Summary of LA JOLLA PHARMACEUTICAL CO

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Introduction
Management's discussion and analysis of financial condition and results of operations is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, the changes in our financial condition and our results of operations. Our discussion is organized as follows:
• Overview and recent developments. This section provides a general description of our business and operating history and a general description of recent events and significant transactions that we believe are important in understanding our financial condition and results of operations.

• Critical accounting policies and estimates. This section contains a discussion of the accounting policies that we believe are important to our financial condition and results of operations and that require significant judgment and estimates on the part of management in their application. In addition, all of our significant accounting policies, including the critical accounting policies and estimates, are summarized in Note 1 to the accompanying consolidated financial statements.

• Results of operations. This section provides an analysis of our results of operations presented in the accompanying consolidated statements of operations by comparing the results for the year ended December 31, 2008 to the results for the year ended December 31, 2007 and comparing the results for the year ended December 31, 2007 to the results for the year ended December 31, 2006.

• Liquidity and capital resources. This section provides an analysis of our cash flows and a discussion of our outstanding debt and commitments, both firm and contingent, that existed as of December 31, 2008, as well as material subsequent changes. Included in the discussion of outstanding debt is a discussion of our financial capacity to fund our future commitments and a discussion of other financing arrangements.

Overview and Recent Developments
Since our inception in May 1989, we have devoted substantially all of our resources to the research and development of technology and potential drugs to treat antibody-mediated diseases. We have never generated any revenue from product sales and have relied on public and private offerings of securities, revenue from collaborative agreements, equipment financings and interest income on invested cash balances for our working capital.
On January 4, 2009, we entered into a development and commercialization agreement (the "Development Agreement") with BioMarin CF Limited ("BioMarin CF"), a wholly-owned subsidiary of BioMarin Pharmaceutical Inc. ("BioMarin Pharma"). Under the terms of the Development Agreement, BioMarin CF was granted co-exclusive rights to develop and commercialize Riquent in the United States, Europe and all other territories of the world, excluding the Asia Pacific region, and the non-exclusive right to manufacture Riquent anywhere in the world. In January 2009, BioMarin CF paid us a non-refundable commencement payment of $7.5 million and BioMarin Pharma purchased $7.5 million of a newly designated series of our preferred stock. As described below, this agreement was terminated on March 27, 2009. See Note 10 to our audited consolidated financial statements included in Part IV.
In February 2009, we were informed by an Independent Monitoring Board for the Riquent Phase 3 ASPEN study that the monitoring board completed their review of the first interim efficacy analysis of Riquent and determined that continuing the study was futile. We subsequently unblinded the data and found that there was no statistical difference in the primary endpoint, delaying time to renal flare, between the Riquent-treated group and the placebo-treated group, although there was a significant difference in the reduction of antibodies to double-stranded DNA. There were 56 renal flares in 587 patients treated with either 300-mg or 900-mg of Riquent, and 28 renal flares in 283 patients treated with placebo.
Based on these results, we immediately discontinued the Riquent Phase 3 ASPEN study and the further development of Riquent. We had previously devoted substantially all of our research, development and clinical efforts and financial resources toward the development of Riquent. In connection with the termination of our clinical

Table of Contents

trials for Riquent, we subsequently initiated steps to significantly reduce our operating costs, including a planned substantial reduction in personnel, which we expect will be effected early in the second quarter of 2009. We have also ceased the manufacture of Riquent at our facility in San Diego, California.
Following the futile results of the first interim efficacy analysis of Riquent, BioMarin CF has elected to not exercise its full license rights to the Riquent program under the Development Agreement. Thus, the Development Agreement between the parties terminated on March 27, 2009 in accordance with its terms. Pursuant to the Securities Purchase Agreement between us and BioMarin Pharma, all of the Company's preferred shares purchased by BioMarin Pharma were converted into common shares. Additionally, all rights to Riquent have been returned to us.
In light of our decision to discontinue development of our Riquent clinical program, we are seeking to maximize the value of our remaining assets. We are currently evaluating our strategic alternatives, which include the following:
• Sell or out-license our remaining assets, including our SSAO compounds, although we do not expect to receive any significant value for them;

• Pursue potential other strategic transactions, which could include mergers, license agreements or other collaborations, with third parties; or

• Implement an orderly wind down of the Company if other alternatives are not deemed viable and in the best interests of the Company.

Following the negative results of the ASPEN trial, we recorded a significant charge for the impairment of our Riquent assets, including our Riquent-related patents, and it is unlikely that we will realize any substantive value from these assets in the future. Additionally, there is a substantial risk that we may not successfully implement any of these strategic alternatives, and even if we determine to pursue one or more of these alternatives, we may be unable to do so on acceptable terms. Any such transactions may be highly dilutive to our existing stockholders and may deplete our limited remaining capital resources.
In January 2009, we sold $10 million of face-value auction rate securities to our broker-dealer, UBS A.G. ("UBS"). As of December 31, 2008, we had recognized a total impairment charge of $2.3 million as a result of the illiquidity of these securities, which was fully offset by a $2.3 million realized gain from UBS's repurchase agreement that provides for a put option on these securities. Following the sale of these investments, we no longer hold any auction-rate securities.
On May 12, 2008, we sold 15.6 million Units (the "Units," where each Unit consists of one share of common stock, $0.01 par value per share and a warrant to purchase 0.25 shares of Common Stock) in an underwritten public offering at a price of approximately $1.92 per Unit, resulting in net proceeds totalling approximately $28.0 million. The warrants, which represent the right to acquire a total of 3.9 million shares of common stock, are exercisable at a price of $2.15 per share and have a five-year term. Certain of our principal stockholders, including affiliates of certain of our directors, purchased an aggregate of approximately $24.3 million, or approximately 81%, of the Units sold.
Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis, including those related to patent costs, clinical/regulatory expenses and, effective January 1, 2008, the fair value of our financial instruments. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions.

Table of Contents

We believe the following critical accounting policies involve significant judgments and estimates used in the preparation of our consolidated financial statements (see also Note 1 to our consolidated financial statements included in

Part IV). Impairment and useful lives of long-lived assets We regularly review our long-lived assets for impairment. Our long-lived assets include costs incurred to file our patent applications. We evaluate the recoverability of long-lived assets by measuring the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. At the time such evaluations indicate that the future undiscounted cash flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values. The estimation of the undiscounted future cash flows associated with long-lived assets requires judgment and assumptions that could differ materially from the actual results.
Costs related to issued patents are amortized using the straight-line method over the lesser of the remaining useful life of the related technology or the remaining patent life, commencing on the date the patent is issued. Legal costs and expenses incurred in connection with pending patent applications have been capitalized. We expense all costs related to abandoned patent applications. If we elect to abandon any of our currently issued or unissued patents, the related expense could be material to our results of operations for the period of abandonment. The estimation of useful lives for long-lived assets requires judgment and assumptions that could differ materially from the actual results. In addition, our results of operations could be materially impacted if we begin amortizing the costs related to unissued patents.
As a result of the futility determination in the ASPEN trial, we decided to discontinue the Riquent Phase 3 ASPEN study and halt the further development of Riquent. We had previously devoted substantially all of our research, development and clinical efforts and financial resources toward the development of Riquent. Therefore, the future cash flows from our Riquent-related patents are no longer expected to exceed their carrying values. In addition, during 2009 the Company expects to sell substantially all of its laboratory equipment, as well as a large portion of its furniture and fixtures and computer equipment and software.
We performed a recoverability test of the long-lived assets included in our Riquent asset group in accordance with Statement of Financial Accounting Standards No. ("SFAS") 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). The recoverability test was based on the estimated undiscounted future cash flows expected to result from our long-lived assets. Based on the recoverability analysis performed, management does not believe that the estimated undiscounted future cash flows expected to result from the disposition of certain of the Company's long-lived assets are sufficient to recover the carrying value of these assets. Accordingly, we recorded a non-cash charge for the impairment of long-lived assets of $2.8 million for the year ended December 31, 2008 to write down the value of our long-lived assets to their estimated fair values. We recognized $0 and $0.1 million in impairment losses for the years ended December 31, 2007 and 2006, respectively.
Accrued clinical/regulatory expenses
We review and accrue clinical trial and regulatory-related expenses based on work performed, which relies on estimates of total costs incurred based on patient enrollment, sites activated and other events. We follow this method because reasonably dependable estimates of the costs applicable to various stages of a clinical trial can be made. Accrued clinical/regulatory costs are subject to revisions as trials progress to completion. Revisions are charged to expense in the period in which the facts that give rise to the revision become known. Historically, revisions have not resulted in material changes to research and development costs.
Share-based compensation
We adopted SFAS 123R, Share-Based Payment,("SFAS 123R") using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our 2006 fiscal year. Our Consolidated Statement of Operations as of and for the years ended December 31, 2008, 2007 and 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, our Consolidated Statements of Operations for prior periods have not been restated to reflect, and do not include, the

Table of Contents

impact of SFAS 123R. Share-based compensation expense recognized under SFAS 123R for the years ended December 31, 2008 and December 31, 2007 was approximately $4.4 million and $4.8 million, respectively. As of December 31, 2008, there was approximately $4.9 million of total unrecognized compensation cost related to non-vested share-based payment awards granted under all equity compensation plans. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We currently expect to recognize the remaining unrecognized compensation cost over a weighted-average period of 1.2 years. Additional share-based compensation expense for any new share-based payment awards granted after December 31, 2008 under all equity compensation plans cannot be predicted at this time because it will depend on, among other matters, the amounts of share-based payment awards granted in the future.
Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the employee and director stock options granted by us have characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in our opinion the existing valuation models may not provide an accurate measure of the fair value of the employee and director stock options granted by us. Although the fair value of the employee and director stock options granted by us is determined in accordance with SFAS 123R using an option-pricing model, that value may not be indicative of the fair value observed in a willing-buyer/willing-seller market transaction. Fair value of financial instruments
Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements ("SFAS 157"). In February 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") No. SFAS 157-2, Effective Date of FASB Statement No. 157, which provides a one-year deferral of the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, we have adopted the provisions of SFAS 157 with respect to financial assets and liabilities only.
SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:
• Level 1 - Quoted prices in active markets for identical assets or liabilities.

• Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The adoption of this statement impacted our calculation of fair value associated with our investments, specifically our auction rate securities, which became illiquid during the first quarter of 2008. In accordance with SFAS 157, we valued these securities using Level 3 hierarchical inputs due to the lack of actively traded market data. These inputs include management's assumptions of pricing by market participants, including assumptions about risk. We based our fair value determination on estimated discounted future cash flows of interest income over a projected period reflective of the length of time we anticipate it will take the securities to become liquid. We considered any impairment on these investments to be other-than-temporary, thus any changes in fair value were recorded to the audited consolidated statement of operations for the year ended December 31, 2008. Because we were required to value those securities using only Level 3 inputs, our valuation determinations are somewhat subjective and the actual fair values as determined at a later date or by a third party may be different than the fair values we have determined.

Table of Contents

During the fourth quarter of 2008, our broker-dealer, UBS, offered to repurchase our outstanding auction-rate securities at their par value. We accepted this offer in November 2008 and, in January 2009, we sold all of our auction rate securities to UBS at par value of $10.0 million. As of December 31, 2008, we had recognized a total impairment charge of $2.3 million as a result of the illiquidity of these securities, which was fully offset by a $2.3 million realized gain from UBS's repurchase agreement that provides for a put option on these securities. (See Notes 2 and 10 to our audited consolidated financial statements included in Part IV)
New Accounting Pronouncements
On January 1, 2008, we adopted the provisions of SFAS 157. SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. The adoption did not have an impact on the audited consolidated financial statements or on our consolidated results of operations and financial condition for the year ended December 31, 2008.
On January 1, 2008, we adopted the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115("SFAS 159"). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. At this time, we have not elected to account for any of our financial assets or liabilities using the provisions of SFAS 159. As such, the adoption of SFAS 159 did not have an impact on our consolidated results of operations and financial condition for the year ended December 31, 2008.
In June 2007, FASB ratified the consensus reached by the Emerging Issues Task Force ("EITF") on EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities ("EITF 07-3"). EITF 07-3 addresses the diversity that exists with respect to the accounting for the non-refundable portion of a payment made by a research and development entity for future research and development activities. Under EITF 07-3, an entity would defer and capitalize non-refundable advance payments made for research and development activities until the related goods are delivered or the related services are performed. EITF 07-3 is effective for fiscal years beginning after December 15, 2007. On January 1, 2008 we adopted the provisions of EITF 07-3, which did not have an impact on our consolidated results of operations and financial condition for the year ended December 31, 2008.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles ("SFAS 162"). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles. SFAS 162 becomes effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to Statement on Auditing Standards No. 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, for periods completed after January 1, 2009. We do not expect that the adoption of SFAS 162 will have a material effect on our consolidated financial statements. Results of Operations
Years Ended December 31, 2008, 2007 and 2006 Research and Development Expense. Our research and development expense increased to $51.0 million for the year ended December 31, 2008 from $46.6 million in 2007. The increase in research and development expenses in 2008 from 2007 resulted primarily from an increase in clinical trial expenses of approximately $7.8 million, offset by a decrease in Riquent-related drug production of $4.1 million.
Research and development expense of $50.8 million for the year ended December 31, 2008 related to lupus research and development-related expense consisting primarily of Riquent-related clinical trial expenses and clinical

Table of Contents

drug supply, salaries and other costs related to manufacturing, clinical and research personnel and fees for consulting and professional outside services.
Our research and development expense increased to $46.6 million for the year ended December 31, 2007 from $32.9 million in 2006. The increase in research and development expenses in 2007 from 2006 resulted primarily from an increase in Riquent-related drug production and clinical trial expenses of approximately $16.0 million. This increase was partially offset by a decrease of approximately $3.2 million in expenses in 2007 as compared to 2006 for the development of our SSAO program, as all of our resources were being devoted to the development of Riquent and further development of the SSAO program depends on our ability to sell, out-license or enter into a collaborative arrangement for this program.
We expect that our research and development expense will decrease significantly during 2009 as we discontinued the research, development and manufacturing of Riquent during February 2009 and will be reducing our research and development workforce substantially in the second quarter of 2009. Because we have not yet ascertained which strategic option we may ultimately pursue, we do not know the specific number of personnel reductions that will be made. We do expect, however, that the reductions in force will be substantial.
General and Administrative Expense. Our general and administrative expense increased to $9.7 million for the year ended December 31, 2008 from $9.1 million in 2007. The increase in general and administrative expense in 2008 from 2007 resulted primarily from an increase in general corporate consulting, professional outside services and salaries and wages of approximately $1.0 million, primarily as a result of our potential partnering efforts for Riquent. This increase was offset by a decrease in our miscellaneous business expenses related to lower patent abandonments during 2008 compared to 2007 (see 2008 patent impairment discussion below) and a decrease in depreciation as a result of more assets being fully depreciated in 2008.
Our general and administrative expense decreased to $9.1 million for the year ended December 31, 2007 from $9.3 million in 2006. The decrease in general and administrative expense in 2007 from 2006 resulted primarily from a decrease in termination benefits, which for 2006 were mainly severance of approximately $0.9 million and compensation expense of approximately $0.8 million for accelerated stock option vesting related to the former Chairman and Chief Executive Officer's departure in the first quarter of 2006. This decrease was partially offset by the increase in the write-off of selected patent applications for technologies not related to Riquent or our small molecule SSAO inhibitors program of approximately $0.7 million, an increase in share-based compensation expense of approximately $0.5 million for stock options granted in 2006 and 2007 and an increase in consulting expenses for business development and market research of approximately $0.4 million.
We expect that our general and administrative expense will decrease significantly during 2009 as we discontinued the development of Riquent during February 2009 and will be reducing our general and administrative workforce substantially in the second quarter of 2009.
Asset Impairments. We recorded a $2.8 million non-cash impairment charge in 2008 (none in 2007 and $0.1 million in 2006) because we no longer believe that the estimated undiscounted future cash flows expected to result from the disposition of certain of the Company's long-lived assets are sufficient to recover the carrying value of these assets. This impairment charge was due to the negative results from the Riquent Phase 3 ASPEN study announced in February 2009, which is an indicator of impairment.
Interest Income and Expense. Our interest income decreased to $0.8 million for the year ended December 31, 2008 from $2.7 million for 2007 due to lower average balances of cash and short-term investments and lower average interest rates on our investments as compared to 2007. Our interest income was comparable for the years ended December 31, 2007 and 2006. Interest expense was comparable for the years ended December 31, 2008, 2007 and 2006.
Net Operating Loss and Research Tax Credit Carryforwards. At December 31, 2008, we had federal and California income tax net operating loss carryforwards that are subject to Section 382/383 limitations of net operating loss and research and development credit carryforwards. In February 2009, we experienced a change in ownership at a time when our enterprise value was minimal. As a result of this ownership change and the low enterprise value, our federal and California net operating loss carryforwards and federal research and development credit carryforwards as of December 31, 2008 will be subject to limitation under IRC Section 382/383 and more likely than not will expire unused.

. . .