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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

or

o     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission File Number 001-33213

AFFYMAX, INC.

(Exact name of registrant as specified in its charter)

4001 Miranda Avenue
Palo Alto,  CA 94304
(650) 812-8700

(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

As of October 31, 2011, 35,730,339 shares of the registrant’s common stock, $0.001 par value, were outstanding.

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AFFYMAX, INC
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PART I—FINANCIAL INFORMATION

Item 1.                          Financial Statements

AFFYMAX, INC.

CONDENSED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of these condensed financial statements.

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AFFYMAX, INC.

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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AFFYMAX, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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AFFYMAX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1.                  The Company

Affymax, Inc., a Delaware corporation, was incorporated on July 20, 2001. We are a biopharmaceutical company committed to developing novel drugs to improve the treatment of serious and often life-threatening conditions. We completed Phase 3 clinical trials of our product candidate, peginesatide (Hematide™), to treat anemia associated with chronic kidney disease in early 2010.  In May 2011, we submitted our New Drug Application, or NDA, to the U.S. Food and Drug Administration, or FDA, seeking approval for peginesatide to treat adult dialysis patients with anemia associated with chronic kidney disease.  Our NDA is currently under review with the FDA, with an action date of March 27, 2012 under the Prescription Drug User Fee Act.  Peginesatide is a synthetic peptide-based erythropoiesis stimulating agent, or ESA, designed to stimulate production of red blood cells.

2.                 Summary of Significant Accounting Policies

Basis of Presentation

Our accompanying condensed financial statements have been prepared following the requirements of the Securities and Exchange Commission, or SEC, for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. generally accepted accounting principles, or GAAP, have been condensed or omitted. The condensed financial statements are unaudited and reflect all adjustments, consisting of only normal recurring adjustments, which in the opinion of management, are necessary to fairly state the financial position at, and the results of operations and cash flows for, the interim periods presented.  The financial information included herein should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010, which includes our audited financial statements and the notes thereto.

Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in the condensed financial statements and accompanying notes may not be indicative of the results for the full year or any future period.

Comprehensive Loss

Comprehensive loss consists of net loss plus the change in unrealized gains and losses on investments. At each balance sheet date presented, our accumulated other comprehensive income (loss) consists solely of unrealized gains and losses on investments. Comprehensive loss for the three and nine months ended September 30, 2011 and 2010 are as follows (in thousands):

Concentration of Risk and Uncertainties

Financial instruments that potentially subject us to a concentration of credit risk consist of cash, cash equivalents and investments. We deposit excess cash in accounts with two major financial institutions in the U.S. Deposits in these banks may exceed the amount of insurance provided on such deposits. We have not experienced any realized losses on our deposits of cash and cash equivalents.

We have experienced significant operating losses since inception. At September 30, 2011, we had an accumulated deficit of $420.9 million. We have generated no revenue from product sales to date. We have funded our operations to date principally from the sale of equity securities, upfront license fees, milestone payments and

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reimbursement for development and commercial expenses and manufacturing costs  under our collaboration agreements with Takeda Pharmaceutical Company Limited, or Takeda, operating and capital lease financing, interest earned on investments and limited license fees and royalties from licensing intellectual property.  We expect to incur substantial losses in the future and may need to obtain additional financing in order to complete the development and commercialization of peginesatide. There can be no assurance that such financing will be available or will be at terms acceptable to us.

As of September 30, 2011, we have an accounts receivable balance with Takeda of $5.5 million under the terms of our two separate collaboration agreements, or together, the Arrangement, with Takeda.  This receivable was comprised of the amounts due from Takeda for the reimbursement of development and commercial expenses we incurred during the third quarter of 2011 partially offset by amounts due to Takeda for reimbursement of development and commercial expenses they incurred during the same quarter.   As of December 31, 2010, we had an accounts payable balance due to Takeda of $6.0 million under the Arrangement.  This balance due to Takeda was primarily due to a change in estimate to our clinical trial accrual and related expense in the fourth quarter of 2010, partially offset by amounts due from Takeda for the reimbursement of development and commercial expenses we incurred.  We have not experienced any credit losses from our Arrangement with Takeda and do not expect any.  We do not require collateral on our receivable.

We are currently developing our first product offering, peginesatide, and have no products that have received regulatory approval.  Peginesatide will require approval from the FDA, and/or foreign regulatory agencies prior to commercial sales. There can be no assurance that peginesatide will receive the necessary approvals. If we are denied such approvals or such approvals are delayed, it would have a material adverse effect on us. To achieve profitable operations, we must successfully develop, test, manufacture and commercialize peginesatide. There can be no assurance that peginesatide can be developed successfully or manufactured at an acceptable cost and with appropriate performance characteristics, or that peginesatide will be successfully commercialized. These factors could have a material adverse effect on our future financial results.

Further, some of our suppliers and manufacturing arrangements, including the provision of bulk poly(ethylene) glycol reagent for the manufacture of peginesatide from Nektar Therapeutics AL, Corporation are currently single-sourced, leaving us at greater risk of supply interruptions and potential delays.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Investments

Investments are classified as available-for-sale and are carried at their fair market value based upon quoted market prices for these or similar instruments at the balance sheet date. Unrealized gains and losses are reported as a separate component of stockholders’ equity until realized. The amortized cost of these securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization as well as realized gains and losses are included in interest income. We assess our investments for potential other-than-temporary impairment based on factors including the length of time and extent to which the fair market value has been below our cost basis, the current financial condition of the investee and our intent and ability to hold the investment for a sufficient period of time to allow for any anticipated recovery in market value. If we conclude that an other-than-temporary impairment exists, we recognize an impairment charge to reduce the investment to fair value and record the related charge as a reduction of interest to other income (expense), net. We have elected to use settlement date accounting for purposes of recording transactions.

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Revenue Recognition

Collaboration Revenue

We recognize revenue in accordance with the SEC Staff Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104, Revision of Topic 13 and Accounting Standards Codification, or ASC, 605-25, Multiple Element Arrangements.  When evaluating multiple element arrangements, we consider whether the components of the arrangement represent separate units of accounting as defined in the authoritative guidance for revenue arrangements with multiple deliverables. Application of this guidance requires subjective determinations and requires management to make judgments about the fair value of the individual elements and whether such elements are separable from the other aspects of the contractual relationship.

On January 1, 2011, we adopted Accounting Standards Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements. This update amends the guidance on accounting for arrangements with multiple deliverables to require that each deliverable be evaluated to determine whether it qualifies as a separate unit of accounting.  This determination is generally based on whether the deliverable has stand-alone value to the customer.  This update also establishes a selling price hierarchy for determining how to allocate arrangement consideration to identified units of accounting.  The selling price used for each unit of accounting will be based on vendor-specific objective evidence, or VSOE, if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third-party evidence is available.  We may be required to exercise considerable judgment in determining whether a deliverable is a separate unit of accounting and the estimated selling price of identified units of accounting for new agreements.  The adoption of ASU No.2009-13 did not impact our financial position or results of operations as of and for the nine month period ended September 30, 2011. The potential future impact of the adoption of this update will depend on the nature of any new arrangements or material modifications of existing arrangements that we enter into in the future.

During the development period under the Arrangement, which ended in May 2011, upon submission of our NDA to the FDA, we recognized collaboration revenue using Contingency Adjusted Performance Model, or CAPM. Under CAPM, revenue was eligible for recognition in the period the payment was earned under the Arrangement including amounts that were either received or due from Takeda. Revenue initially recognized was based on the percentage of time elapsed from inception of the Arrangement in June 2006 to the period in which the payment was earned in relation to the total projected development period. The remaining portion of the payment was then recognized on a straight-line basis over the remaining estimated duration of the development period of the Arrangement.  Payments during the development period included amounts due for upfront license fees, milestone payments earned, purchases of active pharmaceutical ingredient or API and reimbursement of development expenses.  Our obligations under the agreement consisted primarily of  actively developing our product candidate, peginesatide, for the treatment of anemia for chronic kidney disease through the end of the development period which occurred upon our submission of our NDA.

Beginning in June 2011, we have moved into the commercialization period as defined under our Arrangement with Takeda. Per the Arrangement, this includes all activities undertaken before and after regulatory approval relating specifically to pre-marketing, launch, promotions, marketing, sale and distribution of peginesatide.  Prior to approval of the product and commencement of profit sharing payments, our primary source of revenue in the commercialization period will likely consist of reimbursement of ongoing efforts related to regulatory activities for FDA approval of peginesatide and commercial activities in preparation of the launch of our product.   The Arrangement provides us with multiple payment streams, including reimbursement of third party development and commercialization expenses, reimbursement of expenses for full-time employee equivalent or FTE services related to commercialization (which commenced on July 1 2011), the potential to earn at risk milestone payments upon achievement of contractual criteria and profit sharing payments subsequent to product launch if approved.  During the commercialization period, our obligations include ongoing regulatory work to obtain FDA approval and commercial efforts related to our product launch.

Where there are multiple deliverables combined as a single unit of accounting, revenues are deferred and recognized over the period that we remain obligated to perform services. The specific methodology for the recognition of the revenue (e.g., straight-line or according to specific performance criteria) is determined on a case-by-case basis according to the facts and circumstances applicable in the Arrangement.

During the commercialization period of the Arrangement, for each source of collaboration revenue, we apply the following revenue recognition criteria:

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·                  Revenues related to reimbursement by Takeda of third-party development expenses (70/30 split per the Arrangement) and commercial expenses (shared equally 50/50 per the Arrangement) are recognized as revenue, in the period incurred.

·                  Revenues related to reimbursement of costs of FTEs engaged in commercial activities are recognized as revenue in the period incurred. Such reimbursement is based on contractually negotiated reimbursement rates for each FTE as specified in the Arrangement.

·                  Revenue resulting from a milestone payment that is contingent upon the achievement of a substantive event or milestone is recognized in its entirety in the period in which the milestone is achieved and collectability is assured. A milestone is an event (i) that can only be achieved based in whole or in part on either our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there is substantive uncertainty at the date the Arrangement is entered into that the event will be achieved and (iii) results in additional payments being due to us. Milestones are considered substantive when the consideration earned from the achievement of the milestone (i) is commensurate with either our performance to achieve the milestone or the enhancement of value of the item delivered as a result of a specific outcome resulting from our performance; (ii) relates solely to past performance and (iii) is reasonable relative to all deliverable and payment terms in the Arrangement.

·                  Other payments received, such as payments due under the launch allowance (see Note 8 in the Notes to Condensed Financial Statements), for which such payments are contingent solely upon future events are recognized as revenue when earned in accordance with the contract terms and when such payments can be reasonably estimated and collectability is reasonably assured.

We account for milestones under ASU 2010-17, Milestone Method of Revenue Recognition. Under the milestone method, contingent consideration received from the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved, which we believe is more consistent with the substance of our performance under our collaboration agreement. A milestone is defined as an event (i) that can only be achieved based in whole or in part on either the entity’s performance or on the occurrence of a specific outcome resulting from the entity’s performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved, and (iii) that would result in additional payments being due to the entity. A milestone is substantive if the consideration earned from the achievement of the milestone is consistent with our performance required to achieve the milestone or the increase in value to the collaboration resulting from our performance, relates solely to our past performance, and is reasonable relative to all of the other deliverables and payments within the arrangement.

License and Royalty Revenue

Royalties are recognized as earned in accordance with contract terms, when third party results are reported and collectability is reasonably assured.  Royalties received under agreements that were acquired by us in the 2001 spin out from GlaxoSmithKline, or Glaxo, are recorded net of the 50% that we are required to remit to Glaxo.

Clinical Trial Expense and Accruals

We record expense for estimated clinical study external costs, which until 2011, were a significant component of research and development, or R&D, expense. These clinical trial costs were $(1.1) million and $3.1 million during the three months ended September 30, 2011 and 2010, respectively, and $0.3 million and $26.3 million for the nine months ended September 30, 2011 and 2010, respectively. Clinical trials are administered by clinical research organizations, or CROs. CROs typically perform most of the total start-up activities for the trials, including document preparation, site identification pre-study visits, training as well as on-going program management. For the Phase 3 studies, which represented the vast majority of the clinical trial expense, the expense recorded is based on reporting received from CROs and internal analyses. We accrue costs for work performed by CROs based on the achievement of contracted activities during the period. Expense for investigator fees, which include patient costs, is based on internal estimates of activities using patient enrollment and contractual or estimated rates. For the Phase 2 studies, the expense is activities-based such as patient monitoring as reported by the CROs and achievement of milestones. Other costs such as testing and drug materials are expensed as incurred. For all studies, CRO reporting is reviewed by us for appropriateness.

During Q3 2011 we have been working with our CROs on final close-out activities regarding site billings for investigator grants on our Phase 3 trials.  We recently received notification from one of our CROs that they had completed their close-out work and they provided the final amounts due relating to work performed on our Phase 3 studies for which they were responsible.  As a result of this new information, we recorded a change in estimate to decrease our clinical trial accruals for these trials.  As a result, we reversed $1.4 million of clinical trial accrual in the third quarter of 2011.  In addition, as a result of the conclusion of negotiations with our CROs on various billing disputes, we further reduced our clinical trial accrual by $0.7 million as the ultimate settlement was more favorable than our initial estimates. The aggregate change in estimate during the period decreased expense by $2.1 million for the three months ended September 30, 2011.

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Additional changes in estimate or adjustments may result as the final trial close-out audits and fee negotiations are completed relating to our clinical trials which could impact R&D expense, collaboration revenues and amounts due to or from Takeda in subsequent periods.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board or FASB, issued ASU No. 2011-05, which is an update to Topic 220, Presentation Of Comprehensive Income. This update amends current comprehensive income guidance and eliminates the option of presenting the components of other comprehensive income as part of the statement of stockholders’ equity.  This update presents an entity with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The amendments in this update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The new guidance was originally proposed to be effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and applied retrospectively. In October 2011, the FASB proposed to defer the effective date of certain provisions in the guidance related to the presentation of reclassification adjustments. No effective date has been announced. As ASU No. 2011-05 relates only to the presentation of comprehensive income, we do not expect that the adoption of this update will have a material effect on our financial statements.

In May 2011, the FASB issued ASU No. 2011-04, which is an update to Topic 820, Fair Value Measurement. This update establishes common requirements for measuring fair value and related disclosures in accordance with GAAP and international financial reporting standards. This amendment did not require additional fair value measurements. ASU No. 2011-04 is effective for all interim and annual reporting periods beginning after December 15, 2011. We do not believe there will be a significant impact on our financial statements from the adoption of ASU No. 2011-04

Net Loss Per Common Share

Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period.

Diluted net loss per share is computed similarly to basic net loss per share, except that the denominator is increased to include all dilutive potential common shares using the treasury stock method.  For purposes of this calculation, options to purchase common stock, common stock issuable pursuant to the 2006 Employee Stock Purchase Plan, restricted stock units and warrants are considered to be potential common shares and are only included in the calculation of diluted loss per share when their effect is dilutive. The computations for basic and diluted net loss per share were as follows (in thousands):

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The following shares were excluded from the computation of diluted net loss per common share for the periods presented because including them would have an antidilutive effect (in thousands):

3.                 Stock-Based Compensation

During the quarter ended September 30, 2011, we granted 403,124 stock options and 113,356 RSUs to our employees and board of directors with a weighted average grant date fair value of $4.44 and $7.04 per share, respectively.  The stock options generally vest over a four year period and the RSUs vest annually over a three year period.

We measure and recognize all stock-based compensation expense under the authoritative guidance for share-based payments.

Stock-based compensation was recorded in the condensed statements of operations as follows (in thousands):

Included in the amounts in the table above for the nine months ended September 30, 2011 are compensation costs related to the January 31, 2011 resignation of our former Chief Executive Officer, Arlene M. Morris. Under the terms of Ms. Morris’ separation agreement, consistent with her 2008 employment agreement, she has a post-termination exercise period for vested stock options ending on the earlier of one year following the date of termination or the expiration of the option. As part of the separation agreement, Ms. Morris is obligated to provide consulting services through September 30, 2011.  Effective upon her resignation, Ms. Morris’ status changed from an employee to a consultant and her options and awards continued to vest until the end of her consulting arrangement in September 2011.  In accordance with ASC 718, Shared Based Payments, we recorded $268,000 of stock-based compensation expense related to her separation and consulting arrangement during the quarter ended March 31, 2011.  Given the nature of the consulting agreement, all costs were accrued and expensed in the quarter ended March 31, 2011.

In March 2011, our board of directors approved an amendment to our 2006 Equity Incentive Plan to extend the post-termination exercise period from 90 days to two years for non-employee board members’ options vested as of such director’s termination date. No other terms of the awards were modified. This amendment applies to all existing and future option grants to non-employee board members.

As of September 30, 2011, unrecognized compensation costs related to employee and director stock options and restricted stock units totaled $16.0 million. The cost is expected to be recognized over a weighted-average amortization period of 2.7 years.

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4.                 Investments

The following is a summary of our available-for-sale marketable securities (in thousands):

Investments held at September 30, 2011 mature between October 2011 and August 2012.

5.                 Fair Value Measurements

We measure certain financial assets at fair value on a recurring basis, including cash equivalents and available for sale securities.  The fair value of these assets was determined based on a three-tier hierarchy under the authoritative guidance for fair value measurements and disclosures that prioritizes the inputs used in measuring fair value as follows:

·                  Level 1 — observable inputs such as quoted prices in active markets.

·                  Level 2 — inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data.

·                  Level 3 — unobservable inputs in which there is little or no market data, which would require us to develop our own assumptions.

Our cash equivalents and investments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices in active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of investments that are generally classified within Level 1 of the fair value hierarchy include money market securities. The valuation technique we used to measure fair value of our Level 1 money market securities is a market approach, using prices and other relevant information generated by market transactions involving identical securities.  The types of investments that are generally classified within Level 2 of the fair value hierarchy include corporate securities, certificates of deposits and U.S. government securities.  The valuation technique we used to measure fair value of our Level 2 investments is a market approach, which we review trading activity and pricing for these investments as of the measurement date. When sufficient quoted pricing for identical investments was not available, we used market pricing and other observable market inputs for similar investments obtained from various third party data providers. These inputs

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represent quoted prices for similar investments in active markets or these inputs have been derived from observable market data.

The following table presents our investments measured at fair value on a recurring basis classified by the fair value measurements and disclosures valuation hierarchy (in thousands):

We held investments in auction rate securities or ARS and UBS AG of Series C-2 ARS Rights, or ARS Rights during the quarter ended June 30, 2010, which were classified within Level 3 of the fair value hierarchy because of the lack of observable inputs. The valuation technique we used to measure fair value of our Level 3 ARS and ARS Rights was an income approach and we used a discounted cash flow analysis.  As of September 30, 2011 and December 31, 2010, we no longer hold ARS or ARS Rights as these investments were fully redeemed or sold in 2010.

The following table presents changes in Level 3 investments measured at fair value on a recurring basis for the nine months ended September 30, 2011 and 2010 (in thousands):

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Upon the sale and redemptions of our ARS during 2010, we recognized a realized loss of $158,000 for the nine months ended September 20, 2010.  The fair value of our ARS Rights was decreased by $604,000 for the nine months ended September 30, 2010 and this reduction was recorded as a charge to other income (expense), net.   We also reversed other-than-temporary impairment charges of $695,000 during that period.

6.                UBS Loan

In connection with the settlement with UBS AG relating to our ARS, we entered into a loan agreement with UBS Financial Services, Inc., an affiliate of UBS AG, and we obtained a loan of approximately $9.2 million in December 2009.  This “no net cost” loan bore interest at a rate not to exceed the average rate of interest paid on the pledged ARS. For the three and nine months ended September 30, 2010, we paid $2,000 and $56,000 of interest expense associated with the loan, respectively and received $6,000 and $150,000 in interest income from the collateralized ARS, respectively. As required by UBS, for the nine months ended September 30, 2010, we applied the net interest earned of $94,000 and $9.1 million from the sales and redemptions of ARS to the principal of the loan. As part of our redemption of ARS Rights in July 2010, we repaid our outstanding loan balance.

7.                 Commitments and Contingencies

In October 2010, the arbitration panel in our binding arbitration with certain subsidiaries of Johnson & Johnson Pharmaceutical Research & Development, L.L.C. and Ortho-McNeil Pharmaceutical, Inc., or J&J, decided the ownership of a number of U.S. and international patents and patent applications related to certain erythropoietin receptor agonists, or collectively the “intellectual property in dispute.”  The decision maintained J&J’s sole inventorship and sole ownership of U.S. Patent No. 5,767,078, or the ‘078 Patent, and certain related foreign patents and patent applications, including European Patent application EP96/918,317. The arbitrators determined that we and J&J jointly own the remainder of the intellectual property in dispute.

In November 2010, we filed in the U.S. District Court for the Northern District of Illinois, or District Court, a motion to vacate the arbitration award with respect to the ownership of the ‘078 Patent and related foreign cases.  In December 2010, J&J filed its response and requested that the court confirm the arbitration award.

In March 2011, the District Court issued its decision to vacate in part the arbitrators’ award relating to sole ownership by J&J of the European Patent EP96/918,317 and other foreign counterpart patents and patent applications to the ‘078 Patent. As a consequence, the District Court remanded the issues of inventorship and ownership of such foreign patents and patent applications to the arbitration panel. The District Court denied our motion to vacate in part and maintained the arbitration award with respect to the sole ownership by J&J of the ‘078 Patent in the U.S. In May 2011, we filed a notice of appeal relating to the District Court’s decision as to the ‘078 Patent in the U.S. which remains pending with the Court of Appeals for the Federal Circuit. Concurrently, J&J filed an appeal with the Seventh Circuit Court of Appeals, and in October 2011, the Seventh Circuit Court reversed the District Court with the result that it remanded with instruction to confirm the arbitration award in full and set forth its view that the Court of Appeals for the Federal Circuit lacked jurisdiction.

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In November 2011, we entered into a settlement agreement with J&J. or Settlement Agreement, under which we obtain a non-exclusive license to the intellectual property in dispute, a covenant not to sue and a release of all claims associated with the arbitration and dispute. The Settlement Agreement also provides for the dismissal of all pending proceedings.

The Settlement Agreement provides for upfront payments by us to J&J of $6 million within 30 days of execution thereof, $2 million by June 30, 2012, a $2.5 million milestone payment upon FDA regulatory approval of peginesatide, and a $2.5 million milestone payment upon regulatory approval of peginesatide in the first major European country. In addition, we pay royalties to J&J on sales of peginesatide in Europe, Japan and certain other countries outside of the United States until mid-2016.

Concurrent with the execution of the Settlement Agreement, we and Takeda entered into an amendment to the Arrangement in connection with the above settlement payments to J&J, pursuant to which Takeda will reimburse us up to 50% of upfront and milestone payments to J&J or $6.5 million in total contingent upon the accomplishment of certain milestones related to peginesatide regulatory approvals and commercial events. We are solely responsible for the royalty payment to J&J.

8.                 Development and Commercialization Agreements with Takeda

We entered into two separate collaboration agreements with Takeda, which have been combined for accounting purposes due to their proximity of negotiation. Consideration from these collaboration agreements includes nonrefundable upfront license fees, reimbursement for sales of API, clinical and regulatory milestone payments, reimbursement of third party U.S. clinical development expenses, product profit share revenues (as co-promotion revenues) and royalties.

In February 2006, we granted an exclusive license to Takeda for development and commercialization of peginesatide in Japan. Pursuant to this agreement, Takeda has paid us approximately $42 million to date, consisting of $17 million in upfront licensing fees, approximately $10 million for the purchase of equity, a $10 million cash milestone payment for the completion of the first Phase 1 trial of peginesatide in Japan, and in March 2010, a $5 million cash milestone payment for the initiation of Phase 3 trial of peginesatide in Japan. In the event of Takeda’s successful achievement of clinical development and regulatory milestones, we would be eligible to receive from Takeda up to an additional aggregate of $33 million relating to the renal program. Takeda is responsible for all development and commercialization costs in Japan and will purchase the API for peginesatide from us.  In the event peginesatide is approved and launched in Japan, we would receive a royalty from Takeda on peginesatide sales in Japan.

In June 2006, we expanded our collaboration with Takeda to develop and commercialize peginesatide worldwide, which includes the co-development and co-commercialization of peginesatide in the U.S. Takeda received an exclusive license to develop and commercialize peginesatide outside of the U.S. During the development period of the collaboration, beginning January 1, 2007, Takeda was responsible for the first $50 million of third party expenses related to development in pursuit of U.S. regulatory approval of peginesatide, which was fully utilized through the first quarter of 2008. Thereafter, Takeda has borne 70% of the third party U.S. development expenses while we have been responsible for 30% of third party expenses. We retain responsibility for 100% of our internal development expenses, most notably employee-related expenses.

During the commercialization period, which commenced upon submission of our NDA to the FDA, Takeda will continue to bear responsibility for 70% of all third-party expenses related to U.S. development and 50% of all third party expenses related to the commercialization of peginesatide in the U.S.  However, during the commercialization period, certain internal employee-related expenses supporting preparation for commercialization of peginesatide in the U.S. are also shared equally.  By mutual agreement of the parties, the equal sharing of certain FTE expenses commenced July 1, 2011.

Per the terms of the Arrangement, we are also entitled to a launch allowance to help fund the initial costs associated with preparing to launch the product in the U.S.   Under the terms of the launch allowance, Takeda is responsible for 100% of the first $20 million of U.S. commercial expenses, whether third-party costs or employee-related expenses, as opposed to the 50% for which they would otherwise be responsible.  The costs that they bear on our behalf (up to $10 million) as a result of this launch allowance is non-refundable; however, in the event the product is approved for sale in the U.S., Takeda is entitled to deduct up to 8% of net sales from the profit share each period until they have recouped an amount equal to $11 million.  As a result of the potential reductions in profit sharing post-launch stemming from the launch allowance, we have reflected amounts we receive under the terms of

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the launch allowance as a liability on our condensed balance sheets.  As of September 30, 2011, we have received $2.8 million of benefit as a result of the launch allowance, which is reflected in the caption “Advance from Takeda” in the condensed balance sheets.  In the event our product is ultimately approved, we would expect to recognize the amounts being deferred as collaboration revenue as Takeda takes deductions from net sales in recoupment of the launch allowance.

Under the June 2006 agreement, Takeda paid us an upfront license fee of $105 million, and we have received milestone payments upon completion of database lock of the Phase 3 clinical trials of $30 million for dialysis and non-dialysis.  In addition, we earned a $10 million milestone in July 2011, as a result of the FDA acceptance for review of our NDA, which was deemed to be at risk and recognized immediately upon achievement of the milestone.  Further, upon the successful achievement of clinical development and regulatory milestones, we are eligible to receive from Takeda an additional aggregate of $75 million relating to the renal program, including a $50 million milestone payment upon approval by the FDA in the dialysis indication. We and Takeda will share equally in the net profits and losses of peginesatide in the U.S., which include expenses related to the marketing and launch of peginesatide.

The Arrangement establishes a joint steering committee to oversee the development, regulatory approval and commercialization of peginesatide.  We share responsibility with Takeda for clinical development activities required for U.S. regulatory approval of peginesatide. Specifically, we have primary responsibility for peginesatide’s clinical development plan and clinical trials in the dialysis indication, and the non-dialysis indication to the extent of any further development, while Takeda has primary responsibility in the chemotherapy induced anemia and anemia of cancer indications to the extent any such indication is developed. We and Takeda have agreed to suspend the development of peginesatide to treat chemotherapy-induced anemia as well as anemia in chronic kidney disease patients not on dialysis and to focus all development efforts for peginesatide in the U.S. on the treatment of chronic kidney disease anemia in dialysis patients. We are responsible for U.S. regulatory filings in the dialysis and any other indications we pursue, including holding the NDAs for those indications. Takeda is responsible for regulatory filings outside the U.S. and the creation of a global safety database.

Takeda will have primary responsibility and bear all costs for peginesatide clinical development in support of regulatory approval and commercialization activities for all territories outside the U.S either directly or through sublicensees and will pay us a variable royalty based on annual net sales of peginesatide outside the U.S.

We are also responsible for the manufacture and supply of all quantities of API to be used in the development and commercialization of peginesatide worldwide. Takeda is responsible for the fill and finish steps in the manufacture of peginesatide worldwide.

We and Takeda will jointly develop the initial commercial marketing plan for peginesatide in the U.S. pursuant to which we and Takeda will divide peginesatide promotional responsibilities in the U.S. We and Takeda will jointly decide on promotional responsibility for markets outside of these initial indications if any.

Under the February 2006 agreement, Takeda also obtained a right of first negotiation to certain backup products for peginesatide developed by us or our third party partners. Specifically, during the first 10 years of the agreement, if we or third party partners develop a product that advances to Phase 2 clinical trials and competes with peginesatide in the renal or oncology indications, we are obligated to offer to Takeda the right to develop and commercialize such product in Japan before offering the product opportunity in Japan to any other third party.

We recognized $13.2 million and $16.8 million of collaboration revenue in the quarters ended September 30, 2011 and 2010, respectively and $44.0 million and $105.8 million for the nine months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, we have a net receivable balance from Takeda of $5.5 million that is reflected on the accompanying condensed balance sheet under the caption Receivable from Takeda.

In July 2011, as a result of the FDA acceptance of our NDA for review, we earned a $10 million milestone payment from Takeda which we recorded as collaboration revenue during the quarter ended September 30, 2011.  Going forward, we expect collaboration revenue to be directly affected by milestone payments and expenses that are eligible for reimbursement from Takeda under the Arrangement in future periods.  We do not expect to recognize

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any revenue related to commercial product sales under our Arrangement with Takeda, and do not expect to recognize any product profit sharing until after the product is approved by the FDA.

In November 2011, as contemplated under our Arrangement, we and Takeda executed a Commercial API Supply Agreement which formalizes our respective responsibilities as it relates to the manufacture of peginesatide API by Affymax and the purchase of that API by Takeda for commercial manufacturing and sales of the product.  Under the terms of the Commercial API Supply Agreement, Takeda has agreed to pay an aggregate of $10.8 million in deposits against API shipments of existing inventory to be delivered by Affymax to Takeda, $7.2 million of which is payable in the fourth quarter of 2011.

In November 2011, concurrent with the execution of the Settlement Agreement, we and Takeda entered into an amendment to the Arrangement in connection with the above settlement payments to J&J, pursuant to which Takeda will reimburse us up to 50% of upfront and milestone payments to J&J or $6.5 million in total contingent upon the accomplishment of certain milestones related to peginesatide regulatory approvals and commercial events.

9.             Public Stock Offering

In March 2011, we completed the issuance and sale to the public of an aggregate of 9,745,762 shares of our common stock, par value $0.001 per share at $5.90 per share. We received net proceeds of approximately $53.6 million, after deducting underwriting discounts and commissions and offering expenses.

10.          Restructuring Charge

As a result of the May 2010 amendment to our operating lease, we took possession of approximately 16,000 square feet of additional office space adjacent to our corporate headquarters in Palo Alto, California in May 2011.  During the quarter ended June 30, 2011, management concluded that we would not occupy this additional office space, and we are actively seeking to sublease this space.  Given these plans and the fact that this space is adequately separable from our existing facilities, in the second quarter of 2011 we recorded a restructuring charge of $659,000, which represents the present value of the estimated future facility costs for which we will obtain no future economic benefit over the term of our lease, net of estimated future sublease income. The initial $659,000 charge, as well as $16,000 of accretion was recorded during the quarter ended June 30, 2011 in general and administrative or G&A expenses in the condensed statement of operations.

The estimates underlying the fair value of the lease-related restructuring liability involve significant assumptions regarding the time required to contract with a subtenant, the amount of space we may be able to sublease, the range of potential future sublease rates and the level of leasehold improvements expenditures that we may incur to sublease the property. We have evaluated a number of potential sublease scenarios with differing assumptions and have probability weighted these scenarios and calculated the present value of cash flows based on management’s judgment.  We will continue to monitor and update the liability balance when future events impact our cash flow estimates related to this excess space.

In August 2011, we initiated a restructuring plan to lower annual operating expenses that included a planned reduction in force of 22 positions.  As a result, we recorded a restructuring charge in the quarter ended September 30, 2011 of $698,000 related to severance and benefits, of which $655,000 was reflected as R&D expense and $43,000 as G&A expense in the condensed statement of operations.

The following table summarizes the accrual balance and utilization by type for the restructuring (in thousands):

The current portion of the total restructuring accrual balance is included in the caption “Accrued liabilities” and the non-current portion is included in the caption “Other long-term liabilities” in the condensed balance sheets.

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our audited financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2010 and our unaudited condensed financial statements for the nine month period ended September 30, 2011.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “intend”, “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions intended to identify forward-looking statements.  These forward-looking statements include, but are not limited to, statements regarding the timing, design and results of our clinical trials and drug development program and registration strategy, our ability to obtain and maintain regulatory approval of peginesatide (Hematide™) and any other product candidates we pursue, the continuation and success of our collaboration with Takeda Pharmaceutical Company Limited, or Takeda, collaboration revenue and payment streams during the commercialization period, including reimbursements of third party commercialization expenses, under our agreements with Takeda, the timing and likelihood of the commercialization of peginesatide and the size and potential of the commercial opportunity.  These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q under Item 1A “Risk Factors,” including risks relating to the approvability and comprehensiveness of the new drug application, risks relating to timing of and regulatory requirements for approvals, including the U.S. Food and Drug Administration’s, or FDA’s, interpretation and evaluation of the data from the Phase 3 studies of peginesatide, in particular with respect to the secondary analyses in the non-dialysis population, risks relating to data quality and integrity particularly in non-inferiority designed trials, risks related to the continued safety and efficacy of peginesatide in clinical development, the potential for once per month dosing and room temperature stability, the timing of patient accrual in ongoing and planned clinical trials, regulatory requirements and approvals, research and development efforts, the factors affecting the commercial potential of peginesatide, industry and competitive environment, controversy surrounding the class of erythropoiesis stimulating agents, reimbursement coverage, intellectual property rights and disputes and potential costs, disruptions and consequences of litigation, financing requirements and ability to access capital, and other matters.  Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Overview

We are a biopharmaceutical company committed to developing novel drugs to improve the treatment of serious and often life-threatening conditions. The New Drug Application, or NDA, for our product candidate, peginesatide for treatment of adult dialysis patients with anemia associated with chronic kidney disease is currently under review by the FDA.  Anemia is a serious condition in which blood is deficient in red blood cells and hemoglobin. It is common in patients with chronic kidney disease, cancer, heart failure, inflammatory diseases and other critical illnesses, as well as in the elderly. If left untreated, anemia may lead to chronic fatigue or increase the risk of other diseases or death. Currently recombinant EPO, or rEPO, is used to manage the anemia of dialysis, non-dialysis and

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cancer patients. Peginesatide is a synthetic peptide-based erythropoiesis stimulating agent, or ESA, designed to stimulate production of red blood cells. Peginesatide is designed to be longer acting than currently marketed ESAs in the U.S. and therefore has the potential to offer reduced cost and complexity for healthcare providers.

In late June 2010, we announced preliminary top-line results from our peginesatide Phase 3 clinical program for the treatment of patients with anemia associated with chronic kidney disease.  Our Phase 3 clinical program included four open-label, randomized controlled clinical trials. Of these trials, two trials, called PEARL 1 and PEARL 2, were conducted in non-dialysis patients and designed to evaluate the safety and efficacy of peginesatide compared to darbepoetin alfa to correct anemia and maintain hemoglobin in a corrected range over time. The other two trials, called EMERALD 1 and EMERALD 2, were conducted in dialysis patients and designed to evaluate the safety and efficacy of peginesatide and its ability to maintain hemoglobin levels in a corrected range compared to epoetin alpha or epoetin beta when switched to peginesatide. Analysis of efficacy and safety for all of the Phase 3 studies were based on primarily assessments of non-inferiority to the comparator drugs. The primary efficacy endpoint, the mean change in hemoglobin from baseline, in each of the four Phase 3 studies met the statistical criteria for non-inferiority. In addition, peginesatide met the statistical criterion for non-inferiority for the assessment of safety for the cardiovascular composite safety endpoint, or CSE, which was composed of death, stroke, myocardial infarction, congestive heart failure, unstable angina and arrhythmia from a pooled safety database across the four Phase 3 studies.  However, some differences were observed when secondary analyses were conducted as previously described in our Current Report on Form 8-K dated June 21, 2010.

In October 2010, we met with the FDA to discuss the regulatory path for peginesatide based on the initial analysis of the Phase 3 data.  Based on these discussions with the FDA, we submitted a  NDA, to the FDA, for treatment of anemia in chronic kidney disease patients on dialysis in May 2011.  In July 2011, the FDA accepted our submission and filed the NDA for review, with an action date of March 27, 2012 under the Prescription Drug User Fee Act.

Despite meeting the primary efficacy endpoints and the CSE for peginesatide, the differences observed in the Phase 3 secondary analyses present risks to our ability to obtain regulatory approval for peginesatide particularly in view of the heightened concerns surrounding safety of ESAs. Any negative perception of peginesatide’s safety relative to other ESAs would significantly reduce the likelihood of obtaining regulatory approval for peginesatide. The issues arising from the Phase 3 results have caused significant delay and may continue to negatively impact the timelines for development and the likelihood, scope or conditions surrounding regulatory approval.  Any or all of these factors may significantly reduce the ultimate commercial potential of peginesatide.

Effective January 31, 2011, our former Chief Executive Officer, Arlene M. Morris, resigned from her position as well as from our board of directors. As part of her separation agreement, Ms. Morris was obligated to provide consulting services through September 30, 2011.  Under the terms of her severance arrangement, she received severance benefits in the form of cash, reimbursement of COBRA premiums, continued vesting of existing stock-based awards until September 30, 2011, and additional time to exercise vested stock-based awards after September 30, 2011. We recorded $935,000 of expense in the quarter ended March 31, 2011 related to the severance and consulting arrangement with Ms. Morris. Given the nature of the consulting arrangement, all costs were accrued and expensed in the quarter ended March 31, 2011.

In March 2011, we sold an aggregate of 9,745,762 shares of our common stock to the public at $5.90 per share. We received net proceeds of approximately $53.6 million, after deducting underwriting discounts and commissions and offering expenses.

To date, we have not generated any product revenue. We have funded our operations primarily through the sale of equity securities, reimbursement for development expenses and active pharmaceutical ingredient, or API, production, license fees and milestone payments from collaborative partners, operating and capital lease financings, interest earned on investments and limited license fees and royalties from licensing intellectual property. As of September 30, 2011, we had an accumulated deficit of $420.9 million. Due to the recognition of revenues from milestone payments from our collaboration with Takeda, or the Arrangement, we were profitable in the three and six months ended June 30, 2010 and may have profitable quarters from time to time if we are successful in obtaining FDA approval for peginesatide. We continue to expect to incur substantial losses in order to complete the development and commercialization of peginesatide.

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We believe that our existing cash, cash equivalents and investments together with the interest thereon will enable us to maintain our currently planned operations for at least the next 12 months. However, further challenges or delays to approval and commercialization of peginesatide may require us to raise additional funding to complete the development and commercialization of peginesatide. Since the announcement of our Phase 3 data in late June 2010 and the arbitration decision in October 2010, we have experienced a severe decline in our stock price, which has impaired our ability to access capital on potentially favorable terms. In contrast, our funding needs have only increased as the peginesatide development program has suffered delays, the potential loss of milestone payments from Takeda associated with the non-dialysis indication and the potential for future legal proceedings and costs.  There can be no assurance we can raise the additional funds to support our continuing operations and maintain current regulatory timelines, and funding may not be available to us on acceptable terms, or at all.  Our failure to raise capital if and when needed may harm our business and operating results.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our condensed financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition and clinical development costs. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting policies and the use of estimates are consistent with those noted in our Annual Report on Form 10-K for the year ended December 31, 2010 except as noted below:

Revenue recognition

Collaboration Revenue

We recognize revenue in accordance with the Securities and Exchange Commission, or SEC, Staff Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104, Revision of Topic 13 and Accounting Standards Codification 605-25, Multiple Element Arrangements.  When evaluating multiple element arrangements, we consider whether the components of the arrangement represent separate units of accounting as defined in the authoritative guidance for revenue arrangements with multiple deliverables. Application of this guidance requires subjective determinations and requires management to make judgments about the fair value of the individual elements and whether such elements are separable from the other aspects of the contractual relationship.

On January 1, 2011, we adopted Accounting Standards Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements. This update amends the guidance on accounting for arrangements with multiple deliverables to require that each deliverable be evaluated to determine whether it qualifies as a separate unit of accounting.  This determination is generally based on whether the deliverable has stand-alone value to the customer.  This update also establishes a selling price hierarchy for determining how to allocate arrangement consideration to identified units of accounting.  The selling price used for each unit of accounting will be based on vendor-specific objective evidence, or VSOE, if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third-party evidence is available.  We may be required to exercise considerable judgment in determining whether a deliverable is a separate unit of accounting and the estimated selling price of identified units of accounting for new agreements.  The adoption of ASU No.2009-13 did not impact our financial position or results of operations as of and for the nine month period ended September 30, 2011. The potential future impact of the adoption of this update will depend on the nature of any new arrangements or material modifications of existing arrangements that we enter into in the future.

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During the development period under the Arrangement, which ended in May 2011 upon submission of our NDA to the FDA, we recognized collaboration revenue using Contingency Adjusted Performance Model, or CAPM. Under CAPM, revenue is eligible for recognition in the period the payment is earned under the Arrangement including amounts that are either received or due from Takeda. Revenue initially recognized is based on the percentage of time elapsed from inception of the Arrangement in June 2006 to the period in which the payment is earned in relation to the total projected development period. The remaining portion of the payment is then recognized on a straight-line basis over the remaining estimated duration of the development period of the Arrangement.  Payments during the development period included amounts due for upfront license fees, milestone payments earned, purchases of API and reimbursement of development expenses.  In exchange for these payments, we continued to actively develop our compound for the treatment of anemia for chronic kidney disease through the end of the development period which occurred upon our submission of our NDA,

Beginning in June 2011, we have moved into the commercialization period as defined under our Arrangement with Takeda.  Per the Arrangement, this includes all activities undertaken before and after regulatory approval relating specifically to pre-marketing, launch, promotions, marketing, sale and distribution of peginesatide. Prior to approval of the product and commencement of profit sharing payments, our primary source of revenue during the commercialization period will likely consists of reimbursement of ongoing development efforts related to regulatory activities for FDA approval of peginesatide and commercial activities in preparation of the launch of our product. The Arrangement provides us with multiple payment streams, including reimbursement of third party development and commercialization expenses, reimbursement of expenses for full-time employee equivalent or FTE services related to commercialization (which commenced on July 1, 2011) and the potential to earn at risk milestone payments upon achievement of contractual criteria.  During the commercialization period, our obligations include ongoing regulatory work to obtain FDA approval and commercial efforts related to our product launch.

Where there are multiple deliverables combined as a single unit of accounting, revenues are deferred and recognized over the period that we remain obligated to perform services. The specific methodology for the recognition of the revenue (e.g., straight-line or according to specific performance criteria) is determined on a case-by-case basis according to the facts and circumstances applicable in the Arrangement.

During the commercialization period of the Arrangement, for each source of collaboration revenue, we apply the following revenue recognition criteria:

·                  Revenues related to reimbursements by Takeda of third-party development expenses (70/30 split per the Arrangement) and commercial expenses (shared equally 50/50 per the Arrangement) are recognized as revenue, in the period incurred.

·                  Revenues related to reimbursement of costs of FTEs engaged in commercial activities are recognized as revenue in the period incurred. Such reimbursement is based on contractually negotiated reimbursement rates for each FTE as specified in the Arrangement.

·                  Revenue resulting from a milestone payment that is contingent upon the achievement of a substantive scientific or regulatory event or milestone is recognized in its entirety in the period in which the milestone is achieved and collectability is assured. A milestone is an event (i) that can only be achieved based in whole or in part on either our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there is substantive uncertainty at the date the Arrangement is entered into that the event will be achieved and (iii) results in additional payments being due to us. Milestones are considered substantive when the consideration earned from the achievement of the milestone (i) is commensurate with either our performance to achieve the milestone or the enhancement of value of the item delivered as a result of a specific outcome resulting from our performance; (ii) relates solely to past performance and (iii) is reasonable relative to all deliverable and payment terms in the Arrangement.

·                  Other payments received, such as payments due under the launch allowance (see Note 8 in the Notes to Condensed Financial Statements), for which such payments are contingent solely upon future events are recognized as revenue when earned in accordance with the contract terms and when such payments can be reasonably estimated and collectability is reasonably assured.

We account for milestones under ASU 2010-17, Milestone Method of Revenue Recognition. Under the milestone method, contingent consideration received from the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved, which we believe is more consistent with the substance of our performance under our collaboration agreement. A milestone is defined as an event (i) that can only be achieved based in whole or in part on either the entity’s performance or on the occurrence of a specific outcome resulting from the entity’s performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved, and (iii) that would result in additional payments being due to the entity. A milestone is substantive if the consideration earned from the achievement of the milestone is consistent with our performance required to achieve the milestone or the increase in value to the collaboration resulting from our performance, relates solely to our past performance, and is reasonable relative to all of the other deliverables and payments within the arrangement.

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Clinical Trial Expense and Accruals

We record expense for estimated clinical study external costs, which until 2011, were a significant component of research and development, or R&D, expense. These clinical trial costs were $(1.1) million and $3.1 million during the three months ended September 30, 2011 and 2010, respectively, and $0.3 million and $26.3 million for the nine months ended September 30, 2011 and 2010, respectively. Clinical trials are administered by clinical research organizations, or CROs. CROs typically perform most of the total start-up activities for the trials, including document preparation, site identification pre-study visits, training as well as on-going program management. For the Phase 3 studies, which represented the vast majority of the clinical trial expense, the expense recorded is based on reporting received from CROs and internal analyses. We accrue costs for work performed by CROs based on the achievement of contracted activities during the period. Expense for investigator fees, which include patient costs, is based on internal estimates of activities using patient enrollment and contractual or estimated rates. For the Phase 2 studies, the expense is activities-based such as patient monitoring as reported by the CROs and achievement of milestones. Other costs such as testing and drug materials are expensed as incurred. For all studies, CRO reporting is reviewed by us for appropriateness.

During Q3 2011 we have been working with our CROs on final close-out activities regarding site billings for investigator grants on our Phase 3 trials.  We recently received notification from one of our CROs that they had completed their close-out work and they provided the final amounts due relating to work performed on our Phase 3 studies for which they were responsible.  As a result of this new information, we recorded a change in estimate to decrease our clinical trial accruals for these trials.  As a result, we reversed $1.4 million of clinical trial accrual in the third quarter of 2011.  In addition, as a result of the conclusion of negotiations with our CROs on various billing disputes, we further reduced our clinical trial accrual by $0.7 million as the ultimate settlement was more favorable than our initial estimates.  The aggregate change in estimate during the period decreased expense by $2.1 million for the three months ended September 30, 2011.

Additional changes in estimate or adjustments may result as the final trial close-out audits and fee negotiations are completed relating to our clinical trials which could impact R&D expense, collaboration revenues and amounts due to or from Takeda in subsequent periods.

Results of Operations

Revenue

We recognized $13.2 million and $16.8 million of collaboration revenue during the three months ended September 30, 2011 and 2010, respectively and $44.0 million and $105.8 million for the nine months ended September 30, 2011 and 2010, respectively.  The decrease in collaboration revenue for the three and nine months ended September 30, 2011 compared to the three and nine months ended September 30, 2010 was due to a reduction in the amounts eligible for reimbursement under our collaboration arrangement with Takeda as we completed our Phase 3 clinical trials in early 2010.  In addition, we received a $5 million milestone payment from Takeda for the

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initiation of Japan’s Phase 3 renal indication in March 2010 and $30 million in milestone payments for the database lock of our non-dialysis and dialysis Phase 3 trials in the second quarter of 2010.  During the nine months ended September 30, 2011, we received a $10 million cash milestone payment from Takeda for acceptance for review of our NDA by the FDA in the third quarter of 2011. We expect collaboration revenue to be directly affected by milestone payments and expenses that are eligible for reimbursement from Takeda under the Arrangement in future periods.

Research and Development Expenses

Research and development, or R&D, expenses consist of: (i) expenses incurred under agreements with contract research organizations, or CROs, and investigative sites, which conduct a substantial portion of our pre-clinical studies and all of our clinical trials; (ii) payments to contract manufacturing organizations, which produce our API; (iii) payments to consultants; (iv) license fees paid to third parties for use of their intellectual property; (v) employee-related expenses, which include salaries and related costs; and (vi) facilities, depreciation and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities and equipment, depreciation of leasehold improvements and equipment and laboratory and other supplies.

The decrease in research and development expenses for the three and nine months ended September 30, 2011 compared to the three and nine months ended September 30, 2010 was primarily due to a change in estimate of our clinical trial accrual and corresponding expense related to final close-out activities with one of our CROs as well as reduced CRO and investigative site costs as a result of the completion of the treatment and follow up of our Phase 3 clinical trials in early 2010.  This was partially offset by $655,000 in employee-related restructuring costs recorded in the third quarter of 2011 related to a reduction in force.

General and Administrative Expenses

General and administrative expenses consist principally of salaries and related costs for personnel in executive, finance, accounting, business development, information technology, legal and human resources functions as well as for personnel in our commercial and medical affairs departments. Other general and administrative expenses include facility costs not otherwise included in R&D expense, patent filing, prosecution and defense costs and professional fees for legal, consulting, auditing and tax services.

The increase in general and administrative expenses for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 was due to higher commercial expenses related to expansion of our commercial capabilities.  The decrease in general and administrative expenses for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 was due to reductions in legal costs and consulting services partially offset by increased employee compensation costs, which occurred primarily as a result of costs associated with the resignation of our former Chief Executive Officer during the first quarter of 2011 and a facilities-related restructuring charge incurred of $659,000 in the second quarter of 2011 related to unoccupied office space.

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Interest Income (Expense), Net

The decrease in interest income (expense), net, was due primarily to lower interest rates and a lower average cash balance during the three and nine months ended September 30, 2011 compared to the same period in 2010.

Other Income (Expense), Net