UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




Form
10-K




x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the Year Ended December 31, 2008OR ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




Commission
File Number 000-51531




SUNESIS
PHARMACEUTICALS, INC.


(Exact
name of registrant as specified in its charter)




Delaware
              (State
      or other jurisdiction of
              incorporation
      or organization)
            94-3295878
              (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)




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




Title
      of Each Class:
            
            Name
      of Each Exchange on Which Registered:Common
      Stock, par value $0.0001 per share
            
            The
      NASDAQ Stock Market LLC




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


None


(Title of
Class)




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




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




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 period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x  No o




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




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




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




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




The
aggregate market value of Common Stock held by non-affiliates of the registrant,
based on the closing sales price for such stock on June 30, 2008, as
reported by The Nasdaq Global Market, was $41,275,192. Shares of common stock
held by each current executive officer and director and by each person who is
known by the registrant to own 5% or more of the outstanding common stock have
been excluded from this computation in that such persons may be deemed to be
affiliates of the registrant. Share ownership information of certain persons
known by the registrant to own greater than 5% of the outstanding common stock
for purposes of the preceding calculation is based solely on information on
Schedule 13G or 13D filed with the Securities and Exchange Commission and
is as of June 30, 2008. This determination of affiliate status is not a
conclusive determination for other purposes.




The total
number of shares outstanding of the registrant’s common stock, $0.0001 par value
per share, as of March 20, 2009, was 34,409,768.




DOCUMENTS
INCORPORATED BY REFERENCE




Portions
of the registrant’s Definitive Proxy Statement, to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A in connection with the
2009 Annual Meeting of Stockholders of Sunesis Pharmaceuticals, Inc.
(hereinafter referred to as “Proxy Statement”) are incorporated by reference in
Part III of this report. Such Proxy Statement will be filed with the
Securities and Exchange Commission not later than 120 days after the
conclusion of the registrant’s fiscal year ended December 31,
2008.







SUNESIS
PHARMACEUTICALS, INC.




Page
                No.PART
      IITEM
      1.
            Business
            3ITEM
      1A.
            Risk
      Factors
            15ITEM
      1B.
            Unresolved
      Staff Comments
            29ITEM
      2.
            Properties
            29ITEM
      3.
            Legal
      Proceedings
            30ITEM
      4.
            Submission
      of Matters to a Vote of Security Holders
            30PART
      IIITEM
      5.
            Market
      For Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            30ITEM
      6.
            Selected
      Financial Data
            32ITEM
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            32ITEM
      7A.
            Quantitative
      and Qualitative Disclosures About Market RiskITEM
      8.
            Financial
      Statements and Supplementary Data
            43ITEM
      9.
            Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
            69ITEM
      9A(T).
            Controls
      and Procedures
            69ITEM
      9B.
            Other
      Information
            70PART
      IIIITEM
      10.
            Directors,
      Executive Officers and Corporate Governance
            70ITEM
      11.
            Executive
      Compensation
            71ITEM
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            71ITEM
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            72ITEM
      14.
            Principal
      Accountant Fees and Services
            72PART
      IVITEM
      15.
            Exhibits,
      Financial Statement Schedules
            72Signatures
            73Exhibit
      Index
            74





2




PART
I
  SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
  This
report, including the information we incorporate by reference, contains
“forward-looking statements” within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, that involve risks, uncertainties and
assumptions. All statements, other than statements of historical facts, are
“forward-looking statements” for purposes of these provisions, including without
limitation any statements relating to the completion of any financing
transaction or the satisfaction of closing conditions relating to any financing, any
projections of revenue, expenses or other financial items, any statement of
the plans and objectives of management for future operations, any statements
concerning proposed clinical trials, regulatory activities 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, Sunesis Europe
Limited, except where it is made clear that the term refers only to the parent
company.
  ITEM
      1.
              BUSINESS
  General
  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 the 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 leadership team, announced the winding down
of our internal discovery research activities, ceasing development of an
enhanced fragment-based discovery platform, and reduced our workforce by
approximately 60 percent.
  We are
currently advancing voreloxin through Phase 2 development. Voreloxin is a
first-in-class anticancer 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 replication, and have demonstrated promising preclinical
antitumor activity.  We are 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 advanced 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 Bristol-Myers Squibb Company or
BMS.  In December 2008, we notified BMS that we were terminating the
license agreement for SNS-032.  In addition, we recently completed
enrollment in a Phase 1 trial of SNS-314, a potent and selective Aurora kinase
inhibitor discovered 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.
  3
  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 our securities of up to $43.5 million, 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 in
two closings.  $10.0 million of units would be sold in the initial
closing, which is expected to occur in the near term, subject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, an additional $5.0 million of units may be sold in the
second closing, which closing may occur at our election or at the election of
the investors 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 to purchase
the units.  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 besubject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, the remaining tranche of $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.
 In
conjunction with the Private Placement, the investors have been granted a number
of rights, including the right to approve any sale of the company, any issuance
of debt or preferred stock and, except if certain conditions are met, any
issuance of common stock other than the second closing and the common stock
financing described above, and the right to appoint three of eight members of
our Board of Directors following the first closing, and five of nine members of
our Board of Directors following the second closing, if completed.
  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
million.  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.  Sunesis still holds a series
of secured convertible notes issued by SARcode having a total principal value of
$1 million.  We had discontinued our LFA-1 antagonist program in 2004
when we focused our research and development efforts on oncology.
  Our
fragment-based drug discovery approach, called Tethering®, formed the basis of
several strategic research and development collaborations entered into between
2002 and 2004, including collaborations with Biogen Idec, Inc., or Biogen Idec,
Johnson & Johnson Pharmaceutical Research & Development, L.L.C., or
J&JPRD, and Merck & Co., Inc., or Merck.  We are no longer
receiving research funding from any of these 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. J&JPRD is entitled to terminate the collaboration agreement
without cause upon 180 days’ written notice.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.
 
 Voreloxin
  Voreloxin
is a first-in-class anticancer quinolonederivative,
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 replication, and
have demonstrated promising preclinical antitumor activity.
  The
following chart summarizes the status of the clinical trials that have been
conducted or that we are currently conducting with voreloxin.
  4
  Voreloxin
      Clinical Study
                
                Phase
      1
                Phase
      2Acute
      LeukemiasSingle
      Agent Relapsed/Refractory Acute Leukemias
                
                CompleteSingle
      Agent
                  Previously
      Untreated Elderly AML
                  (REVEAL-1)
                Schedule
      A
                
                Ongoing
      –
                  Enrollment
                  CompleteSchedule
      B
                
                Ongoing
      –
                  Enrollment
                  CompleteSchedule
      C
                
                EnrollingCombination
      with Cytarabine
                  Relapsed/Refractory
      AML
                Schedule
      A
                Complete
                Ongoing
      –
                  Enrollment
                  CompleteSchedule
      B
                Enrolling
                PlannedSolid
      TumorsSingle
      Agent Advanced Solid Tumors
                
                CompleteSingle
      Agent Advanced Solid Tumors
                
                CompleteSingle
      Agent Non-Small Cell Lung
                
                
                CompleteSingle
      Agent Small Cell Lung
                
                
                CompleteSingle
      Agent Platinum-Resistant Ovarian Cancer
                
                
                Ongoing
      -
                  Enrollment
                  Complete
  Since
2004, we have initiated eight clinical trials with voreloxin. Two Phase 1
clinical trials were conducted to evaluate doses and schedules of administration
of voreloxin in patients with advanced solid tumors. We conducted a Phase 2
study in non-small cell lung cancer and a second Phase 2 study in small
cell lung cancer. At the time we disclosed the termination of the lung cancer
programs, we also announced the possibility of pursuing these indications either
in combination with other anti-cancer agents or with voreloxin as a single agent
at a later time.
  In the
third quarter of 2007, we commenced a Phase 1b/2 clinical trial of voreloxin in
combination with cytarabine for the treatment of patients with
relapsed/refractory AML and are testing two different cytarabine
schedules.  A maximum tolerated dose (MTD) of 80 mg/m2 of
voreloxin was established for Schedule A (continuous infusion of cytarabine)
with nine patients reported to have achieved complete remission (CR) or complete
remission without platelet recovery (CRp) in the Phase 1b dose escalation. Early
data show that six of fourteen evaluable AML patients in first relapse enrolled
in the Phase 2 portion of Schedule A of this study have achieved CR, with a
preliminary 30-day all-cause mortality of less than 10%.  In addition,
one patient who achieved a partial response proceeded to bone marrow
transplant.  Enrollment for Schedule A is complete.  In
Schedule B (a 2 hour intravenous infusion of cytarabine), the third dose
escalation cohort, with a dose of 90 mg/m2of
voreloxin, is fully enrolled. Complete remissions have been observed in Schedule
B in both relapsed and treatment refractory patients.  Enrollment into
the Phase 2 portion of Schedule B is expected to begin shortly.
 
 In the
second quarter of 2008, we commenced enrollment in a Phase 2 single agent
clinical trial of voreloxin in previously untreated elderly AML patients,
testing three different dosing regimens.  In Schedule A (72 mg/m2 of
voreloxin weekly for three weeks), twelve of 29 patients achieved CR or CRp with
a 30-day all-cause mortality of 17%.  Schedule B (72 mg/m2 of
voreloxin weekly for two weeks) appears to be better tolerated by patients,
while maintaining anti-leukemic activity.  Ten of 35 patients on
Schedule B have achieved CR or CRp. In addition to improved tolerability,
the 30-day all-cause mortality has been reduced to 9%.  To date,
16 of the planned 30 patients have been enrolled in Schedule C (72 mg/m2 of
voreloxin on days one and four) and enrollment continues; enrollment for
Schedules A and B is completed.
 
 In
addition, at the end of 2006, we commenced a Phase 2 clinical trial of single
agent voreloxin in advanced platinum-resistant ovarian cancer
patients.  Three schedules of voreloxin have been studied, 48
mg/m2 given
every three weeks, and 60 mg/m2 and 75
mg/m2 given
every four weeks. Enrollment of this study completed in late
2008.  Data from this trial show encouraging durable anti-tumor
activity in the 48 mg/m2 cohort,
as measured by GOG-RECIST criteria with partial and complete responses, and
progression-free survival. Some of the patients dosed with 60 mg/m2 or 75
mg/m2 of
voreloxin still remain on study and complete and partial responses have been
observed. Voreloxin has generally been well tolerated at all three dose
levels.
  In- License Agreement with Dainippon
Sumitomo Pharma Co., Ltd.
  In
October 2003, we entered into an agreement with Dainippon Sumitomo Pharma Co.,
Ltd. or Dainippon, to acquire exclusive worldwide development and marketing
rights for our lead product candidate, voreloxin.
  5
  In
addition to upfront payments of $0.7 million and milestone payments of
$0.5 million made through December 31, 2008, we may in the future be
required to 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 would 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, we must pay royalties for
third party intellectual property rights necessary to commercialize voreloxin,
but we may reduce our royalty payments to Dainippon if a third party markets a
competitive product. 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.
  If we
discontinue seeking regulatory approval and/or the sale of the product in a
region, we are required to return to Dainippon its rights to the product in that
region. The agreement may be terminated by either party for the other party’s
uncured breach or bankruptcy.
  Strategic
Collaborations
  We
applied our Tethering technology in several strategic research and development
collaborations entered into between 2002 and 2004 to discover and develop novel
small molecules to treat cancer and other diseases.  These
collaborations were designed to enable us to leverage and expand our internal
development capabilities, manage our cash expenditures and diversify risk across
our pipeline.
  To
date, our revenue has been generated primarily through our
collaborations, and has consisted principally of research funding and
milestones paid by our collaborators, substantially offsetting our related
research and development expenses. We are no longer conducting any research
activities in connection with any of our collaborations and are no longer
receiving research funding in any collaboration.  Our collaboration
revenue, if any, will be substantially lower in future years unless, and until,
any products that may result from the two remaining collaborations advance to a
level where significant milestones will be payable to us.  We do not
expect to generate royalty revenue from these collaborations in the foreseeable
future, if at all.  As a result of our 2008 restructuring and the
resulting wind down of our research activities to focus our resources and
efforts on the advancement of voreloxin, we do not anticipate conducting any
research activities in connection with any future strategic
collaboration.
  We may in
the future receive milestones as well as royalty payments based on future sales
of products, if any, resulting from the collaborations with Biogen Idec and
Merck described below.
  In
forming each of our strategic collaborations, we agreed for certain periods of
time not to conduct certain research, independently or with any commercial third
party, on the same target as that covered by the collaboration agreement. Some
of our collaborations also significantly restrict our ability to utilize
intellectual property derived from the collaboration for a purpose outside of
the collaboration.
  Through
December 31, 2008, we had received an aggregate of approximately
$85.8 million in cash from our collaboration partners. In 2006, 2007 and
2008, we received $7.3 million, $7.6 million and $4.3 million,
respectively, in revenue from Biogen Idec. This represents 54%, 83% and 80% of
our total revenue for these periods. Likewise, during this same three-year
period, we received $6.4 million, $1.6 million and $0.1 million,
respectively, in revenue from Merck. This represents 46%, 17% and 2% of our
total revenue for these periods.
  Biogen
Idec—Raf Kinase and Other Kinase Inhibitors
  In August
2004, we entered into a collaboration agreement with Biogen Idec to discover,
develop and commercialize small molecule inhibitors of Raf kinase and up to five
additional targets. Raf kinase is an enzyme in the Ras pathway, a signaling
pathway important to cell proliferation. The primary focus of the program is to
discover small molecule inhibitors of Raf kinase and additional kinase targets
that play a role in oncology and immunology indications or in the regulation of
the human immune system. In connection with our June 2008 restructuring, we
agreed to terminate the research term approximately two months early on June 30,
2008 and we are no longer receiving research funding from Biogen
Idec.   Although the research term of the collaboration has
ended, our agreement with Biogen Idec continues on a product-by-product basis
for so long as there is an obligation to pay royalties on such product under the
agreement.
  6
  Under the
terms of the collaboration agreement, we received a $7.0 million upfront
non-refundable and non-creditable technology access fee, which was recognized as
revenue over the research term.  As a result of the June 2008
termination of the research term, the $0.3 million unrecognized portion of the
upfront technology access fee was recognized as revenue in the first half of
2008.  During the research term, we also received research funding of
$1.2 million per quarter from Biogen Idec, subject to inflation adjustments,
which was paid in advance to support some of our scientific
personnel.   We also received a $0.5 million milestone payment in
the first half of 2008 that was recognized as revenue.  In addition,
in 2006 Biogen Idec made a $14.0 million equity investment in us. To date,
we have received payments totaling $42.5 million under this collaboration,
including the $14.0 million equity investment.
  We
granted Biogen Idec a worldwide non-exclusive license to our intellectual
property relating to Tethering with respect to specific collaboration targets
and an exclusive license to our portion of the collaboration intellectual
property for the commercialization of small molecule compounds that have a
specified activity against the collaboration targets. Biogen Idec agreed to bear
all costs related to this program through at least the completion of
Phase 1 clinical trials, after which 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).
  Biogen
Idec is required to pay up to $60.0 million in pre-commercialization
milestones per target, as well as royalty payments depending on product sales.
Royalty payments may be increased if we exercise our option on co-development
and co-promotion rights. Royalty rates payable to us will be reduced if Biogen
Idec is required to license additional intellectual property related to certain
technology jointly developed under the collaboration agreement from one or more
third parties in order to commercialize a collaboration product. Rights to
collaboration products revert to us with a reverse royalty to Biogen Idec if
Biogen Idec fails to use commercially reasonable and diligent efforts during
development and commercialization of co-funded products. If we do not exercise
our co-funding option for a product directed at a target selected for further
collaborative work, then Biogen Idec may pursue such target on its own. We also
have a non-exclusive license, with the right to obtain an exclusive license,
from Biogen Idec under joint collaboration intellectual property to develop and
commercialize products against other kinase targets. We will owe royalty
payments to Biogen Idec for sales of any such products. 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 claim relating to a
product exists or 10 years from the date of first sale of the
product.
  Merck
  In
February 2003, we entered into a license and collaboration agreement with Merck
to discover, develop and commercialize small molecule inhibitors of
beta-secretase, or BACE, an enzyme that is believed to be important for the
progression of Alzheimer’s disease.  The research term of this
collaboration ended in February 2006 and we are no longer receiving research
funding.  To date, we have received payments totaling
$19.0 million under this collaboration.
  We
granted Merck a worldwide, non-exclusive license to our intellectual property
relating to use of Tethering to develop BACE inhibitors and an exclusive license
to a composition of matter patent and future intellectual property relating
to such inhibitors. Merck is required to pay research and development
milestones of up to $84.3 million, as well as royalty payments depending on
product sales. In 2006 and 2007, we received payments of $4.3 million and
$1.0 million, respectively, from Merck for meeting certain preclinical
milestones related to BACE.  We did not receive any milestones from
Merck in 2008.  Royalty rates payable to us may be reduced if Merck is
required to license additional intellectual property from one or more third
parties in order to commercialize a collaboration product or if a third party
markets a version of the collaboration product. 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 claim relating to a product
exists or 12 years from the date of first sale of the product. We retain
the right to develop and commercialize non-pharmaceutical products containing
compounds arising from the collaboration. We would owe Merck a royalty based on
sales of any such products.
  Although
the research term of the collaboration has ended, the agreement extends for so
long as a product arising from the collaboration is the subject of an active
development project or for so long as there is an obligation to pay royalties
under the agreement.  Merck continues to examine collaboration
compounds in preclinical studies; however, none have advanced to clinical
studies to date.  The agreement may be, terminated by either party for
the other party’s uncured breach or bankruptcy. The agreement may be terminated
by Merck at any time upon three months notice to us.
  In July
2004, we licensed to Merck a series of small molecule compounds we derived from
Tethering to potentially complement Merck’s internal discovery efforts against
an enzyme target for treating viral infections.  Merck agreed to be
responsible for advancing these compounds into lead optimization, preclinical
development, and clinical studies.
  7
  The
agreement provides for a payment by Merck to us of an upfront technology access
fee and annual license fees for our consulting services and ongoing access to
Tethering as a means of identifying additional compounds for the treatment of
viral infections. To date, we have received $3.3 million under this
collaboration, including an upfront, non-refundable and non-creditable
technology access fee of $2.3 million, which was recognized as revenue over
the initial three-year term.  We also received annual license fees
aggregating $1.0 million through December 31, 2008, including a
license fee of $0.2 million in 2007 and a license fee of approximately $0.1
million in 2008.  The annual license fees are recognized as revenue
over a 12-month period when received.  No further annual license fees
are payable to us under the agreement.
  We
assigned to Merck small molecule compounds related to the viral target and our
interest in research program patents and compounds that act on the target
through the inhibition mode that we identified. Merck owns all intellectual
property generated in the course of performing the research, including any
products resulting from the collaboration, except for improvements related to
Tethering, which we own. Merck is required to make payments based on the
achievement of development milestones of up to $22.1 million, as well as
royalty payments based on net sales for any products resulting from the
collaboration. To date, we have not received any milestone payments under the
agreement and we do not expect to receive any milestone or royalty payments in
the future related to the agreement.  Royalty rates payable to us, if
any, may be reduced if Merck is required to license additional intellectual
property from one or more third parties in order to commercialize a
collaboration product. Merck may also reduce its royalty payments to us, if any,
if the product is not covered by a patent. 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 claim relating to a product
exists or 12 years from the date of first sale of the product.
  Our
agreement with Merck extends for so long as a product arising from the
collaboration is the subject of an active development project or for so long as
there is an obligation to pay royalties under the agreement. Either party may
terminate the agreement for the other party’s uncured breach or bankruptcy. The
agreement may be terminated by Merck at any time upon three months’ notice to
us.
  Johnson &
Johnson Pharmaceutical Research & Development, L.L.C
  In May
2002, we entered into a collaboration agreement with J&JPRD, to discover,
develop and commercialize small molecule inhibitors of Cathepsin S, an enzyme
that is important in regulating an inflammatory response. Under the terms of the
agreement, we received a non-refundable and non-creditable technology access fee
and certain research funding paid in advance on a quarterly basis. Costs
associated with research and development activities attributable to this
agreement approximated the research funding recognized. The research term of
this collaboration ended in December 2005 and we are no longer receiving
research funding from J&JPRD.
  We
granted J&JPRD a worldwide non-exclusive license to our 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 of 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 milestone in February 2008 when
J&JPRD selected a Cathepsin
S inhibitorfrom the collaboration as a development
candidate.  We have received payments totaling $7.3 million under
this collaboration.
  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.  J&JPRD is entitled to
terminate the collaboration agreement without cause upon 180 days’ written
notice.
  Manufacturing
  We do not
have internal manufacturing capabilities and outsource the manufacture of
voreloxin active pharmaceutical ingredient, or API, and the finished product
incorporating the API to third-party contract manufacturers. The voreloxin API
is manufactured by a single-source supplier through a multi-step convergent
synthesis in which two intermediates are manufactured in a parallel process and
then combined and deprotected in the final two steps. The API is then formulated
and vials are filled and finished by two different third party manufacturers.
The API is classified as a toxic substance, and the number of suppliers
qualified to manufacture it or the finished product is limited. We have a
sufficient supply of voreloxin API to conduct our current and planned
Phase 1 and Phase 2 clinical trials in North America. Our inventory of
voreloxin finished product is currently sufficient to support clinical
trials through 2009.
New lots of finished product will be manufactured and released as required to
support our current and planned clinical activities.
  8
  Competition
  We face
significant competition from pharmaceutical, biopharmaceutical and biotechnology
companies that are researching, developing and selling products designed to
address the treatment of cancer, including AML and ovarian
cancer.  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 in marketing,
drugs.
  Voreloxin
is currently being clinically tested as a treatment for AML and
platinum-resistant ovarian cancer. Some of the current key competitors to
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 affect the treatment paradigm for acute leukemia. Each of these compounds
is further along in clinical development than voreloxin. To compete effectively
with these agents, voreloxin will need to demonstrate advantages either as a
single agent or in combination settings.  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, including Novartis AG, which has
initiated a head-to-head Phase 3 clinical trial in platinum refractory
patients comparing its compound patupilone against liposomal
doxorubicin.
  We
believe that any Raf kinase inhibitor that might be developed by Biogen Idec as
a result of our collaboration would compete with several compounds being
developed and clinically tested by Pfizer, Inc., Novartis AG,
Plexxikon, Inc. and Exelixis Inc.
  We
believe that our ability to successfully compete will depend on, among other
things:
  • our ability to develop novel compounds
with attractive pharmaceutical properties free of third party patents and to
secure, protect, maintain and enforce intellectual property rights based on our
innovations;
 
 • the efficacy, safety and reliability of
our drug candidates;
 
 • the speed at which we develop our drug
candidates;
 
 • our ability to design and successfully
complete 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;
 
 • the success of our collaborations;
 
 • 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.
  Intellectual
Property
  We
believe that patent protection is crucial to our business and that our future
success depends in part on our ability to obtain patents protecting voreloxin or
future drug candidates, if any. We have an exclusive license to 44 issued
composition-of-matter patents that cover the voreloxin drug substance. The U.S.
composition-of-matter patent is due to expire in October 2015 and most of its
foreign counterparts are due to expire in June 2015. Approximately 52 U.S. and
foreign applications pertaining to voreloxin life cycle development are also
pending. When appropriate, we intend to seek patent term restoration, orphan
drug status and/or data exclusivity in the United States and their equivalents
in other relevant jurisdictions, to the maximum extent that the respective laws
will permit at such time.
  Historically
we have patented a wide range of technology, inventions and improvements
considered important to the development of our business. As of December 31,
2008, we owned, co-owned or licensed rights to approximately 233 issued U.S. and
foreign patents and approximately 370 pending U.S. and foreign patent
applications.  Those patents expire between June 2015 and April
2024.  The number of patents and patent applications as of December
31, 2008 includes 146 patents and 67 patent applications relating to SNS-032,
which were subsequently returned to BMS as a result of our termination
of the license agreement with BMS, and one granted patent and nine patent
applications relating to LFA-1 inhibitors, which we recently sold to SARcode.
The  remaining patents and patent applications relate to SNS-314, our
Tethering and additional drug discovery technology and other aspects of
our  technology or other drug discovery programs, which are no longer
in active development by Sunesis.
  9
  Our
ability to build and maintain our proprietary position for voreloxin and any
future drug candidates, if any, will depend on our success in obtaining
effective claims and enforcing those claims if granted. The patent positions of
biopharmaceutical companies like ours are generally uncertain and involve
complex legal and factual questions for which some important legal principles
remain unresolved. No consistent policy regarding the breadth of patent claims
has emerged to date in the United States. The patent situation outside the
United States is even more uncertain. We do not know whether any of our patent
applications or those patent applications that we license will result in the
issuance of any patents. Even if patents are issued, they may not be sufficient
to protect voreloxin or future drug candidates, if any.  The patents
we own or license and those that may issue in the future may be challenged,
invalidated or circumvented, and the rights granted under any issued patents may
not provide us with proprietary protection or competitive
advantages.
  Patent
applications filed before November 29, 2000 in the United States are
maintained in secrecy until patents issue. Later filed U.S. applications and
patent applications in most foreign countries generally are not published until
at least 18 months after they are filed. Scientific and patent publication
often occurs long after the date of the scientific discoveries disclosed in
those publications. Accordingly, we cannot be certain that we were the first to
invent the subject matter covered by any patent application or that we were the
first to file a patent application for any inventions.
  Our
commercial success depends on our ability to operate without infringing patents
and proprietary rights of third parties. We cannot determine with certainty
whether patents or patent applications of other parties may materially affect
our ability to conduct our business. The existence of third party patent
applications and patents could significantly reduce the coverage of patents
owned by or licensed to us and limit our ability to obtain meaningful patent
protection. If patents containing competitive or conflicting claims are issued
to third parties and these claims are ultimately determined to be valid, we may
be enjoined from pursuing research, development or commercialization of
voreloxin or future drug candidates, if any, or be required to obtain licenses
to these patents or to develop or obtain alternative technology.
  We may
need to commence or defend litigation to enforce or to determine the scope and
validity of any patents issued to us or to determine the scope and validity of
third party proprietary rights. Litigation would result in substantial costs,
even if the eventual outcome is favorable to us. An adverse outcome in
litigation affecting proprietary rights we own or have licensed could present
significant risk of competition for voreloxin or future drug candidates, if any,
we market or seek to develop. Any adverse outcome in litigation affecting third
party proprietary rights could subject us to significant liabilities to third
parties and could require us to seek licenses of the disputed rights from third
parties or to cease using the technology if such licenses are
unavailable.
  We also
rely on trade secrets to protect our technology, especially where we do not
believe patent protection is appropriate or obtainable. However, trade secrets
are difficult to maintain and do not protect technology against independent
developments made by third parties.
  We seek
to protect our proprietary information by requiring our employees, consultants,
contractors and other advisers to execute nondisclosure and assignment of
invention agreements upon commencement of their employment or engagement.
Agreements with our employees also prevent them from bringing the proprietary
rights of third parties to us. We also require confidentiality or material
transfer agreements from third parties that receive our confidential data or
materials. There can be no assurance that these agreements will provide
meaningful protection, that these agreements will not be breached, that we will
have an adequate remedy for any such breach, or that our trade secrets will not
otherwise become known or independently developed by a third party.
  We seek
to protect our company name and the names of our products and technologies by
obtaining trademark registrations, as well as common law rights in trademarks
and service marks, in the United States and in other countries. There can be no
assurance that the trademarks or service marks we use or register will protect
our company name or any products or technologies that we develop and
commercialize, that our trademarks, service marks, or trademark registrations
will be enforceable against third parties, or that our trademarks and service
marks will not interfere with or infringe trademark rights of third
parties.
  We may
need to commence litigation to enforce our trademarks and service marks or to
determine the scope and validity of our or a third party’s trademark rights.
Litigation would result in substantial costs, even if the eventual outcome is
favorable to us. An adverse outcome in litigation could subject us to
significant liabilities to third parties and require us to seek licenses of the
disputed rights from third parties or to cease using the trademarks or service
marks if such licenses are unavailable.
  10
  Government
Regulation
  The
United States Food and Drug Administration, or FDA, and comparable regulatory
agencies in state and local jurisdictions and in foreign countries impose
substantial requirements upon the clinical development, manufacture, marketing
and distribution of drugs. These agencies and other federal, state and local
entities regulate research and development activities and the testing,
manufacture, quality control, safety, efficacy, labeling, storage,
recordkeeping, approval, advertising and promotion of voreloxin and any future
drug candidates.  The application of these regulatory frameworks to
the development, approval and commercialization of voreloxin or our future drug
candidates, if any, will take a number of years to accomplish, if at all, and
involve the expenditure of substantial resources.
  U.S. Government
Regulation In the United States, the FDA regulates drugs under the
Federal Food, Drug, and Cosmetic Act, as amended, or FFDCA, and implementing
regulations. The process required by the FDA before voreloxin and any future
drug candidates may be marketed in the United States generally involves the
following:
  •
              completion
      of extensive preclinical laboratory tests, in vivo preclinical
      studies and formulation studies;
  •
              submission
      to the FDA of an Investigational New Drug, or IND, application which must
      become effective before clinical trials
begin;
  •
              performance
      of adequate and well-controlled clinical trials to establish the safety
      and efficacy of the product candidate for each proposed
      indication;
  •
              submission
      of an NDA to the FDA;
  •
              satisfactory
      completion of an FDA pre-approval inspection of the manufacturing
      facilities at which the product candidate is produced to assess compliance
      with current Good Manufacturing Practice, or cGMP, regulations;
      and
  •
              FDA
      review and approval of the NDA, including proposed labeling (package
      insert information) and promotional materials, prior to any commercial
      marketing, sale or shipment of the
drug.
  The
testing and approval process requires substantial time, effort and financial
resources, and we cannot be certain that any approvals for voreloxin or our
future drug candidates, if any, will be granted on a timely basis, if at
all.
  Preclinical
Testing and INDs
  Preclinical
tests include laboratory evaluation of product chemistry, formulation and
stability, as well as studies to evaluate toxicity in animals. Laboratories that
comply with the FDA Good Laboratory Practice regulations must conduct
preclinical safety tests.  The results of preclinical tests, together
with manufacturing information and analytical data, are submitted as part of an
IND application to the FDA. The IND automatically becomes effective 30 days
after receipt by the FDA, unless the FDA, within the 30-day time period, raises
concerns or questions about the conduct of the clinical trial, including
concerns that human research subjects will be exposed to unreasonable health
risks. In such a case, the IND sponsor and the FDA must resolve any outstanding
concerns before the clinical trial can begin. Our submission of an IND, or those
of our collaboration partners, may not result in FDA authorization to commence a
clinical trial. A protocol amendment for an existing IND must be made for each
successive clinical trial conducted during product development.
  Clinical
Trials
  Clinical
trials involve the administration of the investigational new drug to healthy
volunteers or to patients under the supervision of a qualified principal
investigator. Clinical trials are conducted in accordance with the FDA’s
Protection of Human Subjects regulations and Good Clinical Practices under
protocols that detail the objectives of the study, the parameters to be used to
monitor safety, and the efficacy criteria to be evaluated. Each protocol must be
submitted to the FDA as part of the IND.
  11
  In
addition, each clinical study must be conducted under the auspices of an
independent institutional review board, or IRB, at each institution where the
study will be conducted.  The IRB will consider, among other things,
ethical factors, the safety of human subjects and the possible liability of the
institution.  The FDA, the IRB or the sponsor may suspend a clinical
trial at any time on various grounds, including a finding that the subjects or
patients are being exposed to an unacceptable health risk. Clinical testing also
must satisfy extensive Good Clinical Practices, or GCP, requirements and
regulations for informed consent.
  Clinical
trials are typically conducted in the three sequential phases, which may
overlap, sometimes followed by a fourth phase:
  •
              Phase 1 clinical
      trials are initially conducted in a limited population to test the
      drug candidate for safety (adverse effects), dose tolerance, absorption,
      metabolism, distribution and excretion in healthy humans or, on occasion,
      in patients, such as cancer patients. In some cases, particularly in
      cancer trials, a sponsor may decide to conduct what is referred to as a
      “Phase 1b” evaluation, which is a second safety-focused Phase 1
      clinical trial typically designed to evaluate the impact of the drug
      candidate in combination with currently approved
  drugs.
  •
              Phase 2 clinical
      trials are generally conducted in a limited patient population to
      identify possible adverse effects and safety risks, to determine the
      efficacy of the drug candidate for specific targeted indications and to
      determine dose tolerance and optimal dosage. Multiple Phase 2
      clinical trials may be conducted by the sponsor to obtain information
      prior to beginning larger and more expensive Phase 3 clinical trials.
      In some cases, a sponsor may decide to conduct what is referred to as a
      “Phase 2b” evaluation, which is a second, confirmatory Phase 2
      clinical trial that could, if positive and accepted by the FDA, serve as a
      pivotal clinical trial in the approval of a drug
  candidate.
  •
              Phase 3 clinical
      trials are commonly referred to as pivotal trials. When
      Phase 2 clinical trials demonstrate that a drug candidate has
      potential activity in a disease or condition and has an acceptable safety
      profile, Phase 3 clinical trials are undertaken to further evaluate
      clinical efficacy and to further test for safety in an
      expanded patient population at multiple, geographically dispersed
      clinical trial sites.
  •
              Phase 4 (post-marketing)
      clinical trials may be required by the FDA in some cases. The FDA
      may condition approval of an NDA for a drug candidate on a sponsor’s
      agreement to conduct additional clinical trials to further assess the
      drug’s safety and efficacy after NDA approval. Such post-approval trials
      are typically referred to as Phase 4 clinical
  trials.
  New
Drug Applications
  The
testing and approval processes are likely to require substantial cost, time and
effort, and there can be no assurance that any approval will be granted on a
timely basis, if at all.  The FDA may withdraw product approvals if
compliance with regulatory standards is not maintained or if problems occur
following initial marketing.
  The
results of development, preclinical testing and clinical trials, together with
extensive manufacturing information, are submitted to the FDA as part of an NDA
for approval of the marketing and commercial distribution of the drug. Once the
NDA submission has been accepted for filing, for priority reviews, the FDA has
the goal of reviewing and acting on such NDA filing within 180 days of its
receipt. The review process is often significantly extended by FDA requests for
additional information or clarification. The FDA may refer the NDA to an
advisory committee for review, evaluation and recommendation as to whether the
application should be approved. The FDA is not bound by the recommendation of an
advisory committee, but it generally follows such recommendations. The FDA may
deny approval of an NDA if the applicable regulatory criteria are not satisfied,
or it may require additional clinical testing. Even if data from such testing
are obtained and submitted, the FDA may ultimately decide that the NDA does not
satisfy the criteria for approval. Data from clinical trials are not always
conclusive and the FDA may interpret data differently than we or our
collaboration partners interpret data.  If regulatory approval is
granted, such approval may entail limitations on the indicated uses for which
the product may be marketed.
  Once
issued, the FDA may withdraw drug approval if ongoing regulatory requirements
are not met or if safety problems occur after the drug reaches the market. In
addition, the FDA may require testing, including Phase 4 clinical trials,
and surveillance programs to monitor the effect of approved products that have
been commercialized, and the FDA has the power to prevent or limit further
marketing of a drug based on the results of these post-marketing programs. Drugs
may be marketed only for approved indications and in accordance with the
provisions of the approved label. Further, if there are any modifications to the
drug, including changes in indications, labeling, or manufacturing processes or
facilities, we may be required to submit and obtain FDA approval of a new NDA or
NDA supplement, which may require us to develop additional data or conduct
additional preclinical studies and clinical trials.
  12
  Fast
Track Designation
  FDA’s
fast track program is intended to facilitate the development, and to expedite
the review, of drugs that are intended for the treatment of a serious or
life-threatening condition for which there is no effective treatment and
demonstrate the potential to address unmet medical needs for the condition.
Under the fast track program, the sponsor of a new drug candidate must request
that the FDA designate the drug candidate for a specific indication as a fast
track drug concurrent with or after the filing of the IND for the drug
candidate. The FDA must within 60 days of receipt of the sponsor's request
determine if the drug candidate qualifies for fast track
designation.
  If fast
track designation is obtained, the FDA may initiate review of sections of an NDA
before the application is complete. This rolling review is available if the
applicant provides and the FDA approves a schedule for the submission of the
remaining information and the applicant pays applicable user fees. However, the
time period specified in the Prescription Drug User Fees Act, which governs the
time period goals the FDA has committed to reviewing an application, does not
begin until the complete application is submitted. Additionally, the fast track
designation may be withdrawn by the FDA if the FDA believes that the designation
is no longer supported by data emerging in the clinical trial
process.
  In some
cases, a fast track designated drug candidate may also qualify for one or more
of the following programs:
  •
              Priority
      Review.Under FDA policies, a drug candidate is eligible
      for priority review, or review within six-months from the time a complete
      NDA is accepted for filing, if the drug candidate provides a significant
      improvement compared to marketed drugs in the treatment, diagnosis or
      prevention of a disease. A fast track designated drug candidate would
      ordinarily meet the FDA’s criteria for priority
  review.
  •
              Accelerated
      Approval.Under the FDA’s accelerated approval
      regulations, the FDA is authorized to approve drug candidates that have
      been studied for their safety and efficacy in treating serious or
      life-threatening illnesses and that provide meaningful therapeutic benefit
      to patients over existing treatments based upon either a surrogate
      endpoint that is reasonably likely to predict clinical benefit or on the
      basis of an effect on a clinical endpoint other than patient survival. In
      clinical trials, surrogate endpoints are alternative measurements of the
      symptoms of a disease or condition that are substituted for measurements
      of observable clinical symptoms. A drug candidate approved on this basis
      is subject to rigorous post-marketing compliance requirements, including
      the completion of Phase 4 clinical trials to validate the surrogate
      endpoint or confirm the effect on the clinical endpoint. Failure to
      conduct required post-approval studies, or to validate a surrogate
      endpoint or confirm a clinical benefit during post-marketing studies, will
      allow the FDA to withdraw the drug from the market on an expedited basis.
      All promotional materials for drug candidates approved under accelerated
      regulations are subject to prior review by the
  FDA.
  When
appropriate, we or our collaboration partners may seek fast track designation,
accelerated approval or priority review for voreloxin or our future drug
candidates, if any. We do not
know whether voreloxin or our future drug candidates, if any, will receive a
priority review designation or, if a priority designation is received, whether
that review or approval will be faster than conventional FDA procedures. We also
cannot predict whether voreloxin or our future drug candidates, if any, will
obtain a fast track or accelerated approval designation, or the ultimate impact,
if any, of the fast track or the accelerated approval process on the timing or
likelihood of FDA approval of voreloxin or our future drug candidates, if
any.
  Satisfaction
of FDA regulations and approval requirements or similar requirements of foreign
regulatory agencies typically takes several years, and the actual time required
may vary substantially based upon the type, complexity and novelty of the
product or disease. Typically, if a drug candidate is intended to treat a
chronic disease, as is the case with some of the drug candidates we are
developing, safety and efficacy data must be gathered over an extended period of
time. Government regulation may delay or prevent marketing of drug candidates
for a considerable period of time and impose costly procedures upon our
activities. The FDA or any other regulatory agency may not grant approvals for
new indications for our drug candidates on a timely basis, or at all. Even if a
drug candidate receives regulatory approval, the approval may be significantly
limited to specific disease states, patient populations and dosages. Further,
even after regulatory approval is obtained, later discovery of previously
unknown problems with a drug may result in restrictions on the drug or even
complete withdrawal of the drug from the market. Delays in obtaining, or
failures to obtain, regulatory approvals for any of our drug candidates would
harm our business. In addition, we cannot predict what adverse governmental
regulations may arise from future United States or foreign governmental
action.
  13
  Other
Regulatory Requirements
  Any drugs
manufactured or distributed by us or our collaboration partners pursuant to FDA
approvals are subject to continuing regulation by the FDA, including
recordkeeping requirements and reporting of adverse experiences associated with
the drug. Drug manufacturers and their subcontractors are required to register
with the FDA and certain state agencies, and are subject to periodic unannounced
inspections by the FDA and certain state agencies for compliance with ongoing
regulatory requirements, including cGMPs, which impose certain procedural and
documentation requirements upon us and our third-party manufacturers. Failure to
comply with the statutory and regulatory requirements can subject a manufacturer
to possible legal or regulatory action, such as warning letters, suspension of
manufacturing, seizure of product, injunctive action or possible civil
penalties.
  The FDA
closely regulates the post-approval marketing and promotion of drugs, including
standards and regulations for direct-to-consumer advertising, off-label
promotion, industry-sponsored scientific and educational activities and
promotional activities involving the Internet. A company can make only those
claims relating to safety and efficacy that are approved by the FDA. Failure to
comply with these requirements can result in adverse publicity, warning letters,
corrective advertising and potential civil and criminal penalties. Physicians
may prescribe legally available drugs for uses that are not described in the
drug’s labeling and that differ from those tested by us and approved by the FDA.
Such off-label uses are common across medical specialties, including cancer
therapy. Physicians may believe that such off-label uses are the best treatment
for many patients in varied circumstances. The FDA does not regulate the
behavior of physicians in their choice of treatments. The FDA does, however,
impose stringent restrictions on manufacturers’ communications regarding
off-label use.
  Foreign
Regulation
  In
addition to regulations in the United States, we are subject to foreign
regulations governing clinical trials and commercial sales and distribution of
voreloxin or our future drug candidates, if any. We are currently conducting
clinical trials in Canada and may in the future initiate clinical trials in
countries in the European Union or elsewhere. Whether or not we obtain FDA
approval for a product, we must obtain approval of a product by the comparable
regulatory authorities of foreign countries before we can commence clinical
trials or marketing of the product in those countries. The approval process
varies from country to country, and the time may be longer or shorter than that
required for FDA approval. The requirements governing the conduct of clinical
trials, product licensing, pricing and reimbursement vary greatly from country
to country.
  Under the
Canadian regulatory system, Health Canada is the regulatory body that governs
the sale of drugs for the purposes of use in clinical trials. Accordingly, any
company that wishes to conduct a clinical trial in Canada must submit a clinical
trial application to Health Canada. Health Canada reviews the application and
notifies the company within 30 days if the application is found to be
deficient. If the application is deemed acceptable, Health Canada will issue a
no objection letter to the company within the 30-day review period which means
the company may proceed with its clinical trial(s).
  Under
European Union regulatory systems permission to conduct clinical research is
granted by the Competent Authority of each European Member State, or MS, and the
applicable Ethics Committees, or EC, through the submission of a Clinical Trial
Application. The EC in Europe serves the same function as an IRB in the United
States. The review times vary by MS but may not exceed 60 days. The EC has
a maximum of 60 days to give its opinion on the acceptability of the
Clinical Trial Application to both the governing MS and the sponsor applicant.
If the application is deemed acceptable, the MS informs the applicant (or does
not within the 60 day window inform the applicant of non-acceptance) and
the company may proceed with the clinical trial.
  Under the
European Union regulatory systems, marketing authorizations may be submitted
either under a centralized or mutual recognition procedure. The centralized
procedure provides for the grant of a single marketing authorization that is
valid for all European Union member states. The mutual recognition procedure
provides for mutual recognition of national approval decisions. Under this
procedure, the holder of a national marketing authorization may submit an
application to the remaining member states. Within 90 days of receiving the
application and assessment report, each member state must decide whether to
recognize approval.
  In
addition to regulations in Europe, Canada and the United States, we will be
subject to a variety of other foreign regulations governing clinical trials and
commercial distribution of our current and possible future product candidates.
Our ability to sell drugs will also depend on the availability of reimbursement
from government and private practice insurance companies.
  14
  Research
and Development Expenses
  We
incurred approximately $26.3 million, $36.1 million and
$35.6 million of research and development expenses in 2008, 2007 and 2006,
respectively.  As a result of our June 2008 restructuring and the
resulting wind down of our research activities and focus on voreloxin
development, 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, the development of in-house research capabilities, or on the clinical
development of product candidates other than voreloxin.  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 expenses to conduct further clinical development of
voreloxin.
  Environment
  We have
made, and will continue to make, expenditures for environmental compliance and
protection. In 2008, we incurred approximately $0.3 million in expenses related
to the closure of our laboratory space at 341 Oyster Point Boulevard in South
San Francisco, California, in accordance with environmental laws and
regulations. We do not expect that expenditures for compliance with
environmental laws will have a material effect on our capital expenditures or
results of operations in the future.
  Employees
  As of
December 31, 2008, our workforce consisted of 36 full-time employees, nine
of whom hold Ph.D. or M.D. degrees, and eight of whom hold other advanced
degrees. Of our total workforce, 20 are engaged in development and 16 are
engaged in business development, finance, legal, human resources, facilities,
information technology, administration and general management. We have no
collective bargaining agreements with our employees, and we have not experienced
any work stoppages.
  Corporate
Background
  We were
incorporated in Delaware in February 1998 as Mosaic Pharmaceuticals, Inc.,
and subsequently changed our name to Sunesis Pharmaceuticals, Inc. Our
offices are headquartered at 395 Oyster Point Boulevard, Suite 400, South San
Francisco, California 94080, and our telephone number is (650) 266-3500.
Our website address is www.sunesis.com. Information
contained in, or accessible through, our website is not incorporated by
reference into and does not form a part of this report.
  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 report in weighing a decision 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 adversely affected.  Additional risks
not presently known to us or that we currently believe are immaterial may also
significantly impair our business operations. In addition, the trading price of
our common stock could decline due to the occurrence of any of these risks, and
you may lose all or part of your investment. Please see “Special Note Regarding
Forward-Looking Statements.”
  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.
  15
  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;
 
 ·
              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 our securities of up to $43.5 million, 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 in
two closings.  $10.0 million of units would be sold in the initial
closing, which is expected to occur in the near term, subject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, an additional $5.0 million of units may be sold in the
second closing, which closing may occur at our election or at the election of
the investors 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 to purchase
the units.  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 besubject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, the remaining tranche of $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.
 Assuming
the initial closing for gross proceeds of $10.0 million described above, we
anticipate that the net proceeds from the initial closing, together with our
cash, cash equivalents and marketable securities, will be sufficient to enable
us to fund our operations at least through the end of 2009. In the event the
initial closing in the Private Placement for $10.0 million of units does not
occur, our current cash, cash equivalents and marketable securities are
sufficient to fund our operations only through April 2009.
 While we
expect to complete the initial closing of the Private Placement in the near
term, it is possible that the conditions to the initial closing will
not be met, in which event we will not receive the $10.0 million of gross
proceeds that we expect to receive at that closing.  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.
  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 will hold approximately 54.3% of our outstanding
common stock (assuming conversion of the convertible preferred 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 convertible preferred
at the current conversion price), and will hold approximately 28.3% 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%
of our outstanding common stock (assuming conversion of the convertible
preferred at the current conversion price), and would hold approximately 15% if
the warrants issued at the initial and second closings are exercised in
full.
  Until we
can generate a sufficient amount of product revenue to finance our cash
requirements, which we may never do, we expect to finance future cash needs
primarily through equity issuances (including the possible closings of the sale
of units and common stock 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 sixty percent and implemented a revised operating plan to focus
our efforts on voreloxin, wind down our internal discovery research activities
to streamline our operations and extend our financial resources. 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.
  16
  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.
 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 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 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 balking at buying
stock and corporate bonds and economic growth has slowed. Factors contributing
to a slowing economy appear to be reduced credit availability, falling house
prices and rising prices. If these factors continue to affect equity markets,
our ability to raise capital may be adversely affected.
 
 We
have incurred losses since inception and anticipate that we will continue to
incur losses for the foreseeable future. We may not ever achieve or sustain
profitability.
 
 We are a
clinical-stage biopharmaceutical company with a limited operating history as a
public company. We are not profitable and have incurred losses in each year
since our inception in 1998. Our net loss for the years ended December 31,
2008, 2007 and 2006 was $37.2 million, $38.8 million, and
$31.2 million, respectively. As of December 31, 2008, we had an accumulated
deficit of $316.2 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.
 
 There is a high
risk 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 while we seek a partner or
licensee to support further development.
 
 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.
  17
  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
possibly include temporary clinical hold until the issue has been resolved to
their satisfaction.
  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
AML and ovarian cancer, which can be difficult patient populations to
recruit.
  18
  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 will rely on current inventory to supply our drug product
manufacturing activities. We expect to continue to depend on third-party
contract manufacturers for all our API and 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.
 
 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.
  19
  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 other product candidates in the future
      infringes 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;
 
 ·
                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.
  20
  Some of
the current key competitors to 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 December 31, 2008, we owned,
co-owned or had rights to approximately 233 issued U.S. and foreign patents and
approximately 370 pending U.S. and foreign patent applications. We will be able
to protect our proprietary rights from unauthorized use by third parties only to
the extent that our proprietary technologies and future products are covered by
valid and enforceable patents or are effectively maintained as trade
secrets.
 
 We apply
for patents covering both our technologies and product candidates, as we deem
appropriate. However, we may fail to apply for patents on important technologies
or product candidates in a timely fashion, or at all. Our existing patents and
any future patents we obtain may not be sufficiently broad to prevent others
from practicing our technologies or from developing competing products and
technologies. In addition, we generally do not exclusively control the patent
prosecution of subject matter that we license to or from others. Accordingly, in
such cases we are unable to exercise the same degree of control over this
intellectual property as we would over our own. Moreover, the patent positions
of biopharmaceutical companies are highly uncertain and involve complex legal
and factual questions for which important legal principles remain unresolved. As
a result, the validity and enforceability of patents cannot be predicted with
certainty. In addition, we do not know whether:
  ·
                we,
      our licensors or our collaboration partners were the first to make the
      inventions covered by each of our issued patents and pending patent
      applications;
 
 ·
                we,
      our licensors or our collaboration partners were the first to file patent
      applications for these inventions;
 
 ·
                others
      will independently develop similar or alternative technologies or
      duplicate any of our technologies;
 
 ·
                any
      of our or our licensors’ pending patent applications will result in issued
      patents;
 
 ·
                any
      of our, our licensors’ or our collaboration partners’ patents will be
      valid or enforceable;
 
 ·
                any
      patents issued to us, our licensors or our collaboration partners will
      provide us with any competitive advantages, or will be challenged by third
      parties;
  21
  ·
                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 twenty
five percent in order to reduce expenses. In June 2008, we conducted a second
workforce reduction of approximately sixty percent to focus on the development
of voreloxin. In 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.
 
 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.
  22
  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 directly marketed or sold
voreloxin. 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.
 
 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.
  23
  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 has 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;
 ·
                  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.
  24
  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
and any other 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 voreloxin 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.
 
 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.
  25





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.
 
 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.
 
 On March
31, 2009, we entered intoa 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 includes
up to $15.0 million of units consisting of convertible preferred stock and
warrants to purchase common stock in two closings.  The initial
closing for $10.0 million of unitsis expected to
close in the near term, subject to the satisfaction of customary closing
conditions. Subject to approval by our stockholders, an additional $5.0 million of units may be sold in the
second closing, which
closing may occur at our election or at the election of the investors 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 do not deliver notice to
the investors 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. Notice of an election to complete the
second closing, either by us or the investors, 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 $28.5 million of common stock may be sold in the common equity
closing. The common equity closing may be completed at or prior to the
earlier of December 31, 2010 and a qualifying alternative common stock
financing, subject to approval of a majority of the investors and selling at
least $28.5 million of common stock in the common equity closing. The common
equity closing may also be completed upon the election of the holders of a
majority of the convertible preferred stock prior to a date determined with
reference to our cash balance at certain future
dates.
  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 will hold approximately 54.3% of our outstanding
common stock (assuming conversion of the convertible preferred 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 convertible preferred at the current conversion price), and
will hold approximately 28.3% 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% of our outstanding common stock (assuming
conversion of the convertible preferred at the current conversion
price), and would hold approximately 15% if the warrants issued at
the initial and second closings are exercised in full.
  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 commercializevoreloxin. We plan to continue to finance our operations with a
combination of equity issuances (including the possible closings of the sale of
units and common stock 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.
 26
 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 related to
the convertible preferred to be issued in the Private Placement),
which includes a sale or merger of  Sunesis or a significant
partnering transaction, occurs, the holders of
the convertible preferred 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
consideration 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 convertible preferred would be entitled to the full amount
of any payments made by a corporate partner by surrendering the
convertible preferred, up to the liquidation preference amount, which may
leave us with insufficient resources to continue our business.  This
right of the holders of the convertible preferred 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.
 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 the convertible preferred is outstanding, the holders of the
convertible preferred to be issued in 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, except if 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 convertible preferred and the holders of common stock may be
inconsistent, resulting in the inability to obtain the consent of the holders of
convertible preferred 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 2008,
our common stock 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;
 ·
                  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.
  27
  If we fail to
continue to comply with the listing requirements of The NASDAQ Global Market,
the price of our common stock and our ability to access the capital markets
could be negatively impacted.
  Our
common stock is currently listed on The NASDAQ Global Market. 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 million and stockholders’ equity of at least $10 million. As of December
31, 2008, our stockholders’ equity was $6.5 million.  As a result, we
do not meet The NASDAQ Global Market’s stockholders’ equity listing
requirement.  In the event we complete the first closing contemplated
by the Private Placement, our stockholders’ equity would be in excess of $10
million, which may forestall delisting of the Company by NASDAQ.
  Additionally,
our common stock has traded in the near term 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 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 common stock trades below $5 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 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 listing standards, we may consider transferring to the
NASDAQ Capital Market, provided we met the transfer criteria, which is a lower
tier market, or our common stock may be delisted and traded on the
over-the-counter bulletin board network. Moving our listing to the NASDAQ
Capital Market could adversely affect the liquidity of our common
stock.  If our common stock were to be delisted by NASDAQ, we could
face significant material adverse consequences, including:
 
 ·
              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
  28
  ·
                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 7.5 percent of our outstanding common stock as of March 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.
 
 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
1B.  UNRESOLVED
STAFF COMMENTS
  None.
  ITEM
2.  PROPERTIES
  Prior to
January 15, 2009, we leased approximately 54,000 square feet of office and
laboratory space at 341 Oyster Point Boulevard in South San Francisco,
California, with an initial lease term expiring in June 2013. As a result of the
reorganization and workforce reduction in June 2008, we vacated this building
and consolidated our remaining employees to 395 Oyster Point Boulevard and 349
Allerton Avenue, as described below.  In January 2009, we signed an
agreement for the termination of our lease at 341 Oyster Point Boulevard and
voluntarily surrendered the premises to our landlord.  See Note 17
Subsequent
Events to the Notes to Consolidated Financial Statements for further
information regarding our lease.
  In
December 2006, we leased approximately 15,000 square feet of office space at 395
Oyster Point Boulevard in South San Francisco, California which currently is our
main office. This lease expires in April 2013, subject to our option to extend
the lease through February 2014.
  29
  In
October 2008, we leased approximately 5,500 square feet of laboratory space at
349 Allerton Avenue, South San Francisco, California.  Our lease
expires in October 2010, with an option to extend the lease through October
2012.
  We
believe that our current facilities will be sufficient to meet our needs through
2009.
  ITEM
      3.
              LEGAL
      PROCEEDINGS
  From time
to time, we may be involved in routine legal proceedings, as well as demands,
claims and threatened litigation, that arise in the normal course of our
business. The ultimate outcome of any litigation is uncertain and unfavorable
outcomes could have a negative impact on our results of operations and financial
condition. Regardless of outcome, litigation can have an adverse impact on us
because of the defense costs, diversion of management resources and other
factors.
  We
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
      4.
              SUBMISSION OF MATTERS TO A
      VOTE OF SECURITY HOLDERS
  Not
applicable.
  PART
II
  ITEM
      5.
              MARKET FOR REGISTRANT’S COMMON
      EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
      SECURITIES
  Our
common stock, par value $0.0001 per share, has been traded on the Nasdaq Global
Market, since September 27, 2005, under the symbol SNSS.
  Prior to
such time, there was no public market for our common stock. The following table
sets forth the range of the high and low sales prices by quarter as reported by
the Nasdaq Global Market.
  Year-Ended
      December 31, 2007
                  
                  High
                  
                  
                  LowFirst
      Quarter
                  
                  $
                  5.23
                  
                  
                  $
                  4.04Second
      Quarter
                  
                  $
                  4.70
                  
                  
                  $
                  3.25Third
      Quarter
                  
                  $
                  3.69
                  
                  
                  $
                  2.31Fourth
      Quarter
                  
                  $
                  2.64
                  
                  
                  $
                  1.70
 
 Year-Ended
      December 31, 2008
                    
                    High
                    
                    
                    LowFirst
      Quarter
                    
                    $
                    1.98
                    
                    
                    $
                    1.13Second
      Quarter
                    
                    $
                    2.01
                    
                    
                    $
                    1.26Third
      Quarter
                    
                    $
                    1.82
                    
                    
                    $
                    0.91Fourth
      Quarter
                    
                    $
                    0.95
                    
                    
                    $
                    0.31
  As of
March 20, 2009, there were approximately 207 holders of record of our
common stock. In addition, we believe that a significant number of beneficial
owners of our common stock hold their shares in nominee or in “street name”
accounts through brokers. On March 23, 2009, the last sale price reported
on the Nasdaq Global Market for our common stock was $0.17 per
share.
  Dividend
Policy
  We have
never paid cash dividends on our common stock. We do not anticipate paying any
cash dividends on our capital stock in the foreseeable future. While subject to
periodic review, the current policy of our Board of Directors is to retain cash
and investments primarily to provide funds for our future growth.
  Unregistered
Sales of Equity Securities
  There
were no repurchases of securities or any sales of unregistered equity securities
during the year ended December 31, 2008.
  30




Performance
Graph




The
following graph compares our cumulative total stockholder return since
September 27, 2005 with The NASDAQ Composite Index and The NASDAQ
Biotechnology Index composed of other similarly situated companies. The graph
assumes that the value of the investment in our common stock and each index was
$100.00 on September 27, 2005 and assumes reinvestment of
dividends.  The stock price performance shown on the graph is not
necessarily indicative of future price performance, and we do not make or
endorse any predictions as to future stockholder returns.









The
information presented above in the stock performance graph shall not deemed to
be “soliciting material” or to be “filed” with the Commission or subject to
Regulation 14A or 14C and is not to be incorporated by reference into any
filing by us under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, whether made before or after the date hereof
and irrespective of any general incorporation language in any such
filing.




31




ITEM
      6.
            SELECTED FINANCIAL
      DATA




The
following selected financial data should be read in conjunction with
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and our consolidated financial statements and notes to those
statements included elsewhere in this report.




Year Ended December 31,2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004(In thousands, except per share amounts)Consolidated
      Statement of Operations:Revenues:Collaboration
      revenue
              
              $
              4,917
              
              
              $
              1,576
              
              
              $
              6,353
              
              
              $
              7,395
              
              
              $
              5,938Collaboration
      revenue from related party
              
              
              —
              
              
              
              7,587
              
              
              
              7,318
              
              
              
              9,018
              
              
              
              4,201License
      revenue
              
              
              500
              
              
              
              500
              
              
              
              —
              
              
              
              —
              
              
              
              —Grant
      and fellowship revenue
              
              
              —
              
              
              
              —
              
              
              
              38
              
              
              
              109
              
              
              
              166Total
      revenues
              
              
              5,417
              
              
              
              9,663
              
              
              
              13,709
              
              
              
              16,522
              
              
              
              10,305Operating
      expenses:Research
      and development
              
              
              26,285
              
              
              
              36,060
              
              
              
              35,615
              
              
              
              36,166
              
              
              
              23,616General
      and administrative
              
              
              11,524
              
              
              
              13,570
              
              
              
              12,255
              
              
              
              8,283
              
              
              
              7,352Restructuring
      and impairment charges
              
              
              5,783
              
              
              
              1,563
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
      operating expenses
              
              
              43,592
              
              
              
              51,193
              
              
              
              47,870
              
              
              
              44,449
              
              
              
              30,968Loss
      from operations
              
              
              (38,175
              )
              
              
              (41,530
              )
              
              
              (34,161
              )
              
              
              (27,927
              )
              
              
              (20,663
              )Interest
      income
              
              
              929
              
              
              
              2,972
              
              
              
              3,395
              
              
              
              1,092
              
              
              
              518Interest
      expense
              
              
              (172
              )
              
              
              (210
              )
              
              
              (478
              )
              
              
              (674
              )
              
              
              (387
              )Other
      income (expense), net
              
              
              232
              
              
              
              7
              
              
              
              7
              
              
              
              10
              
              
              
              2Net
      loss
              
              
              (37,186
              )
              
              
              (38,761
              )
              
              
              (31,237
              )
              
              
              (27,499
              )
              
              
              (20,530
              )Convertible
      preferred stock deemed dividend
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (88,092
              )
              
              
              —Loss
      applicable to common stockholders
              
              $
              (37,186
              )
              
              $
              (38,761
              )
              
              $
              (31,237
              )
              
              $
              (115,591
              )
              
              $
              (20,530
              )Basic
      and diluted loss per share applicable to common
    stockholders
              
              $
              (1.08
              )
              
              $
              (1.20
              )
              
              $
              (1.13
              )
              
              $
              (17.41
              )
              
              $
              (15.77
              )Shares
      used in computing basic and diluted loss per share applicable to common
      stockholders
              
              
              34,387,177
              
              
              
              32,340,203
              
              
              
              27,758,348
              
              
              
              6,637,935
              
              
              
              1,302,096





As of December 31,Consolidated Balance Sheet Data:
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004(In thousands)Cash,
      cash equivalents and marketable securities
              
              $
              10,619
              
              
              $
              47,684
              
              
              $
              63,105
              
              
              $
              48,333
              
              
              $
              36,812Working
      capital
              
              
              5,371
              
              
              
              39,707
              
              
              
              55,279
              
              
              
              40,156
              
              
              
              27,707Total
      assets
              
              
              12,784
              
              
              
              53,246
              
              
              
              69,276
              
              
              
              54,708
              
              
              
              43,026Long-term
      portion of equipment leases
              
              
              —
              
              
              
              1,353
              
              
              
              956
              
              
              
              1,306
              
              
              
              4,438Convertible
      preferred stock
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              108,813Common
      stock and additional paid-in capital
              
              
              322,675
              
              
              
              320,583
              
              
              
              298,077
              
              
              
              249,692
              
              
              
              6,494Accumulated
      deficit
              
              
              (316,192
              )
              
              
              (279,006
              )
              
              
              (240,245
              )
              
              
              (209,008
              )
              
              
              (93,417
              )Total
      stockholders’ equity (deficit)
              
              
              6,491
              
              
              
              41,394
              
              
              
              56,804
              
              
              
              38,466
              
              
              
              (90,044
              )




ITEM
      7.
            MANAGEMENT’S DISCUSSION AND
      ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS




The
following discussion and analysis of our financial condition as of
December 31, 2008 and results of operations for the year ended
December 31, 2008 should be read together with our 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 Exchange Act of 1934, as amended, that involve risks,
uncertainties and assumptions. All statements, other than statements of
historical facts, are “forward-looking statements” for purposes of these
provisions, including any projections of revenue, expenses or other financial
items, 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.




32




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. Since 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, ceasing development of  an
enhanced fragment-based discovery platform, and reduced our workforce by
approximately 60 percent.




We are
currently advancing voreloxin through Phase 2 development. Voreloxin is a
first-in-class anticancer 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 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 advanced 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 Bristol-Myers Squibb Company,
or BMS.  In December 2008, we notified BMS that we were terminating
the license agreement for SNS-032.  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.




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 our securities of up to $43.5 million, 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 in
two closings.  $10.0 million of units would be sold in the initial
closing, which is expected to occur in the near term, subject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, an additional $5.0 million of units may be sold in the
second closing, which closing may occur at our election or at the election of
the investors 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 to purchase
the units.  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 besubject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, the remaining tranche of $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.




In
conjunction with the Private Placement, the investors have been granted a number
of rights, including the right to approve any sale of the company, any issuance
of debt or preferred stock and, except if certain conditions are met, any
issuance of common stock other than the second closing and the common stock
financing described above, and the right to appoint three of eight members of
our Board of Directors following the initial closing and five of nine
members of our Board of Directors following the second closing, if
completed.




33




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
million. 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.  We still hold a
series of secured convertible notes issued by SARcode having a total principal
value of $1 million.  We had discontinued our LFA-1 antagonist program
in 2004 when we focused our research and development efforts on
oncology.




Our fragment-based discovery approach,
called Tethering® formed the basis of several strategic research and development
collaborations entered into between 2002 and 2004, including collaborations with
Biogen Idec, Inc., or Biogen Idec, Johnson & Johnson Pharmaceutical Research
& Development, L.L.C., or J&JPRD, and Merck & Co., Inc., or 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.
J&JPRD is entitled to terminate the collaboration
agreement without cause upon 180 days’ written notice.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 December 31,
2008, we had an accumulated deficit of $316.2 million, including a deemed
dividend of $88.1 million recorded in conjunction with our IPO in
September 2005. We expect our significant net losses to continue for the
foreseeable future, as we continue to conduct development of, and seek
regulatory approvals for, voreloxin.





Critical
Accounting Policies and the Use of Estimates




The
accompanying discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements and the related
disclosures, which have been prepared in accordance with U.S. generally accepted
accounting principles. The preparation of these consolidated financial
statements requires our management to make estimates, assumptions and judgments
that affect the amounts reported in our financial statements and accompanying
notes, including reported amounts of assets, liabilities and expenses and the
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements, as well as revenue and expenses during the reporting
periods. We evaluate our estimates, assumptions and judgments on an ongoing
basis. We base our estimates on historical experience and on various other
assumptions 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. Management has
discussed the development, selection and disclosure of these estimates with the
Audit Committee of our Board of Directors. Actual results could differ
materially from these estimates under different assumptions or
conditions.




Our
significant accounting policies are more fully described in Note 1 to our
consolidated financial statements included elsewhere in this report. We believe
the following critical accounting policies reflect our more significant
estimates and assumptions used in the preparation of our consolidated financial
statements.




Revenue
Recognition




In
accordance with Emerging Issues Task Force, or EITF, 00-21, “Accounting for Revenue Arrangements
with Multiple Deliverable”, which we adopted effective July 1, 2003,
revenue arrangements with multiple deliverable items are divided into separate
units of accounting based on whether certain criteria are met, including whether
the delivered item has stand-alone value to the customer and whether there is
objective and reliable evidence of the fair value of the undelivered items. We
allocate the consideration we receive among the separate units of accounting
based on their respective fair value, and we apply the applicable revenue
recognition criteria to each of the separate units. Where an item in a revenue
arrangement with multiple deliverables does not constitute a separate unit of
accounting and for which delivery has not occurred, we defer revenue until the
delivery of the item is completed.




We record
upfront, non-refundable license fees and other fees received in connection with
research and development collaborations as deferred revenue and recognize these
amounts ratably over the relevant period specified in the agreements, generally
the research term.




We
recognize research funding related to collaborative research with our
collaboration partners as the related research services are performed. This
funding is normally based on a specified amount per full-time equivalent
employee per year.




We
recognize revenue from milestone payments, which are substantially at risk at
the time the collaboration agreement is entered into and performance-based at
the date of the collaboration agreement, upon completion of the applicable
milestone events. We intend to recognize any future royalty revenue, if any,
based on reported product sales by third-party licensees.




34




We
recognize grant revenue from government agencies and private research
foundations as the related qualified research and development costs are
incurred, up to the limit of the prior approval funding amounts.




Clinical
Trial Accounting




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




Stock-Based
Compensation




We grant
options to purchase common stock to our employees, directors and consultants
under our stock option plans. Eligible employees can also purchase shares of
common stock at 85 percent of the lower of the fair market value of the
common stock at the beginning of an offering period or at the purchase date
under our 2005 Employee Stock Purchase Plan.




Upon
adoption of FAS 123R, we retained our method of valuation for share-based
awards granted using the Black-Scholes option-pricing model or Black-Scholes
Model. Our determination of fair value of share-based payment awards on the date
of grant using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of highly complex and subjective variables. These
variables include, but are not limited to, our expected stock price volatility
over the term of the awards and actual and projected employee stock option
exercise behaviors. Changes in these input variables would affect the amount of
expense associated with stock-based compensation.




FAS 123R
requires the cash flows resulting from the tax benefits related to tax
deductions in excess of the compensation costs recognized for these options
(excess tax benefits) to be classified as financing cash flows.




Recent
Accounting Pronouncements




Fair
Value Measurements




In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” or
SFAS 157. SFAS 157 establishes a common definition for fair value, creates
a framework for measuring fair value, and expands disclosure requirements about
such fair value measurements. Effective January 1, 2008, we adopted SFAS 157 for
financial assets and liabilities recognized at fair value on a recurring basis.
The adoption of SFAS 157 for financial assets and liabilities did not have a
material impact on our financial statements. See Note 14, Fair Value Measurements,to the Notes to
Consolidated Financial Statements for information and related disclosures
regarding our fair value measurements.





In
February 2008, the FASB issued Statement of Financial Position (FSP) No. 157-2,
which delays the effective date of FAS 157 for non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at
fair value on a recurring basis (items that are remeasured at least annually).
The FSP deferred the effective date of FAS 157 for non-financial assets and
non-financial liabilities until our fiscal year beginning on January 1, 2009. We
do not expect the adoption of FAS 157 for non-financial assets and non-financial
liabilities to have a material effect on our consolidated financial
statements.




Accounting
for Advance Payments for Goods or Services to Be Used in Future Research and
Development




In June
2007, the Emerging Issues Task Force issued EITF Issue 07-03, “Accounting for
Advance Payments for Goods or Services to Be Used in Future Research and
Development,” or EITF 07-03. EITF 07-03 addresses the diversity which
exists with respect to the accounting for the non-refundable portion of a
payment made by a research and development entity for future research and
development activities. Under EITF 07-03, an entity would defer and capitalize
non-refundable advance payments made for research and development activities
until the related goods are delivered or the related services are performed.
EITF 07-03 was effective for fiscal years beginning after December 15, 2007
and interim periods within those years. The adoption of EITF 07-03 did not have
a material impact on our financial statements.




35




Accounting
for Collaborative Agreements




In
December 2007, the EITF reached a consensus on EITF Issue 07-01 “Accounting for
Collaborative Agreements,” or EITF 07-01. EITF 07-01 defines collaborative
arrangements and establishes reporting requirements for transactions between
participants and third parties in a collaborative arrangement. EITF 07-01
prohibits companies from applying the equity method of accounting to activities
performed outside a separate legal entity by a virtual joint venture. Instead,
revenues and costs incurred with third parties in connection with the
collaborative arrangement should be presented gross or net by the collaborators
based on the criteria in EITF Issue No. 99-19,“Reporting Revenue
Gross as a Principal versus Net as an Agent,” and other applicable accounting
literature. The consensus should be applied to collaborative arrangements in
existence at the date of adoption using a modified retrospective method that
requires reclassification in all periods presented for those arrangements still
in effect at the transition date, unless that application is impracticable. The
consensus is effective for fiscal years beginning after December 15,
2008. We do not expect the adoption of EITF 07-01 to have a material
impact on our financial statements.





Overview
of Revenues




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. To date, our revenue has consisted of collaboration revenue,
license revenue and grant and fellowship revenue.




Collaboration
Revenue.  In the past we have generated revenue primarily
through our collaborations consisting principally of research funding and
milestones paid by our collaborators, substantially offsetting our related
research and development expenses. We are no longer conducting any research
activities in connection with any of our collaborations and are no longer
receiving research funding in any collaboration.  As a result of our
2008 restructuring and the resulting wind down of our research activities to
focus our resources and efforts on the advancement of voreloxin, we do not
anticipate conducting any research activities in connection with any future
strategic collaboration or receiving any research funding.




We are
entitled to receive milestone payments under our collaborations with Biogen
Idec, J&JPRD and Merck if one or more of these collaborators achieve a
milestone for which a payment is due to us. Milestone payments earned under
collaborations totaled $4.8 million in 2006, and $1.0 million in each
of 2007 and 2008.  We may in the future receive royalty payments
based on future sales of products, if any, resulting from these collaborations.
However, none of the products under these collaborations have yet entered
clinical testing in humans.  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 the parties 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.




The table
below sets forth our revenue since January 1, 2006 from each of these
collaborators.




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006(In thousands)Biogen
      Idec
                  
                  $
                  4,310
                  
                  
                  $
                  7,587
                  
                  
                  $
                  7,318Merck
                  
                  
                  107
                  
                  
                  
                  1,576
                  
                  
                  
                  6,353J&J
      PRD
                  
                  
                  500
                  
                  
                  
                  —
                  
                  
                  
                  —Total
                  
                  $
                  4,917
                  
                  
                  $
                  9,163
                  
                  
                  $
                  13,671




Our
collaboration revenue, if any, will be substantially lower 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.  We do
not expect to generate royalty revenue from these collaborations in the
foreseeable future, if at all.  See Note 4 Strategic
Collaborative Agreements, to Notes to Consolidated Financial Statements
for more information regarding our strategic collaborations.




Grant and Fellowship
Revenue.  Grant and fellowship revenue is recognized as we
perform services under the applicable grant. Since inception, we had been
awarded an aggregate of $5.4 million in federal grants, and had recognized
$2.5 million as revenue from such grants and other significantly smaller
grants and fellowships.  Grant and fellowship revenues for the period
ended December 31, 2006 was under $0.1 million. There was no grant and
fellowship revenue recognized in 2007 or 2008 and we do not expect to
recognize any grant and fellowship revenue in future years.




36




License
Revenue.  Under our license agreement with SARcode, we
recognized total cash payments of  $1.0 million in license
fees,$0.5 million in each of 2007 and 2008. We also received a series of three
secured notes, with a total principal value of $1.0 million, which are
convertible into preferred stock of SARcode.  We did not record these
notes which are due in 2012, as revenue due to uncertainty of collectibility. In
March 2009, we announced that we sold our interest in all of the patents and
related know-how that had been the subject of the license agreement to SARcode
for a total cash consideration of $2 million.  As a result, the
license with SARcode was terminated and we will not receive any future license
fees, milestones or royalties under that license.




Overview
of Operating Expenses




Research and Development
Expense.  Most of our operating expenses to date have been for
research and development activities. Past research and development expense
primarily represents costs incurred:




•
            in
      the discovery and development of novel small molecule therapeutics and the
      advancement of product candidates towards clinical trials, including the
      Phase 1 and Phase 2 clinical trial costs for voreloxin and the
      Phase 1 clinical trial costs for SNS-032 and
  SNS-314,




•
            in
      the development of our proprietary fragment-based Tethering drug discovery
      approach and other novel fragment-based drug discovery
      methods,




•
            in
      the development of in-house research, preclinical study and development
      capabilities,




•
            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.




The table
below sets forth our research and development expense annually since
January 1, 2006.




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006(In thousands)Voreloxin
                  
                  $
                  16,544
                  
                  
                  $
                  13,699
                  
                  
                  $
                  8,420SNS-032
                  
                  
                  3,480
                  
                  
                  
                  3,723
                  
                  
                  
                  5,446SNS-314
                  
                  
                  2,004
                  
                  
                  
                  4,563
                  
                  
                  
                  5,238Discovery
      programs and new technologies
                  
                  
                  2,233
                  
                  
                  
                  4,128
                  
                  
                  
                  3,762Other
      kinase inhibitors
                  
                  
                  1,997
                  
                  
                  
                  8,785
                  
                  
                  
                  10,728RAF
      kinase inhibitors
                  
                  
                  4
                  
                  
                  
                  881
                  
                  
                  
                  1,482Other
      programs
                  
                  
                  23
                  
                  
                  
                  275
                  
                  
                  
                  213BACE
      inhibitors for Alzheimer’s disease
                  
                  
                  —
                  
                  
                  
                  4
                  
                  
                  
                  316TNF
      family and oncology research
                  
                  
                  —
                  
                  
                  
                  2
                  
                  
                  
                  3Cathepsin
      S inhibitors
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  7Total
                  
                  $
                  26,285
                  
                  
                  $
                  36,060
                  
                  
                  $
                  35,615




We have
incurred research and development expense associated with both our internal
research and development activities and in the conduct of activities we were
required to perform in connection with our strategic collaborations. Each of our
collaborations involved research funding to us which substantially offset the
related research and development expenses.




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 twelve 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 untreated elderly
and Phase 2 clinical trial in ovarian cancer.  As of the date of this
report, 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.




37




In
addition, we are currently focused on trials in voreloxin of 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 can not 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.




General and Administrative
Expense.  Our general and administrative expense consists
primarily of salaries and other related costs for personnel in finance, human
resources, facilities management, 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. In 2009, we expect general and
administrative expenses to be further reduced.




Restructuring and Impairment
Expenses.  In the second quarter of 2008, we implemented a
corporate realignment to focus on the development
of  voreloxin.  In conjunction with this strategic
restructuring, we expanded our late stage development leadership team, announced
the winding down of internal discovery research activities and reduced our
workforce by approximately 60 percent.  All terminated employees were
awarded severance payments and continuation of benefits, based on length of
service, and career transition assistance.  We also consolidated our
remaining employees in our leased premises at 395 Oyster Point Boulevard and 349
Allerton Avenue and vacated our former research and development facility at 341
Oyster Point Boulevard in February 2009.




On March
30, 2009, the Compensation Committee of our Board of Directors, in conjunction
with the closing of the Private Placement, committed to a restructuring
plan that will result in a reduction in force affecting six employees, including
two executives: Valerie Pierce, Senior Vice President and General Counsel, and
Dr. Lesley Stolz, Vice President, Business and Corporate Development. In
addition, Dr. Jim Young is retiring as Executive Chairman and will continue to
serve on the Board of Directors as non-executive Chairman. Employees directly
affected by the restructuring plan have received notification and will be
provided with severance payments. We expect to complete the
restructuring plan in April 2009.
  As a
result of the restructuring plan, we estimate that we will record a
one-time restructuring charge of approximately $0.6 million in the first quarter
of 2009 for severance and other personnel-related expenses. 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. The restructuring charge that we expect to incur in connection
with the restructuring is subject to a number of assumptions, and actual results
may materially differ. We may also incur other material charges not
currently contemplated due to events that may occur as a result of, or
associated with, the restructuring plan.




Results
of Operations




Years
Ended December 31, 2008 and 2007




Revenue.  Total
revenue decreased to $5.4 million in 2008 from $9.7 million in 2007.
Collaboration revenue decreased to $4.9 million in 2008 from
$9.2 million in 2007, primarily due to (i) a $3.3 million decrease in
collaboration revenue from Biogen Idec resulting from the June 2008 termination
of the research phase of our collaboration and (ii) a $1.5 million decrease in
research revenue from our BACE program with Merck.  Partially
offsetting the decrease in collaboration revenue in 2008 was a milestone payment
from J&JPRD for the selection of a compound targeting the Cathepsin S enzyme
using our proprietary Tethering technology.  We expect
that  we will have substantially lower collaboration revenue, if any,
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.




Research and development
expense.  Research and development expense decreased to $26.3
million in 2008 from $36.1 million in 2007. This decrease is primarily due to
(i) a $0.9 million decrease in expenses under our Raf kinase inhibitors program,
(ii) a $6.8 million decrease in expenses under our other kinase inhibitors
discovery programs, (iii) a $2.6 million decrease in clinical trial activity
related to SNS-314, (iv) a $0.2 million decrease in clinical trial activity
related to SNS-032, (v) a $1.9 million decrease in expenses under discovery and
new technology and (vi) a $0.3 million decrease in expenses under other
programs.  These decreases were partially offset by a $2.9 million
increase in voreloxin expenses due to increased clinical development
activities.  We expect that we will continue to incur significant
expenses related to the development of voreloxin in 2009 and future years;
however research and development expenses may be lower in 2009 compared to 2008
as a result of our focus on voreloxin.




38




General and administrative
expense.  General and administrative expense decreased to
$11.5 million in 2008 from $13.6 million in 2007. The decrease was
primarily due to reduced headcount resulting in (i) a $2.1 million
decrease in employee-related expenses, (ii) a $0.3 million decrease in
office-related expenses and (iii) a $0.1 million decrease in
professional services.  These decreases were partially offset by a
$0.4 million increase in facilities and related expenses.  We
expect general and administrative expenses to be further reduced in
2009.




Restructuring and impairment
charge.  In 2008, we recorded a $5.8 million restructuring
charge, comprised of $5.9 million related to the restructuring plan announced
and implemented in June 2008 and $0.3 million of facility exit costs related to
2007 restructuring, partially offset by a $0.4 million reversal of the 2007
restructuring related to the Company’s facilities exit costs.  The
2008 restructuring charge consists of (i) $3.6 million related to employee
severance and related benefit costs, including a non-cash portion of
approximately $0.4 million related to stock-based compensation, and (ii) $2.3
million related to asset impairment and facility exit costs.  Cash
restructuring costs for 2008 totaled approximately $4.0 million, or 68 percent
of the $5.9 million restructuring charge.  In 2007, we recorded a
$1.6 million restructuring charge related to the restructuring plan
announced and implemented in August 2007. The 2007 restructuring charge
consisted of (i) $0.9 million in severance and related personnel
termination costs, (ii) $0.1 million related to the extension of
option exercise periods to 16 months for terminated employees, (iii) a
$0.3 million write-off of leasehold improvements, and (iv) a
$0.3 million accrual for lease obligations for the facility located at 395
Oyster Point Boulevard that at the time in 2007 we were not utilizing. Cash
restructuring costs totaled approximately $1.1 million, or 69 percent
of the $1.6 million restructuring charge, in 2007.




Interest income and
expense.  Interest income decreased to $0.9 million in
2008 from $3.0 million in 2007, primarily due to lower average balances of
cash, cash equivalents and marketable securities during 2008, as well as lower
average interest rates.  We expect 2009 interest income to be
significantly lower due to lower average balances of cash, cash equivalents and
marketable securities.  Interest expense was $0.2 million for both
2008 and 2007.  Interest expense was comparable for both years due to
higher interest rates on lower outstanding debt obligation in 2008, compared to
lower interest rates on higher outstanding debt obligations in
2007.  We expect 2009 interest expense will be significantly lower
compared to 2008 because the Company’s debt obligation was paid off in
2008.




Years
Ended December 31, 2007 and 2006




Revenue.  Total
revenue decreased to $9.7 million in 2007 from $13.7 million in 2006.
Collaboration revenue decreased to $9.2 million in 2007 from
$13.7 million in 2006, primarily due to a $4.8 million decrease in
collaboration revenue from Merck in 2007, offset by a $0.3 million increase
in collaboration revenue from Biogen Idec in 2007 and $0.5 million in
license revenue from SARcode in 2007. The decrease in collaboration revenue from
Merck resulted primarily from the fact that a $4.3 million milestone
payment was made by Merck in 2006, as compared to a milestone payment of
$1.0 million in 2007. The $0.3 million increase in collaboration
revenue from Biogen Idec resulted primarily from increased payments for
scientific personnel working on the collaboration. The license revenue from
SARcode resulted from the out-licensing of our LFA-1 inhibitor
program.




Research and development
expense.  Research and development expense increased to $36.1
million in 2007 from $35.6 million in 2006. Research and development expense
associated with voreloxin increased to $13.7 million in 2007 from $8.4 million
in 2006 due to increased clinical trial activity. The remainder of the increase
was due to a $0.3 million increase in expenses under discovery programs and new
technologies due to increased work on our proprietary technologies and discovery
programs. The increases in research and development expense in 2007 over 2006
were offset by (i) a decrease of $1.7 million in SNS-032 expenses, primarily
because 2006 expense included a $2.0 million non-cash license payment, (ii) a
decrease of $0.6 million in SNS-314 expenses due to a reduced number of research
employees working on this program, partially offset by increased outside
services expense related to clinical studies, (iii) a $2.9 million in
expenses  for all other programs  due to a decrease in
expenses related to Raf and other kinase inhibitor programs.




General and administrative
expense.  General and administrative expense increased to
$13.6 million in 2007 from $12.3 million in 2006. The increase was
primarily due to (i) a $0.9 million increase in employee-related
expenses, (ii) a $0.3 million increase in non-cash stock-based
compensation expense, and (iii) a $0.2 million increase in office and
related expenses, primarily from computer and software expenditures, which were
partially offset by a $0.1 million decrease in professional services
expense.




Restructuring and impairment
charge.  In 2007, we recorded a $1.6 million restructuring
charge related to the restructuring plan announced and implemented in August
2007. The restructuring charge consists of (i) $0.9 million in
severance and related personnel termination costs, (ii) $0.1 million
related to the extension of option exercise periods to 16 months for
terminated employees, (iii) a $0.3 million write-off of leasehold
improvements, and (iv) a $0.3 million accrual for lease obligations
for a facility that we were not then utilizing. Cash restructuring costs totaled
approximately $1.1 million, or 69 percent of the $1.6 million
restructuring charge.




39




Interest income and
expense.  Interest income decreased to $3.0 million in
2007 from $3.4 million in 2006, primarily due to lower average balances of
cash, cash equivalents and marketable securities. The decrease was partially
offset by higher interest rates. Interest expense decreased to $0.2 million
in 2007 from $0.5 million in 2006, primarily due to the recognition of
$0.3 million non-cash interest expense in 2006 related to our venture loan
with Oxford Finance Corporation and Horizon Technology Funding Company LLC
in 2006.




Income
Taxes




We apply
the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” or SFAS
109.  Under SFAS 109, deferred tax liabilities or assets arise from a
difference between the tax basis of liabilities or assets and the basis for
financial reporting.  Deferred tax liabilities and assets are measured
using enacted tax rates expected to apply to taxable income in the years in
which temporary differences are expected to be recovered or
settled.  A valuation allowance is provided for deferred tax assets
for more likely than not they will be realized.




Since
inception, we have incurred operating losses and, accordingly, have not recorded
a provision for income taxes for any of the periods presented. As of
December 31, 2008, we had net operating loss carryforwards for federal and
state income tax purposes of $201.6 million and $102.9 million,
respectively. We also had federal research and development tax credit
carryforwards of $4.9 million and state research and development tax credit
carryforwards of $4.9 million. If not utilized, the federal net operating
loss and tax credit carryforwards will expire at various dates beginning in
2018, and the state net operating loss will expire beginning in 2009. The state
research and development tax credit carryforwards do not expire. Utilization of
the net operating loss and tax credits carryforwards may be subject to a
substantial annual limitation due to the ownership change limitations provided
by Section 382 of the Internal Revenue Code of 1986, as amended, that are
applicable if we experience a substantial “ownership change,” which may occur,
for example, as a result of the IPO and other sales of our stock including our
March 31, 2009 Private Placement (see Note 17, Subsequent
Events) and similar state provisions. The annual limitation may
result in the expiration of net operating losses and credits before utilization.
If a substantial change in our ownership is deemed to have occurred or occurs in
the future, our ability to use our net loss carryforwards in any year may be
limited.




In
January 1, 2007, we adopted FASB Financial Interpretation No. 48, or
FIN 48. The adoption of FIN 48 had no impact to our financial
statements.  As of December 31, 2008, we recognized no material
adjustment in income taxes payable and unrecognized tax benefits because we have
incurred net operating losses and have not been subject to income tax since
inception.




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.




As of
December 31, 2008, we had cash, cash equivalents and marketable securities
of $10.6 million and no outstanding debt.




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 our securities of up to $43.5 million, 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 in
two closings.  $10.0 million of units would be sold in the initial
closing, which is expected to occur in the near term, subject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, an additional $5.0 million of units may be sold in the
second closing, which closing may occur at our election or at the election of
the investors 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 to purchase
the units.  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 besubject to the
satisfaction of customary closing conditions.  Subject to the approval
of our stockholders, the remaining tranche of $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.




Assuming
the initial closing  for gross proceeds of $10.0 million described
above, we anticipate that the net proceeds from the initial closing, together
with our cash, cash equivalents and marketable securities, will be sufficient to
enable us to fund our operations at least through the end of 2009. In the event
the initial closing in the Private Placement for $10.0 million of units does not
occur, our current cash, cash equivalents and marketable securities are
sufficient to fund our operations only through April 2009.




40




Cash
Flows




Net cash
used in operating activities was $35.5 million in 2008, compared to cash
used of $34.5 million and $27.1 million in the years ended
December 31, 2007 and 2006, respectively. The net cash used in operating
activities for 2008 resulted primarily from a net loss of $37.2 million,
changes in operating assets and liabilities of $3.0 million and gain from
the sale of assets held-for-sale of $0.2 million, partially offset by adjustment
for non-cash items of $3.0 million and non-cash restructuring charges of
$1.9 million that resulted from our asset impairment as a part of our 2008
restructuring plan. Net cash used in operating activities for 2007 resulted
primarily from net loss of $38.8 million and changes in operating assets
and liabilities of $1.0 million, partially offset by an adjustment for
non-cash items of $4.9 million and non-cash restructuring charges of $0.4
million resulting from an asset impairment as part of our 2007 restructuring
plan.  Net cash used in operating activities for 2006 resulted
primarily from a net loss of $31.2 million and changes in operating assets
and liabilities of $2.3 million, partially offset by adjustments for
non-cash items of $4.5 million and a non-cash milestone payment of $2.0
million related to in-license of SNS-032.




Net cash
provided by investing activities was $32.3 million in 2008 compared to cash
provided of $19.7 million and cash used of $28.7 million for the years ended
December 31, 2007 and 2006, respectively.  The net cash provided by
investing activities for 2008 resulted primarily from net proceeds from the
maturity of marketable maturities of $31.6 million and $0.9 million from
proceeds from the sale of assets held-for sale, partially offset by capital
expenditures of $0.2 million.  The net cash provided by investing
activities for 2007 resulted primarily from net proceeds from the maturity of
marketable maturities of $21.2 million, partially offset by capital
expenditures of $1.5 million. Net cash used in investing activities for
2006 primarily reflects net purchases of marketable securities of
$26.4 million and capital expenditures of $2.3 million.




Net cash
used in financing activities was $2.2 million in 2008 compared to cash provided
of $20.5 million in 2007 and $44.1 million in 2006.  The net cash used
in by financing activities for 2008 resulted primarily from net payments of $2.3
million on equipment loans, partially offset by net proceeds of $0.1 million
from the sale of common stock to employees.  The  net cash
provided by financing activities in 2007 primarily resulted from net proceeds
from the issuance of common stock of $19.5 million in 2007 in a public
offering, partially offset by net borrowing on equipment loans of
$1.0 million. The net cash provided by financing activities in 2006
primarily resulted from net proceeds of $43.7 million from the private
placement of common stock and warrants completed in March 2006 and
$1.0 million in net proceeds from the sale of common stock to employees,
partially offset by net payments of $0.5 million on equipment
loans.




Credit
and Loan Arrangements




In June
2000, we entered into an equipment financing agreement with General Electric
Capital Corporation, or GECC. Various credit lines were issued under the
financing agreement since 2000. In November 2008, the outstanding balance of
approximately $1.5 million was fully paid off prior to the sale of our
held-for-sale assets and no credit lines remain available under this
agreement.  Our outstanding debt balance was $0 and $2.3 million
as of December 31, 2008 and 2007, respectively.  Our interest rates on
the debt balance ranged from 7.53 percent to 10.61 percent per annum
in 2007 and 2008.




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
United States Food and Drug Administration or FDA, or similar regulatory agency
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.




41




Assuming
the initial closing for gross proceeds of $10.0 million as described above,
we anticipate that the net proceeds of the initial closing, together with our
cash, cash equivalents and marketable securities, will be sufficient to enable
us to fund our operations at least through the end of 2009. In the
event the initial closing in the Private Placement for $10.0 million of units
does not occur, our current cash, cash equivalents and marketable securities,
are sufficient to fund our operations only through April 2009.




Until we
can generate a sufficient amount of product revenue to finance our cash
requirements, which we may never do, we expect to finance future cash
needs primarily through equity issuances (including the possible
closings of the sale of units and common stock 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 December 31, 2008 relate to the leases for
three facilities in South San Francisco, California.
 
 In
December 2006, we leased approximately 15,000 square feet of additional 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.
 
 In May
2000, we entered into operating lease for an office and laboratory space at 341
Oyster Point Boulevard, which was to expire by its terms in June
2013.  After our workforce reduction in June 2008, we moved our
remaining employees to 395 Oyster Point Boulevard and 349 Allerton
Avenue.  On January 15, 2009, we entered into an agreement to
terminate this lease with our landlord.  Pursuant to the terms of the
lease termination agreement, we agreed to pay an aggregate fee of approximately
$2.2 million in consideration of the early termination.
 
 The cost
of this lease termination is expected to be recorded as a restructuring expense
in our financial statements for the first quarter of 2009.
 
 The
following table discloses aggregate information about our contractual
obligations and the periods in which payments are due as of December 31, 2008
(in thousands):
  Payment
      Due by PeriodTotal
              
              
              Less
      than
                  1
      Year
              
              
              1-3
      Years
              
              
              3-5
      Years
              
              
              More
      than
                  5
      yearsOperating
      lease obligations
              
              
              4,303
              
              
              
              2,798
              
              
              
              966
              
              
              
              540
              
              
              
              —
  The
contractual summary above reflects only payment obligations that are fixed and
determinable. It includes the $2.2 million termination fee related to early
termination of the lease for the facility located at 341 Oyster Point Boulevard
which we paid to our landlord in January 2009.  We have additional
contractual payments obligations relating to clinical trial milestones and
product candidate development that are contingent on future events.
 
 We also
have agreements with clinical sites and contract research organizations for the
conduct of our clinical trials. We generally make payments to these sites and
organizations based upon the procedures to be performed in the particular
clinical trial, the number of patients enrolled and the period of follow-up
required for patients in the trial.




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.




42




ITEM
7A:  QUALITATIVE AND
QUANTITATIVE DISCLOSURES ABOUT MARKET RISK




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




ITEM
8:  FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA




Index
to Consolidated Financial Statements




PageReport
      of Independent Registered Public Accounting Firm
            44Consolidated
      Balance Sheets
            45Consolidated
      Statements of Operations
            46Consolidated
      Statements of Stockholders’ Equity
            47Consolidated
      Statements of Cash Flows
            48Notes
      to Consolidated Financial Statements
            49




43




Report
of Independent Registered Public Accounting Firm




The Board
of Directors and Stockholders of Sunesis Pharmaceuticals, Inc.




We have
audited the accompanying consolidated balance sheets of Sunesis
Pharmaceuticals, Inc. as of December 31, 2008 and 2007, and the
related consolidated statements of operations, stockholders’ equity, and cash
flows for each of the three years in the period ended December 31, 2008.
These consolidated financial statements are the responsibility of Sunesis
Pharmaceuticals, Inc.’s management. Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.




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




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sunesis
Pharmaceuticals, Inc. at December 31, 2008 and 2007, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2008, in conformity with U.S. generally accepted
accounting principles.




As
discussed in Note 1 to the consolidated financial statements, the Company’s
recurring operating losses raise substantial doubt about its ability to continue
as a going concern.  Management’s plans as to these matters are
described in Note 1.  The 2008 consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.




/s/
ERNST & YOUNG, LLP




San Jose,
California


March 30,
2009








44




SUNESIS
PHARMACEUTICALS, INC.




CONSOLIDATED
BALANCE SHEETS




December 31,2008
              
              
              2007ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              6,296,942
              
              
              $
              11,726,126Marketable
      securities
              
              
              4,321,844
              
              
              
              35,957,933Prepaids
      and other current assets
              
              
              934,429
              
              
              
              945,583Total
      current assets
              
              
              11,553,215
              
              
              
              48,629,642Property
      and equipment, net
              
              
              612,241
              
              
              
              4,238,498Assets
      held-for-sale
              
              
              470,547
              
              
              
              —Deposits
      and other assets
              
              
              147,826
              
              
              
              377,798Total
      assets
              
              $
              12,783,829
              
              
              $
              53,245,938LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable and other accrued liabilities
              
              $
              4,207,923
              
              
              $
              4,515,426Accrued
      compensation
              
              
              537,215
              
              
              
              2,225,868Current
      portion of deferred rent
              
              
              1,409,513
              
              
              
              —Current
      portion of deferred revenue
              
              
              27,083
              
              
              
              1,227,031Current
      portion of equipment financing
              
              
              —
              
              
              
              953,940Total
      current liabilities
              
              
              6,181,734
              
              
              
              8,922,265Non-current
      portion of equipment financing
              
              
              —
              
              
              
              1,352,684Non-current
      portion of deferred rent
              
              
              110,919
              
              
              
              1,576,734Commitments
      (Note 11)Stockholders’
      equity:Preferred
      stock, $0.0001 par value; 5,000,000 shares authorized, no shares issued
      and outstanding at December 31, 2008 and 2007
              
              
              —
              
              
              
              —Common
      stock, $0.0001 par value; 100,000,000 shares authorized, 34,409,768 shares
      issued and outstanding at December 31, 2008; 100,000,000 shares
      authorized, 34,364,896 shares issued and outstanding at December 31,
      2007
              
              
              3,441
              
              
              
              3,437Additional
      paid-in capital
              
              
              322,671,604
              
              
              
              320,579,240Deferred
      stock-based compensation
              
              
              —
              
              
              
              (251,601
              )Accumulated
      other comprehensive income
              
              
              7,841
              
              
              
              69,262Accumulated
      deficit
              
              
              (316,191,710
              )
              
              
              (279,006,083
              )Total
      stockholders’ equity
              
              
              6,491,176
              
              
              
              41,394,255Total
      liabilities and stockholders’ equity
              
              $
              12,783,829
              
              
              $
              53,245,938




See
accompanying notes to consolidated financial statements.




45




SUNESIS
PHARMACEUTICALS, INC.




CONSOLIDATED
STATEMENTS OF OPERATIONS




Year Ended December 31,2008
              
              
              2007
              
              
              2006Revenue:Collaboration
      revenue
              
              $
              4,917,340
              
              
              $
              1,576,610
              
              
              $
              6,353,585Collaboration
      revenue from related party (Note 4)
              
              
              —
              
              
              
              7,586,903
              
              
              
              7,317,700License
      revenue
              
              
              500,000
              
              
              
              500,000
              
              
              
              —Grant
      and fellowship revenue
              
              
              —
              
              
              
              —
              
              
              
              37,901Total
      revenues
              
              
              5,417,340
              
              
              
              9,663,513
              
              
              
              13,709,186Operating
      expenses:Research
      and development
              
              
              26,285,294
              
              
              
              36,060,470
              
              
              
              35,615,536General
      and administrative
              
              
              11,524,198
              
              
              
              13,569,578
              
              
              
              12,254,892Restructuring
      and impairment charges
              
              
              5,782,903
              
              
              
              1,563,274
              
              
              
              —Total
      operating expenses
              
              
              43,592,395
              
              
              
              51,193,322
              
              
              
              47,870,428Loss
      from operations
              
              
              (38,175,055
              )
              
              
              (41,529,809
              )
              
              
              (34,161,242
              )Interest
      income
              
              
              929,114
              
              
              
              2,971,666
              
              
              
              3,394,751Interest
      expense
              
              
              (171,308
              )
              
              
              (209,885
              )
              
              
              (477,643
              )Other
      income, net
              
              
              231,622
              
              
              
              7,108
              
              
              
              6,873Net
      loss
              
              $
              (37,185,627
              )
              
              $
              (38,760,920
              )
              
              $
              (31,237,261
              )Basic
      and diluted loss per share
              
              $
              (1.08
              )
              
              $
              (1.20
              )
              
              $
              (1.13
              )Shares
      used in computing basic and diluted loss per share
              
              
              34,387,177
              
              
              
              32,340,203
              
              
              
              27,758,348




See
accompanying notes to consolidated financial statements.




46




SUNESIS
PHARMACEUTICALS, INC.


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY




Common Stock
                
                
                Additional
                  Paid-In
                
                
                Deferred
                  Stock
                
                
                Accumulated
                  Other
                  Comprehensive
                  Income
                
                
                Accumulated
                
                
                Total
                  Stockholders’Shares
                
                
                Amount
                
                
                Capital
                
                
                Compensation
                
                
                (Loss)
                
                
                Deficit
                
                
                EquityBalance
      at December 31, 2005
                
                
                21,511,126
                
                
                $
                2,151
                
                
                $
                249,689,714
                
                
                $
                (2,162,688
                )
                
                $
                (55,073
                )
                
                $
                (209,007,902
                )
                
                $
                38,466,202Issuance
      of common stock pursuant to stock options exercises at $1.28 to $5.25 per
      share, including vesting of stock options exercised early
                
                
                126,844
                
                
                
                13
                
                
                
                318,143
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                318,156Expense
      related to fair value of restricted stock award granted to
      non-employee
                
                
                2,001
                
                
                
                —
                
                
                
                11,367
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                11,367Reversal
      of deferred stock-based compensation related to employee stock option
      grants
                
                
                —
                
                
                
                —
                
                
                
                (432,872
                )
                
                
                432,872
                
                
                
                —
                
                
                
                —
                
                
                
                —Amortization
      deferred stock-based compensation
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                723,212
                
                
                
                —
                
                
                
                —
                
                
                
                723,212Stock-based
      compensation expenses related to fair value of options granted to
      non-employees
                
                
                —
                
                
                
                —
                
                
                
                100,470
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                100,470Stock-based
      compensation expenses related to fair value of options granted to
      employees
                
                
                —
                
                
                
                —
                
                
                
                2,046,655
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                2,046,655Issuance
      of common stock for Employee Stock Purchase Program
                
                
                145,632
                
                
                
                14
                
                
                
                652,918
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                652,932Issuance
      of common stock to BMS at $4.95 per share in connection with in-licensing
      arrangement
                
                
                404,040
                
                
                
                41
                
                
                
                1,999,958
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,999,999Issuance
      of common stock to investors at $6.21 per share for cash in March, 2006,
      net of issuance costs of $1,613,471
                
                
                7,246,377
                
                
                
                725
                
                
                
                43,657,543
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                43,658,268Issuance
      of common stock pursuant to warrant exercise at $4.25 per
      share
                
                
                7,059
                
                
                
                —
                
                
                
                30,000
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                30,000Components
      of comprehensive loss:Net
      loss
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (31,237,261
                )
                
                
                (31,237,261
                )Unrealized
      gain on investments
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                33,697
                
                
                
                —
                
                
                
                33,697Comprehensive
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (31,203,564
                )Balance
      at December 31, 2006
                
                
                29,443,079
                
                
                
                2,944
                
                
                
                298,073,896
                
                
                
                (1,006,604
                )
                
                
                (21,376
                )
                
                
                (240,245,163
                )
                
                
                56,803,697Issuance
      of common stock pursuant to stock options exercises at $0.43 to $2.55 per
      share, including vesting of stock options exercised early
                
                
                68,913
                
                
                
                8
                
                
                
                161,008
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                161,016Reversal
      of deferred stock-based compensation related to employee stock option
      grants
                
                
                —
                
                
                
                —
                
                
                
                (76,980
                )
                
                
                76,980
                
                
                
                —
                
                
                
                —
                
                
                
                —Amortization
      deferred stock-based compensation
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                633,023
                
                
                
                —
                
                
                
                —
                
                
                
                633,023Stock-based
      compensation expenses related to fair value of options granted to
      non-employees
                
                
                —
                
                
                
                —
                
                
                
                2,394
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                2,394Stock-based
      compensation expenses related to fair value of options granted to
      employees
                
                
                —
                
                
                
                —
                
                
                
                2,468,898
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                2,468,898Stock-based
      compensation expenses related to fair value of options acceleration and
      extension of exercisable period from restructuring
                
                
                —
                
                
                
                —
                
                
                
                126,456
                
                
                
                45,000
                
                
                
                —
                
                
                
                —
                
                
                
                171,456Issuance
      of common stock for Employee Stock Purchase Program
                
                
                102,904
                
                
                
                10
                
                
                
                301,055
                
                
                
                —
                
                
                
                —
                
                
                
                
                
                
                
                301,065Issuance
      of common stock to pursuant to second public offer at $4.43 per share in
      June, 2007, net of issuance costs of $1,519,513
                
                
                4,750,000
                
                
                
                475
                
                
                
                19,522,513
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                19,522,988Components
      of comprehensive loss:Net
      loss
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                
                
                
                
                (38,760,920
                )
                
                
                (38,760,920
                )Unrealized
      gain on investments
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                90,638
                
                
                
                —
                
                
                
                90,638Comprehensive
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (38,670,282
                )Balance
      at December 31, 2007
                
                
                34,364,896
                
                
                
                3,437
                
                
                
                320,579,240
                
                
                
                (251,601
                )
                
                
                69,262
                
                
                
                (279,006,083
                )
                
                
                41,394,255Issuance
      of  stock to employees
                
                
                70
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Reversal
      of deferred stock-based compensation related to employee stock option
      grants
                
                
                —
                
                
                
                —
                
                
                
                (28,500
                )
                
                
                28,500
                
                
                
                —
                
                
                
                —
                
                
                
                —Amortization
      deferred stock-based compensation
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                223,101
                
                
                
                —
                
                
                
                —
                
                
                
                223,101Stock-based
      compensation expenses related to fair value of options granted to
      non-employees
                
                
                —
                
                
                
                —
                
                
                
                828
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                828Stock-based
      compensation expenses related to fair value of options granted to
      employees
                
                
                —
                
                
                
                —
                
                
                
                1,686,827
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,686,827Stock-based
      compensation expenses related to fair value of option vesting acceleration
      and extension of exercisable period resulting from
      restructuring
                
                
                —
                
                
                
                —
                
                
                
                366,637
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                366,637Issuance
      of common stock for Employee Stock Purchase Program
                
                
                44,802
                
                
                
                4
                
                
                
                66,572
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                66,576Components
      of comprehensive loss:Net
      loss
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (37,185,627
                )
                
                
                (37,185,627
                )Unrealized
      gain on investments
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (61,421
                )
                
                
                —
                
                
                
                (61,421
                )Comprehensive
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (37,247,048
                )Balance
      at December 31, 2008
                
                
                34,409,768
                
                
                $
                3,441
                
                
                $
                322,671,604
                
                
                $
                —
                
                
                $
                7,841
                
                
                $
                (316,191,710
                )
                
                $
                6,491,176




See
accompanying notes to consolidated financial statements.




47




SUNESIS
PHARMACEUTICALS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS




Year Ended December 31,2008
              
              
              2007
              
              
              2006Cash
      flows from operating activitiesNet
      loss
              
              $
              (37,185,627
              )
              
              $
              (38,760,920
              )
              
              $
              (31,237,261
              )Adjustments
      to reconcile loss to net cash used in operating
activities:Depreciation
      and amortization
              
              
              1,103,848
              
              
              
              1,728,714
              
              
              
              1,582,315Stock
      compensation expense
              
              
              1,910,755
              
              
              
              3,189,048
              
              
              
              2,881,704Non-cash
      research and development expense
              
              
              —
              
              
              
              —
              
              
              
              1,999,999Non-cash
      restructuring and impairment charges
              
              
              1,937,821
              
              
              
              359,865
              
              
              
              —Gain
      on sale of assets held-for-sale
              
              
              (180,563
              )
              
              
              —
              
              
              
              —Gain
      on disposal of property and equipment
              
              
              (8,548
              )
              
              
              (5,949
              )
              
              
              —Changes
      in operating assets and liabilities:Prepaids
      and other current assets
              
              
              11,154
              
              
              
              138,064
              
              
              
              985,378Deposits
      and other assets
              
              
              229,972
              
              
              
              (17,824
              )
              
              
              (59,974
              )Accounts
      payable and other accrued liabilities
              
              
              (334,868
              )
              
              
              1,076,004
              
              
              
              117,256Accrued
      compensation
              
              
              (1,688,653
              )
              
              
              (97,874
              )
              
              
              255,973Deferred
      rent and other non-current liabilities
              
              
              (56,302
              )
              
              
              111,832
              
              
              
              93,556Deferred
      revenue
              
              
              (1,199,948
              )
              
              
              (2,176,606
              )
              
              
              (3,703,581
              )Net
      cash used in operating activities
              
              
              (35,460,959
              )
              
              
              (34,455,646
              )
              
              
              (27,084,635
              )Cash
      flows from investing activitiesPurchases
      of property and equipment, net
              
              
              (179,148
              )
              
              
              (1,511,425
              )
              
              
              (2,304,717
              )Purchases
      of marketable securities
              
              
              (25,902,749
              )
              
              
              (92,679,521
              )
              
              
              (68,035,554
              )Proceeds
      from maturities of marketable securities
              
              
              57,477,417
              
              
              
              113,841,425
              
              
              
              41,669,113Proceeds
      from sale of assets held-for-sale
              
              
              865,433
              
              
              
              —
              
              
              
              —Proceeds
      from property and equipment disposal
              
              
              10,870
              
              
              
              5,119
              
              
              
              —Net
      cash provided by (used in) investing activities
              
              
              32,271,823
              
              
              
              19,655,598
              
              
              
              (28,671,158
              )Cash
      flows from financing activitiesProceeds
      from borrowings under equipment financing
              
              
              —
              
              
              
              1,481,611
              
              
              
              563,132Payments
      on borrowing under equipment financing
              
              
              (2,306,624
              )
              
              
              (1,015,955
              )
              
              
              (1,095,711
              )Proceeds
      from issuance of common stock and exercise of stock
options
              
              
              66,576
              
              
              
              19,985,069
              
              
              
              44,659,356Net
      cash (used in) provided by financing activities
              
              
              (2,240,048
              )
              
              
              20,450,725
              
              
              
              44,126,777Net
      (decrease) increase in cash and cash equivalents
              
              
              (5,429,184
              )
              
              
              5,650,677
              
              
              
              (11,629,016
              )Cash
      and cash equivalents at beginning of period
              
              
              11,726,126
              
              
              
              6,075,449
              
              
              
              17,704,465Cash
      and cash equivalents at end of period
              
              $
              6,296,942
              
              
              $
              11,726,126
              
              
              $
              6,075,449Supplemental
      disclosure of cash flow informationInterest
      paid
              
              $
              187,946
              
              
              $
              193,247
              
              
              $
              224,992Non-cash
      activities:Deferred
      stock-based compensation, net of (reversal)
              
              $
              (28,500
              )
              
              $
              (76,980
              )
              
              $
              (432,872
              )




See
accompanying notes to consolidated financial statements.




48




SUNESIS
PHARMACEUTICALS, INC.




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




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. In January 2007, the Company formed a
wholly-owned subsidiary, Sunesis Europe Limited, a United Kingdom
corporation.




Need
to Raise Additional Capital




The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. The Company has incurred
significant losses and negative cash flows from operations since its inception.
At December 31, 2008, the Company had an accumulated deficit of
$316.2 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 possible closings of the sale
of units and common stock described in Note 17 below, Subsequent Events, and subject
to the satisfaction of the conditions described in Note 17 below, Subsequent
Events), debt arrangements, a possible partnership or license of
development and/or commercialization rights to voreloxin and, in the long term,
product sales and royalties. In the
event the initial closing for $10.0 million of units does not occur in the
Company’s
private placement described in Note 17 below, Subsequent Events, the
Company’s cash, cash equivalents and marketable securities are
sufficient to fund its operations only through April
2009.




Principles
of Consolidation




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




Use
of Estimates




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




Clinical
Trial Accounting




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




49




Cash
Equivalents and Marketable Securities




The
Company considers all highly liquid securities with original maturities of three
months or less from the original date of purchase to be cash equivalents, which
consist of money market funds and corporate debt securities. Marketable
securities consist of securities with original maturities greater than three
months, and at times may consist of money market funds, corporate debt
securities and U.S. government obligations.




Management
determines the appropriate classification of securities at the time of purchase.
The Company has classified its entire investment portfolio as
available-for-sale. The Company views its available-for-sale portfolio as
available for use in current operations. Accordingly, the Company has classified
all investments as short-term, even though the stated maturity may be one year
or more beyond the current balance sheet date. Available-for-sale securities are
carried at fair value with unrealized gains and losses reported in accumulated
other comprehensive income (loss) as a separate component of stockholders’
equity. The estimated fair values have been determined by the Company using
available market information.




The
amortized cost of securities is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is included in interest
income. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities, if any, are recorded in
other income (expense), net.  The cost of securities sold is based on
the specific-identification methods. Interest and dividends are included in
interest income.




Concentrations
of Credit Risk and Financial Instruments




The
Company invests cash that is not currently being used for operational purposes
in accordance with its investment policy. The policy allows for the purchase of
low risk debt securities issued by U.S. government agencies and very highly
rated banks and corporations, subject to certain concentration limits. The
maturities of these securities are maintained at no longer than 18 months.
The Company believes its established guidelines for investment of its excess
cash maintain safety and liquidity through its policies on diversification and
investment maturity.




Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash and cash equivalents and available-for-sale
marketable securities.  The carrying amounts of cash equivalents and
available-for-sale marketable securities approximate fair value due to their
short-term nature.




The
Company is exposed to credit risk in the event of default by the institutions
holding the cash, cash equivalents, and available-for-sale securities to the
extent of the amounts recorded on the balance sheets.




Property
and Equipment




Property
and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is determined using the straight-line method over the
estimated useful lives of the respective assets, generally three to five years.
Leasehold improvements are amortized on a straight-line basis over the shorter
of their estimated useful lives or the term of the lease.




Stock-Based
Payments




The
Company grants options to purchase common stock to its employees, directors and
consultants under its stock option plans. Eligible employees can also purchase
shares of common stock at 85 percent of the lower of the fair market value
of the common stock at the beginning of an offering period or at the purchase
date under the Company’s 2005 Employee Stock Purchase Plan, or
ESPP.




50




On
January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), “Share-Based Payment,”or
FAS 123R.  Under FAS 123R, share-based compensation cost is
measured at the grant date, based on the estimated fair value of the award, and
is recognized as expense over the employee’s requisite service period. The
Company has no outstanding awards with market or performance conditions. For
compensation cost recognized during the year ended December 31, 2008, 2007
and 2006, the Company included: (a) compensation cost for all share-based
payments granted subsequent to the initial filing of the Company’s Form S-1
on December 23, 2004, but not yet vested as of January 1, 2006, based
on the grant date fair value estimated in accordance with the original
provisions of SFAS No. 123 (as defined below) and amortized on a
straight-line basis over the options’ vesting period; and (b) compensation
cost for all share-based payments granted subsequent to January 1, 2006,
based on the grant-date fair value estimated in accordance with the provisions
of FAS 123R amortized on a straight-line basis over the options’ vesting
period reduced by estimated forfeitures. FAS 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. The Company reviews
its forfeiture estimates on a quarterly basis.  Under the prospective
transition method, options granted prior to the initial filing of the Company’s
Form S-1 will continue to be accounted for in accordance with APB 25
and Financial Accounting Standards Board, or FASB, Interpretation No. 44 or
FIN 44, “Accounting for Certain Transactions
Involving Stock-Based Compensation, an Interpretation of APB No. 25”, which
were the accounting principles originally applied to those awards.




The
Company’s determination of fair value of share-based payment awards on the date
of grant using Black-Scholes option-pricing model is affected by the Company’s
stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
Company’s expected stock price volatility over the term of the awards, and
actual and projected employee stock option exercise behaviors.




Comprehensive
Income (Loss)




The
Company displays comprehensive income (loss) and its components as part of the
statement of stockholders’ equity. Comprehensive income (loss) is comprised of
income (loss) and unrealized gains (losses) on available-for-sale
securities.




Revenue
Recognition




In
accordance with Emerging Issues Task Force, or EITF, 00-21, “Accounting
for Revenue Arrangements with Multiple Deliverables”, which
the Company adopted effective July 1, 2003, revenue arrangements with
multiple deliverable items are divided into separate units of accounting based
on whether certain criteria are met, including whether the delivered item has
stand-alone value to the customer and whether there is objective and reliable
evidence of the fair value of the undelivered items. The Company allocates the
consideration it receives among the separate units of accounting based on their
respective fair value, and applies the applicable revenue recognition criteria
to each of the separate units. Where an item in a revenue arrangement with
multiple deliverables does not constitute a separate unit of accounting and for
which delivery has not occurred, the Company defers revenue until the delivery
of the item is completed.




Upfront,
non-refundable license fees and other fees received in connection with research
and development collaboration are recorded as deferred revenue and recognized
ratably over their relevant periods specified in the agreements, generally the
research term.




Research
funding related to collaborative research with the Company’s collaboration
partners is recognized as the related research services are performed. This
funding is normally based on a specified amount per full-time equivalent
employee per year.




Revenue
from milestone payments, which are substantially at risk at the time the
collaboration agreement is entered into and performance-based at the date of the
collaboration agreement, is recognized upon completion of the applicable
milestone events. We intend to recognize future royalty revenue, if any, based
on reported product sales by third-party licensees.




Grant
revenues from government agencies and private research foundations are
recognized as the related qualified research and development costs are incurred,
up to the limit of the prior approval funding amounts.




Research
and Development




All
research and development costs, including those funded by third parties, are
expensed as incurred. Research and development costs consist of salaries,
employee benefits, laboratory supplies, costs associated with clinical trials,
including amounts paid to clinical research organizations, other professional
services and facility costs.




51




Income
Taxes




Effective
January 1, 2007, the Company adopted FASB Interpretation No. 48,
“Accounting for Uncertainty in
Income Taxes—an Interpretation of FASB Statement No. 109,” or
FIN 48. FIN 48 addresses recognition and measurement on uncertain tax
positions that the Company has taken or expects to take on tax returns using a
more-likely-than-not threshold. The Company accounts for income taxes under the
liability method. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial reporting and tax
bases of assets and liabilities and are measured using the enacted tax rates
that will be in effect when the differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amounts expected to be realized. The Company’s policy is to recognize interest
charges and penalties under other expense.




Long-Lived
Assets




The
Company periodically assesses the impairment of long-lived assets in accordance
with the provisions of SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets,”
or SFAS 144. A review for impairment is performed whenever events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable, such as a significant industry or economic downturn,
significant changes in the manner of use of the acquired assets or the strategy
for the Company’s overall business.




If
indicators of impairment exist, recoverability is assessed by comparing the
estimated undiscounted cash flows resulting from the use of the asset and its
eventual disposition against its carrying amount. If the aggregate undiscounted
cash flows are less than the carrying amount of the asset, the resulting
impairment charge to be recorded is calculated based on the excess of the
carrying value of the asset over the fair value of such asset, with fair value
determined based on an estimate of discounted future cash flows or other
appropriate measure of fair value. For the years ended December 31, 2008
and 2007, the Company recorded approximately $1.6 million and $0.3 million,
respectively, of impairment charges resulted from the Company’s restructuring
activities (see Note 6 Restructuring).  No
impairment charge was recorded in 2006.




Recent
Accounting Pronouncements




Fair
Value Measurements




In
September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements,” or
SFAS 157. SFAS 157 establishes a common definition for fair value, creates
a framework for measuring fair value, and expands disclosure requirements about
such fair value measurements. Effective January 1, 2008, the Company adopted
SFAS 157 for financial assets and liabilities recognized at fair value on a
recurring basis. The adoption of SFAS 157 for financial assets and liabilities
did not have a material impact on the Company’s financial statements. See Note
14, Fair Value Measurements,to the Consolidated
Financial Statements for information and related disclosures regarding the
Company’s fair value measurements.





In
February 2008, the FASB issued Statement of Financial Position or FSP No. 157-2,
which delays the effective date of SFAS 157 for non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at
fair value on a recurring basis (items that are remeasured at least annually).
The FSP deferred the effective date of SFAS 157 for non-financial assets and
non-financial liabilities until the Company’s fiscal year beginning on January
1, 2009. The Company does not expect the adoption of SFAS 157 for non-financial
assets and non-financial liabilities to have a material effect on its
consolidated financial statements.




Accounting
for Advance Payments for Goods or Services to Be Used in Future Research and
Development




In June
2007, the Emerging Issues Task Force issued EITF Issue 07-03, “Accounting for Advance Payments for Goods or
Services to Be Used in Future Research and Development,” or EITF 07-03.
EITF 07-03 addresses the diversity which exists with respect to the
accounting for the non-refundable portion of a payment made by a research and
development entity for future research and development activities. Under EITF
07-03, an entity would defer and capitalize non-refundable advance payments made
for research and development activities until the related goods are delivered or
the related services are performed. EITF 07-03 was effective for fiscal years
beginning after December 15, 2007 and interim periods within those years.
The adoption of EITF 07-03 did not have a material impact on the Company’s
financial statements.




52




Accounting
for Collaborative Agreements




In
December 2007, the EITF reached a consensus on EITF Issue 07-01 “Accounting for Collaborative Agreements,” or
EITF 07-01. EITF 07-01 defines collaborative arrangements and establishes
reporting requirements for transactions between participants and third parties
in a collaborative arrangement. EITF 07-01 prohibits companies from applying the
equity method of accounting to activities performed outside a separate legal
entity by a virtual joint venture. Instead, revenues and costs incurred with
third parties in connection with the collaborative arrangement should be
presented gross or net by the collaborators based on the criteria in EITF Issue
No. 99-19,“Reporting Revenue Gross as a Principal versus Net as
an Agent,” and other applicable accounting literature. The consensus
should be applied to collaborative arrangements in existence at the date of
adoption using a modified retrospective method that requires reclassification in
all periods presented for those arrangements still in effect at the transition
date, unless that application is impracticable. The consensus is effective for
fiscal years beginning after December 15, 2008. The adoption of EITF
07-01 is not expected to have a material impact on the Company’s
financial statements.




2.
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 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 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:




Year Ended December 31,2008
              
              
              2007
              
              
              2006Historical
      Numerator:Net
      loss
              
              $
              (37,185,627
              )
              
              $
              (38,760,920
              )
              
              $
              (31,237,261
              )Denominator:Weighted-average
      common shares outstanding
              
              
              34,387,177
              
              
              
              32,340,203
              
              
              
              27,758,348Basic
      and diluted loss per share
              
              $
              (1.08
              )
              
              $
              (1.20
              )
              
              $
              (1.13
              )Outstanding
      securities not included in diluted loss per share
    calculationsOptions
      to purchase common stock
              
              
              4,650,955
              
              
              
              5,099,847
              
              
              
              3,942,435Warrants
              
              
              2,660,845
              
              
              
              2,693,237
              
              
              
              2,693,2377,311,800
              
              
              
              7,793,084
              
              
              
              6,635,672




3.
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.




In
addition to upfront payments of $0.7 million and milestone payments of
$0.5 million made through December 31, 2008, 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.




53




If the
Company discontinues seeking regulatory approval and/or the sale of the product
in a region, the Company is  required to return to Dainippon its
rights to the product in that region. The agreement may be terminated by either
party for the other party’s uncured breach or bankruptcy.




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, or IPO, 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
trial 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, on December 18, 2008, the Company notified BMS
that the Company was terminating the license agreement and returning SNS-032 to
BMS.  The termination of the license agreement was effective 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 focused its
research and development efforts on oncology.




Pursuant
to the license agreement, the Company received total cash payments of
$1.0 million in license fees, $0.5 million in each of 2008 and
2007.  The Company recorded these receipts as revenue.  In
addition, the Company received three secured notes, with a total principal value
of $1.0 million, that are convertible into preferred stock of
SARcode.  The Company did not record these notes receivable from
SARcode, which are due in 2012, 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 (see Note 17
Subsequent
Events).  In connection with the sale, the license agreement
was terminated.   Sunesis continues to hold a series of secured
convertible notes issued by SARcode having a total principal value of $1
million.




4.
Strategic Collaborative Agreements




Biogen
Idec, Inc.




In August
2004, the Company entered into a collaboration agreement with 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 the Company’s proprietary Tethering technology to generate small
molecule leads, and received research funding of approximately $1.2 million per
quarter, subject to inflation adjustments, 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 will no longer receive research funding from
Biogen Idec.  In addition, the Company received a $7.0 million upfront
technology access fee from Biogen Idec and, through December 31, 2008 had
received a total of $1.0 million in milestone payments for meeting certain
preclinical milestones, including a $0.5 million milestone received in
2008.  In addition 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 fully
diluted shares outstanding for the years ended at December 31, 2008 and
2007.




54




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 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,
L.L.C.




In May
2002, the Company entered into a collaboration agreement with
Johnson & Johnson Pharmaceutical Research & Development, L.L.C., or
J&JPRD, to discover, develop and commercialize small molecule inhibitors of
Cathepsin S, an enzyme that is important in regulating an inflammatory response.
Under the terms of the agreement, the Company received a
non-refundable and non-creditable technology access fee and certain research
funding paid in advance quarterly. Costs associated with research and
development activities attributable to this agreement approximated the research
funding recognized. The research term of this collaboration ended in December
2005 and the Company is no longer receiving research funding from
J&JPRD.
 
 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 $24.5 million, as well as
royalty payments depending on product sales. To date, J&JPRD has made
milestone payments totaling $0.8 million, including a 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
$6.8 million under this collaboration.
 
 In the
first quarter of 2009, J&JPRD informed the Company that it has
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.  J&JPRD
is entitled to terminate the agreement without cause upon 180 days’ written
notice.




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 important for the progression of Alzheimer’s
disease. The research term of the collaboration ended in February 2006 and the
Company is no longer receiving research funding.  Accordingly, the
upfront, non-refundable and non-creditable technology access fee was recognized
as revenue over the 36-month term of the agreement ending February 2006. To
date, the Company has received payments totaling $19.0 million under this
collaboration.  However, 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. In June 2006 and May 2007,
the Company received milestone payments of $4.3 million and
$1.0 million, respectively, from Merck for meeting certain preclinical
milestones related to BACE.  No milestones were received from Merck in
2008.




Although
the research term of the collaboration has ended, the agreement with Merck
extends for so long as a product arising from the collaboration is the subject
of an active development project or for so long as there is an obligation to pay
royalties under the agreement.  Merck continues to examine
collaboration compounds in preclinical studies; however, none have advanced to
clinical studies to date.  The agreement may be terminated by Merck at
any time upon three months’ notice to the Company.




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.




The
agreement provides for a payment by Merck to the Company of an upfront
technology access fee and annual license fees for the Company’s consulting
services and ongoing access to Tethering as a means of identifying additional
compounds for the treatment of viral infections. Merck receives an exclusive
worldwide license to any products resulting from the
collaboration.  To date, the Company has received $3.3 million under
this collaboration, including an upfront, non-refundable and non-creditable
technology access fee of $2.3 million, which was recognized as revenue over
the initial three-year research term. The Company also received annual license
fees aggregating $1.0 million through December 31, 2008.  No
further annual license fees are payable to us under the agreement.




55




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




In
connection with the above collaboration agreements, the Company recognized the
following revenues in the years ending December 31, 2006, 2007 and 2008, which
include the amortization of upfront fees received, research funding, and
milestones earned:




Year Ended December 31,2008
                
                
                2007
                
                
                2006Biogen
      Idec
                
                $
                4,310,551
                
                
                $
                7,586,903
                
                
                $
                7,317,700Merck
                
                
                106,789
                
                
                
                1,576,610
                
                
                
                6,353,585J&JPRD
                
                
                500,000
                
                
                
                —
                
                
                
                —$
                4,917,340
                
                
                $
                9,163,513
                
                
                $
                13,671,285




56




5.
Marketable Securities




The
following is a summary of available-for-sale securities:




December 31, 2008
              
              Amortized
                  Cost
              
              
              Gross
                  Unrealized
                  Gains
              
              
              Gross
                  Unrealized
                  Losses
              
              
              Estimated Fair
                  ValueMoney
      market funds
              
              $
              5,417,903
              
              
              $
              —
              
              
              $
              —
              
              
              $
              5,417,903Government
      securities
              
              
              4,833,109
              
              
              
              6,804
              
              
              
              (76
              )
              
              
              4,839,837Commercial
      paper
              
              
              248,857
              
              
              
              1,113
              
              
              
              —
              
              
              
              249,970Total
              
              
              10,499,869
              
              
              
              7,917
              
              
              
              (76
              )
              
              
              10,507,710Less
      amounts classified as cash equivalents
              
              
              6,185,942
              
              
              
              —
              
              
              
              (76
              )
              
              
              6,185,866Total
      marketable securities
              
              $
              4,313,927
              
              
              $
              7,917
              
              
              $
              —
              
              
              $
              4,321,844





December 31,
      2007
              
              Amortized
                  Cost
              
              
              Gross
                  Unrealized
                  Gains
              
              
              Gross
                  Unrealized
                  Losses
              
              
              Estimated
      Fair
                  ValueMoney
      market funds
              
              $
              9,182,908
              
              
              $
              —
              
              
              $
              —
              
              
              $
              9,182,908Corporate
      debt obligations
              
              
              6,355,814
              
              
              
              1,081
              
              
              
              (929
              )
              
              
              6,355,966Commercial
      paper
              
              
              31,354,113
              
              
              
              69,592
              
              
              
              (483
              )
              
              
              31,423,222Total
              
              
              46,892,835
              
              
              
              70,673
              
              
              
              (1,412
              )
              
              
              46,962,096Less
      amounts classified as cash equivalents
              
              
              11,004,282
              
              
              
              —
              
              
              
              (119
              )
              
              
              11,004,163Total
      marketable securities
              
              $
              35,888,553
              
              
              $
              70,673
              
              
              $
              (1,293
              )
              
              $
              35,957,933




There
were no realized gains or losses on the sale of available-for-sale securities
for the years ended December 31, 2008, 2007 or 2006.




At
December 31, 2008, the contractual maturities of marketable securities were
as follows:




December 31, 2008Amortized
                    Cost
                
                
                Fair
      ValueDue
      in one year or less
                
                $
                4,313,927
                
                
                $
                4,321,844




6.
Restructuring




2008
Restructuring




On June
3, 2008, the Company implemented a corporate realignment to focus on the
development of voreloxin. In conjunction with this strategic restructuring, the
Company expanded its late-stage development leadership team, ceased its internal
discovery research activities and reduced its workforce by approximately 60
percent. All terminated employees were awarded severance payments and
continuation of benefits, based on length of service at the Company, and career
transition assistance. The Company also decided to consolidate its remaining
employees at 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.  Subsequent to
December 31, 2008, the Company signed an agreement for the termination of the
Company’s lease for its research and development facility at 341 Oyster Point
Boulevard and voluntarily surrendered the premises to the Company’s landlord on
January 15, 2009 (see Note 17 Subsequent
Events).





The
Company currently estimates an aggregate in 2008 and in 2009 of approximately
$7.2 million in restructuring expenses in connection with the 2008
restructuring.  The Company recorded restructuring and impairment
expenses of $5.9 million pertaining to the 2008 restructuring in the year ended
December 31, 2008. Of this total, approximately $3.6 million relates to employee
severance and related benefit costs, including a non-cash portion related to
stock-based compensation of approximately $0.4 million, and $0.7 million related
to facility exit costs and $1.6 million related to asset impairments. These
expenses were included in the line labeled “Restructuring and impairment
charges” in the Company’s Consolidated Statements of Operations. The Company
made cash payments totaling $3.1 million for employee severance and related
benefits in the second and the third quarter of 2008 and expects to pay the
remainder during the first quarter of 2009.





The
Company currently expects to record an additional restructuring expense of
approximately $1.3 million in the first quarter of 2009, of which $2.2 million
relates to the termination of the Company’s lease at 341 Oyster Point Boulevard,
the Company’s former research and development facility, $0.4 million relates to
the commission payable to a third party the Company engaged to negotiate the
lease termination and $0.1 million relates to this facility closure expenses,
partially offset by the reversal of $1.4 million in non-cash deferred rent on
this facility.  The cash portion of these expenses was paid in
the first quarter of 2009.




57




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




Employee
                                  Severance and
                                  Related
                                  Benefits
                                
                                
                                Facilities
                                  Related and
                                  Other Costs
                                
                                
                                TotalRestructuring
      liability at December 31, 2007
                                
                                $
                                —
                                
                                
                                $
                                —
                                
                                
                                $
                                —2008
      charges
                                
                                
                                3,553,184
                                
                                
                                
                                2,336,887
                                
                                
                                
                                5,890,071Cash
      payments
                                
                                
                                (3,124,126
                                )
                                
                                
                                (451,997
                                )
                                
                                
                                (3,576,123
                                )Non-cash
      settlements
                                
                                
                                (366,638
                                )
                                
                                
                                (1,756,140
                                )
                                
                                
                                (2,122,778
                                )Restructuring
      liability at December 31, 2008
                                
                                $
                                62,420
                                
                                
                                $
                                128,750
                                
                                
                                $
                                191,170




2007
Restructuring




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




As a
result of the 2007 restructuring, the Company recorded in 2007 total
restructuring charges of $1.6 million for employee severance and related
benefit costs, including a non-cash portion related to stock-based compensation
of approximately $0.1 million, and approximately $0.6 million of facilities
exit costs, of which $0.3 million was related to the impairment of
leasehold improvements and $0.3 million was related to the lease obligation
on the property at 395 Oyster Point Boulevard which had been vacated in the 2007
consolidation.




In the
first quarter of 2008, the Company recorded an additional $0.3 million in
restructuring charges on the lease obligation on the office facilities at 395
Oyster Point Boulevard that had been vacated.  In the second quarter
of 2008, the Company reversed a previously recorded expense of approximately
$0.4 million related to the lease obligation on 395 Oyster Point Boulevard,
after the Company relocated its remaining employees back into this facility in
connection with the 2008 restructuring discussed above.  Cash payments
related to employee severance for the 2007 restructuring were all made by
December 31, 2007.




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




58


Employee
                Severance and
                Related
                Benefits
            
            
            Facilities
                Related and
                Other
                Costs
            
            
            TotalRestructuring
      liability at December 31, 2006
            
            $
            —
            
            
            $
            —
            
            
            $
            —2007
      charges
            
            
            1,012,394
            
            
            
            550,880
            
            
            
            1,563,274Cash
      payments
            
            
            901,415
            
            
            
            —
            
            
            
            901,415Non-cash
      activity
            
            
            69,580
            
            
            
            276,046
            
            
            
            345,626Restructuring
      liability at December 31, 2007
            
            
            41,399
            
            
            
            274,834
            
            
            
            316,2332008
      reversals charges
            
            
            (9,418
            )
            
            
            (97,749
            )
            
            
            (107,167
            )Cash
      payments
            
            
            (227
            )
            
            
            (197,654
            )
            
            
            (197,881
            )Adjustments
            
            
            (31,754
            )
            
            
            20,569
            
            
            
            (11,185
            )Restructuring
      liability at December 31, 2008
            
            $
            —
            
            
            $
            —
            
            
            $
            —




7.
Assets Held-for-Sale




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 approximately $1.2 million would be sold, and
accordingly this equipment was recorded as held-for-sale.  Of the $1.2
million in assets identified as held-for-sale, assets with a net book value of
approximately $0.7 million were sold in 2008 for net proceeds of approximately
$0.9 million.   The $0.2 million gain on the sale has been
included in the line labeled “Other income, net” in the Company’s Consolidated
Statements of Operations.  As of December 31, 2008, the remaining
held-for-sale equipment was valued at approximately $0.5 million.  The
Company expects to sell the remaining held-for-sale equipment in
the first half of 2009.




8.
Property and Equipment




Property
and equipment are recorded at cost and consisted of the following at
December 31:




2008
                  
                  
                  2007Computer
      equipment and software
                  
                  $
                  1,353,231
                  
                  
                  $
                  2,908,106Furniture
      and office equipment
                  
                  
                  981,989
                  
                  
                  
                  976,266Laboratory
      equipment
                  
                  
                  901,694
                  
                  
                  
                  9,829,148Leasehold
      improvements
                  
                  
                  5,789,944
                  
                  
                  
                  5,784,3339,026,858
                  
                  
                  
                  19,497,853Less
      accumulated depreciation and amortization
                  
                  
                  (8,414,617
                  )
                  
                  
                  (15,259,355
                  )Net
      property and equipment
                  
                  $
                  612,241
                  
                  
                  $
                  4,238,498




Depreciation
expense for property and equipment was $1.1 million, $1.7 million and
$1.6 million for the years ended December 31 2008, 2007 and 2006,
respectively. The Company recorded impairment charges of $1.6 million and
$0.3 million for the years ended December 31, 2008 and 2007,
respectively, in connection with the implementation of the 2008 and 2007
restructurings. These expenses were included in the line labeled “Restructuring
and impairment charges” in the Company’s Consolidated Statement of
Operations.  See Note 6 Restructuringfor
further information regarding the impairment.  No impairment charges
were recorded in 2006.




At
December 31, 2008, there is no financed equipment under the caption of property
and equipment (see Note 10Equipment Financing and Debt Facility).  At December 31,
2007, financed equipment had a cost basis of $4.3 million with accumulated
depreciation of $2.4 million.




9.
Accounts Payable and Other Accrued Liabilities




Accounts
payable and other accrued liabilities at December 31 are as
follows:




2008
                
                
                2007Accounts
      payable
                
                $
                790,546
                
                
                $
                1,462,717Accrued
      outside services
                
                
                1,021,685
                
                
                
                1,392,879Accrued
      clinical expense
                
                
                1,865,773
                
                
                
                1,025,325Accrued
      restructuring charges
                
                
                191,170
                
                
                
                316,233Accrued
      professional services
                
                
                322,945
                
                
                
                296,482Interest
      payable
                
                
                —
                
                
                
                16,637Sales
      taxes payable
                
                
                15,804
                
                
                
                5,153Total
                
                $
                4,207,923
                
                
                $
                4,515,426


59




10.
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 been issued
under the financing agreement since 2000. 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 and no credit lines remain available under
this agreement.  As of December 31, 2007, our outstanding debt
balance was $2.3 million. There was no outstanding balance as of December
31, 2008.  In 2007 and 2008, the interest rates on the debt balance
ranged from 7.53 percent to 10.61 percent per annum, and the
borrowings were due in 36 to 48 monthly payments.




11.
Commitments and Contingencies




Subsequent
to December 31, 2008, the Company signed an agreement for the termination of the
lease at 341 Oyster Point Boulevard and voluntarily surrendered the premises to
the Company’s landlord on January 15, 2009.  In consideration of the
early termination of the lease, the Company made a one-time payment of
approximately $2.2 million to the landlord, plus surrender a $300,000 security
deposit (see Note 17 Subsequent
Events).




In
December 2006, the Company leased approximately 15,000 square feet of office
space at 395 Oyster Point Boulevard in South San Francisco, California which
currently is the Company’s main office. This lease expires in April 2013,
subject to the Company’s option to extend the lease through February
2014.




In
October 2008, the Company leased approximately 5,500 square feet of laboratory
space at 349 Allerton Avenue, South San Francisco, California.  The
lease expires in October 2010 with the Company’s option to extend the lease
through October 2012.




Following
is a schedule of the Company’s noncancellable lease commitments, including the
lease termination fee that was paid in the first quarter of 2009:




Year
      ended December 31,2009
                  
                  
                  2,797,9652010
                  
                  
                  570,4392011
                  
                  
                  395,2152012
                  
                  
                  404,4412013
                  
                  
                  135,3262014
      and thereafter
                  
                  
                  —$
                  4,303,386




The
operating lease agreements provide for increasing monthly rent payment over the
lease term. The Company recognizes rent expense on a straight-line basis. The
Company recorded rent expense of $3.0 million, $3.1 million and $2.8
million for the years ended December 31, 2008, 2007 and 2006,
respectively.  The deferred rent balance of $1.5 million and
$1.6 million at December 31, 2008 and 2007, respectively, represents
the difference between actual rent payments and the straight-line
expense.  Of the $1.5 million deferred rent balance at December 31,
2008, approximately $1.4 million is expected to be reversed in the first quarter
of 2009 as a result of the termination of the lease at 341Oyster Point
Boulevard.




Contingencies




From time
to time, the Company may be involved in legal proceedings, as well as demands,
claims and threatened litigation, that 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.




60




12.
Stockholders’ Equity




Private
Placement




In March
2006, the Company entered into a common stock and warrant purchase agreement
pursuant to which it sold to certain investors, for an aggregate purchase price
of approximately $45.3 million, 7,246,377 shares of its common stock and
warrants to purchase up to 2,173,914 additional shares of its common stock. The
purchase price for the common stock and the exercise price for the warrants was
$6.21 per share. Investors in the financing paid an additional purchase price
equal to $0.125 for each share of common stock underlying the warrants. The
Company received net proceeds of approximately $43.7 million in this
offering.  None of the warrants issued in this private placement have
been exercised, and all were outstanding, as of December 31, 2008.




Public
Offering




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




Common
Stock




Holders
of common stock are entitled to one vote per share on all matters to be voted
upon by the stockholders of the Company. Subject to the preferences that may be
applicable to any outstanding shares of preferred stock, the holders of common
stock are entitled to receive ratably such dividends, if any, as may be declared
by the Board of Directors. No dividends have been declared to date.




Preferred
Stock




The
Company has 5,000,000 shares of authorized preferred stock issuable in one or
more series. Upon issuance, the Company can determine the rights, preferences,
privileges and restrictions thereof. These rights, preferences and privileges
could include dividend rights, conversion rights, voting rights, terms of
redemption, liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of such series, any or all of which
may be greater than the rights of common stock. The issuance of the preferred
stock could adversely affect the voting power of holders of common stock and the
likelihood that such holders will receive dividend payment and payments upon
liquidation. In addition, the issuance of preferred stock could have the effect
of delaying, deferring or preventing a change in control of the Company or other
corporate action. There was no preferred stock outstanding as of
December 31, 2008 or December 31, 2007. See Note 17 Subsequent
Events.




Stock
Option Plans




The
Company generally grants options (i) to new employees which become
exercisable 25 percent on the first anniversary of the vesting commencement
date and then 1/48th for each month thereafter, and (ii) to existing
employees which become exercisable 1/48th each month following the date of grant
over a period of four years.




61


1998 Stock Plan and 2001
Stock Plan




The
Company’s 1998 Stock Plan, or the 1998 Plan, was adopted by the Board of
Directors in February 1998 and provided for the issuance of common stock,
purchase rights, and granting of options to employees, officers, directors, and
consultants of the Company. In October 2001, the Company’s Board of Directors
adopted the 2001 Stock Plan, or 2001 Plan, under which shares were allocated for
grant as either incentive stock options or non-statutory stock option grants
directly from available shares authorized and reserved for issuance under the
1998 Plan. The terms of the 1998 Plan and 2001 Plan are substantially consistent
with one another.




In
conjunction with the Company’s IPO, the Board of Directors elected not to grant
any additional options under either of these stock plans. The Company has
options outstanding pursuant to both the 1998 Plan and the 2001
Plan.




2005 Equity Incentive Award
Plan




In
February 2005, the Board of Directors adopted and, in September 2005, the
stockholders approved the 2005 Equity Incentive Award Plan (as amended, the 2005
Plan). The 2005 Plan is intended to serve as the successor equity incentive
program to the 1998 Plan and 2001 Plan. The Company initially reserved a total
of 1,779,396 shares of common stock for issuance under the 2005 Plan plus shares
underlying any options granted under the Company’s 1998 Plan or 2001 Plan that
expire unexercised or are repurchased by the Company pursuant to the terms of
such options. As of December 31, 2008, options to purchase 4,481,748 shares
of the Company’s common stock have been have been granted under the 2005 Plan
and no shares of common stock have been issued under the 2005 Plan.




Beginning
in 2006, the number of shares of common stock reserved under the 2005 Plan
automatically increases on the first trading day each year by an amount equal to
the lesser of: (i) 4 percent of the Company’s outstanding shares of
common stock outstanding on such date, (ii) 1,082,352 shares, or
(iii) an amount determined by the Board of Directors. On January 1,
2008, the 2005 Plan was increased by 1,082,352 shares according to this
provision based on Board approval. As of December 31, 2008, the total
shares available for future grants under the 2005 Plan were 2,121,116. The
maximum aggregate number of shares which may be issued or transferred over the
term of the 2005 Plan is 11,294,112 shares. In addition, no participant in the
2005 Plan may be issued or transferred more than 235,294 shares of common stock
per calendar year pursuant to the 2005 Plan.




2006 Employment Commencement
Incentive Plan




In
November 2005, the Board of Directors adopted the 2006 Employment Commencement
Incentive Plan (as amended, 2006 Plan), which became effective on
January 1, 2006. The awards granted pursuant to the 2006 Plan are intended
to be inducement awards pursuant to Nasdaq Marketplace
Rule 4350(i)(1)(A)(iv). The 2006 Plan was not subject to the approval of
the Company’s stockholders. Effective January 1, 2008, the Company’s Board
of Directors increased the 2006 Plan by an additional 125,000 shares such that
the aggregate number of shares of common stock reserved for issuance under the
2006 Plan is 525,000 shares. Only those employees who have not previously been
employees or directors of the Company or a subsidiary of the Company, or
following a bona fide period of non-employment by the Company or a subsidiary of
the Company, are eligible to participate in the 2006 Plan. Additionally, grants
awarded to such employees under the 2006 Plan must be made in connection with
his or her commencement of employment with the Company or a subsidiary of the
Company and must be an inducement material to his or her entering into
employment with the Company or a subsidiary of the Company. As of
December 31, 2008, approximately 96,000 options issued under the 2006 Plan
have been cancelled and made available for reissuance and an aggregate of
553,000 options have been granted under the 2006 Plan. There have been no
exercises, nor have there been any shares issued under this plan.




Employee
Stock Purchase Plan




In
February 2005, the Board of Directors adopted and, in September 2005, the
stockholders approved the Company’s Employee Stock Purchase Plan, or
ESPP.  The ESPP permits eligible employees to purchase common stock at
a discount through payroll deductions during defined offering periods. Eligible
employees can purchase shares of the Company’s common stock at 85 percent
of the lower of the fair market value of the common stock at the beginning of an
offering period or at the purchase date. As of December 31, 2008, and 2007,
44,802 and 102,904 shares of common stock, respectively,
were  purchased by eligible employees under the ESPP.




The
Company initially reserved a total of 202,941 shares of common stock for
issuance under the ESPP.  The number of shares of common stock
reserved under the ESPP automatically increases on the first trading day each
year, beginning in 2006, by an amount equal to the lesser of:
(i) 0.5 percent of the Company’s shares of common stock outstanding on
such date, (ii) 135,294 shares, or (iii) a lesser amount determined by
the Board of Directors. On January 1, 2008, the ESPP was increased by
100,000 shares according to this provision based on a determination of the
Board. At December 31, 2008, the total shares reserved for future issuance
under the ESPP was 252,453. The maximum aggregate number of shares which may be
issued over the term of the ESPP is 1,352,941 shares. In addition, no
participant in the ESPP may be issued or transferred shares of common stock
valued at more than $25,000 per calendar year pursuant to awards under the ESPP
and no participant may purchase more than 1,176 shares during any purchase
period. The total estimated fair value of purchase rights outstanding under the
ESPP that vested during the year ended December 31, 2008 was under
$0.1 million.




62


Warrants




The
Company has the following warrants to purchase common stock outstanding at
December 31, 2008:




Shares
                
                
                Exercise Price
                
                Expiration20,800
                
                
                
                8.94
                
                December
      200941,176
                
                
                
                17.00
                
                May
      2010256,740
                
                
                
                9.10
                
                July
      20101,046
                
                
                
                9.10
                
                September
      2015164,830
                
                
                
                9.10
                
                August
      20151,582
                
                
                
                9.10
                
                June
      2013757
                
                
                
                9.10
                
                June
      20142,173,914
                
                
                
                6.21
                
                March
      2013Total
                
                
                2,660,845




Reserved
Shares




As of
December 31, 2008, we had reserved shares of common stock for future
issuance as follows:




Shares
      Available
                    for
      Future
                    Grant
                
                
                Shares
                    Outstanding
                
                
                Total
      Shares
                    ReservedWarrants
                
                
                —
                
                
                
                2,660,845
                
                
                
                2,660,845Stock
      option plans
                
                
                2,189,055
                
                
                
                4,650,955
                
                
                
                6,840,010Employee
      stock purchase plan
                
                
                252,453
                
                
                
                —
                
                
                
                252,453Total
                
                
                2,441,508
                
                
                
                7,311,800
                
                
                
                9,753,308




13.
Stock-Based Compensation




Stock-Based
Compensation




The
weighted-average estimated fair value of employee stock options granted during
the years ended December 31, 2008, 2007, and 2006 were $0.89, $1.76, and
$3.43, respectively, using the Black-Scholes Model with the following
assumptions:




63




Year Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Stock Option PlansRisk-free
      interest rate
                    
                    
                    1.55%-3.34
                    %
                    
                    
                    3.41%-4.92
                    %
                    
                    
                    4.35%-5.07
                    %Dividend
      yield
                    
                    
                    0
                    %
                    
                    
                    0
                    %
                    
                    
                    0
                    %Volatility
                    
                    
                    93.40
                    %
                    
                    
                    68.50
                    %
                    
                    
                    80.00
                    %Annual
      forfeiture rate
                    
                    
                    9.80
                    %
                    
                    
                    7.20
                    %
                    
                    
                    5.52
                    %Expected
      term (years)
                    
                    
                    5
                    
                    
                    
                    5
                    
                    
                    
                    5




The
weighted average estimated fair value of purchase rights under our ESPP for the
year ended December 31, 2008 was $1.09 per share using the Black-Scholes
Model with the following assumptions:




Year
      Ended December 31,2008
                  
                  
                  2007Employee
      Stock Purchase PlanVolatility
                  
                  
                  93.40
                  %
                  
                  
                  68.50
                  %Risk-free
      interest rate
                  
                  
                  0.44%-5.06
                  %
                  
                  
                  3.15%-5.06
                  %Dividend
      yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %Expected
      term (years)
                  
                  
                  0.50 – 1.00
                  
                  
                  
                  0.50 - 1.00




The
Company has based its assumptions for 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 is
equal to the purchase period. The risk-free interest rate assumption is based
upon observed interest rates appropriate for the expected life of the Company’s
employee stock options and employees’ purchase rights. The Company does not
anticipate paying any cash dividends in the foreseeable future and therefore
uses an expected dividend yield of zero in the option valuation model. The
post-vesting forfeiture rate is derived from the Company’s historical option
cancellation information.




A summary
of stock option transactions for all stock option plans is as
follows:




Number
      of
                  Shares
              
              
              Weighted
                  Average
                  Exercise
                  Price
              
              
              Weighted
                  Average
                  Remaining
                  Contractual
                  Term
                  (years)
              
              
              Aggregate
                  Intrinsic
                  ValueOutstanding
      at December 31, 2005
              
              
              2,994,701
              
              
              $
              3.92Options
      granted
              
              
              1,227,700
              
              
              $
              5.11Options
      exercised
              
              
              (126,594
              )
              
              $
              2.51Options
      canceled/forfeited/expired
              
              
              (153,372
              )
              
              $
              4.86Outstanding
      at December 31, 2006
              
              
              3,942,435
              
              
              $
              4.30Options
      granted
              
              
              1,636,750
              
              
              $
              3.04Options
      exercised
              
              
              (68,813
              )
              
              $
              2.34Options
      canceled/forfeited/expired
              
              
              (410,525
              )
              
              $
              4.78Outstanding
      at December 31, 2007
              
              
              5,099,847
              
              
              $
              3.83Options
      granted
              
              
              874,225
              
              
              $
              1.75Options
      exercised
              
              
              —
              
              
              
              —Options
      canceled/forfeited/expired
              
              
              (1,323,117
              )
              
              $
              3.64Outstanding
      at December 31, 2008
              
              
              4,650,955
              
              
              $
              3.44
              
              
              
              7.17
              
              
              $
              —Exercisable
      at December 31, 2008
              
              
              3,144,705
              
              
              $
              3.83
              
              
              
              6.39
              
              
              $
              —




The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e., the difference between the Company’s closing stock
price on the last trading day of its fourth quarter of 2008 and the exercise
price, multiplied by the number of in-the-money options) that would have been
received by the option holders had all option holders exercised their options on
December 31, 2008.  No options were exercised and, as a result,
there is no intrinsic value for options exercised during 2008.  Total
intrinsic value of options exercised for the years ended December 31, 2007
is $0.1 million.




64




The
following table summarizes information about stock options outstanding and
exercisable at December 31, 2008:




Options Outstanding
              
              
              Options ExercisableRange of Exercise Prices
              
              Number of
                  Shares
              
              
              Weighted
                  Average
                  Remaining
                  Contractual Life
                  (In Years)
              
              
              Weighted
                  Average
                  Exercise Price
              
              
              Number of
                  Shares
              
              
              Weighted
                  Average
                  Exercise Price$0.32
      to $1.30
              
              
              55,211
              
              
              
              7.01
              
              
              $
              0.78
              
              
              
              16,711
              
              
              $
              0.80$1.44
              
              
              651,826
              
              
              
              9.50
              
              
              $
              1.44
              
              
              
              86,105
              
              
              $
              1.44$1.55
      to $2.31
              
              
              212,000
              
              
              
              9.14
              
              
              $
              1.97
              
              
              
              67,750
              
              
              $
              1.98$2.55
              
              
              1,070,160
              
              
              
              3.93
              
              
              $
              2.55
              
              
              
              1,061,140
              
              
              $
              2.55$2.59
              
              
              680,905
              
              
              
              8.70
              
              
              $
              2.59
              
              
              
              341,098
              
              
              $
              2.59$2.62
      to $4.85
              
              
              824,568
              
              
              
              7.94
              
              
              $
              4.50
              
              
              
              565,082
              
              
              $
              4.53$4.93
      to $5.16
              
              
              83,405
              
              
              
              7.60
              
              
              $
              5.02
              
              
              
              70,321
              
              
              $
              5.04$5.25
              
              
              845,453
              
              
              
              6.91
              
              
              $
              5.25
              
              
              
              728,322
              
              
              $
              5.25$5.50
      to 7.15
              
              
              179,509
              
              
              
              7.50
              
              
              $
              6.12
              
              
              
              160,258
              
              
              $
              6.16$9.56
              
              
              47,918
              
              
              
              6.42
              
              
              $
              9.56
              
              
              
              47,918
              
              
              $
              9.56$0.32
      to $9.56
              
              
              4,650,955
              
              
              
              7.17
              
              
              $
              3.44
              
              
              
              3,144,705
              
              
              $
              3.83




The
Company’s determination of the fair value of share-based payment awards on the
grant date using an option-pricing model is affected by the Company’s stock
price as well as assumptions regarding a number of highly subjective variables.
The estimated fair value of shares vested during 2008 was $2.2 million, and
was $2.5 million for 2007. At December 31, 2008, total unrecognized
estimated compensation cost related to non-vested stock options granted prior to
that date was approximately $4.1 million and the cost 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
3.26 years. As the Company believes it is more likely than not that all of
the stock option related tax benefits will not be realized, the Company has not
recorded any net tax benefits related to the options exercised.




Stock-Based
Compensation for Options Granted Prior to the IPO




Prior to
the Company’s IPO, certain stock options were granted with exercise prices that
were below the reassessed fair value of the common stock at the date of grant.
In accordance with APB 25, deferred stock-based compensation was recorded
for the difference between the estimated fair value of the common stock
underlying the options and the exercise price of the options. The deferred
stock-based compensation was being amortized over the related vesting terms of
the options. The Company recorded amortization of deferred stock-based
compensation of $0.2 million and $0.7 million in 2008 and 2007,
respectively, under the prospective transition method of FAS 123R for stock
options granted before December 23, 2004, the date on which the Company
filed its initial registration statement on Form S-1 in connection with its
IPO. As of December 31, 2008, the deferred stock-based compensation was fully
amortized.  For stock options granted after December 23, 2004,
the associated unamortized deferred compensation balance of $0.3 million
was reversed as of January 1, 2006 due to the adoption of
FAS 123R.




Total
Stock-based Compensation Expense




Employee
stock-based compensation expense was calculated based on awards ultimately
expected to vest and has been reduced for estimated forfeitures. FAS 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 IPO which continue to be accounted for under APB 25, is as
follows:




Year
      ended
                    December 31,
      2008
                
                
                Year
      ended
                    December 31,
      2007Research
      and development
                
                $
                644,549
                
                
                $
                1,322,656General
      and administrative
                
                
                1,265,379
                
                
                
                1,863,999Restructuring
      charges
                
                
                366,637
                
                
                
                126,456Stock-based
      compensation expense
                
                $
                2,276,565
                
                
                $
                3,313,111




65




14.
Fair Value Measurements




Effective
September 2006, the FASB issued SFAS 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.  In February 2008, the FASB issued Statement of
Financial Position (FSP) No. 157-2, which delays the effective date of FAS 157
for non-financial assets and non-financial liabilities, except for items that
are on a recurring basis (items that are remeasured at least
annually).  The FSP deferred the effective date of FAS 157 for
non-financial assets and non-financial liabilities until the Company’s fiscal
year beginning on January 1, 2009.





As of
January 1, 2008, the Company adopted SFAS 157 on a prospective basis on its
financial assets and liabilities.  The fair value of the Company’s
financial instruments reflect the amounts that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (exit price). SFAS 157 also established a
fair value hierarchy that prioritizes the use of inputs used in valuation
techniques into the following three levels:





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


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


Level
3—unobservable inputs.





The
adoption of SFAS 157 did not have a material effect on the Company’s financial
condition and results of operations, but SFAS 157 introduced new disclosures
about how the Company values certain assets and liabilities, focusing on the
inputs used to measure fair value, particularly in instances where the
measurement uses significant unobservable (Level 3) inputs. The Company’s
financial instruments are valued using quoted prices in active markets (Level 1)
or based upon other observable inputs (Level 2). The following table sets forth
the fair value of the Company’s financial assets that were measured on a
recurring basis during the year ended in December 31, 2008:




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





At
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.
Income Taxes




As of
December 31, 2008, the Company had federal net operating loss carryforwards
of approximately $201.6 million. The Company also had federal research and
development tax credit carryforwards of approximately $4.9 million. The
federal net operating loss and tax credit carryforwards will expire at various
dates beginning in 2018, if not utilized. As of December 31, 2008, the
Company had a state net operating loss carryforward of approximately
$102.9 million, which expires beginning in 2009. The Company also had state
research and development tax credit carryforwards of approximately
$4.9 million which do not expire.




Utilization
of the net operating loss and tax credits carryforwards may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986, as amended, that are applicable if the
Company experiences an “ownership change,” which may occur, for example, as a
result of the Company’s IPO and other sales of the Company’s stock, and similar
state provisions. The annual limitation may result in the expiration of net
operating losses and credits before utilization.


66


As of
December 31, 2008 and 2007, the Company had deferred tax assets of
approximately $95.7 million and $80.7 million, respectively.
Realization of the deferred tax assets is dependent upon future taxable income,
if any, the amount and timing of which are uncertain. Accordingly, the net
deferred tax assets have been fully offset by a valuation allowance. The net
valuation allowance increased by approximately $15.0 million and
$16.2 million during the years ended December 31, 2008, and 2007,
respectively.




The
income tax provision differs from the amount computed by applying the statutory
income tax rate of 34 percent to pretax loss as follows:




Year Ended December 31,2008
                
                
                2007
                
                
                2006At
      statutory rate
                
                $
                (12,642,344
                )
                
                $
                (13,178,440
                )
                
                $
                (10,620,396
                )Current
      year net operating losses and temporary differences for which no tax
      benefit is recognized
                
                
                12,223,875
                
                
                
                12,415,146
                
                
                
                9,871,419Other
      permanent differences
                
                
                418,469
                
                
                
                763,294
                
                
                
                748,977$
                —
                
                
                $
                —
                
                
                $
                —




Deferred
income taxes reflect the net tax effects of loss and credit carryforwards and
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company’s deferred tax assets for federal and
state income taxes are as follows:




December 31,2008
                
                
                2007Deferred
      tax assets:Net
      operating loss carryforwards
                
                $
                74,711,000
                
                
                $
                61,149,000Deferred
      revenue
                
                
                —
                
                
                
                457,000Capitalized
      research costs
                
                
                8,649,000
                
                
                
                8,368,000Property
      and equipment
                
                
                1,966,000
                
                
                
                1,391,000Accrued
      liabilities
                
                
                2,026,000
                
                
                
                1,763,000Federal
      and state research credit carryforwards
                
                
                8,328,000
                
                
                
                7,567,000Gross
      deferred tax assets
                
                
                95,680,000
                
                
                
                80,695,000Valuation
      allowance
                
                
                (95,680,000
                )
                
                
                (80,695,000
                )Net
      deferred tax assets
                
                $
                —
                
                
                $
                —




In July
2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes—an Interpretation of FASB Statement No. 109,or FIN 48.
FIN 48 addresses recognition and measurement on uncertain tax positions
that the Company has taken or expects to take on tax returns using a
more-likely-than-not threshold. It also revises disclosure
requirements.




On
January 1, 2007, the Company adopted the provisions of FIN 48. As of
December 31, 2008, the Company recognized no material adjustment in tax
payable and unrecognized tax benefits since the Company has net operating losses
and has not been subject to income tax since inception.




The
Company files U.S. federal and California tax returns.  The Company’s
wholly owned subsidiary files tax returns in the United Kingdom. To date,
neither the Company nor its wholly owned subsidiary has been audited by the
Internal Revenue Service, any state income tax authority or tax authority in the
United Kingdom.





16.
Guarantees and Indemnification




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




As
permitted under Delaware law and in accordance with the Company’s Bylaws, the
Company indemnifies its officers and directors for certain events or
occurrences, subject to certain limits, while the officer or director is or was
serving at the Company’s request in such capacity. The indemnification
agreements with the Company’s officers and directors terminate upon termination
of their employment, but the termination does not affect claims for
indemnification relating to events occurring prior to the effective date of
termination. The maximum amount of potential future indemnification is
unlimited; however, the Company’s officer and director insurance policy reduces
the Company’s exposure and may enable the Company to recover a portion of any
future amounts paid. The Company believes that the fair value of these
indemnification agreements is minimal. In addition, in the ordinary course of
business the Company enters into agreements, such as licensing agreements,
clinical trial agreements and certain services agreements, containing standard
indemnifications provisions. The Company believes that the likelihood of an
adverse judgment related to such indemnification provisions is remote.
Accordingly, the Company has not recorded any liabilities for any of these
agreements as of December 31, 2008.


67




17.
Subsequent Events




Termination
of Lease Agreement




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, on a leased facility located at 341 Oyster Point Boulevard, South
San Francisco, California 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 approximately $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 approximately
$15.7 million between 2009 and 2013.  The $2.2 million termination fee
was paid in January 2009.  In addition to the $2.2 million termination
fee, the Company also paid in January 2009 approximately $0.3 million of
commission to a third party that the Company engaged to negotiate the lease
termination with the Company’s landlord and the landlord kept the $0.3 million
security deposit it received upon the signing of the lease.




Sale of
LFA-1 Patents and Related Know-How




In March 2009, the Company sold all of
its interest in its LFA-1 and related know-how, to SARcode Corporation or
SARcode, the previous licensee, for a total cash consideration of $2.0
million.  Upon signing the new agreement, the existing license
agreement with SARcode terminated.  The Company continues to hold a
series of secured notes issued by SARcode having a total principal value of $1.0
million and convertible into preferred stock of SARcode
Corporation.




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 our
securities, or the Private Placement. The Private Placement includes up to $15.0
million of units consisting of convertible preferred stock and warrants to
purchase common stock in two closings.  The initial closing for $10.0
million of units is expected to close in the near term, subject to the
satisfaction of customary closing conditions.  Subject to approval by
the Company’s stockholders, an additional $5.0 million of units may be sold in
the second closing,which
closing may occur at our election or at the election of the investors 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 do not deliver notice to
the investors 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. Notice of an election to complete the
second closing, either by us or the investors, 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 $28.5 million of common stock may be sold in the common equity
closing. The common equity closing may be completed at or prior to the earlier
of December 31, 2010 and a qualifying alternative common stock financing,
subject to approval of a majority of the investors and selling at least $28.5
million of common stock in the common equity closing. The common equity closing
may also be completed upon the election of the holders of a majority of the
convertible preferred stock prior to a date determined with reference to our
cash balance at certain future dates.





In the
initial closing for $10.0 million of units, the Company would
issue approximately 2.9 million shares of Series A Preferred Stock, which
would initially be convertible into approximately 29.0 million shares of
common stock, and warrants to purchase approximately 29.0 million shares of
common stock.  In the second closing for an additional $5.0 million of
units, if completed, the Company would issue approximately 14.5 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 would be $3.45 for both the first and second
closings.  The warrants issuable at the first and second closings
would have an exercise price of $0.22 per share and a term of 7 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.





Upon the initial closing, certain of
the investors would 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 this private
placement, when the initial closing takes place, the investors will receive
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, except if certain conditions are met, any
issuance of common stock, other than the second closing and the common stock
closing described above.  Upon any sale of the company or the majority
of its assets or shares or a significant partnering transaction, the holders of
the Series A Preferred Stock would have a right to receive proceeds equal to
three times the purchase price of each unit for each share of Series A Preferred
Stock, in preference to any other class of stock.




2009
Restructuring
 
 On March
30, 2009, the Compensation Committee of our Board of Directors, in
conjunction with the closing of the Private Placement, committed to a
restructuring plan that will result in an immediate reduction in force affecting
six employees, including two executives. Employees were notified on March 31,
2009.




18.
Selected Quarterly Financial Data (unaudited)




Three
      Months EndedMar. 31,
                  2008
              
              
              June 30,
                  2008
              
              
              Sep.
      30,
                  2008
              
              
              Dec. 31,
                  2008
              
              
              Mar. 31,
                  2007
              
              
              June 30,
                  2007
              
              
              Sep.
      30,
                  2007
              
              
              Dec. 31,
                  2007Revenue
              
              $
              2,303,183
              
              
              $
              2,591,240
              
              
              $
              510,417
              
              
              $
              12,500
              
              
              $
              2,516,266
              
              
              $
              3,270,265
              
              
              $
              1,830,274
              
              
              $
              2,046,708Net
      loss
              
              $
              (9,624,905
              )
              
              $
              (13,568,418
              )
              
              $
              (7,065,172
              )
              
              $
              (6,927,132
              )
              
              $
              (9,369,037
              )
              
              $
              (9,771,583
              )
              
              $
              (10,842,325
              )
              
              $
              (8,777,975
              )Basic
      and diluted loss per share applicable to common
    stockholders
              
              $
              (0.28
              )
              
              $
              (0.39
              )
              
              $
              (0.21
              )
              
              $
              (0.20
              )
              
              $
              (0.32
              )
              
              $
              (0.31
              )
              
              $
              (0.32
              )
              
              $
              (0.26
              )Shares
      used in computing basic and diluted net loss per share applicable to
      common stockholders
              
              
              34,364,896
              
              
              
              34,377,367
              
              
              
              34,401,519
              
              
              
              34,404,578
              
              
              
              29,457,247
              
              
              
              31,175,933
              
              
              
              34,315,961
              
              
              
              34,336,345




68




ITEM
      9.
            CHANGES IN AND
      DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE




Not
applicable.




ITEM
      9A(T).
            CONTROLS AND
      PROCEDURES




Disclosure
Controls and Procedures




Based on
their evaluation as of December 31, 2008, our Chief Executive Officer and
Chief Financial Officer, with the participation of management, have concluded
that, subject to the limitations described below, our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act) were effective.




Management’s
Report on Internal Control over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as defined in Rules 13a-15(f) and
15d-15(f) under the Securities Exchange Act. Internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles in the United States.




Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting as of
December 31, 2008.   Management based its assessment on the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in Internal
Control—Integrated Framework. Based on this evaluation, our management
concluded that as of December 31, 2008, our internal control over financial
reporting was effective.




This annual report does not include an
attestation report of the Company’s independent registered public accounting
firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.




Changes
in Internal Control over Financial Reporting




There
were no changes in our internal control over financial reporting during the
quarter ended December 31, 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




Limitations
on the Effectiveness of Controls




Our
disclosure controls and procedures provide our Chief Executive Officer and Chief
Financial Officer reasonable assurances that our disclosure controls and
procedures will achieve their objectives. However, Company management, including
our Chief Executive Officer and Chief Financial Officer, does not expect that
our disclosure controls and procedures or our internal control over financial
reporting can or will prevent all human error. A control system, no matter how
well designed and implemented, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Furthermore, the
design of a control system must reflect the fact that there are internal
resource constraints, and the benefit of controls must be weighed relative to
their corresponding costs. Because of the limitations in all control systems, no
evaluation of controls can provide complete assurance that all control issues
and instances of error, if any, within our company are detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur due to human error or mistake.
Additionally, controls, no matter how well designed, could be circumvented by
the individual acts of specific persons within the organization. The design of
any system of controls is also based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated objectives under all potential future
conditions.


69


ITEM
      9B.
            OTHER
      INFORMATION




None.




PART
III




Certain
information required by Part III is omitted from this report because we
will file with the SEC a definitive proxy statement pursuant to
Regulation 14A in connection with the solicitation of proxies for our
Annual Meeting of Stockholders expected to be held in June 2009 (the “Proxy
Statement”) not later than 120 days after the year ended December 31,
2008 covered by this report, and certain information included therein is
incorporated herein by reference.




ITEM
      10.
            DIRECTORS, EXECUTIVE OFFICERS
      AND CORPORATE GOVERNANCE




Identification
of Directors




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




Identification
of Executive Officers




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




Identification
of Audit Committee and Financial Expert




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




Material
Changes to Procedures for Recommending Directors




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




Compliance
with Section 16(a) of the Exchange Act




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




Code
of Business Conduct & Ethics




We have
adopted a Code of Business Conduct & Ethics which applies to all of our
directors, officers and employees. A copy of our Code of Business Conduct &
Ethics can be found on our website, www.sunesis.com, in the section titled “Investors and Media” under
the subsection titled “Corporate Governance.”
Information found on our website is not incorporated by reference into this
report. In addition, we intend to promptly disclose (1) the nature of any
amendment to our Code of Business Conduct & Ethics that applies to our
principal executive officer, principal financial officer, principal accounting
officer or persons performing similar functions and (2) the nature of any
waiver, including an implicit waiver, from a provision of our Code of Business
Conduct & Ethics that is granted to one of these specified officers, the
name of such person who is granted the waiver and the date of the waiver on our
website in the future.




All
additional information required by this Item 10 will be set forth in our
definitive Proxy Statement and is incorporated in this report by
reference.




70




ITEM
      11.
            EXECUTIVE
      COMPENSATION




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




ITEM
      12.
            SECURITY OWNERSHIP OF CERTAIN
      BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS




Ownership
of Sunesis Securities




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




Equity
Compensation Plan Information




The
following table provides certain information with respect to all of our equity
compensation plans in effectas of December 31,
2008:




(A)
              
              
              (B)
              
              
              (C)Plan Category
              
              Number of Securities
                  to be Issued upon
                  Exercise of
                  Outstanding Options,
                  Warrants
                  and Rights
              
              
              Weighted Average
                  Exercise Price of
                  Outstanding Options,
                  Warrants
                  and Rights
              
              
              Number of Securities
                  Remaining Available for
                  Future Issuance Under
                  Equity Compensation Plans
                  (Excluding Securities
                  Reflected in Column A)Equity
      Compensation Plans Approved by Stockholders(1)
              
              
              4,193,894
              (2)
              
              $
              3.23
              
              
              
              2,373,569
              (3)Equity
      Compensation Plans Not Approved by Stockholders(4)
              
              
              457,061
              
              
              $
              3.43
              
              
              
              67,939Total
              
              
              4,650,955
              
              
              $
              3.44
              
              
              
              2,441,508





(1)
            Includes
      our 1998 Stock Plan, or 1998 Plan, 2001 Stock Plan, or 2001 Plan, 2005
      Equity Incentive Award Plan, or 2005 Plan, and Employee Stock Purchase
      Plan, or ESPP.




(2)
            Includes
      (i) 1,018,642 shares of common stock issuable upon the exercise of
      options granted under our 1998 Plan, all of which were exercisable as of
      December 31, 2008, (ii) 148,304 shares of common stock issuable
      upon the exercise of options granted under our 2001 Plan, all of which
      were exercisable as of December 31, 2008, and (iii) 3,026,948
      shares of common stock issuable upon the exercise of options granted under
      our 2005 Plan, 1,833,135 of which were exercisable as of December 31,
      2008. Excludes purchase rights currently accruing under the ESPP. Offering
      periods under the ESPP are 12-month periods, which are comprised of two
      six-month purchase periods. Eligible employees may purchase shares of
      common stock at a price equal to 85 percent of the lower of the fair
      market value of the common stock at the beginning of each offering period
      or the end of each semi-annual purchase period. Participation is limited
      to 20 percent of an employee’s eligible compensation, subject to
      limitations under the Internal Revenue
Code.




(3)
            Includes
      (i) 2,121,116 shares of common stock available for issuance under our
      2005 Plan and (ii) 252,453 shares of common stock available for
      issuance under our ESPP.  Beginning in 2006, the number of
      shares of common stock reserved under the 2005 Plan automatically
      increases on the first trading day each year by an amount equal to the
      lesser of: (i) 4 percent of the Company’s outstanding shares of
      common stock outstanding on such date, (ii) 1,082,352 shares, or
      (iii) an amount determined by the Board of Directors. The number of
      shares of common stock reserved under our ESPP automatically increases on
      the first trading day each year by an amount equal to the least of:
      (i) 0.5 percent of our outstanding shares of common stock
      outstanding on such date, (ii) 135,294 shares or (iii) a lesser
      amount determined by our Board of
Directors.




(4)
            Represents
      our 2006 Employment Commencement Incentive Plan, or 2006
    Plan.




71




The
additional information required by this Item 12 concerning our
non-stockholder approved equity compensation plans is discussed in Note 12
in the notes to consolidated financial statements contained in Part II,
Item 8 of this report and is incorporated herein by
reference.  Any other information required by this Item 12 will
be set forth in our definitive Proxy Statement and is incorporated in this
report by reference.




ITEM
      13.
            CERTAIN RELATIONSHIPS AND
      RELATED TRANSACTIONS, AND DIRECTOR
  INDEPENDENCE




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




ITEM
      14.
            PRINCIPAL ACCOUNTANT FEES AND
      SERVICES




Information
responsive to this item is incorporated herein by reference to our definitive
Proxy Statement with respect to our 2009 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.




PART
IV




ITEM
      15.
            EXHIBITS AND FINANCIAL
      STATEMENT SCHEDULES




Exhibits
and Financial Statement Schedules:




(a)(1)
            Financial
      Statements




PageReport
      of Independent Registered Public Accounting Firm
                    
                    44Consolidated
      Balance Sheets
                    
                    45Consolidated
      Statements of Operations
                    
                    46Consolidated
      Statements of Stockholders’ Equity
                    
                    47Consolidated
      Statements of Cash Flows
                    
                    48Notes
      to Consolidated Financial Statements
                    
                    49




(a)(2)
            Financial Statement
      Schedules




All
financial statement schedules are omitted because they are not applicable, or
the information is included in the financial statements or notes
thereto.




(a)(3)
            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.




72


SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, Sunesis Pharmaceuticals, Inc. has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized
on April 3, 2009.




SUNESIS
      PHARMACEUTICALS, INC.By:
              /s/
      Eric H. BjerkholtEric
      H. BjerkholtSenior
      Vice President, Corporate Developmentand
      Finance, Chief Financial
Officer




KNOW ALL PERSONS BY THESE
PRESENTS, that each person whose signature appears below constitutes and
appoints Daniel N. Swisher, Jr. and Eric H. Bjerkholt, and each of them, as his
true and lawful attorneys-in-fact and agents, with full power of substitution
for him, and in his name in any and all capacities, to sign any and all
amendments to this Annual Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done therewith, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, and any of them or his
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities on the dates indicated.




Signature
                  
                  Title
                  
                  Date/s/
      James W. Young, Ph.D.
                  
                  Executive
      Chairman of the Board
                  
                  April 3,
      2009James
      W. Young, Ph.D./s/
      Daniel N. Swisher, Jr.
                  
                  President,
      Chief Executive Officer and
                  
                  April 3,
      2009Daniel
      N. Swisher, Jr.
                  
                  Director
      (Principal Executive
      Officer)/s/
      Eric H. Bjerkholt
                  
                  Senior
      Vice President, Corporate
                    Development
      and Finance, Chief
                  
                  April 3,
      2009Eric
      H. Bjerkholt
                  
                  Financial
      Officer (Principal
      FinancialOfficer
      and Principal Accounting Officer)/s/
      Anthony B. Evnin, Ph.D.
                  
                  Director
                  
                  April 3,
      2009Anthony
      B. Evnin, Ph.D./s/
      Stephen P.A. Fodor, Ph.D.
                  
                  Director
                  
                  April 3,
      2009Stephen
      P.A. Fodor, Ph.D./s/
      Matthew K. Fust
                  
                  Director
                  
                  April 3,
      2009Matthew
      K. Fust/s/
      Steven D. Goldby
                  
                  Director
                  
                  April 3,
      2009Steven
      D. Goldby/s/
      Homer L. Pearce
                  
                  Director
                  
                  April 3,
      2009Homer
      L. Pearce




/s/
      David C. Stump, M.D.
                  
                  Director
                  
                  April 3,
      2009David
      C. Stump, M.D.





73




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 Registrant’s Current Report on Form 8-K filed
      on December 11, 2007).4.1
                    
                    Specimen
      Common Stock certificate of the Registrant (incorporated by reference to
      Exhibit 4.1 to the Registrant’s Registration Statement on
      Form S-1 (SEC File No. 333-121646) filed on December 23,
      2004).10.1
                    *
                    1998
      Stock Plan and Form of Stock Option Agreement (incorporated by reference
      to Exhibit 10.1 to Amendment No. 1 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on January 27, 2005).10.2
                    *
                    2001
      Stock Plan and Form of Stock Option Agreement (incorporated by reference
      to Exhibit 10.2 to the Registrant’s Registration Statement on
      Form S-1 (SEC File No. 333-121646) filed on December 23,
      2004).10.3
                    *
                    2005
      Equity Incentive Award Plan, as amended, and Form of Stock Option
      Agreement (incorporated by reference to Exhibit 10.3 to the
      Registrant’s Quarterly Report on Form 10-Q filed on August 8,
      2007).10.4
                    *
                    Employee
      Stock Purchase Plan and Enrollment Form (incorporated by reference to
      Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q
      filed on November 9, 2006).10.5
                    *
                    Form
      of Indemnification Agreement for directors and executive officers
      (incorporated by reference to Exhibit 10.5 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on December 23, 2004).10.6
                    *
                    Amended
      and Restated Consulting Agreement, dated August 8, 2005, by and
      between the Registrant and James A. Wells (incorporated by reference to
      Exhibit 10.12 to Amendment No. 4 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on September 1, 2005).10.7
                    
                    Eighth
      Amended and Restated Investor Rights Agreement, dated August 30,
      2004, by and among the Registrant and certain stockholders and warrant
      holders (incorporated by reference to Exhibit 10.17 to the
      Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on December 23, 2004).10.8
                    *
                    Warrant,
      dated April 9, 1998, issued to James A. Wells (incorporated by
      reference to Exhibit 10.18 to the Registrant’s Registration Statement
      on Form S-1 (SEC File No. 333-121646) filed on December 23,
      2004).10.9
                    
                    Warrant,
      dated December 1, 1999, issued to Three Crowns Capital (Bermuda)
      Limited (incorporated by reference to Exhibit 10.19 to the
      Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on December 23, 2004).10.10
                    
                    Warrant,
      dated July 7, 2000, issued to Broadview Ltd. Limited and
      Amendment No. 1 thereto (incorporated by reference to
      Exhibit 10.20 to the Registrant’s Registration Statement on
      Form S-1 (SEC File No. 333-121646) filed on December 23,
      2004).10.11
                    
                    Warrant,
      dated June 11, 2003, issued to General Electric Capital Corporation
      (incorporated by reference to Exhibit 10.21 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on December 23, 2004).10.12
                    
                    Warrant,
      dated June 21, 2004, issued to General Electric Capital Corporation
      and Amendment No. 1 thereto, dated December 16, 2004
      (incorporated by reference to Exhibit 10.22 to Amendment No. 2
      to the Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on April 29, 2005).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.10.14
                    †
                    Collaboration
      Agreement, dated December 18, 2002, by and between the Registrant and
      Biogen Idec MA Inc. (successor to Biogen Inc.) (incorporated by
      reference to Exhibit 10.26 to Amendment No. 1 to the
      Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on January 27, 2005).10.15
                    †
                    Amendment
      No. 1 to Collaboration Agreement, dated June 17, 2003, between
      the Registrant and Biogen Idec MA Inc. (incorporated by reference to
      Exhibit 10.27 to Amendment No. 1 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on January 27, 2005).10.16
                    †
                    Amendment
      No. 2 to Collaboration Agreement, dated September 17, 2003,
      between the Registrant and Biogen Idec MA Inc. (incorporated by
      reference to Exhibit 10.28 to Amendment No. 1 to the
      Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on January 27,
  2005).




74





10.17
              †
              Collaboration
      Agreement, dated August 25, 2004, between the Registrant and Biogen
      Idec, Inc. (incorporated by reference to Exhibit 10.29 to Amendment
      No. 2 to the Registrant’s Registration Statement on Form S-1
      (SEC File No. 333-121646) filed on April 29,
    2005).10.18
              †
              Collaboration
      Agreement, dated May 3, 2002, by and between the Registrant and
      Johnson & Johnson Pharmaceutical Research &
      Development, LLC (incorporated by reference to Exhibit 10.30 to
      Amendment No. 1 to the Registrant’s Registration Statement on
      Form S-1 (SEC File No. 333-121646) filed on January 27,
      2005).10.19
              †
              Amendment
      to Collaboration Agreement, dated December 15, 2002, between the
      Registrant and Johnson & Johnson Pharmaceutical
      Research & Development, LLC (incorporated by reference to
      Exhibit 10.31 to Amendment No. 1 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on January 27, 2005).10.20
              
              Notice
      of Extension and Second Amendment to Collaboration Agreement, dated
      December 15, 2003, between the Registrant and Johnson &
      Johnson Pharmaceutical Research & Development, LLC
      (incorporated by reference to Exhibit 10.32 to Amendment No. 1
      to the Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on January 27, 2005).10.21
              †
              Third
      Amendment to Collaboration Agreement, dated December 22, 2004,
      between the Registrant and Johnson & Johnson Pharmaceutical
      Research & Development, LLC (incorporated by reference to
      Exhibit 10.33 to Amendment No. 2 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on April 29, 2005).10.22
              †
              License
      and Collaboration Agreement, dated February 12, 2003, by and between
      the Registrant and Merck & Co., Inc. (incorporated by
      reference to Exhibit 10.34 to Amendment No. 1 to the
      Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on January 27, 2005).10.23
              †
              License
      and Research Collaboration Agreement, dated July 22, 2004, by and
      between the Registrant and Merck & Co., Inc.
      (incorporated by reference to Exhibit 10.35 to Amendment No. 1
      to the Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on January 27, 2005).10.24
              †
              License
      Agreement, dated October 14, 2003, by and between the Registrant and
      Dainippon Sumitomo Pharma Co., Ltd. (formerly known as Dainippon
      Pharmaceutical Co., Ltd.) (incorporated by reference to
      Exhibit 10.36 to Amendment No. 2 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on April 29, 2005).10.25
              †
              License
      Agreement, dated as of April 27, 2005, between the Registrant and
      Bristol-Meyers Squibb Company (incorporated by reference to
      Exhibit 10.35 to Amendment No. 4 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on September 1, 2005).10.26
              
              Stock
      Purchase Agreement, dated as of April 27, 2005, between the
      Registrant and Bristol-Meyers Squibb Company (incorporated by reference to
      Exhibit 10.38 to Amendment No. 2 to the Registrant’s
      Registration Statement on Form S-1 (SEC File No. 333-121646)
      filed on April 29, 2005).10.27
              
              Amendment
      to Eighth Amended and Restated Investor Rights Agreement, dated as of
      April 27, 2005, among the Registrant and investors listed on the
      signature pages thereto (incorporated by reference to Exhibit 10.39
      to Amendment No. 2 to the Registrant’s Registration Statement on
      Form S-1 (SEC File No. 333-121646) filed on April 29,
      2005).10.28
              
              Amendment
      to Eighth Amended and Restated Investor Rights Agreement, dated as of
      August 25, 2005, among the Registrant and the investors listed on the
      signature pages thereto (incorporated by reference to Exhibit 10.39
      to Amendment No. 4 to the Registrant’s Registration Statement on
      Form S-1 (SEC File No. 333-121646) filed on September 1,
      2005).10.29
              
              Warrant,
      dated August 25, 2005, issued to Horizon Technology Funding Company
      II LLC (incorporated by reference to Exhibit 10.40 to Amendment
      No. 4 to the Registrant’s Registration Statement on Form S-1
      (SEC File No. 333-121646) filed on September 1,
      2005).10.30
              
              Warrant,
      dated August 25, 2005, issued to Horizon Technology Funding Company
      III LLC (incorporated by reference to Exhibit 10.41 to Amendment
      No. 4 to the Registrant’s Registration Statement on Form S-1
      (SEC File No. 333-121646) filed on September 1,
      2005).10.31
              
              Warrant,
      dated August 25, 2005, issued to Oxford Finance Corporation
      (incorporated by reference to Exhibit 10.42 to Amendment No. 4
      to the Registrant’s Registration Statement on Form S-1 (SEC File
      No. 333-121646) filed on September 1, 2005).10.32
              *
              Amended
      and Restated 2006 Employment Commencement Incentive Plan (incorporated by
      reference to Exhibit 10.43 to the Registrant’s Current Report on
      Form 8-K filed on December 23, 2008).10.33
              
              Common
      Stock and Warrant Purchase Agreement, dated as of March 17, 2006,
      among the Company and the investors listed on the signature pages thereto
      (incorporated by reference to Exhibit 10.44 to the Registrant’s
      Current Report on Form 8-K filed on March 22,
    2006).10.34
              
              Registration
      Rights Agreement, dated as of March 17, 2006, among the Company and
      the investors listed on the signature pages thereto (incorporated by
      reference to Exhibit 10.45 to the Registrant’s Current Report on
      Form 8-K filed on March 22,
2006).




75





10.35
              
              Form
      of Warrant (incorporated by reference to Exhibit 10.46 to the
      Registrant’s Current Report on Form 8-K filed on March 22,
      2006).10.36
              †
              Sublease,
      dated December 22, 2006, by and between the Registrant and Oncology
      Therapeutics Network Joint Venture, L.P., for office space located at
      395 Oyster Point Boulevard, South San Francisco, California (incorporated
      by reference to Exhibit 10.47 to the Registrant’s Annual Report on
      Form 10-K filed on March 17, 2008).10.37
              *
              Amendment,
      dated December 21, 2005, to the Amended and Restated Consulting
      Agreement, dated August 8, 2005, by and between the Registrant and
      James A. Wells, Ph. D. (incorporated by reference to Exhibit 10.48 to
      the Registrant’s Quarterly Report on Form 10-Q filed on May 9,
      2007).10.38
              *
              Consulting
      Agreement, dated August 17, 2006, by and between the Registrant and
      Homer L. Pearce, Ph. D. (incorporated by reference to Exhibit 10.49
      to the Registrant’s Quarterly Report on Form 10-Q filed on
      May 9, 2007).10.39
              *
              Consulting
      Agreement, dated September 2, 2006, by and between the Registrant and
      David C. Stump, M. D. (incorporated by reference to Exhibit 10.50 to
      the Registrant’s Quarterly Report on Form 10-Q filed on May 9,
      2007).10.40
              *
              Forms
      of Stock Option Grant Notice and Stock Option Agreement under the 2005
      Equity Incentive Award Plan (incorporated by reference to
      Exhibit 10.52 to the Registrant’s Current Report on Form 8-K
      filed on September 19, 2007).10.41
              *
              Sunesis
      Pharmaceuticals, Inc. 2008 Executive Bonus Program (incorporated by
      reference to Exhibit 10.56 to the Registrant’s Quarterly Report on Form
      10-Q filed on August 7, 2008).10.42
              *
              Forms
      of Stock Option Grant Notice and Stock Option Agreement under the Amended
      and Restated 2006 Employment Commencement Incentive Plan (incorporated by
      reference to Exhibit 10.57 to the Registrant’s Quarterly Report on Form
      10-Q filed on August 7, 2008).10.43
              *
              Amended
      and Restated Executive Severance Benefits Agreement, dated December 23,
      2008, by and between the Registrant and Steven B. Ketchum,
      Ph.D.10.44
              *
              Second
      Amended and Restated Executive Severance Benefits Agreement, dated
      December 24, 2008, by and between Registrant and Daniel N. Swisher,
      Jr.10.45
              *
              Second
      Amended and Restated Executive Severance Benefits Agreement, dated
      December 24, 2008, by and between Registrant and Eric H.
      Bjerkholt.10.46
              *
              Second
      Amended and Restated Executive Severance Benefits Agreement, dated
      December 23, 2008, by and between Registrant and James W. Young,
      Ph.D.10.47
              *
              Second
      Amended and Restated Executive Severance Benefits Agreement, dated
      December 24, 2008, by and between Registrant and Valerie L.
      Pierce.10.48
              *
              Amended
      and Restated Executive Severance Benefits Agreement, dated May 27, 2008,
      by and between Registrant and Daniel C. Adelman, M.D. (incorporated by
      reference to Exhibit 10.63 to the Registrant’s Quarterly Report on Form
      10-Q filed on August 7, 2008).10.49
              *
              Amended
      and Restated Executive Severance Benefits Agreement, dated May 28, 2008,
      by and between Registrant and Robert S. McDowell, Ph.D. (incorporated by
      reference to Exhibit 10.64 to the Registrant’s Quarterly Report on Form
      10-Q filed on August 7, 2008).10.50
              *
              Release
      Agreement, dated June 6, 2008, by and between Registrant and Daniel C.
      Adelman, M.D. (incorporated by reference to Exhibit 10.65 to the
      Registrant’s Quarterly Report on Form 10-Q filed on August 7,
      2008).10.51
              *
              Release
      Agreement, dated August 4, 2008, by and between Registrant and Robert S.
      McDowell, Ph.D. (incorporated by reference to Exhibit 10.66 to the
      Registrant’s Quarterly Report on Form 10-Q filed on August 7,
      2008).10.52
              *
              Acceptance
      of Option Amendment, dated June 6, 2008, by and between Registrant and
      Daniel C. Adelman, M.D. (incorporated by reference to Exhibit 10.67 to the
      Registrant’s Quarterly Report on Form 10-Q filed on August 7,
      2008).10.53
              *
              Acceptance
      of Option Amendment, dated June 27, 2008, by and between Registrant and
      Robert S. McDowell, Ph.D. (incorporated by reference to Exhibit 10.68 to
      the Registrant’s Quarterly Report on Form 10-Q filed on August 7,
      2008).10.54
              *
              Forms
      of Stock Option Grant Notice and Stock Option Agreement for Automatic
      Grants to Outside Directors under the 2005 Equity Incentive Award Plan
      (incorporated by reference to Exhibit 10.69 to the Registrant’s Quarterly
      Report on Form 10-Q filed on November 7, 2008).10.55
              *
              Consulting
      Agreement, dated August 5, 2008, and First Amendment to Consulting
      Agreement, dated October 1, 2008, by and between Registrant and Robert S.
      McDowell, Ph.D. (incorporated by reference to Exhibit 10.70 to the
      Registrant’s Quarterly Report on Form 10-Q filed on November 7,
      2008).10.56
              
              Forms
      of Stock Option Grant Notice and Stock Option Agreement under the Amended
      and Restated 2006 Employment Commencement Incentive Plan (incorporated by
      reference to Exhibit 10.71 to the Registrant’s Current Report on Form 8-K
      filed on December 23, 2008).




76





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).10.59
                      
                      Summary
      of Non-Employee Director Cash Compensation
Arrangements.21.1
                      
                      Subsidiaries
      of the Registrant.23.1
                      
                      Consent
      of Independent Registered Public Accounting Firm.31.1
                      
                      Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a) or
      Rule 15d-14(a) of the Exchange Act.31.2
                      
                      Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) or
      Rule 15d-14(a) of the Exchange Act.32.1
                      #
                      Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to
      13a-14(b) or 15d-14(b) of the Exchange
Act.





*
            Management
      contract, compensatory plan or
arrangement.




†
            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 Certification furnished in
      Exhibit 32.1 hereto is deemed to accompany this Form 10-K and
      will not be filed for purposes of Section 18 of the Exchange Act.
      Such certification 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.


77