IONIS PHARMACEUTICALS INC 10-Q 2008
Washington, DC 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d) OF
For the Quarterly Period Ended June 30, 2008
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, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12(b)-2 of the Securities Exchange Act of 1934). Yes o No x
The number of shares of voting common stock outstanding as of August 4, 2008 was 95,645,014.
Isis Pharmaceuticals® is a registered trademark of Isis Pharmaceuticals, Inc.
Ibis BiosciencesTM is a trademark of Ibis Biosciences, Inc.
Ibis T5000TM is a trademark of Ibis Biosciences, Inc.
Regulus TherapeuticsTM is a trademark of Regulus Therapeutics LLC.
Vitravene® is a registered trademark of Novartis AG.
ISIS PHARMACEUTICALS, INC.
(in thousands, except share data)
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.
June 30, 2008
1. Basis of Presentation
The unaudited interim condensed consolidated financial statements for the three and six month periods ended June 30, 2008 and 2007 have been prepared on the same basis as the audited financial statements for the year ended December 31, 2007. The financial statements include all normal recurring adjustments, which we consider 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, 2007 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).
The condensed consolidated financial statements include the accounts of Isis Pharmaceuticals, Inc. (we, us or our), our wholly owned subsidiaries, Isis Pharmaceuticals Singapore Pte Ltd., Isis USA Ltd. and Symphony GenIsis, Inc. In addition to our wholly owned subsidiaries, our condensed consolidated financial statements include two variable interest entities, Ibis Biosciences, Inc. and Regulus Therapeutics LLC, for which we are 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
We follow 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.
We generally recognize revenue when we have satisfied all contractual obligations and are reasonably assured of collecting the resulting receivable. We are often entitled to bill our customers and receive payment from our customers in advance of recognizing the revenue under current accounting rules. In those instances where we have received payment from our customers in advance of recognizing revenue, the amounts are included in deferred revenue on the consolidated balance sheet.
Research and development revenue under collaborative agreements
We often enter into collaborations where we receive non-refundable upfront payments for prior or future expenditures. We recognize revenue related to upfront payments ratably over our period of performance relating to the term of the contractual arrangements. Occasionally, we are required to estimate our period of performance when the agreements we enter into do not clearly define such information. Should different estimates prevail, revenue recognized could be materially different. To date our estimates have not required material adjustments. We have made estimates of our continuing obligations on several agreements. Our collaborative agreements typically include a research and/or development project plan that includes activities to be performed during the collaboration and the party responsible for performing them. We estimate the period of time over which we will complete the activities for which we are responsible and use that period of time as our period of performance for purposes of revenue recognition and amortize revenue over such period. When our collaborators have asked us to continue performing work in a collaboration beyond the initial period of performance, we have extended our amortization period to correspond to the new extended period of performance. In no case have adjustments to date to performance periods and related adjustments to revenue amortization periods had a material impact on our revenue.
Our collaborations often include contractual milestones. When we achieve these milestones, we are entitled to payment, as defined by the underlying agreements. We generally recognize revenue related to milestone payments upon completion of the milestones substantive performance requirement, as long as we are reasonably assured of collecting the resulting receivable and we are not obligated for future performance related to the achievement of the milestone.
We generally recognize revenue related to the sale of our drug inventory as we ship or deliver drugs to our partners. In several instances, we completed the manufacturing of drugs, but our partners asked us to deliver the drug on a later date. Under these circumstances, we ensured that the provisions in SAB 104 were met before we recognized the related revenue.
We often enter into revenue arrangements that contain multiple deliverables. In these cases, we recognize revenue from each element of the arrangement as long as we are able to determine a separate fair value for each element, we have completed our obligation to deliver or perform on that element and we are reasonably assured of collecting the resulting receivable.
In the fourth quarter of 2006, we started to sell the Ibis T5000 Biosensor System commercially. The sale of each Ibis T5000 Biosensor System contains multiple elements. Since we had no previous experience commercially selling the Ibis T5000 Biosensor System, we had no basis to determine the fair values of the various elements included in each system; therefore, we account for the entire system as one deliverable and recognize revenue over the period of performance. The assay kits, which are sold separately from the instrument, are considered part of the system from an accounting perspective because the assay kits and the instrument are dependent on each other. For a one-year period following the sale, we have ongoing support obligations for the Ibis T5000 Biosensor System; therefore, we are amortizing the revenue for the entire system, including related assay kits, over a one-year period. Once we obtain a sufficient number of sales to enable us to identify each elements fair value, we will be able to recognize revenue separately for each element.
As part of our Genzyme strategic alliance, in February 2008 Genzyme Corporation made a $150 million equity investment in us by purchasing 5 million shares of our common stock at $30 per share. The price Genzyme paid for our common stock represented a significant premium over the fair value of our stock. Using a Black-Scholes option valuation model, we determined that the value of the premium was $100 million, which represents value Genzyme gave to us to help fund the companies research collaboration, which began in January 2008. We accounted for this premium as deferred revenue and are amortizing it along with the $175 million licensing fee ratably into revenue until June 2012, which represents the end of our performance obligation based on the research and development plan included in the agreement. See further discussion about our collaboration with Genzyme in Note 5, Collaborative Arrangements and Licensing Agreements.
Licensing and royalty revenue
We often enter into agreements to license our proprietary patent rights on an exclusive or non-exclusive basis in exchange for license fees and/or royalties. We generally recognize as revenue immediately those licensing fees and royalties for which we have no future significant performance obligations and are reasonably assured of collecting the resulting receivable.
We have equity investments in privately- and publicly-held biotechnology companies. We hold ownership interests of less than 20% in each of the respective entities. In determining if and when a decrease in market value below our cost in our equity positions is temporary or other-than-temporary, we examine historical trends in the stock price, the financial condition of the issuer, near term prospects of the issuer and our current need for cash. Unrealized gains and losses related to temporary declines are recorded as a separate component of stockholders equity. When we determine that a decline in value is other-than-temporary, we recognize an impairment loss in the period in which the other-than-temporary decline occurs. We determined that there were no other-than-temporary declines in value of our investments in the first half of 2008 and 2007. During the first half of 2007, we sold the remainder of our equity securities of Alnylam Pharmaceuticals, Inc. that we owned resulting in a realized gain of $3.5 million.
In accordance with Statement of Financial Accounting Standards (SFAS) 2, Accounting for Research and Development Costs, we capitalize the costs of raw materials that we purchase for use in producing our drugs because until we use these raw materials they have alternative future uses. We include in inventory raw material costs and related manufacturing costs for drugs that we manufacture for our partners under contractual terms and that we use primarily in our clinical development activities and drug products. Each of our raw materials can be used in multiple products and, as a result, has future economic value independent of the development status of any single drug. For example, if one of our drugs failed, the raw materials allocated for that drug could be used to manufacture our other drugs. We expense these costs when we deliver the drugs to our partners, or as we provide these drugs for our own clinical trials. Also included in inventory are material costs, labor costs and manufacturing overhead costs associated with the Ibis T5000 Biosensor System and related assay kits. We reflect our inventory on the balance sheet at the lower of cost or market value under the first-in, first-out
method. We review inventory periodically and reduce the carrying value of items considered to be slow moving or obsolete to their estimated net realizable value. We consider several factors in estimating the net realizable value, including shelf life of raw materials, alternative uses for our drugs and clinical trial materials and historical write-offs. We did not record any inventory write-offs during the first half of 2008 and 2007.
Total inventory includes the following as of June 30, 2008 and December 31, 2007 (in thousands):
We capitalize costs consisting principally of outside legal costs and filing fees related to obtaining patents. We review our capitalized patent costs regularly to determine that they include costs for patent applications that have future value. We evaluate costs related to patents that we are not actively pursuing and write off any of these costs, if appropriate. We amortize patent costs over their estimated useful lives of ten years, beginning with the date the patents are issued. For the first half of 2008 and 2007, we recorded a non-cash charge of $679,000 and $337,000, respectively, which was included in research and development expenses and was related to the assignment of patents to certain of our partners and the write-down of our patent costs to their estimated net realizable values.
We assess the value of our long-lived assets, which include property, plant and equipment, patent costs, and licenses acquired from third parties, under the provisions set forth by SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and we evaluate our long-lived assets for impairment on at least a quarterly basis.
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. Historically, our estimates have been accurate as we have not experienced any material differences between our estimates and our actual results.
Consolidation of variable interest entities
We have 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 June 30, 2008, we had collaborative arrangements with nine entities that we consider to be variable interest entities under FIN 46R. For the first half of 2008, our condensed consolidated financial statements include two variable interest entities, Ibis and Regulus, for which we are the primary beneficiary. For the first half of 2007, our condensed consolidated financial statements include two variable interest entities, Ibis and Symphony GenIsis, for which we were the primary beneficiary. Until our acquisition of Symphony GenIsis in September 2007, we identified Symphony GenIsis as a variable interest entity that we consolidated.
SFAS 130, Reporting Comprehensive Income, requires us to report, in addition to net loss, comprehensive loss and its components. A summary follows (in thousands):
Stock-based compensation expense
We account for our stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123R, Share-Based Payment. We estimate the fair value of each stock option granted to employees 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 subsequent to January 1, 2008, we estimated the expected term of options granted based on historical exercise patterns. For the stock options granted prior to January 1, 2008, the estimated expected term is a derived output of the simplified method, as allowed under SAB 107.
For the six months ended June 30, 2008 and 2007, we used the following weighted-average assumptions in our Black-Scholes calculations:
Employee Stock Options:
We record stock options granted to non-employees, which consist primarily of options granted to Regulus Scientific Advisory Board, at their fair value in accordance with the requirements of SFAS 123R, then periodically remeasure them in accordance with EITF 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and recognize the expense over the service period.
Stock-based compensation expense for the three and six months ended June 30, 2008 and 2007 (in thousands, except per share data) was allocated as follows:
As part of the Regulus joint venture, both we and Alnylam issued our own companys stock options to members of Regulus Board of Directors and Scientific Advisory Board. The expenses associated with these options are recorded on Regulus books. Since we are consolidating the financial results of Regulus, $681,000 and $1.1 million of non-cash stock based compensation expense associated with these options for the three and six months ended June 30, 2008 was included in our consolidated expenses.
As of June 30, 2008, total unrecognized compensation cost related to non-vested stock-based compensation plans was $18.6 million. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize this cost over a weighted average period of 1.4 years.
Impact of recently issued accounting standards
In December 2007, the Financial Accounting Standards Board (FASB) issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51. This statement states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 applies to all entities that prepare consolidated financial statements, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. This statement is effective for fiscal years beginning after December 15, 2008, which will be effective for our fiscal year 2009. We do not expect the adoption of SFAS 160 to have a material impact on our results of operations and financial position but the retrospective presentation requirements of SFAS 160 will impact how noncontrolling interests are presented in our consolidated financial statements.
In May 2008, FASB issued Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement), (FSP No. APB 14-1). This statement states that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) should separate the liability and equity components of the instruments in a manner that will reflect the entitys nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP No. APB 14-1 will require that the value assigned to the debt component be equal to the estimated fair value of a similar debt instrument without the conversion feature, which results in the debt being recorded at a discount. The resulting debt discount will be amortized over the period during which the debt is expected to be outstanding as additional non-cash interest expense. This opinion is effective for fiscal years beginning on or after December 15, 2008, which will be effective for our fiscal year 2009, and must be applied retrospectively to all periods presented. We are currently evaluating what the impact of adopting FSP No. APB 14-1 will have on our consolidated financial statements.
In June 2008, the EITF issued EITF 07-05, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock. EITF 07-05 clarifies the determination of whether an instrument (or an embedded feature) is indexed to an entitys own stock, which would qualify as a scope exception under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. EITF 07-05 is effective for financial statements issued for fiscal years beginning after December 15, 2008, which will be effective for our fiscal year 2009. Early adoption for an existing instrument is not permitted. We are currently evaluating what the impact of adopting EITF 07-05 will have on our consolidated financial statements.
3. Fair Value Measurements
In September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. We have adopted the provisions of SFAS 157 as of January 1, 2008. Although the adoption of SFAS 157 did not impact our financial condition, results of operations, or cash flow, we are now required to provide additional disclosures as part of our financial statements.
SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets, which includes our available-for-sale securities and equity securities in publicly-held biotechnology companies; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable, which includes our auction rate security and commercial paper classified as available-for-sale securities; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, which includes the derivative instruments related to the subscription right and call option granted to Abbott Molecular Inc.
The fair value of the assets and liabilities required to be measured at fair value on a recurring basis was determined using the following inputs in accordance with SFAS 157 at June 30, 2008 (in thousands):
(1) Included in cash and cash equivalents and short term investments on our Condensed Consolidated Balance Sheet.
(2) Included in current liabilities on our Condensed Consolidated Balance Sheet.
(3) Included in other current assets and deposits and other assets on our Condensed Consolidated Balance Sheets.
(4) Represents the derivative instrument related to the call option granted to Abbott. As of June 30, 2008, the derivative instrument line item did not include the subscription right as it was exercised on June 27, 2008 (see additional discussion in Note 5).
The following table presents a reconciliation of the assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from December 31, 2007 to June 30, 2008 (in thousands):
1) Represents the derivative instruments related to the subscription right and call option granted to Abbott (see additional discussion in Note 5).
2) The subscription right and call option granted to Abbott are revalued at the end of each reporting period until they expire or are exercised. The resulting difference in fair value is included in our results of operations. For the first half of 2008, the adjustment to fair value resulted in a gain and was included in investment income.
3) The subscription right was exercised by Abbott on June 27, 2008 (see additional discussion in Note 5).
Additionally, in February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement allows entities to account for most financial instruments at fair value rather than under other applicable GAAP, such as historical cost. Under SFAS 159, an asset or liability is required to be marked to fair value every reporting period with the gain or loss from a change in fair value recorded in the statement of operations. We adopted the provisions of SFAS 159 in the first quarter of 2008. SFAS 159 permits companies to make an election to carry certain eligible financial assets and liabilities at fair value. We have made the election not to measure any additional assets and liabilities at fair value other than our available-for-sale and equity securities that are currently required by SFAS 115, Accounting for Certain Investments in Debt and Equity Securities and our derivative instrument that is currently required under SFAS 133, Accounting for Derivative Instruments and Hedging Activities, to be revalued at fair value each reporting period. Therefore, the adoption of SFAS 159 did not impact our results of operations, financial position or cash flows.
4. Long-Term Obligations
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. We included the issuance costs in our balance sheet and are amortizing these costs to interest expense over the life of the debt. 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 our common stock at a conversion price of $14.63 per share. We 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 also are able to require us 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.
We used the net proceeds from the issuance of the 25/8% notes to repurchase our 51/2% convertible subordinated notes due in 2009. In January 2007, we repurchased approximately $44.2 million aggregate principal amount of our 51/2% notes at a redemption price of $44.9 million plus accrued but unpaid interest. In May 2007, we 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, we recognized a $3.2 million loss on the early extinguishment of debt in the first half of 2007, which included a $1.2 million non-cash write-off of unamortized debt issuance costs.
5. Collaborative Arrangements and Licensing Agreements
The information discussed below represents partnerships we entered into during 2008. There have been no material changes to the partnerships entered into prior to 2008 from the information provided in Note 6Collaborative Arrangements and Licensing Agreements of the Consolidated Financial Statements section, included in our Annual Report on Form 10-K for the year ended December 31, 2007.
Pharmaceutical Alliances and Licensing
In January 2008, we entered into a strategic alliance with Genzyme focused on the licensing of mipomersen and a research relationship. The transaction included a $175 million licensing fee, a $150 million equity investment in us (5 million shares of our common stock at $30 per share), over $1.5 billion in milestone payments and a share of profits on mipomersen and follow-on drug(s) ranging from 30 to 50 percent of all commercial sales. Under this alliance, we will over time transition the development responsibility to Genzyme and Genzyme will be responsible for the commercialization of mipomersen. We will contribute up to the first $125 million in funding for the development costs of mipomersen. Thereafter we and Genzyme will share development costs equally. Our initial development funding commitment and the shared funding will end when the program is profitable.
Genzyme has agreed that it will not sell its equity investment in Isis stock purchased in February 2008 until the earlier of four years from the date of our mipomersen license agreement, the first commercial sale of mipomersen and the termination of our mipomersen license agreement. Thereafter, Genzyme will be subject to monthly limits on the number of shares it can sell. In addition, Genzyme has agreed that until the earlier of the 10 year anniversary of the mipomersen license agreement and the date Genzyme holds less than 2% of our issued and outstanding common stock, Genzyme will not acquire any additional shares of our common stock without our consent.
The price Genzyme paid for our common stock represented a significant premium over the fair value of our common stock. Using a Black-Scholes option valuation model, we determined that the value of the premium was $100 million, which represents value Genzyme gave to us to help fund the companies research collaboration that began in January 2008. We are amortizing this premium along with the $175 million licensing fee that we received in the second quarter of 2008 ratably into revenue until June 2012, which represents the end of our performance obligation based on the research and development plan included in the agreement. For the three and six months ended June 30, 2008, we recognized revenue of $8.7 million and $15.0 million, respectively, related to the $100 million premium and the $175 million licensing fee, which represented 28% of our total revenue for the first half of 2008. Our Condensed Consolidated Balance Sheet at June 30, 2008 includes deferred revenue of $260.0 million, which represents the remaining premium and licensing fee.
Drug Discovery and Development Satellite Company Collaborations
Antisense Therapeutics Limited
In December 2001, we licensed ATL/TV1102 to ATL, an Australian company publicly traded on the Australian Stock Exchange and in February 2008, ATL licensed ATL/TV1102 to Teva Pharmaceutical Ltd. As part of our licensing agreement with ATL, we will receive one third of sublicense fees and milestone payments ATL receives from Teva as well as a percentage of any royalties. As a result of the encouraging data that ATL and Teva reported from a Phase 2a study on ATL/TV1102 in patients with relapsing and remitting multiple sclerosis, we earned $1.4 million as our portion of ATLs licensing fee and milestone payment from Teva which we included in revenue in the second quarter of 2008.
In addition to ATL/TV1102, ATL is currently developing ATL1103 for growth and sight disorders. ATL1103 is a product of our joint antisense drug discovery and development collaboration, which we extended for an additional two years in January 2007. ATL pays us for access to our antisense expertise and for research and manufacturing services we may provide to ATL during the collaboration. Additionally, ATL will pay royalties to us on any antisense drugs discovered and developed within the partnership.
In connection with this collaboration, we received 30.0 million shares of ATL common stock upon completion of ATLs initial public offering, representing an initial ownership percentage of approximately 14%. The initial ATL common stock we received had a value of $2.8 million, and we recognized this amount into revenue ratably over the five-year period of performance under the collaboration, which ended in November 2006. There were no changes in our period of performance. Our Condensed Consolidated Balance Sheets at June 30, 2008 and December 31, 2007 include deferred revenue of $432,000 and $250,000, respectively. For the three and six months ended June 30, 2008, we recorded revenue of $1.4 million related to this collaboration compared to $44,000 and $55,000 for the same periods in 2007. As of June 30, 2008 and December 31, 2007, our ownership percentage in ATL, including 10.3 million shares we purchased subsequent to shares we acquired in ATLs initial public offering, was less than 10% of ATLs equity. Our balance sheets at June 30, 2008 and December 31, 2007 included a short-term investment at fair market value of $2.7 million and $1.4 million, respectively, related to this equity investment.
Abbott Molecular Inc.
In January 2008, we, Ibis and Abbott entered into a strategic alliance master agreement pursuant to which:
· Abbott purchased Ibis common stock representing approximately 10.25% of the issued and outstanding common stock of Ibis for a total purchase price of $20 million;
· Ibis granted Abbott a subscription right to purchase an additional $20 million of Ibis common stock before July 31, 2008, which when combined with Abbotts initial investment would represent approximately 18.6% of the issued and outstanding common stock of Ibis. On June 27, 2008, Abbott exercised this subscription right by purchasing an additional $20 million of Ibis common stock;
· We granted Abbott a call option to acquire from us all remaining Ibis capital stock for a purchase price of $175 million, which, subject to Ibis satisfying a defined set of objectives, may be increased to as much as $190 million;
· If Abbott ultimately acquires Ibis under the call option agreement, Abbott will make the earn out payments described below, which will enable our shareholders to continue to benefit from Ibis success.
The investment by Abbott provides Ibis the funding to take the key next steps in enhancing its value, while allowing it to remain independent and focused during the option period so as to best enable this progress. This alliance with Abbott also provides Ibis the benefit of an experienced partner in molecular diagnostics and will focus Ibis on commercial success.
If Abbott acquires from us all of the remaining Ibis capital stock under the call option, Abbott will pay us earn out payments equal to a percentage of Ibis revenue related to sales of Ibis T5000 Biosensor Systems, including instruments, assay kits and successor products from the date of the final acquisition through December 31, 2025. These earn out payments will equal 5% of Ibis cumulative net sales over $150 million and up to $2.1 billion, and 3% of Ibis cumulative net sales over $2.1 billion. The earn out payments may be reduced from 5% to as low as 2.5% and from 3% to as low as 1.5%, respectively, upon the occurrence of certain events. In addition, as part of the final acquisition, Ibis will distribute to us, immediately prior to the closing, all of Ibis cash on hand and any receivables or other payments due to Ibis under government contracts and grants held by Ibis as of the closing.
The call option initially expires on December 31, 2008, provided that, subject to certain conditions, Abbott may extend the term of the call option through June 30, 2009.
Until the expiration of the call option, we and Ibis must obtain Abbotts consent before we or Ibis can take specified actions, such as amending Ibis certificate of incorporation, redeeming, repurchasing or paying dividends on Ibis capital stock, issuing any Ibis capital stock, entering into a transaction for the merger, consolidation or sale of Ibis, creating any Ibis indebtedness, or entering into any Ibis strategic alliance, joint venture or joint marketing agreement. In addition, the strategic alliance contains a make whole provision such that in the event of a liquidation or change of control of Ibis, Abbott will receive a payment equal to the price paid per share of the capital stock of Ibis acquired by Abbott in the initial investment and under the subscription right, plus a yield of 3% annually from the date Abbott purchased the Ibis common stock, prior to the distribution of any proceeds to any other holders of Ibis capital stock.
We valued each element of the initial transaction and as a result allocated $14.6 million to the initial stock purchase with the remaining $5.4 million allocated to the call option and the subscription right (the Derivative Instruments). On June 27, 2008, Abbott exercised its subscription right and purchased an additional $20 million of Ibis common stock. As a result of Abbotts investments in Ibis, Abbott is a minority owner of Ibis. Therefore, the cumulative value attributed to the initial and subsequent stock purchase of $34.6 million was recorded as a Noncontrolling Interest in Ibis Biosciences, Inc. on our Condensed Consolidated Balance Sheet. As the strategic alliance progresses, this line item will be reduced by Abbotts share of Ibis net losses, which were $896,000 in the first half of 2008, until the balance becomes zero. The reductions to the Noncontrolling Interest in Ibis will be reflected in our Condensed Consolidated Statement of Operations using a similar caption and will improve our reported net loss. At the close of the initial transaction, $5.4 million of combined value attributed to the derivative instruments was included in the current liabilities section of our Condensed Consolidated Balance Sheet. As required by current accounting rules, we revalue the derivative instruments at the end of each quarter until they expire or are exercised. Since Abbott exercised the subscription right on June 27, 2008, the remaining liability of $5.1 million represents the fair value of only the call option at June 30, 2008.
In addition to the previously mentioned items, Ibis and Abbott have entered into two other important transactions, which enhance the two companies strategic alliance. In the second quarter of 2008, Abbott entered into a distribution agreement with Ibis by paying Ibis $480,000 in the form of an up-front payment for the right to be an non-exclusive distributor for the marketing, promotion, solicitation, sales and distribution of Ibis assay kits and Ibis T5000 Biosensor Systems to customers worldwide. Most recently in the third quarter of 2008, Ibis entered into a consulting agreement with Abbott primarily focused on advancing the regulatory work and implementing the quality systems necessary for Ibis to enter into the clinical diagnostics market.
In April 2008, Regulus entered into a strategic alliance with GlaxoSmithKline to discover, develop and market novel microRNA-targeted therapeutics to treat inflammatory diseases such as rheumatoid arthritis and inflammatory bowel disease. The alliance utilizes Regulus expertise and intellectual property position in the discovery and development of microRNA-targeted therapeutics and provides GSK with an option to license drug candidates directed at four different microRNA targets with relevance in inflammatory disease. Regulus will be responsible for the discovery and development of the microRNA antagonists through completion of clinical proof of concept, unless GSK chooses to exercise its option earlier. After exercise of the option, GSK will have an exclusive license to drugs developed under each program by Regulus for the relevant microRNA target for further development and commercialization on a worldwide basis. Regulus will have the right to further develop and commercialize any microRNA therapeutics which GSK chooses not to develop or commercialize.
Regulus received $20 million in upfront payments from GSK, including a $15 million option fee and a $5 million note. The note plus interest will convert into Regulus common stock in the future if Regulus achieves a minimum level of financing with institutional investors. In addition, we and Alnylam are guarantors of the note, and if the note does not convert or is not repaid in cash after three years, we, Alnylam and Regulus may elect to repay the note plus interest with shares of each companys common stock. Regulus could also be eligible to receive up to $144.5 million in development, regulatory and sales milestone payments for each of the four microRNA-targeted drugs discovered and developed as part of the alliance. In addition to the potential of up to nearly $600 million Regulus could receive in option, license and milestone payments, Regulus would also receive tiered royalties up to double digits on worldwide sales of drugs resulting from the alliance.
The $15 million option fee is being amortized into revenue over Regulus six year period of performance. The $5 million note is shown as a liability on our Condensed Consolidated Balance Sheet. For the three and six months ended June 30, 2008, we recognized revenue of $625,000 related to the $15 million option fee, which represented 1% of our total revenue for the first half of 2008. Our Condensed Consolidated Balance Sheet at June 30, 2008 includes deferred revenue of $14.4 million, which represents the remaining option fee.
6. Segment Information and Concentration of Business Risk
We report our financial results in three reportable segments, Drug Discovery and Development, Ibis and Regulus. Segment loss from operations includes revenue offset by research and development expenses, cost of commercial revenue for our Ibis subsidiary, selling, general and administrative expenses, and other charges attributable to each segment. See the Business Segments discussion within the Managements Discussion and Analysis of Financial Condition and Results of Operations in Item 2 below for additional information on the segments.
Our Drug Discovery and Development segment generates revenue from collaborations with corporate partners and from licensing proprietary patent rights. Revenue from collaborations with corporate partners may consist of upfront payments, funding for research and development activities, milestone payments and royalties or profit sharing payments. This segments proprietary technology to discover and characterize novel antisense inhibitors has enabled our scientists to modify the properties of our antisense drugs for optimal use with particular targets and thus, to produce a broad proprietary portfolio of drugs applicable to many disease targets.
Our Ibis subsidiary generates revenue from grants and contracts from United States government agencies, from sales of its Ibis T5000 Biosensor System and related assay kits and the analysis of samples within its assay services laboratory.
Our Regulus joint venture generates revenue from research grants and collaborations with corporate partners such as the recently announced strategic alliance with GSK in April 2008.
The following is information for revenue, loss from operations and total assets by segment (in thousands):
(1) Ibis commercial revenue has been classified as research and development revenue under collaborative agreements on our Condensed Consolidated Statements of Operations.
Concentrations of business risk
We have historically funded our operations in part from collaborations with corporate partners and as it relates to Ibis, from collaborations with various government agencies. Additionally, 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 our revenue. Revenue from significant partners, which is defined as 10% or more of our total revenue, was as follows:
For the three months ended June 30, 2008 and 2007, we derived approximately 11% and 50%, respectively, of our revenue from agencies of the United States Government in aggregate, compared to 12% and 55% for the six months ended June 30, 2008 and 2007, respectively. For the first half of 2008, none of our significant partners were agencies of the United States Government while three significant partners accounted for 32%, 14% and 10% of revenue from agencies of the United States Government for the first half of 2007.
Contract receivables from four significant partners comprised approximately 28%, 16%, 13% and 12% of contract receivables at June 30, 2008. Contract receivables from three significant partners comprised approximately 25%, 19% and 11% of contract receivables at December 31, 2007.
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 financial position and outlook for Isis Pharmaceuticals, Inc. as well as our Ibis Biosciences subsidiary and our Regulus joint venture, and the therapeutic and commercial potential of our technologies and products in development. 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, 2007, which is on file with the U.S. Securities and Exchange Commission, and those identified within this Item entitled Risk Factors beginning on page 29 of this Report.
We are a leading company in antisense technology exploiting a novel drug discovery platform to create a broad pipeline of first-in-class drugs. Through our highly efficient and prolific drug discovery platform, we can expand our drug pipeline and our partners drug pipelines with antisense drugs that address significant unmet medical needs. Our business strategy is to do what we do bestto discover unique antisense drugs and conduct early development on these drugs to key value inflection points. Because we can discover more drugs than we can develop, our plan is to discover new drugs, outlicense our drugs to partners and build a growing annuity of milestone payments and royalty income. In this way, we maximize the value of the drugs we discover by licensing our drugs to partners at key development points, which allows us to focus on utilizing our antisense technology platform to discover new drugs. At the same time, we benefit from our partners expertise to develop, commercialize and market our drugs. For example, we partner our drugs with leading pharmaceutical companies, such as Bristol-Myers Squibb Company, Genzyme and Ortho-McNeil, Inc. as well as with smaller satellite companies that have expertise in specific disease areas. In addition to our cutting edge antisense programs, we maintain technology leadership beyond our core areas of focus through collaborations with Alnylam and Regulus, our joint venture created to focus on microRNA therapeutics. We explore the technology beyond antisense with additional opportunities in infectious disease identification through our Ibis subsidiary and in the discovery and development of aminoglycoside and aptamer drugs through our technology partners, Achaogen, Inc. and Archemix, respectively. All of these aspects fit into our unique business model and create continued shareholder value.
We protect our proprietary RNA-based technologies and products through our substantial and vast patent estate of more than 1,500 issued patents. We remain one of the largest patent holders in the U.S., and with our ongoing research and development, our patent portfolio continues to grow. The patents not only protect our key assetsour technology, our drugs, and the Ibis T5000 Biosensor Systemthey also form the basis for lucrative licensing and partnering arrangements. We have generated more than $116 million from our intellectual property licensing program that helps support our internal drug discovery and development programs.
In addition to the important progress we and our partners made with our second generation drugs in development and the achievements of our Ibis subsidiary in commercializing the Ibis T5000 Biosensor System, to date in 2008, we have completed several transactions that significantly strengthened our financial position. In January 2008, we entered into a strategic alliance with Genzyme in which Genzyme made a $150 million equity investment in our common stock. Subsequently in June 2008, we received an additional $175 million licensing fee from Genzyme when we completed the detailed mipomersen license agreement. Furthermore in January 2008, we and Ibis entered into a strategic alliance with Abbott in which Abbott made a $20 million investment in Ibis by purchasing 10.25% of Ibis common stock, a subscription right to purchase an additional 8.35% of Ibis common stock and a call option to acquire Ibis remaining equity for $175 million to $190 million. Subsequently in June 2008, Abbott exercised its subscription right and invested an additional $20 million to purchase additional equity in Ibis. Additionally, in April 2008, Regulus entered into a strategic partnership with GSK. These partnerships have provided us with an aggregate of approximately $385 million in cash payments to date and the potential to earn over $2.1 billion in milestone payments. We also will share in the future commercial success of the drugs resulting from these partnerships through profit sharing and royalties as well as in the commercial success of Ibis if Abbott acquires Ibis through earn out payments based on Ibis future cumulative sales. These transactions represent the value that we are realizing from our extensive product pipeline and the successes of our partnering strategy, and provide us with the financial strength to continue to successfully execute our goals.
As evidenced from our recent partnering successes, we continue to benefit from our business strategy that enables us to discover and develop drugs and technologies, nurturing them until the right time to progress them to partners or to satellite companies. This strategy has provided us with the financial strength and the diverse pipeline of drugs that we have today. Looking forward, we expect to grow our pipeline over the remainder of the year by adding two to four new drugs; already we have added the first drug with PCSK9, our development candidate with BMS for which we earned a $2 million milestone payment.
We focus our business on three principal segments:
Drug Discovery and Development Within our primary business segment, we are exploiting a novel drug discovery platform to create a broad pipeline of first-in-class drugs for us and our partners. Our proprietary technology enables us to rapidly identify drugs, providing a wealth of potential targets to treat a broad range of diseases. We focus our efforts in therapeutic areas where our drugs will work best, efficiently screening many targets in parallel and selecting the best drugs. This efficiency combined with our rational approach to selecting disease targets enables us to build a large and diverse
portfolio of drugs designed to treat a variety of health conditions. We currently have 18 drugs in development. Our partners are licensed to develop, with our support, 15 of these 18 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 Biosciences, Inc. Ibis, formerly a wholly owned subsidiary of Isis and now a majority-owned subsidiary of Isis, has developed and is commercializing its biosensor technology, including the Ibis T5000 Biosensor System and assay kits. Ibis T5000 offers a unique solution for rapid identification and characterization of infectious agents. It can identify virtually all bacteria, viruses and fungi and provide information about drug resistance, virulence and strain type of these pathogens within several hours. Ibis is developing, manufacturing and selling the Ibis T5000 instruments along with the Ibis T5000 assay kits. Currently we are selling research use only kits for many applications. Examples of these kits include influenza surveillance, Staphylococcus aureus genotyping and characterization, antibiotic resistance determination and anthrax genotyping. We continue to develop new kits, and as defined through our agreement with Abbott, we are particularly focused on developing those applications that will be of highest commercial value for the clinical diagnostics market.
Much of the development of the Ibis T5000 Biosensor System and related applications has been funded through government contracts and grants. As of June 30, 2008, we had earned $72.9 million in revenue under our government contracts and grants, and we have an additional $7.9 million committed under our existing contracts and grants.
Regulus Therapeutics LLC In September 2007, we and Alnylam established Regulus as a joint venture focused on the discovery, development, and commercialization of microRNA therapeutics. Regulus is addressing therapeutic opportunities that arise from alterations in microRNA expression. Since microRNAs regulate the expression of broad networks of genes and biological pathways, microRNA therapeutics define a new and potentially high-impact strategy to target multiple points on disease pathways.
To date, microRNAs have been implicated in several disease areas, such as cancer, viral infection, metabolic disorders, and inflammatory diseases. Regulus is currently focusing on several of these disease areas, including microRNA therapeutics that target miR-122, an endogenous liver-specific host gene also required for viral infection by hepatitis C virus, or HCV, and metabolics. Regulus is actively exploring additional areas for development of microRNA therapeutics, including cancer, other viral diseases, metabolic disorders and inflammatory diseases.
· We completed licensing transaction for mipomersen.
· We finalized and announced 2008 mipomersen development plan with Genzyme.
· We reported a preclinical study in Circulation showing that mipomersen lowers Lp(a) and oxidized-LDL, independent risk factors for cardiovascular disease.
· We initiated a pivotal quality phase 2 study in heterozygous FH subjects with coronary artery disease.
· We were granted broad patent coverage for antisense compounds targeting apolipoprotein B, U.S. Patent No. 7,407,943 entitled Antisense modulation of Apolipoprotein B Expression.
· We highlighted our robust diabetes and obesity portfolio with nine presentations and posters at the American Diabetes Association meeting:
· We presented new preclinical data relating to ISIS 388626, Isis drug targeting SGLT2.
· We presented results from eight research programs on novel targets that offer new mechanisms to address metabolic diseases, including obesity.
Other Partnered Programs
· ATL and Teva reported encouraging Phase 2 results for ATL/TV1102, targeting VLA-4 in patients with multiple sclerosis.
· Our partnered oncology drugs highlighted at the American Society of Clinical Oncology demonstrate the potential of antisense technology to treat multiple cancers.
· OncoGenex reported encouraging Phase 2 results on OGX-011, targeting clusterin, in patients with hormone refractory prostate cancer.
· Eli Lilly and Company reported positive Phase 1 clinical trial results for LY2181308, targeting surviving.
· Atlantic Healthcare received U.S. orphan drug designation for alicaforsen for the treatment of pouchitis.
· Altair Therapeutics advanced AIR 645 into Phase 1 studies for the treatment of asthma.
Regulus Therapeutics (microRNA Joint Venture)
· Regulus entered into a strategic alliance with GlaxoSmithKline.
· Regulus obtained exclusive rights from Stanford University to worldwide patent applications covering methods and compositions for antagonizing miR-181a.
· Regulus was selected as one of the FierceBiotechs Fierce 15 for 2008.
· We received an additional $20 million investment from Abbott for a total of 18.6 percent equity in Ibis, retaining Abbotts exclusive option to purchase its remaining equity by June 30, 2009.
· Ibis extended government contracts that add to its revenue and fund the expansion of applications of the Ibis T5000 technology.
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. Historically, our estimates have been accurate as we have not experienced any material differences between our estimates and our actual results. The significant accounting policies, which we believe are the most critical to aid in fully understanding and evaluating our reported financial results, require the following:
· 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 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, 2007.
Total revenue for the three and six months ended June 30, 2008 of $33.0 million and $54.3 million, respectively, was significantly higher than the revenue for the same periods in 2007 of $3.8 million and $6.3 million due to the addition of revenue from new collaborations. As part of our strategic relationship with Genzyme, Genzyme purchased $150 million of our common stock at $30 per share and in the second quarter paid us a licensing fee of $175 million. We are amortizing the premium on the stock, $100 million calculated using a Black-Scholes option valuation model, and the licensing fee ratably into revenue until June 2012, which represents the end of our performance obligation based on the research and development plan included in the agreement. In addition to the Genzyme revenue, in the second quarter of 2008, we continued to recognize significant value from our portfolio of antisense drugs and our satellite companies. In the second quarter of 2008, we earned a $2.0 million milestone payment from BMS when it moved PCSK9 into development as well as sublicense revenue of $4.6 million from Alnylam from its transaction with Takeda Pharmaceutical Company Limited and $1.4 million from ATL from its transaction with Teva. Our subsidiaries also contributed to the increase in our 2008 year to date revenue compared to the same period in 2007. In the second quarter of 2008, Regulus began recognizing revenue from its collaboration with GSK while Ibis experienced an 80% growth in its year to date revenues, which is discussed further in the Regulus Therapeutics and Ibis Biosciences, Inc. sections below.
Quarter-to-quarter fluctuations in revenue are common for us as our revenue is significantly affected by the nature and timing of payments under agreements with our partners, including license fees and milestone-related payments, such as the $2 million milestone payment we received from BMS and the $4.6 million and the $1.4 million sublicense fees we earned from Alnylam and ATL, respectively, which are included in revenue in the second quarter of 2008.
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
Research and development revenue under collaborative agreements for the three and six months ended June 30, 2008 was $22.9 million and $40.5 million, respectively, compared to $1.6 million and $2.0 million for the same periods in 2007. The increase is primarily due to revenue from our collaborations with BMS, OMI and Genzyme.
Licensing and Royalty Revenue
Our revenue from licensing activities and royalties for the three and six months ended June 30, 2008 was $6.1 million and $6.8 million, respectively, and was higher compared to $331,000 and $779,000 for the same periods in 2007 due to the $4.6 million and $1.4 million of sublicensing revenue we earned from Alnylam and ATL in the second quarter of 2008.
Ibis revenue for the three and six months ended June 30, 2008 was $3.3 million and $6.2 million, respectively, compared to $1.9 million and $3.5 million for the same periods in 2007. Primarily as a result of the increased number of T5000 Biosensor System placements during fiscal year 2007 compared to 2006, Ibis commercial revenue of $1.1 million and $2.3 million for the three and six months ended June 30, 2008 was higher than its commercial revenue of $810,000 and $1.4 million for the same periods in 2007. Commercial revenue consisted of revenue from sales of Ibis T5000 Biosensor Systems 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 instrument and assay kits over the period of this support obligation. In addition, Ibis commercial revenue included revenue from the distribution agreement Ibis and Abbott entered into in March 2008. Ibis revenue from government contracts was $2.2 million and $3.9 million for the three and six months ended June 30, 2008, representing an increase over $1.1 million and $2.0 million for the same periods in 2007, driven primarily by contracts awarded in late 2007 and 2008 to date. Ibis was awarded $3.2 million of new contracts in the first half of 2008 that support Ibis continued revenue growth by expanding the applications for the T5000 Biosensor System.
From inception through June 30, 2008, Ibis has earned $72.9 million in revenue from various government agencies to further the development of our Ibis T5000 Biosensor System and related assay kits. An additional $7.9 million is committed under existing contracts and grants. Ibis 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.
Regulus revenue for the three and six months ended June 30, 2008 was $656,000 and $748,000 related primarily to revenue from its collaboration with GSK and to a lesser extent to a Small Business Innovation Research grant from the National Institute of Allergy and Infectious Diseases, a part of the National Institutes of Health, which is funding further research for the miR-122 program. As part of Regulus strategic alliance with GSK, Regulus received a $15 million upfront fee, which we began amortizing into revenue in the second quarter of 2008 and will continue to amortize over Regulus six year period of performance under the agreement. Because Regulus was formed in the third quarter of 2007, it did not have revenue in the first half of 2007.
Operating expenses for the three and six months ended June 30, 2008 were $36.1 million and $66.3 million, respectively, compared to $23.5 million and $46.8 million for the same periods of 2007. We have expanded our clinical development programs as our drugs advance in development, resulting in an increase in operating expenses of $2.9 million in the first half of 2008 compared to the first half of 2007. Additionally, Ibis operating expenses have increased by $5.9 million in the first half of 2008 compared to the first half of 2007 to support the growth of its commercial business and the cost of activities to achieve milestones as part of Abbotts investment and purchase option. Also contributing to the increase in operating expenses in the first half of 2008 compared to the first half of 2007 was $4.0 million of expenses associated with our joint venture, Regulus, which are expected to increase over the remainder of the year as Regulus increases its staffing and outside research.
Furthermore, contributing to the increase in operating expenses was an increase in non-cash compensation expense related to stock options. Non-cash compensation expense related to stock options was $4.0 million and $7.8 million for the three and six months ended June 30, 2008 compared to $2.4 million and $4.8 million for the same periods in 2007, primarily reflecting the increase in our stock price from the first half of 2007 to the first half of 2008.
Our operating expenses by segment were as follows (in thousands):
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 expense related to stock options. We believe non-cash compensation expense is not indicative of our operating results or cash flows from our operations. Further, we internally evaluate the performance of our operations excluding it.
Research and Development Expenses
Our research and development expenses consist of costs for antisense drug discovery, antisense drug development, manufacturing and operations and R&D support costs. Also included in research and development expenses are Ibis and Regulus research and development expenses. 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 and six months ended June 30, 2008, we incurred total research and development expenses, excluding non-cash compensation expense, of $28.0 million and $51.4 million, respectively, compared to $18.4 million and $36.5 million for the same periods in 2007. We attribute the increase to the expansion of our key programs, activities required to commercialize the Ibis T5000 Biosensor System and achieve milestones as part of the Abbott transaction and Regulus research activities. Expenses related to Ibis and Regulus are discussed in separate sections below.
Drug Discovery & Development
Antisense Drug Discovery
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 continue to advance our antisense technology, we are investing in our antisense drug discovery programs to expand our and our partners drug pipeline. 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, excluding non-cash compensation expense, for the three and six months ended June 30, 2008 were $4.5 million and $8.7 million, respectively, compared to $3.2 million and $6.6 million for the same periods in 2007. The higher expenses in 2008 compared to 2007 were primarily due to increased activity levels related to our planned investment to fill our pipeline and additional spending to support collaborative research efforts, which required an increase in personnel and lab supplies.
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 $7.9 million and $15.1 million, excluding non-cash compensation expense related to stock options, for the three and six months ended June 30, 2008 compared to $6.5 million and $12.2 million for the same periods in 2007. We attribute the increase primarily to the continued development of mipomersen, including the Phase 3 program, and increases in our metabolic disease development projects. Development overhead costs were $840,000 and $1.7 million for the three and six months ended June 30, 2008, compared to $988,000 and $2.3 million for the same periods in 2007. The decrease in overhead costs was primarily a result of people shifting the hours they worked from non-project specific activities to specific projects related to the development of our drugs. We expect our drug development expenses to fluctuate based on the timing and size of our clinical trials.
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, 15 of our 18 drug candidates, which substantially reduces our development costs. As part of our collaboration with Genzyme, we will over time transition the development responsibility to Genzyme and Genzyme will be responsible for the commercialization of mipomersen. We will contribute up to the first $125 million in funding for the development costs of mipomersen. Thereafter we and Genzyme will share development costs equally. Our initial development funding commitment and the shared funding will end when the program is profitable.
Manufacturing and Operations
Expenditures in our manufacturing and operations function consist primarily of personnel costs, specialized chemicals for oligonucleotide manufacturing, laboratory supplies and outside services. Manufacturing and operations expenses, excluding non-cash compensation expense, for the three and six months ended June 30, 2008 were $2.8 million and
$5.4 million, respectively, compared to $1.5 million and $3.0 million for the same periods in 2007. 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. The increase is primarily due to the costs associated with the manufacturing of drug supplies for our corporate partners and to support our expanded internal drug development programs.
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, excluding non-cash compensation expense related to stock options, for the three and six months ended June 30, 2008 were $6.1 million and $10.1 million, respectively, compared to $4.7 million and $9.8 million for the same periods in 2007. The slight increase in the first half of 2008 compared to the first half of 2007 is primarily a result of the increase in additional expenses to support the continued development of our key programs and an increase in amortization associated with a non-cash charge for patents assigned to certain of our partners, offset by the $750,000 we received from Ercole in March 2008 as repayment of a convertible note that we had previously expensed.
Our R&D support costs by segment were as follows (in thousands):