Unless stated otherwise, references in this Quarterly Report on Form 10-Q to "we," "us," or "our" refer to ARIAD Pharmaceuticals, Inc., a Delaware corporation, and our subsidiaries unless the context requires otherwise.

Overview

Our vision is to transform the lives of cancer patients with breakthrough medicines. Our mission is to discover, develop and commercialize small-molecule drugs to treat cancer in patients with the greatest and most urgent unmet medical need - aggressive cancers where current therapies are inadequate. Our goal is to build a fully integrated oncology company focused on novel, molecularly targeted therapies to treat solid tumors and hematologic cancers, as well as the spread of primary tumors to distant sites.

Our lead cancer product candidate, ridaforolimus, previously known as deforolimus, is being studied in multiple clinical trials in patients with various types of cancers. In July 2007, we entered into a global collaboration with Merck & Co., Inc., or Merck, to jointly develop and commercialize ridaforolimus for use in cancer. We initiated patient enrollment in our initial Phase 3 clinical trial of ridaforolimus in patients with metastatic sarcoma in the third quarter of 2007. In addition, in 2008 we and Merck initiated patient enrollment in Phase 2 clinical trials in patients with metastatic breast cancer, advanced endometrial cancer and advanced prostate cancer, and Phase 1 clinical trials of ridaforolimus in combination with other agents.

Our collaboration with Merck for the global development and commercialization of ridaforolimus anticipates that we together with Merck will conduct a broad-based development program in multiple potential indications. The collaboration agreement provides that each party will fund 50 percent of global development costs, except for certain specific costs to be funded 100 percent by Merck. The collaboration agreement establishes responsibilities for supply of the product for development and commercial purposes, promotion, distribution and sales of the product, governance of the collaboration, termination provisions and other matters.

In addition to cost-sharing provisions, the collaboration agreement provides for an up-front payment by Merck of $75 million, which was paid to us in July 2007, up to $452 million in milestone payments based on the successful development of ridaforolimus in multiple potential cancer indications, of which $43.5 million has been paid to us through March 31, 2009, and up to $200 million in milestone payments based on achievement of specified product sales thresholds. The upfront payment and milestone payments, when earned by us and paid by Merck, are non-refundable. Merck has also agreed to provide us with up to $200 million in interest-bearing, repayable, development cost advances to cover a portion of our share of global development costs, after we have paid $150 million in global development costs and have obtained regulatory approval to market ridaforolimus from the FDA in the United States or similar regulatory authorities in Europe or Japan. The collaboration agreement provides that each party will receive 50 percent of the profit from the sales of ridaforolimus in the United States, and Merck will pay us tiered double-digit royalties on sales of ridaforolimus outside the United States.

Our second product candidate, AP24534, has entered clinical development. We filed an Investigational New Drug application, or IND, for this product candidate with the FDA in the fourth quarter of 2007 and initiated a Phase 1 clinical trial in patients with hematologic cancers in the second quarter of 2008.

In addition to our lead development programs, we have a focused drug discovery program centered on small-molecule, molecularly targeted therapies and cell-signaling pathways implicated in cancer. We also have an exclusive license to a family of patents, three in the United States and one in Europe, including a pioneering U.S. patent covering methods of treating human disease by regulating NF-?B cell-signaling activity. Additionally, we have developed a proprietary portfolio of cell-signaling regulation technologies, our ARGENT technology, to control intracellular processes with small molecules, which may be useful in the development of therapeutic vaccines and gene and cell therapy products and which provide versatile tools for applications in cell biology, functional genomics and drug discovery research.

Since our inception in 1991, we have devoted substantially all of our resources to our research and development programs. We receive no revenue from the sale of pharmaceutical products, and most of our revenue to date was received in connection with a joint venture we had with a major pharmaceutical company from 1997 to 1999. Except for the gain on the sale of our 50 percent interest in that joint venture in December 1999, which resulted in net income for the year ended December 31, 1999, we have not been profitable since inception. As a result of our collaboration with Merck for the development and commercialization of ridaforolimus, we expect that our license and collaboration revenue will increase in future periods. However, we expect to incur substantial and increasing operating losses for the foreseeable future, primarily due to costs associated with our pharmaceutical product development programs, including costs for clinical trials and product manufacturing, pre-commercial activities, personnel and our intellectual property. We expect such costs and operating losses will be offset in part by development cost-sharing provisions and license revenue from our collaboration with Merck for the development and commercialization of ridaforolimus. We expect that losses will fluctuate from quarter to quarter and that these fluctuations may be substantial.

As of March 31, 2009, we had cash, cash equivalents and marketable securities of $50.1 million, working capital of $27.5 million, deferred revenue of $107.9 million related to non-refundable up-front and milestone payments from Merck and total stockholders' deficit of $68.6 million.

General

Our operating losses are primarily due to the costs associated with our pharmaceutical product development programs, personnel and intellectual property protection and enforcement. As our product development programs progress, we incur significant costs for toxicology and pharmacology studies, product development, manufacturing, clinical trials and regulatory support. We also incur costs related to planning for potential regulatory approval and commercial launch of products, including market research and assessment. These costs can vary significantly from quarter to quarter depending on the number of product candidates in development, the stage of development of each product candidate, the number of patients enrolled in and complexity of clinical trials and other factors. Costs associated with our intellectual property include legal fees and other costs to prosecute, maintain, protect and enforce our intellectual property, which can fluctuate from quarter to quarter depending on the status of patent issues being pursued, including our on-going patent litigation.

Historically, we have relied primarily on the capital markets as our source of funding. We may also obtain funding from collaborations with pharmaceutical, biotechnology and/or medical device companies for development and commercialization of our product candidates, such as our collaboration with Merck for the global development and commercialization of ridaforolimus. These collaborations can take the form of licensing arrangements, co-development or joint venture arrangements or other structures. In addition, we utilize long-term debt to supplement our funding, particularly as a means of funding investment in property and equipment and infrastructure needs. If funding from these various sources is unavailable on reasonable terms, we may be required to reduce our operating expenses in order to conserve cash and capital by delaying, scaling back or eliminating one or more of our product development programs.

Critical Accounting Policies and Estimates

Our financial position and results of operations are affected by subjective and complex judgments, particularly in the areas of revenue recognition, the carrying value of intangible assets, stock-based compensation and the fair value of warrants to purchase our common stock.

For the three-month period ended March 31, 2009, we reported license and collaboration revenue of $1.9 million. License and collaboration revenue is recorded based on up-front payments, periodic license payments and milestone payments received or deemed probable of receipt, spread over the estimated performance period of the license or collaboration agreement. Regarding our collaboration with Merck for the development and commercialization of ridaforolimus, as of March 31, 2009, we have received an up-front payment of $75 million and milestone payments of $43.5 million related to the start of Phase 2 and Phase 3 clinical trials of ridaforolimus. We are recognizing revenues related to such payments on a straight-line basis through 2023, the estimated patent life of the underlying technology. Changes in development plans could impact the probability of receipt of future milestone payments on which revenue recognition is based. In addition, changes in estimated performance periods, including changes in patent lives of underlying technology, could impact the rate of revenue recognition in any period. Such changes in revenue could have a material impact on our statement of operations.

At March 31, 2009, we reported $10.0 million of intangible assets, consisting of the recorded value of the technology associated with our acquisition in September 2008 of the 20-percent minority interest of ARIAD Gene Therapeutics, Inc. that we did not previously own, as well as capitalized costs related primarily to purchased and issued patents, patent applications and licenses, net of accumulated amortization. These costs are being amortized over the estimated useful lives of the underlying technology, patents or licenses. Changes in these lives or a decision to discontinue using the technologies could result in material changes to our balance sheet and statements of operations. We have concluded that the carrying value of our intangible assets is not currently impaired because such carrying value does not exceed the future net cash flows expected to be generated by such intangible assets. If we were to abandon the ongoing development of the underlying product candidates or technologies or terminate our efforts to pursue collaborations or license agreements, we may be required to write off a portion of the carrying value of our intangible assets. The net book value as of March 31, 2009 of intangible assets related to our NF-?B technology is $385,000. If the patentability of our NF-?B patents, one of which is currently the subject of litigation and reexamination proceedings, is successfully challenged and such patents are subsequently narrowed, invalidated or circumvented, we may be required to write off some or all of the net book value related to such technology.

In determining expense related to stock-based compensation, we utilize the Black-Scholes option valuation model to estimate the fair value of stock options granted to employees, consultants and directors. Application of the Black-Scholes option valuation model requires the use of factors such as the market value and volatility of our common stock, a risk-free discount rate and an estimate of the life of the option contract. Fluctuations in these factors can result in adjustments to our statements of operations. If, for example, the market value of our common stock, its volatility, or the expected life of stock options granted during the three-month period ended March 31, 2009 were 10% higher or lower than used in the valuation of such stock options, our valuation of, and total stock-based compensation expense to be recognized for, such awards would have increased or decreased by up to $121,000, $82,000, or $44,000 respectively.

Warrants to purchase 10,784,024 shares of our common stock, issued on February 25, 2009 in connection with a registered direct offering of 14,378,698 shares of our common stock, are classified as a derivative liability pursuant to SFAS No.
133. Accordingly, the fair value of the warrants is recorded on our consolidated balance sheet as a liability, and such fair value is adjusted at each financial reporting date with the adjustment to fair value reflected in our consolidated statement of operations. The fair value of the warrants is determined using the Black-Scholes option valuation model. Fluctuations in the assumptions and factors used in the Black-Scholes model can result in adjustments to the fair value of the warrants reflected on our balance sheet and, therefore, our statement of operations. If, for example, the market value of our common stock or its volatility at March 31, 2009 were 10% higher or lower than used in the valuation of such warrants, our valuation of the warrants would have increased or decreased by up to $755,000 or $647,000, respectively, with such difference reflected in our statement of operations.

Results of Operations

For the three months ended March 31, 2009 and 2008

Revenue

We recognized license and collaboration revenue of $1.9 million in the three-month period ended March 31, 2009, compared to $1.5 million in the corresponding period in 2008. The increase in license and collaboration revenue was due primarily to the increase in revenue recognized from the Merck collaboration of $400,000, based on the non-refundable up-front and milestone payments totaling $118.5 million received from Merck to date, in accordance with our revenue recognition policy. We expect that our license and collaboration revenue will increase during the remainder of 2009 based on the expected receipt of additional milestone payments in accordance with the Merck collaboration agreement.

Operating Expenses

Research and Development Expenses

Research and development expenses increased by $6.9 million, or 63%, to $17.7 million in the three-month period ended March 31, 2009, compared to $10.9 million in the corresponding period in 2008, as described in further detail below.

The research and development process necessary to develop a pharmaceutical product for commercialization is subject to extensive regulation by numerous governmental authorities in the United States and other countries. This process typically takes years to complete and requires the expenditure of substantial resources. Current requirements include:

† preclinical toxicology, pharmacology and metabolism studies, as well as in vivo efficacy studies in relevant animal models of disease;

† manufacturing of drug product for preclinical studies and clinical trials and ultimately for commercial supply;

† submission of the results of preclinical studies and information regarding manufacturing and control and proposed clinical protocol to the U.S. Food and Drug Administration, or FDA, in an Investigational New Drug application, or IND (or similar filings with regulatory agencies outside the United States);

† conduct of clinical trials designed to provide data and information regarding the safety and efficacy of the product candidate in humans; and

† submission of all the results of testing to the FDA in a New Drug Application, or NDA (or similar filings with regulatory agencies outside the United States).

Upon approval by the appropriate regulatory authorities, including in some countries approval of product pricing, we may commence commercial marketing and distribution of the product.

We group our research and development, or R&D, expenses into two major categories: direct external expenses and all other R&D expenses. Direct external expenses consist of costs of outside parties to conduct laboratory studies, to develop manufacturing processes and manufacture product candidates, to conduct and manage clinical trials and similar costs related to our clinical and preclinical studies. These costs are accumulated and tracked by product candidate. All other R&D expenses consist of costs to compensate personnel, to purchase lab supplies and services, to lease, operate and maintain our facility, equipment and overhead and similar costs of our research and development efforts. These costs apply to work on our clinical and preclinical candidates as well as our discovery research efforts. These costs have not been tracked by product candidate because the number of product candidates and projects in R&D may vary from time to time and because we utilize internal resources across multiple projects at the same time.

Our R&D expenses for the three-month period ended March 31, 2009, as compared to the corresponding period in 2008, were as follows:

                                    Three months ended March 31,          Increase/
     In thousands                     2009                 2008          (decrease)
     Direct external expenses:
     Clinical programs           $       10,887       $        4,614     $     6,273
     Preclinical programs                     0                    0               0
     All other R&D expenses               6,862                6,261             601
                                 $       17,749       $       10,875     $     6,874

Our clinical programs consist of ridaforolimus, our lead product candidate, and AP24534, our kinase inhibitor program for which we filed an IND in late 2007. The direct external expenses for ridaforolimus reflect our share of such expenses pursuant to the cost-sharing arrangements of our collaboration with Merck. Direct external expenses for ridaforolimus were $8.9 million in the three-month period ended March 31, 2009, an increase of $5.0 million, as compared to the corresponding period in 2008. This increase is due to an increase in clinical costs of $5.2 million, contract manufacturing costs of $678,000, and supporting non-clinical costs of $475,000, offset in part by an increase in Merck's share of expenses of $3.0 million in the three-month period ended March 31, 2009, as compared to the corresponding period in 2008. In addition, costs for Merck's services provided to the collaboration increased by $1.7 million in the three-month period ended March 31, 2009, as compared to the corresponding period in 2008 as a result of an increase in Merck's activities under the global development plan. Clinical trial costs and contract manufacturing costs increased due primarily to increasing enrollment in our Phase 3 clinical trial of ridaforolimus in patients with metastatic sarcomas and the initiation of enrollment in Phase 2 clinical trials of ridaforolimus in patients with breast cancer, endometrial cancer, prostate cancer and non-small cell lung cancer. Costs of non-clinical studies increased due to the initiation and conduct of toxicology studies of ridaforolimus required to support regulatory filings with the FDA. Subject to reductions in spending we may implement in 2009 as discussed in Note 1 to the condensed consolidated financial statements and under the caption "Liquidity" in this Management's Discussion and Analysis of Financial Condition and Results of Operations, we expect that our direct external costs for ridaforolimus, net of Merck's share of such costs, will increase during the remainder of 2009 as we continue enrollment in our Phase 2 and Phase 3 clinical trials for this product candidate and expand other clinical and non-clinical development activities with Merck.

Direct external expenses for our second clinical program, AP24534, were $2.0 million for the three-month period ended March 31, 2009, an increase of $1.3 million as compared to the corresponding period in 2008. The increase is due to an increase in clinical costs of $179,000 and toxicology costs of $1.1 million. Clinical costs increased due to increasing enrollment in our Phase 1 clinical trial in patients with hematologic malignancies. Toxicology costs increased due to the conduct of long-term toxicology studies necessary to support development of this product candidate. We expect that our direct external costs for AP24534 will increase during the remainder of 2009, subject to reductions in spending we may implement in 2009 as discussed in Note 1 and under the caption "Liquidity", as we enroll patients in our Phase 1 trial and continue related manufacturing and non-clinical studies for this product candidate.

We incurred no direct external expenses for preclinical programs in the three-month periods ended March 31, 2009 and 2008 as, during those periods, no R&D programs were designated as preclinical programs. All programs other than clinical programs are designated as discovery research and are included in "all other R&D expenses" in the above table. We expect to nominate our next clinical candidate, an anaplastic lymphoma kinase, or ALK, inhibitor, and move it into preclinical testing in 2009. The direct external expenses to be incurred from the point in time we nominate this clinical candidate will be reflected in this analysis as a preclinical program.

All other R&D expenses increased by $601,000 in the three-month period ended March 31, 2009 as compared to the corresponding period in 2008. This increase is due to an increase in 2009 in personnel expenses of $643,000 related to the hiring of additional R&D personnel, and an increase in overhead and general expenses of $628,000, offset in part by an increase in Merck's allocated share of such expenses under the terms of the collaboration agreement of $666,000. We expect that all other R&D expenses will increase during the remainder of 2009, subject to reductions in spending we may implement in 2009 as discussed in Note 1 and under the caption "Liquidity", to support our R&D programs.

The successful development of our product candidates is uncertain and subject to a number of risks. We cannot be certain that any of our product candidates will prove to be safe and effective or will meet all of the applicable regulatory requirements needed to receive and maintain marketing approval. Data from preclinical studies and clinical trials are susceptible to varying interpretations that could delay, limit or prevent regulatory clearance. We, the FDA or other regulatory authorities may suspend clinical trials at any time if we or they believe that the subjects participating in such trials are being exposed to unacceptable risks or if such regulatory agencies find deficiencies in the conduct of the trials or other problems with our products under development. Delays or rejections may be encountered based on additional governmental regulation, legislation, administrative action or changes in FDA or other regulatory policy during development or the review process. Other risks associated with our product development programs are described under the heading "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 as updated from time to time in our subsequent periodic reports and current reports filed with the SEC. Due to these uncertainties, accurate and meaningful estimates of the ultimate cost to bring a product to market, the timing of completion of any of our drug development programs and the period in which material net cash inflows from any of our drug development programs will commence are unavailable.

General and Administrative Expenses

General and administrative expenses decreased by $4.0 million, or 49%, to $4.1 million in the three-month period ended March 31, 2009, compared to $8.1 million in the corresponding period in 2008. Professional fees decreased by $4.0 million to $2.1 million in the three-month period ended March 31, 2009, compared to $6.1 million in the corresponding period in 2008, due primarily to reduction in activities and costs related to corporate and commercial development initiatives, and to our patent infringement litigation against Eli Lilly and Company, or Lilly, and Amgen Inc., or Amgen. We expect that our general and administrative expenses will increase slightly over the remainder of the year, subject to reductions in spending we may implement in 2009 as discussed in Note 1 and under the caption "Liquidity", reflecting an increase in commercial planning activities and required support of our research and development programs.

We expect that our operating expenses in total, net of Merck's share of development costs of ridaforolimus, will increase during the remainder of 2009 for the reasons described above and subject to reductions in spending we may implement in 2009 as noted above. Operating expenses may fluctuate from quarter to quarter. The actual amount of any change in operating expenses will depend on, among other things, the progress of our product development programs, including the planned increase in clinical trials and other studies related to ridaforolimus pursuant to our collaboration with Merck and the conduct of our clinical trial and the required manufacturing for AP24534.

Other Income (Expense)

Interest Income/Expense

Interest income decreased to $37,000 in the three-month period ended March 31, 2009 from $596,000 in the corresponding period in 2008, as a result of a lower average balance of funds invested in 2009 and lower interest yields from our investments.

Interest expense remained relatively unchanged at $81,000 in the three-month period ended March 31, 2009 and $79,000 in the corresponding period in 2008.

Revaluation of Warrant Liability

The fair value at March 31, 2009 of our warrant liability was $215,000 higher than its fair value at inception, resulting in a loss of $215,000 for the three-month period ended March 31, 2009. Potential future increases or decreases in our stock price, or other changes in the factors that impact the valuation of the warrant liability, will result in losses or gains, respectively, being recognized in our consolidated statement of operations in future periods. Such gains or losses will not have any impact on our cash balances, liquidity or cash flows from operations.

Operating Results

We reported a loss from operations of $20.0 million in the three-month period ended March 31, 2009 compared to a loss from operations of $17.5 million in the corresponding period in 2008, an increase of $2.4 million, or 14%. We also reported a net loss of $20.2 million in the three-month period ended March 31, 2009, compared to a net loss of $17.0 million in the corresponding period in 2008, an increase in net loss of $3.2 million or 19%, and a net loss per share of $0.26 and $0.25, respectively. We expect that our loss from operations and our net loss will increase during the remainder of 2009 due to the various factors discussed under "Revenue" and "Operating Expenses" above and subject to reductions in spending we may implement in 2009, as noted above. Actual losses will depend on the progress of our product development programs, the progress of our discovery research programs, the impact of commercial and business . . .