The following discussion and analysis of our financial condition as of March 31, 2009 and results of operations for the three months ended March 31, 2009 and 2008 should be read together with our condensed consolidated financial statements and related notes included elsewhere in this report. This discussion and analysis contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, which involve risks, uncertainties and assumptions. All statements, other than statements of historical facts, are "forward-looking statements" for purposes of these provisions, including any projections of revenue, expenses or other financial items, cash requirements, financing plans, any statement of the plans and objectives of management for future operations, any statements concerning proposed new clinical trials or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "anticipates," "believe," "continue," "estimates," "expects," "intend," "look forward," "may," "could," "seeks," "plans," "potential," or "will" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under "Risk Factors" and elsewhere in this report. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. All forward-looking statements included in this report are based on information available to us on the date of this report, and we assume no obligation to update any forward-looking statements contained in this report.

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

Overview

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

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

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

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

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

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

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

We have incurred significant losses in each year since our inception. As of March 31, 2009, we had an accumulated deficit of $324.6 million. We expect our significant net losses to continue for the foreseeable future, as we continue to conduct development of, and seek regulatory approvals for, voreloxin.

Critical Accounting Policies and Significant Judgments and Estimates

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

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur periodically, could materially change the financial statements. We believe there have been no significant changes during the three months ended March 31, 2009 to the items that we disclosed as our critical accounting policies and estimates in our management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2008.

Recent Accounting Pronouncements

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

Results of Operations

Revenue

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

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

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

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

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

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

Research and Development Expense

Most of our operating expenses to date have been for research and development activities, and include costs incurred:

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

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

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

• in connection with in-licensing activities, and

• in the conduct of activities we are required to perform in connection with our strategic collaborations.

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

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

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

As a result of our 2008 Restructuring and the resulting wind-down of our research activities, we do not anticipate incurring any significant additional research expenses related to the discovery of additional product candidates, the development or application of our proprietary fragment-based drug discovery methods, or the development of in-house research capabilities. In addition, we are no longer conducting any research activities in connection with any of our collaborations.

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

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

We are currently anticipating that development of voreloxin will be our highest priority. If we engage a development or commercialization partner on our voreloxin program, or if, in the future, we acquire additional product candidates, our research and development expenses could be significantly affected. We cannot predict whether future collaborative or licensing arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

Under our Biogen Idec agreement, we have the right to participate in the co-development and co-promotion of product candidates for up to two targets including, at our option, the Raf kinase target, on a worldwide basis (excluding Japan). If we were to exercise our option on one or more product candidates, our research and development expense would increase significantly.

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

General and Administrative Expense

Our general and administrative expense consists primarily of salaries and other related costs for personnel in finance, human resources, legal (including intellectual property), management and general administration, as well as non-cash stock-based compensation. Other significant costs include facilities costs and fees paid to outside legal advisors and independent auditors.

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

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

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

Interest Income

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

Interest Expense

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

Other income (expense), net

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

Liquidity and Capital Resources

Sources of Liquidity

Since our inception, we have funded our operations primarily through the issuance of common and preferred stock; research funding, technology access fees and milestone payments from our collaboration partners; research grants; loans from Biogen Idec and other debt financings.

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

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

Cash Flows

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

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

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

Operating Capital and Capital Expenditure Requirements

We expect to continue to incur substantial operating losses in the future. We will not receive any product revenue until a product candidate has been approved by the U.S. Food and Drug Administration, or FDA, or similar regulatory agencies in other countries, and has been successfully commercialized. We need to raise substantial additional funds to complete the development and commercialization of voreloxin. Additionally, we may evaluate in-licensing and acquisition opportunities to gain access to new drugs or drug targets that would fit with our strategy. Any such transaction would likely increase our funding needs in the future.

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