**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the fiscal year endedDecember 31, 2006**

**or**

**o**                                 TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Commission File Number 001-33213**

----

**AFFYMAX, INC.**

(Exact name ofregistrant as specified in its charter)

----

| **Delaware**                     |   | **77-0579396**          |
|----------------------------------|--------|-------------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer        |
| incorporation or  organization)  |   | Identification  Number) |

 

**4001 Miranda AvenuePalo Alto, CA 94304(650) 812-8700**

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

**Securitiesregistered pursuant to Section 12(b) of the Act:**

| **Title of Each Class**                        |   | **Name of  Each Exchange on Which Registered** |
|------------------------------------------------|--------|------------------------------------------------|
| Common stock, par  value $0.001 per share |   | The NASDAQ Stock  Market LLC                   |
|                                           |   | (NASDAQ Global  Market)                        |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.  Yes o  No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d)of the Act.  Yes o  No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K   o

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

| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated  filer x |
|---------------------------|--------|---------------------|--------|--------------------------|

 

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

The initial public offeringof Affymax, Inc.’s Common Stock, par value $0.001 per share, commenced on December 15,2006. There was no public market for the Company’s Common Stock prior to thatdate.

As of February 28, 2007, the registrant hadoutstanding 14,878,740 shares of Common Stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

Specifiedportions of the Proxy Statement for the 2007 Annual Meeting of Stockholders(the “Proxy Statement”), to be filed with the Commission within 120 days of theend of the fiscal year ended December 31, 2006, are incorporated byreference into Part III of this Report. Except with respect to informationspecifically incorporated by reference into this Form 10-K, theProxy Statement is not deemed to be filed as part hereof.

 

----

**AFFYMAX,INCTABLE OF CONTENTS**

|            | ** ** | **PART I.**                                                                                                   | ** ** | **Page** | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Item 1.    |       | Business                                                                                                           |       |     | 1          |   |   |
| Item  1A.  |       | Risk  Factors                                                                                                      |       |     | 17         |   |   |
| Item 1B.   |       | Unresolved Staff Comments                                                                                          |       |     | 37         |   |   |
| Item 2.    |       | Properties                                                                                                         |       |     | 37         |   |   |
| Item  3.   |       | Legal  Proceedings                                                                                                 |       |     | 37         |   |   |
| Item 4.    |       | Submission of Matters to a Vote of Security Holders                                                                |       |     | 41         |   |   |
| ** ** | ** ** | **PART II.**                                                                                                  | ** ** |     |       |   |   |
| Item 5.    |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |     | 42         |   |   |
| Item 6.    |       | Selected Financial Data                                                                                            |       |     | 45         |   |   |
| Item 7.    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |     | 46         |   |   |
| Item 7A.   |       | Quantitative and Qualitative Disclosures of Market  Risks                                                          |       |     | 59         |   |   |
| Item 8.    |       | Financial Statements and Supplementary Data                                                                        |       |     | 60         |   |   |
| Item 9.    |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       |     | 94         |   |   |
| Item 9A.   |       | Controls and Procedures                                                                                            |       |     | 94         |   |   |
| Item  9B.  |       | Other  Information                                                                                                 |       |     | 94         |   |   |
| ** ** | ** ** | **PART III.**                                                                                                 | ** ** |     |       |   |   |
| Item 10.   |       | Directors, Executive Officers and Corporate Governance                                                             |       |     | 95         |   |   |
| Item 11.   |       | Executive Compensation                                                                                             |       |     | 95         |   |   |
| Item 12.   |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       |     | 95         |   |   |
| Item 13.   |       | Certain Relationships, Related Transactions and  Director Independence                                             |       |     | 95         |   |   |
| Item 14.   |       | Principal Accountant Fees and Services                                                                             |       |     | 96         |   |   |
| ** ** | ** ** | **PART IV.**                                                                                                  | ** ** |     |       |   |   |
| Item 15.   |       | Exhibits  and Financial Statement Schedules                                                                        |       |     | 97         |   |   |

 

----

*This Annual Report on Form 10-K containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, which are subject to the “safe harbor” createdby those sections. Forward-looking statements are based on our management’sbeliefs and assumptions and on information currently available to ourmanagement. In some cases, you can identify forward-looking statements by termssuch as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,”“believe,” “estimate,” “project,” “predict,” “potential” and similarexpressions intended to identify forward-looking statements. These statementsinvolve known and unknown risks, uncertainties and other factors, which maycause our actual results, performance, time frames or achievements to bematerially different from any future results, performance, time frames orachievements expressed or implied by the forward-looking statements. We discussmany of these risks, uncertainties and other factors in this Annual Report on Form 10-Kunder Item 1A “Risk Factors.” Given these risks, uncertainties and otherfactors, you should not place undue reliance on these forward-lookingstatements. Also, these forward-looking statements represent our estimates andassumptions only as of the date of this filing. You should read this AnnualReport on Form 10-K completely and with the understanding that ouractual future results may be materially different from what we expect. Wehereby qualify our forward-looking statements by these cautionary statements.Except as required by law, we assume no obligation to update theseforward-looking statements publicly, or to update the reasons actual resultscould differ materially from those anticipated in these forward-lookingstatements, even if new information becomes available in the future.*

**PART I.**

**Item 1.   Business.**

**Overview**

We are a biopharmaceutical company developing novelpeptide-based drug candidates to improve the treatment of serious and oftenlife-threatening conditions. Our lead product candidate, HematideTM, is designedto treat anemia associated with chronic kidney disease and cancer. Anemia is aserious condition in which blood is deficient in red blood cells andhemoglobin. It is common in patients with chronic kidney disease, cancer, heartfailure, inflammatory diseases and other critical illnesses, as well as in theelderly. If left untreated, anemia may increase the risk of other diseases ordeath. A major cause of anemia is insufficient production of, or insufficientresponse to, erythropoietin, or EPO, a naturally occurring hormone that stimulatesthe production of red blood cells. Hematide is a synthetic peptide-basederythropoiesis stimulating agent, or ESA, designed to stimulate production ofred blood cells. Hematide is designed to be less frequently dosed thancurrently marketed ESAs, and therefore has the potential to offer both bettercare for patients and reduced cost and complexity for healthcare providers. Weare currently conducting Phase 2 clinical trials in patients suffering fromend-stage renal disease who are on dialysis, as well as in earlier stagechronic kidney disease patients, or predialysis patients. We have hadpreliminary discussions with the Food and Drug Administration, or FDA,regarding Phase 3 clinical trials in both dialysis and predialysis patients.Based on those discussions, we believe that our clinical, preclinical andmanufacturing work is sufficient to proceed to Phase 3 clinical trials and weare continuing discussions with the FDA relating to the design of these trials.Assuming timely conclusion of the discussions with the FDA, we would expect tocommence separate Phase 3 trials in both dialysis and predialysis patientsduring the second half of 2007**.** In oncologysupportive care, we have initiated a Phase 2 clinical trial evaluating Hematidein cancer patients who suffer from anemia as a consequence of theirchemotherapy treatment. We are also building a proprietary pipeline of othernovel drug candidates which are designed to offer advantages over firstgeneration recombinant protein therapeutics currently addressing large markets.

According to IMS Health Incorporated, recombinant EPO,or rEPO, generated $13 billion in worldwide revenues for 12 months ended June 2006,of which we believe approximately $9 billion was generated in the U.S. Of this$9 billion, we estimate that approximately $3 billion is attributable to use ofrEPO in patients on dialysis, and the remaining $6 billion is attributable toother indications, including 

1

----

oncology and use inpredialysis patients. Despite the success of rEPO, we believe that worldwidemarkets for predialysis and cancer are underserved. Currently marketed rEPO istypically given up to three times per week to dialysis patients, and every oneto three weeks to oncology patients. We believe the requirement for relativelyfrequent dosing has historically limited the use of these ESAs in predialysisand oncology treatment settings and that Hematide, with less frequent dosing,has the potential to expand these markets. While the dialysis market iscurrently well penetrated, we believe Hematide has the potential to offerreduced operational cost and complexity for healthcare providers compared tocurrently marketed ESAs.

In February and June 2006, we entered intotwo separate agreements with Takeda Pharmaceutical Company Limited, or Takeda,the largest pharmaceutical company in Japan, which resulted in a worldwidecollaboration to develop and commercialize Hematide. Under our collaboration,the companies will co-develop and co-commercialize Hematide in the U.S. Takedareceived an exclusive license to develop and commercialize Hematide outside ofthe U.S. Beginning January 1, 2007, Takeda bears the first $50 million ofthird party expenses related to development in pursuit of U.S. regulatoryapproval of Hematide. Thereafter, Takeda will bear 70% of the third party U.S.development expenses, while we are responsible for 30% of the expenses. Eachcompany retains responsibility for 100% of its internal development****expenses. Under the agreements, Takeda paid us upfrontlicense fees of $122 million and purchased approximately $10 million of ourpreferred stock. In December 2006, Takeda completed a Phase 1 trial ofHematide in Japan for which Takeda paid us a milestone payment of $10 millionin January 2007. We are eligible to receive additional payments fromTakeda of up to a total of $345 million upon the successful achievement ofclinical development and regulatory milestones. Further, we may receive fromTakeda up to an aggregate of $150 million upon the achievement of certainworldwide annual net sales milestones. We and Takeda will share equally in thenet profits and losses of Hematide in the U.S. which include expenses relatedto the marketing and launch of Hematide. Takeda will pay us royalties based onthe annual net sales of Hematide outside the U.S.

In addition to our leadprogram, we are using our discovery platform to develop a pipeline of peptidebased drug candidates. We are currently advancing research on AdeptideTM, apeptide based, non-injectable ESA. Our InnotideTM program is evaluating a familyof peptide based drug candidates that show early positive results in the areaof tissue protection in preclinical models of stroke, myocardial infarct, andrenal injury. In addition, we have a preclinical research collaboration withEntreMed, Inc. on AngiotideTM, a novel synthetic peptide that may be usefulin treating cancer by blocking angiogenesis, or blood vessel formation intumors.

**Our Lead ProductCandidate: Hematide**

Hematide is a syntheticpeptide-based ESA designed for less frequent dosing. It is currently in Phase 2clinical trials and is being developed for treatment of anemia associated withend-stage renal disease, predialysis chronic kidney disease and cancer. Inclinical trials in both healthy volunteers and patients, Hematide hasdemonstrated the ability to stimulate the production of red blood cells. Invivo studies have also demonstrated that Hematide dosing can be less frequentcompared to rEPOs currently on the market. The primary toxicology observed todate has been associated with the exaggerated red blood cell production seen athigh and frequent doses, a result similar to that observed with the rEPO classof drugs. To date, over 400 patients have received Hematide in ongoing clinicalstudies. The type and frequency of adverse events including serious adverseevents associated with Hematide in these clinical trials are similar to thoseevents that have been reported for currently marketed ESAs in studies targetingsimilar hemoglobin levels. Hematide is designed to be dosed once every fourweeks, compared to recombinant products sold in the U.S. that are dosed eitherseveral times a week, every week to two weeks, or up to every three weeks forsome patients. In addition, we believe that Hematide can be further developedto be stable at room temperature, compared to the cold storage conditionsneeded for recombinant products.

2

----

***Anemia Background***

Anemia, a condition in which the blood is deficient inred blood cells and hemoglobin, is a frequent and serious complicationassociated with a number of common chronic diseases. Anemia is associated withchronic fatigue and, if left untreated, may increase the risk of other diseasesor even death. Red blood cells are normally formed in the circulating bloodfrom progenitor cells, known as stem cells, and from precursor cells which areinitially present primarily in the bone marrow. These cells are stimulated todivide and differentiate and are mobilized into circulation by EPO, a hormonalfactor produced by the kidney. EPO acts by binding to and activating the EPOreceptor on precursor cells. The activation of the EPO receptor stimulates theproliferation and maturation of the precursor cells to form red blood cellsthat contain hemoglobin. Hemoglobin is an iron-containing protein in red bloodcells that functions primarily in the transport of oxygen to, and carbondioxide from, the tissues of the body. Anemia can be caused by conditions suchas chronic kidney disease, or treatments such as chemotherapy, that result inunderproduction of EPO or a muted response to EPO.

Anemia generally exists in men when the hemoglobinlevel in blood, which is a measure of red blood cells, is less than 12 g/dL, orthe hematocrit, which is a ratio of the volume packed red blood cells to thevolume of whole blood, is less than 37%, and in women when hemoglobin is lessthan 11 g/dL or hematocrit is less than 33%. The FDA, the medical community andothers have recently raised significant safety concerns relating to currentlymarketed ESAs as a result of reports of increased mortality and side effectsfrom a number of clinical trials. Some of these safety concerns relate totargeting and maintaining high hemoglobin levels for extended periods of time.The FDA recently required revised warnings, including black box warnings, beadded to labels of currently marketed ESAs advising physicians to monitorhemoglobin levels and to use the lowest dose of ESA to increase the hemoglobin concentrationto the lowest level sufficient to avoid the need for red blood celltransfusions. Black box warnings for currently marketed ESAs also noteincreased risk of death and serious cardiovascular events when administered totarget a hemoglobin of greater than 12 g/dL.

*Anemiaassociated with Chronic Kidney Disease.**  *One of the most common forms ofchronic anemia is that which occurs in patients with chronic kidney disease.According to the American Journal of Kidney Disease, chronic kidney diseaseaffects as many as 19 million Americans. As kidney function deteriorates due tothe underlying disease, the ability of the kidney to produce adequate EPO isimpaired, resulting in decreased production of new red blood cells and anemia.

Over time, chronic kidney disease usually progressesto irreversible end-stage renal disease, the most severe stage of the disease.End-stage renal disease patients require either lifetime dependence on renaldialysis, a medical procedure in which blood is cleansed of impurities, or akidney transplant. Patients with end-stage renal disease are nearly alwaysmoderately to severely anemic unless treated with an ESA like rEPO. Accordingto the Centers for Medicare and Medicaid Services, or CMS, there areapproximately 320,000 end-stage renal disease patients on dialysis in the U.S.served by approximately 4,700 dialysis facilities. Funding and reimbursementfor this care are predominately through the Medicare End Stage Renal DiseaseProgram. In 2005, according to the CMS, reimbursement for many drugs, includingESAs, was at a rate of 106% of the average ESA sales price. This allows thedialysis facilities to realize a profit on the purchase and administration ofESAs, which constitutes an important component of their economic viability. IMSHealth estimates that the U.S. sales of EPOGEN, the dominant therapy for anemiain dialysis patients, totaled $2.9 billion for the 12 months ended June 2006.

We estimate that approximately two-thirds ofpre-dialysis patients with anemia are not treated with an ESA prior toprogression to stage 5, end-stage renal disease, and initiating dialysis. Whilein the U.S., currently marketed ESAs are indicated for up to every two weekdosing in predialysis, these patients often require much less frequent visitsto their nephrologists or primary care physicians for treatment of theirunderlying disease. Because of the incongruity between the optimal dosescheduling of these ESAs and the 

3

----

timing of predialysispatient office visits, we believe that the predialysis market for ESAs isunderserved by existing therapy and could be better served with a product thatcan be dosed once every four weeks.

*Anemiaassociated with Cancer.**  *Anemia in cancer patients may be caused bychemotherapy or the cancer itself. For patients undergoing chemotherapy, thedestruction of progenitor stem cells and precursor cells in the bone marrow bychemotherapy often leads to anemia. Severe fatigue associated with anemiaaffects approximately three-fourths of all cancer patients undergoingchemotherapy. In some cancer patients, such as those with multiple myeloma andacute leukemia, the underlying cancer itself causes anemia. In these patients,the production of and responsiveness to EPO is believed to be reduced bymolecules known as cytokines that are produced by or in response to tumors. Anoncologist’s ability to treat a patient’s cancer is often limited by thepatient’s ability to tolerate the side effects, including anemia, of highlytoxic courses of chemotherapy. Better management of chemotherapy induced anemiacould lead to better dose optimization of chemotherapy in cancer patients.

The FDA has recently issued a public health advisoryre-evaluating the safe use of the ESA class and is scheduled to convene itsOncology Drugs Advisory Committee (ODAC) in May 2007 to consider themechanism of action of ESAs and to review the effects of ESAs on survival andtumor progression in cancer patients. Use of ESAs has been associated withshortened time to tumor progression in certain patients with advanced head andneck cancer. Increased risk of death has been reported when ESAs areadministered to target a hemoglobin of 12 g/dL in patients with activemalignant disease receiving neither chemotherapy nor radiation therapy, apopulation for which ESAs are not approved or indicated.

Based on our marketing research, there areapproximately 3 million actively treated cancer patients in the U.S. Of thosepatients, roughly 1.2 million undergo chemotherapy to treat their cancer. About65% of chemotherapy patients become anemic, with 47% of those receiving ESAtherapy. Further, based on the January to June 2005 Tandem canceraudit, over 90% of chemotherapy patients receive chemotherapy treatment inthree or four week cycles or less frequently, yet the most prevalent dosingintervals of current ESAs for cancer patients are every one to two weeks. Webelieve that a less frequent, more convenient dosing regimen, every three tofour weeks to coincide with chemotherapy, may increase market penetration andexpand use of ESAs for oncology patients.

*Anemia associated withOther Conditions.**  *Anemiacan also occur in any person with a chronic disease that causes significantinflammation, infection, or bleeding, such as rheumatoid arthritis orcardiovascular disease, and it can therefore be considered a characteristicdisease of the elderly. We are testing Hematide in chronic kidney disease andcancer, but are not currently testing Hematide’s effectiveness in treatinganemia in other conditions.

***Current Therapy and Limitations***

According to IMS Health, rEPO generated $13 billion inworldwide revenue for the 12 months ended June 2006, of whichapproximately $9 billion was generated in the U.S. Of the $9 billion in U.S.revenue, we estimate that $3 billion is attributable to use for dialysispatients, and the remaining $6 billion is attributable to other indications,including use in oncology and predialysis patients. ESAs, in the form of rEPOvariants, have been used successfully to manage the anemia of dialysis,predialysis and cancer patients. rEPOs are similar, but not necessarilyidentical, to a patient’s naturally occurring EPO. Differences exist amongrEPOs with regard to composition and structure. As a result, differences mayalso exist among rEPOs with regard to frequency of dosing, duration of effectand rate of rise in hemoglobin. Stability in the blood and circulatinghalf-life, which measure the time it takes the compound to disappear from theblood, generally correlate with less frequent dosing. One of our objectives isto develop a product with a duration of effect that results in a well-controlledhemoglobin response while still allowing optimal dosing, ideally once everyfour weeks.

4

----

Since its initial U.S. market introduction in 1989,rEPO has revolutionized the treatment of patients with anemia resulting fromchronic diseases. To date, the therapeutic options have not progressedsignificantly beyond the relatively short-acting and inconvenient recombinantprotein products currently on the market. Further, the majority of products indevelopment are variations of the existing products on the market.

Two current types of ESAs, epoetin alfa and epoetinbeta, are biologically engineered hormones produced in mammalian cells byrecombinant DNA technology. Both are relatively short-acting forms of rEPO thattypically require frequent dosing to obtain a sustained correction of anemia.Darbepoetin alfa, which is marketed by Amgen, Inc., or Amgen, under thetrade name Aranesp, is a biologically engineered hormone product closelyrelated to and functionally similar to epoetin alfa. However, darbepoetin alfahas a terminal half-life approximately three times longer than epoetin alfa, asa result of the addition of sialic acid to stabilize the protein. The currentlyavailable rEPOs are marketed under a variety of trade names in differentterritories.

*Frequencyof Dosing.**  *Currentlymarketed ESAs are hampered by short duration of effect resulting in the needfor frequent dosing. We believe that the need for frequent dosing has limitedthe use of ESAs in treatment settings such as predialysis, where patient visitsfor the purpose of treating underlying disease are less frequent than forpatients undergoing dialysis multiple times per week. The population ofpredialysis chronic kidney disease patients who may benefit from anemiamanagement far outnumbers the population of patients who have reached end-stagerenal disease. We believe the requirement for relatively frequent dosing hashistorically limited the use of ESAs in predialysis and oncology treatmentsettings and that, with its longer acting profile, Hematide has the potentialto expand these markets. In the oncology setting, anemia management ofteninvolves administration of ESAs more frequently than typical chemotherapyregimens, which usually require treatment every three to four weeks. Althoughexisting ESAs are sometimes given in larger doses in an effort to achieveextended dosing, and despite studies by the manufacturers of these ESAs aimedat extending the dose interval of these products, medical record audit data andoncologist survey response indicate that existing ESAs are still administeredto chemotherapy patients once a week to once every two weeks on average. Inaddition, recent studies by manufacturers of ESAs indicate that the higherlevels of hemoglobin associated with larger and more frequent doses result in astatistically significant increase in cardiovascular events. For these reasons,we believe that an ESA designed for every four weeks administration couldexpand the market opportunity for anemia management therapies in the oncology setting.

*Pure Red Cell Aplasia.**  *Treatment of patients with rEPO hasbeen shown in rare cases to cause the production of antibodies to both rEPO andnaturally-occurring EPO. Typically these antibodies can bind to and neutralizeboth the rEPO drug and any naturally-occurring EPO in a patient’s system. As aresult, such patients become increasingly less sensitive to rEPO therapy andcan develop a form of anemia called Pure Red Cell Aplasia, or PRCA. Thishematological disorder is characterized by severe, transfusion-dependentanemia, a scarcity of reticulocytes and an almost complete absence of red bloodcell precursors in otherwise normal bone marrow. Recently, the FDA has requiredmarketers of rEPO in the U.S. to include in their product prescribing informationwarnings of potential for rEPO induced PRCA and a description of this adversereaction. We believe that an ESA that does not cause PRCA and that can be usedto treat PRCA will have advantages in the marketplace over rEPOs that can causePRCA.

***Potential Hematide Advantages***

Hematide is a relatively small synthetic peptide-basedESA which we are developing for the treatment of anemia in dialysis,predialysis, PRCA and cancer patients. Peptides are composed of amino acids,commonly known as the building blocks of proteins. Typically, a peptide iscomposed of fewer than 50 amino acids, while a protein contains from 50 to wellover 5,000 amino acids. Peptide-based therapeutics may display certainadvantages compared to recombinant proteins, including simplicity and cost of 

5

----

manufacture, andspecificity of effect. Further, because they are composed ofnaturally-occurring amino acids, peptide-based therapeutics theoretically alsocarry the general advantage of reduced toxicity relative to small moleculedrugs. In the past, development of peptide-based drug candidates was oftenslowed by low potency. A second problem historically associated withpeptide-based drugs has been a requirement of frequent dosing in vivo. Morerecently, however, it has been possible to develop peptide-based drugs withpotencies nearly equivalent to recombinant proteins and with less frequentdosing requirements.

Through the use of our technology, we have designedHematide to require less frequent dosing than currently marketed ESAs. Webelieve that Hematide’s properties are superior to the properties of rEPO drugscurrently on the market, particularly in terms of required frequency ofadministration. As a long-acting ESA, we believe that Hematide may overcomemany of the patient care limitations of currently marketed rEPOs. We believethat flexibility of dosing based on duration of effect will allow many patientsto receive anemia management therapy concurrently with therapy for theirunderlying disease.

Hematide is being developed for room temperaturestability, ease-of-handling and long shelf life in order to overcome many ofthe limitations which hamper the cost effectiveness, and thus the physicianadoption, of rEPOs.

Our early clinical trials have shown similar positiveeffects on red blood cell formation when Hematide is given at equivalent doseseither intravenously or subcutaneously. These results suggest that Hematide maybe equally effective in humans when administered by either route. Additionalclinical trials are underway to confirm this observation. We believe it may beeasier to use Hematide than some forms of rEPO, which often have differentclinical effects when given subcutaneously versus intravenously.

Although Hematide has the erythropoietic activitycharacteristic of naturally occurring EPO, its amino acid sequence is unrelatedto EPO, rEPO or any other known naturally-occurring erythropoietic protein.Because Hematide does not appear to display immunologic cross-reactivity tonaturally-occurring EPO, we believe that Hematide will not cause PRCA. We haveconducted preclinical studies which have demonstrated that Hematide canstimulate reticulocytes and elevate hemoglobin levels in animal models of EPOantibody mediated PRCA. An ongoing Phase 2 clinical trial of Hematide in asmall number of patients with PRCA has shown supportive results to date. Theseresults suggest that Hematide is not neutralized by antibodies to rEPO and thusmay be effective in rescuing patients that have developed PRCA.

Based on preclinical andclinical studies to date, we believe that the risk of developing antibodies toHematide will be low. Thus far, we have observed that Hematide-inducedantibodies do not appear to cross-react with rEPO and do not have any apparenteffect on clinical response to the drug.

***Hematide Development Program***

We are currently conducting multiple Phase 2 clinicaltrials of Hematide in patients with chronic anemia due to chronic kidneydisease and cancer. We believe the pharmacokinetics and pharmacodynamics ofHematide have been shown to be appropriate for extended dose intervals anddesired drug activity. We anticipate that Hematide will be dosed once everyfour weeks in most chronic kidney disease patients, and every two, three orfour weeks in cancer patients, coincident with the patient’s chemotherapyregimen. Data from our ongoing open-label human clinical trials indicate thatHematide induces a consistent, appropriately rapid, prolonged, dose-dependentincrease in reticulocytes and hemoglobin. To date, over 400 patients havereceived Hematide in ongoing clinical studies. The type and frequency ofadverse events, including serious adverse events associated with Hematide, inthese clinical trials appear to be similar to those events that have beenreported for currently marketed ESAs in studies targeting similar hemoglobinlevels.

6

----

*Preclinical and ToxicologyStudies.**  *Preclinicalstudies have shown that Hematide, like EPO, acts through activation of the EPOreceptor. Furthermore, preclinical in vivo studies have shown that the effectson erythropoiesis are very similar whether Hematide is given intravenously orsubcutaneously. We have conducted repeat-dose preclinical toxicology studieslasting as long as nine months, and have incorporated single-dose andrepeat-dose studies exploring administration by either intravenous or subcutaneousinjection in a variety of models using doses up to several thousand times theestimated monthly clinical dose. The primary toxicology observed to date hasbeen associated with the exaggerated red blood cell production seen at highand/or frequent doses, a result similar to that observed with the rEPO class ofdrugs.

***Current Phase 2 Clinical Trials***

We are currently conducting multiple Phase 2 clinicaltrials of Hematide at sites in the U.S. and Europe in dialysis patients,predialysis patients, cancer patients on chemotherapy and patients with PRCA.These trials are designed to determine the safety, pharmacodynamics andpharmacokinetics of Hematide when administered to patients suffering fromanemia. Our Phase 2 trials are not designed to establish sufficient safety orefficacy to obtain regulatory approval, and no observations from these trialsshould be taken as conclusive evidence of Hematide’s safety and/or efficacy inany patient population.

The primary objectives of our ongoing Phase 2 clinicaltrials are to evaluate the safety of Hematide and determine the dosing regimenthat produces the appropriate hemoglobin values in the patient populationsaddressed. In patients on dialysis whose hemoglobin values have already beencorrected by three times a week rEPO therapy, we are seeking to maintainhemoglobin values in the corrected range by administering Hematide once everyfour weeks. In trials involving predialysis and chemotherapy induced anemiapatients, we are seeking to correct their anemia by raising hemoglobin values. Secondary endpoints of our clinical trials includefrequency of red blood cell transfusions.

To date, over 400 patients have received Hematide inongoing clinical studies. The type and frequency of adverse events, includingserious adverse events associated with Hematide, in these clinical trialsappear to be similar to those events that have been reported for currentlymarketed ESAs in studies targeting similar hemoglobin levels. Additionally, wehave observed that treatment of predialysis patients and cancer patients onchemotherapy with Hematide leads to corrections of anemia at rates and withintimeframes that are appropriate for effective ESA treatment, given the currentstandard of care and regulatory guidelines. Dialysis patients also appear torespond to Hematide therapy as expected.

Most of our ongoing trialsare dose-ranging trials in which we enroll cohorts of patients until wediscover the correct dose to achieve an appropriate therapeutic response. Ineach of our dose-ranging trials, we will not know exactly how many patientswill eventually be enrolled until the conclusion of the trial. Pre-dialysis anddialysis patients participating in our dose-ranging trials have the option tocontinue treatment and remain in long-term follow up studies being conducted inEurope and the U.S. These studies are intended to support the long term safetyand efficacy of Hematide.

***Phase 3 Development Plans***

In dialysis and predialysis patients with chronickidney disease, we are planning to pursue global regulatory approval forHematide by conducting several registration studies to confirm the safety andefficacy of Hematide, and to compare the safety and efficacy of Hematide tocurrently marketed ESAs. We have had preliminary discussions with the FDAregarding Phase 3 clinical trials in both dialysis and pre-dialysis patients.Based on those discussions, we believe that our clinical, preclinical andmanufacturing work is sufficient to proceed to Phase 3 clinical trials and weare continuing discussions with the FDA relating to the design of these trials.Assuming timely conclusion of the discussions with the FDA, we would expect tocommence separate Phase 3 trials in both dialysis and predialysis patientsduring the 

7

----

second half of 2007.****The trials are expected to address both correction ofanemia and maintenance of correction in ESA-naïve patients, and maintenance ofcorrection of anemia in patients switching from rEPOs to Hematide in thedialysis setting. This program will seek to adequately describe the effectivedose and safety profile of Hematide via both intravenous and subcutaneousroutes of administration.

In oncology, we anticipatethat multiple Phase 3 pivotal trials will be conducted in various cancerpatient populations. In one of these trials, the efficacy of Hematide inreducing the requirement for red blood cell transfusions in patients undergoingchemotherapy will be assessed in a randomized, placebo-controlled, blinded,multi-national study.

**Research Pipeline**

We have leveraged our drugdiscovery platform to produce multiple peptide-based therapeutic productcandidates. The following are some of our research stage programs in which wehave found, through use of our proprietary technologies, novel peptides whichcompete with the natural ligand for binding to target receptors and/or whichhave agonistic or antagonistic activities. The activities of these peptides arebeing further characterized and optimized in our research labs.

***Adeptide—Non-Injectable Peptide-based ESA***

The small size, potencyand stability of our proprietary peptides that can effectively stimulate theproduction of red blood cells suggests that such peptide-based ESAs could bedelivered by routes, such as intranasal or pulmonary, that do not requireinjections. Recently we have observed, for example, the ability to generatesignificant hemoglobin responses in rats after just two intranasal doses ofpeptide-based ESAs. We believe that such alternative delivery forms of ourpeptide-based Hematide and Innotide related peptides may expand the marketpotential for such products.

***Innotide—Tissue Protective Peptides***

In addition to a role inerythropoiesis, EPO has been reported to have tissue protective properties thatmay protect tissues from damage in response to localized insufficiency of bloodand oxygen, known as ischemia, or in response to toxic chemotherapy. Some ofthese reported activities include protection of neural tissues from ischemicstroke and protection of renal tissues from chemotherapeutic drugs. Innotiderepresents a series of synthetic peptides discovered and developed by us whichact through the EPO receptor, and which are being evaluated in preclinicalmodels of stroke, heart attack and chemotherapy induced organ damage. Innotidepeptides bind to and appear to differentially activate the EPO receptor. Webelieve Innotide may have tissue protective properties characteristic of EPO,but potentially without significant erythropoiesis stimulating activity. Otherpotential properties of Innotide, including its specificity, potency,relatively small size, stability and ability to be modified to modulate itsactivity, may also constitute advantages.

***Angiotide—Anti-Angiogenesis Factor***

In September 2004, weentered into a collaboration with EntreMed, Inc. to develop peptides withanti-angiogenic activites for cancer therapy and the prevention of metastases.Angiogenesis, or the formation of blood vessels, plays an essential role inembryonic development, normal growth of tissues, wound healing and the femalereproductive cycle. Angiogenesis, however, is also necessary for tumors to growbeyond a few millimeters in size and for the spread and growth of tumor cellmetastases. Under our collaboration, we have identified several relatedpeptides with significant activity in vitro and in animal models in vivo.

8

----

**Manufacturing andSupply**

All of our current good manufacturing practices, orGMP, manufacturing is outsourced to third parties with oversight by ourinternal managers. We have limited non-GMP manufacturing capacity in-house. Werely on third-party manufacturers to produce sufficient quantities of drugsubstance and product for use in clinical trials. We intend to continue thispractice for any future clinical trials and large-scale commercialization ofHematide and for any other potential products for which we retain significantdevelopment and commercialization rights. All of our current product candidatesare chemically synthesized and peptide-based.

Specifically for Hematide, active pharmaceuticalingredient, or API, has been manufactured by multiple contract manufacturers orCMOs. We intend to establish long term commercial supply agreements with atleast two CMOs for manufacture of drug substance. Under our worldwidecollaboration with Takeda, we will be responsible, through our CMOs, for themanufacture and supply of all quantities of Hematide API to be used in thedevelopment and commercialization of Hematide worldwide.

Final Hematide drugproduct is currently manufactured as a buffered aqueous solution forintravenous or subcutaneous administration. We currently have responsibilityfor production of final Hematide drug product. Over time, responsibility forfinal drug product manufacture and control will be transferred to Takeda, ourworldwide collaboration partner for Hematide.

**IntellectualProperty**

We protect our technology through the use of patents,trade secrets and proprietary know-how. We have more than 20 issued U.S.patents, including claims covering compositions of compounds comprisingpeptides of a broad genus of ESA peptide sequences, methods of treating EPOdisorders using these compounds and methods of synthesizing these types of ESApeptide compounds. We own several pending U.S. patent applications, all ofwhich relate to our core peptide technologies or to particular peptidecompounds. We own foreign equivalent patents and patent applications based onour U.S. patents and patent applications. We also retain technical informationrelated to manufacture and analysis of Hematide as trade secrets. We arecurrently involved in binding arbitration with Johnson & JohnsonPharmaceutical Research & Development, L.L.C., and Ortho-McNeilPharmaceutical, Inc., or, collectively, J&J, over the ownership ofcertain patents and applications currently assigned to J&J, three of ourissued U.S. patents and a number of foreign patents and patent applications.See ‘‘Risk Factors—Risks Related to Our Business’’ and ‘‘Legal Proceedings’’elsewhere in this Annual Report on Form 10-K.

We own and have rights toseveral proprietary peptide screening technologies, including the patentedtechnologies of peptide phage display and peptides-on-plasmids. This technologyenables us to identify initial novel peptide sequences and provides informationthat our scientists can use to design a variety of peptide compounds tooptimize bioactivity and produce pharmaceutical candidate compounds havingdesired properties.

***Third-Party Intellectual Property***

Numerous U.S. and foreign issued patents and pendingpatent applications, which are owned by third parties, exist in the fields inwhich we and our collaborators are developing products. Because patentapplications can take many years to issue, there may be currently pendingapplications, unknown to us, which may later result in issued patents that ourproduct candidates or proprietary technologies may infringe.

We may be exposed to, or threatened with, futurelitigation by third parties having patent or other intellectual property rightsalleging that our product candidates and/or proprietary technologies infringe 

9

----

their intellectualproperty rights. If one of these patents was found to cover our productcandidates, proprietary technologies or their uses, we or our collaboratorscould be required to pay damages and could be restricted from commercializingour product candidates or using our proprietary technologies unless we or theyobtain a license to the patent. A license may not be available to us or ourcollaborators on acceptable terms, if at all. In addition, during litigation,the patent holder could obtain a preliminary injunction or other equitableright, which could prohibit us from making, using or selling our products,technologies or methods.

There is asubstantial amount of litigation involving patent and other intellectualproperty rights in the biotechnology and biopharmaceutical industriesgenerally. If a third party claims that we or our collaborators infringe itsintellectual property rights, we may face a number of issues, including but notlimited to:

·       infringementand other intellectual property claims which, with or without merit, may beexpensive and time-consuming to litigate and may divert our management’sattention from our core business;

·       substantialdamages for infringement, including treble damages and attorneys’ fees, whichwe may have to pay if a court decides that the product or proprietarytechnology at issue infringes on or violates the third party’s rights;

·       acourt prohibiting us from selling or licensing the product or using theproprietary technology unless the third party licenses its technology to us,which it is not required to do;

·       ifa license is available from the third party, we may have to pay substantialroyalties, fees and/or grant cross licenses to our technology; and

·       redesigningour products or processes so they do not infringe, which may not be possible ormay require substantial funds and time.

While we have conducted asearch of patents issued to third parties, no assurance can be given that suchpatents do not exist, have not been filed, or could not be filed or issued,which contain claims covering our products, technology or methods. Because ofthe number of patents issued and patent applications filed in our technicalareas or fields, we believe there is a significant risk that third parties mayallege they have patent rights encompassing our products, technology ormethods.

**Research andDevelopment Expenses**

Since our inception, wehave made substantial investments in research and development. Research anddevelopment costs consist of salaries, stock-based compensation, employeebenefits, license fees, laboratory supplies, costs associated with clinicaltrials, including amounts paid to clinical research organizations, otherprofessional services and facility costs. Research and development expenseswere $54.3 million, $24.1 million and $17.3 million for the years endedDecember 31, 2006, 2005 and 2004, respectively.

**Our StrategicAlliances**

***June 2006 Development andCommercialization Agreement with Takeda***

In June 2006, we entered into a Development andCommercialization Agreement with Takeda to develop and commercialize Hematideworldwide. Under our collaboration, the companies will co-develop andco-commercialize Hematide in the U.S. Takeda received an exclusive license todevelop and commercialize Hematide outside of the U.S. This agreementcontemplates that the February 2006 agreement that we have also enteredinto with Takeda will be harmonized to address the worldwide arrangementbetween the parties.

10

----

We will share responsibility with Takeda for clinicaldevelopment activities required for U.S. regulatory approval of Hematide.Specifically, we will have primary responsibility for Hematide’s clinicaldevelopment plan and clinical trials in the dialysis and pre-dialysisindications, while Takeda will have primary responsibility in the chemotherapyinduced anemia and anemia of cancer indications. Beginning January 1,2007, Takeda will bear the first $50 million of third-party expenses related todevelopment in pursuit of U.S. regulatory approval of Hematide. Thereafter,Takeda will bear 70% of the third-party U.S. development expenses, while we areresponsible for 30% of the expenses. Each company retains responsibility for100% of its internal development expenses. Takeda will have primaryresponsibility and bear all costs for Hematide’s clinical development insupport of regulatory approval for all territories outside the United States.

Under the June 2006 agreement, Takeda paid anupfront license fee of $105 million, and we are eligible to receive from Takedaup to an aggregate of $280 million upon the successful achievement of clinicaldevelopment and regulatory milestones. Further, we may receive from Takeda upto an aggregate of $150 million upon the achievement of certain worldwideannual net sales milestones. We and Takeda will share equally in the netprofits and losses of Hematide in the United States, which include expensesrelated to the marketing and launch of Hematide. Takeda will pay us a variableroyalty based on annual net sales of Hematide outside the United States.

We will own and have responsibility for United StatesNDAs in the dialysis, pre-dialysis, chemotherapy induced anemia and anemia ofcancer indications. Takeda will own and have responsibility for regulatoryfilings outside the United States. Takeda will also be responsible for creatinga global safety database.

We will also be responsible, through our contractmanufacturers, for the manufacture and supply of all quantities of Hematide APIto be used in the development and commercialization of Hematide worldwide.Takeda will be responsible for the fill and finish steps in the manufacture ofHematide worldwide.

The parties have agreed to jointly develop the initialcommercial marketing plan for Hematide in the United States pursuant to whichwe and Takeda will divide Hematide promotional responsibilities in the U.S. Wewill be primarily responsible for commercialization activities within thedialysis and pre-dialysis markets, and Takeda primarily responsible foroncology-related markets. We and Takeda will jointly decide on promotionalresponsibility for markets outside of these initial indications. Takeda willcontrol price, terms of sale and booking of sales of Hematide.

With respect to existing third-party licenseagreements relevant to Hematide, fees and milestones payments related to theseexisting third-party licenses will be shared between us and Takeda asdevelopment expenses, provided that an upfront fee in the amount of $17.6million to a third-party licensor of certain technology related to Hematide wasthe sole responsibility of Affymax. For all territories outside the U.S., anyroyalty payments to a third party for a license will be borne solely by Takedaand other fees or payments will be borne by us and Takeda jointly.

Either party may terminatethe collaboration for material breach by the other party. In addition, Takedawill have the right to terminate the collaboration (a) for certainspecified clinical development events or failures, or (b) for convenienceeffective after the second anniversary upon six months written notice to us. Inthe event of any termination of the agreement, Takeda will transfer and assignto us all rights to Hematide in the affected territories. In addition, ifTakeda terminates the collaboration for convenience prior to the firstcommercial sale in the U.S. for reasons other than specified clinicaldevelopment events or failures, then Takeda will pay us a termination fee.

11

----

***February 2006 Development and CommercializationAgreement with Takeda***

In February 2006, we entered into a collaborationwith Takeda to develop and commercialize Hematide in Japan. Under ouragreement, Takeda obtained the exclusive right to develop and commercializeHematide in Japan for the treatment of anemia in patients with chronic kidneydisease and cancer, while we retained the rights to develop and commercializeHematide in the rest of the world, either alone or with third-party partners.Takeda has granted to us a fully paid, royalty-free, sublicenseable,non-exclusive license under its own related technology to develop andcommercialize Hematide in the rest of the world.

Takeda also obtained a right of first negotiation toany backup products for Hematide developed by us or our third-party partners.Specifically, during the first ten years of the agreement, if we develop, orour third-party partners develop within an Affymax collaboration, a productthat advances to Phase 2 clinical trials and competes with Hematide in therenal or oncology indications, we are obligated to offer to Takeda the right todevelop and commercialize such product in Japan before offering the productopportunity in Japan to any other third party.

Takeda is obligated to use diligent efforts to developand commercialize Hematide in Japan. The agreement establishes a jointcommittee to oversee the development, regulatory approval and commercializationof Hematide. While the joint committee will operate by consensus of theparties, Takeda will generally have the final decision-making authority onmatters pertaining to the development and commercialization of Hematide inJapan.

Takeda is responsible for commercializing Hematide inJapan and will have the discretion to set the price of Hematide in Japan. Underthe agreement, Takeda will provide us with progress reports on itscommercialization activities and we will have the opportunity to review andcomment on the significant marketing decisions including strategy and launchdates.

We will provide Takeda with Hematide API and Takeda isresponsible for the fill and finish of the product. Our pre-clinical andclinical supply of Hematide API to Takeda is governed under the terms of thisagreement, while the supply for Takeda’s requirements for commercial quantitiesof Hematide API will be governed by a separate manufacturing agreement that theparties will enter into prior to the earlier of the Phase 3 clinical trials orthe stability studies for Takeda’s finished product formulation of Hematide.

Pursuant to this agreement, Takeda has paid usapproximately $37 million to date, consisting of $17 million in upfrontlicensing fees, approximately $10 million equity investment in our Series Epreferred stock, and in January 2007, a $10 million cash milestone paymentfor the completion of the first Phase 1 trial of Hematide in Japan. We mayreceive from Takeda up to an additional total of $65 million upon Takeda’ssuccessful achievement of clinical development and regulatory milestonestogether with royalties based on a percentage of the sales of Hematide inJapan.

Under the agreement, each party will solely own allinventions made by such party alone, and jointly own all inventions made by theparties jointly, including all intellectual property rights therein. Suchsolely-owned inventions and jointly-owned inventions will be subject to thecross-licenses between the parties for the development and commercialization ofHematide in each party’s territory. We are obligated to maintain ourthird-party license agreements that may contain technology that is the subjectof the license to Takeda under this agreement.

Each party will be responsible for the worldwidefiling, prosecution and maintenance (including defense against third-partyopposition claims) of patents solely owned by such party and the filing,prosecution and maintenance of jointly-owned patents each in its own territory.The parties will share the responsibility for enforcing patents againstthird-party infringement, and the allocation of responsibilities and sharing ofrecoveries will depend on where the claims arise, and which patents areinvolved. We have the first right, but not the obligation, to defend againstpatent infringement claims or bring patent 

12

----

opposition claims relatingto Hematide in Japan, and Takeda has the backup right to do so. Neither partycan settle any patent infringement claim without the prior consent of the otherparty, if the settlement will negatively affect the other party’s rights.

Each party is obligated to indemnify the other partyfor third-party claims and losses resulting from the development andcommercialization activities involving Hematide in its territory, a breach ofits representations, warranties or obligations under the agreement, or itswillful misconduct or negligent acts, except to the extent such losses aresubject to the indemnification obligations of the other party.

Absent early termination,the agreement will expire when all of Takeda’s payment obligations expire.Either party may terminate the agreement early upon prior written notice if theother party commits an uncured material breach of the agreement. Takeda alsohas the option to terminate the agreement early, without cause, upon six months’prior written notice after the second anniversary of the effective date of theagreement. We may convert Takeda’s license to be non-exclusive or terminate theagreement entirely if Takeda promotes certain products that compete withHematide. If Takeda terminates without cause or if we terminate for Takeda’smaterial breach, Takeda will transfer to us the right to develop and commercializeHematide in Japan.

***License, Manufacturing and Supply Agreement withNektar***

In April 2004, we entered into a License,Manufacturing and Supply Agreement with Nektar under which we obtained fromNektar a worldwide, non-exclusive license, with limited rights to grantsublicenses, under certain intellectual property covering pegylation technologyto manufacture, develop and commercialize Hematide. The license we obtainedconsists of a license under intellectual property owned by Nektar and asublicense under intellectual property owned by Enzon Pharmaceuticals, Inc.,or Enzon, licensed to Nektar pursuant to a cross-license agreement betweenNektar, Inhale Therapeutic Systems, Inc. and Enzon.

In consideration of the license grant, we agreed topay royalties on the sales of Hematide. We also agreed to pay milestonepayments totaling up to an additional $7 million, plus possible additionalmilestones in connection with our partnering activities relating to Hematide ormerger and acquisition activities.

In July 2006, we paid Nektar a $17.6 millionmilestone payment triggered by our receipt of a $105 million upfrontpayment from Takeda.

Under the agreement, we also engaged Nektar for themanufacture and supply of our requirements of bulk poly(ethylene) glycol reagentfor the manufacturing of Hematide. This relationship is managed by a managingcommittee formed by representatives from both us and Nektar. Nektar isobligated to engage a third-party manufacturer in the event of Nektar’s failure(as defined in the agreement) to supply reagent.

This agreement expires, ona country by country basis, upon the expiration of our royalty paymentobligations. The agreement may be terminated by either party for the otherparty’s material breach provided that such other party has been given a chanceto cure such breach, or by Nektar for our challenge of the validity orenforceability of any patents licensed thereunder.

**Marketing and Sales**

We currently do not havesales and marketing capabilities. Our business model is to become a fullyintegrated biopharmaceutical company and we intend to develop commercialcapabilities in the renal market in order to co-commercialize Hematide underour collaboration agreements with Takeda. We also intend to enter into otherlicensing agreements with companies in strategically relevant therapeutic areasto further leverage our capabilities.

13

----

**Competition**

We operate in highly competitive segments of thebiotechnology and biopharmaceutical markets. We face competition from manydifferent sources, including commercial pharmaceutical and biotechnologyenterprises, academic institutions, government agencies and private and publicresearch institutions. Many of our competitors have significantly greaterfinancial, product development, manufacturing and marketing resources than us.Large pharmaceutical companies have extensive experience in clinical testingand obtaining regulatory approval for drugs. These companies also havesignificantly greater research capabilities than us. Many universities and privateand public research institutes are active in chronic kidney disease andoncology research, some in direct competition with us. We also compete withthese organizations to recruit scientists and clinical development personnel.Smaller or early-stage companies may also prove to be significant competitors,particularly through collaborative arrangements with large and establishedcompanies.

According to IMS Health, the worldwide rEPO markettotaled $13 billion in revenue for the 12 months ended June 2006 of whichthe global leaders, PROCRIT, marketed by J&J, and Aranesp, marketed byAmgen, represented the majority of the market. Aranesp, introduced in 2001, israpidly gaining market share, particularly in the oncology market. In late2005, U.S. quarterly sales of Aranesp surpassed those of PROCRIT. Aranesp isapproved for once-monthly dosing for treatment of anemia in prediaysis patientsin Europe. In the U.S., Amgen reportedly is in the process of seeking approvalfor once-monthly dosing of Aranesp for treatment of anemia in predialysispatients. In 2005, Amgen submitted a biologics license supplement to include aonce-monthly dosing regimen for predialysis patients in the label for Aranesp.In October 2006, the FDA responded to Amgen’s filing with a request foradditional clinical data for the once-monthly dosing regimen, including anadditional clinical study.

In addition to marketedESAs, there are several ESA product candidates in various stages of activedevelopment. Roche has filed for U.S. and European marketing approval of aPEGylated ESA, called Mircera, which reportedly has greater serum stabilitythan any of the currently marketed products. PEG is a polymer that increasesthe time rEPO remains in the circulation. Roche and Amgen are currently engagedin patent infringement litigation with respect to this product candidate.Another potential competitor, FibroGen, Inc., or FibroGen, is developing asmall molecule which is designed to inhibit enzymes that promote thedegradation of Hypoxia-Inducible Factor, or HIF, which plays a key role inactivating genes that protect the body against low levels of oxygen, orhypoxia. By increasing the level of HIF in a patient’s circulation, FibroGen’smolecule may promote the production of greater levels of naturally-occurringEPO. In addition, generic versions of short-acting rEPO are being developed inEurope following the expiration of Amgen’s key European EPO patent in 2004.Generic EPOGEN products are not expected to enter the U.S. market until after2015, when the last patent in Amgen’s U.S. EPO patent estate expires.

**GovernmentRegulation and Product Approvals**

The clinical development, manufacturing and potentialmarketing of our products are subject to regulation by various authorities inthe U.S., the E.U. and other countries, including, in the U.S., the FDA, and,in the E.U., the European Agency for the Evaluation of Medical Products, orEMEA. The Federal Food, Drug, and Cosmetic Act and the Public Health ServiceAct in the U.S., and numerous directives, regulations, local laws, andguidelines in the E.U. govern testing, manufacture, safety, efficacy, labeling,storage, record keeping, approval, advertising and promotion of our products.Product development and approval within these regulatory frameworks takes anumber of years, and involves the expenditure of substantial resources.

Regulatory approval will be required in all majormarkets in which we, or our licensors, seek to test our products indevelopment. At a minimum, such approval requires evaluation of data relatingto quality, 

14

----

safety and efficacy of aproduct for its proposed use. The specific types of data required and theregulations relating to these data differ depending on the territory, the druginvolved, the proposed indication and the stage of development.

In the U.S., specific preclinical data, chemical dataand a proposed clinical study protocol, as described above, must be submittedto the FDA as part of an Investigational New Drug application, or IND, which,unless the FDA objects, will become effective 30 days following receipt by theFDA. Phase 1 trials may commence only after the IND application becomeseffective. Prior regulatory approval for human healthy volunteer studies isalso required in member states of the European Union, or E.U. Currently, ineach member state of the E.U., following successful completion of Phase 1trials, data are submitted in summarized format to the applicable regulatoryauthority in the member state in respect of applications for the conduct oflater Phase 2 trials. The regulatory authorities in the E.U. typically havebetween one and three months in which to raise any objections to the proposedclinical trial, and they often have the right to extend this review period attheir discretion. In the U.S., following completion of Phase 1 trials, furthersubmissions to regulatory authorities are necessary in relation to Phase 2 and3 trials to update the existing IND. Authorities may require additional databefore allowing the trials to commence and could demand discontinuation ofstudies at any time if there are significant safety issues. In addition toregulatory review, a clinical trial involving human subjects has to be approvedby an independent body. The exact composition and responsibilities of this bodydiffer from country to country. In the U.S., for example, each clinical trialis conducted under the auspices of an Institutional Review Board at theinstitution at which the clinical trial is conducted. This board considersamong other things, the design of the clinical trial, ethical factors, thesafety of the human subjects and the possible liability risk for theinstitution. Equivalent rules apply in each member state of the E.U.,where one or more independent ethics committees that typically operatesimilarly to an Institutional Review Board, will review the ethics ofconducting the proposed research. Other authorities elsewhere in the world haveslightly differing requirements involving both execution of clinical trials andimport or export of pharmaceutical products. It is our responsibility to ensurethat we conduct our business in accordance with the regulations of eachrelevant territory.

Information generated in this process is susceptibleto varying interpretations that could delay, limit, or prevent regulatoryapproval at any stage of the approval process. Failure to demonstrateadequately the quality, safety and efficacy of a therapeutic drug underdevelopment would delay or prevent regulatory approval of the product. Therecan be no assurance that if clinical trials are completed, either we or ourcollaborative partners will submit applications for required authorizations tomanufacture or market potential products, including a marketing authorizationapplication or an NDA, or that any such application will be reviewed andapproved by appropriate regulatory authorities in a timely manner, if at all.

In order to gain marketingapproval, we must submit a dossier to the relevant authority for review, whichis known in the U.S. as an NDA and in the E.U. as a marketing authorizationapplication. The format is usually specified by each authority, although ingeneral it will include information on the quality of the chemistry,manufacturing and pharmaceutical aspects of the product and non-clinical andclinical data. The FDA undertakes such reviews for the U.S. In the E.U., thereis, for many products, a choice of two different authorization routes:centralized and decentralized. Under the centralized route, one marketingauthorization is granted for the entire E.U., while under the decentralizedroute a series of national marketing authorizations are granted. In thecentralized system, applications are reviewed by members of the Committee forMedicinal Products for Human Use, on behalf of the EMEA. The EMEA will, basedupon the review of the Committee for Medicinal Products for Human Use, providean opinion to the European Commission on the safety, quality and efficacy ofthe product. The decision to grant or refuse an authorization is made by theEuropean Commission. In circumstances where use of the centralized route is notmandatory, we can choose to use the decentralized route, in which case the 

15

----

applicationwill be reviewed by each member state’s regulatory agency. If the regulatoryagency grants the authorization, other member states’ regulatory authoritiesare asked to ‘‘mutually recognize’’ the authorization granted by the firstmember state’s regulatory agency. Approval can take several months to severalyears or be denied. The approval process can be affected by a number offactors. Additional studies or clinical trials may be requested during thereview and may delay marketing approval and involve unbudgeted costs.Regulatory authorities may conduct inspections of relevant facilities andreview manufacturing procedures, operating systems and personnelqualifications. In addition to obtaining approval for each product, in manycases each drug manufacturing facility must be approved. Further, inspectionsmay occur over the life of the product. An inspection of the clinicalinvestigation sites by a competent authority may be required as part of theregulatory approval procedure. As a condition of marketing approval, theregulatory agency may require post-marketing surveillance to monitor adverseeffects, or other additional studies as deemed appropriate. After approval forthe initial indication, further clinical studies are usually necessary to gainapproval for additional indications. The terms of any approval, includinglabeling content, may be more restrictive than expected and could affectproduct marketability.

**Employees**

As of December 31,2006, we had 105 employees, including 32 who hold Ph.D. or M.D. degrees. We had78 employees engaged in research and development, and our remaining employeesare management or administrative staff. None of our employees is subject to acollective bargaining agreement. We believe that we have good relations withour employees.

**About Affymax**

We were incorporated in Delaware in July 2001under the name Affymax, Inc. The address of our principal executive officeis 4001 Miranda Avenue, Palo Alto, California 94304, and our telephonenumber is (650) 812-8700. Our website address is *www.affymax.com*. We do not incorporate theinformation on our website into this Annual Report on Form 10-K, andyou should not consider it part of this Annual Report on Form 10-K.

We have a registration forthe trademark “Affymax” in the U.S. We have applied in the U.S. to register thetrademarks: “Adeptide,” “Angiotide,” “Avixis,” “Gematide,” “Hematide,” “Innotide,”and “Affymax and logo.” We have applied in certain other countries to registerthe trademarks: “Avixis,” “Hematide” and ”Innotide.”

**AvailableInformation**

We file electronicallywith the U.S. Securities and Exchange Commission our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-Kand amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities and Exchange Act of 1934. We make available on ourwebsite at www.affymax.com, free of charge, copies of these reports as soon asreasonably practicable after we electronically file such material with, orfurnish it to, the Securities and Exchange Commission. Further, copies of thesereports are located at the Securities and Exchange Commission’s PublicReference Room at 100 F Street, NE, Washington, D.C. 20549. Information on theoperation of the Public Reference Room can be obtained by calling theSecurities and Exchange Commission at 1-800-SEC-0330. TheSecurities and Exchange Commission maintains a website that contains reports,proxy and information statements, and other information regarding our filings,at *www.sec.gov*.

16

----

**Item 1A.**   RiskFactors.

*You should carefully consider the risks describedbelow, which we believe are the material risks of our business before making aninvestment decision. Our business could be harmed by any of these risks. Thetrading price of our common stock could decline due to any of these risks, andyou may lose all or part of your investment. In assessing these risks, youshould also refer to the other information contained in this Annual Report onForm 10-K, including our financial statements and related notes.*

**Risks Related toOur Business**

***We are dependent on the success of Hematide, and wecannot give any assurance that it will receive regulatory approval or besuccessfully commercialized.***

Hematide, which is our only product candidate inclinical development, is an ESA in multiple Phase 2 clinical trials for thetreatment of anemia associated with chronic kidney disease and cancer. All ofour other compounds or potential product candidates are in the research stage.In order to commercialize Hematide, a new chemical entity, we will be requiredto conduct additional clinical trials to establish that Hematide is safe andeffective which may not succeed and to obtain regulatory approvals which we mayfail to do. We have had preliminary discussions with the FDA regarding Phase 3clinical trials in both dialysis and pre-dialysis patients. Based on thosediscussions, we believe that our clinical, preclinical and manufacturing workis sufficient to proceed to Phase 3 clinical trials and we are continuingdiscussions with the FDA relating to the design of those trials. We do notknow, and are unable to predict, what type and how many clinical trials theFood and Drug Administration, or FDA, will require us to conduct or the cost,timing or risks associated with conducting such trials in order to obtainapproval to market Hematide.

The FDA, the medical community and others haverecently raised significant safety concerns relating to commercially availableESAs as a result of reports of increased mortality and side effects from anumber of clinical trials. The FDA recently required revised warnings,including black box warnings, be added to labels of currently marketed ESAsadvising physicians to monitor hemoglobin levels and to use the lowest dose ofESA to increase the hemoglobin concentration to the lowest level sufficient toavoid the need for red blood cell transfusions. The FDA also issued a publichealth advisory re-evaluating the safe use of the ESA class and is scheduled toconvene its Oncology Drugs Advisory Committee (ODAC) in May 2007 toconsider the mechanism of action of ESAs and to review the effects of ESAs onsurvival and tumor progression in cancer patients. The FDA concerns maynegatively affect the scope, size, risk or timing of completion of our clinicaltrials and significantly delay commercialization of Hematide.

Our clinical development program for Hematide may notlead to a commercial drug either because we fail to demonstrate that it is safeand effective in clinical trials and we therefore fail to obtain necessaryapprovals from the FDA, and similar foreign regulatory agencies, or because wehave inadequate financial or other resources to advance this product candidatethrough the clinical trial process. Any failure to obtain approval of Hematide wouldhave a material and adverse impact on our business as we would have to incursubstantial expense and it would take a significant amount of time andresources to bring our other product candidates to market.

Some of the recent safetyconcerns surrounding commercially available ESAs relate to clinical trialsconducted in patients with anemia of cancer that suggests higher mortality andserious side effects associated with ESA treatment. Restrictions on labeling oruse of ESAs as a result of these concerns may limit the potential marketopportunity such that even if the Company is ultimately successful in obtainingregulatory approval, the commercial market and potential for Hematide may alsobe negatively impacted.

17

----

***We are at an earlystage of development as a company and have limited sources of revenue. Ourcurrent revenue recognition policy may limit our ability to report any profits,and we may never become profitable.***

We are a development stage biopharmaceutical companywith a limited operating history. Currently, we have no products approved forcommercial sale and, to date, we have not generated any revenue from productsales. Our ability to generate revenue depends heavily on our ability tosuccessfully develop and secure regulatory approval for, and commerciallylaunch, our lead product candidate, Hematide, and our other product candidates.If we are unable to commercialize Hematide, it will be a long time before wewill be able to commercialize our other product candidates, if ever. Further,under our current revenue recognition policy, we will not recognize profits, ifany, from our performance under the Takeda collaboration agreements until wecan objectively determine the fair value of all our undelivered obligationsunder our Takeda collaboration agreements or when we have performed all of ourobligations under those agreements. Since the duration of some of thoseobligations is indefinite, even if we successfully commercialize Hematide wemay not be able to report any profits under generally accepted accountingprinciples until a number of years after our receipt of payments under theTakeda collaboration agreements.

Our existing productcandidates will require extensive additional clinical evaluation, regulatoryapproval, significant marketing efforts and substantial investment before theycan provide us or our partners with any revenue. If we or our partners areunable to develop and commercialize one or more of our product candidates or ifsales revenue from any product candidate that receives marketing approval isinsufficient, we may not achieve profitability, and we may be unable tocontinue our operations.

***We have initiated binding arbitration and relatedlitigation with Johnson & Johnson Pharmaceutical Research &Development, L.L.C., and Ortho-McNeil Pharmaceutical, Inc., orcollectively, J&J, over ownership of intellectual property related toerythropoietin receptor, or EPO-R, agonists. An adverse result in this bindingarbitration or litigation, together with adverse results in subsequentlitigation J&J might then bring, could prevent us from manufacturing orcommercializing Hematide in a number of countries in accordance with ourcurrent plans or could limit our ability to license third parties to do so.***

We have initiated binding arbitration and relatedlitigation with J&J over the ownership of a number of U.S. andinternational patents and patent applications related to EPO-R agonists, or the‘‘intellectual property in dispute.’’ We believe that we are the sole owner orco-owner of the intellectual property in dispute. J&J, on the other hand,alleges that it is the sole owner or co-owner of the intellectual property indispute, including several U.S. patents on which we are currently named as soleowner that relate to specified peptide compounds. Although we believe ourposition in this dispute is meritorious and that we have substantial defensesto J&J’s counterclaims, litigation is time consuming and expensive and theoutcome is inherently uncertain. A number of outcomes in the dispute arepossible, including, without limitation, the possibility that we lose or do notacquire specific patents and patent rights in the ESA field, J&J obtains orretains specific patents and patent rights in the ESA field or we become liablefor damages, attorneys’ fees and costs. Moreover, if the arbitration panel wereto determine that J&J is the sole owner of one or more of the disputedpatents, J&J may seek to assert such patents against us in the U.S., Europeand elsewhere.

We believe the U.S. intellectual property in disputedoes not encompass Hematide and that we can manufacture, commercialize and sellHematide in the U.S. regardless of the outcome of this arbitration. However,if, through the ongoing arbitration or otherwise, J&J or another potentialcompetitor obtains or possesses patents or patent rights that are deemed toencompass one or more elements of Hematide, that party could initiateproceedings, an adverse result in which could prevent us from manufacturing orcommercializing Hematide, either for ourselves or with Takeda, in the U.S.

18

----

If the intellectual property in dispute is deemedbroad enough to cover Hematide, then under the laws applicable to most relevantjurisdictions outside the U.S., a finding of joint ownership would permit us tomanufacture and sell Hematide, but may not allow us to license third parties todo so. Because our strategy is to commercialize Hematide worldwide through ourpartnership with Takeda, a finding of joint ownership of the patents andapplications in question could materially affect our business plans outside theU.S. Within the U.S., joint ownership of a patent gives each joint owner theright to license third parties, so even if the patents in question are held tobe jointly owned by us and J&J we do not believe we would be prevented frompursuing our partnership strategy for Hematide in the U.S. If the arbitrationpanel determines that J&J is the sole owner of one or more of the U.S.patents in the dispute that are assigned to us, J&J may seek to assert suchpatent against us in the U.S.

Although J&J’s ownership of its European patentapplication relating to agonist peptide dimers is subject to the pendingarbitration, a patent could be issued from this application to J&J by theEuropean Patent Office in the near future. In the J&J arbitrationproceeding, we have claimed that we should be at least joint owner of thisEuropean application. If this patent issues, J&J could seek to enforce thispatent against us in Europe. In many European countries, a patent cannot beasserted to stop clinical trials, but in some, a patent holder can seek toenjoin clinical trials. We are seeking to minimize the effect this might haveon our development plans, but there can be no assurance that our clinical trialand manufacturing plans would not be delayed if a European patent issues toJ&J.

The outcome of anyarbitration or litigation proceeding is inherently unpredictable. The claimsand underlying facts at issue in this dispute are complex, and couldnecessitate prolonged discovery. Since we acquired assets from Affymax N.V. (adifferent company from us), discovery could uncover documents and otherevidence of which we are not currently aware that are adverse to our position.We have incurred significant expense in pursuing this matter to date, andbecause a final decision on the arbitration and related litigation may not bereached for years, we expect we will continue to incur significant andincreasing expenses for several more years, likely totaling in the millions ofdollars as this matter progresses toward resolution. In addition, the effortsof our technical, legal and management personnel have been and will continue tobe diverted as a result of this dispute.

***Our commercial success depends upon attainingsignificant market acceptance of Hematide among physicians, patients, healthcare payors and, in the renal market, acceptance by the major operators ofdialysis clinics.***

None of our product candidates has been commercializedfor any indication. Even if approved for sale by the appropriate regulatoryauthorities, physicians may not prescribe Hematide or any of our other productcandidates, in which case we would not generate revenue or become profitable.In particular, the therapeutic indications targeted by our lead product candidatehave been served by our competitors’ products for many years. These productsmay now be said to be the standard of care, and it may be difficult toencourage healthcare providers to switch from products with which they andtheir patients have become comfortable.

The dialysis market, which is one of the largest andmost established markets that Hematide will attempt to penetrate, is highlyconcentrated, with two companies serving a significant majority of all dialysispatients on Medicare. In addition, dialysis clinics using ESAs could incursubstantial expense in administration and training if they were to switch fromcurrent ESAs to Hematide. The concentration of customers for ESA’s within thedialysis market may pose a risk to our ability to obtain favorable margins onHematide, if approved. If we cannot come to agreements with one or more of themajor companies operating dialysis clinics in the U.S., the revenue opportunityof Hematide could be significantly reduced. In October 2006, Amgen Inc., orAmgen, marketer of the ESAs EPOGEN and Aranesp, and Fresenius Medical Care, orFresenius, one of the two largest operators of dialysis clinics in the U.S.,announced an agreement whereby Amgen would be the sole supplier of EPO productsfor Fresenius’ dialysis business 

19

----

effective immediatelythrough the end of 2011. We are not aware of the specific terms of theAmgen-Fresenius agreement, and cannot project how it may impact the commercialopportunity for Hematide if and when it is launched. However, agreementsbetween operators of dialysis facilities and marketers of competing ESAproducts could potentially limit the market opportunity for Hematide, andadversely impact our ability to generate revenues.

Currently, the Centers for Medicare and MedicaidServices, or CMS, reimburses healthcare providers for use of ESAs at a rate ofaverage sales price plus a 6% margin to the provider, or ASP plus 6%. We cannotbe certain what reimbursement policies will be in effect at the time we seek toenter the dialysis market in the U.S., or the effect these policies may have onour ability to compete effectively.

In addition, recentstudies by manufacturers of ESAs indicate that the higher levels of hemoglobinachieved through administration of ESAs can result in a statisticallysignificant increase in cardiovascular events. This may in turn reduce thegrowth of the broader market for ESAs and reduce the potential revenues forHematide.

In the predialysis market,one challenge is that patients suffering from anemia may not access health careresources to treat their condition for some time following its onset. As aresult, the available predialysis market may be limited by the overallproportion of patients who are diagnosed with the condition, how early thesepatients are diagnosed, and at what point they begin treatment. Additionally,reaching and educating the doctors who treat predialysis patients may becomparatively difficult, as these patients are spread more thinly across avariety of treatment settings than end stage renal disease patients receivingtreatment at dialysis centers.

Inaddition, market acceptance of ESAs as well as our lead product candidate,Hematide, and any future product candidates by physicians, healthcare payorsand patients will depend on a number of additional factors, including:

·       theclinical indications for which the product candidate is approved;

·       acceptanceby physicians and patients of each product candidate as a safe and effectivetreatment;

·       perceivedadvantages over alternative treatments;

·       thecost of treatment in relation to alternative treatments;

·       theavailability of adequate reimbursement by third parties;

·       thecontinued use of ESA treatments generally for anemia at levels above thosecurrently accepted

·       asindustry guidance;

·       relativeconvenience and ease of administration; and

·       the prevalence and severityof side effects.

***Competition in the pharmaceutical industry is intense.If our competitors are able to develop and market products that are moreeffective, safer or less costly than any future products that we may develop,our commercial opportunity will be reduced or eliminated.***

We face competition fromestablished and emerging pharmaceutical and biotechnology companies, as well asfrom academic institutions, government agencies and private and public researchinstitutions. Our commercial opportunity will be reduced or eliminated if ourcompetitors develop and commercialize products that are more effective, havefewer side effects or are less expensive than Hematide or any other futureproducts that we may develop and commercialize. In addition, significant delaysin the development of our product candidates could allow our competitors tobring products to market before we do and impair our ability to commercializeour product candidates. Competitors may also reduce the price of their 

20

----

ESAs inorder to gain market share. These price reductions could force us to lower theprice of Hematide in order to compete effectively, resulting in lower revenuesand reduced margins on the sales of Hematide.

We anticipate that, ifapproved, Hematide would compete with EPOGEN and Aranesp, which are bothmarketed by Amgen, PROCRIT, which is marketed by Ortho Biotech Products, L.P.(a subsidiary of J&J), and NeoRecormon, currently marketed outside the U.S.by Roche. Aranesp is approved for once-monthly dosing for treatment of anemiain prediaysis patients in Europe. In the U.S., Amgen is reportedly in theprocess of seeking approval for once-monthly dosing of Aranesp for treatment ofanemia in predialysis patients. In addition, in April 2006 Roche filed forU.S. and European marketing approval for Mircera, which reportedly has greaterserum stability and is longer acting than any rEPO product that is currently onthe market. Roche and Amgen are currently engaged in patent litigation. Amgenalleges that Mircera infringes six U.S. patents owned by Amgen. If Amgen doesnot seek or obtain a preliminary injunction, Mircera would likely enter themarket before Hematide. Because of its ability to be longer acting, we believethat Mircera will be in direct competition with Hematide, and therefore couldpotentially limit the market for Hematide. Another potential competitor,FibroGen, Inc., or FibroGen, is developing a small molecule which isdesigned to inhibit enzymes that promote the degradation of Hypoxia-InducibleFactor, or HIF, which plays a key role in activating genes that protect thebody against low levels of oxygen, or hypoxia. By increasing the level of HIFin a patient’s circulation, FibroGen’s molecule may promote the production ofgreater levels of naturally-occurring EPO. The introduction of generics intothe ESA market, or new market entrants, could also prove to be a significantthreat to us as it could not only limit the market for Hematide, but could alsodrive down the price of ESAs.

All of these competitorshave substantially greater financial resources and expertise in research anddevelopment, manufacturing, preclinical testing, conducting clinical trials,obtaining regulatory approvals and marketing approved products than we do.Current marketers of ESAs also have the ability to bundle sales of existing ESAproducts with their other products, potentially disadvantaging Hematide, whichwe plan to sell on a stand-alone basis. Established pharmaceutical and largebiotechnology companies may invest heavily to discover and develop novelcompounds or drug delivery technology that could make our product candidatesobsolete. Smaller or early stage companies may also prove to be significantcompetitors, particularly through strategic partnerships with large andestablished companies. These third parties may compete with us in recruitingand retaining qualified scientific and management personnel, establishingclinical trial sites and patient registration for clinical trials, as well asin acquiring technologies and technology licenses complementary to our programsor advantageous to our business. Our competitors may succeed in obtainingpatent or other intellectual property protection, receiving FDA approval, ordiscovering, developing and commercializing products before we do.

***The U.S. marketopportunity for Hematide may deteriorate significantly after existing rEPOpatents expire in the U.S. in 2015.***

The last significant U.S.patent for epoetin alfa, a version of short-acting rEPO, expires in 2015.Patents related to epoetin alfa expired in the E.U. in 2004. Generic versionsof short-acting rEPO are currently being developed in and for various marketsoutside the U.S., including the E.U. Generic shortacting rEPO is already beingsold in various territories outside the U.S. and the E.U. We expect thatbiogenerics, including rEPO, will be sold at a significant discount to existingbranded products when they are launched in the U.S. and the E.U. The introductionof generics into the ESA market could prove to be a significant threat toHematide if they are able to demonstrate bioequivalence to existing ESAs.Generics will constitute additional competition for Hematide and could driveits price down, which may adversely affect our revenues.

21

----

***Any failure or delay in completing clinical trials forour product candidates could severely harm our business.***

Eachof our product candidates must undergo extensive preclinical studies andclinical trials as a condition to regulatory approval. Preclinical studies andclinical trials are expensive and take many years to complete. We estimate thatclinical trials and related regulatory review in initial indications for ourmost advanced product candidate, Hematide, will continue for at least fouryears, but could take significantly longer to complete. The completion ofclinical trials for our product candidates may be delayed or halted for manyreasons, including:

·       delaysor failure in reaching agreement on acceptable clinical trial contracts orclinical trial protocols with prospective sites;

·       regulatorsor institutional review boards may not authorize us to commence a clinicaltrial;

·       ourinability, or the inability of our collaborators or licensees, to manufactureor obtain from third parties materials sufficient to complete our preclinicalstudies and clinical trials;

·       delaysin patient enrollment, and variability in the number and types of patientsavailable for clinical trials;

·       risksassociated with non-inferiority trial designs, which are studies devised andstatistically powered to show that the test drug is not inferior to the controldrug;

·       difficultyin maintaining contact with patients after treatment, resulting in incompletedata;

·       pooreffectiveness of product candidates during clinical trials;

·       safetyissues, including serious adverse events associated with Hematide;

·       thefailure of patients to complete clinical trials due to side effects,dissatisfaction with the product candidate or other reasons;

·       governmentalor regulatory delays and changes in regulatory requirements, policy and guidelines;and

·       varyinginterpretation of data by FDA and similar foreign regulatory agencies.

Clinical trials mayrequire the enrollment of large numbers of patients, and suitable patients maybe difficult to identify and recruit. Our ability to enroll sufficient numbersof patients in our clinical trials depends on many factors, including the sizeof the patient population, the nature of the protocol, the proximity of patientsto clinical sites, the eligibility criteria for the trial and competingclinical trials. Patients participating in the trials may not live throughcompletion of the trial or may suffer adverse medical effects unrelated totreatment with our product candidate. The results from preclinical testing andprior clinical trials may not be predictive of results obtained in later andlarger clinical trials. A number of companies in the pharmaceutical industryhave suffered significant setbacks in clinical trials, even in advancedclinical trials after showing promising results in earlier clinical trials. Ourfailure to adequately demonstrate the safety and effectiveness of any of ourproduct candidates will prevent us from receiving regulatory approval and negativelyimpact our business.

It is possible that noneof our product candidates will complete clinical trials in any of the marketsin which we intend to sell those product candidates. We also do not know andare unable to predict what clinical trials the FDA will require us to conductor the scope, size or design of such trials, which could result in additionaldelays in bringing our product candidates to market. Accordingly, we may notreceive the regulatory approvals needed to market our product candidates. Anyfailure or delay in completing clinical trials for our product candidates woulddelay commercialization of our product candidates and severely harm ourbusiness and financial condition.

22

----

***All of our productcandidates other than Hematide are in early stage research. If we are unable todevelop, test and commercialize our other product candidates, our business willbe adversely affected.***

A key element ofour strategy is to discover, develop and commercialize a portfolio of newproducts in addition to Hematide. We are seeking to do so through our internalresearch programs and intend to explore strategic collaborations for thedevelopment of new products. Research programs to identify new disease targetsand product candidates require substantial technical, financial and humanresources, whether or not any product candidates are ultimately identified. Ourresearch programs may initially show promise in identifying potential productcandidates, yet fail to yield product candidates for clinical development formany reasons, including the following:

·       theresearch methodology used may not be successful in identifying potentialproduct candidates;

·       competitorsmay develop alternatives that render our product candidates obsolete;

·       aproduct candidate may on further study be shown to have harmful side effects orother characteristics that indicate it is unlikely to be effective or otherwisedoes not meet applicable regulatory approval;

·       aproduct candidate is not capable of being produced in commercial quantities atan acceptable cost, or at all; or

·       aproduct candidate may not be accepted by patients, the medical community orthird-party payors.

Our strategy also includesin-licensing or acquiring product candidates that leverage our productdevelopment strengths. We may not be able to license or acquire promisingproduct candidates on reasonable terms, if at all.

***If we fail to maintain our existing, or enter intonew, strategic collaborations, we may have to reduce or delay our productcandidate development efforts or increase our expenditures.***

Our business modelis based in part upon entering into strategic collaborations for development ofour product candidates. If we are not able to maintain our existingcollaboration with Takeda to develop and commercialize Hematide, our businesscould be severely adversely affected. In addition, if we fail to establish andmaintain additional strategic collaborations for our other potential productcandidates:

·       thedevelopment of our current or future product candidates may be terminated ordelayed;

·       ourcash expenditures related to development of our current or future productcandidates would increase significantly and we may need to seek additionalfinancing;

·       wemay be required to hire additional employees or otherwise develop expertise,such as sales and marketing expertise, for which we have not budgeted;

·       wewill bear all of the risk related to the development of each of our current andfuture product candidates; and

·       wemay be unable to meet demand for any future products that we may develop.

Any of these events couldhave a material adverse effect on our business.

23

----

***We have incurred significant operating losses sinceinception and anticipate that we will incur continued losses for theforeseeable future.***

We have experienced significant operating losses sinceour inception in 2001. At December 31, 2006, we had a deficit accumulatedduring the development stage of approximately $168.7 million. We have generatedno revenue from product sales to date. We have funded our operations to dateprincipally from the sale of our securities and from payments by Takeda underour collaboration agreements. We expect to continue to incur substantialadditional operating losses for the next several years as we pursue ourclinical trials, prepare for commercialization of our initial products, beginnew development programs and add the necessary infrastructure to supportoperating as a public company. Even if we receive regulatory approval for oneor more products, we must successfully commercialize our products before we canbecome profitable. We anticipate that it will be at least several years beforewe can commercialize our lead product candidate, Hematide, and even longer forour current product candidates, if at all. Accordingly, we may never generatesignificant revenues and, even if we do generate significant revenues, we maynever achieve or sustain profitability.

***Reimbursement maynot be available for our product candidates, which could diminish our sales oraffect our ability to sell our products profitably.***

Market acceptance and sales of our product candidateswill depend on reimbursement policies and may be affected by future health carereform measures. Government authorities and third-party payors, such as privatehealth insurers and health maintenance organizations, decide which drugs theywill pay for and establish reimbursement levels. We cannot be sure thatreimbursement will be available for any of our product candidates. Also, wecannot be sure that reimbursement amounts will not reduce the demand for, orthe price of, our products. We have not commenced efforts to have our productcandidates reimbursed by government or third-party payors. If reimbursement isnot available or is available only to limited levels, we may not be able tocommercialize our products.

In both the U.S. and certain foreign jurisdictions,there have been a number of legislative and regulatory proposals in recentyears to change the healthcare system in ways that could impact our ability tosell our products profitably. These proposals include prescription drug benefitproposals for Medicare beneficiaries and measures that would limit or prohibitpayments for certain medical treatments or subject the pricing of drugs togovernment control. Legislation creating a prescription drug benefit and makingcertain changes in Medicaid reimbursement has recently been enacted. Inparticular, in December 2003, President Bush signed into law new Medicareprescription drug coverage legislation that changes the methodology used tocalculate reimbursement for certain drugs such as Hematide. In addition, thelegislation directs the Secretary of Health and Human Services to contract withprocurement organizations to purchase physician-administered drugs from themanufacturers and provides physicians with the option to obtain drugs throughthese organizations as an alternative to purchasing from the manufacturers,which some physicians may find advantageous.

As a result of legislativeproposals and the trend towards managed health care in the U.S., third-partypayors are increasingly attempting to contain health care costs by limitingboth coverage and the level of reimbursement of new drugs. They may also refuseto provide any coverage of approved products for medical indications other thanthose for which the FDA has granted market approvals. As a result, significantuncertainty exists as to whether and how much third-party payors will reimbursepatients for their use of newly approved drugs, which in turn will put pressureon the pricing of drugs. We expect to experience pricing pressures inconnection with the sale of our products due to the trend toward managed healthcare, the increasing influence of health maintenance organizations andadditional legislative proposals.

24

----

***CMS policies are constantly changing and we cannotguarantee that they will not decrease, limit or deny reimbursement of Hematidein the future.***

CMS, the agency within theDepartment of Health and Human Services that manages Medicare and will beresponsible for reimbursement of the cost of Hematide administered to Medicarebeneficiaries, has asserted the authority of Medicare not to cover particulardrugs if it determines that they are not ‘‘reasonable and necessary’’ forMedicare beneficiaries, or to cover them at a lesser rate, compared to drugsthat CMS considers to be therapeutically comparable. We cannot be certain thatCMS will not decrease, limit or deny reimbursement of Hematide for anytherapeutic indication we may pursue. As the costs of the Medicare programcontinue to grow, CMS may be compelled to make difficult decisions regardingthe trade-offs of supporting the reimbursement of certain public healthexpenditures over others. Depending on methods CMS uses to calculate thecost-benefit of treatments competing for share of the Medicare budget, ESAs(including Hematide) may not be considered to offer sufficient overall healthbenefit to justify reimbursement at levels that will allow us to achieve andsustain profitability. In fact, the National Institute for Health and ClinicalExcellence, the body that provides guidance to the U.K.’s National HealthService on what healthcare technologies to reimburse and at what levels,currently recommends against the wide use of ESAs in the treatment ofchemotherapy induced anemia. In addition, further, as a result of the recentsafety concerns relating to ESAs, the Centers for Medicare & Medicaidpolicies has recently announced that it is reviewing policies relating to theuse of ESAs. Further, CMS has instituted dramatic Medicare reimbursementchanges in the past that adversely impacted the businesses of companies inother segments of the healthcare industry, and we cannot determine that CMSwill not do the same in the markets in which we operate. CMS currentlyreimburses healthcare providers for use of ESAs at ASP plus 6%. In the future,CMS may reimburse ESAs under methods other than ASP plus 6%, includingcapitation, a method that reimburses providers a fixed, per capita amount perpatient regardless of the level of service provided. We cannot guarantee thatHematide, or any of our other product candidates, will be reimbursed by CMS toincent physician adoption.

***If we fail to obtain additional financing, we may beunable to complete the development and commercialization of Hematide and ourother product candidates, or to continue our research and development programs.***

Our operations haveconsumed substantial amounts of cash since our inception. We expect to continueto spend substantial amounts in order to:

·       completethe clinical development of Hematide and our other product candidates;

·       launchand commercialize any product candidates for which we receive regulatoryapproval, including building our own commercial organization and sales force toaddress certain markets;

·       continueour research and development programs; and

·       licenseor acquire additional product candidates.

We believe that existing cash, cash equivalents andshort-term investments and the interest thereon, will enable us to maintain ourcurrently planned operations through at least 18 months. However, we may berequired to raise additional capital to complete the development andcommercialization of Hematide. We may be required to raise additional capitalto complete the development and commercialization of our current productcandidates**.**

To date, oursources of cash have been limited primarily to the proceeds from the sale ofour securities to private and public investors and payments by Takeda under ourcollaboration agreements. We cannot be certain that additional funding will beavailable on acceptable terms, or at all. To the extent that we raiseadditional funds by issuing equity securities, our stockholders may experiencesignificant dilution. Any debt financing, if available, may involve restrictivecovenants, such as limitations on our ability to incur 

25

----

additionalindebtedness, limitations on our ability to acquire or license intellectualproperty rights and other operating restrictions that could adversely impactour ability to conduct our business. If we are unable to raise additionalcapital when required or on acceptable terms, we may have to significantlydelay, scale back or discontinue the development and/or commercialization ofone or more of our product candidates. We also may be required to:

·       seekcollaborators for our product candidates at an earlier stage than otherwisewould be desirable and on terms that are less favorable than might otherwise beavailable; and

·       relinquish or license onunfavorable terms our rights to technologies or product candidates that weotherwise would seek to develop or commercialize ourselves.

***We rely on thirdparties to conduct preclinical and clinical trials for our product candidates,and if they do not properly and successfully perform their obligations to us,we may not be able to obtain regulatory approvals for our product candidates.***

We design the clinical trials for our productcandidates, but we rely on contract research organizations and other thirdparties to assist us in managing, monitoring and otherwise carrying out thesetrials. We compete with larger companies for the resources of these thirdparties.

Although we rely on these third parties to conduct ourclinical trials, we are responsible for confirming that each of our clinicaltrials is conducted in accordance with its general investigational plan andprotocol. Moreover, FDA and foreign regulatory agencies require us to complywith regulations and standards, commonly referred to as good clinicalpractices, for conducting, recording and reporting the results of clinicaltrials to assure that the data and results are credible and accurate and thatthe trial participants are adequately protected. Our reliance on third partiesdoes not relieve us of these responsibilities and requirements.

We may not be able to maintain our relationships withthese contract research organizations on acceptable terms. These third-partycollaborators generally may terminate their engagements with us at any time andhaving to enter into alternative collaboration arrangements would delayintroduction of our product candidates to market. As a result, we can control theiractivities only within certain limits, and they will devote only a certainamount of their time to conduct research on our product candidates and developthem.

If these third parties donot successfully carry out their duties under their agreements with us, if thequality or accuracy of the data they obtain is compromised due to failure toadhere to our clinical protocols or regulatory requirements, or if theyotherwise fail to comply with clinical trial protocols or meet expecteddeadlines, our clinical trials may not meet regulatory requirements. If ourclinical trials do not meet regulatory requirements or if these third partiesneed to be replaced, our preclinical development activities or clinical trialsmay be extended, delayed, suspended or terminated. If any of these eventsoccur, we may not be able to obtain regulatory approval of our productcandidates.

***Our dependence upon third parties for the manufactureand supply of our products may cause delays in, or prevent us from,successfully developing and commercializing products.***

We do not currently have the infrastructure orcapability internally to manufacture the drug products that we need to conductour clinical trials. We have entered into agreements with contractmanufacturers to produce our supplies of Hematide; however, we have no longterm contracts for supply of Hematide or any of our other product candidates.Hematide is a new chemical entity that has never been produced at commercialscale, and as such, there are underlying risks associated with the manufactureof the substance, which could include: cost overruns, process scale-up, processreproducibility, stability issues and timely availability of raw materials, aswell as regulatory issues associated with the manufacture of our product 

26

----

candidates. Any of theserisks may prevent or delay us from successfully developing Hematide or otherproduct candidates.

For the foreseeable future, we expect to continue torely on contract manufacturers, partners and other third parties to producesufficient quantities of our product candidates for use in our clinical trials.If our contract manufacturers or other third parties fail to deliver ourproduct candidates for clinical use on a timely basis, with sufficient qualityand at commercially reasonable prices, and we fail to find replacementmanufacturers or to develop our own manufacturing capabilities, we may berequired to delay or suspend clinical trials or otherwise discontinuedevelopment and production of our product candidates.

We, our third-partymanufacturers and our partners are required to comply with applicable FDAmanufacturing practice regulations. If one of our third-party manufacturersfails to maintain compliance with these regulations, the production of ourproduct candidates could be interrupted, resulting in delays and additionalcosts. Additionally, our third-party manufacturers must pass a pre-approvalinspection before we can obtain regulatory approval for any of our productcandidates. If for any reason these third parties are unable or unwilling toperform under our agreements or enter into new agreements with us, we may notbe able to locate alternative manufacturers or enter into favorable agreementswith them in an expeditious manner. We could also experience manufacturing delaysif our third-party manufacturers give greater priority to the production ofother products over our product candidates. Any inability to acquire sufficientquantities of our product candidates or components thereof in a timely mannerfrom third parties could delay clinical trials or result in product shortagesand prevent us from developing and commercializing our product candidates in acost-effective manner or on a timely basis.

***The commercial success of our collaborations dependsin part on the development and marketing efforts of our collaboration partners,over which we have limited control. If our collaborations are unsuccessful, ourability to develop and commercialize products through our collaborations, andto generate future revenue from the sale of these products, would besignificantly reduced.***

Our dependence on collaboration arrangements subjectsour company to a number of risks. Our ability to develop and commercializedrugs that we develop with our collaboration partners depends on our collaborationpartners’ abilities to establish the safety and efficacy of our productcandidates, obtain and maintain regulatory approvals and achieve marketacceptance of a product once commercialized. Our collaboration partners mayelect to delay or terminate development of one or more product candidates,independently develop products that compete with ours, or fail to commitsufficient resources to the marketing and distribution of products developedthrough their collaboration with us. Competing products, either developed byour collaboration partners or to which our collaboration partners have rightsor acquire in the future, may result in our partners’ withdrawal of support forour product candidates.

In the event that one ormore of our collaboration partners fails to diligently develop or commercializea product candidate covered by one of our collaboration agreements, we may havethe right to terminate our partner’s rights to such product candidate but wewill not receive any future revenue from that product candidate unless we areeither able to find another partner or to commercialize the product candidateon our own, which is likely to result in significant additional expense.Business combinations, significant changes in business strategy, litigationand/or financial difficulties may also adversely affect the willingness orability of one or more of our collaboration partners to complete theirobligations under our collaboration agreements. If our collaboration partnersfail to perform in the manner we expect, our potential to develop andcommercialize products through our collaborations and to generate futurerevenue from the sale of these products, would be significantly reduced. If aconflict of interest arises between us and one or more of our collaborationpartners, they may act in their own self-interest and not in the interest ofour company or our stockholders. If one or more of our collaboration partnerswere to breach or terminate their collaboration agreements with us or otherwisefail to perform their obligations 

27

----

thereunderin a timely manner, the preclinical or clinical development orcommercialization of the affected product candidates or research programs couldbe delayed or terminated.

***It is difficult and costly to protect our proprietaryrights, and we may not be able to ensure their protection.***

Our commercial success will depend in part onobtaining and maintaining patent protection and trade secret protection of ourproduct candidates, their use and the methods used to manufacture them, as wellas successfully defending these patents against third-party challenges. Ourability to protect our product candidates from unauthorized making, using,selling, offering to sell or importation by third parties is dependent upon theextent to which we have rights under valid and enforceable patents, or havetrade secrets that cover these activities.

We have licensed from third parties rights to numerousissued patents and patent applications. The rights to product candidates thatwe acquire from licensors or collaborators are protected by patents andproprietary rights owned by them, and we rely on the patent protection andrights established or acquired by them. Because we may acquire rights tolate-stage products, the remaining patent terms of licensed patents relating tothose products may not provide meaningful protection. Moreover, third partiesmay challenge the patents, patent applications and other proprietary rightsheld by our licensors or collaborators. We generally do not unilaterally controlthe prosecution of patent applications licensed from third parties.Accordingly, we are unable to exercise the same degree of control over thisintellectual property as we may exercise over internally developed intellectualproperty.

Even if we are able to obtain patents on our productcandidates, any patent may be challenged, invalidated, held unenforceable orcircumvented. The existence of a patent will not necessarily protect us fromcompetition or from claims of a third party that our products infringe theirissued patents. No consistent policy regarding the breadth of claims allowed inbiotechnology patents has emerged to date in the U.S. The biotechnology patentsituation outside the U.S. is even more uncertain. Competitors may successfullychallenge our patents, produce similar drugs or products that do not infringeour patents, or produce drugs in countries where we have not applied for patentprotection or that do not respect our patents. Accordingly, we cannot predictthe breadth of claims that may be allowed or enforced in our licensed patents,in our patents or in third-party patents or applications therefor.

The degree offuture protection to be afforded by our proprietary rights is uncertain becauselegal means afford only limited protection and may not adequately protect ourrights or permit us to gain or keep our competitive advantage. For example:

·       othersmay be able to make compounds that are similar to our product candidates butthat are not covered by the claims of our patents, or for which we are notlicensed under our license agreements;

·       weor our licensors or collaborators might not have been the first to make theinventions covered by our pending patent application or the pending patentapplications and issued patents of our licensors;

·       weor our licensors or collaborators might not have been the first to file patentapplications for these inventions;

·       othersmay independently develop similar or alternative technologies or duplicate anyof our technologies without infringing our intellectual property rights;

·       itis possible that our pending patent applications will not result in issuedpatents;

·       ourissued patents and the issued patents of our licensors or collaborators may notprovide us with any competitive advantages, or may be held invalid orunenforceable as a result of legal challenges by third parties;

28

----

·  we may not develop additional proprietarytechnologies that are patentable; or

·  the patents of others may have an adverseeffect on our business.

We also may rely on trade secrets to protect ourtechnology, especially where we do not believe patent protection is appropriateor obtainable. However, trade secrets are difficult to protect. Although we usereasonable efforts to protect our trade secrets, our employees, consultants,contractors, outside scientific collaborators and other advisors may unintentionallyor willfully disclose our information to competitors. Enforcing a claim that athird party illegally obtained and is using any of our product candidates isexpensive and time consuming, and the outcome is unpredictable. In addition,courts outside the U.S. are sometimes less willing to protect trade secrets.Moreover, our competitors may independently develop equivalent knowledge,methods and know-how.

Our research anddevelopment collaborators may have rights to publish data and other informationto which we have rights. In addition, we sometimes engage individuals orentities to conduct research that may be relevant to our business. The abilityof these individuals or entities to publish or otherwise publicly disclose dataand other information generated during the course of their research is subjectto certain contractual limitations. These contractual provisions may beinsufficient or inadequate to protect our trade secrets and may impair ourpatent rights. If we do not apply for patent protection prior to suchpublication or if we cannot otherwise maintain the confidentiality of ourtechnology and other confidential information, then our ability to receivepatent protection or protect our proprietary information may be jeopardized.

***We expect to incur substantial costs as a result oflitigation or other proceedings relating to patent and other intellectualproperty rights and we may be unable to protect our rights to, or use, ourtechnology.***

Our ability, and that of our commercial partners, tocommercialize any approved products will depend, in part, on our ability toobtain patents, enforce those patents and operate without infringing theproprietary rights of third parties. The patent positions of biotechnology andpharmaceutical companies can be highly uncertain and involve complex legal andfactual questions. We have filed multiple U.S. patent applications and foreigncounterparts related to Hematide and other programs as well as underlyingplatform technologies and may file additional U.S. and foreign patentapplications related thereto. There can be no assurance that any issued patentswe own or control will provide sufficient protection to conduct our business aspresently conducted or as proposed to be conducted, that any patents will issuefrom the patent applications owned by us, or that we will remain free frominfringement claims by third parties.

The failure to obtain adequate patent protection wouldhave a material adverse effect on us and may adversely affect our ability toenter into, or affect the terms of, any arrangement for the further developmentand marketing of any product. There can also be no assurance that patents ownedby us will not be challenged by others. We are currently involved in bindingarbitration with J&J, which could result in one or more patents beingissued to these parties for technology that we jointly or solely own. We couldincur substantial costs in proceedings, including interference proceedingsbefore the U.S. Patent and Trademark Office and comparable proceedings beforesimilar agencies in other countries in connection with any claims that mayarise in the future. These proceedings could result in adverse decisions aboutthe patentability of our inventions and products, as well as about theenforceability, validity or scope of protection afforded by our patents.

Patent applications in the U.S. and elsewhere arepublished only after 18 months from the priority date. The publication ofdiscoveries in the scientific or patent literature frequently occurs substantiallylater than the date on which the underlying discoveries were made. Therefore,patent applications relating to products similar to Hematide and any futureproducts may have already been filed by others without our knowledge. In theevent an infringement claim is brought against us, we may be required to paysubstantial legal and other expenses to defend such a claim and, if we areunsuccessful in defending the claim, we may 

29

----

be prevented from pursuingrelated product development and commercialization and may be subject to damageawards.

Our ongoing litigation is described in the sectionsentitled ‘‘Business—Intellectual Property’’ and ‘‘Legal Proceedings.’’ We haveincurred substantial expense as a result of our litigation and arbitrationproceedings and we expect to incur even greater expense in the future. Inaddition, any future patent litigation, interference or other administrativeproceedings will result in additional expense and distraction of our personnel.An adverse outcome in such litigation or proceedings may expose us or ourcollaborators to loss of our proprietary position or to significantliabilities, or require us to seek licenses that may not be available fromthird parties on commercially acceptable terms or at all. In addition, we maybe restricted or prevented from manufacturing, developing or commercializingHematide or from developing, manufacturing and selling any future products inthe event of an adverse determination in a judicial or administrativeproceeding or if we fail to obtain necessary licenses. If it is determined thatwe have infringed an issued patent, we could be compelled to pay significantdamages, including punitive damages.

Virtually all of ourcompetitors are able to sustain the costs of complex patent litigation moreeffectively than we can because they have substantially greater resources. Inaddition, any uncertainties resulting from the initiation and continuation ofany litigation could have a material adverse effect on our ability to raise thefunds necessary to continue our operations, in-license technology that we need,out-license our existing technologies or enter into collaborations that wouldassist in bringing our product candidates to market.

***If we are unable either to create sales, marketing anddistribution capabilities or enter into agreements with third parties toperform these functions, we will be unable to commercialize our productcandidates successfully.***

We currently haveno sales, marketing or distribution capabilities. To commercialize our productcandidates, we must either develop internal sales, marketing and distributioncapabilities, which will be expensive and time consuming, or make arrangementswith third parties to perform these services. If we decide to market any of ourproducts directly, we must commit significant financial and managerialresources to develop a marketing and sales force with technical expertise andwith supporting distribution capabilities. Factors that may inhibit our effortsto commercialize our products directly and without strategic partners include:

·       ourinability to recruit and retain adequate numbers of effective sales andmarketing personnel;

·       theinability of sales personnel to obtain access to or persuade adequate numbersof physicians to prescribe our products;

·       thelack of complementary products to be offered by sales personnel, which may putus at a competitive disadvantage relative to companies with more extensiveproduct lines; and

·       unforeseencosts and expenses associated with creating and sustaining an independent salesand marketing organization.

If we are not able tocollaborate with a third party and are not successful in recruiting sales andmarketing personnel or in building a sales and marketing infrastructure, wewill have difficulty commercializing our product candidates, which wouldadversely affect our business and financial condition. If we do collaboratewith and rely on pharmaceutical or biotechnology companies with established sales,marketing and distribution systems to market our products, we will need toestablish and maintain partnership arrangements, and we may not be able toenter into these arrangements on acceptable terms. To the extent that we enterinto co-promotion or other arrangements, any revenues we receive will dependupon the efforts of third parties, which may not be successful and are onlypartially in our control. In that event, our product revenues would likely belower than if we marketed and sold our products directly.

30

----

***If we fail to attract and keep senior management andkey scientific personnel, we may be unable to successfully develop our productcandidates, conduct our clinical trials and commercialize our productcandidates.***

Our success depends in part on our continued abilityto attract, retain and motivate highly qualified management, clinical andscientific personnel and on our ability to develop and maintain importantrelationships with leading academic institutions, clinicians and scientists. Weare highly dependent upon our senior management and scientific staff,particularly Arlene Morris, our President and Chief Executive Officer, andRobert Naso, our Executive Vice President, Research and Development. The lossof services of either Ms. Morris or Dr. Naso or one or more of ourother members of senior management could delay or prevent the successfulcompletion of our planned clinical trials or the commercialization of ourproduct candidates.

Competition for qualifiedpersonnel in the biotechnology and pharmaceuticals field is intense. We willneed to hire additional personnel as we expand our clinical development andcommercial activities. We may not be able to attract and retain qualitypersonnel on acceptable terms. We do not carry ‘‘key person’’ insurancecovering any members of our senior management. Each of our officers and keyemployees may terminate his employment at any time without notice and withoutcause or good reason.

***As we evolve from a company primarily involved inresearch and development to a company also involved in commercialization, wemay encounter difficulties in managing our growth and expanding our operationssuccessfully.***

As we advance our productcandidates through clinical trials, we will need to expand our development,regulatory, manufacturing, marketing and sales capabilities or contract withthird parties to provide these capabilities for us. As our operations expand,we expect that we will need to manage additional relationships with variouscollaborative partners, suppliers and other third parties. Future growth willimpose significant added responsibilities on members of management. Our futurefinancial performance and our ability to commercialize our product candidatesand to compete effectively will depend, in part, on our ability to manage anyfuture growth effectively. To that end, we must be able to manage ourdevelopment efforts effectively, manage our clinical trials effectively andhire, train and integrate additional management, administrative and sales andmarketing personnel. We may not be able to accomplish these tasks, and ourfailure to accomplish any of them could prevent us from successfully growingour company.

**Risks Related toOur Industry**

***The regulatory approval process is expensive, timeconsuming and uncertain and may prevent us or our collaboration partners fromobtaining approvals for the commercialization of some or all of our productcandidates.***

The research, testing, manufacturing, selling andmarketing of drug candidates are subject to extensive regulation by FDA andother regulatory authorities in the U.S. and other countries, and regulationsmay differ from country to country. Neither we nor our collaboration partnersare permitted to market our product candidates in the U.S. until we receiveapproval of a New Drug Application, or NDA, from the FDA. We have not receivedmarketing approval for any of our product candidates. Obtaining approval of anNDA can be a lengthy, expensive and uncertain process. In addition, failure tocomply with FDA and other applicable U.S. and foreign regulatory requirementsmay subject our company to administrative or judicially imposed sanctions,including warning letters, civil and criminal penalties, injunctions, productseizure or detention, product recalls, total or partial suspension ofproduction and refusal to approve pending NDAs or supplements to approved NDAs.

31

----

Regulatory approvalof an NDA or NDA supplement is not guaranteed, and the approval process isexpensive and may take several years. The FDA also has substantial discretionin the drug approval process. Despite the time and expense exerted, failure canoccur at any stage, and we could encounter problems that cause us to abandonclinical trials or to repeat or perform additional preclinical studies andclinical trials. The number of preclinical studies and clinical trials thatwill be required for FDA approval varies depending on the drug candidate, thedisease or condition that the drug candidate is designed to address, and theregulations applicable to any particular drug candidate. The FDA can delay,limit or deny approval of a drug candidate for many reasons, including:

·       adrug candidate may not be deemed safe or effective;

·       FDAofficials may not find the data from preclinical studies and clinical trialssufficient;

·       TheFDA might not approve our or our third-party manufacturer’s processes orfacilities; or

·       The FDA may change itsapproval policies or adopt new regulations.

***Even if we receive regulatory approval for a productcandidate, we will be subject to ongoing FDA obligations and continuedregulatory review, which may result in significant additional expense and limitour ability to commercialize our future products.***

Any regulatory approvals that we or our collaborationpartners receive for our product candidates may also be subject to limitationson the indicated uses for which the product may be marketed, or containrequirements for potentially costly post-marketing follow-up studies. Inaddition, if the FDA approves any of our product candidates, the labeling,packaging, adverse event reporting, storage, advertising, promotion andrecordkeeping for the product will be subject to extensive and ongoingregulatory requirements. The subsequent discovery of previously unknownproblems with the drug, including adverse events of unanticipated severity orfrequency, may result in restrictions on the marketing of the drug, and couldinclude withdrawal of the drug from the market.

The FDA’s policies maychange and additional government regulations may be enacted that could preventor delay regulatory approval of our product candidates. We cannot predict thelikelihood, nature or extent of government regulation that may arise fromfuture legislation or administrative action, either in the U.S. or abroad. Ifwe are not able to maintain regulatory compliance, we might not be permitted tomarket our future products and we may not achieve or sustain profitability.

***Failure to obtain regulatory approval in foreignjurisdictions will prevent us from marketing our products abroad.***

We intend to market ourfuture products in international markets. In order to market our futureproducts in the European Union and many other foreign jurisdictions, we mustobtain separate regulatory approvals. We have had limited interactions withforeign regulatory authorities, and the approval procedures vary amongcountries and can involve additional testing, and the time required to obtainapproval may differ from that required to obtain FDA approval. Approval by theFDA does not ensure approval by regulatory authorities in other countries, andapproval by one foreign regulatory authority does not ensure approval byregulatory authorities in other foreign countries or by the FDA. The foreignregulatory approval process may include all of the risks associated withobtaining FDA approval. We may not obtain foreign regulatory approvals on atimely basis, if at all. We may not be able to file for regulatory approvalsand may not receive necessary approvals to commercialize our products in anymarket.

32

----

***Foreign governmentsoften impose strict price controls, which may adversely affect our futureprofitability.***

We intend to seek approvalto market our future products in both the U.S. and in foreign jurisdictions. Ifwe obtain approval in one or more foreign jurisdictions, we will be subject to rules andregulations in those jurisdictions relating to our product. In some foreigncountries, particularly in the European Union, prescription drug pricing issubject to governmental control. In these countries, pricing negotiations withgovernmental authorities can take considerable time after the receipt ofmarketing approval for a drug candidate. To obtain reimbursement or pricingapproval in some countries, we may be required to conduct a clinical trial thatcompares the cost-effectiveness of our future product to other availabletherapies. If reimbursement of our future products is unavailable or limited inscope or amount, or if pricing is set at unsatisfactory levels, we may beunable to achieve or sustain profitability.

***We may incursignificant costs complying with environmental laws and regulations, andfailure to comply with these laws and regulations could expose us tosignificant liabilities.***

We use hazardous chemicalsand radioactive and biological materials in our business and are subject to avariety of federal, state and local laws and regulations governing the use,generation, manufacture, storage, handling and disposal of these materials.Although we believe our safety procedures for handling and disposing of thesematerials and waste products comply with these laws and regulations, we cannoteliminate the risk of accidental injury or contamination from the use, storage,handling or disposal of hazardous materials. In the event of contamination or injury,we could be held liable for any resulting damages. We are uninsured forthird-party contamination injury.

***If product liability lawsuits are brought against us,we may incur substantial liabilities and may be required to limitcommercialization of our product candidates.***

We face an inherentrisk of product liability as a result of the clinical testing of our productcandidates in clinical trials and will face an even greater risk if wecommercialize any products. We may be held liable if any product we developcauses injury or is found otherwise unsuitable during product testing,manufacturing, marketing or sale. If we cannot successfully defend ourselvesagainst product liability claims, we may incur substantial liabilities or berequired to limit commercialization of our product candidates. Even successfuldefense would require significant financial and management resources.Regardless of the merit or eventual outcome, liability claims may result in:

·       decreaseddemand for our product candidates;

·       injuryto our reputation;

·       withdrawalof clinical trial participants;

·       costsof related litigation;

·       substantialmonetary awards to patients;

·       productrecalls;

·       lossof revenue; and

·       theinability to commercialize our product candidates.

Our inability to obtainand retain sufficient product liability insurance at an acceptable cost toprotect against potential product liability claims could prevent or inhibit thecommercialization of pharmaceutical products we develop. We currently carryproduct liability insurance covering our clinical studies in the amount of $11million in the aggregate. However, our insurance may not reimburse us or maynot be sufficient to reimburse us for the expenses or losses we may suffer. Inaddition, insurance coverage is 

33

----

becomingincreasingly expensive, and in the future we may not be able to maintaininsurance coverage at a reasonable cost or obtain insurance coverage that willbe adequate to satisfy any liability that may arise.

**Risks Related tothe Ownership of Our Common Stock**

***The market price of our common stock may be highlyvolatile, and you may not be able to resell your shares at or above yourpurchase price.***

The trading priceof our common stock is likely to be highly volatile and could be subject towide fluctuations in price in response to various factors, many of which arebeyond our control, including:

·       newproducts or services introduced or announced by us or our commercializationpartners, or our competitors, including Roche’s Mircera, and the timing ofthese introductions or announcements;

·       issuanceof patents to competitors, including the expected issuance of patents toJ&J in Europe;

·       developmentsin our litigation with J&J, including both substantive and proceduralrulings by the arbitration panel;

·       actualor anticipated results from, and any delays in, our clinical trials;

·       actualor anticipated regulatory approvals or our product candidates or competingproducts;

·       actionstaken by regulatory agencies with respect to our product candidates, or ESAsgenerally, clinical trials, manufacturing process or sales and marketingactivities;

·       changesin laws or regulations applicable to our products, including but not limited toclinical trial requirements for approvals;

·       thesuccess of our development efforts and clinical trials;

·       thesuccess of our efforts to discover, acquire or in-license additional productsor product candidates;

·       developmentsconcerning our collaborations, including but not limited to those with oursources of manufacturing supply and our commercialization partners;

·       actualor anticipated variations in our quarterly operating results;

·       announcementsof technological innovations by us, our collaborators or our competitors;

·       actualor anticipated changes in earnings estimates or recommendations by securitiesanalysts;

·       conditionsor trends in the biotechnology and biopharmaceutical industries;

·       announcementsby us or our competitors of significant acquisitions, strategic partnerships,joint ventures or capital commitments;

·       generaleconomic and market conditions and other factors that may be unrelated to ouroperating performance or the operating performance of our competitors;

·       changesin the market valuations of similar companies;

·       salesof common stock or other securities by us or our stockholders in the future;

·       additionsor departures of key scientific or management personnel;

·       developmentsrelating to proprietary rights held by us or our competitors;

·       disputesor other developments relating to proprietary rights, including patents,litigation matters and our ability to obtain patent protection for ourtechnologies;

34

----

·       tradingvolume of our common stock; and

·       salesof our common stock by us or our stockholders.

In addition, the stockmarket in general and the market for biotechnology and biopharmaceuticalcompanies in particular have experienced extreme price and volume fluctuationsthat have often been unrelated or disproportionate to the operating performanceof those companies. These broad market and industry factors may seriously harmthe market price of our common stock, regardless of our operating performance.In the past, following periods of volatility in the market, securitiesclass-action litigation has often been instituted against companies. Suchlitigation, if instituted against us, could result in substantial costs anddiversion of management’s attention and resources, which could materially andadversely affect our business and financial condition.

***Our principal stockholders and management own asignificant percentage of our stock and will be able to exercise significantinfluence over matters subject to stockholder approval.***

As of February 28,2007, our executive officers, directors and principal stockholders, togetherwith their respective affiliates, currently own approximately 65% of our votingstock. Accordingly, these stockholders will be able to exert a significantdegree of influence over our management and affairs and over matters requiringstockholder approval, including the election of our board of directors andapproval of significant corporate transactions. This concentration of ownershipcould have the effect of delaying or preventing a change in our control orotherwise discouraging a potential acquirer from attempting to obtain controlof us, which in turn could have a material and adverse effect on the fairmarket value of our common stock.

***We will incur significant increased costs as a resultof operating as a public company, and our management will be required to devotesubstantial time to new compliance initiatives.***

As a public company, we will incur significant legal,accounting and other expenses that we did not incur as a private company. Inaddition, the Sarbanes-Oxley Act of 2002, as well as rules subsequentlyimplemented by the Securities and Exchange Commission and the Nasdaq GlobalMarket, have imposed various new requirements on public companies, includingrequiring establishment and maintenance of effective disclosure and financialcontrols and changes in corporate governance practices. Our management andother personnel will need to devote a substantial amount of time to these newcompliance initiatives. Moreover, these rules and regulations willincrease our legal and financial compliance costs and will make some activitiesmore time-consuming and costly. For example, we expect these rules andregulations to make it more difficult and more expensive for us to obtaindirector and officer liability insurance, and we may be required to incursubstantial costs to maintain the same or similar coverage.

The Sarbanes-Oxley Act of2002 requires, among other things, that we maintain effective internal controlover financial reporting and disclosure controls and procedures. In particular,commencing in 2007, we must perform system and process evaluation and testingof our internal control over financial reporting to allow management and ourindependent registered public accounting firm to report on the effectiveness ofour internal control over financial reporting, as required by Section 404of the Sarbanes-Oxley Act. As a result of our compliance with Section 404,we will incur substantial accounting expense and expend significant managementefforts and we will need to hire additional accounting and financial staff withappropriate public company experience and technical accounting knowledge toensure such compliance.

35

----

***Future sales of ourcommon stock in the public market could cause our stock price to fall.***

Sales of a substantial number of shares of our commonstock in the public market after this offering, or the perception that thesesales might occur, could depress the market price of our common stock and couldimpair our ability to raise capital through the sale of additional equitysecurities.

As of February 28, 2007, the holders ofapproximately 14,878,740 shares of common stock outstanding, plus an additional1,744,609 shares issuable upon the exercise of outstanding options and 1,987shares issuable upon the exercise of outstanding warrants are subject tolock-up agreements with the underwriters of our initial public offering thatrestrict the stockholders’ ability to transfer shares of our common stock forat least 180 days from the date of the final prospectus. Morgan Stanley couldrelease all or some portion of the shares subject to lock-up agreements priorto expiration of the lock-up period.

As of February 28,2007, the holders of approximately 10,309,784 shares of common stock based onshares outstanding including 1,987 shares underlying outstanding warrants, willbe entitled to rights with respect to registration of such shares under theSecurities Act of 1933, as amended. If such holders, by exercising theirregistration rights, cause a large number of securities to be registered and soldin the public market, these sales could have an adverse effect on the marketprice for our common stock. If we were to initiate a registration and includeshares held by these holders pursuant to the exercise of their registrationrights, these sales may impair our ability to raise capital.

***We are at risk of securities class action litigation.***

In the past, securitiesclass action litigation has often been brought against a company following adecline in the market price of its securities. This risk is especially relevantfor us because biotechnology and biopharmaceutical companies have experiencedsignificant stock price volatility in recent years. If we were to face suchlitigation, it could result in substantial costs and a diversion of management’sattention and resources, which could harm our business.

***Some provisions of our charter documents and Delawarelaw may have anti-takeover effects that could discourage an acquisition of usby others, even if an acquisition would be beneficial to our stockholders.***

Provisions in our certificate of incorporation andbylaws, as well as provisions of Delaware law, could make it more difficult fora third party to acquire us, even if doing so would benefit our stockholders.

These provisions include:

·       authorizingthe issuance of ‘‘blank check’’ preferred stock, the terms of which may beestablished and shares of which may be issued without stockholder approval;

·       limitingthe removal of directors by the stockholders;

·       prohibitingstockholder action by written consent, thereby requiring all stockholderactions to be taken at a meeting of our stockholders;

·       eliminatingthe ability of stockholders to call a special meeting of stockholders; and

·       establishingadvance notice requirements for nominations for election to the board ofdirectors or for proposing matters that can be acted upon at stockholdermeetings.

In addition, we aresubject to Section 203 of the Delaware General Corporation Law, whichgenerally prohibits a Delaware corporation from engaging in any of a broadrange of business combinations with an interested stockholder for a period ofthree years following the date on which the stockholder became an interestedstockholder. This provision could have the effect of delaying or preventing achange of control, whether or not it is desired by or beneficial to ourstockholders.

36

----

**Item 1B.   UnresolvedStaff Comments.**

Not applicable.

**Item 2.   Properties.**

We currently leaseapproximately 69,145 square feet, which will increase to 84,460 square feetstarting in October 2007, of laboratory and office space in Palo Alto,California under lease agreements that terminate in September 2014. Webelieve that our facilities adequately meet our present needs.

**Item 3.   LegalProceedings.**

***J&J Intellectual Property Dispute***

We have initiated binding arbitration and relatedlitigation with certain subsidiaries of Johnson & Johnson, or J&J,over ownership of intellectual property related to erythropoietin receptor, orEPO-R, agonists (compounds capable of binding to and activating the EPO-R).This intellectual property is the subject of a number of U.S. and internationalpatents and patent applications assigned to Affymax and J&J, including aU.S. patent currently assigned to J&J, several U.S. patents currentlyassigned to us and a European patent application currently assigned to J&J.See ‘‘Risk Factors—Risk Related to Our Business.’’ In this section, we refer tothe patents and patent applications subject to the arbitration collectively asthe ‘‘intellectual property in dispute’’. We believe that we are the sole owneror co-owner of the intellectual property in dispute, including a Europeanpatent application currently naming J&J as sole owner that may issue in thenear future and relates to specified ESA peptide compounds. J&J, on theother hand, alleges that they are the sole owner or co-owner of the intellectualproperty in dispute, including several U.S. patents on which we are currentlynamed as sole owner that relate to specified peptide compounds.

We believe the U.S. intellectual property in disputedoes not encompass Hematide and that we can manufacture, commercialize and sellHematide in the U.S. regardless of the outcome of this arbitration. However,if, through the ongoing arbitration or otherwise, J&J or another potentialcompetitor obtains or possesses patents or patent rights that are deemed to encompassone or more elements of Hematide, that party could initiate proceedings, anadverse result in which could prevent us from manufacturing or commercializingHematide, either for ourselves or with Takeda, in the U.S.

If the intellectualproperty in dispute is deemed broad enough to cover Hematide, then under thelaws applicable to most relevant jurisdictions outside the U.S., a finding ofjoint ownership would permit us to manufacture and sell Hematide, but may notallow us to license third parties to do so. We have entered into acollaboration agreement with Takeda to commercialize Hematide worldwide, so afinding of joint ownership of the patents and applications in question couldmaterially affect our business plans outside the U.S. In the U.S., jointownership of a patent gives each joint owner the right to license thirdparties, so even if the patents in question are held to be jointly owned by usand J&J, we do not believe we would be prevented from pursuing ourpartnership strategy for Hematide in the U.S. If the arbitration paneldetermines that J&J is the sole owner of one or more of the U.S. patents inthe dispute that are assigned to us, J&J may seek to assert such patentagainst us in the U.S.; however, we believe that we have strong defenses to anyassertion that Hematide infringes any claims of these U.S. patents.

***The Research and Development Agreement with J&J***

In April 1992, Affymax N.V. (a different companyfrom us) entered into a three-year Research and Development Agreement, which werefer to as the ‘‘R&D Agreement,’’ with a division of Ortho PharmaceuticalCorporation, a subsidiary of J&J. In 2001, we assumed the rights andobligations of 

37

----

Affymax N.V. under theR&D Agreement and acquired rights to patents and patent applications thatcomprise much of the intellectual property in dispute.

Under the R&D Agreement, J&J provided AffymaxN.V. research funding and Affymax N.V. sought to discover compounds directed atthe EPO receptor. The R&D Agreement provided for us to retain rights to ourexisting technology and identified as our technology our methodologies forcreating peptide sequence ‘‘libraries’’, each of which contained billions ofdifferent peptide sequences, and methodologies that could be used to determinewhich if any of the peptide sequences contained in a library would bind to anidentified receptor. The R&D Agreement further provided for any inventionmade by either party to be the property of the party making the invention andthat joint inventions would be jointly owned.

Our position is based on the following chronology:From 1992 through 1995, a group of scientists working for Affymax N.V.,performed extensive research under the R&D Agreement and discoverednumerous peptides and peptide dimers that bind to and activate the EPO-R. TheseAffymax N.V. scientists started with the Affymax N.V. peptide sequencelibraries, conducted numerous tests, experiments and analyses and discoveredand identified a set of active peptides that bind to and activate the EPO-R.The Affymax scientists disclosed the inventions and the results of theirresearch to J&J. In November 1993, Affymax N.V., through AffymaxTechnologies, N.V., a related entity, filed U.S. Patent Application No. 08/155,940,or the ‘940 application, claiming various of the Affymax N.V. scientists’inventions and identifying four Affymax scientists, and no J&J scientists,as the inventors. Affymax N.V. provided J&J with a draft copy of the ‘940application before filing it. The Affymax scientists’ research gave rise tonumerous other patent applications, including continuation-in-part applicationsbased on and claiming priority from the ‘940 application, a continuation of oneof those applications, and numerous foreign and international patentapplications based on one or more of these applications. Ultimately, the ‘940application was abandoned in favor of these other applications. In 2001, weacquired the rights, previously held by Affymax N.V. and Affymax Technologies,N.V., to these patents and patent applications. Some of the applications haveissued as patents, and these patents and patent applications comprise much ofthe intellectual property in dispute. Based on the inventions of the AffymaxN.V. scientists, we believe we are the sole owner or a co-owner of theintellectual property in dispute.

J&J, however, allegesthat it discovered the idea of searching peptide sequence libraries, such asAffymax N.V.’s libraries, to find peptides that bind to and activate the EPO-R,and that the Affymax N.V. scientists did not make inventive contributions whenthey discovered and identified the specific peptides that bind to and activatethe EPO-R. J&J also alleges that it discovered the idea of, and methodologyfor, dimerizing these peptides to make them more biologically active, and thatit provided Affymax with reagents and control substances for use in researchunder the R&D Agreement, as well as instructions on how to use them.J&J further alleges that Affymax N.V. improperly removed the names of theJ&J employees who had been identified as inventors on the parties’ jointapplications pending before the U.S. Patent and Trademark Office withoutnotifying or consulting J&J. For these reasons, J&J claims that itshould be granted sole ownership or joint ownership of the intellectualproperty in dispute.

***Post-R&D Agreement Development Activities***

In March 1995,Affymax N.V., Affymax Technologies, N.V. and Affymax Research Institute, or theAffymax Entities, were acquired by Glaxo Wellcome plc. In July 2001, weacquired specified assets from Glaxo Wellcome plc and related entities,including the rights to the R&D Agreement and the rights to specifiedpatents and patent applications that had previously been held by Affymax N.V.and Affymax Technologies, N.V. After the termination of the R&D Agreementin 1995, the Affymax Entities pursued efforts to create a synthetic compoundthat activated the EPO-R and had the biological and physical properties neededto be a commercially viable pharmaceutical product. Our efforts culminated inthe first chemical synthesis of Hematide in 2003.

38

----

***Patent Applications Filed During and After the R&DAgreement***

The intellectual property in dispute relates primarilyto the following patents and patent applications: U.S. Patent No. 5,767,078;U.S. Patent Application No. 08/484,135; PCT Application No. PCT/US96/09469(International Publication No. WO96/40772); European Patent Officeapplication EP96/918,317; Canadian Patent Application No. CA 2228277;Japanese Patent Application No. JP 09-(1997) 501781; AustralianPatent No. 732,294; Australian Patent Application AU01/054,337; AustralianPatent Application AU04/203,690; U.S. Patent No. 5,773,569; U.S. Patent No. 5,830,851;U.S. Patent No. 5,986,047; European Patent No. EP 0 886,648; PCTApplication No. PCT/US96/09810 (International Publication No. WO96/40749);U.S. Patent Application No. 08/155/940; U.S. Patent Application No. 08/484,631;U.S. Patent Application No. 08/484,635; and U.S. Patent Application No. 08/827,570.

In November 1993, the Affymax Entities filed aU.S. patent application (U.S.S.N. 08/155,940), or the ‘940 application,identifying four of their scientists as inventors. In June 1995, theAffymax Entities filed U.S. Patent Application Nos. 08/484,631 and 08/484,635,or the ‘631 and ‘635 applications. These applications were continuation-in-partapplications based on and claiming priority from the ‘940 application. Theyalso included certain subject matter that J&J specifically requested beadded. At the time of filing, the ‘631 and ‘635 applications listed certainJ&J employees as inventors in addition to the Affymax scientists. Prior tofiling the ‘940, ‘631, and ‘635 applications, the Affymax Entities providedJ&J with drafts and/or copies of the applications or informed them of theirintent to file them. On or about June 7, 1996, the Affymax Entities filedPCT Application No. PCT/US96/09810, which was based on and clamed priorityfrom the ‘631 and ‘635 applications and has given rise to a European patent (EP 0 866 648),which has been assigned jointly to us and J&J.

On the same day in June 1995 that the AffymaxEntities filed the ‘631 and ‘635 applications, J&J separately filed U.S.Patent Application No. 08/484,135, or the ‘135 application, whichidentified J&J employees as the sole inventors of the described subjectmatter and J&J as the sole assignee. J&J later filed a PCT application(PCT Application No. PCT/US96/09810) based on and claiming priority fromthe ‘135 application, and various foreign patent applications (including inEurope, Canada, Japan and Australia) based on the PCT application. The partiesdispute whether J&J informed the Affymax Entities prior to filing theseapplications. U.S. Patent No. 5,767,078 and Australian Patent No. 732,294issued to J&J based on these applications, and other applications arepending, including European patent application EP96/918,317. We claim in thearbitration that we are the sole or joint owner of these patents andapplications and any U.S., foreign or international patents or applicationsbased on, claiming priority from or relating to them.

On March 28, 1997, the Affymax Entities filedU.S. Patent Application No. 08/827,570, or the ‘570 application, a continuationof the ‘635 application. That day, the Affymax Entities also filed apreliminary amendment and a petition for correction of inventorship inconnection with the ‘570 application, as well as supplemental responses andpetitions for correction of inventorship in connection with the ‘631 and ‘635applications. The ‘631, ‘635, and ‘570 applications have now issued to Affymaxas U.S. Patents Nos. 5,773,569; 5,830,851; and 5,986,047. J&J alleges thatthe Affymax Entities filed the ‘570 application and the above-referencedpetitions, preliminary amendment and supplemental responses without notifyingor consulting with J&J. J&J claims in the arbitration that it is thesole or joint owner of these patents and applications and any U.S., foreign, orinternational patents or applications based on, claiming priority from, orrelating to them.

J&J’s European patentapplication EP96/918,317, which relates to agonist peptide dimers, could resultin a patent being issued to J&J in the near future. In the J&J arbitrationproceeding, we have claimed that we should be at least joint owner of thisEuropean application. If the patent issues, J&J could seek to enforce thispatent against us in Europe. In many European countries, a patent cannot beasserted to stop clinical trials, but in some, a patent holder can seek toenjoin clinical trials.

39

----

***Litigation and Arbitration Chronology***

On June 9, 2004, we filed a civil complaint inthe Munich Regional Court in the Federal Republic of Germany against J&Jalleging that we are an owner or co-owner of J&J’s European patentapplication relating to agonist peptide dimers (European Patent ApplicationEP96/918,317). In October 2005, J&J filed its response to ourcomplaint, denying our claims of inventorship and ownership. In April 2006,we requested the court to dismiss the complaint so that the issues it raisedcould be resolved pursuant to the arbitration proceeding described below. Thecourt has done so.

On September 23, 2004, we filed a civil complaintin the U.S. District Court for the Northern District of Illinois, or theIllinois case, against J&J alleging claims for correction of inventorshipand ownership of the above-referenced patents and patent applications assignedto J&J, for corresponding declaratory and injunctive relief, for breach ofcontract, and for unjust enrichment and constructive trust. The complaintalleges that the Affymax N.V. scientists are sole or co-inventors of theintellectual property in dispute, including the above-referenced J&Jpatents and patent applications, and that we are the sole or co-owner of them.The complaint also alleges that J&J breached the R&D Agreement by,among other things, engaging in a course of conduct designed to obtain patentsfor itself and to deny us patents on the Affymax scientists’ inventions. Thecomplaint further alleges that we have suffered damages as a result of J&J’sbreaches and that J&J has been unjustly enriched through its misconduct andshould be subject to the imposition of a constructive trust.

J&J denied all material claims in our complaintand, among other things, counterclaimed that its employees are the trueinventors of the intellectual property in dispute and that it is thereforeentitled to sole or co-ownership of the above-referenced patents and patentapplications assigned solely or jointly to us (including U.S. Patent Nos.5,986,047, 5,773,569, and 5,830,851, which are solely assigned to us, andEuropean Patent No. EP 0 866 648, which is assigned jointly to us and J&J).J&J also brought related claims for breach of contract, breach of fiduciaryduty, unjust enrichment and constructive trust. J&J alleges, among otherthings, that the Affymax Entities filed in their own name certain patentapplications allegedly claiming inventions of J&J employees withoutnotifying or consulting with J&J, that during patent prosecution theAffymax Entities improperly removed the names of J&J employees from certainpatent applications on which those employees had been identified as inventors,and that these and other alleged breaches entitle J&J to damages and waiveall rights we may have had to the intellectual property in dispute.

J&J requested that the Illinois case be dismissedand the matter decided under the R&D Agreement’s arbitration provisions. OnFebruary 28, 2006, the Illinois court entered an order that theappropriate forum for us and J&J to resolve the inventorship, ownership,breach of contract and related claims was binding arbitration under theAmerican Arbitration Association, or AAA, rules in Illinois. The Illinoiscourt held that the claims pending in the German court were also subject toarbitration and required us to dismiss the German complaint, which we havedone. The Illinois court further stated that it will retain jurisdiction overthe subject matter during the arbitration in Illinois.

On April 12, 2006, we filed a demand forarbitration with the AAA claiming that we are the owner or co-owner of theintellectual property in dispute and alleging claims for correction ofinventorship and ownership of the above-referenced patents and patentapplications assigned to J&J, for corresponding declaratory and injunctiverelief, for breach of contract, for unjust enrichment and constructive trust,and for breach of fiduciary duty. On May 8, 2006, J&J filed its answerand counterclaims, substantially restating their allegations made in the U.S.and German courts. The AAA has appointed a panel of arbitrators, and thearbitrators have established a schedule for the arbitration. The parties havecommenced discovery.  The arbitrationhearing is scheduled to occur during the second half of 2008.

40

----

**Item 4.   Submissionof Matters to a Vote of Security Holders.**

In November 2006, we submitted certain matters toour stockholders for their approval by written consent in connection with ourinitial public offering. On November 22, 2006, our stockholders approvedeach of these matters, as set forth below. We did not receive written consentsfrom every stockholder. On November 22, 2006, there were 41,527,386 sharesof common stock outstanding (on an as-if converted basis and without givingeffect to the one-for-four reverse split of our common stock and preferredstock effected on November 30, 2006). The results of the voting (on anas-if-converted basis and without giving effect to the one-for-four reversesplit of our common stock and preferred stock effected on November 30,2006) from the stockholders that returned written consents to us is as follows:

1. The amendmentand restatement of our Amended and Restated Certificate of Incorporation toeffect a one-for-four reverse split of our common stock and preferred stock,and in connection therewith, to reduce the number of outstanding shares of ourcapital stock;

For:31,717,134Against: 0

2. The amendment and restatement of our Amended andRestated Certificate of Incorporation following our initial public offering;

For:31,717,134Against: 0

3. The amendment and restatement of our Bylawsfollowing our initial public offering;

For:31,717,134Against: 0

4. The adoption of the 2006 Equity Incentive Plan;

For:31,717,134Against: 0

5. The adoption of the 2006 Employee Stock PurchasePlan;

For:31,717,134Against: 0

7. The approval of our form of Indemnity Agreement;and

For:31,717,134Against: 0

8. The amendment of our 2001 Stock Option/StockIssuance Plan to increase the number of shares available for issuancethereunder by 1,122,500 (280,625 shares on a post-reverse split basis).

For:31,717,134Against: 0

41

----

**PART II.**

**Item 5.   Market for Registrant’s Common Equity,Related Stockholder Matters and Issuer Purchases of Equity Securities.**

**Market For OurCommon Stock**

Ourcommon stock has been traded on the NASDAQ Global Market under the symbol “AFFY”since December 15, 2006. As of February 28, 2007, there wereapproximately 190 holders of record of our common stock. The following tablesets forth, for the periods indicated, the range of high and low closing salesprices of our common stock as quoted on the NASDAQ Global Market for the periodsince our initial public offering on December 15, 2006.

| ** **                                 | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------------------|------------|----------|------------|---------|------------|
| **2006**                                   |       |     |       |    |       |
| 4th Quarter (from  December 15, 2006) |       | $        | 37.20      |    | $          | 33.80 |   |
|                                            |            |          |            |         |            |  |  |

 

The closing price for ourcommon stock as reported by the NASDAQ Global Market on February 28, 2007was $35.61 per share.

**Dividend Policy**

We have never declared orpaid any cash dividends on our common stock. We currently expect to retain anyfuture earnings for use in the operation and expansion of our business and donot anticipate paying any cash dividends on our common stock in the foreseeablefuture.

**Recent Sales ofUnregistered Securities**

The following setsforth information regarding all unregistered securities sold by us during 2006(with share amounts adjusted to give effect to a one-for-four reverse stocksplit effected in connection with our initial public offering):

(1)   On February 16,2006, we issued and sold an aggregate of 530,082 shares of Series Epreferred stock to Takeda for approximately $10,000,000 in cash. Theshares of our Series E preferred stock converted into shares of our commonstock at the rate of one share of common stock for each share of Series Epreferred stock in connection with the closing of our initial public offering.

(2)   From January 1,2006 to December 31, 2006, we granted options under our 2001 StockOption/Stock Issuance Plan, or 2001 Plan, to purchase 810,815 shares of commonstock at exercise prices ranging from $4.36 to $18.84 per share. During theperiod, options to purchase 202,401 shares of common stock were exercised foraggregate consideration of $203,655 at exercise prices ranging from $0.80 to$4.36 per share. Also, of the options granted, options to purchase 13,510shares of common stock were canceled without being exercised.

(3)   In December 2006,we issued 133,293 shares of common stock to 10 accredited investors upon thenet exercise of outstanding warrants. Also, in December 2006, we issued107,268 shares of common stock to one accredited investor for cashconsideration in the aggregate amount of $1,823,556 upon the exercise ofoutstanding warrants.

The offers, sales and issuances of the securitiesdescribed in paragraphs (1) and (3) were exempt from registrationunder the Securities Act under Section 4(2) of the Securities Actand/or Regulation D promulgated thereunder as transactions by an issuernot involving a public offering. All of the purchasers of securities for whichwe relied on Rule 506 of Regulation D and/or Section 4(2) representedthat they were accredited investors as defined under the Securities Act or aperson described under Rule 506(b)(2)(ii) under the Securities Act.We believe that the issuances are exempt from the registration 

42

----

requirements of theSecurities Act on the basis that (a) the purchasers in each caserepresented to us that they intended to acquire the securities for investmentonly and not with a view to the distribution thereof and that they eitherreceived adequate information about us or had access, through employment orother relationships, to such information and (b) appropriate legends wereaffixed to the stock certificates issued in such transactions.

The offers, sales andissuances of the securities described in paragraph (2) were deemed to beexempt from registration under the Securities Act pursuant to either (1) Rule 701promulgated under the Securities Act as offers and sale of securities pursuantto certain compensatory benefit plans and contracts relating to compensation incompliance with Rule 701 or (2) Section 4(2) of theSecurities Act as transactions by an issuer not involving any public offering.

**Use of Proceedsfrom the Sale of Registered Securities**

Our initial public offering of common stock waseffected through a Registration Statement on Form S-1, as amended(File No. 333-136125) and a Registration Statement on Form S-1filed pursuant to Rule 462(b) (File No. 333-139363) thatwere declared effective by the Securities and Exchange Commission on December 14,2006. We registered 4,255,000 shares of our common stock for an aggregateoffering price of $106,375,000, all of which were sold. The offering wascompleted after the sale of all 4,255,000 shares. Morgan Stanley & Co.Incorporated acted as the sole book running and lead manager for the offering,Cowen and Company, LLC, Thomas Weisel Partners LLC and RBC Capital Marketsacted as co-managers for the offering. Of this amount, $7.4 million was paid inunderwriting discount and commissions, and an additional $2.9 million of otherexpenses were incurred, all of which was incurred during the fiscal year ended December 31,2006. None of the expenses were paid, directly or indirectly, to directors,officers or persons owning 10% or more of our common stock, or to ouraffiliates. As of December 31, 2006, we had applied the aggregate netproceeds of $96 million from our initial public offering in short-term andlong-term investment accounts.

The foregoing representsour best estimate of our use of proceeds for the period indicated. No paymentswere made to directors, officers or persons owning ten percent or more of ourcommon stock or to their associates, or to our affiliates, other than paymentsin the ordinary course of business to officers for salaries and to non-employeedirectors as compensation for board or board committee service.

**Issuer Purchases ofEquity Securities**

The following table provides information relating torepurchases of our common stock in the three months ended December 31,2006:

| **Period**                                      | ** ** | ** ** | ** ** | **Total  Number of  Shares  Purchased(1)** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased  as Part of a  Publicly  Announced  Program** | ** ** | **Approximate  Dollar Value of  Shares That May  Yet Be Purchased  Under the  Program** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| October 1,  2006 - October 31, 2006   |       |       | 0          |                                            |       |                                         | $          | —                                                                                                          |       |                                                                                                                       |       | N/A |   |   |   | N/A |   |   |
| November 1,  2006 - November 30, 2006 |       |       | 875        |                                            |       |                                         | $          | 0.80                                                                                                            |       |                                                                                                                       |       | N/A |   |   |   | N/A |   |   |
| December 1,  2006 - December 31, 2006 |       |       | 0          |                                            |       |                                         | $          | —                                                                                                          |       |                                                                                                                       |       | N/A |   |   |   | N/A |   |   |
| Total                                           |       |       | 875        |                                            |       |                                         | $          | 0.80                                                                                                            |       |                                                                                                                       |       | N/A |   |   |   | N/A |   |   |

----

(1)          The875 shares of our common stock were repurchased by us from an employee upontermination of services pursuant to the terms and conditions of our 2001 StockOption/Stock Issuance Plan, which permits us to elect to purchase such sharesat the original issuance price.

43

----

**PerformanceGraph(1)**

The following graph showsthe total stockholder return of an investment of $100 in cash on December 15,2006, the date our common stock first started trading on the NASDAQ GlobalMarket, for (i) our common stock, (ii) the Nasdaq Composite Index(U.S.) and (iii) the Nasdaq Biotechnology Index as of December 31,2006. Pursuant to applicable Securities and Exchange Commission rules, allvalues assume reinvestment of the full amount of all dividends, however nodividends have been declared on our common stock to date. The stockholderreturn shown on the graph below is not necessarily indicative of futureperformance, and we do not make or endorse any predictions as to futurestockholder returns.

**COMPARISON OFCUMULATIVE TOTAL RETURN***AmongAffymax Inc., The NASDAQ Composite IndexAnd The NASDAQ Biotechnology Index

----

*                    $100invested on 12/15/06 in Affymax, Inc. stock or on 11/30/06 in Index-includingreinvestment of dividends.

----

(1)          This Section is not“soliciting material,” is not deemed “filed” with the Commission and is not tobe incorporated by reference into any filing of Affymax, Inc. under theSecurities Act of 1933, as amended, or the Securities Exchange Act of 1934, asamended, whether made before or after the date hereof and irrespective of anygeneral incorporation language in any such filing.

44

----

**Item 6.   Selected FinancialData.**

The following selected financial data should beread together with our audited financial statements and accompanying notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”section and other financial information included in this Annual Report on Form 10-K.The selected financial data in this section is not intended to replace ouraudited financial statements and the accompanying notes. Our historical resultsare not necessarily indicative of our future results.

| ** **                                                                | ** ** | **Years Ended December 31,**                        | ** ** | **Cumulative Period  From July 20, 2001  (Date of Inception)  to** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                                           | ** ** | **2005**                                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **December 31, 2006** | ** ** |
| ** **                                                                | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statements of Operations Data:**                                        |       |                                                               |       |                                                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Collaboration  revenue                                                    |       | $                                                                  | 11,688     |                                                                                             | $          | — |   | $ | — |   | $ | — |   | $ | — |   |   | $ | 11,688 |   |   |
| License and  royalty revenue                                              |       | 38                                                                 |       | 74                                                                                               |       | 151 |   | 225 |   | 103 |   |   | 591 |   |   |
| Total revenue                                                             |       | 11,726                                                             |       | 74                                                                                               |       | 151 |   | 225 |   | 103 |   |   | 12,279 |   |   |
| **Operating expenses:**                                                   |       |                                                               |       |                                                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Research and development                                                  |       | 54,347                                                             |       | 24,051                                                                                           |       | 17,338 |   | 13,660 |   | 16,834 |   |   | 132,170 |   |   |
| General and administrative                                                |       | 11,089                                                             |       | 10,032                                                                                           |       | 4,931 |   | 4,953 |   | 5,529 |   |   | 39,060 |   |   |
| Amortization of intangible assets                                         |       | —                                                             |       | —                                                                                           |       | — |   | 6,107 |   | 6,085 |   |   | 14,471 |   |   |
| Impairment of assets                                                      |       | —                                                             |       | —                                                                                           |       | — |   | 4,224 |   | — |   |   | 4,224 |   |   |
| Total operating expenses                                                  |       | 65,436                                                             |       | 34,083                                                                                           |       | 22,269 |   | 28,944 |   | 28,448 |   |   | 189,925 |   |   |
| Loss from  operations                                                     |       | (53,710                                                            | )          | (34,009                                                                                          | )          | (22,118 | ) | (28,719 | ) | (28,345 | ) |   | (177,646 | ) |   |
| Interest income                                                           |       | 5,549                                                              |       | 1,413                                                                                            |       | 439 |   | 357 |   | 645 |   |   | 8,924 |   |   |
| Interest expense                                                          |       | (84                                                                | )          | (29                                                                                              | )          | — |   | (7 | ) | (26 | ) |   | (170 | ) |   |
| Other income  (expense), net                                              |       | (43                                                                | )          | 49                                                                                               |       | 281 |   | 172 |   | (320 | ) |   | 143 |   |   |
| Net loss(2)                                                               |       | (48,288                                                            | )          | (32,576                                                                                          | )          | (21,398 | ) | (28,197 | ) | (28,046 | ) |   | (168,749 | ) |   |
| Accretion of  mandatorily redeemable preferred stock                      |       | (815                                                               | )          | (597                                                                                             | )          | (105 | ) | (164 | ) | (154 | ) |   | (1,899 | ) |   |
| Net loss  attributable to common stockholders                             |       | $                                                                  | (49,103    | )                                                                                                | $          | (33,173 | ) | $ | (21,503 | ) | $ | (28,361 | ) | $ | (28,200 | ) |   | $ | (170,648 | ) |   |
| Net loss per  common share:                                               |       |                                                               |       |                                                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted(1)(2)                                                   |       | $                                                                  | (32.56     | )                                                                                                | $          | (101.65 | ) | $ | (70.39 | ) | $ | (103.10 | ) | $ | (105.69 | ) |   |   |   |   |
| Weighted-average  number of common shares used in per share calculations: |       | 1,508                                                              |       | 326                                                                                              |       | 305 |   | 275 |   | 267 |   |   |   |   |   |

 

| ** **                                          | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(in thousands)** | ** ** |
| **Balance  Sheet Data:**                            |       |                    |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents  and short-term investments  |       | $                       | 224,292    |   | $ | 57,893 |   | $ | 24,720 |   | $ | 24,654 |   | $ | 21,507 |   |
| Related party  receivable                           |       | 10,191                  |       | — |   | — |   | — |   | — |   |
| Long-term  investments                              |       | 6,133                   |       | — |   | — |   | — |   | — |   |
| Total assets                                        |       | 249,988                 |       | 60,960 |   | 27,728 |   | 28,353 |   | 36,907 |   |
| Mandatorily redeemable  convertible preferred stock |       | —                  |       | 168,784 |   | 112,396 |   | 92,361 |   | 72,292 |   |
| Deficit  accumulated during the development stage   |       | (168,749                | )          | (120,461 | ) | (87,885 | ) | (66,487 | ) | (38,290 | ) |
| Total stockholders’  equity (deficit)          |       | 116,899                 |       | (113,691 | ) | (87,162 | ) | (65,677 | ) | (37,281 | ) |
|                                                     |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)             Please see Note 2 to the notes to our auditedfinancial statements for an explanation of the method used to calculate the netloss per common share and the number of shares used in the computation of theper share amounts.

(2)             In 2006, loss from operations, net lossand basic and diluted net loss per common share include the impact of SFAS No.123(R) stock-based compensation charges, which were not present in prior years.Please see Notes 2 and 8 to the notes to our audited financial statements.

45

----

**Item 7.   Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

**Overview**

We are a biopharmaceutical company developing novelpeptide-based drug candidates to improve the treatment of serious and oftenlife-threatening conditions. Our lead product candidate, Hematide, is designedto treat anemia associated with chronic kidney disease and cancer. Anemia is aserious condition in which blood is deficient in red blood cells andhemoglobin. It is common in patients with chronic kidney disease, cancer, heartfailure, inflammatory diseases and other critical illnesses, as well as in theelderly. If left untreated, anemia may increase the risk of other diseases ordeath. Hematide is a synthetic peptide based erythropoiesis stimulating agent,or ESA, designed to stimulate production of red blood cells. Hematide isdesigned to be longer acting than currently marketed ESAs, and therefore hasthe potential to offer both better care for patients and reduced cost andcomplexity for healthcare providers. We are currently conducting Phase 2clinical trials in patients suffering from end-stage renal disease who are ondialysis, as well as in earlier stage chronic kidney disease patients, orpredialysis patients. We have had preliminary discussions with the FDAregarding Phase 3 clinical trials in both dialysis and predialysis patients.Based on those discussions, we believe our clinical, preclinical andmanufacturing work is sufficient to proceed to Phase 3 clinical trials and weare continuing discussions with the FDA relating to the design of these trials.Assuming timely conclusion of the discussions with the FDA, we would expect tocommence separate Phase 3 trials in both dialysis and predialysis patientsduring the second half 2007. In oncology supportive care, we have initiated aPhase 2 clinical trial evaluating Hematide in cancer patients who suffer fromanemia as a consequence of their chemotherapy treatment. We are also building aproprietary pipeline of other novel drug candidates which are designed to offeradvantages over first generation recombinant protein therapeutics currentlyaddressing large markets.

To date, we have not generated any product revenue. Wehave funded our operations primarily through the sale of equity securities,license fees from collaborative partners, operating and capital leasefinancings and limited license fees and royalties from licensing intellectualproperty. Since inception we have incurred net losses and expect to incursubstantial and increasing losses for the next several years as we expand ourresearch and development activities and move our product candidates into laterstages of development. As of December 31, 2006, we had an accumulateddeficit of approximately $168.7 million.

In December 2006, weissued 4,255,000 shares of our common stock in connection with our initialpublic offering, including the issuance of 555,000 shares upon the fullexercise of the underwriters’ option to cover over-allotments. The aggregatenet proceeds from the offering, including the shares issued upon exercise ofthe over-allotment option, were approximately $96 million, after deductingunderwriting discounts and commissions and other offering expenses.

***Collaboration with Takeda Pharmaceutical CompanyLimited, or Takeda***

We have entered into two collaboration agreements, orthe Arrangement, with Takeda, which have been combined for accounting purposesdue to their proximity of negotiation. Consideration from these collaborationagreements includes nonrefundable upfront license fees, reimbursement for salesof active pharmaceutical ingredients, or API, clinical and regulatory milestonepayments, reimbursement of third party U.S. clinical development expenses,product profit share revenues (as co-promotion revenues) and royalties.

46

----

In February 2006, weissued an exclusive license to Takeda for the development and commercializationof Hematide in Japan. Pursuant to this agreement, Takeda has paid usapproximately $37 million to date, consisting of $17 million in upfront licensefees, $10 million in milestone payments, and approximately $10 million for thepurchase of 530,082 shares of our Series E Redeemable ConvertiblePreferred Stock at a price of $18.86 per share, which we determined was at fairvalue. In addition, we are eligible to receive additional clinical andregulatory milestone payments of up to an aggregate of $65 million uponTakeda’s successful achievement of clinical development and regulatorymilestones in Japan. Takeda is responsible for all development and commercializationcosts in Japan and will purchase API for Hematide from us. Assuming Hematide isapproved and launched in Japan, we will receive a royalty from Takeda onHematide sales in Japan.

In June 2006, weexpanded our collaboration to develop and commercialize Hematide worldwide,which includes the co-development and co-commercialization of Hematide in theU.S. Takeda received an exclusive license to develop and commercialize Hematideoutside of the U.S. Beginning January 1, 2007, Takeda will bear the first$50 million of third-party expenses related to development in pursuit of U.S.regulatory approval of Hematide. Thereafter, Takeda will bear 70% of thethird-party U.S. development expenses, while we are responsible for 30% of theexpenses. Each company retains responsibility for 100% of its internaldevelopment expenses. Under the June 2006 agreement, Takeda paid us anupfront license fee of $105 million, and we are eligible to receive from Takedaup to an aggregate of $280 million upon the successful achievement of clinicaldevelopment and regulatory milestones. Further, we may receive from Takeda upto an aggregate of $150 million upon the achievement of certain worldwideannual net sales milestones. We and Takeda will share equally in the netprofits and losses of Hematide in the U.S., which include expenses related tothe marketing and launch of Hematide. Takeda will pay us a variable royaltybased on annual net sales of Hematide outside the U.S. The agreementestablishes a joint steering committee to oversee the development, regulatoryapproval and commercialization of Hematide.

We will shareresponsibility with Takeda for clinical development activities required forU.S. regulatory approval of Hematide. Specifically, we have primaryresponsibility for Hematide’s clinical development plan and clinical trials inthe dialysis and pre-dialysis indications, while Takeda has primaryresponsibility in the chemotherapy induced anemia and anemia of cancerindications. We are responsible for U.S. regulatory filings in the dialysis,pre-dialysis, chemotherapy induced anemia and anemia of cancer indications,including holding the NDAs for those indications. Takeda is responsible forregulatory filings outside the U.S. and the creation of a global safetydatabase.

We are also responsiblefor the manufacture and supply of all quantities of API to be used in thedevelopment and commercialization of Hematide worldwide. Takeda is responsiblefor the fill and finish steps in the manufacture of Hematide worldwide.

We have agreed to jointlydevelop the initial commercial marketing plan for Hematide in the U.S. pursuantto which we and Takeda will divide Hematide promotional responsibilities in theU.S. We and Takeda will jointly decide on promotional responsibility formarkets outside of these initial indications.

Under the February 2006agreement, Takeda also obtained a right of first negotiation to any backupproducts for Hematide developed by us or our third-party partners.Specifically, during the first ten years of the agreement, if we or ourthird-party partners develop a product that advances to Phase 2 clinical trialsand competes with Hematide in the renal or oncology indications, we areobligated to offer to Takeda the right to develop and commercialize suchproduct in Japan before offering the product opportunity in Japan to any otherthird party.

We have recognized $11.7million of revenue under our Arrangement with Takeda during the year ended December 31,2006. In December 2006, Takeda completed a Phase 1 trial of Hematide inJapan resulting in the payment in January 2007 to us of a $10 millionmilestone under the collaboration.

47

----

***Research andDevelopment Expenses***

Research and developmentexpenses consist of: (i) license fees paid to third parties for use oftheir intellectual property; (ii) expenses incurred under agreements withcontract research organizations and investigative sites, which conduct asubstantial portion of our preclinical studies and all of our clinical trials; (iii) paymentsto contract manufacturing organizations, which produce our activepharmaceutical ingredient; (iv) payments to consultants; (v) employee-relatedexpenses, which include salaries and benefits; and (vi) facilities,depreciation and other allocated expenses, which include direct and allocatedexpenses for rent and maintenance of facilities and equipment, depreciation ofleasehold improvements and equipment and laboratory and other supplies. Allresearch and development expenses are expensed as incurred.

We expect to incurincreasing research and development expenses in future periods as we conductmore research and perform preclinical studies and clinical trials for ourproduct candidate pipeline. Our strategy includes entering into collaborationswith third parties to participate in the development and commercialization ofsome of our product candidates. As a result, we cannot predict our futureresearch and development expenses with any degree of certainty.

Thetable below sets out our research and development expenses excludingstock-based compensation by project since 2004 as a percentage of totalresearch and development expenses for the applicable period. We commencetracking the costs for a project when we are working with another company orwhen the related prototype peptide demonstrates significant biologicalactivity, typically in a cell-free assay, and merits substantial increase inthe level of effort.

| ** ** | ** ** | **Hematide** | ** ** | **Gematide** | ** ** | **Other  Research  Programs** | ** ** | **Total** | ** ** |
|------------|------------|--------------|------------|--------------|------------|-------------------------------|------------|-----------|------------|
| **2004**   |       |         | 74         | %            |       |                          | 18         | %         |       |   | 8 | % |   |   | 100 | % |   |
| **2005**   |       |         | 78         | %            |       |                          | 6          | %         |       |   | 16 | % |   |   | 100 | % |   |
| **2006**   |       |         | 90         | %            |       |                          | 0          | %         |       |   | 10 | % |   |   | 100 | % |   |

 

Under the worldwideagreement with Takeda, we will share responsibility for clinical developmentactivities required for U.S. regulatory approval of Hematide. We will haveprimary responsibility for Hematide’s clinical development plan and clinicaltrials in the dialysis and predialysis indications, while Takeda will haveprimary responsibility in the chemotherapy induced anemia and anemia of cancerindications. Beginning January 1, 2007, Takeda will bear the first $50million of third-party expenses related to development in pursuit of U.S.regulatory approval of Hematide. Thereafter, Takeda will bear 70% of the U.S.third-party development expenses, while we are responsible for 30% of theexpenses. The Company retains responsibility for 100% of its internaldevelopment expenses. Takeda will have primary responsibility and bear allcosts for Hematide clinical development in support of regulatory approval forall territories outside the United States. Except for Hematide, we can notforecast with any degree of certainty which of our product candidates, if any,will be subject to future partnerships or how such arrangements would affect ourdevelopment plans or capital requirements.

The process of conductingpreclinical studies and clinical trials necessary to obtain Food and DrugAdministration, or FDA, approval is costly and time consuming. The probabilityof success for each product candidate and clinical trial may be affected by avariety of factors, including, among others, the quality of the productcandidate’s early clinical data, investment in the program, competition,manufacturing capabilities and commercial viability. As a result of theuncertainties discussed above, the uncertainty associated with clinical trialenrollments and the risks inherent in the development process, we are unable todetermine the duration and completion costs of current or future clinicalstages of our product candidates or when, or to what extent, we will generaterevenues from the commercialization and sale of any of our product candidates.Development timelines, probability of success and development 

48

----

costsvary widely. While we are currently focused on developing our lead productcandidate, we anticipate that we will make determinations as to whichadditional programs to pursue and how much funding to direct to each program onan ongoing basis in response to the scientific and clinical success of each productcandidate, as well as ongoing assessment as to the product candidate’scommercial potential. We anticipate developing additional product candidatesinternally and intend to consider in-licensing product candidates, which willincrease our research and development expenses in future periods. We believethat the cash received from Takeda, existing cash, cash equivalents andshort-term investments and the interest thereon, will enable us to maintain ourcurrently planned operations through at least 18 months**.**However, we may be required to raise additional capital to complete thedevelopment and commercialization of Hematide and we will need to raiseadditional capital to support continued development of our product candidatesthereafter. We cannot be certain that that additional funding will be availableon acceptable terms, or at all.

***General andAdministrative Expenses***

General and administrativeexpenses consist principally of salaries and related costs for personnel inexecutive, finance, accounting, business and commercial development,information technology, legal and human resources functions. Other general andadministrative expenses include facility costs not otherwise included inresearch and development expenses, patent prosecution and defense costs andprofessional fees for legal, consulting, auditing and tax services.

**Critical Accounting Policies and Significant Judgmentsand Estimates**

Our management’sdiscussion and analysis of our financial condition and results of operations isbased on our financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the financial statements,as well as the reported revenues and expenses during the reporting periods. Onan ongoing basis, we evaluate our estimates and judgments related to revenuerecognition and clinical development costs. We base our estimates on historicalexperience and on various other factors that we believe are reasonable underthe circumstances, the results of which form the basis for making judgmentsabout the carrying value of assets and liabilities that are not readilyapparent from other sources. Actual results may differ from these estimatesunder different assumptions or conditions.

While our significantaccounting policies are more fully described in Note 2 to our audited financialstatements appearing elsewhere in this Annual Report on Form 10-K,we believe the following accounting policies are critical to the process ofmaking significant judgments and estimates in the preparation of our financialstatements.

***Revenue Recognition***

We recognize revenue inaccordance with the Securities and Exchange Commission’s Staff AccountingBulletin No. 104, *Revenue Recognitionin Financial Statements*. When evaluating multiple elementarrangements, we consider whether the components of the arrangement representseparate units of accounting as defined in Emerging Issues Task Force (‘‘EITF’’)Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*(‘‘EITF 00-21’’).Application of this standard requires subjective determinations and requiresmanagement to make judgments about the fair value of the individual elementsand whether such elements are separable from the other aspects of thecontractual relationship.

49

----

***Takeda Agreements***

We have entered into twoseparate collaboration agreements, or the Arrangement, with Takeda, which havebeen combined for accounting purposes due to their proximity of negotiation. Weevaluated the multiple elements under the combined single arrangement inaccordance with the provisions of EITF 00-21. We determined thedeliverables do not have value to the customer on a stand alone basis and wewere unable to obtain verifiable objective evidence to determine the fair valueof the undelivered elements. Accordingly, we concluded that there was a singleunit of accounting.

We are unable to determinethe period of our performance obligations under the Arrangement as our requiredparticipation on the joint steering committee extends for as long as productssubject to the collaboration with Takeda are being sold by either of theparties. Accordingly, the contractual term of our joint steering committeeobligations is currently indefinite. As a result, revenue for the single unitof accounting is recorded on a proportional performance basis as long as theoverall Arrangement is determined to be profitable.

We account for theArrangement using a zero profit proportional performance model (i.e., revenuewill be recognized equal to direct costs incurred, but not in excess of cashreceived or receivable assuming that the overall Arrangement is expected to beprofitable). We use an input based measure, specifically direct costs, todetermine proportional performance because we believe that the inputs arerepresentative of the value being conveyed to Takeda through the research anddevelopment activities and delivery of the API. We believe that using directcosts as the unit of measure of proportional performance also most closelyreflects the level of effort related to our performance under the Arrangement. Directcosts are those costs that directly result in the culmination of an earningsprocess for which Takeda receives a direct benefit. The nature of these costsare third party and internal costs associated with conducting clinical trialactivities for dialysis and pre-dialysis indications, costs associated with themanufacturing of API and API stability testing, allocated payroll related costsfor representatives participating on the joint steering committee and sales andmarketing costs during the co-commercialization period. Direct costsspecifically exclude costs of a general and administrative nature, upfrontpayments to manufacturers unrelated to specific product manufactured such asreservation of capacity, cost for API not yet delivered to Takeda, travel andexpense related costs, sales and marketing costs during the development period,any research and development costs not associated with Hematide, interest,depreciation and amortization expense.

Amounts resulting frompayments received in advance of revenue recognized are recorded as deferredrevenue in accordance with the zero profit proportional performance modeldescribed above until the earlier of (i) when we can meet the criteria forseparate recognition of each element under the guidance of EITF 00-21; or(ii) after we have fulfilled all of our contractual obligations under theArrangement.

We are required to assessthe profitability of the overall Arrangement on a periodic basis throughout thelife of the Arrangement when events or circumstances indicate a potentialchange in facts. Profitability is defined as a net cash inflow resulting fromthe Arrangement over its life. Such assessment is based on estimates todetermine the most likely outcome based on available facts and circumstances ateach assessment date. The estimates include the consideration of factors suchas the progress and timing of clinical trials, competitive ESAs in the market,the development progress of other potential ESAs, drug related serious adverseevents and other safety issues in the clinical trials, pricing reimbursement inrelevant markets and historical costs incurred compared to original estimates.When the periodic assessment or other events or circumstances indicate a losswill result from performance under the Arrangement, we will continue torecognize costs as they are incurred. However, revenue will be deferred untileither (i) the Arrangement becomes profitable, at which point we willcontinue to recognize revenue under the zero profit proportional performancemodel, or (ii) the end of the Arrangement.

50

----

***Preclinical Studyand Clinical Trial Accruals***

Weestimate our preclinical study and clinical trial expenses based on our estimatesof the services received pursuant to contracts with several researchinstitutions and clinical research organizations that conduct and managepreclinical studies and clinical trials on our behalf. The financial terms ofthese agreements vary from contract to contract and may result in unevenexpenses and payment flows. Preclinical study and clinical trial expensesinclude the following:

·       feespaid to contract research organizations in connection with preclinical studies;

·       feespaid to contract research organizations and clinical research organizations inconnection with clinical trials; and

·       feespaid to contract manufacturers and service providers in connection with theproduction and testing of active pharmaceutical ingredients and drug materialsfor preclinical studies and clinical trials.

Payments under some ofthese contracts depend on factors such as the milestones accomplished,successful enrollment of certain numbers of patients, site initiation and thecompletion of clinical trial milestones. In accruing service fees, we estimatethe time period over which services will be performed and the level of effortto be expended in each period. If the actual timing of the performance ofservices or the level of effort varies from our estimate, we will adjust theaccrual accordingly. If we do not identify costs that we have begun to incur orif we underestimate or overestimate the level of services performed or thecosts of these services, our actual expenses could differ from our estimates.

***Stock-BasedCompensation***

Through December 31,2005, we have accounted for stock-based employee compensation******arrangements usingthe intrinsic value method in accordance with the recognition and measurementprovisions of Accounting Principles Board Opinion, or APB, No. 25, *Accounting for Stock Issued to Employees*,and related interpretations, including the Financial Accounting StandardsBoard, or FASB, Interpretation, or FIN, No. 44, *Accounting for Certain Transactions Involving Stock Compensation, anInterpretation of APB Opinion No. 25*. Under APB No. 25,compensation expense is based on the difference, if any, on the date of grantbetween the fair value of our common stock and the exercise price of the stockoption. For periods prior to December 31, 2005, we have complied with thedisclosure-only provisions required by Statement of Financial AccountingStandards, or SFAS, No. 123, *Accountingfor Stock-Based Compensation*, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation, Transitionand Disclosure, an amendment to SFAS Statement No. 123*.

Under APB No. 25, werecognized stock-based compensation expense, which is a non-cash charge, foremployee stock options granted in 2005 at exercise prices that, for financialreporting purposes, were determined to be below the fair value of theunderlying common stock on the date of grant.

The fair value of thecommon stock underlying stock options granted during this period was estimatedby the board of directors with input from management based upon severalfactors, including progress and milestones attained in our business. In theabsence of a public trading market for our common stock, our board of directorswas required to estimate the fair value of our common stock.

In connection with thepreparation of the financial statements necessary for the filing of our initialpublic offering, we reassessed the fair value of our common stock at optiongrant dates from January 2005 through September 2006. InJuly 2006, we engaged an independent valuation firm to perform a retrospectiveanalysis to determine the fair value of our common stock for accountingpurposes as of February 13, 2006, which report was prepared using anincome approach. Subsequently, we reassessed the valuations of common stockrelated to our other grants of stock options from January 1, 2005 throughSeptember 30, 2006 using a market-based approach.

51

----

We recorded deferred stock-based compensation relativeto employee stock options granted in 2005 of approximately $195,000, net of acancellation due to an employee termination, during the year endedDecember 31, 2005 in accordance with the requirements of APB No. 25.We amortized $28,000 and $43,000 of deferred stock-based compensation expenseduring the years ended December 31, 2005 and 2006, respectively.

In addition, during September 2003, we approvedthe repricing of existing employee stock options from $4.00 to $0.80 per share,which was deemed to be the fair market value. The repriced stock options aresubject to variable accounting. We measure the additional compensation expensefor each period based on the difference between the reassessed fair value ofthe shares and the exercise price of the stock options of $0.80 per share andincur compensation expense on a graded vesting basis in accordance with FINNo. 28, *Accounting for StockAppreciation Rights and other Variable Stock Option or Award Plans*.We incurred stock-based compensation expense related to the repriced stockoptions of approximately $0, $4.0 million and $1.9 million during the yearsended December 31, 2004, 2005 and 2006, respectively. As ofDecember 31, 2006, stock options to purchase approximately 40,000 shareswere subject to variable accounting. In addition, in 2006 there was a reversalof stock-based compensation expense of $2.4 million (see Note 12 toour audited financial statements).

While our financial statements throughDecember 31, 2005 account for stock option grants pursuant to APBNo. 25, in accordance with SFAS No. 123, we disclosed in the notes toour financial statements the pro forma impact on our net loss had we accountedfor stock option grants using the minimum value method of accounting. We did notutilize the minimum value method subsequent to our adoption of SFASNo. 123(R) on January 1, 2006 for options granted subsequent toDecember 31, 2005, and the fair value of our stock options will be higheras a result.

We account for stock-basedcompensation arrangements with nonemployees in accordance with SFASNo. 123, as amended by SFAS No. 148, and Emerging Issues Task Force,or EITF, No. 96-18, *Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services*, using a fairvalue approach. For stock options granted to nonemployees, the fair value ofthe stock options is estimated using the Black-Scholes valuation model. Thismodel utilizes the estimated fair value of common stock and requires that, atthe date of grant, we make assumptions with respect to the expected term of theoption, the volatility of the fair value of our common stock, risk freeinterest rates and expected dividend yields of our common stock. Different estimatesof volatility and expected term of the option could materially change the valueof an option and the resulting expense. As of December 31, 2006, stockoptions to nonemployees to purchase approximately 31,000 shares wereoutstanding.

***Adoption of SFAS No. 123(R)***

Effective January 1, 2006, we adopted Statementof Financial Accounting Standards No. 123(R), *Share-Based Payment,*or SFAS No.123(R), which requirescompensation costs related to share-based transactions, including employeestock options, to be recognized in the financial statements based on fairvalue. SFAS No. 123(R) revises SFAS No. 123, as amended, andsupersedes APB No. 25. We adopted SFAS No. 123(R) using theprospective transition method. Under this method, compensation cost is measuredand recognized for all share-based payments granted, modified and settledsubsequent to December 31, 2005. In accordance with the prospective transitionmethod, our financial statements for prior periods have not been restated toreflect, and do not include, the impact of SFAS No. 123(R). As ofDecember 31, 2006, we had unrecognized stock-based compensation costs of$9.0 million related to stock options granted during the year endedDecember 31, 2006. The cost is expected to be amortized over a weightedaverage amortization period of 3.14 years.

We selected the Black-Scholes valuation model as themost appropriate valuation method for stock option grants. The fair value ofthese stock option grants is estimated as of the date of grant using the 

52

----

Black-Scholes valuationmodel with the following weighted-average assumptions for stock options grantedduring the year ended December 31, 2006: expected term of 5.77 years,expected stock price volatility of 87%, weighted-average risk-free interestrate of 4.61% and dividend yield of 0%. The expected term of stock optionsrepresents the weighted-average period the stock options are expected to remainoutstanding and is based on the expected terms for industry peers as we did nothave sufficient historical information to develop reasonable expectations aboutfuture exercise patterns and post-vesting employment termination behavior forour stock options. The expected stock price volatility for our common stock forthe year ended December 31, 2006 was determined by examining thehistorical volatilities for industry peers and using an average of thehistorical volatilities of our industry peers as we did not have anysignificant trading history for our common stock. Industry peers consist ofseveral public companies in the biopharmaceutical industry similar in size,stage of life cycle and financial leverage. We will continue to analyze thehistorical stock price volatility and expected term assumptions as morehistorical data for our common stock becomes available. The risk-free interestrate assumption was based on U.S. Treasury instruments whose term wasconsistent with the expected term of our stock options. The expected dividendassumption was based on our history and expectation of dividend payouts.

In addition, SFAS No. 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates.Forfeitures were estimated based on historical experience. Prior to theadoption of SFAS No. 123(R), we accounted for forfeitures as theyoccurred.

We had a choice of twoattribution methods for allocating compensation costs under SFASNo. 123(R): the ‘‘straight-line method,’’ which allocates expense on astraight-line basis over the requisite service period of the last separatelyvesting portion of an award, or the ‘‘graded vesting attribution method,’’which allocates expense on a straight-line basis over the requisite serviceperiod for each separately vesting portion of the award as if the award was, insubstance, multiple awards. We chose the former method and amortized the fairvalue of each option on a straight-line basis over the requisite period of thelast separately vesting portion of each award.

***Net Operating Losses and Tax Credit Carryforwards***

At December 31, 2006, we had federal and statenet operating loss carryforwards of approximately $83.1 million and $81.6million, respectively. The federal net operating loss carryforwards begin toexpire in 2021 and state net operating loss carryforwards begin to expire in2013, if not utilized. Under the provisions of Section 382 of the InternalRevenue Code, substantial changes in our ownership may limit the amount of netoperating loss carryforwards that can be utilized annually in the future tooffset taxable income. A valuation allowance has been established to reservethe potential benefits of these carryforwards in our financial statements toreflect the uncertainty of future taxable income required to utilize availabletax loss carryforwards and other deferred tax assets. If a change in ourownership is deemed to have occurred or occurs in the future, our ability touse our net operating loss carryforwards in any fiscal year may besignificantly limited.

At December 31, 2006, we had federal and stateresearch credit carryforwards of approximately $3.5 million and $3.8million, respectively. If not utilized, the federal carryforward will expire invarious amounts beginning in 2021. The California credit can be carried forwardindefinitely. We also had $42.5 million of capitalized research anddevelopment costs, in excess of book basis, under Internal Revenue Code §59e.These costs will be amortized over a ten year period beginning with the monthof the expenditure. In 2006, we expensed our research and development costs fortax purposes. Additionally, we had $22.4 million of capitalized start-up costs,in excess of book basis, under Internal Revenue Code §195. Such costscapitalized on or before October 22, 2004, will be amortized over a periodof 60 months beginning with the month we have an active trade or business.Start-up costs capitalized after October 22, 2004, will be amortized overa 180 month period beginning with the month we have an active trade or 

53

----

business. In 2006, therequirements to cease capitalization of start-up expenses were met andamortization expense of $4.7 million will be reported for tax purposes relatedto the capitalization of start-up costs in prior years. We also had $11.5million of capitalized intangible assets acquired as part of the net assetsacquired from GlaxoSmithKline plc., in excess of book basis, under InternalRevenue Code §197. These costs will be amortized over a fifteen year periodbeginning with the month the intangible asset was acquired.

As discussed above, wereceived advance royalties under the Arrangement with Takeda and have deferredthe recognition of these payments to future years for book purposes. For taxpurposes, we expect to defer the recognition of taxable income generated by thereceipt of these payments until 2007. While we expect that we will likelyrecognize some of the deferred tax asset related to our net operating loss carryforwardsas a result of the taxable income generated by these royalty payments, a fullvaluation allowance of $70.8 million has been established for net operatingloss and credit carryovers and for the future tax benefit for the deferred taxassets related to the other temporary deductible differences as we believe,based on available objective evidence, that it is more likely than not that thedeferred tax assets are not realizable. The net change in the valuationallowance in 2006 was an increase of $20.8 million.

**Results ofOperations**

***Comparison of YearsEnded December 31, 2006 and 2005***

| ** **                                                                | ** ** | **Years Ended  December 31,**               | ** ** | **Increase/** | ** ** | **% Increase/** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                                                                | ** ** | **2006**                                              | ** ** | **2005**      | ** ** | **(Decrease)**       | ** ** | **(Decrease)** | ** ** |
| ** **                                                                | ** ** | **(in thousands, except percentages)** | ** ** |
| Revenue                                                                   |       | $                                                     | 11,726     |          | $          | 74                   |       |   | $ | 11,652 |   |   |   | 15,746 | % |   |
| Research and  development expenses(1)                                     |       | 54,347                                                |       | 24,051        |       |                 | 30,296     |   |   |   | 126 |   |   |
| General and  administrative expenses(1)                                   |       | 11,089                                                |       | 10,032        |       |                 | 1,057      |   |   |   | 11 |   |   |
| Interest income  (expense), net                                           |       | 5,465                                                 |       | 1,384         |       |                 | 4,081      |   |   |   | 295 |   |   |
| Other income  (expense), net                                              |       | (43                                                   | )          | 49            |       |                 | (92        | ) |   |   | (188 | ) |   |
| Accretion of  redeemable convertible preferred stock to redemption value  |       | 815                                                   |       | 597           |       |                 | 218        |   |   |   | 37 |   |   |
| (1) Includes the  following stock-based compensation   charges: |       |                                                  |       |          |       |                 |       |   |   |   |   |   |   |
| Research and development  expenses                                        |       | $                                                     | 1,746      |          | $          | 1,343                |       |   | $ | 403 |   |   |   | 30 | % |   |
| General and administrative expenses                                       |       | 276                                                   |       | 2,958         |       |                 | (2,682     | ) |   |   | (91 | ) |   |

* *

*Revenue.*   Werecognized $11.7 million of revenue under our Arrangement with Takeda for theyear ended December 31, 2006. We recognized immaterial revenues for theyear ended December 31, 2005 from royalty payments.

*Researchand Development Expenses.*   The increase inresearch and development expenses was primarily due to an increase ofapproximately $17 million in milestone payments in connection with the Nektarlicense, an increase of approximately $7 million in clinical trial costsresulting from three additional clinical trials and enrollment of higher numberof patients, an increase of approximately $4 million in personnel costs resultingfrom increased headcount and stock-based compensation expense and an increasein costs associated with the manufacturing and testing of Hematide.

*Generaland Administrative Expenses.*   The increase ingeneral and administrative expenses was primarily due to an increase ofapproximately $2 million in personnel costs resulting from higherheadcount, net of lower stock-based compensation expenses, and increased legaland audit fees.

54

----

General and administrative expenses for 2006 arereduced by an out-of-period adjustment. The Company identified an overstatementof stock-based compensation charges of $2.4 million for the year endingDecember 31, 2005. It was determined that the 2005 overstatement of stock-basedcompensation expense was immaterial to the annual financial statements for theyears ending December 31, 2006 and 2005 and to the quarterly financialinformation for the same periods and therefore was corrected in the firstquarter of 2006.

*InterestIncome (Expense), Net.*   The increase in interestincome, net, was due primarily to higher level of cash, cash equivalents andshort-term investments as well as higher interest rates during the year.

*OtherIncome (Expense), Net.*   Other income (expense),net, was immaterial for the years ended December 31, 2005 and 2006.

*Accretion of RedeemableConvertible Preferred Stock to Redemption Value.*   Ourconvertible preferred stock was redeemable at the request of the holders on orafter July 11, 2010. We were accreting the carrying value of the preferredstock to the mandatory redemption amount using the effective interest methodthrough periodic charges to additional paid in capital. We recorded accretionon the preferred stock through the date of the automatic conversion of all ofour outstanding preferred stock into common stock upon the closing of ourinitial public offering in December 2006. Pursuant to our previous amendedand restated certificate of incorporation, all outstanding shares of preferredstock would have been converted into common stock upon the closing of anoffering where the price per share is greater than $15.09, the gross proceedsto us are at least $40 million and we have a pre-offering market capitalizationof at least $200 million. We recorded a non-cash charge of $597,000 and$815,000 in the year ended December 31, 2005 and 2006, respectively.

***Comparison of YearsEnded December 31, 2005 and 2004***

|                                                                          | ** ** | **Years Ended  December 31,**               | ** ** | **Increase/** | ** ** | **%  Increase/** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                                               | ** ** | **2005**                                              | ** ** | **2004**      | ** ** | **(Decrease)**   | ** ** | **(Decrease)** | ** ** |
| ** **                                                               | ** ** | **(in thousands, except percentages)** | ** ** |
| Revenue                                                                  |       | $                                                     | 74         |          | $          | 151              |       |   | $ | (77 | ) |   |   | (51 | )% |   |
| Research and  development expenses(1)                                    |       | 24,051                                                |       | 17,338        |       |             | 6,713      |   |   |   | 39 |   |   |
| General and administrative  expenses(1)                                  |       | 10,032                                                |       | 4,931         |       |             | 5,101      |   |   |   | 103 |   |   |
| Interest income  (expense), net                                          |       | 1,384                                                 |       | 439           |       |             | 945        |   |   |   | 215 |   |   |
| Other income (expense), net                                              |       | 49                                                    |       | 281           |       |             | (232       | ) |   |   | (83 | ) |   |
| Accretion of  redeemable convertible preferred stock to redemption value |       | 597                                                   |       | 105           |       |             | 492        |   |   |   | 469 |   |   |
| (1) Includes the  following stock-based compensation charges:            |       |                                                  |       |          |       |             |       |   |   |   |   |   |   |
| Research and development  expenses                                       |       | $                                                     | 1,343      |          | $          | 13               |       |   | $ | 1,330 |   |   |   | 10,231 | % |   |
| General and  administrative expenses                                     |       | 2,958                                                 |       | —        |       |             | 2,958      |   |   |   | 100 |   |   |

* *

*Revenue.*   Werecognized immaterial revenues for the years ended December 31, 2004 and2005 from license and royalty payments.

*Researchand Development Expenses.*   The increase inresearch and development expenses was primarily due to an increase ofapproximately $4 million in personnel costs resulting from increased headcountand an increase in stock-based compensation expense, an increase ofapproximately $2 million in clinical trial costs resulting fromcommencement of three Phase 2 clinical trials, an increase of approximately$1 million in costs associated with manufacturing and stability testing ofHematide.

55

----

*Generaland Administrative Expenses.*   The increase ingeneral and administrative expenses resulted primarily from an increase ofapproximately $3 million in charges associated with stock-based compensation,increased legal fees of approximately $1 million resulting from the payment ofinternational patent maintenance fees, various corporate transactions andlitigation-related expenses, an increase of approximately $1 million inpersonnel costs and increased professional and consulting expenses.

*InterestIncome (Expense), Net.*   The increase in interestincome, net, was due primarily to higher levels of cash, cash equivalents andshort-term investments and higher interest rates during the period.

*OtherIncome (Expense), Net.*   Other income (expense),net, decreased due to lower level of profit on sales of excess fixed assets.

*Accretion of RedeemableConvertible Preferred Stock to Redemption Value.*   Werecorded a non-cash charge of $105,000 and $597,000 for the accretion on ourredeemable convertible preferred stock in 2004 and 2005, respectively.

**Liquidity andCapital Resources**

Sinceour inception, we have financed our operations through sale of capital stock,license fees from collaborative partners, operating and capital leasefinancing, interest earned on investments and limited license fees and royaltiesfrom licensing intellectual property. Through December 31, 2006, we havereceived net proceeds of $256.2 million from the issuance of common stockand convertible preferred stock and $122 million of upfront license feesfrom our collaboration agreements with Takeda. As of December 31, 2006, wehad $230.4 million in unrestricted cash, cash equivalents, short-terminvestments and long-term investments. Our cash and investment balances areheld in a variety of interest bearing instruments, including obligations ofU.S. government agencies, corporate bonds, commercial paper, auction ratesecurities and money market funds. Cash in excess of immediate requirements isinvested in accordance with our investment policy primarily with a view to liquidityand capital preservation.

| ** **                                                                | ** ** | **Years Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| ** **                                                                | ** ** | **(in thousands)**                 | ** ** |
| Cash, cash  equivalents, short-term investments and long-term investments |       | $                                       | 230,425    |   | $ | 57,893 |   |
| Working capital                                                           |       | $                                       | 228,652    |   | $ | 53,238 |   |

 

| ** **                                                     | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**                     | ** ** |
| Cash provided by (used  in):                                   |       |                                        |       |   |   |   |   |
| Operating  activities                                          |       | $                                           | 68,298     |   | $ | (24,765 | ) | $ | (19,949 | ) |
| Investing  activities                                          |       | $                                           | (42,978    | ) | $ | (20,502 | ) | $ | 64 |   |
| Financing  activities                                          |       | $                                           | 107,822    |   | $ | 58,009 |   | $ | 19,934 |   |
| Capital expenditures  (included in investing activities above) |       | $                                           | (1,452     | ) | $ | (127 | ) | $ | (134 | ) |

 

Net cash used in operating activities primarilyreflects the net loss for those periods, which was reduced in part bydepreciation and amortization, non-cash stock-based compensation andnon-cash changes in operating assets and liabilities. Net cash provided byoperating activities for the year ended December 31, 2006 includes upfrontlicense fees received from Takeda. Net cash used in investing activities was primarilyrelated to purchase of investments and, to a lesser extent, purchase ofproperty and equipment. Net cash provided by financing activities was primarilyattributable to net proceeds of the Company’s initial public offering of $96.1million and issuance of Series E preferred stock in the year 

56

----

ended December 31,2006, issuance of Series D preferred stock in the year ended December 31,2005 and issuance of Series C preferred stock in a second closing in theyear ended December 31, 2004.

Ourfuture contractual obligations, including financing costs, at December 31,2006 were as follows:

| ** **                           | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**     | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| ** **                           | ** ** | **(in thousands)**                        | ** ** |
| Capitalized lease  obligations       |       | $                                         | 448        |   |   | $ | 306 |   |   |   | $ | 142 |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Operating lease  obligations         |       | $                                         | 22,142     |   |   | $ | 3,389 |   |   |   | $ | 5,077 |   |   |   | $ | 5,464 |   |   |   | $ | 8,212 |   |   |
| Total fixed  contractual obligations |       | $                                         | 22,590     |   |   | $ | 3,695 |   |   |   | $ | 5,219 |   |   |   | $ | 5,464 |   |   |   | $ | 8,212 |   |   |
|                                      |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In April 2004, we entered into a License,Manufacturing and Supply Agreement with Nektar Therapeutics AL, Corporation, orNektar, under which we obtained from Nektar a worldwide, non-exclusive license,with limited rights to grant sublicenses, under certain intellectual propertycovering pegylation technology to manufacture, develop and commercializeHematide. In consideration of the license grant, we agreed to pay royalties onthe sales of Hematide. We also agreed to pay milestone payments totaling up to$7 million, plus possible additional milestones in connection with ourpartnering activities relating to Hematide or merger and acquisitionactivities. In July 2006, we paid Nektar a $17.6 million milestonepayment triggered by the collaboration agreements signed with Takeda in February andJune 2006.

Under the agreement, we also engaged Nektar for themanufacture and supply of our requirements of bulk poly(ethylene) glycolreagent for the manufacture of Hematide. This relationship is managed by amanaging committee formed by representatives from both us and Nektar. Nektar isobligated to engage a third-party manufacturer in the event of Nektar’s failure(as defined in the agreement) to supply reagent. This agreement expires, on acountry by country basis, upon the expiration of our royalty paymentobligations. The agreement may be terminated by either party for the otherparty’s material breach provided that such other party has been given a chanceto cure such breach, or by Nektar for our challenge of the validity orenforceability of any patents licensed thereunder.

In September 2006, we entered into an operatinglease for additional office space in Palo Alto, California. The lease commencedin November 2006 and terminates in December 2010. The total squarefootage covered by the new lease is 30,630 square feet, of which we leased15,315 square feet starting in November 2006 and the remaining 15,315square feet starting in September 2007.

In December 2006, we entered into an extension ofthe operating lease for office space in Palo Alto, California. The leaseextension commences in October 2007 and terminates in September 2014.The total square footage covered by the lease extension is 84,460 square feet,of which we lease 53,830 square feet starting in October 2007 and theremaining 30,630 square feet starting in January 2011.

Our future capitalrequirements will depend on many forward looking factors and are not limited tothe following:

·       theinitiation, progress, timing and completion of preclinical studies and clinicaltrials for our drug candidates and potential drug candidates;

·       ourability to achieve milestones under our collaboration agreements with Takeda;

·       costsof litigation;

·       outcome,timing and cost of regulatory approvals;

·       delaysthat may be caused by changing regulatory requirements;

57

----

·       thenumber of drug candidates that we pursue;

·       thecosts involved in filing and prosecuting patent applications and enforcing anddefending patent claims;

·       timingand terms of future in-licensing and out-licensing transactions;

·       thecost and timing of establishing sales, marketing and distribution capabilities;

·       costof procuring clinical and commercial supplies of our productcandidates; and

·       theextent to which we acquire or invest in businesses, products or technologies,although we currently have no commitments or agreements relating to any ofthese types of transactions.

We believe that theexisting cash, cash equivalents, short-term investments and long-terminvestments together with the interest thereon, will enable us to maintain ourcurrently planned operations through at least 18 months.****However, we may be required to raise additional capital tocomplete the development and commercialization of Hematide. Our capitalrequirements are likely to increase. As a result, we may need to raiseadditional funds to support our operations, and such funding may not beavailable to us on acceptable terms, or at all. If we are unable to raiseadditional funds when needed we may not be able to continue development of ourproduct candidates or we could be required to delay, scale back or eliminatesome or all of our development programs and other operations. We may seek toraise additional funds through public or private financing, strategicpartnerships or other arrangements. Any additional equity financing may bedilutive to stockholders and debt financing, if available, may involverestrictive covenants. If we raise funds through collaborative or licensingarrangements, we may be required to relinquish, on terms that are not favorableto us, rights to some of our technologies or product candidates that we wouldotherwise seek to develop or commercialize ourselves. Our failure to raisecapital when needed may harm our business and operating results.

**Recent AccountingPronouncements**

In June 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109*, orFIN No. 48, which clarifies the accounting for uncertainty in taxpositions. FIN No. 48 requires that we recognize the impact of a taxposition in our financial statements, if that position is more likely than notto be sustained on audit, based on the technical merits of the position. Theprovisions of FIN No. 48 are effective as of the beginning of our 2007fiscal year, with the cumulative effect, if any, of the change in accountingprinciple recorded as an adjustment to opening retained earnings. We arecurrently evaluating the potential impact that the adoption of FIN No. 48may have on our financial statements.

In September 2006, the SEC staff issued StaffAccounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*, or SAB 108. SAB 108 was issued inorder to eliminate the diversity of practice surrounding how public companiesquantify financial statement misstatements. Traditionally, there have been twowidely-recognized methods for quantifying the effects of financial statementmisstatements: the ‘‘roll-over’’ method and the ‘‘iron curtain’’ method. Theroll-over method focuses primarily on the impact of a misstatement on theincome statement—including the reversing effect of prior year misstatements—butits use can lead to the accumulation of misstatements in the balance sheet. Theiron-curtain method, on the other hand, focuses primarily on the effect ofcorrecting the period-end balance sheet with less emphasis on the reversingeffects of prior year errors on the income statement. In SAB 108, the SEC staffestablished an approach that requires quantification of financial statementmisstatements based on the effects of the misstatements on each of the company’sfinancial statements and the related financial statement disclosures. Thismodel is commonly referred to as a ‘‘dual approach’’ because it requiresquantification of errors under both the iron curtain and the roll-over methods.We adopted SAB 108 during the third quarter of 2006.

58

----

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*, whichdefines fair value, establishes a framework for measuring fair value undergenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, but provides guidance on how to measure fair value by providing afair value hierarchy used to classify the source of the information. SFAS No. 157is effective commencing with our fiscal year 2009 annual financial statements.We are currently assessing the potential impact that the adoption of SFAS No. 157will have on our financial statements.

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities—Including an amendment of FASBStatement No. 115,*or SFAS No. 159, which is effective January 1,2008. SFAS No. 159 permits us to choose to measure many financialinstruments and certain other items at fair value. The objective is to improvefinancial reporting by providing entities with the opportunity to mitigatevolatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. SFAS No. 159 is expected to expand the use of fair valuemeasurement, with is consistent with the Board’s long-term measurementobjectives for accounting for financial instruments. We are currentlyevaluating the impact, if any, that the adoption of SFAS No. 159 will haveon our financial statements on the adoption date of January 1, 2008.

**Off-Balance Sheet Arrangements**

There were no significantoff-balance sheet arrangements at December 31, 2006.

**Item 7A.   Quantitativeand Qualitative Disclosure of Market Risks**

Our exposure to market risk is confined to our cash,cash equivalents, short-term investments and long-term investments which havematurities of less than thirteen months. The goals of our investment policy arepreservation of capital, fulfillment of liquidity needs and fiduciary controlof cash and investments. We also seek to maximize income from our investmentswithout assuming significant risk. To achieve our goals, we maintain aportfolio of cash equivalents and investments in a variety of securities ofhigh credit quality. The securities in our investment portfolio are notleveraged, are classified as available for sale and are, due to their veryshort-term nature, subject to minimal interest rate risk. We currently do nothedge interest rate exposure. Because of the short-term maturities of ourinvestments, we do not believe that an increase in interest rates would have amaterial negative impact on the value of our investment portfolio.

59

----

**Item 8.   FinancialStatements and Supplementary Data.**

Our financial statements and notes thereto appear on pages 63to 96 of this Annual Report on Form 10-K.

|                                                                                                                                                                                                                  | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of PricewaterhouseCoopers LLP, Independent  Registered Public Accounting Firm                                                                                                                             |       |     | 61         |   |   |
| Balance Sheets as of December 31, 2006 and 2005                                                                                                                                                             |       |     | 62         |   |   |
| Statements of Operations for the years ended  December 31, 2006, 2005 and 2004 and the cumulative period from  July 20, 2001 (date of inception) through December 31, 2006                        |       |     | 63         |   |   |
| Statements of Stockholders’ Equity (Deficit) for the  years ended December 31, 2006, 2005, 2004, 2003, 2002 and the period  from July 20, 2001 (date of inception) through December 31, 2001 |       |     | 64         |   |   |
| Statements of Cash Flows for the years ended  December 31, 2006, 2005 and 2004 and the cumulative period from  July 20, 2001 (date of inception) through December 31, 2006                        |       |     | 68         |   |   |
| Notes  to Financial Statements                                                                                                                                                                                   |       |     | 70         |   |   |

 

60

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of Affymax, Inc.(a development stage company)

In our opinion, theaccompanying balance sheets and the related statements of operations, ofstockholders’ equity and of cash flows present fairly, in all materialrespects, the financial position of Affymax, Inc. (a development stagecompany) at December 31, 2006 and 2005, and the results of its operationsand its cash flows for each of the three years in the period ended December 31,2006 and cumulatively, for the period from July 20, 2001 (date ofinception) to December 31, 2006 in conformity with accounting principlesgenerally accepted in the United States of America. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits. Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

As discussed in Note 2 tothe financial statements, the Company changed the manner in which it accountsfor stock-based compensation for the year ended December 31, 2006.

/s/ *PRICEWATERHOUSECOOPERS LLP*

San Jose, CaliforniaMarch 30, 2007

61

----

**AFFYMAX, INC.(A development stage company)**

**BALANCESHEETS**

**(inthousands, except share and per share data)**

| ** **                                                                                                                                                                                                                                                                                                        | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                        | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                                        |       |                  |       |   |   |
| Current assets                                                                                                                                                                                                                                                                                                    |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                        |       | $                     | 147,541    |   | $ | 14,399 |   |
| Restricted cash                                                                                                                                                                                                                                                                                                   |       | 1,051                 |       | — |   |
| Short-term investments                                                                                                                                                                                                                                                                                            |       | 76,751                |       | 43,494 |   |
| Related party receivable                                                                                                                                                                                                                                                                                          |       | 10,191                |       | — |   |
| Prepaid expenses and  other current assets                                                                                                                                                                                                                                                                        |       | 5,090                 |       | 722 |   |
| Total current assets                                                                                                                                                                                                                                                                                              |       | 240,624               |       | 58,615 |   |
| Property and equipment,  net                                                                                                                                                                                                                                                                                      |       | 2,014                 |       | 1,110 |   |
| Restricted cash                                                                                                                                                                                                                                                                                                   |       | 1,135                 |       | — |   |
| Long-term investments                                                                                                                                                                                                                                                                                             |       | 6,133                 |       | — |   |
| Other assets                                                                                                                                                                                                                                                                                                      |       | 82                    |       | 1,235 |   |
| Total assets                                                                                                                                                                                                                                                                                                      |       | $                     | 249,988    |   | $ | 60,960 |   |
| **Liabilities, Mandatorily Redeemable Convertible  Preferred Stock and Stockholders’ Equity (Deficit)**                                                                                                                                                                                                      |       |                  |       |   |   |
| Current liabilities                                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                                                                                                                                                  |       | $                     | 9,113      |   | $ | 3,336 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                               |       | 2,566                 |       | 1,818 |   |
| Capitalized lease  obligations, current                                                                                                                                                                                                                                                                           |       | 293                   |       | 223 |   |
| Total current  liabilities                                                                                                                                                                                                                                                                                        |       | 11,972                |       | 5,377 |   |
| Deferred revenue                                                                                                                                                                                                                                                                                                  |       | 120,821               |       | — |   |
| Other long term  liabilities                                                                                                                                                                                                                                                                                      |       | 156                   |       | 180 |   |
| Capitalized lease  obligations, net of current                                                                                                                                                                                                                                                                    |       | 140                   |       | 310 |   |
| Total liabilities                                                                                                                                                                                                                                                                                                 |       | 133,089               |       | 5,867 |   |
| Commitments and contingencies (Note 5)                                                                                                                                                                                                                                                                       |       |                  |       |   |   |
| Mandatorily redeemable  convertible preferred stock: no shares authorized and no shares issued and  outstanding at December 31, 2006; $0.0001 par value, 34,609,592 shares  authorized at December 31, 2005 and 8,451,004 shares issued and  outstanding at December 31, 2005                      |       | —                |       | 168,784 |   |
| Stockholders’ equity (deficit)                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Common stock: $0.001 par  value, 100,000,000 shares authorized at December 31, 2006 and 14,878,304  shares issued and outstanding at December 31, 2006; $0.0001 par value,  50,500,000 shares authorized at December 31, 2005 and 332,731 shares  issued and outstanding at December 31, 2005 |       | 15                    |       | — |   |
| Additional paid-in  capital                                                                                                                                                                                                                                                                                       |       | 285,771               |       | 7,200 |   |
| Deferred stock-based  compensation                                                                                                                                                                                                                                                                                |       | (94                   | )          | (409 | ) |
| Deficit accumulated  during the development stage                                                                                                                                                                                                                                                                 |       | (168,749              | )          | (120,461 | ) |
| Other comprehensive loss                                                                                                                                                                                                                                                                                          |       | (44                   | )          | (21 | ) |
| Total stockholders’  equity (deficit)                                                                                                                                                                                                                                                                        |       | 116,899               |       | (113,691 | ) |
| Total liabilities, mandatorily redeemable  convertible preferred stock and stockholders’ equity (deficit)                                                                                                                                                                                                    |       | $                     | 249,988    |   | $ | 60,960 |   |

 

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

62

----

**AFFYMAX,INC.(A development stage company)**

**STATEMENTSOF OPERATIONS**

**(inthousands, except per share data)**

| ** **                                                                                                            | ** ** | **Year Ended December 31,** | ** ** | **Cumulative  Period From  July 20, 2001  (Date of  Inception) to  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2006**                                   | ** ** | **2005**                                                                                                        | ** ** | **2004** | ** ** | **2006** | ** ** |
| Collaboration  revenue                                                                                                |       | $                                          | 11,688     |                                                                                                            | $          | — |   | $ | — |   |   | $ | 11,688 |   |   |
| License and  royalty revenue                                                                                          |       | 38                                         |       | 74                                                                                                              |       | 151 |   |   | 591 |   |   |
| Total revenue                                                                                                         |       | 11,726                                     |       | 74                                                                                                              |       | 151 |   |   |       12,279 |   |   |
| Operating expenses                                                                                                    |       |                                       |       |                                                                                                            |       |   |   |   |   |   |   |
| Research and  development                                                                                             |       | 54,347                                     |       | 24,051                                                                                                          |       | 17,338 |   |   | 132,170 |   |   |
| General and  administrative                                                                                           |       | 11,089                                     |       | 10,032                                                                                                          |       | 4,931 |   |   | 39,060 |   |   |
| Amortization of  intangible assets                                                                                    |       | —                                     |       | —                                                                                                          |       | — |   |   | 14,471 |   |   |
| Impairment of  assets                                                                                                 |       | —                                     |       | —                                                                                                          |       | — |   |   | 4,224 |   |   |
| Total operating expenses                                                                                              |       | 65,436                                     |       | 34,083                                                                                                          |       | 22,269 |   |   | 189,925 |   |   |
| Loss from operations                                                                                                  |       | (53,710                                    | )          | (34,009                                                                                                         | )          | (22,118 | ) |   | (177,646 | ) |   |
| Interest income                                                                                                       |       | 5,549                                      |       | 1,413                                                                                                           |       | 439 |   |   | 8,924 |   |   |
| Interest expense                                                                                                      |       | (84                                        | )          | (29                                                                                                             | )          | — |   |   | (170 | ) |   |
| Other income  (expense), net                                                                                          |       | (43                                        | )          | 49                                                                                                              |       | 281 |   |   | 143 |   |   |
| Net loss                                                                                                              |       | (48,288                                    | )          | (32,576                                                                                                         | )          | (21,398 | ) |   | (168,749 | ) |   |
| Accretion of  mandatorily redeemable convertible preferred stock                                                      |       | (815                                       | )          | (597                                                                                                            | )          | (105 | ) |   | (1,899 | ) |   |
| Net loss  attributable to common stockholders                                                                         |       | $                                          | (49,103    | )                                                                                                               | $          | (33,173 | ) | $ | (21,503 | ) |   | $ | (170,648 | ) |   |
| Net loss per common  share:                                                                                           |       |                                       |       |                                                                                                            |       |   |   |   |   |   |   |
| Basic and diluted                                                                                                     |       | $                                          | (32.56     | )                                                                                                               | $          | (101.65 | ) | $ | (70.39 | ) |   |   |   |   |
| Weighted-average  number of common shares used in computing basic and diluted net loss per  common share calculations |       | 1,508                                      |       | 326                                                                                                             |       | 305 |   |   |   |   |   |

 

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

63

----

**AFFYMAX,INC.**

**(Adevelopment stage company)**

**STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)Cumulative Period from July 20, 2001 (Date of Inception) toDecember 31, 2006(in thousands, except share and per share data)**

| ** **                                                                                                        | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | ** **          | ** ** | ** **        | ** ** | ** **             | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-----------------|------------|---------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                        | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Deficit**         | ** ** | ** **        | ** ** | ** **             | ** ** |
| ** **                                                                                                        | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Accumulated**     | ** ** | ** **        | ** ** | **Total**              | ** ** |
| ** **                                                                                                        | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred**    | ** ** | **During the** | ** ** | **Other**         | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                        | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Stock-Based** | ** ** | **Development**     | ** ** | **Comprehensive** | ** ** | **Equity**             | ** ** |
| ** **                                                                                                        | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**     | ** ** | **Compensation**    | ** ** | **Stage**         | ** ** | **(Loss) Income** | ** ** | **(Deficit)** | ** ** |
| Issuance of common stock in August 2001 at $4.00  per share for cash                                         |       | 249,995               |       |           | $          | —          |       |                |       | $                 | 1,000      |                   |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 1,000 |   |   |
| Issuance of common stock upon exercise of stock  options at $4.00 per share for cash                              |       | 3,342                 |       |           | —     |            |       |                | 13         |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 13 |   |   |
| Value of common stock issued in September 2001  through November 2001 in exchange for services rendered |       | 4,210                 |       |           | —     |            |       |                | 76         |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 76 |   |   |
| Accretion on mandatorily redeemable convertible  preferred stock                                                  |       | —                |       |           | —     |            |       |                | (64        | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (64 | ) |   |
| Components of other comprehensive  loss:                                                                          |       |                  |       |           |       |            |       |                |       |              |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                                          |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | (10,244 | ) |   |   | — |   |   |   | (10,244 | ) |   |
| Change in unrealized gain (loss) on marketable  securities                                                        |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | 47 |   |   |   | 47 |   |   |
| Total comprehensive loss                                                                                          |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (10,197 | ) |   |
| **Balance at December 31, 2001**                                                                             |       | 257,547               |       |           | —     |            |       |                | 1,025      |              |       |                   | —     |   |   |   | (10,244 | ) |   |   | 47 |   |   |   | (9,172 | ) |   |
| Issuance of common stock upon exercise of stock  options at $4.00 per share for cash                              |       | 122,604               |       |           | —     |            |       |                | 490        |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 490 |   |   |
| Value of common stock issued to employees in  February 2002 in exchange for  services rendered               |       | 2,294                 |       |           | —     |            |       |                | 9          |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 9 |   |   |
| Value of common stock issued to nonemployees in  exchange for services rendered                                   |       | 9,037                 |       |           | —     |            |       |                | 42         |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 42 |   |   |
| Repurchase of common stock in December 2002                                                                  |       | (112,500              | )          |           | —     |            |       |                | (450       | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (450 | ) |   |
| Accretion on mandatorily redeemable convertible  preferred stock                                                  |       | —                |       |           | —     |            |       |                | (154       | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (154 | ) |   |
| Components of  other comprehensive loss:                                                                          |       |                  |       |           |       |            |       |                |       |              |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                                          |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | (28,046 | ) |   |   | — |   |   |   | (28,046 | ) |   |
| Change in unrealized gain (loss) on marketable  securities                                                        |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total comprehensive loss                                                                                          |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (28,046 | ) |   |
| **Balance  at December 31, 2002**                                                                            |       | 278,982               |       |           | —     |            |       |                | 962        |              |       |                   | —     |   |   |   | (38,290 | ) |   |   | 47 |   |   |   | (37,281 | ) |   |

 

64

----

**AFFYMAX, INC.(A development stage company)STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)Cumulative Period from July 20, 2001 (Date of Inception) toDecember 31, 2006(in thousands, except share and per share data)**

| ** **                                                                           | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | ** **          | ** ** | ** **        | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-----------------|------------|---------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                           | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Deficit**         | ** ** | ** **        | ** ** | ** **             | ** ** |
| ** **                                                                           | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Accumulated**     | ** ** | ** **        | ** ** | **Total**              | ** ** |
| ** **                                                                           | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred**    | ** ** | **During the** | ** ** | **Other**         | ** ** | **Stockholders’** | ** ** |
| ** **                                                                           | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Stock-Based** | ** ** | **Development**     | ** ** | **Comprehensive** | ** ** | **Equity**             | ** ** |
| ** **                                                                           | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**     | ** ** | **Compensation**    | ** ** | **Stage**         | ** ** | **(Loss) Income** | ** ** | **(Deficit)** | ** ** |
| Issuance of common  stock upon exercise of stock options at $4.00 per share for cash |       | 2,168                 |       |           | —     |            |       |                | 9          |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 9 |   |   |
| Issuance of common  stock upon exercise of stock options at $0.80 per share for cash |       | 1,150                 |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Value of common  stock issued to nonemployees in exchange for services rendered      |       | 2,187                 |       |           | —     |            |       |                | 3          |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 3 |   |   |
| Accretion on  mandatorily redeemable convertible preferred stock                     |       | —                |       |           | —     |            |       |                | (164       | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (164 | ) |   |
| Components of other  comprehensive loss:                                             |       |                  |       |           |       |            |       |                |       |              |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                             |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | (28,197 | ) |   |   | — |   |   |   | (28,197 | ) |   |
| Change in  unrealized gain (loss) on marketable securities                           |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | (47 | ) |   |   | (47 | ) |   |
| Total  comprehensive loss                                                            |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (28,244 | ) |   |
| **Balance  at December 31, 2003**                                               |       | 284,487               |       |           | —     |            |       |                | 810        |              |       |                   | —     |   |   |   | (66,487 | ) |   |   | — |   |   |   | (65,677 | ) |   |
| Issuance of common  stock upon exercise of stock options at $0.80 per share for cash |       | 22,629                |       |           | —     |            |       |                | 18         |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 18 |   |   |
| Repurchase of  common stock                                                          |       | (3,281                | )          |           | —     |            |       |                | (13        | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (13 | ) |   |
| Accretion on  mandatorily redeemable convertible preferred stock                     |       | —                |       |           | —     |            |       |                | (105       | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (105 | ) |   |
| Value of common  stock issued to nonemployees in exchange for services rendered      |       | 15,646                |       |           | —     |            |       |                | 13         |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 13 |   |   |
| Components of other  comprehensive loss:                                             |       |                  |       |           |       |            |       |                |       |              |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                             |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | (21,398 | ) |   |   | — |   |   |   | (21,398 | ) |   |
| Change in  unrealized gain (loss) on marketable securities                           |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total  comprehensive loss                                                            |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (21,398 | ) |   |
| **Balance  at December 31, 2004**                                               |       | 319,481               |       |           | —     |            |       |                | 723        |              |       |                   | —     |   |   |   | (87,885 | ) |   |   | — |   |   |   | (87,162 | ) |   |

 

65

----

**AFFYMAX, INC.(A development stage company)STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)Cumulative Period from July 20, 2001 (Date of Inception) toDecember 31, 2006(in thousands, except share and per share data)**

| ** **                                                                           | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | ** **          | ** ** | ** **        | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-----------------|------------|---------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                           | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Deficit**         | ** ** | ** **        | ** ** | ** **             | ** ** |
| ** **                                                                           | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Accumulated**     | ** ** | ** **        | ** ** | **Total**              | ** ** |
| ** **                                                                           | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred**    | ** ** | **During the** | ** ** | **Other**         | ** ** | **Stockholders’** | ** ** |
| ** **                                                                           | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Stock-Based** | ** ** | **Development**     | ** ** | **Comprehensive** | ** ** | **Equity**             | ** ** |
| ** **                                                                           | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**     | ** ** | **Compensation**    | ** ** | **Stage**         | ** ** | **(Loss) Income** | ** ** | **(Deficit)** | ** ** |
| Issuance of common  stock upon exercise of stock options at $0.80 per share for cash |       | 13,250                |       |           | —     |            |       |                | 11         |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 11 |   |   |
| Accretion on  mandatorily redeemable convertible preferred stock                     |       | —                |       |           | —     |            |       |                | (597       | )                 |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (597 | ) |   |
| Deferred stock-based  compensation                                                   |       | —                |       |           | —     |            |       |                | 4,710      |              |       |                   | (4,710     | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of  deferred stock-based compensation                                   |       | —                |       |           | —     |            |       |                | —     |              |       |                   | 4,001      |   |   |   | — |   |   |   | — |   |   |   | 4,001 |   |   |
| Reversal of  deferred stock-based compensation due to cancellation                   |       | —                |       |           | —     |            |       |                | (300       | )                 |       |                   | 300        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Issuance of stock  options to nonemployees for services                              |       | —                |       |           | —     |            |       |                | 300        |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 300 |   |   |
| Issuance of  warrants to purchase common stock                                       |       | —                |       |           | —     |            |       |                | 2,353      |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 2,353 |   |   |
| Components of other  comprehensive loss:                                             |       |                  |       |           |       |            |       |                |       |              |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                             |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | (32,576 | ) |   |   | — |   |   |   | (32,576 | ) |   |
| Change in  unrealized gain (loss) on marketable securities                           |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | (21 | ) |   |   | (21 | ) |   |
| Total  comprehensive loss                                                            |       | —                |       |           | —     |            |       |                | —     |              |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (32,597 | ) |   |
| **Balance  at December 31, 2005**                                               |       | 332,731               |       |           | —     |            |       |                | 7,200      |              |       |                   | (409       | ) |   |   | (120,461 | ) |   |   | (21 | ) |   |   | (113,691 | ) |   |

 

66

----

**AFFYMAX, INC.(A development stage company)STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)Cumulative Period from July 20, 2001 (Date of Inception) toDecember 31, 2006(in thousands, except share and per share data)**
|                                                                                               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **       | ** ** | **Deficit**         | ** ** | ** **             | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------|------------|---------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **       | ** ** | **Accumulated**     | ** ** | ** **             | ** ** | **Total**              | ** ** |
| ** **                                                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **Deferred**     | ** ** | **During the** | ** ** | **Other**              | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                    | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Stock-Based** | ** ** | **Development**  | ** ** | **Comprehensive**   | ** ** | **Equity**             | ** ** |
| ** **                                                                                    | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Compensation** | ** ** | **Stage**           | ** ** | **(Loss) Income** | ** ** | **(Deficit)**          | ** ** |
| Issuance of common stock upon exercise of stock  options at $0.80 to $4.36 per share for cash |       | 202,401               |       |        | 1          |            |       |             | 150        |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 151 |   |   |
| Conversion of Series A preferred stock                                                   |       | 848,293               |       |        | 1          |            |       |             | 22,999     |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 23,000 |   |   |
| Conversion of Series C preferred stock                                                   |       | 6,626                 |       |        | —     |            |       |             | 100        |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 100 |   |   |
| Revision of allocated fair value of warrants                                                  |       | —                |       |        | —     |            |       |             | (247       | )                   |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | (247 | ) |   |
| Accretion on mandatorily redeemable convertible  preferred stock                              |       | —                |       |        | —     |            |       |             | (815       | )                   |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | (815 | ) |   |
| Deferred stock-based compensation                                                             |       | —                |       |        | —     |            |       |             | (809       | )                   |       |                   | 809        |                   |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of deferred stock-based  compensation                                            |       | —                |       |        | —     |            |       |             | —     |                |       |                   | (476       | )                      |       |   | — |   |   |   | — |   |   |   | (476 | ) |   |
| Employee stock-based compensation under  SFAS No. 123(R)                            |       | —                |       |        | —     |            |       |             | 2,152      |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 2,152 |   |   |
| Reversal of deferred stock-based compensation  due to cancellations                           |       | —                |       |        | —     |            |       |             | 18         |                |       |                   | (18        | )                      |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Issuance of stock options to nonemployees for  services                                       |       | —                |       |        | —     |            |       |             | 346        |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 346 |   |   |
| Repurchase of common stock                                                                    |       | (880                  | )          |        | —     |            |       |             | (1         | )                   |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | (1 | ) |   |
| Conversion of Series C warrant to common stock  warrant                                  |       | —                |       |        | —     |            |       |             | 56         |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 56 |   |   |
| Conversion of preferred stock to common stock upon  IPO                                       |       | 8,993,572             |       |        | 9          |            |       |             | 156,719    |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 156,728 |   |   |
| Issuance of common stock upon exercise of warrant for  cash                                   |       | 107,268               |       |        | —     |            |       |             | 1,824      |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 1,824 |   |   |
| Issuance of common stock upon cashless exercise of  warrants                                  |       | 133,293               |       |        | —     |            |       |             | —     |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Proceeds from common stock issued upon IPO, net of  issuance costs                            |       | 4,255,000             |       |        | 4          |            |       |             | 96,081     |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | 96,085 |   |   |
| Elimination of fractional shares resulting from  reverse stock split                          |       | —                |       |        | —     |            |       |             | (2         | )                   |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | (2 | ) |   |
| Components of  other comprehensive loss:                                                      |       |                  |       |        |       |            |       |             |       |                |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                      |       | —                |       |        | —     |            |       |             | —     |                |       |                   | —     |                   |       |   | (48,288 | ) |   |   | — |   |   |   | (48,288 | ) |   |
| Change in unrealized gain (loss) on marketable  securities                                    |       | —                |       |        | —     |            |       |             | —     |                |       |                   | —     |                   |       |   | — |   |   |   | (23 | ) |   |   | (23 | ) |   |
| Total comprehensive loss                                                                      |       | —                |       |        | —     |            |       |             | —     |                |       |                   | —     |                   |       |   | — |   |   |   | — |   |   |   | (48,311 | ) |   |
| **Balance  at December 31, 2006**                                                        |       | 14,878,304            |       |        | $          | 15              |       |             |       | $                   | 285,771    |                   |       |                   | $          | (94 | ) |   |   | $ | (168,749 | ) |   |   | $ | (44 | ) |   |   | $ | 116,899 |   |   |
|                                                                                               |            |                       |            |             |            |                 |            |                  |            |                     |            |                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes arean integral part of these financial statements.

67

----

**AFFYMAX,INC.(A development stage company)**

**STATEMENTSOF CASH FLOWS**

**(inthousands)**

| ** **                                                                                                              | ** ** | **Year Ended December 31,** | ** ** | **Cumulative Period   From July 20, 2001   (Date of Inception) to** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2006**                                   | ** ** | **2005**                                                                                               | ** ** | **2004** | ** ** | **December 31, 2006** | ** ** |
| **Cash  flows from operating activities**                                                                               |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Net loss                                                                                                                |       | $                                          | (48,288    | )                                                                                                      | $          | (32,576 | ) | $ | (21,398 | ) |   | $ | (168,749 | ) |   |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities                               |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Depreciation and  amortization                                                                                          |       | 704                                        |       | 729                                                                                                    |       | 860 |   |   | 21,030 |   |   |
| Stock-based  compensation expense                                                                                       |       | 2,022                                      |       | 4,301                                                                                                  |       | 13 |   |   | 6,466 |   |   |
| Interest expense related to  common stock warrants                                                                      |       | 56                                         |       | —                                                                                                 |       | — |   |   | 56 |   |   |
| Loss on termination of  capital lease                                                                                   |       | —                                     |       | —                                                                                                 |       | — |   |   | 156 |   |   |
| (Gain) loss on disposal of  fixed assets                                                                                |       | (11                                        | )          | (57                                                                                                    | )          | (201 | ) |   | 175 |   |   |
| Impairment of assets                                                                                                    |       | —                                     |       | —                                                                                                 |       | — |   |   | 4,224 |   |   |
| Realized (gain) loss on  investments                                                                                    |       | (46                                        | )          | —                                                                                                 |       | — |   |   | (93 | ) |   |
| Lease deposit write off                                                                                                 |       | —                                     |       | —                                                                                                 |       | — |   |   | 23 |   |   |
| Changes in operating assets and liabilities :                                                                           |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Related party receivable                                                                                                |       | (10,191                                    | )          | —                                                                                                 |       | — |   |   | (10,191 | ) |   |
| Prepaid expenses and other  current assets                                                                              |       | (4,368                                     | )          | (102                                                                                                   | )          | (148 | ) |   | (4,818 | ) |   |
| Other assets                                                                                                            |       | 1,153                                      |       | 100                                                                                                    |       | 100 |   |   | 1,353 |   |   |
| Accounts payable                                                                                                        |       | 5,777                                      |       | 2,530                                                                                                  |       | 253 |   |   | 8,507 |   |   |
| Accrued liabilities                                                                                                     |       | 693                                        |       | 478                                                                                                    |       | 702 |   |   | 1,968 |   |   |
| Deferred revenue                                                                                                        |       | 120,821                                    |       | —                                                                                                 |       | — |   |   | 120,821 |   |   |
| Other long term liabilities                                                                                             |       | (24                                        | )          | (168                                                                                                   | )          | (130 | ) |   | 156 |   |   |
| Net cash provided by (used  in) operating activities                                                                    |       | 68,298                                     |       | (24,765                                                                                                | )          | (19,949 | ) |   | (18,916 | ) |   |
| **Cash  flows from investing activities**                                                                               |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Purchases of property and equipment                                                                                     |       | (1,452                                     | )          | (127                                                                                                   | )          | (134 | ) |   | (3,261 | ) |   |
| Purchases of marketable securities                                                                                      |       | (226,999                                   | )          | (141,031                                                                                               | )          | (41,118 | ) |   | (524,145 | ) |   |
| Maturities of marketable securities                                                                                     |       | 187,632                                    |       | 120,579                                                                                                |       | 41,101 |   |   | 441,310 |   |   |
| Proceeds from sale of property and equipment                                                                            |       | 27                                         |       | 77                                                                                                     |       | 215 |   |   | 533 |   |   |
| Acquisition of net assets, net of cash acquired                                                                         |       | —                                     |       | —                                                                                                 |       | — |   |   | (1,086 | ) |   |
| Change in restricted cash                                                                                               |       | (2,186                                     | )          | —                                                                                                 |       | — |   |   | (2,186 | ) |   |
| Net cash provided by (used  in) investing activities                                                                    |       | (42,978                                    | )          | (20,502                                                                                                | )          | 64 |   |   | (88,835 | ) |   |
| **Cash  flows from financing activities**                                                                               |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Repurchases  of common stock                                                                                            |       | (1                                         | )          | —                                                                                                 |       | (13 | ) |   | (464 | ) |   |
| Proceeds  from issuance of common stock upon exercise of stock options, including  early exercise of stock options |       | 204                                        |       | 11                                                                                                     |       | 18 |   |   | 744 |   |   |
| Proceeds  from issuance of common stock upon exercise of common stock warrant                                           |       | 1,824                                      |       | —                                                                                                 |       | — |   |   | 1,824 |   |   |
| Proceeds  from issuance of common stock                                                                                 |       | —                                     |       | —                                                                                                 |       | — |   |   | 1,000 |   |   |
| Proceeds  from issuance of preferred stock, net of issuance costs                                                       |       | 9,982                                      |       | 58,144                                                                                                 |       | 19,929 |   |   | 157,035 |   |   |
| Proceeds  from IPO, net of issuance costs                                                                               |       | 96,085                                     |       | —                                                                                                 |       | — |   |   | 96,085 |   |   |
| Principal  payments under capital lease  obligations                                                                    |       | (272                                       | )          | (146                                                                                                   | )          | — |   |   | (932 | ) |   |
| Net  cash provided by financing activities                                                                              |       | 107,822                                    |       | 58,009                                                                                                 |       | 19,934 |   |   | 255,292 |   |   |
| Net  increase in cash and cash equivalents                                                                              |       | 133,142                                    |       | 12,742                                                                                                 |       | 49 |   |   | 147,541 |   |   |
| Cash  and cash equivalents at beginning of the period                                                                   |       | 14,399                                     |       | 1,657                                                                                                  |       | 1,608 |   |   | — |   |   |
| Cash  and cash equivalents at end of the period                                                                         |       | $                                          | 147,541    |                                                                                                   | $          | 14,399 |   | $ | 1,657 |   |   | $ | 147,541 |   |   |

 

68

----

**AFFYMAX,INC.(A development stage company) (Continued)**

**STATEMENTSOF CASH FLOWS**

**(inthousands)**

| ** **                                                                                     | ** ** | **Year Ended December 31,** | ** ** | **Cumulative Period   From July 20, 2001   (Date of Inception) to** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                   | ** ** | **2005**                                                                                               | ** ** | **2004** | ** ** | **December 31, 2006** | ** ** |
| **Supplemental disclosures for  cash flow information**                                        |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Interest paid                                                                                  |       | $                                          | 27         |                                                                                                   | $          | 26 |   | $ | — |   |   | $ | 110 |   |   |
| **Noncash investing and financing  activities**                                                |       |                                       |       |                                                                                                   |       |   |   |   |   |   |   |
| Accretion on  mandatorily redeemable convertible preferred stock                               |       | 815                                        |       | 597                                                                                                    |       | 105 |   |   | 1,899 |   |   |
| Change in  unrealized loss on marketable securities                                            |       | (23                                        | )          | (21                                                                                                    | )          | — |   |   | (44 | ) |   |
| Deferred stock-based  compensation, net of cancellations                                       |       | (791                                       | )          | 4,410                                                                                                  |       | — |   |   | 3,619 |   |   |
| Issuance of  warrants to purchase common stock/(Revision of allocated fair value of  warrants) |       | (247                                       | )          | 2,353                                                                                                  |       | — |   |   | 2,106 |   |   |
| Additions to  property and equipment under capital lease obligations                           |       | 172                                        |       | 679                                                                                                    |       | — |   |   | 1,426 |   |   |
| Conversion of  Series A preferred stock                                                   |       | 23,000                                     |       | —                                                                                                 |       | — |   |   | 23,000 |   |   |
| Conversion of  Series C preferred stock                                                   |       | 100                                        |       | —                                                                                                 |       | — |   |   | 100 |   |   |
| Conversion of preferred  stock upon IPO                                                        |       | 156,728                                    |       | —                                                                                                 |       | — |   |   | 156,728 |   |   |
|                                                                                                |            |                                            |            |                                                                                                        |            |  |  |  |  |  |  |  |  |  |  |

 

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

69

----

**AFFYMAX, INC.(A development stage company)**

**NOTES TO FINANCIALSTATEMENTS**

**1.**                 TheCompany

Affymax, Inc. (the “Company”), a Delawarecorporation, was incorporated on July 20, 2001. The Company is abiopharmaceutical company developing novel peptide-based drug candidatesto improve the treatment of serious and often life-threatening conditions. TheCompany’s lead product candidate, Hematide, is designed to treat anemiaassociated with chronic kidney disease and cancer. Hematide is a syntheticpeptide-based erythropoiesis stimulating agent, or ESA, designed tostimulate production of red blood cells. Hematide is currently in Phase 2clinical trials in patients suffering from end-stage renal disease who are ondialysis, as well as in earlier stage chronic kidney disease patients, orpredialysis patients.

In July 2001, the Company entered into an AssetPurchase Agreement (the “Agreement”) with Affymax Research Institute, itsparent company, GlaxoSmithKline plc and certain other subsidiaries ofGlaxoSmithKline plc (collectively, “GSK”). Pursuant to the Agreement, theCompany acquired from GSK certain assets, technology and intellectual property,while assuming certain liabilities. In exchange for the assets and liabilities,the Company issued shares of Series A Mandatorily Redeemable ConvertiblePreferred Stock which were converted into 848,293 shares of common stock in April 2006(Note 6).

In December 2006, the Company completed itsinitial public offering of 4,255,000 shares of its common stock at a publicoffering price of $25.00 per share, including the underwriters’ exercise oftheir option to purchase an additional 555,000 shares to cover over-allotments.The aggregate net cash proceeds from the offering, including the shares issuedupon exercise of the over-allotment option, were approximately $96.1 million,after deducting the underwriting discount and commissions and other offeringexpenses. In connection with the closing of the initial public offering, all ofthe Company’s shares of convertible preferred stock outstanding at the time ofthe offering were automatically converted into 8,993,572 shares of commonstock. In addition, the Company issued 240,561 shares of its common stock in December 2006upon the net and cash exercise of outstanding warrants that would haveterminated if not exercised prior to the closing of the Company’s initialpublic offering.

The Company is in thedevelopment stage and since inception has devoted substantially all of itsefforts to research and development, raising capital and recruiting personnel.

**2.**                 Summaryof Significant Accounting Policies

**Reverse Stock Split**

In October 2006, theCompany’s board of directors approved a one-for-four reverse stock split of theCompany’s common stock and redeemable convertible preferred stock, which wasapproved by the Company’s stockholders in November 2006. The split becameeffective in November 2006 upon the filing of an amendment to the restatedcertificate of incorporation. All share and per share amounts included in theCompany’s financial statements have been adjusted to reflect this stock splitfor all periods presented.

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period. Actual results could differ from those estimates.

70

----

**Cash and CashEquivalents**

Cash and cash equivalentsare stated at cost, which approximates market value. The Company considers allhighly liquid investments purchased with an original maturity of three monthsor less to be cash equivalents.

**Concentration ofRisk and Uncertainties**

Financial instruments that potentially subject theCompany to a concentration of credit risk consist of cash, cash equivalents andmarketable securities. The Company deposits excess cash in accounts with threemajor financial institutions in the United States. Deposits in these banksmay exceed the amount of insurance provided on such deposits. The Company hasnot experienced any losses on its deposits of cash and cash equivalents. TheCompany believes that its guidelines for investment of its excess cashmaintains safety and liquidity through its policies on diversification andinvestment maturity.

The Company has experienced significant operatinglosses since inception. At December 31, 2006, the Company had a deficitaccumulated during the development stage of approximately $168.7 million.The Company has generated no revenue from product sales to date. The Companyhas funded its operations to date principally from the sale of securities andcollaboration agreements. The Company expects to incur substantial additionaloperating losses for the next several years and may need to obtain additionalfinancing in order to complete the clinical development of Hematide and otherproduct candidates, launch and commercialize and product candidates for whichit receives regulatory approval, continue research and development programs andlicense or acquire additional product candidates. There can be no assurancethat such financing will be available or will be at terms acceptable to theCompany.

The Company is currentlydeveloping its first product offering and has no products that have receivedregulatory approval. Any products developed by the Company will requireapproval from the U.S. Food and Drug Administration (“FDA”) or foreignregulatory agencies prior to commercial sales. There can be no assurance thatthe Company’s products will receive the necessary approvals. If the Company isdenied such approvals or such approvals are delayed, it could have a materialadverse effect on the Company. To achieve profitable operations, the Companymust successfully develop, test, manufacture and market products. There can beno assurance that any such products can be developed successfully or manufacturedat an acceptable cost and with appropriate performance characteristics, or thatsuch products will be successfully marketed. These factors could have amaterial adverse effect on the Company’s future financial results.

**Fair Value ofFinancial Instruments**

For financial instrumentsconsisting of cash and cash equivalents, accounts payable and accruedliabilities included in the Company’s financial statements, the carryingamounts are reasonable estimates of fair value due to their short maturities.Estimated fair values for short-term and long-term investments, which areseparately disclosed elsewhere, are based on quoted market prices for the sameor similar instruments. Based on borrowing rates currently available to theCompany for loans with similar terms, the carrying value of lease obligationsapproximates fair value.

**MarketableSecurities**

Marketable securities are classified asavailable-for-sale in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities,* and arecarried at their market value at the balance sheet date. Realized gains andlosses on sales of all such securities are reported in earnings and computedusing the specific identification method. Unrealized gains and losses arereported as a separate component of stockholders’ equity (deficit) untilrealized.

71

----

Marketable securitiesinclude auction rate securities that are structured as short-term, highlyliquid investments that can be readily converted into cash every 30 to90 days. However, since the stated or contractual maturities of thesesecurities is greater than 90 days, these securities were classified asshort-term investments.

**MandatorilyRedeemable Convertible Preferred Stock**

The carrying value of thepreviously outstanding Series A, Series B, Series C and Series DMandatorily Redeemable Convertible Preferred Stock was increased by periodicaccretion, using the effective interest method, so that the carrying amountwould equal the redemption value at the redemption date.

**Research andDevelopment**

All research anddevelopment costs are expensed as incurred.

**Property andEquipment**

Property and equipment arestated at cost less accumulated depreciation and amortization. Depreciation andamortization of property and equipment are calculated using the straight-linemethod over the estimated useful lives of the assets, generally three to fiveyears. Assets under capital lease and leasehold improvements are amortized overthe lesser of their estimated useful lives or the term of the related lease.Maintenance and repairs are charged to operations as incurred.

**Revenue Recognition**

The Company recognizes revenue in accordance with theSecurities and Exchange Commission’s Staff Accounting Bulletin No. 104, *Revenue Recognition in Financial Statements*.When evaluating multiple element arrangements, the Company considers whetherthe components of the arrangement represent separate units of accounting asdefined in Emerging Issues Task Force (“EITF”) Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables*(“EITF 00-21”). Application of this standard requires subjectivedeterminations and requires management to make judgments about the fair valueof the individual elements and whether such elements are separable from theother aspects of the contractual relationship.

The Company has entered into two separatecollaboration agreements (the “Arrangement”) with Takeda, which have beencombined for accounting purposes due to their proximity of negotiation. TheCompany evaluated the multiple elements under the combined single arrangementin accordance with the provisions of EITF 00-21. As the Company wasunable to determine the stand-alone value of the delivered elements andobtain verifiable objective evidence to determine the fair value of theundelivered elements, the Company concluded that there was a single unitof accounting.

The Company was unable to determine the period of itsperformance obligations under the Arrangement as the Company’s required participationon the joint steering committee extends for as long as products subject to thecollaboration with Takeda are being sold by either of the parties. Accordingly,the contractual term of the Company’s joint steering committee obligations iscurrently indefinite. As a result, revenue for the single unit of accounting isrecorded on a proportional performance basis as long as the overall Arrangementis determined to be profitable.

The Company accounts forthe Arrangement using a zero profit proportional performance model (i.e.,revenue will be recognized equal to direct costs incurred, but not in excess ofcash received or receivable assuming that the overall Arrangement is expectedto be profitable). The Company uses an inputbased measure, specifically direct costs, to determine proportional performancebecause the Company believes that the inputs are representative of the valuebeing conveyed to Takeda through the research and development 

72

----

activitiesand delivery of the active pharmaceutical ingredients (“API”). The Companybelieves that using direct costs as the unit of measure of proportionalperformance also most closely reflects the level of effort related to theCompany’s performance under the Arrangement. Direct costs are those costs thatdirectly result in the culmination of an earnings process for which Takedareceives a direct benefit. The nature of these costs are third party andinternal costs associated with conducting clinical trial activities fordialysis and pre-dialysis indications, costs associated with the manufacturingof API and API stability testing, allocated payroll related costs forrepresentatives participating on the joint steering committee and sales andmarketing costs during the co-commercialization period. Direct costs specificallyexclude costs of a general and administrative nature, upfront paymentsto manufacturers unrelated to specific product manufactured such as reservationof capacity, cost for API not yet deliveredto Takeda, travel and expense related costs, sales and marketing costs duringthe development period, any research and development costs not associated withHematide, interest, depreciation and amortization expense. Revenue will berecognized equal to direct costs incurred, but not in excess of cash received or receivable.

Amounts resulting from payments received in advance ofrevenue recognized are recorded as deferred revenue until the earlier of (i) whenthe Company can meet the criteria for separate recognition of each elementunder the guidance of EITF 00-21 or (ii) after the Company hasfulfilled all of its contractual obligations under the Arrangement.

The Company is required toassess the profitability of the overall Arrangement on a periodic basisthroughout the life of the Arrangement when events or circumstances indicate apotential change in facts. Profitability is defined as a net cash inflowresulting from the Arrangement over its life. Such assessment is based onestimates to determine the most likely outcome based on available facts andcircumstances at each assessment date. The estimates include the considerationof factors such as the progress and timing of clinical trials, competitive ESAs(erythropoiesis stimulating agents) in the market, drug related serious adverseevents and other safety issues in the clinical trials, pricing reimbursement inrelevant markets and historical costs incurred compared to original estimates.When the periodic assessment or other events or circumstances indicate a losswill result from performance under the Arrangement, costs will continue to berecognized as they are incurred. However, revenue will be deferred untileither: i) the Arrangement becomes profitable, at which point revenue willcontinue to be recognized under the zero profit proportional performance model,or (ii) the end of the Arrangement.

**Impairment ofLong-Lived Assets**

The Company evaluates itslong-lived assets for indicators of possible impairment by comparison of thecarrying amounts to future net undiscounted cash flows expected to be generatedby such assets when events or changes in circumstances indicate the carryingamount of an asset may not be recoverable. Should an impairment exist, theimpairment loss would be measured based on the excess carrying value of theasset over the asset’s fair value or discounted estimates of future cash flows.

**Intangible Assets**

Intangible assetsresulting from the acquisition of assets and liabilities from GSK were beingamortized on a straight-line basis over their estimated useful lives of threeyears. Amortization expense for the years ended December 31, 2004, 2005,2006 and for the cumulative period from July 20, 2001 (date of inception)through December 31, 2006 was $0, $0, $0 and $14.5 million,respectively.

**ComprehensiveIncome (Loss)**

Comprehensive income(loss) generally represents all changes in stockholders’ equity except thoseresulting from investments or contributions by stockholders. The Company’sunrealized gains (losses) on 

73

----

available-for-salesecurities represent the components of comprehensive loss that are excludedfrom the net loss.

**Segment Information**

The Company operates inone business segment, which encompasses all the geographical regions.Management uses one measurement of profitability and does not segregate itsbusiness for internal reporting.

**Income Taxes**

The Company accounts forincome taxes under the liability method, whereby deferred tax assets andliabilities are determined based on the difference between the financialstatement and tax bases of assets and liabilities using enacted tax rates ineffect for the year in which the differences are expected to affect taxableincome. Valuation allowances are established when necessary to reduce deferredtax assets to the amounts expected to be realized.

**Net Loss per CommonShare**

Basic and diluted net lossper common share is computed using the weighted-average number of sharesof common stock outstanding during the period. Stock options, common stocksubject to repurchase, warrants, mandatorily redeemable convertible preferredstock and redeemable convertible preferred stock were not included in thediluted net loss per common share calculation for all periods presented becausethe inclusion of such shares would have had an antidilutive effect.

| ** **                                                                                                          | ** ** | **Year Ended December 31,**                         | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| Numerator:                                                                                                          |       |                                                               |       |   |   |   |   |
| Net loss attributable to common stockholders                                                                        |       | $                                                                  | (49,103    | ) | $ | (33,173 | ) | $ | (21,503 | ) |
| Denominator:                                                                                                        |       |                                                               |       |   |   |   |   |
| Weighted-average number of common shares  outstanding used in computing basic and diluted net loss per common share |       | 1,508                                                              |       | 326 |   | 305 |   |
| Basic and diluted net  loss per common share                                                                        |       | $                                                                  | (32.56     | ) | $ | (101.65 | ) | $ | (70.39 | ) |

 

The following mandatorily redeemable convertiblepreferred stock, redeemable convertible preferred stock, stock options, commonstock subject to repurchase and warrants were excluded from the computation ofdiluted net loss per common share for the periods presented because includingthem would have an antidilutive effect (in thousands):

| ** **                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Mandatorily  redeemable convertible preferred stock (as if converted) |       | —                                     |       | 9,280 |   | 5,305 |   |
| Options to  purchase common stock                                          |       | 1,333                                      |       | 700 |   | 677 |   |
| Common stock  subject to repurchase                                        |       | 31                                         |       | 2 |   | — |   |
| Warrants to  purchase common stock                                         |       | 2                                          |       | 438 |   | — |   |
| Warrants to purchase  mandatorily redeemable convertible preferred stock   |       | —                                     |       | 2 |   | — |   |

 

**Stock-BasedCompensation**

Prior to January 1, 2006 the Company accountedfor stock-based employee compensation arrangements using the intrinsicvalue method in accordance with the recognition and measurement provisions ofAccounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*,and related interpretations, including the Financial Accounting Standards Board(“FASB”) 

74

----

Interpretation No. 44,*Accounting for Certain TransactionsInvolving Stock Compensation, an Interpretation of APB Opinion No. 25*.Under APB No. 25, compensation expense is based on the difference, ifany, on the date of grant between the fair value of the Company’s common stockand the exercise price of the stock option.

Effective January 1, 2006, the Company adoptedSFAS No. 123(R), *Share-BasedPayment*, using the prospective transition method, which requires themeasurement and recognition of compensation expense for all share-basedpayment awards granted, modified and settled to the Company’s employees anddirectors after January 1, 2006. The Company’s financial statements as ofand for the year ended December 31, 2006 reflect the impact of SFAS No. 123(R).In accordance with the prospective transition method, the Company’s financialstatements for prior periods have not been restated to reflect, and do notinclude, the impact of SFAS No. 123(R).

The Company had a choice of two attribution methodsfor allocating compensation costs under SFAS No. 123(R): the “straight-linemethod,” which allocates expense on a straight-line basis over the requisiteservice period of the last separately vesting portion of an award, or the “gradedvesting attribution method,” which allocates expense on a straight-line basisover the requisite service period for each separately vesting portion of theaward as if the award was, in substance, multiple awards. The Company chose theformer method and amortized the fair value of each option on a straight-linebasis over the requisite period of the last separately vesting portion of eachaward.

The Company accounts forequity instruments issued to nonemployees in accordance with the provisions ofEmerging Issues Task Force No. 96-18, *Accounting for Equity Instruments That Are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods or Services*(“EITF 96-18”). The equity instruments, consisting of stock options,are valued using the Black-Scholes valuation model. The measurement ofstock-based compensation is subject to periodic adjustments as theunderlying equity instruments vest.

**Revisions toPreviously Reported Financial Information**

***Stock-based compensation***

The Company identified an overstatement of stock-basedcompensation charges of $2.4 million for the year ending December 31,2005. It was determined that the 2005 overstatement of stock based compensationwas immaterial to the annual financial statements for the years ending December31, 2006 and 2005 and to the quarterly financial information for the sameperiods and therefore was corrected in the first quarter of 2006.

***Other items***

The Company concluded thatit was appropriate to revise certain balances in the statement of cash flowsfor the year ended December 31, 2005. The revision resulted from theinclusion of cash equivalents in the purchases and maturities of marketablesecurities. Accordingly, the Company revised the statement of cash flows for theyear ended December 31, 2005 to reduce the purchases and maturities ofmarketable securities by $47 million. This revision had no impact on thebalance sheets or statement of operations. Furthermore, this revision does notaffect previously reported cash flows from operations, investing activities orfrom financing activities in the previously reported statements of cash flows.

**Recent AccountingPronouncements**

In June 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109* (“FIN No. 48”),which clarifies the accounting for uncertainty in tax positions. FIN No. 48requires that the Company recognize the impact of a tax position in thefinancial statements, if that position is more likely than not to be sustainedon audit, based on the 

75

----

technical merits of theposition. The provisions of FIN No. 48 are effective as of the beginningof the Company’s 2007 fiscal year, with the cumulative effect, if any, of thechange in accounting principle recorded as an adjustment to opening retainedearnings. The Company is currently evaluating the potential impact that theadoption of FIN No. 48 will have on its financial statements.

In September 2006, the SEC staff issued StaffAccounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*. SAB 108 was issued in orderto eliminate the diversity of practice surrounding how public companiesquantify financial statement misstatements. Traditionally, there have been twowidely-recognized methods for quantifying the effects of financialstatement misstatements: the “roll-over” method and the “iron curtain”method. The roll-over method focuses primarily on the impact of amisstatement on the income statement—including the reversing effect of prioryear misstatements—but its use can lead to the accumulation of misstatements inthe balance sheet. The iron-curtain method, on the other hand, focusesprimarily on the effect of correcting the period-end balance sheet withless emphasis on the reversing effects of prior year errors on the incomestatement. In SAB 108, the SEC staff established an approach that requiresquantification of financial statement misstatements based on the effects of themisstatements on each of the company’s financial statements and the relatedfinancial statement disclosures. This model is commonly referred to as a “dualapproach” because it requires quantification of errors under both the ironcurtain and the roll-over methods. The Company adopted SAB 108 during thethird quarter of 2006.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*, whichdefines fair value, establishes a framework for measuring fair value undergenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, but provides guidance on how to measure fair value by providing afair value hierarchy used to classify the source of the information. SFAS No. 157is effective commencing with the Company’s fiscal year 2009 annual financialstatements. The Company is currently assessing the potential impact that theadoption of SFAS No. 157 will have on its financial statements.

In February 2007, theFASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities-Including an amendment of FASBStatement No. 115* (“SFAS No. 159”), which is effective January 1,2008. SFAS No. 159 permits the Company to choose to measure many financialinstruments and certain other items at fair value. The objective is to improvefinancial reporting by providing entities with the opportunity to mitigatevolatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. SFAS No. 159 is expected to expand the use of fair valuemeasurement, with is consistent with the Board’s long-term measurementobjectives for accounting for financial instruments. The Company is currentlyevaluating the impact, if any, that the adoption of SFAS No. 159 will haveon its financial statements on the adoption date of January 1, 2008.

**3.**                 BalanceSheet Components

**Property andEquipment, Net**

Propertyand equipment consist of the following (in thousands):

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Leasehold  improvements                          |       | $                     | 486        |   | $ | 303 |   |
| Equipment                                        |       | 5,757                 |       | 4,864 |   |
| Software                                         |       | 489                   |       | 449 |   |
|                                             |       | 6,732                 |       | 5,616 |   |
| Less: Accumulated  depreciation and amortization |       | (4,718                | )          | (4,506 | ) |
|                                             |       | $                     | 2,014      |   | $ | 1,110 |   |

 

76

----

Depreciation andamortization expense for the years ended December 31, 2004, 2005 and 2006was $860,000, $729,000 and $704,000, respectively. Depreciation andamortization expense for the cumulative period from July 20, 2001 (date ofinception) through December 31, 2006 was $6.6 million.

The Company leases certainassets under capital leases having terms up to 3 years. Assets held by theCompany at December 31, 2005 and 2006 under such lease arrangements areincluded in property and equipment on the balance sheets as follows(in thousands):

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Equipment                                        |       | $                     | 966        |   | $ | 924 |   |
| Less: Accumulated  depreciation and amortization |       | (549                  | )          | (401 | ) |
|                                             |       | $                     | 417        |   | $ | 523 |   |

 

**Accrued Liabilities**

Accrued liabilitiesconsist of the following (in thousands):

| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Payroll and  related expenses |       | $                     | 1,923      |   | $ | 1,199 |   |
| Legal expenses                |       | 299                   |       | 264 |   |
| Deferred rent                 |       | 177                   |       | 171 |   |
| Sales and use tax             |       | 19                    |       | 103 |   |
| Other                         |       | 148                   |       | 81 |   |
|                          |       | $                     | 2,566      |   | $ | 1,818 |   |

 

**4.**                 Investments

Thefollowing is a summary of the Company’s available-for-sale marketablesecurities (in thousands):

| ** **                    | ** ** | **As of December 31, 2006** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|
| ** **                    | ** ** | **Cost**                                        | ** ** | **Unrealized  Gain  (Loss)** | ** ** | **Fair  Value** | ** ** |
| Short-term investments:       |       |                                            |       |   |   |   |   |   |   |
| Corporate securities          |       | $                                               | 12,342     |   |   | $ | (7 | ) |   | $ | 12,335 |   |
| Foreign securities            |       | 3,196                                           |       |   | (1 | ) |   | 3,195 |   |
| Certificates of deposit       |       | 5,507                                           |       |   | 2 |   |   | 5,509 |   |
| Government securities         |       | 13,000                                          |       |   | (28 | ) |   | 12,972 |   |
| Auction rate securities       |       | 42,740                                          |       |   | — |   |   | 42,740 |   |
| Total short-term  investments |       | $                                               | 76,785     |   |   | $ | (34 | ) |   | $ | 76,751 |   |
| Long-term investments:        |       |                                            |       |   |   |   |   |   |   |
| Government  securities        |       | $                                               | 6,143      |   |   | $ | (10 | ) |   | $ | 6,133 |   |

 

| ** **                    | ** ** | **As of December 31, 2005** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|
| ** **                    | ** ** | **Cost**                                        | ** ** | **Unrealized  Gain  (Loss)** | ** ** | **Fair  Value** | ** ** |
| Short-term investments:       |       |                                            |       |   |   |   |   |   |   |
| Corporate  securities         |       | $                                               | 1,805      |   |   | $ | (4 | ) |   | $ | 1,801 |   |
| Foreign  securities           |       | 950                                             |       |   | (2 | ) |   | 948 |   |
| Government securities         |       | 18,160                                          |       |   | (16 | ) |   | 18,144 |   |
| Auction rate securities       |       | 22,600                                          |       |   | 1 |   |   | 22,601 |   |
| Total short-term  investments |       | $                                               | 43,515     |   |   | $ | (21 | ) |   | $ | 43,494 |   |

 

77

----

At December 31, 2006,the securities bear interest at rates between 4.0% and 5.4% per annum andmature between January 2007 and January 2008. Since inception therehave been no material realized gains and losses.

**5.**                 Commitmentsand Contingencies

The Company leases certain equipment under capitallease arrangements expiring at various dates through November 2008 atinterest rates of 2.2% to 7.2%. The capital leases are collateralized bycertain assets of the Company.

The Company rents its office facilities and certainequipment under noncancelable operating leases, which expire at various datesthrough September 2014. Under the terms of the leases, the Company isresponsible for certain taxes, insurance and maintenance expenses.

In September 2006, the Company entered into anoperating lease for additional office space in Palo Alto, California. The leasecommenced in November 2006 and terminates in December 2010. The totalsquare footage covered by the new lease is 30,630 square feet, of which weleased 15,315 square feet starting in November 2006 and the remaining15,315 square feet starting in September 2007.

In December 2006, the Company entered into anextension of the operating lease for office space in Palo Alto, California. Thelease extension commences in October 2007 and terminates in September 2014.The total square footage covered by the lease extension is 84,460 square feet,of which we lease 53,830 square feet starting in October 2007 and theremaining 30,630 square feet starting in January 2011.

Rent expense for the years ended December 31,2004, 2005, 2006 and, cumulatively, for the period from July 20, 2001(date of inception) through December 31, 2006 was $3.0 million,$3.0 million, $3.1 million and $16.4 million, respectively. TheCompany recognizes rent expense on a straight-line basis over the lease periodand has accrued for rent expense incurred but not paid.

Futureminimum payments under noncancelable lease obligations as of December 31,2006 are as follows (in thousands):

| ** **                               | ** ** | **Capital  Leases** | ** ** | **Operating  Leases** | ** ** |
|------------------------------------------|------------|---------------------|------------|-----------------------|------------|
| 2007                                     |       |                | $          | 306                   |       |   |   | $ | 3,389 |   |   |
| 2008                                     |       |                | 134        |                  |       |   | 2,505 |   |   |
| 2009                                     |       |                | 8          |                  |       |   | 2,572 |   |   |
| 2010                                     |       |                | —     |                  |       |   | 2,638 |   |   |
| 2011                                     |       |                | —     |                  |       |   | 2,826 |   |   |
| Thereafter                               |       |                | —     |                  |       |   | 8,212 |   |   |
| Total minimum  lease payments            |       |                | 448        |                  |       |   | $ | 22,142 |   |   |
| Less: Interest                           |       |                | (15        | )                     |       |   |   |   |   |
| Present value of  minimum lease payments |       |                | 433        |                  |       |   |   |   |   |
| Less: Amount due  within one year        |       |                | (293       | )                     |       |   |   |   |   |
| Amount due after one  year               |       |                | $          | 140                   |       |   |   |   |   |   |

 

***Legal Proceedings***

The Company has initiated binding arbitration andrelated litigation with Johnson & Johnson, Ortho-McNeilPharmaceutical, Inc., Ortho Pharmaceutical Corporation, The R.W. JohnsonPharmaceutical Research Institute and Johnson & Johnson PharmaceuticalResearch and Development, L.L.C., or, collectively, J&J, over ownership ofintellectual property related to erythropoietin receptor, or EPO-R, agonists(compounds capable of binding to and activating the EPO-R). This intellectualproperty 

78

----

is the subject of a numberof U.S. and international patents and patent applications assigned to theCompany and J&J, including a U.S. patent currently assigned to J&J,several U.S. patents currently assigned to the Company and a European patentapplication currently assigned to J&J. In this section, the Company refersto the patents and patent applications subject to the arbitration collectivelyas the “intellectual property in dispute”. The Company believes that it is thesole owner or co-owner of the intellectual property in dispute, including aEuropean patent application currently naming J&J as sole owner that mayissue in the near future and relates to specified ESA peptide compounds.J&J, on the other hand, alleges that they are the sole owner or co-owner ofthe intellectual property in dispute, including several U.S. patents on whichthe Company is currently named as sole owner that relate to specified peptidecompounds.

In June 2004, the Company filed a civil complaintin the Munich Regional Court in the Federal Republic of Germany against J&Jalleging that it is an owner or co-owner of J&J’s European patentapplication relating to agonist peptide dimers. In October 2005, J&Jfiled its response to the Company’s complaint, denying its claims ofinventorship and ownership. In April 2006, the Company requested the courtto dismiss the complaint so that the issues it raised could be resolvedpursuant to the arbitration proceeding described below. The court has done so.

In September 2004, the Company filed a civilcomplaint in the U.S. District Court for the Northern District of Illinois, orthe Illinois case, against J&J alleging claims for correction ofinventorship and ownership of the above-referenced patents and patentapplications assigned to J&J, for corresponding declaratory and injunctiverelief, for breach of contract, and for unjust enrichment and constructivetrust. The complaint alleges that the Affymax N.V. scientists are sole or co-inventorsof the intellectual property in dispute, including the above-referencedJ&J patents and patent applications, and that we are the sole or co-ownerof them. The complaint also alleges that J&J breached the three-yearResearch and Development Agreement between Affymax N.V. and a division of OrthoPharmaceutical Corporation, a subsidiary of J&J, or the R&D Agreement,by, among other things, engaging in a course of conduct designed to obtainpatents for itself and to deny the Company patents on the Affymax scientists’inventions. The complaint further alleges that the Company has suffered damagesas a result of J&J’s breaches and that J&J has been unjustly enrichedthrough its misconduct and should be subject to the imposition of aconstructive trust.

J&J denied all material claims in the Company’scomplaint and, among other things, counterclaimed that its employees are thetrue inventors of the intellectual property in dispute and that it is thereforeentitled to sole or co-ownership of the above-referenced patentsand patent applications assigned solely or jointly to the Company. J&J alsobrought related claims for breach of contract, breach of fiduciary duty, unjustenrichment and constructive trust. J&J alleges, among other things, thatAffymax N.V., Affymax Technologies, N.V. and Affymax Research Institute, or theAffymax Entities, filed in their own name certain patent applications allegedlyclaiming inventions of J&J employees without notifying or consulting withJ&J, that during patent prosecution the Affymax Entities improperly removedthe names of J&J employees from certain patent applications on which thoseemployees had been identified as inventors, and that these and other allegedbreaches entitle J&J to damages and waive all rights we may have had to theintellectual property in dispute.

J&J requested that the Illinois case be dismissedand the matter decided under the R&D Agreement’s arbitration provisions. InFebruary 2006, the Illinois court entered an order that the appropriateforum for us and J&J to resolve the inventorship, ownership, breach ofcontract and related claims was binding arbitration under the AmericanArbitration Association, or AAA, rules in Illinois. The Illinois courtheld that the claims pending in the German court were also subject to arbitrationand required us to dismiss the German complaint, which the Company has done.The Illinois court further stated that it will retain jurisdiction over thesubject matter during the arbitration in Illinois.

79

----

In April 2006, the Company filed a demand forarbitration with the AAA claiming that it is the owner or co-owner of theintellectual property in dispute and alleging claims for correction ofinventorship and ownership of the above-referenced patents and patentapplications assigned to J&J, for corresponding declaratory and injunctiverelief, for breach of contract, for unjust enrichment and constructive trust,and for breach of fiduciary duty. In May 2006, J&J filed its answerand counterclaims, substantially restating their allegations made in the U.S.and German courts. The AAA has appointed a panel of arbitrators, and thearbitrators have established a schedule for the arbitration. The parties havecommenced discovery.  The arbitrationhearing is scheduled to occur during the second half of 2008. The outcome ofthe matter is uncertain and regardless of outcome, the matter may have anadverse impact on the Company because of legal costs, diversion of managementresources and other factors.

From time to time, theCompany is involved in legal proceedings arising in the ordinary course of business.The Company believes there is no other litigation pending that could have,individually or in the aggregate, a material adverse effect on the financialposition, results of operations or cash flows.

**6.**                 Preferred Stock

The Company’s Certificateof Incorporation, as amended in February 2006, designates and authorizes34,609,592 shares of Series A, Series B, Series C and Series DMandatorily Redeemable Convertible Preferred Stock and 530,082 shares of Series ERedeemable Convertible Preferred Stock of which no shares are issued andoutstanding as of December 31, 2006. Series A, Series B, Series Cand Series D Mandatorily Redeemable Convertible Preferred Stock and Series ERedeemable Convertible Preferred Stock hereinafter are collectively referred toas preferred stock.

In April 2006, theholders of Series A Mandatorily Redeemable Convertible Preferred Stockvoluntarily elected to convert their shares of preferred stock at a conversionratio of approximately 1.4753 shares of common stock for each share ofpreferred stock, for an aggregate number of 848,293 shares of the Company’scommon stock.

In April 2006, 6,626shares of Series C Mandatorily Redeemable Convertible Preferred Stock heldby an individual automatically converted into 6,626 shares of the Company’scommon stock pursuant to the Company’s Certificate of Incorporation whichprovided that such shares would automatically convert into an equal number ofshares of the Company’s common stock if holders do not participate insubsequent equity financings within nine months of such financing.

In connection with theclosing of the Company’s initial public offering in December 2006, all ofthe Company’s shares of preferred stock outstanding at the time of the offeringwere automatically converted into 8,993,572 shares of the Company’s commonstock. Prior to the completion of theCompany’s initial public offering, each share of Series B MandatorilyRedeemable Convertible Preferred Stock was convertible into approximately1.4753 shares of common stock and each share of Series C and Series DMandatorily Redeemable Convertible Preferred Stock and Series E RedeemableConvertible Preferred Stock was convertible into one share ofcommon stock.

The Company’s Certificateof Incorporation, as amended and restated in December 2006, designates andauthorizes 10,000,000 shares of $0.001 par value preferred stock, of which noshares are issued and outstanding as of December 31, 2006. The rights,preferences and privileges of any preferred stock to be issued pursuant to theCompany’s current Certificate of Incorporation, as amended and restated, haveyet to be established.

80

----

As of December 31,2005, the preferred stock comprised of (in thousands, except share and pershare data):

| **Series** | ** ** | ** ** | ** ** | **Original  Issue  Price Per  Share** | ** ** | **Shares  Authorized** | ** ** | **Shares  Issued and  Outstanding** | ** ** | **Carrying  Amount** | ** ** | **Liquidation  Value Per  Share** | ** ** | **Liquidation  Amount** | ** ** |
|------------|------------|------------|------------|--------------------------------------------|------------|------------------------|------------|------------------------------------------|------------|----------------------|------------|----------------------------------------|------------|-------------------------|------------|
| A          |       |       | $          | 40.00                                      |       |                   | 2,300,000  |                                     |       | 575,000              |       |                                   | $          | 23,000                  |       |   | $ | 40.00 |   |   |   | $ | 23,000 |   |   |
| B          |       |       | 40.00      |                                       |       | 5,000,000              |       |                                     | 1,249,998  |                 |       | 49,711                                 |       |                    | 40.00      |   |   |   | 50,000 |   |   |
| C          |       |       | 15.09      |                                       |       | 10,609,592             |       |                                     | 2,650,399  |                 |       | 39,897                                 |       |                    | 15.09      |   |   |   | 40,000 |   |   |
| D          |       |       | 15.09      |                                       |       | 16,700,000             |       |                                     | 3,975,607  |                 |       | 56,176                                 |       |                    | 22.64      |   |   |   | 90,000 |   |   |
|       |       |       |       |                                       |       | 34,609,592             |       |                                     | 8,451,004  |                 |       | $                                      | 168,784    |                    |       |   |   |   |   | $ | 203,000 |   |   |

 

No dividends on preferredstock have been declared since inception through December 31, 2006.

**7.**                 Common Stock

The Company’s Certificateof Incorporation, as amended and restated in December 2006 in connectionwith the closing of the Company’s initial public offering, authorizes theCompany to issue 100,000,000 shares of $0.001 par value common stock.

The Company’s Certificateof Incorporation, as amended on July 8, 2005, authorized the Company toissue 50,500,000 shares of $0.0001 par value common stock.

**8.**                 Stock-BasedCompensation

***Equity IncentivePlans***

*2001 Stock Option/Stock Issuance Plan*

In September 2001,the Company adopted the 2001 Stock Option/Stock Issuance Plan (the “2001Plan”). The 2001 Plan provides for both the granting of stock options andissuing shares of stock to employees and consultants of the Company. Stockoptions granted under the 2001 Plan may be either incentive stock options ornonqualified stock options. Incentive stock options (“ISO”) may be granted onlyto Company employees. Nonqualified stock options (“NSO”) may be granted toCompany employees, directors and consultants. Stock issued under the 2001 Planmay be issued to employees, directors and consultants. Stock options under the2001 Plan may be granted for periods of up to ten years and at prices no lessthan the fair market value for ISO’s and 85% of the fair market value for NSOs,as determined by the Board of Directors. The exercise price of an ISO or NSOgranted to a 10% stockholder shall not be less than 110% of the estimated fairvalue of the shares on the date of grant. To date, stock options grantedgenerally become exercisable over four years. As of December 31, 2005 and2006, the Company has reserved 1,306,655 and 1,587,280,respectively, shares of common stock for issuance under the 2001 Plan. TheCompany issues new shares of common stock upon exercise of stock options.

The 2001 Plan allows forthe early exercise of options prior to vesting. A portion of the shares soldare subject to a right of repurchase at the original issuance price by theCompany, which lapses over the vesting period of the original stock option. At December 31,2005 and 2006, the Company had a total of 1,755 and 31,427 shares subjectto repurchase by the Company, respectively.

Subsequent to the initialpublic offering of the Company’s common stock in December 2006, no furtheroptions will be granted under the 2001 Plan. At the date of the initial publicoffering, the 7,948 shares remaining and available for future grant werecancelled.

*2006 Equity Incentive Plan*

Upon the effectiveness ofthe Company’s initial public offering in December 2006, the Companyadopted the 2006 Equity Incentive Plan (the “2006 Plan”). Shares of commonstock issuable pursuant to all 

81

----

thenoutstanding stock awards granted under the 2001 Plan remained subject to theterms of the 2001 Plan and no additional stock awards will be granted pursuantto the terms of the 2001 Plan upon the effective date of the 2006 Plan.

The 2006 Plan provides forboth the granting of stock awards to employees and consultants of the Company.Stock options granted under the 2006 Plan may be either ISO’s or NSO’s. ISO’smay be granted only to Company employees. NSO’s may be granted to Companyemployees, directors and consultants. Stock issued under the 2006 Plan may beissued to employees, directors and consultants. Stock options under the 2006Plan may be granted for periods of up to ten years and at prices no less thanthe fair market value of the Company’s common stock on the date of grant. Theexercise price of an ISO granted to a 10% stockholder shall not be less than110% of the fair market value of the Company’s common stock on the date ofgrant. To date, stock options granted generally become exercisable over fouryears. The 2006 Plan does not allow for the early exercise of options prior tovesting. As of December 31, 2006, the Company has reserved1,250,000 shares of common stock for issuance under the 2006 Plan. TheCompany issues new shares of common stock upon exercise of stock options.The number of shares of common stock reserved for issuance will automaticallyincrease on January 1st of each year, from January 1, 2007 through January 1,2016, by the lesser of (a) 4.5% of the total number of shares of commonstock outstanding on December 31st of the preceding calendar year, or (b) 1,400,000shares. The maximum number of shares that may be issued pursuant to theexercise of incentive stock options under the 2006 incentive plan is equal tothe total share reserve, as increased from time to time pursuant to annualincreases and shares subject to options granted pursuant to the 2001 Plan thathave expired without being exercised in full.

*2006 Employee Stock Purchase Plan*

Upon the effectiveness ofthe Company’s initial public offering in December 2006, the Companyadopted the 2006 Employee Stock Purchase Plan (the “Purchase Plan”). TheCompany has reserved a total of 100,000 shares of common stock for issuanceunder the Purchase Plan. The share reserve automatically increases on January 1of each year, from January 1, 2007 through January 1, 2016, by anamount equal to the lesser of (i) 0.5% of the total number of shares ofcommon stock outstanding on December 31 of the preceding calendar year or (ii) 175,000shares. The Company issues new shares of common stock upon exercise ofstock options. The Purchase Plan permits eligible employees to purchasecommon stock at a discount through payroll deductions during defined offeringperiods. The price at which the stock is purchased is equal to the lower of 85%of the fair market value of the common stock at the beginning of an offeringperiod or at the end of a purchase period. For the year ended December 31,2006, no shares of common stock were purchased under the Purchase Plan.

***Stock-BasedCompensation Before Adoption of SFAS No. 123(R)***

Prior to January 1,2006 the Company accounted for stock-based employee compensationarrangements using the intrinsic value method in accordance with therecognition and measurement provisions of Accounting Principles Board Opinion (“APB”)No. 25, *Accounting for StockIssued to Employees*, and related interpretations, including theFinancial Accounting Standards Board (“FASB”) Interpretation No. 44, *Accounting for Certain Transactions InvolvingStock Compensation, an Interpretation of APB Opinion No. 25*.Under APB No. 25, compensation expense is based on the difference, ifany, on the date of grant between the fair value of the Company’s common stockand the exercise price of the stock option.

82

----

Hadcompensation cost for the Company’s employee stock-based compensationarrangements been determined based upon the fair value of each stock option onthe date of grant consistent with the methodology prescribed underSFAS No. 123, the Company’s pro forma net loss attributable tocommon stockholders and pro forma net loss per common share underSFAS No. 123 would have been as follows (in thousands, except pershare data):

| ** **                                                                                            | ** ** | **Years Ended December 31,** | ** ** | **Cumulative  Period From  July 20, 2001  (Date of  Inception) to  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                    | ** ** | **2004**                                                                                                        | ** ** | **2005** | ** ** |
| Net loss  attributable to common stockholders, as reported                                            |       | $                                           | (33,173    | )                                                                                                               | $          | (21,503 | ) |   | $ | (121,545 | ) |   |
| Add: Employee stock-based compensation based  on intrinsic value method included in reported net loss |       | 4,001                                       |       | —                                                                                                          |       |   | 4,001 |   |   |
| Deduct: Employee stock-based compensation  determined under fair value based method                   |       | (115                                        | )          | (98                                                                                                             | )          |   | (527 | ) |   |
| Pro forma net loss attributable to common  stockholders                                          |       | $                                           | (29,287    | )                                                                                                               | $          | (21,601 | ) |   | $ | (118,071 | ) |   |
| Net loss per common  share, basic and diluted:                                                        |       |                                        |       |                                                                                                            |       |   |   |   |   |
| As reported                                                                                           |       | $                                           | (101.65    | )                                                                                                               | $          | (70.39 | ) |   |   |   |   |
| Pro forma                                                                                        |       | $                                           | (89.74     | )                                                                                                               | $          | (70.71 | ) |   |   |   |   |

 

The above pro forma effects on net loss may not berepresentative of the effects on net loss for future years as stock optiongrants typically vest over several years and additional stock options aregenerally granted each year.

The Company estimated thefair value of the stock options using the minimum value method in accordancewith the provisions of SFAS No. 123. The fair value of the stockoptions was estimated at the grant date with the following assumptions:

| ** **                     | ** ** | **Years Ended December 31,** | ** ** | **Cumulative  Period From  July 20, 2001  (Date of  Inception) to  December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **2005**                                    | ** ** | **2004**                                                                                                        | ** ** | **2005** | ** ** |
| Expected term  (in years) |       | 6                                           |       | 4                                                                                                               |       | 4.12 |   |
| Dividend yield                 |       | 0%                                          |       | 0%                                                                                                              |       | 0% |   |
| Risk-free interest rate        |       | 3.92% - 4.34%                               |       | 2.83% - 3.72%                                                                                                   |       | 2.29% - 4.55% |   |

 

The weighted-average grant date fair value pershare of employee stock options granted during the years ended December 31,2004, 2005 and, cumulatively, for the period from July 10, 2001 (date ofinception) through December 31, 2005 was $0.10, $7.33 and$0.70, respectively.

Pro forma disclosuresfor the year ended December 31, 2006 are not presented because stock-basedemployee compensation was accounted for under SFAS No. 123(R)’s fair-valuemethod during this period.

***Stock-Based Compensation After Adoption of SFAS No. 123(R)***

Effective January 1,2006, the Company adopted SFAS No. 123(R), *Share-Based Payment*, using the prospective transitionmethod, which requires the measurement and recognition of compensation expensefor all share-based payment awards granted, modified and settled to theCompany’s employees and directors after January 1, 2006. The Company’sfinancial statements as of and for the year ended 

83

----

December 31,2006 reflect the impact of SFAS No. 123(R). In accordance with theprospective transition method, the Company’s financial statements for priorperiods have not been restated to reflect, and do not include, the impact ofSFAS No. 123(R). Stock-based compensation expense recognized duringthe year ended December 31, 2006 includes:

·       compensationexpense for stock-based awards granted to employees subsequent to January 1,2006 based on the grant date fair value estimated in accordance with theprovisions of SFAS No. 123(R) of $2.2 million;

·       amortizationof deferred stock-based compensation based on the intrinsic value methodfor stock options granted to employees during the year ended December 31,2005 of $43,000;

·       stock-basedcompensation expense in connection with the repricing of employee stock optionsin September 2003 of $1.9 million;

·       reversalof stock-based compensation expense of $2.4 million (see Note 12);and

·       compensationexpense for stock-based awards granted to non-employees prior andsubsequent to January 1, 2006 that were earned during the year ended December 31,2006 of $346,000.

Theeffect of the change of recording stock-based compensation expense fromthe original provisions of SFAS No. 123 to the provisions of SFAS No. 123(R)for the year ended December 31, 2006 is as follows:

| ** **                                             | ** ** | **Impact from  SFAS No. 123(R)  Provisions for  Year Ended  December 31, 2006** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **(in thousands of dollars,  except per share data)**                                | ** ** |
| Operating expenses                                     |       |                                                                                                               |       |   |   |
| Research and development                               |       |                                                                                                               | $          | 493 |   |   |
| General and administrative                             |       |                                                                                                               | 1,659      |   |   |
| Total stock-based compensation expense                 |       |                                                                                                               | $          | 2,152 |   |   |
| Effect on basic  and diluted net loss per common share |       |                                                                                                               | $          | 1.43 |   |   |

 

No income tax benefit has been recognized relating tostock-based compensation expense and no tax benefits have been realizedfrom exercised stock options. The implementation of SFAS No. 123(R) didnot have an impact on cash flows from financing activities during the yearended December 31, 2006.

During the year ended December 31, 2006, theCompany granted 842,065 stock options to employees with a weighted-averagegrant date fair value of $15.48 per share. As of December 31, 2006, therewas unrecognized compensation costs of $9.0 million related to these stockoptions. The cost is expected to be recognized over a weighted-averageamortization period of 3.14 years.

The Company estimated thefair value of employee stock options using the Black-Scholes valuationmodel. The fair value of employee stock options is being amortized on astraight-line basis over the requisite service period of the awards. The fairvalue of employee stock options were estimated using the following weighted-averageassumptions for the year ended December 31, 2006:

| ** **               | ** ** | **Year Ended  December 31, 2006** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|
| Expected  volatility     |       |                                             | 87         | % |   |
| Risk-free  interest rate |       |                                             | 4.61       | % |   |
| Dividend yield           |       |                                             | 0.00       | % |   |
| Expected term (in years) |       |                                             | 5.77       |   |   |

 

84

----

The expected term of stock options represents theaverage period the stock options are expected to remain outstanding and isbased on the expected terms for industry peers as the Company did not havesufficient historical information to develop reasonable expectations aboutfuture exercise patterns and post-vesting employment termination behavior. Theexpected stock price volatility for the Company’s stock options for the yearended December 31, 2006 was determined by examining the historicalvolatilities for industry peers and using an average of the historicalvolatilities of the Company’s industry peers as the Company did not have anysignificant trading history for the Company’s common stock. Industry peersconsist of several public companies in the biopharmaceutical industry similarin size, stage of life cycle and financial leverage. The Company will continueto analyze the historical stock price volatility and expected term assumptionas more historical data for the Company’s common stock becomes available. Therisk-free interest rate assumption is based on the U.S. Treasuryinstruments whose term was consistent with the expected term of the Company’sstock options. The expected dividend assumption is based on the Company’shistory and expectation of dividend payouts.

The Company estimated the fair value of employee stockpurchase rights granted under the Purchase Plan using the Black-Scholesvaluation model. The weighted-average fair value of each stock purchase rightfor the year ended December 31, 2006 was $9.43 per share. The fair value ofemployee stock purchase rights is being amortized on a straight-line basis overthe requisite service period of the purchase rights. The fair value of employeestock purchase rights were estimated using the following assumptions for theyear ended December 31, 2006:

| ** **                 | ** ** | **Year Ended  December 31, 2006** |
|----------------------------|------------|----------------------------------------|
| Expected  volatility       |       | 62% - 65%                              |
| Risk-free  interest rate   |       | 4.67% - 4.92%                          |
| Dividend yield             |       | 0.00%                                  |
| Expected term (in  months) |       | 4.5 - 22.5                             |

 

In addition, SFAS No. 123(R)requires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. Forfeitures were estimated based on historical experience. Prior tothe adoption of SFAS No. 123(R), the Company accounted forforfeitures as they occurred.

85

----

***Stock Option Activity***

Thefollowing tables summarize information about stock options granted and stockissued from July 20, 2001 (date of inception) through December 31,2006 and stock options outstanding and exercisable and options vested at December 31,2006:

| ** **                              | ** ** | **Shares**                    | ** ** | **Options Outstanding** | ** ** |
|-----------------------------------------|------------|-------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | **Available  for Grant** | ** ** | **Number  of Shares**   | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| Shares authorized                       |       | 425,000                       |       | —                       |       |   | — |   |   |
| Options granted                         |       | (214,410                      | )          | 214,410                      |       |   | $ | 4.00 |   |   |
| Options exercised                       |       | —                        |       | (3,342                       | )          |   | 4.00 |   |   |
| Options forfeited                       |       | 11,120                        |       | (11,120                      | )          |   | 4.00 |   |   |
| Options cancelled                       |       | 243                           |       | (243                         | )          |   | 4.00 |   |   |
| Stock issuance                          |       | (4,210                        | )          | —                       |       |   |   |   |   |
| **Balances  at December 31, 2001** |       | 217,743                       |       | 199,705                      |       |   | 4.00 |   |   |
| Additional shares  authorized           |       | 156,250                       |       | —                       |       |   | — |   |   |
| Options granted                         |       | (367,750                      | )          | 367,750                      |       |   | 4.00 |   |   |
| Options exercised                       |       | —                        |       | (122,604                     | )          |   | 4.00 |   |   |
| Options forfeited                       |       | 40,883                        |       | (40,883                      | )          |   | 4.00 |   |   |
| Options cancelled                       |       | 8,130                         |       | (8,130                       | )          |   | 4.00 |   |   |
| Stock issuance                          |       | (11,331                       | )          | —                       |       |   | — |   |   |
| Stock repurchased                       |       | 112,500                       |       | —                       |       |   | — |   |   |
| **Balances  at December 31, 2002** |       | 156,425                       |       | 395,838                      |       |   | 4.00 |   |   |
| Options granted                         |       | (245,211                      | )          | 245,211                      |       |   | 1.03 |   |   |
| Options exercised                       |       | —                        |       | (3,318                       | )          |   | 2.89 |   |   |
| Options forfeited                       |       | 186,746                       |       | (186,746                     | )          |   | 4.00 |   |   |
| Options cancelled                       |       | 76,784                        |       | (76,784                      | )          |   | 4.00 |   |   |
| Stock issuance                          |       | (2,187                        | )          | —                       |       |   | — |   |   |
| **Balances  at December 31, 2003** |       | 172,557                       |       | 374,201                      |       |   | 2.07 |   |   |
| Additional shares  authorized           |       | 343,500                       |       | —                       |       |   | — |   |   |
| Options granted                         |       | (330,895                      | )          | 330,895                      |       |   | 0.80 |   |   |
| Options exercised                       |       | —                        |       | (22,629                      | )          |   | 0.80 |   |   |
| Options forfeited                       |       | 4,189                         |       | (4,189                       | )          |   | 0.86 |   |   |
| Options cancelled                       |       | 832                           |       | (832                         | )          |   | 0.80 |   |   |
| Stock issuance                          |       | (15,646                       | )          | —                       |       |   | — |   |   |
| Stock repurchased                       |       | 3,281                         |       | —                       |       |   | — |   |   |
| **Balances  at December 31, 2004** |       | 177,818                       |       | 677,446                      |       |   | 0.80 |   |   |
| Additional shares  authorized           |       | 381,905                       |       | —                       |       |   | — |   |   |
| Options granted                         |       | (70,975                       | )          | 70,975                       |       |   | 0.80 |   |   |
| Options exercised                       |       | —                        |       | (13,250                      | )          |   | 0.80 |   |   |
| Options forfeited                       |       | 35,000                        |       | (35,000                      | )          |   | 0.80 |   |   |
| **Balances  at December 31, 2005** |       | 523,748                       |       | 700,171                      |       |   | 0.80 |   |   |
| Additional shares  authorized           |       | 1,530,625                     |       | —                       |       |   | — |   |   |
| Shares cancelled                        |       | (7,948                        | )          | —                       |       |   | — |   |   |
| Options granted                         |       | (848,315                      | )          | 848,315                      |       |   | 10.22 |   |   |
| Options exercised                       |       | —                        |       | (202,401                     | )          |   | 1.01 |   |   |
| Options forfeited                       |       | 12,260                        |       | (12,260                      | )          |   | 10.81 |   |   |
| Options cancelled                       |       | 1,250                         |       | (1,250                       | )          |   | 4.36 |   |   |
| Stock repurchased                       |       | 880                           |       | —                       |       |   | — |   |   |
| **Balances at December 31,  2006** |       | 1,212,500                     |       | 1,332,575                    |       |   | $ | 6.67 |   |   |

 

86

----

The options outstandingand vested by exercise price at December 31, 2005 are as follows:

| **Options Outstanding and Exercisable** | ** ** | **Options Vested** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| **Exercise Price**                                | ** ** | ** **              | ** ** | **Number  Outstanding** | ** ** | **Weighted-Average  Remaining  Contractual Life  (in Years)** | ** ** | **Number  Vested** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| $0.80                                                  |       |                    | 700,171    |   |   |   | 7.83 |   |   | 363,981 |   |   | $ | 0.80 |   |   |
|                                                        |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The options outstandingand vested by exercise price at December 31, 2006 are as follows:

| **Options Outstanding and Exercisable** | ** ** | **Options Vested** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| **Exercise  Price**                                    | ** ** | **Number  Outstanding** | ** ** | **Number  Outstanding  and  Exercisable** | ** ** | **Weighted-Average  Remaining  Contractual Life  (in Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Number  Vested** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Contractual Life  (in Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| $ 0.80                                            |       |                    | 505,267    |   |   |   | 505,267 |   |   |   | 7.04 |   |   |   |   |   | 356,320 |   |   |   | $ | 0.80 |   |   |   | 6.85 |   |   |   |   |
| 4.36                                                   |       |                    | 506,211    |   |   |   | 506,211 |   |   |   | 9.11 |   |   |   |   |   | 88,395 |   |   |   | 4.36 |   |   |   | 9.11 |   |   |   |   |
| 18.84                                                  |       |                    | 283,597    |   |   |   | 283,597 |   |   |   | 9.62 |   |   |   |   |   | 2,589 |   |   |   | 18.84 |   |   |   | 9.63 |   |   |   |   |
| 25.00                                                  |       |                    | 37,500     |   |   |   | — |   |   |   | 9.95 |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   |   |
|                                                   |       |                    | 1,332,575  |   |   |   | 1,295,075 |   |   |   | 8.46 |   |   | $ | 36,130,000 |   |   | 447,304 |   |   |   | $ | 1.61 |   |   |   | 7.31 |   |   | $ | 14,507,000 |   |
|                                                        |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The aggregate intrinsicvalue is calculated as the difference between the exercise price of theunderlying stock options and the fair value of the Company’s common stock forstock options that were in-the-money at December 31, 2006. The totalintrinsic value of stock options exercised during the year ended December 31,2006 was $4.1 million determined at the date of each stockoption exercise.

***Deferred Stock-Based Compensation***

In July 2003, the Company determined the fairvalue of common stock to be $0.80 per share. During September 2003, theCompany approved the repricing of existing employee stock options from $4.00 to$0.80 per share, which was deemed to be the fair market value. As a result ofthe repricing, stock options are subject to variable accounting. Accordingly,subsequent increases in the value of the common stock will result in additionalcompensation expense. At December 31, 2006, the fair value of the commonstock was $34.04 per share and approximately 40,000 repriced stock optionsremain outstanding. During the year ended December 31, 2005 and 2006, theCompany has recorded deferred stock-based compensation related to thesestock options of $4.2 million and $1.3 million, respectively, and recordedamortization of such deferred stock-based compensation of$4.0 million and $1.9 million, respectively. During 2006, the Companyreversed deferred stock-based compensation related to year ended December 31,2005 of $2.1 million and reversed amortization of deferred stock-basedcompensation of $2.4 million (see Note 12).

During the year ended December 31, 2005 the Companyissued stock options to certain employees under the Plan with exercise pricesbelow the fair value of the Company’ common stock at the date of grant. TheCompany estimated the fair value of its common stock based upon severalfactors, including progress and milestones attained in its business. Inaccordance with the requirements of APB No. 25, the Company hasrecorded deferred stock-based compensation for the difference between theexercise price of the stock option and the fair value of the Company’s stock atthe date of grant. This deferred stock-based compensation is amortized toexpense on a straight-line basis over the period during which the options vest,generally four years. During the year ended December 31, 2005, the Companyhas recorded deferred stock-based compensation related to these stockoptions of $195,000, net of cancellations, and recorded amortization of suchdeferred stock-based compensation of $28,000 and $43,000,respectively, during the year ended December 31, 2005 and 2006.

87

----

TheCompany granted stock options to employees with exercise prices below the fairvalue on the date of grant as follows:

| **Grant Date**      | ** ** | ** ** | ** ** | **Number of  Options  Granted** | ** ** | **Exercise  Price  Per Share** | ** ** | **Reassessed  Fair Value  Per Share** | ** ** | **Intrinsic  Value  Per Share** | ** ** |
|--------------------------|------------|------------|------------|--------------------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------|------------|
| January 19,  2005   |       |       | 16,275     |                                 |       |                                | $          | 0.80                                            |       |                                 |       | $ | 4.16 |   |   |   | $ | 3.36 |   |   |
| April 20,  2005     |       |       | 9,750      |                                 |       |                                | $          | 0.80                                            |       |                                 |       | $ | 7.80 |   |   |   | $ | 7.00 |   |   |
| July 26,  2005      |       |       | 35,000     |                                 |       |                                | $          | 0.80                                            |       |                                 |       | $ | 8.24 |   |   |   | $ | 7.44 |   |   |
| October 12,  2005   |       |       | 8,200      |                                 |       |                                | $          | 0.80                                            |       |                                 |       | $ | 8.56 |   |   |   | $ | 7.76 |   |   |
| February 7,  2006   |       |       | 160,721    |                                 |       |                                | $          | 4.36                                            |       |                                 |       | $ | 15.20 |   |   |   | $ | 10.84 |   |   |
| February 10,  2006  |       |       | 346,247    |                                 |       |                                | $          | 4.36                                            |       |                                 |       | $ | 15.20 |   |   |   | $ | 10.84 |   |   |
| July 28,  2006      |       |       | 210,645    |                                 |       |                                | $          | 18.84                                           |       |                                 |       | $ | 24.00 |   |   |   | $ | 5.16 |   |   |
| September 27,  2006 |       |       | 54,952     |                                 |       |                                | $          | 18.84                                           |       |                                 |       | $ | 25.44 |   |   |   | $ | 6.60 |   |   |
| October 25, 2006(1) |       |       | 9,500      |                                 |       |                                | $          | 18.84                                           |       |                                 |       | $ | 25.44 |   |   |   | $ | 6.60 |   |   |

----

(1)          TheCompany did not grant any stock options to employees between October 26,2006 and December 31, 2006.

***Warrants***

In connection with an equipment lease agreement, theCompany issued a warrant in January 2005 to purchase 1,987 shares of Series CMandatorily Redeemable Convertible Preferred Stock at a price of $15.09 pershare to the lessor. The warrant expires in January 2012 or five yearsfrom the effective date of the Company’s initial public offering, whichever islonger. In December 2006, the warrant to purchase Series CMandatorily Redeemable Convertible Preferred Stock was automatically convertedinto a warrant to purchase 1,987 shares of common stock in connection with thecompletion of the Company’s initial public offering. The fair value of thewarrant of $56,000 was recorded as interest expense. The warrant remainsoutstanding at December 31, 2006.

In connection with the sale of Series DMandatorily Redeemable Convertible Preferred Stock, the Company issued warrantsin July 2005 to purchase 383,097 shares of common stock at a price of$17.00 per share to certain investors. The warrants expire upon the earlier of July 2010,on the effective date of the Company’s initial public offering, a sale of allor substantially all of the assets or a change of control. The allocated fairvalue of the warrants of $1.9 million was recorded as a reduction to thecarrying value of the Series D Mandatorily Redeemable ConvertiblePreferred Stock. The fair value of the warrants was determined using the Black-Scholesvaluation model with the following assumptions: volatility of 87%, risk-freeinterest rate of 3.79%, dividend yield of 0%, exercise price of $17.00, and anexpected term of 5 years.

In connection with the sale of Series D MandatorilyRedeemable Convertible Preferred Stock, the Company issued a warrant in July 2005to purchase 55,079 shares of common stock at a price of $4.56 per share toan investment bank. The warrant expires upon the earlier of 2012, on theeffective date of the Company’s initial public offering, a sale of all orsubstantially all of the assets or a change of control. The allocated fairvalue of the warrant of $412,000 was recorded as a reduction to the carryingvalue of the Series D Mandatorily Redeemable Convertible Preferred Stock.The fair value of the warrant was determined using the Black-Scholesvaluation model with the following assumptions: volatility of 94%, risk-freeinterest rate of 4.02%, dividend yield of 0%, exercise price of $4.56, and anexpected term of 7 years

The Company issued 240,561shares of its common stock in December 2006 upon the net and cash exerciseof outstanding warrants that would have terminated if not exercised prior tothe closing of the 

88

----

Company’sinitial public offering. As of December 31, 2006, a warrant to purchase1,987 shares of common stock remains outstanding.

***Nonemployee Stock-Based Compensation***

Stock-basedcompensation expense related to stock options granted and common stock issuedto nonemployees is recognized as the stock options are earned. The Companybelieves that the estimated fair value of the stock options is more readilymeasurable than the fair value of the services received. The fair value ofstock options granted to nonemployees is calculated at each grant date andremeasured at each reporting date. The stock-based compensation expenserelated to a grant will fluctuate as the fair value of the Company’s commonstock fluctuates over the period from the grant date to the vesting date. TheCompany has recorded stock-based compensation expense of $13,000,$300,000, $346,000 and $780,000 for the years ended December 31, 2004,2005, 2006 and for the cumulative period from July 20, 2001 (date ofinception) through December 31, 2006.

**9.**                 RelatedParty Transactions

**Employee Loans**

The Company had two notesreceivable from employees in the amount of $100,000 each. Each note wascollateralized by the deed to the respective home. Interest accrued at the rateof 5.5% and 8.0% per annum for the two notes. Accrued interest was forgiven oneach note’s anniversary date, if the employee remained in good standing withthe Company. The two notes were due in June 2007 unless forgiven on thedate, if ever, the Company became subject to the reporting requirements of theSecurities Exchange Commission in connection with the Company’s initial publicoffering of its common stock. Accordingly, the two notes were forgivenupon the effectiveness of the initial public offering of the Company’s commonstock in December 2006.

**10.**          Developmentand Commercialization Agreements with Takeda

The Company has entered into two separatecollaboration agreements (“Arrangement”) with Takeda, which have been combinedfor accounting purposes due to their proximity of negotiation. Considerationfrom these collaboration agreements includes nonrefundable upfront licensefees, reimbursement for sales of active pharmaceutical ingredients (“API”),clinical and regulatory milestone payments, reimbursement of third partyU.S. clinical development expenses, product profit share revenues(as co-promotion revenues) and royalties.

In February 2006, the Company issued an exclusivelicense to Takeda for development and commercialization of Hematide in Japan.Pursuant to this agreement, Takeda paid the Company approximately$27 million, consisting of $17 million in upfront licensing fees andapproximately $10 million for the purchase of 530,082 shares of theCompany’s Series E Redeemable Convertible Preferred Stock at a price of$18.86 per share. In addition, the Company is eligible to receive clinical andregulatory milestone payments of up to an aggregate of $75 million uponTakeda’s successful achievement of clinical development and regulatorymilestones in Japan. Takeda is responsible for all development and commercializationcosts in Japan and will purchase the active pharmaceutical ingredient (“API”)for Hematide from the Company. Assuming Hematide is approved and launched inJapan, the Company will receive a royalty from Takeda on Hematide salesin Japan.

In June 2006, the parties expanded theircollaboration to develop and commercialize Hematide worldwide, which includesthe co-development and co-commercialization of Hematide in the U.S. Takedareceived an exclusive license to develop and commercialize Hematide outside ofthe U.S. Beginning January 1, 2007, Takeda will bear the first$50 million of third-party expenses related to development inpursuit of U.S. regulatory approval of Hematide. Thereafter, Takeda willbear 70% of the third-party U.S. 

89

----

development expenses,while the Company will be responsible for 30% of the expenses. The Companyretains responsibility for 100% of its internal development expenses. Under theJune 2006 agreement, Takeda paid the Company an upfront license fee of$105 million, and the Company is eligible to receive from Takeda up to anaggregate of $280 million upon the successful achievement of clinicaldevelopment and regulatory milestones. Further, the Company may receive fromTakeda up to an aggregate of $150 million upon the achievement of certainworldwide annual net sales milestones. The Company and Takeda will shareequally in the net profits and losses of Hematide in the United States,which include expenses related to the marketing and launch of Hematide. Takedawill pay the Company a variable royalty based on annual net sales of Hematideoutside the United States. The agreement establishes a joint steeringcommittee to oversee the development, regulatory approval and commercializationof Hematide.

The Company will share responsibility with Takeda forclinical development activities required for U.S. regulatory approval ofHematide. Specifically, the Company has primary responsibility for Hematide’sclinical development plan and clinical trials in the dialysis and pre-dialysisindications, while Takeda has primary responsibility in the chemotherapyinduced anemia and anemia of cancer indications. The Company is responsible forUnited States regulatory filings in the dialysis, pre-dialysis,chemotherapy induced anemia and anemia of cancer indications, including holdingthe NDAs for those indications. Takeda is responsible for regulatory filingsoutside the United States and the creation of a global safety database.

The Company is also responsible for the manufactureand supply of all quantities of API to be used in the development andcommercialization of Hematide worldwide. Takeda is responsible for the fill andfinish steps in the manufacture of Hematide worldwide.

The parties have agreed to jointly develop the initialcommercial marketing plan for Hematide in the United States pursuant towhich the Company and Takeda will divide Hematide promotional responsibilitiesin the U.S. The Company and Takeda will jointly decide on promotionalresponsibility for markets outside of these initial indications.

Under the February 2006 agreement, Takeda alsoobtained a right of first negotiation to any backup products for Hematidedeveloped by the Company or its third-party partners. Specifically,during the first ten years of the agreement, if the Company or third-partypartners develop a product that advances to Phase 2 clinical trials andcompetes with Hematide in the renal or oncology indications, the Company isobligated to offer to Takeda the right to develop and commercialize suchproduct in Japan before offering the product opportunity in Japan to any otherthird party.

The Company has recognized$11.7 million of revenue under the Arrangement with Takeda during the yearended December 31, 2006. In December 2006, Takeda completed aPhase 1 trial of Hematide in Japan resulting in the payment in January 2007to the Company of a $10 million milestone under the collaboration. The amountwas included as a related party receivable at December 31, 2006. As of December 31,2006, the amount receivable from Takeda was $10.2 million, which was recordedas a related party receivable.

In July 2006, theCompany paid Nektar Therapeutics AL Corporation a $17.6 million milestonepayment in connection with a license agreement related to Hematide. The paymentwas triggered by the collaboration agreement signed with Takeda in February andJune 2006. The $17.6 million payment was recorded as research anddevelopment expenses during the year ended December 31, 2006 astechnological feasibility for Hematide has not been established and there is noalternative future use.

90

----

**11.**          IncomeTaxes

Deferredtax assets consist of the following (in thousands):

| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Net operating  loss carryforwards       |       | $                     | 33,014     |   | $ | 9,898 |   |
| Federal and State  credit carryforwards |       | 6,055                 |       | 4,025 |   |
| Depreciation and  amortization          |       | 21,631                |       | 24,592 |   |
| Capitalized start  up costs             |       | 8,919                 |       | 11,242 |   |
| Accrued  liabilities and allowances     |       | 1,131                 |       | 222 |   |
| Gross deferred tax assets               |       | 70,750                |       | 49,979 |   |
| Deferred tax  liability                 |       | —                |       | — |   |
| Net deferred tax asset                  |       | 70,750                |       | 49,979 |   |
| Less: Valuation  allowance              |       | (70,750               | )          | (49,979 | ) |
| Net deferred tax  assets                |       | $                     | —     |   | $ | — |   |

 

At December 31, 2006,the Company had federal and state net operating loss carryforwards of $83.1million and $81.6 million, respectively. The federal net operating losscarryforwards begin to expire in 2021 and state net operating losscarryforwards begin to expire in 2013, if not utilized.

At December 31, 2006,the Company had federal and state research credit carryforwards of $3.5 millionand $3.8 million, respectively. If not utilized, the federal carryforward willexpire in various amounts beginning in 2021. The California credit can becarried forward indefinitely. The Company also had $42.5 million of capitalizedresearch and development costs, in excess of book basis, under Internal RevenueCode §59e. The decision to make the election to capitalize the Company’sresearch and development costs is made on a year by year basis in order topreserve the Company’s net operating loss carryforwards into future years.These costs are amortized over a ten year period beginning with the month ofthe expenditure. The Company expensed its research and development costs fortax purposes.

Under the provisions of Section 382of the Internal Revenue Code, substantial changes in the Company’s ownershipmay limit the amount of net operating loss carryforwards that can be utilizedin the future to offset taxable income. The Company has completed its analysisof this issue and determined that it experienced a change in ownership during December 2006.Notwithstanding such ownership change, the Company believes that it will beable to utilize a portion of its net operating loss carryforwards in 2007against the income recognized for tax purposes with respect to the Takedaroyalty payments.

Management establishes avaluation allowance for those deductible temporary differences when it is morelikely than not that the benefit of such deferred tax assets will not berecognized. The ultimate realization of deferred tax assets is dependent uponthe Company’s ability to generate taxable income during the periods in whichthe temporary differences become deductible. Management considers thehistorical level of taxable income, projections for future taxable income, andtax planning strategies in making this assessment. Management’s assessment inthe near term is subject to change if estimates of future taxable income duringthe carryforward period are reduced.

The valuation allowanceincreased $9.3 million, $12.7 million and $20.8 million duringthe years ended December 31, 2004, 2005 and 2006.

The Company receivedadvance royalties related to its collaboration agreement with Takeda and hasdeferred the recognition of these payments to future years for book purposes.For tax purposes, the Company expects to defer the recognition of taxableincome generated by the receipt of these payments until 2007. While managementexpects that the Company will likely recognize some of the deferred tax assetrelated to its net operating loss carryforwards as a result of the taxableincome generated by these royalty payments, a full valuation allowance of $70.8 millionhas been established for net operating loss and 

91

----

creditcarryovers and for the future tax benefit for the deferred tax assets relatedto the other temporary deductible differences.

Additionally, the Companyhad $22.4 million of capitalized start-up costs, in excess of book basis, underInternal Revenue Code §195. In 2006, the requirements to cease capitalizationof start up expenses were met and amortization expense of $4.7 million will bereported for tax purposes related to the capitalization of start up costs in prioryears.

The Company also had $11.5million of capitalized intangible assets acquired as part of the net assetsacquired from GlaxoSmithKline plc., in excess of book basis, under InternalRevenue Code §197. These costs are amortized over a fifteen year periodbeginning with the month the intangible asset was acquired.

**12.**          QuarterlyFinancial Data (unaudited)

The following tablessummarize the unaudited quarterly financial data for the last two fiscal years.

| ** **                                                                                               | ** ** | **Fiscal 2006 Quarter Ended**                       | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **March 31,**                                                 | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                               | ** ** | **(in thousands, except per share data)** | ** ** |
| Collaboration  revenue                                                                                   |       |                                                               | $          | — |   |   | $ | 127 |   |   | $ | 4,124 |   |   |   | $ | 7,437 |   |   |
| Total revenue                                                                                            |       |                                                               | 8          |   |   | 141 |   |   | 4,134 |   |   |   | 7,443 |   |   |
| Loss from  operations                                                                                    |       |                                                               | (7,332     | ) |   | (28,698 | ) |   | (8,108 | ) |   |   | (9,572 | ) |   |
| Net loss  attributable to common stockholders                                                            |       |                                                               | (6,865     | ) |   | (28,053 | ) |   | (6,389 | ) |   |   | (7,796 | ) |   |
| Basic and diluted  net loss per common share                                                             |       |                                                               | $          | (20.34 | ) |   | $ | (23.49 | ) |   | $ | (4.76 | ) |   |   | $ | (2.49 | ) |   |
| Weighted-average  number of common shares used in computing basic and diluted net loss per  common share |       |                                                               | 338        |   |   | 1,194 |   |   | 1,343 |   |   |   | 3,126 |   |   |

 

| ** **                                                                                               | ** ** | **Fiscal 2005 Quarter Ended**                       | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **March 31,**                                                 | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                               | ** ** | **(in thousands, except per share data)** | ** ** |
| Collaboration  revenue                                                                                   |       |                                                               | $          | — |   |   | $ | — |   |   | $ | — |   |   |   | $ | — |   |   |
| Total revenue                                                                                            |       |                                                               | 37         |   |   | 16 |   |   | 14 |   |   |   | 7 |   |   |
| Loss from  operations                                                                                    |       |                                                               | (7,521     | ) |   | (7,356 | ) |   | (8,068 | ) |   |   | (11,064 | ) |   |
| Net loss  attributable to common stockholders                                                            |       |                                                               | (7,414     | ) |   | (7,286 | ) |   | (7,626 | ) |   |   | (10,847 | ) |   |
| Basic and diluted  net loss per common share                                                             |       |                                                               | $          | (22.95 | ) |   | $ | (22.43 | ) |   | $ | (23.39 | ) |   |   | $ | (32.80 | ) |   |
| Weighted-average number  of common shares used in computing basic and diluted net loss per common  share |       |                                                               | 323        |   |   | 325 |   |   | 326 |   |   |   | 331 |   |   |

 

***Stock-basedcompensation***

In connection with thepreparation of the financial statements necessary for the filing of the Company’sinitial public offering, the Company reassessed the fair value of its commonstock at stock option grant dates from January 2005 through September 30,2006.

The revised values of thecommon stock resulted in an overstatement of stock-based compensation relatedcharges of $0.4 million and $1.3 million for the three month periods ended March 31,2006 and June 30, 2006, respectively. The quarterly financial datapresented above includes adjustments to correct the overstatement ofstock-based compensation expense in the respective quarters.

92

----

The Company identified an overstatement of stock-basedcompensation charges of $0.7 million, $0.8 million and $0.6 million for thethree month periods ended March 31, 2006, June 30, 2006 and September 30, 2006,respectively, related to the accounting for stock options. The quarterlyfinancial data presented above includes adjustments to correct theoverstatement of stock based compensation in each of the respective quarters.In addition, the quarter ending March 31, 2006 includes an out of periodadjustment of $2.4 million related to 2005. It was determined that the 2005overstatement of stock based compensation was immaterial to the annual financialstatements for the years ending December 31, 2006 and 2005 and to the quarterlyfinancial information for the same periods and therefore was corrected in thefirst quarter of 2006.

***Revenue recognition***

TheCompany identified an overstatement of collaboration revenue of $0.7 millionfor the three month period ended September 30, 2006. There is no impact onthe amount of revenue recorded during the year ended December 31, 2006, asthe financial statements for the three month period ended December 31,2006 include a $0.7 million adjustment to correct the overstatement of revenue**.**The quarterly financial data presented above includesadjustments to correct the overstatement of revenue in the three month periodended September 30, 2006.

93

----

**Item 9.   Changesin and Disagreements with Accountants on Accounting and Financial Disclosure.**

None.

**Item 9A.   Controlsand Procedures.**

**Evaluation ofDisclosure Controls and Procedures.**

Rule 13a-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), defines the term “disclosurecontrols and procedures” as those controls and procedures designed to ensurethat information required to be disclosed by a company in the reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and formsand that such information is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure. Based on their evaluation as of December 31,2006, our chief executive officer and chief financial officer have concludedthat our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) were effective.

There have been no changesin our internal controls over financial reporting during the fourth quarter ofthe year ended December 31, 2006 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

**Exemption fromManagement’s Report on Internal Control Over Financial Reporting for 2006**

This annual report doesnot include a report of management’s assessment regarding internal control overfinancial reporting or an attestation report of our registered publicaccounting firm due to a transition period established by rules of the SECfor newly-public companies.

**Item 9B.   Other Information.**

None.

94

----

**PART III.**

Certain informationrequired by Part III is omitted from this Annual Report on Form 10-Kbecause we intend to file our definitive proxy statement for our 2007 annualmeeting of stockholders, pursuant to Regulation 14A of the Securities ExchangeAct, not later than 120 days after the end of the fiscal year covered by thisAnnual Report on Form 10-K, and certain information to be includedin the proxy statement is incorporated herein by reference.

**Item 10.   Directors,Executive Officers and Corporate Governance.**

The information required by this item with respect toour executive officers may be found under the caption, “Executive Officers andKey Employees” appearing in our proxy statement for our 2007 annual meeting ofstockholders and is incorporated herein by reference. The information requiredby this item relating to our directors and nominees, including information withrespect to audit committee financial experts, may be found under the sectionentitled “Proposal 1—Election of Directors” appearing in the proxy statementfor our 2007 annual meeting of stockholders and is incorporated herein byreference. Information regarding compliance with Section 16(a) of theSecurities Exchange Act may be found under the section entitled “Section 16(a) BeneficialOwnership Reporting Compliance” appearing in our proxy statement for our 2007annual meeting of stockholders and is incorporated herein by reference.

In 2006, we adopted a codeof ethics that applies to our employees, officers and directors andincorporates guidelines designed to deter wrongdoing and to promote the honestand ethical conduct and compliance with applicable laws and regulations. Inaddition, the code of ethics incorporates our guidelines pertaining to topicssuch as conflicts of interest and workplace behavior. We have posted the textof our code of ethics on our website at www.affymax.com in connection with “InvestorRelations/Corporate Governance” materials. In addition, we intend to promptlydisclose (1) the nature of any amendment to our code of ethics thatapplies to our principal executive officer, principal financial officer,principal accounting officer or controller, or persons performing similarfunctions and (2) the nature of any waiver, including an implicit waiver,from a provision of our code of ethics that is granted to one of thesespecified officers, the name of such person who is granted the waiver and thedate of the waiver on our website in the future.

**Item 11.   ExecutiveCompensation.**

The information requiredby this item is included in our proxy statement for our 2007 annual meeting ofstockholders under the section entitled “Executive Compensation” and isincorporated herein by reference.

**Item12.   Security Ownership of Certain Beneficial Owners and Management andRelated StockholderMatters.**

The information requiredby this item with respect to securities authorized for issuance under ourequity compensation plans is included in our proxy statement for our 2007annual meeting of stockholders under the section entitled “SecuritiesAuthorized for Issuance under Equity Compensation Plans” and is incorporatedherein by reference. The information required by this item relating to securityownership of certain beneficial owners and management is included in our proxystatement for our 2007 annual meeting of stockholders under the sectionentitled “Security Ownership of Certain Beneficial Owners and Management” andis incorporated herein by reference.

**Item 13.   CertainRelationships, Related Transactions and Director Independence.**

The information requiredby this item is incorporated herein by reference to the information included inour proxy statement for our 2007 annual meeting of stockholders under thesections entitled 

95

----

“InformationRegarding The Board of Directors and Corporate Governance” and “TransactionsWith Related Persons.”

**Item 14.   PrincipalAccounting Fees and Services.**

The information required by this item is incorporatedherein by reference to the information included in our proxy statement for our2007 annual meeting of stockholders under the section entitled “Proposal 2—Ratificationof Selection of Independent Registered Public Accounting Firm.”

96

----

**PART IV.**

**Item 15.   Exhibits and Financial Statement Schedules.**

(a)          Thefollowing documents are filed as part of this Form 10-K:

(1)          FinancialStatements (included in Part II of this report):

·       Reportof Independent Registered Public Accounting Firm

·       BalanceSheets

·       Statementsof Operations

·       Statementsof Stockholders’ Equity (Deficit)

·       Statementsof Cash Flows

·       Notes to FinancialStatements

(2)          FinancialStatement Schedules

All other financial statement schedules are omittedbecause the information is inapplicable or presented in the notes to thefinancial statements.

(3)          ManagementContract or Compensatory Plan or Arrangement

Thefollowing exhibits are included herein or incorporated herein by reference:

| 3.3    |   | Amended and Restated  Certificate of Incorporation(1)                                                                                                                        |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 3.5    |   | Amended and Restated  Bylaws(1)                                                                                                                                              |   |
| 4.1    |   | Reference is made to  exhibits 3.3 and 3.5                                                                                                                              |   |
| 4.2    |   | Specimen Common Stock  Certificate(1)                                                                                                                                        |   |
| 4.3    |   | Warrant to purchase  shares of Series C Preferred Stock(1)                                                                                                              |   |
| 4.4    |   | Amended and Restated  Investor Rights Agreement, dated September 7, 2006, by and between the  Registrant and certain of its stockholders(1)                             |   |
| 10.1+  |   | Form of Indemnity  Agreement for Directors and Executive Officers(1)                                                                                                    |   |
| 10.2+  |   | 2001 Stock Option/Stock  Issuance Plan(1)                                                                                                                                    |   |
| 10.3+  |   | Form of Notice of  Grant of Stock Option, Form of Stock Option Agreement and Form of  Stock Purchase Agreement under 2001 Stock Option/Stock Issuance Plan(1) |   |
| 10.4+  |   | Form of Stock  Issuance Agreement under 2001 Stock Option/Stock Issuance Agreement(1)                                                                                   |   |
| 10.5+  |   | 2006 Equity Incentive  Plan(1)                                                                                                                                               |   |
| 10.6+  |   | Form of Option  Grant Notice and Form of Option Agreement under 2006 Equity Incentive  Plan(1)                                                                     |   |
| 10.7+  |   | 2006 Employee Stock  Purchase Plan(1)                                                                                                                                        |   |
| 10.8+  |   | Form of Offering  Document under 2006 Employee Stock Purchase Plan(1)                                                                                                   |   |
| 10.9+  |   | Employment Agreement,  dated June 10, 2003, by and between the Registrant and Arlene M. Morris(1)                                                                       |   |
| 10.10+ |   | Executive Employment  Agreement, dated November 17, 2005, by and between the Registrant and  Paul B. Cleveland(1)                                                       |   |

 

97

----

 

| 10.11+ |   | Executive Employment  Agreement, dated March 4, 2004, by and between the Registrant and Robert B.  Naso(1)                                                                                                              |   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.12+ |   | Executive Employment  Agreement, dated August 9, 2005, by and between the Registrant and Ali  Mahdavi(1)                                                                                                           |   |
| 10.13+ |   | Summary of Non-Employee  Director Compensation Program(1)                                                                                                                                                               |   |
| 10.14  |   | Research and  Development/Office Lease, dated May 30, 1990, by and between Miranda  Associates and Affymax Research Institute(1)                                                                                   |   |
| 10.15  |   | First Amendment to  Lease, dated November 16, 1999, by and between Spieker  Properties, L.P., successor in interest to Miranda Associates, and  Affymax Research Institute(1)                                 |   |
| 10.16  |   | Second Amendment to  Lease, dated December 20, 1999, by and between Spieker  Properties, L.P. and Affymax Research Institute(1)                                                                               |   |
| 10.17  |   | Third Amendment, dated  December 31, 2001, by and between EOP-Foothill Research Center, L.L.C.,  successor by merger to Spieker Properties L.P., and the Registrant(1)                                        |   |
| 10.18* |   | EPO Receptor License  Agreement, dated September 5, 1996, by and between the Registrant and  Genetics Institute, Inc.(1)                                                                                      |   |
| 10.19  |   | License Agreement  (Therapeutic Products), dated June 28, 1996, by and between the  Registrant, Dyax Corp. and Protein Engineering Corporation(1)                                                                  |   |
| 10.20  |   | License Agreement, dated  July 25, 2001, by and between the Registrant and Dyax Corp.(1)                                                                                                                           |   |
| 10.21* |   | License Agreement, dated  July 27, 2001, by and between the Registrant, Glaxo Group Limited,  SmithKline Beecham Corporation, Affymax N.V., Affymax Research Institute  and Affymax Technologies N.V.(1) |   |
| 10.22* |   | License Agreement, dated  August 13, 2001, by and between the Registrant and XOMA Ireland  Limited(1)                                                                                                              |   |
| 10.23* |   | License, Manufacturing,  and Supply Agreement, dated April 8, 2004, by and between the Registrant  and Nektar Therapeutics AL, Corporation(1)                                                                      |   |
| 10.24* |   | Letter Agreement, dated  September 20, 2004, by and between the Registrant and  EntreMed, Inc.(1)                                                                                                             |   |
| 10.25  |   | Extension of Letter  Agreement for TFPI Product Candidates, dated August 23, 2005, by and  between the Registrant and EntreMed, Inc.(1)                                                                       |   |
| 10.26  |   | Second Extension of  Letter Agreement for TFPI Product Candidates, dated December 19, 2005,  by and between the Registrant and EntreMed, Inc.(1)                                                              |   |
| 10.27  |   | Third Extension of  Letter Agreement for TFPI Product Candidates, dated February 28, 2006,  by and between the Registrant and EntreMed, Inc. (previously filed as  Exhibit No. 10.30)(1)            |   |
| 10.28  |   | Fourth Extension of  Letter Agreement for TFPI Product Candidates, dated May 24, 2006, by and  between the Registrant and EntreMed, Inc. (previously filed as  Exhibit No. 10.31)(1)                |   |
| 10.29* |   | Collaboration and  License Agreement, dated February 13, 2006, by and between the  Registrant and Takeda Pharmaceutical Company Limited(1)                                                                         |   |
| 10.30* |   | Collaboration and  License Agreement, dated June 27, 2006, by and between the Registrant  and Takeda Pharmaceutical Company Limited(1)                                                                             |   |
| 10.31  |   | Research and Development  Agreement, dated April 2, 1992, by and between the Registrant and The  R.W. Johnson Pharmaceutical Research Institute(1)                                                                 |   |
| 10.32  |   | Sublease Agreement,  dated September 1, 2006, by and between the Registrant and TIBCO  Software Inc.(1)                                                                                                            |   |
| 10.33  |   | Fifth Extension Letter  Agreement for TFPI Product Candidates, dated August 23, 2006, by and  between the Registrant and EntreMed, Inc.(1)                                                                    |   |
| 10.34  |   | Sixth Extension Letter  Agreement for TFPI Product Candidates, dated November 27, 2006, by and  between the Registrant and EntreMed, Inc.(1)                                                                            |   |

 

98

----

 

| 10.35 |   | Fourth Amendment to  Lease dated November 30, 2006, by and between Registrant and CA-Foothill  Research Center L.P.                                                                   |   |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.36 |   | Seventh Extension Letter  Agreement for TFPI Product Candidates, dated February 23, 2007, by and  between the Registrant and Entremed, Inc.                                      |   |
| 23.1  |   | Consent of independent  registered public accounting firm                                                                                                                                  |   |
| 24.1  |   | Power of Attorney.  Reference is made to the signature page.                                                                                                                               |   |
| 31.1  |   | Certification required  by Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                 |   |
| 31.2  |   | Certification required  by Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                 |   |
| 32.1  |   | Certification required by Rule 13a-14(b) or  Rule 15d-14(b) and Section 1350 of Chapter 63 of  Title 18 of the United States Code (18 U.S.C. 1350) |   |

----

(1)          Incorporated byreference to the indicated exhibit of our registration statement on Form S-1,registration no. 333-136125, declared effective by the Securities andExchange Commission on December 14, 2006.

+                Indicatesmanagement contract or compensatory plan.

*                    Confidentialtreatment has been requested with respect to certain portions of this exhibit.Omitted portions have been filed separately with the Securities andExchange Commission.

99

----

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

|        | ** ** | **AFFYMAX, INC.** |
|--------|------------|------------------------|
|   |       | By:                    |   | /s/ ARLENE M. MORRIS |
|   |       | * *               | * * | Arlene M. Morris*President, Chief Executive Officer and Member of the Board of Directors* |

 

**POWEROF ATTORNEY**

KNOW ALL PERSONS BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Arlene M. Morris and Paul B. Cleveland, and each of them, as his orher true and lawful attorneys-in-fact and agents, each with the full power ofsubstitution for him or her, and in his or her name and in any and allcapacities, to sign any and all amendments to this Annual Report on Form 10-K,and to file the same, with exhibits thereto and other documents in connectiontherewith, with the Securities and Exchange Commission, granting unto saidattorneys-in-fact and agents, and each of them, full power and authority to doand perform each and every act and thing requisite and necessary to be donetherewith, as fully to all intents and purposes as he or she might or could doin person, hereby ratifying and confirming all that each of saidattorneys-in-fact and agents, and any of them or his or her substitute orsubstitutes, may lawfully do or cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated:

|                               | **Signature** | ** **                                                               | ** ** | ** **            | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------------|---------------|--------------------------------------------------------------------------|------------|-----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ ARLENE M. MORRIS          |          | President, Chief  Executive Officer and                                  |       | March 30, 2007   |
| Arlene M. Morris              |          | Member of the Board of  Directors (*Principal Executive Officer*)        |       |                  |
| /s/ PAUL B. CLEVELAND         |          | Executive Vice  President, Corporate                                     |       | March 30 ,  2007 |
| Paul B. Cleveland             |          | Development and Chief  Financial Officer (*Principal Financial Officer*) |       |                  |
| /s/ A. MAHDAVI                |          | Vice President,  Finance and Administration                              |       | March 30,  2007  |
| Ali Mahdavi                   |          | (*Principal Accounting Officer*)                                         |       |                  |
| /s/ JOHN P. WALKER            |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| John P. Walker                |          |                                                                     |       |                  |
| /s/ NICHOLAS G. GALAKATOS     |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| Nicholas G. Galakatos,  Ph.D. |          |                                                                     |       |                  |
| /s/ KATHLEEN LAPORTE          |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| Kathleen LaPorte              |          |                                                                     |       |                  |
| /s/ ELIZABETH CZEREPAK        |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| Elizabeth Czerepak            |          |                                                                     |       |                  |
| /s/ R. LEE DOUGLAS            |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| R. Lee Douglas                |          |                                                                     |       |                  |
| /s/ TED W. LOVE               |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| Ted W. Love                   |          |                                                                     |       |                  |
| /s/ DAN SPIEGELMAN            |          | Member of the  Board of Directors                                        |       | March 30,  2007  |
| Daniel K. Spiegelman          |          |                                                                     |       |                  |

 

100

----

**EXHIBITINDEX**

| Exhibit   Number | ** ** | **Description**                                                                                                                                                                                                         |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.3              |       | Amended and  Restated Certificate of Incorporation(1)                                                                                                                                                                   |
| 3.5              |       | Amended and  Restated Bylaws(1)                                                                                                                                                                                         |
| 4.1              |       | Reference is made  to exhibits 3.3 and 3.5                                                                                                                                                                         |
| 4.2              |       | Specimen Common  Stock Certificate(1)                                                                                                                                                                                   |
| 4.3              |       | Warrant to  purchase shares of Series C Preferred Stock(1)                                                                                                                                                         |
| 4.4              |       | Amended and  Restated Investor Rights Agreement, dated September 7, 2006, by and  between the Registrant and certain of its stockholders(1)                                                                        |
| 10.1+            |       | Form of  Indemnity Agreement for Directors and Executive Officers(1)                                                                                                                                               |
| 10.2+            |       | 2001 Stock  Option/Stock Issuance Plan(1)                                                                                                                                                                               |
| 10.3+            |       | Form of  Notice of Grant of Stock Option, Form of Stock Option Agreement and  Form of Stock Purchase Agreement under 2001 Stock Option/Stock Issuance  Plan(1)                                           |
| 10.4+            |       | Form of  Stock Issuance Agreement under 2001 Stock Option/Stock Issuance Agreement(1)                                                                                                                              |
| 10.5+            |       | 2006 Equity  Incentive Plan(1)                                                                                                                                                                                          |
| 10.6+            |       | Form of  Option Grant Notice and Form of Option Agreement under 2006 Equity  Incentive Plan(1)                                                                                                                |
| 10.7+            |       | 2006 Employee  Stock Purchase Plan(1)                                                                                                                                                                                   |
| 10.8+            |       | Form of  Offering Document under 2006 Employee Stock Purchase Plan(1)                                                                                                                                              |
| 10.9+            |       | Employment  Agreement, dated June 10, 2003, by and between the Registrant and Arlene  M. Morris(1)                                                                                                                 |
| 10.10+           |       | Executive  Employment Agreement, dated November 17, 2005, by and between the  Registrant and Paul B. Cleveland(1)                                                                                                  |
| 10.11+           |       | Executive  Employment Agreement, dated March 4, 2004, by and between the Registrant  and Robert B. Naso(1)                                                                                                         |
| 10.12+           |       | Executive  Employment Agreement, dated August 9, 2005, by and between the  Registrant and Ali Mahdavi(1)                                                                                                           |
| 10.13+           |       | Summary of  Non-Employee Director Compensation Program(1)                                                                                                                                                               |
| 10.14            |       | Research and  Development/Office Lease, dated May 30, 1990, by and between Miranda  Associates and Affymax Research Institute(1)                                                                                   |
| 10.15            |       | First Amendment  to Lease, dated November 16, 1999, by and between Spieker  Properties, L.P., successor in interest to Miranda Associates, and  Affymax Research Institute(1)                                 |
| 10.16            |       | Second Amendment  to Lease, dated December 20, 1999, by and between Spieker  Properties, L.P. and Affymax Research Institute(1)                                                                               |
| 10.17            |       | Third Amendment,  dated December 31, 2001, by and between EOP-Foothill Research Center,  L.L.C., successor by merger to Spieker Properties L.P., and the  Registrant(1)                                       |
| 10.18*           |       | EPO Receptor  License Agreement, dated September 5, 1996, by and between the  Registrant and Genetics Institute, Inc.(1)                                                                                      |
| 10.19            |       | License Agreement  (Therapeutic Products), dated June 28, 1996, by and between the  Registrant, Dyax Corp. and Protein Engineering Corporation(1)                                                                  |
| 10.20            |       | License  Agreement, dated July 25, 2001, by and between the Registrant and Dyax  Corp.(1)                                                                                                                          |
| 10.21*           |       | License  Agreement, dated July 27, 2001, by and between the Registrant, Glaxo  Group Limited, SmithKline Beecham Corporation, Affymax N.V., Affymax  Research Institute and Affymax Technologies N.V.(1) |
| 10.22*           |       | License  Agreement, dated August 13, 2001, by and between the Registrant and XOMA  Ireland Limited(1)                                                                                                              |
| 10.23*           |       | License,  Manufacturing, and Supply Agreement, dated April 8, 2004, by and between  the Registrant and Nektar Therapeutics AL, Corporation(1)                                                                      |

101

----

 

| 10.24* |   | Letter Agreement,  dated September 20, 2004, by and between the Registrant and  EntreMed, Inc.(1)                                                                                                  |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25  |   | Extension of  Letter Agreement for TFPI Product Candidates, dated August 23, 2005, by  and between the Registrant and EntreMed, Inc.(1)                                                            |
| 10.26  |   | Second Extension  of Letter Agreement for TFPI Product Candidates, dated December 19,  2005, by and between the Registrant and EntreMed, Inc.(1)                                                   |
| 10.27  |   | Third Extension  of Letter Agreement for TFPI Product Candidates, dated February 28,  2006, by and between the Registrant and EntreMed, Inc. (previously filed  as Exhibit No. 10.30)(1) |
| 10.28  |   | Fourth Extension  of Letter Agreement for TFPI Product Candidates, dated May 24, 2006, by  and between the Registrant and EntreMed, Inc. (previously filed as  Exhibit No. 10.31)(1)     |
| 10.29* |   | Collaboration and  License Agreement, dated February 13, 2006, by and between the  Registrant and Takeda Pharmaceutical Company Limited(1)                                                              |
| 10.30* |   | Collaboration and  License Agreement, dated June 27, 2006, by and between the Registrant  and Takeda Pharmaceutical Company Limited(1)                                                                  |
| 10.31  |   | Research and  Development Agreement, dated April 2, 1992, by and between the  Registrant and The R.W. Johnson Pharmaceutical Research Institute(1)                                                      |
| 10.32  |   | Sublease  Agreement, dated September 1, 2006, by and between the Registrant and  TIBCO Software Inc.(1)                                                                                                 |
| 10.33  |   | Fifth Extension  Letter Agreement for TFPI Product Candidates, dated August 23, 2006, by  and between the Registrant and EntreMed, Inc.(1)                                                         |
| 10.34  |   | Sixth Extension  Letter Agreement for TFPI Product Candidates, dated November 27, 2006,  by and between the Registrant and EntreMed, Inc.(1)                                                       |
| 10.35  |   | Fourth Amendment  to Lease dated November 30, 2006, by and between Registrant and  CA-Foothill Research Center L.P.                                                                                     |
| 10.36  |   | Seventh Extension  Letter Agreement for TFPI Product Candidates, dated February 23, 2007,  by and between the Registrant and Entremed, Inc.                                                        |
| 23.1   |   | Consent of  independent registered public accounting firm                                                                                                                                                    |
| 24.1   |   | Power of  Attorney. Reference is made to the signature page.                                                                                                                                                 |
| 31.1   |   | Certification  required by Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                                   |
| 31.2   |   | Certification  required by Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                                   |
| 32.1   |   | Certification  required by Rule 13a-14(b) or Rule 15d-14(b) and  Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. 1350)                  |

----

(1)          Incorporated byreference to the indicated exhibit of our registration statement on Form S-1,registration no. 333-136125, declared effective by the Securities andExchange Commission on December 14, 2006.

+                Indicatesmanagement contract or compensatory plan.

*                    Confidentialtreatment has been requested with respect to certain portions of this exhibit.Omitted portions have been filed separately with the Securities andExchange Commission.

102

----