Viracta Therapeutics 10Q 2005 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 000-51531

Sunesis Pharmaceuticals, Inc.

(Exact name of Registrant as specified in its Charter)

Delaware		94-3295878
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

341 Oyster Point Boulevard

South San Francisco, California 94080

(Address of Principal Executive Offices including Zip Code)

(650) 266-3500

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES o NO ý

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act). YES o NO ý

The Registrant had 21,460,214 shares of Common Stock, $0.0001 par value per share, outstanding as of November 10, 2005.

Sunesis Pharmaceuticals, Inc.

TABLE OF CONTENTS

		Page No.
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Condensed balance sheets as of September 30, 2005 and December 31, 2004	1

	Condensed statements of operations for the three months and nine months ended September 30, 2005 and 2004	2

	Condensed statements of cash flows for the nine months ended September 30, 2005 and 2004	3

	Notes to unaudited, condensed financial statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30

Item 4.	Controls and Procedures	31

PART II. OTHER INFORMATION

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32

Item 4.	Submission of Matters to a Vote of Security Holders	33

Item 6.	Exhibits	33

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

SUNESIS PHARMACEUTICALS, INC.

CONDENSED BALANCE SHEETS

	September 30, 2005			December 31, 2004
	(Unaudited)			(Note 1)
Assets

Current assets:
Cash and cash equivalents	$	45,212,955		$	7,587,512
Marketable securities	9,777,438			29,224,509
Note and interest receivable from officers and employees	—			163,720
Prepaids and other current assets	1,803,917			1,675,539
Total current assets	56,794,310			38,651,280

Note and interest receivable from officers and employees	—			85,350
Property and equipment, net	3,982,635			3,989,357
Deposits and other assets	300,000			300,000
Total assets	$	61,076,945		$	43,025,987

Liabilities and stockholders’ equity (deficit)

Current liabilities:
Accounts payable	$	2,264,924		$	1,662,535
Accrued compensation	1,591,186			1,599,217
Other accrued liabilities	979,222			359,404
Current portion of deferred revenue	4,807,215			6,031,895
Current portion of equipment financing	1,138,076			1,291,363
Total current liabilities	10,780,623			10,944,414

Deferred revenue	4,406,506			7,677,805
Borrowings under debt facility with related party	—			3,200,000
Non current portion of equipment financing	1,351,785			1,238,430
Deferred rent and other non-current liabilities	1,335,940			1,196,288

Commitments
Convertible preferred stock, $0.0001 par value: 38,894,500 shares authorized, no shares and 9,032,636 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively	—			108,812,619

Stockholders’ equity (deficit):
Preferred stock, $0.0001 per value, 5,000,000 shares authorized, no shares issued and outstanding at September 30,2005; no shares authorized, issued and outstanding at December 31, 2004.	—			—
Common stock, $0.0001 par value:110,000,000 shares authorized, 21,459,149 shares and 1,390,158 shares issued and outstanding at September 30, 2005 and December 30, 2004, respectively	2,146			139
Additional paid-in capital	249,515,745			6,493,378
Notes receivable from stockholders	—			(135,000		)
Deferred stock compensation	(2,592,358		)	(2,915,673		)
Accumulated other comprehensive loss	(30,244		)	(69,770		)
Accumulated deficit	(203,693,198		)	(93,416,643		)
Total stockholders’ equity (deficit)	43,202,091			(90,043,569		)

Total liabilities, convertible preferred stock and stockholders’ equity (deficit)	$	61,076,945		$	43,025,987

See accompanying notes to financial statements.

SUNESIS PHARMACEUTICALS, INC.

CONDENSED STATEMENTS OF OPERATIONS

	Three months ended September 30,						Nine months ended September 30,
	2005			2004			2005			2004
	(unaudited)						(unaudited)
Revenue:
Collaboration revenue	$	1,685,537		$	1,574,669		$	5,028,923		$	4,302,942
Collaboration revenue from related party	1,637,499			1,205,657			6,880,943			1,991,731
Grant and fellowship revenue	21,942			38,914			89,347			135,505
Total revenues	3,344,978			2,819,240			11,999,213			6,430,178

Operating expenses:
Research and development	6,870,942			5,604,924			28,263,850			17,504,300
General and administrative	2,067,215			1,779,898			6,056,145			5,477,888
Total operating expenses	8,938,157			7,384,822			34,319,995			22,982,188

Loss from operations	(5,593,179		)	(4,565,582		)	(22,320,782		)	(16,552,010		)

Interest income	178,515			111,400			574,204			316,102
Interest expense	(229,450		)	(88,755		)	(445,975		)	(299,494		)
Other income (expense), net	2,094			726			8,300			733
Net loss	(5,642,020		)	(4,542,211		)	(22,184,253		)	(16,534,669		)
Convertible preferred stock deemed dividends	(88,092,302		)	—			(88,092,302		)	—
Net loss applicable to common stockholders	(93,734,322		)	(4,542,211		)	(110,276,555		)	(16,534,669		)


Basic and diluted net loss per share applicable to common stockholders	$	(45.12	)	$	(3.51	)	$	(67.58	)	$	(12.89	)
Shares used in computing basic and diluted loss per share applicable to common stockholders	2,077,245			1,294,835			1,631,700			1,283,179

See accompanying notes to financial statements.

SUNESIS PHARMACEUTICALS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

	Nine months ended September 30,
	2005			2004
	(unaudited)
Cash flows from operating activities

Net Loss	$	(22,184,253	)	$	(16,534,668	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and Amortization	1,278,527			1,749,761
Stock compensation expense	930,066			280,397
Non-cash research and development expense	8,000,000			—
Changes in operating assets and liabilities:
Prepaids and other current assets	(631,678		)	98,839
Notes and interests receivable from officers and employees	249,070			2,260
Deposits and other assets	—			—
Accounts payable	602,389			257,521
Accrued compensation	(8,031		)	142,227
Other accrued liabilities	608,823			112,168
Deferred rent	139,652			198,291
Deferred revenue	(4,495,979		)	7,731,779
Net cash used in operating activities	(15,511,414		)	(5,961,425		)

Cash flows from investing activities
Purchases of property and equipment, net	(1,273,170		)	(788,373		)
Purchases of marketable securities	(9,980,838		)	(24,278,477		)
Maturities of marketable securities	29,467,435			18,003,555
Proceeds from sale of fixed assets	1,365			—
Net cash provided by (used in) investing activities	18,214,792			(7,063,295		)

Cash flows from financing activities
Proceeds from borrowings under debt facility with related party	800,000			1,600,000
Proceeds from borrowings under note payable and equipment loans	1,054,079			370,272
Payments on note payable and equipment loans	(5,094,011		)	(1,854,509		)
Proceeds from issuance of common stock and exercise of options, net of repurchases	38,161,997			302,851
Proceeds from issuance of convertible preferred stock, net of issuance costs	—			13,991,150
Net cash provided by financing activities	34,922,065			14,409,764

Net increase (decrease) in cash and cash equivalents	37,625,443			1,385,044
Cash and cash equivalents at beginning of period	7,587,512			10,477,503
Cash and cash equivalents at end of period	$	45,212,955		$	11,862,547

Supplemental disclosure of Cash flow information
Interest paid	$	445,975		$	299,494
Non-cash activities:
Conversion of convertible preferred stock to common stock upon initial public offering	$	116,812,619		$	—
Deferred stock-based compensation	$	393,708		$	2,982,978
Issuance of warrants for financing arrangement	$	503,300		$	3,304
Stock dividend payable to preferred stockholders	$	88,092,302		$	—

See accompanying notes to financial statements.

SUNESIS PHARMACEUTICALS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Information as of September 30, 2005 and for the three and
nine months ended September 30, 2004 and 2005 is unaudited)

1. Organization and Summary of Significant Accounting Policies

Organization

Sunesis Pharmaceuticals, Inc. (“Sunesis” or the “Company”) was incorporated in the state of Delaware on February 10, 1998, and its facilities are located in South San Francisco, California. Sunesis is a clinical-stage biopharmaceutical company focused on discovering, developing and commercializing novel small molecule therapeutics for oncology and other unmet medical needs. The Company’s primary activities since incorporation have been conducting research and development internally and through corporate collaborators, in-licensing pharmaceutical compounds, performing business and financial planning, and raising capital.

Sunesis, Tethering and , our logo, are registered trademarks of our company. All other trademarks, trade names and service marks appearing in this prospectus are the property of their respective owners.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from these estimates.

Basis of Presentation

The accompanying unaudited, condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all normal, recurring adjustments considered necessary for a fair presentation have been included. The condensed balance sheet at December 31, 2004 was derived from the audited financial statements included in the Company’s registration statement on Form S-1 (Reg. No. 333-121646) (the “S-1”) which was filed with the Securities and Exchange Commission. The financial statements included in this report should be read in conjunction with the audited financial statements for the year ended December 31, 2004 included in the S-1. Stockholders are encouraged to review the S-1 for a broader discussion of Sunesis’ business and the risks inherent therein. The results for the interim period ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year ending December 31, 2005 or future operating periods.

Loss Per Share

Basic net loss per common share is calculated by dividing the net loss applicable to common stockholders by the weighted-average number of common shares outstanding for the period, less the weighted average unvested common shares subject to repurchase. Diluted net loss applicable to common stockholders per share is computed by dividing the net loss by the weighted-average number of common shares outstanding, less the weighted average unvested common shares subject to repurchase, and dilutive potential common shares for the period determined using the treasury stock method. For purpose of this calculation, preferred stock, options to purchase stock, and warrants to purchase stock are considered to be potential common shares and are only included in the calculation of diluted net loss per common share when their effect is dilutive.

The following table sets forth the computation of basic and diluted net loss per share applicable to common stockholders.

	Three months ended September 30,						Nine months ended September 30,
	2005			2004			2005			2004
Historical Numerator:
Net loss applicable to common stockholders	$	(93,734,322	)	$	(4,542,211	)	$	(110,276,555	)	$	(16,534,669	)

Denominator:
Weighted-average common shares outstanding	2,086,938			1,328,699			1,648,298			1,331,057
Less: Weighted-average unvested common shares subject to repurchase	(9,693		)	(33,864		)	(16,598		)	(47,878		)
Denominator for basic and diluted net loss per share applicable to common stockholders	2,077,245			1,294,835			1,631,700			1,283,179

Basic and diluted net loss per share applicable to common stockholders	$	(45.12	)	$	(3.51	)	$	(67.58	)	$	(12.89	)

Outstanding securities not included in diluted loss per share applicable to common stock holder calculations

Preferred stock	—			8,587,003			—			8,587,003
Options to purchase common stock	1,707,864			1,662,253			1,707,864			1,662,253
Warrants	526,373			231,088			526,373			231,088
	2,234,237			10,480,344			2,234,237			10,480,344

Comprehensive Loss

Comprehensive loss is comprised of net less and unrealized gains/losses on available-for-sale securities, in accordance with SFAS No. 130, Reporting Comprehensive Income.

Comprehensive loss and its components for the three and nine-month periods ended September 30, 2005 and 2004 are as follows:

	Three months ended September 30,						Nine months ended September 30,
	2005			2004			2005			2004

Net loss	$	(5,642,020	)	$	(4,542,211	)	$	(22,184,253	)	$	(16,534,669	)
Change in unrealized loss on investments	21,891			(14,371		)	39,526			(47,076		)
Comprehensive loss	$	(5,620,129	)	$	(4,556,582	)	$	(22,144,727	)	$	(16,581,745	)

Stock-Based Compensation

The Company accounts for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and Financial Accounting Standards Board Interpretation (“FIN”) No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25, and has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation.

The Company has elected to continue to follow the intrinsic-value method of accounting as prescribed by APB Opinion No. 25. The information regarding net loss as required by SFAS No. 123 has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The resulting effect on net losses to date pursuant to SFAS No. 123 is not likely to be representative of the effects on net loss pursuant to SFAS No. 123 in future years, since future years are likely to include additional grants and the impact of future years’ vesting.

Stock compensation arrangements to non-employees are accounted for in accordance with SFAS No. 123, as amended, and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, using a fair value approach. The compensation costs of these arrangements are subject to remeasurement over the vesting terms as earned.

The following table illustrates the effect on net loss per share had the Company applied the fair value provisions of SFAS No. 123 to employee stock compensation:

	Three months ended September 30,						Nine months ended September 30,
	2005			2004			2005			2004
	(Unaudited)						(Unaudited)
Net loss applicable to common stockholders	$	(93,734,322	)	$	(4,542,211	)	$	(110,276,555	)	$	(16,534,669	)

Add: employee stock compensation expense based on the intrinsic value method	258,765			156,748			717,022			240,561

Deduct: total employee stock-based compensation expense determined under the fair value method for all awards	(485,402		)	(328,342		)	(1,248,969		)	(732,750		)

Pro forma net loss applicable to common stockholders	$	(93,960,959	)	$	(4,713,805	)	$	(110,808,502	)	$	(17,026,858	)

Net loss per share applicable to common stockholders:
Basic and diluted, as reported	$	(45.12	)	$	(3.51	)	$	(67.58	)	$	(12.89	)
Basic and diluted, pro forma	$	(45.23	)	$	(3.64	)	$	(67.91	)	$	(13.27	)

Prior to the Company’s initial public offering (the “IPO”), certain stock options were granted with exercise prices that were below the reassessed fair value of the common stock at the date of grant. In accordance with APB Opinion No. 25, deferred stock compensation of $3,339,691 and $393,708 was recorded during the year ended December 31, 2004 and the nine months ended September 30, 2005, respectively. The deferred stock compensation will be amortized over the related vesting terms of the options. The Company recorded employee stock compensation expense of $424,018 and $717,022 for the year ended December 31, 2004 and the nine months ended September 30, 2005, respectively.

As of September 30, 2005, the expected future amortization expense for deferred stock compensation during each of the following periods is as follows:

Year ended December 31,
2005 remaining period	$	257,716
2006	963,365
2007	895,865
2008	456,897
2009	18,515
Total	$	2,592,358

We estimate the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Three months ended September 30,				Nine months ended September30,
	2005		2004		2005		2004

Risk-free interest rate	3.9	%	3.6	%	3.8	%	3.5	%
Dividend yield	0.0	%	0.0	%	0.0	%	0.0	%
Volatility	80.0	%	80.0	%	80.0	%	80.0	%
Weighted-average expected life	5 years		5 years		5 years		5 years

Recent Accounting Pronouncements

In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment, or SFAS No. 123R, which is a revision of SFAS No. 123, and supersedes APB Opinion 25. SFAS 123R requires all share-based payments to employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values, beginning with the first annual period after June 15, 2005, with early adoption encouraged. On April 14, 2005, the SEC adopted a new rule that amended the compliance dates for SFAS No. 123R such that the Company is now allowed to adopt the new standard effective January 1, 2006. The pro forma

disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options.

Under SFAS 123R, the Company must determine the appropriate fair value model and related assumptions to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive method would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is currently evaluating the requirements of SFAS 123R as well as option valuation methodologies related to its stock option plans. Although the Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, we expect that the adoption of SFAS 123R will have a material impact on the Company’s results of operations. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

2. License Agreements

Bristol-Myers Squibb Company

In April 2005, the Company entered into an agreement with Bristol-Myers Squibb Company (“BMS”) to acquire worldwide development and commercialization rights for BMS’ anti-cancer compound, referred to as SNS-032.

Under the terms of this agreement, the Company made an up-front $8,000,000 equity payment through the issuance of shares of the Company’s Series C-2 preferred stock. This amount was included in research and development expense for the nine months ended September 30, 2005 due to uncertainties surrounding the remaining efforts for completion of the research and development activities. The Company may in the future make a series of milestone payments of up to $29.0 million in cash, equity or any combination thereof to BMS based on the successful development and approval for the first indication and formulation of SNS-032. In addition, the Company may make a series of development and commercialization milestone payments totaling up to $49.0 million in cash, equity or any combination thereof, as well as royalty payments based on any future product net sales. In return, the Company received worldwide exclusive and non-exclusive diagnostic and therapeutic licenses to SNS-032 and future CDK inhibitors derived from related intellectual property.

3. Collaborative Research Agreements

Johnson & Johnson Pharmaceutical Research and Development, L.L.C.

In May 2002, the Company entered into a research collaboration to discover small molecule inhibitors of Cathepsin S with Johnson & Johnson Pharmaceutical Research & Development, L.L.C (“JJPRD”). The Company applies its proprietary Tethering technology to discover novel inhibitors of Cathepsin S in this collaboration.

Under the terms of the agreement, the Company received a non-refundable and non-creditable technology access fee of $500,000 in February 2003, and certain research funding to be paid in advance quarterly. The Company may in the future receive research and development milestones of up to $24.5 million as well as royalty payments from JJPRD based on future product sales. On December 15, 2002, the Company and JJPRD amended their collaboration to increase the number of JJPRD funded full-time equivalents for 2003. In December 2002, JJPRD also made the first milestone payment of $250,000 to the Company for the delivery of a novel lead series of compounds. On December 15, 2003, the Company and JJPRD again amended their collaboration to extend the research funding for one additional year from May 3, 2004 through May 2, 2005. On December 22, 2004, the Company and JJPRD amended their collaboration to extend the research funding from May 3, 2005 until December 31, 2005. Unamortized upfront fees are being recognized as revenue ratably over the remaining research term. Costs associated with research and development activities attributable to this agreement approximate the research funding recognized.

Biogen Idec, Inc.

In December 2002, the Company entered into a research collaboration with Biogen Idec, Inc. (“Biogen Idec”) to discover oral therapeutics. The collaboration applies the Company’s proprietary Tethering technology to generate small molecule leads to selected TNF family cytokines involved in immune and inflammatory disease and two additional un-named targets.

During the initial phase of the collaboration, both companies contribute scientists and discovery resources to the collaboration at their own cost. Under an exclusive, worldwide license to compounds resulting from these efforts, Biogen Idec has the right to develop, manufacture, and commercialize compounds discovered under the collaboration.

Under the terms of the agreement, the Company received an upfront, non-refundable and non-creditable technology access fee of $3,000,000 which is being recognized as revenue over the 30-month term of the agreement and the one-year option period. In addition, the Company started receiving quarterly maintenance fees of $357,500 commencing April 1, 2004, and the Company may in the future receive research and development milestones of up to $60.5 million and royalty payments based on total annual future product sales. In certain circumstances, such as the cessation of the development of particular compounds, milestone payments received may be credited against future milestone payments with respect to compounds directed to the same target as the discontinued compound. As such, the Company recognizes the milestones received as revenue ratably over the remaining term of the agreement. On June 18, 2005, the one-year option was not exercised by Biogen Idec and the agreement was terminated. Accordingly, the remaining deferred revenue of $824,872 was recognized in the nine months ended September 30, 2005.

Concurrent with the signing of the agreement, Biogen Idec made a $6,000,000 equity investment and purchased shares of the Company’s Series C-1 preferred stock. Biogen Idec also agreed to loan the Company up to $4,000,000 with a drawdown period of ten calendar quarters beginning on January 1, 2003 and ending on September 30, 2005. The principal and accrued interest of each draw is due five years from the date of advance of each draw and bear interest at three percent above LIBOR (LIBOR was 1.46% at December 31, 2003, 3.10% at December 31, 2004 and 3.86% at September 30, 2005) to be paid quarterly. As of December 31, 2003 and 2004 and September 30, 2005, the Company had drawn $1,600,000, $3,200,000 and $4,000,000, respectively, with $2,400,000, $800,000 and none, respectively, available for future draws. On September 30, 2005, this loan was repaid in full with interest.

On August 27, 2004, the Company entered into the second research collaboration with Biogen Idec to discover and develop small molecules targeting kinases, a family of cell signaling enzymes that play a role in the progression of cancer. The Company applies its proprietary Tethering technology to generate novel small molecule leads that inhibit the oncology kinase targets that are covered by this collaboration.

One of the kinase targets in the collaboration is Raf, and the Company’s Raf program was folded into the collaboration. Under the terms of the agreement, the Company received a $7,000,000 upfront, non-refundable and non-creditable technology access fee, which is being recognized as revenue over an initial four-year research term. In the event that Biogen Idec decides to exercise its option to extend the initial four-year research term for one additional year, Biogen Idec will pay to the Company an additional technology access fee specified in the agreement. In addition, the Company will receive quarterly research funding of $1.2 million to be paid in advance to support some of its scientific personnel, and the Company may in the future receive pre-commercialization milestone payments of up to $60.5 million and royalty payments based on any product sales. The Company retains an option to participate in the co-development and co-promotion of product candidates for up to two targets that may emerge from this collaboration.

Concurrent with the signing of the agreement, Biogen Idec made a $14,000,000 equity investment and purchased shares of the Company’s Series C-2 preferred stock.

Merck & Co., Inc.

In February 2003, the Company and Merck & Co., Inc. (“Merck”), entered into a research collaboration to identify and optimize inhibitors of BACE, an Alzheimer’s disease target. This collaboration had an initial three-year research term which expires in February 2006. The Company currently does not expect that the research term will be extended. However, the Company will retain the right to earn milestone payments and royalties on any compound that results from the collaboration.

On July 22, 2004, the Company and Merck entered into a multi-year research collaboration to discover novel oral drugs for the treatment of viral infections. The Company provided Merck with a series of small molecule compounds targeting viral infections. These compounds were derived from Tethering. Merck will be responsible

for advancing these compounds into lead optimization, preclinical development, and clinical studies. Merck will pay annual license fees for the Company’s consulting services and ongoing access to Tethering as a means of identifying additional compounds for the treatment of viral infections.

Under the terms of the agreement, the Company received an upfront, non-refundable and non-creditable technology access fee of $2.3 million which is being recognized as revenue over an initial three-year research term, annual license fees aggregating $950,000 and payments based on the achievement of development milestones of up to $22.1 million. In addition, the Company will receive royalty payments based on net sales for any products resulting from the collaboration. Merck receives an exclusive, worldwide license to any products resulting from the collaboration.

In connection with the above collaboration agreements, the Company recognized the following revenues, which include the amortization of upfront fees received, research funding, and milestones earned:

	Three months ended September 30,				Nine months ended September 30,
	2005		2004		2005		2004
	(in thousands)				(in thousands)

J&J PRD	$	358	$	336	$	1,060	$	999

Merck	1,328		1,239		3,969		3,304

	1,686		1,575		5,029		4,303

Biogen Idec-related party	1,637		1,206		6,881		1,992

Total collaboration revenue	$	3,323	$	2,781	$	11,910	$	6,295

4. Property and Equipment

Property and equipment consist of the following:

	September 30, 2005			December 31, 2004
Computer equipment and software	$	2,581,928		$	2,242,659

Furniture and office equipment	592,929			576,188

Laboratory equipment	8,136,526			7,446,076

Leasehold improvements	5,101,443			4,930,832

	16,412,826			15,195,755

Less accumulated depreciation and amortization	(12,430,191		)	(11,206,398		)

Net Property, plant and equipment	$	3,982,635		$	3,989,357

Equipment purchased under equipment financing agreements (see Note 5 below) is included in property and equipment. At December 31, 2004 and September 30, 2005, financed equipment had a cost basis of $5,886,831 and $5,559,823, respectively, with accumulated depreciation of $3,474,704 and $3,197,318, respectively.

5. Equipment Financing and Debt Facility

In June 2000, the Company entered into an equipment financing agreement with General Electric Capital Corporation, which has been amended from time to time. The credit facility was available through May 2005. In August 2005 the Company entered into a new $2.5 million credit facility with the same financing company. The Company can borrow under this facility to finance capital equipment purchases until December 31, 2006. The equipment loans are secured by the equipment financed.

In conjunction with this new credit facility, the Company issued warrants to the financing company to purchase shares of the Series C preferred stock, which converted into warrants to purchase 1,046 shares of common stock in connection with the IPO.

The fair value of the warrants issued is $4,862, as determined using the Black-Scholes options pricing model, and is being accounted for as prepaid interest and expensed on a straight-line basis over the term of the agreement.

As of December 31, 2004 and September 30, 2005, the Company had drawn $7,399,281 and $8,453,361 respectively, to finance equipment purchases and leasehold improvements and had $1,117,234 and $1,907,179, respectively, available under the facility. Outstanding borrowings bear interest at rates ranging from 7.4% to 9.89% as of December 31, 2004 and September 30, 2005, and are to be paid over 36 to 48 months.

As of December 31, 2004 and September 30, 2005, the Company was in compliance with all the covenants in these loan agreements.

Pursuant to the collaboration agreement with Biogen Idec, the Company had drawn $3,200,000 and $4,000,000 under a facility loan agreement as of December 31, 2004 and September 30, 2005, respectively. On September 30, 2005, this loan was repaid in full with interest.

In August 2005, the Company entered into a Venture Loan and Security Agreement with Oxford Finance Corporation and Horizon Technology Funding Company LLC, pursuant to which the Company may borrow up to $15.0 million. The full $15.0 million loan commitment was available until October 15, 2005, $10.0 million is available until January 31, 2006, and the remaining $5.0 million is available until May 31, 2006. The loan facility has an interest-only period ending January 1, 2007 followed by a 30-month principal repayment period, provided that any outstanding loan amounts become due upon an event of default. Outstanding principal accrues interest at a rate equal to the higher of 11.5% or the three-year Treasury rate plus 7.73%. The Company’s obligations under the loan agreement are secured by a first priority security interest in substantially all of the Company’s assets, other than the Company’s intellectual property. In connection with this transaction, the Company issued warrants to the lenders, half of which are currently exercisable, to purchase shares of Series C preferred stock, which converted into warrants to purchase 164,821 shares of common stock in connection with the IPO. The warrants expire ten years from the date of issuance. The Company also granted the lenders registration rights under the Company’s Eighth Amended and Restated Investor Rights Agreement.

The fair value of the warrant issued is $498,000, as determined using the Black-Scholes options pricing model, and are being accounted for as prepaid interest and expensed on a straight-line basis over the term of the agreement.

Contingencies

From time to time, the Company may become involved in claims and other legal matters arising in the ordinary course of business. As of September 30, 2005, management is not aware of any matters that could have a material adverse effect on the financial position, results of operations or cash flows of the Company.

6. Stockholders’ Equity

Reverse Stock Split and Conversion of Preferred Stock in Connection with IPO

In September 2005, in connection with the Company’s IPO, the Board of Directors and stockholders of the Company approved an amendment to the Company’s eighth amended and restated certificate of incorporation (as amended, the “Restated Certificate”) effecting an approximately 1-for-4.25 reverse stock split of common stock, an approximately 1-for-5.5 reverse stock split of Series A preferred stock and an approximately 1-for-3.74 reverse stock split of Series B, C, C-1 and C-2 preferred stock (collectively, the “Reverse Stock Split”). All issued and outstanding common stock, preferred stock and per share amounts contained in the financial statements have been retroactively adjusted to reflect this stock split.

The Series A, B, C, C-1 and C-2 preferred stock were convertible into common stock at the option of the holder at the then-effective conversion price. The initial conversion price per share of Series A, B, C, C-1 and C-2 preferred stock was $5.50, $9.72, $17.95, $17.95, and $17.95, respectively, and was subject to adjustment as specified in the Restated Certificate.

Pursuant to the provisions of the Restated Certificate, the conversion prices of the Series B, C, C-1 and C-2 preferred stock were adjusted based on the Pre-Money Valuation (as defined in the Restated Certificate) of the Company immediately prior to the completion of the IPO. On September 30, 2005, pursuant to the Restated Certificate and upon the election of the holders of preferred stock each outstanding share of Series A preferred stock

converted into one share of common stock, each outstanding share of Series B Preferred Stock converted into approximately 1.087 shares of common stock and each outstanding share of Series C, C-1 and C-2 preferred stock converted into approximately 1.973 shares of common stock, effective as of immediately prior to the closing of the IPO.

On September 30, 2005, the Company completed the IPO of 6,000,000 shares of its common stock at a public offering price of $7.00 per share. On November 1, 2005, the Company sold an additional 51,126 shares of common stock in connection with the partial exercise of the underwriters’ over-allotment option. Net cash proceeds from the IPO were approximately $37.2 million (including proceeds from the partial exercise of the over-allotment option) after deducting underwriting discounts and commissions and other offering expenses. In connection with the closing of the IPO, all of the Company’s shares of convertible preferred stock outstanding at the time of the IPO were automatically converted into 14,027,236 shares of common stock. Concurrent with the conversion of the preferred stock to common stock, the Company recorded a one-time non-cash deemed dividend of $88.1 million. This non-cash dividend results from the redistribution of pre-IPO ownership which occurred in conjunction with the Company’s IPO in accordance with an ownership adjustment mechanism approved by the Company’s shareholders. This redistribution of ownership is accounted for as a deemed dividend and the stock price used for calculating the dividend was the estimated fair market value of the Company per share in December 2004 when the agreement was reached between the Company’s shareholders.

2005 Equity Incentive Award Plan

In February 2005, the Board of Directors adopted and in September 2005, the stockholders approved the 2005 Equity Incentive Award Plan (the “2005 Plan”). The Company has reserved a total of 1,779,396 shares of common stock for issuance under the 2005 Plan plus any options granted under the Company’s predecessor plans that expire unexercised or are repurchased by the Company pursuant to the terms of such options. As of September 30, 2005, no shares have been issued under this plan.

The number of shares of common stock reserved under the 2005 Plan will automatically increase on the first trading day each year, beginning in 2006, by an amount equal to the least of: (i) 4% of the Company’s outstanding shares of common stock outstanding on such date, (ii) 1,082,352 shares or (iii) a lesser amount determined by the Board of Directors. The maximum aggregate number of shares which may be issued or transferred over the term of the 2005 Plan is 11,294,112 shares. In addition, no participant in the 2005 Plan may be issued or transferred more than 235,294 shares of common stock pursuant to awards under the 2005 Plan per calendar year.

2005 Employee Stock Purchase Plan

In February 2005, the Board of Directors adopted and in September 2005, the stockholders approved the 2005 Employee Stock Purchase Plan (the “ESPP”). The Company has reserved a total of 202,941 shares of common stock for issuance under the ESPP. The ESPP permits eligible employees to purchase common stock at a discount through payroll deductions during defined offering periods. The price at which the stock is purchased is equal to the lower of 85% of the fair market value of the common stock at the beginning of an offering period or after a purchase period end. As of September 30, 2005, no shares have been issued under this plan.

The number of shares of common stock reserved under the ESPP will automatically increase on the first trading day each year, beginning in 2006, by an amount equal to the least of: (i) 0.5% of the Company’s outstanding shares of common stock outstanding on such date, (ii) 135,294 shares, or (iii) a lesser amount determined by the Board of Directors. The maximum aggregate number of shares which may be issued over the term of the ESPP is 1,352,941 shares. In addition, no participant in the Company’s ESPP may be issued or transferred more than $25,000 of shares of common stock pursuant to awards under the ESPP per calendar year.

Notes Receivable from Officers and Employees

In April 2000, the Company issued a full recourse note receivable of $100,000 to an officer to finance the purchase of a home. The note was secured by shares of the Company’s common stock held by the employee, and bore an interest rate of 6.6% per annum, with a five-year term. Under the terms of the loan, the principal and accrued interest were forgiven in April 2005.

In July 2001, the Company issued a full recourse note receivable of $85,350 to an employee to finance the purchase of personal assets. The note was secured by a second deed of trust on the employee’s residence, and was non-interest bearing with a five-year term. The note was not forgivable, and in the event the employee ceased employment with the Company, the note became due immediately. This loan was repaid in full in May 2005.

7. Guarantees and Indemnification

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

As permitted under Delaware law and in accordance with the Company’s Bylaws, the Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Company’s request in such capacity. The indemnification agreements with the Company’s officers and directors terminate upon termination of their employment, but the termination does not affect claims for indemnification relating to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited; however, the Company’s officer and director insurance policy reduces the Company’s exposure and may enable the Company to recover a portion of any future amounts paid. The Company believes that the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of September 30, 2005.

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition as of September 30, 2005 and results of operations for the three and nine months ended September 30, 2005 and 2004 should be read together with our financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. 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.

Business Overview

We are a clinical-stage biopharmaceutical company focused on the discovery, development and commercialization of novel small molecule therapeutics for oncology and other unmet medical needs. We have developed a proprietary fragment-based drug discovery approach, called “Tethering,” that we combine with other drug discovery tools, such as structure-based design and medicinal chemistry, to discover and develop novel therapeutics. We have built our product candidate portfolio through internal discovery and the in-licensing of novel cancer therapeutics. We are advancing our product candidates through in-house research and development efforts and strategic collaborations with leading pharmaceutical and biopharmaceutical companies.

From our incorporation in 1998 through 2001, our operations consisted primarily of developing and refining our drug discovery technologies. Since 2002, we have focused on developing novel small molecule drugs mainly to treat cancer and other unmet medical needs.

We are advancing three proprietary oncology product candidates, SNS-595, SNS-032 and SNS-314, through in-house research and development efforts. All three are inhibitors of the cell division process, known as cell-cycle inhibitors, intended for the treatment of cancer. Our lead product candidate, SNS-595, is a novel cytotoxic. We are currently conducting three Phase I clinical trials with SNS-595, two with patients with advanced solid tumors and one with patients with certain leukemias. We are planning to launch two Phase II clinical trials for patients with lung cancer, one in small cell and the other in non-small cell, in the fourth quarter of 2005. Our second most advanced product candidate, SNS-032, is a CDK inhibitor. We expect to commence a Phase I/II clinical trial with SNS-032 by early 2006. We in-licensed this compound from BMS in April 2005. We are also developing SNS-314, an Aurora kinase inhibitor, for the treatment of cancer, for which we expect to file an investigational new drug application in 2006. We have worldwide development and commercialization rights to SNS-595, SNS-032 (for diagnostic and therapeutic applications) and SNS-314. We may in the future enter into collaborations to maximize the commercial potential of these programs.

We currently have five strategic collaborations with Biogen Idec, Johnson & Johnson PRD and Merck focused on the discovery and development of new product candidates. As of September 30, 2005, we had received an aggregate of approximately $65.7 million in cash in the form of stock purchase proceeds, fees and loans from our collaboration partners.

Since our inception, we have generated significant losses. As of September 30, 2005, we had an accumulated deficit of $203.7 million, including $88.1 million deemed dividend recorded as of September 30, 2005 in connection with the closing of our IPO and the conversion of preferred stock to common stock. We expect our net losses to increase primarily due to our anticipated clinical trial activities.

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 U.S. generally accepted accounting principles. 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 at 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.

We believe there have been no significant changes in our critical accounting policies as compared to what was previously disclosed in our Form S-1, filed with the Securities and Exchange Commission on September 27, 2005.

Results of Operations

Three and Nine Months Ended September 30, 2005 and 2004

Revenue. We have not generated any revenue from sales of commercial products and do not expect to generate any product revenue for the foreseeable future. To date, our revenue has consisted of collaboration revenue and grant and fellowship revenue.

Collaboration Revenue. We generate revenue primarily through our collaborations. We currently have five ongoing research-based collaborations. Each of these collaborations includes a technology access fee, research funding, milestone payments and royalties upon sales of future products that may result from the collaborations. The table below sets forth our revenue for the three and nine months periods ended September 30, 2005 and 2004 from each of our collaborators.

	Three months ended September 30,				Nine months ended September 30,
	2005		2004		2005		2004
	(in thousands)				(in thousands)

Johnson & Johnson PRD	$	358	$	336	$	1,060	$	999

Merck	1,328		1,239		3,969		3,304

	1,686		1,575		5,029		4,303

Biogen Idec-related party	1,637		1,206		6,881		1,992

Total collaboration revenue	$	3,323	$	2,781	$	11,910	$	6,295

Collaboration revenue increased from $2.8 million for the three months period ended September 30, 2004 to $3.3 million for the same period in 2005, primarily due to a $431,000 increase in collaboration revenue from Biogen Idec resulting from the signing of the kinase collaboration at the end of August of 2004. Collaboration revenue increased from $6.3 million for the nine months ended September 30, 2004 to $11.9 million for the nine months ended September 30, 2005, primarily due to a $4.9 million increase in collaboration revenue from Biogen Idec, including the recognition of $825,000 of deferred revenue upon completion of the research phase of our initial collaboration with Biogen Idec. We expect that revenue from reimbursed research services will decrease for the fourth quarter of 2005 and for 2006 compared to the same period in prior years due to the completion of the research phase of Biogen Idec TNF-family collaboration in July 2005 and the expected completion of the research phases of the Johnson & Johnson PRD Cathepsin S collaboration at the end of 2005 and the Merck BACE collaboration in February 2006. After completion of the research phase of these collaborations, we will continue to be eligible to earn milestone payments and royalties on any compound that results from the collaborations. It is our goal to generate revenue from achieving milestones in 2005 and 2006. However, there are no assurances that any such milestone will be reached.

Grant and Fellowship Revenue. Grant and fellowship revenue is recognized as we perform services under the applicable grant. As of September 30, 2005, we had been awarded $5.4 million, and had recognized as revenue $2.5 million, in federal grants under the Small Business Innovation Research, or SBIR, program. In addition, we have recognized revenue from other grants and fellowships. We do not plan to perform any additional work under our SBIR grants in the foreseeable future.

Research and Development Expense. Most of our operating expenses to date have been for research and development activities. Research and development expense represents costs incurred to discover and develop novel small molecule therapeutics, including Phase I clinical trial costs for SNS-595, to develop our proprietary fragment-based Tethering drug discovery approach, to develop in-house research and preclinical study capabilities, to discover and advance product candidates toward clinical trials and in connection with in-licensing activities. We expense all research and development costs as they are incurred.

The table below sets forth our research and development expense for the three and nine months ended September 30, 2004 and 2005 for our product candidate programs.

	Three months ended September 30,				Nine months ended September 30,
	2005		2004		2005		2004
	(in thousands)				(in thousands)
SNS-595	$	1,558	$	985	$	4,570	$	3,160
SNS-032	676		—		8,939		—
SNS-314	1,819		1,071		5,224		2,425
Raf kinase inhibitors	357		908		1,161		2,293
Other kinase inhibitors	1,498		199		4,133		199
Cathepsin S inhibitors	233		198		554		754
BACE inhibitors for Alzheimer’s disease	399		526		1,290		1,810
Anti-viral inhibitors	—		5		37		31
TNF family and oncology research	14		619		950		1,991
Other programs	317		1,094		1,406		4,841
Total	$	6,871	$	5,605	$	28,264	$	17,504

Research and development expense increased from $5.6 million to $6.9 million for the three months ended September 30, 2004 and 2005, respectively, due to (i) a $1.3 million increase in expense related to other kinase inhibitors as a result of an increase in headcount focused on the discovery of novel kinase inhibitors, (ii) a $748,000 increase in the SNS-314 program as a result of increased headcount and outside expenses for pre-clinical activities, (iii) a $676,000 increase in SNS-032 related to technology transfer from BMS and preparations of a Phase I clinical trial protocol, and (iv) a $573,000 increase in expense related to SNS-595 as a result of our Phase I clinical trials. This increased expense was partially off-set by (a) a $605,000 decrease in expense related to the TNF family and oncology research program following the conclusion of the research phase of the first collaboration with Biogen Idec in July 2005, and (b) a $777,000 decrease in expense related to other programs due to changing research priorities at Sunesis.

Research and development expense increased from $17.5 million for the nine months ended September 30, 2004 to $28.3 million for the nine months ended September 30, 2005, primarily due to (i) an $8.9 million expense related to the in-license in April 2005 and subsequent development of SNS-032, including an $8.0 million licensing fee that was recorded as a research and development expense, (ii) a $2.8 million increase in expense related to our SNS-314 Aurora kinase program related to the selection of a development candidate, (iii) a $3.9 million increase in expense related to our other kinase inhibitor programs primarily due to increased staffing for these programs and (iv) a $1.4 million increase in expense related to the enrollment and management of Phase I clinical trials for SNS-595. This increased expense was partially offset by (a) a $520,000 reduction in expense related to our BACE Alzheimer’s program due to reduced staffing of this program, (b) a $200,000 reduction in expense related to our Cathepsin S program due to reduced staffing of this program, and (c) a $3.4 million reduction in expense for other programs due to changing research priorities at Sunesis. We expect to incur significant research and development expenses over the next several years, only a portion of which we expect to be funded by our collaboration partners. If SNS-595 progresses through the clinic and we bring additional product candidates, such as SNS-032, into clinical trials, our spending will further increase. In addition, under our August 2004 collaboration with Biogen Idec, we have an option to co-fund a portion of the development costs of product candidates for up to two targets that may

result from this collaboration. Our decision to exercise this option would materially increase our research and development expenses.

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 and non-cash stock compensation. Other significant costs include facilities costs and fees paid to outside legal advisors and auditors. General and administrative expense was $1.8 million and $2.1 million for the three months ended September 30, 2004 and 2005, respectively. This $287,000 increase is due mainly to a $220,000 increase in payroll and related expenses. General and administrative expense increased from $5.5 million for the nine months ended September 30, 2004 to $6.1 million for the nine months ended September 30, 2005. This $0.6 million increase is primarily due to a $337,000 increase in non-cash stock compensation expense and a $251,000 increase in other salary and related expense. As a public company, we operate in an increasingly demanding regulatory environment that requires us to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the Securities and Exchange Commission, or SEC, and the Nasdaq National Market, including those related to expanded disclosures, accelerated reporting requirements and more complex accounting rules. We expect that our general and administrative expenses will continue to increase in subsequent periods due to these requirements and to increasing personnel and infrastructure expenses as we advance our product candidates.

Interest Income and Expense. Interest income increased from $111,000 and $316,000 for the three and nine months ended September 30, 2004, respectively, to $179,000 and $574,000 for the three and nine months ended September 30, 2005, respectively, primarily due to higher interest rates and higher average balances of cash, cash equivalents and marketable securities. Interest expense increased from $89,000 and $299,000 for the three and nine months ended September 30, 2004, respectively, to $229,000 and $446,000 for the three and nine months ended September 30, 2005, respectively, due to higher outstanding debt obligations.

Liquidity and Capital Resources

Sources of Liquidity

As of September 30, 2005, we had cash, cash equivalents and marketable securities of $55.0 million and outstanding equipment financing and debt obligations of $2.5 million. Since our inception, we have funded our operations primarily through the issuance of common and preferred stock, research funding and technology access fees from our collaboration partners, research grants, loans from Biogen Idec and other debt financings. Through September 30, 2005, we had received net proceeds of approximately $146.8 million from the issuance of stock, including $20.0 million from Biogen Idec, $36.9 million from our IPO in September of 2005 during which we sold 6,000,000 shares of common stock at $7.00 per share, and $2.5 million in SBIR grants.

Cash Flow

Net cash used in operating activities was $6.0 million and $15.5 million for the nine months ended September 30, 2004 and 2005, respectively. Net cash used in operating activities for these periods consisted primarily of our net loss, partially offset by depreciation and amortization and deferred revenue. The 2004 period included a $7.7 million increase in deferred revenue due to the June 2004 signing of a license agreement with Merck & Co. and the August 2004 signing of a license agreement with Biogen Idec. The 2005 period included an $8.0 million non-cash research and development expense related to the in-license of SNS-032 in April 2005.

Net cash used in investing activities was $7.1 million for the nine months ended September 30, 2004. Net cash provided by investing activities was $18.2 million for the nine months ended September 30, 2005. The cash used during the nine months period ended September 30, 2004 was primarily related to the purchases of $24.3 million of marketable securities and property and equipment totaling $788,000, partially off-set by maturities of marketable securities totaling $18.0 million. The cash provided during the nine months ended September 30, 2005 was primarily related to maturities of available-for-sale securities of $29.5 million offset by purchases of such securities of $10.0 million and purchases of property and equipment of $1.3 million. Our investing activities for these periods consisted primarily of the management of proceeds of our sales of preferred stock.

Net cash provided by financing activities was $14.4 million and $34.9 million for the nine months ended September 30, 2004 and 2005, respectively. Our financing activities for the 2004 period consisted of the issuance of $14.0 million of preferred stock to Biogen Idec in conjunction with the August 2004 signing of the kinase collaboration. Our financing activities for the 2005 period consisted primarily of the issuance of six million shares of common stock in our IPO which closed on September 30, 2005.

Net increase in cash and equivalents was $1.4 million and $37.6 million for the nine months ended September 30, 2004 and 2005, respectively.

Credit and Loan Arrangements

In June 2000, we entered into an equipment financing agreement with General Electric Capital Corporation, which has been amended from time to time. The credit facility was available through May 2005. As of September 30, 2005, we had outstanding $2.5 million to finance equipment purchases and leasehold improvements. In August 2005 we entered into a new $2.5 million credit facility with General Electric Capital Corporation. The equipment loans are secured by the equipment financed. Outstanding borrowings bear interest at annual rates ranging from 7.4% to 9.9%, and are payable over 36 to 48 months. In connection with the original credit facility, we issued in May 2003 a warrant to purchase 1,582 shares of common stock at $9.10 per share, and in June 2004, a warrant to purchase 757 shares of common stock at $9.10 per share. The warrants expire in June 2013 and June 2014, respectively. In connection with the new credit facility in August 2005, we issued warrants to purchase up 1,046 shares of common stock at $9.10 per share.

In December 2002, we executed a promissory note in favor of Biogen Idec for an aggregate principal amount of up to $4.0 million. Under the promissory note, we have a drawdown period of ten calendar quarters beginning on April 1, 2003 and ending on June 30, 2005. The principal and accrued interest of each draw are due five years from the date of advance of each draw and bear interest at 3.0% above LIBOR to be paid quarterly. As of September 30, 2005, we had drawn $4.0 million; however, the full $4.0 million was repaid with interest with the proceeds from our IPO on September 30, 2005.

In August 2005, we entered into a Venture Loan and Security Agreement with Oxford Finance Corporation and Horizon Technology Funding Company LLC, pursuant to which we may borrow up to $15.0 million. The full $15.0 million loan commitment was available until October 15, 2005; $10.0 million is available until January 31, 2006. The remaining $5.0 million is available until May 31, 2006. The loan facility has an interest-only period ending January 1, 2007 followed by a 30-month repayment period during which outstanding principal amounts amortize, provided that any outstanding loan amounts become due upon an event of default. Outstanding principal accrues interest at a rate equal to the higher of 11.5% or the three-year Treasury rate plus 7.73%. Our obligations under the loan agreement are secured by a first priority security interest in substantially all of our assets, other than our intellectual property. In conjunction with this transaction, we issued warrants to the lenders, half of which are currently exercisable, to purchase an aggregate of up to 164,821 shares of common stock at a price of $9.10 per share. We also granted the lenders registration rights under our Eighth Amended and Restated Investor Rights Agreement.

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 FDA or similar regulatory agencies in other countries and successfully commercialized. We currently anticipate that our cash, cash equivalents, marketable securities and available credit facilities, together with the proceeds from this offering and revenue generated from our collaborations, will be sufficient to fund our operations at least through April 2007. However, we will need to raise substantial additional funds to continue our operations and bring future products to market. We cannot be certain that any of our programs will be successful or that we will be able to raise sufficient funds to complete the development and commercialize any of our product candidates currently in development, should they succeed. Additionally, we plan to continue to 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, preclinical studies and other discovery and research and development activities;

• the costs associated with establishing manufacturing and commercialization capabilities;

• the costs of acquiring or investing in businesses, product candidates and technologies;

• 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;

• the effect of competing technological and market developments; and

• the economic and other terms and timing of any collaboration, licensing or other arrangements into which we may enter.

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 public or private equity offerings, debt financings or strategic collaborations. 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 research and development programs. In addition, we may have to partner one or more of our product candidate programs at an earlier stage of development, which would lower the economic value of those programs to our company.

Related Party Transactions

In August 2004, we entered into a research collaboration with Biogen Idec to discover and develop small molecules targeting kinases, a family of cell signaling enzymes that play a role in the progression of cancer. Under the terms of the agreement, the Company received a $7.0 million upfront, non-refundable and non-creditable technology access fee, which is being recognized as revenue over an initial four-year research term. Concurrent with the signing of the agreement, Biogen Idec made a $14.0 million equity investment and purchased shares of the Company’s Series C-2 preferred stock that were converted into 1,538,415 shares of common stock immediately prior to the closing of our IPO.

Biogen Idec purchased 714,286 shares of common stock at a price of $7.00 per share in our IPO in September 2005. On September 30, 2005, the Company repaid an outstanding $4.0 million loan to Biogen Idec, with interest.

Affiliates of Warburg Pincus Equity Partners, L.P. purchased 445,000 shares of common stock at a price of $7.00 per share in our IPO in September 2005.

Affiliates of Venrock Associates II, L.P. purchased 135,000 shares of common stock and affiliates of Mayfield Associates Fund III, L.P. purchased 70,000 shares of common stock, each at a price of $7.00 per share, in our IPO in September 2005.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report, including particularly the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical fact, included in this report regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, plans and objectives of management are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “hope,” “intend,” “may,” “plan,” “project,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this report, particularly in the “Risk Factors” section, that we believe could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, in-licensing transactions, joint ventures or investments we may make. We do not assume any obligation to update any forward-looking statements.

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 before you decide to purchase our common stock. If any of the possible adverse events described below actually occurs, we may be unable to conduct our business as currently planned and our financial condition and operating results could be harmed. In addition, the trading price of our common stock could decline due to the occurrence of any of these risks, and you may lose all or part of your investment.

Risks Related to Our Business

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. We are not profitable and have incurred losses in each year since our inception in 1998. We do not currently have any products that have been approved for marketing, and we continue to incur research and development and general and administrative expenses related to our operations. Our net loss for the three and nine months ended September 30, 2005 was $5.6 million and $22.2 million, respectively. As of September 30, 2005, we had an accumulated deficit of $203.7 million, including a $88.1 million deemed dividend related to our IPO. We expect to continue to incur losses for the foreseeable future, and we expect these losses to increase as we continue our research activities and conduct development of, and seek regulatory approvals for, our product candidates, and commercialize any approved drugs. Our losses, among other things, have caused and will continue to cause our stockholders’ equity and working capital to decrease. To date, we have derived all of our revenue from collaboration agreements and, to a lesser extent, grants and fellowships. We do not anticipate that we will generate revenue from the sale of products for the foreseeable future. If our product candidates 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 that our drug discovery and development activities could be significantly delayed for various reasons.

Our product candidates are in the early stages of drug discovery or development and are prone to the risks of failure inherent in drug development. As of the date of this report, only two of our product candidates, SNS-595 and SNS-032, have been tested in humans. We and our collaboration partners will need to conduct significant additional preclinical studies and clinical trials before we or our collaboration partners can demonstrate that our product candidates are safe and effective to the satisfaction of the U.S. Food and Drug Administration, or FDA, and other regulatory authorities. In our industry, it is unlikely that the limited number of compounds that we have identified as potential product candidates will actually lead to successful product development efforts. Failure can occur at any stage of the process, and successful preclinical studies and early clinical trials do not ensure that later clinical trials will be successful. Product candidates in later stage trials may fail to show desired efficacy and safety traits despite having progressed through initial clinical trials. A number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier trials.

We do not know whether our ongoing Phase I clinical trials with SNS-595, our planned Phase I/II clinical trial with SNS-032, our planned Phase I clinical trial with SNS-314, or any other future clinical trials with any of our product candidates will be completed on schedule, or at all, or whether our planned Phase I, Phase I/II and Phase II clinical trials will begin on time. The commencement of our planned clinical trials could be substantially delayed or prevented by several factors, including:

• 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 reaching agreement on acceptable clinical trial agreement terms or clinical trial protocols with prospective sites; and

• delays or failures in obtaining institutional review board approval to conduct a clinical trial at a prospective site.

The completion of our clinical trials could also be substantially delayed or prevented by several factors, including:

• 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 medical investigators to follow our clinical trial protocols; and

• inability to monitor patients adequately during or after treatment.

For example, due to toxicities observed in previous Phase I clinical trials of SNS-032, our planned Phase I/II clinical trial for the use of SNS-032 to treat human malignancies will be complex and require stringent eligibility criteria, and there will be a limited patient population that will be able to participate in this trial. In addition, our planned dosing regimen for this trial is time-consuming and patients may choose to participate in alternative clinical trials. As a result, we believe that our planned Phase I/II clinical trial for SNS-032 may be lengthier and more expensive than similar clinical trials. In addition, our clinical trials may be suspended or terminated at any time by FDA, other regulatory authorities, our company or, in some cases, our collaboration partners. Any failure or significant delay in completing clinical trials for our product candidates could harm our financial results and the commercial prospects for our product candidates.

We will require substantial additional funding, which may not be available to us on acceptable terms, or at all.

We are advancing multiple product candidates through discovery and development. We will need to raise substantial additional capital to continue our discovery, development and commercialization activities. We plan to retain the development and commercialization rights to some of our novel cancer therapeutics at least until we have completed a Phase II clinical trial to maximize our economic upside, which will require substantial expenditures by our company.

We will need to raise substantial additional capital to:

• fund clinical trials and seek regulatory approvals;

• pursue the development of additional product candidates;

• expand our research and development activities;

• build or access manufacturing and commercialization capabilities;

• implement additional internal systems and infrastructure;

• maintain, defend and expand the scope of our intellectual property portfolio; and

• hire additional management and scientific personnel.