ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Statements contained herein that are not historical fact may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are subject to a variety of risks and uncertainties. There are a number of important factors that could cause actual results to differ materially from those projected or suggested in any forward-looking statement made by us. These factors include, but are not limited to: (i) the ability of our company to obtain additional and substantial funding in the immediate future; (ii) the ability of our company to attract and/or maintain research, development, commercialization and manufacturing partners;
(iii) the ability of our company and/or a partner to successfully complete product research and development, including pre-clinical and clinical studies and commercialization; (iv) the ability of our company and/or a partner to obtain required governmental approvals, including product and patent approvals; and (v) the ability of our company and/or a partner to develop and commercialize products that can compete favorably with those of competitors. In addition, significant fluctuations in quarterly results may occur as a result of the timing of milestone payments, the recognition of revenue from milestone payments and other sources, and the timing of costs and expenses related to our research and development programs. Additional factors that could cause actual results to differ materially from those projected or suggested in any forward-looking statements are contained in our filings with the Securities and Exchange Commission, including those factors discussed under the captions "Risk Factors" and "Forward-Looking Statements" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, as may be supplemented or amended from time to time, which we urge investors to consider. We undertake no obligation to publicly release revisions in such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events or circumstances, except as otherwise required by securities and other applicable laws.

We are a biotechnology company focused on the discovery, development and commercialization of nucleic acid-based therapies utilizing gene silencing approaches such as RNA interference ("RNAi") and blocking messenger RNA ("mRNA") translation. Our goal is to improve human health through the development, either through our own efforts or those of our collaboration partners and licensees, of these nucleic acid-based therapeutics as well as the delivery technologies that together provide superior treatment options for patients. We have multiple proprietary technologies integrated into a broad nucleic acid-based drug discovery platform, with the capability to deliver novel nucleic acid-based therapeutics via systemic, local and oral administration to target a wide range of human diseases, based on the unique characteristics of the cells and organs involved in each disease.

Our pipeline includes a clinical program in Familial Adenomatous Polyposis ("FAP") and preclinical programs in bladder cancer and myotonic dystrophy. During the past year, we have entered into the following agreements regarding our technology:

· In December 2011, we entered into an exclusive license agreement with Mirna Therapeutics, Inc., a privately-held biotechnology company pioneering microRNA replacement therapy for cancer, regarding the development and commercialization of microRNA-based therapeutics utilizing Mirna's proprietary microRNAs and our novel SMARTICLESŪ-based liposomal delivery technology.

· In March 2012, we entered into an exclusive license agreement with ProNAi Therapeutics, Inc., a privately-held biotechnology company pioneering DNA interference (DNAi) therapies for cancer, regarding the development and commercialization of DNAi-based therapeutics utilizing our novel SMARTICLESŪ-based liposomal delivery technology.

· In May 2012, we entered into a worldwide exclusive license agreement with Monsanto Company, a global leader in agriculture and crop sciences, regarding the agricultural applications for our delivery and chemistry technologies.

· In May 2012, we entered into a strategic alliance with Girindus Group, a recognized leader in process development, analytical method development and cGMP manufacture of oligonucleotide therapeutics, regarding the development, supply and commercialization of certain oligonucleotide constructs using our conformationally restricted nucleotide ("CRN") technology.

· In August 2012, we entered into a worldwide, non-exclusive license agreement with Novartis Institutes for Biomedical Research, Inc., a global leader in the development of human therapeutics, regarding the development of oligonucleotide therapeutics utilizing our CRN technology.

· In November 2012, we entered into a worldwide, non-exclusive license agreement with Protiva Biotherapeutics Inc., a wholly owned subsidiary of Tekmira Pharmaceuticals Corporation ("Tekmira"), a leading oligonucleotide-based drug discovery and development company, regarding the development of oligonucleotide therapeutics using our Unlocked Nucleobase Analog (UNA) technology.

In addition to our own, internally developed technologies, we have strategically in-licensed and further developed nucleic acid- and delivery-related technologies, forming an integrated drug discovery platform. We are employing our platform, through our own efforts and those of our partners, for the discovery of multiple nucleic acid-based therapeutics including siRNA, microRNA and single stranded oligonucleotide-based drugs.

Our business strategy is two-fold. First, we strive to establish collaborations and strategic partnerships with pharmaceutical and biotechnology companies in the area of nucleic acid-based therapeutics to: (1) generate revenue through up-front, milestone and royalty payments related to our technology and/or the products that are developed using such technology; (2) gain access to technical resources; and (3) further validate our drug discovery platforms. Secondly, and pending receipt of sufficient funding, we plan to advance our own pipeline of nucleic acid-based therapeutics as a foundation upon which to improve all aspects of our drug discovery platform and to have the opportunity to commercialize drug therapies.

In terms of collaborations and strategic partnerships: (i) Mirna has the right to fund and develop specific microRNA-based nucleic acid therapeutics using our SMARTICLESŪ-based liposomal delivery technology, which arrangement includes the potential for milestone and royalty payments; (ii) ProNAi has the right to fund and develop DNAi-based nucleic acid therapeutics using our SMARTICLESŪ-based liposomal delivery technology, which arrangement includes the potential for milestone and royalty payments; (iii) Monsanto has the right to fund and develop applications in the agriculture field if any, using our delivery and chemistry technologies, which arrangement includes the potential for royalty payments;
(iv) Girindus will fund the commercialization of CRN-based amidites and CRN-based oligonucleotides for sale to industry and academia, which arrangement includes the potential for royalty payments; (v) Novartis has the right to fund and develop CRN-based nucleic acid therapeutics; and (vi) Tekmira has the right to fund and develop oligonucleotide therapeutics using our UNA technology, which arrangement includes the potential for milestone and royalty payments. Furthermore, ProNAi is funding their Phase 1 clinical trial, and using our proprietary SMARTICLESŪ-based liposomal delivery technology for systemic administration, which arrangement does not provide any financial benefit to us but continues to validate and advance our SMARTICLESŪ-based liposomal delivery technology.

With these relationships facilitating the advancement of several of our proprietary delivery technologies for small interfering RNA ("siRNA") and other nucleic acid-based therapeutics, we have focused resources on the Phase 1b/2a clinical trial of CEQ508 in Familial Adenomatous Polyposis as well as the CRN technology for the development of double- and single-stranded nucleic acid-based therapies. In April 2012, we announced the completion of dosing for Cohort 2 in the Dose Escalation Phase of the START-FAP (Safety and Tolerability of An RNAi Therapeutic in Familial Adenomatous Polyposis) clinical trial of CEQ508. The CEQ508 trial is currently on hold pending the receipt of sufficient funding to continue. We expect to begin the dosing of Cohort 3 as soon as we secure sufficient funding to complete the trial.

With respect to collaborations and strategic partnerships our concept is to provide multiple therapeutic options based on a partner's disease target and indication. We can apply our broad capabilities to pursue the most appropriate nucleic acid-based therapeutic approach to a specific, often undruggable, target for a specific indication. Each approach, i.e. siRNA, microRNA or single-strand oligonucleotide, has its advantages and disadvantages and we can utilize our broad capabilities to screen across multiple modalities to identify the most effective therapeutic. We believe this capability makes us extremely unique in the sector. We have structured, and expect to continue to structure, certain of our collaborative agreements to receive upfront non-refundable payments, research and development funding, milestone payments and royalties on commercial sales of products.

In order to protect our innovations, which encompass a broad platform of both nucleic acid-based therapeutic constructs and delivery technologies, as well as the drug products that may emerge from that platform, we have aggressively built upon our extensive and enabling intellectual property ("IP") estate, and, pending receipt of adequate funding, plan to continue to do so.

We believe we have successfully leveraged our broad and proven expertise to create an industry-leading integrated nucleic acid-based drug discovery platform, which is protected by a strong IP position and validated through licensing agreements with Mirna and ProNAi using our SMARTICLESŪ-based liposomal delivery technology, licensing agreements with Girindus and Novartis using our CRN technology, a licensing agreement with Tekmira using our UNA technology, the Phase 1 clinical trial by ProNAi using our SMARTICLESŪ-based liposomal delivery technology, licensing agreements with three large international companies (i.e., Roche, Novartis and Monsanto) for certain chemistry and delivery technologies and our own FAP Phase 1b/2a clinical trial with the Trans Kingdom RNA interference ("tkRNAi") platform.

Reduction of Operations

On June 1, 2012, we announced that, due to our financial condition, we had implemented a furlough of approximately 90% of our employees and ceased substantially all day-to-day operations. Since that time substantially all of the furloughed employees have been terminated. As of November 30, 2012, we had approximately 10 remaining employees, including all of our executive officers, all of whom are either furloughed or working on reduced salary. We have also sold substantially all of our equipment, and have ceased operations at our facility located at 3830 Monte Villa Parkway in Bothell, WA. As a result, since June 1, 2012 our internal research and development ("R&D") efforts have been, and as of the date of the filing of this report they continue to be, minimal, pending receipt of adequate funding.

Cash Position and Going Concern

The accompanying condensed consolidated financial statements have been prepared on the basis that we will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business.

As of September 30, 2012, we had an accumulated deficit of approximately $325.7 million, and have incurred, and may in the future continue to incur, losses and negative cash flows from operations as we continue our planned business operations. We expect that our operating expenses will consume the majority of our limited cash resources during the remainder of 2012 and will require ongoing funding. We have funded our losses primarily through the sale of common stock and warrants in the public markets and private placements, revenue provided by our collaboration partners, and, to a lesser extent, secured loans.

We plan to continue to work with large pharmaceutical companies regarding R&D collaboration agreements or investments, and to pursue public and private sources of financing to raise cash. However, there can be no assurance that we will be successful in such endeavors.

The market value and the volatility of our stock price, as well as general market conditions, could make it difficult for us to complete a financing or collaboration transaction on favorable terms, or at all. Any financing we obtain may further dilute the ownership interest of our current stockholders, which dilution could be substantial, or provide new stockholders with superior rights than those possessed by our current stockholders. If we are unable to obtain additional capital when required, and in the amounts required, we may be forced to modify, delay or abandon some or all of our programs, or to discontinue operations altogether. Additionally, any collaboration may require us to relinquish rights to our technologies. These factors, among others, raise substantial doubt about our ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty. The Report of Independent Registered Public Accounting Firm included in our Annual Report on Form 10-K for the year ended December 31, 2011 states that we have ceased substantially all day-to-day operations, including most research and development activities, have incurred recurring losses, have a working capital and accumulated deficit, and have had recurring negative cash flows from operations, that raise substantial doubt about our ability to continue as a going concern.

At September 30, 2012, we had a working capital deficit (current assets less current liabilities) of approximately $4.2 million and approximately $1.1 million in cash, including approximately $0.7 million in restricted cash.

We believe that our resources as of the date of the filing of this report will be sufficient to fund our planned limited operations until the end of 2012.

Recent Financing Activities

In February 2012, we received net proceeds of approximately $1.5 million by issuance of secured promissory notes and warrants to purchase up to 3,690,944 shares of our common stock. Through a series of amendments to the purchase agreement and the notes issued pursuant thereto, we have extended the maturity date of the notes to December 31, 2012, and in connection with such extensions have issued to the secured parties additional warrants to purchase up to 3,199,848 shares of our common stock. The warrants are exercisable at $0.28 per share, which is subject to adjustment (including as a result of subsequent financings), and are exercisable for a period of five years beginning six months and one day following the issuance of the warrants. The notes are secured by the assets of our company and our wholly-owned subsidiaries, Cequent Pharmaceuticals, Inc. and MDRNA Research, Inc. The security agreement that we entered into in connection with this transaction provides a security interest in, but not limited to, all of the property, equipment and fixtures, accounts, negotiable collateral, cash, and cash equivalents of our company and our wholly-owned subsidiaries, Cequent and MDRNA Research, subject to certain exceptions. The security interest created in the collateral is first priority, subject to the permitted encumbrances provided in the security agreement, and is perfected to the extent such security interest can be perfected by the filing of a financing statement and filings with the U.S. Patent and Trademark Office. The security interest created in the collateral will be removed at such time as the notes are paid in full.

As a result of amendments to the purchase agreement and the notes issued pursuant thereto, we and the holders of the notes agreed that if we, at any time prior to December 31, 2012, effect any merger or consolidation of our company whereby the holders of the issued and outstanding shares of our common stock immediately prior to the consummation of such transaction hold less than fifty percent (50%) of the issued and outstanding shares of the voting securities of the surviving corporation immediately following the consummation of such transaction, we will have fully satisfied the obligation to repay the entire unpaid principal balance under the notes and all accrued and unpaid interest thereon through the issuance to the noteholders of an aggregate number of shares of common stock calculated by converting the then total outstanding principal and interest under the notes at a value of $0.28 per share of common stock.

In March 2012, we received net proceeds of approximately $1.1 million by issuance of 1,600,002 shares of our common stock and warrants to purchase up to 800,001 shares of our common stock. The warrants have an exercise price of $0.75 per share, are immediately exercisable (subject to registration or the availability of an exemption under federal and state securities laws), and will be exercisable for a period of five years from the date of issuance. The exercise price and the number of shares issuable upon exercise of the warrants are subject to adjustment in the event of stock splits or dividends, business combinations, sale of assets or other similar transactions, but not as a result of future securities offerings at lower prices.

In May and July, 2012, we received an aggregate of $1.5 million as an upfront payment in connection with the Intellectual Property License Agreement that we entered into with Monsanto Company. At the same time that we entered into the Intellectual Property License Agreement, we and Monsanto also entered into a Security Agreement pursuant to which we granted to Monsanto a security interest in that portion of our intellectual property that is the subject of the license agreement in order to secure the performance of our obligations under the license agreement.

In August 2012 we received $1 million in a one-time upfront payment in connection with the License Agreement that we entered into with Novartis Institutes for Biomedical Research, Inc. Between September and November 2012, we received additional funds as a result of the sale of certain equipment at our corporate headquarters, the receipt of the upfront payment in connection with the license agreement that we entered into with ProNAi Therapeutics, and the receipt of an accelerated milestone payment in connection with the license agreement that we entered into with Mirna Therapeutics. In addition, on November 28, 2012, we entered into a license agreement with Tekmira, in connection with which we received an upfront payment in the amount of $300,000.

Cash flows

Our operating activities used cash of approximately $3.4 million in the nine months ended September 30, 2012, compared to approximately $14.2 million in the nine months ended September 30, 2011. In the nine months ended September 30, 2012, cash used in operating activities related primarily to funding our net loss, adjusted for changes in the liability for fair value of price adjustable warrants and subscription investment units and changes in accounts payable, offset by non-cash amortization of the discount on notes payable, non-cash restructuring expense, stock-based compensation, depreciation and amortization and changes in prepaid and other assets. In the nine months ended September 30, 2011, cash used in operating activities related primarily to funding our net loss, adjusted for changes in the liability for fair value of price adjustable warrants and subscription investment units, and changes in accounts payable and accrued expenses, offset in part by non-cash restructuring charges, stock-based compensation, depreciation and amortization and changes in deferred revenues. To the extent that we obtain sufficient funding, we expect to use cash for operating activities in the foreseeable future as we continue our R&D activities.

Our investing activities provided cash of approximately $0.4 million in the nine months ended September 30, 2012, compared to using cash of approximately $0.1 million in the nine months ended September 30, 2011. In the nine months ended September 30, 2012 cash used in investing activities was the result of proceeds from sales of property and equipment. In the nine months ended September 30, 2011 cash used in investing activities was the result of changes in restricted cash.

Our financing activities provided cash of approximately $2.5 million in the nine months ended September 30, 2012, compared to approximately $14.3 million in the nine months ended September 30, 2011. Changes in cash from financing activities are primarily due to issuance of common stock and warrants, proceeds and repayment of notes payable and proceeds from exercises of stock options, warrants and subscription investment units. In February 2012, we received net proceeds of $1.5 million from the issuance of notes payable and warrants to purchase shares of common stock. In March 2012, we raised net proceeds of approximately $1.1 million through an offering of shares of common stock and warrants to purchase shares of common stock. In February 2011, we raised net proceeds of approximately $4.5 million through an offering of shares of common stock and warrants to purchase shares of common stock and in May 2011, we raised net proceeds of approximately $6.3 million through an offering of shares of common stock and warrants. In the nine months ended September 30, 2011, we received proceeds of approximately $3.6 million from the exercise of warrants and subscription investment units.

Summary

We believe that our resources as of the date of the filing of this report are sufficient to fund our planned limited operations until the end of 2012. The market value and the volatility of our stock price, as well as our current financial situation and general market conditions, could make it difficult for us to complete a financing or collaboration transaction on favorable terms, or at all. Any financing we obtain may further, and substantially, dilute or otherwise impair the ownership interests of our current stockholders. If we fail to obtain significant additional capital in the immediate future, we will be forced to further delay, reduce or eliminate some or all of our planned activities.