UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE
ACT OF 1934

For the Quarter Ended June 30, 2009

Commission File Number 000-13789





MDRNA, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 11-2658569                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|3830 Monte Villa Parkway, Bothell, WA    |  | 98021     
|(Address of principal executive offices) |  | (Zip Code)

Registrants telephone number, including area code: (425) 908-3600





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   ̈

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 (§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).    Yes   ̈    No   ̈

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
definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One):



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | x

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

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:



|              |  |                                 |  |                   
|------------- |  | ------------------------------- |  | ------------------
|Date          |  | Class                           |  | Shares Outstanding
|July 28, 2009 |  | Common stock  $0.006 par value |  | 40,752,025        









---

MDRNA, INC. AND SUBSIDIARIES

TABLE OF CONTENTS



|                                                                                                          |  |   
|--------------------------------------------------------------------------------------------------------- |  | --
|PART I  FINANCIAL INFORMATION                                                                           
|                                                                                                          | 
|ITEM 1  FINANCIAL STATEMENTS (unaudited)                                                                 |  |   
|Condensed Consolidated Balance Sheets as of December 31, 2008 and June 30, 2009                           |  | 3 
|Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2008 and
2009 |  | 4 
|Condensed Consolidated Statement of Stockholders Equity (Deficit) for the six months ended June 30, 2009 |  | 5 
|Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2009           |  | 6 
|Notes to Condensed Consolidated Financial Statements                                                      |  | 7 
|ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS            |  | 17
|ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                       |  | 25
|ITEM 4  CONTROLS AND PROCEDURES                                                                          |  | 25
|                                                                                                         
|PART II  OTHER INFORMATION                                                                              
|                                                                                                          | 
|ITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                      |  | 26
|ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                              |  | 26
|ITEM 5  OTHER INFORMATION                                                                                |  | 26
|ITEM 6  EXHIBITS                                                                                         |  | 26
|SIGNATURES                                                                                                |  | 27
|EXHIBIT INDEX                                                                                             |  | 28

Items 1, 1A and 3 of PART II have not been included as they are not applicable.



2



---

PART I  FINANCIAL INFORMATION

ITEM 1  FINANCIAL STATEMENTS

MDRNA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------- | -------- | - | ------------ | - | -------- | -
|                                                                                                                           |  | December 31,2008                                |          |   | June 30,2009 |  
|                                                                                                                           |  | (In thousands, except share and per share data) |         
|ASSETS                                                                                                                     |  |                                                 |          |   |              |   |          |  
|Current assets:                                                                                                            |  |                                                 |          |   |              |   |          |  
|Cash and cash equivalents                                                                                                  |  | $                                               | 1,084    |   |              | $ | 7,926    |  
|Restricted cash                                                                                                            |  |                                                 | 2,268    |   |              |   | 1,451    |  
|Accounts receivable                                                                                                        |  |                                                 | 32       |   |              |   | 60       |  
|Inventories                                                                                                                |  |                                                 | 98       |   |              |   |         |  
|Prepaid expenses and other current assets                                                                                  |  |                                                 | 935      |   |              |   | 454      |  
|Assets held for sale                                                                                                       |  |                                                 | 541      |   |              |   |         |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|Total current assets                                                                                                       |  |                                                 | 4,958    |   |              |   | 9,891    |  
|Property and equipment, net                                                                                                |  |                                                 | 7,844    |   |              |   | 5,841    |  
|Other assets                                                                                                               |  |                                                 | 335      |   |              |   | 3        |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|Total assets                                                                                                               |  | $                                               | 13,137   |   |              | $ | 15,735   |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                      |  |                                                 |          |   |              |   |          |  
|Current liabilities:                                                                                                       |  |                                                 |          |   |              |   |          |  
|Accounts payable                                                                                                           |  | $                                               | 2,039    |   |              | $ | 1,239    |  
|Accrued payroll and employee benefits                                                                                      |  |                                                 | 2,410    |   |              |   | 468      |  
|Accrued expenses                                                                                                           |  |                                                 | 1,472    |   |              |   | 1,594    |  
|Accrued restructuring  current portion                                                                                    |  |                                                 | 2,091    |   |              |   | 199      |  
|Capital lease obligations  current portion                                                                                |  |                                                 | 4,112    |   |              |   |         |  
|Deferred revenue  current portion                                                                                         |  |                                                 | 400      |   |              |   |         |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|Total current liabilities                                                                                                  |  |                                                 | 12,524   |   |              |   | 3,500    |  
|Accrued restructuring, net of current portion                                                                              |  |                                                 | 609      |   |              |   | 656      |  
|Capital lease obligations, net of current portion                                                                          |  |                                                 | 1,017    |   |              |   |         |  
|Deferred revenue, net of current portion                                                                                   |  |                                                 | 318      |   |              |   |         |  
|Fair value liability for price adjustable warrants                                                                         |  |                                                 |         |   |              |   | 10,820   |  
|Deferred rent and other liabilities                                                                                        |  |                                                 | 1,928    |   |              |   | 1,712    |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|Total liabilities                                                                                                          |  |                                                 | 16,396   |   |              |   | 16,688   |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|                                                                                                                           |  |                                                
|Commitments and contingencies                                                                                              |  |                                                 |          |   |              |   |          |  
|Stockholders deficit):                                                                                                    |  |                                                 |          |   |              |   |          |  
|Preferred stock, $0.01 par value; 100,000 authorized: no shares issued and outstanding:                                    |  |                                                 |         |   |              |   |         |  
|Common stock and additional paid-in capital, $0.006 par value; 90,000,000 authorized:                                      |  |                                                 |          |   |              |   |          |  
|31,244,018 shares issued and outstanding as of December 31, 2008 and 40,752,025 issued and outstanding as of June 30,
2009 |  |                                                 | 250,826  |   |              |   | 254,269  |  
|Accumulated deficit                                                                                                        |  |                                                 | (254,085 | ) |              |   | (255,222 | )
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|Total stockholders deficit                                                                                                |  |                                                 | (3,259   | ) |              |   | (953     | )
|                                                                                                                           |  |                                                 |          |   |              |   |          |  
|Total liabilities and stockholders deficit                                                                                |  | $                                               | 13,137   |   |              | $ | 15,735   |  
|                                                                                                                           |  |                                                 |          |   |              |   |          |  

See notes to condensed consolidated financial statements



3



---

MDRNA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------- | ------- | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                                                                         |  | Three Months EndedJune 30,            |         |   | Six Months EndedJune 30, |  
|                                                                                                                         |  | 2008                                  |         |   | 2009                     |   |        | 2008 |  |   | 2009    |  
|                                                                                                                         |  | (In thousands, except per share data) |        
|Revenue                                                                                                                  |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|License and research fees                                                                                                |  | $                                     | 431     |   |                          | $ | 306    |      |  | $ | 1,113   |   |  | $ | 14,374 |  
|Product revenue                                                                                                          |  |                                       | 241     |   |                          |   |       |      |  |   | 729     |   |  |   | 70     |  
|Government grants                                                                                                        |  |                                       | 82      |   |                          |   | 3      |      |  |   | 175     |   |  |   | 16     |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Total revenue                                                                                                            |  |                                       | 754     |   |                          |   | 309    |      |  |   | 2,017   |   |  |   | 14,460 |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Operating expenses:                                                                                                      |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Cost of product revenue, including inventory write-down of $2,579 in the three and six month periods ended June 30, 2008 |  |                                       | 2,665   |   |                          |   |       |      |  |   | 2,829   |   |  |   |       |  
|Research and development                                                                                                 |  |                                       | 8,493   |   |                          |   | 4,340  |      |  |   | 19,419  |   |  |   | 8,456  |  
|Sales and marketing                                                                                                      |  |                                       | 445     |   |                          |   | 70     |      |  |   | 1,018   |   |  |   | 213    |  
|General and administrative                                                                                               |  |                                       | 3,380   |   |                          |   | 2,181  |      |  |   | 7,609   |   |  |   | 4,145  |  
|Restructuring                                                                                                            |  |                                       |        |   |                          |   | 178    |      |  |   | 1,917   |   |  |   | 311    |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Total operating expenses                                                                                                 |  |                                       | 14,983  |   |                          |   | 6,769  |      |  |   | 32,792  |   |  |   | 13,125 |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Income (loss) from operations                                                                                            |  |                                       | (14,229 | ) |                          |   | (6,460 | )    |  |   | (30,775 | ) |  |   | 1,335  |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Other income (expense):                                                                                                  |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Interest income                                                                                                          |  |                                       | 135     |   |                          |   | 1      |      |  |   | 428     |   |  |   | 3      |  
|Interest and other expense                                                                                               |  |                                       | (237    | ) |                          |   | (168   | )    |  |   | (502    | ) |  |   | (311   | )
|Change in fair value liability for price adjustable warrants                                                             |  |                                       |        |   |                          |   | (905   | )    |  |   |        |   |  |   | (1,932 | )
|Gain on settlement of liabilities, net                                                                                   |  |                                       |        |   |                          |   |       |      |  |   |        |   |  |   | 654    |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Total other expense                                                                                                      |  |                                       | (102    | ) |                          |   | (1,072 | )    |  |   | (74     | ) |  |   | (1,586 | )
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Net loss                                                                                                                 |  | $                                     | (14,331 | ) |                          | $ | (7,532 | )    |  | $ | (30,849 | ) |  | $ | (251   | )
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Loss per common share  basic and diluted:                                                                               |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Net loss per common share  basic and diluted                                                                            |  | $                                     | (0.48   | ) |                          | $ | (0.21  | )    |  | $ | (1.10   | ) |  | $ | (0.01  | )
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  
|Shares used in computing net loss per share  basic and diluted                                                          |  |                                       | 29,722  |   |                          |   | 35,962 |      |  |   | 27,966  |   |  |   | 34,113 |  
|                                                                                                                         |  |                                       |         |   |                          |   |        |      |  |   |         |   |  |   |        |  

See notes to condensed consolidated financial statements



4



---

MDRNA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT

For the Six Months Ended June 30, 2009

(Unaudited)



|                                                                                           |  |                                            |   |  |                    |         |   |                           |   |          |   |  |   |        |  
|------------------------------------------------------------------------------------------ |  | ------------------------------------------ | - |  | ------------------ | ------- | - | ------------------------- | - | -------- | - |  | - | ------ | -
|                                                                                           |  | Common Stock and AdditionalPaid-In Capital |   |  | AccumulatedDeficit |         |   | TotalStockholdersDeficit |  
|                                                                                           |  | Shares                                     |   |  | Amount             |         |   |                          
|                                                                                           |  | (In thousands, except share data)          |  
|Balance December 31, 2008                                                                  |  | 31,244,018                                 |   |  | $                  | 250,826 |   |                           | $ | (254,085 | ) |  | $ | (3,259 | )
|Cumulative effect of change in accounting principle                                        |  |                                           |   |  |                    |        |   |                           |   | (886     | ) |  |   | (886   | )
|                                                                                           |  |                                            |   |  |                    |         |   |                           |   |          |   |  |   |        |  
|Balance January 1, 2009                                                                    |  | 31,244,018                                 |   |  |                    | 250,826 |   |                           |   | (254,971 | ) |  |   | (4,145 | )
|Proceeds from the issuance of common shares, net                                           |  | 5,250,000                                  |   |  |                    | 1,221   |   |                           |   |         |   |  |   | 1,221  |  
|Shares issued in connection with settlement of liabilities                                 |  | 3,596,010                                  |   |  |                    | 982     |   |                           |   |         |   |  |   | 982    |  
|Shares issued in connection with amendment of license agreement                            |  | 606,061                                    |   |  |                    | 1,000   |   |                           |   |         |   |  |   | 1,000  |  
|Proceeds from the exercise of options, warrants and employee stock purchase plan purchases |  | 68,500                                     |   |  |                    | 152     |   |                           |   |         |   |  |   | 152    |  
|Reclassification of fair value of warrants exercised on June 9, 2009                       |  |                                           |   |  |                    | 109     |   |                           |   |         |   |  |   | 109    |  
|Compensation related to restricted stock, net of forfeitures                               |  | (12,564                                    | ) |  |                    | (469    | ) |                           |   |         |   |  |   | (469   | )
|Compensation related to stock options and employee stock purchase plan, net of forfeitures |  |                                           |   |  |                    | 448     |   |                           |   |         |   |  |   | 448    |  
|Net loss                                                                                   |  |                                           |   |  |                    |        |   |                           |   | (251     | ) |  |   | (251   | )
|                                                                                           |  |                                            |   |  |                    |         |   |                           |   |          |   |  |   |        |  
|Balance June 30, 2009                                                                      |  | 40,752,025                                 |   |  | $                  | 254,269 |   |                           | $ | (255,222 | ) |  | $ | (953   | )
|                                                                                           |  |                                            |   |  |                    |         |   |                           |   |          |   |  |   |        |  

See notes to condensed consolidated financial statements



5



---

MDRNA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                             |  |                          |         |   |      |   |        |  
|-------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | -
|                                                                                             |  | Six Months EndedJune 30, |        
|                                                                                             |  | 2008                     |         |   | 2009 |  
|                                                                                             |  | (In thousands)           |        
|Operating activities:                                                                        |  |                          |         |   |      |   |        |  
|Net loss                                                                                     |  | $                        | (30,849 | ) |      | $ | (251   | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities:    |  |                          |         |   |      |   |        |  
|Non-cash compensation related to stock options and employee stock purchase plan              |  |                          | 1,366   |   |      |   | 448    |  
|Non-cash compensation related to restricted stock                                            |  |                          | 1,392   |   |      |   | (469   | )
|Depreciation and amortization                                                                |  |                          | 2,365   |   |      |   | 1,333  |  
|Accretion of restructuring liability                                                         |  |                          |        |   |      |   | 122    |  
|Loss on disposition of property and equipment                                                |  |                          | 30      |   |      |   | 68     |  
|Write-down of inventory and prepaid supplies                                                 |  |                          | 2,681   |   |      |   |       |  
|Net gain on settlement of liabilities                                                        |  |                          |        |   |      |   | (654   | )
|Non-cash change in fair value of price adjustable warrants                                   |  |                          |        |   |      |   | 1,932  |  
|Changes in assets and liabilities:                                                           |  |                          |         |   |      |   |        |  
|Accounts receivable                                                                          |  |                          | (61     | ) |      |   | (28    | )
|Inventories                                                                                  |  |                          | 11      |   |      |   | 6      |  
|Prepaid expenses and other assets                                                            |  |                          | 394     |   |      |   | 580    |  
|Accounts payable                                                                             |  |                          | (1,897  | ) |      |   | (234   | )
|Deferred revenue                                                                             |  |                          | (475    | ) |      |   | (718   | )
|Accrued expenses and deferred rent and other liabilities                                     |  |                          | (1,585  | ) |      |   | 54     |  
|Accrued restructuring                                                                        |  |                          |        |   |      |   | (1,249 | )
|                                                                                             |  |                          |         |   |      |   |        |  
|Net cash provided by (used in) operating activities                                          |  |                          | (26,628 | ) |      |   | 940    |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Investing activities:                                                                        |  |                          |         |   |      |   |        |  
|Change in restricted cash                                                                    |  |                          |        |   |      |   | 817    |  
|Purchases of property and equipment                                                          |  |                          | (63     | ) |      |   | (8     | )
|Proceeds from sales of property and equipment                                                |  |                          |        |   |      |   | 1,156  |  
|Purchases of investments                                                                     |  |                          | (1,024  | ) |      |   |       |  
|Sales and maturities of investments                                                          |  |                          | 11,799  |   |      |   |       |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Net cash provided by investing activities                                                    |  |                          | 10,712  |   |      |   | 1,965  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Financing activities:                                                                        |  |                          |         |   |      |   |        |  
|Payments on note payable                                                                     |  |                          |        |   |      |   | (5,547 | )
|Payments on capital lease obligations                                                        |  |                          | (2,513  | ) |      |   |       |  
|Proceeds from exercise of stock options, warrants and employee stock purchase plan purchases |  |                          | 85      |   |      |   | 152    |  
|Proceeds from the issuance of common shares and warrants, net                                |  |                          | 7,254   |   |      |   | 9,332  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Net cash provided by financing activities                                                    |  |                          | 4,826   |   |      |   | 3,937  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                         |  |                          | (11,090 | ) |      |   | 6,842  |  
|Cash and cash equivalents  beginning of period                                              |  |                          | 27,704  |   |      |   | 1,084  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Cash and cash equivalents  end of period                                                    |  | $                        | 16,614  |   |      | $ | 7,926  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Non-cash financing activities:                                                               |  |                          |         |   |      |   |        |  
|Note payable issued upon cancellation of capital lease obligations                           |  | $                        |        |   |      | $ | 5,128  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Issuance of common stock to settle liabilities                                               |  |                          |        |   |      |   | 1,982  |  
|                                                                                             |  |                          |         |   |      |   |        |  
|Supplemental disclosure:                                                                     |  |                          |         |   |      |   |        |  
|Cash paid for interest                                                                       |  | $                        | 502     |   |      | $ | 311    |  
|                                                                                             |  |                          |         |   |      |   |        |  

See notes to condensed consolidated financial statements



6



---

MDRNA, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the three and six months ended June 30, 2009 and 2008 (Unaudited)

Note 1  Business, Going Concern
and Summary of Significant Accounting Policies

Business

We are a biotechnology company focused on the discovery, development and commercialization of pharmaceuticals based on RNA interference
(RNAi). Our goal is to be the leader in RNAi therapeutics and improve human health through the development of RNAi-based compounds that provide superior therapeutic options for patients. Our team of approximately 30 scientists brings
expertise in the discovery, evaluation and optimization of small interfering RNAs (siRNAs) as well as siRNA delivery. We have the requisite experience in the areas of RNAi, molecular and cellular biology, lipid, oligonucleotide and
peptide chemistry, pharmacology and bioinformatics necessary to discover and develop tailored RNAi-based compounds designed to elicit specific therapeutic effects on a target-by-target basis. Our infrastructure provides for pre-clinical scale
manufacturing of both siRNAs and delivery materials, the comprehensive analysis and optimization of these compounds both individually and as drug candidates, and the filing of Investigational New Drug Applications. In addition to our own, internally
developed technologies, we strategically in-license and further develop RNAi- and delivery-related technologies, forming a single integrated drug discovery platform. In order to protect our innovations, which encompass a broad platform of both siRNA
and delivery technologies, and the eventual drug products that emerge from that platform, we will aggressively continue to build upon our extensive and enabling intellectual property (IP) estate.

We have recently completed a major restructuring of our business. Our business strategy is two-fold. First, we strive to establish
collaborations and strategic partnerships with pharmaceutical and biotechnology companies in the area of RNAi-based therapeutics to: (1) generate revenue and non-dilutive financing; (2) gain access to technical resources; and
(3) validate our drug discovery platform. Secondly, we expect to advance our own pipeline of RNAi-based therapeutics as a foundation upon which to improve all aspects of our drug discovery platform and eventually to have the opportunity to
commercialize a drug therapy. With respect to collaborations and strategic partnerships, we are currently focused on our Meroduplex and UsiRNA constructs, as well as our DiLA2and peptide delivery technologies. Typically, we would expect to collaborate with partners who can take a drug candidate through to
commercialization by utilizing their late stage clinical development, regulatory, marketing and sales capabilities. We expect to structure our collaborative arrangements in such a manner to receive upfront non-refundable payments, research and
development funding, milestone payments and royalties on commercial sales of products.

We believe we have established ourselves as a
leading RNAi-based therapeutics company by leveraging our broad and proven expertise in RNAi science and delivery into an industry-leading RNAi drug discovery platform, which is protected by a strong IP position and validated through licensing
agreements with two large international pharmaceutical companies.

Going Concern

The accompanying unaudited condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which
contemplates realization of assets and the satisfaction of liabilities in the normal course of business for the twelve month period following the date of these financial statements. As of June 30, 2009, we had an accumulated deficit of
approximately $255.2 million and expect to incur additional losses in the future as we continue our research and development (R&D) activities. We have funded our losses primarily through the sale of common stock and warrants in the
public markets and private placements, revenue provided by our collaboration partners, and, to a lesser extent, equipment financing facilities and loans. The further development of our RNAi programs will require additional funding. At June 30,
2009, we had working capital (current assets less current liabilities) of $6.4 million and approximately $9.4 million in cash and cash equivalents, including approximately $1.5 million in restricted cash. While we continue to implement cost
containment efforts, our operating expenses, primarily R&D, will consume the majority of our cash resources.

On June 12, 2009, we
raised net proceeds of approximately $9.3 million in a private placement of 5,250,000 shares of common stock along with warrants to purchase up to 5,250,000 shares of common stock at a negotiated purchase price of $2.00 per share, which warrants are
exercisable during the five-year period beginning December 13, 2009 at a price of $2.38 per share. We believe that our current resources are sufficient to fund our planned operations to approximately year-end 2009. We based our estimate on our
ability to perform planned R&D activities and our recent financing activity. The volatility in our stock price, as well as global market conditions, could make it difficult for us to raise capital on favorable terms, or at all. Any financing we
obtain may further dilute the ownership interest of our current stockholders. If we fail to generate positive cash flows or fail to obtain additional capital when required, we could modify, delay or abandon some or all of our programs. These
factors, among others, raise substantial doubt about our ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty.

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



7



---

Basis of Preparation and Summary of Significant Accounting Policies

Basis of Preparation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and note
disclosures required by U.S. generally accepted accounting principles for complete financial statements. The accompanying unaudited financial information should be read in conjunction with the audited consolidated financial statements, including the
notes thereto, as of and for the year ended December 31, 2008, included in our 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the SEC). The information furnished in this report reflects all
adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of our financial position, results of operations and cash flows for each period presented. The results of operations
for the interim period ended June 30, 2009 are not necessarily indicative of the results for the year ending December 31, 2009 or for any future period.

Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting periods.
Estimates having relatively greater significance include revenue recognition, R&D costs, stock-based compensation, valuation of our warrants, inventory reserves, impairment of long-lived assets, estimated accrued restructuring charges and income
taxes. Actual results could differ from those estimates.

Impairment of Long-Lived Assets and Assets Held for Sale Long-lived
assets, such as property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). Conditions that would necessitate an impairment include a significant decline in the observable market value of an
asset, a significant change in the extent or manner in which an asset is used, or any other significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment
charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Long-lived assets are considered held for sale when certain criteria are met, including whether management has committed to a plan to
sell the asset, whether the asset is available for sale in its immediate condition, and whether the sale is probable within one year of the reporting date. Assets held for sale are measured as the lower of carrying amount or fair value less cost to
sell.

Accrued Restructuring We follow the provisions of SFAS No. 146, Accounting for Costs Associated with Exit
or Disposal Activities (SFAS 146), as it relates to our facility at 3450 Monte Villa Parkway, Bothell, Washington (3450 Monte Villa), which we ceased to use in 2008. Under SFAS 146, an accrued liability for remaining
lease termination costs is initially measured at fair value, based on the remaining payments due under the lease and other costs, reduced by sublease rental income that could be reasonably obtained from the property, and discounted using a
credit-adjusted risk-free interest rate. We use a credit-adjusted risk-free interest rate of 15%, and we based our estimated future payments on current rental rates available in the Bothell real estate market, cash incentives available from the
landlord to attract new tenants, our evaluation of the ability to sublease our facility in light of tightening credit markets, deteriorating conditions in the Bothell real estate market and increased vacancy rates in the competing downtown real
estate markets. Accrued restructuring, and in particular those charges associated with exiting a facility, are subject to managements assumptions and estimates. In addition to the interest rate used, the assumptions as to estimated future
payments significantly impact the accrual and actual results may differ from our estimates. We review these estimates quarterly and adjust our accrual if necessary. For a further discussion of our restructuring charges, see Note 3  Accrued
Restructuring and Assets Held for Sale.

Fair Value of Financial Instruments  We consider the fair value of cash and cash
equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities to not be materially different from their carrying value. These financial instruments have short-term maturities.

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements (SFAS 157), for financial assets and
liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements
that require or permit fair value measurements and does not apply to measurements related to share-based payments. SFAS 157 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of
future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value
into three broad levels. The following is a brief description of those three levels:

Level 1: Observable inputs such as quoted prices
(unadjusted) in active markets for identical assets or liabilities.



8



---

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either
directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3: Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which
reflect those that a market participant would use.

We currently measure and report at fair value the liability for price adjustable
warrants. The following table summarizes our financial liabilities measured at fair value on a recurring basis in accordance with SFAS 157 as of June 30, 2009 (in thousands):



|                                                   |  |                        |        |                                                           |   |                                          |   |                                      |   |       
|-------------------------------------------------- |  | ---------------------- | ------ | --------------------------------------------------------- | - | ---------------------------------------- | - | ------------------------------------ | - | ------
|                                                   |  | Balance atJune 30,2009 |        | Level 1Quoted prices inactive markets foridentical assets |   | Level 2Significant otherobservableinputs |   | Level 3Significantunobservableinputs
|Liabilities:                                       |  |                        |        |                                                           |   |                                          |   |                                      |   |       
|Fair value liability for price adjustable warrants |  | $                      | 10,820 |                                                           |  |                                          |  |                                      | $ | 10,820
|                                                   |  |                        |        |                                                           |   |                                          |   |                                      |   |       
|Total financial liabilities at fair value          |  | $                      | 10,820 |                                                           |  |                                          |  |                                      | $ | 10,820
|                                                   |  |                        |        |                                                           |   |                                          |   |                                      |   |       

The following table is a roll forward for the three and six months ended June 30, 2009 of the
fair value liability of price adjustable warrants, as to which fair value is determined by Level 3 inputs (in thousands):



|                                                         |  |   |        |  
|-------------------------------------------------------- |  | - | ------ | -
|Beginning balance at January 1, 2009                     |  | $ | 886    |  
|Change in fair value included in statement of operations |  |   | 1,027  |  
|                                                         |  |   |        |  
|Balance, March 31, 2009                                  |  | $ | 1,913  |  
|Fair value of warrants exercised on June 12, 2009        |  |   | (109   | )
|Fair value of warrants issued on June 12, 2009           |  |   | 8,111  |  
|Change in fair value included in statement of operations |  |   | 905    |  
|                                                         |  |   |        |  
|Ending balance at June 30, 2009                          |  | $ | 10,820 |  
|                                                         |  |   |        |  

Net Loss Per Common Share  Basic and diluted net loss per common share is computed by
dividing the net loss by the weighted average number of common shares outstanding during the periods. Diluted net loss per share excludes the effect of common stock equivalents (stock options, unvested restricted stock and warrants) since such
inclusion in the computation would be anti-dilutive. The number of shares that have been excluded in per share computations for the three and six month periods ended are as follows (in thousands):



|                                                               |  |                               |  |                              
|-------------------------------------------------------------- |  | ----------------------------- |  | -----------------------------
|                                                               |  | Six Months EndedJune 30, 2008 |  | Six Months EndedJune 30, 2009
|Stock options outstanding under our various stock option plans |  | 8,432                         |  | 7,828                        
|Unvested restricted stock                                      |  | 360                           |  | 57                           
|Warrants                                                       |  | 6,341                         |  | 10,020                       
|                                                               |  |                               |  |                              
|Total                                                          |  | 15,133                        |  | 17,905                       
|                                                               |  |                               |  |                              



9



---

Note 2  Concentration of Credit Risk and Significant Customers

We operate in an industry that is highly regulated, competitive and rapidly changing and involves numerous risks and uncertainties. Significant
technological and/or regulatory changes, the emergence of competitive products and other factors could negatively impact our consolidated financial position or results of operations.

We have been dependent on our collaborative agreements with a limited number of third parties for a substantial portion of our revenue, and our discovery
and development activities may be delayed or reduced if we do not maintain successful collaborative arrangements. We had revenue from customers, as a percentage of total revenue, as follows:



|                                            |  |                            |   |  |                          |   |  |      |   |  |      |  
|------------------------------------------- |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                                            |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                                            |  | 2008                       |   |  | 2009                     |   |  | 2008 |   |  | 2009 |  
|Novartis                                    |  |                           |   |  | 60                       | % |  |     |   |  | 52   | %
|Roche                                       |  |                           |   |  |                         |   |  |     |   |  | 34   | %
|Amylin                                      |  |                           |   |  |                         |   |  |     |   |  | 7    | %
|QOL Medical, LLC                            |  | 47                         | % |  |                         |   |  | 49   | % |  | 6    | %
|Par Pharmaceuticals                         |  |                           |   |  | 39                       | % |  |     |   |  | 1    | %
|Government grant                            |  | 11                         | % |  | 1                        | % |  | 9    | % |  |     |  
|Undisclosed partner  undisclosed compounds |  | 24                         | % |  |                         |   |  | 28   | % |  |     |  
|Undisclosed partner  Factor IX             |  | 18                         | % |  |                         |   |  | 14   | % |  |     |  
|                                            |  |                            |   |  |                          |   |  |      |   |  |      |  
|Total                                       |  | 100                        | % |  | 100                      | % |  | 100  | % |  | 100  | %
|                                            |  |                            |   |  |                          |   |  |      |   |  |      |  

Note 3  Accrued Restructuring and Assets Held For Sale

Since late 2007, we have restructured our operations to focus on our RNAi programs. As part of the restructuring, we have reduced our workforce from
approximately 235 employees in late 2007 to approximately 40 full-time employees at June 30, 2009. We have also exited certain of our facilities and have taken other steps to reduce our cash expenditures. We have recorded restructuring charges
related to employee termination costs, our facility consolidation and impairment of assets in accordance with our long-lived assets policy. During 2008, we exited our facility at 3450 Monte Villa Parkway, Bothell, Washington and recorded a
restructuring liability, representing remaining lease payments due under the lease and other costs and discounted using a credit-adjusted risk-free interest rate. In March 2009, we entered into an amendment of our lease for this facility, which
reduced our lease obligations by approximately $1.9 million until July 2010. Under the terms of the amendment, we released both a cash deposit of approximately $0.3 million and restricted cash under a letter of credit for approximately $1.0 million
to the landlord, to be used by them to cover rent payments or as incentives to attract new tenants. As inducement to enter into the amendment, we issued 1.5 million shares of our common stock to the sole member of the landlord. Because of this
amendment, we will have no further rent obligations under the 3450 Monte Villa lease for the period from January 2009 until July 2010. We use a credit-adjusted risk-free interest rate of 15%, and we based our sublease expectations on current rental
rates available in the Bothell real estate market, cash incentives available from the landlord to attract new tenants, our evaluation of the likelihood of subleasing our facility in light of tightening credit markets, deteriorating conditions in the
Bothell real estate market and increased vacancy rates in the competing downtown real estate markets. During the three and six months ended June 30, 2009, we recorded approximately $54,000 and $122,000 in accretion expense. We expect to incur
approximately $0.2 million in accretion expense through the expiration of this lease in January 2016. As of June 30, 2009, the cash deposit had been released and offset against the restructuring liability, and $0.7 million of the restricted
cash has been released to the landlord. Subsequent to June 30, 2009, approximately $0.2 million of restricted cash was released to the landlord.

Given the triggering event as a result of the employee terminations and facility consolidation, we have evaluated our long-lived assets for possible impairment under the guidance in SFAS 144. At December 31, 2008
property and equipment having a net realizable value of approximately $0.5 million, net of estimated costs to sell, was held for sale. All of these assets were sold as of June 30, 2009 and an additional loss on sale of assets of approximately
$0.1 million was included in restructuring expense in the second quarter of 2009.

Accrued restructuring, and in particular those charges
associated with exiting a facility, are subject to managements assumptions and estimates, as well as changes in facts and circumstances. In addition to the interest rate used, the assumptions as to estimated future payments significantly
impact the accrual and actual results may differ from our estimates.



10



---

The components of restructuring are summarized as follows (in thousands):



|                                                                                   |  |                            |   |                          |   |                           |  |      |       |  |   |     |  |   |      
|---------------------------------------------------------------------------------- |  | -------------------------- | - | ------------------------ | - | ------------------------- |  | ---- | ----- |  | - | --- |  | - | -----
|                                                                                   |  | Three Months endedJune 30, |   | Six Months endedJune 30, |   | Cumulative toJune 30,2009
|                                                                                   |  | 2008                       |   | 2009                     |   | 2008                      |  | 2009 |      
|Employee severance and termination benefits (including stock compensation charges) |  | $                          |  |                          | $ |                          |  | $    | 1,623 |  | $ |    |  | $ | 3,986
|Property and equipment impairment                                                  |  |                            |  |                          |   | 137                       |  |      |      |  |   | 137 |  |   | 2,099
|Facility related charges                                                           |  |                            |  |                          |   | 41                        |  |      |      |  |   | 174 |  |   | 2,189
|Other restructuring charges                                                        |  |                            |  |                          |   |                          |  |      | 294   |  |   |    |  |   | 294  
|                                                                                   |  |                            |   |                          |   |                           |  |      |       |  |   |     |  |   |      
|Total restructuring                                                                |  | $                          |  |                          | $ | 178                       |  | $    | 1,917 |  | $ | 311 |  | $ | 8,568
|                                                                                   |  |                            |   |                          |   |                           |  |      |       |  |   |     |  |   |      

The following table reflects the activity in accrued restructuring for the six months ended
June 30, 2009 (in thousands):



|                           |  |                                         |      |   |                        |   |        |       |  |   |        |  
|-------------------------- |  | --------------------------------------- | ---- | - | ---------------------- | - | ------ | ----- |  | - | ------ | -
|                           |  | EmployeeSeveranceandTerminationBenefits |      |   | FacilityRelatedCharges |   |        | Total | 
|Balance, December 31, 2008 |  | $                                       | 349  |   |                        | $ | 2,351  |       |  | $ | 2,700  |  
|Additional accruals        |  |                                         |     |   |                        |   | 52     |       |  |   | 52     |  
|Payments                   |  |                                         | (349 | ) |                        |   | (1,670 | )     |  |   | (2,019 | )
|Accretion                  |  |                                         |     |   |                        |   | 122    |       |  |   | 122    |  
|                           |  |                                         |      |   |                        |   |        |       |  |   |        |  
|Balance, June 30, 2009     |  | $                                       |     |   |                        | $ | 855    |       |  | $ | 855    |  
|                           |  |                                         |      |   |                        |   |        |       |  |   |        |  

Note 4  Note Payable and Capital Lease Obligations

In January 2009, we entered into a Loan and Security Agreement (the Loan Agreement) with General Electric Capital Corporation
(GECC) pursuant to which GECC converted the balance due under the capital lease obligations, along with a lease termination fee and amounts payable for property taxes, to a promissory note in the amount of $5.5 million at a fixed
interest rate of 12.29% per year. The loan was paid off in full in June 2009 including the loan fee of 2% of the original loan balance, or approximately $0.1 million. As a result of the capital lease termination and issuance of the note
payable, we recorded a lease termination fee of approximately $0.2 million during the first quarter of 2009, which has been presented as a component of gain on settlement of liabilities, net. The balance of the note payable at June 30, 2009 is
zero.

Note 5  Stockholders Equity

Common Stock Issuances In January 2008, we filed a universal shelf registration statement with the SEC pursuant to which we can issue up to $50.0 million of our common stock, preferred stock, debt securities, warrants to
purchase any of the foregoing securities and units comprised of any of the foregoing securities. The universal shelf registration statement was declared effective by the SEC on February 4, 2008. We accessed our universal shelf registration
statement in connection with our April 2008 and June 2009 registered direct offerings of common stock and warrants described below. As of June 30, 2009, we had approximately $8.6 million remaining on our universal shelf registration statement.
As of June 30, 2009, we also had approximately $82.8 million remaining on the registration statement that we filed with the SEC on October 19, 2006, and that was subsequently declared effective by the SEC on November 29, 2006,
pursuant to which we were originally eligible to issue up to $125.0 million of our common stock. We previously accessed this latter registration statement in connection with our January 2007 offering of common stock.

In April 2008, we raised net proceeds of approximately $7.3 million in a registered direct offering of 4,590,277 shares of common stock along with
warrants to purchase up to 5,967,361 shares of common stock at a negotiated purchase price of $1.728 per share. Warrants to purchase up to 4,590,277 shares of common stock are exercisable during the seven-year period beginning October 25, 2008
at a price of $2.376 per share. Additional warrants to purchase up to 1,377,084 shares of common stock at a price of $2.17 per share were exercisable for a 90-day period beginning October 25, 2008 and subsequently expired in January 2009. In
addition, warrants to purchase up to 229,514 shares of common stock, which were exercisable during the five-year period beginning October 25, 2008 at a price of $2.376 per share, were issued to the placement agent in connection with the
transaction. On June 9, 2009, 50,000 of the placement agent warrants were exercised resulting in cash proceeds of approximately $119,000.

In February and March 2009, we issued to eight of our vendors an aggregate of 1,364,285 shares of our common stock having an estimated market value of approximately $0.4 million on the issue dates to settle amounts due to these vendors of
approximately $0.6 million in total and as a result we recorded a gain on settlement of liabilities of approximately $0.2 million during the first quarter of 2009.



11



---

In March 2009, we entered into an amendment of our lease for 3450 Monte Villa Parkway which reduced our
future cash expenditures related to this lease. As inducement to enter into the amendment, we issued 1.5 million shares of our common stock (the Shares) to the landlord pursuant to the Stock Purchase Agreement, which among other
things provides the holder of the Shares with certain piggyback registration rights with respect to the Shares, which rights continue until such time as the Shares may be sold publicly without restriction under the Securities Act. The estimated
market value of the shares issued was approximately $0.4 million on the date of issuance and was recorded as an increase in common stock and additional paid-in capital and as a decrease to the previously recorded restructuring liability.

In March 2009, we entered into an amendment of our agreement regarding severance obligations with our former Chief Scientific Officer, pursuant to
which we agreed to pay the former executive a reduced sum of $0.9 million on June 30, 2009, and to issue the former executive 731,275 unregistered shares of our common stock having an estimated market value of approximately $0.2 million as of
the agreement date, in full satisfaction of $1.7 million in severance obligations which was included in accrued employee compensation and employee benefits at December 31, 2008. As a result, we recorded a gain on settlement of liabilities of
approximately $0.6 million during the first quarter of 2009. We have also agreed to use our best efforts to file a registration statement with the SEC to register the shares to be issued to the former executive on or prior to September 30,
2009. There is no requirement to transfer consideration if the registration statement is not filed by September 30, 2009.

On
June 12, 2009, we raised net proceeds of approximately $9.3 million in a registered direct offering of 5,250,000 shares of common stock along with warrants to purchase up to 5,250,000 shares of common stock at a negotiated purchase price of
$2.00 per share. The warrants are exercisable during the five-year period beginning December 13, 2009 at a price of $2.38 per share.

On June 18, 2009, we issued 606,061 shares of our common stock to Ribotask ApS as consideration for an amendment of our Patent Assignment and License Agreement dated May 21, 2008, as amended October 9, 2008. The estimated
market value of the common stock of approximately $1.0 million was recorded as research and development expense during the second quarter of 2009.

Warrants In connection with offerings of our common stock, we have issued warrants to purchase shares of our common stock. In April 2008, we raised net proceeds of approximately $7.3 million in a registered direct offering of
4,590,277 shares of common stock along with warrants to purchase up to 5,967,361 shares of common stock at a negotiated purchase price of $1.728 per share. Warrants to purchase up to 4,590,277 shares of common stock are exercisable during the
seven-year period beginning October 25, 2008 at a price of $2.376 per share, and warrants to purchase up to 1,377,084 shares of common stock were exercisable during the 90-day period beginning October 25, 2008 at a price of $2.17 per
share. These 1,377,084 warrants expired on January 25, 2009. In addition, warrants to purchase up to 229,514 shares of common stock, which are exercisable during the five-year period beginning October 25, 2008 at a price of $2.376 per
share, were issued to the placement agent in connection with the transaction. On June 9, 2009, 50,000 of the placement agent warrants were exercised resulting in cash proceeds of approximately $119,000 and the issuance of 50,000 shares of our
common stock.

The warrants provide that the exercise price of the warrant will be reduced in the event of subsequent financings at an
effective price per share less than the exercise price of the warrants, subject to certain exceptions and limitations. These provisions are commonly known as down-round provisions. The warrants were originally evaluated under the
guidance set forth in EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock (EITF 00-19). We originally considered the provisions of EITF
00-19 with respect to the warrants and had concluded that the warrants may be physically or net-share settled at the investors option and did not contain any net-cash settlement provisions or any provisions deemed under EITF 00-19 to be
equivalent to net-cash settlement provisions and were appropriately classified as equity.

In June 2008, the Emerging Issues Task Force of
the FASB issued EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock (EITF 07-5), which is effective for fiscal years ending after December 15, 2008,
with earlier application not permitted by entities that have previously adopted an alternative accounting policy. The adoption of EITF 07-5s requirements will affect accounting for convertible instruments and warrants with provisions that
protect holders from declines in the stock price (down-round provisions). Warrants with such provisions will no longer be recorded in equity. EITF 07-5 guidance is to be applied to outstanding instruments as of the beginning of the
fiscal year in which the EITF 07-5 is applied. The cumulative effect of the change in accounting principle shall be recognized as an adjustment to the opening balance of retained earnings (or other appropriate components of equity) for that fiscal
year, presented separately. The cumulative-effect adjustment is the difference between the amounts recognized in the statement of financial position before initial application of EITF 07-5 and the amounts recognized in the statement of financial
position at its initial application. The amounts recognized in the statement of financial position as a result of the initial application are determined based on the amounts that would have been recognized if the guidance in EITF 07-5 had been
applied from the issuance date of the instrument. Effective January 1, 2009, we adopted EITF 07-5.



12



---

In connection with warrants issued in April 2008, the financial reporting (non-cash) effect of initial
adoption of this accounting requirement for future financial statements resulted in a cumulative effect of change in accounting principle of approximately $0.9 million, based on a per share price of $0.34 at December 31, 2008, which increased
accumulated deficit and recorded a fair value liability for price adjustable warrants. The warrants issued in June 2009 also contained down-round provisions and were valued at $8.1 million as of June 12, 2009, which was recorded as
fair value liability of price adjustable warrants, based on a per share price of $1.91 as of June 12, 2009. The June 2009 financing, at $2.00 per share of common stock along with warrants, was specifically excluded by the April 2008 investors
from triggering any potential anti-dilution provisions of the April 2008 financing that could have resulted from the June 2009 financing.

The fair value liability is revalued quarterly utilizing Black-Scholes valuation model computations with the increase or decrease in fair value being reported in the statement of operations as other income (expense). At June 30, 2009
the weighted average assumptions used in our Black Scholes calculation as of June 30, 2009 were as follows: contractual life equal to 5.8 years, volatility equal to 111%, risk-free rate of 2.9% and dividend rate of 0%. During the three and six
months ended June 30, 2009, the fair value increased approximately $0.9 and $1.9 million, respectively, which increased net loss.

The
following summarizes warrant activity during the six months ended June 30, 2009 (in thousands).



|                                               |  |   |        |  
|---------------------------------------------- |  | - | ------ | -
|Warrants outstanding, December 31, 2008        |  |   | 6,197  |  
|Warrants issued                                |  |   | 5,250  |  
|Warrants exercised                             |  |   | (50    | )
|Warrants expired                               |  |   | (1,377 | )
|                                               |  |   |        |  
|Warrants outstanding, June 30, 2009            |  |   | 10,020 |  
|                                               |  |   |        |  
|Weighted average exercise price, June 30, 2009 |  | $ | 2.38   |  
|                                               |  |   |        |  

Stockholder Rights Plan In February 2000, our board of directors adopted a
stockholder rights plan and declared a dividend of one preferred stock purchase right for each outstanding share of common stock. Each right entitles the holder, once the right becomes exercisable, to purchase from us one one-thousandth of a share
of our Series A Junior Participating Preferred Stock, par value $.01 per share. We issued these rights in March 2000 to each stockholder of record on such date, and these rights attach to shares of common stock subsequently issued. The rights will
cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our board of directors and could, therefore, have the effect of delaying or preventing someone from taking control of us, even if a change of
control were in the best interest of our stockholders.

Holders of our preferred share purchase rights are generally entitled to purchase
from us one one-thousandth of a share of Series A preferred stock at a price of $50.00, subject to adjustment as provided in the Stockholder Rights Agreement. These preferred share purchase rights will generally be exercisable only if a person or
group becomes the beneficial owner of 15 percent or more of our outstanding common stock or announces a tender offer for 15 percent or more of our outstanding common stock. Each holder of a preferred share purchase right, excluding an acquiring
entity or any of its affiliates, will have the right to receive, upon exercise, shares of our common stock, or shares of stock of the acquiring entity, having a market value equal to two times the purchase price paid for one one-thousandth of a
share of Series A preferred stock. The preferred share purchase rights expire on March 17, 2010, unless we extend the expiration date or in certain limited circumstances, we redeem or exchange such rights prior to such date. Initially, 10,000
Series A Junior Participating Preferred shares were authorized. In January 2007 this was increased to 50,000 shares, and in June 2008 this was further increased to 90,000 shares, so that a sufficient number of Series A Junior Participating Preferred
shares would be available to the holders of shares of common stock for issuance in satisfaction of such rights, given increases in the number of shares of common stock outstanding.

Note 6  Stock Incentive Plans

At June 30, 2009, options to purchase up to 7,827,731
shares of our common stock were outstanding, unvested restricted stock awards for an aggregate of 57,465 shares of our common stock were outstanding under our 2004 Plan and 846,336 shares were available for future grants or awards under our various
stock incentive plans.

We generally issue new shares for option exercises unless treasury shares are available for issuance. We had no
treasury shares as of June 30, 2009 and have no plans to purchase any in the next year, however, we may accept the surrender of vested restricted shares from employees to cover tax requirements at our discretion.



13



---

Stock-based Compensation  The following table summarizes stock-based compensation expense
(benefit) (in thousands):



|                               |  |                            |       |      |                          |      |      |  |      |       |  |   |      |  
|------------------------------ |  | -------------------------- | ----- | ---- | ------------------------ | ---- | ---- |  | ---- | ----- |  | - | ---- | -
|                               |  | Three Months endedJune 30, |       |      | Six Months endedJune 30, |     
|                               |  | 2008                       |       | 2009 |                          |      | 2008 |  | 2009 |      
|Stock-based compensation:      |  |                            |       |      |                          |      |      |  |      |       |  |   |      |  
|Research and development       |  | $                          | 695   |      | $                        | (200 | )    |  | $    | 1,453 |  | $ | (279 | )
|Sales and marketing            |  |                            | 106   |      |                          | (20  | )    |  |      | 236   |  |   | (13  | )
|General and administrative     |  |                            | 543   |      |                          | 203  |      |  |      | 1,069 |  |   | 271  |  
|                               |  |                            |       |      |                          |      |      |  |      |       |  |   |      |  
|Total stock-based compensation |  | $                          | 1,344 |      | $                        | (17  | )    |  | $    | 2,758 |  | $ | (21  | )
|                               |  |                            |       |      |                          |      |      |  |      |       |  |   |      |  

The net benefit in the 2009 periods is due to a change in estimation of forfeitures.

Non-cash compensation expense is recognized on a straight-line basis over the applicable vesting periods of one to five years, based on the fair value
on the grant date. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the applicable plan and certain employment agreements we have with key officers).

Stock Options Stock options to purchase shares of our common stock are granted under our existing stock-based incentive plans to certain
employees, at prices at or above the fair market value on the date of grant. In addition, in June 2008, we granted 1,099,963 options to our Chief Executive Officer, outside of our stock-based incentive plans as an employment inducement grant. In
March 2009, our former Chief Scientific Officer agreed to surrender, without consideration, for cancellation, options to purchase 800,000 shares of common stock at an exercise price of $12.94 per share.

Option activity was as follows during the six-month period ended June 30, 2009:



|                              |  |                |   |  |                              |       |                                         |           |                         |   |    
|----------------------------- |  | -------------- | - |  | ---------------------------- | ----- | --------------------------------------- | --------- | ----------------------- | - | ---
|                              |  | Options        |   |  | WeightedAverageExercisePrice |       | WeightedAverageRemainingContractualLife |           | AggregateIntrinsicValue
|                              |  | (in thousands) |   |  |                              |       |                                         |           | (in thousands)         
|Outstanding December 31, 2008 |  | 6,189          |   |  | $                            | 4.35  |                                         |           |                         |   |    
|Options granted               |  | 2,764          |   |  |                              | 1.26  |                                         |           |                         |   |    
|Options exercised             |  | (15            | ) |  |                              | 2.14  |                                         |           |                         |   |    
|Options expired               |  | (115           | ) |  |                              | 11.67 |                                         |           |                         |   |    
|Options forfeited             |  | (195           | ) |  |                              | 1.61  |                                         |           |                         |   |    
|Options cancelled             |  | (800           | ) |  |                              | 12.94 |                                         |           |                         |   |    
|                              |  |                |   |  |                              |       |                                         |           |                         |   |    
|Outstanding at June 30, 2009  |  | 7,828          |   |  | $                            | 2.34  |                                         | 8.4 years |                         | $ | 927
|                              |  |                |   |  |                              |       |                                         |           |                         |   |    
|Exercisable at June 30, 2009  |  | 3,699          |   |  | $                            | 2.99  |                                         | 7.3 years |                         | $ | 315
|                              |  |                |   |  |                              |       |                                         |           |                         |   |    

The fair value of stock-based awards was estimated at the date of grant using the Black-Scholes
option valuation model with the following weighted average assumptions for the periods presented as follows:



|                              |  |                            |           |   |                          |   |           |      |  |   |           |   |  |   |           |  
|----------------------------- |  | -------------------------- | --------- | - | ------------------------ | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                              |  | Three months endedJune 30, |           |   | Six months endedJune 30, |  
|                              |  | 2008                       |           |   | 2009                     |   |           | 2008 |  |   | 2009      |  
|Expected dividend yield       |  |                            | 0         | % |                          |   | 0         | %    |  |   | 0         | % |  |   | 0         | %
|Risk free interest rate       |  |                            | 3.6       | % |                          |   | 2.6       | %    |  |   | 3.5       | % |  |   | 2.3       | %
|Expected stock volatility     |  |                            | 71        | % |                          |   | 106       | %    |  |   | 71        | % |  |   | 103       | %
|Expected option life          |  |                            | 5.8 years |   |                          |   | 5.9 years |      |  |   | 5.8 years |   |  |   | 5.8 years |  
|Fair value of options granted |  | $                          | 0.66      |   |                          | $ | 1.21      |      |  | $ | 0.73      |   |  | $ | 0.91      |  

As of June 30, 2009, we had approximately $2.7 million of total unrecognized compensation
cost related to unvested stock options. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize this cost over a weighted average period of approximately 1.9 years.



14



---

The intrinsic value of stock options outstanding and exercisable at June 30, 2009 is based on the
$1.38 closing market price of our common stock on that date, and is calculated by aggregating the difference between $1.38 and the exercise price of each of the outstanding vested and unvested stock options which have an exercise price less than
$1.38. No options were exercised during the three and six-month periods ended June 30, 2008. In the three and six-month periods ended June 30, 2009, 15,000 options were exercised. We recorded stock-based compensation expense related to
stock options of approximately $0.7 million and $1.3 million in the three and six-month periods ended June 30, 2008 and $0.4 million and $0.4 million in the three and six-month periods ended June 30, 2009, respectively. The total fair
value of options that vested during the three and six-month periods ended June 30, 2008 was approximately $0.5 million and $0.8 million, respectively. The total fair value of options that vested during the three and six-month periods ended
June 30, 2009 was approximately $1.0 million and approximately $1.3 million, respectively.

On June 10, 2008, in connection with
our annual shareholders meeting, five members of our board of directors retired. Our board of directors approved a resolution to extend the amount of time the retiring directors have to exercise their vested options from 90 days to two years.
Additional compensation expense recognized as a result of the modification was not material. On May 20, 2009, in connection with our annual shareholders meeting, three members of our board of directors retired. Our board of directors approved a
resolution to extend the amount of time two of the retiring directors have to exercise their vested options from 90 days to two years. Additional compensation expense recognized as a result of the modification was approximately $117,000. The third
retiring directors options were governed by his employment contract at his employment termination date of November 30, 2008

Non-Employee Option Grants  In June 2008 and in May 2009 we granted stock options to non-employee members of our Scientific Advisory Board. For stock options granted as consideration for services rendered by non-employees,
we recognize compensation expense in accordance with the requirements of SFAS 123(R), Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring,
or in Conjunction with Selling, Goods or Services and EITF 00-18 Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees, as amended. Non-employee option grants are recorded as
an expense over the vesting period of the underlying stock options. At the end of each financial reporting period prior to vesting, the value of these options, as calculated using the Black-Scholes option pricing model, will be re-measured using the
fair value of our common stock and the non-cash compensation recognized during the period will be adjusted accordingly. Since the fair value of options granted to non-employees is subject to change in the future, the amount of future compensation
expense will include fair value re-measurements until the stock options are fully vested. During the three and six-month periods ended June 30, 2008, we recognized expense of approximately $38,000 relating to options granted to non-employee
members of our Scientific Advisory Board. During the three and six-month periods ended June 30, 2009, we recognized expense of approximately $17,000 relating to options granted to non-employee members of our Scientific Advisory Board.

Restricted Stock Awards Pursuant to restricted stock awards granted under our 2004 Stock Incentive Plan, we have issued
shares of restricted stock to certain employees and members of our Board. Non-cash compensation expense is recognized on a straight-line basis over the applicable vesting periods of one to four years of the restricted shares based on the fair value
of such restricted stock on the grant date. We granted restricted stock awards representing 66,429 shares of common stock with a per share weighted average fair value of $2.28 in the six-month period ending June 30, 2008. There were no
restricted stock awards granted during the six-month period ending June 30, 2009. Additional information on restricted shares is as follows (in thousands, except per share amount):



|                                                        |  |   |      |  
|------------------------------------------------------- |  | - | ---- | -
|Unvested restricted shares outstanding, January 1, 2009 |  |   | 107  |  
|Restricted shares granted                               |  |   |     |  
|Restricted shares forfeited                             |  |   | (12  | )
|Restricted shares vested                                |  |   | (38  | )
|                                                        |  |   |      |  
|Unvested restricted shares outstanding, June 30, 2009   |  |   | 57   |  
|                                                        |  |   |      |  
|Weighted average grant date fair value per share        |  | $ | 8.11 |  
|                                                        |  |   |      |  

Our total unrecognized compensation cost related to unvested restricted stock awards granted under
our 2004 Stock Incentive Plan was approximately $0.2 million at June 30, 2009. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize this cost over a weighted average period of
approximately 1.1 years.

We recorded stock-based compensation expense related to restricted stock grants of approximately $0.6 million and
$1.4 million in the three and six months ended June 30, 2008. In the three months ended June 30, 2009 we recorded a benefit of $0.4 million and in the six months ended June 30, 2009 we recorded a benefit of $0.5 million due to
forfeitures. The fair value of restricted stock vested during the three and six-month periods ended June 30, 2008 was approximately $0.8 million and $1.6 million and the fair value of restricted stock vested during the three and six-month
periods ended June 30, 2009 was approximately $0.2 million and approximately $0.3 million.

On June 10, 2008, in connection with
our annual shareholders meeting, five members of our board of directors retired. Our board of directors approved a resolution to accelerate the vesting of approximately 21,320 restricted shares which would have vested for the retiring directors over
the next one or two years. Additional compensation expense recognized as a result of the modification



15



---

was not material. On May 20, 2009, in connection with our annual shareholders meeting, three members of our board of
directors retired. Our board of directors approved a resolution to accelerate the vesting of approximately 10,000 restricted shares which would have vested for two of the retiring directors over the next one or two years. The third retiring director
held no unvested shares. The benefit to compensation expense recognized as a result of the modifications was not material.

Employee
Stock Purchase Plan In June 2007, our shareholders approved the adoption of our 2007 Employee Stock Purchase Plan (ESPP). A total of 300,000 shares of common stock have been reserved for issuance under our ESPP, of which
78,091 have been issued as of June 30, 2009. Under the terms of the ESPP, a participant may purchase shares of our common stock at a price equal to the lesser of 85% of the fair market value on the date of offering or on the date of purchase.
We recorded stock-based compensation expense related to the ESPP of approximately $33,000 and $72,000 in the three and six months ended June 30, 2008 and $14,000 and $22,000 in the three and six months ended June 30, 2009, respectively.

Note 7  Contractual Agreements

RNAi-related

Roche In February 2009, we entered into an agreement with Hoffman-La Roche Inc., a New
Jersey corporation, and F. Hoffmann-La Roche Ltd., a Swiss corporation (collectively, Roche), pursuant to which we granted to Roche a worldwide, non-exclusive license to a portion of our technology platform, for the development of
RNAi-based therapeutics, in consideration of a one-time non-refundable licensing fee of $5 million, which was recognized as license fee revenue during the three months ended March 31, 2009.

Novartis  In March 2009, we entered into an agreement with Novartis Institutes for BioMedical Research, Inc.
(Novartis), pursuant to which we granted to Novartis a worldwide, non-exclusive license to our DiLA2-based siRNA delivery platform in consideration of a one-time, non-refundable fee of $7.25 million, which was recognized as license fee revenue during the three months ended March 31, 2009. Additionally, we
entered into a separate agreement with Novartis to provide them with an exclusive period in which to negotiate a potential research and development collaboration as well as possible broader licensing rights related to our RNAi drug delivery
platform. This exclusive period expired in the second quarter of 2009 and all remaining deferred revenue under this separate agreement of approximately $0.2 million was recognized as license fee revenue.

Ribotask ApS. In October 2008, we announced that we had acquired the intellectual property related to Unlocked Non-nucleotide
Analogs from Ribotask ApS, a privately held Danish company specializing in the development and synthesis of novel RNA chemistries. We believe that the technology will permit us to stabilize and provide drug-like properties to UsiRNAs in a novel and
proprietary manner. This includes protection from enzymatic destruction and reduction, or elimination, of a cytokine response, two primary limitations for therapeutic application of siRNA; yet the appropriate substitution of UNA preserves high
efficacy. These attributes have the potential for effective protein down regulation with lower total doses of siRNA while improving the safety profile. On June 18, 2009, we issued 606,061 shares of our common stock to Ribotask ApS and agreed to
certain payments in consideration of an amendment to eliminate all downstream financial consideration to Ribotask resulting from collaborations established between us and potential pharmaceutical and biotechnology partners. The estimated market
value of the common stock of $1.0 million was recorded as research and development expense in the three months ended June 30, 2009.

City of Hope In November 2006, we entered into a license with the Beckman Research Institute/City of Hope for exclusive and non-exclusive licenses to the Dicer-substrate RNAi IP developed there. In the first quarter of 2009,
we terminated our license agreement with the City of Hope for technology and intellectual property related to Dicer substrates to focus on the development of UsiRNA and meroduplex constructs.

Intranasal related

Amylin
Pharmaceuticals, Inc.  In January 2009 we received a milestone payment, in the amount of $1.0 million, which was recognized as license fee revenue, from Amylin Pharmaceuticals, Inc. (Amylin) under our 2006 Development and
License Agreement, as amended, for the development of intranasal exenatide (the License Agreement). The License Agreement was amended in January 2009 to provide for the accelerated $1.0 million milestone payment, and to reduce the
aggregate amount of milestone and royalty payments that could be due to us from $89 million to $80 million. We are no longer responsible for any further development of the nasal spray formulation of intranasal exenatide or its manufacture.

Par Pharmaceutical  In March 2009 we entered into an Asset Purchase Agreement with Par Pharmaceutical (Par)
pursuant to which, among other things, Par acquired certain assets pertaining to calcitonin, including tooling and equipment, inventories and the related technology, trade secrets, know-how, proprietary information and other intellectual property
rights, and assumed certain contracts, including our manufacturing obligation to QOL Medical as well as our two building leases related to our operations in Hauppauge, New York. We received $0.8 million in cash and will receive profit sharing for
five years on commercial sales of calcitonin. Calcitonin received full FDA approval and was launched in June 2009. In connection with this agreement, a 2004 License and Supply Agreement with Par, and a 2005 Supply Agreement with QOL Medical LLC,
were terminated on 31 March 2009. We recognized a gain of approximately $0.1 million on the asset sale to Par which is included in research and development expense in the first quarter of 2009. In addition, in the first quarter of 2009 we
recognized $0.7 million in deferred revenue related to the QOL Agreement.



16



---

Thiakis Limited (Thiakis)  In September 2004, we acquired exclusive worldwide
rights to the Imperial College Innovations and Oregon Health & Science University PYY patent applications in the field of nasal delivery of PYY and the use of glucagon-like peptide-1 (GLP-1) used in conjunction with PYY for the treatment of
obesity, diabetes and other metabolic conditions. We recorded $1.2 million in research and development expense in the fourth quarter of 2008 related to the estimated obligations under this license agreement at December 31, 2008. This agreement
terminated on May 6, 2009. In April 2009 we entered into a Deed of Release and termination pursuant to which we agreed to pay $1.1 million, payable in quarterly amounts commencing April 2009 and ending April 2010. The difference between $1.1
million and the amount originally estimated was recorded as reduction of expense in the first quarter of 2009.

Note 8  Income Taxes

We continue to record a valuation allowance in the full amount of deferred tax assets since realization of such tax benefits has not
been determined by our management to be more likely than not. At the end of each interim period, we make our best estimate of the effective tax rate expected to be applicable for the full fiscal year, and the rate so determined is used in providing
for income taxes on a current year-to-date basis. The difference between the expected provision or benefit computed using the statutory tax rate and the recorded provision or benefit of zero, is primarily due to the estimated change in valuation
allowance more likely to result due to taxable losses anticipated for the applicable fiscal year.

Note 9  Commitments and Contingencies

Leases We lease space for our research and development and corporate offices in Bothell, Washington under operating
leases expiring in 2016. In connection with the terms of our lease of our Bothell, Washington facilities, we provide our landlords with stand-by letters of credit that total approximately $1.5 million.

Until March 2009, we had facilities for manufacturing, warehousing and research and development activities in Hauppauge, New York under operating leases
expiring in June 2010. In March 2009 we entered into an Asset Purchase Agreement with Par under which Par assumed full responsibility for all future operating costs and leases associated with the facilities.

In March 2009, we entered into an amendment of our lease for 3450 Monte Villa Parkway, which reduces our lease obligations by approximately $1.9 million
until July 2010. Under the terms of the amendment, we released both a cash deposit of $0.3 million and restricted cash under a letter of credit for $1.0 million to the landlord, to be used by them to cover rent payments or as incentives to attract
new tenants. In connection with the amendment, we issued 1.5 million shares of our common stock (the Shares) to the sole member of the landlord, and granted certain piggyback registration rights with respect to the Shares until the
Shares may be sold publicly without restriction under the Securities Act. Because of this amendment, we have no further rent obligations under the 3450 Monte Villa Parkway lease until July 2010.

We had a capital lease agreement with General Electric Capital Corporation (GECC), which allowed us to finance certain property and equipment
purchases over three- or four-year terms depending on the type of equipment. Under this agreement, we purchased assets approved by GECC, at which date GECC assumed ownership of the assets and we were reimbursed. The equipment was then leased to us.
Interest rates on capital lease borrowings averaged approximately 10% during 2008. Assets leased were pledged as collateral for capital lease borrowings. The lease agreement was cancelled in January 2009 pursuant to the Loan Agreement further
described in Note 4  Note Payable and Capital Lease Obligations.

Contingencies We are subject to various legal
proceedings and claims that arise in the ordinary course of business. Our management currently believes that resolution of such legal matters will not have a material adverse impact on our consolidated financial position, results of operations or
cash flows.

Note 10  Subsequent Events through July 30, 2009

There were no significant events that have occurred from June 30, 2009 through July 30, 2009.

ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Statements contained herein that are not historical fact
may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are subject
to a variety of risks and uncertainties. There are a number of important factors that could cause



17



---

actual results to differ materially from those projected or suggested in any forward-looking statement made by us.
These factors include, but are not limited to: (i) the ability of our company to obtain additional funding; (ii) the ability of our company to attract and/or maintain manufacturing, research, development and commercialization partners;
(iii) the ability of our company and/or a partner to successfully complete product research and development, including pre-clinical and clinical studies and commercialization; (iv) the ability of our company and/or a partner to obtain
required governmental approvals, including product and patent approvals; and (v) the ability of our company and/or a partner to develop and commercialize products that can compete favorably with those of competitors. In addition, significant
fluctuations in quarterly results may occur as a result of the timing of milestone payments, the recognition of revenue from milestone payments and other sources not related to product sales to third parties, and the timing of costs and expenses
related to our research and development programs. Additional factors that would cause actual results to differ materially from those projected or suggested in any forward-looking statements are contained in our filings with the Securities and
Exchange Commission, including those factors discussed under the caption Forward-Looking Information in our most recent Annual Report on Form 10-K, as may be supplemented or amended from time to time, which we urge investors to consider.
We undertake no obligation to publicly release revisions in such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events or circumstances, except as
otherwise required by securities and other applicable laws.

We are a biotechnology company focused on the discovery, development and
commercialization of pharmaceuticals based on RNA interference (RNAi). Our goal is to be the leader in RNAi therapeutics and improve human health through the development of RNAi-based compounds that provide superior therapeutic options
for patients. Our team of approximately 30 scientists brings expertise in the discovery, evaluation and optimization of small interfering RNAs (siRNAs) as well as siRNA delivery. We have the requisite experience in the areas of RNAi,
molecular and cellular biology, lipid, oligonucleotide and peptide chemistry, pharmacology and bioinformatics necessary to discover and develop tailored RNAi-based compounds designed to elicit specific therapeutic effects on a target-by-target
basis. Our infrastructure provides for pre-clinical scale manufacturing of both siRNAs and delivery materials, the comprehensive analysis and optimization of these compounds both individually and as drug candidates, and the filing of Investigational
New Drug Applications. In addition to our own, internally developed technologies, we strategically in-license and further develop RNAi- and delivery-related technologies, forming a single integrated drug discovery platform. In order to protect our
innovations, which encompass a broad platform of both siRNA and delivery technologies, and the eventual drug products that emerge from that platform, we will aggressively continue to build upon our extensive and enabling intellectual property
(IP) estate.

We believe we have established ourselves as a leading RNAi-based therapeutics company by leveraging our broad and
proven expertise in RNAi science and delivery into an industry-leading RNAi drug discovery platform, which is protected by a strong IP position and validated through licensing agreements with two large international pharmaceutical companies.

We have recently completed a year-long effort to restructure our business from a clinical stage intranasal drug delivery company to a
pre-clinical RNAi drug discovery company. Since July 2008, we have accomplished the following: (1) reduced our workforce from approximately 75 employees in July 2008 to approximately 40 employees as of the date of this filing;
(2) suspended all further clinical development of our intranasal programs in August 2008; (3) renegotiated and significantly reduced our long-term legacy liabilities; and (4) sold our intranasal contract manufacturing operations, in
New York, to Par Pharmaceutical Companies, Inc. (Par) in March 2009. Our business model is now centered on the development of strategic R&D partnerships with international pharmaceutical companies as well as the pre-clinical and
early stage clinical development of our own pipeline of RNAi-based therapeutics. Over the near- and mid-term, we will focus on: (1) expanding our delivery technologies; (2) maintaining and expanding our IP estate; (3) continuing our
cost containment efforts; and (4) raising sufficient capital necessary to support and execute our business model. There can be no assurance that our efforts will produce acceptable results. This business model or any other future changes to the
business may not prove successful in the short or long term due to a variety of factors, including competition, success of our research efforts or our ability to establish pharmaceutical partnerships, and may have a material impact on our financial
results including a decline in our stock price.



18



---

We are developing novel technologies and therapeutics based on the Nobel Prize-winning discovery of RNAi.
The discovery of RNAi, in 1988, has led not only to its widespread use in the research of biological mechanisms and target validation but also to its application in down-regulating the expression of certain disease-causing proteins found in multiple
diseases such as inflammation, cancer, and metabolic dysfunction. RNAi-based therapeutics work through a naturally occurring process within cells that has the effect of reducing levels of messenger RNA (mRNA) required for the production of proteins.
RNAi enables the targeting of disease at a genetic level and thus is highly specific to particular disease-causing proteins. At this time, several RNAi-based therapeutics are being evaluated in human clinical trials.

We have created a drug discovery platform that combines novel and proprietary siRNA constructs with novel and proprietary siRNA delivery technologies, to
develop RNAi-based therapeutics for the treatment of human diseases. In 2008, we demonstrated pre-clinical efficacy using both local and systemic routes of administration in rodent models of cancer and metabolic dysfunction. At present, we are
focusing our resources on liver (hepatocellular carcinoma  HCC) and bladder cancer. We intend to build on our pre-clinical successes in 2008 as we move these programs toward early clinical studies. In addition, we will continue to increase the
breadth and capabilities of our drug discovery platform including advancing additional proprietary delivery technologies. Our business model anticipates that the advancement of a therapeutic pipeline, either through partnerships or on our own, will
provide proof of concept for our drug discovery platform as well as value for shareholders.

We will continue to focus our R&D efforts
on RNAi-based therapeutics, and continue to develop and expand our RNAi technologies and IP estate. As of July 22, 2009, we owned or controlled 4 issued U.S. patents and 40 pending U.S. patent applications, including provisional patent
applications, to protect our RNAi proprietary technologies.

Our collaboration efforts are expected to generate license
fees, non-refundable upfront payments, R&D funding, milestone payments, patent- and product-based royalties and profit sharing. Because of our collaborations and other agreements, we recognized revenue of approximately $0.8 million and $2.0
million in the three and six months ended June 30, 2008 and $0.3 million and $14.5 in the three and six months ended June 30 2009, respectively. In 2008, our revenue related primarily to our intranasal programs including the supply
agreement with QOL for Nascobal® and agreements with feasibility partners. In 2009, our revenue was primarily from revenue
from licensing our RNAi platforms including agreements with Novartis and Roche.

Cash Position, Going Concern and Recent Financings

We have prepared our consolidated financial statements assuming that we will continue as a going concern, which contemplates
realization of assets and the satisfaction of liabilities in the normal course of business. As of June 30, 2009, we had an accumulated deficit of approximately $255.2 million and expect to incur additional losses in the future as we continue
our R&D activities. We have funded our losses primarily through the sale of common stock and warrants in the public markets and private placements, revenue provided by our collaboration partners and, to a lesser extent, equipment financing
facilities. The further development of our RNAi programs will require capital. At June 30, 2009, we had working capital (current assets less current liabilities) of $6.4 million and approximately $9.4 million in cash and cash equivalents,
including $1.5 million in restricted cash. Our operating expenses, primarily R&D, will consume the majority of our cash resources. We have received an opinion from our independent registered public accounting firm indicating the substantial
doubt about our ability to continue as a going concern due primarily to our cash position at December 31, 2008.

Discussion of cash flows

We generated cash of approximately $0.9 million in our operating activities in the first half of 2009, compared to using cash of $26.6
million in the first half of 2008. Cash generated from operating activities relates primarily to amounts received under our license agreements offset by funding operating expenses. Cash used in operating activities relates primarily to funding net
losses and changes in deferred revenue, accounts and other receivables, accounts payable and accrued expenses and other liabilities, partially offset by non-cash restructuring charges, depreciation and amortization and non-cash compensation related
to restricted stock, stock options and our employee stock purchase plan. We expect to use cash for operating activities in the foreseeable future as we continue our R&D activities.

Our investing activities provided cash of approximately $2.0 million in the first half of 2009, compared to $10.7 million in the first half of 2008.
Changes in cash from investing activities are due primarily to changes in restricted cash, maturities of short-term investments net of purchases and sales and purchases of property and equipment. In 2009 and 2008, we pledged some of our cash as
collateral for letters of credit and we report changes in our restricted cash as investing activities in the consolidated statements of cash flows.

Our financing activities in the first half of 2009 consisted of net proceeds from the sale of common stock and warrants of $9.3 million, offset by fully paying off our note payable with GECC in the amount of approximately $5.5 million. In
the first half of 2008, our financing activities consisted of regular monthly lease payments under our former capital lease obligations with GECC which amounted to approximately $2.5 million in total for the first half of 2008, offset by net
proceeds from the sale of common stock and warrants of $7.3 million.



19



---

Recent Financing Activities

In January 2008, we filed a universal shelf registration statement with the SEC pursuant to which we can issue up to $50.0 million of our common stock, preferred stock, debt securities, warrants to purchase any of the
foregoing securities and units comprised of any of the foregoing securities. The universal shelf registration statement was declared effective by the SEC on February 4, 2008. We accessed our universal shelf registration statement in connection
with our April 2008 and June 2009 registered direct offerings of common stock and warrants described below. As of June 30, 2009, we had approximately $8.6 million remaining on our universal shelf registration statement. As of June 30,
2009, we also had approximately $82.8 million remaining on the registration statement that we filed with the SEC on October 19, 2006, and that was subsequently declared effective by the SEC on November 29, 2006, pursuant to which we were
originally eligible to issue up to $125.0 million of our common stock. We previously accessed this latter registration statement in connection with our January 2007 offering of common stock.

On June 12, 2009, we raised net proceeds of approximately $9.3 million in a private placement of 5,250,000 shares of common stock along with
warrants to purchase up to 5,250,000 shares of common stock at a negotiated purchase price of $2.00 per share, which warrants are exercisable during the five-year period beginning December 12, 2009 at a price of $2.38 per share. The warrants
contain down-round provisions and as such, are subject to the provisions of EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock (EITF 07-5).
The warrants were valued at June 12, 2009 at $8.1 million which was recorded as fair value liability for price adjustable warrants, based on a per share price of $1.91 as of June 12, 2009. The warrants will be revalued quarterly during the
periods that the warrants remain outstanding.

On April 25, 2008, we raised net proceeds of approximately $7.3 million in a registered
direct offering of 4,590,277 shares of common stock along with warrants to purchase up to 5,967,361 shares of common stock at a negotiated purchase price of $1.728 per share. Warrants to purchase up to 4,590,277 shares of common stock are
exercisable during the seven-year period beginning October 25, 2008 at a price of $2.376 per share. Additional warrants to purchase up to 1,377,084 shares of common stock at a price of $2.17 per share were exercisable during the 90-day period
beginning October 25, 2008 and subsequently expired in January 2009. In addition, warrants to purchase up to 229,514 shares of common stock, which are exercisable during the five-year period beginning October 25, 2008 at a price of $2.376
per share, were issued to the placement agent in connection with the transaction. On June 9, 2009, 50,000 of the warrants issued to the placement agent were exercised resulting in $119,000 cash proceeds. The warrants provide that the exercise
price of the warrant will be reduced in the event of subsequent financings at an effective price per share less than the exercise price of the warrants, subject to certain exceptions and limitations. These provisions are commonly known as
down-round provisions. The warrants were originally evaluated under the guidance set forth in EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own
Stock (EITF 00-19). We originally considered the provisions of EITF 00-19 with respect to the warrants and had concluded that the warrants may be physically or net-share settled at the investors option and did not contain any
net-cash settlement provisions or any provisions deemed under EITF 00-19 to be equivalent to net-cash settlement provisions and were appropriately classified as equity. According to the provisions of EITF 07-5, warrants with down-round provisions
are no longer classified as equity. The adoption of EITF 07-5 resulted in a cumulative effect from accounting change of $0.9 million and a non-current liability for the fair value of the warrants as of January 1, 2009, which reflected the net
cumulative impact of initial application, determined based upon the amounts that would have been recognized if the guidance in EITF 07-5 had been applied from the issuance date of the warrants. The warrants are revalued quarterly thereafter during
the periods that the warrants remain outstanding.

For the three and six months ended June 30, 2009, we recorded expense related to
valuation of the fair value of the price adjustable warrants of $0.9 million and $1.9 million, respectively.

Debt restructuring and reduction of other
liabilities

In January 2009, we entered into a Loan and Security Agreement (the Loan Agreement) with General Electric
Capital Corporation (GECC) pursuant to which GECC converted the balance due under the capital lease obligations, along with a lease termination fee and amounts payable for property taxes, to a promissory note in the amount of $5.5
million at a fixed interest rate of 12.29% per year. The loan was paid off in full in June 2009 including the loan fee of 2% of the original loan balance, or approximately $0.1 million. As a result of the capital lease termination and issuance
of the note payable, we recorded a lease termination fee of approximately $0.2 million during the first quarter of 2009, which was presented as a component of gain on settlement of liabilities, net.



20



---

Beginning in January 2009, we engaged in negotiations to reduce certain current and future obligations,
including professional service fees due to our vendors incurred in the normal course of our business, rent on our 3450 Monte Villa Parkway facility (3450 Monte Villa) in Bothell, Washington, which we had ceased to use in 2008, and
severance obligations due to former employees of our company. In February and March 2009, we issued to eight of our vendors an aggregate of 1,364,285 shares of our common stock to settle amounts due to these vendors of approximately $0.6 million in
total.

In March 2009, we negotiated amendments to our agreements regarding severance obligations to both our former President and to our
former Chief Scientific Officer to reduce our overall cash obligations through September 2009. In particular, we entered into an amendment of our agreement regarding severance obligations with our former Chief Scientific Officer, pursuant to which
we agreed to pay to him a reduced sum of $0.9 million and to issue to him 731,275 unregistered shares of our common stock, in full satisfaction of $1.7 million in severance obligations. These obligations were included in accrued payroll and employee
benefits at December 31, 2008. We made the cash payment to the former executive in June 2009. We have also agreed to use our best efforts to file a registration statement with the SEC to register the shares to be issued to the former executive
on or prior to September 30, 2009. There is no requirement to transfer consideration if the registration statement is not filed by September 30, 2009.

Corporate restructuring

We have recently completed a major restructuring of our business from a clinical stage intranasal
drug delivery company to a pre-clinical RNAi drug discovery company. Since July 2008, we have accomplished the following: (1) reduced our workforce from approximately 75 employees in July 2008 to approximately 40 employees as of the date of
this filing; (2) suspended all further clinical development of our intranasal programs in August 2008; (3) renegotiated and significantly reduced our long-term legacy liabilities; and (4) sold our intranasal contract manufacturing
operations, in New York, to Par in March 2009. We have recorded restructuring charges related to employee termination costs, our facility consolidation and impairment of assets in accordance with our long-lived assets policy. We continue to work to
identify a partner or partners to further develop and commercialize our remaining legacy intranasal programs through either a sale or licensing transaction; however, there can be no assurance that we will be able to identify suitable partners for
our intranasal programs or a sale or licensing transaction on terms acceptable to us or at all. In March 2009, we engaged a consulting firm with expertise in international markets to assist in the sale or licensing of these remaining programs.

We have streamlined operations and reduced expenses, which has included reductions in our workforce. We continue to focus on maximizing
the performance of our business and controlling costs to respond to the economic environment and will continue to evaluate our underlying cost structure to improve our operating results and better position ourselves for growth. We have in the past
and may in the future find it advisable to restructure operations and reduce expenses, including, without limitation, such measures as reductions in the workforce, discretionary spending, and/or capital expenditures, as well as other steps to reduce
expenses. As such, we may incur further restructuring charges, including severance, benefits and related costs due to a reduction in workforce and/or charges for facilities consolidation or for assets disposed of or removed from operations as a
direct result of a reduction of workforce. In the second half of 2009, we anticipate that our costs and operating expenses will track to a level that is consistent with our expected revenue and allow us to continue to invest in accordance with our
strategic priorities. However, we may be unable to achieve these expense levels without adversely affecting our business and results of operations. We may continue to experience losses and negative cash flows in the near term, even if revenue
related to collaborative partnerships grows.

Summary

We believe that our current resources are sufficient to fund our planned operations to approximately year-end 2009. We based our estimate on our ability to perform planned R&D activities and the receipt of planned
funding. Volatility in our stock price, as well as global market conditions, could make it difficult for us to raise capital on favorable terms, or at all. Any financing we obtain may further dilute or otherwise impair the ownership interest of our
current stockholders. If we fail to generate positive cash flows or fail to obtain additional capital when required, we could modify, delay or abandon some or all of our programs. These factors, among others, raise substantial doubt about our
ability to continue as a going concern.



21



---

Consolidated Results of Operations

Comparison of Quarterly Results of Operations

Percentage comparisons have been omitted within
the following table where they are not considered meaningful. All amounts, except amounts expressed as a percentage, are presented in thousands in the following table.



|                                                             |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|------------------------------------------------------------ |  | -------------------------- | ------- | - | ------ | - | ------ | ------------------------ |  | - | ------ | - |  | ---- | -- |  | ---- | ------- | - | - | - | ------ | - |  | - | ------- | - |  | ----- | --
|                                                             |  | Three Months EndedJune 30, |         |   | Change |   |        | Six Months EndedJune 30, |  |   | Change |  
|                                                             |  | 2008                       |         |   | 2009   |   |        | $                        |  |   | %      |   |  | 2008 |    |  | 2009 |         |   | $ |   |        | % | 
|Revenue                                                      |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|License and research fees                                    |  | $                          | 431     |   |        | $ | 306    |                          |  | $ | (125   | ) |  | (29  | )% |  | $    | 1,113   |   |   | $ | 14,374 |   |  | $ | 13,261  |   |  | 1,191 | % 
|Product revenue                                              |  |                            | 241     |   |        |   |       |                          |  |   | (241   | ) |  |      |    |  |      | 729     |   |   |   | 70     |   |  |   | (659    | ) |  | (90   | )%
|Government grants                                            |  |                            | 82      |   |        |   | 3      |                          |  |   | (79    | ) |  | (96  | )% |  |      | 175     |   |   |   | 16     |   |  |   | (159    | ) |  | (91   | )%
|                                                             |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|Total revenue                                                |  |                            | 754     |   |        |   | 309    |                          |  |   | (445   | ) |  | (59  | )% |  |      | 2,017   |   |   |   | 14,460 |   |  |   | 12,443  |   |  | 617   | % 
|                                                             |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|Operating expenses                                           |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|Cost of product revenue                                      |  |                            | 2,665   |   |        |   |       |                          |  |   | (2,665 | ) |  |      |    |  |      | 2,829   |   |   |   |       |   |  |   | (2,829  | ) |  |       |   
|Research and development                                     |  |                            | 8,493   |   |        |   | 4,340  |                          |  |   | (4,153 | ) |  | (49  | )% |  |      | 19,419  |   |   |   | 8,456  |   |  |   | (10,963 | ) |  | (56   | )%
|Sales and marketing                                          |  |                            | 445     |   |        |   | 70     |                          |  |   | (375   | ) |  | (84  | )% |  |      | 1,018   |   |   |   | 213    |   |  |   | (805    | ) |  | (79   | )%
|General and administrative                                   |  |                            | 3,380   |   |        |   | 2,181  |                          |  |   | (1,199 | ) |  | (35  | )% |  |      | 7,609   |   |   |   | 4,145  |   |  |   | (3,464  | ) |  | (46   | )%
|Restructuring                                                |  |                            |        |   |        |   | 178    |                          |  |   | 178    |   |  |      |    |  |      | 1,917   |   |   |   | 311    |   |  |   | (1,606  | ) |  | (84   | )%
|                                                             |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|Total operating expenses                                     |  |                            | 14,983  |   |        |   | 6,769  |                          |  |   | (8,214 | ) |  | (55  | )% |  |      | 32,792  |   |   |   | 13,125 |   |  |   | (19,667 | ) |  | (60   | )%
|Interest income                                              |  |                            | 135     |   |        |   | 1      |                          |  |   | (134   | ) |  | (99  | )% |  |      | 428     |   |   |   | 3      |   |  |   | (425    | ) |  | (99   | )%
|Interest and other expense                                   |  |                            | (237    | ) |        |   | (168   | )                        |  |   | 69     |   |  | (29  | )% |  |      | (502    | ) |   |   | (311   | ) |  |   | 191     |   |  | (38   | )%
|Change in fair value liability for price adjustable warrants |  |                            |        |   |        |   | (905   | )                        |  |   | (905   | ) |  |      |    |  |      |        |   |   |   | (1,932 | ) |  |   | (1,932  | ) |  |       |   
|Gain on settlement of liabilities, net                       |  |                            |        |   |        |   |       |                          |  |   |       |   |  |      |    |  |      |        |   |   |   | 654    |   |  |   | 654     |   |  |       |   
|                                                             |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   
|Net loss                                                     |  | $                          | (14,331 | ) |        | $ | (7,532 | )                        |  | $ | (6,799 | ) |  | (47  | )% |  | $    | (30,849 | ) |   | $ | (251   | ) |  | $ | 30,598  |   |  | (99   | )%
|                                                             |  |                            |         |   |        |   |        |                          |  |   |        |   |  |      |    |  |      |         |   |   |   |        |   |  |   |         |   |  |       |   

Comparison of the Three and Six Months Ended June 30, 2008 to the Three and Six Months Ended June 30,
2009

Revenue.We had revenue from certain customers, as a percentage of total revenue, as follows:



|                                            |  |                            |   |  |                          |   |  |      |   |  |      |  
|------------------------------------------- |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                                            |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                                            |  | 2008                       |   |  | 2009                     |   |  | 2008 |   |  | 2009 |  
|Novartis                                    |  |                           |   |  | 60                       | % |  |     |   |  | 52   | %
|Roche                                       |  |                           |   |  |                         |   |  |     |   |  | 34   | %
|Amylin                                      |  |                           |   |  |                         |   |  |     |   |  | 7    | %
|QOL Medical, LLC                            |  | 47                         | % |  |                         |   |  | 49   | % |  | 6    | %
|Par Pharmaceuticals                         |  |                           |   |  | 39                       | % |  |     |   |  | 1    | %
|Government grant                            |  | 11                         | % |  | 1                        | % |  | 9    | % |  |     |  
|Undisclosed partner  undisclosed compounds |  | 24                         | % |  |                         |   |  | 28   | % |  |     |  
|Undisclosed partner  Factor IX             |  | 18                         | % |  |                         |   |  | 14   | % |  |     |  
|                                            |  |                            |   |  |                          |   |  |      |   |  |      |  
|Total                                       |  | 100                        | % |  | 100                      | % |  | 100  | % |  | 100  | %
|                                            |  |                            |   |  |                          |   |  |      |   |  |      |  

License and research fees revenue.Revenue from license and research fees increased by
$13.3 million to $14.4 million in the six months ended June 30, 2009 compared to the same period in 2008. For the three month period ended June 30, 2009, revenue decreased by $0.1 million compared to the same period in 2008.

In the six months ended June 30, 2009, license and research fee revenue was primarily from licensing our RNAi platforms including agreements with
Novartis and Roche as well as a $1.0 million milestone payment received from Amylin, recognition of $0.7 million in deferred revenue recognized upon termination of the QOL agreement and revenue recognized under the asset purchase agreement with Par.
In the three months ended June 30, 2009, license and research fee revenue included revenue from Novartis and Par. Revenue recognized in the three and six month periods ended June 30, 2008 consisted primarily of revenue from our intranasal
partners including QOL Medical and other collaboration or feasibility partners.

Government grants revenue.The National Institutes
of Health awarded us a grant in September 2006 for $1.9 million over a five year period to prevent and treat influenza. Revenue recognized under this grant totaled $0.1 million and $0.2 million for the three and six months ended June 30, 2008
and $3,000 and $16,000 for the three and six months ended June 30, 2009. We are terminating our government grant in the third quarter of 2009 and we expect government grant revenue to be minimal for the rest of 2009.



22



---

Product Revenue.During the three and six months ended June 30, 2008,
product revenue was $0.2 million and $0.7 million, respectively, which consisted of sales of Nascobal® brand products. As a
result of the Asset Purchase Agreement with Par, our Supply Agreement with QOL was terminated as of March 31, 2009. We recognized $0.1 million in the first quarter of 2009 related to a cancellation fee paid by QOL for cancellation of a planned
production lot. We expect no product revenue for the rest of 2009.

Cost of product revenue.Cost of product
revenue consists of raw materials, labor and overhead expenses. We did not produce any production lots of Nascobal® nasal
spray in 2009. We recorded a non-cash impairment charge of approximately $2.6 million to cost of goods sold related to the write-down of inventory in the second quarter of 2008. We expect no cost of product revenue for the rest of 2009.

Research and Development.R&D expense consists primarily of salaries and other personnel-related expenses, costs of clinical trials,
consulting and other outside services, laboratory supplies, facilities costs and other costs. We expense all R&D costs as incurred. R&D expense for the three and six months ended June 30, 2009 decreased $4.2 million and $11.0 million as
compared to the 2008 periods, due to the following:



| |  |  | Personnel-related expenses decreased by 57% and 60% to $1.1 million and $2.5 million in the three and six months ended June 30, 2009 compared to $2.6 million
and $6.2 million in the three and six months ended June 30, 2008 due to a decrease in headcount as a result of our restructuring.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Costs of clinical trials, lab supplies, consulting, and outside testing and services decreased by 81% and 90% to $0.5 million and $0.7 million in the three and six
months ended June 30, 2009 compared to $2.7 million and $6.7 million in the three and six months ended June 30, 2008. We discontinued our PTH(1-34) clinical trial in the first quarter of 2008, and completed a Phase 2 clinical trial for
PYY(3-36) in July 2008. The costs for the 2009 period were significantly lower than 2008 as we restructured our business from a clinical stage intranasal drug delivery company to a pre-clinical RNAi drug discovery company.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Facilities and equipment costs decreased by 63% and 55% to $0.9 million and $2.0 million in the three and six months ended June 30, 2009 compared to $2.4
million and $4.6 million in the three and six months ended June 30, 2008 due to a decrease in rent and related expenses and a decrease in depreciation of equipment and related maintenance and calibration costs. Depreciation expense included in
R&D in the three and six months ended June 30, 2009 was $0.4 million and $0.9 million, compared with $0.9 million and $1.7 million in the three and six months ended June 30, 2008.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based compensation included in R&D expense decreased from approximately $.7 million and $1.5 million in the three and six months ended June 30, 2008
to a benefit of $0.2 million and a benefit of $0.3 million in the three and six months ended June 30, 2009. The decrease was due to lower headcount and to recognize the accounting impact of forfeitures of restricted stock awards in the current
year periods.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | R&D expense by project, as a percentage of total R&D project expense, was as follows:
| | - |  | -------------------------------------------------------------------------------------



|                           |  |                            |   |  |                          |   |  |      |   |  |      |  
|-------------------------- |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                           |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                           |  | 2008                       |   |  | 2009                     |   |  | 2008 |   |  | 2009 |  
|RNAi Projects              |  | 44                         | % |  | 94                       | % |  | 36   | % |  | 95   | %
|Legacy Intranasal Projects |  | 56                         | % |  | 6                        | % |  | 64   | % |  | 5    | %
|                           |  |                            |   |  |                          |   |  |      |   |  |      |  
|Total                      |  | 100                        | % |  | 100                      | % |  | 100  | % |  | 100  | %
|                           |  |                            |   |  |                          |   |  |      |   |  |      |  

We expect our R&D expenses to decrease in 2009 due to the restructuring of our business from a
clinical stage intranasal drug delivery company to a pre-clinical RNAi drug discovery company. Our current strategy is focused on entering into collaborations with third parties to participate in the development of, and ultimately the
commercialization of, our RNAi technology.

Sales and marketing.Sales and marketing expense consists primarily of salaries and
other personnel-related expenses, consulting, trade shows and advertising. The 84% and 79% decrease in sales and marketing expense in the three and six months ended June 30, 2009 compared to the three and six months ended June 30, 2008
resulted primarily from headcount reductions in connection with our restructuring and our cost containment efforts. We expect sales and marketing costs, which primarily include business development staff and activities, to continue to decrease in
2009 compared to 2008 due to continued cost containment efforts and the restructuring of our business from a clinical stage intranasal drug delivery company to a pre-clinical RNAi drug discovery company.



23



---

General and administrative.General and administrative expense consists primarily of salaries and
other personnel-related expenses to support our R&D activities, non-cash stock-based compensation for general and administrative personnel and non-employee members of our Board, professional fees, such as accounting and legal, corporate
insurance and facilities costs. The 35% and 46% decrease in general and administrative expenses in the three and six months ended June 30, 2009 compared to the three and six months ended June 30, 2008 resulted primarily from the following:



| |  |  | Personnel-related expenses decreased by 10% and 39% to $0.6 million and $1.1 million in the three and six months ended June 30, 2009 compared to $0.7 million
and $1.7 million in the three and six months ended June 30, 2008 due primarily to decreased headcount related to administrative activities.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Costs of legal and accounting fees, consulting, corporate insurance and other administrative costs decreased by 46% and 49% to approximately $1.0 million and $2.2
million in the three and six months ended June 30, 2009 compared to approximately $1.9 million and $4.3 million in the three and six months ended June 30, 2008, due primarily to cost containment efforts and the restructuring of our
business from a clinical stage intranasal drug delivery company to a pre-clinical RNAi drug discovery company.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Non-cash stock-based compensation included in general and administrative expense decreased from approximately $0.5 million and $1.1 million in the three and six
months ended June 30, 2008 to $0.2 million and $0.3 million in the three and six months ended June 30, 2009.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We expect general and administrative expenses to decrease in 2009 compared to 2008 due to continued cost containment efforts.

Restructuring. We have recorded restructuring charges related to employee termination costs, our facility consolidation and impairment of assets in accordance with our long-lived assets policy. In addition, we also incurred
approximately $0.3 million related to our decision in the first quarter of 2008 to place our Phase 2 PTH(1-34) clinical trial on hold until further funding has been obtained. We continue to work to identify a partner or partners to further develop
and commercialize our remaining legacy intranasal programs through either a sale or licensing transaction; however, there can be no assurance that we will be able to identify suitable partners for our intranasal programs or a sale or licensing
transaction on terms acceptable to us or at all.

During 2008, we exited our facility at 3450 Monte Villa Parkway and recorded a
restructuring liability, representing estimated future payments and other costs, and discounted using a credit-adjusted risk-free interest rate. In March 2009, we entered into an amendment of our lease for this facility, which reduced our lease
obligations by approximately $1.9 million until July 2010. Under the terms of the amendment, we released both a cash deposit of $0.3 million and restricted cash under a letter of credit for $1.0 million to the landlord, to be used by them to cover
rent payments or as incentives to attract new tenants. As inducement to enter into the amendment, we issued 1.5 million shares of our common stock to the sole member of the landlord. Because of this amendment, we will have no further rent
obligations under the 3450 Monte Villa Parkway lease for the period from January 2009 until July 2010. We use a credit-adjusted risk-free interest rate of 15%, and we based estimated future payments on current rental rates available in the Bothell
real estate market, cash incentives available from the landlord to attract new tenants, our evaluation of the likelihood of subleasing our facility in light of tightening credit markets, deteriorating conditions in the Bothell real estate market and
increased vacancy rates in the competing downtown real estate markets. During the three and six months ended June 30, 2009, we recorded approximately $54,000 and $122,000 in accretion expense. We expect to incur approximately $0.2 million in
accretion expense through the expiration of this lease in January 2016.

Given the triggering event as a result of the employee
terminations and facility consolidation, we have evaluated our long-lived assets for possible impairment under the guidance in SFAS 144. In 2008, leasehold improvements having a net book value of approximately $1.5 million and fixed assets whose net
book value exceeded the net realizable value by approximately $0.4 million in aggregate were considered impaired by management as they related to our facility which we had ceased to use. A related charge was included in restructuring expense in
2008. At December 31, 2008, property and equipment having a net realizable value of approximately $0.5 million, net of estimated costs to sell, was held for sale. All of these assets were sold as of June 30, 2009.

Interest Income.The 99% decrease in interest income in the both the three and six months ended June 30, 2009 compared to the same periods in
2008 was primarily due to lower average balances available for investment.

Interest Expense.We incurred interest expense on our
capital leases and in 2009 on our note payable. The 29% and 38% decrease in interest expense in the three and six months ended June 30, 2009 compared to the same periods in 2008 was due to a decrease in the average borrowings. At June 30,
2009 we have no interest-bearing debt outstanding.

Change in fair value liability for price adjustable warrants.For the three and
six months ended June 30, 2009, we recorded expense related to valuation of the price adjustable warrants of $0.9 million and $1.9 million based on the June 30, 2009 closing price of our stock of $1.38 per common share.

Gain on settlement of liabilities, net. We recorded a net gain on settlement of liabilities of approximately $0.7 million in the first quarter
of 2009. This included a $0.7 million gain relating to the amendment of our agreement regarding severance obligations with our former Chief Scientific Officer. In addition, we recorded a gain of approximately $0.2 million related to the issuance of
shares of



24



---

stock valued at $0.4 million to eight of our vendors to settle amounts due to these vendors of approximately $0.6 million
in total. These gain amounts were partially offset by a lease termination fee of approximately $0.2 million incurred pursuant to the termination of our lease agreement with GECC and subsequent refinance of the amounts due under our Loan and Security
Agreement with GECC.

Off-Balance Sheet Arrangements

As of June 30, 2009, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 4.  CONTROLS AND PROCEDURES

(a) Disclosure Controls and Procedures. As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation,
under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information that we are required to disclose in reports filed under
the Securities Exchange Act of 1934, as amended.

(b) Internal Control Over Financial Reporting.There have been no changes in our
internal controls over financial reporting or in other factors during the fiscal quarter ended June 30, 2009, that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting .



25



---

PART II  OTHER INFORMATION

ITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On June 18, 2009, we issued 606,061 shares of our common stock to Ribotask ApS as consideration for an amendment of our Patent Assignment and License
Agreement dated May 21, 2008, as amended October 9, 2008. The shares were offered and sold in reliance on the exemption from registration afforded by Section 4(2) of the Securities Act.

ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our stockholders approved the following proposals at our Annual Meeting of Stockholders held on Wednesday, May 20, 2009:



| | 1) | The election of the following five (5) directors, each to hold office for a term of one (1) year or until their respective successors have been duly elected or appointed:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                        |  |            |  |               
|----------------------- |  | ---------- |  | --------------
|Nominee                 |  | Votes FOR  |  | Votes WITHHELD
|J. Michael French       |  | 28,037,709 |  | 1,175,531     
|Daniel Peters           |  | 27,982,103 |  | 1,213,137     
|James E. Rothman, Ph.D. |  | 28,000,598 |  | 1,212,642     
|Gregory Sessler         |  | 27,968,049 |  | 1,245,197     
|Bruce R. Thaw           |  | 27,761,649 |  | 1,451,591     



| | 2) | Ratification of the appointment of KPMG LLP as our independent registered public accountants for the year ending December 31, 2009:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------



|           |  |               |  |                
|---------- |  | ------------- |  | ---------------
|          
|Votes FOR  |  | Votes AGAINST |  | Votes ABSTAINED
|28,971,267 |  | 204,715       |  | 37,256         



| | 3) | The approval of the amendment to our amended and restated certificate of incorporation to effect a reverse split, at a time in the future, and in such ratio between a one-for-two
and one-for-ten reverse stock split, to be determined by the Board of Directors, in conjunction with advice from our investment bankers, to be in the best interest of MDRNA, Inc.:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|           |  |               |  |                
|---------- |  | ------------- |  | ---------------
|Votes FOR  |  | Votes AGAINST |  | Votes ABSTAINED
|23,744,638 |  | 5,398,555     |  | 70,044         

ITEM 5  OTHER INFORMATION

On July 27, 2009, we and BMR-3450 Monte Villa Parkway LLC (BMR), the successor-in-interest to Phase 3 Science Center LLC, entered into a
fourth amendment (the Fourth Amendment) of that certain Lease dated as of April 23, 2002, as amended by that certain First Amendment to Lease dated as of July 1, 2003, that certain Second Amendment to Lease dated as of
January 29, 2004, and that certain Third Amendment to Lease dated as of March 5, 2009 (as amended, the Lease), whereby we lease certain premises from BMR at 3450 Monte Villa Parkway in Bothell, Washington (the
Premises). Pursuant to the Fourth Amendment, the rentable area of the Premises shall be reduced by approximately 19,108 square feet to approximately 31,892 square feet. As previously disclosed, as a result of the Third Amendment to the
Lease, we have no obligation to pay rent on the Premises until July 1, 2010, upon which date, and with accrual commencing as of such date, our obligation to pay rent and operating expenses shall resume in accordance with the terms of the Lease.

The foregoing summary is qualified in its entirety by reference to the text of the Fourth Amendment, a copy of which is attached to this
Quarterly Report as Exhibit 10.3 and incorporated herein by reference.

ITEM 6  EXHIBITS

The exhibits required by this item are set forth in the Exhibit Index attached hereto.



26



---

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, duly authorized, in Bothell, State of Washington, on July 30, 2009.



MDRNA, INC.By:

/s/    J. Michael FrenchJ. Michael FrenchChief Executive Officer and PresidentBy:

/s/    Peter S. GarciaPeter S. Garcia Chief Financial
Officer




27



---

EXHIBIT INDEX



|            |  |                                                                                                                                                                                          
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                              
|10.1        |  | Amendment No. 1 to the Securities Purchase Agreement, dated as of April 25, 2008, between the Registrant and the purchasers identified therein. (1)                                      
|            | 
|10.2        |  | Form of Amended and Restated Common Stock Purchase Warrant issued to the investors in the April 2008 financing. (1)                                                                      
|            | 
|10.3        |  | Fourth Amendment, dated as of July 27, 2009, to Lease Agreement dated April 23, 2002, with BMR-3450 Monte Villa Parkway LLC (as successor-in-interest to Phase 3 Science Center LLC).
(1)
|            | 
|31.1        |  | Certification of our Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended. (1)                                              
|            | 
|31.2        |  | Certification of our Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended. (1)                                              
|            | 
|32.1        |  | Certification of our Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1)                               
|            | 
|32.2        |  | Certification of our Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1)                               



|(1) | Filed Herewith.
|--- | ---------------



28