Forward-Looking Statements

The following discussion and analysis should be read in conjunction with the financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2008. This report contains, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. This Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. Factors that could cause or contribute to such differences include, but are not limited to, risks associated with our unproven marketing and sales capabilities, preclinical and clinical development, manufacturing of products, product safety, regulatory oversight, relationships with third parties, intellectual property claims and litigation and other risks detailed in our public filings with the Securities and Exchange Commission, including those risks described in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2008. All statements other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking. When used in this document, the words "believes," "expects," "anticipates," "intends," "plans" and similar expressions, are intended to identify certain of these forward-looking statements. However, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this document should be read as being applicable to all related forward-looking statements wherever they appear in this document. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and other factors that may affect our business, prospects, results of operations and financial condition.

Business 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.

RECOTHROM ®, recombinant thrombin, is a topical hemostatic agent used for the control of moderate bleeding during surgical procedures, which was approved by the FDA on January 17, 2008. We are marketing RECOTHROM in the U.S. using our own commercial infrastructure, which includes a dedicated field force of sales people and medical scientific liaisons. We have retained all RECOTHROM rights in the U.S. In June 2007, we entered into a license and collaboration agreement with Bayer Schering Pharma AG for development and commercialization of RECOTHROM outside of the U.S. Bayer has agreed to commercialize RECOTHROM in countries outside the U.S. Simultaneously, we entered into a co-promotion agreement with Bayer Healthcare LLC under which Bayer will co-promote RECOTHROM with us in the U.S. for up to four years, ending in March 2012. 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 maintaining significant levels of inventory and have entered into long-term manufacturing agreements with contractual minimum purchase commitments to meet the expected demand for the product and minimize the risk of product shortages. These commercialization activities have and will continue to utilize substantial cash resources until such time as RECOTHROM sales reach a level, if ever, that will cover our related costs. 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, 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, which provide revenues while also enabling us to fund 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 $100.0 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. Additionally, as part of our corporate restructuring effective in April 2009, we reduced our work force by 32% as a means of further reducing operating costs, primarily in research and development. We believe this reduction will generate annual cost savings of approximately $30 million.

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 expect sales of RECOTHROM to increase over the next several years as we further penetrate the market. We recognized net product sales revenue of $4.5 million for the three-month period ended March 31, 2009, which, as anticipated, was substantially higher than the $1.0 million for the first quarter of 2008 when the product was launched.

Royalties. We earn royalties on sales of certain products subject to license agreements with other companies. Royalties decreased $1.2 million for the three-month period ended March 31, 2009 as compared to the corresponding period in 2008. The decrease in royalties was primarily due to the discontinuation of a minimum royalty payment obligation payable by BioMimetic Therapeutics, Inc. on its product GEM 21S and the expiration of royalty rights 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 such 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 services 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. 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.

In January 2009, we entered into a co-development/co-promotion and license agreement with Bristol-Myers Squibb for the type-3 interferon family. We received $105.0 million in license fees in March 2009; and may 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. We also received profit sharing and co-promotion rights in the U.S. and will receive royalties on sales outside of the United States. We are also eligible for sales bonuses based on world-wide sales of licensed products. We are providing 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 are recognizing revenue using a proportional performance model. We are recording revenue related to the license fees and near-term milestone payments over approximately three years, which corresponds to the period we anticipate will satisfy our performance obligations under the agreement.

Collaboration and license revenue was $20.0 million for the three-month period ended March 31, 2009, an increase of $9.0 million as compared to the corresponding period in 2008. The increase resulted primarily from revenues earned under the Bristol-Myers Squibb agreement for PEG-Interferon lambda of $8.9 million and $3.2 million of increased amortization associated with the 2008 restructuring of our agreements with Merck Serono. These increases were partially offset by a decrease in license and

collaboration fees related to the Bayer collaboration of $1.8 million and a decrease in milestone revenue related to licenses with Novo Nordisk of $1.0 million.

For the three months ended March 31, 2009, changes in deferred collaboration and license revenue were as follows:

                       Balance, January 1, 2009   $  67,846
                       Cash receipts                  5,500
                       Revenue recognized           (12,381 )

                       Balance, March 31, 2009    $  60,965

As of March 31, 2009, the deferred revenue related to the Merck Serono agreements, the Bayer agreement, and the Bristol-Myers Squibb agreements were $10.6 million, $50.2 million and $200,000, respectively. As of March 31, 2009, the remaining collaboration obligation related to funding the first $100.0 million of development costs under the Bristol-Myers Squibb collaboration was $95.9 million.

Costs and expenses

Costs of product sales. Prior to FDA approval of RECOTHROM in January 2008, 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, we expect that costs of product sales will be lower during the time we are selling product manufactured prior to approval. Costs of product sales includes the inventory and distribution costs associated with RECOTHROM product revenue. For the three-month periods ended March 31, 2009 and 2008, we recognized $1.0 million and $106,000, respectively, as total costs of product sales.

Research and development. Research and development expense consists primarily of salaries and benefit expenses, costs of consumables, facility costs, contracted services and stock-based compensation. Research and development expense has been partially offset by cost reimbursements from collaborators for work performed on various co-development programs where each party shares costs and actively participates throughout the collaboration.. The breakdown of research and development expense for the three-month periods ended March 31 are shown in the following table (in thousands):

                                                      2009         2008
            Salaries and benefits                   $ 13,143     $ 17,480
            Consumables                                2,269        2,868
            Facility costs                             2,126        2,504
            Contracted services                        4,653       15,586
            Depreciation and amortization              1,240        1,293
            Stock-based compensation                   2,445        3,948

            Subtotal                                  25,876       43,679
            Cost reimbursement from collaborators     (1,139 )     (4,431 )

            Net research and development expense    $ 24,737     $ 39,248

Salaries and benefits and consumables generally track with changes in our employee base from year to year; however, in February 2008, we terminated 37 research and development employees and recorded a severance related charge of $2.0 million in the first quarter of 2008. In addition, salary and benefit costs related to RECOTHROM manufacturing subsequent to FDA approval in January 2008 have been included in inventory costs instead of being recorded as research and development expense. As a result of these

events, salaries and benefits decreased in the three-month period ended March 31, 2009 to a greater extent than would have otherwise been expected as compared to the same period in 2008.

Effective April 2009, as part of our corporate restructuring, we reduced our research and development workforce by 130 employees. We will record a charge to research and development of approximately $7.0 million related to these terminations in the second quarter of 2009.

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. Our contracted services costs decreased by $10.9 million for the three-month period ended March 31, 2009 as compared to the corresponding period in 2008 primarily due to the discontinuation of our co-development and co-funding obligations under the atacicept Collaborative Development and Marketing Agreement with Merck Serono.

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, pre-development and discovery research programs, together with the unallocated costs that benefit all programs for the three-month periods ended March 31 (in thousands):

                                                     2009       2008
               Clinical development programs:
               Hemostasis                          $  2,909   $  5,517
               Autoimmunity and oncology              1,855     10,440
               Antiviral                              3,698        796
               Preclinical and research programs      6,212      6,468
               Unallocated indirect costs            10,063     16,027

               Total                               $ 24,737   $ 39,248

The major trends in research and development program costs for the periods presented in the table were as follows:

• Hemostasis clinical development program costs decreased for the three months ended March 31, 2009 as compared to the first quarter of 2008, reflecting internal and external manufacturing costs related to RECOTHROM that were charged to expense in 2008 and that are now being charged to inventory subsequent to FDA approval on January 17, 2008.

• Autoimmunity and oncology clinical development program (atacicept and IL-21) costs decreased for the 2009 period primarily due to the discontinuation of our co-development and co-funding obligations under the atacicept Collaborative Development and Marketing Agreement with Merck Serono.

• Antiviral clinical development program costs increased for the three months ended March 31, 2009 as compared to the same periods in 2008, primarily due to an increase in both internal and external costs related to the ongoing Phase 1b clinical trial for PEG-Interferon lambda.

• Unallocated indirect costs decreased for the three months ended March 31, 2009 as compared to the same periods in 2008, primarily reflecting decreased personnel-related costs associated with the terminated research and development employees in February 2008.

Selling, general and administrative. Selling, general and administrative expense, which consists primarily of salaries and benefit expenses, professional fees and other corporate costs, increased 2.6% for the three-month period ended March 31, 2009, as compared to the corresponding period in 2008. The increase was primarily due to higher personnel costs and higher commissions paid to Bayer related to RECOTHROM sales, offset by a decrease in legal and patent expenses.

Stock-based compensation. Stock-based compensation expense decreased $2.0 million for the three-month period ended March 31, 2009 as compared to the corresponding period in 2008. The decrease was primarily due to a lower underlying share price for stock options granted in 2008 and 2009. The following table shows stock-based compensation expense by expense classification and type of award for the three-month periods ended March 31 (in thousands):

                                                          2009      2008
           Research and development expense
           Stock options                                 $ 2,140   $ 3,265
           Restricted stock units                            305       164
           Unrestricted stock grants                          -        519

                                                           2,445     3,948
           Selling, general and administrative expense
           Stock options                                   1,500     1,844
           Restricted stock units                             83        35
           Unrestricted stock grants                          -        228

                                                           1,583     2,107


           Total                                         $ 4,028   $ 6,055

Other income (expense)

Investment income. Investment income is generated primarily from investment of our cash reserves in fixed-income securities. The primary factors affecting the amount of investment income that we report are: the amount of cash reserves invested, the effective interest rate, the amount of realized gains or losses on investments sold during the period and the amount of other-than-temporary impairment recorded in the period. The following table shows how each of these factors affected investment income for the three-month periods ended March 31 (in thousands, except percentages):

                                                       2009         2008
          Weighted average amount of cash reserves   $ 97,672     $ 165,275
          Effective interest rate                        0.52 %        1.01 %

          Investment income before losses                 506         1,664
          Net loss on investments                          -           (202 )

          Investment income, as reported             $    506     $   1,462

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 $2.0 million and $1.9 million for the three months ended March 31, 2009 and 2008, respectively. In addition, we recorded interest expense of $744,000 for the three months ended March 31, 2009 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.

Liquidity and Capital Resources

As of March 31, 2009, we had cash, cash equivalents and short-term investments of $152.6 million, an increase of $62.7 million from December 31, 2008, primarily due to receipt of the $105.0 million in March 2009 from Bristol-Myers Squibb related to the PEG-Interferon lambda collaboration and license agreement. We intend to use these assets to fund our operations and capital expenditures. These cash reserves are held in a variety of fixed-income securities, including corporate bonds, commercial paper and money market instruments that were investment grade at the time of purchase. Subsequent to our purchase, some asset-backed securities have been downgraded by the major bond rating agencies. Together with the discretionary investment manager responsible for investing our portfolio, we monitor our investments closely and, based on market conditions and our expected working capital requirements, recorded other-than-temporary impairment loss of $400,000 on one security in the third quarter of 2008. We consider all other unrealized losses totaling $2.7 million to be temporary.

In June 2008, we completed a debt financing arrangement with Deerfield Management enabling us to draw up to $100.0 million in $25.0 million increments until January 2010. In November 2008, we received our first draw of $25.0 million. Interest accrues on amounts outstanding at a rate of 4.9% per annum, compounded quarterly, and will be due, along with outstanding principal, in June 2013. Each $25.0 million draw entitles the lender to a royalty equal to 2% of RECOTHROM net sales in the U.S. The cumulative royalty will not exceed $45.0 million over the five-year term of the arrangement assuming we draw the entire $100.0 million. In addition, we issued 1.5 million in six-year warrants upon receiving the initial draw in November 2008 and will issue an additional 1.0 million warrants upon receipt of each additional draw.

Cash flows from operating activities

The amount of cash used to fund our operating activities differs from our reported net losses due to the following items:

• noncash items, such as depreciation and amortization of fixed assets, . . .