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Isis Pharmaceuticals 10-K 2006 Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 Form 10-K/A ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 Commission file number 0-19125 Isis Pharmaceuticals, Inc. (Exact name of Registrant as specified in its charter)
1896 Rutherford Road, Carlsbad, CA 92008 (Address of principal executive offices, including zip code) 760-931-9200 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to
Section 12(g) of the Act: Indicate by check mark whether the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” 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 12b-2 of the Act). Yes o No x The approximate aggregate market value of the voting common stock held by non-affiliates of the registrant, based upon the last sale price of the common stock reported on the National Association of Securities Dealers Automated Quotation National Market System was $174,075,233 as of June 30, 2005.* The number of shares of voting common stock outstanding as of March 1, 2006 was 72,479,785. DOCUMENTS INCORPORATED BY REFERENCE (To the extent indicated herein) Portions of the registrant’s definitive Proxy Statement to be filed on or about March 22, 2006 with the Securities and Exchange Commission in connection with Registrant’s annual meeting of stockholders to ber held on May 3, 2006 are incorporated by reference into Part III of this Report. The Exhibit Index (Item No. 15) located on pages 72 to 77 incorporates several documents by reference as indicated therein. * Excludes 13,007,479 shares of common stock held by directors and officers and by stockholders whose beneficial ownership is known by the Registrant to exceed 10% of the common stock outstanding at June 30, 2005. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant.
EXPLANATORY NOTE Isis Pharmaceuticals, Inc.
(the “Company”) is filing this Amendment to its Annual Report on Form 10-K for
the year ended December 31, 2005, filed with the Securities Exchange Commission
on March 16, 2006 (“Original Filing”), to modify Part II, Item 8, Consolidated Financial Statements (“F Pages”),
to reclassify cash equivalents that were inadvertently classified as short term
investments in the Company’s Consolidated Balance Sheet at December 31, 2005.
The Company’s working capital and total of cash, cash equivalents and
short-term investments were accurately stated in all items of the Original
Filing. Although we are including in this Amendment the complete text of the F
Pages, the only changes to the F Pages from those previously filed with the Original
Filing are as follows:
Item 15. of Part IV, Exhibits, of this Amendment has been revised to contain a currently-dated consent of our independent registered public accounting firm. Additionally, Item 15. of Part IV, Exhibits, of this Amendment has been revised to contain currently-dated certifications from our Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of our Chief Executive Officer and Chief Financial Officer are attached to this Form 10-K/A as Exhibits 31.1, 31.2 and 32.1, respectively.
As this Amendment only relates to the F Pages, the previously issued Management’s Discussion and Analysis in the Original Filing is unchanged. This Amendment does not reflect events occurring after the filing of our Annual Report on Form 10-K or include, or otherwise modify or update, the disclosure contained therein in any way except as expressly indicated above. Accordingly, this Amendment should be read in conjunction with the Original Filing and the Company’s filings made with the Securities and Exchange Commission subsequent to the Original Filing.
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FORWARD-LOOKING STATEMENTS This report on Form 10-K/A and the information incorporated herein by reference contain forward-looking statements regarding our business, our financial position and the therapeutic and commercial potential of our technologies and products in development. Any statement describing our goals, expectations, intentions or beliefs is a forward-looking statement and should be considered an at-risk statement, including those statements that are described as our goals. 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, in developing and commercializing systems to identify infectious organisms that are effective and commercially attractive, and in the endeavor of building a business around such products. 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. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in our report on Form 10-K for the year ended December 31, 2005 filed with the Securities Exchange Commission on March 16, 2006, including those identified in Item 1A entitled “Risk Factors”. 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. TRADEMARKS Affinitak™
is a trademark of Eli Lilly and Company.
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PART IV Item 15. Exhibits and Financial Statement Schedules (a)(1) Index to Financial Statements We submitted the consolidated financial statements required by this item in a separate section beginning on page F-1 of this Report. (a)(2) Index to Financial Statement Schedules We omitted these schedules because they are not required, or are not applicable, or the required information is shown in the consolidated financial statements or notes thereto. (a)(3) Index to Exhibits See Index to Exhibits on pages 6. (b) Exhibits We listed the exhibits required by this Item under Item 15(a)(3). (c) Financial Statement Schedules None.
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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly authorized on the 9th day of August, 2006.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
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INDEX TO EXHIBITS
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(1) Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (No. 33-39640) or amendments thereto and incorporated herein by reference.
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(2) Filed as an exhibit to Registrant’s Notice of Annual Meeting and Proxy Statement for the 2004 Annual Meeting of Stockholders, filed with the SEC on April 12, 2004, and incorporated herein by reference. (3) Not used. (4) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. (5) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. (6) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. (7) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 and incorporated herein by reference. (8) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 and incorporated herein by reference. (9) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference. (10) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. (11) Filed as an exhibit to the Registrant’s Registration Statement on Form S-3 (No. 333-71911) or amendments thereto and incorporated herein by reference. (12) Filed as an exhibit to the Registrant’s Annual Report Form 10-K for the year ended Dec 31, 2003 and incorporated herein by reference. (13) Filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and incorporated herein by reference. (14) Filed as an exhibit to the Registrant’s Report on Form 8-K dated January 28, 2000, as amended on October 5, 2001, and incorporated herein by reference. (15) Filed as an exhibit to the Registrant’s Report on Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference. (16) Filed as an exhibit to the Registrant’s Registration Statement on Form S-3 (No. 333-89066), originally filed on May 24, 2002, or amendment thereto and incorporated by reference. (17) Filed as an exhibit to Registrant’s Report on Form 8-K dated December 8, 2000 and incorporated herein by reference. (18) Filed as Exhibit 10.24 to Alnylam Pharmaceutical Inc.’s Registration Statement on Form S-1, File No. 333-113162, and incorporated herein by reference. (19) Filed as an exhibit to the Registrant’s report on Form 10-Q/A for the quarter ended June 30, 2001 and incorporated herein by reference. (20) Filed as an exhibit to the Registrant’s Report on Form 8-K dated August 29, 2001 and incorporated herein by reference. (21) Filed as an exhibit to the Registrant’s Report on Form 8-K filed October 29, 2001 and incorporated herein by reference. (22) Filed as an exhibit to the Registrant’s Report on Form 8-K filed December 12, 2001 and incorporated herein by reference.
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(23) Filed as Exhibit 10.25 to Alnylam Pharmaceutical Inc.’s Registration Statement on Form S-1, File No. 333-113162, and incorporated herein by reference. (24) Filed as an exhibit to the Registrant’s Report on Form 8-K filed January 4, 2002 and incorporated herein by reference. (25) Filed as an exhibit to the Registrant’s Report on Form 8-K dated January 7, 2002 and incorporated herein by reference. (26) Filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference. (27) Filed as an exhibit to the Registrant’s Report on Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference. (28) Filed as an exhibit to the Registrant’s Report on Form 8-K dated September 16, 2002 and incorporated herein by reference. (29) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference. (30) Filed as an exhibit to the Registrant’s Report on Form 8-K dated November 6, 2002 and incorporated herein by reference. (31) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. (32) Filed as an exhibit to the Registrant’s Report on Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference. (33) Filed as an exhibit to the Registrant’s Report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference. (34) Filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference. (35) Filed as an exhibit to Registrant’s Current Report on Form 8-K dated April 7, 2005 and incorporated herein by reference. (36) Filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005 and incorporated herein by reference. (37) Filed as an exhibit to Registrant’s Current Report on Form 8-K dated August 22, 2005 and incorporated herein by reference. (38) Filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and incorporated herein by reference. (39) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference. (40) Filed as an exhibit to Registrant’s Current Report on Form 8-K dated February 27, 2006 and incorporated herein by reference. (41) Previously filed as an exhibit to the initial filing of this Report on Form 10-K. (42) Filed as part of of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005, reference is made to page 71. * Indicates management compensatory plans and arrangements as required to be filed as exhibits to this Report pursuant to Item 14(c).
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ISIS PHARMACEUTICALS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The Board of Directors and Stockholders of Isis Pharmaceuticals, Inc. We have audited the accompanying consolidated balance sheets of Isis Pharmaceuticals, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Isis Pharmaceuticals, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Isis Pharmaceuticals, Inc.’s and subsidiaries’ internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2006 expressed an unqualified opinion thereon.
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ISIS PHARMACEUTICALS, INC. CONSOLIDATED BALANCE
SHEETS
See accompanying notes.
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ISIS PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS
OF OPERATIONS
See accompanying notes.
F-4
ISIS PHARMACEUTICALS, INC. CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
See accompanying notes.
F-5
ISIS PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
See accompanying notes.
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ISIS PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Significant Accounting Policies Basis of Presentation The condensed consolidated financial statements include the accounts of Isis Pharmaceuticals, Inc. (“the Company”) and its wholly-owned subsidiaries, Isis Pharmaceuticals Singapore Pte Ltd., Isis USA Limited, Hepasense, Ltd., and Orasense, Ltd. On July 25, 2005, Isis dissolved the Hepasense, Ltd. subsidiary. As more fully described in Note 8—Restructuring Activities, the Company closed its Singapore operations in early 2005. Organization and business activity Isis Pharmaceuticals was incorporated in California on January 10, 1989. In conjunction with its initial public offering, Isis Pharmaceuticals was reorganized as a Delaware corporation, as Isis Pharmaceuticals, Inc. (“Isis” or the “Company”), in April 1991. Isis was organized principally to develop human therapeutic drugs using antisense and combinatorial technology. Basic net loss per share Isis follows the provisions of Statement of Financial Accounting Standards (SFAS) No. 128 Earnings per Share. Isis computes basic loss per share by dividing the net loss applicable to common stock by the weighted average number of common shares outstanding during the period (“Basic EPS method”). Isis computes diluted earnings (loss) per common share using the weighted-average number of common and dilutive common equivalent shares outstanding during the period (“Diluted EPS method”). Diluted common equivalent shares of 13.0 million at December 31, 2005 consisted of shares issuable upon exercise of stock options and convertible debt. As Isis incurred a loss in the years ended December 31, 2005, 2004 and 2003, Isis did not include diluted common equivalent shares in the computation of diluted net loss per share because the effect would be anti-dilutive. Contract revenue and expenses Contract revenue consists of non-refundable research and development funding and Isis records contract revenue as earned based on the performance requirements of Isis’ collaborative research and development contracts. Isis recognizes contract fees for which no further performance obligations exist when Isis receives the payments or when Isis is reasonably certain it can collect the receivable. Isis records payments received in excess of amounts earned as deferred contract revenue. The Company expenses research and development costs as incurred. For the years ended December 31, 2005, 2004 and 2003, research and development costs of approximately $30.4 million, $36.3 million, and $30.2 million, respectively, were related to collaborative research and development arrangements. Revenue recognition Isis recognizes revenue when all of its contractual obligations are satisfied and collection of the underlying receivable is reasonably assured. Research and development revenue under collaborative agreements Isis recognizes research and development revenue under collaborative agreements as it incurs the related expenses, up to contractual limits. Isis defers payments received under these agreements that relate to future performance and records revenue as Isis earns it over the specified future performance period. Isis recognizes revenue that relates to nonrefundable, upfront fees over the period of the contractual arrangements as Isis satisfies
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its performance obligations. Isis recognizes revenue that relates to milestones, under existing arrangements, upon completion of the milestone’s performance requirement. Isis recognizes revenue from arrangements entered into subsequent to June 30, 2003 in accordance with Emerging Issues Task Force Issue No. 00-21 (“EITF 00-21”) Accounting for Revenue Arrangements with Multiple Deliverables. This issue addresses the timing and method of revenue recognition for revenue arrangements that include the delivery of more than one product or service. Isis sometimes enters into revenue arrangements that contain multiple deliverables. In these cases, Isis recognizes revenue from each element of the arrangement as long as Isis can determine a separate value for each element, Isis has completed its obligation to deliver or perform on that element, and Isis is reasonably assured of collecting the resulting receivable. Isis recognizes revenue from federal contracts and grants in the period in which it pays for the related expenditures. Isis recognizes revenue from product sales as it ships the products. Isis has implemented the provisions of Staff Accounting Bulletin No. 104 (“SAB 104”), which was issued in December 2003. SAB 104 updates portions of the interpretive guidance included in Topic 13 of the codification of Staff Accounting Bulletin No. 101 in order to make this interpretive guidance consistent with current authoritative accounting guidance and SEC rules and regulations. SAB 104 provides interpretation on selected revenue recognition issues and when revenue is properly recognizable. Revenue should not be recognized until it is realized or realizable and earned. It must meet the following criteria: 1) persuasive evidence of an arrangement exists, 2) delivery occurred or services were rendered, 3) the seller’s price to the buyer is fixed or determinable and 4) collectibility is reasonably assured. As part of Isis’ alliance with Eli Lilly and Company (“Lilly”) in August 2001, Lilly provided Isis a $100.0 million interest free loan to fund the research collaboration. In August 2005, Isis converted the loan into 2.5 million shares of its common stock. During the four years prior to conversion Isis made quarterly draw downs on the loan, which Isis discounted to their net present value by imputing interest on the amount at 20%, which represented market conditions in place at the time Isis entered into the loan. Isis accreted the loan up to its face value over its term by recording interest expense. The difference between the cash received and the present value of the loan represented value Lilly gave to Isis to help fund the research collaboration. Isis accounted for this value as deferred revenue and recognized it as revenue over the period of performance. This is more fully described in Note 4—Long-Term Obligations and Commitments and Note 6—Collaborative Arrangements and Licensing Agreements. Licensing and royalty revenue Isis recognizes licensing and royalty revenue immediately, if collectibility is reasonably assured, and if Isis is not required to provide services in the future. Concentration of credit risk Financial instruments that potentially subject Isis to concentrations of credit risk consist primarily of cash equivalents, short-term investments and receivables. Isis places its cash equivalents and certain of its short-term investments with high credit-quality financial institutions. Isis invests its excess cash primarily in auction and money market instruments, and municipal and floating rate bonds. Isis and its audit committee establish guidelines relative to credit ratings, diversification and maturities that seek to maintain safety and liquidity. Cash, cash equivalents and short-term investments Isis considers all liquid investments with maturities of ninety days or less when purchased to be cash equivalents. Isis’ short-term investments have initial maturities of greater than ninety days from date of purchase. Isis classifies its securities as “available-for-sale” in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. Isis carries these investments at fair market value with any unrealized
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gains and losses recorded as a separate component of stockholders’ equity. Fair value is based upon market prices quoted on the last day of the fiscal period. Isis uses the specific identification method to determine the cost of debt securities sold. Isis includes gross realized gains and losses in investment income. During 2005, Isis sold a portion of its investment in Alnylam Pharmaceuticals, Inc. resulting in a realized gain of $951,000. Further, Isis determined that there were no other-than-temporary declines in value of investments during the year. During the third quarter of 2004, Isis recorded a non-cash loss on investments of $5.1 million, principally related to the impairment of the Company’s equity investment in Alnylam. This loss on investments reflected a decrease in the market value of Alnylam’s stock in 2004, which Isis believes was primarily a result of financial market conditions related to biotechnology companies. In the fourth quarter of 2004, Isis recorded a net unrealized gain of $1.4 million related to its equity investment in Alnylam as a separate component of stockholders’ equity. This reflected the increase in the market value of the investment since the impairment in the third quarter of 2004. Additionally, Isis recorded a net unrealized gain of $2.8 million in 2005 reflecting the further increase in market value of its investment in Alnylam. Inventory valuation Isis includes in inventory material costs and related manufacturing 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. Isis expenses these costs when it delivers its drugs to partners, or as it provides these drugs for its own clinical trials. Isis reflects its inventory on the balance sheet at the lower of cost or market value under the first-in, first-out method. Isis reviews inventory periodically and reduces the carrying value of items considered to be slow moving or obsolete to their estimated net realizable value. Isis considers several factors in estimating the net realizable value; including shelf life of raw materials, alternative uses for its drugs and clinical trial materials and historical write-offs. In 2004, Isis reduced the carrying value of its inventory by $21.0 million related to its restructuring activities. (Note 8—Restructuring Activities). Inventory includes the following categories as of December 31, 2005 and 2004 (net realizable value, in thousands):
Property, plant and equipment Property, plant and equipment are stated at cost and consist of the following (in thousands):
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Depreciation of property, plant and equipment is provided on the straight-line method over estimated useful lives as follows:
Leasehold improvements are depreciated using the shorter of the estimated useful life or remaining lease term. Licenses Isis obtains licenses from third parties and capitalizes the costs related to exclusive licenses. Isis’ license from Hybridon comprises the majority of the license balance as of December 31, 2005, 2004 and 2003. Isis amortizes capitalized licenses over their estimated useful life or term of the agreement, which for current licenses is between 8 years and 15 years. Accumulated amortization related to licenses was $12.2 million and $9.8 million at December 31, 2005 and 2004, respectively. Based on existing licenses, estimated amortization expense related to licenses is $2.3 million for each of the years ending December 31, 2006, 2007, 2008, 2009 and 2010. Patents Isis capitalizes costs consisting principally of outside legal costs and filing fees related to obtaining patents. Isis reviews its capitalized patent costs regularly to determine that they include costs for patent applications Isis is pursuing. Isis evaluates costs related to patents that the Company is not actively pursuing for impairment and writes off any of these costs, if appropriate. Isis amortizes patent costs over their estimated useful lives of 10 years, beginning with the date the patents are issued. The weighted average remaining life of issued patents was 5.2 years and 6.1 years at December 31, 2005 and 2004, respectively. In 2005 and 2004, Isis recorded a non-cash charge of $1.7 million and $6.1 million, respectively, related to the write-down of its patent costs to their estimated net realizable values (Note 8—Restructuring Activities). Accumulated amortization related to patents was $7.0 million and $5.4 million at December 31, 2005 and 2004, respectively. Based on existing patents, estimated amortization expense related to patents is as follows (in millions):
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Investment in affiliates In April 1999 and January 2000, Isis and Elan formed Orasense, Ltd. and Hepasense, Ltd., respectively, both Bermuda limited companies. Each joint venture was owned 80.1% by Isis and 19.9% by Elan. In 2002, Elan concluded its participation in both the Orasense and HepaSense collaborations. In June 2004, Isis acquired Elan’s minority interest in Orasense and HepaSense. As a result, Isis owned 100% of Orasense and HepaSense at December 31, 2004. Isis dissolved the Hepasense subsidiary in July 2005. At December 31, 2005, Isis owned 100% of Orasense.
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Fair value of financial instruments Isis has determined the estimated fair value of its financial instruments. The amounts reported for cash, accounts receivable, accounts payable and accrued expenses approximate the fair value because of their short maturities. Isis reports its investment securities at their estimated fair value based on quoted market prices of comparable instruments. Long-lived assets Isis periodically evaluates carrying values of long-lived assets including property, plant and equipment and intangible assets, when events and circumstances indicate that these assets may have been impaired. Isis has adopted SFAS 144, Accounting for the Impairment of Long-Lived Assets. In 2005 and 2004, Isis recorded a charge of $15.6 million and $11.5 million, respectively, related to the write-down of equipment and intangible assets to their estimated net realizable values. (Note 8—Restructuring Activities). Use of estimates The preparation of 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 consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Consolidation of variable interest entities Isis has implemented the provisions of Financial Accounting Standards Board Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, which addresses consolidation by business enterprises of 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. As of December 31, 2005, Isis had collaborative arrangements with three entities that it considers to be Variable Interest Entities (“VIE”) under FIN 46. As part of the collaboration between Isis and Ercole Biotech, Inc., during 2003 and early 2004, Isis paid Ercole $750,000 in exchange for a convertible note. Isis expensed the payments when made. The note will convert into securities that Ercole issues in a financing. Isis is not required to consolidate Ercole’s results of operations under FIN No. 46 as Isis is not the primary beneficiary. As part of the collaboration between Isis and Sarissa Inc., during February 2005, Isis licensed an anti-cancer antisense drug to Sarissa in exchange for a $1.0 million convertible note. The note will convert into securities that Sarissa issues in a financing. Isis has recognized a valuation allowance of $1.0 million to offset the note, as realization of this asset is uncertain. Isis is not required to consolidate Sarissa’s results of operations under FIN No. 46 as Isis is not the primary beneficiary. As part of the collaboration between Isis and iCo Therapeutics, Inc., during August 2005, Isis licensed iCO 007, an antisense drug to iCo in exchange for a $500,000 upfront fee consisting of a $250,000 cash payment and a $250,000 convertible note. The note will convert into securities that iCo issues in a financing. Isis has recognized a valuation allowance of $250,000 to offset the note, as realization of this asset is uncertain. In December 2005, the Company entered into a manufacturing and supply agreement with iCo. Under the agreement, iCo will purchase drug manufactured by Isis for $700,000. iCo made a $525,000 prepayment to Isis consisting of $175,000 in cash and a $350,000 convertible note, which will convert into iCo stock upon iCo’s completion of a
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financing. The remaining $175,000 will be paid upon shipment of the drug. Isis has recognized a valuation allowance of $350,000 to offset the note, as realization of this asset is uncertain. Isis is not required to consolidate iCo’s results of operations under FIN No. 46 as Isis is not the primary beneficiary. Stock-based compensation In January 2000, Isis offered non-officer employees an opportunity to exchange certain of their existing out-of-the-money stock options for new options with exercise prices at the then-current market value. These options are required to be accounted for as variable stock options in accordance with Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB Opinion No. 25. Isis reported the resulting compensation expense in its statements of operations. As of December 31, 2002, option holders had exchanged all of these options, or the options had expired. As of December 31, 2005 all of the exchanged, unexpired options were fully vested. In April 2003, Isis implemented an employee stock option exchange program (“2003 option exchange program”). The 2003 option exchange program allowed employees during the offering period, which began on April 8, 2003 and ended on May 8, 2003, to surrender options granted prior to January 5, 2002, which had higher exercise prices, in exchange for a lesser number of options, which had lower exercise prices. Employees exchanged 2.2 million options having a weighted-average exercise price of $14.89 for 1.0 million options having an exercise price of $5.15. The new options vest over three years beginning on January 1, 2003 and expire on December 31, 2008. Isis accounts for the affected options, until all these options have been exercised or cancelled, using variable accounting consistent with the provisions of APB 25 and FIN 44. As a result, Isis recorded non-cash compensation benefit of $544,000 and $6,000 in 2005 and 2004, respectively, and will continue to account for the affected options using variable accounting. These amounts are included in Compensation benefit related to stock options on the Consolidated Statements of Operations and include compensation expense related to non-employee options of $13,000 and $2,000 for 2005 and 2004, respectively. Isis has adopted the disclosure-only provision of SFAS 123, Accounting for Stock-Based Compensation (“SFAS 123”). Accordingly, Isis has not recognized compensation expense, except for compensation expense primarily related to the affected options from the 2000 and 2003 option exchange programs, for the Isis stock option plans and the employee stock purchase plan (“ESPP”). Had Isis determined compensation expense consistent with SFAS 123, Isis would have reported the following pro forma amounts for net loss and basic and diluted net loss per share (in thousands, except per share amounts):
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For purposes of pro forma disclosures, Isis estimated the fair value of each option grant and ESPP purchase rights on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
The weighted average fair value of options granted was $5.51 for 2005, $6.58 for 2004, and $5.70 for 2003. The weighted average fair value of the ESPP purchase rights was $4.59, $4.67, and $4.46 for 2005, 2004, and 2003, respectively. Comprehensive loss SFAS 130, Reporting Comprehensive Income (“SFAS 130”) requires Isis to display comprehensive loss and its components as part of Isis’ full set of consolidated financial statements. The measurement and presentation of net loss did not change. Comprehensive loss is comprised of net loss and certain changes in equity that are excluded from net loss. Specifically, SFAS 130 requires unrealized holding gains and losses on Isis’ available-for-sale securities, which Isis reports separately in stockholders’ equity, to be included in accumulated other comprehensive loss. Comprehensive loss for the years ended December 31, 2005, 2004 and 2003 has been reflected in the Consolidated Statements of Stockholders’ Equity. Segment Information Isis operates in two separate segments; Drug Discovery and Development and its Ibis division. In accordance with SFAS 131, Disclosure about Segments of an Enterprise and Related Information, Isis provides segment financial information and results for Drug Discovery and Development and its Ibis division based on the segregation of revenues and expenses used for management’s assessment of operating performance and operating decisions. Expenses shared by the segments require the use of judgments and estimates in determining the allocation of expenses to the two segments. Different assumptions or allocation methods could result in materially different results by segment. Isis does not include asset or liability information by reportable segment since Isis does not currently segregate this information by segment and it is not used for purposes of making decisions about allocating resources to the segments and assessing their performance. Impact of recently issued accounting standards In November 2005, the Financial Accounting Standards Board issued FASB Staff Position FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss. FSP 115-1 codifies the guidance set forth in EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, issued in March 2004. FSP 115-1 also includes accounting considerations subsequent to the recognition of other-than-temporary impairment and requires certain disclosure about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is effective for reporting periods beginning after December 15, 2005 and Isis will adopt FSP 115-1 on January 1, 2006. Isis does not believe the adoption of FSP 115-1 will have a material impact on its financial statements.
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In May 2005, the FASB released Statement of Financial Accounting Standard (“SFAS”) No. 154, “Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3”. FAS 154 requires retrospective application to prior periods’ financial statements for any changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. The statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The statement carries forward, without change, the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. In accordance with the new rule requirements, Isis will adopt FAS 154 for any accounting changes or corrections of errors on January 1, 2006. Isis does not expect the adoption of FAS 154 to have a material impact on its consolidated financial position, results of operations, or cash flows. On December 16, 2004, the FASB issued SFAS 123(R), “Share-Based Payment” which requires companies to expense the estimated fair value of employee stock options and similar awards. On April 14, 2005, the U.S. Securities and Exchange Commission adopted a new rule amending the compliance dates for FAS 123(R). In accordance with the new rule, the accounting provisions of FAS 123(R) will be effective for Isis on January 1, 2006. Isis will adopt the provisions of FAS 123(R) using a modified prospective application. The modified prospective application will apply to new awards and to awards that are outstanding on the effective date and are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been rendered as of the effective date will be recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under FAS 123. As permitted by FAS 123, Isis currently accounts for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of FAS 123(R)’s fair value method may have a significant impact on its results of operations, although it will have no impact on its overall financial position. Isis cannot predict at this time the impact of adoption of FAS 123(R) because it will depend on levels of share-based payments granted in the future. However, had Isis adopted FAS 123(R) in prior periods, the impact of that standard would have approximated the impact of FAS 123 as described in the disclosure of pro forma net income and earnings per share in Note 1 to the consolidated financial statements. FAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While Isis cannot estimate what those amounts will be in the future, as a result of its accumulated losses to date, Isis has not recognized a benefit of tax deductions in excess of recognized compensation cost in operating cash flows. In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”, an amendment of ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43 Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “ . . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal to require treatment as current period charges . . .” This statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production
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facilities. The provisions of this statement will be effective for inventory costs during the fiscal years beginning after June 15, 2005. Isis does not believe that the adoption of this statement will have a material impact on its financial condition or results of operations. 2. Investments Isis invests its excess cash in United States Government securities and debt instruments of financial institutions and corporations with strong credit ratings. Isis has established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to maximize trends in yields and interest rates without compromising safety and liquidity. The following table summarizes the contract maturity of debt securities held by Isis as of December 31, 2005:
Isis has an ownership interest of less than 20% each in two public and two private companies it conducts business with, and accounts for them under the cost method of accounting according to APB 18. The companies are Alnylam and ATL, which are publicly-traded, and Santaris Pharma A/S (“Santaris”) and OncoGenex, which are privately-held. In determining if and when decreases in market value of Isis’ equity positions below their cost are other-than-temporary, Isis examines historical trends in stock prices, the financial condition and near term prospects of the issuers, and Isis’ current need for cash. When Isis determines that a decline in value is other-than-temporary, Isis recognizes an impairment loss in the current period operating results to the extent of the decline. See Note 1—Organization and Significant Accounting Policies for a discussion of impairment losses incurred in 2005 and 2004. The following is a summary of Isis’ investments accounted for as available-for-sale securities (in thousands):
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Investments considered to be temporarily impaired at December 31, 2005 are as follows (in thousands):
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