15.0 million of units consisting of Series A
preferred stock and warrants to purchase common stock, and up to $28.5 million
of common stock in three closings.  $10.0 million of units were sold
in the initial closing, which occurred on April 3, 2009, resulting in net
proceeds of $8.8 million. Subject to the approval of our stockholders, an
additional $5.0 million of units may be sold in the second closing, which may
occur at our election or at the election of the holders of a majority of the
Series A preferred stock issued in the Private Placement.  We may
elect to hold the second closing if the achievement of a specified milestone
with respect to voreloxin has occurred and our common stock is trading above a
specified floor price. If we have not delivered notice to the investors in the
Private Placement of our election to complete the second closing, or if the
conditions for the second closing have not been met, the investors may elect to
purchase the units in the second closing by delivering notice to us of their
election.  Notice of an election to complete the second closing,
either by us or the investors in the Private Placement, must be delivered on or
before the earliest to occur of December 31, 2009, the common equity closing
described below or the occurrence of a qualifying alternative common stock
financing.   If the second closing occurs, it will be subject to
the satisfaction of customary closing conditions.  Subject to the
approval of our stockholders, the remaining tranche of up to $28.5 million of
common stock may be sold in the common equity closing. The common equity
closing may be completed at our election prior to the earlier of December
31, 2010 and a qualifying alternative common stock financing, or upon the
election of the holders of a majority of the Series A preferred stock issued in
the Private Placement prior to a date determined with reference to our cash
balance dropping below $4.0 million at certain future dates.  If we
elect to hold the common equity closing, it will be subject to the approval of
the purchasers holding a majority of the Series A preferred stock issued in the
Private Placement and subject to a condition that we sell at least $28.5 million
of common stock in the common equity closing.





Cash
Flows





Net cash
used in operating activities was $6.6 million for the three months ended
March 31, 2009, as compared to $10.5 million for the same period in
2008. Net cash used in operating activities for the three months ended
March 31, 2009 resulted primarily from our net loss of $8.4 million and net
adjustments for non-cash items of $0.8 million, partially offset by changes in
operating assets and liabilities of $2.5 million, including $1.8 million related
to deferred revenue. Net cash used in operating activities for the three months
ended March 31, 2008 resulted primarily from our net loss of $9.6 million
and changes in operating assets and liabilities of $2.0 million, partially
offset by adjustments for non-cash items of $1.1 million, primarily related to
stock-based compensation and depreciation and amortization.





Net cash
provided by investing activities was $4.6 million for the three months ended
March 31, 2009, as compared to $5.2 million for the same period in 2008.
Net cash provided by investing activities during the three months ended
March 31, 2009 was attributable to the net proceeds from maturities of
marketable securities of $4.3 million and proceeds from the sale of
held-for-sale assets totaling $0.3 million. Net cash provided by investing
activities during the three months ended March 31, 2008 was primarily
attributable to net proceeds from the maturity of marketable securities of $5.4
million, partially offset by capital expenditures of $0.2 million.





There
were no cash flows from financing activities for the three months ended
March 31, 2009 as compared to net cash used of $0.3 million for the same
period in 2008. Our financing activities for the three months ended
March 31, 2008 consisted of equipment loan repayments of $0.3
million.


22


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 until a product candidate has been approved by the
U.S. Food and Drug Administration, or FDA, or similar regulatory agencies in
other countries, and has been successfully commercialized. We need to raise
substantial additional funds to complete the development and commercialization
of voreloxin. Additionally, we may 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 other
      development activities;




•
            the
      economic and other terms and timing of any licensing or other partnering
      arrangement 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, if any;




•
            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
anticipate that our cash, cash equivalents and marketable securities as of March
31, 2009, together with the net proceeds from the initial closing of the Private
Placement and an anticipated milestone payment under one of our collaborations,
will be sufficient to find our operations through at least the end of
2009.




Until we
can generate a sufficient amount of collaboration or product revenue to finance
our cash requirements, which we may never do, we expect to finance future cash
needs primarily through equity issuances (including the possible
second closing of the sale of units and common equity closing in the Private
Placement described above and subject to the satisfaction of the conditions
described above), debt arrangements and a possible partnership or license of
development and/or commercialization rights to voreloxin. 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 scale back our
development program or conduct additional workforce or other expense reductions.
In addition, we may have to partner voreloxin at an earlier stage of development
than we might otherwise choose to do, which would lower the economic value of
that program to us.





Contractual
Obligations





Our
operating lease obligations as of March 31, 2009 relate to the leases for two
facilities in South San Francisco, California.  In December 2006, we
leased approximately 15,000 square feet of office space in a building at 395
Oyster Point Boulevard. This lease expires in April 2013, subject to our option
to extend the lease through February 2014.  In October 2008, we leased
approximately 5,500 square feet of laboratory space at 349 Allerton
Avenue.  This lease expires in October 2010 with our option to extend
the lease through October 2012.





The lease
for the facility located at 341 Oyster Point Boulevard, which formerly served as
our headquarters and research and development facility, was terminated in the
first quarter of 2009.





Off-Balance
Sheet Arrangements





Since our
inception, we have not had 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.


23


Item 3.   Quantitative and Qualitative
Disclosures About Market Risk





This item
is not applicable to us as a smaller reporting company.





Item 4T.   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 Quarterly Report on 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 Quarterly Report on Form 10-Q.





Changes
in Internal Control over Financial Reporting





There
were no changes in our internal control over financial reporting during the
quarter ended March 31, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.


24


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, which 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
believe there is no litigation pending that could, individually or in the
aggregate, have a material adverse effect on our results of operations or
financial condition.





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.





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 Annual Report on
Form 10-K filed with the Securities and Exchange Commission on April 3,
2009.





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 the development
and commercialization of voreloxin. 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 licensing or other partnering
      arrangement 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, if any;


25





·
            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.





On March
31, 2009, we entered into a securities purchase agreement with accredited
investors, including certain members of management, providing for a private
placement of up to $43.5 million of our securities, or the Private Placement.
The Private Placement contemplates the sale of up to $15.0 million of units
consisting of Series A preferred stock and warrants to purchase common stock,
and up to $28.5 million in common stock in three closings.  $10.0
million of units were sold in the initial closing on April 3, 2009. 
Subject to the approval of our stockholders, an additional $5.0 million of units
may be sold in the second closing, which may occur at our election or at the
election of the holders of a majority of the Series A preferred stock issued in
the Private Placement.  We may elect to hold the second closing if the
achievement of a specified milestone with respect to voreloxin has occurred and
our common stock is trading above a specified floor price. If we have not
delivered notice to the investors in the Private Placement of our election to
complete the second closing, or if the conditions for the second closing have
not been met, the investors may elect to purchase the units in the second
closing by delivering a notice to us of their election.  Notice of an
election to complete the second closing, either by us or the investors in the
Private Placement, must be delivered on or before the earliest to occur of
December 31, 2009, the common equity closing described below or the occurrence
of a qualifying alternative common stock financing.   If the
second closing occurs, it will be subject to the satisfaction of customary
closing conditions.  Subject to the approval of our stockholders, the
remaining tranche of up to $28.5 million of common stock may be sold in the
common equity closing. The common equity closing may be completed at our
election prior to the earlier of December 31, 2010 or a qualifying alternative
common stock financing, or upon the election of the holders of a majority of the
Series A preferred stock issued in the Private Placement prior to a date
determined with reference to our cash balance dropping below $4.0 million at
certain future dates.  If we elect to hold the common equity closing,
it will be subject to the approval of the purchasers holding a majority of the
Series A preferred stock issued in the Private Placement and subject to a
condition that we sell at least $28.5 million of common stock in the common
equity closing.




We
anticipate that our cash, cash equivalents and marketable securitie as of March
31, 2009, together with the net proceeds from the initial closing of the Private
Placement and an anticipated milestone payment under one of our collaborations,
will be sufficient to find our operations through at least the end of
2009.




The
conditions to the second closing for $5.0 million of units are substantial,
including conditions related to approval by our stockholders, the
development of voreloxin and our stock price, and it is possible that the
conditions to this second closing will not be met, in which event we would
not receive the $5.0 million of gross proceeds that are contemplated for that
closing. The $28.5 million common equity closing is entirely in the
discretion of the investors in the Private Placement, and it is possible that
they will elect not to complete that closing for reasons related to our business
or other factors.




Until we
can generate a sufficient amount of collaboration or product revenue to finance
our cash requirements, which we may never do, we expect to finance future cash
needs primarily through equity issuances (including the possible second closing
of the sale of units and common equity closing in the Private Placement
described above and subject to the satisfaction of the conditions described
above), debt arrangements and a possible partnership or license of
development and/or commercialization rights to voreloxin. We do not know whether
additional funding will be available on acceptable terms, or at
all.





We are
currently continuing to conduct our ongoing clinical trials of voreloxin in
acute myeloid leukemia, or 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 60% 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. In addition, we may have to
partner voreloxin at an earlier stage of development than we might otherwise
choose to do, which would lower the economic value of that program to
us.





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.


26





*Our
independent registered public accountants have indicated that our recurring
operating losses raise substantial doubt as to our ability to continue as a
going concern.




Our
audited financial statements for the fiscal year ended December 31, 2008 and our
unaudited financial statements for the three months ended March 31, 2009 were
prepared on a going concern basis in accordance with United States generally
accepted accounting principles. The going concern basis of presentation assumes
that we will continue in operation for the foreseeable future and will be able
to realize our assets and discharge our liabilities and commitments in the
normal course of business. However, our independent registered public
accountants have indicated in their audit report on our 2008 consolidated
financial statements that our recurring operating losses raise substantial
doubt as to our ability to continue as a going concern. We may be forced to
reduce our operating expenses and raise additional funds to meet our working
capital needs. However, we cannot guarantee that will be able to obtain
sufficient additional funds when needed or that such funds, if available, will
be obtainable on terms satisfactory to us. In the event that these plans cannot
be effectively realized, there can be no assurance that we will be able to
continue as a going concern.




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 increasingly
unwilling to buy stock and corporate bonds and economic growth has slowed.
Factors contributing to a slowing economy appear to be reduced credit
availability and falling house 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. Our net losses for the three months ended March 31,
2009 and the years ended December 31, 2008 and 2007 were $8.4 million,
$37.2 million and $38.8 million, respectively. As of March 31, 2009,
we had an accumulated deficit of $324.6 million. 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. 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 voreloxin or future product candidates, if any, 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.





The development of
voreloxin could be halted or significantly delayed for various reasons; our
clinical trials for voreloxin may not demonstrate safety or efficacy or lead to
regulatory approval.





Voreloxin
is prone to the risks of failure inherent in the drug development process. We
need to conduct significant additional preclinical studies and clinical trials
before we can attempt to demonstrate that voreloxin is safe and effective to the
satisfaction of the FDA and other regulatory authorities. Failure can occur at
any stage of the development process, and successful preclinical studies and
early clinical trials do not ensure that later clinical trials will be
successful. A number of companies in the pharmaceutical industry have suffered
significant setbacks in advanced clinical trials, even after obtaining promising
results in earlier trials.





For
example, we terminated two Phase 2 trials of voreloxin in small cell and
non-small cell lung cancer. We recently ceased development of SNS-032 and
terminated our related license agreement with BMS after completion of a Phase 1
trial as no responses demonstrating efficacy were observed in that trial. In
addition, in our Phase 1 trial of SNS-314, a maximum tolerated dose was not
established and no responses were observed.  As a result, we have
suspended further development of SNS-314 and plan to seek a partner or licensee
to support further development in the future.


27


If our
clinical trials result in unacceptable toxicity or lack of efficacy, we may have
to terminate them. If clinical trials are halted, or if they do not show that
voreloxin is safe and effective in the indications for which we are seeking
regulatory approval, our future growth will be limited and we may not have any
other product candidates to develop.




We do not
know whether our ongoing clinical trials or any other future clinical trials
with voreloxin or any of our product candidates will be completed on schedule,
or at all, or whether our ongoing or planned clinical trials will begin or
progress on the time schedule we anticipate. 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 during stability
studies of one of our voreloxin drug product lots. We have since identified a
process impurity in the voreloxin active pharmaceutical ingredient, or API,
that, when formulated into the packaged vial of the voreloxin drug product, can
result in the formation of particles over time. As a response to these
findings, we implemented a revised manufacturing process to attempt to control
the impurity and thereby prevent particle formation. One lot of voreloxin
API manufactured using the revised manufacturing process has been formulated
into a drug product lot that has completed nine months of stability testing
without formation of particles. This drug product lot is currently being
used in our clinical trials. It will take time to evaluate whether or not
this revised manufacturing process for voreloxin API will be successful in
stopping the formation of particles in this drug product lot over the longer
term, and to evaluate whether or not such control of particle formation would
also be reliably and consistently achieved in subsequent lots over the shorter
or longer term. We provided an update on the results from our process
optimization activities to the FDA in December 2008. If the change in
manufacturing process does not adequately control the formation of visible
particles, we will need to discuss other possibilities with the FDA, which could
include temporary clinical hold until the issue has been resolved to their
satisfaction.


28


The
failure to enroll patients for clinical trials may cause delays in developing
voreloxin.





We may
encounter delays if we are unable to enroll enough patients to complete clinical
trials of voreloxin. 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. Voreloxin is being tested in
patients with AML and ovarian cancer, which can be difficult patient populations
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 voreloxin or future product candidates, if
any, 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 are promising, such data may not be sufficient to support approval by the
FDA and other regulatory authorities.





We
rely on third parties to manufacture our voreloxin drug product and its active
pharmaceutical ingredient, and depend on a single supplier for the active
pharmaceutical ingredient. There are a limited number of manufacturers that are
capable of manufacturing voreloxin.





We do not
currently own or operate manufacturing facilities and lack the capability to
manufacture voreloxin on a clinical or commercial scale. As a result, we rely on
third parties to manufacture both the voreloxin API and the finished drug
product. The API is classified as a toxic substance, 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 finished drug product. We currently have established
relationships with only one manufacturer for API and two manufacturers for the
finished drug product. If our third-party API manufacturer is unable or
unwilling to produce 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 API for six to nine months,
during which time we would 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 finished drug product needs in
the foreseeable future.





Voreloxin
requires 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,
or 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 voreloxin, cost overruns or other problems that could seriously
harm our business.





To date,
voreloxin has been manufactured in small quantities for preclinical studies and
clinical trials. Prior to being approved for commercial sale, we will need to
manufacture finished drug 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 voreloxin, 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 voreloxin API, 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 be an approved commercial supplier. 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.


29


We
expect to expand our clinical development 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 development staff. We expect to
expand our clinical development 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 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 specialized personnel required for clinical development. 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 voreloxin.





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. 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 challenges 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;·
            substantial
      damages for past infringement, which we may have to pay if a court
      determines that voreloxin or any future product candidates infringe a
      third party’s patent or other proprietary rights;·
            a
      court order prohibiting us from selling or licensing voreloxin or any
      future product candidates 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 voreloxin, 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, developing and marketing products designed to address the treatment
of cancer, including AML and ovarian cancer.  Voreloxin is a small
molecule therapeutic 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, and marketing, drugs.





We
believe that our ability to successfully compete with voreloxin and any future
product candidates, if any, 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;


30





·
            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 of voreloxin in AML include Genzyme Corporation’s clofarabine, Eisai
Corporation’s decitabine, Celgene Corporation’s azacitidine and Vion
Pharmaceuticals, Inc.’s laromustine, 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.





We expect
competition for voreloxin to increase as additional products are developed and
approved to treat AML and ovarian cancer in various patient
populations.  If our competitors market products that are more
effective, safer or less expensive than voreloxin or our other future products,
if any, or that reach the market sooner we may not achieve commercial success or
substantial market penetration. In addition, the biopharmaceutical industry is
characterized by rapid change. Products developed by our competitors may
render voreloxin or any future 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
voreloxin drug product.





We rely
on third parties, such as contract research organizations, medical institutions,
clinical investigators and contract laboratories, to conduct our planned and
existing clinical trials for voreloxin. 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 voreloxin or future product
candidates, if any.





Our
commercial success will depend on our ability to obtain patents and maintain
adequate protection for voreloxin and any future product candidates in the
United States and other countries. As of March 31, 2009, we owned, co-owned
or had rights to approximately 86 issued U.S. and foreign patents and
approximately 311 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:


31





·
            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.





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
voreloxin API composition of matter 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 our voreloxin product 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.





Our
workforce reductions in August 2007, June 2008, March 2009 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
25%  in order to reduce expenses. In June 2008, we conducted a second
workforce reduction of approximately 60% to focus on the development of
voreloxin. In March 2009, in conjunction with the closing of the Private
Placement we conducted an additional workforce reduction of six
employees. 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.


32


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 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 voreloxin, 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 voreloxin.




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
voreloxin in North America, 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. We plan to collaborate with third parties that have direct sales
forces and established distribution systems to commercialize voreloxin. To the
extent that we enter into co-promotion or other licensing arrangements, our
product revenue is likely to be lower than if we marketed or sold voreloxin
directly. 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 voreloxin. If we are
not successful in commercializing voreloxin or our future product candidates, if
any, 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 consultants and advisors for the success and continuation of
development efforts.





We work
extensively with various consultants and advisors, who provide advice and or
services in various business and development functions, including clinical
development, operations and strategy, regulatory matters, accounting and
finance. The potential success of our drug development programs depends, in
part, on continued collaborations with certain of these consultants and
advisors. Our 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 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.





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. Our collaboration
partners are conducting 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 a product
candidate covered by the collaboration agreement.





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 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.


33


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. 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, 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 from obtaining approval for the commercialization of
voreloxin.





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 or NDA, from the FDA, or in any other country without the
equivalent marketing approval from such country. We have not received marketing
approval for voreloxin.  None of our collaboration partners have had a
product resulting from our collaboration enter clinical trials.  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;·
            regulatory
      officials may not find the data from preclinical studies and clinical
      trials sufficient;


34





·
            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 voreloxin
or future product candidates, if any, 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 sell voreloxin, the market may not be
receptive to voreloxin.





Even if
voreloxin obtains regulatory approval, it 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 voreloxin, 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.





If
voreloxin fails 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.




35




Even
if we receive regulatory approval for voreloxin, 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
voreloxin.





Any
regulatory approvals that we or our collaboration partners receive for voreloxin
or our future product candidates, if any, 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.





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 voreloxin or 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 voreloxin 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 voreloxin and our future products, if any, 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 voreloxin abroad.





We intend
to market voreloxin in international markets. In order to market voreloxin 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 processes 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 voreloxin or any other
future 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 voreloxin 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
voreloxin. 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
voreloxin to other available therapies. If reimbursement of voreloxin 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.


36





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.




Risks
Related to Our Common Stock




*The
closing of the Private Placement will result in substantial dilution to our
stockholders. If we sell shares of our common stock in future financings or
other arrangements, stockholders may experience additional
dilution.





We need
to raise substantial additional funds, through the Private Placement and
otherwise, to continue our operations, fund additional clinical trials of
voreloxin and potentially commercialize voreloxin. We plan to continue
to finance our operations with a combination of equity issuances (including the
possible second closing of the sale of units and common equity closing in the
Private Placement and subject to the satisfaction of the conditions described
above), debt arrangements and a possible partnership or license of development
and/or commercialization rights to voreloxin. Any issuance of convertible
debt securities, preferred stock or common stock may be at a discount from the
then 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 additional dilution, which may be significant.





The
closing of the Private Placement will result in substantial dilution to our
stockholders.  Following the initial closing, the holders of
our common stock prior thereto hold approximately 54.3% of our outstanding
common stock (assuming conversion of the Series A preferred stock at
the current conversion price), and will hold approximately 37.2% if the warrants
issued at the initial closing are exercised in full.  Following the
second closing for $5.0 million of units, if completed, the holders of our
common stock prior to the Private Placement will hold approximately 44.2% of our
outstanding common stock (assuming conversion of the Series A preferred
stock at the current conversion price), and will hold approximately 28.4% if the
warrants issued at the initial and second closings are exercised in
full.  Following the common equity closing, if completed, the holders
of our common stock prior to the Private Placement would hold approximately
19.0% of our outstanding common stock (assuming conversion of the Series A
preferred stock at the current conversion price), and would hold approximately
15.3% if the warrants issued at the initial and second closings are
exercised in full.





We
may not have the sufficient funding to distribute capital to our common
stockholders or continue our business upon a change of control
event.





If a
change of control (as that term is defined in the certificate of
designation related to the convertible Series A preferred stock),
which includes a sale or merger of  Sunesis or a significant
partnering transaction, occurs, the holders of the Series A preferred stock
would be entitled to receive, before any proceeds are distributed to common
stockholders, three times the amount that the investors in the Private Placement
paid for the units ($10.0 million at the initial closing and, if
consummated, an additional $5.0 million at the second closing), which could
equal up to a total of $45.0 million.  We would not have any capital
to distribute to our common stockholders if the consider+ation received in a
transaction that triggers a change of control event under the certificate of
designation is less than this liquidation preference amount.  Further,
if the investors elect to treat a partnering transaction as a change of control,
entitling the holders of the convertible preferred to the liquidation
preference described above, the holders of the Series A preferred
stock would be entitled to the full amount of any payments made by a
corporate partner by surrendering the Series A preferred stock, up to the
liquidation preference amount, which may leave us with insufficient resources to
continue our business.  This right of the holders of the Series A
preferred stock may also impair our ability to enter into a significant
partnering transaction since a partner would be willing to enter into a
partnering agreement with us only if we have or had access to sufficient capital
to satisfy our obligations under the partnering agreement.  Whether or
not we would have sufficient resources would depend on the terms of the
partnering agreement and other cash resources available to us at that
time.


37





We
cannot take fundamental actions related to Sunesis without the consent of a
majority of the holders of the convertible preferred to be issued in the
Private Placement.





For as
long as our convertible Series A preferred stock is outstanding, the
holders of the Series A preferred stock issued or to be issued in the second
closing, if this ever occurs, of the Private Placement, will have a number of
rights, including the right to approve any sale of the company, any significant
partnering transaction, any issuance of debt or convertible preferred and,
unless certain conditions are met, any issuance of common stock other than the
second closing and the common equity closing contemplated by the
Private Placement.  It is possible that the interests of the holders
of the  Series A preferred stock and the holders of common stock may be
inconsistent, resulting in the inability to obtain the consent of the holders of
Series A preferred stock to matters that may be in the best interests of the
common stockholders.




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





In the
three months ended March 31, 2009, our common stock traded as low as $0.16 and
as high as $0.51, and in 2008, 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 current and future operations;·
            results
      from, and any delays in or discontinuance of, ongoing and planned clinical
      trials for voreloxin;·
            announcements
      of FDA non-approval of voreloxin, 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 collaborations with Biogen Idec, J&JPRD and
      Merck;·
            announcements
      relating to restructuring and other operational
changes;·
            delays
      in the commercialization of voreloxin or our future products, if
      any;·
            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 new products by our competitors;·
            issues
      in manufacturing voreloxin drug substance or drug product ,or future
      products, if any;·
            market
      acceptance of voreloxin or 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 voreloxin or future products, if
      any;·
            failure
      to develop or sustain an active and liquid trading market for our common
      stock;


38





·
            sales
      of our common stock by our officers, directors or significant
      stockholders; and·
            additions
      or departures of key personnel.





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.





*We no longer
comply with certain of the listing requirements of The NASDAQ Global Market. We
may be delisted, and 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. To maintain the listing of our common stock on The
NASDAQ Global Market we are required to meet certain listing requirements,
including a minimum closing bid price of $1.00 per share, a market value of
publicly held shares (excluding shares held by our executive officers, directors
and 10% or more stockholders) of at least $5.0 million and stockholders’
equity of at least $10.0 million. We announced on April 17, 2009 we had received
a letter, dated April 14, 2009, from the Listing Qualifications Department of
The NASDAQ Stock Market notifying us that we do not comply with the $10.0
million minimum stockholders' equity requirement for continued listing on The
NASDAQ Global Market set forth in NASDAQ Marketplace Rule 5450(b)(1)(A).
NASDAQ's determination was based on a review of our Annual Report on Form 10-K
for the period ended December 31, 2008. At that time, our stockholders’ equity
was reported at $6.5 million. Since that time, we announced an up to $43.5
million financing, of which the first $10.0 million was received on April 3,
2009 upon the issuance of shares of Series A preferred stock and warrants to
purchase our common stock and the remainder of which may be issued by us,
subject to approval by our stockholders, upon the satisfaction of a certain
clinical milestone and our common stock trading above a specified floor price or
upon approval by a majority of the investors in the Private Placement, among
other conditions. While we do not anticipate that we will meet the $10.0 million
of stockholders’ equity continued listing requirement as of March 31, 2009 on a
GAAP or pro-forma basis after giving effect to the approximately $8.8 million of
net proceeds from the $10.0 million initial closing of the Private Placement,
the amount of the shortfall depends on the application of GAAP to the terms of
the newly issued securities, which we are in the process of analyzing. As
provided in the NASDAQ rules, we have the opportunity to submit to NASDAQ a
specific plan and timeline to achieve and sustain compliance. On April 29, 2009,
we submitted a plan, ahead of the deadline prescribed by NASDAQ,
to continue our listing on The NASDAQ Global Market. There is no assurance
that NASDAQ will accept our plan to satisfy the stockholders' equity
requirement. If, after the completion of its review, NASDAQ determines that we
have not presented a plan that adequately addresses the stockholders' equity
issue, NASDAQ will provide written notice that our securities will be subject to
delisting from The NASDAQ Global Market. In that event, we may either apply for
listing on The NASDAQ Capital Market, provided we meet the continued listing
requirements of that market, or appeal the decision to a NASDAQ Listing
Qualifications Panel. In the event of an appeal, we would remain listed on The
NASDAQ Global Market pending a decision by the Panel following the
hearing.


Additionally,
our common stock has traded below the $1.00 minimum bid price every trading day
since September 17, 2008. Under normal circumstances, companies traded on NASDAQ
would receive a deficiency notice from NASDAQ if their common stock has traded
below the $1.00 minimum bid price for 30 consecutive business days. Due to
market conditions, however, on October 16, 2008, NASDAQ announced
suspension of the enforcement of rules requiring a minimum $1.00 closing bid
price and the market value of publicly held shares, with the suspension to
remain in place until Monday, July 20, 2009. If our common stock is still
listed on The NASDAQ Global Market on July 20, 2009 and our common stock
continues to trade below the $1.00 minimum bid price for 30 consecutive business
days following the end of NASDAQ’s enforcement suspension or if the market value
of our publicly held shares remains below $5.0 million for 30 consecutive
business days following the end of NASDAQ’s enforcement suspension, we would
likely receive a deficiency notice. Following receipt of a deficiency notice, we
expect we would have 180 calendar days to regain compliance by having our common
stock trade over the $1.00 minimum bid price for at least a 10-day period and we
would have 90 calendar days to regain compliance by having our publicly held
shares trade over $5.0 million in value for at least a 10-day period. If we were
to fail to regain compliance during the grace period, our common stock could be
delisted.





If we
fail to comply with The NASDAQ Global Market listing standards, we may consider
transferring to The NASDAQ Capital Market, which is a lower tier market,
provided we met the transfer criteria, 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 or having our common stock traded on the over-the-counter
bulletin board network could adversely affect the liquidity of our common
stock.  If our common stock were to be delisted by NASDAQ, we could
face significant material adverse consequences, including:


39





·
            a
      limited availability of market quotations for our common
      stock;·
            a
      reduced amount of news and analyst coverage for
  us;


·
            a
      decreased ability to issue additional securities or obtain additional
      financing in the future;·
            reduced
      liquidity for our stockholders;


·
            potential
      loss of confidence by collaboration partners and employees;
      and·
            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 might otherwise 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.





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 31.4% of our outstanding common stock as of April 15, 2009.
Accordingly, these stockholders, acting as a group, could 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.
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.


40





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 March 31, 2009.





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





A list of
exhibits filed with this report or incorporated herein by reference is found in
the Exhibit Index immediately following the signature page of this
report.


41


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:  May 7,
      2009
              
              /S/
      ERIC H. BJERKHOLTEric
      H. Bjerkholt
                Senior
      Vice President, Corporate Development and Finance,
                Chief
      Financial Officer


42


Exhibit
Index





Exhibit
                Number
              
              Description3.1
              
              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 Company’s Annual Report on Form 10K-A on
      Form S-1 filed on May 23, 2007).3.3
              
              Certificate
      of Designation of the Series A Preferred Stock of the Registrant
      (incorporated by reference to Exhibit 3.3 to the Registrant’s Current
      Report on Form 8-K filed on April 3, 2009).4.1
              
              Reference
      is made to Exhibits 3.1 and 3.2.4.2
              
              Investor
      Rights Agreement, dated April 3, 2009, by and among the Registrant and the
      purchasers identified on the signature pages thereto (incorporated by
      reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K
      filed on April 3, 2009).10.13
              
              Agreement
      for Termination of Lease and Voluntary Surrender of Premises, dated as of
      January 15, 2009, by and between the Registrant and ARE-Technology Center,
      SSF, LLC (incorporated by reference to Exhibit 10.13 to the
      Registrant’s Annual Report on Form 10-K filed on April 3,
      2009).10.57
              
              Intellectual
      Property Assignment and License Termination Agreement by and between the
      Registrant and SARcode Corporation, dated March 6, 2009 (incorporated by
      reference to Exhibit 10.72 to the Registrant’s Current Report on Form 8-K
      filed on March 10, 2009).10.58
              
              Form
      of Amended and Restated Convertible Secured Promissory Notes issued by
      SARcode Corporation to the Registrant, dated March 6, 2009 (incorporated
      by reference to Exhibit 10.73 to the Registrant’s Current Report on Form
      8-K filed on March 10, 2009).10.60†
              
              Securities
      Purchase Agreement, dated March 31, 2009, by and among the Registrant and
      the purchasers identified on the signature pages thereto (incorporated by
      reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K
      filed on April 3, 2009).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.





†
            Portions
      of the exhibit have been omitted pursuant to a request for confidential
      treatment. The omitted information has been filed separately with the
      Securities and Exchange Commission.#
            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.


43