The following discussion and analysis of our financial condition as of September 30, 2009 and results of operations for the three and nine months ended September 30, 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.

We own worldwide development and commercialization rights to voreloxin and are currently preparing for anticipated Phase 3 development of the compound. 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 anti-tumor activity by targeting mammalian topoisomerase II, an enzyme critical for cell replication, and have demonstrated promising preclinical anti-tumor activity.

We are completing three clinical trials of voreloxin: (i) a Phase 2 clinical trial (known as the REVEAL-1 trial) in previously untreated elderly patients with acute myeloid leukemia, or AML, for which enrollment of a total of 113 patients dosed in one of three dosing schedules was completed in October 2009,
(ii) a Phase 1b/2 clinical trial of voreloxin in combination with cytarabine for the treatment of patients with relapsed/refractory AML, and (iii) a Phase 2 single agent clinical trial in platinum-resistant ovarian cancer patients. In November 2009, we announced that the U.S. Food and Drug Administration, or FDA, had granted voreloxin orphan drug designation for the treatment of AML. We anticipate launching a pivotal trial of voreloxin for AML in 2010, and we may enter into partnering arrangements for this product candidate to maximize its commercial potential.

Two abstracts related to the voreloxin clinical program in AML have been accepted for presentation at the 51st Annual Meeting of the American Society of Hematology (ASH) in December 2009. At the American Society of Clinical Oncology (ASCO) 2009 Annual Meeting in June, we presented new data from the three ongoing clinical trials that we believe demonstrates that voreloxin shows promising safety and efficacy in acute myeloid leukemia and in platinum-resistant ovarian cancer.

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 March 2009, the license agreement was terminated and SNS-032 was returned to BMS. In addition, in the first quarter of 2009, we completed 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 the trial, and no responses were observed. We currently have no plans to conduct further development activities involving SNS-314 on our own, but we plan to seek a partner or licensee to support further development of SNS-314 in the future.

In March 2009, we announced the sale of 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 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 was recorded as revenue in the second quarter of 2009. In connection with the sale, the license agreement was terminated. SARcode had been the exclusive licensee of those assets since March 2006.

In June 2009, we earned a milestone of $1.5 million for Biogen Idec's selection of a Raf kinase inhibitor development candidate for the treatment of cancer, which was recorded as revenue in the second quarter of 2009. The milestone payment was received in July 2009. Biogen Idec is currently conducting IND-enabling preclinical work with the Raf kinase development candidate.

On April 3, 2009, we completed the initial closing of $10.0 million of a Private Placement of up to $43.5 million of the Company's securities. On October 30, 2009, we completed the second closing of $5.0 million of the Private Placement. In the initial closing, $10.0 million of units were sold, resulting in net proceeds of $8.8 million, and in the second closing, $5.0 million of units were sold, resulting in net proceeds of approximately $4.7 million. The units consist of Series A convertible preferred stock and warrants to purchase common stock, and were sold to accredited investors, including certain members of management. The Private Placement also contemplates the sale of up to $28.5 million in common stock to the same group of investors, subject to conditions described in 'Sources of Liquidity' below.

We have incurred significant losses in each year since our inception. As of September 30, 2009, we had an accumulated deficit of $352.4 million. We expect to continue to incur significant net losses for the foreseeable future, as we continue the development of, and seek regulatory approvals for, voreloxin. We believe that currently available cash, cash equivalents and marketable securities, including the net proceeds of approximately $4.7 million from the second closing of the Private Placement completed on October 30, 2009, are sufficient to fund our operations until the end of the first quarter of 2010, and we will need to raise additional funds in the near term in order to sustain operations beyond that time.

On August 3, 2009, upon NASDAQ's approval, the listing of our common stock was transferred from The NASDAQ Global Market to The NASDAQ Capital Market. To maintain a listing on The NASDAQ Capital Market, we are required to meet certain requirements, including a minimum closing bid price of $1.00 per share, a market value of publicly held shares of at least $1.0 million, and stockholders' equity of at least $2.5 million. After accounting for the $4.7 million in net proceeds from the second closing of the Private Placement and the $1.5 million net loss for the month of October 2009, our stockholders' equity was $4.4 million as of October 31, 2009.

On September 16, 2009, we received a letter from NASDAQ notifying us that we do not comply with the minimum $1.00 per share requirement for a continued listing. To regain compliance, prior to March 15, 2010, the bid price of our common stock must close at $1.00 or more for at least 10 consecutive business days. If we do not demonstrate compliance by March 15, 2010, a determination will be made as to whether we meet the initial listing criteria for The NASDAQ Capital Market except for the $1.00 per share bid price requirement. If we do meet these criteria, we would expect to be granted an additional 180 calendar day compliance period. If we are not eligible for an additional compliance period, NASDAQ will notify us that our common stock may be delisted. At that time, we may appeal to the NASDAQ Listing Qualifications Panel, and would remain listed pending the Panel's decision. We cannot provide any assurance that the Panel will allow us to remain listed in the event of any appeal.

Critical Accounting Policies and Significant Judgments and Estimates

There have been no significant changes during the quarter ended September 30, 2009 to our critical accounting policies and significant judgments and estimates as disclosed 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, except as follows:

Private Placement Accounting

The accounting for the initial closing of the sale of $10.0 million of units under our Private Placement, and subsequent revaluations of the related financial instruments, required fair values to be established at different time-points for the four primary components of the Private Placement: (a) the Series A convertible preferred stock, (b) the warrants to purchase common stock,
(c) the Second Closing Option, and (d) the Common Equity Closing Option. The Black-Scholes option-pricing model, or Black-Scholes Model, was selected to determine these fair values, which were calculated as a series of call options on the potential enterprise value of the company at different valuation points at which the claims of the different stakeholder groups on the enterprise value would change. The results of the Black-Scholes Model are affected by the company's stock price, as well as assumptions regarding a number of highly subjective variables. These variables include the expected term of the financial instruments and our expected stock price volatility, risk-free interest rate and dividend rate over the expected term.

Alternative models could have been selected to calculate these fair values, which may have produced significantly different results. If we adopt a different valuation model in the future, this may result in a lack of consistency between periods and materially affect our fair value estimates. It may also result in a lack of comparability with other companies that use different models, methods and assumptions. Additionally, because the estimated fair values are affected by our stock price, fluctuations in our stock price, which has historically been volatile, may significantly affect our financial results.

Recent Accounting Pronouncements

The impact of recent accounting pronouncements that we have adopted is detailed in Note 1 to our consolidated financial statements.

Results of Operations

Revenue

We have not generated any revenue from sales of commercial products and do not expect to generate any product revenue in 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.

Collaboration revenue was $12,500 and $1.5 million for the three and nine months ended September 30, 2009 as compared to $10,000 and $4.9 million for the same periods in 2008. The decrease of $3.4 million between the nine month periods was primarily due to the completion in June 2008 of research funding and technology access fee amortization under the Biogen Idec collaboration, partially offset by an increase in milestone revenue as a result of the $1.5 million milestone earned in the 2009 period from Biogen Idec's selection of a Raf kinase inhibitor development candidate for the treatment of cancer.

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 July 2009, Johnson & Johnson Pharmaceutical Research & Development LLC, or J&JPRD, provided written notice that it was terminating its collaboration related to the enzyme Cathepsin S, which it entered into with us in May 2002. In accordance with the terms of the collaboration agreement, the termination will be effective on January 13, 2010. As a result, we do not expect to receive any additional funding revenues from J&JPRD or record any additional revenues under this collaboration agreement.

We expect to have substantially lower collaboration revenue in 2009 and in future years from existing collaborations unless, and until, any products that may result from them advance to a level where significant milestones will be payable to us.

License and Other Revenue. License and other revenue was zero and $2.2 million for the three and nine months ended September 30, 2009 as compared to $0.5 million for each of the same periods in 2008. In March 2009, we sold to SARcode our interest in all of the patents and related know-how that had been the subject of a license agreement with them, and for which we received a $0.5 million payment in September 2008, for a total cash consideration of $2.0 million. Of this amount, $1.8 million was received in March 2009 and $0.2 million was received in April 2009. All deliverables under the agreement were completed in April 2009, and as a result, the entire $2.0 million was recorded as revenue in the second quarter. 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. We still hold three secured convertible promissory notes issued under the original license agreement, with a total principal value of $1.0 million, which are due in 2012 and are convertible into the preferred stock of SARcode at our option. We have yet to record these notes as revenue due to uncertainty of their collectibility.

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;

• in the execution of clinical trials, including those for voreloxin, 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 and nine months ended September 30, 2009 and 2008 (in thousands):

                                              Three months ended September 30,            Nine months ended September 30,
                                                 2009                  2008                 2009                  2008
Voreloxin                                  $           3,285     $           3,730    $          10,656     $          12,614
SNS-032                                                   60                   634                  204                 3,042
SNS-314                                                   11                   299                  209                 1,755
Discovery programs and new technologies                   -                     -                    -                  2,233
Other kinase inhibitors                                   -                     -                    -                  2,024

Total research and development expense     $           3,356     $           4,663    $          11,069     $          21,668

The decrease of $1.3 million in research and development expense between the three month periods was primarily due to our 2008 Restructuring, which resulted in decreases in facility costs of $0.5 million, outside services of $0.4 million and clinical expenses of $0.3 million. The decrease of $10.6 million between the nine month periods was also primarily due to the 2008 Restructuring, which resulted in decreases in headcount-related expenses of $4.2 million, facility costs of $2.8 million, clinical expenses of $1.4 million, outside services of $1.1 million and lab costs of $0.7 million. Research and development expenses are expected to be lower for 2009 as a whole as compared to 2008, primarily as a result of the reduction in research staffing and related facility costs.

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 our collaborations.

However, we expect to continue to incur significant expenses related to the development of voreloxin in 2009 and future years, including for the completion of the current Phase 2 clinical trials and in preparation for and conduct of anticipated pivotal trials. Due to the risks inherent in the clinical trial process, we are unable to estimate the additional substantial costs we will incur in the voreloxin development program.

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 for 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.

General and Administrative Expense

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

General and administrative expense was $1.5 million and $5.9 million for the three and nine months ended September 30, 2009 as compared to $2.8 million and $9.3 million for the same periods in 2008. The decrease of $1.3 million between the three month periods was primarily due to the 2008 and 2009 Restructurings, which resulted in decreases in headcount-related expenses of $0.6 million, facility costs of $0.4 million and professional service costs of $0.2 million. The decrease of $3.4 million between the nine month periods was also primarily due to the 2008 and 2009 Restructurings, which resulted in decreases in headcount-related expenses of $2.2 million, facility costs of $0.5 million and professional service costs of $0.5 million. We expect general and administrative expense to be lower for 2009 as a whole as compared to 2008, primarily as a result of the reduction in administrative headcount.

Restructuring Charges

Restructuring charges were $0.1 million and $1.9 million for the three and nine months ended September 30, 2009 as compared to $0.2 million and $5.4 million for the same periods in 2008. Net charges for the nine months ended September 30, 2009 included $1.3 million for lease termination activities related to the 2008 Restructuring and $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 $0.4 million for third party commission, partially offset by the reversal of $1.4 million in non-cash deferred rent on this facility. Net charges for the nine months ended September 30, 2008 included $5.8 million related to the 2008 Restructuring, partially offset by a $0.4 million reversal of charges related to facility exit costs from a restructuring in 2007.

Interest Income

Interest income was $2,000 and $21,000 for the three and nine months ended September 30, 2009 as compared to $0.1 million and $0.9 million for the same periods in 2008. The decreases between the periods were primarily due to lower average balances of cash, cash equivalents and marketable securities and lower average interest rates during the 2009 periods.

Interest Expense

Interest expense was zero and $1,000 for the three and nine months ended September 30, 2009 as compared to $40,000 and $0.2 million for the same periods in 2008. The decreases between the periods 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 $4,000 and $21.1 million for the three and nine months ended September 30, 2009 as compared to other income, net of $9,000 for each of the same periods in 2008. The expense in the nine months ended September 30, 2009 was primarily due to non-cash charges of $21.0 million related to the accounting for the Private Placement, which consisted of $7.5 million recorded upon the initial closing in April 2009 and $13.5 million upon the revaluation in June 2009 of the options to participate in the second closing and common equity closing.

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 $3.9 million as of September 30, 2009, as compared to $10.6 million as of December 31, 2008. The decrease of $6.7 million was primarily due to $15.9 million of net cash used in operating activities, partially offset by net proceeds of $8.8 million from the first closing of the Private Placement, as described below. No debt was outstanding at either balance sheet date.

On April 3, 2009, we completed the initial closing of $10.0 million of a Private Placement of up to $43.5 million of our securities. On October 30, 2009, we completed the second closing of $5.0 million of the Private Placement. In the initial closing, $10.0 million of units were sold, resulting in net proceeds of $8.8 million, and in the second closing, $5.0 million of units were sold, resulting in net proceeds of approximately $4.7 million. The units consist of Series A convertible preferred stock and warrants to purchase common stock, and were sold to accredited investors, including certain members of management.

Under the Private Placement, an additional $28.5 million of common stock may be sold in a common equity closing, as approved by our stockholders on June 18, 2009. 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 convertible preferred stock issued in the Private Placement prior to a date determined with reference to our cash and investments balance dropping below $2.5 million at certain future dates. If we elect to complete the common equity closing, it will be subject to the approval of the purchasers holding a majority of the Series A convertible 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 $15.9 million for the nine months ended September 30, 2009, as compared to $28.5 million for the same period in 2008. Net cash used in the 2009 period resulted primarily from the net loss of $36.2 million and changes in operating assets and liabilities of $0.8 million, partially offset by net adjustments for non-cash items of $21.1 million, including non-cash expense of $21.0 million related to the Private Placement, and a credit of $1.4 million for deferred rent related to the 2008 Restructuring. Net cash used in the 2008 period resulted primarily from our net loss of $30.3 million and changes in operating assets and liabilities of $2.5 million (including decreases of $1.2 million in deferred revenue, $1.0 million . . .