UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)

Commission file number 0-19125

Isis Pharmaceuticals, Inc.

(Exact name of Registrant as specified in its charter)

1896 Rutherford Road, Carlsbad, CA 92008

(Address of principal executive offices, including zip code)

760-931-9200

(Registrant’s telephone number, including area code)

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

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

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 November 5, 2007 was 86,950,330.

ISIS PHARMACEUTICALS, INC.

FORM 10-Q

INDEX

TRADEMARKS

Orasense^TM is a trademark of Isis Pharmaceuticals, Inc.

Ibis Biosciences^TM is a trademark of Ibis Biosciences, Inc.

Ibis T5000^TM is a trademark of Ibis Biosciences, Inc.

Vitravene^® is a registered trademark of Novartis AG.

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

Regulus Therapeutics^TM is a trademark of Regulus Therapeutics LLC.

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

See accompanying notes.

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(Unaudited)

See accompanying notes.

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ISIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See accompanying notes.

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ISIS PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

(Unaudited)

1.                                      Basis of Presentation

The unaudited interim condensed consolidated financial statements for the three and nine month periods ended September 30, 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., Orasense, Ltd. and Symphony GenIsis, Inc.  On September 27, 2007, Isis purchased all of the equity in Symphony GenIsis, Inc.  On October 25, 2006, Isis dissolved its 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, Regulus Therapeutics LLC, 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.  Until the acquisition of Symphony GenIsis, Inc., in September 2007, Isis identified Symphony GenIsis as a variable interest entity for which Isis was the primary beneficiary.  The condensed consolidated financial statements leading up to the acquisition date also include the financial condition and results of operations of Symphony GenIsis, Inc.  All significant intercompany balances and transactions have been eliminated.

2.                                      Significant Accounting Policies

Revenue recognition

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 its period of performance relating to the term of the contractual arrangements.  Occasionally, Isis is required to estimate its period of performance when the agreements it enters into do not clearly define such information. Should different estimates prevail, revenue recognized could be materially different. To date Isis’ estimates have not required material adjustments.  Isis has made estimates of its continuing obligations on several agreements.  Isis’ collaborative agreements typically include a research and/or development project plan that includes activities to be performed in the collaboration and the party responsible for performing them.  Isis estimates the period of time over which it will complete the activities for which it is responsible and uses that period of time as its period of performance for purposes of revenue recognition and amortizes revenue over such period.  When Isis’ collaborators have asked Isis to continue performing work in a collaboration beyond the initial period of performance, Isis has extended its amortization period to correspond to the new extended period of performance.  In no case have adjustments to performance periods and related adjustments to revenue amortization periods had a material impact on Isis’ revenue.

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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 milestone’s 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 the provisions in SAB 104 were met 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, Isis started to sell the Ibis T5000 Biosensor System commercially. The sale of each Ibis T5000 Biosensor System contains multiple elements.  Since Isis had no previous experience 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 accounts for the entire system as one deliverable and recognizes 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, Isis has ongoing support obligations for the Ibis T5000 Biosensor System, therefore it is amortizing the revenue for the entire system including related assay kits, over a one-year period. Once Isis obtains a sufficient number of sales to enable it to identify each element’s 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.

Short-term investments

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.  During the first nine months of 2007, Isis sold the remainder of its equity securities of Alnylam Pharmaceuticals, Inc. that it owned resulting in a realized gain of $3.5 million compared to a net gain on investments of $2.3 million during the same period in 2006.  The net gain on investments during the first nine months of 2006 represented a gain of $2.7 million realized on the sale of a portion of the equity securities of Alnylam that Isis owned, offset by a non-cash loss on investment of $465,000 related to the impairment of Isis’ equity in Antisense Therapeutics Ltd.  Since the impairment in the second quarter of 2006, Isis has recorded a net unrealized gain of $550,000 related to its equity investment in ATL as a separate component of stockholders’ equity, reflecting the increase in the market value of the investment since the impairment.  Isis determined that there were no other-than-temporary declines in value of investments in the first nine months of 2007.

Inventory valuation

In accordance with Statement of Financial Accounting Standards (“SFAS”) 2, Accounting for Research and Development Costs, Isis capitalizes the costs of raw materials that it purchases for use in producing its drugs because until Isis uses these raw materials they have alternative future uses.  Isis includes in inventory raw material costs and related manufacturing 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. Each of Isis’ 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 Isis’ drugs failed, the raw materials allocated for that drug could be used to manufacture its other drugs.  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

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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 includes $1.7 million of raw materials and $173,000 of work-in-process as of September 30, 2007, compared to $861,000 of raw materials as of December 31, 2006.

Patents

Isis capitalizes costs consisting principally of outside legal costs and filing fees related to obtaining patents. Isis reviews its capitalized patent costs regularly to determine that they include costs for patent applications 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 ten years, beginning with the date the patents are issued.  For the first nine months of 2007 and 2006, Isis recorded a non-cash charge of $515,000 and $2.2 million, respectively, 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.

Long-lived assets

Isis periodically evaluates carrying values of long-lived assets including property, plant and equipment and intangible assets or when events and circumstances indicate that these assets may have been impaired. Isis has adopted SFAS 144, Accounting for the Impairment of Long-Lived Assets.

Income taxes

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, California and foreign tax net operating loss (“NOL”) carryfowards of approximately $560.0 million, $179.5 million and $1.0 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 tax benefits related to NOL carryforwards and R&D credits 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 September 30, 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 September 30, 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 a 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 NOL’s and R&D credits.  Isis’ tax years for 2001 and 2002 are currently being audited by California’s Franchise Tax Board.

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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, Isis’ estimates have been accurate as it has not experienced any material differences between its estimates and its actual results.

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 September 30, 2007, Isis had collaborative arrangements with six entities that it considers to be variable interest entities (“VIE”) under FIN 46R.  Described below is Isis’ relationship with Symphony GenIsis and the collaborative arrangements entered into in 2007 that Isis considers to be VIE’s.

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, mipomersen (formerly 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 treated Symphony GenIsis as a VIE for which Isis was 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.  In September 2007, Isis purchased all of the equity of Symphony GenIsis at which point it became a wholly owned subsidiary of Isis and ceased being a VIE.

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 Atlantic’s 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 Atlantic’s results of operations under FIN 46R as Isis is not the primary beneficiary.

In September 2007, Isis and Alnylam launched Regulus Therapeutics LLC, a joint venture focused on the discovery, development, and commercialization of microRNA therapeutics.  Alnylam made an initial investment of $10 million to balance venture ownership; thereafter Isis and Alnylam will share funding of Regulus. Regulus will be operated as an independent company with a separate Board of Directors and management team. Alnylam and Isis will retain rights to develop and commercialize on pre-negotiated terms microRNA therapeutic products that Regulus decides not to develop either itself or with a partner. Isis treats Regulus as a VIE for which Isis is the primary beneficiary. As a result, beginning in the third quarter of 2007, Isis included the financial condition and results of operations of Regulus in its condensed consolidated financial statements.  The creditors of Regulus do not have recourse to the general credit of Isis.

Comprehensive income (loss)

SFAS 130, Reporting Comprehensive Income, requires Isis to report, in addition to net income (loss), comprehensive income (loss) and its components. A summary follows (in thousands):

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Stock-based compensation expense

Isis accounts for its stock-based compensation expense related to employee stock options, board of director 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 nine months of 2007 and 2006, the estimated expected term is a derived output of the simplified method, as allowed under SAB 107, Share-Based Payment.

For the nine months ended September 30, 2007 and 2006, Isis used the following weighted-average assumptions in its Black-Scholes calculations:

Employee Stock Option Grants:

Board of Director Stock Option Grants:

ESPP:

Isis records stock options granted to non-employees at their fair value in accordance with the requirements of SFAS 123, Accounting for Stock-Based Compensation, then periodically remeasures 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 recognizes them over the service period.

Stock-based compensation expense for the three and nine months ended September 30, 2007 and 2006 (in thousands, except per share data) was allocated as follows:

As part of the Regulus joint venture, both Isis and Alnylam issued their own company’s stock options to members of Regulus’ Board of Directors and Scientific Advisory Board.  These options are recorded on Regulus’ books and treated as non-employee options.  Since Isis is consolidating the financial results of Regulus, the non-cash stock based compensation expense associated with these options is included in Isis’ consolidated expenses.

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As of September 30, 2007, total unrecognized compensation cost related to non-vested stock-based compensation plans was $11.6 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 1.3 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.  Under SFAS 159, a financial instrument is 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.

In June 2007, the FASB ratified EITF No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities. EITF No. 07-3 requires that nonrefundable advance payments for goods and services that will be used or rendered in future research and development activities pursuant to executory contractual arrangements be deferred and recognized as an expense in the period that the related goods are delivered or services are performed. EITF No. 07-3 is effective for fiscal years beginning after November 15, 2007 and, as such, Isis plans to adopt the provisions of EITF No. 07-3 as of January 1, 2008.  Isis is currently evaluating the impact that the adoption of EITF No. 07-3 will have on its results of operations, financial position and cash flows.

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 2 ⁵/₈%, which is payable semi-annually.  The 2 ⁵/₈% 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. Isis will be able to redeem the 2 ⁵/₈% 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 2 ⁵/₈% 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 2 ⁵/₈% notes being repurchased plus accrued interest and unpaid interest.

Isis used the net proceeds from the issuance of the 2 ⁵/₈% notes to repurchase its 5 ½% convertible subordinated notes due in 2009.  In January 2007, Isis repurchased approximately $44.2 million aggregate principal amount of its 5 ¹/₂% 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 recognized a $3.2 million loss on the early extinguishment of debt in the first nine months of 2007, which included a $1.2 million non-cash write-off of unamortized debt issuance costs.

4.                                    Collaborative Arrangements and Licensing Agreements

Antisense Drug Discovery and Development Collaborations

National Institutes of Health

In September 2007, Isis received a multi-year Phase 2 Small Business Innovation Research (SBIR) grant by the National Institutes of Health (“NIH”) for up to $1.5 million to design oligonucleotide drugs that can exploit the RNA interference (RNAi) antisense mechanism for disease treatment. The Phase 2 grant builds upon a successfully completed Phase 1 program that demonstrated the feasibility of using single-stranded antisense drugs to target the RNAi pathway.

The multi-year grant will fund research by Isis to improve the stability and tissue distribution of RNAi drugs. Much of the work will focus on optimizing the chemical properties of single-stranded oligonucleotides that trigger the RNAi pathway. In addition to demonstrating that compounds optimized with Isis’ chemistries produce superior results in animal models when compared to unoptimized compounds, the grant funds the discovery of RNAi-based drugs.  As of September 30, 2007, Isis has recognized revenue of $77,000 related to this grant.

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Ortho-McNeil, Inc.

In September 2007, Isis entered into a collaboration with Ortho-McNeil (“OMI”), a Johnson & Johnson company, to discover, develop and commercialize antisense drugs to treat metabolic diseases, including Type 2 diabetes. As part of the collaboration, Isis granted OMI worldwide development and commercialization rights to two of its diabetes drugs, ISIS 325568 and ISIS 377131, which selectively inhibit the production of glucagon receptor (GCGR) and glucocorticoid receptor (GCCR), respectively. Additionally, OMI will provide funding to Isis to support a focused research program in metabolic disease. After the initial collaboration phase, Johnson & Johnson Pharmaceutical Research & Development, L.L.C. will continue development of these drugs.

Under the terms of the agreement, OMI paid Isis a $45 million upfront licensing fee which is amortized over the two year period of Isis’ performance obligation based on the research plan included in the agreement.  OMI will also provide Isis with research and development funding over the two year period of the collaboration.  In addition to the licensing fee, Isis could receive over $225 million in milestone payments upon successful development and regulatory approvals of ISIS 325568 and ISIS 377131, as well as royalties on sales. Isis could also receive milestones and royalties on the successful development and regulatory approvals of additional drugs discovered as part of the collaboration.

In September 2007, Isis earned $5 million for achieving the first development milestone by initiating the Phase 1 clinical trial of ISIS 325568.  Since the milestone was achieved before the contract was finalized, from an accounting perspective, it is treated as part of the upfront licensing fees and is amortized over the two year period of Isis’ performance obligation.  As of September 30, 2007, Isis has recognized revenue of $4.9 million related to the upfront licensing fee, the milestone payment and the initial research and development funding.  Isis’ balance sheet at September 30, 2007 does not include any deferred revenue since Isis had not received the cash payment for the upfront licensing fee and milestone payment as of September 30, 2007.  Isis received these payments in October 2007, therefore Isis’ balance sheet at December 31, 2007 will include deferred revenue reflecting the unamortized portion of these payments.

Regulus Therapeutics LLC

In September 2007, Isis and Alnylam launched Regulus, a joint venture focused on the discovery, development, and commercialization of microRNA therapeutics. Because microRNAs regulate whole networks of genes that can be involved in discrete disease processes, microRNA therapeutics represent a new approach to target the pathways of human disease. Regulus will combine the strengths and assets of Isis’ and Alnylam’s technologies, know-how, and intellectual property.

Both Isis and Alnylam granted Regulus exclusive licenses to their intellectual property for microRNA therapeutic applications, as well as certain early fundamental patents in the microRNA field including the “Tuschl III” patent. Alnylam made an initial investment of $10 million to balance venture ownership.  Thereafter Isis and Alnylam will share funding of Regulus. Regulus is operated as an independent company with a separate Board of Directors and management team. Alnylam and Isis will retain rights to develop and commercialize on pre-negotiated terms microRNA therapeutic products that Regulus decides not to develop either itself or with a partner.

In accordance with FIN 46R, Isis has determined that Regulus is a variable interest entity for which Isis is the primary beneficiary. As a result, beginning in the third quarter of 2007, Isis included the financial condition and results of operations of Regulus in its condensed consolidated financial statements.  Additionally, the condensed consolidated financial statements include line items called “Noncontrolling Interest in Regulus Therapeutics LLC.”  On the Condensed Consolidated Balance Sheet, this line reflects Alnylam’s minority ownership of Regulus’ equity. As the joint venture progresses, this line item will be reduced by Alnylam’s share of Regulus’ net losses, which were $87,000 in the third quarter, until the balance becomes zero. The reductions to the Noncontrolling Interest in Regulus will be reflected in Isis’ Condensed Consolidated Statement of Operations using a similar line item and will provide a positive adjustment to Isis’ net income (loss) equal to Alnylam’s share of Regulus’ losses.

Bristol-Myers Squibb Company

In May 2007, Isis entered into a collaboration agreement with Bristol-Myers Squibb (“BMS”) to discover, develop and commercialize novel antisense drugs targeting proprotein convertase subtilisin/kexin type 9 (“PCSK9”).  Under the terms of the agreement, Isis received a $15 million upfront licensing fee and is amortizing this amount over the three year period of Isis’ performance obligation based on the research plan included in the agreement.  BMS will also provide Isis with at least $9 million in research funding over a period of three years.  As of September 30, 2007, Isis has recognized revenue of $3.3 million related to the upfront licensing fee and the research funding.  Isis’ balance sheet at September 30, 2007 includes deferred revenue of $12.9 million related to the upfront licensing fee.  Isis will also receive up to $168 million for the

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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.

Symphony GenIsis, Inc.

In April 2006, Isis entered into a series of related agreements in connection with a transaction with Symphony Capital and a group of co-investors to provide $75 million to fund the development of Isis’ cholesterol-lowering drug, mipomersen, and two novel drugs from Isis’ metabolic disease program ISIS 325568 and ISIS 377131.  In addition to providing the financial support to move these three drugs forward, the transaction allowed Isis to continue to control and manage the development of these drugs through key development milestones.

Symphony Capital formed Symphony GenIsis, capitalized with $75 million, to provide funding for the development of these three drugs in collaboration with Isis. Isis licensed to Symphony GenIsis the intellectual property for its apoB-100, GCGR and GCCR programs. Isis received an exclusive purchase option from Symphony GenIsis’ investors that allowed it to reacquire the intellectual property by purchasing all of Symphony GenIsis’ equity at a predetermined price.

In September 2007, Isis purchased the equity of Symphony GenIsis for $120 million, $80.4 million in cash and the remaining amount in approximately 3.4 million shares of Isis’ common stock.  Isis granted OMI, as part of the collaboration agreement, worldwide development and commercialization rights to two of its diabetes drugs, ISIS 325568 and ISIS 377131 plus up to four antisense drugs.  ISIS 325568 and ISIS 377131 were previously held by Symphony GenIsis.  In addition, Isis has reaquired full ownership of mipomersen, its cholesterol-lowering drug targeting apolipoprotein B-100.  The $125.3 million on Isis’ Condensed Consolidated Statement of Operations in a line item called Excess Purchase Price over Carrying Value of Noncontrolling Interest in Symphony GenIsis, Inc. represents a deemed dividend to the previous owners of Symphony GenIsis.  A portion of the $125.3 million reflects the significant increase in Isis’ stock price used to calculate the value of the shares issued to Symphony Capital.  This deemed dividend only impacts Isis’ net loss applicable to common stock and its net loss per share calculations and does not affect Isis’ net income (loss).

In exchange for the purchase option, Isis granted to Symphony GenIsis Holdings LLC a five-year warrant to purchase 4.25 million shares of common stock at an exercise price of $8.93 per share, a 25% premium over Isis’ prior 60-day average trading price, which was $7.14. To compensate Symphony Capital for structuring the transaction and to pay a portion of its expenses, Isis paid structuring and legal fees of $4.1 million. Using a Black-Scholes option-pricing model, Isis estimated the fair value of the warrant, at the grant date, to be $18.6 million. Isis’ determination of the fair value of the warrant on the date of grant using an option-pricing model is affected by Isis’ stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, Isis’ expected stock price volatility over the term of the warrant. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the warrant has certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the warrant, specifically the value determined may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

In accordance with FIN 46R, Isis has determined that prior to the acquisition in September 2007, Symphony GenIsis was a variable interest entity for which Isis was the primary beneficiary. As a result, Isis included the financial condition and results of operations of Symphony GenIsis in Isis’ condensed consolidated financial statements. Isis’ condensed consolidated financial statements include the cash and cash equivalents held by Symphony GenIsis. Additionally, the condensed consolidated financial statements include line items called “Noncontrolling interest in Symphony GenIsis.” On the Condensed Consolidated Balance Sheets, this line item initially reflected the $75 million proceeds contributed into Symphony GenIsis less $4.1 million of structuring and legal fees and the $18.6 million fair value of the warrant issued by Isis to Symphony Capital. From the inception of the collaboration to the acquisition of Symphony GenIsis on September 27, 2007, this line item was reduced by Symphony GenIsis’ expenditures, which were $46.2 million.  The reductions to the “Noncontrolling Interest in Symphony GenIsis” on the Condensed Consolidated Balance Sheets are also recognized in Isis’ Condensed Consolidated Statements of Operations using a similar caption and reduce Isis’ net loss applicable to common stock.  For the three and nine months ended September 30, 2007, Isis’ net loss was reduced by $8.7 million and $23.2 million, respectively, compared to $6.7 million and $20.3 million for the same periods in 2006.

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The Ludwig Institute; Center for Neurological Studies

In October 2005, Isis entered a collaboration agreement with the Ludwig Institute, the Center for Neurologic Study (CNS) and researchers from these institutions to discover and develop antisense drugs in the areas of amyotrophic lateral sclerosis (ALS) and other neurodegenerative diseases. Under this agreement, Isis agreed to pay the Ludwig Institute and CNS royalties and modest milestones on any antisense drugs resulting from the collaboration. The researchers from the Ludwig Institute and CNS, through funding from the ALS Association, will conduct preclinical safety and efficacy studies of ISIS 333611.

Pfizer Inc.

In May 2005, Isis entered into a multi-year drug discovery collaboration with Pfizer to identify second generation antisense drugs for the treatment of ophthalmic disease. In addition to the collaboration agreement, Isis has entered into a target validation agreement with Pfizer.  Under the terms of the collaboration agreement, Isis received an upfront technology access fee of $1.0 million and amortized this amount over the one year period of Isis’ performance, which ended in April 2006, based on the research plan included in the agreement.  There were no changes in Isis’ period of performance.  Isis’ balance sheet as of September 30, 2007 and December 31, 2006 included deferred revenue of $60,000 and $0, respectively, related to Isis’ agreements with Pfizer.  As of September 30, 2007, Isis has earned milestone payments totaling $1.2 million under the collaboration agreement. Pfizer will also pay Isis additional milestone payments under the collaboration agreement if key research, clinical, regulatory and sales milestones are achieved, and provide research funding. Assuming that Pfizer successfully develops and commercializes the first drug for the first indication, Isis will earn milestone payments totaling up to $26.1 million. In addition, under the collaboration agreement, Isis will receive royalties on the sale of drugs resulting from the collaboration.  For the nine months ended September 30, 2007 and 2006, Isis earned revenue of $385,000 and $533,000, respectively.  Isis did not recognize any revenues for the three months ended September 30, 2007 and 2006.

Eli Lilly and Company

In August 2001, Isis entered into a broad strategic relationship with Lilly, which included a joint antisense research collaboration in the areas of cancer, metabolic and inflammatory diseases and a $100 million loan that Lilly provided to Isis to fund its obligations under the research collaboration.

In August 2005, Isis extended the research collaboration with Lilly to focus on a select number of targets. During the extension, Isis and Lilly will continue to advance antisense drugs identified during the initial collaboration, and continue their efforts to develop and refine antisense technologies. During the extension, Isis is using collaboration funds to support its scientists and Lilly is supporting Lilly scientists. The extended collaboration provides Lilly access to Isis’ patents to support Lilly’s internal antisense drug discovery and development program for a limited number of targets. As part of the extension, Isis and Lilly will continue to characterize and develop RNase H, siRNA, and splicing modulating inhibitors for the treatment of cancer using advanced generation chemistries. In connection with the extension, Isis converted the $100 million loan that Lilly previously provided to it into 2.5 million shares of Isis common stock.

As part of the collaboration, Lilly licensed LY2181308, Isis’ antisense inhibitor of survivin and LY2275796, an antisense inhibitor of eIF-4E.  As of September 30, 2007, Isis has earned $4.1 million and $1.5 million in license fees and milestone payments related to the continued development of LY2181308 and LY2275796, respectively.  Isis amortized the $1.1 million license fee related to LY2181308 over a two-year period, which ended in June 2004.  The two-year period corresponded to Isis’ period of performance for LY2181308 and there were no changes to the period of performance.  In September 2004, Isis recognized $750,000 associated with the license fee it received for LY2275796.  Lilly is responsible for the preclinical and clinical development of LY2275796 and Isis has no performance obligations for this drug.  Isis’ balance sheet as of September 30, 2007 and December 31, 2006 included deferred revenue of $156,000 and $0, respectively.  Isis will receive additional milestone payments aggregating up to $25.0 million and $19.5 million if LY2181308 and LY2275796, respectively, achieve specified regulatory and commercial milestones, and royalties on future product sales of these drugs.

As part of the collaboration extension, Isis is exploring with Lilly antisense drugs targeting Signal Transducer and Activator of Transcription 3 (STAT-3), a protein that regulates cell division and growth, and prevents cell death. Isis is working closely with Lilly to advance an improved STAT-3 candidate into development.

During the three and nine months ended September 30, 2007, Isis earned revenue from its relationship with Lilly totaling $300,000 and $402,000, respectively, compared to $30,000 and $1.2 million for the same periods in 2006.

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Merck & Co., Inc.

In June 1998, Isis entered into a multi-year research collaboration and license agreement with Merck to discover small molecule drug candidates to treat patients infected with HCV. The research collaboration ended in May 2003 in accordance with its terms. However, in December 2006, Merck advanced a drug discovered in this collaboration into Phase 1 clinical trials for which Isis received a $1 million milestone payment.  In addition, Merck will pay Isis aggregate milestone payments of up to $16 million upon the achievement of key clinical and regulatory milestones, and royalties on future product sales.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with Merck.

Satellite Company Drug Discovery and Development Collaborations

Achaogen, Inc.

In January 2006, Isis licensed its proprietary aminoglycosides program to Achaogen, a biotechnology company pursuing unique strategies to combat drug-resistant pathogens. Aminoglycosides are a group of antibiotics that inhibit bacterial protein synthesis and are used to treat serious bacterial infections. In exchange for the exclusive, worldwide license to Isis’ aminoglycoside program, Achaogen issued to Isis $1.5 million of Achaogen Series A Preferred stock. Isis has recognized a valuation allowance of $1.5 million to offset this asset as realization of this asset is uncertain. In addition, assuming Achaogen successfully develops and commercializes the first drug in the first major market, Isis will receive milestone payments totaling up to $34.5 million for the achievement of key clinical, regulatory and sales milestones.  Isis will also receive royalties on sales of drugs resulting from the program. Achaogen is solely responsible for the continued development of the aminoglycoside program and products.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with Achaogen.

Antisense Therapeutics Limited

In December 2001, Isis licensed ATL1102 to ATL, an Australian company publicly-traded on the Australian Stock Exchange. Isis was responsible for completing the required preclinical studies for ATL1102 and for manufacturing the drug for human clinical trials at ATL’s expense. ATL agreed to undertake the future clinical development and commercialization of the drug.

In addition to ATL1102, ATL is currently developing ATL1103 for growth and site disorders. ATL1103 is a product of Isis’ and ATL’s joint antisense drug discovery and development collaboration, which Isis extended for an additional two years in January 2007. ATL pays Isis for access to its antisense expertise and for research and manufacturing services Isis may provide to ATL during the collaboration. Additionally, ATL will pay Isis royalties on any antisense drugs discovered and developed within the partnership.

In connection with this collaboration, Isis received 30.0 million shares of ATL common stock upon completion of ATL’s initial public offering, representing an initial ownership percentage of approximately 14%, and options to purchase an additional 20.0 million shares of ATL common stock, which expired in 2006. The initial ATL common stock Isis received had a value of $2.8 million, and Isis 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 Isis’ period of performance. Isis’ balance sheet as of September 30, 2007 and December 31, 2006 include deferred revenue of $250,000 and $0, respectively.  For the three and nine months ended September 30, 2007, Isis recorded revenue of $3,000 and $58,000, respectively, related to this collaboration compared to $148,000 and $503,000 for the same periods in 2006.  As of September 30, 2007, Isis’ ownership percentage in ATL, including 10.3 million shares Isis purchased subsequent to shares it acquired in ATL’s initial public offering, was less than 10%.  Isis’ balance sheet at September 30, 2007 and December 31, 2006 included a short-term investment at fair market value of $1.4 million and $1.3 million, respectively, related to this equity investment.

Atlantic Healthcare (UK) Limited

In March 2007, Isis licensed alicaforsen to Atlantic Healthcare (UK) Limited, a UK-based company that was founded in 2006 by gastrointestinal drug developers to develop alicaforsen for the treatment of ulcerative colitis and other inflammatory diseases. Atlantic Healthcare plans to initially develop alicaforsen for pouchitis, an ulcerative colitis indication, followed by ulcerative colitis and other inflammatory diseases. In exchange for the exclusive, worldwide license to alicaforsen, Isis received an upfront payment from Atlantic Healthcare in the form of equity valued at $2 million.  Isis has recognized a valuation allowance of $2 million to offset this asset as realization of this asset is uncertain.  In addition,

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assuming Atlantic Healthcare successfully develops and commercializes alicaforsen, Isis will receive milestone payments and royalties on future product sales of alicaforsen. If Atlantic Healthcare meets certain of these milestones, at Atlantic Healthcare’s request, Isis will attempt to identify a second generation lead drug candidate for Atlantic Healthcare. Atlantic Healthcare may take an exclusive worldwide license to the lead candidate under the terms and conditions of the agreement. Atlantic Healthcare is solely responsible for the continued development of alicaforsen, and, if selected, the second generation lead drug candidate.  During the first nine months of 2007, Isis did not recognize any revenue from its relationship with Atlantic Healthcare.

iCo Therapeutics Inc.

In August 2005, Isis granted a license to iCo for the development and commercialization of iCo 007, a second generation antisense drug.  iCo is initially developing iCo 007 for the treatment of various eye diseases caused by the formation and leakage of new blood vessels, such as diabetic macular edema and diabetic retinopathy. iCo paid Isis a $500,000 upfront fee consisting of $250,000 in cash and a $250,000 convertible note. Isis has recognized a valuation allowance of $250,000 to offset the convertible note and the resulting common stock of iCo as the realization of this asset is uncertain.  iCo will also pay Isis milestone payments totaling up to $22.0 million for the achievement of clinical and regulatory milestones. In addition, Isis will receive royalties on any product sales of this drug. Under the terms of the agreement, iCo is solely responsible for the clinical development and commercialization of the drug. In December 2006, iCo filed an IND application with the FDA for iCo 007 for which Isis earned a $200,000 milestone payment.  In September 2007, Isis received a $1.25 million milestone payment in the form of equity securities in iCo which it has recognized a full valuation allowance for as the realization of this asset is uncertain.  The milestone was related to the initiation of Phase 1 clinical trials of iCo 007.

In December 2005, Isis entered into a manufacturing and supply agreement with iCo. Under the agreement, iCo purchased drug manufactured by Isis for $700,000. iCo made a $525,000 prepayment to Isis consisting of $175,000 in cash and a $350,000 convertible note.  Isis has recognized a valuation allowance of $350,000 to offset the convertible note and the resulting common stock of iCo as the realization of this asset is uncertain.  In December 2006, Isis’ obligations under the manufacturing and supply agreement were completed and title of the product transferred to iCo.  As a result, in January 2007, iCo paid Isis the remaining balance of $175,000.  In May 2006, Isis received 869,025 shares of iCo common stock for the conversion of both convertible notes.  There was no deferred revenue as of September 30, 2007 and December 31, 2006.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with iCo.

ImQuest Pharmaceuticals, Inc.

In April 2006, Isis granted an exclusive worldwide license to ImQuest for the development and commercialization of ISIS 5320, a compound that has been shown to be a potent and specific inhibitor of HIV, the virus that causes AIDS. ImQuest plans to develop ISIS 5320 as a topical microbicide therapy to prevent the sexual transmission of HIV throughout the world, but especially in developing countries. In exchange for the exclusive worldwide license, Isis will receive royalties on sales of drugs resulting from ISIS 5320. In addition, if ImQuest sublicenses ISIS 5320, Isis is entitled to a portion of the consideration received.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with ImQuest.

OncoGenex Technologies Inc.

In November 2001, Isis established a drug development collaboration with OncoGenex, a biotechnology company committed to the development of cancer therapeutics for patients with drug resistant and metastatic cancers, to co-develop and commercialize OGX-011, an anti-cancer antisense drug. Isis funds 35% of the costs of developing OGX-011. In exchange, Isis receives 35% of any revenue generated by OncoGenex for OGX-011. OGX-011 combines OncoGenex’s proprietary antisense position in inhibitors to the target clusterin, with Isis’ proprietary second generation antisense chemistry. Isis conducted preclinical toxicology and pharmacokinetic studies of OGX-011 during 2002. Isis also manufactured OGX-011 for preclinical and Phase 1/2 studies. OncoGenex’s Phase 1 clinical trials to assess the safety of OGX-011 in combination with hormone ablation therapy in men with localized prostate cancer and in combination with standard chemotherapy in patients with solid tumors known to express clusterin formed the basis for OncoGenex’s broad Phase 2 program for OGX-011. OncoGenex currently has five ongoing Phase 2 studies of OGX-011 for the treatment of prostate, non-small cell lung and breast cancers.

In September 2003, the companies expanded their antisense drug development partnership to include the development of the second generation antisense anti-cancer drug, OGX-225. OncoGenex is responsible for the preclinical and clinical development of the drug and Isis has no performance obligations. OncoGenex issued to Isis $750,000 of OncoGenex securities as payment for an upfront fee. In addition, OncoGenex will pay Isis milestone payments totaling up to

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$3.5 million for the achievement of clinical and regulatory milestones, and pay Isis royalties on product sales. As of September 30, 2007, OncoGenex had not triggered any of the milestone payments related to OGX-225.

In January 2005, Isis further broadened its antisense drug development partnership with OncoGenex to allow for the development of two additional second generation antisense anti-cancer drugs. Under the terms of the agreement, OncoGenex is responsible for the preclinical and clinical development of the drugs and Isis has no performance obligations. In April 2005, OncoGenex selected its first drug under this expansion, OGX-427. OGX-427 targets heat shock protein 27, or Hsp27, which is over-expressed in numerous tumor types and is associated with treatment resistance through its ability to help cancer cells survive stress-induced injury. OncoGenex paid Isis an upfront fee of $750,000 with a convertible note, which, in August 2005, converted into 244,300 shares of OncoGenex’s preferred stock. OncoGenex will also pay Isis milestone payments totaling up to $5 million for the achievement of key clinical and regulatory milestones, and royalties on future product sales of these drugs.  As of September 30, 2007, OncoGenex had not triggered any of the milestone payments related to OGX-427.

For the three and nine months ended September 30, 2007, Isis earned revenue of $0 and $4,000, respectively, related to its collaboration with OncoGenex compared to $63,000 and $1.2 million for the same periods in 2006.  Isis’ balance sheet at September 30, 2007 and December 31, 2006 included a long-term investment of $1.5 million related to Isis’ equity investment in OncoGenex. While there is no readily determinable market value for these securities, there has been no indication that Isis’ investment in OncoGenex has been impaired.  Accordingly, Isis believes that the carrying value of this investment is equal to or below its current fair market value.

Sarissa, Inc.

In February 2005, Isis licensed an anti-cancer antisense drug to Sarissa, Inc., a biotechnology company emerging from the University of Western Ontario. The drug is an antisense inhibitor of thymidylate synthase, or TS, a drug target that protects cancer cells from the effects of several chemotherapy treatments. In preclinical studies, antisense inhibition of TS suppressed human tumor cell growth and overcame tumor cell resistance to marketed TS-targeted drugs.

Under the terms of the agreement, Sarissa paid Isis a $1.0 million upfront fee in exchange for the exclusive, worldwide license to the TS antisense drug.  Sarissa paid the upfront fee with a convertible note, which will convert into Sarissa stock upon Sarissa’s successful completion of a venture capital financing. Isis has recognized a valuation allowance of $1.0 million to offset the note as realization of this asset is uncertain. Sarissa will also pay Isis milestone payments totaling up to $5.5 million for the achievement of clinical and regulatory milestones. In addition, Isis will receive royalties on any sales of the TS antisense drug. Sarissa is solely responsible for preclinical and clinical development of the drug.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with Sarissa.

Satellite Company Technology Research Collaborations

Alnylam Pharmaceuticals, Inc.

In March 2004, Isis entered into a strategic alliance with Alnylam to develop and commercialize RNAi therapeutics. Under the terms of the agreement, Isis exclusively licensed to Alnylam its patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry for double-stranded RNAi therapeutics in exchange for a $5.0 million technology access fee, participation in fees for Alnylam’s partnering programs, as well as future milestone and royalty payments from Alnylam. For each drug developed by Alnylam under this alliance, the potential milestone payments from Alnylam total $3.4 million and are payable to Isis upon the occurrence of specified development and regulatory events. Isis retained rights to a limited number of double-stranded RNAi therapeutic targets and all rights to single-stranded RNAi therapeutics. Isis also made a $10 million equity investment in Alnylam.

In turn, Alnylam nonexclusively licensed to Isis Alnylam’s patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry to research, develop and commercialize single-stranded RNAi therapeutics and to research double-stranded RNAi compounds. Isis also received a license to develop and commercialize double-stranded RNAi drugs targeting a limited number of therapeutic targets on either an exclusive or co-exclusive basis depending on the target. If Isis develops or commercializes an RNAi-based drug using Alnylam’s technology, Isis will pay Alnylam milestones and royalties. For each drug, the potential milestone payments to Alnylam total $3.4 million and are payable by Isis upon the occurrence of specified development and regulatory events. As of September 30, 2007, Isis did not have an RNAi-based drug in clinical development.  As part of the collaboration, each party granted the other party a nonexclusive cross license to its respective patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry for microRNA therapeutics.

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Isis’ Alnylam alliance provides it with an opportunity to realize substantial value from its pioneering work in antisense mechanism and oligonucleotide chemistry and is an example of Isis’ strategy to participate in all areas of RNA-based drug discovery. As of September 30, 2007, Isis has earned a total of $31.5 million from Alnylam resulting from sublicenses of Isis’ technology for the development of RNA interference therapeutics that Alnylam has granted to pharmaceutical partners, including $26.5 million resulting from Alnylam’s sublicense of Isis’ techonology to Roche, which Isis recognized in the third quarter of 2007.

As of September 30, 2007, Isis no longer owns any shares of Alnylam.  At December 31, 2006, Isis’ balance sheet included a short-term investment at carrying value of $5.6 million, which represented 290,000 shares of Alnylam’s stock.  During the first nine months of 2007 and 2006, Isis sold portions of its Alnylam stock for cash proceeds of $5.2 million and $4.4 million, respectively.  For the three and nine months ended September 30, 2007, Isis earned revenue of $26.5 million from Alnylam compared to $750,000 for the same periods in 2006.

Archemix

In August 2007, Isis and Archemix entered into a new strategic alliance focused on aptamer drug discovery and development.  Archemix obtained a license to Isis’ technology for aptamer drugs, which take advantage of the three-dimensional structure of oligonucleotides to bind to proteins rather than the mRNA-targeting aspect that antisense mechanisms, including RNAi, exploit.  Through this licensing partnership, Isis is providing access to its oligonucleotide chemistry and other relevant patents to facilitate the discovery and development of aptamer drugs.  Isis will receive a portion of any sublicensing fees Archemix generates as well as milestones and royalties on its drugs.

Ercole Biotech, Inc.

In May 2003, Isis and Ercole initiated a multi-year collaboration to discover antisense drugs that regulate alternative RNA splicing. Part of this collaboration includes a cross-license of Isis’ respective splicing-related intellectual property with Ercole. Isis is combining its alternative splicing expertise with Ercole to discover antisense drugs that regulate alternative RNA splicing. As part of this collaboration, Isis granted Ercole a license to Isis’ Bcl-x molecule and certain of its chemistry patents. In addition, Isis took an equity ownership position in Ercole with the initial funding, in the form of a convertible note, which the companies anticipate will convert into securities that Ercole issues in its next venture capital financing. Isis also has the option to make an additional equity investment in Ercole. Pursuant to the terms of a Note and Warrant Purchase Agreement, during 2003 and early 2004, Isis made cash payments to Ercole of $500,000 and $250,000, respectively in exchange for a convertible note. Isis expensed the payments when made. The note is secured by all of Ercole’s assets, including intellectual property and licenses. The note will convert into securities that Ercole issues in a qualified financing, as defined by the agreement.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with Ercole.

Rosetta Genomics, Ltd.

In January 2006, Isis initiated a joint research collaboration with Rosetta to discover and develop antisense drugs that regulate microRNAs for the treatment of the most prevalent type of liver cancer, hepatocellular carcinoma. For each drug that meets specific success factors outlined in the collaboration, Isis and Rosetta will mutually agree on a development strategy for the drug. This collaboration has an initial term of two years.

Santaris Pharma A/S (formerly Pantheco A/S)

In November 1998 and September 2000, Isis entered into license agreements with Santaris, formerly Pantheco. Isis amended and restated the agreement in May 2003. Under the terms of the amended and restated license agreements, Isis licensed its novel antisense chemistry, Peptide Nucleic Acid, or PNA, to Santaris on a limited exclusive basis to develop products. The license restricts Santaris to a limited number of molecular targets that are subject to Isis’ approval. Santaris has agreed to pay Isis royalties on any products developed under the license.

As part of its original license agreements with Pantheco, Isis received shares of Pantheco stock.  In May 2003, Pantheco and Cureon A/S merged to form Santaris. Prior to the merger, Isis purchased additional shares of Pantheco for $55,000 as a result of anti-dilution provisions related to Pantheco’s stock.  As of September 30, 2007 and December 31, 2006, Isis’ ownership interest in Santaris was less than 10%. Isis’ balance sheet at September 30, 2007 and December 31, 2006 included a long-term investment of $625,000, respectively, related to this equity investment, reflecting the value of Isis’ initial investment and additional purchase due to anti-dilution provisions. While there is no readily determinable market value

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for these securities, there has been no indication that Isis’ investment in Santaris has been impaired; accordingly, Isis believes that the carrying value of this investment is equal to or below its current fair market value.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with Santaris.

Intellectual Property Licensing Agreements

In-Licensing Arrangements

Idera Pharmaceuticals, Inc., formerly Hybridon, Inc.

In May 2001, Isis entered into an agreement with Hybridon under which Isis acquired an exclusive license to all of Hybridon’s antisense chemistry and delivery patents and technology.  Hybridon retained the right to practice its licensed antisense patent technologies and to sublicense it to collaborators under certain circumstances.  In addition, Hybridon received a non-exclusive license to Isis’ suite of RNase H patents. In exchange for the license to Hybridon’s antisense patents, Isis paid $15.0 million in cash and agreed to pay Hybridon $19.5 million in Isis common stock before May 2003.  In return for access to Isis’ patents, Hybridon agreed to pay Isis $6.0 million in Hybridon common stock before May 2004.  Isis’ balance sheet at September 30, 2007 and December 31, 2006 reflected a licensing asset, net of amortization, of $16.2 million and $17.6 million, respectively.  During 2004 and 2005, Isis sold all of its short term investment in Hybridon for net proceeds of approximately $665,000.  In September 2005, Hybridon changed its name to Idera Pharmaceuticals, Inc.  For the three and nine months ended September 30, 2007, Isis earned revenue of $0 and $10,000, respectively, related to its relationship with Hybridon compared to $0 for the same periods in 2006.

Integrated DNA Technologies, Inc.

In March 1999, Isis further solidified its intellectual property leadership position in antisense technology by licensing certain antisense patents from Integrated DNA Technologies, Inc. (“IDT”), a leading supplier of antisense inhibitors for research. The patents Isis licensed from IDT are useful in functional genomics and in making certain antisense drugs. In December 2001, Isis expanded this license agreement to allow it to exclusively sublicense this intellectual property for functional genomics purposes. Under the license, Isis paid IDT $4.9 million in license fees and will pay royalties on drugs utilizing the technology IDT licensed to Isis.  For the three and nine months ended September 30, 2007, Isis earned revenue of $0 related to its relationship with IDT compared to $0 and $20,000 for the same periods in 2006.

Out-Licensing Arrangements; Royalty Sharing Agreements

Drug Royalty USA, Inc. (now Drug Royalty Trust 3)

In December 2004, Isis sold a portion of its royalty rights in Macugen to Drug Royalty USA, Inc. (“DRC”). In exchange for this sale, DRC has paid Isis $15.0 million as of September 30, 2007.  Under the terms of the agreement, Isis and DRC share the royalty rights on Macugen through 2009. After 2009, Isis retains all royalties for Macugen under its Eyetech agreement. Under the agreement, through 2009, DRC will receive the royalties on the first $500 million of annual sales of Macugen. Isis and DRC will each receive 50 percent of royalties on annual sales between $500 million and $1.0 billion. Isis retains 90 percent of all royalties on annual sales in excess of $1.0 billion and 100 percent of all royalties after 2009. Isis has retained all milestones payable to Isis by Eyetech under the license agreement.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with DRC.  In October 2007, Isis received a total of $8 million as the final purchase price installment which was due under the agreement as a resolution for the various alleged competing breaches between Isis and DRC.  DRC paid Isis $7 million subject to the terms of an amendment to the agreement and an unaffiliated third party paid Isis $1 million.

As part of the sale, Isis agreed to pay DRC liquidated damages if any one of a defined set of defaults occurs. The amount of liquidated damages will be calculated such that DRC will receive a ten percent per annum return, compounded quarterly on the total of all purchase price payments made by DRC to Isis through the default date minus the total of any royalties received by DRC through the default date. As of September 30, 2007, DRC has received $6.1 million in royalties. In addition, DRC may withhold any installment of the purchase price if immediately prior to such payment, Isis fails to meet a minimum liquidity requirement equal to the then outstanding balance on its loan with Silicon Valley Bank; plus the potential amount of liquidated damages, assuming that DRC has paid the impending purchase price installment; plus its cash burn over the most recent three months. As collateral for its obligations under the sale agreement, Isis granted DRC a first priority security interest in the patents licensed by Isis to Eyetech under the license agreement and in the license agreement itself.

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Eyetech Pharmaceuticals, Inc.

In December 2001, Isis licensed to Eyetech Pharmaceuticals, Inc., a wholly owned subsidiary of OSI Pharmaceuticals, Inc., certain of its patents necessary for Eyetech to develop, make and commercialize Macugen, a non-antisense drug for use in the treatment of ophthalmic diseases, that Eyetech is co-developing and commercializing with Pfizer.  Eyetech paid Isis a $2.0 million upfront fee and agreed to pay Isis milestone and royalty payments in exchange for non-exclusive, worldwide rights to the intellectual property licensed from Isis.

During 2004, Isis earned $4.0 million in milestones associated with the filing of an NDA and FDA approval for Macugen for the treatment of wet age-related macular degeneration.  Isis’ license with Eyetech will also generate additional milestone payments aggregating up to $2.8 million for the achievement of specified regulatory milestones with respect to the use of Macugen for each additional therapeutic indication.  During the first nine months of 2007 and 2006, Isis did not recognize any revenue from its relationship with Eyetech.

Ibis Collaborations

Isis developed, within Ibis, the Ibis T5000 Biosensor System with substantial funding from government agencies.  Ibis continues to work with government collaborators to further develop the Ibis technology and applications for the Ibis T5000.  Ibis is now commercializing the Ibis T5000 instrument, assay kits and its assay services to both government and non-government customers.

Commercial Agreements

Ibis plans to work with partners to manufacture, install and support Ibis T5000 instruments.  For research markets Ibis is working with Bruker Daltonics to accomplish this.  Ibis expects in the future to work with a partner to complete development, regulatory approval, and then market the Ibis instruments for the in vitro diagnostics market.  Ibis plans to focus on the manufacture and sale of high-volume, high-margin consumables.  Ibis also generates commercial revenue through its assay services laboratory, in which it analyzes customers’ samples in its own facilities, providing prospective instrument customers the opportunity to assess the Ibis T5000 Biosensor System’s capabilities before purchasing an instrument.

Bruker Daltonics, Inc.

In July 2006, Ibis 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 systems and Ibis assay kits for various government applications, and non-exclusive rights to sell to customers for all other applications except diagnostics. Ibis has maintained worldwide marketing rights to the diagnostics market.

Assay Services Collaboration

In July 2006, Ibis received a contract to perform forensic analyses of up to 10,000 samples in its assay services laboratory.  Initial funding from this contract was $1.9 million.  In June 2007, Ibis received additional funding of $1.6 million relating to this contract.  For the three and nine months ended September 30, 2007, Isis recognized $700,000 and $1.8 million, respectively, relating to this contract, compared to $151,000 for the same periods in 2006.  This assay services capability represents a key part of the Ibis business strategy, as it not only has the potential to be an important revenue-generating opportunity for the business, but also represents an important resource for customers evaluating the capabilities of the Ibis T5000 and collaborating in applications development.

Research and Development Collaborations

To develop the Ibis T5000 Biosensor System and its applications, Ibis received contracts and grants from a number of government agencies, including Defense Advanced Research Projects Agency (“DARPA”), the Department of Homeland Security (“DHS”), the Centers for Disease Control (“CDC”), and the National Institute of Allergy and Infectious Diseases (“NIAID”), a part of the NIH.  Government collaborations continue to represent a significant source of funding for the Ibis

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T5000 program. As a result of these collaborations, Ibis is now developing various applications for the Ibis T5000 Biosensor System that it will sell to commercial customers, including government collaborators.

Biodefense

The earliest application of the Ibis T5000 Biosensor System to be funded by the government focused on bioagent detection. In March 2004, Ibis received a two-year contract from DARPA under a subcontract from Science Applications International Corporation (“SAIC”) to further develop the Ibis biosensor system to identify infectious agents in biological warfare attacks. As part of this program, Ibis successfully demonstrated proof-of-principle of the Ibis biosensor system by identifying a variety of bacteria and viruses in both environmental and human clinical samples.

In September 2007, Ibis was awarded three new government contracts totaling up to $2.6 million to advance the detection and identification of microbial threat agents for biodefense applications. Two of these contracts are from the Department of Homeland Security Science and Technology Directorate (“DHS-S&T”) and total up to approximately $1.7 million and a third contract, worth up to $0.9 million, is from the Defense Threat Reduction Agency (“DTRA”), an agency within the Department of Defense.  As part of the contracts awarded by DHS-S&T, Ibis will continue to develop broad biological applications to identify and characterize important bacterial and viral agents that are considered crucial to maintain homeland security. Under the DTRA contract, Ibis will broaden its core technology in the area of biodefense through advances in sample preparation to allow detection of trace amounts of broad groups of microbial agents.

Forensics

Microbial forensics is a type of forensics used to investigate crimes involving infectious organisms. Microbial forensics uses the “biological fingerprint” of an infectious organism to help pinpoint the source, allowing law enforcement and public health officials to effectively respond to a biological threat. Additionally, through a government grant, Ibis is continuing its ongoing development of an informational database on microbial agents. The program is a database of biological threat agents, their DNA sequences, and their effects, that law enforcement officials can use to confer deterrence and support forensic investigations.  In September 2007, Ibis received a new government contracts for up to $1.6 million from DHS-S&T to advance the application of the Ibis T5000 system in microbial forensics.

Epidemiological Surveillance, Infectious Disease Research and Hospital-Associated Infection Control

Ibis and its government partners continue to develop applications for the T5000 Biosensor System to rapidly identify, monitor, and control infectious diseases.  Specifically, in September 2007, Ibis received a grant for up to $1.2 million from the NIH to aid in influenza surveillance research through application of the Ibis T5000 Biosensor System. The NIH grant, applied for jointly by Ibis and the Lovelace Respiratory Research Institute (“LRRI”) and subcontracted to Ibis by LRRI, provides funding for research studies, including assay development, and sample characterization in order to expand the understanding of transmission of influenza viruses, including the highly pathogenic H5N1 avian influenza viral strain.

In August 2005, Ibis received a three-year grant worth up to $4.9 million from the NIAID, a part of the NIH.  The grant funds the continued development of applications to diagnose infectious diseases and to identify and control hospital-associated infections (“HAI”) using the Ibis T5000 Biosensor System. In September 2006, Ibis successfully completed the first phase of this grant and was granted funding for the second and third phases of the grant, which included installing an Ibis T5000 Biosensor System at Johns Hopkins University Medical Center. The purpose of the grant is to develop infectious organism identification (ID) test kits to identify a broad range of respiratory and blood-borne infectious agents, including bacteria and viruses on the NIAID’s priority list. In addition to deployment of an Ibis T5000 Biosensor System, the second and third phases of the grant—approximately $2.6 million—include funding for the purchase of assay kits to analyze human samples in validation studies.

In addition, in September 2003, Ibis received a three-year grant for up to $6.0 million from the CDC to develop and apply the Ibis biosensor system technology to the surveillance of human infectious disease in the United States.

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5.                                    Symphony Warrant

In April 2006, Isis granted the members of Symphony GenIsis Holdings LLC warrants to purchase 4.25 million shares of common stock at an exercise price of $8.93 per share. These warrants expire on April 7, 2011 and can be settled with unregistered shares of Isis’ common stock.  At September 30, 2007, all of these warrants remained issued and outstanding. If Isis enters into a merger or acquisition in which the surviving or resulting “parent” entity is an entity other than Isis, then the holders of these warrants may exchange the warrants for a new warrant exercisable in return for shares of common stock of the surviving entity as follows:

•                  if the terms of such merger or acquisition provide for consideration that consists solely of stock of the surviving entity, and the surviving entity has a class of common stock traded on a major national exchange or foreign exchange (“Public Common Shares”), then any replacement warrants issued to the holders will be solely for such publicly traded common shares, at an exchange ratio reflecting the stock consideration paid at the time of such change in control; or

•                  if the terms of such merger or acquisition shall provide for consideration that consists of cash or a combination of cash and Public Common Shares of the surviving entity, then any replacement warrants issued to the holders will be solely for Public Common Shares of the surviving entity, at an exchange ratio reflecting the total consideration paid by the surviving entity at the time of such change in control, as if the total consideration (including cash) for each share of Isis’ common stock was instead paid only in Public Common Shares of the surviving entity at the time of such change of control; or

•                  if the surviving entity is a private corporation, closely held company or other entity that does not have a class of Public Common Shares, then the holders of the warrants may elect to surrender all outstanding warrants to Isis in consideration of a cash payment for each share of its common stock subject to purchase under the warrants in an amount equal to 40% of the per share cash consideration to be received by a holder of one share of its common stock to be tendered in the merger or acquisition, subject to an aggregate limit of $22,000,000.

In connection with the issuance of the warrants, Isis entered into a registration rights agreement with Symphony GenIsis Holdings LLC.  Pursuant to the registration rights agreement, Isis filed a registration statement with the SEC covering the shares of common stock issuable upon exercise of the warrants.  Isis is required to use commercially reasonable efforts to maintain the effectiveness of the registration statement over the term of the warrant.

Isis evaluated the provisions of the Registration Rights Agreement and the Warrant Purchase Agreement under EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and determined that the criteria for equity classification were met; therefore, the warrants were accounted for as part of stockholders’ equity.

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6.                                      Segment Information and Concentration of Business Risk

Segment information

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,

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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 Isis’ revenue. Revenue from significant partners as a percentage of total revenue was as follows:

For the three months ended September 30, 2007 and 2006, Isis derived approximately 12% and 66%, respectively, of its revenue from agencies of the United States Government compared to 18% and 62% for the nine months ended September 30, 2007 and 2006, respectively.  For the first nine months of 2007, 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 53%, 21% and 10% of contract receivables at September 30, 2007. Contract receivables from four significant partners comprised approximately 25%, 20%, 19%, and 16% of contract receivables at December 31, 2006.

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ITEM 2.                  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS

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.

Forward-Looking Statements

In addition to historical information contained in this Report on Form 10-Q, this Report includes forward-looking statements regarding our business, the therapeutic and commercial potential of our technologies and products in development, and the financial position of Isis Pharmaceuticals, Inc., our Ibis Biosciences subsidiary and our Regulus Therapeutics joint venture. 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 or 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 SEC, and those identified within this Item entitled “Risk Factors” beginning on page 40 of this Report.

Overview

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 drugs—antisense 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. We have generated more than $109.8 million from our intellectual property licensing

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program that helps support our internal drug discovery and development programs, included in this amount is the $26.5 million we received from Alnylam resulting from Alnylam’s sublicense of our technology to Roche.

Business Segments

We focus our business on two principal segments:

Drug Discovery and Development—Within 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 world’s first antisense drug and, along with our partners, we currently have 18 drugs in development. Our partners are licensed to develop, with our support, 14 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—Ibis 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 Biosensor System and related applications has been funded through government contracts and grants.  As of September 30, 2007, we had earned $65.1 million in revenue under our government contracts and grants, and we had an additional $6.9 million committed under our existing contracts and grants.

Recent Events

CHDI, Inc.

In November 2007, we announced that CHDI will provide up to $9.9 million in funding to us for the discovery and development of an antisense drug for the treatment of Huntington’s Disease, a fatal neurodegenerative disease.  CHDI’s funding builds upon an earlier successful collaboration between us and CHDI, in which CHDI funded proof-of–concept studies that demonstrated the feasibility of using antisense drugs to treat Huntington’s Disease.

Altair Therapeutics Inc.

In October 2007, Altair, a new venture capital-funded biotechnology company, was created to focus on the discovery, development and commercialization of our antisense drugs to treat asthma and other respiratory conditions.  We granted an exclusive worldwide license to Altair for the development and commercialization of ISIS 369645, an inhaled inhibitor of the IL-4/IL-13 signaling pathways for the treatment of asthma. We and Altair will also be collaborating to discover drugs directed to other promising targets for the treatment of respiratory conditions.  We own 18 percent of Altair in the form of preferred stock.  Furthermore, as ISIS 369645 and other drugs arising out of the research collaboration progress, Altair will pay us additional license fees and royalties.

Ibis Collaborations

In September 2007, Ibis was awarded four new government contracts totaling up to $4.2 million to advance the detection and identification of microbial threat agents for biodefense applications. Three of these contracts are from DHS-S&T and total up to approximately $3.3 million and a fourth contract, worth up to $0.9 million, is from DTRA. These contracts will fund Ibis' planned development of advanced sample preparation methodologies and validation of applications on the Ibis T5000 for broad biological weapon detection, the advancement of Ibis' microbial forensics applications, and the enhancement of Ibis' microbial database.

Additionally, in September 2007, Ibis received a grant for up to $1.2 million from the NIH to aid in influenza surveillance research through application of the Ibis T5000 Biosensor System. The NIH grant, applied for jointly by Ibis and the LRRI and subcontracted to Ibis by LRRI, provides funding for research studies, including assay development, and sample characterization in order to expand the understanding of transmission of influenza viruses, including the highly pathogenic H5N1 avian influenza viral strain.

iCo Therapeutics

In September 2007, we received a $1.25 million milestone payment in the form of equity securities in iCo. The milestone was related to the initiation of Phase 1 clinical trials of iCo 007, a drug licensed to iCo by us in 2005 for the treatment of various eye diseases, including diabetic macular edema.

National Institutes of Health

In September 2007, we received a multi-year Phase 2 SBIR grant by the NIH for up to $1.5 million to design oligonucleotide drugs that can exploit the RNAi antisense mechanism for disease treatment. The Phase 2 grant builds upon a successfully completed Phase 1 program that demonstrated the feasibility of using single-stranded antisense drugs to target the RNAi pathway.

The multi-year grant will fund research by us to improve the stability and tissue distribution of RNAi drugs. Much of the work will focus on optimizing the chemical properties of single-stranded oligonucleotides that trigger the RNAi pathway.

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In addition to demonstrating that compounds optimized with our chemistries produce superior results in animal models when compared to unoptimized compounds, the grant funds the discovery of RNAi-based drugs.

Ortho-McNeil, Inc.

In September 2007, we entered into a collaboration with OMI, a Johnson & Johnson company, to discover, develop and commercialize antisense drugs to treat metabolic diseases, including Type 2 diabetes. As part of the collaboration, we granted OMI worldwide development and commercialization rights to two of our diabetes drugs, ISIS 325568 and ISIS 377131, which selectively inhibit the production of GCGR and GCCR, respectively. Additionally, OMI will provide funding to us to support a focused research program in metabolic disease. After the initial collaboration phase, Johnson & Johnson Pharmaceutical Research & Development, L.L.C. will continue development of these drugs.

Under the terms of the agreement, OMI paid us a $45 million upfront licensing fee, and will provide us with research and development funding over the period of the collaboration. In addition to the licensing fee, we could receive over $225 million in milestone payments upon successful development and regulatory approvals of ISIS 325568 and ISIS 377131, as well as royalties on sales. We could also receive milestones and royalties on the successful development and regulatory approvals of additional drugs discovered as part of the collaboration.  In September 2007, we earned a milestone payment of $5 million for achieving the first development milestone by initiating the Phase 1 clinical trial of ISIS 325568.

In connection with this transaction, we purchased all of the equity in Symphony GenIsis, Inc. and reacquired the intellectual property related to the GCGR and GCCR programs as well as regaining full ownership of mipomersen, our lipid-lowering drug targeting Apolipoprotein B-100.  As part of the $120 million Symphony GenIsis purchase price, we paid Symphony Capital $80.4 million in cash and the remaining amount in approximately 3.4 million shares of our common stock.

Regulus Therapeutics LLC

In September 2007, we and Alnylam launched Regulus, a joint venture focused on the discovery, development, and commercialization of microRNA therapeutics. Because microRNAs regulate whole networks of genes that can be involved in discrete disease processes, microRNA therapeutics represent a new approach to target the pathways of human disease. Regulus will combine the strengths and assets of Alnylam’s and our technologies, know-how, and intellectual property with strong leadership from a focused management team and Scientific Advisory Board to be chaired by Nobel laureate David Baltimore and include key pioneers in the microRNA field.

Both we and Alnylam granted Regulus exclusive licenses to their intellectual property for microRNA therapeutic applications, as well as certain early fundamental patents in the microRNA field including the “Tuschl III” patent. Alnylam made an initial investment of $10 million to balance venture ownership; thereafter Alnylam and us will share funding of Regulus. Regulus is operating as an independent company with a separate Board of Directors and management team. Alnylam and us will retain rights to develop and commercialize on pre-negotiated terms microRNA therapeutic products that Regulus decides not to develop either itself or with a partner.

Archemix

In August 2007, we entered into a new strategic alliance with Archemix focused on aptamer drug discovery and development.  Archemix obtained a license to our technology for aptamer drugs, which take advantage of the three-dimensional structure of oligonucleotides to bind to proteins rather than the mRNA-targeting aspect that antisense mechanisms, including RNAi, exploit.  Through this licensing partnership, we are providing access to our oligonucleotide chemistry and other relevant patents to facilitate the discovery and development of aptamer drugs.  We will receive a portion of any sublicensing fees Archemix generates as well as milestones and royalties on its drugs.

Alnylam Collaboration

In the third quarter of 2007, we earned licensing revenue of $26.5 million resulting from Alnylam’s sublicense of our technology for the development of RNA interference therapeutics to Roche.  This payment is according to the terms of the 2004 strategic alliance agreement between Alnylam and us, under which Alnylam obtained an exclusive license to our intellectual property for double-stranded oligonucleotide therapeutics that mediate RNAi.  Additionally, during the second quarter of 2007, Alnylam announced the achievement of an important milestone in its strategic alliance with us, in initiating

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IND-enabling studies with an RNAi therapeutic clinical candidate that utilizes technology and intellectual property licensed exclusively from us.  Alnylam and we continue to collaborate on siRNA-related technology platform advancements.

Bristol-Myers Squibb Company

In May 2007, we entered into a collaboration agreement with BMS to discover, develop and commercialize novel antisense drugs targeting PCSK9.  BMS paid us a $15 million upfront licensing fee, and under the terms of the agreement will provide us with at least $9 million in research funding over 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 pay us royalties on sales of products resulting from the collaboration.

Mipomersen Development Highlights

At the Drugs Affecting Lipid Metabolism (DALM) Symposium, we announced further data supporting the attractive profile of mipomersen:

•                  Mipomersen effectively reduces lipids in all patient populations tested. Data presented in heterozygous familial hypercholesterolemia patients at DALM adds to the previously presented data for homozygous familial hypercholesterolemia and routine high cholesterol in showing potent, dose dependent, linear decrease in lipids alone and in combination with other lipid lowering therapies.

•                  Mipomersen has a unique profile in lowering all atherogenic lipids. Adding to data previously presented showing statistically significant reductions of low-density lipoproteins, very low-density lipoproteins and triglycerides. Data presented at DALM showed statistically significant reductions of lipoprotein (a), an independent cardiovascular risk factor.

•                  We presented the first safety data from long-term treatment with mipomersen showing that, as predicted by long term studies in monkeys and mice, the drug continues to be well tolerated in patients treated for five months and longer.

•                  We presented preclinical data showing that inhibition of ApoB-100 (the target of mipomersen) results in changes in fat metabolism that reduce liver fat, adding additional mechanistic support for the mipomersen safety profile.

•      We initiated a Phase 3 program for mipomersen in patients with familial hypercholesterolemia.

Issuance of 2 ⁵/₈%  Convertible Subordinated Notes; Repurchase of 5 ¹/₂% Convertible Subordinated Notes

In January 2007, we issued $162.5 million of 2 ⁵/₈% convertible subordinated notes due 2027.  Using the net proceeds from the issuance of the 2 ⁵/₈ % notes, we repurchased our 5 ¹/₂% convertible subordinated notes due 2009.  The significantly lower interest rate of the 2 ⁵/₈% notes reduces our cash interest payments by approximately $2.6 million annually.  In addition, the extended maturity date of the 2 ⁵/₈% notes further strengthens our financial position.

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 the audit committee of our Board of Directors. There are specific risks associated with these critical accounting policies that we describe in the following paragraphs. For all of these policies, 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;

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•       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.

Descriptions of these critical accounting policies follow.

Revenue Recognition

We follow the provisions as set forth by current accounting rules, which primarily include SAB 101, Revenue Recognition in Financial Statements, SAB 104, Revenue Recognition, and EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables.

We generally recognize revenue when we have satisfied all contractual obligations and we 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 billed our customers or received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on the balance sheet.

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, including our collaborations with Antisense Therapeutics Ltd., BMS, Lilly, OncoGenex, OMI and Pfizer.  Our collaborative agreements typically include a research and/or development project plan that includes activities to be performed in 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 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 milestone’s 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. To date, we have earned milestone payments totaling $1.2 million under our Pfizer collaboration.  In January 2006, Lilly initiated clinical trials of LY2275796 for which we received a $750,000 milestone payment and Merck initiated clinical trials of a drug for HCV for which we earned a $1 million milestone payment.  Additionally, in September 2007, we earned a $5 million milestone payment for the initiation of a Phase 1 trial for ISIS 325568 under our recently announced collaboration with OMI.  Since the milestone was achieved before the contract was finalized, the $5 million is treated as an upfront licensing fees and it will be amortized over the two year period of our performance obligation.

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 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

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for which we have no future performance obligations and are reasonably assured of collecting the resulting receivable.  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 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 entire period of performance.  The assay kits, which are sold separately from the instrument, are considered part of the entire 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 element’s fair value, we will be able to recognize revenue separately for each element.

Valuation of Investments in Marketable Securities

We account for our investments in marketable securities in accordance with current accounting rules as set forth by SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. We carry these investments at fair market value based upon market prices quoted on the last day of the fiscal quarter. We record unrealized gains and losses as a separate component of stockholders’ equity, and include gross realized gains and losses in investment income.

In addition to our investments in marketable securities, 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 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. 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.  During the first nine months of 2007, we sold the remaining equity securities of Alnylam Pharmaceuticals, Inc. that we owned resulting in a realized gain of $3.5 million compared to a net gain on investments of $2.3 million during the same period in 2006.  The net gain on investments during the first nine months of 2006 represented a gain of $2.7 million realized on the sale of a portion of the equity securities of Alnylam that we owned offset by a non-cash loss on investment of $465,000 related to the other-than-temporary impairment of our equity investment in Antisense Therapeutics Ltd.  Since the impairment in the second quarter of 2006, we have recorded a net unrealized gain of $550,000 related to our equity investment in ATL as a separate component of stockholders’ equity. This reflected the increase in the market value of the investment since the impairment.  We determined that there were no other-than-temporary declines in value of investments in the first nine months of 2007.

Valuation of Long-Lived Assets

We assess the value of our long-lived assets, which include property 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. We evaluate our long-lived assets for impairment on at least a quarterly basis. During this process, we review our property and equipment listings, pending domestic and international patent applications, domestic and international issued patents, and licenses we have acquired from other parties to determine if any impairment is present. We consider the following factors:

•                  Evidence of decreases in market value;

•                  Changes in the extent or manner in which we use an asset;

•                  Adverse changes in legal factors or in the business climate that would affect the value of an asset;

•                  An adverse action or assessment by a regulator;

•                  An accumulation of costs significantly in excess of amounts originally expected to acquire or construct an asset;

•                  Current period operating or cash flow loss combined with a history of operating or cash flow losses associated with an asset used for the purpose of producing revenue; and

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•                  Challenges or potential challenges to our existing patents, the likelihood of applications being issued and the scope of our issued patents.

We recorded a charge of $515,000 and $2.2 million for the first nine months of 2007 and 2006, respectively, primarily related to the write-down of intangible assets to their estimated net realizable values.

Valuation of Inventory

In accordance with 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, have 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 our drugs to partners, or as we use these drugs in our own clinical trials. Also included in inventory are material costs and related manufacturing costs associated with our 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 our 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 lives of raw materials, alternative uses for our drugs and clinical trial materials and historical write-offs.

Estimated Liability for Clinical Development Costs

We record accrued liabilities related to unbilled expenses for which service providers have not yet billed us related to products or services that we have received, specifically related to ongoing preclinical studies and clinical trials. These costs primarily relate to third-party clinical management costs, laboratory and analysis costs, toxicology studies and investigator grants. We have multiple drugs in concurrent preclinical studies and clinical trials at several clinical sites throughout the world. In order to ensure that we have adequately provided for ongoing preclinical and clinical development costs during the period in which we incur such costs, we maintain an accrual to cover these expenses. We update our estimate for this accrual on at least a quarterly basis. The assessment of these costs is a subjective process that requires judgment. Upon settlement, these costs may differ materially from the amounts accrued in our condensed consolidated financial statements.  Our historical accrual estimates have not been materially different from our actual amounts.

Valuation Allowance for Net Deferred Tax Assets

We record a valuation allowance to offset our net deferred tax assets because we are uncertain that we will realize these net tax assets. We have had net operating losses since inception, and as a result, we have established a 100% valuation allowance for our net deferred tax asset. When and if circumstances warrant, we will assess the likelihood that our net deferred tax assets will more likely than not be recovered from future taxable income and record an appropriate reversal to the valuation allowance.

Segment Information

We provide segment financial information and results for our Drug Discovery and Development segment and our Ibis Biosciences, Inc. subsidiary based on the segregation of revenues and expenses used for management’s assessment of operating performance and operating decisions. Expenses shared by the segments require the use of judgments and estimates in determining the allocation of expenses to the two segments.  We have not made material changes to our allocation methodologies since we began reporting segment financial information and results.  Different assumptions or allocation methods could result in materially different results by segment.

Stock-Based Compensation

On January 1, 2006, we adopted SFAS 123R, Share-Based Payment, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and employee stock purchases related to our Employee Stock Purchase Plan based on estimated fair values. SFAS 123R supersedes our previous accounting under Accounting Principles Board Opinion (“APB”) 25, Accounting for Stock Issued to Employees and SFAS 123, Accounting for Stock-Based Compensation, beginning January 1, 2006. In

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March 2005, the SEC issued SAB 107, Share-Based Payment, relating to SFAS 123R. We have applied the provisions of SAB 107 in our adoption of SFAS 123R.

We adopted SFAS 123R using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, our Condensed Consolidated Statements of Operations for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. As of September 30, 2007, there was $11.6 million of total unrecognized compensation cost related to non-vested stock-based compensation plans. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize that cost over a weighted average period of 1.3 years.

We utilize the Black-Scholes model and assumptions discussed in Note 1 for estimating the fair value of the stock-based awards we granted. Compensation expense for all stock-based payment awards is recognized using the accelerated multiple-option approach. Under the accelerated multiple-option approach (also known as the graded-vesting method), an entity recognizes compensation expense over the requisite service period for each separately vesting tranche of the award as though the award were in substance multiple awards, which results in the expense being front-loaded over the vesting period. Our risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options and our ESPP. The dividend yield assumption is based on our history and expectation of dividend payouts. We have not paid dividends in the past and do not expect to in the future. We use a weighted average of the historical stock price volatility of our stock to calculate the expected volatility assumption required for the Black-Scholes model consistent with SFAS 123R. The expected term of stock options granted represents the period of time that they are expected to be outstanding. For our 2002 Non-Employee Directors’ Stock Option Plan, we estimate the expected term of options granted based on historical exercise patterns. For our employee stock option plans, the estimated expected term is a derived output of the simplified method, as allowed under SAB 107. We estimated forfeitures based on historical experience. There were no material changes to our estimated forfeitures for the first nine months of 2007 and 2006.  For the periods prior to fiscal 2006, we accounted for forfeitures as they occurred in our pro forma information as required under SFAS 123.

We record stock options granted to non-employees at their fair value in accordance with the requirements of SFAS 123, Accounting for Stock-Based Compensation, 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 them over the service period.

Results of Operations

Revenue

Total revenue for the three and nine months ended September 30, 2007 was $38.6 million and $44.9 million, respectively, compared to $3.3 million and $12.6 million for the same periods in 2006.  Revenue was higher in 2007 compared to 2006 due to the $26.5 million licensing revenue that we earned from Alnylam in the third quarter of 2007 and revenue associated with our collaboration with BMS, which began in May 2007 and OMI, which began in September 2007.

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. For example, we recorded the $26.5 million of licensing revenue from Alnylam in the current quarter, without similar revenue in the third quarter of 2006.

The following table sets forth information on our revenue by segment (in thousands):

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