IONIS PHARMACEUTICALS INC - Quarter Report: 2016 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, 2016

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

Ionis 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 2, 2016 was 121,202,967.

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IONIS PHARMACEUTICALS, INC.

FORM 10-Q

INDEX

TRADEMARKS

Ionis Pharmaceuticals^TM is a trademark of Ionis Pharmaceuticals, Inc.

Akcea Therapeutics^TM is a trademark of Ionis Pharmaceuticals, Inc.

Regulus Therapeutics^® is a registered trademark of Regulus Therapeutics Inc.

SPINRAZA^TM is a trademark of Biogen, Inc.

KYNAMRO^® is a registered trademark of Kastle Therapeutics LLC

IONIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

See accompanying notes.

IONIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(Unaudited)

 See accompanying notes.

IONIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(Unaudited)

 

See accompanying notes.

IONIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See accompanying notes.

IONIS PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(Unaudited)

1.

Basis of Presentation

We prepared the unaudited interim condensed consolidated financial statements for the nine months ended September 30, 2016 and 2015 on the same basis as the audited financial statements for the year ended December 31, 2015. We included all normal recurring adjustments in the financial statements, which we considered 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, 2015 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC.

In the condensed consolidated financial statements we included the accounts of Ionis Pharmaceuticals, Inc. ("we", "us" or "our") and our wholly owned subsidiary, Akcea Therapeutics, Inc., which we incorporated 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. 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. For example, in May 2015, we entered into an exclusive license agreement with Bayer to develop and commercialize IONIS-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 and tiered royalties on gross margins of IONIS-FXI_Rx. We are responsible for completing the ongoing development services for IONIS-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 IONIS-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 IONIS-FXIRx for the treatment of thrombosis;



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



The initial supply of API.

We determined that each of these three units of accounting have stand-alone value. The license we granted to Bayer has stand-alone value because it gives Bayer the exclusive right to develop IONIS-FXI_Rx or to sublicense its rights. The development services and the initial supply of API each 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 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. 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. 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 IONIS-FXI_Rx by using the relief from royalty method. Under this method, we estimated the amount of income, net of taxes, for IONIS-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 BESP of the services we will perform and the API in our Bayer transaction, accounting guidance required us 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 IONIS-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 IONIS-FXI_Rx license, we determined that the revenue we would have allocated to the IONIS-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 IONIS-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 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 IONIS-FXIRx license immediately because we delivered the license and earned the revenue;



We are recognizing the amount attributed to the ongoing development services for IONIS-FXIRx over the period of time we are performing the services; and



We are recognizing the amount attributed to the API supply as we deliver it to Bayer. During the nine months ended  September 30, 2016, we recognized $3.2 million related to a portion of the API we delivered to Bayer during the first nine months of 2016.

From time to time, we may enter into separate agreements at or near the same time with the same partner. 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, in 2012 and 2013, we entered into four collaboration agreements with Biogen:



In January 2012, we entered into a collaboration agreement with Biogen to develop and commercialize SPINRAZA (nusinersen) 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 SPINRAZA 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 a $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.

Under our collaboration agreement, in July 2016, Biogen exercised its option to license SPINRAZA. Our other three collaboration agreements with Biogen give Biogen the option to license one or more drugs resulting from the specific collaboration. Similar to our collaboration agreement for SPINRAZA, 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 from any 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.

Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and/ or 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 paragraphs.

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 Investigational New Drug, or IND,

-enabling studies, which are animal studies intended to support an 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 authorization 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 authorization. This stage of the drug’s life-cycle is the regulatory stage.

If a drug achieves marketing authorization, 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 marketing authorization 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 authorization 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 authorization 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 authorization 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. 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.

In several of our collaboration agreements, we provide our partner with an option to obtain a license to one or more of our drugs.  When we have a multiple element arrangement that includes an option to obtain a license, we evaluate if the option is a deliverable at the inception of the arrangement.  We do not consider the option to be a deliverable if we conclude that it is substantive and not priced at a significant and incremental discount. We consider an option substantive if, at the inception of the arrangement, we are at risk as to whether our collaborative partner will choose to exercise its option to obtain the license. In those circumstances, we do

not include the associated license fee in the allocable consideration at the inception of the agreement. Rather, we account for the license fee when our partner exercises its option. For example, in the third quarter of 2016, we recognized $85.0 million in license fee revenue when two of our partners, Biogen and Janssen, exercised their option to license two of our drugs, which under the respective agreements we concluded to be substantive options at inception. As these amounts relate to research and development collaboration arrangements, we include these amounts in research and development revenue under collaborative agreements on our statement of operations.

We often enter into agreements to license and sell our proprietary patent rights on an exclusive or non-exclusive basis in exchange for upfront fees, milestone payments and/or royalties. We generally recognize as revenue immediately those payments for which we have no significant future performance obligations and for which we are reasonably assured of collecting the resulting receivable.

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, 2016, 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). At September 30, 2016, we held equity investments in two publicly held companies, Antisense Therapeutics Limited and Regulus Therapeutics. 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. At September 30, 2016, we held two cost method investments in Atlantic Pharmaceuticals Limited and Kastle Therapeutics. Realization of our equity position in these private companies 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, 2016 and 2015. Total inventory was $9.3 million and $6.9 million as of September 30, 2016 and December 31, 2015, 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. We recorded charges primarily related to the write-down of intangible assets of $0.7 million and $0.1 million for the three months ended September 30, 2016 and 2015, respectively, and $1.1 million and $0.2 million for the nine months ended September 30, 2016 and 2015, respectively.

Long-lived assets

We evaluate long-lived assets, which include property, plant and equipment and patent costs 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 income (loss) per share

We compute basic net income (loss) per share by dividing the net income or loss by the weighted-average number of common shares outstanding during the period. For the nine months ended September 30, 2016 and the three and nine months ended September 30, 2015 we incurred a net loss, therefore 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:



Dilutive stock options;



Unvested restricted stock units;



Employee Stock Purchase Plan, or ESPP;



2¾ percent convertible senior notes; and



1 percent convertible senior notes.

For the three months ended September 30, 2016, we had net income. As a result, we computed diluted net income per share using the weighted-average number of common shares and dilutive common equivalent shares outstanding during those periods. Diluted common equivalent shares for the three months ended September 30, 2016, consisted of the following (in thousands except per share amounts):

For the three months ended September 30, 2016, the calculation excludes the 2¾ percent notes and the 1 percent notes because the effect on diluted earnings per share would be anti-dilutive.

Accumulated other comprehensive income (loss)

We include unrealized gains and losses on investments, net of taxes, in accumulated other comprehensive income (loss) along with adjustments we make to reclassify realized gains and losses on investments from other accumulated comprehensive income (loss) to our condensed consolidated statement of operations. The following table summarizes changes in accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2016 and 2015 (in thousands):

(1)

There was no tax expense or benefit for the three and nine months ended September 30, 2016 and 2015.

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 assigned 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.

At January 1, 2016, we adopted the amended accounting guidance to simplify the presentation of debt issuance costs. As a result of this amended guidance, we reclassed our debt issuance costs in all periods presented from other assets to the carrying amount of the related debt liability on our consolidated balance sheet. We are amortizing our debt issuance costs and debt discount over the life of the convertible notes as additional non-cash interest expense utilizing the effective interest method.

Segment information

We have two operating segments, our Ionis Core segment and Akcea Therapeutics, which includes the operations of our wholly-owned subsidiary, Akcea Therapeutics, Inc. We formed Akcea to develop and commercialize drugs for patients with serious cardiometabolic diseases caused by lipid disorders. We provide segment financial information and results for our Ionis 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, 2016 and 2015, 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 the members of our board of directors for the nine months ended September 30, 2016 was $42.94 and $24.42 per share, respectively.

The following table summarizes stock-based compensation expense for the three and nine months ended September 30, 2016 and 2015 (in thousands).  Our consolidated non-cash stock-based compensation expense includes $2.9 million and $1.3 million of stock-based compensation expense for Akcea employees for the three months ended September 30, 2016 and 2015, respectively, and $9.1 million and $2.8 million of stock-based compensation expense for Akcea employees for the nine months ended September 30, 2016 and 2015, respectively.

The amount of non-cash stock-based compensation expense we recognized in the first nine months of 2016 has increased compared to the same period in 2015 because the average fair value of unvested stock options has risen due to the increase in the exercise price of the stock options we have granted over the past several years. As of September 30, 2016, total unrecognized estimated non-cash stock-based compensation expense related to non-vested stock options and RSUs was $60.5 million and $17.3 million, respectively. We will adjust total unrecognized compensation cost for future 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.

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 will adopt this guidance beginning 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 accumulated deficit balance. We are currently determining the adoption method and 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 annual periods ending after December 15, 2016, and interim and annual periods thereafter. We will adopt this guidance for our year ended December 31, 2016. We do not expect this guidance to have any effect on our consolidated financial statements and disclosures.

In January 2016, the FASB issued amended accounting guidance related to the recognition, measurement, presentation, and disclosure of certain financial instruments. The amended guidance requires us to measure and record equity investments, except those accounted for under the equity method of accounting that have a readily determinable fair value, at fair value and for us to recognize the changes in fair value in our net income (loss), instead of recognizing unrealized gains and losses through accumulated other comprehensive income, as we currently do under the existing guidance. The amended guidance also changes several disclosure requirements for financial instruments, including the methods and significant assumptions we use to estimate fair value. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2017. We will adopt this guidance on January 1, 2018 and we will make any adjustments to beginning balances through a cumulative-effect adjustment to accumulated deficit on that date. We are currently determining the effects the adoption will have on our consolidated financial statements and disclosures.

In February 2016, the FASB issued amended accounting guidance related to leasing, which requires us to record all leases longer than one year on our balance sheet. When we record leases on our balance sheet under the new guidance, we will record a liability with a value equal to the present value of payments we will make over the life of the lease and an asset representing the underlying leased asset. The new accounting guidance requires us to determine if our leases are operating or financing leases, similar to current accounting guidance. We will record expense for operating type leases on a straight-line basis as an operating expense and we will record expense for finance type leases as interest expense. The new lease standard is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. We must adopt the new standard on a modified retrospective basis, which requires us to reflect our leases on our consolidated balance sheet for the earliest comparative period presented. We are currently assessing the timing of adoption as well as the effects it will have on our consolidated financial statements and disclosures.

In March 2016, the FASB issued amended guidance to simplify certain aspects of share-based payment accounting. Under the amended guidance, we will recognize excess tax benefits and tax deficiencies as income tax expense or benefit in our statement of operations on a prospective basis. As we have a valuation allowance, this change will impact our net operating loss carryforward and our valuation allowance disclosures. Additionally, we will classify excess tax benefits as an operating activity and classify amounts we withhold in shares for the payment of employee taxes as a financing activity on our statement of cash flows for each period we present. Lastly, the amended guidance allows us to account for forfeitures when they occur or continue to estimate them. We will continue to estimate our forfeitures. The amended share-based payment standard is effective for annual and interim periods beginning after December 15, 2016, with early adoption permitted in any interim or annual period. We will adopt this guidance on January 1, 2017. We do not expect the amended guidance to have a significant impact on our financial results.

In June 2016, the FASB issued guidance that changes the measurement of credit losses for most financial assets and certain other instruments. If we have credit losses, this updated guidance requires us to record allowances for these instruments under a new expected credit loss model. This model requires us to estimate the lifetime expected credit loss, which represents the portion of the amortized cost basis we do not expect to collect. This change will result in us remeasuring our allowance in each reporting period we have credit losses. The new standard is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for periods beginning after December 15, 2018. When we adopt  the new standard, we will make any adjustments to beginning balances through a cumulative-effect adjustment to accumulated deficit on that date. We are currently assessing the timing of adoption as well as the effects it will have on our consolidated financial statements and disclosures.

3.

Investments

As of September 30, 2016, we had 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, 2016:

As illustrated above, at September 30, 2016, 82 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, 2016, we had an ownership interest of less than 20 percent in two private companies and two public companies with which we conduct business. The privately-held companies are Atlantic Pharmaceuticals Limited and Kastle and the publicly-traded companies are Antisense Therapeutics Limited and Regulus. We account for equity investments in the privately-held companies 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.

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 consider to be temporarily impaired at September 30, 2016 were as follows (in thousands):

We believe that the decline in value of these securities is temporary and for our debt securities is 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 our debt securities to maturity. Therefore we anticipate full recovery of our debt securities’ 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. 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, 2016, 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 did not have investments that were valued with significant unobservable inputs, or Level 3 investments, at September 30, 2016 and December 31, 2015.

The following tables present the major security types we held at September 30, 2016 and December 31, 2015 that are regularly measured and carried at fair value. The tables segregate each security type by the level within the fair value hierarchy of the valuation techniques we utilized to determine the respective securities’ fair value (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)

At September 30, 2016, $6.0 million was 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)

At September 30, 2016 and December 31, 2015, $11.1 million and $7.5 million, respectively, were 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.

Other Fair Value Disclosures

Our 1 percent and 2¾ percent notes had a fair value of $467.2 million and $137.3 million, respectively, at September 30, 2016. 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 $30 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. As of September 30, 2016 we had $12.5 million in outstanding borrowings under the credit facility, which we used to fund our capital equipment needs in 2015 and is consistent with our historical practice to finance these costs. In September 2016, we converted our total borrowings of $12.5 million into a fixed rate note with a 2.31 percent interest rate and a maturity date of September 2019.

The credit agreement includes customary affirmative and negative covenants and restrictions. We are in compliance with all covenants of the credit agreement.

6. Collaborative Arrangements and Licensing Agreements

Below, we have included our collaborations with substantive changes during the first nine months of 2016 from those included in Note 6 of our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015.

Strategic Partnership

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 with Biogen's expertise in developing therapies for neurological disorders. We and Biogen are currently developing six drugs to treat neurological diseases under these collaborations, including SPINRAZA, IONIS-DMPK-2.5_Rx, IONIS-SOD1_Rx, and three drugs to treat undisclosed neurodegenerative diseases, IONIS-BIIB4_Rx, IONIS-BIIB5_Rx and IONIS-BIIB6_Rx. In addition to these six drugs, we and Biogen are evaluating numerous additional targets for the development of drugs to treat neurological diseases. We have included the following two Biogen collaborations because they had substantive changes during the first nine months of 2016 from those included in Note 6 of our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015.

SPINRAZA

In January 2012, we entered into a collaboration agreement with Biogen to develop and commercialize SPINRAZA for the treatment of SMA. SPINRAZA is an RNA-targeted therapy in development for the treatment of infants and children with SMA.  SPINRAZA is currently under Priority Review with the FDA and Accelerated Assessment with the EMA for marketing authorization.  Recently, a number of positive events have provided evidence for the transformative potential of this drug, including:



CHERISH, our Phase 3 trial evaluating SPINRAZA in children with later-onset SMA- In November 2016, we announced that SPINRAZA met the primary endpoint at the interim analysis of CHERISH.



ENDEAR, our Phase 3 trial evaluating SPINRAZA in infants with infantile-onset SMA- In August 2016, we announced that SPINRAZA met the primary endpoint at the interim analysis of ENDEAR.



License Fee- In July 2016, Biogen exercised its option to SPINRAZA and paid us a $75 million license fee. We are now transitioning all SPINRAZA development activities to Biogen as they are responsible for all development, regulatory and commercialization activities and costs.

Based on the results of these pre-specified interim analyses, we are stopping the CHERISH and ENDEAR studies and participants are transitioning into the SHINE open-label study in which all patients receive SPINRAZA. Additionally, participants enrolled in the sham-controlled arm of EMBRACE, a Phase 2 study which also included infantile-onset patients, will have the opportunity to receive SPINRAZA. The open-label NURTURE study in pre-symptomatic infants with SMA will continue as planned in order to collect the data to demonstrate the safety and efficacy of SPINRAZA in this population. We will complete the Phase 3 studies and we are working with Biogen to transition the clinical programs for SPINRAZA that we are conducting to Biogen.

Under the terms of the agreement, we received an upfront payment of $29 million in January 2012, which we are amortizing through December 2016. Over the term of the collaboration, we are eligible to receive up to an additional $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 SPINRAZA prior to licensing and up to $150 million in substantive milestone payments if Biogen achieves pre-specified regulatory milestones. We are also eligible to receive tiered royalties up to the mid-teens on any sales of SPINRAZA. We have exclusively in-licensed patents related to SPINRAZA from Cold Spring Harbor Laboratory and the University of Massachusetts. We will pay Cold Spring Harbor Laboratory and the University of Massachusetts nominal amounts when we receive license fees and milestone payments and a low single digit royalty on sales of SPINRAZA.

From inception through September 2016, we have received more than $235 million in payments for advancing SPINRAZA, including the $75 million license fee we received from Biogen when Biogen licensed SPINRAZA, which we recognized as revenue in the third quarter of 2016. In the first nine months of 2016, we earned $11.5 million in milestone payments for advancing SPINRAZA. We will earn the next milestone payment of up to $60 million if Biogen receives regulatory approval for SPINRAZA.

 

Neurology

In December 2012, we and Biogen entered into a third and separate collaboration agreement to develop and commercialize novel antisense drugs to up 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. We are currently advancing IONIS-BIIB4_Rx under this collaboration. 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 an additional $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 sales from any drugs resulting from each of the three programs. From inception through September 2016, we have received $43 million in payments under this collaboration. In February 2016, we earned a $3 million milestone payment for further advancing IONIS-BIIB4_Rx. We will earn the next milestone payment of up to $10 million for the continued development of IONIS-BIIB4_Rx.

During the three and nine months ended September 30, 2016, we earned revenue of $90.2 million and $120.9 million, respectively from our relationship with Biogen. This revenue represented 81 percent and 65 percent of our total revenue for the three and nine months ended September 30, 2016, respectively. In comparison, we earned revenue of $18.1 million and $75.1 million for the same periods in 2015, respectively, which represented 37 percent and 32 percent of our total revenue for those periods, respectively. Our condensed consolidated balance sheet at September 30, 2016 included deferred revenue of $73.1 million related to our relationship with Biogen.

Research, Development and Commercialization Partners

GSK

In March 2010, we entered into an alliance with GSK using our antisense drug discovery platform to discover and develop new drugs against targets for rare and serious diseases, including infectious diseases and some conditions causing blindness. Our alliance currently comprises five drugs in development, including our Phase 3 drug IONIS-TTR_Rx. We are responsible for completing the Phase 3 study we are currently conducting for IONIS-TTR_Rx. GSK has the option to license IONIS-TTR_Rx. If GSK exercises its option it will pay us a license fee. GSK has the exclusive option to license the other 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 and costs for such drug. Under the terms of the agreement, we received $38 million in upfront and expansion payments, which we are amortizing through September 2017.

In October 2012, we and GSK amended the original agreement to reflect an accelerated clinical development plan for IONIS-TTR_Rx. We have completed enrollment in the Phase 3 study we are conducting in patients with TTR familial amyloid polyneuropathy, or FAP. From inception through September 2016, we have earned $60 million from GSK related to the development of IONIS-TTR_Rx, primarily in milestone payments. In addition, under the amended agreement, we and GSK increased the regulatory and commercial milestone payments we can earn should IONIS-TTR_Rx receive marketing authorization and meet pre-agreed sales targets.

 In addition to IONIS-TTR_Rx, we have four drugs in development with GSK. We are developing two antisense drugs we designed to reduce the production of viral proteins associated with hepatitis B virus, or HBV infection; IONIS-HBV_Rx and IONIS-HBV-L_Rx, a follow-on drug using our LICA technology. We are also developing IONIS-GSK4-L_Rx and IONIS-RHO-2.5_Rx, which are antisense drugs we designed to treat ocular diseases. In March 2016, we and GSK amended the development plan for IONIS-HBV_Rx to allow GSK to conduct all further development activities for this program.

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 $1.0 billion, including up to $168.5 million for the achievement of development milestones, up to $363.5 million for the achievement of regulatory milestones and up to $338 million for the achievement of commercialization milestones. Through September 2016, we have received more than $154 million in payments under this alliance with GSK. In the first quarter of 2016, we earned a $1.5 million milestone payment when GSK initiated a Phase 1 study of IONIS-HBV-L_Rx. We will earn the next milestone payment of up to $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.

During the three and nine months ended September 30, 2016, we earned revenue of $1.2 million, and $8.2 million, respectively, from our relationship with GSK, which represented one percent and four percent, respectively, of our total revenue for those periods. In comparison, we earned revenue of $1.6 million and $22.4 million for the same periods in 2015, respectively, which represented three percent and ten percent of our total revenue for those periods, respectively. Our condensed consolidated balance sheet at September 30, 2016 included deferred revenue of $4.7 million related to our relationship with GSK.

Janssen Biotech, Inc., a pharmaceutical company of Johnson & Johnson

In December 2014, we entered into a collaboration agreement with Janssen Biotech, Inc. to discover and develop antisense drugs that can be locally administered, including oral delivery, to treat autoimmune disorders of the gastrointestinal tract. Janssen has the option to license drugs from us through the designation of a development candidate for up to three programs. Prior to option exercise we are responsible for the discovery activities to identify a development candidate. If Janssen exercises an option for one of the programs, it will be responsible for the global development, regulatory and commercial activities under that program. Under the terms of the agreement, we received $35 million in upfront payments, which we are amortizing through December 2018. We are eligible to receive an additional up to nearly $800 million in license fees and substantive milestone payments for these programs, including up to $175 million for the achievement of development milestones, up to $420 million for the achievement of regulatory milestones and up to $180 million for the achievement of commercialization milestones. In addition, we are eligible to receive tiered royalties up to the near teens on sales from any drugs resulting from this collaboration.

From inception through September 2016, we received nearly $47 million in payments under this collaboration with Janssen, including the $10 million license fee we earned in July 2016 when Janssen licensed IONIS-JBI1-2.5_Rx from us, which we recognized as revenue in the third quarter of 2016. We will earn the next milestone payment of $5 million if Janssen chooses another target to advance under this collaboration.

During the three and nine months ended September 30, 2016, we earned revenue of $12.2 million and $16.6 million, respectively, from our relationship with Janssen, which represented 11 percent and nine percent, respectively, of our total revenue for those periods. In comparison, we earned revenue of $2.2 million and $6.6 million for the same periods in 2015, respectively, which represented four percent and three percent, respectively, of our total revenue for those periods. Our condensed consolidated balance sheet at September 30, 2016 included deferred revenue of $21.6 million related to our relationship with Janssen.

 

Kastle Therapeutics

In May 2016, we entered into an agreement with Kastle under which Kastle acquired the global rights to develop and commercialize Kynamro. Kynamro is approved in the United States for use in patients with homozygous familial hypercholesterolemia to reduce low density lipoprotein-cholesterol, apolipoprotein B, total cholesterol and non-high density lipoprotein-cholesterol as an adjunct to lipid lowering medications and diet. Under the terms of the agreement, we are eligible to receive up to $95 million, which includes the $15 million up-front payment we received in May 2016, a $10 million payment in May 2019 and up to $70 million in sales milestones. Beginning in 2017, we are eligible to earn tiered royalties on global sales of Kynamro that average in the mid to low teens.  In addition, we also received a 10 percent common equity position in Kastle. Because realization of our equity position is uncertain, we recorded a full valuation allowance. Sanofi Genzyme will earn a three percent royalty on sales of Kynamro and three percent of non-royalty cash payments we receive from Kastle.

During the nine months ended September 30, 2016, we earned revenue of $15 million from our relationship with Kastle, which represented eight percent of our total revenue for that period.

7.

Segment Information and Concentration of Business Risk

We have two reportable segments Ionis Core and Akcea Therapeutics, our wholly owned subsidiary. Segment income (loss) from operations includes revenue less operating expenses attributable to each segment.

In our Ionis 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 Ionis Core segment generates revenue from a multifaceted partnering strategy.

We formed Akcea to develop and commercialize drugs for patients with serious cardiometabolic diseases caused by lipid disorders. Moving our lipid drugs into a company that we own and control ensures that our core focus at Ionis 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 table shows our segment revenue and income (loss) from operations for the three and nine months ended September 30, 2016 and September 30, 2015 (in thousands), respectively.

The following table shows our total assets by segment at September 30, 2016 and December 31, 2015 (in thousands), respectively.

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 one significant partner comprised approximately 95 percent of our contracts receivables at September 30, 2016. Contracts receivables from two significant partners comprised approximately 99 percent of our contracts receivables at December 31, 2015.

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, “Ionis,” “Company,” “we,” “our,” and “us,” means Ionis 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 Therapeutics, Inc., a subsidiary of Ionis Pharmaceuticals, and the therapeutic and commercial potential of our technologies and products in development, including SPINRAZA (nusinersen), IONIS-TTR_Rx and volanesorsen. 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. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in additional detail in our annual report on Form 10-K for the year ended December 31, 2015, which is on file with the U.S. Securities and Exchange Commission and is available from us, and those identified within this Item in the section entitled “Risk Factors” beginning on page 32 of this Report. 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.

Overview

We are leaders in discovering and developing RNA-targeted therapeutics. We have created an efficient and broadly applicable drug discovery platform. Using this platform, we have developed a large, diverse and advanced pipeline of potentially first-in-class and/or best-in-class drugs that we believe can provide high value for patients with significant unmet medical needs. In this way, we believe that we are fundamentally changing medicine with the goal to improve the quality of and save lives. We have discovered and are developing three potentially transformational drugs, SPINRAZA, IONIS-TTR_Rx and volanesorsen, which we believe are close to commercialization. We designed these drugs to treat patients with orphan diseases who have limited or no therapeutic options.

SPINRAZA is an RNA-targeted therapy in development for the treatment of infants and children with SMA.  SPINRAZA is currently under Priority Review with the FDA and Accelerated Assessment with the EMA for marketing authorization.  Recently, a number of positive events have provided evidence for the transformative potential of this drug, including:

·

FDA and MAA Filing- In October 2016, the FDA and the EMA accepted their respective application for SPINRAZA marketing authorization. The FDA has granted Priority Review in the U.S. and the EMA has granted Accelerated Assessment in the E.U., both of which can reduce the standard review time.



CHERISH, our Phase 3 trial evaluating SPINRAZA in children with later-onset SMA- In November 2016, we announced that SPINRAZA met the primary endpoint at the interim analysis of CHERISH. The interim analysis found that children receiving SPINRAZA experienced a highly statistically significant  improvement in motor function compared to those who did not receive treatment (p=0.0000002), as measured by the Hammersmith Functional Motor Scale Expanded, or HFMSE. SPINRAZA demonstrated a favorable safety profile in the study.

·

ENDEAR, our Phase 3 trial evaluating SPINRAZA in infants with infantile-onset SMA- In August 2016, we announced that SPINRAZA met the primary endpoint at the interim analysis of ENDEAR. The interim analysis found that infants receiving SPINRAZA experienced a statistically and clinically significant improvement in the primary endpoint (p<0.0001), defined as the proportion of motor milestone responders as measured by the Hammersmith Infant Neurological Examination, or HINE. SPINRAZA demonstrated an acceptable safety profile in the study.



NURTURE, the Phase 2 open-label study in pre-symptomatic infants- In October 2016, we announced positive new results at the World Muscle Society Congress from NURTURE. The data showed that SPINRAZA-treated infants exhibited improvements in motor function and developmental milestones such as full head control, independent sitting, standing with support, standing unaided, and walking with support, as measured by validated scales.



CS2/CS12, the Phase 2 open-label study in patients with later-onset SMA- We also presented positive data from the Phase 2 open-label study in patients with later-onset SMA at the World Muscle Society Congress. These data showed that children with SMA treated with SPINRAZA exhibited improvement on several measures of motor function for up to nearly three years.



License Fee- In July 2016, Biogen exercised its option to SPINRAZA and paid us a $75 million license fee. We are now transitioning all SPINRAZA development activities to Biogen as they are responsible for all development, regulatory and commercialization activities and costs.

Based on the results of these pre-specified interim analyses, the CHERISH and ENDEAR studies are being stopped and participants are transitioning into the SHINE open-label study in which all patients receive SPINRAZA. Additionally, participants enrolled in the sham-controlled arm of EMBRACE, a Phase 2 study which also included infantile-onset patients, will have the opportunity to receive SPINRAZA. The open-label NURTURE study in pre-symptomatic infants with SMA will continue as planned in order to collect the data to demonstrate the safety and efficacy of SPINRAZA in this population. We will complete the Phase 3 studies and we are working together to transition the clinical programs for SPINRAZA that we are conducting to Biogen.

Volanesorsen has the potential to significantly improve the lives of patients who, because of their severely elevated triglycerides, are at constant risk of pancreatitis, which can require hospitalization and is potentially life-threatening. We designed volanesorsen to treat patients with diseases associated with extremely high levels of triglycerides, including two rare genetic lipid disorders, familial chylomicronemia syndrome, or FCS, and familial partial lipodystrophy, or FPL. We demonstrated in our Phase 2 studies that volanesorsen robustly reduced ApoC-III and triglycerides in patients, including in FCS patients, and also had a beneficial impact on insulin sensitivity. We are currently conducting two Phase 3 registrational studies of volanesorsen. We anticipate that the data from our pivotal Phase 3 studies of this drug, if positive, will support global regulatory filings for volanesorsen. We believe that the significant unmet medical need and the severity of these diseases could warrant a rapid path to market. Our wholly owned subsidiary, Akcea Therapeutics Inc., or Akcea, is preparing to commercialize volanesorsen and is engaged in pre-commercialization activities to understand the patient journey, build disease awareness with physicians and patients and develop their launch plans. To maximize the value of volanesorsen and other earlier-stage drugs for serious cardiometabolic diseases caused by lipids, we formed Akcea Therapeutics to focus on developing and commercializing these drugs. Akcea’s pipeline includes volanesorsen, IONIS-APO(a)-L_Rx, IONIS-ANGPTL3-L_Rx and IONIS-APOCIII-L_Rx. Moving these drugs into a company that we own and control allows us to retain substantial value from them and ensures Ionis’ core focus remains on innovation. Akcea is building development and commercialization expertise in lipid and cardiometabolic diseases, including highly trained, specialized medical, marketing and sales teams, to successfully commercialize volanesorsen and the other lipid drugs in its pipeline.

In addition to our Phase 3 programs, we have a pipeline of drugs with the potential to be first-in-class and/or best-in-class drugs to treat patients with inadequately treated diseases. Our pipeline has over a dozen drugs in Phase 2 development, and includes drugs to treat patients with diseases spanning numerous therapeutic areas, including severe and rare diseases, viral infections, ocular diseases, metabolic disorders and cardiovascular diseases. We believe that our technology is the most versatile and most efficient drug discovery technology today and we plan to expand the therapeutic reach of our technology by adding three to five new drugs to our pipeline every year. Additionally, we actively patent the advances we have made across all areas of our technology and the drugs we are developing. In this way, we have amassed a substantial intellectual property position that provides us with extensive protection for our drugs and our technology.

We have established alliances with a cadre of leading global pharmaceutical companies that are working alongside us in developing our drugs, advancing our technology and preparing to commercialize our products. Our partners bring resources and expertise that augment and build upon our internal capabilities. We have strategic partnerships with Biogen and AstraZeneca through which we can broadly expand our drug discovery efforts to new disease targets in specific therapeutic areas that are outside of our expertise or in which our partners can provide tools and resources to complement our drug discovery efforts. We also form early stage research and development partnerships that allow us to expand the application of our technology to new therapeutic areas, such as we did with Janssen. Additionally, we form development and commercialization partnerships that enable us to leverage our partner’s global expertise and resources needed to support large commercial opportunities, such as we did with Bayer. Lastly, we also work with a consortium of companies that can exploit our drugs and technologies outside our primary areas of focus. We refer to these companies as satellite companies.

Through our partnerships, we have created a broad and sustaining base of potential license fees, upfront payments, milestone payments, royalties, and earn out payments while controlling our drug development expenses. We have the potential to earn significant revenue from all of our partnerships. Since 2007, we have received over $1.8 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 more than $11.5 billion in future milestone payments and licensing fees from our current 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 or royalty arrangements.

Financial Highlights

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

We finished the first nine months of 2016 in a strong financial position with results in line with our expectations. We are on track to meet our year-end pro forma net operating loss and cash balance projections. For the first nine months of 2016 we earned $186.3 million of revenue, including license fees of $85 million, $45.9 million in the amortization of upfront payments, $40.4 million from payments reflecting the progress of our partnered programs and $15 million from Kastle. Our revenue fluctuates based on the nature and timing of payments under agreements with our partners.

Through the first nine months of 2016, we have continued to advance our Phase 3 programs and Akcea is preparing to commercialize volanesorsen while we have prudently managed our expenses.  As a result, we finished the first nine months of 2016 with a loss from operations of $87.5 million and more than $685 million in cash, cash equivalents and short-term investments. As these activities continue, we expect our expenses in the fourth quarter of 2016 to be modestly higher compared to the third quarter of 2016. Additionally, our non-cash compensation expense increased due to an increase in the exercise price of the stock options we have granted over the past several years.

Recent Events

 

 



The FDA accepted the NDA filing and granted Priority Review in the U.S. for SPINRAZA for the treatment of patients with SMA.

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The EMA validated the MAA and granted Accelerated Assessment in the E.U. for SPINRAZA for the treatment of patients with SMA.

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We and Biogen reported positive data from an interim analysis of the Phase 3 CHERISH study in patients with later-onset (consistent with Type 2) SMA.

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We and Biogen presented new positive clinical data with SPINRAZA at the World Muscle Society Congress supporting the companies’ efforts to rapidly make SPINRAZA available to patients with SMA, including:

o

Safety results from the interim analysis of the Phase 3 ENDEAR study in patients with infantile-onset (consistent with Type 1) SMA;

o

Encouraging preliminary results from NURTURE, a Phase 2 open-label study in pre-symptomatic infants; and

o

A recent analysis of the ongoing Phase 2 open-label study in patients with later-onset SMA.



We reported positive data from an interim analysis of the ENDEAR Phase 3 study in patients with infantile-onset (consistent with Type 1) SMA. Biogen paid us $75 million to license SPINRAZA.

 



We and Dr. Merrill Benson reported positive data from the IONIS-TTRRx program at the International Symposium on Amyloidosis, or ISA, meeting. In line with previously reported data from his investigator-initiated study, Dr. Benson observed continued evidence of cardiac disease stabilization in eight TTR cardiomyopathy patients treated for 12 months with IONIS-TTRRx.



Akcea and we received Orphan Designation in the E.U. for volanesorsen for the treatment of patients with familial partial lipodystrophy, or FPL.



We reported positive, top-line Phase 2 data with IONIS-FXIRx demonstrating robust, statistically significant reductions in Factor XI activity in patients with end-stage renal disease receiving chronic hemodialysis. IONIS-FXIRx was safe and well tolerated in treated patients with no clinically meaningful platelet declines and no increase in major or clinically relevant non-major bleeding.



We reported positive interim data from a Phase 2 dose-optimization study of IONIS-GCGRRx in patients with type 2 diabetes demonstrating that doses of 75 mg and 50 mg could produce reductions in HbA1c of greater than two percent and one percent, respectively, with minimal to no effects on liver enzyme elevations.



We reported positive data from a Phase 2 study of IONIS-AR-2.5Rx in patients with prostate cancer showing durable prostate-specific antigen, or PSA, responses with prolonged stable disease in heavily pre-treated castrate-resistant prostate cancer patients.



Akcea and we published clinical results with Lp(a)-lowering drugs, IONIS-APO(a)Rx and IONIS-APO(a)-LRx, in The Lancet demonstrating robust reductions in Lp(a) levels, regardless of a patient’s starting Lp(a) level.



We reported positive results from studies in normal volunteers with IONIS-ANGPTL3-LRx and IONIS-GSK4-LRx that demonstrated these drugs had similar potency to IONIS-APO(a)-LRx, confirming the high potency of our LICA platform.



We added to our pipeline our first oral antisense drug acting locally in the gastrointestinal tract for which we earned a $10 million license fee from Janssen.

 



Our CEO, Dr. Stanley Crooke, received two awards, the E. B. Hershberg Award from the American Chemical Society and the Lifetime Achievement Award from the Oligonucleotide Therapeutics Society recognizing his achievements in the field of oligonucleotide therapeutics.



We published a paper in Nature Biotechnology on the novel mechanism of action for antisense drugs that significantly expands therapeutic opportunities for the technology.

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. We caution that future events rarely develop exactly as one may expect, and that best estimates may require adjustment.

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



Assess the propriety of revenue recognition and associated deferred revenue;



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



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



Estimate our net deferred income tax asset valuation allowance.

There have been no 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, 2015.

Results of Operations

Revenue

Total revenue for the three and nine months ended September 30, 2016 was $110.9 million and $186.3 million, compared to $49.1 million and $232.1 million for the same periods in 2015. See below for our discussion of the changes in our revenue.

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. For example in the third quarter of 2016 we earned a $75 million license fee from Biogen for SPINRAZA, and a $10 million license fee from Janssen for the first development candidate under our collaboration with Janssen. In the second quarter of 2015 we earned $91.2 million from Bayer related to its license of IONIS-FXI_Rx.

Research and Development Revenue Under Collaborative Agreements

Research and development revenue under collaborative agreements for the three and nine months ended September 30, 2016 was $108.9 million and $166.6 million, respectively, compared to $48.9 million and $230.5 million for the same periods in 2015. The change in our revenue is primarily due to variations in the timing of revenue from license and milestone payments. Our revenue for the first nine months of 2016 primarily consisted of the following:



$ million from Biogen for licensing and advancing the Phase 3 program for SPINRAZA and advancing IONIS-BIIB4Rx;



$10 million from Janssen for licensing IONIS-JBI1-2.5Rx;



$1.5 million from GSK when GSK initiated the Phase 1 study for IONIS-HBV-LRx; and



$58.2 million primarily from the amortization of upfront fees and manufacturing services we performed for our partners.

Our revenue in the first nine months of 2015 included $91.2 million in connection with our exclusive license agreement with Bayer, $89.8 million in milestone payments from partnered programs and $51.2 million primarily from the amortization of upfront fees and manufacturing services we performed for our partners.

Licensing and Royalty Revenue

Our revenue from licensing activities and royalties for the three and nine months ended September 30, 2016 was $2.0 million and $19.7 million, respectively, compared to $0.2 million and $1.7 million for the same periods in 2015. Our revenue from licensing and royalties for the nine months ended September 30, 2016 primarily consisted of the $15 million we earned from Kastle when it acquired the global rights to develop and commercialize Kynamro.

Operating Expenses

Operating expenses for the three and nine months ended September 30, 2016 were $94.8 million and $273.7 million, respectively, compared to $97.3 million and $245.0 million for the same periods in 2015. For the nine months ended September 30, 2016, operating expenses increased as a result of the following:



During the first nine months of 2016, we were conducting five Phase 3 studies and three open-label extension studies for our three Phase 3 drugs: SPINRAZA, IONIS-TTRRx and volanesorsen. We have completed target enrollment in four of these Phase 3 studies, and as a result, these studies were in their most expensive stage during the first nine months of 2016.



Akcea operating expenses increased as it continued to build its commercial infrastructure and advance the pre-commercialization activities necessary to successfully launch volanesorsen within the next couple of years.



Our non-cash compensation expense increased due to an increase in the exercise price of the stock options we have granted over the past several years.

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 expenses for antisense drug discovery, antisense drug development, manufacturing and operations and R&D support expenses.

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, 2016, our total research, development and patent expenses were $71.4 million and $200.6 million, respectively, compared to $77.2 million and $188.7 million for the same periods in 2015, and were higher for the nine months ended primarily due to the progression of our drugs currently in Phase 3 trials. As a result of the positive data from our Phase 3 SPINRAZA studies, ENDEAR and CHERISH, we are in the process of transitioning the clinical programs for SPINRAZA that we are conducting to Biogen. Our research, development and patent expenses declined for the three months ended September 30, 2016, primarily due to completing the FOCUS FH Phase 3 study of Kynamro in 2015 and our shift to LICA drugs, which are in earlier stages of development. 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 Ionis Core business segment:

Antisense drug discovery expenses for the three and nine months ended September 30, 2016 were $13.1 million and $36.1 million, respectively, compared to $12.3 million and $33.6 million for the same periods in 2015. 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 $45.4 million and $123.1 million for the three months ended September 30, 2016, respectively, compared to $51.2 million and $116.2 million for the same periods in 2015. Expenses for the nine months ended September 30, 2016 were higher compared to the same periods in 2015 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. Our expenses declined for the three months ended September 30, 2016, primarily due to completing the FOCUS FH Phase 3 study of Kynamro in 2015 and our shift to LICA drugs, which are in earlier stages of development. All amounts exclude non-cash compensation expense related to equity awards.

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):