IONIS PHARMACEUTICALS INC - Quarter Report: 2015 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)



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

For the Quarterly Period Ended September 30, 2015

OR



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

For the transition period from to

Commission file number 0-19125

Isis Pharmaceuticals, Inc.

(Exact name of Registrant as specified in its charter)

2855 Gazelle Court, Carlsbad, CA 92010

(Address of principal executive offices, including zip code)

760-931-9200

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 Par Value

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  No

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12(b)-2 of the Securities Exchange Act of 1934). Yes  No 

The number of shares of voting common stock outstanding as of November 4, 2015 was 120,117,708.

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ISIS PHARMACEUTICALS, INC.

FORM 10-Q

INDEX

TRADEMARKS

Isis Pharmaceuticals^® is a registered trademark of Isis Pharmaceuticals, Inc.

Akcea Therapeutics™ is a trademark of Isis Pharmaceuticals, Inc.

Regulus Therapeutics™ is a trademark of Regulus Therapeutics Inc.

KYNAMRO^® is a registered trademark of Genzyme Corporation

ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

See accompanying notes.

ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(Unaudited)

 

See accompanying notes.

ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(Unaudited)

 

See accompanying notes.

ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See accompanying notes.

ISIS PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Unaudited)

1.

Basis of Presentation

The unaudited interim condensed consolidated financial statements for the three and nine months ended September 30, 2015 and 2014 have been prepared on the same basis as the audited financial statements for the year ended December 31, 2014. The financial statements include all normal recurring adjustments, which we consider necessary for a fair presentation of our financial position at such dates and our operating results and cash flows for those periods. Results for the interim periods are not necessarily indicative of the results for the entire year. For more complete financial information, these financial statements, and notes thereto, should be read in conjunction with the audited financial statements for the year ended December 31, 2014 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC.

The condensed consolidated financial statements include the accounts of Isis Pharmaceuticals, Inc. ("we", "us" or "our") and our wholly owned subsidiary, Akcea Therapeutics, Inc., which we formed in December 2014.

2.

Significant Accounting Policies

Revenue Recognition

We generally recognize revenue when we have satisfied all contractual obligations and are reasonably assured of collecting the resulting receivable. We are often entitled to bill our customers and receive payment from our customers in advance of recognizing the revenue. In the instances in which we have received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on our consolidated condensed balance sheet.

Our collaboration agreements typically contain multiple elements, or deliverables, including technology licenses or options to obtain technology licenses, research and development services, and in certain cases manufacturing services, and we allocate the consideration to each unit of accounting based on the relative selling price of each deliverable.

Identifying deliverables and units of accounting

We evaluate the deliverables in our collaboration agreements to determine whether they meet the criteria to be accounted for as separate units of accounting or whether they should be combined with other deliverables and accounted for as a single unit of accounting. When the delivered items in an arrangement have "stand-alone value" to our customer, we account for the deliverables as separate units of accounting. For example, in May 2015, we entered into an exclusive license agreement with Bayer to develop and commercialize ISIS-FXI_Rx for the prevention of thrombosis. As part of the agreement, Bayer paid us a $100 million upfront payment in the second quarter of 2015. We are also eligible to receive milestone payments, license fees and tiered royalties on gross margins of ISIS-FXI_Rx. We are responsible for completing the ongoing development services for ISIS-FXI_Rx and for providing an initial supply of active pharmaceutical ingredient, or API. Bayer is responsible for all other development and commercialization activities for ISIS-FXI_Rx. Since this agreement has multiple elements, we evaluated the deliverables in this arrangement when we entered into the agreement and determined that certain deliverables have stand-alone value. Below is a list of the three units of accounting under our agreement:



The exclusive license we granted to Bayer to develop and commercialize ISIS-FXIRx for the treatment of thrombosis;



The development services we agreed to perform for ISIS-FXIRx; and



The initial supply of API.

We determined that each of these three units of accounting have stand-alone value. The exclusive license we granted to Bayer has stand-alone value because it is an exclusive license that gives Bayer the right to develop ISIS-FXI_Rx or to sublicense its rights. The development services and the initial supply of API have stand-alone value because Bayer or another third party could provide these items without our assistance.

Measurement and allocation of arrangement consideration

Our collaborations may provide for various types of payments to us including upfront payments, funding of research and development, milestone payments, licensing fees, profit sharing and royalties on product sales. We initially allocate the amount of consideration that is fixed and determinable at the time the agreement is entered into and exclude contingent consideration. We allocate the consideration to each unit of accounting based on the relative selling price of each deliverable. Delivered items have stand-alone value if they are sold separately by any vendor or the customer could resell the delivered items on a stand-alone basis. We use the following hierarchy of values to estimate the selling price of each deliverable: (i) vendor-specific objective evidence of fair value; (ii) third-party evidence of selling price; and (iii) best estimate of selling price, or BESP. The BESP reflects our best estimate of what the selling price would be if we regularly sold the deliverable on a stand-alone basis. We recognize the revenue allocated to each unit of accounting as we deliver the related goods or services. If we determine that we should treat certain deliverables as a single unit of accounting, then we recognize the revenue ratably over our estimated period of performance.

We determined that the allocable arrangement consideration for the Bayer collaboration was $100 million and we allocated it based on the relative BESP of each unit of accounting. We engaged a third party, independent valuation expert to assist us with determining BESP. We estimated the selling price of the license granted for ISIS-FXI_Rx by using the relief from royalty method. Under this method, we estimated the amount of income, net of taxes, for ISIS-FXI_Rx. We then discounted the projected income to present value. The significant inputs we used to determine the projected income of the license included:



Estimated future product sales;



Estimated royalties on future product sales;



Contractual milestone payments;



Expenses we expect to incur;



Income taxes; and



An appropriate discount rate.

We estimated the selling price of the ongoing development services by using our internal estimates of the cost to perform the specific services and estimates of expected cash outflows to third parties for services and supplies over the expected period that we will perform the development services. The significant inputs we used to determine the selling price of the ongoing development services included:



The number of internal hours we will spend performing these services;



The estimated cost of work we will perform;



The estimated cost of work that we will contract with third parties to perform; and



The estimated cost of drug product we will use.

We determine the selling price of our API consistently for all of our partnerships. On an annual basis, we calculate our fully absorbed cost to manufacture API. We then determine the unit price we will charge our partners by dividing our fully absorbed costs by the quantity of API we expect to produce during the year.

For purposes of determining the BESP of the services we will perform and the API in our Bayer transaction, we were required to include a markup for a reasonable profit margin.

Based on the units of accounting under the agreement, we allocated the $100 million upfront payment from Bayer as follows:



$91.2 million to the ISIS-FXIRx exclusive license;



$4.3 million for ongoing development services; and



$4.5 million for the delivery of API.

Assuming a constant selling price for the other elements in the arrangement, if there was an assumed ten percent increase or decrease in the estimated selling price of the ISIS-FXI_Rx license, we determined that the revenue we would have allocated to the ISIS-FXI_Rx license would change by approximately one percent, or $0.9 million, from the amount we recorded.

We recognize revenue as we deliver each item under the arrangement and the related revenue is realizable and earned. For example, we recognized revenue for the exclusive license we granted Bayer for ISIS-FXI_Rx in the second quarter of 2015 because that was when we delivered the license. We also recognize revenue over time. Our collaborative agreements typically include a research and/or development project plan outlining the activities the agreement requires each party to perform during the collaboration. We must estimate our period of performance when the agreements we enter into do not clearly define such information. We estimate the period of time over which we will complete the activities for which we are responsible and use that period of time as our period of performance for purposes of revenue recognition. We then recognize revenue ratably over such period. We have made estimates of our continuing obligations under numerous agreements and in certain instances the timing of satisfying these obligations may change as the development plans for our drugs progress. Accordingly, our estimates may change in the future. If our estimates and judgments change over the course of our collaboration agreements, it may affect the timing and amount of revenue that we recognize in future periods.

The following are the periods over which we are recognizing revenue for each of our units of accounting under our Bayer agreement:



We recognized the portion of the consideration attributed to the ISIS-FXIRx license immediately because we delivered the license and earned the revenue;



We will recognize the amount attributed to the API supply when we deliver it to Bayer.

From time to time, we may enter into separate agreements at or near the same time with the same customer. We evaluate such agreements to determine whether they should be accounted for individually as distinct arrangements or whether the separate agreements are, in substance, a single multiple element arrangement. We evaluate whether the negotiations are conducted jointly as part of a single negotiation, whether the deliverables are interrelated or interdependent, whether fees in one arrangement are tied to performance in another arrangement, and whether elements in one arrangement are essential to another arrangement. Our evaluation involves significant judgment to determine whether a group of agreements might be so closely related that they are, in effect, part of a single arrangement. For example, since early 2012, we have entered into four collaboration agreements with Biogen:



In January 2012, we entered into a collaboration agreement with Biogen to develop and commercialize nusinersen (formerly ISIS-SMNRx) for spinal muscular atrophy, or SMA. As part of the collaboration, we received a $29 million upfront payment and we are responsible for global development of nusinersen through completion of Phase 2/3 clinical trials.



In June 2012, we entered into a second and separate collaboration agreement with Biogen to develop and commercialize a novel antisense drug targeting DMPK, or dystrophia myotonica-protein kinase. As part of the collaboration, we received a $12 million upfront payment and we are responsible for global development of the drug through the completion of a Phase 2 clinical trial.



In December 2012, we entered into a third and separate collaboration agreement with Biogen to discover and develop antisense drugs against three targets to treat neurological or neuromuscular disorders. As part of the collaboration, we received $30 million upfront payment and we are responsible for the discovery of a lead antisense drug for each of three targets.



In September 2013, we entered into a fourth and separate collaboration agreement with Biogen to leverage antisense technology to advance the treatment of neurological diseases. We granted Biogen exclusive rights to the use of our antisense technology to develop therapies for neurological diseases as part of this broad collaboration. We received a $100 million upfront payment and we are responsible for discovery and early development through the completion of a Phase 2 clinical trial for each antisense drug identified during the six year term of this collaboration, while Biogen is responsible for the creation and development of small molecule treatments and biologics.

All four of these collaboration agreements give Biogen the option to license one or more drugs resulting from the specific collaboration. If Biogen exercises an option, it will pay us a license fee and will assume future development, regulatory and commercialization responsibilities for the licensed drug. We are also eligible to receive milestone payments associated with the research and/or development of the drugs prior to licensing, milestone payments if Biogen achieves pre-specified regulatory milestones, and royalties on any product sales of drugs resulting from these collaborations.

We evaluated all four of the Biogen agreements to determine whether we should account for them as separate agreements. We determined that we should account for the agreements separately because we conducted the negotiations independently of one another, each agreement focuses on different drugs, there are no interrelated or interdependent deliverables, there are no provisions in any of these agreements that are essential to the other agreement, and the payment terms and fees under each agreement are independent of each other. We also evaluated the deliverables in each of these agreements to determine whether they met the criteria to be accounted for as separate units of accounting or whether they should be combined with other deliverables and accounted for as a single unit of accounting. For all four of these agreements, we determined that the options did not have stand-alone value because Biogen cannot pursue the development or commercialization of the drugs resulting from these collaborations until it exercises the respective option or options. As such, for each agreement we considered the deliverables to be a single unit of accounting and we are recognizing the upfront payment for each of the agreements over the respective estimated period of our performance.

Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and commercialization events. These three categories of milestone events reflect the three stages of the life-cycle of our drugs, which we describe in more detail in the following paragraph.

Prior to the first stage in the life-cycle of our drugs, we perform a significant amount of work using our proprietary antisense technology to design chemical compounds that interact with specific genes that are good targets for drug discovery. From these research efforts, we hope to identify a development candidate. The designation of a development candidate is the first stage in the life-cycle of our drugs. A development candidate is a chemical compound that has demonstrated the necessary safety and efficacy in preclinical animal studies to warrant further study in humans.

During the first step of the development stage, we or our partners study our drugs in IND-enabling studies, which are animal studies intended to support an Investigational New Drug, or IND, application and/or the foreign equivalent. An approved IND allows us or our partners to study our development candidate in humans. If the regulatory agency approves the IND, we or our partners initiate Phase 1 clinical trials in which we typically enroll a small number of healthy volunteers to ensure the development candidate is safe for use in patients. If we or our partners determine that a development candidate is safe based on the Phase 1 data, we or our partners initiate Phase 2 studies that are generally larger scale studies in patients with the primary intent of determining the efficacy of the development candidate.

The final step in the development stage is Phase 3 studies to gather the necessary safety and efficacy data to request marketing approval from the Food and Drug Administration, or FDA, and/or foreign equivalents. The Phase 3 studies typically involve large numbers of patients and can take up to several years to complete. If the data gathered during the trials demonstrates acceptable safety and efficacy results, we or our partner will submit an application to the FDA and/or its foreign equivalents for marketing approval. This stage of the drug’s life-cycle is the regulatory stage.

If a drug achieves marketing approval, it moves into the commercialization stage, during which our partner will market and sell the drug to patients. Although our partner will ultimately be responsible for marketing and selling the partnered drug, our efforts to discover and develop a drug that is safe, effective and reliable contributes significantly to our partner’s ability to successfully sell the drug. The FDA and its foreign equivalents have the authority to impose significant restrictions on an approved drug through the product label and on advertising, promotional and distribution activities. Therefore, our efforts designing and executing the necessary animal and human studies are critical to obtaining claims in the product label from the regulatory agencies that would allow us or our partner to successfully commercialize our drug. Further, the patent protection afforded our drugs as a result of our initial patent applications and related prosecution activities in the United States and foreign jurisdictions are critical to our partner’s ability to sell our drugs without competition from generic drugs. The potential sales volume of an approved drug is dependent on several factors including the size of the patient population, market penetration of the drug, and the price charged for the drug.

Generally, the milestone events contained in our partnership agreements coincide with the progression of our drugs from development, to regulatory approval and then to commercialization. The process of successfully discovering a new development candidate, having it approved and ultimately sold for a profit is highly uncertain. As such, the milestone payments we may earn from our partners involve a significant degree of risk to achieve. Therefore, as a drug progresses through the stages of its life-cycle, the value of the drug generally increases.

Development milestones in our partnerships may include the following types of events:



Designation of a development candidate. Following the designation of a development candidate, IND-enabling animal studies for a new development candidate generally take 12 to 18 months to complete;



Initiation of a Phase 1 clinical trial. Generally, Phase 1 clinical trials take one to two years to complete;



Initiation or completion of a Phase 2 clinical trial. Generally, Phase 2 clinical trials take one to three years to complete;



Initiation or completion of a Phase 3 clinical trial. Generally, Phase 3 clinical trials take two to four years to complete.

Regulatory milestones in our partnerships may include the following types of events:



Filing of regulatory applications for marketing approval such as a New Drug Application, or NDA, in the United States or a Marketing Authorization Application, or MAA, in Europe. Generally, it takes six to twelve months to prepare and submit regulatory filings.



Marketing approval in a major market, such as the United States, Europe or Japan. Generally it takes one to two years after an application is submitted to obtain approval from the applicable regulatory agency.

Commercialization milestones in our partnerships may include the following types of events:



First commercial sale in a particular market, such as in the United States or Europe.



Product sales in excess of a pre-specified threshold, such as annual sales exceeding $1 billion. The amount of time to achieve this type of milestone depends on several factors including but not limited to the dollar amount of the threshold, the pricing of the product and the pace at which customers begin using the product.

We assess whether a substantive milestone exists at the inception of our agreements. When a substantive milestone is achieved, we recognize revenue related to the milestone payment immediately. For our existing licensing and collaboration agreements in which we are involved in the discovery and/or development of the related drug or provide the partner with access to new technologies we discover, we have determined that the majority of future development, regulatory and commercialization milestones are substantive. For example, we consider most of the milestones associated with our strategic alliance with Biogen substantive because we are using our antisense drug discovery platform to discover and develop new drugs against targets for neurological diseases. We also consider milestones associated with our strategic alliance with Alnylam Pharmaceuticals, Inc. substantive because we provide Alnylam ongoing access to our technology to develop and commercialize RNA interference, or RNAi, therapeutics. In evaluating if a milestone is substantive we consider whether:



Substantive uncertainty exists as to the achievement of the milestone event at the inception of the arrangement;



The achievement of the milestone involves substantive effort and can only be achieved based in whole or in part on our performance or the occurrence of a specific outcome resulting from our performance;



The amount of the milestone payment appears reasonable either in relation to the effort expended or to the enhancement of the value of the delivered items;



There is no future performance required to earn the milestone; and



The consideration is reasonable relative to all deliverables and payment terms in the arrangement.

If any of these conditions are not met, we do not consider the milestone to be substantive and we defer recognition of the milestone payment and recognize it as revenue over our estimated period of performance, if any. Further information about our collaborative arrangements can be found in Note 6, Collaborative Arrangements and Licensing Agreements.

We often enter into agreements to license our proprietary patent rights on an exclusive or non-exclusive basis in exchange for license fees and/or royalties. We generally recognize as revenue immediately those licensing fees and royalties for which we have no significant future performance obligations and are reasonably assured of collecting the resulting receivable. For example, in the first quarter of 2014, we recognized $7.7 million in revenue from Alnylam related to its license of our technology to one of its partners because we had no performance obligations and collectability was reasonably assured.

Cash, cash equivalents and short-term investments

We consider all liquid investments with maturities of three months or less when we purchase them to be cash equivalents. Our short-term investments have initial maturities of greater than three months from date of purchase. We classify our short-term investments as “available-for-sale” and carry them at fair market value based upon prices for identical or similar items on the last day of the fiscal period. We record unrealized gains and losses as a separate component of comprehensive income (loss) and include net realized gains and losses in gain (loss) on investments. We use the specific identification method to determine the cost of securities sold.

We have equity investments in privately- and publicly-held biotechnology companies that we have received as part of a technology license or collaboration agreement. At September 30, 2015, we held ownership interests of less than 20 percent in each of the respective companies.

We account for our equity investments in publicly-held companies at fair value and record unrealized gains and losses related to temporary increases and decreases in the stock of these publicly-held companies as a separate component of comprehensive income (loss). We account for equity investments in privately-held companies under the cost method of accounting because we own less than 20 percent and do not have significant influence over their operations. We hold one cost method investment in Atlantic Pharmaceuticals Limited. Realization of our equity position in this company is uncertain. When realization of our investment is uncertain, we record a full valuation allowance. In determining if and when a decrease in market value below our cost in our equity positions is temporary or other-than-temporary, we examine historical trends in the stock price, the financial condition of the company, near term prospects of the company and our current need for cash. If we determine that a decline in value in either a public or private investment is other-than-temporary, we recognize an impairment loss in the period in which the other-than-temporary decline occurs.

Inventory valuation

We capitalize the costs of raw materials that we purchase for use in producing our drugs because until we use these raw materials they have alternative future uses. We include in inventory raw material costs for drugs that we manufacture for our partners under contractual terms and that we use primarily in our clinical development activities and drug products. We can use each of our raw materials in multiple products and, as a result, each raw material has future economic value independent of the development status of any single drug. For example, if one of our drugs failed, we could use the raw materials for that drug to manufacture our other drugs. We expense these costs when we deliver the drugs to our partners, or as we provide these drugs for our own clinical trials. We reflect our inventory on the balance sheet at the lower of cost or market value under the first-in, first-out method, or FIFO. We review inventory periodically and reduce the carrying value of items we consider to be slow moving or obsolete to their estimated net realizable value. We consider several factors in estimating the net realizable value, including shelf life of raw materials, alternative uses for our drugs and clinical trial materials, and historical write-offs. We did not record any inventory write-offs for the nine months ended September 30, 2015 and 2014. Total inventory, which consisted of raw materials, was $6.6 million and $6.3 million as of September 30, 2015 and December 31, 2014, respectively.

Research, development and patent expenses

Our research and development expenses include wages, benefits, facilities, supplies, external services, clinical trial and manufacturing costs and other expenses that are directly related to our research and development operations. We expense research and development costs as we incur them. When we make payments for research and development services prior to the services being rendered, we record those amounts as prepaid assets on our condensed consolidated balance sheet and we expense them as the services are provided.

We capitalize costs consisting principally of outside legal costs and filing fees related to obtaining patents. We amortize patent costs over the useful life of the patent, beginning with the date the United States Patent and Trademark Office, or foreign equivalent, issues the patent. We review our capitalized patent costs regularly to ensure that they include costs for patents and patent applications that have future value. We evaluate patents and patent applications that we are not actively pursuing and write off any associated costs.

Long-lived assets

We evaluate long-lived assets, which include property, plant and equipment, patent costs, and exclusive licenses acquired from third parties, for impairment on at least a quarterly basis and whenever events or changes in circumstances indicate that we may not be able to recover the carrying amount of such assets.

Use of estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Basic and diluted net loss per share

We compute basic net loss per share by dividing the net loss by the weighted-average number of common shares outstanding during the period. As we incurred a net loss for the three and nine months ended September 30, 2015 and 2014, we did not include dilutive common equivalent shares in the computation of diluted net loss per share because the effect would have been anti-dilutive. Common stock from the following would have had an anti-dilutive effect on net loss per share:



1 percent convertible senior notes;



2¾ percent convertible senior notes;



Dilutive stock options;



Unvested restricted stock units; and



Employee Stock Purchase Plan, or ESPP.

Consolidation of variable interest entities

We identify entities as variable interest entities either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. We perform ongoing qualitative assessments of our variable interest entities to determine whether we have a controlling financial interest in the variable interest entity and therefore are the primary beneficiary. As of September 30, 2015 and December 31, 2014, we had collaborative arrangements with two entities, Regulus and Antisense Therapeutics Limited, that we considered to be variable interest entities. We are not the primary beneficiary for any of these entities as we do not have the power to direct the activities that most significantly impact the economic performance of our variable interest entities, the obligation to absorb losses, or the right to receive benefits from our variable interest entities that could potentially be significant to the variable interest entities. As of September 30, 2015, the total carrying value of our investments in variable interest entities was $18.6 million, and was related to our investment in Regulus. Our maximum exposure to loss related to our variable interest entities is limited to the carrying value of our investments.

Accumulated other comprehensive (loss) income

Accumulated other comprehensive (loss) income is comprised of unrealized gains and losses on investments, net of taxes, and adjustments we made to reclassify realized gains and losses on investments from other accumulated comprehensive (loss) income to our condensed consolidated statement of operations. The following table summarizes changes in accumulated other comprehensive (loss) income for the three and nine months ended September 30, 2015 and 2014 (in thousands):

(1)

Other comprehensive loss for the three months ended September 30, 2014 included income tax benefit of $2.5 million. There was no tax expense or benefit for the three and nine months ended September 30, 2015 and the nine months ended September 30, 2014.

(2)

Amounts for the three and nine months ended September 30, 2015 are included in gain on investment in Regulus Therapeutics Inc. on our condensed consolidated statement of operations. For the three and nine months ended September 30, 2014, $0.5 million is included in the gain on investment in Regulus Therapeutics Inc., with the remaining amount included in gain on investments, net on our condensed consolidated statement of operations.

Convertible debt

We account for convertible debt instruments, including our 1 percent and 2¾ percent notes, that may be settled in cash upon conversion (including partial cash settlement) by separating the liability and equity components of the instruments in a manner that reflects our nonconvertible debt borrowing rate. We determine the carrying amount of the liability component by measuring the fair value of similar debt instruments that do not have the conversion feature. If no similar debt instrument exists, we estimate fair value by using assumptions that market participants would use in pricing a debt instrument, including market interest rates, credit standing, yield curves and volatilities. Determining the fair value of the debt component requires the use of accounting estimates and assumptions. These estimates and assumptions are judgmental in nature and could have a significant impact on the determination of the debt component, and the associated non-cash interest expense.

We assign a value to the debt component of our convertible notes equal to the estimated fair value of similar debt instruments without the conversion feature, which resulted in us recording our debt at a discount. We are amortizing the debt discount over the life of the convertible notes as additional non-cash interest expense utilizing the effective interest method.

Segment information

In 2015, we began operating as two segments, our Isis Core segment, previously referred to as Drug Discovery and Development, and our new segment, Akcea Therapeutics, which includes the operations of our newly-formed and wholly-owned subsidiary, Akcea Therapeutics, Inc. We formed Akcea to develop and commercialize the drugs from our lipid franchise. We provide segment financial information and results for our Isis Core segment and our Akcea Therapeutics segment based on the segregation of revenues and expenses that our chief decision maker reviews to assess operating performance and to make operating decisions. We use judgments and estimates in determining the allocation of shared expenses to the two segments.

Stock-based compensation expense

We measure stock-based compensation expense for equity-classified awards, principally related to stock options, restricted stock units, or RSUs, and stock purchase rights under our ESPP, based on the estimated fair value of the award on the date of grant. We recognize the value of the portion of the award that we ultimately expect to vest as stock-based compensation expense over the requisite service period in our condensed consolidated statements of operations. We reduce stock-based compensation expense for estimated forfeitures at the time of grant and revise in subsequent periods if actual forfeitures differ from those estimates.

We use the Black-Scholes model to estimate the fair value of stock options granted and stock purchase rights under our ESPP. The expected term of stock options granted represents the period of time that we expect them to be outstanding. We estimate the expected term of options granted based on historical exercise patterns. For the nine months ended September 30, 2015 and 2014, we used the following weighted-average assumptions in our Black-Scholes calculations:

Employee Stock Options:

ESPP:

Board of Director Stock Options:

The fair value of RSUs is based on the market price of our common stock on the date of grant. RSUs vest annually over a four year period. The weighted-average grant date fair value of RSUs granted to employees and board of directors for the nine months ended September 30, 2015 was $67.57 and $57.16 per share, respectively.

The following table summarizes stock-based compensation expense for the three and nine months ended September 30, 2015 and 2014 (in thousands), which was allocated as follows:

Non-cash stock-based compensation expense was $15.0 million and $41.9 million for the three and nine months ended September 30, 2015, respectively, and increased compared to $8.1 million and $22.9 million for the same periods in 2014 primarily due to the increase in our stock price in January 2015 compared to January 2014. As of September 30, 2015, total unrecognized estimated non-cash stock-based compensation expense related to non-vested stock options and RSUs was $53.1 million and $20.2 million, respectively. We will adjust total unrecognized compensation cost for future changes in estimated forfeitures. We expect to recognize the cost of non-cash, stock-based compensation expense related to non-vested stock options and RSUs over a weighted average amortization period of 1.3 years and 1.4 years, respectively.

Amendments to equity plans

In June 2015, after receiving approval from our stockholders, we amended our 2011 Equity Incentive Plan and our 2002 Non-Employee Directors Stock Option Plan to increase the total number of shares reserved for issuance under each plan. We increased the shares available under our 2011 Equity Incentive Plan from 5.5 million to 11 million and we increased our 2002 Non-Employee Directors Stock Option Plan from 1.2 million to 2 million.

Impact of recently issued accounting standards

In May 2014, the FASB issued accounting guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what the entity expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance as originally issued is effective for fiscal years, and interim periods within that year, beginning after December 15, 2016. In July 2015, the FASB issued updated accounting guidance to allow for an optional one year deferral from the original effective date. As a result, we can choose to adopt this guidance beginning January 1, 2017 or on January 1, 2018. The guidance allows us to select one of two methods of adoption, either the full retrospective approach, meaning the guidance would be applied to all periods presented, or modified retrospective, meaning the cumulative effect of applying the guidance would be recognized as an adjustment to our opening retained earnings balance. We are currently determining the adoption method and timing as well as the effects the adoption will have on our consolidated financial statements and disclosures.

In August 2014, the FASB issued accounting guidance on how and when to disclose going-concern uncertainties in the financial statements. This guidance will require us to perform interim and annual assessments to determine our ability to continue as a going concern within one year from the date that we issue our financial statements. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2016. We will adopt this guidance in our fiscal year beginning January 1, 2017. We do not expect this guidance to have any effect on our consolidated financial statements.

In February 2015, the FASB issued accounting guidance which amends existing consolidation guidance for entities that are required to evaluate whether they should consolidate certain legal entities. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2015. We will adopt this guidance in our fiscal year beginning January 1, 2016. We do not expect this guidance to have any effect on our consolidated financial statements.

In April 2015, the FASB issued accounting guidance to simplify the presentation of debt issuance costs. The amended guidance requires us to present debt issuance costs as a direct deduction from the carrying amount of the related debt liability rather than as an asset. The guidance does not require us to change how we recognize and measure our debt issuance costs. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2015. We will adopt this guidance in our fiscal year beginning January 1, 2016. We do not expect this guidance to have a material impact on our consolidated financial statements.

In April 2015, the FASB issued accounting guidance to clarify the accounting for fees paid in cloud computing arrangements. The amendment provides guidance to customers about whether a cloud computing arrangement includes a software license element consistent with the acquisition of other software licenses or if the arrangement excludes a software license and should be accounted for as a service contract. The guidance does not change the accounting for service contracts. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2015. We will adopt this guidance in our fiscal year beginning January 1, 2016 on a prospective basis. We do not expect this guidance to have a material impact on our consolidated financial statements.

In July 2015, the FASB issued accounting guidance to simplify the remeasurment of inventory. The amended guidance applies to entities that value inventory under methods other than last-in first-out (LIFO) or the retail inventory method and applies to us because we value our inventory under the FIFO method. The amended guidance requires us to measure our inventory at the lower of cost and net realizable value. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2015 on a prospective basis. We will adopt this guidance in our fiscal year beginning January 1, 2016. We do not expect this guidance to have any effect on our consolidated financial statements.

3.

Investments

As of September 30, 2015, we have primarily invested our excess cash in debt instruments of the U.S. Treasury, financial institutions, corporations, and U.S. government agencies with strong credit ratings and an investment grade rating at or above A-1, P-1 or F-1 by Moody’s, Standard & Poor’s, or S&P, or Fitch, respectively. We have established guidelines relative to diversification and maturities that maintain safety and liquidity. We periodically review and modify these guidelines to maximize trends in yields and interest rates without compromising safety and liquidity.

The following table summarizes the contract maturity of the available-for-sale securities we held as of September 30, 2015:

As illustrated above, at September 30, 2015, 80 percent of our available-for-sale securities had a maturity of less than two years.

All of our available-for-sale securities are available to us for use in our current operations. As a result, we categorize all of these securities as current assets even though the stated maturity of some individual securities may be one year or more beyond the balance sheet date.

At September 30, 2015, we had an ownership interest of less than 20 percent in one private company and two public companies with which we conduct business. The privately-held company is Atlantic Pharmaceuticals Limited and the publicly-traded companies are Antisense Therapeutics Limited and Regulus. We account for equity investments in the privately-held company under the cost method of accounting and we account for equity investments in the publicly-traded companies at fair value. We record unrealized gains and losses as a separate component of comprehensive income (loss) and include net realized gains and losses in gain (loss) on investments.

In July 2015, we sold approximately 2.7 million shares of Regulus’ common stock for total proceeds of $25.5 million, resulting in a $20.2 million gain, which we recognized in the third quarter of 2015. We remain a significant shareholder of Regulus’ common stock.

The following is a summary of our investments (in thousands):

(1)

Our available-for-sale securities are held at amortized cost.

(2)

Includes investments classified as cash equivalents on our condensed consolidated balance sheet.

Investments we considered to be temporarily impaired at September 30, 2015 were as follows (in thousands):

We believe that the decline in value of these securities is temporary and primarily related to the change in market interest rates since purchase. We believe it is more likely than not that we will be able to hold these securities to maturity. Therefore we anticipate full recovery of their amortized cost basis at maturity.

4.

Fair Value Measurements

We use a three-tier fair value hierarchy to prioritize the inputs used in our fair value measurements. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets, which includes our money market funds and treasury securities classified as available-for-sale securities and our investment in equity securities in publicly-held biotechnology companies; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable, which includes our fixed income securities and commercial paper classified as available-for-sale securities; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring us to develop our own assumptions. Our Level 3 investments include our investments in the equity securities of publicly-held biotechnology companies for which we calculated a lack of marketability discount because there were restrictions on when we could trade the securities. We determine the lack of marketability discount by using a Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the stock until the restriction ends. The majority of our securities have been classified as Level 2. We obtain the fair value of our Level 2 investments from our custodian bank or from a professional pricing service. We validate the fair value of our Level 2 investments by understanding the pricing model used by the custodian banks or professional pricing service provider and comparing that fair value to the fair value based on observable market prices. During the nine months ended September 30, 2015, there were no transfers between our Level 1 and Level 2 investments. We recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer.

We measure the following major security types at fair value on a recurring basis. The following summary breaks down the fair-value hierarchy that we used to value each security at September 30, 2015 and December 31, 2014 (in thousands):

(1)

Included in cash and cash equivalents on our condensed consolidated balance sheet.

(2)

Included in short-term investments on our condensed consolidated balance sheet.

(3)

$7.6 million included in cash and cash equivalents on our condensed consolidated balance sheet, with the difference included in short-term investments on our condensed consolidated balance sheet.

(4)

$0.8 million included in cash and cash equivalents on our condensed consolidated balance sheet, with the difference included in short-term investments on our condensed consolidated balance sheet.

(5)

$10 million included in cash and cash equivalents on our condensed consolidated balance sheet, with the difference included in short-term investments on our condensed consolidated balance sheet.

(6)

$9.3 million included in cash and cash equivalents on our condensed consolidated balance sheet, with the difference included in short-term investments on our condensed consolidated balance sheet.

In November 2014, Regulus completed a public offering. As part of the offering, we sold shares of Regulus' common stock and became subject to trading restrictions on our remaining shares through January 2015. Therefore, at December 31, 2014, we recorded a lack of marketability discount on our investment in Regulus and classified it as a Level 3 investment. At the end of January 2015, we reclassified our investment in Regulus to a Level 1 investment because the contractual trading restrictions on the shares we own ended.

The following is a reconciliation of our investments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2015 (in thousands):

Other Fair Value Disclosures

Our 1 percent and 2¾ percent notes had a fair value of $454.6 million and $149.4 million, respectively at September 30, 2015. We determine the fair value of our notes based on quoted market prices for these notes, which are Level 2 measurements because the notes do not trade regularly.

In June 2015, we entered into a five-year revolving line of credit agreement with Morgan Stanley Private Bank, National Association, or Morgan Stanley. Under the credit agreement, we can borrow up to a maximum of $20 million of revolving credit for general working capital purposes. Under the credit agreement interest is payable monthly in arrears on the outstanding principal at a rate based on our option of:

(i)	a floating rate equal to the one-month London Interbank Offered Rate, or LIBOR, in effect plus 1.25 percent per annum;

(ii)	a fixed rate equal to LIBOR plus 1.25 percent for a period of one, two, three, four, six, or twelve months as elected by us; or

(iii)

a fixed rate equal to the LIBOR swap rate during the period of the loan.

Additionally, we will pay 0.25 percent per annum, payable quarterly in arrears, for any amount unused under the credit facility beginning after June 2016. We did not have any outstanding borrowings under the credit facility as of September 30, 2015.

The credit agreement includes customary affirmative and negative covenants and restrictions. We were in compliance with all covenants of the credit agreement as of September 30, 2015.

6.

Collaborative Arrangements and Licensing Agreements

Traditional Pharmaceutical Alliances and Licensing

AstraZeneca

 

Oncology Collaboration

In December 2012, we entered into a collaboration agreement with AstraZeneca to discover and develop antisense drugs against five cancer targets. As part of the agreement, we granted AstraZeneca an exclusive license to develop and commercialize ISIS-STAT3-2.5_Rx and ISIS-AR-2.5_Rx for the treatment of cancer and an option to license up to three anti-cancer drugs under a separate research program. Together with AstraZeneca we are evaluating ISIS-STAT3-2.5Rx in patients with advanced cancer. AstraZeneca is conducting a clinical study of ISIS-STAT3-2.5_Rx in patients with advanced metastatic hepatocellular carcinoma, or HCC. We are conducting a clinical study evaluating ISIS-STAT3-2.5_Rx in patients with advanced lymphomas, including patients with diffuse large b-cell lymphoma. We are responsible for completing our clinical study in patients with advanced lymphomas and AstraZeneca is responsible for all other global development, regulatory and commercialization activities for ISIS-STAT3-2.5_Rx. In June 2013, we and AstraZeneca added a second development candidate, ISIS-AR-2.5_Rx, to our collaboration. ISIS-AR-2.5_Rx is an antisense drug we designed to treat patients with prostate cancer by inhibiting the production of the androgen receptor, or AR. AstraZeneca is currently evaluating ISIS-AR-2.5_Rx in a Phase 1/2 study in patients with AR-related cancers. AstraZeneca is responsible for all other global development, regulatory and commercialization activities for ISIS-AR-2.5_Rx. In addition, we are responsible for identifying a development candidate for each of the three anti-cancer research programs. AstraZeneca has the option to license drugs resulting from each of the three anti-cancer research programs, and if AstraZeneca exercises its option for a drug, it will be responsible for all further global development, regulatory and commercialization activities for such drug.

Under the terms of the agreement, we received $31 million comprised of a $25 million upfront payment we received in December 2012 and a $6 million payment we received in June 2013. We recorded revenue of $11.5 million upon receipt of these payments and we have amortized $11.9 million into revenue as we have performed development activities under this collaboration. We are recognizing the remaining $7.6 million related to the option to license three drugs under the research program through December 2016.

In October 2014, we and AstraZeneca amended our agreement for ISIS-STAT3-2.5_Rx. Under the amended terms of the agreement, we received a $7.5 million milestone payment in November 2014 from AstraZeneca for advancing ISIS-STAT3-2.5_Rx in patients with advanced cancers. Upon AstraZeneca's initiation of a Phase 2 study, we will earn a $17.5 million milestone payment.

We are eligible to receive milestone payments and license fees from AstraZeneca as programs advance in development. In addition, we are eligible to receive tiered royalties up to the low to mid-teens on any product sales of drugs resulting from these programs. If AstraZeneca successfully develops ISIS-STAT3-2.5_Rx, ISIS-AR-2.5_Rx, and the three drugs under the research program, we could receive substantive milestone payments of more than $858 million, including up to $238 million for the achievement of development milestones and up to $620 million for the achievement of regulatory milestones. From inception through September 2015, we have received $63.5 million in payments under these collaboration programs. We will earn the next milestone payment of $10 million if we designate a development candidate for a cancer drug under our research program with AstraZeneca.

In August 2013, we added another collaboration program with AstraZeneca to discover and develop an antisense drug against an undisclosed target. AstraZeneca has the option to license a drug resulting from this collaboration program. If AstraZeneca exercises its option, it will be responsible for all further global development, regulatory and commercialization activities for such drug. We received a $0.8 million upfront payment, which we are amortizing through December 2016. We are eligible to receive license fees and substantive milestone payments of $163.2 million, including up to $45.3 million for the achievement of research and development milestones and up to $105 million for regulatory milestones. From inception through September 2015, we have received $0.8 million in payments under this collaboration program. We will earn the next $3.3 million milestone payment if AstraZeneca selects a development candidate under this collaboration. In addition, we are eligible to receive tiered royalties up to the low teens on sales from any product that AstraZeneca successfully commercializes under this collaboration program.

Cardiometabolic and Renal Diseases Collaboration

In July 2015, we and AstraZeneca formed a strategic collaboration to discover and develop antisense therapies for treating cardiovascular and metabolic diseases, primarily focused on targets in the kidney, and renal diseases. As part of the agreement, we granted AstraZeneca an exclusive license to a preclinical program and the option to license a drug for each target advanced under this research collaboration. Upon acceptance of a drug development candidate, AstraZeneca will be responsible for all further global development, regulatory and commercialization activities for such drug. Under the terms of the agreement, we received a $65 million upfront payment. Since this agreement has multiple elements, we evaluated the deliverables in this arrangement and determined that none of the deliverables have stand-alone value because of the early stage of research for this collaboration. Therefore, we concluded there is one unit of accounting and we are amortizing the $65 million upfront payment through August 2021. We are eligible to receive license fees and substantive milestone payments of up to more than $4 billion, including up to $1.1 billion for the achievement of development milestones and up to $2.9 billion for regulatory milestones. We will earn the next milestone payment of $25 million under this collaboration upon identification of the first drug candidate to move into development. In addition, we are eligible to receive tiered royalties up to the low teens on sales from any product that AstraZeneca successfully commercializes under this collaboration agreement.

Each of our agreements with AstraZeneca will continue until the expiration of all payment obligations under the applicable agreement. In addition, the agreement, or any program under the applicable agreement, may terminate early under the following situations:



AstraZeneca may terminate the agreement or any program at any time by providing written notice to us;



AstraZeneca may terminate the agreement or any program by providing written notice if we undergo a change of control with a third party; and



Either we or AstraZeneca may terminate the agreement or any program by providing written notice to the other party upon the other party's uncured failure to perform a material obligation under the agreement, or the entire agreement if the other party becomes insolvent.

During the three and nine months ended September 30, 2015, we earned revenue of $1.5 million and $3.0 million, respectively, from our relationship with AstraZeneca. In comparison, we earned $0.6 million and $19.7 million for the same periods in 2014. Our condensed consolidated balance sheet at September 30, 2015 included deferred revenue of $66.7 million related to our relationship with AstraZeneca.

Bayer

In May 2015, we entered into an exclusive license agreement with Bayer to develop and commercialize ISIS-FXI_Rx for the prevention of thrombosis. We are responsible for completing ongoing development activities. Bayer is responsible for all other development and commercialization activities for ISIS-FXI_Rx.

Under the terms of the agreement, we are eligible to receive $155 million in near-term payments, including a $100 million upfront payment we received in the second quarter of 2015 and a $55 million milestone payment that we are eligible to receive upon advancement of the program following a Phase 2 study in patients with compromised kidney function. We recorded revenue of $91.2 million related to the license for ISIS-FXI_Rx in June 2015 and we are recognizing the remaining $8.8 million related to the ongoing development activities for ISIS-FXI_Rx through July 2016.

Over the term of the agreement, we are eligible to receive up to $375 million in license fees, substantive milestone payments and other payments, including up to $120 million for the achievement of development milestones and up to $110 million for the achievement of commercialization milestones. In addition, we are eligible to receive tiered royalties in the low to high 20 percent range on gross margins of ISIS-FXI_Rx. We will earn the next milestone payment of $55 million upon the advancement of the program following an ongoing Phase 2 study of ISIS-FXI_Rx in patients with compromised kidney function.

Our agreement with Bayer will continue until the expiration of all payment obligations under the agreement. In addition, the agreement, or any program under the agreement, may terminate early under the following situations:



Bayer may terminate the agreement or any program at any time by providing written notice to us;



Either we or Bayer may terminate the agreement or any program by providing written notice to the other party upon the other party’s uncured failure to perform a material obligation under the agreement, or the entire agreement if the other party becomes insolvent.

During the three and nine months ended September 30, 2015, we earned revenue of $1.0 million and $92.4 million, respectively, from our relationship with Bayer, which represented 2 percent and 40 percent, respectively, of our total revenue for those periods. Our condensed consolidated balance sheet at September 30, 2015 included deferred revenue of $7.6 million related to our relationship with Bayer.

Biogen

We have established four strategic collaborations with Biogen focused on using antisense technology to advance the treatment of neurological and neuromuscular disorders. These collaborations combine our expertise in creating antisense drugs to evaluate potential neurological targets with Biogen's expertise in developing therapies for neurological disorders. We and Biogen are developing four drugs to treat neurological disorders under these collaborations, including nusinersen, ISIS-DMPK-2.5_Rx, and two drugs to treat undisclosed neurodegenerative diseases, ISIS-BIIB3_Rx and ISIS-BIIB4_Rx. In addition to these four drugs, we and Biogen are evaluating numerous additional targets for the development of drugs to treat neurological disorders.

Nusinersen (formerly ISIS-SMN_Rx)

In January 2012, we entered into a collaboration agreement with Biogen to develop and commercialize nusinersen for the treatment of SMA. We are currently conducting a Phase 3 study evaluating nusinersen in infants with SMA and a Phase 3 study evaluating nusinersen in children with SMA. Patients from both of the Phase 3 studies continue to have access to nusinersen through our Phase 3 open-label extension study. In addition, we are evaluating nusinersen in two Phase 2 open-label, multiple-dose, dose-escalation studies, one in children with SMA and one in infants with SMA. Patients from both of the Phase 2 studies continue to have access to nusinersen through open-label extension dosing. We are responsible for completing the Phase 2 and Phase 3 trials we are currently conducting. Biogen has the option to license nusinersen. If Biogen exercises its option, it will pay us a license fee and will assume all other global development, regulatory and commercialization responsibilities. Biogen may exercise this option upon completion of and data review of the first successful Phase 2/3 trial or completion of both Phase 2/3 trials. An amendment in December 2014 provided for additional opt-in scenarios, based on the filing or the acceptance of a new drug application or marketing authorization application with the FDA or EMA. In June 2015, we and Biogen amended the development plan for nusinersen to include conducting the open-label extension study for the Phase 3 studies in infants and children. As a result of the change to the development plan, we earned an $11 million milestone payment when we initiated the Phase 3 open-label extension study and we are eligible to earn additional milestone and other payments.

Under the terms of the agreement, we received an upfront payment of $29 million, which we are amortizing through February 2017. We are also eligible to receive a license fee, milestone payments and tiered royalties up to the mid-teens on any product sales of nusinersen. Under the terms of the amended agreement, we are eligible to receive up to $346 million in a license fee and payments, including up to $121 million in substantive milestone and other payments associated with the clinical development of nusinersen prior to licensing and up to $150 million in substantive milestone payments if Biogen achieves pre-specified regulatory milestones. In the first nine months of 2015, we earned $26.7 million for advancing the studies we are conducting in infants and children with SMA. From inception through September 2015, we have received over $120 million in payments for advancing nusinersen, not including an $11 million milestone payment we earned in October 2015 for initiating the open-label extension study of nusinersen for the Phase 3 studies in infants and children. We will earn the next milestone payment of $2 million if we further advance the Phase 3 study of nusinersen in children.

ISIS-DMPK-2.5_Rx

In June 2012, we and Biogen entered into a second and separate collaboration agreement to develop and commercialize a novel antisense drug, ISIS-DMPK-2.5_Rx, targeting DMPK for the treatment of DM1. We are responsible for global development of the drug through the completion of the first Phase 2 clinical trial. Biogen has the option to license the drug through the completion of the first Phase 2 trial. If Biogen exercises its option, it will assume all other global development, regulatory and commercialization responsibilities. Under the terms of the agreement, we received an upfront payment of $12 million, which we are amortizing through October 2018. In June 2015, we and Biogen amended the development plan for ISIS-DMPK-2.5_Rx under which we are eligible to earn additional milestone payments of up to $4.2 million for further advancing the Phase 1/2a study of ISIS-DMPK-2.5_Rx. Over the term of the collaboration, we are eligible to receive up to $263 million in a license fee and substantive milestone payments, including up to $63 million in development milestone payments and up to $130 million in milestone payments if Biogen achieves pre-specified regulatory milestones. In addition, we are eligible to receive tiered royalties up to the mid-teens on any product sales of the drug. From inception through September 2015, we have received $36 million in payments for advancing ISIS-DMPK-2.5_Rx. We will earn the next milestone payment of $2.8 million if we further advance the Phase 1/2a study for ISIS-DMPK-2.5_Rx and we will earn a $35 million milestone payment if we initiate a Phase 2 study for ISIS-DMPK-2.5_Rx.

Neurology

In December 2012, we and Biogen entered into a third and separate collaboration agreement to develop and commercialize novel antisense drugs to three targets to treat neurological or neuromuscular diseases. We are responsible for the development of each of the drugs through the completion of the initial Phase 2 clinical study for such drug. Biogen has the option to license a drug from each of the three programs through the completion of the first Phase 2 study for each program. If Biogen exercises its option for a drug, it will assume all further global development, regulatory and commercialization responsibilities for that drug. Under the terms of the agreement, we received an upfront payment of $30 million, which we are amortizing through December 2020. Over the term of the collaboration, we are eligible to receive up to $259 million in a license fee and substantive milestone payments per program. We are eligible to receive up to $59 million in development milestone payments to support research and development of each program, including amounts related to the cost of clinical trials. We are also eligible to receive up to $130 million in milestone payments per program if Biogen achieves pre-specified regulatory milestones. In addition, we are eligible to receive tiered royalties up to the mid-teens on any product sales of drugs resulting from each of the three programs. In February 2015, we earned a $10 million milestone payment when we initiated an IND-enabling toxicology study of ISIS-BIIB4_Rx, a drug for an undisclosed target designed to treat a neurodegenerative disease. From inception through September 2015, we have received $40 million in payments under this collaboration. We will earn the next milestone payment of $3 million for the continued development of an undisclosed target under this collaboration.

Strategic Neurology

In September 2013, we and Biogen entered into a fourth and separate collaboration agreement, which is a long-term strategic relationship focused on applying antisense technology to advance the treatment of neurological diseases. As part of the collaboration, Biogen gained exclusive rights to the use of our antisense technology to develop therapies for neurological diseases and has the option to license drugs resulting from this collaboration. The exclusivity for neurological diseases will last through September 2019, and may be extended for any drug development programs being pursued under the collaboration. We will usually be responsible for drug discovery and early development of antisense drugs and Biogen will have the option to license antisense drugs after Phase 2 proof of concept. If Biogen exercises its option for a drug, it will assume all further global development, regulatory and commercialization responsibilities for that drug. Biogen will be responsible for all of the drug discovery and development activities for drugs using other modalities.

Under the terms of the agreement, we received an upfront payment of $100 million and are eligible to receive milestone payments, license fees and royalty payments for all drugs developed through this collaboration, with the specific amounts dependent upon the modality of the molecule advanced by Biogen. If we have a change of control during the first six years of the collaboration, we may be required to refund Biogen a portion of the $100 million upfront payment, with the amount of the potential refund decreasing ratably as we progress through the initial six year term of the collaboration. We are amortizing the $100 million upfront payment through September 2019. Because the amortization period for the upfront payment will never be less than the initial six year term of the collaboration, the amount of revenue we recognize from the upfront payment will never exceed the amount that Biogen could potentially require us to refund.

For each antisense molecule that is chosen for drug discovery and development under this collaboration, we are eligible to receive up to approximately $260 million in a license fee and substantive milestone payments. We are eligible to receive up to approximately $60 million for the achievement of research and development milestones, including amounts related to the cost of clinical trials, and up to $130 million for the achievement of regulatory milestones. In addition, we are eligible to receive tiered royalties up to the mid-teens on any product sales of antisense drugs developed under this collaboration. If other modalities are chosen, such as small molecules or monoclonal antibodies, we are eligible to receive up to $90 million in substantive milestone payments, including up to $35 million for the achievement of research and development milestones and up to $55 million for the achievement of regulatory milestones. In addition, we are eligible to receive tiered single-digit royalties on any product sales of drugs using non-antisense modalities developed under this collaboration. From inception through September 2015, we have received $135 million in payments under this collaboration. In April 2015, we earned a $10 million milestone payment for validating a fourth target under this collaboration. We will earn the next milestone payment of up to $10 million if we choose another target to advance under this collaboration.

Each of our agreements with Biogen will continue until the earlier of the date all of Biogen's options to obtain the exclusive licenses under the applicable agreement expire unexercised or, if Biogen exercises its option, until the expiration of all payment obligations under the applicable agreement. In addition, each agreement, or any program under an agreement, may terminate early under the following situations:



Biogen may terminate the agreement or any program at any time by providing written notice to us;



Under specific circumstances, if we are acquired by a third party with a product that directly competes with a compound being developed under the agreement, Biogen may terminate the affected program by providing written notice to us;



If, within a specified period of time, any required clearance of a transaction contemplated by an agreement under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, is not received, then either we or Biogen may terminate the affected program by providing written notice to the other party; and



Either we or Biogen may terminate any program by providing written notice to the other party upon the other party's uncured failure to perform a material obligation under the agreement with respect to the affected program, or the entire agreement if the other party becomes insolvent.

During the three and nine months ended September 30, 2015, we earned revenue of $18.1 million and $75.1 million, respectively, from our relationship with Biogen, which represented 37 percent and 32 percent, respectively, of our total revenue for those periods. In comparison, we earned revenue of $31.7 million and $76.4 million for the same periods in 2014. Our condensed consolidated balance sheet at September 30, 2015 included deferred revenue of $98.1 million related to our relationship with Biogen.

GSK

In March 2010, we entered into a strategic alliance with GSK using our antisense drug discovery platform to seek out and develop new drugs against targets for rare and serious diseases, including infectious diseases and some conditions causing blindness. Our strategic alliance currently includes five drugs in development. GSK has the exclusive option to license drugs resulting from this alliance at Phase 2 proof-of-concept for a license fee. If GSK exercises its exclusive option for any drugs resulting from this alliance, it will be responsible for all further global development, regulatory and commercialization activities for such drug. Under the terms of the agreement, we received $38 million in upfront and expansion payments, which we are amortizing through March 2017.

In October 2012, we and GSK amended the original agreement to reflect an accelerated clinical development plan for ISIS-TTR_Rx. From inception through September 2015, we have earned $60 million, primarily in milestone payments, from GSK related to the development of ISIS-TTR_Rx. We are also eligible to earn an additional $10 million pre-licensing milestone payment associated with the ISIS-TTR_Rx Phase 2/3 study. In addition, under the amended agreement, we and GSK increased the regulatory and commercial milestone payments we can earn should ISIS-TTR_Rx receive marketing approval and meet pre-agreed sales targets. In September 2015, we and GSK amended the development plan for ISIS-TTR_Rx to support the Phase 3 cardiomyopathy study, which GSK will conduct.

 In addition to ISIS-TTR_Rx, we have four drugs in development. We are developing ISIS-HBV_Rx, an antisense drug designed to reduce the production of viral proteins associated with hepatitis B virus, or HBV infection. We are also developing ISIS-GSK4-L_Rx and ISIS-RHO-2.5_Rx, which are antisense drugs we designed to treat ocular diseases. In addition, we are developing a drug to treat an undisclosed target, ISIS-GSK6-L_Rx.

Under our agreement, if GSK successfully develops all five drugs for one or more indications and achieves pre-agreed sales targets, we could receive license fees and substantive milestone payments of more than $1.3 billion, including up to $223.5 million for the achievement of development milestones, up to $483.5 million for the achievement of regulatory milestones and up to $428 million for the achievement of commercialization milestones. Through September 2015, we have received $129.5 million in payments under this strategic alliance with GSK, not including a $5 million milestone payment we earned in October when we initiated a Phase 1 study of ISIS-GSK4-L_Rx. We will earn the next milestone payment of $1.5 million if we further advance a program under this collaboration. In addition, we are eligible to receive tiered royalties up to the mid-teens on sales from any product that GSK successfully commercializes under this alliance.

Our alliance with GSK will continue until the earlier of the date that all of GSK's options to obtain the exclusive licenses under the agreement expire unexercised or, if GSK exercises its option, until the expiration of all payment obligations under the agreement. In addition, the agreement, or any program under the agreement, may terminate early under the following situations:



GSK may terminate any program, other than the ISIS-TTRRx program, at any time by providing written notice to us;



GSK may terminate the ISIS-TTRRx program by providing written notice to us after reviewing specific data from the Phase 3 study for the program; and



Either we or GSK may terminate any program by providing written notice to the other party upon the other party's uncured failure to perform a material obligation under the agreement with respect to the affected program, or the entire agreement if the other party becomes insolvent.

During the three and nine months ended September 30, 2015, we earned revenue of $1.6 million and $22.4 million, respectively, from our relationship with GSK. In comparison, we earned revenue of $5.1 million and $11.9 million for the same periods in 2014. Our condensed consolidated balance sheet at September 30, 2015 included deferred revenue of $5.5 million related to our relationship with GSK.

Roche

 

In April 2013, we formed an alliance with Hoffman-La Roche Inc. and F. Hoffmann-La Roche Ltd., collectively Roche, to develop treatments for Huntington's disease based on our antisense technology. Roche has the option to license the drugs from us through the completion of the first Phase 1 trial. Prior to option exercise, we are responsible for the discovery and development of an antisense drug targeting huntingtin, or HTT, protein. If Roche exercises its option, it will be responsible for global development, regulatory and commercialization activities for any drug arising out of the collaboration. We are also working collaboratively with Roche on the discovery of an antisense drug utilizing Roche's "brain shuttle" program. Under the terms of the agreement, we received an upfront payment of $30 million in April 2013, which we are amortizing through January 2017. We are eligible to receive up to $362 million in a license fee and substantive milestone payments including up to $67 million for the achievement of development milestones, up to $170 million for the achievement of regulatory milestones and up to $80 million for the achievement of commercialization milestone payments. In addition, we are eligible to receive up to $136.5 million in milestone payments for each additional drug successfully developed and up to $50 million in commercial milestones if a drug using Roche's proprietary brain shuttle technology is successfully commercialized. We are also eligible to receive tiered royalties up to the mid-teens on any product sales of drugs resulting from this alliance. Through September 2015, we have received $52 million in payments under this strategic alliance with Roche, including the $22 million milestone payment we earned in July 2015 when we initiated a Phase 1/2 study of ISIS-HTT_Rx. We will earn the next milestone payment of $10 million if we initiate a Phase 2 trial for ISIS-HTT_Rx.

Our alliance with Roche will continue until the earlier of the date Roche's option to obtain the exclusive license under the agreement expires unexercised or, if Roche exercises its option, until the expiration of all payment obligations under the agreement. In addition, the agreement may terminate early under the following situations:



Roche may terminate the agreement at any time by providing written notice to us;



Either we or Roche may terminate the agreement by providing written notice to the other party upon the other party's uncured failure to perform a material obligation under the agreement or if the other party becomes insolvent; and



Either we or Roche may terminate the brain shuttle program if at least one development candidate is not designated under such program by a mutually agreed deadline.

During the three and nine months ended September 30, 2015, we earned revenue of $24.2 million and $29.0 million, respectively, from our relationship with Roche. In comparison, we earned $2.3 million and $6.7 million for the same periods in 2014. Our condensed consolidated balance sheet at September 30, 2015 included deferred revenue of $10.9 million related to our relationship with Roche.

7.

Segment Information and Concentration of Business Risk

In 2015, we began reporting our financial results in two reportable segments, Isis Core, previously referred to as Drug Discovery and Development, and Akcea Therapeutics, our new wholly owned subsidiary. Segment loss from operations includes revenue less operating expenses attributable to each segment.

In our Isis Core segment we are exploiting a novel drug discovery platform we created to generate a broad pipeline of first-in-class or best-in-class drugs for us and our partners. Our Isis Core segment generates revenue from a multifaceted partnering strategy.

We established Akcea to develop and commercialize the drugs from our lipid franchise. Moving our lipid drugs into a company that we own and control ensures that our core focus at Isis remains on innovation while allowing us to maintain control over and retain more value from our lipid drugs. To date, Akcea has not earned any revenue.

The following is our segment information for the three and nine months ended September 30, 2015 (in thousands).

The following is our segment information for the three and nine months ended September 30, 2014 (in thousands) revised for comparative purposes to show operating costs for Akcea-related projects in 2014:

        We have historically funded our operations from collaborations with corporate partners and a relatively small number of partners have accounted for a significant percentage of our revenue. Revenue from significant partners, which is defined as ten percent or more of our total revenue, was as follows:

Contracts receivables from three significant partners comprised approximately 96 percent and 99 percent of our contracts receivables at September 30, 2015 and December 31, 2014, respectively.

ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this Report on Form 10-Q, unless the context requires otherwise, “Isis,” “Company,” “we,” “our,” and “us,” means Isis Pharmaceuticals, Inc. and its wholly owned subsidiary, Akcea Therapeutics, Inc.

Forward-Looking Statements

In addition to historical information contained in this Report on Form 10-Q, this Report includes forward-looking statements regarding our business, the business of Akcea, our subsidiary, the therapeutic and commercial potential of our technologies and drugs, including KYNAMRO, volanesorsen (formerly ISIS-APOCIII_Rx), nusinersen and ISIS-TTR_Rx, and other products in development, and the financial position of Isis Pharmaceuticals, Inc. Any statement describing our goals, expectations, financial or other projections, intentions or beliefs, is a forward-looking statement and should be considered an at-risk statement. Such statements are subject to certain risks and uncertainties, particularly those inherent in the process of discovering, developing and commercializing drugs that are safe and effective for use as human therapeutics, and in the endeavor of building a business around such drugs. Our forward-looking statements also involve assumptions that, if they never materialize or prove correct, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Although our forward-looking statements reflect the good faith judgment of our management, these statements are based only on facts and factors currently known by us. As a result, you are cautioned not to rely on these forward-looking statements. These and other risks concerning our programs are described in additional detail in our Annual Report on Form 10-K for the year ended December 31, 2014, which is on file with the U.S. Securities and Exchange Commission and are available from us, and those identified within this Item in the section entitled “Risk Factors” beginning on page 33 of this Report.

Overview

We are the leading company in RNA-targeted drug discovery and development, exploiting a proven novel drug discovery platform we created to generate a broad pipeline of first-in-class or best-in-class antisense drugs. The efficiency and broad applicability of our drug discovery platform allows us to discover and develop antisense drugs to treat a wide range of diseases with an emphasis on cardiovascular, metabolic, severe and rare diseases, including neurological disorders, and cancer. The efficiency of our drug discovery technology allows us to employ a unique business strategy designed to maximize the value of our drugs and technology while maintaining an effective cost structure that limits our cash needs. Our business strategy is supported by our platform technology, our robust pipeline of drugs and our diverse partnering strategies, which have enabled us to focus on doing what we do best – to discover and develop novel antisense drugs.

We have created a mature and broad pipeline of 38 drugs in development that represents the potential for significant commercial opportunities in many therapeutic areas. We have a number of drugs in later-stage development that we believe represent significant near-term commercial opportunities, including three drugs in Phase 3 trials, ISIS-TTR_Rx, nusinersen and volanesorsen. We designed these drugs to treat patients with severe and rare diseases who have very limited or no therapeutic options. ISIS-TTR_Rx is designed to treat patients with transthyretin amyloidosis, or TTR amyloidosis, a fatal genetic disease in which patients experience progressive buildup of amyloid plaque deposits in tissues throughout the body, including peripheral nerves, heart, intestinal tract, kidney and bladder. ISIS-TTR_Rx is currently in Phase 3 development to treat all forms of TTR amyloidosis, including the polyneuropathy and cardiomyopathy forms of the disease. Nusinersen is designed to treat patients with spinal muscular atrophy, or SMA, which is a severe motor-neuron disease that is the leading genetic cause of infant mortality. Volanesorsen is designed to treat patients with severely high triglyceride levels, including patients with a severe and rare genetic condition called familial chylomicronemia syndrome, or FCS and patients with partial lipodystrophy, another severe and rare genetic condition. The significant unmet medical need and the severity of these diseases could warrant a rapid path to market. Already this year, we have reported positive Phase 2 or open-label extension data on these three drugs, which, together with the safety profile we have reported for each, support continued development of these programs. We expect Phase 3 data in 2016/2017 for all three of these drugs, which may support regulatory filings for marketing approvals. We believe all of these drugs have the potential to reach the market in the next few years. We also have numerous drugs in our pipeline advancing in mid-stage clinical development that could represent significant near and mid-term licensing opportunities.

Our novel lipid-lowering product, KYNAMRO (mipomersen sodium) injection, is on the market in the United States for patients with HoFH. Patients with HoFH are at high cardiovascular risk and cannot reduce their LDL-C sufficiently with currently available lipid-lowering therapies. In January 2013, the FDA approved the marketing application for KYNAMRO for patients with HoFH. Genzyme, a Sanofi Company, has also obtained marketing approval in other countries, and is pursuing marketing approval in multiple additional markets. We reported positive clinical results for KYNAMRO in a late-stage clinical study, FOCUS FH, in patients with severe HeFH in August 2015.

The efficiency and broad utility of our drug discovery technology supports the continued growth of our pipeline of antisense drugs. To maximize the value of our drugs and technologies, we have a multifaceted partnering strategy. Our partnering strategy provides us the flexibility to license each of our drugs at what we believe is the optimal time to maximize the near- and long-term value of our drugs. In this way, we can expand our and our partners' pipelines with antisense drugs that we design to address significant medical needs while remaining small and focused.

One component of our partnering strategy is to form traditional partnering alliances that enable us to discover and conduct early development of new drugs, outlicense our drugs to partners and build a base of license fees, milestone payments and profit share or royalty income. An example of this is our recent exclusive license of ISIS-FXI_Rx to Bayer to develop and commercialize ISIS-FXI_Rx for the prevention of thrombosis. As a leader in the antithrombotic market, Bayer has the expertise, resources and commitment to broadly develop ISIS-FXI_Rx. Bayer is preparing to conduct a robust development plan that represents a commitment to make a substantial investment in ISIS-FXI_Rx. Bayer is planning to focus on advancing ISIS-FXI_Rx to the market first for patients who have a high bleeding risk and as such are unable to take currently available antithrombotic agents, followed by a broader group of patients who are underserved by current anti-thrombotic treatments. Another example of our traditional partnering strategy was our license of KYNAMRO to Genzyme.

We also form preferred partner transactions that provide us with a vested partner early in the development of a drug. Typically, the drugs we partner early in development are in therapeutic areas of high risk, like severe neurological diseases, or in areas where Phase 2 results would likely not provide a significant increase in value, like cancer. These preferred partner transactions allow us to develop select drugs that could have significant commercial potential with a knowledgeable and committed partner with the financial resources to fund later-stage clinical studies and expertise to complement our own development efforts. We benefit from this strategy because it allows us to expand and broaden our drug discovery efforts to new disease targets. We have formed preferred partner collaborations with the following companies:



GSK - We are developing five drugs, including ISIS-TTRRx, which is in Phase 3 development.



Janssen - We are discovering and developing antisense drugs that can be locally administered, including oral delivery, to treat autoimmune disorders in the gastrointestinal tract.



Roche - We are discovering and developing antisense drugs to treat Huntington's disease.

In addition to our preferred partner collaborations, we have also built broad strategic relationships over time with Biogen and most recently with AstraZeneca.



Biogen - We have four collaborations with Biogen to discover and develop antisense drugs to treat neurologic diseases, including nusinersen, which is in Phase 3 development. We currently have four drugs we are advancing through these collaborations, nusinersen, ISIS-DMPK-2.5Rx, ISIS-BIIB3Rx and ISIS BIIB4Rx. In addition to these four drugs, we and Biogen are evaluating numerous additional targets for the development of drugs to treat neurological disorders. Through our broad strategic partnership with Biogen, we are capitalizing on Biogen's extensive resources and expertise in neurological diseases to create a franchise of novel treatments for neurological disorders.



AstraZeneca - We recently expanded our relationship with AstraZeneca with a strategic collaboration to discover and develop antisense drugs for cardiovascular, metabolic and renal diseases. The new collaboration builds on our broad existing relationship and supports AstraZeneca’s strategic approach in these therapeutic areas using novel RNA-targeted treatments. It also enables us to extend our use of our antisense technology to diseases of the kidney. This recent transaction adds to our existing collaboration to discover and develop antisense drugs to treat cancer and our drug delivery collaboration.

Similar to our other partnerships, we benefit financially from our preferred partner collaborations and our strategic collaborations from upfront payments, milestone payments, licensing fees and royalties.

Earlier this year, we established a wholly owned subsidiary, Akcea Therapeutics, Inc., to develop and commercialize the drugs from our lipid franchise, including volanesorsen, a Phase 3 drug in development to treat two severe and rare diseases; ISIS-APO(a)-L_Rx, the only drug in clinical development to selectively reduce Lp(a) for patients with high Lp(a); and ISIS-ANGPTL3-L_Rx, designed to be a broadly acting drug for mixed dyslipidemias and lipid disorders. To lead Akcea, we hired a senior business leader with commercialization expertise in severe and rare and cardiovascular diseases to maximize the value of our lipid franchise assets. Akcea has been building development and commercialization expertise in lipid and cardiometabolic diseases, and preparing for commercialization of volanesorsen, which is in Phase 3 development with data expected in late 2016/early 2017. Moving our lipid drugs into a company that we own and control ensures that our core focus at Isis remains on innovation while allowing us to maintain control over and retain more value from our lipid drugs.

We also work with a consortium of companies that can further develop our drugs and technology. We call these companies satellite companies. We benefit from the disease-specific expertise of our satellite company partners, who are advancing drugs in our pipeline in areas that are outside of our core focus. For example, Regulus is a satellite company partner that we co-founded to discover and develop antisense drugs targeting microRNAs. Since 2014, we have received nearly $50 million from the sale of a portion of our Regulus stock and we remain a significant shareholder in the company. We also maintain our broad RNA technology leadership through collaborations with satellite companies. All of these different types of relationships are part of our partnering strategy, which we designed to maximize the value of our assets, minimize the development risks of a broad pipeline of novel new drugs, and provide us with significant reliable near-term revenue.

We have the potential to earn significant revenue from all of our partnerships. Since 2007, we have received more than $1.6 billion in cash from upfront and licensing fees, equity purchase payments, milestone payments and research and development funding from our partnerships. We have the potential to earn nearly $13 billion in future milestone payments and licensing fees from all of our partnerships. We also have the potential to share in the future commercial success of our inventions and drugs resulting from our partnerships through earn out, profit sharing, or royalty arrangements.

As an innovator in RNA-targeting drug discovery and development, we designed and execute our patent strategy to provide us with extensive protection for our drugs and our technology. With our ongoing research and development, we continue to add to our substantial patent estate. Our patents not only protect our key assets—our technology and our drugs—they also form the basis for lucrative licensing and partnering arrangements. Through September 2015, we have generated more than $420 million from our intellectual property sale and licensing program that helps support our internal drug discovery and development programs.



We and AstraZeneca formed a strategic collaboration to discover and develop antisense therapies for treating cardiovascular and metabolic diseases, primarily focused on targets in the kidney, and renal diseases. The collaboration enables us to broaden the application of our antisense technology to targets in the kidney.

o	In total, we have the potential to earn up to more than $4 billion in license fees and milestone payments.



We received a $65 million upfront payment from AstraZeneca and are eligible to earn substantial development and regulatory milestone payments and license fees. We are eligible to earn a payment of $25 million under this collaboration upon identification of the first drug candidate to move into development.



We are also eligible to earn tiered royalties up to the low teens on annual net sales for each of the programs.

	We reported positive clinical results from ISIS-APO(a)Rx and ISIS-APO(a)-LRx, ISIS-TTRRx and KYNAMRO. These data exemplify the broad applicability and potential for antisense drugs to provide therapeutic benefit for many different diseases.

o

We and our subsidiary, Akcea Therapeutics, reported results from a Phase 2 study of ISIS-APO(a)Rx in patients with high lipoprotein(a), or Lp(a), a known driver of cardiovascular disease. In the Phase 2 study patients treated with ISIS-APO(a)Rx achieved reductions in Lp(a) of up to 94 percent. Data from this study were presented at the American Heart Association Scientific Sessions.

o

We and Akcea reported results from a Phase 1/2a, study of ISIS-APO(a)-LRx, a LIgand Conjugated Antisense (LICA) version of ISIS-APO(a)Rx, in subjects with elevated Lp(a). In the Phase 1 study, subjects (with Lp(a) greater than 30 mg/dL) who received a single, low volume, subcutaneous injection of ISIS-APO(a)-LRx, achieved dose-dependent reductions in Lp(a) of up to 97 percent. Subjects who received multiple doses of ISIS-APO(a)-LRx achieved up to 99 percent reduction in Lp(a) levels. In addition, ISIS-APO(a)-LRx demonstrated the potential for a variety of convenient dose schedules- weekly, monthly, quarterly or less frequent dosing. This is the first clinical data from our LICA program and represents a greater than 30-fold increase in potency over ISIS-APO(a)Rx, the non-LICA Lp(a) drug. These data significantly exceeded the potency and duration expectations predicted by preclinical experiments. Data from this study were presented at the American Heart Association Scientific Sessions.

o

Dr. Merrill Benson reported positive preliminary results from an ongoing Phase 2 study in patients with familial amyloid cardiomyopathy (FAC) and patients with wild-type transthyretin amyloidosis (wt-TTR amyloidosis, previously referred to as senile systemic amyloidosis, or SSA). In this open-label, investigator initiated study, after six and 12 months of treatment with ISIS-TTRRx, Dr. Benson observed:



Evidence of disease stabilization. These observations compare favorably to those from Benson’s previously published natural history data, in which, disease progression was observed at 12 months.



Sustained reductions in TTR compared to baseline.

o

We reported positive results from an ongoing open-label extension study (OLE) of ISIS-TTRRx in patients with familial amyloid polyneuropathy (FAP). An analysis conducted on the first 38 patients to reach at least three months of treatment in the OLE study showed a maximum reduction in TTR protein levels of up to 92 percent with a mean maximum (nadir) reduction of 76 percent as compared to patients’ TTR levels at entry into the Phase 3 study.

o

We reported that the FOCUS FH study evaluating KYNAMRO in patients with severe heterozygous familial hypercholesterolemia met its primary efficacy endpoint with a statistically significant reduction of LDL-Cholesterol. We and Genzyme plan to report the full data from this study at an upcoming medical meeting.



We and Akcea published clinical data from two novel lipid drugs, volanesorsen and ISIS-APO(a)Rx, in the New England Journal of Medicine and The Lancet, respectively. These data highlight the significant interest from the medical community in our and Akcea’s lipid drugs and the medical importance of the clinical data from these programs.

	Volanesorsen was granted orphan drug designation from the FDA for the treatment of patients with familial chylomicronemia syndrome.

	We continued to advance our pipeline of drugs:

o	We and Akcea initiated a Phase 3 study of volanesorsen in patients with familial partial lipodystrophy. This study is designed to support regulatory filing for volanesorsen in this patient population.

o	We initiated a Phase 2 study of ISIS-FXIRx in patients who have compromised renal function. These data will be important to form the basis for Bayer’s first Phase 3 study.

o	We initiated a Phase 2 dose-optimization study of ISIS-GCGRRx in patients with type 2 diabetes.

o	We initiated a Phase 1/2 study of ISIS-HTTRx in patients with Huntington’s disease (HD). ISIS-HTTRx was granted orphan drug designation by the European Medicines Agency for the treatment of patients with HD.

o	We initiated a Phase 2 study to evaluate the safety and activity of ISIS-FGFR4Rx in obese patients.

o	We initiated Phase 1 studies of ISIS-DGAT2Rx and ISIS-GSK4-LRx in healthy volunteers.

Critical Accounting Policies

We prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States. As such, we make certain estimates, judgments and assumptions that we believe are reasonable, based upon the information available to us. These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact our quarterly or annual results of operations and financial condition. Each quarter, our senior management reviews the development, selection and disclosure of such estimates with our audit committee of our board of directors. In the following paragraphs, we describe the specific risks associated with these critical accounting policies and we caution that future events rarely develop exactly as one may expect, and that best estimates may require adjustment.

The following are our significant accounting policies, which we believe are the most critical to aid in fully understanding and evaluating our reported financial results:



Assessing the propriety of revenue recognition and associated deferred revenue;



Determining the proper valuation of investments in marketable securities and other equity investments;



Determining the appropriate cost estimates for unbilled preclinical studies and clinical development activities; and



Estimating our net deferred income tax asset valuation allowance.

Based on our ongoing evaluation of our business, in the second quarter of 2015 we determined the following policies are no longer critical to our business and have therefore omitted them from our critical accounting policies:



Assessing the recoverability of long-lived assets, including property and equipment, intellectual property and licensed technology; and



Determining the fair value of convertible debt without the conversion feature.

There have been no other material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our Annual Report on Form 10-K for the year ended December 31, 2014.

Results of Operations

Revenue

Total revenue for the three and nine months ended September 30, 2015 was $49.1 million and $232.1 million, respectively, compared to $44.1 million and $129.3 million for the same periods in 2014. We earned $180.9 million of revenue from the license fee we received from Bayer and milestone payments we earned from our partners and $49.5 million from the amortization of upfront fees and manufacturing services we performed for our partners during the nine months ended September 30, 2015.

Our revenue fluctuates based on the nature and timing of payments under agreements with our partners and consists primarily of revenue from the amortization of upfront fees, milestone payments and license fees.

Research and Development Revenue Under Collaborative Agreements

Research and development revenue under collaborative agreements for the three and nine months ended September 30, 2015 was $48.9 million and $230.5 million, respectively, compared to $43.8 million and $120.0 million for the same periods in 2014. Our revenue for the nine months ended September 30, 2015 consisted of the following:



$91.2 million from Bayer in connection with our exclusive license agreement for ISIS-FXIRx;



$51.7 million in milestone payments from Biogen for advancing nusinersen in late-stage clinical development, advancing ISIS-BIIB4Rx into development and validating two new undisclosed targets for neurological disorders;



$22 million from a milestone payment from Roche for initiating a Phase 1/2 study of ISIS-HTTRx;



$15 million from a milestone payment from GSK for advancing the Phase 3 study of ISIS-TTRRx; and



$49.5 million from the amortization of upfront fees and manufacturing services we performed for our partners.

Already in the fourth quarter of 2015, we have earned $16 million in milestone payments from Biogen and GSK.

Licensing and Royalty Revenue

Our revenue from licensing activities and royalties for the three and nine months ended September 30, 2015 was $0.2 million and $1.7 million, respectively, compared to $0.3 million and $9.3 million for the same periods in 2014. The decrease in 2015 compared to 2014 was primarily a result of the $7.7 million in sublicensing revenue we earned in the first quarter of 2014 from Alnylam related to its license of our technology to one of its partners.

Operating Expenses

Operating expenses for the three and nine months ended September 30, 2015 were $97.3 million and $245.0 million, respectively, and increased compared to $65.6 million and $187.1 million for the same periods in 2014. We are conducting more later-stage clinical trials in 2015 than we did in 2014, including the continuation of our Phase 3 programs for ISIS-TTR_Rx, nusinersen, and volanesorsen. As drugs move forward to more advanced stages of development, including into larger, longer clinical studies, the costs of development increase. As our Phase 3 programs continue to progress in the fourth quarter, we expect the costs associated with these programs to continue to increase. Additionally, our operating expenses increased in 2015 as Akcea is building the commercial infrastructure and continues to advance the pre-commercialization activities necessary to successfully launch volanesorsen within the next few years. We also had an increase in stock compensation expense due to the increase in our stock price in January 2015 compared to January 2014.

In 2015 we began disclosing segment information for Akcea, our wholly owned subsidiary. We have revised 2014 for comparative purposes to show operating costs for Akcea-related projects.

Our operating expenses by segment were as follows (in thousands):

In order to analyze and compare our results of operations to other similar companies, we believe it is important to exclude non-cash compensation expense related to equity awards from our operating expenses. We believe non-cash compensation expense is not indicative of our operating results or cash flows from our operations. Further, we internally evaluate the performance of our operations excluding it.

Research, Development and Patent Expenses

Our research, development and patent expenses consist of costs for antisense drug discovery, antisense drug development, manufacturing and operations and R&D support costs.

The following table sets forth information on research, development and patent expenses (in thousands):

Our research, development and patent expenses by segment were as follows (in thousands):

For the three and nine months ended September 30, 2015, our total research, development and patent expenses were $77.2 million and $188.7 million, respectively, compared to $54.5 million and $154.9 million for the same periods in 2014, and were higher primarily due to the progression of our drugs currently in Phase 3 trials. All amounts exclude non-cash compensation expense related to equity awards.

We use our proprietary antisense technology to generate information about the function of genes and to determine the value of genes as drug discovery targets. We use this information to direct our own antisense drug discovery research, and that of our partners. Antisense drug discovery is also the function that is responsible for advancing our antisense core technology.

As we continue to advance our antisense technology, we are investing in our drug discovery programs to expand our and our partners' drug pipelines. We anticipate that our existing relationships and collaborations, as well as prospective new partners, will continue to help fund our research programs and contribute to the advancement of the science by funding core antisense technology research.

Our antisense drug discovery expenses were as follows (in thousands) and are part of our Isis Core business segment:

Antisense drug discovery costs for the three and nine months ended September 30, 2015 were $12.3 million and $33.6 million, respectively, and were slightly higher as expected, compared to $11.2 million and $31.0 million for the same periods in 2014. Expenses were higher because we are conducting more research activities to support our partnerships. All amounts exclude non-cash compensation expense related to equity awards.

The following table sets forth research and development expenses for our major antisense drug development projects (in thousands):

Antisense drug development expenses were $51.2 million and $116.2 million for the three and nine months ended September 30, 2015, respectively, compared to $31.0 million and $87.6 million for the same periods in 2014. Expenses for the nine months ended September 30, 2015 were higher compared to the same period in 2014 primarily due to the progression of our drugs currently in Phase 3 trials. As drugs move forward to more advanced stages of development, including into larger, longer clinical studies, the costs of development increase. All amounts exclude non-cash compensation expense related to equity awards. In our Form 10-K for fiscal year end 2014, we began presenting salaries and benefits in the development overhead costs line in our antisense drug development table. We have adjusted 2014 to conform to the current year presentation.

Our antisense drug development expenses by segment were as follows (in thousands):

We may conduct multiple clinical trials on a drug candidate, including multiple clinical trials for the various indications we may be studying. Furthermore, as we obtain results from trials we may elect to discontinue clinical trials for certain drug candidates in certain indications in order to focus our resources on more promising drug candidates or indications. Our Phase 1 and Phase 2 programs are clinical research programs that fuel our Phase 3 pipeline. When our products are in Phase 1 or Phase 2 clinical trials, they are in a dynamic state in which we may adjust the development strategy for each product. Although we may characterize a product as "in Phase 1" or "in Phase 2," it does not mean that we are conducting a single, well-defined study with dedicated resources. Instead, we allocate our internal resources on a shared basis across numerous products based on each product's particular needs at that time. This means we are constantly shifting resources among products. Therefore, what we spend on each product during a particular period is usually a function of what is required to keep the products progressing in clinical development, not what products we think are most important. For example, the number of people required to start a new study is large, the number of people required to keep a study going is modest and the number of people required to finish a study is large. However, such fluctuations are not indicative of a shift in our emphasis from one product to another and cannot be used to accurately predict future costs for each product. And, because we always have numerous drugs in preclinical and early stage clinical research, the fluctuations in expenses from drug to drug, in large part, offset one another. If we partner a drug, it may affect the size of a trial, its timing, its total cost and the timing of the related costs.

Expenditures in our manufacturing and operations function consist primarily of personnel costs, specialized chemicals for oligonucleotide manufacturing, laboratory supplies and outside services. Our manufacturing and operations function is responsible for providing drug supplies to antisense drug development, our Akcea subsidiary and our collaboration partners. Our manufacturing procedures include testing to satisfy good laboratory and good manufacturing practice requirements.

Our manufacturing and operations expenses were as follows (in thousands):

Manufacturing and operations expenses were $6.9 million and $18.9 million for the three and nine months ended September 30, 2015, respectively, and increased compared to $5.6 million and $16.6 million for the same periods in 2014. The increase in manufacturing and operations expenses was primarily related to the manufacturing activities needed to support the increase in our drug development activities. All amounts exclude non-cash compensation expense related to equity awards.