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ISIS > SEC Filings for ISIS > Form 10-K on 29-Feb-2012All Recent SEC Filings

Show all filings for ISIS PHARMACEUTICALS INC

Form 10-K for ISIS PHARMACEUTICALS INC


29-Feb-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are the leading company in antisense drug discovery and development, exploiting a novel drug discovery platform we created to generate a broad pipeline of first-in-class drugs. Antisense technology provides a direct route from genomics to drugs. With our highly efficient and prolific drug discovery platform we can expand our pipeline and our partners' pipelines with antisense drugs that address significant medical needs. Our strategy is to do what we do best-to discover unique antisense drugs and develop these drugs to key clinical value inflection points. We discover and conduct early development of new drugs and, at the key clinical value inflection points, outlicense our drugs to partners. We maximize the value of the drugs we discover by putting them in the hands of leading pharmaceutical companies with late-stage development, commercialization and marketing expertise, such as Biogen Idec, Bristol-Myers Squibb, Genzyme, a Sanofi company, GlaxoSmithKline, or GSK, and Eli Lilly and Company. For instance, our partner, Genzyme, plans to commercialize our lead product, KYNAMRO™, following planned regulatory approval in 2012. We also work with a consortium of smaller companies that can exploit our drugs and technologies in areas that are outside of our core focus. As a result of our unique strategy, we can keep our organization small and focused. Our strong financial position is a result of the successful execution of our business strategy as well as our inventive and focused research and development capabilities.

Our flagship product, KYNAMRO (formerly mipomersen), is moving closer to the market for patients with severe forms of FH, at high cardiovascular risk, who cannot reduce their low-density lipoprotein cholesterol, or LDL-C, sufficiently with currently available lipid-lowering therapies. In July 2011, Genzyme submitted a marketing application in Europe for KYNAMRO for patients with homozygous familial hypercholesterolemia, or hoFH, and severe heterozygous familial hypercholesterolemia, or severe heFH, and plans to submit the U.S. application for marketing approval for patients with hoFH in the first quarter of 2012. Genzyme plans to request priority review, if granted, in the United States and based on estimated approval times, Genzyme is preparing to launch KYNAMRO in the United States and Europe in 2012. Genzyme is also preparing to commercialize KYNAMRO in other major markets.

To maximize the value of our drugs and technologies, we have a multifaceted partnering strategy. We form traditional partnering alliances that enable us to discover and conduct early development of new drugs, outlicense our drugs to partners, such as Genzyme and Eli Lilly and Company, and build a broad base of license fees, milestone payments and royalty income. We also form preferred partner transactions that provide us with a vested partner, such as Biogen Idec and GSK, early in the development of a drug. In this way, we benefit in the short term from upfront option fees and development milestone payments while we maintain control over the early development of the drug. We benefit in the long term by having a knowledgeable and committed partner to license the drug at clinical proof-of-concept and by receiving regulatory milestone payments and royalties as our partner moves the drug to the market. In all of our partnerships, we benefit from the expertise our partners bring to our drugs. We also work with a consortium of smaller companies that can exploit our drugs and technologies. We call these smaller companies our satellite companies. In this way, we benefit from the disease-specific expertise of our satellite company partners, who are advancing drugs in our pipeline in areas that are outside of our core focus. In addition, we can maintain our broad RNA technology leadership through collaborations with companies such as Alnylam Pharmaceuticals, Inc., or Alnylam, and Regulus Therapeutics Inc., or Regulus, a company we jointly own focused on microRNA therapeutics. All of these different types of relationships are part of our unique business model and create near and long-term shareholder value.

The clinical successes of the drugs in our pipeline continue to create new partnering opportunities. For example, in January 2012, we formed a new strategic alliance with Biogen Idec to develop and commercialize ISIS-SMNRx to treat spinal muscular atrophy. We received a $29 million upfront payment and are eligible to receive up to $270 million in payments and double-digit royalties on sales from ISIS-SMNRx. Since 2007, our partnerships have generated an aggregate of more than $880 million in payments from upfront and licensing fees, equity purchase payments, milestone payments and research and development funding. In addition, for our current partnered programs we have the potential to earn more than $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, or royalty arrangements. Our strong financial position is a result of the successful execution of our business strategy as well as our inventive and focused research and development capabilities.

We protect our proprietary technologies and products through our substantial patent estate. As an innovator in RNA-targeting 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, we continue to add to our substantial patent estate. 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.


Business Segments

Prior to 2011, we reported our results in two separate segments: Drug Discovery and Development and Regulus. Beginning in 2011, we no longer consider Regulus as an operating segment because our chief decision making officer no longer reviews Regulus' operating results for purposes of making resource allocations. Therefore we now only operate in, and will provide financial information and results for, our Drug Discovery and Development operations.

In our Drug Discovery and Development operations we are exploiting a novel drug discovery platform we created to generate a broad pipeline of first-in-class drugs for us and our partners. With our proprietary drug discovery platform we can rapidly identify drugs, providing a wealth of potential targets to treat a broad range of diseases. We focus our efforts in therapeutic areas where our drugs will work best, efficiently screening many targets in parallel and carefully selecting the best drugs. When we combine this efficiency with our rational approach to selecting disease targets we can build a large and diverse portfolio of drugs to treat a variety of health conditions, including cardiovascular, metabolic, inflammatory, ocular, severe and rare diseases, and cancer. We currently have 26 drugs in development. Our partners are developing, with our support, 10 of these 26 drugs, which substantially reduces our development costs.

Critical Accounting Policies

We prepare our 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, our estimates have been accurate as we have not experienced any material differences between our estimates and our actual results. 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.

Descriptions of these critical accounting policies follow.

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 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 estimated 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 year ended December 31, 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 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 because our research and development efforts are directly tied to the upfront payment, we recognize revenue related to upfront payments ratably over our estimated 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. The revenue we recognize could be materially different if different estimates prevail. We have made estimates of our continuing obligations on several agreements, including our collaborations with ATL, Bristol-Myers Squibb, Genzyme, GSK, Eli Lilly and Company, OncoGenex and Pfizer Inc. 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 terminated the companies' 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.

As part of our Genzyme 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.

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

Prior to the first stage in the life-cycle of our drugs, we perform a significant amount of work using our proprietary antisense technology to design chemical compounds that interact with specific genes that are good targets for drug discovery. From these research efforts, we hope to identify a development candidate. The designation of a development candidate is the first stage in the life-cycle of our drugs. A development candidate is a chemical compound that has demonstrated the necessary safety and efficacy in preclinical animal studies to warrant further study in humans. During the first step of the development stage, we or our partners study our drugs in IND-enabling studies, which are animal studies intended to support an Investigational New Drug, or IND, application and/or the foreign equivalent. An approved IND allows us or our partners to study our development candidate in humans. If the regulatory agency approves the IND, we or our partners initiate Phase 1 clinical trials in which we typically enroll a small number of healthy volunteers to ensure the development candidate is safe for use in patients. If we or our partners determine that a development candidate is safe based on the Phase 1 data, we or our partners initiate Phase 2 studies that are generally larger scale studies in patients with the primary intent of determining the efficacy of the development candidate. The final step in the development stage is Phase 3 studies to gather the necessary safety and efficacy data to request marketing approval from the FDA and/or foreign equivalents. The Phase 3 studies typically involve large numbers of patients and can take up to several years to complete. If the data gathered during the trials demonstrates acceptable safety and efficacy results, we or our partner will submit an application to the FDA and/or its foreign equivalents for marketing approval. This stage of the drug's life-cycle is the regulatory stage. If a drug achieves marketing


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

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

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

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

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

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

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

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

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

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

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

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

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

We assess whether a substantive milestone exists at the inception of our agreements. When a substantive milestone is achieved, we recognize revenue related to the milestone payment. For our existing licensing and collaboration agreements in which we are involved in the discovery and/or development of the related drug or provide the partner with ongoing access to new technologies we discover, we have determined that all future development, regulatory and commercialization milestones are substantive. For example, for our strategic alliance with GSK we are using our antisense drug discovery platform to seek out and develop new drugs against targets for rare and serious diseases. Alternatively, we provide on-going access to our technology to Alnylam to develop and commercialize RNA interference, or RNAi, therapeutics. We consider milestones for both of these collaborations to be substantive. For those agreements that do not meet the following criteria, we do not consider the future milestones to be substantive. In evaluating if a milestone is substantive we consider whether:

†

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

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

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

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

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


If any of these conditions are not met, we will defer recognition of the milestone payment and recognize it as revenue over the estimated period of performance, if any. In 2011, OncoGenex Pharmaceuticals Inc. initiated a Phase 2 trial of OGX-427 in men with metastatic prostate cancer. Also in 2011, we initiated a Phase 1 clinical study on ISIS-TTRRX, the first drug selected as part of our collaboration with GSK and we selected ISIS-AATRX as the second development candidate as part of our collaboration. We consider milestones related to progression of a drug through the development stage of its life cycle to be substantive milestones because the level of effort and inherent risk associated with these events is high. Therefore, we recognized the entire $750,000 milestone payment from OncoGenex and two $5 million milestone payments from GSK in 2011. Further information about our collaborative arrangements can be found in Note 8, Collaborative Arrangements and Licensing Agreements, in the Notes to the Consolidated Financial Statements.

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.

Valuation of 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 use a three-tier fair value hierarchy to prioritize the inputs used in our fair value measurements. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets, which includes our money market funds and treasury securities classified as available-for-sale securities and 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. The majority of our securities have been classified as Level 2. 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. We validate the fair value of securities from our pricing provider by understanding the pricing models they used and comparing their assessment of the fair value of our Level 2 investments to the fair value from the custodians of our Level 2 investments. Our pricing provider and custodians use similar techniques to derive fair value for Level 2 securities. We may also validate the fair value by obtaining market values from other pricing sources.

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.

During 2011, we recognized a $4.2 million net gain on investments primarily consisting of a $4.4 million gain we recorded in the fourth quarter of 2011 from our ownership interest in Excaliard when they were acquired by Pfizer Inc. During 2010, we recognized a $713,000 loss on investments primarily consisting of an $880,000 non-cash loss primarily related to the other-than-temporary impairment of our equity investment in ATL. See further discussion about our investments in these satellite companies in Note 8, Collaborative Arrangements and Licensing Agreements, in the Notes to the Consolidated Financial Statements.


Valuation of 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. During this process, we review our property and equipment listings, pending domestic and international patent applications, domestic and international issued patents, . . .

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