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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

or

Commission File Number 001-33213

AFFYMAX, INC.

(Exact name of registrant as specified in its charter)

4001 Miranda Avenue
Palo Alto, CA 94304
(650) 812-8700

(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

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 such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o                                                                                           Accelerated filer x

Non-accelerated filer o (Do not check if a smaller reporting company)      Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

As of October 31, 2010, 25,451,078 shares of the registrant’s common stock, $0.001 par value, were outstanding.

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AFFYMAX, INC
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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

AFFYMAX, INC.

CONDENSED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of these condensed financial statements.

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AFFYMAX, INC.

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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AFFYMAX, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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AFFYMAX, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1.                 The Company

Affymax, Inc., a Delaware corporation, was incorporated on July 20, 2001. We are a biopharmaceutical company committed to developing novel drugs to improve the treatment of serious and often life-threatening conditions. Our product candidate, Hematide TM/peginesatide (USAN or nonproprietary name), is a synthetic peptide-based erythropoiesis stimulating agent, or ESA, designed to stimulate production of red blood cells. As previously reported in our Current Report on Form 8-K dated June 21, 2010, we recently announced preliminary top-line results from the Hematide Phase 3 clinical program for the treatment of patients with anemia associated with chronic renal failure.

2.                 Summary of Significant Accounting Policies

Basis of Presentation

Our accompanying condensed financial statements have been prepared following the requirements of the Securities and Exchange Commission, or SEC, for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by United States or U.S. generally accepted accounting principles, or GAAP, have been condensed or omitted. The condensed financial statements are unaudited and reflect all adjustments, consisting of only normal recurring adjustments, which in the opinion of management, are necessary to fairly state the financial position at, and the results of operations and cash flows for, the interim periods presented.  In February 2010, the Financial Accounting Standards Board, or FASB, amended certain recognition and disclosure requirements for events that occur after the balance sheet date but before financial statements are issued.  We have evaluated subsequent events through the date the financial statements were issued and filed with the SEC.  The financial information included herein should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009, which includes our audited financial statements and the notes thereto.

Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in the condensed financial statements and accompanying notes may not be indicative of the results for the full year or any future period.

Comprehensive Loss

Comprehensive loss consists of net loss plus the change in unrealized gains and losses on investments. At each balance sheet date presented, our accumulated other comprehensive income (loss) consists solely of unrealized gains and losses on investments. Comprehensive loss for the three and nine months ended September 30, 2010 and 2009 are as follows (in thousands):

Concentration of Risk and Uncertainties

Financial instruments that potentially subject us to a concentration of credit risk consist of cash, cash equivalents and investments. We deposit excess cash in accounts with two major financial institutions in the U.S. Deposits in these banks may exceed the amount of insurance provided on such deposits. We have not experienced

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any realized losses on our deposits of cash and cash equivalents. We have adopted guidelines for investment of excess cash with the objective of maintaining safety and liquidity through our policies on diversification and investment maturity.  As of September 30, 2010, we no longer maintained any auction rate securities, or ARS, in our investment portfolio.

At September 30, 2010, we had an accumulated deficit of $377.4 million. Due to the recognition of revenues from milestone payments from our collaboration with Takeda Pharmaceutical Company Limited, or Takeda, we were profitable in the three and six months ended June 30, 2010.  Prior to the three and six month periods ended June 30, 2010, we had incurred net losses since our inception. We continue to expect to incur substantial additional operating losses for the next several years and will need to obtain additional financing in order to complete the development and commercialization of Hematide. In addition, we have generated no revenue from product sales to date and we have funded our operations to date principally from our collaboration agreements with Takeda and the sale of equity securities. There can be no assurance that such financing will be available or will be at terms acceptable to us.

Our accounts receivable balance contains receivables in connection with our two separate collaboration agreements, or the Arrangement, with Takeda.  We have not experienced any credit losses from our Arrangement with Takeda and none are expected. We do not require collateral on our receivable.

We are currently developing our first product offering, Hematide, and have no products that have received regulatory approval. Hematide will require approval from the U.S. Food and Drug Administration, or FDA, and/or foreign regulatory agencies prior to commercial sales. There can be no assurance that Hematide will receive the necessary approvals. If we are denied such approvals or such approvals are delayed, it would have a material adverse effect on us. To achieve profitable operations, we must successfully develop, test, manufacture and commercialize Hematide. There can be no assurance that Hematide can be developed successfully or manufactured at an acceptable cost and with appropriate performance characteristics, or that Hematide will be successfully commercialized. These factors could have a material adverse effect on our future financial results.

Further, some of our suppliers and manufacturing arrangements, including the provision of bulk poly(ethylene) glycol reagent for the manufacture of Hematide from Nektar Therapeutics AL, Corporation are currently single-sourced, leaving us at greater risk of supply interruptions and potential delays.

Recent Accounting Pronouncements

In October 2009, the FASB issued Accounting Standards Update, or ASU, No. 2009-13, multiple deliverable revenue arrangements. This update provides amendments to the criteria in ASC Topic 605, “Revenue Recognition, “ for separating consideration in multiple-deliverable arrangements by establishing a selling price hierarchy. The selling price used for each deliverable will be based on vendor-specific objective evidence, or VSOE, if available, third party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third party evidence is available. ASU No. 2009-13 also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We are currently assessing the potential impact that the adoption of ASU No. 2009-13 will have on our financial statements.

In April 2010, the FASB issued ASU No. 2010-17, revenue recognition — milestone method (Topic 605), which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions.  However, the FASB clarified that, even if the requirements in ASU No. 2010-17 are met, entities would not be precluded from making an accounting policy election to apply another appropriate accounting policy that results in the deferral of some portion of the arrangement consideration. ASU No. 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010.  Early adoption is permitted. We are currently assessing the potential impact that the adoption of ASU No. 2010-17 will have on our financial statements.

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Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Investments

Investments are classified as available-for-sale and are carried at their fair market value based upon quoted market prices for these or similar instruments at the balance sheet date. Unrealized gains and losses are reported as a separate component of stockholders’ equity until realized. The amortized cost of these securities is adjusted for amortization of premiums and accretions of discounts to maturity. Such amortization as well as realized gains and losses are included in interest income. We assess our investments for potential other-than-temporary impairment based on factors including the length of time and extent to which the fair value has been below our cost basis and the current financial condition of the investee.  We do not intend to sell an impaired security and it is not more likely than not that we will be required to sell the security before the recovery of its amortized cost basis. If we conclude that an other-than-temporary impairment exists, we recognize an impairment charge to reduce the investment to fair value and record the related charge as a reduction of interest to other income (expense), net. We have elected to use settlement date accounting for purposes of recording transactions.

Revenue Recognition

We recognize revenue in accordance with the authoritative guidance, revenue recognition in financial statements. When evaluating multiple element arrangements, we consider whether the components of the arrangement represent separate units of accounting as defined in the authoritative guidance for revenue arrangements with multiple deliverables. Application of this guidance requires subjective determinations and requires management to make judgments about the fair value of the individual elements and whether such elements are separable from the other aspects of the contractual relationship.

We evaluated the multiple elements under the combined single arrangement in accordance with the provisions of the guidance for revenue arrangements with multiple deliverables. We recognize revenue using the Contingency-Adjusted Performance Model, or CAPM. Under CAPM, revenue is eligible for recognition in the period the payment is earned under the Arrangement including amounts that are either received or due from Takeda. Revenue initially recognized is based on the percentage of time elapsed from inception of the Arrangement in June 2006 to the period in which the payment is earned in relation to the total projected development period.  The remaining portion of the payment is then recognized on a straight-line basis over the remaining estimated duration of the development period of the Arrangement.  Payments during the development period include amounts due for upfront license fees, milestone payments earned, purchases of active pharmaceutical ingredient, or API, and reimbursement of development and commercial expenses.  We had previously estimated the development period to end on January 1, 2011. Based on the announcement on June 21, 2010 of our top-line results from our Phase 3 clinical program, we re-evaluated our development period and determined that the development period is now estimated to end in the first half of 2011.  The extension of the development period results in the deferred collaboration revenue as of June 30, 2010 to be recognized over a longer period then previously estimated. During the development period, we expect collaboration revenue to be directly affected by milestone payments and expenses that are eligible for reimbursement from Takeda under the Arrangement in future periods. Included in the reimbursable expense is the cost of API that we manufacture and supply to Takeda during the development period, which we will also supply during the commercialization period. Further changes in the estimated term of the development period could materially affect the amount of collaboration revenue recognized in future periods.

We have recognized $16.8 million and $29.2 million of collaboration revenue during the three months ended September 30, 2010 and 2009, respectively, and $105.8 million and $81.9 million for the nine months ended September 30, 2010 and 2009, respectively.  As of September 30, 2010, the amount receivable from Takeda was $4.3 million.

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Clinical Trial Expense and Accruals

We record expense for estimated clinical study external costs, which are a significant component of research and development, or R&D, expense. These clinical study expenses involve significant estimates due to the complexity and magnitude of the clinical trial activities and have been subject to frequent adjustments, especially for our Phase 3 trials, in part due to our negotiations with third-parties with respect to timing of reporting, patient progression and payments. This also includes our continuing negotiations with contract research organizations, or CROs, on timely delivery and access to information necessary to validate our accruals. The activities in our trials are performed globally at many sites and in various countries, involving numerous CROs and third parties which makes estimation difficult.  Our clinical trial costs were $3.1 million and $20.6 million during the three months ended September 30, 2010 and 2009, respectively, and $26.3 million and $68.8 million during the nine months ended September 30, 2010 and 2009, respectively.  As of September 30, 2010, our Phase 3 trials and substantially all of our Phase 2 trials have been completed, however, we are continuing to obtain additional information which will be needed for reconciliation of actual expense to the accruals.

Our clinical studies are administered by CROs that typically perform most of the start-up activities for the trials, including document preparation, site identification, pre-study visits, training as well as on-going program management and close down of the trials. For the Phase 3 studies, which represent the vast majority of the clinical trial expense to date, the expense recorded has been based on reporting received from CROs and internal analyses. We accrue costs for work performed by CROs based on the achievement of contracted activities during the period. Expense for investigator fees, which include patient costs, has been based on internal estimates of activities using patient enrollment and contractual or estimated rates. For the Phase 2 studies, the expense has been based on activities such as patient monitoring as reported by the CROs and achievement of milestones. Other costs such as testing and drug materials are expensed as incurred. For all studies, CRO reporting is reviewed by us for appropriateness.

During the three months ended March 31, 2010, we concluded negotiations and finalized amendments for activities completed in 2009 resulting in adjustments to estimates recorded in our expense for the year ended December 31, 2009. These changes in estimate decreased expense by $553,000 or $0.02 per share in the three months ended March 31, 2010. Additional changes in estimate or adjustments to previously presented amounts in R&D expense may result as the reconciliation activities and final negotiations with our CROs are completed on our clinical trials.  We plan to complete this reconciliation and have the results reflected in our financials as of December 31, 2010.

Net Loss per Share

Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period less the weighted-average unvested shares subject to repurchase, without consideration for potential common shares.

Diluted net loss per share is computed similarly to basic net loss per share, except that the denominator is increased to include all dilutive potential common shares using the treasury stock method.  For purposes of this calculation, options to purchase common stock, common stock issuable pursuant to the 2006 Employee Stock Purchase Plan, restricted stock units and warrants are considered to be potential common shares and are only included in the calculation of diluted loss per share when their effect is dilutive. The computations for basic and diluted net loss per share were as follows (in thousands):

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The following were excluded from the computation of diluted net loss per share for the periods presented because including them would have an antidilutive effect (in thousands):

3.                 Stock-Based Compensation

In July 2010, we granted 667,855 stock options and 235,158 restricted stock units, or RSUs, to certain non-executive employees with an estimated grant date fair value of $4.19 and $6.23 per share, respectively.  Options vest monthly over a four year period and RSUs vest annually over a two year period.

In September 2010, we granted 300,000 stock options and 225,000 RSUs to certain executive officers with an estimated grant date fair value of $4.00 and $5.83 per share, respectively.  Options vest monthly over a four year period.  RSUs are performance-based and vest as follows: (a) 50% upon FDA acceptance of our NDA for Hematide and (b) 50% upon product launch of Hematide.

We recognized stock-based compensation expense related to employee and director stock options, RSUs and stock purchase rights of $3.2 million and $2.4 million for the three months ended September 30, 2010 and 2009, respectively, and $8.7 million and $7.2 million for the nine months ended September 30, 2010 and 2009, respectively, under the authoritative guidance for share-based payments.  As of September 30, 2010, unrecognized compensation costs related to employee and director stock options and restricted stock units totaled $24.2 million. The cost is expected to be recognized over a weighted-average amortization period of 2.25 years.

4.                 Investments and Fair Value Measurements

The following is a summary of our available-for-sale marketable securities (in thousands):

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Fair Value Measurements

We measure certain financial assets at fair value on a recurring basis, including cash equivalents and available for sale securities.  The fair value of these assets was determined based on a three-tier hierarchy under the authoritative guidance for fair value measurements and disclosures that prioritizes the inputs used in measuring fair value as follows:

·                  Level 1 — observable inputs such as quoted prices in active markets.

·                  Level 2 — inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data.

·                  Level 3 — unobservable inputs in which there is little or no market data, which would require us to develop our own assumptions.

Effective January 2010, we adopted the provisions of the authoritative guidance for improving fair value disclosures. Our cash equivalents and investments, other than ARS, are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices in active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.  The types of investments that are generally classified within Level 1 of the fair value hierarchy include money market securities.  The valuation technique we used to measure fair value of our Level 1 money market securities is a market approach, using prices and other relevant information generated by market transactions involving identical securities.  The types of investments that are generally classified within Level 2 of the fair value hierarchy include certificates of deposits and U.S. government securities.  The valuation technique we used to measure fair value of our Level 2 investments is a market approach, which we review trading activity and pricing for these investments as of the measurement date. When sufficient quoted pricing for identical investments was not available, we used market pricing and other observable market inputs for similar investments obtained from various third party data providers. These inputs represent quoted prices for similar investments in active markets or these inputs have been derived from observable market data. Our investments in ARS and UBS AG of Series C-2 ARS Rights, or ARS Rights, were classified within Level 3 of the fair value hierarchy because of the lack of observable inputs.  The valuation technique we used to measure fair value of our Level 3 ARS and ARS Rights was an income approach and we used a discounted cash flow analysis.  As of September 30, 2010, we no longer maintained any ARS or ARS Rights.  Further, there were no transfers in and out between the fair value hierarchy Level 1, Level 2 and Level 3, and there were no changes in our valuation technique in the nine months ended September 30, 2010.  Our policy is to recognize transfers into or out of Level 3 classifications as of the actual date of the event or change in circumstances that caused the transfer.

ARS are structured to provide liquidity by an auction process that resets the applicable interest rate at predetermined calendar intervals, usually every 28 days but have stated or contractual maturities that are generally greater than one year.  In July, we sold our remaining $15.0 million of par value of ARS which was comprised of

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$12.4 million of municipal issuances that were collateralized by student loans guaranteed by the U.S. government under the Federal Family Education Loan Program, and we sold a $2.6 million closed end preferred issuance.  We exercised our ARS Rights on June 30, 2010 which resulted in a repurchase by UBS of the ARS at par of $10.4 million on July 1, 2010.  In July, we also sold our long-term ARS securities with a par value of $4.6 million for $3.7 million which resulted in a loss of $158,000 of fair value upon acceptance of a tender offer below market. Previously, our sales of ARS had not resulted in any loss of principal except for a $62,000 loss of par value upon acceptance of a tender offer below market.

We determined fair value of our ARS using a discounted cash flow analysis. The analysis considers, among other things, the amount and timing of coupon payments, contractual terms, underlying collateralization and credit risk. In addition, we included in our analysis an illiquidity factor to estimate the discount necessary to sell a security for which there is no active market. The analysis considers that issuers have continued to meet interest payment obligations and are expected to continue to do so at levels consistent with issuer’s credit risk. The analysis is based on dynamic market conditions and changes in our assumptions could lead to a significant change in determined value. For the nine months ended September 30, 2009, our analysis resulted in a net decrease in fair value of ARS totaling $160,000 that was deemed to be other-than-temporary and was recorded as impairment charges to other income (expense) net.  Upon sale, the other-than-temporary impairment charges were reversed to the extent that the proceeds from the sale exceeded the fair value of the ARS. We reversed other-than-temporary impairment charges of $695,000 and $372,000 for the nine months ended September 30, 2010 and 2009, respectively.

In November 2008, we accepted the terms of the ARS Rights and delivered the required legal release of claims against the UBS entities. These ARS Rights gave us the option to require UBS to repurchase, at par, the ARS beginning on June 30, 2010, which we exercised on June 30, 2010 as described above.  In connection with the ARS Rights, UBS also offered, through UBS Financial Services, Inc., an affiliate of UBS AG, a loan facility that allows draws of up to 75% of the stated value of our ARS portfolio, as determined by UBS Financial Services, Inc.  In December 2009, we obtained a loan of approximately $9.2 million, which was secured by the ARS and ARS Rights as collateral.  See Note 5 to our Condensed Financial Statements — UBS Loan.  As part of our ARS Rights cash settlement on July 1, 2010, we repaid our outstanding loan balance of $5.4 million.  As of September 30, 2010, we no longer have any debt liability.

We determined that the ARS Rights did not meet the definition of a derivative security as described in the authoritative guidance for accounting for derivative instruments and hedging activities because the ARS Rights were non-transferrable, and we must tender the related ARS to receive the cash settlement.  Therefore, we elected to measure the ARS Rights separately under the authoritative guidance pertaining to the fair value option for financial assets and financial liabilities in order to partially offset the changes in the fair value of the ARS to the ARS Rights. We did not elect to adopt the guidance for the fair value option for financial assets and financial liabilities to measure financial instruments, except for the ARS Rights. We determined the fair value of our ARS Rights using a discounted cash flow analysis based on, among other things, the timing and likelihood of the recovery of the par value of the ARS from UBS. For the nine months ended September 30, 2009, our analysis resulted in a net increase in the fair value of our ARS Rights of $57,000 and was recorded as an other current asset with a corresponding credit to other income (expense), net. Upon sale of the related ARS, the fair value of our ARS Rights was decreased by $604,000 and $126,000 for the nine months ended September 30, 2010 and 2009, respectively, and was recorded as a charge to other income (expense), net.

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The following table presents our investments measured at fair value on a recurring basis classified by the fair value measurements and disclosures valuation hierarchy (in thousands):

The following table presents changes in Level 3 investments measured at fair value on a recurring basis for the nine months ended September 30, 2010 and 2009 (in thousands):

5.                 UBS Loan

In connection with the settlement with UBS AG relating to our ARS, we entered into a loan agreement with UBS Financial Services, Inc., an affiliate of UBS AG.  In December 2009, we obtained a loan of approximately $9.2 million, the full available amount, which was secured by the ARS. The loan amount was based on 75% of the fair value of the ARS as assessed by UBS at the time of the loan. This “no net cost loan” bears interest at a rate that will not exceed the average rate of interest paid on the pledged ARS such that the net interest cost to us will be zero. As part of our ARS Rights cash settlement on July 1, 2010, we repaid our outstanding loan balance of $5.4 million.  As of September 30, 2010, we no longer have any debt liability.

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As required by UBS, we applied the net interest received in and the proceeds from the sales and redemptions of ARS to the principal of the loan.  For the three months ended September 30, 2010, we paid $2,000 of interest expense associated with the loan and received $6,000 in interest income from the collateralized ARS.  For the three months ended September 30, 2010, the net interest earned of $4,000 and $5.4 million from redemptions was applied to the principal of the loan. For the nine months ended September 30, 2010, we paid $56,000 of interest expense associated with the loan and received $150,000 in interest income from the collateralized ARS. For the nine months ended September 30, 2010, the net interest earned of $94,000 and $9.1 million from sales and redemptions was applied to the principal of the loan.

6.                 Commitments and Contingencies

In October 2010, the arbitration panel in our binding arbitration with certain subsidiaries of Johnson & Johnson, or J&J, decided the ownership of a number of U.S. and international patents and patent applications related to certain EPO-R agonists, or the “intellectual property in dispute.”  The decision maintained J&J’s sole inventorship and sole ownership of U.S. Patent No. 5,767,078, or the “078 Patent,” and certain related foreign patents and patent applications, including European Patent application EP96/918,317. The arbitrators determined that we and J&J jointly own the remainder of the intellectual property in dispute.

We are continuing to review the arbitrators’ decision and consider potential courses of action with our counsel and Takeda. While we believe the ‘078 Patent and related foreign cases do not encompass Hematide, J&J may now or in the future attempt to assert claims based upon the ‘078 Patent and related foreign cases. The arbitration decision did not address validity or infringement of any patents, and we believe that Hematide does not infringe the ‘078 Patent and related foreign cases.

However, we expect that this dispute with J&J could involve additional litigation or legal proceedings that may take years to resolve.  Although we believe our position in this dispute is meritorious and that we would have substantial defenses to any potential claims by J&J, litigation is time consuming and expensive and the outcome is inherently uncertain, particularly due to the complexity of patent laws, which vary substantially from country to country.  See ‘‘Risk Factors—Risk Related to Our Business.’’

From time to time, we are involved in legal proceedings arising in the ordinary course of business. We believe there is no other litigation pending that could have, individually or in the aggregate, a material adverse effect on our financial position, results of operations or cash flows.

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7.                 Development and Commercialization Agreements with Takeda

In February 2006, we granted an exclusive license to Takeda for development and commercialization of Hematide in Japan. Pursuant to this agreement, Takeda paid us approximately $27 million, consisting of $17 million in upfront licensing fees and approximately $10 million for the purchase of equity. In January 2007, Takeda paid us a $10 million cash milestone payment for the completion of the first Phase 1 trial of Hematide in Japan. In March 2010, Takeda paid us a $5 million cash milestone payment for the initiation of Japan’s Phase 3 renal indication.  In addition, we are eligible to receive clinical and regulatory milestone payments of up to an aggregate of $60 million upon Takeda’s successful achievement of clinical development and regulatory milestones in Japan. Takeda is responsible for all development and commercialization costs in Japan and will purchase the API for Hematide from us. Assuming Hematide is approved and launched in Japan, we will receive a royalty from Takeda on Hematide sales in Japan.

In June 2006, the parties expanded their collaboration to develop and commercialize Hematide worldwide, which includes the co-development and co-commercialization of Hematide in the U.S. Takeda received an exclusive license to develop and commercialize Hematide outside of the U.S. Takeda bears 70% of the third party U.S. development expenses while we are responsible for 30% of the expenses. We retain responsibility for 100% of our internal development expenses. In addition, third party expenses related to the commercialization of Hematide in the U.S. are equally shared by both parties.  Certain employee expenses related to commercialization will also be equally shared, which we expect to occur in the first half of 2011. Takeda will have primary responsibility and bear all costs for Hematide clinical development in support of regulatory approval for all territories outside the U.S. Under the June 2006 agreement, Takeda paid us an upfront license fee of $105 million.  In May 2010, Takeda paid us a $15 million milestone payment for database lock of the non-dialysis Phase 3 clinical trials and in June 2010, Takeda paid us an additional $15 million milestone payment for database lock of the dialysis Phase 3 clinical trials.  We are eligible to receive from Takeda a $10 million milestone payment upon FDA acceptance of the submission of the NDA for the dialysis indication and an additional $50 million milestone payment upon approval by the FDA for dialysis as the first renal indication as well as $25 million milestone payments for clinical development and regulatory milestones for the dialysis indication for territories outside the U.S.  In addition to milestone payments for dialysis as the first renal indication, to the extent we pursue other indications, an aggregate of approximately $165 million of milestone payments may be payable to us by Takeda upon the successful achievement of clinical development and regulatory milestones of which $75 million relate to the non-dialysis indication as a second renal indication (including $10 million milestone payments upon FDA acceptance of the submission of NDA and $45 million of milestone payments upon approval by the FDA) and the remainder of milestones relate to oncology indications. Further, we may receive from Takeda up to an aggregate of $150 million upon the achievement of certain worldwide annual net sales milestones. We and Takeda will share equally in the net profits and losses of Hematide in the U.S., which include expenses related to the marketing and launch of Hematide. Takeda will pay us a variable royalty based on annual net sales of Hematide outside the U.S. The arrangement establishes a joint steering committee to oversee the development, regulatory approval and commercialization of Hematide.

We share responsibility with Takeda for clinical development activities required for U.S. regulatory approval of Hematide. Specifically, we have primary responsibility for Hematide’s clinical development plan and clinical trials in the dialysis and non-dialysis indications, while Takeda has primary responsibility in the chemotherapy induced anemia and anemia of cancer indications to the extent any such indication is developed. We and Takeda have agreed to suspend the development of Hematide to treat chemotherapy-induced anemia and to focus all development efforts for Hematide on the treatment of chronic renal failure anemia. We are responsible for U.S. regulatory filings for all renal indications we pursue, including for the dialysis indication, and holding the NDAs for those indications. Takeda is responsible for regulatory filings outside the U.S. and the creation of a global safety database.

We are also responsible for the manufacture and supply of all quantities of API to be used in the development and commercialization of Hematide worldwide. Takeda is responsible for the fill and finish steps in the manufacture of Hematide worldwide.

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The parties have agreed to jointly develop the initial commercial marketing plan for Hematide in the U.S. pursuant to which we and Takeda will divide Hematide promotional responsibilities in the U.S. We and Takeda will jointly decide on promotional responsibility for markets outside of these initial indications if any.

Under the February 2006 agreement, Takeda also obtained a right of first negotiation to any backup products for Hematide developed by us or our third-party partners. Specifically, during the first ten years of the agreement, if we or third-party partners develop a product that advances to Phase 2 clinical trials and competes with Hematide in the renal or oncology indications, we are obligated to offer to Takeda the right to develop and commercialize such product in Japan before offering the product opportunity in Japan to any other third party.

8.                 Azimuth Equity Line of Credit

In September 2009, we entered into an equity line of credit arrangement, with Azimuth Opportunity Ltd., or Azimuth, that provides that, upon the terms and subject to the conditions set forth in the purchase agreement, Azimuth is committed to purchase up to $60.0 million shares of our common stock over the 24-month term of the purchase agreement which ends October 1, 2011. This agreement was amended on September 17, 2010 to extend the term of the agreement to September 2012 and reduce the minimum threshold price that we may establish at which, upon presentation to Azimuth of a draw down notice, Azimuth is required to purchase shares of our common stock.  The per share purchase price for these shares equals the daily volume weighted average price of our common stock on each date during the Azimuth draw down period on which shares are purchased, less a discount ranging from 3.75% to 5.75%, based on a minimum price of $4.00 as specified in the amended agreement.  All other terms in the agreement remain the same.

In addition, we are required to pay Reedland Capital Partners a placement fee equal to 1% of the aggregate dollar amount of common stock purchased by Azimuth.  Our equity facility is subject to a number of conditions that limit our ability to draw against such facility.

In October 2010, we closed on the sale of 999,061 shares of common stock to Azimuth under the Common Stock Purchase Agreement for an aggregate purchase price of $5.0 million.  Our net proceeds from the sale of these shares was approximately $4.9 million after deducting our estimated offering expenses.

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

You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our audited financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2009 and our unaudited condensed financial statements for the three and nine month periods ended September 30, 2010.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions intended to identify forward-looking statements.  These forward-looking statements include statements regarding the timing, design and results of our clinical trials, drug development program and registration strategy, the continuation and success of our collaboration with Takeda, the scope, validity and applicability of the intellectual property in dispute, and the timing and likelihood of the commercialization of Hematide. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q under Item 1A “Risk Factors,” including risks relating to timing of and regulatory requirements for approvals, including the FDA’s interpretation of the data from the Phase 3 studies,

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in particular with respect to the secondary analyses in the non-dialysis patients, risks relating to the continued safety and efficacy of Hematide in clinical development, the potential for once per month dosing and room temperature stability, regulatory requirements and approvals, research and development efforts, the factors affecting the commercial potential of Hematide, industry and competitive environment, controversy surrounding the class of erythropoiesis stimulating agents, reimbursement coverage, intellectual property rights and disputes and potential costs, disruptions and consequences of litigation, financing requirements and ability to access capital, and other matters.  Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Overview

We are a biopharmaceutical company committed to developing novel drugs to improve the treatment of serious and often life-threatening conditions. Our product candidate, Hematide TM/peginesatide, recently completed Phase 3 clinical trials to treat anemia associated with chronic renal failure. Anemia is a serious condition in which blood is deficient in red blood cells and hemoglobin. It is common in patients with chronic renal failure, cancer, heart failure, inflammatory diseases and other critical illnesses, as well as in the elderly. If left untreated, anemia may lead to chronic fatigue or increase the risk of other diseases or death. Currently recombinant EPO, or rEPO, is used to manage the anemia of dialysis, non-dialysis and cancer patients. According to IMS Health Incorporated, rEPO generated $6.3 billion in the United States or U.S. revenues for 2009, of which we estimate that over one-half is attributable to use of rEPO in dialysis patients with chronic renal failure, and the remainder is attributable to use in non-dialysis patients and other indications, primarily cancer patients. Hematide is a synthetic peptide-based erythropoiesis stimulating agent, or ESA, designed to stimulate production of red blood cells. Hematide is designed to be longer acting than currently marketed ESAs in the U.S. and therefore has the potential to offer both better care for patients and reduced cost and complexity for healthcare providers.

In late June 2010, we announced preliminary top-line results from the Hematide Phase 3 clinical program for the treatment of patients with anemia associated with chronic renal failure.  Our Phase 3 clinical program included four open-label, randomized controlled clinical trials. Of these trials, two trials, called PEARL 1 and PEARL 2, were conducted in non-dialysis patients and designed to evaluate the safety and efficacy of Hematide compared to darbepoetin alfa to correct anemia and maintain hemoglobin in a corrected range over time. The other two trials, called EMERALD 1 and EMERALD 2, were conducted in dialysis patients and designed to evaluate the safety and efficacy of Hematide and its ability to maintain hemoglobin levels in a corrected range compared to epoetin alpha or epoetin beta when switched to Hematide. Analysis of efficacy and safety for all of the Phase 3 studies were based on assessments of non-inferiority to the comparator drugs. The primary efficacy endpoint, the mean change in hemoglobin from baseline, in each of the four Phase 3 studies met the statistical criteria for non-inferiority. In addition, Hematide met the statistical criterion for non-inferiority for the assessment of safety for the cardiovascular composite safety endpoint, or CSE, which was composed of death, stroke, myocardial infarction, congestive heart failure, unstable angina and arrhythmia from a pooled safety database across the four Phase 3 studies.  However, some differences were observed when secondary analyses were conducted as previously described in our Current Report on Form 8-K dated June 21, 2010.

Despite meeting the primary efficacy endpoints and the CSE for Hematide, the differences observed in the Phase 3 secondary analyses present risks to our ability to obtain regulatory approval for Hematide particularly in the non-dialysis setting due to the heightened concerns surrounding safety of ESAs. We plan to submit a New Drug Application, or NDA, to the U.S. Food and Drug Administration, or FDA, for treatment of anemia in chronic renal failure patients on dialysis targeted for the first half of 2011, pending further feedback from the FDA. Any negative perception of Hematide’s safety relative to other ESAs would significantly limit the likelihood of obtaining regulatory approval for Hematide. The issues arising from the Phase 3 results have caused significant delay and may continue to negatively impact the timelines for development and the likelihood, scope or conditions surrounding regulatory approval.  Any or all of these factors may significantly reduce the ultimate commercial potential of Hematide.

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In September 2010, we entered into an amendment, or the Amendment, to the Common Stock Purchase Agreement with Azimuth Opportunity Ltd., or Azimuth, dated as of September 25, 2009.  The Amendment extends the term of the equity facility to September 2012 and reduces the minimum threshold price we may establish at which, upon presentation to Azimuth of a draw down notice, Azimuth is required to purchase shares of our common stock. Our equity facility is subject to a number of conditions that limit our ability to draw against such facility.

In October 2010, we closed on the sale of 999,061 shares of common stock to Azimuth under the Common Stock Purchase Agreement for an aggregate purchase price of $5.0 million.  Our net proceeds from the sale of these shares was approximately $4.9 million after deducting our estimated offering expenses.

To date, we have not generated any product revenue. We have funded our operations primarily through the sale of equity securities, reimbursement for development expenses and active pharmaceutical ingredient, or API, production, license fees and milestone payments from collaborative partners, operating and capital lease financings, interest earned on investments and limited license fees and royalties from licensing intellectual property. As of September 30, 2010, we had an accumulated deficit of $377.4 million. Prior to the three and six month periods ended June 30, 2010, we had incurred net losses since our inception.  However, due to the recognition of revenues from milestone payments from our collaboration with Takeda Pharmaceutical Company Limited, or Takeda, we were profitable in the three and six months ended June 30, 2010 and may have profitable quarters from time to time.  We continue to expect to incur substantial and increasing losses for the next several years in order to complete the development and commercialization of Hematide.

We believe that our existing cash, cash equivalents and investments together with the interest thereon will enable us to maintain our currently planned operations for at least 12 months. However, we expect that we will need to raise additional funding to complete the development and commercialization of Hematide. Since the announcement of our Phase 3 data and the arbitration decision relating to our dispute with J&J, we have experienced a severe decline in our stock price, which has impaired our ability to access capital on potentially favorable terms. In contrast, our need to raise funding has only increased due to the Hematide development program delays, the reduction of potential milestone payments from Takeda associated with the non-dialysis indication and the potential for future legal proceedings.  As we continue to develop and ultimately commercialize Hematide, if approved, we may experience further challenges or delays if issues arise or additional requirements are imposed based on our discussions with the FDA and other regulatory agencies or as a consequence of our dispute with J&J.

Our current view of the worldwide capital markets is that they are extremely volatile with limited accessibility, and many biotechnology companies have been limited or unsuccessful in obtaining funding in this environment.  We intend to evaluate the capital markets from time to time to determine whether to raise additional capital, in the form of equity or otherwise, depending upon market conditions relative to our need for funds at such time. Continuation of this market and the issues arising from our Phase 3 results significantly limit our ability to raise funds such that there can be no assurance we can raise the additional funds to support our continuing operations and maintain current development timelines, and funding may not be available to us on acceptable terms, or at all. Further, we have had to reduce our research capabilities and efforts, including the elimination of certain research programs, and even some activities related to the support of Hematide. If we are unable to raise additional funds when needed, we could be required to further delay, scale back or eliminate some or all of our development programs and other operations, which could negatively impact our ability to complete development or commercialize Hematide. We may seek to raise additional funds through public or private financing, strategic partnerships or other arrangements. Any additional equity financing, particularly at our recent stock trading levels, would be difficult to obtain, if accessible at all, and our current stockholders may be significantly diluted. Any debt financing, if available, may involve restrictive covenants or security interests in our assets. Further, any strategic or licensing arrangements, if available, may require us to relinquish product rights that we would otherwise seek to develop or commercialize ourselves. Our failure to raise capital when needed may harm our business and operating results.

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Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our condensed financial statements, which have been prepared in accordance with United States or U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition and clinical development costs. We base our estimates on historical experience and on various other factors that 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 may differ from these estimates under different assumptions or conditions.

We record expense for estimated clinical study external costs, which involve significant estimates due to the complexity and magnitude of the clinical trial activities.   These estimates have been subject to frequent adjustments, especially for our Phase 3 trials, in part due to our negotiations with third-parties with respect to timing of reporting, patient progression and payments as well as our continuing negotiations with contract research organizations, or CROs, on timely delivery and access to information necessary to validate our accruals.  Additional changes in estimate or adjustments to previously presented amounts in research and development, or R&D, expense may result as the reconciliation activities and final negotiations with our CROs are completed on our clinical trials.

Our critical accounting policies and the use of estimates are consistent with those noted in our Annual Report on Form 10-K for the year ended December 31, 2009.

Results of Operations

Revenue

We have recognized $16.8 million and $29.2 million of collaboration revenue during the three months ended September 30, 2010 and 2009, respectively, and $105.8 million and $81.9 million for the nine months ended September 30 2010 and 2009, respectively.  The decrease in revenue for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 was due to the extension of the development period as described below, resulting in lower amortization of collaboration revenue under the Contingency-Adjusted Performance Model, or CAPM, from expense reimbursements and milestones received from Takeda in prior periods and a decrease in recognition of payments received or due from Takeda in the current period.

We had previously estimated the development period to end on January 1, 2011. Based on the announcement on June 21, 2010 of our top-line results from our Phase 3 clinical program, we re-evaluated our development period and determined that the development period is now estimated to end in the first half of 2011.  The extension of the development period will result in the remaining deferred collaboration revenue to be recognized over a longer period.  Further changes in the estimated term of the development period could materially affect the amount of collaboration revenue recognized in future periods.  We expect collaboration revenue to be directly affected by milestone payments and expenses that are eligible for reimbursement from Takeda under the Arrangement in future periods.

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The increase in collaboration revenue for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 was due to the continued amortization of collaboration revenue under the CAPM, from expense reimbursements and milestones received from Takeda in prior periods.  In March 2010, we received a $5 million cash milestone payment from Takeda for the initiation of Japan’s Phase 3 renal indication.  In May 2010, Takeda paid us a $15 million milestone payment for database lock of the Phase 3 non-dialysis clinical trials and in June 2010, Takeda paid us an additional $15 million milestone payment for database lock of the dialysis Phase 3 clinical trials.

Further changes in the estimated term of the development period could materially affect the amount of collaboration revenue recognized in future periods.  We expect collaboration revenue to be directly affected by milestone payments and expenses that are eligible for reimbursement from Takeda under the Arrangement in future periods.

Research and Development Expenses

The decrease in R&D expenses for the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009 was primarily due to the completion of the treatment and follow up of our Phase 3 clinical trials at the start of 2010 and we expect such expenses in 2010 to continue to remain below 2009 levels.

During the three months ended March 31, 2010, we concluded negotiations and finalized amendments for activities completed in 2009 resulting in adjustments to estimates recorded in our expense for the year ended December 31, 2009. These changes in estimate decreased expense by $553,000 or $0.02 per share in the three months ended March 31, 2010. Additional changes in estimate or adjustments may result as the reconciliation activities are completed on our clinical trials which could impact R&D expense in subsequent periods.

General and Administrative Expenses

The decrease in general and administrative, or G&A, expenses for the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009 was primarily due to lower legal fees.  We expect to incur increasing G&A expenses in future periods to support our preparation for the NDA for Hematide and expansion of commercial capabilities.

Interest Income (Expense), Net

The decrease in interest income, net, was due primarily to lower interest rates during the three and nine months ended September 30, 2010 compared to the same periods in 2009.

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Other Income (Expense), Net

Other income (expense), net, for the three and nine months ended September 30, 2009 primarily includes the other-than-temporary impairment charge related to the decrease in fair value of our investments in auction rate securities, or ARS, in comparison to the three and nine months ended September 30, 2010 which only reflects the subsequent adjustment to fair value. We do not intend to sell an impaired security and it is not more likely than not that we will be required to sell the security before the recovery of its amortized cost basis. If we conclude that an other-than-temporary impairment exists, we recognize an impairment charge to reduce the investment to fair value and record the related charge as a reduction of interest to other income (expense), net.

Benefit for Income Taxes

We are subject to federal and California state income taxes. We anticipate being in a net operating loss position for 2010 and therefore have not recorded any federal or California tax liability for the three and nine months ended September 30, 2010. We were also in a taxable loss position for the year ended December 31, 2009 and therefore did not record any federal and state tax liability for the three and nine months ended September 30, 2009.  We recorded $24,000 and $86,000 of federal tax benefit for the three and nine months ended September 30, 2009, respectively, due to a research and development credit refund available to us pursuant to a provision within the American Recovery and Reinvestment Tax Act of 2009.

Liquidity and Capital Resources