The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section as well as factors described in "Part II, Item 1A-Risk Factors." Overview
Strategic Direction of Our Business
We are a clinical-stage biopharmaceutical company developing a pipeline of drug candidates that utilize our PEGylation and advanced polymer conjugate technology platforms to improve the therapeutic benefits of drugs. Our proprietary product pipeline is comprised of drug candidates across a number of therapeutic areas, including oncology, pain, anti-infectives and immunology. We create our innovative product candidates by using our proprietary chemistry platform to modify the chemical structure of drugs using unique polymer conjugates. Additionally, we may utilize established pharmacologic targets to engineer a new drug candidate relying on a combination of the known properties of these targets and the attributes of our customized polymer chemistry. Our drug candidates are designed to correct deficiencies in the pharmacokinetics, half-life, oral bioavailability, metabolism or distribution of drugs to improve their therapeutic efficacy.
During 2009, we expect to continue to make substantial investments to advance our pipeline of drug candidates from early stage discovery research through clinical development. On March 2, 2009, we announced that we were terminating our Phase 2 clinical trial for Oral NKTR-118 (oral PEGylated naloxol) as a result of positive preliminary results. We also have several Phase 2 clinical trials for NKTR-102 (PEGylated irinotecan) directed at a number of different indications in the oncology therapeutic area already underway or scheduled to begin during 2009. In addition, on February 17, 2009, we announced that we had dosed the first patient in a Phase 1 clinical trial for NKTR-105 (PEGylated docetaxel) for patients with refractory solid tumors. We also have several other products in the early discovery or preclinical stage that we are preparing to move into clinical development or will be moving into clinical development in 2009.
Our focus on research and clinical development requires substantial investments that continue to increase as we advance each drug candidate through the development cycle. While we believe that our strategy has the potential to create significant value if one or more of our drug candidates demonstrates positive clinical results and/or receives regulatory approval in one or more major markets, drug development is an inherently uncertain process and there is a high risk of failure at every stage prior to approval and clinical results are very difficult to predict. Clinical development success and failures can have an unpredictable and disproportionate positive or negative impact on our scientific and medical prospects, financial prospects, financial condition, and market value.
We intend to decide on a product-by-product basis whether we wish to continue development into Phase 3 pivotal clinical trials and commercialize products on our own, or seek a partner, or pursue a combination of these approaches. Following completion of Phase 2 development, or earlier in the development cycle in certain circumstances, we will generally be seeking collaborations with one or more biotechnology or pharmaceutical companies to conduct Phase 3 clinical development, to be responsible for the regulatory approval process and, if such drug candidate is approved, to market and sell the drug in one or more world markets. The commercial terms of such future collaborations, if any, including, without limitation, up-front payments, development milestone payments, and royalty rates, will be critical to the future prospects of our business and financial condition. In particular, our ability to successfully conclude a new collaboration for Oral NKTR-118 on commercially favorable terms (or at all), will have a significant impact on our financial position and business prospects in 2009.

We also have a number of existing license and collaboration agreements with third parties who have licensed our proprietary technologies for drugs that have either received regulatory approval in one or more markets or drug candidates that are still in the clinical development stage. For example, the future clinical and commercial success of Bayer's Amikacin Inhale (BAY41-6551 or NKTR-061), UCB's CIMZIA™, Roche's MIRCERA and Affymax's Hematide, among others, will together have a material impact on our long-term revenue prospects, as will the success of Bayer's Cipro Inhale program, in relation to which we have certain royalty rights. Because drug development and commercialization is subject to a number of risks and uncertainties, there is a risk that our future revenue from one or more of these agreements will be less than we anticipate. Key Developments and Trends in Liquidity and Capital Resources At March 31, 2009, we had approximately $325.3 million in cash, cash equivalents, and short-term investments and $242.4 million in indebtedness. We may from time to time purchase or retire additional convertible subordinated notes through cash purchase or exchanges for other securities of the Company in open market or privately negotiated transactions, depending on, among other factors, our levels of available cash and the price at which such convertible notes are available for purchase. We will evaluate such transactions, if any, in light of then-existing market conditions. These transactions, individually or in the aggregate, may be material to our business.
We have financed our operations primarily through revenue from product sales and royalties and research and development contracts and public and private placements of debt and equity. To date we have incurred substantial debt as a result of our issuances of subordinated notes that are convertible into our common stock. Our substantial debt, the market price of our securities, and the general economic climate, among other factors, could have material consequences for our financial condition and could affect our sources of short-term and long-term funding. Our ability to meet our ongoing operating expenses and repay our outstanding indebtedness is dependent upon our and our partners' ability to successfully complete clinical development of, obtain regulatory approvals for and successfully commercialize new drugs. Even if we or our partners are successful, we may require additional capital to continue to fund our operations and repay our debt obligations as they become due. There can be no assurance that additional funds, if and when required, will be available to us on favorable terms, if at all.
Our substantial investment in our preclinical and clinical research and any potential new licensing or partnership agreements, if any, will be the key drivers of our results of operations and financial position during 2009. One of our collaboration partners has a one-time license extension option exercisable in December 2009. If this partner elects to exercise this license extension option right, we will receive a cash payment of $31.0 million in December 2009. Results of Operations
Three Months Ended March 31, 2009 and 2008 Revenue (in thousands except percentages)

                                                                                                         Percentage
                                         Three months         Three months          Increase /           Increase /
                                            ended                 ended             (Decrease)           (Decrease)
                                        March 31, 2009       March 31, 2008        2009 vs. 2008        2009 vs. 2008
Product sales and royalties            $          6,470      $        10,371      $        (3,901 )                (38 %)
Collaboration and other                           3,241                9,621               (6,380 )                (66 %)

Total revenue                          $          9,711      $        19,992      $       (10,281 )                (51 %)

The decrease in total revenue for the three months ended March 31, 2009, as compared to the three months ended March 31, 2008, was attributable to lower product sales volumes required by our collaboration partners, the termination of our Tobramycin Inhalation Powder (TIP) collaborative agreement with Novartis Vaccines and Diagnostics Inc., and the assignment of our Cipro Inhale collaborative agreement with Bayer Schering Pharma AG to Novartis. Pursuant to the terms of the transaction, we maintain the right to receive certain potential royalties in the future based on net product sales if Cipro Inhale receives regulatory approval and is successfully commercialized.

The timing of our product sales depends upon our collaboration partners' requirements and we do not expect to recognize our revenue ratably each quarter in 2009. One of our collaboration partners has a one-time license extension option exercisable in December 2009. If this partner elects to exercise this license extension option right, we will receive a cash payment of $31.0 million in December 2009.
Our revenue is derived from our collaboration agreements with partners, under which we may receive contract research payments, milestone payments based on clinical progress, regulatory progress or net sales achievements, royalties or manufacturing revenue. Significant variations in the timing of receipt of cash payments and our recognition of revenue can result from the nature of significant milestone payments based on the execution of new collaboration agreements, the timing of clinical, regulatory or sales events which result in single milestone payments and the timing and success of the commercial launch of new drugs by our collaboration partners. Product sales and royalties
The decrease in product sales and royalties for the three months ended March 31, 2009 compared to the three months ended March 31, 2008 is attributable to lower product sales volumes required by our licensing partners and changes in the timing of shipments. We expect product sales and royalties to increase for the three months ended June 30, 2009 compared to the three months ended March 31, 2009.
Collaboration and other
Collaboration and other revenue includes reimbursed research and development expenses, amortization of deferred up-front signing and milestone payments received from our collaboration partners, and intellectual property license fee revenue. Collaboration revenue fluctuates from year to year, and therefore future collaboration revenue cannot be predicted accurately. The level of collaboration and other revenues depends in part upon the continuation of existing collaborations, the stage of program development, and the achievement of milestones.
The decrease in Collaboration and other revenue for the three months ended March 31, 2009 compared to the three months ended March 31, 2008 attributable to the termination of our TIP agreement and the assignment of the Cipro Inhale agreement was approximately $6.0 million. We do not expect to recognize any additional revenue related to these two agreements in 2009.
The timing and future success of our product development programs are subject to a number of risks and uncertainties. See "Part II, Item 1A-Risk Factors" for discussion of the risks associated with our partnered research and development programs.
Cost of Goods Sold and Product Gross Margin (in thousands except percentages)

                                                                                                          Percentage
                                         Three months          Three months          Increase /           Increase /
                                            ended                 ended              (Decrease)           (Decrease)
                                        March 31, 2009        March 31, 2008        2009 vs. 2008        2009 vs. 2008
Cost of goods sold                     $          5,099      $          7,227      $        (2,128 )                (29 %)
Product gross margin                   $          1,371      $          3,144      $        (1,773 )                (56 %)
Product gross margin %                               21 %                  30 %

The decrease in Cost of goods sold for the three months ended March 31, 2009 compared to the three months ended March 31, 2008 is attributable to decreased sales volume. The decrease in product gross margin for the three months ended March 31, 2009 compared to the three months ended March 31, 2008 resulted from a $2.1 million success fee that became due to one of our former consulting firms as the final payment due under the agreement. This decrease is partially offset by higher gross product margin recognized due to a change in product mix and royalty revenue. For the three months ended March 31, 2009 compared to the three months ended March 31, 2008, royalty revenue remained at a consistent level, but contributed a larger gross margin percentage due to the overall decrease in product sales and royalties.

Other Cost of Revenue (in thousands except percentages)

                                                                                                        Percentage
                                        Three months         Three months          Increase /           Increase /
                                            ended                ended             (Decrease)           (Decrease)
                                       March 31, 2009       March 31, 2008        2009 vs. 2008        2009 vs. 2008
Other cost of revenue                  $             -      $         5,334      $        (5,334 )              >(100 %)

Other cost of revenue for the three months ended March 31, 2008 includes the costs of maintaining our manufacturing operating capacity after the termination of the Pfizer agreements on November 9, 2007 through the termination of our inhaled insulin programs on April 9, 2008.
Research and Development Expense (in thousands except percentages)

                                                                                                        Percentage
                                        Three months         Three months          Increase /           Increase /
                                            ended                ended             (Decrease)           (Decrease)
                                       March 31, 2009       March 31, 2008        2009 vs. 2008        2009 vs. 2008
Research and development expense       $        23,890      $        37,373      $       (13,483 )                (36 %)

Research and development expenses consist primarily of personnel costs, including salaries, benefits, and stock-based compensation, clinical studies performed by contract research organizations (CROs), materials and supplies, licenses and fees, and overhead allocations consisting of various support and facilities related costs.
The decrease in Research and development expense for the three months ended March 31, 2009 compared to the three months ended March 31, 2008, is primarily attributable to the completion of the sale of certain assets related to our pulmonary business, associated property, and intellectual property to Novartis on December 31, 2008 (Novartis Pulmonary Asset Sale) and the workforce reduction executed in February 2008. As part of the Novartis Pulmonary Asset Sale, we transferred approximately 140 of our personnel dedicated to our pulmonary operations and our San Carlos research and manufacturing facility to Novartis; additionally, we ceased research activities on the TIP program, the Cipro Inhale program and certain other proprietary pulmonary development programs. For the three months ended March 31, 2009 compared to the three months ended March 31, 2008, personnel costs decreased by approximately $9.6 million, comprised of $6.6 million of salaries and benefits and $3.0 million of severance costs, and facilities costs decreased by approximately $3.7 million. General and Administrative Expense (in thousands except percentages)

                                                                                                        Percentage
                                        Three months         Three months          Increase /           Increase /
                                            ended                ended             (Decrease)           (Decrease)
                                       March 31, 2009       March 31, 2008        2009 vs. 2008        2009 vs. 2008
General and administrative expense     $        11,020      $        11,947      $          (927 )                 (8 %)

General and administrative expense is associated with administrative staffing, business development and marketing. For the three months ended March 31, 2009 compared to the three months ended March 31, 2008, professional outside services decreased by approximately $1.1 million and personnel costs decreased by approximately $0.5 million due to headcount reductions. These decreases were partially offset by increased stock-based compensation expense and increased information technology expenses.

Interest Income and Interest Expense (in thousands except percentages)

                                                                                                        Percentage
                                        Three months         Three months          Increase /           Increase /
                                            ended                ended             (Decrease)           (Decrease)
                                       March 31, 2009       March 31, 2008        2009 vs. 2008        2009 vs. 2008
Interest Income                        $         1,650      $         5,013      $        (3,363 )                (67 %)
Interest Expense                       $        (3,337 )    $        (3,918 )    $          (581 )                (15 %)

The decrease in interest income for the three months ended March 31, 2009, compared to the three months ended March 31, 2008, was primarily attributable to lower interest rates and a lower average balance of our cash, cash equivalents, and available-for-sale investments. The decrease in interest expense for the three months ended March 31, 2009, compared to the three months ended March 31, 2008, was primarily attributable to a lower average balance of convertible subordinated notes outstanding. We repurchased $100.0 million of our 3.25% convertible subordinated notes in the fourth quarter of 2008. Liquidity and Capital Resources
We have financed our operations primarily through revenue from partner licensing and collaboration arrangements, public and private placements of debt and equity securities and financing of equipment acquisitions and certain tenant leasehold improvements.
We had cash, cash equivalents and short-term investments in marketable securities of $325.3 million and indebtedness of $242.4 million, including $215.0 million of 3.25% convertible subordinated notes, $21.3 million in capital lease obligations, and $6.1 million in other liabilities as of March 31, 2009. Due to the recent adverse developments in the credit markets, we may experience reduced liquidity with respect to some of our short-term investments. These investments are generally held to maturity, which is less than one year. However, if the need arose to liquidate such securities before maturity, we may experience losses on liquidation. At March 31, 2009, the average portfolio duration was approximately three months and the contractual maturity of any single investment did not exceed twelve months. To date we have not experienced any liquidity issues with respect to these securities, but should such issues arise, we may be required to hold some, or all, of these securities until maturity. We believe that, even allowing for potential liquidity issues with respect to these securities, our remaining cash, cash equivalents, and short-term investments will be sufficient to meet our anticipated cash needs for at least the next twelve months. We have the ability and intent to hold our debt securities to maturity when they will be redeemed at full par value. Accordingly, we consider unrealized losses to be temporary and have not recorded a provision for impairment.
Cash flows used in operating activities
Cash flows used in operating activities for the three months ended March 31, 2009 totaled $42.4 million and includes $4.9 million for employee bonus payments related to services performed in 2008, $3.5 million for our semi-annual interest payment on our convertible subordinated notes, $2.7 million for severance payments for employees terminated in December 2008, and $31.7 million of other net operating cash uses. Because of the nature and timing of certain cash receipts and payments, net cash utilization is not expected to be ratable over the four quarters of the year.
For the three months ended March 31, 2008, cash used in operations includes payments to Bespak and Tech Group of $32.4 million for amounts due under our termination agreements with those companies, all of which was recorded as an expense in 2007, $2.6 million to maintain Exubera inhaler manufacturing capacity at Tech Group's facility, and $3.9 million for severance, employee benefits, and outplacement services in connection with our workforce reduction plans.

Cash flows from investing activities
We purchased $5.1 million and $5.3 million of property and equipment in the three-months ended March 31, 2009 and 2008, respectively. For the three months ended March 31, 2009 we paid $4.8 million of previously expensed transaction costs related to the Novartis Pulmonary Asset Sale, which was completed on December 31, 2008.
Cash flows used in financing activities
Cash used in financing activities were not significant for the three months ended March 31, 2009 and for the three months ended March 31, 2008. Contractual Obligations
In the three-months ended March 31, 2009, there was no material change to the summary of contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2008.
Off-Balance Sheet Arrangements
We do not utilize off-balance sheet financing arrangements as a source of liquidity or financing.
Critical Accounting Policies and Recent Accounting Pronouncements
EITF 07-1
In December 2007, the FASB ratified EITF Issue No. 07-1 (EITF 07-1), Accounting for Collaborative Arrangements, which defines collaborative arrangements and establishes reporting and disclosure requirements for transactions between participants in a collaborative arrangement and between participants in the arrangements and third parties. On January 1, 2009, we adopted EITF 07-1 retrospectively to all prior periods presented for all collaborative arrangements. The adoption of EITF 07-1 did not have a material impact on our financial statements.
FASB Staff Position No. 157-4
In April 2009, the FASB issued FASB Staff Position No. 157-4 (FSP 157-4), Determining Fair Value when the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which provides guidance on determining fair value when there is no active market or where the price inputs being used represent distressed sales. FSP 157-4 is effective for interim and annual periods ending after June 15, 2009 and shall be applied prospectively. We do not expect the adoption of FSP 157-4 will have a material impact on our financial position or results of operations. FASB Statement of Position No. 115-2 and 124-2 In April 2009, the FASB issued FASB Staff Position No. 115-2 and 124-2 (FSP 115-2 and 124-2), Recognition and Presentation of Other-Than-Temporary Impairments, which provides operational guidance for determining other-than-temporary impairments (OTTI) for debt securities. FSP 115-2 and 124-2 is effective for interim and annual periods ending after June 15, 2009. FSP FAS 115-2 and 124-2 requires a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption with a corresponding adjustment to Accumulated other comprehensive income. We do not expect the adoption of FSP 115-2 and 124-2 to have a material impact on our financial position or our results of operations.