Isis Pharmaceuticals 10-Q 2007
Washington, DC 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
For the Quarterly Period Ended March 31, 2007
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
For the transition period from to
Commission file number 0-19125
Isis Pharmaceuticals, Inc.
(Exact name of Registrant as specified in its charter)
1896 Rutherford Road, Carlsbad, CA 92008
(Address of principal executive offices, including zip code)
(Registrants 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 is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act): Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o
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 May 7, 2007 was 82,534,511.
ISIS PHARMACEUTICALS, INC.
AffinitakTM is a trademark of Eli Lilly and Company.
OrasenseTM is a trademark of Isis Pharmaceuticals, Inc.
Ibis BiosciencesTM is a trademark of Isis Pharmaceuticals, Inc.
Ibis T5000TM is a trademark of Isis Pharmaceuticals, Inc.
Vitravene® is a registered trademark of Novartis AG.
Isis Pharmaceuticals® is a registered trademark of Isis Pharmaceuticals, Inc.
See accompanying notes
ISIS PHARMACEUTICALS, INC.
(in thousands, except for per share amounts)
See accompanying notes.
ISIS PHARMACEUTICALS, INC.
See accompanying notes.
ISIS PHARMACEUTICALS, INC.
March 31, 2007
1. Basis of Presentation
The unaudited interim condensed consolidated financial statements for the three month periods ended March 31, 2007 and 2006 have been prepared on the same basis as the audited financial statements for the year ended December 31, 2006. The financial statements include all normal recurring adjustments, which Isis considers necessary for a fair presentation of the financial position at such dates and the operating results and cash flows for those periods. Results for the interim periods are not necessarily indicative of the results for the entire year. For more complete financial information, these financial statements, and notes thereto, should be read in conjunction with the audited financial statements for the year ended December 31, 2006 included in Isis 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. and its wholly owned subsidiaries, Ibis Biosciences, Inc. (Ibis), Isis Pharmaceuticals Singapore Pte Ltd., Isis USA Ltd. and Orasense, Ltd. On October 25, 2006, Isis dissolved the Orasense, Ltd. subsidiary. As part of its restructuring activities, Isis closed its Singapore operations in early 2005. In addition to its wholly owned subsidiaries, the condensed consolidated financial statements include one variable interest entity, Symphony GenIsis, Inc., for which Isis is the primary beneficiary as defined by Financial Accounting Standards Board Interpretation (FIN) 46R (revised 2003), Consolidation of Variable Interest Entities, an Interpretation of ARB 51. All significant intercompany balances and transactions have been eliminated.
2. Significant Accounting Policies
Isis follows the provisions as set forth by Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements, SAB 104, Revenue Recognition, and Financial Accounting Standards Board Emerging Issues Task Force (EITF) 00-21, Accounting for Revenue Arrangements with Multiple Deliverables.
Isis generally recognizes revenue when it has satisfied all contractual obligations and is reasonably assured of collecting the resulting receivable. Isis is often entitled to bill its customers and receive payment from its customers in advance of recognizing the revenue under current accounting rules. In those instances where Isis has billed its customers or received payment from its customers in advance of recognizing revenue, the amounts are included in deferred revenue on the balance sheet.
Research and development revenue under collaborative agreements
Isis often enters into collaborations where it receives non-refundable upfront payments for prior or future expenditures. Isis recognizes revenue related to upfront payments ratably over the period of the contractual arrangements as it satisfies its performance obligations. Occasionally, Isis is required to estimate the period of a contractual arrangement or its performance obligations when the agreements it enters into do not clearly define such information. Should different estimates prevail, revenue recognized could be materially different. Isis has made estimates of its continuing obligations on several agreements.
Isis collaborations often include contractual milestones. When it achieves these milestones, it is entitled to payment, as defined by the underlying agreements. Isis generally recognizes revenue related to milestone payments upon completion of the milestones performance requirement, as long as it is reasonably assured of collecting the resulting receivable and it is not obligated for future performance related to the achievement of the milestone.
Isis generally recognizes revenue related to the sale of its drug inventory as it ships or delivers drugs to its partners. In several instances, Isis completed the manufacturing of drugs, but its partners asked it to deliver the drug on a later date. Under these circumstances, Isis ensured that its obligations were complete under the terms of the manufacturing agreement in place and title had transferred to the customer before it recognized the related revenue.
Isis often enters into revenue arrangements that contain multiple deliverables. In these cases, it recognizes revenue from each element of the arrangement as long as it is able to determine a separate value for each element, it has completed its obligation to deliver or perform on that element and it is reasonably assured of collecting the resulting receivable.
In the fourth quarter of 2006 and the first quarter of 2007, Isis delivered its first two commercial Ibis T5000 Biosensor Systems. The sale of each Ibis T5000 Biosensor System contains multiple elements. Since Isis had no previous experience of commercially selling the Ibis T5000 Biosensor System, it had no basis to determine the fair values of the various elements included in each system; therefore, it must account for the entire system as one deliverable and recognize revenue over the entire period of performance. For a one-year period following the sale, Isis has ongoing support obligations for the Ibis T5000 Biosensor System, therefore it is amortizing the revenue for the entire system over a one-year period. Once Isis obtains a sufficient number of sales to enable it to identify each elements fair value, it will be able to recognize revenue separately for each element.
Licensing and royalty revenue
Isis often enters into agreements to license its proprietary patent rights on an exclusive or non-exclusive basis in exchange for license fees and/or royalties. Isis generally recognizes as revenue immediately those licensing fees and royalties for which it has no future performance obligations and is reasonably assured of collecting the resulting receivable.
Isis has equity investments in privately- and publicly-held biotechnology companies. Isis holds ownership interests of less than 20% in each of the respective entities. In determining if and when a decrease in market value below cost in Isis equity positions is other-than-temporary, Isis examines historical trends in the stock price, the financial condition of the issuer and the near term prospects of the issuer. When Isis determines that a decline in value is other-than-temporary, Isis recognizes an impairment loss in the period in which the other-than-temporary decline occurs. Isis determined that there were no other-than-temporary declines in value of its investments during the three months ended March 31, 2007 and 2006. During the first quarter of 2007, Isis sold a portion of the equity securities of Alnylam Pharmaceuticals, Inc. that it owned resulting in a realized gain of $1.5 million. In April 2007, Isis sold the remaining equity securities of Alnylam resulting in a realized gain of $2.0 million, which will be reflected in the statement of operations in the second quarter of 2007.
Isis includes in inventory material costs for drugs that Isis manufactures for its partners under contractual terms and that Isis uses primarily in its 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. Also included in inventory are material costs and related manufacturing costs associated with the Ibis T5000 Biosensor System and related assay kits. 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. Total inventory, which consisted solely of raw materials, was $1.1 million and $861,000 as of March 31, 2007 and December 31, 2006, respectively.
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 that have future value. Isis evaluates costs related to patents that Isis is not actively pursuing 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. For the first three months of 2007 and 2006, Isis recorded a non-cash charge of $168,000 and $176,000, which was included in
research and development expenses and was related to the write-down of its patent costs to their estimated net realizable values.
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 Statement of Financial Accounting Standards (SFAS) 144, Accounting for the Impairment of Long-Lived Assets. Isis recorded a charge of $168,000 and $176,000 for the first quarter of 2007 and 2006, respectively, primarily related to the write-down of intangible assets to their estimated net realizable values.
In July 2006, the Financial Accounting Standards Board (FASB) issued FIN 48, Accounting for Uncertainty in Income Taxes, which addressed the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, Isis must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. The accounting provisions of FIN 48 became effective for Isis beginning January 1, 2007.
At December 31, 2006, Isis had federal, foreign and California tax net operating loss (NOL) carryfowards of approximately $560.0 million, $1.0 million and $179.5 million, respectively. The federal and California NOL carryforwards began expiring in 2007. The foreign NOL may be carried forward indefinitely and used to offset future taxable profits in the foreign jurisdiction in which this NOL arose, provided there is no substantial change in ownership. Isis also had federal and California research and development (R&D) credit carryforwards of approximately $25.7 million and $18.5 million, respectively. The R&D tax credits began expiring in 2007. Because realization of such tax benefits is uncertain, Isis has provided a 100% valuation allowance. As a result of the adoption of FIN 48, Isis has not recorded any change to retained earnings at January 1, 2007 and it had no unrecognized tax benefits that, if recognized, would favorably affect Isis' effective income tax rate in future periods. At March 31, 2007, Isis had no unrecognized tax benefits. Isis' continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. Isis had no accrued interest or penalties at January 1, 2007 and March 31, 2007.
Isis has not currently completed a study to assess whether a change in control has occurred or whether there have been multiple changes of control since Isis formation due to the significant complexity and cost associated with such study and the possibility that there could be additional changes in the future. If Isis experienced a greater than 50% change or shift in ownership over a 3-year time frame since its formation, utilization of its NOL or R&D credit carryforwards would be subject to an annual limitation under Sections 382 and 383. The annual limitation generally is determined by multiplying the value of Isis stock at the time of the ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization. Further, until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48.
Isis is subject to taxation in the US and various state jurisdictions. Isis tax years for 1989 and forward are subject to examination by the US and California tax authorities due to the carryforward of unutilized NOLs and R&D credits. Isis tax years for 2001 and 2002 are currently being audited by Californias Franchise Tax Board.
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.
Consolidation of variable interest entities
Isis has implemented the provisions of FIN 46R 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 March 31, 2007, Isis had collaborative arrangements with six entities that it considers to be variable interest entities (VIE) under FIN 46R.
In April 2006, Isis entered into a collaboration with Symphony Capital Partners, L.P. and a group of co-investors to fund the development of Isis cholesterol-lowering drug, ISIS 301012, and two novel drugs from Isis metabolic disease program, ISIS 325568 and ISIS 377131. Symphony Capital formed Symphony GenIsis, Inc., capitalized with $75 million, to provide funding for the development of these three drugs in collaboration with Isis. Isis treats Symphony GenIsis as a VIE for which Isis is the primary beneficiary. As a result, beginning in the second quarter of 2006, Isis included the financial condition and results of operations of Symphony GenIsis in its condensed consolidated financial statements. The creditors of Symphony GenIsis do not have recourse to the general credit of Isis.
As part of the collaboration between Isis and Atlantic Healthcare (UK) Limited, during March 2007, Isis licensed alicaforsen, its ICAM-1 antisense drug, to Atlantic, in exchange for $2.0 million of Atlantics common stock. Isis has recognized a valuation allowance of $2.0 million to offset the equity instrument, as realization of this asset is uncertain. Isis is not required to consolidate Atlantics results of operations under FIN 46R as Isis is not the primary beneficiary.
SFAS 130, Reporting Comprehensive Income, requires Isis to report, in addition to net loss, comprehensive loss and its components. A summary follows (in thousands):
Stock-based compensation expense
Isis accounts for its stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123R, Share-Based Payment. Isis estimates the fair value of each stock option grant and the employee stock purchase plan (ESPP) purchase rights on the date of grant using the Black-Scholes model. The expected term of stock options granted represents the period of time that they are expected to be outstanding. For the stock options granted in the first quarter of 2007 and 2006, the estimated expected term is a derived output of the simplified method, as allowed under SAB 107.
For the quarter ended March 31, 2007 and 2006, Isis used the following weighted-average assumptions in its Black-Scholes calculations:
Employee Stock Option Plan:
Stock-based compensation expense for the three months ended March 31, 2007 and 2006 (in thousands, except per share data) was allocated as follows:
As of March 31, 2007, total unrecognized compensation cost related to non-vested stock-based compensation plans was $15.4 million. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. Isis expects to recognize this cost over a weighted average period of 1.5 years.
Impact of recently issued accounting standards
In September 2006, the FASB issued SFAS 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies across a broad number of other accounting pronouncements that require or permit fair value measurements. This Statement is effective for all financial statements issued for fiscal years that begin after November 15, 2007. Isis is currently evaluating the impact of adopting SFAS 157 to determine the effects, if any, on its operating results and financial position.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, which allows entities to account for most financial instruments at fair value rather than under other applicable generally accepted accounting principles (GAAP), such as historical cost. The accounting results in the instrument being marked to fair value every reporting period with the gain/loss from a change in fair value recorded in the income statement. SFAS 159 is effective for all financial statements issued for fiscal years that begin after November 15, 2007. Isis does not expect a material impact on its financial statements.
3. Long-Term Obligations
In January 2007, Isis completed a $162.5 million convertible debt offering, which raised proceeds of approximately $157.1 million, net of $5.4 million in issuance costs. The $162.5 million convertible subordinated notes mature in 2027 and bear interest at 25¤8%, which is payable semi-annually. The 25¤8% notes are convertible, at the option of the note holders, into approximately 11.1 million shares of common stock at a conversion price of approximately $14.63 per share. Isis will be able to redeem the 25¤8% notes at a redemption price equal to 100.75% of the principal amount between February 15, 2012 and February 14, 2013; 100.375% of the principal amount between February 15, 2013 and February 14, 2014; and 100% of the principal amount thereafter. Holders of the 25¤8% notes will also be able to require Isis to repurchase these notes on February 15, 2014, February 15, 2017 and February 15, 2022, and upon the occurrence of certain defined conditions, at 100% of the principal amount of the 25¤8% notes being repurchased plus accrued interest and unpaid interest.
Isis used the net proceeds from the issuance of the 25¤8% notes to repurchase its 51¤2% convertible subordinated notes due in 2009. In January 2007, Isis repurchased approximately $44.2 million aggregate principal amount of its 51¤2% notes at a redemption price of $44.9 million plus accrued but unpaid interest. In May 2007, Isis redeemed the remaining $80.8 million principal balance at a redemption price of $82.1 million plus accrued but unpaid interest. As a result of the repayment of these notes, Isis will recognize a $3.2 million loss on the early extinguishment of debt in 2007, which includes a $1.2 million write-off of unamortized debt issuance costs. Included in the first quarter 2007 Condensed Consolidated Statement of Operations was $1.2 million of that loss and the remainder will be recorded in the second quarter of 2007. As a result of the
May 2007 redemption, the $80.8 million principal is classified as a current liability at March 31, 2007 in the Condensed Consolidated Balance Sheet.
4. Collaborative Arrangements and Licensing Agreements
Bristol-Myers Squibb Company
In May 2007, Isis entered into a collaboration agreement with Bristol-Myers Squibb Company (BMS) to discover, develop and commercialize novel therapeutic antisense drugs targeting proprotein convertase subtilisin/kexin type 9
(PCSK9). Under the terms of the agreement, BMS will pay Isis a $15 million upfront licensing fee, and will provide Isis with at least $9 million in research funding over a period of three years. Isis will also receive up to $168 million for the achievement of pre-specified development and regulatory milestones for the first drug in the collaboration, as well as additional milestones associated with development of follow-on compounds. BMS will also pay Isis royalties on sales of products resulting from the collaboration.
5. Segment Information and Concentration of Business Risk
The following is information for revenue and loss from operations by segment (in thousands):
(1) Ibis commercial revenue has been classified as research and development revenue under collaborative agreements on Isis Condensed Consolidated Statements of Operations.
Isis does not include asset or liability information by reportable segment since it does not use the information for purposes of making decisions about allocating resources to the segments and assessing their performance.
Concentrations of business risk
Isis has historically funded its operations in part from collaborations with corporate partners and as it relates to Ibis, from collaborations with various government agencies. Beginning in the second half of 2006, Ibis began selling commercial products and services. A relatively small number of partners historically have accounted for a significant percentage of Isis revenue. Revenue from significant partners as a percentage of total revenue was as follows:
For the three months ended March 31, 2007 and 2006, Isis derived approximately 64% and 65%, respectively, of its revenue from agencies of the United States Government. For both of the quarters ended March 31, 2007 and 2006, three of the five significant partners listed above represent revenue from agencies of the United States Government.
Contract receivables from three significant partners comprised approximately 49%, 24% and 22% of contract receivables at March 31, 2007. Contract receivables from four significant partners comprised approximately 25%, 20%, 19%, and 16% of contract receivables at December 31, 2006.
In this Report on Form 10-Q, unless the context requires otherwise, Isis, Company, we, our, and us, means Isis Pharmaceuticals, Inc. and its subsidiaries.
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. and our Ibis Biosciences subsidiary. 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, including those statements that are described as Isis goals and projections. 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. 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, 2006, which is on file with the U.S. Securities and Exchange Commission, and those identified within this Item entitled Risk Factors beginning on page 26 of this Report.
We are a biopharmaceutical company that, since our inception in 1989, has pioneered the science of antisense for the development of a new class of drugs to treat important diseases. We are the leader in making drugs that target RNA, and we have a strong proprietary position in RNA-based drug discovery technologies. RNA, or ribonucleic acid, is a molecule that provides to a cell the information the cell needs to produce proteins, including those proteins associated with disease. Interference with RNA can keep the body from producing the proteins that are involved in disease. With our primary technology, antisense, we create inhibitors, called oligonucleotides, designed to hybridize, with a high degree of specificity to their RNA target and modulate the production of specific proteins associated with disease. Separately, within our Ibis Biosciences subsidiary, we have developed a revolutionary biosensor system, called the Ibis T5000 Biosensor System, that can simultaneously identify from a sample a broad range of infectious organisms without needing to know beforehand what might be present in the sample.
We have built a business dedicated to RNA-based drug discovery and development. This is our expertise, and we are fostering the innovations that enable creation of this entirely new class of drugsantisense drugs. We successfully developed the first marketed antisense drug, Vitravene. The regulatory approval we received for Vitravene demonstrated our ability to meet Food and Drug Administration (FDA), and European regulatory requirements for safety and efficacy, and for the commercial manufacture of antisense drugs. With the pioneering work we have done in developing our technology platform, we can discover and validate many more drug candidates than we can advance ourselves. Our strategy is to apply our expertise to discover and develop drugs, advancing them to strategic points and then to license them to others to leverage their resources and existing infrastructures. Our key therapeutic areas are cardiovascular and metabolic diseases, and we develop drugs in these franchises internally to points where we believe we have established significant value before partnering them. In other therapeutic areas, our strategy is to work with partners sooner in the discovery and development process to take advantage of their therapeutic area of focus to build on our development pipeline. The strategy is working. It has allowed us to maintain internal focus while creating an expansive pipeline with multiple partnership franchises in cancer, inflammation, ocular, and other disease areas. Our pipeline has matured to consist almost entirely of drugs based on our proprietary second generation chemistry. Our second generation antisense drugs have the potential to be safer and more effective than our first generation drugs. In addition, because second generation drugs have a longer half-life, they have the potential to produce long-duration of therapeutic response and to support more convenient, less-frequent dosing.
We have a broad patent portfolio to protect our substantial innovation and investment in RNA-based technologies and products. We own or exclusively license more than 1,500 issued patents, which we believe represents the largest antisense and RNA-oriented patent estate in the pharmaceutical industry. In addition to protecting our key assets, our
intellectual property is a strategic asset that we are exploiting to generate near-term revenue and that we expect will also provide us with revenue in the future. As of March 31, 2007, we had generated more than $92.5 million from our intellectual property licensing program that helps support our internal drug discovery and development programs.
We focus our business on two principal segments:
Drug Discovery and DevelopmentWithin our primary business segment, we are exploiting our expertise in RNA to discover and develop novel drugs for our product pipeline and for that of our partners. We have successfully commercialized the worlds first antisense drug and, along with our partners, we currently have 17 drugs in development. Our partners are licensed to develop, with our support, eleven of these 17 drugs, which substantially reduces our development costs. We focus our internal drug development programs on drugs to treat cardiovascular, metabolic and inflammatory diseases. Our partners focus on disease areas such as ocular, viral, inflammatory and neurodegenerative diseases, and cancer.
Ibis BiosciencesIbis Biosciences, Inc., formerly a division of Isis and now a wholly owned subsidiary of Isis, has developed a revolutionary biosensor system, called the Ibis T5000 Biosensor System, for rapid identification and characterization of infectious agents. The Ibis T5000 is capable of identifying virtually all bacteria, virus and fungi, and can provide information about drug resistance, virulence and strain type of these pathogens. We are commercializing the Ibis T5000 Biosensor System and related assay kits for use in biodefense, forensics, epidemiological surveillance, infectious disease research, hospital-associated infection control and plan to commercialize the Ibis T5000 Biosensor System for use in in vitro diagnostics.
Much of the development of the Ibis T5000 system and related applications has been funded through government contracts and grants. As of March 31, 2007, we had earned $59.0 million in revenue under our government contracts and grants, and we had an additional $5.6 million committed under our existing contracts and grants.
Issuance of 25¤8% Convertible Subordinated Notes; Repurchase of 51¤2% Convertible Subordinated Notes
In January 2007, we issued $162.5 million of 25¤8% Convertible Subordinated Notes due 2027. Using the net proceeds from the issuance of the 25¤8% notes, we repurchased our 51¤2% Convertible Subordinated Notes due 2009. The significantly lower interest rate of the 25¤8% notes reduces our annual cash interest payments by approximately $2.6 million. In addition, the extended maturity date of the 25¤8% notes further strengthens our financial position.
Clinical Data on ISIS 301012
In March 2007, we reported positive results from three studies of ISIS 301012. ISIS 301012 inhibits production of apoB-100 to reduce low-density lipoproteins (LDL-C) and other atherogenic lipids and triglycerides. We are developing ISIS 301012 to reduce LDL-C in the significant and growing number of patients who are unable to achieve recommended LDL-C levels. At the American College of Cardiology meeting at the end of March, Isis reported new data from three Phase 2 studies. Collectively, the key conclusions from the Phase 2 studies are that treatment with ISIS 301012:
· Resulted in highly consistent and predictable linear, dose-dependent, prolonged reductions of apoB and related atherogenic lipids including LDL-C and triglycerides in patients with polygenic hypercholesterolemia (routine high cholesterol) and in patients with homozygous familial hypercholesterolemia (FH).
· Was similarly effective when administered as a single agent, when coadministered with moderately-dosed statins and when added to maximally-tolerated lipid-lowering therapies.
· Was well-tolerated in all Phase 2 trials.
Development of ISIS 301012 is continuing in three ongoing studies in which it is being coadministered with statins for three months in polygenic hypercholesterolemic patients, and with maximally-tolerated lipid-lowering therapies in homozygous and heterozygous FH patients. Isis expects results from these studies later in the year. Additionally, Isis plans
to start its pivotal FH trials this year, as well as to initiate a longer-term dosing study in coadministration with statins in patients with routine high cholesterol.
Bristol-Myers Squibb Company
In May 2007, we entered into a collaboration agreement with BMS to discover, develop and commercialize novel therapeutic antisense drugs targeting PCSK9. Under the terms of the agreement, BMS will pay us a $15 million upfront licensing fee, and will provide us with at least $9 million in research funding over a period of three years. We will also receive up to $168 million for the achievement of pre-specified development and regulatory milestones for the first drug in the collaboration, as well as additional milestones associated with development of follow-on compounds. BMS will also pay us royalties on sales of products resulting from the collaboration.
Critical Accounting Policies
We prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable, based upon the information available to us. These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact our quarterly or annual results of operations and financial condition. Each quarter, our senior management discusses the development, selection and disclosure of such estimates with our audit committee of our Board of Directors. There are specific risks associated with these critical accounting policies and we caution that future events rarely develop exactly as expected, and that best estimates routinely require adjustment. 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:
· Assessment of the propriety of revenue recognition and associated deferred revenue;
· Determination of the proper valuation of investments in marketable securities and other equity investments;
· Estimations to assess the recoverability of long-lived assets, including property and equipment, intellectual property and licensed technology;
· Determination of the proper valuation of inventory;
· Determination of the appropriate cost estimates for unbilled preclinical studies and clinical development activities;
· Estimation of our net deferred income tax asset valuation allowance;
· Determination of the appropriateness of the judgments and estimates used in allocating revenue and expenses to operating segments; and
· Estimations to determine the fair value of stock-based compensation, including the expected life of the option, the expected stock price volatility over the term of the expected life and estimated forfeitures.
There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, Managements 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, 2006.
Results of Operations
Total revenue for the three months ended March 31, 2007 was $2.5 million compared to $5.0 million for the same period in 2006. Revenue was lower for the first quarter of 2007 compared to the same period in 2006 because of lower revenue from our collaborations and differences in the timing of Ibis Biosciences, Inc.s government contract revenue. Our revenue fluctuates based on the nature and timing of payments under agreements with our partners, including license fees, milestone-related payments and other payments, including those for drugs we manufacture for our partners. For example, in the first quarter of 2006, revenue included a one-time milestone of $750,000 that we received from Eli Lilly and Company. As a result of our recently announced collaboration with BMS, not including milestone or manufacturing revenue, we will recognize approximately $8 million in revenue annually for the three years of the collaboration since we will amortize the $15 million upfront payment, and receive research funding of approximately $3 million per year.
The following table sets forth information on our revenue by segment (in thousands):
(1) Ibis Biosciences commercial revenue has been classified as research and development revenue under collaborative agreements on Isis Condensed Consolidated Statements of Operations.
Drug Discovery & Development
Research and Development Revenue Under Collaborative Agreements
Revenue for our drug discovery and development segment includes revenue from research and development under collaborative agreements and licensing and royalty revenue. Research and development revenue under collaborative agreements for the three months ended March 31, 2007 was $426,000 compared to $1.3 million for the same period in 2006. The decrease was primarily a result of lower revenue from our research collaborations, including a decrease in revenue associated with our collaboration with Lilly. Our research and development revenue under collaborative agreements fluctuates based on the timing of activities under contract, and as a result, it frequently includes non-recurring items.
Licensing and Royalty Revenue
Our revenue from licensing activities and royalties for the three months ended March 31, 2007 was $448,000 compared to $490,000 for the same period in 2006.
Ibis revenue for the three months ended March 31, 2007 was $1.6 million compared to $3.2 million for the same period in 2006. Ibis earned commercial revenue of $631,000 for the three months ended March 31, 2007, which consisted of
the amortization of revenue for Ibis first commercial instrument and assay kits, as well as revenue from Ibis assay services business. Because Ibis provides a full year of support for each Ibis T5000 Biosensor System following installation, Ibis is amortizing the revenue for each instrument sold over the period of this support obligation. Additionally, Ibis generated revenue from its government contracts and grants of $945,000 for the three months ended March 31, 2007 compared to $3.2 million for the same period in 2006. As Ibis has matured from research and development to commercial stage, some of its large government contracts that supported technology development have been successfully completed. New contracts supporting application development are being initiated, resulting in this transient decline in contract revenue. Isis expects that revenue from government contracts will continue to provide a solid revenue base going forward.
From inception through March 31, 2007, Ibis has earned $59.0 million in revenue from various government agencies to further the development of our Ibis T5000 Biosensor System and related assay kits. An additional $5.6 million is committed under existing contracts and grants. We may receive additional funding under these contracts based upon a variety of factors, including the accomplishment of program objectives and the exercise of contract options by the contracting agencies. These agencies may terminate these contracts and grants at their convenience at any time, even if we have fully performed our obligations. Consequently, we may never receive the full amount of the potential value of these awards.
Even with our increased costs associated with the expansion of our clinical development programs and with building the manufacturing, marketing and sales infrastructure required to successfully commercialize the Ibis T5000 Biosensor System, careful control of expenses in other areas resulted in total operating expenses for the quarter ended March 31, 2007 of $23.4 million compared to $21.0 million for the same period in 2006. Included in our operating expenses is non-cash compensation expense related to stock options, which increased from $1.4 million for the first quarter of 2006 to $2.4 million for the same period in 2007, primarily reflecting the increase in our stock price from period to period.
In order to analyze and compare our results of operations to other similar companies, we believe that it is important to exclude non-cash compensation related to stock options and costs associated with restructuring activities, which are not part of ongoing operations. We believe these items are not indicative of our operating results or cash flows from our operations. Further, we internally evaluate the performance of our operations excluding them.
Research and Development Expenses
Our research and development expenses consist of costs for antisense drug discovery, antisense drug development, manufacturing and operations, our Ibis Biosciences subsidiary and R&D support costs. The following table sets forth information on research and development costs (in thousands):
Our research and development expenses by segment were as follows (in thousands):
For the three months ended March 31, 2007, we incurred total research and development expenses, excluding stock compensation, of $18.0 million compared to $17.2 million for the same period in 2006. The increase is attributed to the continued development of our key programs including the additional costs required for the initiation of larger Phase 2 studies of ISIS 301012.
Drug Discovery & Development
Using proprietary antisense oligonucleotides to identify what a gene does, called gene functionalization, and then determining whether a specific gene is a good target for drug discovery, called target validation, are the first steps in our drug discovery process. 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 have advanced our antisense technology to a point where we and our partners now have extensive clinical and preclinical development pipelines that are full of product opportunities, we have far more drug assets than we can afford to develop on our own. As a result, we have significantly reduced our antisense drug discovery activities so that we can focus on our drugs in development. We anticipate that our existing relationships and collaborations, as well as prospective new partners, will continue to help fund our research programs, as well as contribute to the advancement of the science by funding core antisense technology research.
Antisense drug discovery costs for the three months ended March 31, 2007 were $3.8 million compared to $3.4 million for the same period in 2006. The increase was primarily due to an increase in the use of lab supplies. Additionally, the price of lab supplies increased in the first quarter of 2007 compared to the same period in 2006.
Antisense Drug Development
The following table sets forth research and development expenses for our major antisense drug development projects (in thousands):
Antisense drug development expenditures were $5.7 million, excluding $650,000 of non-cash stock compensation expense, and $5.2 million, excluding $358,000 of non-cash stock compensation expense for the quarter ended March 31, 2007 and 2006, respectively. The increase of $455,000 was primarily attributed to the continued development of our key programs including additional costs incurred as we prepare to initiate larger Phase 2 studies of ISIS 301012. We expect our drug development expenses to fluctuate based on the timing and size of our clinical trials. We are currently conducting multiple Phase 2 trials for ISIS 301012. Development overhead costs were $1.3 million and $770,000 for the quarter ended March 31, 2007 and 2006, respectively. The increase of $570,000 was primarily due to increased personnel costs.
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 research programs that fuel our Phase 3 pipeline. When our products are in Phase 1 or Phase 2 clinical trials, they are in a dynamic state where we continually adjust the development strategy for each product. Although we may characterize a product as in Phase 1 or in Phase 2, it does not mean that we are conducting a single, well-defined study with dedicated resources. Instead, we allocate our internal resources on a shared basis across numerous products based on each products 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 products in preclinical and early stage clinical research, the fluctuations in expenses from product to product, in large part, offset one another. If we partner a drug, it may affect the size of a trial, its timing, its total cost and the timing of the related cost. Our partners are developing, with our support, eleven of our 17 drug candidates, which substantially reduces our development costs.
Expenditures in our manufacturing and operations function consist primarily of personnel costs, specialized chemicals for oligonucleotide manufacturing, laboratory supplies and outside services. These costs for the three months ended March 31, 2007 were $1.6 million compared to $1.7 million for the same period in 2006. 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.
Ibis Biosciences, Inc.
Ibis research and development expenses are primarily the result of its performance under government contracts in support of the ongoing development of the Ibis T5000 Biosensor System and related assay kits. Ibis expenses include all contract-related costs it incurs on behalf of government agencies in connection with the performance of its obligations under the respective contracts, including costs for equipment to which the government retains title. Research and development expenditures in Ibis include costs for scientists, pass-through equipment costs, laboratory supplies, chemicals and highly specialized information technology consultants to advance the research and development of the Ibis T5000 Biosensor System. Further, we allocate a portion of R&D support costs and selling, general and administrative costs to Ibis Biosciences.
The following table sets forth information on Ibis research and development expenses (in thousands):
Ibis research and development expenses, excluding R&D support costs and non-cash compensation expense related to stock options, for the three months ended March 31, 2007 and 2006 were $2.7 million and $2.4 million, respectively. The increase in expenses primarily reflects an increase in costs necessary to support commercialization of the Ibis T5000 Biosensor System. Ibis has delivered four systems to its government partners for use in biodefense and epidemiological surveillance and two systems under a commercial purchase order. The first commercial systems, one of which was delivered in the fourth quarter of 2006 and one that was delivered in the first quarter of 2007, were part of an order for two Ibis T5000 Biosensor Systems from a U.S. government agency for human forensics applications. We expect costs and expenses for Ibis to increase as we continue to expand this business.
In our research and development expenses, we include support costs such as rent, repair and maintenance for buildings and equipment, utilities, depreciation of laboratory equipment and facilities, amortization of our intellectual property, information technology costs, procurement costs and waste disposal costs. We call these costs R&D support costs.
The following table sets forth information on R&D support costs (in thousands):
R&D support costs for the three months ended March 31, 2007 were $5.3 million and were only slightly higher as compared to $5.1 million for the same period in 2006.
Our R&D support costs by segment were as follows (in thousands):
Selling, General and Administrative Expenses
Selling, 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 business development, legal, human resources, investor relations, finance and Ibis sales and marketing. Additionally, we include in selling, 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. Beginning in the second quarter of 2006, as a result of the consolidation of Symphony GenIsis, selling, general and administrative expenses also include Symphony GenIsis general and administrative expenses.
The following table sets forth information on selling, general and administrative expenses (in thousands):
Selling, general and administrative expenses, excluding non-cash compensation expense related to stock options, for the three months ended March 31, 2007 were $3.0 million compared to $2.3 million for the same period in 2006. The increase is a result of increased selling, general and administrative expenses associated with the commercialization of the Ibis T5000 Biosensor System and the addition of general and administrative expenses that are consolidated from Symphony GenIsis. As Ibis continues to execute its commercialization plan, we expect selling, general and administrative expense for Ibis to continue to increase.
Our selling, general and administrative expenses by segment were as follows (in thousands):
During the three months ended March 31, 2006, we recorded a charge of $36,000 for restructuring activities resulting from our decision to focus our resources on key programs.
Investment income for the three months ended March 31, 2007 totaled $3.4 million compared to $811,000 for the same period in 2006. The increase in investment income was primarily due to a higher average cash balance during the first three months of 2007 compared to the same period in 2006 as a result of the funds held by Symphony GenIsis, the proceeds we received from the Azimuth equity financing and the proceeds we received from the issuance of our 25¤8% convertible subordinated notes in January 2007.
Interest expense for the three months ended March 31, 2007 totaled $2.6 million compared to $2.3 million for the same period in 2006. This increase was due to the effect of a higher debt balance for the first quarter of 2007 compared to 2006 primarily related to the issuance of our 25¤8% convertible subordinated notes in January 2007.
Gain on Investments
Gain on investments for the three months ended March 31, 2007 and 2006 was $1.5 million and $0, respectively. The gain on investments reflected a gain realized on the sale of a portion of the equity securities of Alnylam that we owned. In April 2007, we sold our remaining equity securities of Alnylam resulting in a realized gain of $2.0 million, which will be reflected in the statement of operations in the second quarter of 2007.
Loss on Early Retirement of Debt
Loss on early retirement of debt for the three months ended March 31, 2007 and 2006 was $1.2 million and $0, respectively. The loss on early retirement of debt reflected the early extinguishment of a portion of our 51¤2% convertible subordinated notes in January 2007. In May 2007, we redeemed the remaining balance of the 51¤2% convertible subordinated notes. As a result of the May 2007 redemption, we incurred an additional loss on the early retirement of debt of $2.0 million, which will be reflected in the statement of operations in the second quarter of 2007.
Net Loss Applicable to Common Stock
Net loss applicable to common stock for the three months ended March 31, 2007 was $13.0 million compared with a net loss applicable to common stock of $17.5 million for the same period in 2006. We recognized a benefit of $6.8 million for the three months ended March 31, 2007 in the loss attributed to noncontrolling interest in Symphony GenIsis, Inc. This benefit was a significant reason for the improvement in our net loss applicable to common stock in the first quarter of 2007 compared to the same period in 2006 offset by the increase in the loss from operations. As further discussed below under Liquidity and Capital Resources, in January 2007, we issued new convertible subordinated notes which increased our average cash and debt balances resulting in additional interest income and interest expense in the first quarter of 2007 compared to the same period in 2006. Additionally, in conjunction with the issuance of these new notes, during the first quarter of 2007, we repaid a portion of our existing 5½% convertible subordinated notes, and as a result recognized a $1.2 million loss on the early extinguishment of debt as discussed above under Loss on Early Retirement of Debt. The decrease in the net loss applicable to common stock was also impacted by the gain on investments.
Net Loss Per Share
Net loss per share for the three months ended March 31, 2007 was $0.16 per share compared to a net loss per share for the same period in 2006 of $0.24 per share. In the second half of 2006, we issued approximately 8 million shares of our common stock to Azimuth under an equity financing that raised $75 million and approximately 1.4 million shares of our common stock in connection with the exercise of stock options and warrants, and the purchase of shares under our employee stock purchase plan. These additional shares, combined with the substantial decrease in net loss applicable to common stock, resulted in the significant decrease in our net loss per share for the first quarter of 2007 compared to the same period in 2006.
We have financed our operations with revenue from research and development under collaborative agreements and from affiliates. Additionally, we have earned licensing and royalty 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 March 31, 2007, we have earned approximately $510.2 million in revenue from contract research and development and the sale and licensing of our intellectual property. From the time we were founded through March 31, 2007, we have raised net proceeds of approximately $730.0 million from the sale of our equity securities and we have borrowed approximately $543.8 million under long-term debt arrangements to finance a portion of our operations.
At March 31, 2007, we had cash, cash equivalents and short-term investments of $285.6 million, which included $49.6 million of cash and cash equivalents held by Symphony GenIsis, consolidated working capital of $194.1 million and stockholders equity of $56.9 million. In comparison, we had cash, cash equivalents and short-term investments of $193.3 million, which included $54.8 million of cash and cash equivalents held by Symphony GenIsis, consolidated working capital of $181.1 million and stockholders equity of $68.6 million as of December 31, 2006. The increase in our cash, cash equivalents and short-term investments was due primarily to the net proceeds received from the issuance of our 25¤8% convertible subordinated notes in January 2007, along with proceeds of $2.2 million that we received from the sale of a portion of our Alnylam equity securities, offset by cash used in operations and to repurchase the 5 ½% notes. The significantly lower interest rate of the 25¤8% convertible subordinated notes reduces our annual cash interest payments by approximately $2.6 million. In addition, the extended maturity date of the 25¤8% notes further strengthens our balance sheet.
As of March 31, 2007, our debt and other obligations totaled $256.7 million, compared to $140.3 million at December 31, 2006. The increase in our debt and other obligations was primarily due to the issuance of our 25¤8% convertible subordinated notes offset by the January 2007 partial repayment of our 5 1¤2 % convertible subordinated notes and the declining balance on our Silicon Valley Bank term loan. In May 2007, we redeemed the $80.8 million remaining principal balance of our 51¤2% convertible subordinated notes, which will be reflected in the balance sheet for the second quarter of 2007 as a reduction in cash and current liabilities. We will continue to use lease financing as long as the terms remain commercially attractive.
Based on our current operating plan with reasonable assumptions for new sources of revenue and cash, we believe our resources will be sufficient to meet our anticipated requirements through at least the middle of 2010.
The following table summarizes our contractual obligations as of March 31, 2007. The table provides a breakdown of when obligations become due. A more detailed description of the major components of our debt is provided in the paragraphs following the table:
Our contractual obligations consist primarily of our publicly traded convertible debt. In addition, we also have a term loan from Silicon Valley Bank, capital leases and other obligations.
In December 2003, we secured a $32.0 million term loan from Silicon Valley Bank to retire debt from two partners. We amortize the term loan over sixty months. The term loan requires monthly payments of principal plus accrued interest, and bears interest at the prime interest rate less applicable discounts based on the balances in the cash and investment accounts that we maintain at Silicon Valley Bank, which was 8.0% at March 31, 2007. The loan is secured by substantially all of our operating assets, excluding intellectual property, real estate, and certain equity investments. The loan is subject to certain liquidity requirements, including a requirement that we maintain a minimum balance in an account at Silicon Valley Bank at all times equal to the outstanding balance of the loan. The loan is convertible to a fixed interest rate at our option at any time at the then-applicable prime rate plus 1.25%. The carrying value of the term loan at March 31, 2007 was $12.3 million.
In January 2007, we completed a $162.5 million convertible debt offering, which raised proceeds of approximately $157.1 million, net of $5.4 million in issuance costs. The $162.5 million convertible subordinated notes bear interest at 25¤8%, which is payable semi-annually, and mature in 2027. Using the net proceeds from the issuance of the 25¤8% notes, we repaid the entire $125 million of our 51¤2% convertible subordinated notes due 2009. The 25¤8% notes are convertible, at the option of the note holders, into approximately 11.1 million shares of common stock at a conversion price of $14.63 per share. We will be able to redeem these notes at a redemption price equal to 100.75% of the principal amount between February 15, 2012 and February 14, 2013; 100.375% of the principal amount between February 15, 2013 and February 14, 2014; and 100% of the principal amount thereafter. Holders of the 25¤8% notes are also able to require us to repurchase the 25¤8% notes on February 15, 2014, February 15, 2017 and February 15, 2022, and upon the occurrence of certain defined conditions, at 100% of the principal amount of the 25¤8% notes being repurchased plus accrued interest and unpaid interest.
In addition to contractual obligations, we had outstanding purchase orders as of March 31, 2007 for the purchase of services, capital equipment and materials as part of our normal course of business.
We plan to continue to enter into collaborations with partners to provide for additional revenue to us and we may be required to incur additional cash expenditures related to our obligations under any of the new agreements we may enter into. We currently intend to use our cash and short-term equivalents to finance our activities. However, we may also pursue other financing alternatives, like issuing additional shares of our common stock, issuing debt instruments, refinancing our existing debt, or securing lines of credit. Whether we use our existing capital resources or choose to obtain financing will depend on various factors, including the future success of our business, the prevailing interest rate environment and the condition of financial markets generally.
Investing in our securities involves a high degree of risk. In addition to the other information in this report on Form 10-Q, you should carefully consider the risks described below before purchasing our securities. If any of the following risks actually occur, our business could be materially harmed, and our financial condition and results of operations could be materially and adversely affected. As a result, the trading price of our securities could decline, and you might lose all or part of your investment. We have marked with an asterisk those risk factors that reflect substantive changes from the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2006.
Risks Associated with our Businesses as a Whole
We have incurred losses, and our business will suffer if we fail to achieve profitability in the future.*
Because product discovery and development require substantial lead-time and money prior to commercialization, our expenses have exceeded our revenue since we were founded in January 1989. As of March 31, 2007, we had accumulated losses of approximately $829.8 million and stockholders equity of approximately $56.9 million. Most of the losses resulted from costs incurred in connection with our research and development programs and from selling, general and administrative costs associated with our operations. Most of our revenue has come from collaborative arrangements, with additional revenue from research grants and the sale or licensing of patents as well as interest income. We currently have only one product, Vitravene, approved for commercial use. This product has limited sales potential, and Novartis, our exclusive distribution partner for this product no longer markets it. We expect to incur additional operating losses over the next several years, and
these losses may increase if we cannot increase or sustain revenue. We may not successfully develop any additional products or services, or achieve or sustain future profitability.
If we fail to obtain timely funding, we may need to curtail or abandon some of our programs.
All of our drugs are undergoing clinical trials or are in the early stages of research and development. All of our drugs under development will require significant additional research, development, preclinical and/or clinical testing, regulatory approval and a commitment of significant additional resources prior to their commercialization. Based on reasonable assumptions for new sources of revenue and cash, we believe we have sufficient resources to meet our anticipated requirements through at least the middle of 2010. If we do not meet our goals to commercialize our products, or to license our drugs and proprietary technologies, we will need additional funding in the future. Our future capital requirements will depend on many factors, such as the following:
· changes in existing collaborative relationships and our ability to establish and maintain additional collaborative arrangements;
· continued scientific progress in our research, drug discovery and development programs;
· the size of our programs and progress with preclinical and clinical trials;
· the time and costs involved in obtaining regulatory approvals;
· competing technological and market developments, including the introduction by others of new therapies that address our markets;
· success in developing and commercializing a business based on our Ibis T5000 Biosensor System to identify infectious organisms; and
· the profile and launch timing of our drugs.
If we need additional funds, we may need to raise them through public or private financing. Additional financing may not be available at all or on acceptable terms. If we raise additional funds by issuing equity securities, the shares of existing stockholders will be diluted and their price, as well as the price of our other securities, may decline. If adequate funds are not available or not available on acceptable terms, we may have to cut back on one or more of our research, drug discovery or development programs. For example, in January 2005 we decided to terminate the development of two lower priority drugs, ISIS 14803 and ISIS 104838. Alternatively, as in our transaction with Symphony GenIsis, we may obtain funds through arrangements with collaborative partners or others, which could require us to give up rights to certain of our technologies, drugs or products.
Since corporate partnering is a key part of our strategy to fund the development and commercialization of our development programs, if any of our collaborative partners fail to fund our collaborative programs, or if we cannot obtain additional partners, we may have to delay or stop progress on our product development programs.*
To date, corporate partnering has played a key role in our strategy to fund our development programs and to add key development resources. We plan to continue to rely on additional collaborative arrangements to develop and commercialize our products, including our two lead products ISIS 301012 and ISIS 113715. However, we may not be able to negotiate additional attractive collaborative arrangements.
Many of the drugs in our development pipeline are being developed and/or funded by corporate partners, including Antisense Therapeutics Limited, Atlantic Healthcare, iCo Therapeutics, Inc., ImQuest Pharmaceuticals, Inc., Merck & Co., Inc., OncoGenex Technologies Inc. and Lilly. If any of these pharmaceutical companies stopped funding and/or developing these products, our business could suffer and we may not have the resources available to develop these products on our own.
Our collaborators can terminate their relationships with us under certain circumstances, some of which are outside of our control. For example, in November 2004 based on the disappointing results of the Phase 3 clinical trials, Lilly discontinued its investment in Affinitak.
In addition, the disappointing results of the two Affinitak clinical trials, our Phase 3 clinical trials of alicaforsen in patients with active Crohns disease, or any future clinical trials could impair our ability to attract new collaborative partners. If we cannot continue to secure additional collaborative partners, our revenues could decrease and the development of our drugs could suffer.
Even with funding from corporate partners, if our partners do not effectively perform their obligations under our agreements with them, it would delay or stop the progress of our product development programs.
In addition to receiving funding, we enter into collaborative arrangements with third parties to:
· conduct clinical trials;
· seek and obtain regulatory approvals; and
· manufacture, market and sell existing and future products.
Once we have secured a collaborative arrangement to further develop and commercialize one of our development programs, these collaborations may not continue or result in commercialized drugs, or may not progress as quickly as we anticipated.
For example, a collaborator could determine that it is in its financial interest to:
· pursue alternative technologies or develop alternative products that may be competitive with the product that is part of the collaboration with us;
· pursue higher-priority programs or change the focus of its own development programs; or
· choose to devote fewer resources to our drugs than it does for drugs of its own development.
If any of these occur, it could affect our partners commitment to the collaboration with us and could delay or otherwise negatively affect the commercialization of our drugs.
If we cannot protect our patents or our other proprietary rights, others may compete more effectively against us.
Our success depends to a significant degree upon our ability to continue to develop and secure intellectual property rights to proprietary products and services. However, we may not receive issued patents on any of our pending patent applications in the United States or in other countries. In addition, the scope of any of our issued patents may not be sufficiently broad to provide us with a competitive advantage. Furthermore, our issued patents or patents licensed to us may be successfully challenged, invalidated or circumvented so that our patent rights would not create an effective competitive barrier or revenue source.
In addition, our Ibis business relies in part on trade secret laws and nondisclosure, confidentiality and other agreements to protect some of the proprietary technology that is part of the Ibis T5000 Biosensor System. However, these laws and agreements may not be enforceable or may not provide meaningful protection for Ibis trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of these agreements.
To date, virtually all of Ibis research and development activities have been funded under contracts from the U.S. government (either directly or through subcontracts from prime contractors or higher-tier subcontractors). As a general matter, subject to certain disclosure, notice, filing, acknowledgement and reporting obligations, Ibis is entitled to retain title to any inventions conceived or first reduced to practice under government contracts, but the government will have a nonexclusive, nontransferable, irrevocable, paid-up license to practice or have practiced these inventions for or on behalf of the United States.
Intellectual property litigation could be expensive and prevent us from pursuing our programs.
It is possible that in the future we may have to defend our intellectual property rights. In the event of an intellectual property dispute, we may be forced to litigate to defend our rights or assert them against others. Disputes could involve arbitration, litigation or proceedings declared by the United States Patent and Trademark Office or the International Trade Commission or foreign patent authorities. Intellectual property litigation can be extremely expensive, and this expense, as well as the consequences should we not prevail, could seriously harm our business.
For example, in December 2006, the European Patent Office (EPO) Technical Board of Appeal reinstated with amended claims our Patent EP0618925 which claims a class of antisense compounds, any of which is designed to have a
sequence of phosphorothioate-linked nucleotides having two regions of chemically modified RNA flanking a region of DNA. Prior to its reinstatement, this patent was originally opposed by several parties and revoked by an EPO Opposition Division in December of 2003. We intend to fully exercise our rights under this patent by pursuing licensing arrangements, but if licensing efforts are unsuccessful we may choose to assert our rights through litigation.
If a third party claims that our products or technology infringe their patents or other intellectual property rights, we may have to discontinue an important product or product line, alter our products and processes, pay license fees or cease certain activities. We may not be able to obtain a license to needed intellectual property on favorable terms, if at all. There are many patents issued or applied for in the biotechnology industry, and we may not be aware of patents or applications held by others that relate to our business. This is especially true since patent applications in the United States are filed confidentially. Moreover, the validity and breadth of biotechnology patents involve complex legal and factual questions for which important legal issues remain unresolved.
If we do not progress in our programs as anticipated, the price of our securities could decrease.
For planning purposes, we estimate and may disclose the timing of a variety of clinical, regulatory and other milestones, such as when we anticipate a certain drug will enter the clinic, when we anticipate completing a clinical trial, or when we anticipate filing an application for marketing approval. We base our estimates on present facts and a variety of assumptions. Many underlying assumption are outside of our control. If we do not achieve milestones in accordance with our or investors expectations, the price of our securities would likely decrease.
The loss of key personnel, or the inability to attract and retain highly skilled personnel, could make it more difficult to run our business and reduce our likelihood of success.
We are dependent on the principal members of our management and scientific staff. We do not have employment agreements with any of our executive officers that would prevent them from leaving Isis. The loss of our management and key scientific employees might slow the achievement of important research and development goals. It is also critical to our success that we recruit and retain qualified scientific personnel to perform research and development work. We may not be able to attract and retain skilled and experienced scientific personnel on acceptable terms because of intense competition for experienced scientists among many pharmaceutical and health care companies, universities and non-profit research institutions. In addition, failure to succeed in clinical trials may make it more challenging to recruit and retain qualified scientific personnel.
If the price of our securities continues to be highly volatile, this could make it harder for you to liquidate your investment and could increase your risk of suffering a loss.
The market price of our common stock, like that of the securities of many other biopharmaceutical companies, has been and is likely to continue to be highly volatile. These fluctuations in our common stock price may significantly affect the trading price of our securities. During the 12 months preceding March 31, 2007, the market price of our common stock ranged from $5.57 to $14.00 per share. Many factors can affect the market price of our securities, including, for example, fluctuations in our operating results, announcements of collaborations, clinical trial results, technological innovations or new products being developed by us or our competitors, governmental regulation, regulatory approval, developments in patent or other proprietary rights, public concern regarding the safety of our drugs and general market conditions.
Because we use biological materials, hazardous materials, chemicals and radioactive compounds, if we do not comply with laws regulating the protection of the environment and health and human safety, our business could be adversely affected.
Our research, development and manufacturing activities involve the use of potentially harmful biological materials as well as materials, chemicals and various radioactive compounds that could be hazardous to human health and safety or the environment. These materials and various wastes resulting from their use are stored at our facilities in Carlsbad, California pending ultimate use and disposal. We cannot completely eliminate the risk of contamination, which could cause:
· interruption of our research, development and manufacturing efforts;
· injury to our employees and others;
· environmental damage resulting in costly clean up; and
· liabilities under federal, state and local laws and regulations governing health and human safety, as well as the use, storage, handling and disposal of these materials and resultant waste products.
In such an event, we may be held liable for any resulting damages, and any such liability could exceed our resources. Although we carry insurance in amounts and type that we consider commercially reasonable, we do not have insurance coverage for losses relating to an interruption of our research, development or manufacturing efforts caused by contamination, and we cannot be certain that the coverage or coverage limits of our insurance policies will be adequate. In the event our losses exceed our insurance coverage, our financial condition would be adversely affected.
If a natural or man-made disaster strikes our research and development facilities, it could delay our progress developing and commercializing our drugs or our Ibis T5000 Biosensor System.
We are developing our Ibis T5000 Biosensor System in our facility located in Carlsbad, California. Additionally, we manufacture our research and clinical supplies in a separate manufacturing facility located in Carlsbad, California. The facilities and the equipment we use to develop the Ibis T5000 Biosensor System and manufacture our drugs would be costly to replace and could require substantial lead time to repair or replace. Either of our facilities may be harmed by natural or man-made disasters, including, without limitation, earthquakes, floods, fires and acts of terrorism, and in the event they are affected by a disaster, our development and commercialization efforts would be delayed. Although we possess insurance for damage to our property and the disruption of our business from casualties, this insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.
Provisions in our certificate of incorporation, other agreements and Delaware law may prevent stockholders from receiving a premium for their shares.
Our certificate of incorporation provides for classified terms for the members of our board of directors. Our certificate also includes a provision that requires at least 66% of our voting stockholders to approve a merger or certain other business transactions with, or proposed by, any holder of 15% or more of our voting stock, except in cases where certain directors approve the transaction or certain minimum price criteria and other procedural requirements are met.
Our certificate of incorporation also requires that any action required or permitted to be taken by our stockholders must be taken at a duly called annual or special meeting of stockholders and may not be taken by written consent. In addition, only our board of directors, chairman of the board or chief executive officer can call special meetings of our stockholders. We also have implemented a stockholders rights plan, also called a poison pill, which could make it uneconomical for a third party to acquire our company on a hostile basis. These provisions, as well as Delaware law and other of our agreements, may discourage certain types of transactions in which our stockholders might otherwise receive a premium for their shares over then current market prices, and may limit the ability of our stockholders to approve transactions that they think may be in their best interests. In addition, our board of directors has the authority to fix the rights and preferences of and issue shares of preferred stock, which may have the effect of delaying or preventing a change in control of our company without action by our stockholders.
In addition, the provisions of our convertible subordinated notes could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of certain transactions constituting a fundamental change, holders of the notes will have the right, at their option, to require us to repurchase all of their notes or a portion of their notes, which may discourage certain types of transactions in which our stockholders might otherwise receive a premium for their shares over the then current market prices.
Future sales of our common stock in the public market could adversely affect the trading price of our securities.
Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect trading prices of our securities. We have granted registration rights to Lilly, which cover approximately 2.5 million shares of our common stock, which we issued to Lilly upon the conversion of outstanding convertible securities. We also registered for resale 12,000,000 shares of our common stock and 2,999,998 shares of our common stock issuable upon the exercise of the warrants we issued as part of our August 2005 private placement as well as 4.25 million shares of our common stock issuable upon the exercise of the warrant we issued to Symphony GenIsis Holdings. In addition, on December 22, 2005, we filed a Form S-3 shelf registration statement with the SEC to register up to $200,000,000 worth of our common stock for possible issuance. Finally, we have registered for resale our 25¤8% convertible subordinated notes, including the approximately 11,111,116 shares issuable upon conversion of the notes. The addition of any of these shares into the market may have an adverse effect on the price of our securities.
Our business is subject to changing regulations for corporate governance and public disclosure that has increased both our costs and the risk of noncompliance.
Each year we are required to evaluate our internal controls systems in order to allow management to report on and our Independent Registered Public Accounting Firm to attest to, our internal controls as required by Section 404 of the Sarbanes-Oxley Act. As a result, we will incur additional expenses and will suffer a diversion of managements time. In addition, if we cannot continue to comply with the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission, the Public Company Accounting Oversight Board (PCAOB) or the NASDAQ Stock Market. Any such action could adversely affect our financial results and the market price of our common stock.
Risks Associated with our Drug Discovery and Development Business
If we or our partners fail to obtain regulatory approval for our drugs, we will not be able to sell them.
We and our partners must conduct time-consuming, extensive and costly clinical trials to show the safety and efficacy of each of our drugs, including ISIS 301012 and ISIS 113715, before a drug can be approved for sale. We must conduct these trials in compliance with FDA regulations and with comparable regulations in other countries. If the FDA or another regulatory agency believes that we or our partners have not sufficiently demonstrated the safety or efficacy of our drugs, including ISIS 301012 and ISIS 113715, it will not approve them or will require additional studies, which can be time consuming and expensive and which will delay commercialization of a drug. We and our partners may not be able to obtain necessary regulatory approvals on a timely basis, if at all, for any of our drugs, including ISIS 301012 and ISIS 113715. Failure to receive these approvals or delays in these approvals could prevent or delay commercial introduction of a product, including ISIS 301012 and ISIS 113715, and, as a result, could negatively impact our ability to generate revenue from product sales. In addition, following approval of a drug, we and our partners must comply with comprehensive government regulations regarding how we manufacture, market and distribute drug products. If we fail to comply with these regulations, regulators could force us to withdraw a drug from the market or impose other penalties or requirements that also could have a negative impact on our financial results.
We have only introduced one commercial drug product, Vitravene. We cannot guarantee that any of our other drugs, including ISIS 301012 and ISIS 113715, will be safe and effective, will be approved for commercialization or that our partners or we can successfully commercialize these drugs.
If the results of clinical testing indicate that any of our drugs under development are not suitable for commercial use we may need to abandon one or more of our drug development programs.
Drug discovery and development has inherent risks and the historical failure rate for drugs is high. Antisense technology in particular is relatively new and unproven. If we cannot demonstrate that our drugs, including ISIS 301012 and ISIS 113715, are safe and effective drugs for human use, we may need to abandon one or more of our drug development programs.
In the past, we have invested in clinical studies of drugs that have not met the primary clinical end points in their Phase 3 studies. In March 2003, we reported the results of a Phase 3 clinical trial of Affinitak in patients with late-stage non-small cell lung cancer and in October 2004, we reported the results of a second similar Phase 3 clinical trial. In each case, Affinitak failed to demonstrate improved survival sufficient to support an NDA filing. In December 2004, we reported the results of our Phase 3 clinical trials of alicaforsen in patients with active Crohns disease, in which alicaforsen did not demonstrate statistically significant induction of clinical remissions compared to placebo. Similar results could occur with the clinical trials for our other drugs ISIS 301012 and ISIS 113715. If any of our drugs in clinical studies ISIS 301012 and ISIS 113715 do not show sufficient efficacy in patients with the targeted indication, it could negatively impact our development and commercialization goals for this and other drugs and our stock price could decline.
Even if our drugs are successful in preclinical and early human clinical studies, these results do not guarantee these drugs will be successful in late-stage clinical trials.
Successful results in preclinical or early human clinical trials, including the recently announced Phase 2 results for ISIS 301012 and ISIS 113715, may not predict the results of late-stage clinical trials. There are a number of factors that could cause a clinical trial to fail or be delayed, including:
· the clinical trial may produce negative or inconclusive results;
· regulators may require that we hold, suspend or terminate clinical research for noncompliance with regulatory requirements;
· we, our partners, the FDA or foreign regulatory authorities could suspend or terminate a clinical trial due to adverse side effects of a drug on subjects or patients in the trial;
· we may decide, or regulators may require us, to conduct additional preclinical testing or clinical trials;
· enrollment in our clinical trials may be slower than we currently anticipate;
· the cost of our clinical trials may be greater than we anticipate; and
· the supply or quality of our drugs or other materials necessary to conduct our clinical trials may be insufficient, inadequate or delayed.
Any failure or delay in one of our clinical trials, including our Phase 2 development programs for ISIS 301012 and ISIS 113715, could reduce the commercial viability of our drugs, including ISIS 301012 and ISIS 113715.
We have licensed the intellectual property, including commercialization rights, to our apoB-100, GCGR, and GCCR programs to Symphony GenIsis, Inc. and will not receive any future royalties or revenues with respect to the products in these programs, including ISIS 301012, ISIS 325568 and ISIS 377131 unless we exercise our option to acquire all of these drugs in the future. We may not have the financial resources to exercise this option or sufficient clinical data in order to determine whether we should exercise this option prior to its expiration.
We have licensed to Symphony GenIsis our intellectual property rights, including commercialization rights, to our apoB-100, GCGR, and GCCR programs in exchange for Symphony GenIsis investment of $75 million to advance the clinical development of these programs. In exchange for this investment and for a five-year warrant to purchase shares of our common stock we issued to Symphony GenIsis, we received an exclusive purchase option to acquire all of the equity of Symphony GenIsis, thereby allowing us to reacquire our apoB-100, GCGR and GCCR programs, which include ISIS 301012, ISIS 325568 and ISIS 377131. The purchase option exercise price reflects a compounded annual rate of return that averages 32% and is 27% at the end of the anticipated four-year collaborative development period. We may pay the option exercise price in cash or a combination of cash and our common stock, at our sole discretion, provided that the common stock portion may not exceed 33% of the purchase option exercise price.
If we elect to exercise the purchase option, we will be required to make a substantial cash payment and/or issue a substantial number of shares of our common stock, or enter into a financing arrangement or license arrangement with one or more third parties, or some combination of the foregoing. A payment in cash would substantially reduce our capital resources. A payment in shares of our common stock will result in dilution to our stockholders at that time. Other financing or licensing alternatives may be expensive or impossible to obtain. If we do not exercise the purchase option prior to its expiration, we will lose our rights in our apoB-100, GCGR, and GCCR programs. We may not have the financial resources to exercise the purchase option, which would result in our loss of these rights. Additionally, we may not have sufficient clinical data in order to determine whether we should exercise the option.
Disagreements between Symphony GenIsis and us regarding the development of our drugs in our apoB-100, GCGR, and GCCR programs may cause significant delays and other impediments in the development of these drugs, which could negatively affect the value of these drugs.
We have licensed to Symphony GenIsis our intellectual property rights, including commercialization rights, to our drugs in our apoB-100, GCGR, and GCCR programs in exchange for Symphony GenIsis investment of $75 million to advance the clinical development of these programs. We are responsible for developing these drugs in accordance with a specified development plan and related development budget. The Symphony GenIsis development committee supervises our development activities. The development committee is comprised of an equal number of representatives from Isis and Symphony GenIsis. If the development committee cannot resolve a particular development issue, the issue will be referred to the chief executive officers of Isis and Symphony GenIsis. Any disagreements between Symphony GenIsis and us regarding a development decision may cause significant delays in the development and commercialization of our drugs within our apoB-100, GCGR, and GCCR programs.
If the market does not accept our products, we are not likely to generate revenues or become profitable.
Our success will depend upon the medical community, patients and third-party payors accepting our products as medically useful, cost-effective and safe. We cannot guarantee that, if approved for commercialization, doctors will use our products to treat patients. We currently have one commercially available drug product, Vitravene, a treatment for cytomegalovirus, or CMV, retinitis in AIDS patients, which addresses a small market. Our partners and we may not successfully commercialize additional products.
The degree of market acceptance for any of our products depends upon a number of factors, including:
· the receipt and scope of regulatory approvals;
· the establishment and demonstration in the medical and patient community of the efficacy and safety of our drugs and their potential advantages over competing products;
· the cost and effectiveness of our drugs compared to other available therapies;
· the patient convenience of the dosing regimen for our drugs; and
· reimbursement policies of government and third-party payors.
Based on the profile of our drugs, physicians, patients, patient advocates, payors or the medical community in general may not accept and use any products that we may develop.
If we cannot manufacture our drug products or contract with a third party to manufacture our drug products at costs that allow us to charge competitive prices to buyers, we will not be able to market products profitably.
If we successfully commercialize any of our drugs, we may be required to establish large-scale commercial manufacturing capabilities. In addition, as our drug development pipeline increases and matures, we will have a greater need for clinical trial and commercial manufacturing capacity. We have limited experience manufacturing pharmaceutical products of the chemical class represented by our drugs, called oligonucleotides, on a commercial scale for the systemic administration of a drug. There are a small number of suppliers for certain capital equipment and raw materials that we use to manufacture our drugs, and some of these suppliers will need to increase their scale of production to meet our projected needs for commercial manufacturing. Further, we must continue to improve our manufacturing processes to allow us to reduce our product costs. We may not be able to manufacture at a cost or in quantities necessary to make commercially successful products.
Also, manufacturers, including us, must adhere to the FDAs current Good Manufacturing Practices regulations which the FDA enforces through its facilities inspection program. We and our contract manufacturers may not be able to comply or maintain compliance with Good Manufacturing Practices regulations. Non-compliance could significantly delay or prevent our receipt of marketing approval for potential products or result in FDA enforcement action after approval that could limit the commercial success of our potential product.
If our drug discovery and development business fails to compete effectively, our drugs will not contribute significant revenues.
Our competitors are engaged in all areas of drug discovery throughout the world, are numerous, and include, among others, major pharmaceutical companies and specialized biopharmaceutical firms. Other companies are engaged in developing antisense technology. Our competitors may succeed in developing drugs that are:
· priced lower than our drugs;
· safer than our drugs; or
· more effective than our drugs.
These competitive developments could make our products obsolete or non-competitive.
Certain of our partners are pursuing other technologies or developing other drugs either on their own or in collaboration with others, including our competitors, to develop treatments for the same diseases targeted by our own collaborative programs. Competition may negatively impact a partners focus on and commitment to our drugs and, as a result, could delay or otherwise negatively affect the commercialization of our drugs.
Many of our competitors have substantially greater financial, technical and human resources than we do. In addition, many of these competitors have significantly greater experience than we do in conducting preclinical testing and human clinical trials of new pharmaceutical products and in obtaining FDA and other regulatory approvals of products for use in health care. Accordingly, our competitors may succeed in obtaining regulatory approval for products earlier than we do. We will also compete with respect to marketing and sales capabilities, areas in which we have limited or no experience.
We depend on third parties in the conduct of our clinical trials for our drugs and any failure of those parties to fulfill their obligations could adversely affect our development and commercialization plans.
We depend on independent clinical investigators, contract research organizations and other third-party service providers in the conduct of our clinical trials for our drugs and expect to continue to do so in the future. For example, Medpace is the primary clinical research organization for clinical trials for ISIS 301012. We rely heavily on these parties for successful execution of our clinical trials, but do not control many aspects of their activities. For example, the investigators are not our employees. However, we are responsible for ensuring that each of our clinical trials is conducted in accordance with the general investigational plan and protocols for the trial. Third parties may not complete activities on schedule, or may not conduct our clinical trials in accordance with regulatory requirements or our stated protocols. The failure of these third parties to carry out their obligations or a termination of our relationship with these third parties could delay or prevent the development, approval and commercialization of our drugs, including ISIS 301012.
Risks Associated With Our Ibis Biosciences Business
We may not successfully develop or derive revenues from our business based on our Ibis T5000 Biosensor System.
Our Ibis T5000 Biosensor System is subject to the risks inherent in developing tools based on innovative technologies. Our product is at an early stage of development and requires continued research and development to achieve our business objectives. For Ibis to be commercially successful, we must convince potential customers that our Ibis T5000 Biosensor System is an attractive alternative to existing methods of identifying pathogens. If our potential customers fail to purchase our Ibis T5000 Biosensor System due to competition or other factors, or if we fail to develop applications that lead to market acceptance, we may not recover our investment in this technology and our Ibis T5000 Biosensor System business could fail to meet our business and financial objectives.
If we fail to sell the Ibis T5000 Biosensor System to a minimum customer base, our ability to generate revenues from sales of assay kits will be negatively affected.
A key element of our business plan for Ibis calls for us to deploy the Ibis T5000 Biosensor System to a broad customer base. If we cannot create a broad installed base of our Ibis T5000 Biosensor System, our ability to sell assay kits, the consumables used to operate the system, may be significantly and adversely affected. Even if we successfully achieve broad installation of the Ibis T5000 Biosensor System, customers may not perform as many analyses as we anticipate, which may affect the assumptions underlying our business plan for Ibis and lead to lower-than-expected revenues.
We will depend on Bruker Daltonics to manufacture the Ibis T5000 Biosensor System and any failure of Bruker Daltonics to fulfill its obligations could harm or delay our commercialization efforts.
In July 2006, we entered into a strategic alliance with Bruker Daltonics to manufacture and distribute the Ibis T5000 Biosensor System. Bruker Daltonics will be the exclusive, worldwide manufacturer of the Ibis T5000 Biosensor System and will also be responsible for order processing, system installations and service in North America, Europe and the Middle East. In Europe and the Middle East, Bruker Daltonics will have exclusive rights to sell Ibis T5000 Biosensor Systems and Ibis assay kits for various government applications, and non-exclusive rights to sell to customers for all other applications except diagnostics. As such, we rely heavily on Bruker Daltonics to successfully manufacture and distribute our Ibis T5000
Biosensor System, but do not control many aspects of Bruker Daltonics activities. If Bruker Daltonics fails to carry out its obligations under our alliance, such failure could harm or delay the commercialization of our Ibis T5000 Biosensor System.
If we fail to secure additional commercial or financial partners for our Ibis T5000 Biosensor System, our commercialization efforts for our Ibis T5000 Biosensor System may be harmed or delayed.
In addition to Bruker Daltonics, we may depend on third parties to commercialize our Ibis T5000 Biosensor System, particularly in the areas of hospital-associated infection control and infectious disease diagnostics. Specifically, Ibis expects to depend on third parties to sell and distribute its assay kits to non-government customers in the healthcare-associated infection control and infectious disease diagnostic markets. We may not successfully establish a relationship in these markets or be able to make alternative arrangements. If we are unable to reach agreements with suitable commercial or financial partners, we may fail to meet our business objectives for the Ibis T5000 Biosensor System. Moreover, these relationships may not succeed, may require us to give up a part of our ownership interest, or may diminish our revenue targets on our Ibis instruments and related assay kits.
We depend on government contracts for most of Ibis revenues and the loss of government contracts or a decline in funding of existing or future government contracts could adversely affect our revenues and cash flows.
Virtually all of Ibis revenues are from the sale of services and products to the U.S. government. The U.S. government may cancel these contracts at any time without penalty or may change its requirements, programs or contract budget or decline to exercise option periods, even if we have fully performed our obligations. Since a large portion of Ibis government contracts are milestone based, if Ibis fails to meet a specific milestone within the specified delivery date, our government partner may be more likely to reduce or cancel its contract with Ibis. Our revenues and cash flows from U.S. government contracts could also be reduced by declines in U.S. defense, homeland security and other federal agency budgets.
For the three months ended March 31, 2007 and 2006, we derived approximately 64% and 65%, respectively, of our revenue from agencies of the U.S. government. Because of the concentration of our contracts, we are vulnerable to adverse changes in our revenues and cash flows if a significant number of our U.S. government contracts and subcontracts are simultaneously delayed or canceled for budgetary, performance or other reasons.
If U.S. defense and other federal agencies choose to reduce their purchases under our contracts, exercise their right to terminate contracts, fail to exercise options to renew contracts or limit our ability to obtain new contract awards, our revenues and cash flows could be adversely affected.
We may be liable for penalties under a variety of procurement rules and regulations, and changes in government regulations could adversely impact our revenues, operating expenses and operating margins.
Under our agreements with the U.S. government, we must comply with and are affected by various government regulations that impact our operating costs, operating margins and our internal organization and operation of our businesses. These regulations affect how our customers and we do business and, in some instances, impose added costs on our businesses. Any changes in applicable laws could adversely affect the financial performance of Ibis. With respect to U.S. government contracts, any failure to comply with applicable laws could result in contract termination, price or fee reductions or suspension or debarment from contracting with the U.S. government. Among the most significant regulations are the following:
· the U.S. Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of government contracts;
· the U.S. Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with contract negotiations; and
· the U.S. Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under certain cost-based government contracts.
If our Ibis T5000 Biosensor Systems reliability does not meet market expectations, we may be unable to retain our existing customers and attract new customers.
Complex instruments such as our Ibis T5000 Biosensor System typically require operating and reliability improvements following their initial introduction. As we continue to develop our Ibis T5000 Biosensor System and its related applications, we will need to make sure our customers are satisfied with the sensors reliability. Our efforts to satisfy our customers needs for instrument reliability could result in greater than anticipated service expenses or divert other resources. Additionally, if we fail to resolve reliability issues as they develop, we could materially damage our reputation, which could prevent us from retaining our existing customers and attracting new customers.
If we had to replace a supplier of one of the major hardware components of our Ibis T5000 Biosensor System, it could delay our commercialization efforts and lengthen our sales cycle.
We have a single supplier for each major hardware component of our Ibis T5000 Biosensor System. Although, we believe we would be able to find a replacement provider, if any of these suppliers stopped providing us with their respective components, identifying and securing a suitable replacement could delay our commercialization efforts and lengthen our sales cycle.
If Ibis fails to compete effectively, it may not succeed or contribute significant revenues.
The market for products such as Ibis is highly competitive. Currently, large reference laboratories, public health laboratories and hospitals perform the majority of diagnostic tests used by physicians and other health care providers. We expect that these laboratories will compete vigorously to maintain their dominance in the diagnostic testing market. To remain competitive, we will need to continually improve Ibis products so that, when compared to alternatives, its products:
· provide faster results;
· are cost-effective;
· deliver more accurate information;
· are more user friendly; and
· support a broad range of applications.
If Ibis cannot keep its products ahead of its competitors in these areas, Ibis revenues will suffer and we may not meet our commercialization goals.
Many of our competitors have, and in the future these and other competitors may have, significantly greater financial, marketing, sales, manufacturing, distribution and technological resources than us. Moreover, these companies may have substantially greater expertise in conducting clinical trials and research and development, greater ability to obtain necessary intellectual property licenses and greater brand recognition than we do. In addition, our competitors may be in a better position to respond quickly to new or emerging technologies, may be able to undertake more extensive marketing campaigns, may adopt more aggressive pricing policies and may be more successful in attracting potential customers, employees and strategic partners than we are.
Improvements in preventing major diseases could reduce the need for our Ibis T5000 Biosensor System and related assay kits, which in turn could reduce our revenues.
We expect to derive a significant portion of our Ibis revenues from the sale of assay kits necessary to use our Ibis T5000 Biosensor System. The need to quickly identify and contain major threats, such as the avian flu, could increase the demand for our assay kits. Conversely, improvements in containing or treating a threat, such as vaccines, would significantly reduce the need to identify and contain the threat. Any reduction in the need to identify or contain a threat could diminish the need for our assay kits, which could reduce our revenues.
Our plans to commercialize the Ibis T5000 Biosensor System internationally are subject to additional risks that could negatively affect our operating results.
Our success will depend in part on our ability and Brukers ability to market and sell the Ibis T5000 Biosensor System and assay kits in foreign markets. Expanding our international operations could impose substantial burdens on our resources, divert managements attention from domestic operations and otherwise adversely affect our business. Furthermore, international operations are subject to several inherent risks including:
· trade protective measures and import or export licensing requirements or other restrictive actions by U.S. and foreign governments could prevent or limit our international sales;
· reduced protection of intellectual property rights;
· changes in foreign currency exchange rates;
· changes in specific countrys or regions political or economic conditions; and
· changes in tax laws.
If we cannot access or license rights to particular nucleic acid sequences for targeted diseases in the future, we may be limited in our ability to develop new products and access new markets.
Although our research staff seeks to discover particular nucleic acid sequences for targeted diseases, our ability to offer diagnostic tests for diseases may depend on the ability of third parties to discover particular sequences or markers and correlate them with disease, as well as the rate at which such discoveries are made. Our ability to design products that target these diseases may depend on our ability to obtain the necessary access to raw materials or intellectual property rights from third parties who make any of these discoveries. If we are unable to access new technologies or the rights to particular sequences or markers necessary for additional diagnostic products on commercially reasonable terms or at all, we may not be able to develop new diagnostic products or enter new markets.
The sales cycles for our Ibis T5000 Biosensor Systems are lengthy, and we may expend substantial funds and management effort with no assurance of successfully selling our Ibis T5000 Biosensor Systems or services.
The sales cycles for Ibis T5000 Biosensor Systems are typically lengthy. Our sales and licensing efforts, and those of our partners, will require the effective demonstration of the benefits, value, and differentiation and validation of our products and services, and significant training of multiple personnel and departments within a potential customer organization. We or our partners may be required to negotiate agreements containing terms unique to each prospective customer or licensee, which would lengthen the sales cycle. We may expend substantial funds and management effort with no assurance that we will sell our products. In addition, this lengthy sales cycle makes it more difficult for us to accurately forecast revenue in future periods and may cause revenues and operating results to vary significantly in future periods.
If we or our partners are required to obtain regulatory approval for our Ibis T5000 Biosensor System, we may not successfully obtain approval.
Ibis business plan assumes a significant portion of its revenues will come from Ibis T5000 Biosensor Systems and assay kits for in vitro diagnostic purposes, whose uses are regulated by the FDA and comparable agencies of other countries. In addition, customers may wish to utilize the Ibis T5000 Biosensor System and assay kits in manners that require additional regulatory approval. To access these markets, Ibis products may require either premarket approval or 510(k) clearance from the FDA and other regulatory agencies prior to marketing. The 510(k) clearance process usually takes from three to twelve months from submission, but can take longer. The premarket approval process is much more costly, lengthy, and uncertain and generally takes from six months to two years or longer from submission. In addition, commercialization of any diagnostic or other product that our licensees or collaborators or we develop would depend upon successful completion of preclinical testing and clinical trials. Preclinical testing and clinical trials are long, expensive and uncertain processes, and we do not know whether we, our licensees or any of our collaborators, would be permitted or able to undertake clinical trials of any potential products. It may take us or our licensees or collaborators many years to complete any such testing, and failure could occur at any stage. Preliminary results of clinical trials do not necessarily predict final results, and acceptable results in early clinical trials may not be repeated in later clinical trials. We or our collaborators may encounter delays or rejections of
potential products based on changes in regulatory policy for product approval during the period of product development and regulatory agency review. If our Ibis T5000 Biosensor System is considered a medical device, after gaining market approval from the FDA, our Ibis T5000 Biosensor System may be subject to ongoing FDA requirements governing the labeling, packaging, storage, advertising, promotion, recordkeeping and reporting of safety and other post-market information.
If we become subject to product liability claims relating to Ibis, we may be required to pay damages that exceed our insurance coverage.
Any product liability claim brought against us with respect to Ibis, with or without merit, could result in the increase of our product liability insurance rates or the inability to secure coverage in the future. Expenses incurred by our insurance provider in defending these claims will reduce funds available to settle claims or pay adverse judgments. In addition, we could be liable for amounts in excess of policy limits, which would have to be paid out of our cash reserves, and our cash reserves may be insufficient to satisfy the liability. Finally, even a meritless or unsuccessful product liability claim could harm Ibis reputation in the industry, lead to significant legal fees, and could result in the diversion of managements attention from managing our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to changes in interest rates primarily from our long-term debt arrangements and, secondarily, investments in certain short-term investments. We invest our excess cash in highly liquid short-term investments that are typically held for the duration of the term of the respective instrument. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions to manage exposure to interest rate changes. Accordingly, we believe that, while the securities we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.
As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2007. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to March 31, 2007.
An evaluation was also performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of any change in our internal control over financial reporting that occurred during our last fiscal quarter and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. That evaluation did not identify any change in our internal control over financial reporting that occurred during our latest fiscal quarter and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable and not absolute assurance of achieving the desired control objectives.
Issuer Purchases of 51¤2% Convertible Subordinated Notes due 2009
(1) In January 2007, through privately negotiated transactions, we repurchased $44,175,000 aggregate principal amount of our 5 1¤2% convertible subordinated notes due 2009. The average price paid per $1,000 principal amount reflected above does not include the interest on the notes that was accrued but unpaid as of the repurchase date.
(2) In May 2007, we voluntarily redeemed all of the remaining outstanding 5 1¤2% convertible subordinated notes due 2009, pursuant to Isis optional redemption under paragraph 6 of the convertible subordinated notes. The redemption price was $1,015.71 per $1,000 principal amount outstanding, plus $1.375 in accrued but unpaid interest per $1,000 principal amount outstanding.
Isis Pharmaceuticals, Inc.
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.