Overview

We are a biopharmaceutical company focused on discovering, developing and commercializing therapeutic protein-based products for the treatment of human diseases. The process for taking one of our discoveries to the marketplace is long, complex and very costly. It is difficult to predict the time it will take to reach the market with any given product candidate, but it would not be unusual to span ten years or more and cost hundreds of millions of dollars. It is also a business of attrition; it is expected that, for the industry as a whole, less than 20% of the drug candidates entering human clinical trials will actually make it to the marketplace. For the products that do make it, particularly for those that address previously unmet medical needs, the markets can be significant, with a number of successful products selling in excess of $1 billion per year.

In late 2006, we began preparations for the commercial launch of our first product, RECOTHROM ®, which was approved by the FDA on January 17, 2008. In June 2007, we entered into a global collaboration with Bayer for development and commercialization of RECOTHROM. Bayer has agreed to commercialize RECOTHROM in countries outside the United States and will co-promote the product with us in the United States for up to four years. We have hired approximately 60 field personnel and additional headquarters-based personnel to support the commercial operations that are necessary for selling RECOTHROM. We are incurring substantial marketing costs to support the selling effort. We are also building significant levels of inventory to meet the expected demand for the product and minimize the risk of product shortages. These commercialization activities are utilizing substantial cash resources until such time as RECOTHROM sales reach a level, if ever, that will cover our related costs. We recorded net sales revenue of $8.8 million in 2008, and we anticipate significantly higher revenue generation from RECOTHROM sales over time; however, we cannot be certain of the future rate of market penetration or when, if ever, our revenues will exceed our related costs.

An important element of our business strategy is that we intend to maintain a significant share of the commercial value for certain of our products under development. As a result, we will be required to pay a significant portion of the development and commercialization costs for these products. Even if we decide to license a product candidate to another company, we will generally be required to pay research and development costs up to the point of licensing. Another important element of our strategy is that we maintain fully integrated research and development operations to enable us to discover new product candidates and advance them to the point where we can demonstrate clinical proof of concept. These operations, although critical to our long-term business strategy, are expensive to maintain and the level of output is uncertain. Substantial funding is required on an ongoing basis to maintain these operations.

Generating the funding necessary to operate our business is challenging. There are a number of potential sources of revenues and cash that we pursue in order to address our funding needs, including the following:

• sales of RECOTHROM, which were $8.8 million in 2008, net of all related discounts and allowances;

• research, development and commercialization collaborations, such as the ones we have entered into with Bayer for RECOTHROM and Bristol-Myers Squibb for PEG-Interferon lambda (PEG-IFN-†), which provide revenues while also enabling us to reduce our ongoing research and development expenses;

• licensing of technologies or product candidates, such as atacicept and recombinant Factor XIII, to other companies, which typically provide license fees and potential milestone payments and royalties on sales;

• issuance of equity or equity-based securities;

• debt financing, such as the $100 million financing arrangement we entered into with Deerfield Management in June 2008; and

• investment income on our cash reserves.

We expect that it will be at least several years before we can generate enough product-related revenues for our company to reach net income or cash flow breakeven, and we expect to continue to invest significant amounts of cash in developing our business. We intend to pursue additional collaboration and license transactions as a means of generating additional cash and reducing our ongoing expenses. These transactions may involve our product candidate IL-21, currently in Phase 2 clinical trials, and our earlier stage candidates that have not yet begun clinical testing. In addition, we expect to continue our efforts to reduce our operating cost structure.

In addition, it is possible that we will look for opportunities to raise capital by issuing equity or equity-related securities, to help fund our company over the next several years. These opportunities may arise at any time, depending on things such as overall market conditions; dynamics in the biotechnology sector of the market; investor appetite for certain types of companies; and fundamental characteristics of our business. At other times, it may be difficult to raise capital on terms favorable to our company, if at all, especially in light of the current global economic crisis. Accordingly, we would expect to raise capital when it is available, not when there is an immediate need. We believe this strategy is important to minimize the financial risks to our company and our shareholders.

Results of Operations

Revenues

Product sales. The FDA granted marketing approval of RECOTHROM on January 17, 2008 for the 5,000 IU vial configuration and on May 27, 2008 for the 20,000 IU vial configuration, both with and without a spray kit. Sales of RECOTHROM are recognized as revenue when the product is shipped and title and risk of loss have passed. Product sales are recorded net of provisions for estimated discounts, rebates, chargebacks and returns. We recognized net product sales revenue of $8.8 million in 2008. We expect sales of RECOTHROM to increase over the next several years as we penetrate the market further.

Royalties. We earn royalties on sales of certain products subject to license agreements with other companies. Royalties decreased slightly year-to-year in 2008, 2007 and 2006 primarily due to insulin and glucagon patent expiration in most countries. Most of the effects of reduced insulin and glucagon royalties were offset by increasing minimum royalties earned on GEM 21S, a product of BioMimetic Therapeutics, Inc. Royalties are expected to be substantially less in 2009 as royalties from sales of GEM 21S decrease, due to the discontinuation of minimum royalty obligations, and the expiration of our patent related to BeneFIX, a product of Wyeth Pharmaceuticals, Inc., in December 2008.

Collaborations and licenses. We enter into various collaborative agreements that may generate significant license, option or other upfront fees with subsequent milestone payments earned upon completion of development milestones. Where we have no continuing performance obligations under an arrangement, we recognize these fees and payments as revenue when contractually due and payment is reasonably assured, as these payments represent the culmination of a separate earnings process. Where we have continuing performance obligations under an arrangement, revenue is recognized using one of two methods. Where we are able to estimate the total amount of costs we will incur under the arrangement, revenue is recognized using a proportional performance model. Costs incurred to date compared to total expected costs are used to determine proportional performance, as this is considered to be representative of the delivery of outputs under the arrangement. Revenue recognized at any point in time is limited to cash received and amounts contractually due. Changes in estimates of total expected performance are accounted for prospectively as a change in estimate. Where we cannot estimate the total amount of service that is to be provided, a time-based method is used to recognize revenue. Under the time-based method, revenue is recognized over the arrangement's estimated performance period, starting with the contract's commencement, but not before the removal of any contingencies for each milestone. Revenue recognition is determined based on the elapsed time compared to the total estimated performance period. Revenue recognized at any point in time is limited to the cash received and amounts contractually due. From period to period, license fees and milestone payments can fluctuate substantially based

on the completion of new licensing or collaborative agreements and the achievement of development-related milestones.

On August 28, 2008, we amended the Strategic Alliance Agreement with Serono S.A. (Merck Serono) and simultaneously exercised our right under the atacicept Collaborative Development and Marketing Agreement to discontinue our co-development and co-funding obligations and convert our position to an exclusive milestone and royalty bearing license. Based on these actions, our responsibility for funding atacicept product development costs ended June 1, 2008 and all significant continuing obligations under the agreements will end in October 2009. Since the agreements were negotiated in tandem, we are considering them as a single agreement for revenue recognition purposes. We have recorded our share of the collaboration expenses from January 1, 2008 to August 28, 2008 of $24.7 million as research and development expense. Additionally, as part of the amended agreements with Merck Serono, we do not have to pay for $9.8 million of development costs that were previously required to be reimbursed to Merck Serono under the prior agreements. These development costs were expensed as research and development costs in the period June 1, 2008 to August 28, 2008. The forgiveness of these expenses was determined to be consideration for the licenses granted to Merck Serono and therefore we have considered the $9.8 million to be incremental revenue which is being deferred and recognized as license fee revenue on a straight-line basis through October 2009, our remaining obligated performance period under the Strategic Alliance Agreement.

In June 2007, we entered into license and collaboration and co-promotion agreements with Bayer. The agreements provide Bayer with an exclusive license to develop and sell RECOTHROM outside of the United States and Bayer will also promote RECOTHROM in the United States for up to four years. We will record all United States product sales revenue and Bayer will be entitled to a commission on United States sales for five or six years, depending on how long they co-promote RECOTHROM in the United States. We received a $30.0 million upfront milestone payment in 2007, and $46.5 million in milestone payments in 2008, $20.0 million of which will be repaid to Bayer as United States sales bonuses under the co-promotion. We are entitled to various other milestones based on regulatory filings, regulatory approvals and annual sales thresholds achieved by Bayer outside of the United States. These milestone payments will be recorded as deferred revenue and recognized as revenue using the proportional performance model to the extent they are received during the remaining period in which we will fulfill our obligations under the agreements. We currently anticipate completing these obligations in 2013.

Collaborations and licenses revenue was $58.9 million for the year ended December 31, 2008, an increase of $26.7 million as compared to the same period in 2007. The increase primarily resulted from license fees of $21.0 million earned in October 2008 under our Ig fusion agreement with Bristol-Myers Squibb and an increase in the recognition of license fees related to our RECOTHROM agreements with Bayer. Partially offsetting this increase were milestones earned in 2007 under our IL-21 and IL-31 agreements with Novo Nordisk for which no comparable amounts were earned in 2008. Revenues from collaborations and licenses increased from $18.5 million in 2006 to $32.2 million in 2007. The increase was primarily attributable to recognition in 2007 of license fee revenue related to our RECOTHROM agreements with Bayer; milestone payment revenue from Novo Nordisk under our Factor XIII, IL-31 and IL-21 agreements; and milestone payment revenue from Merck Serono under our atacicept and FGF-18 agreements.

As of December 31, 2008, the deferred revenue related to the Merck Serono agreements and the Bayer agreement was $15.5 million and $52.3 million, respectively. We currently expect all of the remaining Merck Serono deferred revenue to be recognized in 2009.

In addition, in January 2009, we entered into a co-development/co-promotion and license agreement with Bristol-Myers Squibb for the type-3 interferon family, which includes our development candidate PEG-Interferon lambda. On February 26, 2009, the effective date, we became eligible to receive an initial license fee of $85.0 million within 10 days and will receive an additional license fee of $20.0 million in March 2009. Additionally, we expect to receive various milestone payments based on the achievement of certain objectives, including $95.0 million expected later in 2009 related to the initiation of Phase 2 clinical trials; profit sharing and

co-promotion rights in the U.S.; and may receive royalties on sales outside of the U.S. We are also eligible for sales bonuses based on world-wide sales of licensed products. We provide a license to related technology and are obligated to fund the first $100.0 million of costs for development in the U.S. and Europe, after which we will be responsible for 20% of such costs. We expect to record revenue related to the license fees and near-term milestone payments over an approximately three-year period, which corresponds to the period in which we will incur most of our costs and perform our obligations under the agreement.

Costs and expenses

Costs of product sales. Costs of product sales were $5.7 million in 2008, following approval of RECOTHROM January 2008. Prior to FDA approval of RECOTHROM, all third party manufacturing costs and an allocation of our labor and overhead associated with the manufacturing of RECOTHROM for commercial sale were expensed as research and development costs as incurred. Subsequent to approval, third party manufacturing costs and labor and overhead associated with the commercial manufacturing of RECOTHROM are recorded as inventory. Accordingly, our costs of product sales will be reduced during the time we are selling product manufactured prior to approval, which included 2008 and will include all of 2009. Costs of product sales include the inventory and distribution costs associated with RECOTHROM product revenue. Additionally, we recorded a $4.2 million charge to costs of product sales in 2008 for manufacturing costs incurred subsequent to FDA approval for product that is expected to become obsolete.

Research and development. Research and development expense has been our most significant expense to date, primarily consisting of salaries and benefit expenses, costs of consumables, contracted services and stock- based compensation. Our research and development activities have generally expanded from year-to-year, particularly related to our recently approved commercial product, RECOTHROM, and clinical stage product candidates, atacicept, IL-21 and PEG-IFN-†. However, this trend was reversed in 2008 following the approval of RECOTHROM and a reduction in research and development headcount. In each of the past three years, research and development expense was partially offset by cost reimbursements from our collaborators for work we performed on various development programs. The breakdowns within major categories of research and development expense are shown in the following table (in thousands):

                                                2008          2007          2006
      Salaries and benefits                   $  53,457     $  57,731     $  52,554
      Consumables                                10,907        11,658        11,093
      Facility costs                              8,886         8,934         8,090
      Contracted services                        47,391        55,668        43,552
      Depreciation and amortization               4,902         5,421         5,370
      Stock-based compensation                   13,572        13,591        12,102

      Subtotal                                  139,115       153,003       132,761
      Cost reimbursement from collaborators     (12,437 )     (10,663 )      (4,311 )

      Net research and development expense    $ 126,678     $ 142,340     $ 128,450

Salaries and benefits and consumables generally track with changes in our employee base from year to year. The $4.3 million decrease in salaries and benefits in 2008 and the corresponding decrease in consumables was due to the February 2008 termination of 37 research and development employees and costs related to RECOTHROM manufacturing being included in inventory costs subsequent to the January 17, 2008 FDA approval of RECOTHROM instead of being recorded as research and development expense. The $5.2 million increase in salaries and benefits in 2007 was attributable to an increase in research and development headcount.

Contracted services include the cost of items such as contract research, contract manufacturing, clinical trials, non-clinical studies and payments to collaborators. These costs relate primarily to clinical development programs and can fluctuate substantially from period to period depending on the stage of our various programs.

Generally, these external costs increase as a program advances toward commercialization, but there can be periods between major clinical trials or manufacturing campaigns during which costs decline. Contracted services decreased by $8.3 million in 2008 due to reduced contract manufacturing costs, which decreased to $2.8 million in 2008 as compared to $22.7 million for the same period in 2007, reflecting the discontinued expensing of pre-approval manufacturing of rThrombin (RECOTHROM) bulk drug and finished product inventory after FDA approval in January 2008. This decrease was offset by other cost increases. Our clinical trial costs increased in 2008 as compared to 2007, primarily reflecting the costs incurred for the atacicept lupus nephritis clinical trial that began in late 2007. Payments to collaborators also increased for the same period primarily reflecting our portion of atacicept development costs under our collaboration with Merck Serono. In August 2008, we amended our collaboration with Merck Serono whereby Merck Serono will be responsible for all development costs associated with atacicept subsequent to August 2008. Contracted services increased by $12.1 million in 2007 due to increased contract manufacturing costs related to the manufacture of rThrombin bulk drug and finished product inventory and clinical trial material for IL-21 and atacicept. Our clinical trial costs slightly decreased in 2007, as compared to the same period in 2006, primarily reflecting the completion of rThrombin Phase 3 clinical trials prior to FDA submission in late 2006, partially offset by the increase in preparation costs associated with the atacicept lupus nephritis clinical trial.

To date, our business needs have not required us to fully allocate all research and development costs among our various programs. However, we track direct labor, contracted services and certain consumable costs by program, which we monitor to ensure appropriate utilization of our company resources. We also incur indirect costs that are not allocated to specific programs. These costs include indirect labor, certain consumable costs, facility costs and depreciation and amortization, all of which benefit all of our research and development programs. The following table presents our research and development costs allocated to clinical development, preclinical and research programs, together with the unallocated costs that benefit all programs for the periods presented (in thousands):

                                                                             Inception
                                           2008        2007        2006       To Date
     Clinical development programs:
     Hemostasis                          $  18,708   $  39,690   $  41,938   $  198,730
     Autoimmunity and oncology              30,119      25,962      17,077      112,495
     Antiviral                               5,094       5,125       5,240       18,937
     Preclinical and research programs      22,836      22,051      18,428
     Unallocated indirect costs             49,921      49,512      45,767

     Total                               $ 126,678   $ 142,340   $ 128,450

The following summarizes the reasons for fluctuations in research and development program costs for the three years presented in the table:

• Hemostasis clinical development program (Factor XIII and rThrombin) costs in 2006 reflected the conduct of process validation and manufacturing campaigns for rThrombin to support the filing of a license application with the FDA in late 2006. The 2007 costs included approximately $19.0 million of manufacturing costs incurred for rThrombin commercial product prior to FDA approval on January 17, 2008. Without these manufacturing-related costs, the program costs would have substantially declined, reflecting the lower level of development activities while awaiting FDA approval. The reduction in costs from 2007 to 2008 reflect the discontinued expensing of RECOTHROM manufacturing costs, which were included in inventory subsequent to FDA approval on January 17, 2008.

• Autoimmunity and oncology clinical development program (atacicept and IL-21) costs increased from 2006 to 2007 primarily due to an increase in our share of atacicept joint development costs paid to Merck Serono. Costs increased in 2008 as compared to 2007 primarily due to an increase in our share of costs related to the manufacturing of clinical material and clinical trial activity. Such increases were primarily related to evaluating atacicept for the treatment of lupus, rheumatoid arthritis and multiple

• Antiviral clinical development program costs have not changed significantly over the three years presented.

• Preclinical and research program costs were flat in 2008 as compared to 2007. The increase in costs from 2006 to 2007 reflected increased activity in new discovery programs.

• Unallocated indirect costs were consistent between 2008 and 2007. The increase in 2007 as compared to 2006 was primarily due to an increase in personnel-related costs.

Selling, general and administrative. Selling, general and administrative expense, which consists primarily of salaries and benefit expenses, professional fees and other corporate costs, increased 28% in 2008 as compared to 2007 and 41% in 2007 as compared to 2006. The increases were primarily due to the hiring of our sales force early in the third quarter of 2007 to support the launch and commercialization of RECOTHROM in 2008 and then the increased sales and marketing activities throughout all of 2008. An increase in legal costs also contributed to the 2007 increase.

Stock-based compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R) Share-Based Payment, which addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. The Statement eliminated the election to account for share-based compensation transactions using APB 25 and generally requires that such transactions be accounted for using a fair-value-based method. We determine fair value using the Black-Scholes valuation method. The following amounts of stock-based compensation expense were recorded for the three years reported (in thousands):

                                                      2008       2007       2006
      Research and development expense              $ 13,572   $ 13,591   $ 12,102
      Selling, general and administrative expense      7,700      7,286      6,813

      Total                                         $ 21,272   $ 20,877   $ 18,915

Other Income (Expense)

Investment income. Investment income is generated primarily from investment of our cash reserves in investment grade, fixed-income securities. There are four primary factors affecting the amount of investment income that we report: the amount of cash reserves invested, the effective interest rate, the amount of realized gains or losses on investments held during the period and the amount of other-than-temporary impairment recorded in the period. The decrease in 2008 as compared to 2007 was primarily due to a lower average cash balance and effective interest rate, as well as realized losses on investments and an other-than-temporary loss on an investment security. The decrease in 2007 as compared to 2006 was primarily due to a lower average cash balance. The following table shows how each of these factors affected investment income for the three years reported (in thousands):

                                                  2008          2007          2006
     Weighted average amount of cash reserves   $ 119,939     $ 207,817     $ 308,912
     Effective interest rate                         3.72 %        4.92 %        4.55 %

     Investment income before gains (losses)        4,464        10,218        14,050
     Net gain (loss) on investments                  (231 )          66          (148 )
     Other-than-temporary impairment loss            (400 )          -             -

     Investment income, as reported             $   3,833     $  10,284     $  13,902

Interest expense. We have accounted for a sale-leaseback transaction completed in October 2002 as a financing transaction. Under this method of accounting, an amount equal to the net proceeds of the sale is considered a long-term interest bearing liability. Rent payments under the leases are considered to be payments toward the liability and are allocated to principal and interest. We recorded related interest expense of $7.7 million, $7.7 million and $7.6 million for the years ended December 31, 2008, 2007 and 2006, respectively. In addition, we recorded interest expense of $933,000 in 2008 related to the Deerfield financing arrangement, which represents amortization of the deferred financing costs, including the fair value of the warrants issued; 4.9% interest on the $25.0 million drawn in November 2008; and additional interest expense equal to 2% of RECOTHROM net sales in the U.S. beginning upon receipt of the $25.0 million draw.

Gain on sale of fixed assets, net. In August of 2008, we sold undeveloped land near our corporate headquarters for $11.8 million and recognized a gain of $7.0 million.