Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition as of September 30, 2008 and results of operations for the three and nine months ended September 30, 2008 and 2007 should be read together with our 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, that involve risks, uncertainties and assumptions. All statements other than statements of historical facts, are “forward-looking statements” for purposes of these provisions, including any projections of revenue, expenses or other financial items, 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 cancers. We have built a highly experienced cancer drug development organization committed to advancing our lead product candidate, voreloxin, in multiple indications to improve the lives of people with cancer.

From our incorporation in 1998 through 2001, our operations consisted primarily of developing and refining our drug discovery technologies. From 2002 through June 2008, we focused on the discovery and development of novel small molecule drugs. On June 3, 2008, we announced a corporate realignment to focus on the development of voreloxin. In conjunction with this strategic restructuring, we expanded our late-stage development leadership team, announced the winding down of our internal discovery research activities and reduced our workforce by approximately 60 percent.

 We are currently advancing voreloxin through later stage development efforts. Voreloxin is a first-in-class naphthyridine analog, a chemical structure closely related to that of the quinolone antibacterial agents. We are in the process of conducting three clinical trials of voreloxin: a Phase 2 clinical trial (known as the REVEAL-1 trial) in previously untreated elderly patients with acute myeloid leukemia (“AML”), a Phase 1b/2 combination clinical trial combining voreloxin with cytarabine in patients with relapsed/refractory AML, and a Phase 2 single agent clinical trial in advanced platinum-resistant ovarian cancer patients. We have worldwide development and commercialization rights to voreloxin. In the future, we may enter into partnering arrangements for this product candidate to maximize its commercial potential.

We also have two other proprietary oncology product candidates, SNS-032 and SNS-314, completing Phase 1 clinical trials. SNS- 032, is a selective inhibitor of cyclin-dependent kinases (“CDKs”) 2, 7 and 9 and we have been conducting a Phase 1 clinical trial of SNS-032 in patients with relapsed/refractory chronic lymphocytic leukemia (“CLL”) or multiple myeloma and recently completed dose escalations in both arms. No objective responses have been observed to date in either the CLL or multiple myeloma arm. Based on trial results to date, we expect that we will cease further development after completion of the Phase 1 trial. SNS-314, a potent and selective pan-Aurora kinase inhibitor, is being studied in a Phase 1 dose-escalating clinical trial in patients with advanced solid tumors. Dose escalation is ongoing. Depending upon results from this trial, we will seek a partner to support additional development of SNS-314.

 

 

 

We had developed proprietary methods of discovering drugs in pieces, or fragments. Our initial fragment-based discovery approach was called “Tethering ^® .” The Tethering approach to drug discovery formed the basis of several collaborations. While we are no longer receiving research funding in any collaboration, as of September 30, 2008, we had received an aggregate of approximately $85.8 million in cash from our collaboration partners in the form of stock purchase proceeds and fees. This includes collaborations with Biogen Idec, Inc. (“Biogen Idec”), Johnson & Johnson Pharmaceutical Research & Development, L.L.C. (“J&J PRD”) and Merck & Co., Inc. (“Merck”). We may in the future receive milestones as well as royalty payments based on future sales of products resulting from such collaborations.

Prior to our restructuring announced in June 2008 and the resulting wind down of our internal discovery research activities, we had developed further enhancements to our fragment-based discovery platform that were being used to discover new targeted agents. We are also exploring opportunities to monetize our exclusive fragment-based drug discovery capabilities, our preclinical programs and/or our intellectual property portfolio.

 

In addition, we have licensed worldwide rights to all of our LFA-1 patents and related know-how to SARcode Corporation.

Since our inception, we have generated significant losses. As of September 30, 2008, we had an accumulated deficit of $309.3 million, including a deemed dividend of $88.1 million recorded in conjunction with our IPO in September 2005. We expect our significant net losses to continue for the foreseeable future, as we continue to conduct development of, and seek regulatory approvals for, voreloxin.

Critical Accounting Policies and 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 accounting principles generally accepted in the United States. 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.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur periodically, could materially change the financial statements. We believe there have been no significant changes during the nine months ended September 30, 2008 to the items that we disclosed as our critical accounting policies and estimates under Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

Recent Accounting Pronouncements

In February 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Position (FSP) No. 157-2, which delays the effective date of FASB Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at a fair value on a recurring basis (items that are measured annually). The FSP defers the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. We will adopt FSP No. 157-2 in the first quarter of 2009 and currently does not believe the adoption of FSP No. 157-2 will have a material effect on our financial position or results of operations.

In June 2007, the FASB ratified the Emerging Issues Task Force (“EITF”) 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities (“EITF 07-3”). EITF 07-3 requires nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. Such amounts should be recognized as an expense when the related goods are delivered or services are performed. EITF 07-3 is effective for fiscal years beginning after December 15, 2007. We adopted EITF 07-3 in the first quarter of 2008. The adoption of EITF 07-3 did not have a material effect on our financial position or results of operations.

In December 2007, the EITF reached a consensus on EITF 07-1, Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property (“EITF 07-1”). EITF 07-1 discusses the appropriate income statement presentation and classification for the activities and payments between participants in arrangements related to the development and commercialization of intellectual property. The sufficiency of disclosure related to these arrangements is also specified. EITF 07-1 is effective for fiscal years beginning after December 15, 2008. We will adopt EITF 07-1 in the first quarter of 2009 and currently do not believe the adoption of EITF 07-1 will have a material impact on our financial position or results of operations.

 

 

Results of Operations

Three and Nine Months Ended September 30, 2008 and 2007

Revenues

Collaboration Revenue. Since inception, 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, substantially all of our revenue has consisted of technology access fees, research funding and milestone payments we have received in connection with our collaborations. The research term of all of our collaborations is completed, including the research term of our collaboration with Biogen Idec which ended June 30, 2008. As a result, we are no longer receiving research funding, and our personnel are not actively participating in continued development of product candidates resulting from such collaborations.

 

  The table below sets forth our revenue for the three and nine months ended September 30, 2008 and 2007 from our collaborations with Biogen Idec, J&J PRD and Merck.

 

Collaboration revenue for the three months ended September 30, 2008 decreased to $10,000 compared to $1.8 million in the same period in 2007. The decrease was primarily due to the termination of the research phase of our kinase inhibitor collaboration with Biogen Idec in June 2008 and the resulting cessation of research revenue from Biogen Idec and a decrease in research revenue from our BACE program with Merck. Collaboration revenue for the nine months ended September 30, 2008 decreased to $4.9 million compared to $7.4 million in the same period in 2007. In addition to the reasons stated above with respect to the most recent quarter, the decrease was due to (i) lower research revenue from Biogen Idec throughout 2008 because fewer Company research personnel were working on the collaboration activities and (ii) a $1.0 million payment received from Merck in 2007 for the achievement of a preclinical milestone. Partially offsetting the decrease in 2008 was a milestone payment from J&J PRD for the selection of a compound targeting the Cathepsin S enzyme using our proprietary Tethering technology.

We expect to have no ongoing research funding. As a result, collaboration revenue will be substantially lower in the next couple of years and may continue to be substantially lower in future years, unless and until any products that may result from our collaborations advance to a level where significant milestones will be payable to us.

License Revenue.     License revenue for the three months ended September 30, 2008 increased to $0.5 million compared to zero dollars in the same period in 2007 due to a $0.5 million license fee   pursuant to our out-license agreement with SARcode.  License revenue for the nine months ended September 30, 2008 increased to $0.5 million compared to $0.3 million in the same period in 2007 due to increased license fees under our out-license agreement with SARcode . We do not expect to receive license revenue from SARcode in the fourth quarter of 2008. However, based on SARcode’s future achievements using our propietary LFA-1 patients and related know-how, we may receive future license revenue.

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

·		in the discovery and development of novel small-molecule therapeutics and the advancement of product candidates towards clinical trials, including the Phase 1 and Phase 2 clinical trial costs for voreloxin and the Phase 1 clinical trial costs for SNS-032 and SNS-314,
·		in the development of our proprietary fragment-based Tethering drug discovery approach and other novel fragment-based drug discovery methods,
·		in the development of in-house research, preclinical study and development capabilities,

 

 

·		in connection with in-licensing activities, and
·		in the conduct of activities we were 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 for the three and nine months ended September 30, 2008 and 2007 for each of our product candidate programs (in thousands):

 

Research and development expense decreased by $4.1 million, or 47 percent, to $4.7 million for the three months ended September 30, 2008 from $8.8 million for the same period in 2007. This decrease is primarily due to (i) a $0.7 million and $0.3 million decrease in clinical trial activities related to SNS-314 and SNS-032, respectively; and (ii) a $2.3 million and $0.8 million decrease in expenses under our other kinase inhibitors and our discovery and new technologies programs, respectively.

 

Research and development expense decreased by $6.1 million, or 22 percent, to $21.7 million for the nine months ended September 30, 2008 from $27.8 million for the same period in 2007. This decrease is primarily due to (i) a $6.5 million decrease in expenses under our other kinase inhibitors program, (ii) a $1.7 million decrease in clinical trial activity related to SNS-314, (iii) a $0.6 million decrease in expenses for discovery programs and new technologies, and (iv) a $0.1 million decrease in other programs, partially offset by a $2.6 million increase in voreloxin expenses and $0.2 million of increased expenses, particularly in the early months of 2008, on SNS-032 due to increased clinical trial activities.

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

However, we have incurred and expect to continue to incur substantial research and development expense to conduct clinical trials primarily on voreloxin, but also to complete our ongoing Phase 1 clinical trials of SNS-032 and SNS-314. Clinical trials are costly, and as we continue to advance voreloxin through preclinical and clinical development, we expect our related expenses to remain high. For example, we expect to spend approximately $8.0 million over the next twelve months (i) to advance our voreloxin program to completion of the current Phase 1b/2 combination trial in AML, Phase 2 AML clinical trial in the untreated elderly, and Phase 2 clinical trial in ovarian cancer,  (ii) to complete our ongoing Phase 1 clinical trial in SNS-032, and (iii) to complete the ongoing Phase 1 clinical trial for SNS-314. As of the date of this report, due to the risks inherent in the clinical trial process and given the early state of development of our programs, we are unable to estimate the additional substantial costs we will incur in any continued development program.

In addition, while we are currently focused on trials in voreloxin, SNS-032 and SNS-314, we anticipate that we will make determinations as to which programs to pursue and how much funding to direct to each program on an ongoing basis in response to the scientific and clinical success of each product candidate, an assessment as to the product candidate’s commercial potential and our overall financial objectives. This will affect our research and development expense going forward. We are currently anticipating that development of voreloxin will be our highest priority, that we will cease further development of SNS-032 after the completion of the ongoing Phase 1 trial and that SNS-314 will be deemphasized in 2009 as we seek a development partner for that product candidate depending on our results from the ongoing SNS-314 Phase 1 clinical trial. We cannot forecast which product candidates will be subject to future collaborative or licensing arrangements, when such 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 an option on a target-by-target basis to co-fund post-Phase 1 development costs for product candidates directed to up to two collaboration targets, which may, at our option, include the Raf kinase target. If we exercise our option on one or more product candidates, our research and development expense will increase significantly. We expect that research and development expense related to co-development activities that we might elect to co-fund would consist primarily of manufacturing costs for the product candidate, clinical trial-related costs, costs for consultants and contract research organizations, employee and facilities costs and depreciation of equipment.

 

 

General and Administrative Expense. Our general and administrative expense consists primarily of salaries and other related costs for personnel in finance, human resources, legal, including intellectual property management, and general administration, as well as non-cash stock-based compensation. Other significant costs include facilities costs and fees paid to outside legal advisors and auditors. General and administrative expense for the three months ended September 30, 2008 decreased by approximately $0.6 million, or 18 percent, to $2.8 million for the three months ended September 30, 2008 from $3.4 million for the same period in 2007, primarily due to reduced headcount compared to 2007, a decrease in personnel- and office-related expenses and a decrease in professional and consulting expenses. For the nine months ended September 30, 2008, general and administrative expense decreased by approximately $1.4 million, or 13 percent, to $9.3 million from $10.7 million for the same period in 2007, primarily due to reduced headcount, lower personnel-, office- and facilities- related expenses and a decrease in professional and consulting expenses. As a result of the 2008 restructuring, we expect our general and administrative expenses to decrease over the next twelve months due to reduced headcount.

  Restructuring Charge. For the three months ended September 30, 2008, we recorded approximately $0.2 million related to the 2008 restructuring, of which $0.1 million is related to employee severance and related benefit costs and another $0.1million is related to facility exit costs. For the nine months ended September 30, 2008, we recorded approximately $5.4 million of restructuring charges, comprised of $5.8 million related to the 2008 restructuring, partially offset by a $0.4 million reversal of the 2007 restructuring related to Company’s facilities exit costs. For the three and nine months ended September 30, 2007, we recorded a $1.2 million charge related to the 2007 restructuring. These charges consist of $1.1 million in severance and related benefit costs and $0.1 million in leasehold improvement write-offs. We currently expect to record additional restructuring expenses of approximately $6.3 million in the first quarter of 2009.

Interest Income. Interest income decreased by $0.7 million, or 88 percent, to $0.1 million for the three months ended September 30, 2008 from $0.8 million for the same period in 2007. Interest income decreased by $1.4 million, or 61 percent, to $0.9 million for the nine months ended September 30, 2008 from $2.3 million in the same period in 2007. The lower interest income for the three and nine months ended September 30, 2008 was due to lower average balances of cash, cash equivalents and marketable securities during 2008, as well as lower average interest rates.

 

  Interest Expense. Interest expense decreased to $40,000 in the three months ended September 30, 2008 from $56,000 for the same period in 2007 mainly due to a decrease in outstanding debt obligation in 2008 compared to 2007. Interest expense increased to $154,000 in the nine months ended September 30, 2008 from $152,000 for the same period in 2007 due to higher interest rates on outstanding debt obligation in 2008.

Liquidity and Capital Resources

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, debt financings and research grants. As of September 30, 2008, we had cash, cash equivalents and marketable securities of $18.3 million and outstanding debt from equipment financing of $1.6 million.

Cash Flows

Net cash used in operating activities was $28.5 million and $27.3 million for the nine months ended September 30, 2008 and 2007, respectively. Net cash used in operating activities for the nine months ended September 30, 2008 resulted primarily from our net loss of $30.3 million and changes in operating assets and liabilities of $2.4 million, partially offset by adjustments for non-cash items of $4.2 million primarily from depreciation and amortization, the non-cash portion of restructuring charges, and stock-based compensation expense. Net cash used in operating activities for the nine months ended September 30, 2007 resulted primarily from our net loss of $30.0 million and changes in operating assets and liabilities of $1.3 million, partially offset by adjustments for non-cash items of $4.0 million primarily from depreciation and amortization and stock-based compensation expense.

Net cash provided by investing activities was $25.9 million for the nine months ended September 30, 2008, compared to $13.3 million for the nine months ended September 30, 2007. The cash provided by investing activities during the nine months ended September 30, 2008 was primarily attributable to net proceeds from the maturity of marketable securities of $26.1 million, partially offset by capital expenditures of $0.2 million. Net cash provided by investing activities during the nine months ended September 30, 2007 was related to the net proceeds from maturities of marketable securities of $14.5 million, partially offset by the purchase of capital equipment totaling $1.2 million.

Net cash used in financing activities was $0.7 million for the nine months ended September 30, 2008, as compared with $20.3 million in net cash provided by financing activities for the nine months ended September 30, 2007. Our financing activities for the nine months ended September 30, 2008 consist primarily of equipment loan re-payments of $0.7 million. Our financing activities for the nine months ended September 30, 2007 consisted primarily of $19.5 million in net proceeds from a public offering in May 2007, $0.4 million of proceeds from common stock issuance under the ESPP and stock option exercises and $0.4 million borrowed under equipment loans borrowing net of equipment financing repayments.

 

 

Credit and Loan Arrangements

In June 2000, we entered into an equipment financing agreement with General Electric Capital Corporation (“GECC”). Various credit lines have been issued under the financing agreement since 2000. As of September 30, 2008, we had drawn an aggregate of $10.7 million under various credit lines under the financing agreement. At September 30, 2008, the outstanding balance was $1.6 million. The outstanding balance bears interest at rates ranging from 8.70 percent to 10.61 percent per annum and is due in 36 to 48 monthly payments. The equipment loans are secured by the equipment financed. Prior to the sale of the our held-for-sale assets, we will be required to pay the entire outstanding balance. No credit lines remain available under this 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 unless and until a product candidate has been approved by the United States Food and Drug Administration (“FDA”) or similar regulatory agency in other countries and has been successfully commercialized. As of September 30, 2008, our cash, cash equivalents and marketable securities totaled $18.3 million. We also have outstanding debt from equipment financing of $1.6 million. We believe that our cash, cash equivalents and marketable securities will be sufficient to enable us to meet our obligations to approximately the middle of 2009. We need to raise substantial additional funds to continue our operations, fund additional clinical trials of voreloxin and bring future products to market. We cannot be certain that we will be able to raise sufficient funds to complete the development and commercialization of voreloxin or that the voreloxin will be successful. 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.

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