The following discussion should be read in conjunction with our consolidated financial statements and the related notes and other financial information appearing elsewhere in this report. This report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those indicated in forward-looking statements. See "Forward-Looking Statements" and "Risk Factors."

Overview

We are a biotechnology company engaged in the discovery and development of improved next-generation protein pharmaceuticals for the treatment of disease and serious medical conditions. We use our MolecularBreeding™ directed evolution technology platform, along with ancillary technologies, in an effort to create improved, proprietary proteins. Our portfolio of next-generation product candidates includes MAXY-G34 and MAXY-4.

Our MAXY-G34 product candidate has been designed to be an improved next-generation pegylated, granulocyte colony stimulating factor, or G-CSF, for the treatment of chemotherapy-induced neutropenia. We recently completed a Phase IIa clinical trial of MAXY-G34 in breast cancer patients in Eastern Europe.

Our MAXY-4 product candidates are designed to be superior, next-generation CTLA-4 Ig therapeutics for the treatment of a broad array of autoimmune disorders, including rheumatoid arthritis. In September 2008, we entered into a co-development and commercialization agreement with Astellas Pharma, Inc., or Astellas, relating to the development and commercialization of our MAXY-4 product candidates for autoimmune diseases and transplant rejection.

In addition to our development stage product candidates, we have other, earlier stage programs in preclinical research and assets outside of our core business, including vaccine research and an investment in Codexis, Inc., a biotechnology company focused on developing biocatalytic process technologies for certain pharmaceutical, energy and industrial chemical applications.

Developments in 2008

In July 2008, we sold our hematology assets, including MAXY-VII, our factor VIIa program, and our assets related to factor VIII and factor IX, and granted certain licenses to our MolecularBreeding™ technology platform to Bayer HealthCare LLC, or Bayer, for aggregate cash proceeds of $90 million. We are also eligible to receive future cash milestone payments of up to an additional $30 million based on the achievement of certain events related to the potential initiation of a phase II clinical trial of MAXY-VII and the satisfaction of certain patent related conditions associated with the MAXY-VII program. Our MAXY-VII product candidate was designed to be a superior next-generation factor VIIa product to treat hemophilia and, potentially, acute bleeding indications. Factor VIIa is a natural protein with a pivotal role in blood coagulation and clotting.

In September 2008, we entered into a co-development and collaboration agreement with Astellas Pharma Inc., or Astellas, relating to the development and commercialization of our MAXY-4 product candidates for autoimmune diseases and transplant rejection. Under the agreement, we received an upfront fee of $10 million and are eligible to receive future milestone payments totaling $160 million. Astellas will also be responsible for payment of the first $10 million of certain pre-clinical development costs that would otherwise be shared by the parties.

In October 2008, we announced plans to delay both Phase III manufacturing activities and a Phase IIb clinical trial of our MAXY-G34 program until we identify a partner who can share these costs. The Phase III manufacturing costs were anticipated to begin in September 2008, and the delay of this expenditure is expected to have a material impact on the MAXY-G34 project timeline. Our original schedule called for the Phase IIb trial

to begin in the second half of 2009. We also implemented a restructuring plan that will result in the termination of approximately 30% of our workforce and announced that we would be evaluating potential strategic options, including a sale or disposition of one or more corporate assets, a strategic business combination, or other transactions, and that we had hired a financial advisor to assist us in this process.

In December 2008, we completed a Phase IIa clinical trial of MAXY-G34 in breast cancer patients in Eastern Europe. In this Phase IIa clinical trial, patients were administered a single dose of MAXY-G34 therapy per three week chemotherapy cycle, with each patient receiving six cycles of TAC (docetaxel, adriamycin and cyclophosphamide) chemotherapy. The study investigated safety, efficacy and pharmacokinetics of MAXY-G34 across the dose range of 10 µg/kg to 100 µg/kg.

Background

To date, we have generated revenues from collaborations with pharmaceutical, chemical and agriculture companies and from government grants and from the sale of certain assets. Revenues from our collaboration agreements were $4.4 million, $8.7 million and $20.5 million in 2008, 2007 and 2006, respectively. Astellas was the only collaborative partner that contributed to our collaborative research and development revenues during 2008. During 2007 and 2008, we also recorded $8.3 million and $664,000 in revenue from related party under our license agreement with Codexis. These revenues reflect amounts due to us from payments received by Codexis under its collaboration arrangement with Shell Oil Products US that began in November 2006 and an expanded collaboration agreement between Royal Dutch Shell plc and Codexis for the development of new enzymes to convert biomass to fuel. We expect our total revenues to decrease in 2009 compared to 2008, primarily due to the $90 million we received from Bayer in July 2008 in connection with the sale of our hematology assets and grant of certain licenses to our MolecularBreeding™ technology platform. Our revenues may fluctuate substantially from year to year based on the completion of new licensing or collaborative agreements, our receipt of any development related milestones, royalties and other payments under such agreements, or the completion of any strategic transactions. However, we cannot predict with any certainty whether we will enter into any new licensing or collaborative agreements, receive any milestone, royalty or other payments under any existing or future licensing, collaboration or other agreements, whether any particular collaboration or research effort will ultimately result in a commercial product or whether we will consummate any strategic transaction.

We have incurred significant operating losses from continuing operations since our inception. As of December 31, 2008, our accumulated deficit was $239.7 million. We have invested heavily in establishing our proprietary technologies. Our research and development expenses for 2008 were $46.3 million, compared to $59.9 million in 2007 and $49.1 million in 2006. We expect to incur additional operating losses over at least the next several years and may never achieve sustained profitability.

We continue to maintain a strong cash position to fund our expanded product development efforts, with cash, cash equivalents and marketable securities totaling $206.5 million as of December 31, 2008.

For the purposes of this report, our continuing operations consist of the results of Maxygen, Inc. and its wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands).

Critical Accounting Policies and Estimates

General

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make judgments, estimates and assumptions in the preparation of our consolidated financial statements and accompanying notes (see Note 1 of Notes to Consolidated Financial Statements). Actual results could differ from those estimates. We believe the following are our critical accounting policies, including those that reflect the more significant judgments, estimates and assumptions we make in the preparation of our consolidated financial statements.

Goodwill Impairment

Statement of Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible Assets" (SFAS 142) requires that goodwill be tested for impairment at the reporting unit level at least annually, or whenever events or changes in circumstances indicate that it may be impaired, using a two step methodology. The initial step requires us to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such unit. We operate one reporting unit, that is, our human therapeutics segment. If the fair value of the reporting unit exceeds its carrying value, no impairment loss would be recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of the unit may be impaired. The amount, if any, of the impairment would then be measured in the second step in which we determine the implied fair value of goodwill based on the allocation of the estimated fair value determined in the initial step to all assets and liabilities of the reporting unit.

In the second quarter of 2008, we performed an interim goodwill impairment test due to the significant decline of our stock price subsequent to the announcement on June 13, 2008 of certain patent matters related to our MAXY-G34 product candidate and concluded that the carrying value of the our net assets (that is, the carrying value of the reporting unit) exceeded our fair value, based on quoted market prices of our common stock. Accordingly, we performed the second step, as required by SFAS 142, which indicated that an impairment loss existed because the implied fair value of goodwill recorded on our balance sheet was zero. As a result, we recorded an estimated impairment charge of $12.2 million in the second quarter of 2008 relating to the write-off of our goodwill. We completed our determination of the fair value of the affected goodwill during the third quarter of 2008 and concluded that no revision of the estimated charge was required. No impairment charges were recorded in 2006 or 2007.

Source of Revenue and Revenue Recognition Policy

We recognize revenues from collaboration agreements as earned upon our achievement of the performance requirements of the agreements. Our corporate collaboration agreements have generally provided for research funding for a specified number of full-time equivalent researchers working in defined research programs. Revenue related to these payments is earned as the related research work is performed. In addition, a collaborator may make technology advancement payments that are intended to fund further development of our core technology, as opposed to a defined research program. Payments received that are related to future performance are deferred and recognized as revenue as the performance requirements are achieved. Such payments are recognized ratably over the related research and development period.

Revenue related to performance milestones is recognized based upon the achievement of the milestones, as defined in the respective agreements. Substantive, at-risk incentive milestones, if any, are recognized as revenue upon achievement of the incentive milestone event when we have no future performance obligations related to the payment and we judge the event to be the culmination of a separate earnings process. Incentive milestone payments are triggered either by the results of our research efforts or by events external to us, such as regulatory approval to market a product. We receive royalties from licensees, which are based on sales to third parties of licensed products. Royalties are recorded as earned in accordance with the contract terms when third-party results can be reliably measured and collectibility is reasonably assured.

Non-refundable upfront payments received in connection with collaboration agreements, including license fees, and technology advancement funding that is intended for the development of the Company's core technologies, are deferred upon receipt and recognized as revenue over the relevant research and development periods specified in the agreement. Under arrangements where the Company expects its research and development obligations to be performed evenly over the specified period, the upfront payments are recognized on a straight-line basis over the period. Under arrangements where the Company expects its research and development obligations to vary significantly from period to period, the Company recognizes the upfront payments based upon the actual amount of research and development efforts incurred relative to the amount of the total expected effort to be incurred by the Company. In cases where the planned levels of research services

fluctuate substantially over the research term, this requires the Company to make critical estimates of both the remaining time period and the total expected costs of its obligations and, therefore, a change in the estimate of total costs to be incurred or in the remaining time period could have a significant impact on the revenue recognized in future periods.

The determination of separate units of accounting in arrangements involving multiple deliverables as required under EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," requires management to exercise judgment as to whether the delivered item has stand alone value to the collaborator and to estimate whether there is objective and reliable evidence of fair value for the undelivered items. Collaborative agreements also may contain multiple deliverables that require management to determine whether or not the deliverables are separate units of accounting.

Revenue from license agreements for which no further performance obligations exist is recognized as revenue on the earlier of when payments are received or when the amount can be reliably measured and collectibility is reasonably assured.

Revenue related to grant agreements with various government agencies is recognized as the related research and development expenses are incurred, and when these research and development expenses are within the prior approved funding amounts. Certain grant agreements provide an option for the government to audit the amount of research and development expenses, both direct and indirect, that have been submitted to the government agency for reimbursement. We believe the overhead rates we used to calculate our indirect research and development expenses are within the contractual guidelines of allowable costs and are reasonable estimates of our indirect expenses incurred through the term of the agreements.

As noted above, we are currently evaluation our strategic options, which may include a sale or disposition of one or more corporate assets, a strategic business combination, or other transactions, If we continue our operations, our sources of potential revenues for the next several years are likely to be license payments and research funding under existing and possible future government research grants and may include research funding and milestone payments under our existing collaboration agreement with Astellas or under possible future collaborative arrangements. See Note 4 of Notes to Consolidated Financial Statements.

Accounting for Clinical Trial Costs

We charge research and development costs, including clinical study costs, to expense when incurred, consistent with SFAS No. 2, "Accounting for Research and Development Costs." Clinical study costs are a significant component of research and development expenses. Most of our clinical studies are performed by a third-party contract research organization (CRO). The clinical trials generally have three distinctive stages plus pass through costs:

• start-up-initial setting up of the trial;

• site and study management of the trial; and

• close down and reporting of the trial.

We review the list of expenses for the trial from the original signed agreements and separate them into what we perceive as start-up, enrollment or closedown expenses of the clinical trial. The start up costs, which usually occur within a few months after the contract has been executed and include costs, such as study initiation, site recruitment, regulatory applications and investigator meetings, are expensed ratably over the start up period. The site management, study management, medical and safety monitoring and data management expenses are calculated on a per patient basis and expensed ratably over the treatment period beginning on the date that the patient enrolls. The close down and reporting expenses are expensed ratably over the close out period of time. Pass through costs, including the costs of the drugs, are expensed as incurred.

In general, our service agreements permit us to terminate at will where we would continue to be responsible for payment of all services completed (or pro-rata completed) at the time of notice of termination, plus any non-cancellable expenses that have been entered into by the CRO on our behalf.

Restructuring Charges

In October 2008, we implemented a restructuring plan that will result in the termination of approximately 30% of our workforce, with staggered terminations through the end of April 2009. In addition, in November 2007, we implemented a plan to consolidate our research and development activities at our U.S. facilities in Redwood City, California. The consolidation resulted in the cessation of research and development operations at Maxygen ApS, our wholly owned subsidiary in Denmark. In connection with these restructuring and consolidation plans, we recorded estimated expenses for severance and outplacement costs and other restructuring costs. In accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146), costs associated with restructuring activities generally have been recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. However, in the case of leases, the expense is estimated and accrued when the property is vacated or at the point when we cease to use the leased equipment. Given the significance of, and the timing of, the execution of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made, including estimating the salvage value of equipment consistent with abandonment date. In addition, post-employment benefits accrued for workforce reductions related to restructuring activities are accounted for under SFAS No. 112, "Employers' Accounting for Postemployment Benefits" (SFAS 112). A liability for post-employment benefits is recorded when payment is probable, the amount is reasonably estimable, the obligation is attributable to employees' services already rendered and the obligation relates to rights that have vested or accumulated. We continually evaluate the adequacy of the remaining liabilities under this restructuring. Although we believe that these estimates accurately reflect the costs of our restructuring plans, actual results may differ, thereby requiring us to record additional provisions or reverse a portion of such provisions.

In connection with the cessation of research and development operations at Maxygen ApS, we determined that the remaining useful lives of certain of the fixed assets at Maxygen ApS had been shortened to three months for equipment and to six months for leasehold improvements at November 30, 2007. The remaining book value of these assets was depreciated over the shorter estimated remaining useful lives and the depreciation expense is reflected in research and development expenses in the Consolidated Statements of Operations.

Stock-Based Compensation Expense

We account for stock options and shares purchased under our Employee Stock Purchase Plan, or ESPP, under the provisions of SFAS No. 123(R), "Share-Based Payment," (SFAS 123(R)), which requires the recognition of the fair value of equity-based compensation. We estimate the fair value of stock options and ESPP shares using the Black-Scholes-Merton option valuation model. This model requires the input of subjective assumptions in implementing SFAS 123(R), the most significant of which are our estimates of the expected volatility of the market price of our stock and the expected term of each award. We estimate expected volatility and future stock price trends based on historical volatilities. When establishing an estimate of the expected term of an award, we consider the vesting period for the award, our historical experience of employee stock option exercises (including forfeitures), the expected volatility, and a comparison to relevant peer group data. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be significantly different from what we have recorded in the current period.

We have adopted SFAS 123(R) using the modified prospective transition method. Under this transition method, compensation cost recognized during the years ended December 31, 2006, 2007 and 2008 include: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123,

"Accounting For Stock-Based Compensation" (SFAS 123), amortized on a graded vesting basis over the options' vesting period, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R) amortized on a straight-line basis over the options' vesting period. Under this method of implementation, no restatement of prior periods has been made. Prior to our implementation of SFAS 123(R), we accounted for stock options and ESPP shares under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations and made pro forma footnote disclosures as required by SFAS No. 148, "Accounting For Stock-Based Compensation-Transition and Disclosure," which amended SFAS 123. Since the exercise price of all options granted was not below the fair market price of the underlying common stock on the grant date, prior to our implementation of SFAS 123(R) we generally recognized no equity-based compensation expense in our Consolidated Statements of Operations. See Note 1 of Notes to Consolidated Financial Statements under the caption "Stock-Based Compensation" for a further discussion.

Stock-based compensation expense recognized under SFAS 123(R) in the Consolidated Statements of Operations for the year ended December 31, 2006, 2007 and 2008 was as follows (in thousands):

                                                            Year Ended December 31,
                                                       2006           2007           2008
Employee stock options                              $    5,742     $    5,804     $    4,731
Restricted stock units                                      -              -           3,213
Consultant options                                         914            666             44
ESPP                                                        87             80            194

Stock-based compensation expense before income
taxes                                               $    6,743     $    6,550     $    8,182

Income tax benefit                                          -              -              -

Total stock-based compensation expense after
income taxes                                        $    6,743     $    6,550     $    8,182

The implementation of SFAS 123(R) increased basic and fully diluted loss per share from continuing operations by $0.16, $0.16 and $0.21 for the years ended December 31, 2006, 2007 and 2008, respectively. SFAS 123(R) did not have an impact on cash flows from operations during the years ended December 31, 2007 and 2008.

For the years ended December 31, 2006, 2007 and 2008, stock-based compensation expense related to the grant of stock options to consultants was allocated as follows (in thousands):

                                                             Year Ended December 31,
                                                       2006           2007            2008
Research and development                             $      12      $     236      $       44
General and administrative                                 902            430              -

Stock-based compensation expense before income
taxes                                                $     914      $     666      $       44

Income tax benefit                                          -              -               -

Total stock-based compensation expense after
income taxes                                         $     914      $     666      $       44

In connection with the cessation of our operations in Denmark and the consolidation of our operations in the United States, we recorded stock compensation expense of $287,000 in 2007 as part of the restructuring charge. This expense resulted from the extension of the exercise period of certain stock options held by affected employees of Maxygen ApS, as required under Danish law in connection with the termination of such employees.

Results of Operations

Revenues

Our revenues have been derived primarily from collaboration agreements, technology and license arrangements and government research grants. Total revenues were $100.7 million in 2008, $23.2 million in 2007 and $25.0 million in 2006. The increase in revenue from 2007 to 2008 was primarily due to the recognition of the $90 million of cash proceeds we received under our agreements with Bayer for the sale of our hematology assets and the license of our MolecularBreeding™ technology platform. The decrease in revenue from 2006 to 2007 resulted primarily from changes in revenues recognized under our prior collaboration agreement with Roche for our MAXY-VII product candidates, as discussed below.

Revenues from our collaboration agreements were $4.4 million in 2008, $8.7 million in 2007 and $20.5 million in 2006. Astellas was the only collaborative partner that contributed to our collaborative research and development revenues during 2008. Collaborative research and development revenues during 2008 includes the recognition of $1.7 million of the $10 million upfront fee we received from Astellas under the MAXY-4 co-development and commercialization agreement and $2.7 million earned as net reimbursement of our research and development activities performed under this agreement during 2008. Roche was the only collaborative partner that contributed significantly to our collaborative research and development revenues during 2006 and 2007. The initial funded research term of our collaboration with Roche for our MAXY-alpha product candidates ended in December 2005 and the collaboration agreement was terminated in November 2007. In December 2005, we entered into a new collaboration with . . .