Regulus Therapeutics Inc. - Quarter Report: 2012 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012

or

FOR THE TRANSITION PERIOD FROM              TO             

Commission file number: 001-35670

Regulus Therapeutics Inc.

(Exact name of registrant as specified in its charter)

858-202-6300

(Registrant’s Telephone Number, Including Area Code)

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  x

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  x    No  ¨

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

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

As of November 16, 2012, the registrant had 35,829,029 shares of Common Stock ($0.001 par value) outstanding.

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REGULUS THERAPEUTICS INC.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Regulus Therapeutics Inc.

Condensed Balance Sheets

(In thousands, except share and par value amounts)

See accompanying notes.

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Regulus Therapeutics Inc.

Condensed Statements of Operations and Comprehensive Loss

(In thousands, except share and per share amounts)

See accompanying notes.

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Regulus Therapeutics Inc.

Condensed Statements of Cash Flows

(In thousands)

See accompanying notes.

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Regulus Therapeutics Inc.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. The Business and Summary of Significant Accounting Policies

Description of Business

Regulus Therapeutics Inc. was originally formed as a Delaware limited liability company under the name Regulus Therapeutics LLC on September 6, 2007, and was converted to a Delaware corporation on January 2, 2009. As used in this report, unless the context suggests otherwise, “the Company,” “our,” “us” and “we” means Regulus Therapeutics Inc.

We are a biopharmaceutical company focused on discovering and developing first-in-class drugs that target microRNAs to treat a broad range of diseases. We are using our microRNA product platform to develop chemically modified, single-stranded oligonucleotides that we call anti-miRs. We use these anti-miRs to modulate microRNAs and by doing so return diseased cells to their healthy state.

Basis of Presentation

We have prepared the accompanying unaudited condensed financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the entire year. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2011 included in our final prospectus filed with the Securities and Exchange Commission on October 5, 2012 relating to our Registration Statement on Form S1/A (File No. 333-183384) for our initial public offering (IPO).

On September 7, 2012, our board of directors approved a one-for-two reverse stock split of our common stock. The accompanying financial statements and notes to the financial statements give retroactive effect to the reverse split for all periods presented.

Use of Estimates

Our unaudited condensed financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our financial statements and accompanying notes. Our most significant estimates relate to revenue recognition and stock-based compensation. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions.

Revenue Recognition

Our revenues generally consist of upfront payments for licenses or options to obtain licenses in the future, research and development funding and milestone payments under strategic alliance agreements, as well as funding received under government grants. We recognize revenues when all four of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery of the products and/or services has occurred; (3) the selling price is fixed or determinable; and (4) collectibility is reasonably assured.

Milestones

In January 2011, we adopted new authoritative guidance on revenue recognition for milestone payments related to agreements under which we have continuing performance obligations. We recognize revenue from milestone payments when earned, provided that (i) the milestone event is substantive in that it can only be achieved based in whole or in part on either our performance or on the occurrence of a specific outcome resulting from our performance and its achievability was not reasonably assured at the inception of the agreement, (ii) we do not have ongoing performance obligations related to the achievement of the milestone and (iii) it would result in the receipt of additional payments. A milestone payment is considered substantive if all of the following conditions are met: (i) the milestone payment is non-refundable; (ii) achievement of the milestone was not reasonably assured at the inception of the arrangement; (iii) substantive effort is involved to achieve the milestone; and (iv) the amount of the milestone payments appears reasonable in relation to the effort expended, the other milestones in the arrangement and the related risk associated with the achievement of the milestone. Any amounts received under the agreements in advance of performance, if deemed substantive, are recorded as deferred revenue and recognized as revenue as we complete our performance obligations. The adoption of this guidance did not materially change our previous method for recognizing milestone payments.

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Strategic Alliance Agreements entered into or materially modified after December 31, 2010

In January 2011, we adopted new authoritative guidance for multiple element arrangements. The guidance, which applies to multiple element agreements entered into or materially modified after December 31, 2010 amends the criteria for separating and allocating consideration in a multiple element agreement by modifying the fair value requirements for revenue recognition and eliminating the use of the residual method. Deliverables under the agreement will be accounted for as separate units of accounting provided that (i) a delivered item has value to the customer on a stand-alone basis; and (ii) if the agreement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor. The allocation of consideration amongst the deliverables under the agreement is derived using a “best estimate of selling price” if vendor-specific objective evidence and third-party evidence of fair value is not available. We did not enter into any significant multiple element agreements or materially modify any existing multiple element agreements during 2011. In June 2012, we materially modified our strategic alliance agreement with GlaxoSmithKline plc (GSK) and in July 2012, we materially modified our strategic alliance agreement with Sanofi. In August 2012, we entered into new collaboration and license agreements with both AstraZeneca AB (AstraZeneca) and Biogen Idec MA Inc. (Biogen Idec). For additional information see Note 7.

Deferred Revenue

Amounts received prior to satisfying the above revenue recognition criteria are recorded as deferred revenue in the accompanying balance sheets. Amounts not expected to be recognized within the next 12 months are classified as non-current deferred revenue.

Stock-Based Compensation

We account for stock-based compensation expense related to stock options granted to employees and members of our board of directors by estimating the fair value of each stock option on the date of grant using the Black-Scholes model. We recognize stock-based compensation expense using the accelerated multiple-option approach. Under the accelerated multiple-option approach (also known as the graded-vesting method), we recognize compensation expense over the requisite service period for each separately vesting tranche of the award as though the award was in substance multiple awards, resulting in accelerated expense recognition over the vesting period.

We account for stock options granted to non-employees, which primarily consist of members of our scientific advisory board, using the fair value approach. Stock options granted to non-employees are subject to periodic revaluation over their vesting terms.

The following table summarizes the weighted average assumptions we used in our Black-Scholes calculations:

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The following table summarizes the allocation of our stock compensation expense (in thousands):

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is calculated by dividing the net loss by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method. Dilutive common stock equivalents are comprised of convertible preferred stock and options outstanding under our stock option plan. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to our net loss position.

Potentially dilutive securities not included in the calculation of diluted net loss per share because to do so would be anti-dilutive are as follows (in common equivalent shares):

In addition to the potentially dilutive securities noted above, as of September 30, 2012 we had $15.0 million principal amount of outstanding convertible notes payable that were potentially convertible into common stock upon the occurrence of various future stock financing events at prices that were not determinable until the occurrence of the future events. As such, we have excluded these convertible notes payable from the table above. Upon the completion of our IPO in October 2012, $10.0 million principal amount of the convertible notes (and related accrued interest) were converted into 2,703,269 shares of common stock. See Note 4 for information regarding the terms of the $5.0 million of convertible notes payable that became convertible into common stock upon, and remain outstanding after, our IPO.

Other Assets

Deferred IPO costs totaling $2.0 million are included in other assets at September 30, 2012. These costs represent legal, accounting and other direct costs related to our efforts to raise capital through a public sale of our common stock. We incurred no IPO costs prior to 2012. IPO costs were deferred until the completion of the IPO in October 2012, and such costs will be reclassified to additional paid-in capital as a reduction of the IPO proceeds.

Fair Value Option

Applicable accounting policies permit entities to choose, at specified election dates, to measure specified items at fair value if the decision about the election is: 1) applied instrument by instrument, 2) irrevocable, and 3) applied to an entire instrument. In addition, an entity may choose to elect the fair value option only at the date of an event (i.e., significant modifications of debt, as defined) that requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that.

In July 2012, we accounted for the amended and restated note issued to GSK in February 2010 as a debt extinguishment of the original note. We elected to measure the amended note under the fair value option. The difference between the carrying value of the original note and the fair value of the amended note was recorded as a loss on extinguishment of debt to non-operating earnings. Thereafter, any change to the fair value of the amended note will be recorded as gain (loss) from valuation of convertible notes payable to non-operating earnings.

Recent Accounting Pronouncements

In September 2011, a new accounting standard was issued that changed the disclosure requirements for the presentation of other comprehensive income (OCI) in the financial statements, including the elimination of the option to present OCI in our statements of stockholders’ deficit. We have elected to present OCI and its components for both interim and annual periods in a single statement which is our statement of operations and comprehensive loss. This standard was adopted as of January 1, 2012 and the retrospective application of this standard did not have a material impact on our financial statements.

2. Investments

We invest our excess cash in commercial paper and debt instruments of financial institutions, corporations, U.S. government-sponsored agencies, and the U.S. Treasury. As of September 30, 2012, our short-term investments had a weighted average maturity of less than one year.

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The following tables summarize our short-term investments (in thousands):

3. Fair Value Measurements

Applicable accounting guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants as of the measurement date. Additionally, the guidance provides an established hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the factors that market participants would use in valuing the asset or liability. There are three levels of inputs that may be used to measure fair value:

The following table presents our fair value hierarchy for assets and liabilities measured at fair value on a recurring basis at September 30, 2012 and December 31, 2011 (in thousands):

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We obtain pricing information for our assets measured at fair value from quoted market prices or quotes from brokers/dealers. We generally determine the fair value of our investment securities using standard observable inputs, including reported trades, broker/dealer quotes, bids and/or offers.

On July 27, 2012, we amended and restated our $5.0 million convertible promissory note originally issued in February 2010 to GSK (“2010 GSK note”), which resulted in a debt extinguishment for accounting purposes. Concurrent with the debt extinguishment, we elected the fair value option for the 2010 GSK note. We used a third party valuation firm to value the 2010 GSK note at the extinguishment date and again at September 30, 2012. Based on the valuation, we recorded a $1.7 million loss on extinguishment of debt (the difference between the original $5.0 million carrying value and the fair value) on the Condensed Statements of Operations and Comprehensive Loss. In future periods, the fair value of the 2010 GSK note will be recorded on a quarterly basis with changes in fair value recorded in non-operating earnings. For the three and nine months ended September 30, 2012, we recorded a loss from valuation of convertible notes payable of $331,000 on the Condensed Statements of Operations and Comprehensive Loss.

The third-party valuation firm used an income approach in the form of a convertible bond valuation model to value the note. The convertible bond model considered the debt and option characteristics of the note. The key inputs to the model as of July 27, 2012 and September 30, 2012 were volatility (75%), risk-free rate (0.15%-0.71% and 0.15%-0.67%, respectively), and credit spread (11.0% and 10.5%, respectively). The absolute stock and strike price were not key inputs because upon an IPO, the conversion option is assumed to be set at-the-money. The estimated fair value of the note is based on the probability weighted average of an IPO and a Non-IPO scenario. The volatility inputs were based on historical and implied volatility of peer companies. Peer companies were consistent with those used previously in our 409A analyses. The risk-free rate inputs were based on the yield of US Treasury Strips as of each date. The credit spread inputs were based on a creditworthiness analysis of the Company and the guarantors of the February 2010 convertible promissory note, as applicable, and market rates for comparable straight debt instruments.

At September 30, 2012, the fair value of the note is classified as “Convertible notes payable, at fair value” on the Condensed Balance Sheet at $7.1 million ($5.0 million principal).

4. Convertible Notes Payable

In July 2012, we amended and restated the convertible promissory notes issued to GSK in April 2008 and February 2010 to provide, among other things, that (i) in the case of the $5.0 million note originally issued in April 2008, the principal amount plus interest under the note would, upon completion of our initial public offering in which we receive a minimum level of proceeds from new investors or that results in certain of our current stockholders together owning less than 50% of our voting securities, automatically convert into shares of our common stock at the initial public offering price and (ii) in the case of the $5.0 million note originally issued in February 2010, the principal amount plus accrued interest would, upon the completion of our initial public offering in which we receive a minimum level of proceeds from new investors or that results in certain of our current stockholders together owning less than 50% of our voting securities, become convertible, at the election of GSK, into shares of our common stock at the initial public offering price for a period of three years following such initial public offering. As of September 30, 2012, both notes continued to accrue interest at the prime rate as published by The Wall Street Journal at the beginning of each calendar quarter, which for the quarter ended September 30, 2012, was 3.25%. In addition, as of September 30, 2012, both notes were set to mature in February 2013, if not earlier converted or repaid. The notes are guaranteed by Alnylam Pharmaceuticals, Inc. (Alnylam), and Isis Pharmaceuticals, Inc. (Isis), until the completion of our IPO. On October 10, 2012, upon the completion of our IPO, the $5.0 million note originally issued in April 2008 was converted into 1,447,037 shares of our common stock concurrently with the closing of the IPO at a conversion price of $4.00 per share. In addition, following the IPO, we cancelled the note issued to GSK in February 2010 and issued GSK a new note in the principal amount of $5.4 million, which accrues interest at 3.297% and has a maturity date of October 9, 2015. For additional information, see Note 8.

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We accounted for the amended and restated note issued to GSK in April 2008 as a debt modification. We accounted for the amended and restated 2010 GSK note as a debt extinguishment, and elected the fair value option as of the July 2012 amendment date. We recognized $1.7 million as loss on extinguishment of debt on the Condensed Statements of Operations and Comprehensive Loss and recorded the 2010 GSK note at $6.7 million on the Condensed Balance Sheets. At September 30, 2012, the fair value of the 2010 GSK note was recorded as $7.1 million on the Condensed Balance Sheets and we recognized $331,000 as “Loss from valuation of convertible notes payable” on the Condensed Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2012.

In August 2012, we entered into a note purchase agreement with Biogen Idec, pursuant to which we issued Biogen Idec a convertible promissory note in the principal amount of $5.0 million. Unless earlier converted into our equity securities, all outstanding principal and accrued interest will become due on the maturity date, which will be the earlier of February 15, 2013 or the occurrence of a change in control. All outstanding principal and accrued interest under the convertible promissory note will convert into the same class of securities in our next qualified financing, which in the case of a private offering, is a financing in which new gross proceeds to us equal or exceed $10.0 million and in which case such conversion is at the election of Biogen Idec, and in the case of a public offering, is a firmly underwritten public offering pursuant to which all of our outstanding preferred stock is converted into common stock or pursuant to which we offer and sell at least $50.0 million of our common stock to the public and in which case such conversion is automatic. The price at which the convertible note will convert in such qualified financing will be the lowest price per share paid by other investors in such qualified financing, and if the conversion would cause Biogen Idec to own more than 5% of our outstanding capital stock, then the conversion may, at the election of Biogen Idec, be limited to a number of shares not to exceed 5% of our outstanding capital stock. The $5.0 million note and accrued interest thereunder of approximately $25,000 was converted into 1,256,232 shares of our common stock upon the closing of our initial public offering in October 2012 at a conversion price of $4.00 per share.

5. Stockholders’ Equity

Shares Reserved for Future Issuance

6. Related-Party Transactions

The following table summarizes the amounts included in our operating expenses, which resulted from our activities with Isis (in thousands):

No amounts were due from or payable to any related parties as of September 30, 2012 or December 31, 2011.

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7. Strategic Alliances and Collaboration

The following table summarizes the amounts included in our revenues which resulted from our strategic alliances and collaboration (in thousands):

GSK

In June 2012, we and GSK amended our product development and commercialization agreement to extend the target selection period for the fourth collaboration target under the agreement. The modification made to the agreement was considered a material modification, which required the application of the new authoritative guidance adopted by us in January 2011 for multiple element arrangements. We determined that the elements within the strategic alliance should be treated as a single unit of accounting because the delivered elements, the opt-in licenses for microRNA product candidates, did not have stand-alone value to GSK. As a result of the extension of the target selection period, we will recognize the remaining deferred revenue over approximately eight years, which we believe represents our new performance period under the amended agreement.

Immuno-Inflammatory Alliance

The immuno-inflammatory alliance also includes contractual milestones. If all the product candidates are successfully developed and commercialized through pre-agreed sales targets we could receive milestone payments up to $432.5 million, including up to $15.5 million for preclinical milestones, up to $87.0 million for clinical milestones, up to $150.0 million for regulatory milestones and up to $180.0 million for commercialization milestones. We are also entitled to receive tiered royalties as a percentage of annual sales which can increase up to the low end of the 10 to 20% range. In July 2011, we earned a milestone payment under the immuno-inflammatory alliance, and recognized revenue of $500,000.

We have evaluated the remaining contingent event-based payments under our strategic alliance agreement with GSK based on the new authoritative guidance for milestones and determined that the preclinical and clinical payments meet the definition of a substantive milestone because they are related to events (i) that can be achieved based in whole or in part on our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and (iii) that would result in additional payments being due to us. Accordingly, revenue for these achievements will be recognized in its entirety in the period when the milestone is achieved and collectibility is reasonably assured. Other contingent event-based payments under the strategic alliance agreement for which payment is contingent upon the results of GSK’s performance will not be accounted for using the milestone method. Such payments will be recognized as revenue over the remaining estimated period of performance, if any, and when collectibility is reasonably assured. We can earn the following preclinical milestones: $500,000 upon the selection of a fourth microRNA target and $5.0 million upon the selection of a development candidate for each of the selected three targets. We can also earn the following clinical milestones for each of the selected three targets: $4.0 million for the initiation of a Phase 1 clinical trial; $5.0 million for the initiation of a Phase 2 clinical trial; and $20.0 million if GSK chooses to opt-in to the program following the completion of a proof-of-concept trial.

HCV Alliance

The HCV alliance also includes contractual milestones. If the HCV program is successful, we could receive milestone payments up to $144.0 million, including up to $5.0 million for preclinical milestones, up to $29.0 million for clinical milestones, up to $50.0 million for regulatory milestones and up to $60.0 million for commercialization milestones. In addition, we will receive up to double-digit royalties on sales from any product that GSK successfully commercializes under this alliance.

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We have evaluated the remaining contingent event-based payments under our strategic alliance agreement with GSK based on the new authoritative guidance for milestones and determined that the preclinical and clinical payments meet the definition of a substantive milestone because they are related to events (1) that can be achieved based in whole or in part on our performance or on the occurrence of a specific outcome resulting from our performance, (2) for which there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and (3) that would result in additional payments being due to us. Accordingly, revenue for these achievements will be recognized in its entirety in the period when the milestone is achieved and collectibility is reasonably assured. Other contingent event-based payments under the strategic alliance agreement for which payment is contingent upon the results of GSK’s performance will not be accounted for using the milestone method. Such payments will be recognized as revenue over the remaining estimated period of performance, if any, and when collectibility is reasonably assured. We can earn a preclinical milestone of $5.0 million upon the selection of a development candidate. We can also earn the following clinical milestones: $4.0 million for initiation of a Phase 1 clinical trial; $5.0 million for the initiation of a Phase 2 clinical trial; and $20.0 million if GSK chooses to opt-in to the program following the completion of a proof-of-concept trial.

Sanofi

In July 2012, we amended and restated our collaboration and license agreement with Sanofi to expand the potential therapeutic applications of the microRNA alliance targets to be developed under such agreement. The modification made to the agreement was considered a material modification, which required the application of the new authoritative guidance adopted by us in January 2011 for multiple element arrangements. We determined that the elements within the strategic alliance agreement with Sanofi should be treated as a single unit of accounting because the delivered elements did not have stand-alone value to Sanofi. The following three elements were delivered as part of the strategic alliance with Sanofi: (1) a license for up to four microRNA targets; (2) an option to obtain a license for optional microRNA compounds; and (3) an option to a research license under the Technology Alliance. As a result of our assessment, we will continue to recognize the remaining deferred revenue over five years, which we believe continues to represent our performance period under the amended agreement.

We have evaluated the remaining contingent event-based payments under our strategic alliance agreement with Sanofi based on the new authoritative guidance for milestones and determined that the preclinical payments meet the definition of a substantive milestone because they are related to events (i) that can be achieved based in whole or in part on our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and (iii) that would result in additional payments being due to us. Accordingly, revenue for these achievements will be recognized in its entirety in the period when the milestone is achieved and collectibility is reasonably assured. Other contingent event-based payments under the strategic alliance agreement for which payment is contingent upon the results of Sanofi’s performance will not be accounted for using the milestone method. Such payments will be recognized as revenue over the remaining estimated period of performance, if any, and when collectibility is reasonably assured. We can earn the following preclinical milestones: $5.0 million upon the selection of each of the three remaining microRNA targets; and $15.0 million upon the filing of an IND for each of the four microRNA targets.

AstraZeneca

In August 2012, we entered into a collaboration and license agreement with AstraZeneca. Under the terms of the agreement, we have agreed to collaborate with AstraZeneca to identify, research and develop compounds targeting three microRNA alliance targets primarily in the fields of cardiovascular diseases, metabolic diseases and oncology and granted to AstraZeneca an exclusive, worldwide license to thereafter develop, manufacture and commercialize lead compounds designated by AstraZeneca in the course of the collaboration activities against the alliance targets for all human therapeutic uses. Under the terms of the agreement we are required to use commercially reasonable efforts to perform all research, development and manufacturing activities described in the research plan, at our cost, until the acceptance of an IND or the end of the research term, which extends until the fourth anniversary of the date of the agreement, and may be extended only by mutual written agreement of us and AstraZeneca. Following the earlier to occur of the acceptance of an IND in a major market or the end of the research term, AstraZeneca will assume all costs, responsibilities and obligations for further development, manufacture and commercialization of alliance product candidates.

Under the terms of the agreement, we received an upfront payment of $3.0 million in October 2012. We considered the elements within the strategic alliance agreement as a single unit of accounting because the delivered element, the license, does not have stand-alone value. As a result, we are recognizing the upfront payment of $3.0 million to revenue on a straight-line basis over our estimated period of performance, which we have initially estimated to be four years based on the expected term of the research and development plan. If all three targets are successfully developed and commercialized through pre-agreed sales targets we could receive milestone payments up to $509.0 million, including up to $10.0 million for preclinical milestones, up to $129.0 million for clinical milestones, and up to $370.0 million for commercialization milestones. In addition, we are entitled to receive royalties based on a percentage of net sales which will range from the mid-single digits to the low end of the 10 to 20% range, depending upon the product and the volume of sales, which royalties may be reduced in certain, limited circumstances.

We have evaluated the contingent event-based payments under our strategic alliance agreement with AstraZeneca based on the new authoritative guidance for milestones and determined that the preclinical payments meet the definition of substantive milestones because they are related to events (i) that can be achieved based in whole or in part on our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and (iii) that would result in additional payments being due to us. Accordingly, revenue for these achievements will be recognized in its entirety in the period when the milestone is achieved and collectibility is reasonably assured. Other contingent event-based payments under the strategic alliance agreement for which payment is contingent upon the results of AstraZeneca’s performance will not be accounted for using the milestone method. Such payments will be recognized as revenue over the remaining estimated period of performance, if any, and when collectibility is reasonably assured. We can earn the following preclinical milestones: $5.0 million for selection of a development candidate for microRNA-33 (within a more limited time period) and $2.5 million for selection of a development candidate for each of the other two targets.

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Concurrently with the collaboration and license agreement, we entered into a common stock purchase agreement with AstraZeneca, pursuant to which we agreed to sell to AstraZeneca an aggregate of $25.0 million of our common stock concurrently with our initial public offering, at a price per share equal to the price at which we sell our common stock to the public in such initial public offering. In October 2012, in accordance with the common stock purchase agreement, we sold AstraZeneca 6,250,000 shares of our common stock at a price per share of $4.00 as further discussed in Note 8.

Biogen Idec

In August 2012, we entered into a collaboration and license agreement with Biogen Idec pursuant to which we and Biogen Idec have agreed to collaborate on microRNA biomarkers for multiple sclerosis, or MS. Under the terms of the agreement, we granted Biogen Idec an exclusive, royalty free, worldwide license to our interest in the collaboration intellectual property for the purpose of commercializing non-microRNA products for the treatment, diagnosis and prevention of MS and non-MS diseases and disorders. We also granted Biogen Idec an exclusive, royalty-free, worldwide license, with the right to sublicense, to our interest in the collaboration intellectual property (and a non-exclusive license to our background intellectual property) for the purpose of commercializing products for the diagnosis of MS. Biogen Idec granted us an exclusive, royalty-free, worldwide license, with the right to sublicense, to their interest in the collaboration intellectual property for the purpose of commercializing microRNA products for the treatment of any disease, disorder or condition in humans. Pursuant to the agreement, we granted Biogen Idec a right of first negotiation on certain commercial transactions relating to microRNA products which utilize intellectual property developed during the collaboration. Pursuant to the terms of the agreement, in August 2012 we received an upfront payment of $750,000. We are also eligible to receive research milestone payments of up to an aggregate of approximately $1.3 million. We considered the elements within the collaboration and license agreement as a single unit of accounting because the delivered element, the license, does not have stand-alone value. As a result, we are recognizing the upfront payment of $750,000 to revenue on a straight-line basis over our estimated period of performance, which we determined was approximately two years based on the expected term of the research and development plan.

We have evaluated the contingent event-based payments under our collaboration and license agreement with Biogen Idec based on the new authoritative guidance for milestones and determined that the research payments meet the definition of substantive milestones because they are related to events (i) that can be achieved based in whole or in part on our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and (iii) that would result in additional payments being due to us. Accordingly, revenue for these achievements will be recognized in its entirety in the period when the milestone is achieved and collectibility is reasonably assured. We can earn the following research milestones: $250,000 for identification of a microRNA biomarker; $500,000 for validation of the microRNA biomarker in a second independent sample set; and $500,000 upon the completion of a longitudinal study of patient samples on MS therapy.

Concurrently with the collaboration and license agreement, we entered into a note purchase agreement with Biogen Idec, pursuant to which we issued Biogen Idec a convertible promissory note in the principal amount of $5.0 million. The $5.0 million note and accrued interest thereunder of approximately $25,000 converted into 1,256,232 shares of our common stock upon the closing of our initial public offering in October 2012 at a conversion price of $4.00 per share.

8. Subsequent Events

Initial Public Offering and Other Financing Transactions

The unaudited pro forma balance sheet information below assumes the following transactions that were completed subsequent to September 30, 2012 had occurred on September 30, 2012:

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Pro forma net proceeds from our IPO and concurrent private placement were determined as follows (in thousands):

The following table summarizes certain actual balance sheet data and pro forma balance sheet data to reflect the activities related to our IPO noted above, as of September 30, 2012 (in thousands):

Effective upon the closing of our IPO, 5,630,419 shares of common stock were reserved for future issuance under our 2012 equity incentive plan (2012 Plan), including 3,398,638 shares of common stock reserved for issuance upon the exercise of outstanding options issued under our 2009 equity incentive plan and 731,781 shares of common stock previously reserved for issuance under our 2009 equity incentive plan, in each case that were added to the shares reserved under the 2012 Plan upon its effectiveness.

Effective upon the closing of our IPO, 150,000 shares of common stock were reserved for future issuance under our 2012 employee stock purchase plan.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The interim unaudited condensed financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2011 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our final prospectus filed with the Securities and Exchange Commission on October 5, 2012 relating to our Registration Statement on Form S-1/A (File No. 333-183384) for our initial public offering.

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FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q may contain “forward-looking statements” within the meaning of the federal securities laws made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under Part II, Item 1A, “Risk Factors” in this quarterly report on Form 10-Q. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise. These statements, which represent our expectations or beliefs concerning various future events, may contain words such as “may,” “will,” “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate” or other words indicating future results. Such statements may include, but are not limited to, statements concerning the following:

OVERVIEW

We are a biopharmaceutical company focused on discovering and developing first-in-class drugs that target microRNAs to treat a broad range of diseases. We were formed in 2007 when Alnylam Pharmaceuticals, Inc., or Alnylam, and Isis Pharmaceuticals, Inc., or Isis, contributed significant intellectual property, know-how and financial and human capital to pursue the development of drugs targeting microRNAs pursuant to a license and collaboration agreement. microRNAs are recently discovered, naturally occurring ribonucleic acid, or RNA, molecules that play a critical role in regulating key biological pathways. Scientific research has shown the improper balance, or dysregulation, of microRNAs is directly linked to many diseases. We believe we have assembled the leading position in the microRNA field, including expertise in microRNA biology and oligonucleotide chemistry, a broad intellectual property estate, key opinion leaders and disciplined drug discovery and development processes. We refer to these assets as our microRNA product platform. We are using our microRNA product platform to develop chemically modified, single-stranded oligonucleotides that we call anti-miRs. We use these anti-miRs to modulate microRNAs and by doing so return diseased cells to their healthy state. We believe microRNAs may be transformative in the field of drug discovery and that anti-miRs may become a new and major class of drugs with broad therapeutic application much like small molecules, biologics and monoclonal antibodies. We are currently optimizing anti-miRs in five distinct programs, both independently and with our strategic alliance partners, AstraZeneca AB, or AstraZeneca, GlaxoSmithKline plc, or GSK, and Sanofi.

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Under these strategic alliances, we are eligible to receive up to approximately $1.7 billion in milestone payments upon successful commercialization of microRNA therapeutics for the eleven programs contemplated by our agreements. These payments include up to $106.5 million upon achievement of preclinical and investigational new drug application, or IND, milestones, up to $350.0 million upon achievement of clinical development milestones, up to $420.0 million upon achievement of regulatory milestones and up to $850.0 million upon achievement of commercialization milestones. We anticipate that we will nominate at least two clinical development candidates within the next 12 months and file at least two INDs with the U.S. Food and Drug Administration, or FDA, by 2014.

Recent developments

FINANCIAL OPERATIONS OVERVIEW

Revenues

Our revenues generally consist of upfront payments for licenses or options to obtain licenses in the future, research and development funding and milestone payments under strategic alliance agreements, as well as funding received under government grants.

In the future, we may generate revenue from a combination of license fees and other upfront payments, research and development payments, milestone payments, product sales and royalties in connection with strategic alliances. We expect that any revenue we generate will fluctuate from quarter-to-quarter as a result of the timing of our achievement of preclinical, clinical, regulatory and commercialization milestones, if at all, the timing and amount of payments relating to such milestones and the extent to which any of our products are approved and successfully commercialized by us or our strategic alliance partners. If our strategic alliance partners do not elect or otherwise agree to fund our development costs pursuant to our strategic alliance agreements, or we or our strategic alliance partners fail to develop product candidates in a timely manner or obtain regulatory approval for them, our ability to generate future revenues, and our results of operations and financial position would be adversely affected.

Research and development expenses

Research and development expenses consist of costs associated with our research activities, including our drug discovery efforts, the preclinical development of our therapeutic programs, and our microRNA biomarker program. Our research and development expenses include:

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We expense research and development costs as incurred. We account for nonrefundable advance payments for goods and services that will be used in future research and development activities as expenses when the service has been performed or when the goods have been received.

To date, we have conducted research on many different microRNAs with the goal of understanding how they function and identifying those that might be targets for therapeutic modulation. At any given time we are working on multiple targets, primarily within our five therapeutic areas of focus. Our organization is structured to allow the rapid deployment and shifting of resources to focus on the best targets based on our ongoing research. As a result, in the early phase of our development, our research and development costs are not tied to any specific target. However, we are currently spending the vast majority of our research and development resources on our lead development programs.

Since our conversion to a corporation in January 2009, we have grown from 15 researchers to 34 and have spent a total of $61.2 million in research and development expenses through September 30, 2012.

We expect our research and development expenses to increase for the foreseeable future as we advance our research programs toward the clinic and initiate clinical trials. The process of conducting preclinical studies and clinical trials necessary to obtain regulatory approval is costly and time consuming. We or our strategic alliance partners may never succeed in achieving marketing approval for any of our product candidates. The probability of success for each product candidate may be affected by numerous factors, including preclinical data, clinical data, competition, manufacturing capability and commercial viability. Under our strategic alliance with GSK, we may be responsible for the development of product candidates through clinical proof-of-concept, depending on the time at which GSK may choose to exercise its option to obtain an exclusive license to develop, manufacture and commercialize product candidates on a program-by-program basis. Under our strategic alliance with Sanofi, we are responsible for the development of product candidates up to initiation of Phase 1 clinical trials, after which time Sanofi would be responsible for the costs of clinical development and commercialization and all related costs. Under our strategic alliance agreement with AstraZeneca, we are responsible for certain research and development activities with respect to each alliance target under a mutually agreed upon research and development plan until the earlier to occur of IND approval in a major market or the end of the research term under the agreement. We also have several independent programs for which we are responsible for all of the research and development costs, unless and until we partner any of these programs in the future.

Most of our product development programs are at an early stage, and successful development of future product candidates from these programs is highly uncertain and may not result in approved products. Completion dates and completion costs can vary significantly for each future product candidate and are difficult to predict. We anticipate that we will make determinations as to which programs to pursue and how much funding to direct to each program on an ongoing basis in response to our ability to maintain or enter into new strategic alliances with respect to each program or potential product candidate, the scientific and clinical success of each future product candidate, as well as ongoing assessments as to each future product candidate’s commercial potential. We will need to raise additional capital and may seek additional strategic alliances in the future in order to advance our various programs.

General and administrative expenses

General and administrative expenses consist primarily of salaries and related benefits, including stock-based compensation, related to our executive, finance, legal, business development and support functions. Other general and administrative expenses include allocated facility-related costs not otherwise included in research and development expenses, travel expenses and professional fees for auditing, tax and legal services. We expect that general and administrative expenses will increase in the future as we expand our operating activities and incur additional costs associated with being a publicly-traded company. These increases will likely include legal fees, accounting fees, directors’ and officers’ liability insurance premiums and fees associated with investor relations.

Other income (expense), net

Other income (expense) includes interest income and expense, and on occasion income or expense of a non-recurring nature. We earn interest income from interest-bearing accounts and money market funds for cash and cash equivalents and marketable securities, such as interest-bearing bonds, for our short-term investments. Interest expense represents the amounts payable to GSK and Biogen Idec under convertible notes and amounts paid under equipment and tenant improvement financing arrangements. In addition, we recognized a loss on the extinguishment of debt as a result of amending and restating our convertible note payable issued to GSK in February 2010. As a result of electing to value the note under the fair value option, we will recognize all changes to the fair value of the note as gain (loss) from valuation of convertible note payable.

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CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES

The preparation of our unaudited condensed financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the revenues and expenses incurred during the reported periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discussed accounting policies and assumptions that involve a higher degree of judgment and complexity within Note 1 to our financial statements in our Registration Statement on Form S-1/A (File No. 333-183384). Except as set forth in the paragraph below, there have been no material changes to our critical accounting policies and estimates from those disclosed in our Registration Statement on Form S-1/A (File No. 333-183384).

Fair Value Option

Applicable accounting policies permit entities to choose, at specified election dates, to measure specified items at fair value if the decision about the election is: 1) applied instrument by instrument, 2) irrevocable, and 3) applied to an entire instrument. In addition, an entity may choose to elect the fair value option only at the date of an event (i.e., significant modifications of debt, as defined) that requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that. In July 2012, we accounted for the amended and restated note issued to GSK in February 2010 as a debt extinguishment of the original note. We elected to measure the amended note under the fair value option. The difference between the carrying value of the original note and the fair value of the amended note was recorded as a loss on extinguishment of debt to non-operating earnings. Thereafter, any change to the fair value of the amended note will be recorded as gain (loss) from valuation of convertible notes payable to non-operating earnings.

RESULTS OF OPERATIONS

Comparison of the three months ended September 30, 2012 and 2011

The following table summarizes the results of our operations for the three months ended September 30, 2012 and 2011, together with the changes in those items in dollars (in thousands):