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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, 2014

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)

2855 Gazelle Court, Carlsbad, CA 92010

(Address of principal executive offices, including zip code)

760-931-9200

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 Par Value

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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):

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, 2014 was 117,735,360.

 

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ISIS PHARMACEUTICALS, INC.

FORM 10-Q

INDEX

 

TRADEMARKS

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

Regulus Therapeutics™ is a trademark of Regulus Therapeutics Inc.

KYNAMRO® is a registered trademark of Genzyme Corporation

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

See accompanying notes.

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(Unaudited)

 

See accompanying notes.

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(Unaudited)

 

See accompanying notes.

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See accompanying notes.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2014

(Unaudited)

1.

Basis of Presentation

The unaudited interim condensed consolidated financial statements for the three and six months ended June 30, 2014 and 2013 have been prepared on the same basis as the audited financial statements for the year ended  December 31, 2013. The financial statements include all normal recurring adjustments, which we consider necessary for a fair presentation of our financial position at such dates and our operating results and cash flows for those periods. Results for the interim periods are not necessarily indicative of the results for the entire year. For more complete financial information, these financial statements, and notes thereto, should be read in conjunction with the audited financial statements for the year ended December 31, 2013 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 subsidiary, Symphony GenIsis, Inc., which is currently inactive.

2.

Significant Accounting Policies

Revenue Recognition

We generally recognize revenue when we have satisfied all contractual obligations and are reasonably assured of collecting the resulting receivable. We are often entitled to bill our customers and receive payment from our customers in advance of recognizing the revenue. In the instances in which we have received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on our condensed consolidated balance sheet.

Research and development revenue under collaborative agreements

Our collaboration agreements typically contain multiple elements, or deliverables, including technology licenses or options to obtain technology licenses, research and development services, and in certain cases manufacturing services. Our collaborations may provide for various types of payments to us including upfront payments, funding of research and development, milestone payments, licensing fees, profit sharing and royalties on product sales. We evaluate the deliverables in our collaboration agreements to determine whether they meet the criteria to be accounted for as separate units of accounting or whether they should be combined with other deliverables and accounted for as a single unit of accounting. When the delivered items in an arrangement have "stand-alone value" to our customer, we account for the deliverables as separate units of accounting and we allocate the consideration to each unit of accounting based on the relative selling price of each deliverable. Delivered items have stand-alone value if they are sold separately by any vendor or the customer could resell the delivered items on a stand-alone basis. We use the following hierarchy of values to estimate the selling price of each deliverable: (i) vendor-specific objective evidence of fair value; (ii) third-party evidence of selling price; and (iii) best estimate of selling price, or BESP. The BESP reflects our best estimate of what the selling price would be if we regularly sold the deliverable on a stand-alone basis. We recognize the revenue allocated to each unit of accounting as we deliver the related goods or services. If we determine that we should treat certain deliverables as a single unit of accounting, then we recognize the revenue ratably over our estimated period of performance.

In December 2012, we entered into a collaboration agreement with AstraZeneca to discover and develop antisense therapeutics against five cancer targets. As part of the collaboration, we received a $25 million upfront payment in December 2012 and a $6 million payment in June 2013 when AstraZeneca elected to continue the research collaboration.  We are also eligible to receive milestone payments, license fees for the research program targets and royalties on any product sales of drugs resulting from this collaboration. In exchange, we granted AstraZeneca an exclusive license to develop and commercialize ISIS-STAT3_Rx and ISIS-AR_Rx.  We also granted AstraZeneca options to license up to three cancer drugs under the separate research program. We were responsible for completing IND-enabling studies for ISIS-AR_Rx, which we completed earlier this year. We are also responsible for completing an ongoing clinical study of ISIS-STAT3_Rx. AstraZeneca is responsible for all other global development, regulatory and commercialization activities for ISIS-STAT3_Rx and ISIS-AR_Rx. In addition, if AstraZeneca exercises its option for any drugs resulting from the research program, AstraZeneca will assume global development, regulatory and commercialization responsibilities for such drug. Since this agreement has multiple elements, we evaluated the deliverables in this arrangement when we entered into the agreement and determined that certain deliverables, either individually or in combination, have stand-alone value.  Below is a list of the four separate units of accounting under our agreement:

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The exclusive license we granted to AstraZeneca to develop and commercialize ISIS-STAT3Rx for the treatment of cancer;

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The development services we are performing for ISIS-STAT3Rx;

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The exclusive license we granted to AstraZeneca to develop and commercialize ISIS-ARRx and the research services we performed for ISIS-ARRx; and

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The option to license up to three drugs under a research program and the research services we will perform for this program.

We determined that the ISIS-STAT3_Rx license had stand-alone value because it is an exclusive license that gives AstraZeneca the right to develop ISIS-STAT3_Rx or to sublicense its rights.  In addition, ISIS-STAT3_Rx is currently in development and it is possible that AstraZeneca or another third party could conduct clinical trials without assistance from us.  As a result, we considered the ISIS-STAT3_Rx license and the development services for ISIS-STAT3_Rx to be separate units of accounting. We recognized the portion of the consideration allocated to the ISIS-STAT3_Rx license immediately because we delivered the license and earned the revenue.  We are recognizing as revenue the amount allocated to the development services for ISIS-STAT3_Rx over the period of time we perform services. The ISIS-AR_Rx license is also an exclusive license.  At the inception of the agreement, ISIS-AR_Rx was in an early stage of research. Therefore, we concluded that our knowledge and expertise with antisense technology was essential for AstraZeneca or another third party to successfully develop ISIS-AR_Rx. As a result, we determined that the ISIS-AR_Rx license did not have stand-alone value and we combined the ISIS-AR_Rx license and related research services into one unit of accounting.  We recognized revenue for the combined unit of accounting over the period of time we performed services, which ended in the first quarter of 2014. We determined that the options under the research program did not have stand-alone value because AstraZeneca cannot develop or commercialize drugs resulting from the research program until AstraZeneca exercises the respective option or options. As a result, we considered the research options and the related research services as a combined unit of accounting. We are recognizing revenue for the combined unit of accounting over the period of our performance.

We determined that the initial allocable arrangement consideration was the $25 million upfront payment because it was the only payment that was fixed and determinable when we entered into the agreement.  In June 2013, we increased the allocable consideration to $31 million when we received the $6 million payment.  There was considerable uncertainty at the date of the agreement as to whether we would earn the milestone payments, royalty payments, payments for manufacturing clinical trial materials or payments for finished drug product. As such, we did not include those payments in the allocable consideration.

We allocated the allocable consideration based on the relative BESP of each unit of accounting. We engaged a third party, independent valuation expert to assist us with determining BESP. We estimated the selling price of the licenses granted for ISIS-STAT3_Rx and ISIS-AR_Rx by using the relief from royalty method. Under this method, we estimated the amount of income, net of taxes, for each drug. We then discounted the projected income for each license to present value. The significant inputs we used to determine the projected income of the licenses included:

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Estimated future product sales;

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Estimated royalties on future product sales;

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Contractual milestone payments;

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Expenses we expect to incur;

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Income taxes; and

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An appropriate discount rate.

 

We estimated the selling price of the research and development services by using our internal estimates of the cost to perform the specific services, marked up to include a reasonable profit margin, and estimates of expected cash outflows to third parties for services and supplies over the expected period that we will perform research and development. The significant inputs we used to determine the selling price of the research and development services included:

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The number of internal hours we will spend performing these services;

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The estimated number and cost of studies we will perform;

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The estimated number and cost of studies that we will contract with third parties to perform; and

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The estimated cost of drug product we will use in the studies.

As a result of the allocation, we recognized $9.3 million of the $25 million upfront payment for the ISIS-STAT3_Rx license in December 2012 and we recognized $2.2 million of the $6 million payment for the ISIS-STAT3_Rx license in June 2013.  We are recognizing the remaining $19.5 million of the $31 million over the estimated period of our performance. Assuming a constant selling price for the other elements in the arrangement, if there was an assumed ten  percent increase or decrease in the estimated selling price of the ISIS-STAT3_Rx  license, we determined that the revenue we would have allocated to the ISIS-STAT3_Rx  license would change by approximately seven  percent, or $750,000, from the amount we recorded.

Typically, we must estimate our period of performance when the agreements we enter into do not clearly define such information. Our collaborative agreements typically include a research and/or development project plan outlining the activities the agreement requires each party to perform during the collaboration. We 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. We have made estimates of our continuing obligations under numerous agreements and in certain instances the timing of satisfying these obligations is difficult to estimate. Accordingly, our estimates may change in the future. If our estimates and judgments change over the course of these agreements, it may affect the timing and amount of revenue that we recognize in future periods.  For example, we adjusted the period of performance on our collaboration with GlaxoSmithKline, or GSK, and our ISIS-SMN_Rx collaboration with Biogen Idec.  As a result of adding two new development candidates, ISIS-HBV_Rx and ISIS-GSK4_Rx, to our collaboration with GSK, our period of performance was extended beyond our initial estimate. Therefore, we extended the amortization period to correspond to the new extended period of performance. Similarly, with our ISIS-SMN_Rx collaboration, we extended the amortization period to correspond to the expansion of the Phase 3 study in infants with Spinal Muscular Atrophy, or SMA. Since we extended the amortization period for our GSK collaboration and our ISIS-SMN_Rx collaboration, revenue from the amortization of upfront payments for these collaborations will be $3.3 million less in 2014 compared to 2013.

From time to time, we may enter into separate agreements at or near the same time with the same customer. We evaluate such agreements to determine whether they should be accounted for individually as distinct arrangements or whether the separate agreements are, in substance, a single multiple element arrangement.  We evaluate whether the negotiations are conducted jointly as part of a single negotiation, whether the deliverables are interrelated or interdependent, whether fees in one arrangement are tied to performance in another arrangement, and whether elements in one arrangement are essential to another arrangement. Our evaluation involves significant judgment to determine whether a group of agreements might be so closely related that they are, in effect, part of a single arrangement.  For example, since early 2012 we have entered into four collaboration agreements with Biogen Idec:

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In January 2012, we entered into a collaboration agreement with Biogen Idec to develop and commercialize ISIS-SMNRx for SMA. As part of the collaboration, we received a $29 million upfront payment and we are responsible for global development of ISIS-SMNRx through completion of Phase 2/3 clinical trials.

 

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In June 2012, we entered into a second and separate collaboration agreement with Biogen Idec to develop and commercialize a novel antisense drug targeting DMPK, or dystrophia myotonica-protein kinase. As part of the collaboration, we received a $12 million upfront payment and we are responsible for global development of the drug through the completion of a Phase 2 clinical trial.

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In December 2012, we entered into a third and separate collaboration agreement with Biogen Idec to discover and develop antisense drugs against three targets to treat neurological or neuromuscular disorders. As part of the collaboration, we received a $30 million upfront payment and we are responsible for the discovery of a lead antisense drug for each of three targets.

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In September 2013, we entered into a fourth and separate collaboration agreement with Biogen Idec to leverage antisense technology to advance the treatment of neurological diseases. We granted Biogen Idec exclusive rights to the use of our antisense technology to develop therapies for neurological diseases as part of this broad collaboration. We received a $100 million upfront payment and we are responsible for discovery and early development through the completion of a Phase 2 clinical trial for each antisense drug identified during the six year term of this collaboration, while Biogen Idec is responsible for the creation and development of small molecule treatments and biologics.

All four of these collaboration agreements give Biogen Idec the option or options to license one or more drugs resulting from the specific collaboration. If Biogen Idec exercises an option, it will pay us a license fee and will assume future development, regulatory and commercialization responsibilities for the licensed drug. We are also eligible to receive milestone payments associated with the research and/or development of the drugs prior to licensing, milestone payments if Biogen Idec achieves pre-specified regulatory milestones, and royalties on any product sales of drugs resulting from these collaborations.

We evaluated all four of the Biogen Idec agreements to determine whether we should account for them as separate agreements.  We determined that we should account for the agreements separately because we conducted the negotiations independently of one another, each agreement focuses on different drugs, there are no interrelated or interdependent deliverables, there are no provisions in any of these agreements that are essential to the other agreement, and the payment terms and fees under each agreement are independent of each other. We also evaluated the deliverables in each of these agreements to determine whether they met the criteria to be accounted for as separate units of accounting or whether they should be combined with other deliverables and accounted for as a single unit of accounting.  For all four of these agreements, we determined that the options did not have stand-alone value because Biogen Idec cannot pursue the development or commercialization of the drugs resulting from these collaborations until it exercises the respective option or options. As such, for each agreement we considered the deliverables to be a single unit of accounting and we are recognizing the upfront payment for each of the agreements over the respective estimated period of our performance.

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.

 

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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 Food and Drug Administration, or FDA, and/or foreign equivalents. The Phase 3 studies typically involve large numbers of patients and can take up to several years to complete. If the data gathered during the trials demonstrates acceptable safety and efficacy results, we or our partner will submit an application to the FDA and/or its foreign equivalents for marketing 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 partnered drug, our efforts to discover and develop a drug that is safe, effective and reliable contributes significantly to our partner's ability to successfully sell the drug.  The FDA and its foreign equivalents have the authority to impose significant restrictions on an approved drug through the product label and on advertising, promotional and distribution activities.  Therefore, our efforts designing and executing the necessary animal and human studies are critical to obtaining claims in the product label from the regulatory agencies that would allow 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:

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

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

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

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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:

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

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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

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

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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 access to new technologies we discover, we have determined that all future development, regulatory and commercialization milestones are substantive. For example, we consider milestones associated with our strategic alliance with Biogen Idec substantive because we are using our antisense drug discovery platform to discover and develop new drugs against targets for neurological diseases. Alternatively, we considered milestones associated with our strategic alliance with Alnylam Pharmaceuticals, Inc. substantive because we provided Alnylam ongoing access to our technology to develop and commercialize RNA interference, or RNAi, therapeutics. In evaluating if a milestone is substantive we consider whether:

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

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

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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;

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

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

If any of these conditions are not met, we do not consider the milestone to be substantive and we defer recognition of the milestone payment and recognize it as revenue over the estimated period of performance, if any.  We consider milestone payments related to progression of a drug through the development and regulatory stages of its life cycle to be substantive milestones because the level of effort and inherent risk associated with these events is high.  Further information about our collaborative arrangements can be found in Note 7, Collaborative Arrangements and Licensing Agreements.

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. For example, in the first quarter of 2014, we recognized $7.7 million in sublicensing revenue from Alnylam related to its collaboration with Genzyme because we have no performance obligations related to Alnylam's relationship with Genzyme and collectability was reasonably assured.

Cash, cash equivalents and short-term investments

We consider all liquid investments with maturities of three months or less when we purchase them to be cash equivalents. Our short-term investments have initial maturities of greater than three months from date of purchase. We classify our short-term investments as "available-for-sale" and carry them at fair market value based upon prices for identical or similar items on the last day of the fiscal period. We record unrealized gains and losses as a separate component of comprehensive income (loss) and include net realized gains and losses in gain (loss) on investments. We use the specific identification method to determine the cost of securities sold.

We have equity investments in privately- and publicly-held biotechnology companies that we have received as part of a technology license or collaboration agreement.  At June 30, 2014 we held ownership interests of less than 20 percent in each of the respective companies.

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We account for our equity investments in publicly-held companies at fair value and record unrealized gains and losses related to temporary increases and decreases in the stock of these publicly-held companies as a separate component of comprehensive income (loss).  We account for equity investments in privately-held companies under the cost method of accounting because we own less than 20 percent and do not have significant influence over their operations. The cost method investments we hold are in small companies, which we call satellite companies, and realization of our equity position in those companies is uncertain. In those circumstances we record a full valuation allowance. In determining if and when a decrease in market value below our cost in our equity positions is temporary or other-than-temporary, we examine historical trends in the stock price, the financial condition of the company, near term prospects of the company and our current need for cash. If we determine that a decline in value in either a public or private investment is other-than-temporary, we recognize an impairment loss in the period in which the other-than-temporary decline occurs.

Inventory valuation

We capitalize the costs of raw materials that we purchase for use in producing our drugs because until we use these raw materials they have alternative future uses. We include in inventory raw material costs for drugs that we manufacture for our partners under contractual terms and that we use primarily in our clinical development activities and drug products. We can use each of our raw materials in multiple products and, as a result, each raw material has future economic value independent of the development status of any single drug. For example, if one of our drugs failed, we could use the raw materials for that drug to manufacture our other drugs. We expense these costs when we deliver the drugs to our partners, or as we provide these drugs for our own clinical trials. We reflect our inventory on the balance sheet at the lower of cost or market value under the first-in, first-out method. We review inventory periodically and reduce the carrying value of items we consider to be slow moving or obsolete to their estimated net realizable value. We consider several factors in estimating the net realizable value, including shelf life of raw materials, alternative uses for our drugs and clinical trial materials, and historical write-offs.  We did not record any inventory write-offs for the six months ended June 30, 2014 and 2013. Total inventory, which consisted of raw materials, was $7.8 million and $8.0 million as of June 30, 2014 and December 31, 2013, respectively.

Research, development and patent expenses

Our research and development expenses include wages, benefits, facilities, supplies, external services, clinical trial and manufacturing costs and other expenses that are directly related to our research and development operations.  We expense research and development costs as we incur them.  When we make payments for research and development services prior to the services being rendered, we record those amounts as prepaid assets on our condensed consolidated balance sheet and we expense them as the services are provided.

We capitalize costs consisting principally of outside legal costs and filing fees related to obtaining patents. We amortize patent costs over the useful life of the patent, beginning with the date the United States Patent and Trademark Office, or foreign equivalent, issues the patent. We review our capitalized patent costs regularly to ensure that they include costs for patents and patent applications that have future value.  We evaluate patents and patent applications that we are not actively pursuing and write off any associated costs.

Long-lived assets

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

Use of estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Reclassifications

We have reclassified certain immaterial prior period amounts to conform to the current period presentation.   Certain amounts previously reported as research and development revenue have been reclassified to licensing and royalty revenue to conform to the current period presentation.

Basic and diluted net 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 net loss for the three and six months ended June 30, 2014 and 2013, we did not include dilutive common equivalent shares in the computation of diluted net loss per share because the effect would have been anti-dilutive. Common stock from the following would have had an anti-dilutive effect on net loss per share:

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2¾ percent convertible senior notes;

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Dilutive stock options; and

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Restricted stock units.

 

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, 2014 and December 31, 2013, we had collaborative arrangements with five entities that we considered to be variable interest entities.  We are not the primary beneficiary for any of these entities because we do not have the power to direct the activities that most significantly impact the economic performance of our variable interest entities, the obligation to absorb losses, or the right to receive benefits from our variable interest entities that could potentially be significant to the variable interest entities.  As of June 30, 2014, the total carrying value of our investments in variable interest entities was $59.0 million, and was primarily related to our investment in Regulus. Our maximum exposure to loss related to these variable interest entities is limited to the carrying value of our investments.

Accumulated other comprehensive income

Accumulated other comprehensive income is comprised of unrealized gains and losses on securities, net of taxes, and  adjustments we made to reclassify realized gains and losses on securities from other accumulated comprehensive income to our condensed consolidated statement of operations. The following table summarizes changes in accumulated other comprehensive income for the three and six months ended June 30, 2014 and 2013 (in thousands):

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(1)

Other comprehensive income for the three and six months ended June 30, 2014 includes income tax benefit of $2.9 million and income tax expense of $2.5 million, respectively, compared to an income tax benefit of $2.9 million and $10.0 million for same periods in 2013.

 

(2)

Included in gain (loss) on investments, net on our condensed consolidated statement of operations.

Convertible debt

In August 2012, we completed a $201.3 million offering of convertible senior notes, which mature in 2019 and bear interest at 2 ¾ percent. In September 2012, we used a substantial portion of the net proceeds from the issuance of the 2 ¾ percent notes to redeem our 2 5/8 percent convertible subordinated notes. We account for our 2 ¾ percent notes by separating the liability and equity components of the instrument in a manner that reflects our nonconvertible debt borrowing rate. As a result, we assigned a value to the debt component of our 2 ¾ percent notes equal to the estimated fair value of similar debt instruments without the conversion feature, which resulted in us recording the debt instrument at a discount. We are amortizing the debt discount over the life of these 2 ¾ percent notes as additional non-cash interest expense utilizing the effective interest method.

Segment information

We operate in a single segment, Drug Discovery and Development operations, because our chief decision maker reviews operating results on an aggregate basis and manages our operations as a single operating segment.

Stock-based compensation expense

We measure stock-based compensation expense for equity-classified awards, principally related to stock options, restricted stock units, or RSUs, and stock purchase rights under our Employee Stock Purchase Plan, or ESPP, based on the estimated fair value of the award on the date of grant. We recognize the value of the portion of the award that we ultimately expect to vest as stock-based compensation expense over the requisite service period in our condensed consolidated statements of operations.  We reduce stock-based compensation expense for estimated forfeitures at the time of grant and revise in subsequent periods if actual forfeitures differ from those estimates.

We use the Black-Scholes model to estimate the fair value of stock options granted and stock purchase rights under the ESPP. The expected term of stock options granted represents the period of time that we expect them to be outstanding.  We estimate the expected term of options granted based on historical exercise patterns. For the six months ended June 30, 2014 and 2013, we used the following weighted-average assumptions in our Black-Scholes calculations:

Employee Stock Options:

ESPP:

Board of Director Stock Options:

The fair value of RSUs is based on the market price of our common stock on the date of grant.  RSUs vest annually over a four year period.  The weighted-average grant date fair value of RSUs granted to employees and the Board of Directors for the six months ended June 30, 2014  was $46.49 and $49.09, respectively.

The following table summarizes stock-based compensation expense for the three and six months ended June 30, 2014 and 2013 (in thousands), which was allocated as follows:

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Non-cash stock-based compensation was $7.7 million and $14.8 million for the three and six months ended June 30, 2014, respectively, and increased compared to $2.6 million and $5.5 million for the same periods in 2013 primarily due to the increase in our stock price.  As of June 30, 2014, total unrecognized estimated non-cash stock-based compensation expense related to non-vested stock options and RSUs was $29.0 million and $13.2 million, respectively. We will adjust total unrecognized compensation cost for future changes in estimated forfeitures.  We expect to recognize the cost of non-cash, stock-based compensation expense related to non-vested stock options and RSUs over a weighted average amortization period of 1.3 years and 1.8 years, respectively.

Impact of recently issued accounting standards

In May 2014, the FASB issued accounting guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what the entity expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016.  The guidance allows entities to select one of two methods of adoption, either the full retrospective approach, meaning the guidance would be applied to all periods presented, or modified retrospective, meaning the cumulative effect of applying the guidance would be recognized as an adjustment to our opening retained earnings balance.  We will adopt this guidance in our fiscal year beginning January 1, 2017. We are currently evaluating an adoption method and the impact this guidance will have on our consolidated financial position, results of operations, cash flows and disclosures and are currently unable to estimate the impact of this guidance.

3.

Investments

As of June 30, 2014, we have invested our excess cash primarily in debt instruments of the U.S. Treasury, financial institutions, corporations, and U.S. government agencies with strong credit ratings and an investment grade rating at or above A-1, P-1 or F-1 by Moody's, Standard & Poor's (S&P) or Fitch, respectively. We have established guidelines relative to diversification and maturities that maintain safety and liquidity. We periodically review and modify these guidelines to maximize trends in yields and interest rates without compromising safety and liquidity.

The following table summarizes the contract maturity of the available-for-sale securities we held as of June 30, 2014:

As illustrated above, we primarily invest our excess cash in short-term instruments with 89 percent of our available-for-sale securities having a maturity of less than two years.

All of our available-for-sale securities are available to us for use in our current operations. As a result, we categorize all of these securities as current assets even though the stated maturity of some individual securities may be one year or more beyond the balance sheet date.

At June 30, 2014, we had an ownership interest of less than 20 percent in each of two private companies and four public companies with which we conduct business.  The privately-held companies are Santaris Pharma A/S (formerly Pantheco A/S) and Atlantic Pharmaceuticals Limited. The publicly-traded companies are Antisense Therapeutics Limited, Achaogen Inc., iCo Therapeutics Inc., and Regulus. We account for equity investments in the privately-held companies under the cost method of accounting and we account for equity investments in the publicly-traded companies at fair value. We record unrealized gains and losses as a separate component of comprehensive income (loss) and include net realized gains and losses in gain (loss) on investments.

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

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(1)

Includes investments classified as cash equivalents on our condensed consolidated balance sheet.

Investments we considered to be temporarily impaired at June 30, 2014 were as follows (in thousands):

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 for identical assets, which includes our money market funds and treasury securities classified as available-for-sale securities and our investment in equity securities in publicly-held biotechnology companies; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable, which includes our fixed income securities and commercial paper classified as available-for-sale securities; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Our Level 3 investments include investments in the equity securities of publicly-held biotechnology companies for which we calculated a lack of marketability discount because there were restrictions on when we could trade the securities. The majority of our securities have been classified as Level 2. We obtain the fair value of our Level 2 investments from our custodian bank or from a professional pricing service. We validate the fair value of our Level 2 investments by understanding the pricing model used by the custodian banks or professional pricing service provider and comparing that fair value to the fair value based on observable market prices. During the six months ended June 30, 2014 there were no transfers between our Level 1 and Level 2 investments. We use the end of reporting period method for determining transfers between levels.

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We measure the following major security types at fair value on a recurring basis. We break down the inputs used to measure fair value for these assets at June 30, 2014 and December 31, 2013 as follows (in thousands):

(1)

Includes investments classified as cash equivalents on our condensed consolidated balance sheet.

(2)

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

 

We classified as Level 3 the fair value of our investments in the equity securities of publicly-held biotechnology companies that are subject to trading restrictions for which we calculate a lack of marketability discount on the fair value of the investments. We consider the inputs we used to calculate the lack of marketability discount and, as a result, we categorized these investments as Level 3. We determined the lack of marketability discount by using a Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the stock until the restriction ended.

As of January 1, 2013, we classified the fair value measurements of our investments in the equity securities of Regulus and Sarepta Therapeutics, Inc. as Level 3.  In the six months ended June 30, 2013, we sold all of the common stock of Sarepta that we owned resulting in a realized gain of $1.1 million. As of June 30, 2013, our Level 3 investments consisted of our investment in Regulus, with a gross fair value of $69.2 million and a lack of marketability discount of $7.0 million.  In the fourth quarter of 2013, we re-classified our investment in Regulus to a Level 1 investment because the contractual trading restrictions on the Regulus shares we own ended. We recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. In March 2014, Achaogen completed an initial public offering. As a result, we stopped using the cost method of accounting for our equity investment in Achaogen and instead we began accounting for it at fair value, which includes a lack of marketability discount because there are restrictions on when we can trade the securities.  As of June 30, 2014, we classified our investment in the equity securities of Achaogen as Level 3 with a gross fair value of $2.1 million and a lack of marketability discount of $214,000.

The following is a summary of our investments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended June 30, 2014 (in thousands):

Other Fair Value Disclosures

Our 2¾ percent convertible notes had a fair value of $448.3 million at June 30, 2014.  We determine the fair value of our 2¾ percent convertible notes based on quoted market prices for these notes, which is a Level 2 measurement.

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:

 

Contract receivables from three significant partners comprised approximately 97 percent of our contract receivables at June 30, 2014. Contract receivables from three significant partners comprised approximately 91 percent of our contract receivables at December 31, 2013.

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6.

Income Taxes

Intraperiod tax allocation rules require us to allocate our provision for income taxes between continuing operations and other categories of earnings, such as other comprehensive income. In periods in which we have a year-to-date pre-tax loss from continuing operations and pre-tax income in other categories of earnings, such as other comprehensive income, we must allocate the tax provision to the other categories of earnings. We then record a related tax benefit in continuing operations. During the six months ended June 30, 2014 and 2013, we recorded unrealized gains on our investments in available-for-sale securities in other comprehensive income net of taxes.  As a result, for the six months ended June 30, 2014 and 2013, we recorded a $1.4 million and $1.2 million tax benefit, respectively, on our condensed consolidated statements of operations and a $2.5 million and $10.0 million tax expense, respectively, in other comprehensive income.

7.

Collaborative Arrangements and Licensing Agreements

Traditional Pharmaceutical Alliances and Licensing

AstraZeneca

In December 2012, we entered into a global collaboration agreement with AstraZeneca to discover and develop antisense drugs against five cancer targets.  As part of the agreement, we granted AstraZeneca an exclusive license to develop and commercialize ISIS-STAT3_Rx and ISIS-AR_Rx for the treatment of cancer and an option to license up to three cancer drugs under a separate research program.  We are eligible to receive milestone payments and license fees from AstraZeneca as programs advance in development.  In addition, we are eligible to receive royalties up to the low to mid-teens on any product sales of drugs resulting from this collaboration.  Under the terms of the agreement, we received $31 million in upfront and near-term payments comprised of a $25 million upfront payment we received in December 2012 and a $6 million payment we received in June 2013, of which we recognized $11.5 million upon receipt of the payments.  We are recognizing the remaining $19.5 million as follows:

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$11.2 million related to the ISIS-ARRx program, which we amortized through March 2014;

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$7.6 million related to the option to license three drugs under a separate research program, which we are amortizing through December 2016; and

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$0.7 million related to the ISIS-STAT3Rx program, which we are amortizing through November 2014.

Together with AstraZeneca, we are evaluating ISIS-STAT3_Rx in patients with advanced cancer. AstraZeneca is conducting a Phase 1b/2a clinical study of ISIS-STAT3_Rx in patients with advanced metastatic hepatocellular carcinoma, or HCC.  We are also conducting a clinical study evaluating ISIS-STAT3_Rx in patients with advanced lymphomas, including patients with diffuse large b-cell lymphoma.  We are responsible for completing our clinical study in patients with advanced lymphomas and AstraZeneca is responsible for all other development activities for ISIS-STAT3_Rx. In June 2013, we and AstraZeneca added a second development candidate, ISIS-AR_Rx, to our collaboration. ISIS-AR_Rx is an antisense drug we designed to treat patients with prostate cancer by inhibiting the production of the androgen receptor, or AR. Through June 2014, we have earned $25 million in milestone payments related to the development of ISIS-AR_Rx, including a $15 million milestone payment we earned in June 2014 when we initiated a Phase 1 study of ISIS-AR_Rx.  If AstraZeneca successfully develops ISIS-STAT3_Rx, ISIS-AR_Rx, and three drugs under the research program, we could receive substantive milestone payments of more than $955 million, including up to $300.5 million for the achievement of development milestones and up to $655 million for the achievement of regulatory milestones.  We could earn the next milestone payment of $15 million if we meet pre-agreed efficacy and safety criteria in our ongoing ISIS-STAT3_Rx study in patients with advanced cancer.

In August 2013, we added another collaboration program with AstraZeneca to discover and develop an antisense drug against an undisclosed target. AstraZeneca has the option to license a drug resulting from this research collaboration, and if AstraZeneca exercises its option, it will be responsible for all further development and commercialization of the drug. We received a $750,000 upfront payment, which we are amortizing through December 2015. We are eligible to receive license fees and substantive milestone payments of $163.2 million, including up to $45.3 million for the achievement of research and development milestones and up to $105 million for regulatory milestones.  We will earn the next $3.3 million milestone payment if AstraZeneca selects a development candidate under this collaboration.  In addition, we are eligible to receive royalties up to the low teens on sales from any product that AstraZeneca successfully commercializes under this collaboration program.

Our agreement with AstraZeneca will continue until the expiration of all payment obligations under the agreement. In addition, the agreement, or any program under the agreement, may terminate early under the following situations:

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AstraZeneca may terminate the agreement or any program at any time by providing written notice to us;

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AstraZeneca may terminate the agreement or any program by providing written notice if we undergo a change of control with a third party; and

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Either we or AstraZeneca may terminate the agreement or any program by providing written notice to the other party upon the other party’s uncured failure to perform a material obligation under the agreement, or the entire agreement if the other party becomes insolvent.

During the three and six months ended June 30, 2014, we earned revenue of $15.6 million and $19.1 million, respectively, from our relationship with AstraZeneca which represented 27 percent and 22 percent, respectively, of our total revenue for those periods. In comparison, we earned revenue of $15.3 million and $17.8 million for the same periods in 2013.  Our balance sheet at June 30, 2014 included deferred revenue of $5.5 million related to our relationship with AstraZeneca.

Biogen Idec

We have established four strategic collaborations with Biogen Idec that broaden and expand our severe and rare disease franchise for neurological disorders.

ISIS-SMN_Rx

In January 2012, we entered into a global collaboration agreement with Biogen Idec to develop and commercialize ISIS-SMN_Rx for the treatment of SMA.  We received an upfront payment of $29 million, which we are amortizing through February 2017.  We are eligible to receive a license fee, milestone payments and royalties up to the mid-teens on any product sales of ISIS-SMN_Rx. Biogen Idec has the option to license ISIS-SMN_Rx until completion of the first successful Phase 2/3 study or the completion of two Phase 2/3 studies. If Biogen Idec exercises its option, it will pay us a license fee and will assume global development, regulatory and commercialization responsibilities.

We and Biogen Idec amended our original agreement to reflect changes made to the clinical development plan for ISIS-SMN_Rx in January 2014.  We and Biogen Idec added a new open-label extension study, which is being offered to those children with SMA who have completed dosing in our previous studies.  We also expanded the dosing in the Phase 2 study in infants with SMA.  In addition, we increased the number of patients to be included in the Phase 3 studies in infants.  As a result of these changes, we and Biogen Idec agreed to increase the payments that we are eligible to receive under this collaboration by nearly $35 million.

 

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In July 2014, we initiated the Phase 3 study evaluating ISIS-SMN_Rx in infants with SMA. In addition, we are evaluating ISIS-SMN_Rx in a Phase 2 open-label, multiple-dose, dose-escalation study in children with SMA and a Phase 2 open-label, multiple-dose, dose-escalation pilot study in infants with SMA.  Through July 2014, we have earned $17.3 million in payments for advancing ISIS-SMN_Rx, including $9.3 million in payments we earned in the first quarter of 2014 related to the amendments made to the clinical development plan for ISIS-SMN_Rx.  Accounting rules require us to amortize the $9.3 million we received related to the amendment of the clinical development plan for ISIS-SMN_Rx over our estimated period of performance, which is as follows:

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$3.8 million related to the Phase 2 studies in children and infants with SMA, which we are amortizing through July 2014; and

●

$5.5 million related to an open-label extension study in children with SMA, which we are amortizing through December 2014.

 

Under the terms of the amended agreement, we are eligible to receive up to $303.8 million in a license fee and payments, including $78.8 million in substantive milestone and other payments associated with the clinical development of ISIS-SMN_Rx prior to licensing and $150 million in substantive milestone payments if Biogen Idec achieves pre-specified regulatory milestones. We will earn the next milestone payment of $18 million if we dose the first patient in the Phase 3 study in infants with SMA, which is designed to support marketing registration for ISIS-SMN_Rx in the United States and Europe.

ISIS-DMPK_Rx

In June 2012, we and Biogen Idec entered into a second and separate collaboration and license agreement to develop and commercialize a novel antisense drug targeting DMPK for the treatment of myotonic dystrophy type 1, or DM1, ISIS-DMPK_Rx.  We are responsible for global development of the drug through the completion of the first Phase 2 clinical trial.  Biogen Idec has the option to license the drug through the completion of the first Phase 2 trial. Under the terms of the agreement, we received an upfront payment of $12 million, which we are amortizing through June 2017.  Over the term of the collaboration we are eligible to receive up to $259 million in a license fee and substantive milestone payments. As of June 30, 2014, we have earned $24 million in substantive milestone payments associated with the clinical development of ISIS-DMPK_Rx, including a $14 million milestone payment we earned in June 2014 when we initiated a Phase 1 study for ISIS-DMPK_Rx. We are eligible to receive up to another $35 million in milestone payments associated with the development of ISIS-DMPK_Rx prior to licensing.  We are also eligible to receive up to $130 million in milestone payments if Biogen Idec achieves pre-specified regulatory milestones. In addition, we are eligible to receive royalties up to the mid-teens on any product sales of the drug. We will earn the next milestone payment of $35 million if we initiate a Phase 2 study for ISIS-DMPK_Rx.

Neurology

In December 2012, we and Biogen Idec entered into a third and separate collaboration to develop and commercialize novel antisense drugs to three targets to treat neurological or neuromuscular diseases.  We are responsible for the development of the drugs through the completion of the initial Phase 2 clinical study.  Biogen Idec has the option to license a drug from each of the three programs through the completion of Phase 2 studies. Under the terms of the agreement, we received an upfront payment of $30 million, which we are amortizing through December 2020. Over the term of the collaboration we are eligible to receive up to $259 million in a license fee and substantive milestone payments per program.  We could receive up to $59 million in development milestone payments to support research and development of each program, including amounts related to the cost of clinical trials. We could also receive up to $130 million in milestone payments if Biogen Idec achieves pre-specified regulatory milestones.  In addition, we are eligible to receive royalties up to the mid-teens on any product sales of drugs resulting from each of the three programs.  We will earn the next milestone payment of $10 million if we initiate an IND-enabling toxicology study for a development candidate identified under this collaboration.

Strategic Neurology

In September 2013, we and Biogen Idec entered into a fourth and separate collaboration, which is a long-term strategic relationship focused on applying antisense technology to advance the treatment of neurological diseases.  As part of the collaboration, Biogen Idec gained exclusive rights to the use of our antisense technology to develop therapies for neurological diseases and has the option to license drugs resulting from this collaboration. The exclusivity for neurological diseases will last six years, and may be extended for any drug development programs being pursued under the collaboration. Under the terms of the agreement, we received an upfront payment of $100 million and are eligible to receive milestone payments, license fees and royalty payments for all drugs developed through this collaboration, with the specific amounts dependent upon the modality of the molecule advanced by Biogen Idec.  If we have a change of control during the first six years of the collaboration, we may be required to refund Biogen Idec a portion of the $100 million upfront payment, with the amount of the potential refund decreasing ratably as we progress through the initial six year term of the collaboration. We are amortizing the $100 million upfront payment through September 2019.  Because the amortization period for the upfront payment will never be less than the initial six year term of the collaboration, the amount of revenue we recognize from the upfront payment will never exceed the amount that Biogen Idec could potentially require us to refund.

For each antisense molecule that is chosen for drug discovery and development under this collaboration, we are eligible to receive up to approximately $260 million in a license fee and substantive milestone payments. We are eligible to receive up to approximately $60 million for the achievement of research and development milestones, including amounts related to the cost of clinical trials, and up to $130 million for the achievement of regulatory milestones. We will usually be responsible for drug discovery and early development of antisense drugs and Biogen Idec will have the option to license antisense drugs after Phase 2 proof of concept. Biogen Idec will then be responsible for later phase development and commercialization of the licensed drug. In addition, we are eligible to receive royalties up to the mid-teens on any product sales of antisense drugs developed under this collaboration. If other modalities, such as small molecules or monoclonal antibodies are chosen, we are eligible to receive up to $90 million in substantive milestone payments, including up to $57 million for the achievement of research and development milestones and up to $55 million for the achievement of regulatory milestones. Biogen Idec will be responsible for all of the drug discovery and development activities for drugs using other modalities.  In addition, we are eligible to receive single-digit royalties on any product sales of any drugs using non-antisense modalities developed under this collaboration.  In June 2014, we earned a $10 million milestone payment when Biogen Idec chose the first target to advance under this collaboration. We could earn the next milestone payment of up to $10 million if we initiate an IND-enabling toxicology study for a target under this collaboration.

Each of our agreements with Biogen Idec will continue until the earlier of the date all of Biogen Idec’s options to obtain the exclusive licenses under the applicable agreement expire unexercised or, if Biogen Idec exercises its option, until the expiration of all payment obligations under the applicable agreement. In addition, each agreement, or any program under an agreement, may terminate early under the following situations:

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Biogen Idec may terminate the agreement or any program at any time by providing written notice to us;

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Under specific circumstances, if we are acquired by a third party with a product that directly competes with a compound being developed under the agreement, Biogen Idec may terminate the affected program by providing written notice to us;

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If, within a specified period of time, any required clearance of a transaction contemplated by an agreement under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, is not received, then either we or Biogen Idec may terminate the affected program by providing written notice to the other party; and

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Either we or Biogen Idec may terminate any program by providing written notice to the other party upon the other party’s uncured failure to perform a material obligation under the agreement with respect to the affected program, or the entire agreement if the other party becomes insolvent.

During the three and six months ended June 30, 2014, we earned revenue of $34.5 million and $44.7 million, respectively, from our relationship with Biogen Idec, which represented 60 percent and 52 percent of our total revenue for those periods.   In comparison, we earned revenue of $7.4 million and $11.2 million for the same periods in 2013.  Our balance sheet at June 30, 2014 included deferred revenue of $136.3 million related to our relationship with Biogen Idec.

 

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GlaxoSmithKline

In March 2010, we entered into a strategic alliance with GSK, for up to six programs, using 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 development of drugs while still being eligible to receive milestone payments as we advance these drugs in clinical development.  Our strategic alliance currently includes five active programs.  Under the terms of the agreement, we received a $35 million upfront payment and in May 2011 we received a $3 million payment when GSK expanded the collaboration.  In addition, we are eligible to receive on average up to $20 million in milestone payments through Phase 2 proof-of-concept for each program, except for ISIS-TTR_Rx and the fifth target, which we describe below. GSK has the exclusive option to license drugs resulting from this alliance at Phase 2 proof-of-concept for a license fee. If GSK exercises its exclusive option for any drugs resulting from this alliance, it will be responsible for all further development and commercialization for such drug.

In October 2012, we and GSK amended the original agreement to reflect an accelerated clinical development plan for ISIS-TTR_Rx. Under the amended terms of the agreement, we received a $2.5 million upfront payment in December 2012.  Through June 2014, we have received $26 million primarily in milestone payments from GSK related to the development of ISIS-TTR_Rx.  In July 2014, we earned a $1 million milestone payment for further advancing the Phase 2/3 study of ISIS-TTR_Rx. We are eligible to earn an additional $43 million in pre-licensing milestone payments associated with the ISIS-TTR_Rx Phase 2/3 study.  In addition, under the amended agreement, we and GSK increased the regulatory and commercial milestone payments we can earn should ISIS-TTR_Rx receive marketing approval and meet pre-agreed sales targets.

In September 2013, we designated ISIS-HBV_Rx, formerly ISIS-GSK3_Rx, as a development candidate under our collaboration with GSK. ISIS-HBV_Rx is an antisense drug designed to reduce the production of viral proteins associated with hepatitis B virus, or HBV, infection and replication. In June 2014, we amended our agreement to modify the development plans for ISIS-HBV_Rx. As a result, we received a $1 million payment. Through June 2014, we have earned $10 million in substantive milestone payments associated with advancing the ISIS-HBV_Rx program.

In November 2013, we designated ISIS-GSK4_Rx as a development candidate under our collaboration with GSK and earned a $5 million milestone payment.  ISIS-GSK4_Rx is an antisense drug we designed to treat an undisclosed ocular disease.  In April 2014, we and GSK amended our agreement to modify the development plans for ISIS-GSK4_Rx and for the fifth target in our collaboration.  Under the amended terms of the agreement, we are eligible to receive up to $142 million in a license fee, milestone and other payments for the advancement of the fifth target.

Under our agreement, if GSK successfully develops all five programs for one or more indications and achieves pre-agreed sales targets, we could receive license fees and substantive milestone payments of more than $1.2 billion, including up to $172 million for the achievement of development milestones, up to $483.5 million for the achievement of regulatory milestones and up to $428 million for the achievement of commercialization milestones. We will earn the next $1.5 million milestone payment if we initiate an IND-enabling study of ISIS-GSK4_Rx. In addition, we are eligible to receive royalties up to the mid-teens on sales from any product that GSK successfully commercializes under this alliance.

Our alliance with GSK will continue until the earlier of the date all of GSK’s options to obtain the exclusive licenses under the agreement expire unexercised or, if GSK exercises its option, until the expiration of all payment obligations under the agreement. In addition, the agreement, or any program under the agreement, may terminate early under the following situations:

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GSK may terminate any program other than the ISIS-TTRRx program at any time by providing written notice to us;

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GSK may terminate the ISIS-TTRRx program by providing written notice to us after reviewing specific data from the Phase 3 study for the program; and

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Either we or GSK may terminate any program by providing written notice to the other party upon the other party’s uncured failure to perform a material obligation under the agreement with respect to the affected program, or the entire agreement if the other party becomes insolvent.

During the three and six months ended June 30, 2014, we earned revenue of $3.5 million and $6.8 million, respectively, from our relationship with GSK, which represented six  percent and eight  percent, respectively, of our total revenue for those periods.  In comparison, we earned revenue of $2.3 million and $12.2 million for the same periods in 2013. Our balance sheet at June 30, 2014 included deferred revenue of $9.1 million related to our relationship with GSK, $7.9 million of which is related to the upfront payments associated with our collaboration with GSK that we are amortizing through our estimated period of performance of July 2015.

Roche

In April 2013, we formed an alliance with Hoffman-La Roche Inc. and F. Hoffmann-La Roche Ltd., collectively Roche, to develop treatments for Huntington’s disease based on our antisense technology. Roche has the option to license the drugs from us through the completion of the first Phase 1 trial. Prior to option exercise, we are responsible for the discovery and development of an antisense drug targeting huntingtin, or HTT, protein. We are also working collaboratively with Roche on the discovery of an antisense drug utilizing Roche’s “brain shuttle” program. If Roche exercises its option, it will be responsible for global development, regulatory and commercialization activities for any drug arising out of the collaboration. Under the terms of the agreement, we received an upfront payment of $30 million in April 2013, which we are amortizing through April 2017.  We are eligible to receive up to $362 million in a license fee and substantive milestone payments including up to $67 million for the achievement of development milestones, up to $170 million for the achievement of regulatory milestones and up to $80 million for the achievement of commercialization milestones. In addition, we are eligible to receive up to $136.5 million in milestone payments for each additional drug successfully developed and up to $50 million in commercial milestones if a drug using Roche’s proprietary brain shuttle technology is successfully commercialized. We are also eligible to receive tiered royalties up to the mid-teens on any product sales of drugs resulting from this alliance. We will earn the next milestone payment of $22 million if we initiate a Phase 1 trial for a drug targeting HTT protein.

Our alliance with Roche will continue until the earlier of the date Roche’s option to obtain the exclusive license under the agreement expires unexercised or, if Roche exercises its option, until the expiration of all payment obligations under the agreement. In addition, the agreement may terminate early under the following situations:

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Roche may terminate the agreement at any time by providing written notice to us;

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Either we or Roche may terminate the agreement by providing written notice to the other party upon the other party’s uncured failure to perform a material obligation under the agreement or if the other party becomes insolvent; and

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Either we or Roche may terminate the brain shuttle program if at least one development candidate is not designated under such program by a mutually agreed deadline.

During the three and six months ended June 30, 2014, we earned revenue of $2.4 million and $4.4 million, respectively, from our relationship with Roche.  In comparison, we earned revenue of $1.3 million for the three and six months ended June 30, 2013. Our balance sheet at June 30, 2014 included deferred revenue of $21.0 million related to our relationship with Roche.

Satellite Company Collaborations

Achaogen, Inc.

In 2006, we exclusively outlicensed to Achaogen, Inc. specific know-how, patents and patent applications relating to aminoglycosides. In exchange, Achaogen agreed to certain payment obligations related to aminoglycosides Achaogen developed. Aminoglycosides are a class of small molecule antibiotics that inhibit bacterial protein synthesis and that physicians use to treat serious bacterial infections. Achaogen is developing plazomicin, an aminoglycoside Achaogen discovered based on the technology we licensed to Achaogen.  Plazomicin has displayed broad-spectrum activity in animals against multi-drug resistant gram-negative bacteria that cause systemic infections, including E. coli.  The compound has also demonstrated activity against methicillin-resistant staphylococcus aureus, or MRSA.

 

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In connection with the license, Achaogen issued to us $1.5 million of Achaogen Series A Preferred Stock. Since early 2009, we have received $3 million in milestone payments from Achaogen, of which $500,000 was in Achaogen securities.  Assuming Achaogen successfully develops and commercializes the first two drugs under our agreement, we will receive payments totaling up to $46.3 million for the achievement of key clinical, regulatory and sales events. We will earn the next payment of $4 million if Achaogen initiates a Phase 3 study for plazomicin. We are also eligible to receive royalties on sales of drugs resulting from the program. Achaogen is solely responsible for the continued development of plazomicin.

In March 2014, Achaogen completed an initial public offering. Upon the close of the offering, our investment in Achaogen’s preferred stock converted into approximately 148,000 shares of common stock.  As of June 30, 2014, the fair value of our investment in Achaogen was $1.9 million, which includes a lack of marketability discount because there are restrictions on when we can trade the securities.  At June 30, 2014 and December 31, 2013, we owned less than 10 percent of Achaogen’s equity.

Alnylam Pharmaceuticals, Inc.

In March 2004, we entered into a strategic alliance with Alnylam to develop and commercialize RNA interference therapeutics. Under the terms of the agreement, we exclusively licensed to Alnylam our patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry for double-stranded RNAi therapeutics in exchange for a $5 million technology access fee, participation in fees from Alnylam’s partnering programs, as well as future milestone and royalty payments from Alnylam. In August 2012, we expanded the license to include using the double-stranded RNAi technology for agricultural products. For each drug Alnylam develops under this alliance, we may receive up to $3.4 million in substantive milestone payments, including up to $1.1 million for the achievement of development milestones and $2.3 million for regulatory milestones. In 2013, we earned a $750,000 milestone payment when Alnylam initiated a Phase 3 study for a drug targeting transthyretin amyloidosis, or TTR.  We will earn the next milestone payment of $375,000 if Alnylam initiates a Phase 1 study for a drug in Alnylam’s pipeline. We retained rights to a limited number of double-stranded RNAi therapeutic targets and all rights to single-stranded RNAi, or ssRNAi, therapeutics.

In turn, Alnylam nonexclusively licensed to us its patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry to research, develop and commercialize ssRNAi therapeutics and to research double-stranded RNAi compounds. We also received a license to develop and commercialize double-stranded RNAi drugs targeting a limited number of therapeutic targets on a nonexclusive basis. If we develop or commercialize an RNAi-based drug using Alnylam’s technology, we will pay Alnylam milestone payments and royalties. For each drug, the potential milestone payments to Alnylam total $3.4 million, which we will pay if we achieve specified development and regulatory events. To date, we do not have an RNAi-based drug in clinical development. Our Alnylam alliance provides us with an opportunity to realize substantial value from our pioneering work in antisense mechanisms and oligonucleotide chemistry and is an example of our strategy to participate in all areas of RNA-targeting drug discovery.

We have the potential to earn sublicense revenue and a portion of milestone payments and royalty payments that Alnylam receives from licenses of our technology it grants to its partners. Through June 2014, we have earned a total of $48.2 million from Alnylam resulting from licenses of our technology for the development of RNAi technology that we granted to Alnylam and Alnylam has granted to its partners, including $7.7 million we earned in the first quarter of 2014 related to Alnylam’s recently announced collaboration with Genzyme. During the six months ended June 30, 2014 and 2013, we earned revenue of $7.7 million and $0.3 million, respectively, from our relationship with Alnylam.

In this Report on Form 10-Q, unless the context requires otherwise, "Isis," "Company," "we," "our," and "us," means Isis Pharmaceuticals, Inc. and its wholly owned subsidiary, Symphony GenIsis, Inc., which is currently inactive.

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, 2013, 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 23 of this Report.

Overview

We are the leading company in antisense drug discovery and development, exploiting a proven novel drug discovery platform we created to generate a broad pipeline of first-in-class drugs. Our strategy is to do what we do best—to discover and develop unique antisense drugs. The efficiency and broad applicability of our drug discovery platform allows us to discover and develop antisense drugs to treat a wide range of diseases, including severe and rare, cardiovascular, neurologic and metabolic diseases and cancer.  The efficiency of our drug discovery technology allows us to employ a unique business strategy designed to maximize the value of our drugs and technology while maintaining an effective cost structure that limits our cash needs.

Our flagship product, KYNAMRO (mipomersen sodium) injection, is on the market in the United States for patients with homozygous familial hypercholesterolemia, or HoFH. Patients with HoFH are at high cardiovascular risk and cannot reduce their low-density lipoprotein cholesterol, or LDL-C, sufficiently with currently available lipid-lowering therapies. In January 2013, the U.S. Food and Drug Administration, or FDA, approved the marketing application for KYNAMRO for patients with HoFH. Genzyme, a Sanofi Company, has also obtained marketing approval in other countries, including Mexico, Argentina and South Korea, and is pursuing marketing approval in multiple additional markets. Genzyme has substantial expertise in successfully marketing drugs in the United States and internationally for severe and rare diseases and is leveraging this expertise to reach patients with HoFH who are in desperate need of new treatment options. Genzyme is concentrating marketing and sales efforts on lipid specialists, and physicians who refer HoFH patients to these specialists, to reach patients with HoFH in the United States and other countries.

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To maximize the value of our drugs and technologies, we have a multifaceted partnering strategy.  Our partnering strategy provides us the flexibility to license each of our drugs at an optimal time to maximize the near- and long-term value for each drug.  In this way, we can expand our and our partners' pipelines with antisense drugs that we design to address significant medical needs while remaining small and focused. 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 build a base of license fees, milestone payments, profit share and royalty income. We also form preferred partner transactions that provide us with a vested partner, such as AstraZeneca, Biogen Idec, GSK, and Roche, early in the development of a drug. Typically, the drugs we partner early in development are in therapeutic areas of high risk, like severe neurological diseases, or in areas where Phase 2 results would likely not provide a significant increase in value, like cancer. These preferred partner transactions allow us to develop select drugs that could have significant commercial potential with a knowledgeable and committed partner with the financial resources to fund later-stage clinical studies and expertise to complement our own development efforts. We benefit from this strategy because it allows us to expand and broaden our drug discovery efforts to new disease targets. For example, through our broad strategic partnership with Biogen Idec, we are capitalizing on Biogen Idec's extensive resources and expertise in neurological diseases to create a franchise of novel treatments for neurological disorders. Similar to our other partnerships, with our preferred partner transactions we benefit financially from upfront payments, milestone payments, licensing fees and royalties.

We also work with a consortium of smaller companies that can exploit our drugs and technology. We call these smaller companies our satellite companies. 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. We also maintain our broad ribonucleic acid, or RNA, technology leadership through collaborations with satellite companies. All of these different types of relationships are part of our partnership strategy, which allow us to maximize the value of our assets, minimize the development risks of a broad pipeline of novel new drugs, and provide us with significant reliable near-term revenue.

The broad applicability of our drug discovery technology and the clinical successes of the drugs in our pipeline continue to create new partnering opportunities. Since January 2012, we have initiated six new partnerships that involve antisense drugs for the treatment of neurological diseases or cancer, including four strategic alliances with Biogen Idec to discover and develop antisense drugs for the treatment of neurologic diseases, a strategic alliance with AstraZeneca to discover and develop antisense drugs to treat cancer and a strategic alliance with Roche to discover and develop antisense drugs to treat Huntington's disease. We have received more than $230 million in upfront payments and have the potential to earn nearly $6 billion in future milestone payments and licensing fees from these partnerships.  In addition, we have the potential to earn nearly $3 billion in future milestone payments and licensing fees from our other partnered programs. We also have the potential to share in the future commercial success of our inventions and drugs resulting from our partnerships through earn out, profit sharing, or royalty arrangements. Since 2007, our partnerships have generated an aggregate of more than $1.2 billion in payments from upfront and licensing fees, equity purchase payments, milestone payments and research and development funding.

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. Our 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 nearly $420 million from our intellectual property sale and licensing program that helps support our internal drug discovery and development programs.

Recent Events

●	We reported positive clinical results from five drugs in later-stage development. These data exemplify the broad applicability and potential for antisense drugs to provide therapeutic benefit to many different diseases.

o

We reported positive Phase 2 data on ISIS-APOCIIIRx in patients with high to extremely high triglyceride levels as a single agent and in combination with fibrates. In these studies, patients experienced substantial reductions of triglyceride and apoC-III levels with significant increases in HDL-cholesterol. These Phase 2 data were presented at the Arteriosclerosis, Thrombosis and Vascular Biology and the National Lipid Association meetings.

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We presented positive results from both of the ongoing multiple-dose open label Phase 2 studies of ISIS-SMNRx in infants and children with SMA, which were consistent with earlier reported data. In these studies, we reported increases in muscle function scores in infants and children treated with ISIS-SMNRx. These Phase 2 data were presented at the American Academy of Neurology meeting.

o

We reported positive Phase 2 data for ISIS-GCGRRx in patients with type 2 diabetes.  In this study, patients with type 2 diabetes uncontrolled on stable metformin therapy experienced up to a 2.25 percentage point mean reduction in hemoglobin A1c levels after 13 weeks of dosing. These Phase 2 data were presented at the American Diabetes Association Scientific Sessions.

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We reported positive top-line Phase 2 clinical results for ISIS-FXIRx in patients undergoing total knee replacement.  In this study, ISIS-FXIRx-treated patients experienced a dose-dependent decrease in venous thromboembolism and numerically fewer bleeding events compared to patients treated with enoxaparin.

o

We reported Phase 2 results showing that ISIS-CRPRx produced statistically significant mean reductions of C-reactive protein, or CRP, protein of 65 % with reductions as great as 84% in patients with atrial fibrillation, or AF.  In addition, two patients who had elevated levels of CRP (>5 mg/L) experienced a reduction of CRP that was associated with a decline to zero in overall AF burden while on treatment.

●	We continued to advance our pipeline of drugs.

o	We initiated a Phase 3 study, ENDEAR, of ISIS-SMNRx in infants with SMA and will earn an $18 million milestone payment upon dosing of the first infant.  This is the first of several planned studies in a broad and comprehensive late-stage clinical development program for ISIS-SMNRx.

o	We initiated a Phase 2 study of ISIS-APO(a)Rx in patients with high levels of lipoprotein(a), an independent risk factor for cardiovascular disease.

o	We initiated a Phase 1 study of ISIS-PKKRx, an antisense drug to treat patients with hereditary angioedemia, and a Phase 1 study of ISIS-DMPKRx, an antisense drug to treat patients with myotonic dystrophy type 1.

o	AstraZeneca initiated a Phase 1 study of ISIS-ARRx, an antisense drug discovered by us to treat patients with cancer.

o	We added a new drug, ISIS-HTTRx, to our pipeline. ISIS-HTTRx is part of our alliance with Roche and is in development to treat patients with Huntington's Disease.

●	We and our partners were recognized by the drug development community for our innovative and collaborative alliances and our commitment to developing drugs to treat patients with serious, unmet medical needs.

Critical Accounting Policies

We prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States. As such, we make certain estimates, judgments and assumptions that we believe are reasonable, based upon the information available to us. These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact our quarterly or annual results of operations and financial condition. Each quarter, our senior management reviews the development, selection and disclosure of such estimates with our audit committee of our board of directors. In the following paragraphs, we describe the specific risks associated with these critical accounting policies and we caution that future events rarely develop exactly as one may expect, and that best estimates may require adjustment.

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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:

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Assessing the propriety of revenue recognition and associated deferred revenue;

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

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

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

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Estimating our net deferred income tax asset valuation allowance;

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

 

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, 2013.

Results of Operations

Revenue

Total revenue for the three and six months ended June 30, 2014 was $57.1 million and $85.2 million, respectively, compared to $38.1 million and $81.5 million for the same periods in 2013. Our revenue fluctuates based on the nature and timing of payments under agreements with our partners and consists primarily of revenue from the amortization of upfront fees, milestone payments and license fees.  We earned $40.5 million in revenue from milestone payments in the second quarter of 2014 compared to $1.0 million in the first quarter.

Research and Development Revenue Under Collaborative Agreements

Research and development revenue under collaborative agreements for the three and six months ended June 30, 2014 was $56.6 million and $76.2 million, respectively, compared to $37.6 million and $79.3 million for the same periods in 2013. Our revenue from the amortization of payments from our partners was $31.4 million in the first half of 2014, compared to $19.2 million for the same period in 2013, and increased primarily due to the amortization of upfront fees related to the strategic neurology partnership we entered into with Biogen Idec in September 2013. We also earned $41.5 million in milestone payments in the first half of 2014. The revenue from milestone payments in 2014 was comprised of:

●	$24.5 million from Biogen Idec related to advancing ISIS-SMNRx, initiating a Phase 1 study for ISIS-DMPKRx, and validating an undisclosed target to treat a neurological disorder;

●	$15 million from AstraZeneca related to initiating a Phase 1 clinical study of ISIS-ARRx; and

●	$2 million from GSK related to advancing ISIS-TTRRx.

Licensing and Royalty Revenue

Our revenue from licensing activities and royalties for the three and six months ended June 30, 2014 was $0.4 million and $9.1 million, respectively, compared to $0.5 million and $2.2 million for the same periods in 2013. The increase in the first half of 2014 was primarily a result of the $7.7 million in sublicensing revenue we earned from Alnylam related to its collaboration with Genzyme.

Operating Expenses

Operating expenses for the three and six months ended June 30, 2014 were $63.7 million and $121.6 million, respectively, compared to $46.0 million and $87.8 million for the same periods in 2013 due to higher development costs associated with our maturing pipeline of drugs.

In order to analyze and compare our results of operations to other similar companies, we believe it is important to exclude non-cash compensation expense related to equity awards from our operating expenses. We believe non-cash compensation expense is not indicative of our operating results or cash flows from our operations. Further, we internally evaluate the performance of our operations excluding it. Non-cash compensation expense related to equity awards increased significantly in 2014 compared to 2013 primarily due to the increase in our stock price.

Research, Development and Patent Expenses

Our research, development and patent 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, development and patent expenses (in thousands):

For the three and six months ended June 30, 2014, our total research, development and patent expenses were $52.9 million and $100.4 million, respectively, and were higher compared to $40.4 million and $76.1 million for the same periods in 2013 primarily due to the progression of numerous drugs in our pipeline into later stage clinical trials. As drugs move forward to more advanced stages of development, including into larger, longer clinical studies, the costs of development increase. For example, we initiated Phase 2 studies for several of the drugs in our pipeline in the second half of 2013, which are ongoing. In addition, we incurred more costs in 2014 compared to 2013 associated with the clinical studies of ISIS-SMN_Rx and the Phase 3 study of ISIS-TTR_Rx as we continued to advance those drugs.  All amounts exclude non-cash compensation expense related to equity awards.

We use our proprietary antisense technology to generate information about the function of genes and to determine the value of genes as drug discovery targets. We use this information to direct our own antisense drug discovery research, and that of our 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 drug discovery programs to expand our and our partners' drug pipelines. We anticipate that our existing relationships and collaborations, as well as prospective new partners, will continue to help fund our research programs and contribute to the advancement of the science by funding core antisense technology research.

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

Antisense drug discovery costs for the three and six months ended June 30, 2014 were $10.8 and $19.9 million, respectively, and were essentially flat compared to $10.9 million and $20.3 million for the same periods in  2013. All amounts exclude non-cash compensation expense related to equity awards.

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

Antisense drug development expenses were $30.1 million and $56.5 million, respectively, for the three and six months ended June 30, 2014, compared to $18.3 million and $32.7 million for the same periods in 2013. Expenses in the first half of 2014 were higher compared to the same period in 2013 primarily due to an increase in development costs associated with the progression of numerous drugs in our pipeline into later stage clinical trials.  As drugs move forward to more advanced stages of development, including into larger, longer clinical studies the costs of development increase. For example, we initiated Phase 2 studies for several of the drugs in our pipeline in the second half of 2013, which are ongoing. In addition, we incurred more costs in 2014 compared to 2013 associated with the clinical studies of ISIS-SMN_Rx and the Phase 3 study of ISIS-TTR_Rx as we continued to advance those drugs.  All amounts exclude non-cash compensation expense related to equity awards.

We may conduct multiple clinical trials on a drug candidate, including multiple clinical trials for the various indications we may be studying. Furthermore, as we obtain results from trials we may elect to discontinue clinical trials for certain drug candidates in certain indications in order to focus our resources on more promising drug candidates or indications. Our Phase 1 and Phase 2 programs are clinical research programs that fuel our Phase 3 pipeline. When our products are in Phase 1 or Phase 2 clinical trials, they are in a dynamic state in which we 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 time. This means we are constantly shifting resources among products. Therefore, what we spend on each product during a particular period is usually a function of what is required to keep the products progressing in clinical development, not what products we think are most important. For example, the number of people required to start a new study is large, the number of people required to keep a study going is modest and the number of people required to finish a study is large. However, such fluctuations are not indicative of a shift in our emphasis from one product to another and cannot be used to accurately predict future costs for each product. And, because we always have numerous drugs in preclinical and early stage clinical research, the fluctuations in expenses from drug to drug, in large part, offset one another. If we partner a drug, it may affect the size of a trial, its timing, its total cost and the timing of the related costs. As part of our collaboration with Genzyme, we have transitioned development responsibility for KYNAMRO to Genzyme.  We and Genzyme share development costs equally until KYNAMRO is profitable.

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):

Manufacturing and operations expenses were $5.2 million and $11.0 million, respectively, for the three and six months ended June 30, 2014, compared to $4.4 million and $8.6 million for the same periods in 2013.  Manufacturing increased primarily because we manufactured more drug product to support our drug development activities, including drug product to support the upcoming Phase 3 trial for ISIS-APOCIII_Rx. All amounts exclude non-cash compensation expense related to equity awards.

In our research, development and patent 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.

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

R&D support costs for the three and six months ended June 30, 2014 were $6.7 million and $13.0 million, respectively, and were essentially flat compared to $6.9 million and $13.1 million for the same periods in 2013. All amounts exclude non-cash compensation expense related to equity awards.

General and Administrative Expenses

General and administrative expenses include corporate costs required to support our company, our employees and our stockholders. These costs include personnel and outside costs in the areas of legal, human resources, investor relations, and finance. Additionally, we include in general and administrative expenses such costs as rent, repair and maintenance of buildings and equipment, depreciation, utilities, information technology and procurement costs that we need to support the corporate functions listed above.

The following table sets forth information on general and administrative expenses (in thousands):

General and administrative expenses were $3.2 million and $6.3 million, respectively, for the three and six months ended June 30, 2014, and were essentially flat compared to $3.0 million and $6.1 million for the same periods in 2013. All amounts exclude non-cash compensation expense related to equity awards.

Investment Income

Investment income for the three and six months ended June 30, 2014 was $671,000 and $1.3 million, respectively, compared to $589,000 and $967,000 for the same periods in 2013. The increase in investment income was primarily due to a higher average cash balance and market conditions during the first half of 2014.

Interest Expense

Interest expense for the three and six months ended June 30, 2014 was $5.0 million and $9.9 million, respectively, and was essentially flat compared to $4.8 million and $9.6 million for the same periods in 2013.

Gain (loss) on Investments, net

We recorded a loss on investments of $260,000 and a gain on investments of $137,000 for the three and six months ended June 30, 2014, respectively, compared to a gain on investments of $840,000 and $1.9 million for the same periods in 2013. The net gain on investments in the first half of 2013 was primarily due to $1.1 million we received in the first quarter of 2013 when we sold the stock we held in Sarepta Therapeutics, Inc. and the $844,000 payment we received from Pfizer, Inc. in the second quarter of 2013 related to its acquisition of Excaliard Pharmaceuticals, Inc.

Income Tax Benefit

We recorded a tax expense of $0.9 million and a tax benefit of $1.4 million for the three and six months ended June 30, 2014, respectively, compared to a $1.2 million tax benefit for both the three and six month periods ended  June 30, 2013. Accounting rules require us to allocate our provision for income taxes between continuing operations and other categories of earnings, such as other comprehensive income.  In periods in which we have a year-to-date pre-tax loss from continuing operations and pre-tax income in other categories of earnings, such as other comprehensive income, we must allocate the tax provision to the other categories of earnings. We then record a related tax benefit in continuing operations. The tax benefit we recorded in the first half of 2014 and 2013 is primarily related to the unrealized gains associated with our investments in Regulus and Achaogen.

Net Loss and Net Loss per Share

Net loss for the three and six months ended June 30, 2014 was $12.1 million and $43.4 million, respectively, compared to $10.1 million and $11.8 million for the same periods in 2013. Basic and diluted net loss per share for the three and six months ended June 30, 2014 was $0.10 and $0.37 per share, respectively, compared to $0.09 and $0.11 per share for the same periods in 2013.  Our net loss increased in the first half of 2014 primarily due to the planned increase in operating expenses associated with our maturing pipeline of drugs.

Liquidity and Capital Resources

We have financed our operations with revenue primarily from research and development collaborative agreements. Additionally, we have earned revenue from the sale or licensing of our intellectual property. We have also financed our operations through the sale of our equity securities and the issuance of long-term debt. From our inception through June 30, 2014, we have earned approximately $1.3 billion in revenue from contract research and development and the sale and licensing of our intellectual property.  From the time we were founded through June 30, 2014, we have raised net proceeds of approximately $1.1 billion from the sale of our equity securities and we have borrowed approximately $786.9 million under long-term debt arrangements to finance a portion of our operations.

At June 30, 2014, we had cash, cash equivalents and short-term investments of $590.8 million and stockholders' equity of $366.9 million. In comparison, we had cash, cash equivalents and short-term investments of $656.8 million and stockholders' equity of $378.4 million at December 31, 2013. At June 30, 2014, we had consolidated working capital of $605.0 million, compared to $637.7 million at December 31, 2013. The decrease in our cash and working capital relates to cash used to fund our operations. Our cash balance at June 30, 2014 does not include approximately $41 million in payments that we recognized into revenue in the second quarter and received in the third quarter.

As of  June 30, 2014, our debt and other obligations totaled $281.5 million compared to $283.5 million at December 31, 2013. The decrease was primarily due to rent and principal payments we made in the first half of 2014 on our lease obligations and notes payable.

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The following table summarizes our contractual obligations as of June 30, 2014. The table provides a breakdown of when obligations become due. We provide a more detailed description of the major components of our debt in the paragraphs following the table: