1. Organization and Significant Accounting Policies

Basis of Presentation

In our consolidated financial statements we included the accounts of Ionis Pharmaceuticals, Inc. ("we", "us" or "our") and the consolidated results of our majority-owned affiliate, Akcea Therapeutics, Inc., which we formed in December 2014. In July 2017, Akcea completed an initial public offering, or IPO, and therefore beginning in July 2017, we no longer own 100 percent of Akcea. As of July 19, 2017, the closing of the IPO, we owned approximately 68 percent of Akcea. Refer to the noncontrolling interest in Akcea section in this note for further information related to our accounting for our investment in Akcea.

Organization and Business Activity

We incorporated in California on January 10, 1989. In conjunction with our IPO, we reorganized as a Delaware corporation in April 1991. We were organized principally to develop human therapeutic drugs using antisense technology. In December 2015, we changed our name from Isis Pharmaceuticals, Inc. to Ionis Pharmaceuticals, Inc.

Basic and Diluted Net Income (Loss) per Share

We compute basic net income (loss) per share by dividing the net income (loss) attributable to our common stockholders by our weighted average number of common shares outstanding during the period.

The calculation of total net income (loss) attributable to our common stockholders for 2017 considered our net income for Ionis on a stand-alone basis plus our share of Akcea’s net loss. To calculate the portion of Akcea’s net loss attributable to our ownership, we multiplied Akcea’s loss per share by the weighted average shares we owned in Akcea during the year. Prior to Akcea’s IPO, we owned Akcea Series A convertible preferred stock, which included a six percent cumulative dividend. Upon completion of Akcea’s IPO in July 2017, our preferred stock was converted into common stock on a 1:1 basis. The preferred stock dividend was not paid at the IPO because it was not a liquidation event or a change in control. For 2017, Akcea used a two-class method to compute its net income (loss) per share because it had both common and preferred shares outstanding during the year. The two-class method required Akcea to calculate its net income (loss) per share for each class of stock by dividing total distributable losses applicable to preferred and common stock, including the six percent cumulative dividend contractually due to Series A convertible preferred shareholders, by the weighted average of preferred and common shares outstanding during the requisite period. Since Akcea used the two-class method, accounting rules required us to include our portion of Akcea's net income (loss) per share for both Akcea's common and preferred shares which we owned in our calculation of basic and diluted net income per share for 2017. As a result of this calculation, our total net income available to Ionis common stockholders for the calculation of net income per share is different than net income (loss) attributable to Ionis Pharmaceuticals, Inc. common stockholders in the consolidated statements of operations.

We calculated our basic net income per share for 2017 as follows (in thousands, except per share amounts):

Year Ended December 31, 2017	Weighted Average Shares Owned in Akcea		Akcea’s Net Loss Per Share			Ionis’ Portion of Akcea’s Net Loss
Common shares		20,669	$	(2.82	)	$	(58,332	)
Preferred shares		15,748		(1.55	)		(24,344	)
Akcea’s net loss attributable to our ownership						$	(82,676	)
Ionis’ stand-alone net income							92,336
Net income available to Ionis common stockholders						$	9,661
Weighted average shares outstanding							124,016
Basic net income per share						$	0.08

For 2017, we had net income available to Ionis common stockholders. As a result, we computed diluted net income per share using the weighted-average number of common shares and dilutive common equivalent shares outstanding during those periods. Diluted common equivalent shares for 2017 consisted of the following (in thousands except per share amounts):

Year Ended December 31, 2017	Income (Numerator)		Shares (Denominator)		Per-Share Amount
Net income available to Ionis common stockholders	$	9,661		124,016	$	0.08
Effect of dilutive securities:
Shares issuable upon exercise of stock options		—		1,619
Shares issuable upon restricted stock award issuance		—		459
Shares issuable related to our ESPP		—		4
Income available to Ionis common stockholders, plus assumed conversions	$	9,661		126,098	$	0.08

For 2017, the calculation excluded the 1 percent and 2¾ percent notes because the effect on diluted earnings per share was anti-dilutive.

As we incurred a net loss for 2016 and 2015, we did not include dilutive common equivalent shares in the computation of diluted net loss per share because the effect would have been anti-dilutive. Common stock from the following would have had an anti-dilutive effect on net loss per share:

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percent convertible senior notes;

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2¾ percent convertible senior notes;

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Dilutive stock options;

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Unvested restricted stock units; and

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Employee Stock Purchase Plan, or ESPP.

Revenue Recognition

We generally recognize revenue when we have satisfied all contractual obligations and are reasonably assured of collecting the resulting receivable. We are often entitled to bill our customers and receive payment from our customers in advance of recognizing the revenue. In the instances in which we have received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on our consolidated balance sheet.

Commercial Revenue: SPINRAZA royalties and Licensing and other royalty revenue

We often enter into agreements to license and sell our technology on an exclusive or non-exclusive basis in exchange for upfront fees, license fees, milestone payments and/or royalties. We generally recognize as revenue immediately license payments with stand-alone value when the license is delivered and we are reasonably assured of collecting the resulting receivable. We recognize royalty revenue in the period in which the counterparty sells the related product, unless we are unable to obtain information to estimate the royalty. For example, in 2017 we recorded SPINRAZA royalty revenue of $112.5 million.

Research and development revenue under collaborative agreements

Arrangements with multiple deliverables

Our collaboration agreements typically contain multiple elements, or deliverables, including technology licenses or options to obtain technology licenses, research and development services, and in certain cases manufacturing services, and we allocate the consideration to each unit of accounting based on the relative selling price of each deliverable.

Amendments to agreements

From time to time we amend our collaboration agreements. For these agreements, before we identify our deliverables and allocate consideration to each unit of accounting, we must determine if the amendment should be accounted for as a separate agreement, or if the amendment and any undelivered elements for the original agreement should be accounted for as a single new arrangement.

For example, in May 2015, we entered into an exclusive license agreement with Bayer to develop and commercialize IONIS-FXI_Rx for the prevention of thrombosis. As part of the agreement, Bayer paid us a $100 million upfront payment. At the onset of the agreement, we were responsible for completing a Phase 2 study of IONIS-FXI_Rx in people with end-stage renal disease on hemodialysis and for providing an initial supply of active pharmaceutical ingredient, or API. In February 2017, we amended our agreement with Bayer to advance IONIS-FXI_Rx and to initiate development of IONIS-FXI-L_Rx, which Bayer licensed. As part of the 2017 amendment, Bayer paid us $75 million. We are also eligible to receive milestone payments and tiered royalties on gross margins of IONIS-FXI_Rx and IONIS-FXI-L_Rx.

Under the 2017 amendment, there was a substantial increase in the consideration we are eligible to receive and a significant change in the deliverables we will provide to Bayer. As a result, we concluded that the amendment should be evaluated with the undelivered elements of the original agreement as a single new arrangement. Therefore, we evaluated our original and 2017 amended agreements with Bayer together to determine our deliverables. We concluded that the 2017 amendment did not impact the items we already delivered to Bayer.

Identifying deliverables and units of accounting

We evaluate the deliverables in our collaboration agreements to determine whether they meet the criteria to be accounted for as separate units of accounting or whether they should be combined with other deliverables and accounted for as a single unit of accounting. When the delivered items in an arrangement have "stand-alone value" to our customer, we account for the deliverables as separate units of accounting. Delivered items have stand-alone value if they are sold separately by any vendor or the customer could resell the delivered items on a stand-alone basis. For example, our 2017 amended agreement with Bayer has multiple elements. We evaluated the deliverables in this arrangement when we entered into the 2017 amended agreement and determined that certain of the deliverables have stand-alone value. Below is a list of the three units of accounting under our 2017 amended agreement:

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The exclusive license we granted to Bayer to develop and commercialize IONIS-FXI-L_Rx for the treatment of thrombosis;

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The development services we agreed to perform for IONIS-FXI-L_Rxand IONIS-FXI_Rx; and

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The remaining undelivered IONIS-FXI_Rx API that was part of the original agreement.

We determined that each of these three units of accounting have stand-alone value. The license we granted to Bayer has stand-alone value because it gives Bayer the exclusive right to develop IONIS-FXI-L_Rx or to sublicense its rights. The development services and the remaining undelivered supply of API each have stand-alone value because Bayer or another third party could provide these items without our assistance.

Measurement and allocation of arrangement consideration

Our collaborations may provide for various types of payments to us including upfront payments, funding of research and development, milestone payments, licensing fees and royalties on product sales. We initially allocate the amount of consideration that is fixed and determinable at the time the agreement is entered into and exclude contingent consideration. We allocate the consideration to each unit of accounting based on the relative selling price of each deliverable. We use the following hierarchy of values to estimate the selling price of each deliverable: (i) vendor-specific objective evidence of fair value; (ii) third-party evidence of selling price; and (iii) best estimate of selling price, or BESP. BESP reflects our best estimate of what the selling price would be if we regularly sold the deliverable on a stand-alone basis. We recognize the revenue allocated to each unit of accounting as we deliver the related goods or services. If we determine that we should treat certain deliverables as a single unit of accounting, then we recognize the revenue ratably over our estimated period of performance.

We determined that the allocable arrangement consideration for the Bayer 2017 amended agreement was $76.3 million, comprised of the $75 million we received as part of the amendment and the remaining amount of the $100 million upfront payment we had not yet recognized into revenue, related to the undelivered API. We allocated the consideration based on the relative BESP of each unit of accounting. We engaged a third party, independent valuation specialist to assist us with determining BESP. We estimated the selling price of the license granted for IONIS-FXI-L_Rx by using the relief from royalty method. Under this method, we estimated the amount of income, net of taxes, for IONIS-FXI-L_Rx. We then discounted the projected income to present value. The significant inputs we used to determine the projected income of the license included:

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Estimated future product sales;

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Estimated royalties on future product sales;

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Contractual milestone payments;

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Expenses we expect to incur;

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Income taxes; and

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An appropriate discount rate.

We estimated the selling price of the development services by using our internal estimates of the cost to perform the specific services and estimates of expected cash outflows to third parties for services and supplies over the expected period that we will perform the development services. The significant inputs we used to determine the selling price of the development services included:

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The number of internal hours we will spend performing these services;

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The estimated cost of work we will perform;

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The estimated cost of work that we will contract with third parties to perform; and

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The estimated cost of API we will use.

For purposes of determining BESP of the services we will perform and the API we will deliver in our 2017 amended Bayer transaction, accounting guidance required us to include a markup for a reasonable profit margin.

Based on the units of accounting under the 2017 amended agreement, we allocated the $76.3 million of allocable consideration as follows:

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$64.9 million to the IONIS-FXI-L_Rx exclusive license;

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$11.0 million for development services for IONIS-FXI-L_Rxand IONIS-FXI_Rx; and

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$0.4 million for the remaining delivery of IONIS-FXI_RxAPI.

Assuming a constant selling price for the other elements in the arrangement, if there was an assumed 10 percent increase or decrease in the estimated selling price of the IONIS-FXI-L_Rx license, we determined that the revenue we would have allocated to the IONIS-FXI-L_Rx license would change by approximately one percent, or $0.7 million, from the amount we recorded.

Timing of revenue recognition

We recognize revenue as we deliver each item under the arrangement and the related revenue is realizable and earned. For example, we recognized revenue for the exclusive license we granted Bayer for IONIS-FXI-L_Rx in the first quarter of 2017 because that was when we delivered the license. We also recognize revenue over time as we provide services. Our collaborative agreements typically include a research and/or development project plan outlining the activities the agreement requires each party to perform during the collaboration. We estimate our period of performance at the inception of the agreement when the agreements we enter into do not clearly define such information. We then recognize revenue from development services ratably over such period. In certain instances, the period of performance may change as the development plans for our drugs progress. If our estimates and judgments change over the course of our collaboration agreements, it may affect the timing and amount of revenue that we recognize in future periods. We recognize any changes in estimates on a prospective basis.

The following are the periods over which we are recognizing revenue for each of our units of accounting under our 2017 amended Bayer agreement:

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We recognized the portion of the consideration attributed to the IONIS-FXI-L_Rx license in the first quarter of 2017 because we delivered the license and earned the revenue;

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We are recognizing the amount attributed to the development services for IONIS-FXI-L_Rx and IONIS-FXI_Rx over the period of time we are performing the services; and

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We are recognizing the amount attributed to the remaining API supply as we deliver it to Bayer.

Multiple agreements

From time to time, we may enter into separate agreements at or near the same time with the same partner. We evaluate such agreements to determine whether they should be accounted for individually as distinct arrangements or whether the separate agreements are, in substance, a single multiple element arrangement. We evaluate whether the negotiations are conducted jointly as part of a single negotiation, whether the deliverables are interrelated or interdependent, whether fees in one arrangement are tied to performance in another arrangement, and whether elements in one arrangement are essential to another arrangement. Our evaluation involves significant judgment to determine whether a group of agreements might be so closely related that they are, in effect, part of a single arrangement. For example, in the first quarter of 2017, we and Akcea entered into two separate agreements with Novartis at the same time: a collaboration agreement and a stock purchase agreement, or SPA.

Akcea entered into a collaboration agreement with Novartis to develop and commercialize AKCEA-APO(a)-L_Rx and AKCEA-APOCIII-L_Rx. Under the collaboration agreement, Akcea received a $75 million upfront payment. For each drug, Akcea is responsible for completing a Phase 2 program, conducting an end-of-Phase 2 meeting with the Food and Drug Administration, or FDA, and delivering API. Under the collaboration agreement, Novartis has an exclusive option to develop and commercialize AKCEA-APO(a)-L_Rx and AKCEA-APOCIII-L_Rx. If Novartis exercises an option for one of these drugs, Novartis will pay Akcea a $150 million license fee and will assume all further global development, regulatory and commercialization activities and costs for the licensed drug. Akcea is also eligible to receive a development milestone payment, milestone payments if Novartis achieves pre-specified regulatory milestones, commercial milestones and tiered royalties on net sales from each drug under the collaboration.

Under the SPA, Novartis purchased 1.6 million shares of Ionis’ common stock for $100 million in the first quarter of 2017 and paid a premium over the weighted average trading price at the time of purchase. Additionally, the SPA required Novartis to purchase $50 million of Akcea’s common stock in a concurrent private placement with Akcea’s IPO in July 2017.

We evaluated the Novartis agreements to determine whether we should treat the agreements separately or as a single arrangement. We considered that the agreements were negotiated concurrently and in contemplation of one another. Additionally, the same individuals were involved in the negotiations of both agreements. Based on these facts and circumstances, we concluded that we should treat both agreements as a single arrangement and evaluate the provisions of the agreements on a combined basis. Refer to Note 6, Collaborative Arrangements and Licensing Agreements for further discussion of the accounting treatment for the Novartis collaboration.

Milestone payments

Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and/ or commercialization events. These three categories of milestone events reflect the three stages of the life-cycle of our drugs, which we describe in more detail in the following paragraphs.

Prior to the first stage in the life-cycle of our drugs, we perform a significant amount of work using our proprietary antisense technology to design chemical compounds that interact with specific genes that are good targets for drug discovery. From these research efforts, we hope to identify a development candidate. The designation of a development candidate is the start of the development stage, which is the first stage in the life-cycle of our drugs. A development candidate is a chemical compound that has demonstrated the necessary safety and efficacy in preclinical animal studies to warrant further study in humans.

During the first step of the development stage, we or our partners study our drugs in Investigational New Drug, or IND,-enabling studies, which are animal studies intended to support an IND application and/or the foreign equivalent. An approved IND allows us or our partners to study our development candidate in humans. If the regulatory agency approves the IND, we or our partners initiate a Phase 1 clinical trial in which we typically enroll a small number of healthy volunteers to ensure the development candidate is safe for use in patients. If we or our partners determine that a development candidate is safe based on the Phase 1 data, we or our partners initiate Phase 2 studies that are generally larger studies in patients with the primary intent of determining the preliminary efficacy and safety of the development candidate.

The final step in the development stage is Phase 3 studies to gather the necessary safety and efficacy data to request marketing authorization from the FDA and/or foreign equivalents. Phase 3 studies typically involve larger numbers of patients and can take up to several years to complete.

If the data gathered during the Phase 3 trials demonstrates acceptable safety and efficacy results, we or our partner will submit an application to the FDA and/or its foreign equivalents for marketing authorization. This stage of the drug’s life-cycle is the regulatory stage.

If the FDA or a foreign equivalent grants marketing authorization for a drug, it moves into the commercialization stage. During this stage we or our partner will market and sell the drug to patients. Although our partner may ultimately be responsible for marketing and selling a partnered drug, our efforts to discover and develop a drug that is safe, effective and reliable contributes significantly to our partner’s ability to successfully sell the drug. The FDA and its foreign equivalents have the authority to impose significant restrictions on an approved drug through the product label and on advertising, promotional and distribution activities. Therefore, our efforts designing and executing the necessary animal and human studies are critical to obtaining claims in the product label from the regulatory agencies that would allow us or our partner to successfully commercialize our drug. Further, the patent protection afforded our drugs as a result of our initial patent applications and related prosecution activities in the United States and foreign jurisdictions are critical to our partner’s ability to sell our drugs without competition from generic drugs. The potential sales volume of an approved drug is dependent on several factors including the size of the patient population, market penetration of the drug, and the price charged for the drug.

Generally, the milestone events contained in our partnership agreements coincide with the progression of our drugs from development, to marketing authorization and then to commercialization. The process of successfully discovering a new development candidate, having it approved and ultimately selling it for a profit is highly uncertain. As such, the milestone payments we may earn from our partners involve a significant degree of risk to achieve. Therefore, as a drug progresses through the stages of its life-cycle, the value of the drug generally increases.

Development milestones in our partnerships may include the following types of events:

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Designation of a development candidate. Following the designation of a development candidate, IND-enabling animal studies for a new development candidate generally take 12 to 18 months to complete.

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Initiation of a Phase 1 clinical trial. Generally, Phase 1 clinical trials take one to two years to complete.

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Initiation or completion of a Phase 2 clinical trial. Generally, Phase 2 clinical trials take one to three years to complete.

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Initiation or completion of a Phase 3 clinical trial. Generally, Phase 3 clinical trials take two to four years to complete.

Regulatory milestones in our partnerships may include the following types of events:

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Filing of regulatory applications for marketing authorization such as a New Drug Application, or NDA, in the United States or a Marketing Authorization Application, or MAA, in Europe. Generally, it takes six to twelve months to prepare and submit regulatory filings.

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Obtaining marketing authorization in a major market, such as the United States, Europe or Japan. Generally it takes one to two years after an application is submitted to obtain authorization from the applicable regulatory agency.

Commercialization milestones in our partnerships may include the following types of events:

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First commercial sale in a particular market, such as in the United States or Europe.

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Product sales in excess of a pre-specified threshold, such as annual sales exceeding $1 billion. The amount of time to achieve this type of milestone depends on several factors including but not limited to the dollar amount of the threshold, the pricing of the product and the pace at which customers begin using the product.

We assess whether a substantive milestone exists at the inception of our agreements. When a substantive milestone is achieved, we recognize revenue related to the milestone payment immediately. For our licensing and collaboration agreements in which we are involved in the discovery and/or development of the related drug or provide the partner with access to new technologies we discover, we have determined that the majority of future development, regulatory and commercialization milestones are substantive. For example, we consider most of the milestones associated with our strategic alliance with Biogen substantive because we are using our antisense drug discovery platform to discover and develop new drugs against targets for neurological diseases. In evaluating if a milestone is substantive we consider whether:

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Substantive uncertainty exists as to the achievement of the milestone event at the inception of the arrangement;

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The achievement of the milestone involves substantive effort and can only be achieved based in whole or in part on our performance or the occurrence of a specific outcome resulting from our performance;

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The amount of the milestone payment appears reasonable either in relation to the effort expended or to the enhancement of the value of the delivered items;

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There is no future performance required to earn the milestone; and

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The consideration is reasonable relative to all deliverables and payment terms in the arrangement.

If any of these conditions are not met, we do not consider the milestone to be substantive and we defer recognition of the milestone payment and recognize it as revenue over our estimated period of performance, if any. Further information about our collaborative arrangements can be found in Note 6, Collaborative Arrangements and Licensing Agreements.

Option to license

In several of our collaboration agreements, we provide our partner with an option to obtain a license to one or more of our drugs. When we have a multiple element arrangement that includes an option to obtain a license, we evaluate if the option is a deliverable at the inception of the arrangement. We do not consider the option to be a deliverable if we conclude that it is substantive and not priced at a significant and incremental discount. We consider an option substantive if, at the inception of the arrangement, we are at risk as to whether our collaboration partner will choose to exercise its option to obtain the license. In those circumstances, we do not include the associated license fee in the allocable consideration at the inception of the agreement. Rather, we account for the license fee when our partner exercises its option. For example, during 2017, we earned license fee revenue when three of our partners, Bayer, Janssen and Roche, exercised their options to license three of our drugs, which under the respective agreements we concluded to be substantive options at inception. As a result, in 2017 we recognized the related revenue immediately in research and development revenue under collaborative agreements on our statement of operations as these amounts relate to drugs in development under research and development collaboration arrangements.

Research, Development and Patent Expenses

Our research and development expenses include wages, benefits, facilities, supplies, external services, clinical trial and manufacturing costs and other expenses that are directly related to our research and development operations. We expense research and development costs as we incur them. When we make payments for research and development services prior to the services being rendered, we record those amounts as prepaid assets on our consolidated balance sheet and we expense them as the services are provided. For the years ended December 31, 2017, 2016 and 2015, research and development expenses were $372.5 million, $340.4 million and $319.5 million, respectively. A portion of the costs included in research and development expenses are costs associated with our partner agreements. For the years ended December 31, 2017, 2016 and 2015, research and development costs of approximately $59.5 million, $187.1 million and $161.7 million, respectively, were related to our partner agreements.

We capitalize costs consisting principally of outside legal costs and filing fees related to obtaining patents. We amortize patent costs over the useful life of the patent, beginning with the date the United States Patent and Trademark Office, or foreign equivalent, issues the patent. The weighted average remaining amortizable life of our issued patents was 10.1 years at December 31, 2017.

The cost of our patents capitalized on our consolidated balance sheet at December 31, 2017 and 2016 was $30.8 million and $28.8 million, respectively. Accumulated amortization related to patents was $8.8 million and $8.4 million at December 31, 2017 and 2016, respectively.

Based on our existing patents, we estimate amortization expense related to patents in each of the next five years to be the following:

Years Ending December 31,	Amortization (in millions)
2018	$	1.6
2019	$	1.4
2020	$	1.3
2021	$	1.3
2022	$	1.2

We review our capitalized patent costs regularly to ensure that they include costs for patents and patent applications that have future value. When we identify patents and patent applications that we are not actively pursuing, we write off any associated costs. In 2017, 2016 and 2015, patent expenses were $2.1 million, $3.9 million and $2.8 million, respectively, and included non-cash charges related to the write-down of our patent costs to their estimated net realizable values of $0.4 million, $2.3 million and $1.1 million, respectively.

Accrued Liabilities

Our accrued liabilities consisted of the following (in thousands):

	December 31,
	2017		2016
Clinical expenses	$	16,347	$	23,428
In-licensing expenses		33,790		6,430
Other miscellaneous expenses		16,481		6,155
Total accrued liabilities	$	66,618	$	36,013

Noncontrolling Interest in Akcea Therapeutics, Inc.

In July 2017, Akcea completed an IPO. Akcea raised $193.8 million of aggregate gross proceeds from the IPO, including $50.0 million from a private placement by Novartis. Akcea’s net proceeds were $182.4 million. As part of Akcea’s IPO, we invested $25.0 million. In conjunction with the IPO, the shares of Akcea’s series A convertible preferred stock we owned converted into shares of Akcea’s common stock. Additionally, the amount outstanding under Akcea’s line of credit with us converted into shares of Akcea’s common stock.

Prior to Akcea’s IPO in July 2017, we owned 100 percent of Akcea’s stock and consolidated 100 percent of Akcea’s results in our financial statements. In connection with Akcea’s IPO, shares of Akcea’s common stock were sold to third parties. We owned approximately 68 percent of Akcea after the IPO and at December 31, 2017. The shares third parties own represent an interest in Akcea’s equity that is not controlled by us. However, as we continue to maintain overall control of Akcea through our voting interest, we reflect the assets, liabilities and results of operations of Akcea in our consolidated financial statements. The noncontrolling interest attributable to other owners of Akcea’s common stock is reflected in a separate line on the statement of operations and a separate line within stockholders’ equity in our consolidated financial statements. In addition, we recorded a noncontrolling interest adjustment to account for the stock options that Akcea grants for its common stock, which if exercised, will dilute our ownership in Akcea. This adjustment was reflected as a reclassification within stockholders’ equity from additional paid-in capital to noncontrolling interest in Akcea equal to the amount of stock-based compensation expense Akcea had recognized from inception through the IPO. Going forward, each period we will reclassify Akcea’s stock-based compensation expense in a similar fashion.

Concentration of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, short-term investments and receivables. We place our cash equivalents and short-term investments with reputable financial institutions. We primarily invest our excess cash in commercial paper and debt instruments of the U.S. Treasury, financial institutions, corporations, and U.S. government agencies with strong credit ratings and an investment grade rating at or above A-1, P-1 or F-1 by Moody’s, Standard & Poor’s, or S&P, or Fitch, respectively. We have established guidelines relative to diversification and maturities that maintain safety and liquidity. We periodically review and modify these guidelines to maximize trends in yields and interest rates without compromising safety and liquidity.

Cash, Cash Equivalents and Short-Term Investments

We consider all liquid investments with maturities of three months or less when we purchase them to be cash equivalents. Our short-term investments have initial maturities of greater than three months from date of purchase. We classify our short-term investments as “available-for-sale” and carry them at fair market value based upon prices for identical or similar items on the last day of the fiscal period. We record unrealized gains and losses as a separate component of comprehensive income (loss) and include net realized gains and losses in gain (loss) on investments. We use the specific identification method to determine the cost of securities sold.

We have equity investments of less than 20 percent in privately and publicly held biotechnology companies that we received as part of a technology license or partner agreement. At December 31, 2017, we held equity investments in one publicly held company, Antisense Therapeutics Limited, or ATL. Furthermore, we held cost method investments in five companies, Atlantic Pharmaceuticals Limited, Dynacure SAS, Kastle Therapeutics, Seventh Sense Biosystems and Suzhou Ribo Life Science Co., Ltd.

We account for our equity investments in publicly held companies at fair value and record unrealized gains and losses related to temporary increases and decreases in the stock as a separate component of comprehensive income (loss). We account for our equity investments in privately held companies under the cost method of accounting because we own less than 20 percent and do not have significant influence over their operations. Realization of our equity position in these private companies is usually uncertain. When realization of our investment is uncertain, we record a full valuation allowance. In determining if and when a decrease in market value below our cost in our equity positions is temporary or other-than-temporary, we examine historical trends in the stock price, the financial condition of the company, near term prospects of the company and our current need for cash. If we determine that a decline in value in either a public or private investment is other-than-temporary, we recognize an impairment loss in the period in which the other-than-temporary decline occurs.

Inventory Valuation

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 for drugs that we manufacture for our partners under contractual terms and that we use primarily in our clinical development activities and drug products. We can use each of our raw materials in multiple products and, as a result, each raw material has future economic value independent of the development status of any single drug. For example, if one of our drugs failed, we could use the raw materials for that drug to manufacture our other drugs. We expense these costs when we begin to manufacture API for a particular drug. We reflect our inventory on the balance sheet at the lower of cost or market value under the first-in, first-out method, or FIFO. We review inventory periodically and reduce the carrying value of items we consider to be slow moving or obsolete to their estimated net realizable value. We consider several factors in estimating the net realizable value, including shelf life of raw materials, alternative uses for our drugs and clinical trial materials, and historical write-offs. We did not record any inventory write-offs for the years ended December 31, 2017, 2016 or 2015. Total inventory was $10.0 million and $7.5 million as of December 31, 2017 and 2016, respectively.

Property, Plant and Equipment

We carry our property, plant and equipment at cost and depreciate it on the straight-line method over its estimated useful life, which consists of the following (in thousands):

	Estimated Useful Lives	December 31,
	(in years)	2017			2016
Computer software, laboratory, manufacturing and other equipment	3 to 10	$	66,558		$	63,287
Building, building improvements and building systems	15 to 40		92,770			48,909
Land improvements	20		2,853			2,853
Leasehold improvements	5 to 15		26,748			41,736
Furniture and fixtures	5 to 10		6,161			5,937
			195,090			162,722
Less accumulated depreciation			(87,676	)		(80,075	)
			107,414			82,647
Land			14,493			10,198
Total		$	121,907		$	92,845

We depreciate our leasehold improvements using the shorter of the estimated useful life or remaining lease term. As a result of the purchase of our primary manufacturing facility in 2017, we reclassed previously capitalized leasehold improvements to building, building improvements and building systems. Additionally, during 2017 we made additional improvements and expansions of our buildings to accommodate the growth in our business.

Fair Value of Financial Instruments

We have estimated the fair value of our financial instruments. The amounts reported for cash, accounts receivable, accounts payable and accrued expenses approximate the fair value because of their short maturities. We report our investment securities at their estimated fair value based on quoted market prices for identical or similar instruments.

Long-Lived Assets

We evaluate long-lived assets, which include property, plant and equipment and patent costs, for impairment on at least a quarterly basis and whenever events or changes in circumstances indicate that we may not be able to recover the carrying amount of such assets. We recorded charges of $0.8 million, $2.3 million and $1.9 million for the years ended December 31, 2017, 2016 and 2015, respectively, related primarily to the write-down of intangible assets.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Stock-Based Compensation Expense

We measure stock-based compensation expense for equity-classified awards, principally related to stock options, restricted stock units, or RSUs, and stock purchase rights under our ESPP based on the estimated fair value of the award on the date of grant. We recognize the value of the portion of the award that we ultimately expect to vest as stock-based compensation expense over the requisite service period in our Consolidated Statements of Operations. We reduce stock-based compensation expense for estimated forfeitures at the time of grant and revise in subsequent periods if actual forfeitures differ from those estimates.

We use the Black-Scholes model as our method of valuing option awards and stock purchase rights under our ESPP. On the grant date, we use our stock price and assumptions regarding a number of highly complex and subjective variables to determine the estimated fair value of stock-based payment awards. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. 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 our employee stock options have 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 our employee stock options. Although we determine the estimated fair value of employee stock options using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

We recognize compensation expense for option awards using the accelerated multiple-option approach. Under the accelerated multiple-option approach (also known as the graded-vesting method), we recognize 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.

The fair value of RSUs is based on the market price of our common stock on the date of grant. The RSUs we have granted vest annually over a four-year period.

See Note 4, Stockholders’ Equity, for additional information regarding our stock-based compensation plans.

Accumulated other comprehensive income (loss)

Accumulated other comprehensive income (loss) is primarily comprised of unrealized gains and losses on investments, net of taxes and adjustments we made to reclassify realized gains and losses on investments from other accumulated comprehensive income (loss) to our Consolidated Statement of Operations. The following table summarizes changes in accumulated other comprehensive income (loss) for the years ended December 31, 2017, 2016 and 2015 (in thousands):

	Years Ended December 31,
	2017			2016			2015
Beginning balance accumulated other comprehensive (loss) income	$	(30,358	)	$	(13,565	)	$	39,747
Unrealized losses on securities, net of tax (1)		(960	)		(17,219	)		(33,101	)
Amounts reclassified from accumulated other comprehensive (loss) income (2)		(374	)		447			(20,211	)
Currency translation adjustment		(67	)		(21	)		—
Net other comprehensive loss for the period		(1,401	)		(16,793	)		(53,312	)
Ending balance accumulated other comprehensive loss	$	(31,759	)	$	(30,358	)	$	(13,565	)

(1)	There was no tax expense for other comprehensive loss for the years ended December 31, 2017, 2016 or 2015.

(2)	Amounts for 2015 and 2017 are included in the separate line called “Gain on investment in Regulus Therapeutics Inc.” on our Consolidated Statement of Operations.

Convertible Debt

We account for convertible debt instruments, including our 1 percent and 2¾ percent notes that may be settled in cash upon conversion (including partial cash settlement) by separating the liability and equity components of the instruments in a manner that reflects our nonconvertible debt borrowing rate. We determine the carrying amount of the liability component by measuring the fair value of similar debt instruments that do not have the conversion feature. If no similar debt instrument exists, we estimate fair value by using assumptions that market participants would use in pricing a debt instrument, including market interest rates, credit standing, yield curves and volatilities. Determining the fair value of the debt component requires the use of accounting estimates and assumptions. These estimates and assumptions are judgmental in nature and could have a significant impact on the determination of the debt component, and the associated non-cash interest expense.

We assigned a value to the debt component of our convertible notes equal to the estimated fair value of similar debt instruments without the conversion feature, which resulted in us recording our debt at a discount. We are amortizing our debt issuance costs and debt discount over the life of the convertible notes as additional non-cash interest expense utilizing the effective interest method. For additional information, see Note 3, Long-Term Obligations and Commitments.

Segment Information

We have two operating segments, our Ionis Core segment and Akcea Therapeutics. Prior to Akcea’s IPO in July 2017, we owned 100 percent of Akcea’s stock. After Akcea’s IPO, we owned approximately 68 percent of Akcea. We did not change our reportable segments as a result of Akcea’s IPO. Akcea is a late-stage biopharmaceutical company focused on developing and commercializing drugs to treat people with serious cardiometabolic diseases caused by lipid disorders. We provide segment financial information and results for our Ionis Core segment and our Akcea Therapeutics segment based on the segregation of revenues and expenses that our chief decision maker reviews to assess operating performance and to make operating decisions. We allocate a portion of Ionis’ development, R&D support expenses and general and administrative expenses to Akcea for work we performed on behalf of Akcea.

Fair Value Measurements

We use a three-tier fair value hierarchy to prioritize the inputs used in our fair value measurements. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets, which includes our money market funds and treasury securities classified as available-for-sale securities and our investment in equity securities in publicly held biotechnology companies; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable, which includes our fixed income securities and commercial paper classified as available-for-sale securities; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring us to develop our own assumptions. We classify the majority of our securities as Level 2. We obtain the fair value of our Level 2 investments from our custodian bank or from a professional pricing service. We validate the fair value of our Level 2 investments by understanding the pricing model used by the custodian banks or professional pricing service provider and comparing that fair value to the fair value based on observable market prices. During 2017 and 2016, there were no transfers between our Level 1 and Level 2 investments. When we recognize transfers between levels of the fair value hierarchy, we recognize the transfer on the date the event or change in circumstances that caused the transfer occurs. When we recognize transfers between levels of the fair value hierarchy, we recognize the transfer on the date the event or change in circumstances that caused the transfer occurs. During 2017 and 2016 we did not have any investments that were classified as Level 3 investments.

The following tables present the major security types we held at December 31, 2017 and 2016 that are regularly measured and carried at fair value. The tables segregate each security type by the level within the fair value hierarchy of the valuation techniques we utilized to determine the respective securities’ fair value (in thousands):

	At December 31, 2017		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)
Cash equivalents (1)	$	86,262	$	86,262	$	—
Corporate debt securities (2)		647,461		—		647,461
Debt securities issued by U.S. government agencies (3)		136,325		—		136,325
Debt securities issued by the U.S. Treasury (3)		30,818		30,818		—
Debt securities issued by states of the U.S. and political subdivisions of the states (4)		93,932		—		93,932
Total	$	994,798	$	117,080	$	877,718

	At December 31, 2016		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)
Cash equivalents (1)	$	54,137	$	54,137	$	—
Corporate debt securities (3)		396,221		—		396,221
Debt securities issued by U.S. government agencies (3)		55,179		—		55,179
Debt securities issued by the U.S. Treasury (3)		29,286		29,286		—
Debt securities issued by states of the U.S. and political subdivisions of the states (5)		109,111		—		109,111
Investment in Regulus Therapeutics Inc.		2,414		2,414		—
Total	$	646,348	$	85,837	$	560,511

(1)	Included in cash and cash equivalents on our consolidated balance sheet.

(2)	$11.9 million included in cash and cash equivalents on our consolidated balance sheet, with the difference included in short-term investments on our consolidated balance sheet.

(3)	Included in short-term investments on our consolidated balance sheet.

(4)	$3.5 million included in cash and cash equivalents on our consolidated balance sheet, with the difference included in short-term investments on our consolidated balance sheet.

(5)	$9.3 million included in cash and cash equivalents on our consolidated balance sheet, with the difference included in short-term investments on our consolidated balance sheet.

Novartis Future Stock Purchase

In January 2017, we and Akcea entered into a SPA with Novartis. As part of the SPA, Novartis was required to purchase $50 million of Akcea’s common stock at the IPO price or our common stock at a premium if an IPO did not occur by April 2018. Therefore, at the inception of the SPA, we recorded a $5.0 million asset representing the fair value of the potential future premium we could have received if Novartis purchased our common stock. We determined the fair value of the future premium by calculating the value based on the stated premium in the SPA and estimating the probability of an Akcea IPO. We also included a lack of marketability discount when we determined the fair value of the premium because we would have issued unregistered shares to Novartis if they had purchased our common stock. We measured this asset using Level 3 inputs and recorded it in other assets on our consolidated balance sheet. Because Akcea completed its IPO before April 2018, Novartis will not purchase additional shares of Ionis stock. Therefore, this asset no longer had any value and we wrote-off the remaining balance to other expenses on our third quarter 2017 consolidated statement of operations.

The following is a reconciliation of the potential premium we would have received if Akcea had not completed its IPO, measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for 2017 (in thousands):

	Year Ended December 31, 2017
Beginning balance of Level 3 instruments	$	—
Value of the potential premium we will receive from Novartis at inception of the SPA (January 2017)		5,035
Write-off of premium to other expenses		(5,035	)
Ending balance of Level 3 instruments	$	—

Income Taxes

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act of 2017, or the Tax Act. The Tax Act makes broad and complex changes to the U.S. tax code. The changes include, but are not limited to, reducing the U.S. federal corporate tax rate from 35 percent to 21 percent, imposing a mandatory one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, introducing bonus depreciation that will allow for full expensing of qualified property, eliminating the corporate alternative minimum tax, or AMT, and changing how existing AMT credits can be realized, and modifying or repealing many business tax deductions and credits.

The SEC staff issued guidance to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act.

We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses and research and development credit carryforwards. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.

We apply the authoritative accounting guidance prescribing a threshold and measurement attribute for the financial recognition and measurement of a tax position taken or expected to be taken in a tax return. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation settlement. The second step is to estimate and measure the tax benefit as the largest amount that is more than 50 percent likely to be realized upon ultimate settlement.

We recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within other long-term liabilities in the consolidated balance sheets.

We are required to use significant judgment in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves for changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences may impact the provision for income taxes in the period in which such determination is made.

We are also required to use significant judgment in determining any valuation allowance recorded against our deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including scheduled reversal of deferred tax liabilities, past operating results, the feasibility of tax planning strategies and estimates of future taxable income. Estimates of future taxable income are based on assumptions that are consistent with our plans. The assumptions we use represent our best estimates and involve inherent uncertainties and the application of our judgment. Should actual amounts differ from our estimates, the amount of our tax expense and liabilities we recognize could be materially impacted.

We record a valuation allowance to reduce the balance of our net deferred tax assets to the amount we believe is more-likely-than-not to be realized. We have incurred historical financial statement losses and as a result we had a full valuation allowance recorded against our net deferred tax assets for each of the years in these financial statements. We regularly assess the future realization of our net deferred tax assets and will reduce the valuation allowance in any such period in which we determine that all, or a portion, of our deferred tax assets are more-likely-than-not to be realized.

We do not provide for a U.S. income tax liability and foreign withholding taxes on undistributed foreign earnings of our foreign subsidiaries.

Impact of Recently Issued Accounting Standards

In May 2014, the FASB issued accounting guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers control of promised goods or services to customers in an amount that reflects what the entity expects to receive in exchange for the goods or services. Further an entity will recognize revenue upon satisfying the performance obligation(s) under the related contract. Our performance obligation under our collaboration agreements is typically the research and development activities associated with the delivery of a drug candidate or drug to our partner. Under the current accounting guidance, we recognize revenue from milestone payments we earn under the milestone method from our collaboration agreements. Under the new guidance, the milestone method of revenue recognition is eliminated. Specifically, certain R&D milestone payments we previously recognized in full when we achieved a milestone will now be recognized over a period of time. If we achieve an R&D milestone payment related to activities we are performing under a collaboration agreement, we will recognize the associated revenue from the milestone payment over our estimated performance obligation period. For example, in 2017, we initiated a Phase 1/2a clinical study of IONIS-MAPT_Rx in patients with mild Alzheimer's disease. We earned a $10 million milestone payment from Biogen related to the initiation of this study. In 2017, we recognized the entire $10 million as revenue. Under the new standard, we will recognize this milestone payment over the period we are providing R&D services for Biogen. For milestones achieved for which we do not have a continuing performance obligation, we will continue to recognize the milestone payment in its entirety as revenue in the period in which our partner achieves the milestone. For example, in 2017, we earned a $50 million milestone payment from Biogen for the EU approval of SPINRAZA. Under both the new and old standard, we account for this milestone payment the same by recognizing the entire amount upon achievement of the event. This guidance does not change our recognition of commercial revenue from SPINRAZA royalties. We adopted this guidance on January 1, 2018 under the full retrospective approach, which requires us to recast our prior period amounts in the period of adoption.

Our adoption of the standard in 2018 will result in the recognition of additional revenue of approximately $17 million and approximately $27 million for 2017 and 2016, respectively. In addition, our adoption of the standard will result in an increase in our deferred revenue balance of approximately $39 million at December 31, 2017 and a corresponding adjustment to our accumulated deficit for the same amount. Since our collaboration revenue has no associated cost of sales, the impact to our net loss (income) is equal to our revenue adjustment for each period. Additionally, as a result of adopting this new guidance there is no impact to our income tax expense because we have a full valuation allowance. This new guidance also requires additional disclosures about the attributes of our revenue and balances associated with our contracts, which we will include in our first quarter of 2018 financial statements.

In January 2016, the FASB issued amended accounting guidance related to the recognition, measurement, presentation, and disclosure of certain financial instruments. The amended guidance requires us to measure and record equity investments, except those accounted for under the equity method of accounting that have a readily determinable fair value, at fair value and for us to recognize the changes in fair value in our net income (loss), instead of recognizing unrealized gains and losses through accumulated other comprehensive income, as we currently do under the existing guidance. The amended guidance also changes several disclosure requirements for financial instruments, including the methods and significant assumptions we use to estimate fair value. The guidance is effective for fiscal years, and interim periods within that year, beginning after December 15, 2017. We adopted this guidance on January 1, 2018. The adoption of this guidance did not have an impact on our financial results.

In February 2016, the FASB issued amended accounting guidance related to lease accounting, which will require us to record all leases with a term longer than one year on our balance sheet. When we record leases on our balance sheet under the new guidance, we will record a liability with a value equal to the present value of payments we will make over the life of the lease and an asset representing the underlying leased asset. The new accounting guidance requires us to determine if our leases are operating or financing leases. We will record expense for operating type leases on a straight-line basis as an operating expense. If we determine a lease is a financing lease, we will record both interest and amortization expense and generally the expense will be higher in the earlier periods of the lease. The new lease standard is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. We must adopt the new standard on a modified retrospective basis, which requires us to reflect our leases on our consolidated balance sheet for the earliest comparative period presented. We plan to adopt this guidance on January 1, 2019. We are currently assessing the effects the new guidance will have on our consolidated financial statements and disclosures.

In June 2016, the FASB issued guidance that changes the measurement of credit losses for most financial assets and certain other instruments. If we have credit losses, this updated guidance requires us to record allowances for these instruments under a new expected credit loss model. This model requires us to estimate the expected credit loss of an instrument over its lifetime, which represents the portion of the amortized cost basis we do not expect to collect. This change will result in us remeasuring our allowance in each reporting period we have credit losses. The new standard is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for periods beginning after December 15, 2018. When we adopt the new standard, we will make any adjustments to beginning balances through a cumulative-effect adjustment to accumulated deficit on that date. We are currently assessing the timing of adoption as well as the effects it will have on our consolidated financial statements and disclosures.

In May 2017, the FASB issued clarifying guidance related to the accounting for modifications of stock-based payment awards. The new guidance is meant to clarify when modification accounting is required. We early adopted this guidance in our financial statements for the quarter ended June 30, 2017 and it did not have an effect on our consolidated financial statements and disclosures.