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, which are designed to enable the development of new molecular entities that target known mechanisms of action. Our current proprietary pipeline is comprised of drug candidates across a number of therapeutic areas including oncology, pain, anti-infectives, and immunology. Our research and development activities involve small molecule drugs, peptides and other biologic drug candidates. We create innovative drug candidates by using our proprietary advanced polymer conjugate technologies and expertise to modify the chemical structure of pharmacophores to create new molecular entities. Polymer chemistry is a science focused on the synthesis or bonding of polymer architectures with drug molecules to alter the properties of a molecule when it is bonded with polymers. 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 our proprietary polymer chemistry technology and expertise. Our drug candidates are designed to improve the overall benefits and use of a drug for patients by improving the metabolism, distribution, pharmacokinetics, pharmacodynamics, half-life and/or bioavailability of drugs. Our objective is to apply our advanced polymer conjugate technology platform to create new drug candidates in multiple therapeutic areas that address large potential markets.

Our most advanced proprietary product candidate, naloxegol (formerly known as NKTR-118), is a peripheral opioid antagonist which has completed Phase 3 clinical studies for the treatment of opioid-induced constipation (OIC). We are a party to an exclusive worldwide license agreement with AstraZeneca for the global development and commercialization of naloxegol and naloxegol fixed-dose combination products (formerly known as NKTR-119). The core Phase 3 clinical development program for naloxegol, which AstraZeneca calls the KODIAC program, is comprised of four clinical trials which are designed to investigate the safety and efficacy of naloxegol for the treatment of OIC in patients with non-cancer related pain. The outcome and timing of the naloxegol development program will have a substantial impact on our financial condition as we are entitled to up to $95 million in regulatory filing milestones and $140 million in commercial launch milestones.

On November 12, 2012, AstraZeneca announced positive top-line results from two Phase 3 efficacy and safety clinical trials and from a safety extension trial (KODIAC-04, -05, and -07). On February 26, 2013, AstraZeneca announced positive top-line results from the long-term safety study (KODIAC-08) of naloxegol in patients with OIC. AstraZeneca has stated that it plans to submit an NDA filing in the U.S. and a marketing authorization application (MAA) filing in the E.U. in the third quarter of 2013, pending AstraZeneca's final preparation of the registration package and a pre-NDA meeting with the FDA. In the event regulatory approval filings are submitted by AstraZeneca and accepted by the U.S. Food and Drug Administration (FDA) and by the European Medicines Agency (EMA), we would be entitled to receive $95.0 million in milestone payments. As a

result, the outcome of AstraZeneca's determination to make regulatory filings for naloxegol with the FDA and EMA is critical to our financial position in 2013 as well as our future business prospects as a result of the significant economic stake that we have in success of the potential commercialization of naloxegol.

Our second most advanced proprietary drug candidate, etirinotecan pegol (formerly known as NKTR-102), is a next-generation topoisomerase I inhibitor. Etirinotecan pegol is currently being evaluated as a single-agent therapy in a Phase 3 open-label, randomized, multicenter clinical study in patients with metastatic breast cancer. This Phase 3 clinical study, which we call the BEACON study (BrEAst Cancer Outcomes with NKTR-102), is scheduled to enroll approximately 840 patients with metastatic breast cancer that have previously received treatment with an anthracycline, a taxane, and capecitabine. The BEACON study will require a substantial investment over the next two years. In November 2012, etirinotecan pegol was designated by the FDA as a Fast Track development program for the treatment of patients with locally recurrent or metastatic breast cancer progressing after treatment with an anthracycline, a taxane, and capecitabine. We have completed an expanded Phase 2 clinical study for etirinotecan pegol in patients with platinum-resistant ovarian cancer. We are currently in the process of finalizing the data in furtherance of planned meetings with health authorities in 2013 which will guide our future development and regulatory strategy for etirinotecan pegol in ovarian cancer. In addition, a Phase 2 clinical study for etirinotecan pegol in patients with metastatic colorectal cancer is still open for enrollment.

We have a significant collaboration with Bayer Healthcare LLC (Bayer) to develop BAY41-6551 (Amikacin Inhale, formerly known as NKTR-061), which is an inhaled solution of amikacin, an aminoglycoside antibiotic, that has completed Phase 2 clinical development. We originally developed the liquid aerosol inhalation platform and Amikacin Inhale and entered into a collaboration agreement with Bayer in August 2007 to further advance the drug candidate's development and potential commercialization. The stability studies on the nebulizer device that needed to be completed prior to the start of the Phase 3 clinical study were successfully completed in February 2013. The Phase 3 clinical program is expected to be initiated by Bayer in March 2013. In 2011, Bayer achieved agreement with the FDA on the design of the planned Phase 3 clinical studies of BAY41-6551 under the Special Protocol Assessment process that is intended to support the submission of a NDA if the planned Phase 3 clinical study is successful.

We also have a significant collaboration with Baxter Healthcare to identify and develop PEGylated drug candidates with the objective of providing new long-acting therapies for hemophilia patients. Under the terms of this collaboration, we are providing a license to our intellectual property and our PEGylation technology and expertise. Baxter is responsible for all clinical development. The first drug candidate in this collaboration, BAX 855, is a longer-acting (PEGylated) form of a full-length recombinant factor VIII (rFVIII) protein which has completed Phase 1 clinical development in patients with hemophilia A. In February 2013, Baxter initiated a Phase 3 multi-center, open-label clinical study called PROLONG-ATE that will enroll more than 100 previously treated adult patients with severe hemophilia A to assess the efficacy, safety and pharmacokinetics of BAX 855 for prophylaxis and on-demand treatment of bleeding. If BAX 855 is approved by health authorities and is successfully commercialized by Baxter, this would represent a substantial royalty revenue opportunity for us, subject to significant risks and uncertainties relating to regulatory approval with health authorities and subsequent commercial success.

While the late stage clinical development programs described above are key elements of the future success of our company, we believe it is critically important that we continue to make substantial investments in our earlier-stage drug candidate pipeline. For example, in April 2012 we advanced NKTR-192, our short-acting opioid drug candidate, into Phase 1 clinical studies and in July 2012 we advanced NKTR-181 into a Phase 2 clinical study and plan to conduct a human abuse liability study for NKTR-181 in the first half of 2013. While we believe that our substantial investment in research and development has the potential to create significant value if one or more of our drug candidates demonstrate positive clinical results and receive regulatory approval in one or more major markets, drug research and development is an inherently uncertain process and there is a high risk of failure at every stage prior to approval and the timing and outcome of clinical trial results are extremely difficult

to predict. Clinical development successes and failures can have a disproportionate positive or negative impact on our scientific and medical prospects, financial prospects, financial condition, and market value.

Historically, we have entered into a number of license and supply contracts under which we manufactured and supplied our proprietary PEGylation reagents on a cost-plus or fixed price basis. Our current strategy is to manufacture and supply PEGylation reagents to support our proprietary drug candidates or our third party collaborators where we have a strategic development and commercialization relationship or where we derive substantial economic benefit. As a result, whenever possible, we are renegotiating or not seeking renewal of legacy manufacturing supply arrangements that do not include a strategic development or commercialization component. For example, in October 2010, we entered into a supply, dedicated suite and manufacturing guarantee agreement with Amgen, Inc. and Amgen Manufacturing, Limited, which has significantly amended economic and other terms in the non-exclusive supply and license agreement we previously entered into with Amgen in 1995. In addition, in December 2010, we entered into an amended manufacturing and supply agreement with Merck (through its acquisition of Schering-Plough Corporation) to provide for transfer to an alternative manufacturer and revised economics for an interim supply arrangement until that transition is completed.

Key Developments and Trends in Liquidity and Capital Resources

At December 31, 2012, we had approximately $302.2 million in cash, cash equivalents, and investments in marketable securities and $149.0 million in indebtedness. The indebtedness includes $125.0 million in aggregate principal amount of 12.0% senior secured notes due July 15, 2017 which we issued during the three months ended September 30, 2012, but excludes our long-term liability relating to the sale of future royalties under the Purchase and Sale Agreement with RPI Finance Trust (RPI). As is further described in Note 7, this royalty obligation liability will not be settled in cash, but we may be required to make a payment of up to $7.0 million in 2014 if the worldwide net sales thresholds of MIRCERA® in 2013 are not met. During the year-ended December 31, 2012, we retired $215.0 million in aggregate principal amount of our previously outstanding convertible subordinated notes.

As of December 31, 2012, we had at least twelve months of working capital to fund our current business plans. We expect the clinical development of our proprietary drug candidates including etirinotecan pegol, Amikacin Inhale, NKTR-181, and NKTR-192 will require significant investment in order to continue to advance in clinical development with the objective of entering into a collaboration partnership or obtaining regulatory approval. However, we have no credit facility or any other sources of committed capital. In addition, while in the past we have received a number of significant payments from license and collaboration agreements and other significant transactions, we do not currently anticipate completing new transactions with substantial upfront payments in the near -term. Our current business plan is also subject to significant uncertainties and risks as a result of, among other factors, expenses being higher than anticipated, unplanned expenses, cash receipts being lower than anticipated, and the need to satisfy contingent liabilities including litigation matters and indemnification obligations.

The availability and terms of various financing alternatives substantially depend on the success or failure of our drug development programs including naloxegol, etirinotecan pegol, BAX 855, Amikacin Inhale, NKTR-181, and NKTR-192. The availability and terms of financing alternatives and any future significant payments from existing or new collaborations all depend on the positive outcome of ongoing or planned clinical studies, whether we or our partners are successful in obtaining health authority approvals in major markets, and if approved, the commercial success of these drugs. In particular, we are entitled to up to $235.0 million of regulatory and commercial launch milestones under our license agreement with AstraZeneca, $95.0 million of which is related to AstraZeneca submitting regulatory approval filings for naloxegol with the FDA and with the EMA. AstraZeneca has indicated that it plans to submit regulatory filings for naloxegol subject to subject to AstraZeneca's final preparation of the registration package and a pre-NDA meeting with the FDA. In the event we do not enter into any new collaboration partnerships with significant up-front payments or do not receive the naloxegol regulatory milestone payments in 2013, we would likely be required to pursue financing alternatives.

In the event we determine to explore financing alternatives, our objective would be to first pursue financing alternatives that are not dilutive to the ownership of our common stock security holders. However, if non-dilutive financing alternatives are not available to us on commercially reasonable terms or at all, we could be required to pursue dilutive equity-based financing alternatives such as an offering of convertible debt or common stock.

Results of Operations

Years Ended December 31, 2012, 2011, and 2010

Revenue (in thousands, except percentages)



                                                                                                              Percentage         Percentage
                                                                          Increase/         Increase/         Increase/          Increase/
                                       Year Ended December 31,            (Decrease)        (Decrease)        (Decrease)         (Decrease)
                                                                           2012 vs.          2011 vs.          2012 vs.           2011 vs.
                                   2012         2011         2010            2011              2010              2011               2010
Product sales                    $ 35,399     $ 24,864     $  27,412     $     10,535      $     (2,548 )              42 %               (9 )%
Royalty revenues                    4,874       10,327         7,255           (5,453 )           3,072               (53 )%              42 %
Non cash royalty revenue
related to sale of future
royalties                          10,791           -             -            10,791                -                100 %              N/A
License, collaboration and
other                              30,127       36,289       124,372           (6,162 )         (88,083 )             (17 )%             (71 )%

Total revenue                    $ 81,191     $ 71,480     $ 159,039     $      9,711      $    (87,559 )              14 %              (55 )%

Our revenue is derived from our collaboration agreements, under which we may receive product sales revenue, royalties, license fees, milestone payments or contract research payments. Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable, and collection is reasonably assured. The amount of upfront fees received under our license and collaboration agreements allocated to continuing obligations, such as manufacturing and supply commitments, are recognized ratably over our expected performance period under the arrangement. As a result, there may be significant variations in the timing of receipt of cash payments and our recognition of revenue. We make our best estimate of the period over which we expect to fulfill our performance obligations. Given the uncertainties in research and development collaborations, significant judgment is required by us to determine the performance periods.

Product sales

Product sales include fixed price and cost-plus manufacturing and supply agreements with our collaboration partners. Product sales increased during the year ended December 31, 2012 compared to the year ended December 31, 2011 as a result of increased product demand from a number of our collaboration partners. Product sales decreased during the year ended December 31, 2011 compared to the year ended December 31, 2010 due in part to the transfer of manufacturing activities to certain collaboration partners. The timing of shipments is based solely on the demand and requirements of our collaboration partners and is not ratable throughout the year. We expect product sales to increase in 2013 as compared to 2012.

Royalty revenues and non cash royalty revenue related to sale of future royalties

We receive royalty revenue from certain of our collaboration partners based on their net sales of commercial products. Royalty revenues decreased during the year ended December 31, 2012 compared to the year ended December 31, 2011 primarily as a result of the sale of the royalties we receive from UCB's CIMZIA ® and Roche's MIRCERA® product sales as is further described below. Royalty revenues increased during the year ended December 31, 2011 as compared to the year ended December 31, 2010 primarily as a result of the increase in royalties received from net sales of CIMZIA® and MIRCERA ®. We expect royalties to decrease in 2013 as compared to 2012.

During the years ended December 31, 2011 and 2010, we recognized $8.3 million and $5.4 million, respectively, in aggregate royalties from net sales of CIMZIA® and MIRCERA ®. In February 2012, we sold all of our rights to receive future royalty payments on CIMZIA ® and MIRCERA® effective for all periods from January 1, 2012 through the life of the royalty obligation. As described in Note 7 to our Consolidated Financial Statements, this royalty sale transaction has been recorded as a liability that amortizes over the estimated royalty payment period. As a result of this liability accounting, even though the royalties from UCB and Roche are remitted directly to the purchaser, we will continue to record revenue for these royalties. During the year ended December 31, 2012, we recognized $13.5 million in aggregate royalties from net sales of CIMZIA® and MIRCERA®, of which the $2.7 million recognized in the three months ended March 31, 2012 was retained by us as these amounts resulted from product sales in the fourth quarter of 2011 and the $10.8 million recognized in the nine months ended December 31, 2012 was remitted directly to the purchaser as these amounts resulted from product sales in the first three quarters of 2012. We expect non cash royalties from net sales of CIMZIA® and MIRCERA® to increase in 2013 as compared to 2012.

License, collaboration and other revenue

License, collaboration and other revenue includes amortization of upfront payments and milestone payments received in connection with our license and collaboration agreements and reimbursed research and development expenses. The level of license, collaboration and other revenue depends in part upon the estimated amortization period of the upfront payments, the achievement of milestones, the continuation of existing collaborations, the amount of reimbursed research and development work, and entering into new collaboration agreements, if any. License, collaboration and other revenue for the year ended December 31, 2012 decreased compared to the year ended December 31, 2011 primarily due to the recognition in 2011 of a $5.0 million license fee from an agreement signed in September 2011.

License, collaboration and other revenue for the year ended December 31, 2011 decreased compared to the year ended December 31, 2010 primarily due to the complete recognition as of December 31, 2010 of the $125.0 million upfront payment received in the fourth quarter of 2009 from AstraZeneca in connection with the global license agreement for naloxegol (formerly known as NKTR-118) and naloxegol fixed-dose combination program (formerly known as NKTR-119) This decrease was partially offset by the recognition of the $5.0 million license fee noted above, $6.0 million in milestones earned under existing collaboration agreements, and increases in revenue recognized in 2011 from upfront payments received by us during 2010.

We expect license, collaboration and other revenue in 2013 to increase as compared to 2012 primarily as a result of the recognition of milestones under existing collaboration agreements. In the event regulatory approval filings for naloxegol are submitted by AstraZeneca and accepted by the FDA and by the EMA, we would be entitled to $95.0 million in milestone payments. If these filings occur in 2013, our license, collaboration and other revenue in 2013 will increase significantly from 2012.

The timing and future success of our drug development programs and those of our collaboration partners are subject to a number of risks and uncertainties. See "Part I, Item 1A - Risk Factors" for discussion of the risks associated with the complex nature of our collaboration agreements.

Revenue by geography

Revenue by geographic area is based on locations of our partners. The following table sets forth revenue by geographic area (in thousands):

                                            Year Ended December 31,
                                        2012         2011         2010
                 United States        $ 34,591     $ 37,896     $  29,636
                 European countries     46,600       33,584       129,403

                 Total revenue        $ 81,191     $ 71,480     $ 159,039

The increase in revenue attributable to European countries for the year ended December 31, 2012 compared to the year ended December 31, 2011 is primarily attributable to increased product sales and royalty revenues from our existing European collaboration partners. The decrease in revenue attributable to European countries for the year ended December 31, 2011 compared to the year ended December 31, 2010 is primarily attributable to the revenue we recognized in 2010 from the AstraZeneca license agreement.

Cost of goods sold (in thousands, except percentages)

                                                                                                                 Percentage         Percentage
                                                                            Increase/         Increase/          Increase/          Increase/
                                                                            (Decrease)        (Decrease)         (Decrease)         (Decrease)
                                     Year Ended December 31,                 2012 vs.          2011 vs.           2012 vs.           2011 vs.
                                2012           2011           2010             2011              2010               2011               2010
Cost of goods sold            $ 30,428       $ 21,891       $ 25,667       $      8,537      $     (3,776 )               39 %              (15 )%
Product gross profit             4,971          2,973          1,745              1,998             1,228                 67 %               70 %
Product gross margin                14 %           12 %            6 %

Cost of goods sold increased during the year ended December 31, 2012 compared to the year ended December 31, 2011 primarily due to the $10.5 million increase in product sales in 2012. The increase in product gross margin during the year ended December 31, 2012 compared to the year ended December 31, 2011 is primarily due to the decreased cost per unit in 2012 resulting from increased manufacturing activity, resulting in improved overhead absorption.

The decrease in cost of goods sold during the year ended December 31, 2011 compared to the year ended December 31, 2010 is primarily due to the $2.5 million decrease in product sales in 2011 and an increase in overall commercial and proprietary manufacturing activity in 2011 compared to 2010 that resulted in decreased costs per unit. The increase in product gross margin during the year ended December 31, 2011 compared to the year ended December 31, 2010 is primarily due to the different mix of products sold and the decreased costs per unit in 2011 resulting from increased manufacturing activity.

We expect product gross margin to fluctuate in future periods depending on the level and mix of manufacturing orders from our customers due to the fixed cost base associated with our manufacturing activities.

Research and development expense (in thousands, except percentages)

                                                                                                                Percentage        Percentage
                                                                              Increase/        Increase/        Increase/         Increase/
                                                                              (Decrease)       (Decrease)       (Decrease)        (Decrease)
                                          Year Ended December 31,              2012 vs.         2011 vs.         2012 vs.          2011 vs.
                                     2012          2011          2010            2011             2010             2011              2010

Research and development expense consists primarily of personnel costs (including salaries, benefits, and stock-based compensation), clinical study costs, direct costs of outside research conducted by clinical research organizations, materials, supplies, licenses and fees. Research and development expense also includes certain overhead allocations consisting of various support and facilities related costs.

The increase in research and development expense for the year ended December 31, 2012 compared to the year ended December 31, 2011 is primarily attributable to the $15.2 million increase in direct research and development program costs, a substantial portion of which is attributable to the etirinotecan pegol (NKTR-102) Phase 3 BEACON clinical study initiated in December 2011 as well as the NKTR-181 Phase 2 clinical study initiated in July 2012. In addition, research and development expense increased due to a $6.2 million increase in salaries and employee benefits resulting from increased headcount to support our expanded clinical development activities.

The increase in research and development expense for the year ended December 31, 2011 compared to the year ended December 31, 2010 is primarily attributable to a $7.5 million increase in direct research and development program and materials costs, a $3.0 million increase in salaries and employee benefits, and a $6.3 million increase in support and facilities-related costs, which includes increased non-cash depreciation and non-cash rent expenses related to the move to our facility in the Mission Bay Area of San Francisco, California (Mission Bay Facility) at the end of 2010.

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