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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Form 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended June 30, 2011

 

OR

 

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

 

For the transition period from                       to                       

 

Commission file number 0-19125

 

 

Isis Pharmaceuticals, Inc.

(Exact name of Registrant as specified in its charter)

 

 

1896 Rutherford Road, Carlsbad, CA 92008

(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  x No  o

 

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  o

 

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):

 

Large accelerated filer  x		Accelerated filer  o
Non-accelerated filer  o		Smaller reporting company  o
(Do not check if a smaller reporting company)

 

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  o No  x

 

The number of shares of voting common stock outstanding as of August 1, 2011 was 99,660,883.

 

 

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ISIS PHARMACEUTICALS, INC.

FORM 10-Q

 

INDEX

 

PART I	FINANCIAL INFORMATION
ITEM 1:	Financial Statements:
	Condensed Consolidated Balance Sheets as of June 30, 2011 (unaudited) and December 31, 2010	3
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2011 and 2010 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements	6
ITEM 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
	Results of Operations	16
	Liquidity and Capital Resources	21
	Risk Factors	22
ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	31
ITEM 4:	Controls and Procedures	31
PART II	OTHER INFORMATION	32
ITEM 1:	Legal Proceedings	32
ITEM 2:	Unregistered Sales of Equity Securities and Use of Proceeds	32
ITEM 3:	Default upon Senior Securities	32
ITEM 4:	(Removed and Reserved)	32
ITEM 5:	Other Information	32
ITEM 6:	Exhibits	32
SIGNATURES		33

 

TRADEMARKS

 

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

 

Regulus Therapeutics™ is a trademark of Regulus Therapeutics Inc.

 

Ibis T5000™ is a trademark of Ibis Biosciences, Inc.

 

Vitravene ®  is a registered trademark of Novartis AG.

 

Kynamro ™ is a trademark of Genzyme Corporation.

 

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		June 30, 2011			December 31, 2010
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	85,022		$	70,052
Short-term investments		310,162			402,301
Contracts receivable		5,674			1,242
Inventories		2,249			2,484
Other current assets		7,613			7,058
Total current assets		410,720			483,137
Property, plant and equipment, net		88,010			35,703
Licenses, net		11,129			12,288
Patents, net		16,444			15,821
Deposits and other assets		3,269			3,528
Total assets		$	529,572		$	550,477
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	3,071		$	6,523
Accrued compensation		4,406			6,831
Accrued liabilities		10,873			12,389
Current portion of long-term obligations		4,911			5,645
Current portion of deferred contract revenue		68,719			74,502
Total current liabilities		91,980			105,890
Long-term deferred contract revenue		21,356			50,413
2 5 / 8 % convertible subordinated notes		137,073			132,895
Long-term obligations, less current portion		5,465			5,720
Long-term financing liability for leased facility		58,722			10,147
Investment in Regulus Therapeutics Inc.		2,759			870
Total liabilities		317,355			305,935
Stockholders’ equity:
Common stock, $0.001 par value; 200,000,000 shares authorized, 99,618,525 and 99,393,780 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		100			99
Additional paid-in capital		1,006,288			1,000,181
Accumulated other comprehensive income		399			949
Accumulated deficit		(794,570		)	(756,687		)
Total stockholders’ equity		212,217			244,542
Total liabilities and stockholders’ equity		$	529,572		$	550,477

 

See accompanying notes.

 

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Revenue:
Research and development revenue under collaborative agreements		$	24,305		$	21,143		$	44,319		$	49,699
Licensing and royalty revenue		518			2,360			1,651			3,730
Total revenue		24,823			23,503			45,970			53,429
Expenses:
Research and development		36,009			39,124			70,254			71,111
General and administrative		2,874			3,051			5,884			5,869
Total operating expenses		38,883			42,175			76,138			76,980
Loss from operations		(14,060		)	(18,672		)	(30,168		)	(23,551		)
Other income (expense):
Equity in net loss of Regulus Therapeutics Inc.		(1,033		)	(3,942		)	(1,889		)	(5,428		)
Investment income		616			859			1,321			1,814
Interest expense		(3,437		)	(3,261		)	(6,851		)	(6,498		)
Gain (loss) on investments, net		34			(136		)	(285		)	(1,146		)
Loss before income tax expense		(17,880		)	(25,152		)	(37,872		)	(34,809		)
Income tax expense		(9		)	(2		)	(11		)	(2		)
Net loss		$	(17,889	)	$	(25,154	)	$	(37,883	)	$	(34,811	)
Basic and diluted net loss per share		$	(0.18	)	$	(0.25	)	$	(0.38	)	$	(0.35	)
Shares used in computing basic and diluted net loss per share		99,602			99,091			99,586			99,052

 

See accompanying notes.

 

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2011			2010
Net cash used in operating activities		$	(66,019	)	$	(16,661	)
Investing activities:
Purchases of short-term investments		(208,723		)	(326,163		)
Proceeds from the sale of short-term investments		298,177			302,273
Purchases of property, plant and equipment		(5,982		)	(11,894		)
Proceeds from land sold to BioMed		—			10,147
Reduction of cash due to deconsolidation of Regulus Therapeutics Inc. upon adoption of a new accounting standard		—			(16,228		)
Acquisition of licenses and other assets		(1,755		)	(2,455		)
Purchases of strategic investments		(359		)	(658		)
Net cash (used in) provided by investing activities		81,358			(44,978		)
Financing activities:
Proceeds from issuance of equity		876			1,282
Proceeds from equipment financing arrangement		1,625			3,083
Principal payments on debt obligations		(2,870		)	(1,943		)
Net cash (used in) provided by financing activities		(369		)	2,422
Net (decrease) increase in cash and cash equivalents		14,970			(59,217		)
Cash and cash equivalents at beginning of period		70,052			105,255
Cash and cash equivalents at end of period		$	85,022		$	46,038
Supplemental disclosures of cash flow information:
Interest paid		$	2,398		$	2,413
Income taxes paid		$	2		$	7,700
Supplemental disclosures of non-cash investing and financing activities:
Amounts accrued for capital and patent expenditures		$	1,080		$	831
Capitalized costs and financing liability associated with leased facility		$	48,575		$	—

 

See accompanying notes.

 

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ISIS PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

(Unaudited)

 

1.                                       Basis of Presentation

 

The unaudited interim condensed consolidated financial statements for the three and six month periods ended June 30, 2011 and 2010 have been prepared on the same basis as the audited financial statements for the year ended December 31, 2010. The financial statements include all normal recurring adjustments, which we consider necessary for a fair presentation of the financial position at such dates and the 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, 2010 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”).

 

The condensed consolidated financial statements include the accounts of Isis Pharmaceuticals, Inc. (“we”, “us” or “our”) and our wholly owned subsidiaries, Isis USA Ltd. and Symphony GenIsis, Inc.  We use the equity method of accounting to account for our investment in Regulus Therapeutics Inc. (formerly Regulus Therapeutics LLC).

 

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 under current accounting rules. In those instances in which we have received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on our condensed consolidated balance sheet.

 

Research and development revenue under collaborative agreements

 

On January 1, 2011, we adopted an accounting standard, which amended the criteria to identify separate units of accounting for revenue arrangements with multiple deliverables.  The new guidance replaces the concept of allocating revenue among deliverables in a multiple-element revenue arrangement according to fair value with an allocation based on selling price.  The new standard is applicable on a prospective basis to agreements we entered into or materially modified after January 1, 2011.  The adoption of the standard did not impact our financial position or results of operations as of and for the six month period ended June 30, 2011 as we did not enter into or materially modify any multiple-element arrangements during that period. However, the adoption of this standard may result in revenue recognition for future agreements that is different from our existing multiple-element arrangements.

 

For agreements that we entered into or materially modified prior to the adoption of the revised multiple element guidance, we recognize revenue from arrangements that contain multiple deliverables from each element of the arrangement as long as we can determine a standalone value for the delivered element and fair value for the undelivered elements, we have completed our obligation to deliver or perform on that element and we are reasonably assured of collecting the resulting receivable.

 

We often enter into collaborations with multiple deliverables under which we receive non-refundable upfront payments.  For collaborations where we determine that there is a single unit of accounting, we recognize revenue related to upfront payments ratably over our period of performance relating to the term of the contractual arrangements. Occasionally, we must estimate our period of performance when the agreements we entered into do not clearly define such information.  Our collaborative agreements typically include a research and/or development project plan that includes the activities the agreement requires each party to perform during the collaboration and the party responsible for performing them. 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 and amortize revenue over such period. If our collaborators ask us to continue performing work in a collaboration beyond the initial period of performance, we extend our amortization period to correspond to the new extended period of performance.  The revenue we recognize could be materially different if different estimates prevail. We have made estimates of our continuing obligations on several agreements.  Adjustments to performance periods and related adjustments to revenue amortization periods have had a material impact on our revenue on only one occasion.  When Alnylam Pharmaceuticals, Inc. terminated the companies’ single-stranded RNAi, or ssRNAi, research program in November 2010, we recognized as revenue $4.9 million, which was the remaining deferred revenue from the upfront fee that we were amortizing into revenue over the research term.

 

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Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and commercialization events.  When we achieve these milestones, we are entitled to payment, according to the underlying agreements. 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.  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;

·                   Substantive effort is involved to achieve the milestone event;

·                   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 will defer recognition of the milestone payment and recognize it as revenue over the estimated period of performance, if any.  In May 2011, we initiated a Phase 1 clinical study on ISIS-TTR Rx , the first drug selected as part of our collaboration with GSK and in January 2011 OncoGenex Pharmaceuticals Inc., initiated a Phase 2 trial of OGX-427 in men with metastatic prostate cancer.   We considered the initiation of Phase 1 and Phase 2 clinical trials to be substantive milestones because the level of effort and inherent risk associated with successfully moving a drug into Phase 1 and Phase 2 clinical development is high.  Therefore, we recognized the entire $5 million milestone payment from GSK in the second quarter of 2011 and the entire $750,000 milestone payment from OncoGenex in the first quarter of 2011.  Further information about our collaborative arrangements can be found in Note 6, Collaborative Arrangements and Licensing Agreements , below and Note 8 of our audited financial statements for the year ended December 31, 2010 included in our Annual Report on Form 10-K filed with the SEC.

 

As part of our Genzyme, a Sanofi company, strategic alliance, in February 2008 Genzyme made a $150 million equity investment in us by purchasing five million shares of our common stock at $30 per share. The price Genzyme paid for our common stock represented a significant premium over the fair value of our stock.  We accounted for this premium as deferred revenue and are amortizing it along with the $175 million licensing fee that we received in June 2008 ratably into revenue until June 2012, which represents the end of our performance obligation based on the current research and development plan.

 

Licensing and royalty revenue

 

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

 

Short-term investments

 

We consider all liquid investments with maturities of 90 days or less when purchased to be cash equivalents. Our short-term investments have initial maturities of greater than 90 days 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 stockholders’ equity 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.  We hold ownership interests of less than 20 percent in each of the respective companies except Regulus, our jointly owned subsidiary.  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.  We record unrealized gains and losses related to temporary declines in the publicly-held companies as a separate component of stockholders’ equity and account for securities in the privately-held companies, except for Regulus, under the cost method of accounting because we own less than 20 percent and do not have significant influence in their operations. Most of the cost method investments we hold are in early stage biotechnology companies and realization of our equity position in those companies is uncertain. In those circumstances we record a full valuation allowance. When 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.

 

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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 allocated 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. 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-off for the first six months of 2011 and 2010.  Total inventory, which consisted of raw materials, was $2.2 million and $2.5 million as of June 30, 2011 and December 31, 2010, respectively.

 

Patents

 

We capitalize costs consisting principally of outside legal costs and filing fees related to obtaining patents. 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 amortize patent costs over their estimated useful lives of 10 years, beginning with the date the United States Patent and Trademark Office, or foreign equivalent, issues the patent.  For the first six months of 2011 and 2010, we recorded a non-cash charge of $801,000 and $385,000, respectively, which we included in research and development expenses, related to the write-down of our patent costs to their estimated net realizable values.

 

Long-lived assets

 

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

 

Equity method of accounting

 

We account for our ownership interest in Regulus using the equity method of accounting.  We include our share of Regulus’ operating results on a separate line in our condensed consolidated statement of operations called “Equity in net loss of Regulus Therapeutics Inc.”  On our condensed consolidated balance sheet, we present our investment in Regulus on a separate line in the non-current liabilities section called “Investment in Regulus Therapeutics Inc.”  Under the equity method of accounting, we are required to suspend recognizing losses if the carrying amount of our investment in Regulus exceeds the amount of funding we are required to provide to Regulus.  Since we and Alnylam are guarantors of both of the convertible notes that Regulus issued to GlaxoSmithKline, or GSK, we will continue to recognize losses in excess of our net investment in Regulus up to the principal plus accrued interest we guaranteed, which was $5.4 million at June 30, 2011.

 

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.  Adjustments to our estimates have had a material impact to our actual results on only one occasion.  When Alnylam terminated the ssRNAi research program in November 2010, we recognized as revenue $4.9 million, which was the remaining deferred revenue from the upfront fee that we were amortizing into revenue over the research term.

 

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Basic and diluted net income (loss) per share

 

We compute basic net loss per share by dividing the net loss by the weighted-average number of common shares outstanding during the period. As we incurred a loss from continuing operations for the three and six months ended June 30, 2011 and 2010, we did not include the following diluted common equivalent shares in the computation of diluted net loss from continuing operations per share because the effect would have been anti-dilutive:

 

·                   2 5 / 8  percent convertible subordinated notes;

·                   GlaxoSmithKline convertible promissory notes; and

·                   Dilutive stock options

 

Consolidation of variable interest entities

 

We identify entities as variable interest entities either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest.  We perform ongoing qualitative assessments of our variable interest entities to determine whether we have a controlling financial interest in the variable interest entity and therefore are the primary beneficiary.  As of June 30, 2011 and December 31, 2010, we had collaborative arrangements with eight entities that we consider to be variable interest entities.  We are not the primary beneficiary for any of these entities as we do not have both the power to direct the activities that most significantly impact the economic performance of our variable interest entities and the obligation to absorb losses or right to receive benefits from our variable interest entities that could potentially be significant to the variable interest entities.  In the case of Regulus, since we and Alnylam share the ability to impact Regulus’ economic performance, we are not the primary beneficiary of Regulus.

 

Comprehensive loss

 

We report, in addition to net loss, comprehensive loss and its components as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Comprehensive loss:
Unrealized holding losses		$	(290	)	$	(437	)	$	(550	)	$	(286	)
Reclassification adjustment for realized loss included in net loss		—			—			—			(925		)
Net loss		(17,889		)	(25,154		)	(37,883		)	(34,811		)
Comprehensive loss		$	(18,179	)	$	(25,591	)	$	(38,433	)	$	(36,022	)

 

Convertible debt

 

We account for our 2 5 / 8  percent convertible notes by separating the liability and equity components of the instruments in a manner that reflects our nonconvertible debt borrowing rate when we recognize interest expense in subsequent periods.  As a result, we assigned a value to the debt component of our 2 5 / 8  percent convertible notes equal to the estimated fair value of a similar debt instrument without the conversion feature, which resulted in us recording the debt at a discount.  We are amortizing the resulting debt discount over the life of the debt as additional non-cash interest expense utilizing the effective interest method.

 

Stock-based compensation expense

 

We account for our stock-based compensation expense related to employee stock options and employee stock purchases by estimating the fair value of each employee stock option grant and the employee stock purchase plan (“ESPP”) purchase rights on the date of grant using the Black-Scholes model.  The expected term of stock options granted represents the period of time that they are expected to be outstanding.  We estimated the expected term of options granted based on historical exercise patterns.

 

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For the six months ended June 30, 2011 and 2010, we used the following weighted-average assumptions in our Black-Scholes calculations:

 

Employee Stock Options:

 

		Six Months Ended June 30,
		2011		2010
Risk-free interest rate		2.3	%	2.8	%
Dividend yield		0.0	%	0.0	%
Volatility		51.4	%	55.7	%
Expected Life		5.3 years		5.1 years

 

ESPP:

 

		Six Months Ended June 30,
		2011		2010
Risk-free interest rate		0.2	%	0.2	%
Dividend yield		0.0	%	0.0	%
Volatility		26.5	%	54.8	%
Expected Life		6 months		6 months

 

The following table summarizes stock-based compensation expense related to employee and non-employee stock options and the ESPP for the three and six months ended June 30, 2011 and 2010 (in thousands, except per share data), which was allocated as follows:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Research and development		$	2,284		$	2,611		$	4,572		$	5,436
General and administrative		216			521			660			1,052
Total		$	2,500		$	3,132		$	5,232		$	6,488

 

As of June 30, 2011, total unrecognized compensation cost related to non-vested stock-based compensation plans was $11.6 million.  We will adjust total unrecognized compensation cost for future changes in estimated forfeitures.  We expect to recognize this cost over a weighted average period of 1.3 years.

 

Impact of recently issued accounting standards

 

In June 2011, the FASB amended its authoritative guidance on the presentation of comprehensive income. Under the amendment, companies have the option to present the components of net income and other comprehensive income either in a single continuous statement of comprehensive income or in separate but consecutive statements. This amendment eliminates the currently available option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendment does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The guidance is effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2011 and is effective for our fiscal year beginning January 1, 2012. As this guidance relates to presentation only, the adoption of this guidance will not have any other effect on our financial statements.

 

3.                                       Investments

 

As of June 30, 2011, our excess cash was primarily invested in commercial paper and debt instruments with strong credit ratings of financial institutions, corporations, U.S. government agencies and the U.S. Treasury with an investment grade rating at or above A-1, P-1 or F-1 by Moody’s, Standard & Poor’s (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.

 

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The following table summarizes the contract maturity of the available-for-sale securities we held as of June 30, 2011:

 

One year or less		76	%
After one year but within two years		20	%
After two years but within three years		4	%
Total		100	%

 

In April 2011, S&P affirmed the ‘AAA/A-1+’ rating on the sovereign credit rating of the United States.  At the same time, however, S&P lowered the outlook of the long-term rating to ‘Negative’ from ‘Stable.’  In July 2011 Moody’s placed the AAA bond rating for the United States on review for a possible downgrade.  The actions taken by S&P and Moody’s pertain primarily to the long-term challenges associated with the United States’ budget deficits and rising indebtedness.  As illustrated above, our excess cash is invested primarily in short-term instruments with 96 percent of our available-for-sale securities having a maturity of less than two years.  Therefore, we do not believe the action taken by S&P and Moody’s impact the carrying value of our available-for-sale securities at June 30, 2011.

 

At June 30, 2011, we had an ownership interest of less than 20 percent in each of five private companies and two public companies with which we conduct business.  The companies are Santaris Pharma A/S (formerly Pantheco A/S), Achaogen, Inc., Atlantic Pharmaceuticals Limited, Altair Therapeutics Inc. and Excaliard Pharmaceuticals, Inc., which are privately-held and Antisense Therapeutics Limited, or ATL, and iCo Therapeutics Inc., which are publicly-traded.  We account for securities in the privately-held companies under the cost method of accounting and we classify the securities in the publicly-traded companies as available-for-sale.  In the first half of 2011, we recognized a $285,000 loss on investments primarily consisting of a $359,000 valuation allowance we recorded related to our investment in Excaliard.  Because realization of our Excaliard investment is uncertain we recorded a full valuation allowance.

 

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

 

		Amortized			Unrealized						Other-Than- Temporary Impairment			Estimated
June 30, 2011		Cost			Gains			Losses			Loss			Fair Value
Short-term investments:
Corporate debt securities		$	167,417		$	196		$	(51	)	$	—		$	167,562
Debt securities issued by U.S. government agencies		57,128			25			(8		)	—			57,145
Debt securities issued by the U.S. Treasury		6,513			10			—			—			6,523
Debt securities issued by states of the United States and political subdivisions of the states		7,401			—			—			—			7,401
Total securities with a maturity of one year or less		238,459			231			(59		)	—			238,631
Corporate debt securities		57,591			140			(57		)	—			57,674
Debt securities issued by U.S. government agencies		10,117			13			—			—			10,130
Debt securities issued by states of the United States and political subdivisions of the states		3,730			—			(3		)	—			3,727
Total securities with a maturity of more than one year		71,438			153			(60		)	—			71,531
Subtotal		$	309,897		$	384		$	(119	)	$	—		$	310,162
Equity securities:
Current portion (included in Other current assets)		$	1,538		$	939		$	—		$	(880	)	$	1,597
Long-term portion (included in Deposits and other assets)		625			—			—			—			625
Subtotal		$	2,163		$	939		$	—		$	(880	)	$	2,222
		$	312,060		$	1,323		$	(119	)	$	(880	)	$	312,384

 

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		Amortized			Unrealized						Other-Than- Temporary Impairment			Estimated
December 31, 2010		Cost			Gains			Losses			Loss			Fair Value
Short-term investments:
Corporate debt securities		$	196,010		$	294		$	(41	)	$	—		$	196,263
Debt securities issued by U.S. government agencies		119,890			53			(34		)	—			119,909
Debt securities issued by the U.S. Treasury		24,030			10			—			—			24,040
Debt securities issued by states of the United States and political subdivisions of the states		6,989			3			—			—			6,992
Total securities with a maturity of one year or less		346,919			360			(75		)	—			347,204
Corporate debt securities		47,842			167			(44		)	—			47,965
Debt securities issued by U.S. government agencies		7,139			4			(11		)	—			7,132
Total securities with a maturity of more than one year		54,981			171			(55		)	—			55,097
Subtotal		$	401,900		$	531		$	(130	)	$	—		$	402,301
Equity securities:
Current portion (included in Other current assets)		$	1,538		$	1,353		$	—		$	(880	)	$	2,011
Long-term portion (included in Deposits and other assets)		625			—			—			—			625
Subtotal		$	2,163		$	1,353		$	—		$	(880	)	$	2,636
		$	404,063		$	1,884		$	(130	)	$	(880	)	$	404,937

 

Investments we consider to be temporarily impaired at June 30, 2011 are as follows (in thousands):

 

				Less than 12 months of temporary impairment
		Number of Investments		Estimated Fair Value			Unrealized Losses
Corporate debt securities		45		$	97,370		$	(108	)
Debt securities issued by U.S. government agencies		4		11,541			(8		)
Debt securities issued by states of the United States and political subdivisions of the states		3		3,733			(3		)
Total temporarily impaired securities		52		$	112,644		$	(119	)

 

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

 

4.                                     Fair Value Measurements

 

We use a three-tier fair value hierarchy to prioritize the inputs used in our fair value measurements.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets, which includes our money market funds and treasury securities classified as available-for-sale securities and 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 an entity to develop its own assumptions.  To estimate the fair value of securities classified as Level 2, we utilize the services of a fixed income pricing provider that uses an industry standard valuation model, which is based on a market approach.  The significant inputs for the valuation model include reported trades, broker/dealer quotes, benchmark securities and bids.  At June 30, 2011, we had no securities that we classified as Level 3.

 

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Below is a table of our assets that we measure at fair value on a recurring basis. For the following major security types, we break down the inputs used to measure fair value at June 30, 2011 (in thousands):

 

		Total			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Cash equivalents (1)		$	84,740		$	72,845		$	11,895		$	—
Corporate debt securities (2)		225,236			—			225,236			—
Debt securities issued by U.S. government agencies (2)		67,275			—			67,275			—
Debt securities issued by the U.S. Treasury (2)		6,523			6,523			—			—
Debt securities issued by states of the United States and political subdivisions of the states (2)		11,128			—			11,128			—
Equity securities (3)		1,597			1,597			—			—
Total		$	396,499		$	80,965		$	315,534		$	—

(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)           Included in other current assets on our condensed consolidated balance sheet.

 

5.                                     New Facility

 

The leases on our primary research and development facilities expire at the end of 2011. Rather than invest in costly renovations to our existing facilities, we chose to consolidate the majority of our operations in a new leased facility that Biomed Realty Trust, Inc. constructed. To make our move, scheduled for August 2011, as efficient as possible, we requested access to the new facility prior to the completion of construction.   To gain early access, in May 2011, we agreed to modify our lease with BioMed to accept additional responsibility.  As a result, we were required to record the construction in progress costs for the facility as a fixed asset, which at June 30, 2011 was $48.6 million.  We also recorded a corresponding liability.  This amount is in addition to the $10.1 million we recorded in 2010 for the cost of the land.  In July 2011, we took possession of the new facility.  Therefore beginning in the third quarter, we will depreciate the cost of the facility over its economic useful life.  Our rent payments begin on January 1, 2012 and will decrease the liability over the term of the lease.

 

6.                                     Collaborative Arrangements and Licensing Agreements

 

The information discussed below represents changes to partnerships entered into prior to 2011.  There are no other changes from the information provided in Note 8— Collaborative Arrangements and Licensing Agreements of the Consolidated Financial Statements section, included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Traditional Pharmaceutical Alliances and Licensing

 

GlaxoSmithKline

 

In March 2010, we entered into a strategic alliance with GSK, which covers up to six programs, in which we use our antisense drug discovery platform to seek out and develop new drugs against targets for rare and serious diseases, including infectious diseases and some conditions causing blindness.  This alliance allows us to control and facilitate rapid development of drugs while still being eligible to receive milestone payments as we advance these drugs in clinical development.

 

Since March 2010, we have received $48 million from GSK, which includes the $35 million upfront payment and the $3 million payment we received in May 2011 when GSK expanded the collaboration by initiating a sixth program, both of which we are amortizing over the five year period of our performance. In addition we have received $10 million in milestone payments, including a $5 million milestone payment we earned in the second quarter of 2011 for initiating a Phase 1 clinical study for ISIS-TTR Rx , the first antisense drug to enter development under our strategic alliance with GSK.  We are also eligible to receive on average up to $20 million in milestone payments per program up to Phase 2 proof-of-concept. GSK has the option to license drugs from these programs at Phase 2 proof-of-concept, and will be responsible for all further development and commercialization.  If all six programs are successfully developed for one or more indications and commercialized through pre-agreed sales targets we could receive license fees

 

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and milestone payments totaling up to nearly $1.5 billion. In addition, we will receive up to double-digit royalties on sales from any product that GSK successfully commercializes under this alliance.  During the three and six months ended June 30, 2011, we recognized revenue of $7.0 million and $8.7 million, respectively, from our relationship with GSK compared to $1.8 million in the same periods of 2010. Our balance sheet at June 30, 2011 included deferred revenue of $29.1 million, related to the upfront and expansion payments.

 

7.                                       Concentration of Business Risk

 

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:

 

		Three Months Ended June 30,				Six Months Ended June 30,
		2011		2010		2011		2010
Partner A		67	%	71	%	72	%	62	%
Partner B		28	%	7	%	19	%	3	%
Partner C		3	%	4	%	3	%	20	%

 

Contract receivables from one significant partner comprised approximately 90 percent of our contract receivables at June 30, 2011. Contract receivables from two significant partners comprised approximately 30 percent and 15 percent of our contract receivables at December 31, 2010. Included in our contract receivables at June 30, 2011 and December 31, 2010 was $499,000 and $544,000, respectively, representing nine percent and 44 percent, respectively, of our contract receivables, due from Regulus.

 

ITEM 2.

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

 

In this Report on Form 10-Q, unless the context requires otherwise, “Isis,” “Company,” “we,” “our,” and “us,” refers to Isis Pharmaceuticals, Inc. and its subsidiaries, including Regulus Therapeutics Inc., its jointly owned subsidiary.

 

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 therapeutic and commercial potential of our technologies and products in development, and the financial position of Isis Pharmaceuticals, Inc.  Any statement describing our goals, expectations, financial or other projections, intentions or beliefs is a forward-looking statement and should be considered an at-risk statement.  Such statements are subject to certain risks and uncertainties, particularly those inherent in the process of discovering, developing and commercializing drugs that are safe and effective for use as human therapeutics, and in the endeavor of building a business around such drugs.  Our forward-looking statements also involve assumptions that, if they never materialize or prove correct, could cause our results to differ materially from those expressed or implied by such forward-looking statements.  Although our forward-looking statements reflect the good faith judgment of our management, these statements are based only on facts and factors currently known by us.  As a result, you are cautioned not to rely on these forward-looking statements.  These and other risks concerning our programs are described in additional detail in our Annual Report on Form 10-K for the year ended December 31, 2010, which is on file with the U.S. Securities and Exchange Commission, and those identified within this Item in the section entitled “Risk Factors” beginning on page 22 of this Report.

 

Overview

 

We are the leading company in antisense technology, exploiting a novel drug discovery platform we created to generate a broad pipeline of first-in-class drugs. Antisense technology is a direct route from genomics to drugs.  With our highly efficient and prolific drug discovery platform we can expand our drug pipeline and our partners’ pipelines with antisense drugs that address significant unmet medical needs.  Our business strategy is to do what we do best—to discover unique antisense drugs and develop these drugs to key clinical value inflection points.  In this way, our organization remains small and focused.  We discover and conduct early development of new drugs, outlicense our drugs to partners and build a broad base of license fees, milestone payments and royalty income. We maximize the value of the drugs we discover by putting them in the hands of quality partners with late-stage development, commercialization and marketing expertise such as Bristol-Myers Squibb, Genzyme, GSK and Eli Lilly and Company.  We benefit from the expertise our partners bring to our drugs. For instance, our partner, Genzyme, plans to commercialize our lead product, mipomersen, following regulatory approval, which is expected in 2012. We also work with a consortium of smaller companies that can exploit our technology outside our primary areas of focus using their expertise in specific disease areas. We call these smaller companies our satellite companies.  In addition to our cutting edge antisense programs, we maintain technology leadership through collaborations with Alnylam and Regulus, a company we established and jointly own focused on microRNA therapeutics. We also exploit our inventions with other therapeutic opportunities such as through

 

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collaborations with Achaogen and others.  Beyond human therapeutics, we benefit from the commercialization of products incorporating our technology by other companies that are better positioned to maximize the commercial potential of these inventions, such as when we sold our subsidiary, Ibis Biosciences, to Abbott Molecular Inc.  All of these different types of relationships are part of our unique business model and create current and future shareholder value.

 

We protect our proprietary RNA-based technologies and products through our substantial patent estate.  As an innovator in RNA-based drug discovery and development, we design and execute our patent strategy to provide us with extensive protection for our drugs and our technology.  With our ongoing research and development, our patent portfolio continues to grow. The patents not only protect our key assets—our technology and our drugs—they also form the basis for lucrative licensing and partnering arrangements. To date, we have generated over $400 million from our intellectual property sale and licensing program that helps support our internal drug discovery and development programs.

 

The clinical success of mipomersen, the lead drug in our cardiovascular franchise, is a clear example of the power of our RNA-based technology.  We and Genzyme reported positive data from four Phase 3 studies demonstrating consistent and robust lowering of low-density lipoprotein cholesterol, or LDL-C, and other atherogenic lipids. Across these four studies, treatment with mipomersen reduced LDL-C in patients who have persistently high LDL-C levels despite being treated on maximally tolerated lipid-lowering therapy.  Mipomersen also reduced many other atherogenic lipids, including triglycerides, lipoprotein a, or Lp(a), and non-high-density lipoprotein cholesterol, or non HDL-C, due to its unique mechanism of action.  We believe the safety profile of mipomersen supports our initial market opportunity in patients who cannot currently reach their recommended LDL-C goal.  The mipomersen data from all four of our Phase 3 studies support the profile of the drug as a novel treatment to reduce LDL-C in patients with very high cholesterol, at high cardiovascular risk and who cannot reduce their LDL-C sufficiently with currently available lipid-lowering therapies.

 

Our clinical experience with mipomersen demonstrates that antisense drugs work in man.  With mipomersen we have additional evidence, as we have shown with other antisense drugs, that we can predict the activity of our drugs in man from the preclinical successes we observe in animals. We believe mipomersen’s success has validated our technology platform and increased the value of our drugs.

 

In addition to mipomersen, many of the other drugs in our pipeline are demonstrating encouraging therapeutic activity in a variety of diseases.  Over the past couple of years, we and our partners have reported positive data from five Phase 2 studies and seven Phase 1 studies.  For example, we reported data from a positive Phase 2 study from our protein tyrosine phosphatase 1B, or PTP-1B, drug showing consistent and statistically significant reductions in short and intermediate measures of glucose control, reductions in LDL-C and a tendency toward weight loss.  We believe these characteristics create an encouraging profile for a new therapy to treat type 2 diabetics.  Many of our partnered drugs are also showing encouraging activity in numerous diseases.  Our partner Excaliard reported data from three Phase 2 studies showing that treatment with EXC 001, a locally administered antisense drug, significantly reduced scarring in patients.  These data highlight the broad therapeutic activity of antisense drugs and the power of our antisense technology platform to generate drugs that address significant medical needs.

 

The clinical successes of the drugs in our pipeline continue to result in new partnering opportunities.  Since 2007, our partnerships have generated an aggregate of more than $840 million in payments from licensing fees, equity purchase payments, milestone payments and research and development funding.  In addition, for our currently partnered programs we have the potential to earn approximately $3.5 billion in future milestone payments. We also will share in the future commercial success of our inventions and drugs resulting from these partnerships through earn out, profit sharing, and/or royalty arrangements. Our strong financial position is a result of the persistent execution of our business strategy as well as our inventive and focused research and development capabilities.

 

Recent Events

 

Drug Development and Corporate Highlights

 

·                   Genzyme submitted a marketing application for mipomersen in Europe for patients with homozygous FH and severe heterozygous FH.

·       Genzyme announced the brand name, Kynamro ™ , that mipomersen will be marketed under if the necessary approvals are granted.

·                   Data from two Phase 3 studies of mipomersen was presented at the 79th European Atherosclerosis Society Congress.  The data highlight the potential of mipomersen in lowering Lp(a) and reducing the necessity for lipid-apheresis.

·                   We initiated Phase 1 studies on ISIS-PTP1B Rx  and ISIS-TTR Rx , the first drug selected as part of its collaboration with GSK. Upon Phase 1 initiation,we earned a $5 million milestone payment from GSK.

·                   We and GSK expanded our collaboration by initiating a sixth program to discover and develop drugs to treat rare and infectious diseases and we received a $3 million payment from GSK.

·                   Our collaboration with GSK was awarded the Breakthrough Alliance Award of 2011 as the breakthrough deal of 2010.

 

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Critical Accounting Policies

 

We prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. 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 discusses the development, selection and disclosure of such estimates with our audit committee of our board of directors. In the following paragraphs, we describe the specific risks associated with these critical accounting policies.  For all of these policies, we caution that future events rarely develop exactly as one may expect, and that best estimates routinely require adjustment.

 

Historically, adjustments to our estimates have had a material impact to our actual results on only one occasion. When Alnylam terminated the ssRNAi research program in November 2010, we recognized as revenue $4.9 million, which was the remaining deferred revenue from the upfront fee that we were amortizing into revenue over the research term.  The significant accounting policies, which we believe are the most critical to aid in fully understanding and evaluating our reported financial results, require the following:

 

·                   Assessing the propriety of revenue recognition and associated deferred revenue;

 

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

 

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

 

·                   Determining the proper valuation of inventory;

 

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

 

·                   Estimating our net deferred income tax asset valuation allowance;

 

·                   Determining when we are the primary beneficiary for entities that we identify as variable interest entities;

 

·                   Determining the fair value of convertible debt without the conversion feature; and

 

·                   Determining the fair value of stock-based compensation, including the expected life of the option, the expected stock price volatility over the term of the expected life and estimated forfeitures.

 

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, 2010.

 

Results of Operations

 

Revenue

 

Total revenue for the three and six months ended June 30, 2011 was $24.8 million and $46.0 million, respectively, compared to $23.5 million and $53.4 million for the same periods in 2010.  Our revenue fluctuates based on the nature and timing of payments under agreements with our partners, including license fees, milestone-related payments and other payments.  For example, in the first half of 2011 we recognized as revenue a $5 million milestone payment we earned from GSK for the initiation of a Phase 1 study for ISIS-TTR Rx .  However, revenue in the first half of 2011 included less revenue from Bristol-Myers Squibb and Alnylam compared to the first half of 2010, primarily because amortization of upfront fees from these collaborations ended in 2010, although we continue to receive research support from Bristol-Myers Squibb.  In the second quarter of 2010, we earned $1.9 million from Regulus related to its strategic alliance with Sanofi, which also contributed to lower revenue in the first half of 2011.

 

Collaborations with our partners include ongoing research and development activities.  Therefore, we will continue to recognize significant amounts of revenue from these collaborations in the future from the amortization of the upfront fees we received.

 

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Research and Development Revenue Under Collaborative Agreements

 

Research and development revenue under collaborative agreements for the three and six months ended June 30, 2011 was $24.3 million and $44.3 million, respectively, compared to $21.1 million and $49.7 million for the same periods in 2010.  The lower revenue in the first half of 2011 compared to 2010 was primarily due to a $5 million milestone payment we earned from GSK in the first half of 2011 for the initiation of a Phase 1 study for ISIS-TTR Rx  offset by less revenue from Bristol-Myers Squibb and Alnylam, primarily because amortization of upfront fees from these collaborations ended in 2010, although we continue to receive research support from Bristol-Myers Squibb.

 

Licensing and Royalty Revenue

 

Our revenue from licensing activities and royalties for the three and six months ended June 30, 2011 was $518,000 and $1.7 million, respectively, compared to $2.4 million and $3.7 million for the same periods in 2010.  Revenue for the first half of 2011 was lower because in the second quarter of 2010 we earned $1.9 million from Regulus related to its strategic alliance with Sanofi.

 

Operating Expenses

 

Operating expenses for the three and six months ended June 30, 2011 were $38.9 million and $76.1 million, respectively, compared to $42.2 million and $77.0 million for the same periods in 2010.  Our operating expenses were lower in the first half of 2011 compared to the same period in 2010 primarily due to lower non-cash compensation expense related to stock options resulting from a decrease in the average price of Isis’ stock in 2011.  Excluding non-cash stock compensation expense, our operating expenses in the first half of 2011 reflect higher costs associated with our maturing pipeline of drugs offset by lower costs associated with the completion of the mipomersen Phase 3 program that supports the initial regulatory filings.  Although our operating expenses were essentially flat compared to 2010, we expect the costs of development will increase as drugs move forward to more advanced stages of development, including into larger, longer clinical studies.

 

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 stock options 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 and Development Expenses

 

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

 

The following table sets forth information on research and development costs (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Research and development expenses		$	33,724		$	36,513		$	65,677		$	65,675
Non-cash compensation expense related to stock options		2,285			2,611			4,577			5,436
Total research and development		$	36,009		$	39,124		$	70,254		$	71,111

 

For the three and six months ended June 30, 2011, we incurred total research and development expenses of $33.7 million and $65.7 million, respectively, compared to $36.5 million and $65.7 million for the same periods in 2010.  Although our year-to-date research and development expenses were flat compared to 2010, we expect higher expenses in the full year 2011 compared to 2010 primarily due to an increase in costs associated with our maturing pipeline of drugs.  As drugs move forward to more advanced stages of development, including into larger, longer clinical studies, the costs of development will likely increase.  All amounts discussed exclude non-cash compensation expense related to stock options.

 

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Antisense Drug Discovery

 

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 antisense drug discovery partners. Antisense drug discovery is also the function within Isis that is responsible for advancing antisense core technology.

 

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

 

Our antisense drug discovery expenses were as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Antisense drug discovery		$	8,019		$	8,293		$	15,200		$	16,039
Non-cash compensation expense related to stock options		671			778			1,313			1,581
Total antisense drug discovery		$	8,690		$	9,071		$	16,513		$	17,620

 

Antisense drug discovery costs for the three and six months ended June 30, 2011 were $8.0 million and $15.2 million, respectively, compared to $8.3 million and $16.0 million for the same periods in 2010, all amounts exclude non-cash compensation expense related to stock options.  Expenses in the first half of 2011 were lower compared to 2010 primarily due to a decrease in costs related to ongoing research activities.  We expect our 2011 antisense drug discovery costs to be comparable to 2010.

 

Antisense Drug Development

 

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

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Mipomersen		$	2,433		$	9,356		$	5,976		$	15,859
Other antisense development projects		10,742			7,298			19,297			11,163
Development overhead costs		1,498			1,344			3,109			2,759
Non-cash compensation expense related to stock options		747			776			1,520			1,681
Total antisense drug development		$	15,420		$	18,774		$	29,902		$	31,462

 

Antisense drug development expenditures for the three and six months ended June 30, 2011 were $14.7 million and $28.4 million, respectively, compared to $18.0 million and $29.8 million for the same periods in 2010, all amounts exclude non-cash compensation expense related to stock options.  The lower expenses in the first half of 2011 were primarily due to lower costs associated with the completion of the mipomersen Phase 3 program that supports the initial regulatory filings offset by higher costs associated with our maturing pipeline of drugs.  As drugs move forward to more advanced stages of development, including into larger, longer clinical studies, the costs of development increase.

 

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 where we continually 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

 

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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 products in preclinical and early stage clinical research, the fluctuations in expenses from product to product, 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 cost. Our partners are developing, with our support, 11 of our 24 drug candidates, which substantially reduces our development costs. As part of our collaboration with Genzyme, we are over time transitioning the development responsibility to Genzyme and Genzyme will be responsible for the commercialization of mipomersen.  We are contributing up to the first $125 million in funding for the development costs of mipomersen.  We anticipate that we will reach $125 million in spending in the second half of 2011, thereafter we and Genzyme will share development costs equally.  Our initial development funding commitment and the shared funding will end when the program is profitable.

 

Manufacturing and Operations

 

Expenditures in our manufacturing and operations function consist primarily of personnel costs, specialized chemicals for oligonucleotide manufacturing, laboratory supplies and outside services. This function is responsible for providing drug supplies to antisense drug discovery and antisense drug development, including the analytical testing to satisfy good laboratory and good manufacturing practices requirements.

 

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

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Manufacturing and operations		$	4,734		$	4,636		$	9,285		$	8,770
Non-cash compensation expense related to stock options		304			400			611			803
Total manufacturing and operations		$	5,038		$	5,036		$	9,896		$	9,573

 

Manufacturing and operations expenses for the three and six months ended June 30, 2011 were $4.7 million and $9.3 million, respectively, compared to $4.6 million and $8.8 million for the same periods in 2010, all amounts exclude non-cash compensation expense related to stock options.  Manufacturing and operations expense was essentially flat in the first half of 2011 compared to 2010.

 

R&D Support

 

In our research and development expenses, we include support costs such as rent, repair and maintenance for buildings and equipment, utilities, depreciation of laboratory equipment and facilities, amortization of our intellectual property, information technology costs, procurement costs and waste disposal costs. We call these costs R&D support costs.

 

The following table sets forth information on R&D support costs (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2011			2010			2011			2010
Personnel costs		$	2,118		$	1,962		$	4,182		3,946
Occupancy		1,862			1,464			3,648			3,008
Depreciation and amortization		1,478			1,506			3,294			2,745
Insurance		214			254			427			481
Other		626			400			1,258			905
Non-cash compensation expense related to stock options		563			657			1,133			1,370
Total R&D support costs		$	6,861		$	6,243		$	13,942		$	12,455

 

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