ZymoGenetics ( ZGEN) has landed Bristol-Myers Squibb ( BMY - Get Report) as its worldwide development partner for PEG-Interferon lambda, a new experimental treatment for hepatitis C.

Bristol-Myers has agreed to pay $85 million upfront to ZymoGenetics for rights to PEG-Interferon lambda, which is currently in phase I studies. Bristol-Myers will pay another $20 million license fee to ZymoGenetics in 2009, the companies announced Monday.

Long-acting interferons taken by weekly injection, sold by Schering-Plough ( SGP) and Roche, are a current mainstay of hepatitis C treatment, but the drugs produce flu-like symptoms among other side effects and are generally not tolerated well by patients.

Early data generated by PEG-Interferon lambda and presented at a hepatitis C conference in the fall suggested the drug might be safer and better tolerated than the current long-acting interferons.

ZymoGenetics and Bristol-Myers will co-develop PEG-Interferon lambda in the U.S. and Europe, and the two companies will share development costs. ZymoGenetics said it could be entitled to additional payments from Bristol-Myers of up to $430 million based on pre-defined development and regulatory milestones for the drug in hepatitis C, and $285 million in sales-based milestone payments.

If PEG-Interferon lambda can be developed to treat other diseases, Bristol-Myers may pay ZymoGenetics another $287 million in milestone payments.

While long-acting interferon plus the drug ribavirin are the current standard of care for hepatitis C patients, the treatment market is evolving with the development of new and novel drugs from companies like Vertex Pharmaceuticals ( VRTX - Get Report), Pharmasset ( VRUS), Schering-Plough and InterMune ( ITMN). Updated from 4:01 p.m. EST

Moreover, ZymoGenetics is not the only company seeking to develop an alternative to the current long-acting interferons. Human Genome Sciences ( HGSI) is in the midst of a phase III study program for Albuferon, a long-acting interferon that can be administered twice a month instead of weekly. Results from the Albuferon studies are expected in March.

ZymoGenetics is testing a once-weekly and once-every-two week dosing schedule for PEG-Interferon lambda.

Bristol-Myers is not a major player in hepatitis C, but the company is in early-stage testing with a new drug, BMS 790052, that aims to target the virus by working against a protein known as NS5a.

ZymoGenetics' stock price has fallen from $12 to less than $3 over the past year due to disappointing sales of Recothrom, a drug that helps surgeons control bleeding.

ZymoGenetics' shares closed up roughly 8% to $3.12 Monday, and Bristol-Myers shares closed down about 1% to $22.14.

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