1. Description of the Business and Summary of Significant Accounting Policies

Insmed® Incorporated is a development-stage biopharmaceutical company with expertise in proprietary, advanced liposomal technology designed specifically for inhalation lung delivery. We develop innovative inhaled treatments for serious lung infections. Our proprietary liposomal technology is designed specifically for delivery of pharmaceuticals to the lung, and we believe it provides for potential improvements to the conventional inhalation methods of delivering drug to the pulmonary system. These potential advantages include improvements in efficacy, safety and patient convenience. Our primary focus is on orphan markets with high unmet medical needs, which we believe presents a significant opportunity, as their challenge and complexity best fit our knowledge, know-how and expertise.

Our strategy is to utilize our patented advanced liposomal technology to develop safe and effective medicines that improve upon standards of care for those orphan respiratory diseases in which patient needs are currently unmet. Our initial primary target indications are Pseudomonas aeruginosa (hereafter referred to as Pseudomonas) lung infections in CF patients and patients with NTM lung infections.

Insmed is the result of a business combination completed on December 1, 2010, with Transave, Inc., a privately-held, NJ-based pharmaceutical company focused on the development of differentiated and innovative inhaled pharmaceuticals for the site-specific treatment of serious lung infections. Integration of the two companies was completed in 2011 including the relocation of corporate headquarters to Monmouth Junction, New Jersey, and cessation of operations at the Richmond, Virginia, location as of December 31, 2011. On March 2, 2011, we completed a conversion of all of our outstanding preferred stock to common stock and also we completed a one-for-ten reverse stock split of our common stock. Unless otherwise noted, the per share amounts in this 10-K give retroactive effect to the reverse stock split for all periods presented.

After giving effect to the Merger, former Transave stockholders had approximately a 46.7% equity interest in the combined Company (on an as-converted, fully diluted basis), and legacy Insmed Incorporated shareholders had a 53.3% equity interest. The shares retained by us pursuant to the Merger agreement (approximately 1.76 million shares of common stock after giving effect to the conversion of the Series B Conditional Preferred Stock and the one-for-ten reverse stock split of our common stock) will be delivered on June 12, 2012, subject to reduction for any claims and indemnification payments that are pending in accordance with the terms of the Merger agreement.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Transave, LLC, Insmed Therapeutic Proteins, Insmed Pharmaceuticals, Incorporated, and Celtrix Pharmaceuticals, Incorporated (Celtrix). All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company bases its estimates and judgments on historical experience and on various other assumptions that it believes are reasonable under the circumstances. The amounts of assets and liabilities reported in the Company's balance sheets and the amounts of revenue and expenses reported for each periods presented are effected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, stock-based compensation, income taxes, loss contingencies, impairment of intangibles and long lived assets and accounting for research and development costs. Actual results could differ from those estimates.

Common Stock Reverse Split

On March 2, 2011, our shareholders approved a one-for-ten reverse stock split of the Company's outstanding common stock (see Note 6). Unless otherwise noted, the accompanying consolidated financial statements and notes give retroactive effect to the reverse stock split for all periods presented.

Cash, Cash Equivalents and Short-Term Investments

The Company considers cash equivalents to be investments with maturities of three months or less when purchased. Short-term investments are available for sale and consist primarily of short-term municipal bonds, U. S. treasuries and mutual funds. These securities are carried at fair value of the investment based on quoted market prices. The cost of the specific security sold is used to compute the gain or loss on the sale of marketable securities.

Fixed Assets

Fixed assets are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives of the assets. Estimated useful lives of five to seven years are used for computer equipment, laboratory equipment, office equipment and furniture and fixtures. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the asset. Long-lived assets, such as lab equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, then an impairment charge is recognized for the amount by which the carrying value of the asset exceeds the fair value of the asset. As of December 31, 2011 and 2010, management believes that no revision of the remaining useful lives or write-down of long-lived assets is required.

Goodwill and Identified Intangible Assets

As part of the Merger, we recorded in-process research and development identified intangible assets. Identifiable intangible assets are measured at their respective fair values as of the acquisition date and are not amortized until commercialization. Once commercialization occurs, these intangible assets will be amortized over the estimated useful lives. While we believe the fair values assigned to our acquired intangible assets are based on reasonable estimates and assumptions given the available facts and circumstances as of the acquisition date, unanticipated events or circumstances may occur that require us to review the assets for impairment. Events or circumstances that may require an impairment assessment include negative clinical trial results, the non-approval of a new drug application (NDA) by the FDA, material delays in our development program or a sustained decline in market capitalization.

Goodwill and other indefinite-lived intangible assets are not subject to periodic amortization. Rather goodwill and other indefinite-lived intangibles are reviewed for impairment by applying a fair value based test on an annual basis or more frequently if events or circumstances indicate impairment may have occurred. Events or circumstances that may require an interim impairment assessment are consistent with those described above related to the in-process research and development intangible assets. The potential impairment of goodwill is assessed by comparing the fair value (using income or market approaches) of the reporting unit with its carrying amount, including goodwill. If the carrying value of the reporting unit exceeds its fair value, an impairment charge would be recorded in the amount that the carrying amount of goodwill exceeds its implied fair value. The Company has elected to perform its annual impairment test as of October 1 of each year.

In the quarter ended September 30, 2011, the FDA placed a clinical hold on our Phase 3 clinical trials for ARIKACE for CF and NTM. The clinical hold for the NTM indication was subsequently lifted in January 2012. Our management determined the clinical hold was an indicator of possible intangible asset impairment due to the associated additional costs and material delay in our development program and, therefore, interim impairment testing was performed as of September 30, 2011. The annual impairment review resulted in a non-cash charge of $26.0 million to reflect the decline in the fair value of goodwill and in-process research and development intangible assets as of September 30, 2011 due to the material impact of the clinical hold on our ARIKACE development program. No additional impairment losses were identified as of our December 31, 2011 impairment testing due primarily to the subsequent lifting of the clinical hold in the NTM indication and additional external market data which indicated that the NTM market may be larger than originally anticipated. In January 2012 the FDA lifted the clinical hold on ARIKACE in the NTM indication. In February 2012, the Company announced that it would be initiating the ARIKACE NTM trial as a Phase 2 trial, as well as the previously planned Phase 3 trial for ARIKACE in the CF indication in Europe.

Fair Value of Financial Instruments

We consider the recorded cost of our financial assets and liabilities, which consist primarily of cash, cash equivalents and short-term investments, to approximate the fair value of the respective assets and liabilities at December 31, 2011 and 2010, due to the short-term maturities of these instruments. See Note 9 for further discussion on fair value of our cash and investments.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company places its cash equivalents with high credit-quality financial institutions and invests its short-term investments in U.S. treasury securities, mutual funds and government agency bonds. The Company has established guidelines relative to credit ratings and maturities that seek to maintain safety and liquidity.

The Company's drugs supplies are supplied from by a sole manufacturer. The inability of the manufacturer to fulfill supply requirements of the Company could materially impact future operating results. A change in the relationship with this manufacturer, or an adverse change in their business, could materially impact future operating results.

Beneficial Conversion Charge (“BCC”)

When issuing debt or equity securities that are convertible into common stock at a discount from the fair value of the common stock at the date the debt or equity financing is committed, we are required to record a BCC in accordance with Accounting Standards Codification (“ASC”) 470-20. This BCC is measured as the difference between the fair values of the securities at the time of issue, $6.10 in this case, and the fair value of the common stock at the commitment date, which was $7.10. The carrying value of the preferred stock was based on its fair value at issuance, which was estimated using the common stock price reduced for a lack of marketability between the issuance date and the anticipated date of conversion. The BCC is recorded as a non-cash charge to earnings. A BCC of $9.2 million was recognized at the time of the Series B Preferred Stock conversions and represents a $1.00 discount on the fair value of our common stock purchased by the note holders. See Note 6 for further information about the beneficial conversion feature.

Revenue Recognition and Collaboration Agreements

Revenue from our Expanded Access Program in Italy is recognized when the drugs have been provided to program patients and collectability is assured. Revenue from collaborations is recognized as license fees when milestones are achieved and payments are due. The Company analyzes each element of an agreement to determine if it shall be accounted for as a separate element or single unit of accounting. If an element shall be treated separately for revenue recognition purposes, the revenue recognition principles most appropriate for that element are applied to determine when revenue shall be recognized. If an element shall not be treated separately for revenue recognition purposes, the revenue recognition principles most appropriate for the bundled group of elements are applied to determine when revenue shall be recognized. Payments received in excess of revenues recognized are recorded as deferred revenue until such time as the revenue recognition criteria have been met.

Research and Development

Research and development costs are expensed as incurred except for purchased in-process research and development (see Goodwill and Identified Intangible Assets policy above and Note 4). Research and development expenses consist primarily of salaries and related expenses, cost to develop and manufacture drug candidates, patent protection costs, amounts paid to contract research organizations, hospitals and laboratories for the provision of services and materials for drug development and clinical trials. Our expenses related to clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with third-party organizations that conduct and manage clinical trials on our behalf. These contracts set forth the scope of work to be completed at a fixed fee or amount per patient enrolled. Payments under these contracts primarily depend on performance criteria such as the successful enrollment of patients or the completion of clinical trial milestones as well as time-based fees. Expenses are accrued based on contracted amounts applied to the level of patient enrollment and to activity according to the clinical trial protocol.

Stock-Based Compensation

In some instances, consultants received equity instruments of the Company or liabilities for services provided that are based on the fair value of our equity instruments or that may be settled by the issuance of such equity instruments. These share-based transactions are accounted for using a fair-value-based method to recognize non-cash compensation expense; this expense is recognized ratably over the requisite service period, which generally equals the vesting period of options, and is adjusted for expected forfeitures.

Income Taxes

Income taxes are accounted for in accordance with ASC 740, Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has no uncertain tax positions as of December 31, 2011 that qualify for either recognition or disclosure in the financial statements.

Valuation allowances are recorded if it is more likely than not that some portion of the deferred tax asset will not be realized. In evaluating the need for a valuation allowance, we take into account various factors, including the expected level of future taxable income and available tax planning strategies. If actual results differ from the assumptions made in the evaluation of our valuation allowance, we record a change in valuation allowance through income tax expense in the period such determination is made.

The Company follows the provisions of ASC 740, Accounting for Uncertainty in Income Taxes, which provides a financial statement recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. Under ASC 740, the Company may 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 taxing authorities, based solely on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood to be sustained upon ultimate settlement.

The Company's policy for interest and penalties related to income tax exposures is to recognize interest and penalties as a component of the income taxes on continuing operations in the consolidated statements of operations.

Net (Loss) Income Per Share

Basic net (loss) income per share is computed based upon the weighted average number of common shares outstanding during the year. The following table sets forth the reconciliation of the weighted average number of shares attributable to common stockholders used to compute basic net (loss) income per share to those used to compute diluted net (loss) income per share for the years ended December 31, 2011, 2010 and 2009.

	2011		2010		2009
Weighted average number of shares - basic		23,348		13,250		12,712
Add dilutive effect of shares - restricted stock units and options		-		-		15
Weighted average number of shares - diluted		23,348		13,250		12,727

The following potentially dilutive securities have been excluded from the computations of diluted weighted-average shares outstanding as of December 31, 2011, 2010 and 2009 as they would be anti-dilutive.

	2011		2010		2009
Shares underlying warrants to purchase outstanding common stock		158		158		519
Shares underlying options to purchase outstanding common stock		892		214		259
Shares underlying restricted stock units		487		-		-

Comprehensive (Loss) Income

Comprehensive (loss) income consists of net loss plus unrealized (losses) gains on short-term investments. Comprehensive (loss) income as of December 31, 2011, 2010 and 2009 is as follows:

	Year Ended December 31,
	2011			2010			2009
Net (loss) income	$	(59,664	)	$	(6,434	)	$	118,350
Unrealized (loss) gain on short-term investments		(543	)		548			445
Total comprehensive (loss) income	$	(60,207	)	$	(5,886	)	$	118,795

Segment Information

The Company currently operates in one business segment, which is the development and commercialization of pharmaceutical products. A single management team that reports to the Chief Executive Officer comprehensively manages the entire business. The Company does not operate separate lines of business with respect to its products or product candidates. Accordingly, the Company does not have separately reportable segments.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements. The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence (“VSOE”) if available, third-party evidence (“TPE”) if VSOE is not available, or estimated selling price if neither VSOE or TPE is available. ASU 2009-13 is effective for revenue arrangements entered into in fiscal years beginning on or after June 15, 2010. We adopted ASU 2009-13 effective January 1, 2011 and it did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (ASU 2010-06), which amends the existing fair value measurement and disclosure guidance currently included in ASC Topic 820, Fair Value Measurements and Disclosures, to require additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfer in or out of Level 3 and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. In addition, ASU 2010-06 also clarifies the requirement for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The adoption of ASU 2010-06 did not impact our consolidated financial statements.

In April 2010, the FASB issued ASU 2010-17, Revenue Recognition-Milestone Method (Topic 605): Milestone Method of Revenue Recognition, a consensus of the FASB Emerging Issues Task Force, which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. ASU 2010-17 is effective for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. We adopted ASU 2010-17 effective January 1, 2011 and it did not have a material impact on our consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. ASU 2011-04 is effective for years beginning after December 15, 2011 and is not expected to have a material impact on our consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of equity. In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05. ASU 2011-12 defers the effective date of the requirement in ASU 2011-05 to disclose on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. All other requirements of ASU 2011-05 are not affected by ASU 2011-12. ASU 2011-05 and 2011-12 are effective for years beginning after December 15, 2011. The adoption of ASU 2011-05 and 2011-12 are not expected to have a material impact on our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other, which amends current guidance to allow a company to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The amendment also revises previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of ASU 2011-08 is not expected to have a material impact on our consolidated financial statements.