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 1934
For the Year Ended December 31, 2008
OR
¨
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 I
ITEM 1.
Business
  3
ITEM 1A.
Risk Factors
  15
ITEM 1B.
Unresolved Staff Comments
  29
ITEM 2.
Properties
  29
ITEM 3.
Legal Proceedings
  30
ITEM 4.
Submission of Matters to a Vote of Security Holders
  30
PART II
ITEM 5.
Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
30
ITEM 6.
Selected Financial Data
  32
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  32
ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
ITEM 8.
Financial Statements and Supplementary Data
  43
ITEM 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
  69
ITEM 9A(T).
Controls and Procedures
  69
ITEM 9B.
Other Information
  70
PART III
ITEM 10.
Directors, Executive Officers and Corporate Governance
  70
ITEM 11.
Executive Compensation
  71
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  71
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
  72
ITEM 14.
Principal Accountant Fees and Services
72
PART IV
ITEM 15.
Exhibits, Financial Statement Schedules
  72
 
Signatures
  73
 
Exhibit 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.

 
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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 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 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 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. Voreloxin acts by DNA intercalation and inhibition of topoisomerase II in replicating cancer cells. The resulting site-selective DNA damage rapidly causes the cancer cells to stop dividing and die. In preclinical studies, voreloxin demonstrates broad anti-tumor activity and appears to act synergistically when combined with several therapeutic agents currently used in the treatment of cancer. Clinical activity is observed in both solid and hematologic malignancies.  We licensed worldwide development and commercialization rights to voreloxin from Dainippon Sumitomo Pharma Co., Ltd. in 2003.
 
The following chart summarizes the status of the clinical trials that have been conducted or that we are currently conducting with voreloxin.
 
 
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Voreloxin Clinical Study
 
 
Phase 1
Phase 2
Acute Leukemias
 
     
Single Agent Relapsed/Refractory Acute Leukemias
 
 
Complete
 
Single Agent
Previously Untreated Elderly AML
(REVEAL-1)
Schedule A
 
Ongoing –
Enrollment
Complete
 
Schedule B
 
Ongoing –
Enrollment
Complete
 
Schedule C
 
Enrolling
 
Combination with Cytarabine
Relapsed/Refractory AML
Schedule A
Complete
Ongoing –
Enrollment
Complete
 
Schedule B
Enrolling
Planned
 
Solid Tumors
 
     
Single Agent Advanced Solid Tumors
 
Complete
 
 
Single Agent Advanced Solid Tumors
 
Complete
 
 
Single Agent Non-Small Cell Lung
   
Complete
 
Single Agent Small Cell Lung
   
Complete
 
Single 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/m2 of 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 inhibitor from 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.
 
 
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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 Corporations 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.
 
 
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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.
 
 
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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.
 
 
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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.
 
 
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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.
 
 
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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.
 
 
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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 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 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.

 
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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.
 
 
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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.
 
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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.

 
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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.
 
 
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Some of the current key competitors to voreloxin in AML include Genzyme Corporation’s clofarabine, Eisai Corporation’s decitabine, Celgene Corporations 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;
 
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·
we will develop additional proprietary technologies that are patentable; or

·
the patents of others will have an adverse effect on our business.
 
We also rely on trade secrets to protect some of our technology, especially where we do not believe patent protection is appropriate 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.
 
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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.
 
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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 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 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 commercialize voreloxin. 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
   
Low
 
First Quarter
  $ 5.23     $ 4.04  
Second Quarter
  $ 4.70     $ 3.25  
Third Quarter
  $ 3.69     $ 2.31  
Fourth Quarter
  $ 2.64     $ 1.70  

Year-Ended December 31, 2008
 
High
   
Low
 
First Quarter
  $ 1.98     $ 1.13  
Second Quarter
  $ 2.01     $ 1.26  
Third Quarter
  $ 1.82     $ 0.91  
Fourth 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     $ 5,938  
Collaboration revenue from related party
          7,587       7,318       9,018       4,201  
License revenue
    500       500                    
Grant and fellowship revenue
                38       109       166  
Total revenues
    5,417       9,663       13,709       16,522       10,305  
Operating expenses:
                                       
Research and development
    26,285       36,060       35,615       36,166       23,616  
General and administrative
    11,524       13,570       12,255       8,283       7,352  
Restructuring and impairment charges
    5,783       1,563                    
Total operating expenses
    43,592       51,193       47,870       44,449       30,968  
Loss from operations
    (38,175 )     (41,530 )     (34,161 )     (27,927 )     (20,663 )
Interest income
    929       2,972       3,395       1,092       518  
Interest expense
    (172 )     (210 )     (478 )     (674 )     (387 )
Other income (expense), net
    232       7       7       10       2  
Net 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     $ 36,812  
Working capital
    5,371       39,707       55,279       40,156       27,707  
Total assets
    12,784       53,246       69,276       54,708       43,026  
Long-term portion of equipment leases
          1,353       956       1,306       4,438  
Convertible preferred stock
                            108,813  
Common stock and additional paid-in capital
    322,675       320,583       298,077       249,692       6,494  
Accumulated 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.
 
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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 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 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.
 
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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.
 
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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.
 
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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     $ 7,318  
Merck
    107       1,576       6,353  
J&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.
 
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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     $ 8,420  
SNS-032
    3,480       3,723       5,446  
SNS-314
    2,004       4,563       5,238  
Discovery programs and new technologies
    2,233       4,128       3,762  
Other kinase inhibitors
    1,997       8,785       10,728  
RAF kinase inhibitors
    4       881       1,482  
Other programs
    23       275       213  
BACE inhibitors for Alzheimer’s disease
          4       316  
TNF family and oncology research
          2       3  
Cathepsin S inhibitors
                7  
Total
  $ 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.
 
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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.
 
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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 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 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 Period
 
   
Total
   
Less than
1 Year
   
1-3 Years
   
3-5 Years
   
More than
5 years
 
Operating 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
 
 
Page
Report of Independent Registered Public Accounting Firm
  44
Consolidated Balance Sheets
  45
Consolidated Statements of Operations
  46
Consolidated Statements of Stockholders’ Equity
  47
Consolidated Statements of Cash Flows
  48
Notes 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
except for Note 17, as to which the date is
March 31, 2009
 
44

 
SUNESIS PHARMACEUTICALS, INC.
 
CONSOLIDATED BALANCE SHEETS
 
   
December 31,
 
   
2008
   
2007
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 6,296,942     $ 11,726,126  
Marketable securities
    4,321,844       35,957,933  
Prepaids and other current assets
    934,429       945,583  
Total current assets
    11,553,215       48,629,642  
Property and equipment, net
    612,241       4,238,498  
Assets held-for-sale
    470,547        
Deposits and other assets
    147,826       377,798  
Total assets
  $ 12,783,829     $ 53,245,938  
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable and other accrued liabilities
  $ 4,207,923     $ 4,515,426  
Accrued compensation
    537,215       2,225,868  
Current portion of deferred rent
    1,409,513        
Current portion of deferred revenue
    27,083       1,227,031  
Current portion of equipment financing
          953,940  
Total current liabilities
    6,181,734       8,922,265  
Non-current portion of equipment financing
          1,352,684  
Non-current portion of deferred rent
    110,919       1,576,734  
Commitments (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       3,437  
Additional paid-in capital
    322,671,604       320,579,240  
Deferred stock-based compensation
          (251,601 )
Accumulated other comprehensive income
    7,841       69,262  
Accumulated deficit
    (316,191,710 )     (279,006,083 )
Total stockholders’ equity
    6,491,176       41,394,255  
Total 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
   
2006
 
Revenue:
                 
Collaboration revenue
  $ 4,917,340     $ 1,576,610     $ 6,353,585  
Collaboration revenue from related party (Note 4)
          7,586,903       7,317,700  
License revenue
    500,000       500,000        
Grant and fellowship revenue
                37,901  
Total revenues
    5,417,340       9,663,513       13,709,186  
Operating expenses:
                       
Research and development
    26,285,294       36,060,470       35,615,536  
General and administrative
    11,524,198       13,569,578       12,254,892  
Restructuring and impairment charges
    5,782,903       1,563,274        
Total operating expenses
    43,592,395       51,193,322       47,870,428  
Loss from operations
    (38,175,055 )     (41,529,809 )     (34,161,242 )
Interest income
    929,114       2,971,666       3,394,751  
Interest expense
    (171,308 )     (209,885 )     (477,643 )
Other income, net
    231,622       7,108       6,873  
Net 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
   
Equity
 
Balance at December 31, 2005
    21,511,126     $ 2,151     $ 249,689,714     $ (2,162,688 )   $ (55,073 )   $ (209,007,902 )   $ 38,466,202  
Issuance 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                         318,156  
Expense related to fair value of restricted stock award granted to non-employee
    2,001             11,367                         11,367  
Reversal of deferred stock-based compensation related to employee stock option grants
                (432,872 )     432,872                    
Amortization deferred stock-based compensation
                      723,212                   723,212  
Stock-based compensation expenses related to fair value of options granted to non-employees
                100,470                         100,470  
Stock-based compensation expenses related to fair value of options granted to employees
                2,046,655                         2,046,655  
Issuance of common stock for Employee Stock Purchase Program
    145,632       14       652,918                         652,932  
Issuance of common stock to BMS at $4.95 per share in connection with in-licensing arrangement
    404,040       41       1,999,958                         1,999,999  
Issuance 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                         43,658,268  
Issuance of common stock pursuant to warrant exercise at $4.25 per share
    7,059             30,000                         30,000  
Components of comprehensive loss:
                                                       
Net loss
                                  (31,237,261 )     (31,237,261 )
Unrealized gain on investments
                            33,697             33,697  
Comprehensive 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 )     56,803,697  
Issuance 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                         161,016  
Reversal of deferred stock-based compensation related to employee stock option grants
                (76,980 )     76,980                    
Amortization deferred stock-based compensation
                      633,023                   633,023  
Stock-based compensation expenses related to fair value of options granted to non-employees
                2,394                         2,394  
Stock-based compensation expenses related to fair value of options granted to employees
                2,468,898                         2,468,898  
Stock-based compensation expenses related to fair value of options acceleration and extension of exercisable period from restructuring
                126,456       45,000                   171,456  
Issuance of common stock for Employee Stock Purchase Program
    102,904       10       301,055                           301,065  
Issuance 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                         19,522,988  
Components of comprehensive loss:
                                                       
Net loss
                                    (38,760,920 )     (38,760,920 )
Unrealized gain on investments
                            90,638             90,638  
Comprehensive loss
                                                    (38,670,282 )
Balance at December 31, 2007
    34,364,896       3,437       320,579,240       (251,601 )     69,262       (279,006,083 )     41,394,255  
Issuance 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