2. Significant Accounting Policies

Revenue Recognition

Adoption of New Revenue Recognition Accounting Standard (Topic 606)

In May 2014, the FASB issued accounting guidance on the recognition of revenue from customers. This guidance supersedes the revenue recognition requirements we previously followed in Accounting Standards Codification, or ASC, Topic 605, Revenue Recognition, or Topic 605, and created a new Topic 606, Revenue from Contracts with Customers, or Topic 606. Under Topic 606, 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. We adopted Topic 606 on January 1, 2018 under the full retrospective approach, which required us to revise our prior period revenue. Under Topic 606, we were required to review all of our ongoing collaboration agreements in which we recognized revenue after January 1, 2016. We were required to assess what our revenue would have been for the period from January 1, 2016 to December 31, 2017 under Topic 606. As a result of this analysis, we determined that the cumulative revenue we would have recognized under Topic 606 decreased by $53.6 million. We recorded this amount as a cumulative adjustment to our accumulated deficit as of December 31, 2017. We have labeled our prior period financial statements “as revised” to indicate the change required under the accounting rules.

The following tables summarize the adjustments we were required to make to amounts we originally reported in 2017 to adopt Topic 606 (in thousands, except per share amounts):

Condensed Consolidated Balance Sheet

	At December 31, 2017
	As Previously Reported under Topic 605			Topic 606 Adjustment			As Revised
Current portion of deferred revenue	$	106,465		$	18,871		$	125,336
Long-term portion of deferred revenue	$	72,708		$	35,318		$	108,026
Accumulated deficit	$	(1,187,398	)	$	(53,636	)	$	(1,241,034	)
Noncontrolling interest in Akcea Therapeutics, Inc.	$	87,847		$	(3,580	)	$	84,267
Total stockholders’ equity	$	418,719		$	(53,439	)	$	365,280

Condensed Consolidated Statement of Operations

	Three Months Ended September 30, 2017
	As Previously Reported under Topic 605			Topic 606 Adjustment			As Revised
Revenue:
Commercial revenue:
SPINRAZA royalties	$	32,890		$	—		$	32,890
Licensing and other royalty revenue		879			848			1,727
Total commercial revenue		33,769			848			34,617
Research and development revenue under collaborative agreements		87,142			(3,445	)		83,697
Total revenue	$	120,911		$	(2,597	)	$	118,314
Income (loss) from operations	$	13,909		$	(2,597	)	$	11,312
Net income (loss)	$	(4,896	)	$	(2,597	)	$	(7,493	)
Net income (loss) attributable to Ionis Pharmaceuticals, Inc. common stockholders	$	(976	)	$	(1,635	)	$	(2,611	)
Net income (loss) per share, basic and diluted	$	0.00		$	(0.02	)	$	(0.02	)

	Nine Months Ended September 30, 2017
	As Previously Reported under Topic 605			Topic 606 Adjustment		As Revised
Revenue:
Commercial revenue:
SPINRAZA royalties	$	60,467		$	—	$	60,467
Licensing and other royalty revenue		4,983			656		5,639
Total commercial revenue		65,450			656		66,106
Research and development revenue under collaborative agreements		269,917			10,364		280,281
Total revenue	$	335,367		$	11,020	$	346,387
Income from operations	$	26,227		$	11,020	$	37,247
Net income (loss)	$	(12,636	)	$	11,020	$	(1,616	)
Net income (loss) attributable to Ionis Pharmaceuticals, Inc. common stockholders	$	(8,716	)	$	11,982	$	3,266
Net income (loss) per share, basic	$	0.02		$	0.11	$	0.13
Net income (loss) per share, diluted	$	0.02		$	0.11	$	0.13

Condensed Consolidated Statement of Cash Flows

	Nine Months Ended September 30, 2017
	As Previously Reported under Topic 605			Topic 606 Adjustment			As Revised
Net income (loss)	$	(12,636	)	$	11,020		$	(1,616	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Deferred contract revenue	$	42,091		$	(11,020	)	$	31,071
Cash and cash equivalents at beginning of period	$	84,685		$	—		$	84,685
Cash and cash equivalents at end of period	$	159,184		$	—		$	159,184

Under Topic 606, compared to Topic 605, our revenue decreased $2.6 million for the three months ended September 30, 2017, and increased $11.0 million for the nine months ended September 30, 2017. The change in our revenue was primarily due to:

●

A change in how we recognize milestone payments: Topic 606 requires us to amortize more of the milestone payments we achieve, rather than recognizing the milestone payments in full in the period in which we achieved the milestone event as we did under Topic 605. This change resulted in an increase of $0.5 million and $27.9 million for the three and nine months ended September 30, 2017, respectively.

●

A change in how we calculate revenue for payments we are recognizing into revenue over time: Under Topic 605, we amortized payments into revenue evenly over the period of our obligations. When we made a change to our estimated completion period, we recognized that change on a prospective basis. Under Topic 606, we are required to use an input method to determine the amount we amortize each reporting period. Each period, we review our “inputs” such as our level of effort expended, including the time we estimate it will take us to complete the activities, or costs incurred relative to the total expected inputs to satisfy the performance obligation. For certain collaborations, such as Bayer, Janssen and Novartis, the input method resulted in a change to the revenue we had previously recognized using a straight-line amortization method. This change resulted in a decrease of $4.0 million and $17.5 million for the three and nine months ended September 30, 2017, respectively.

Our updated revenue recognition policy reflecting Topic 606 is as follows:

Our Revenue Sources

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 condensed consolidated balance sheet.

Commercial Revenue: SPINRAZA royalties and Licensing and other royalty revenue

We earn commercial revenue primarily in the form of royalty payments on net sales of SPINRAZA. We expect to add product sales from TEGSEDI to our commercial revenue in the fourth quarter of 2018 as a result of TEGSEDI’s approval in the U.S., EU and Canada. We will also recognize as commercial revenue future sales milestone payments and royalties we earn under our partnerships.

Research and development revenue under collaborative agreements

We often enter into collaboration agreements to license and sell our technology on an exclusive or non-exclusive basis. Our collaboration agreements typically contain multiple elements, or performance obligations, including technology licenses or options to obtain technology licenses, research and development, or R&D, services, and manufacturing services.

Our collaboration agreements are detailed in Note 6, Collaborative Arrangements and Licensing Agreements. Under each collaboration note we discuss our specific revenue recognition conclusions, including our significant performance obligations under each collaboration.

Steps to Recognize Revenue

We use a five step process to determine the amount of revenue we should recognize and when we should recognize it. The five step process is as follows:

Identify the contract

Accounting rules require us to first determine if we have a contract with our partner, including confirming that we have met each of the following criteria:

●

We and our partner approved the contract and we are both committed to perform our obligations;

●

We have identified our rights, our partner’s rights and the payment terms;

●

We have concluded that the contract has commercial substance, meaning that the risk, timing, or amount of our future cash flows is expected to change as a result of the contract; and

●

We believe collectability is probable.

Identify the performance obligations

We next identify the distinct goods and services we are required to provide under the contract. Accounting rules refer to these as our performance obligations. We typically have only one performance obligation at the inception of a contract, which is to perform R&D services.

Often times when we enter into a collaboration agreement in which we provide our partner with an option to license a drug in the future. We may also provide our partner with an option to request that we provide additional goods or services in the future, such as active pharmaceutical ingredient, or API. We evaluate whether these options are material rights at the inception of the agreement. If we determine an option is a material right, we will consider the option a separate performance obligation. Historically, we have concluded that the options we grant to license a drug in the future or to provide additional goods and services as requested by our partner are not material rights. These items are contingent upon future events that may not occur. When a partner exercises its option to license a drug or requests additional goods or services, then we identify a new performance obligation for that item.

In some cases, we deliver a license at the start of an agreement. If we determine that our partner has full use of the license and we do not have any additional performance obligations related to the license after delivery, then we consider the license to be a separate performance obligation.

Determine the transaction price

We then determine the transaction price by reviewing the amount of consideration we are eligible to earn under the collaboration agreement, including any variable consideration. Under our collaboration agreements, consideration typically includes fixed consideration in the form of an upfront payment and variable consideration in the form of potential milestone payments, license fees and royalties. At the start of an agreement, our transaction price usually consists of only the upfront payment. We do not typically include any payments we may receive in the future in our initial transaction price because the payments are not probable. We reassess the total transaction price at each reporting period to determine if we should include additional payments in the transaction price.

Milestone payments are our most common type of variable consideration. We recognize milestone payments using the most likely amount method because we will either receive the milestone payment or we will not, which makes the potential milestone payment a binary event. The most likely amount method requires us to determine the likelihood of earning the milestone payment. We include a milestone payment in the transaction price once it is probable we will achieve the milestone event. Most often, we do not consider our milestone payments probable until we or our partner achieve the milestone event because the majority of our milestone payments are contingent upon events that are not within our control.

Allocate the transaction price

Next, we allocate the transaction price to each of our performance obligations. When we have to allocate the transaction price to more than one performance obligation, we make estimates of the relative stand-alone selling price of each performance obligation because we do not typically sell our goods or services on a stand-alone basis. We then allocate the transaction price to each performance obligation based on the relative stand-alone selling price.

We may engage a third party, independent valuation specialist to assist us with determining a stand-alone selling price for collaborations in which we deliver a license at the start of an agreement. We estimate the stand-alone selling price of these licenses using valuation methodologies, such as the relief from royalty method. Under this method, we estimate the amount of income, net of taxes, for the license. We then discount the projected income to present value. The significant inputs we use to determine the projected income of a license could include:

●

Estimated future product sales;

●

Estimated royalties on future product sales;

●

Contractual milestone payments;

●

Expenses we expect to incur;

●

Income taxes; and

●

A discount rate.

We typically estimate the selling price of R&D services by using our internal estimates of the cost to perform the specific services. The significant inputs we use to determine the selling price of our R&D services include:

●

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

●

The estimated cost of work we will perform;

●

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

●

The estimated cost of API we will use.

For purposes of determining the stand-alone selling price of the R&D services we perform and the API we will deliver, accounting guidance requires us to include a markup for a reasonable profit margin.

We do not reallocate the transaction price after the start of an agreement to reflect subsequent changes in stand-alone selling prices.

Recognize revenue

We recognize revenue in one of two ways, over time or at a point in time. We recognize revenue over time when we are executing on our performance obligation over time and our partner receives benefit over time. For example, we recognize revenue over time when we provide R&D services. We recognize revenue at a point in time when our partner receives full use of an item at a specific point in time. For example, we recognize revenue at a point in time when we deliver a license or API to a partner.

For R&D services that we recognize over time, we measure our progress using an input method. The input methods we use are based on the effort we expend or costs we incur toward the satisfaction of our performance obligation. We estimate the amount of effort we expend, including the time we estimate it will take us to complete the activities, or costs we incur in a given period, relative to the estimated total effort or costs to satisfy the performance obligation. This results in a percentage that we multiply by the transaction price to determine the amount of revenue we recognize each period. This approach requires us to make numerous estimates and use significant judgement. If our estimates or judgements change over the course of the collaboration, they may affect the timing and amount of revenue that we recognize in the current and future periods.

The following are examples of when we typically recognize revenue based on the types of payments we receive.

Commercial Revenue: SPINRAZA royalties and Licensing and other royalty revenue

We recognize royalty revenue in the period in which the counterparty sells the related product, which in certain cases may require us to estimate our royalty revenue. We recognize royalties from SPINRAZA sales in the period Biogen records the sale of SPINRAZA. Our accounting for SPINRAZA royalties did not change as a result of adopting Topic 606.

Research and development revenue under collaboration agreements:

Upfront Payments

When we enter into a collaboration agreement with an upfront payment, we typically record the entire upfront payment as deferred revenue if our only performance obligation is for R&D services we will provide in the future. We amortize the upfront payment into revenue as we perform the R&D services. For example, under our new SMA collaboration with Biogen, we received a $25 million upfront payment in December 2017. We allocated the upfront payment to our single performance obligation, R&D services. We are amortizing the $25 million upfront payment using an input method over the estimated period of time we are providing R&D services. Refer to Note 6, Collaborative Arrangements and Licensing Agreements, for further discussion. Under Topic 605, we amortized upfront payments evenly over the period of our obligation.

Milestone Payments

We typically include milestone payments for R&D services in the transaction price when they are achieved. We include these milestone payments when they are achieved because there is considerable uncertainty in the research and development processes that trigger these payments under our collaboration agreements. Similarly, we include approval milestone payments in the transaction price once the drug is approved by the applicable regulator. We will recognize sales based milestone payments in the period we achieve the milestone under the sales-based royalty exception allowed under accounting rules.

We recognize milestone payments that relate to an ongoing performance obligation over our period of performance. For example, in the third quarter of 2017, we initiated a Phase 1/2a clinical study of IONIS-MAPT_Rxin patients with mild Alzheimer’s disease. We earned a $10 million milestone payment from Biogen related to the initiation of this study. Under Topic 606, we allocated this payment to our R&D services performance obligation. We are recognizing revenue from this milestone payment over our estimated period of performance. Under Topic 605, this milestone payment was recognized in full in the third quarter of 2017, which was the period in which we achieved the milestone event.

Conversely, we recognize in full those milestone payments that we earn based on our partners’ activities when our partner achieves the milestone event. For example, in the third quarter of 2018, we earned a $10 million milestone payment when AstraZeneca initiated a Phase 1 study of IONIS-AZ4-2.5-L_Rx. Our revenue recognition of milestone payments we earn based on our partners’ activities did not change as a result of adopting Topic 606.

License Fees

We generally recognize as revenue the total amount we determine to be the stand-alone selling price of a license when we deliver the license to our partner. This is because our partner has full use of the license and we do not have any additional performance obligations related to the license after delivery. For example, in the third quarter of 2018, we earned a $12 million license fee when our majority-owned affiliate, Akcea, entered into an exclusive license agreement with PTC Therapeutics to commercialize TEGSEDI and WAYLIVRA in Latin America. Our recognition of license fees did not change as a result of adopting Topic 606.

Amendments to Agreements

From time to time we amend our collaboration agreements. When this occurs, we are required to assess the following items to determine the accounting for the amendment:

If the additional goods and/or services are distinct from the other performance obligations in the original agreement; and

If the goods and/or services are at a stand-alone selling price.

If we conclude the goods and/or services in the amendment are distinct from the performance obligations in the original agreement and at a stand-alone selling price, we account for the amendment as a separate agreement. If we conclude the goods and/or services are not distinct and at their standalone selling price, we then assess whether the remaining goods or services are distinct from those already provided. If the goods and/or services are distinct from what we have already provided, then we allocate the remaining transaction price from the original agreement and the additional transaction price from the amendment to the remaining goods and/or services. If the goods and/or services are not distinct from what we have already provided, we update the transaction price for our single performance obligation and recognize any change in our estimated revenue as a cumulative adjustment.

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 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, we concluded we had a new agreement with three performance obligations. These performance obligations were to deliver the license of IONIS-FXI-L_Rx, to provide R&D services and to deliver API. We allocated the $75 million transaction price to these performance obligations. Refer to Note 6, Collaborative Arrangements and Licensing Agreements, for further discussion of our accounting treatment for our Bayer collaboration. Our allocation of the consideration we received for the Bayer amendment did not change as a result of adopting Topic 606. However, the method in which we are recognizing revenue related to our R&D services performance obligation did change. We are amortizing revenue related to our R&D services performance obligation using the input method under Topic 606.

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 we should account for them individually as distinct arrangements or whether the separate agreements should be combined and accounted for together. We evaluate the following to determine the accounting for the agreements:

●

Whether the agreements were negotiated together with a single objective;

●

Whether the amount of consideration in one contract depends on the price or performance of the other agreement; or

●

Whether the goods and/or services promised under the agreements are a single performance obligation.

Our evaluation involves significant judgment to determine whether a group of agreements might be so closely related that accounting guidance requires us to account for them as a combined arrangement.

For example, in the second quarter of 2018, we entered into two separate agreements with Biogen at the same time: a new strategic neurology collaboration agreement and a stock purchase agreement, or SPA. We evaluated the Biogen agreements to determine whether we should treat the agreements separately or combine them. We considered that the agreements were negotiated concurrently and in contemplation of one another. Based on these facts and circumstances, we concluded that we should 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 2018 strategic neurology collaboration with Biogen.

Contracts Receivable

Our contracts receivable balance represents the amounts we have billed our partners for goods we have delivered or services we have performed that are due to us unconditionally. When we bill our partners with payment terms based on the passage of time, we consider the contract receivable to be unconditional. We typically receive payment within one quarter of billing our partner. Our contracts receivable balance as of December 31, 2017 did not change when we adopted Topic 606.

Unbilled SPINRAZA Royalties

Our unbilled SPINRAZA royalties represent our right to receive consideration from Biogen in advance of when we are eligible to bill Biogen for SPINRAZA royalties. We include these unbilled amounts in other current assets on our condensed consolidated balance sheet. Our unbilled SPINRAZA royalties as of December 31, 2017 did not change when we adopted Topic 606.

Deferred Revenue

We are often entitled to bill our customers and receive payment from our customers in advance of our obligation to provide services or transfer goods to our partners. In these instances, we include the amounts in deferred revenue on our condensed consolidated balance sheet. During the three and nine months ended September 30, 2018, we recognized $37.2 million and $80.4 million of revenue from amounts that were in our beginning deferred revenue balances for those periods, respectively. During the three and nine months ended September 30, 2017, we recognized $31.6 million and $84.4 million of revenue from amounts that were in our beginning deferred revenue balances for those periods, respectively. Refer to our revenue recognition policy above detailing how we recognize revenue for further discussion.

The following table summarizes the adjustments we were required to make to our deferred revenue amounts to adopt Topic 606 (in thousands):

	At December 31, 2017
	As Previously Reported under Topic 605			Topic 606 Adjustment			As Revised
Current portion of deferred revenue		$	106,465		$	18,871		$	125,336
Long-term portion of deferred revenue			72,708			35,318			108,026
Total deferred revenue		$	179,173		$	54,189		$	233,362

Our deferred revenue balance increased $54.2 million at December 31, 2017 under Topic 606, compared to Topic 605. The increase was primarily related to the change in the accounting for certain milestone payments and the way in which we amortize payments. Under Topic 605, we previously recognized the majority of the milestone payments we earned in the period we achieved the milestone event, which did not impact our deferred revenue balance. Under Topic 606 we are now amortizing more milestone payments over the period of our performance obligation, which adds to our deferred revenue balance. Additionally, under Topic 605 we amortized payments evenly over the period of our obligation. Under Topic 606, we are required to use an input method to determine the amount we amortize each reporting period. The increase in deferred revenue relates to agreements with the following partners:

●

$24.2 million from Biogen;

●

$15.9 million from AstraZeneca;

●

$11.8 from Novartis; and

●

$2.3 million from other partners.

Noncontrolling Interest in Akcea Therapeutics, Inc.

Prior to Akcea’s IPO in July 2017, we owned 100 percent of Akcea. From the closing of Akcea’s IPO in July 2017 through mid-April 2018, we owned approximately 68 percent of Akcea. In the second and third quarters of 2018, we received additional shares of Akcea’s stock related to our license of TEGSEDI and AKCEA-TTR-L_Rx to Akcea, increasing our ownership percentage to approximately 75 percent. We reflected this increase in our ownership percentage in these financial statements as an adjustment to noncontrolling interest. In October 2018, we received an additional 1.7 million shares of Akcea’s stock when TEGSEDI received marketing authorization in the U.S., increasing our ownership to approximately 76 percent. 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. We reflect the noncontrolling interest attributable to other owners of Akcea’s common stock in a separate line on the statement of operations and a separate line within stockholders’ equity in our condensed consolidated balance sheet. In addition, we record a noncontrolling interest adjustment to account for the stock options Akcea grants, which if exercised, will dilute our ownership in Akcea. This adjustment is 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.

Cash, cash equivalents and 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 debt investments as “available-for-sale” and carry them at fair market value based upon prices on the last day of the fiscal period for identical or similar items. We record unrealized gains and losses on debt securities 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 also have equity investments of less than 20 percent ownership in publicly and privately held biotechnology companies that we received as part of a technology license or partner agreement. At September 30, 2018, we held an equity investment in one publicly held company, Antisense Therapeutics Limited, or ATL. We also held equity investments in four privately-held companies, Atlantic Pharmaceuticals Limited, Dynacure SAS, Seventh Sense Biosystems and Suzhou Ribo Life Science Co, Ltd.

In January 2018, we adopted the amended accounting guidance related to the recognition, measurement, presentation, and disclosure of certain financial instruments. The amended guidance requires us to measure and record our equity investments at fair value. Additionally, the amended accounting guidance requires us to recognize the changes in fair value in our consolidated statement of operations, instead of through accumulated other comprehensive income. Prior to 2018, we accounted for our equity investments in privately held companies under the cost method of accounting. Under the amended guidance we account for our equity investments in privately held companies at their cost minus impairments, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. Our adoption of this guidance did not have an impact on our results.

Inventory valuation

We reflect our inventory on our consolidated balance sheet at the lower of cost or market value under the first-in, first-out method, or FIFO. 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 as R&D expenses when we begin to manufacture API for a particular drug if the drug has not been approved for marketing by a regulatory agency.

We obtained the first regulatory approval for TEGSEDI in July 2018. At September 30, 2018 and December 31, 2017, our physical inventory for TEGSEDI included API that we produced prior to when we obtained regulatory approval and accordingly has no cost basis as we had previously expensed the costs as R&D expenses.

We review our inventory periodically and reduce the carrying value of items we consider to be slow moving or obsolete to their estimated net realizable value based on forecasted demand compared to quantities on hand. We consider several factors in estimating the net realizable value, including shelf life of our inventory, alternative uses for our drugs and historical write-offs. We did not record any inventory write-offs for the nine months ended September 30, 2018 and 2017.

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 condensed consolidated balance sheet and we expense them as the services are provided.

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. We review our capitalized patent costs regularly to ensure that they include costs for patents and patent applications that have future value. We evaluate patents and patent applications that we are not actively pursuing and write off any associated costs.

Long-lived assets

We evaluate long-lived assets, which include property, plant and equipment and patent costs acquired from third parties, 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.

Use of estimates

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

Basic and diluted net income (loss) per share

Basic net income (loss) per share

We compute basic net income (loss) per share by dividing the total 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 the three and nine months ended September 30, 2018 and 2017 considered our net income for Ionis on a stand-alone basis plus our share of Akcea’s net loss for the period. 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 period. As a result of this calculation, our total net income (loss) available to Ionis common stockholders for the calculation of net income (loss) per share is different than net income (loss) attributable to Ionis Pharmaceuticals, Inc. common stockholders in the condensed consolidated statements of operations.

Our basic net loss per share for the three months ended September 30, 2018, was calculated as follows (in thousands, except per share amounts):

Three months ended September 30, 2018	Weighted Average Shares Owned in Akcea		Akcea’s Net Income (Loss) Per Share			Ionis’ Portion of Akcea’s Net Loss

Common shares		65,538	$	(0.73	)	$	(47,843	)
Akcea’s net loss attributable to our ownership						$	(47,843	)
Ionis’ stand-alone net income							43,226
Net loss available to Ionis common stockholders						$	(4,616	)
Weighted average shares outstanding							143,314
Basic net loss per share						$	(0.03	)

Akcea’s net loss per share calculation for the nine months ended September 30, 2018 included two components: (1) Akcea’s net loss from its statement of operations and (2) deemed distributions related to the license of TEGSEDI in the second quarter of 2018. Because we own more than 50 percent of Akcea, we and Akcea are under common control. As such, Akcea accounted for the TEGSEDI transaction using common control guidance. Accordingly, Akcea recorded the license we granted to them at carrying value. In addition, Akcea recorded the consideration it paid to us in excess of the carrying value as a deemed distribution. Accounting rules required Akcea to include these deemed distributions in their net loss per share calculation as if Akcea had paid us a dividend.

Our basic net loss per share for the nine months ended September 30, 2018, was calculated as follows (in thousands, except per share amounts):

Nine months ended September 30, 2018	Weighted Average Shares Owned in Akcea		Akcea’s Net Loss Per Share			Ionis’ Portion of Akcea’s Net Loss

Common shares		57,347	$	(1.93	)	$	(110,680	)
Akcea’s net loss attributable to our ownership						$	(110,680	)
Ionis’ stand-alone net income							67,517
Net income available to Ionis common stockholders						$	(43,162	)
Weighted average shares outstanding							132,518
Basic net loss per share						$	(0.33	)

Prior to Akcea’s IPO in July 2017, 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 the IPO was not a liquidation event or a change in control. During the three and nine months ended September 30, 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 periods. 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 that we owned in our calculation of basic and diluted net income (loss) per share for three and nine months ended September 30, 2017.

Our basic net income per share for the three months ended September 30, 2017, was calculated as follows (in thousands, except per share amounts):

Three months ended September 30, 2017	Weighted Average Shares Owned in Akcea		Akcea’s Net Loss Per Share			Ionis’ Portion of Akcea’s Net Loss

Common shares		36,556	$	(0.33	)	$	(12,063	)
Preferred shares		5,651		(0.01	)		(57	)
Akcea’s net loss attributable to our ownership						$	(12,120	)
Ionis’ stand-alone net income							10,144
Net loss available to Ionis common stockholders						$	(1,976	)
Weighted average shares outstanding							124,370
Basic net income per share						$	(0.02	)

Our basic net income per share for the nine months ended September 30, 2017, was calculated as follows (in thousands, except per share amounts):

Nine months ended September 30, 2017	Weighted Average Shares Owned in Akcea		Akcea’s Net Loss Per Share			Ionis’ Portion of Akcea’s Net Loss

Common shares		12,319	$	(3.12	)	$	(38,435	)
Preferred shares		21,055		(2.16	)		(45,479	)
Akcea’s net loss attributable to our ownership						$	(83,914	)
Ionis’ stand-alone net income							100,235
Net income available to Ionis common stockholders						$	16,321
Weighted average shares outstanding							123,746
Basic net income per share						$	0.13

Dilutive net income (loss per share)

For the three and nine months ended September 30, 2018 and for the three months ended September 30, 2017, we incurred a net loss; therefore, 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:

●

1 percent convertible senior notes;

●

2¾ percent convertible senior notes;

●

Dilutive stock options;

●

Unvested restricted stock units; and

●

Employee Stock Purchase Plan, or ESPP.

For the nine months ended September 30, 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 the nine months ended September 30, 2017 consisted of the following (in thousands except per share amounts):

Nine months ended September 30, 2017	Income (Numerator)		Shares (Denominator)		Per-Share Amount

Net income available to Ionis common stockholders	$	16,321		123,746	$	0.13
Effect of dilutive securities:
Shares issuable upon exercise of stock options		—		1,658
Shares issuable upon restricted stock award issuance		—		430
Shares issuable related to our ESPP		—		24
Income available to Ionis common stockholders, plus assumed conversions	$	16,321		125,858	$	0.13

For the nine months ended September 30, 2017, the calculation excluded the 1 percent and 2¾ percent notes because the effect on diluted earnings per share was anti-dilutive.

Accumulated other comprehensive loss

We include unrealized gains and losses on investments, net of taxes, in accumulated other comprehensive income (loss) along with adjustments we make to reclassify realized gains and losses on investments from other accumulated comprehensive income (loss) to our condensed consolidated statement of operations. The following table summarizes changes in accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2018 and 2017 (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Beginning balance accumulated other comprehensive loss	$	(32,637	)	$	(30,372	)	$	(31,759	)	$	(30,358	)
Unrealized gains (losses) on securities (1)		133			215			(834	)		610
Amounts reclassified from accumulated other comprehensive loss		—			—			—			(374	)
Currency translation adjustment		(28	)		(42	)		61			(77	)
Net current period other comprehensive income (loss)		105			173			(773	)		159
Ending balance accumulated other comprehensive loss	$	(32,532	)	$	(30,199	)	$	(32,532	)	$	(30,199	)

(1)

There was no income tax expense or benefit related to elements of other comprehensive income (loss) for the three and nine months ended September 30, 2018 and 2017.

Convertible debt

We account for convertible debt instruments 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. To determine the fair value of the debt component we are required to use 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.

Segment information

We have two operating segments, our Ionis Core segment and Akcea Therapeutics, our majority owned affiliate. Akcea is a biopharmaceutical company focused on developing and commercializing drugs to treat patients with rare and serious diseases. 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 and general and administrative expenses to Akcea for work Ionis performs on behalf of Akcea.

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 condensed 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 to estimate the fair value of stock options granted and stock purchase rights under our ESPP. The expected term of stock options granted represents the period of time that we expect them to be outstanding. We estimate the expected term of options granted based on historical exercise patterns. For the nine months ended September 30, 2018 and 2017, we used the following weighted-average assumptions in our Black-Scholes calculations:

Employee Stock Options:

	Nine Months Ended September 30,
	2018		2017
Risk-free interest rate		2.3%		1.8%
Dividend yield		0.0%		0.0%
Volatility		63.1%		66.1%
Expected life		4.6 years		4.5 years

Board of Director Stock Options:

	Nine Months Ended September 30,
	2018		2017
Risk-free interest rate		2.8 %		2.2 %
Dividend yield		0.0 %		0.0 %
Volatility		61.5 %		61.2 %
Expected life		6.6 years		6.6 years

ESPP:

	Nine Months Ended September 30,
	2018		2017
Risk-free interest rate		1.8%		0.8%
Dividend yield		0.0%		0.0%
Volatility		47.3%		59.9%
Expected life		6 months		6 months

The fair value of RSUs is based on the market price of our common stock on the date of grant. RSUs vest annually over a four-year period. The weighted-average grant date fair value of RSUs granted to employees and members of our board of directors for the nine months ended September 30, 2018 was $51.83 and $42.88 per share, respectively.

The following table summarizes stock-based compensation expense for the three and nine months ended September 30, 2018 and 2017 (in thousands). Our consolidated non-cash stock-based compensation expense includes $12.7 million and $4.7 million of stock-based compensation expense for Akcea for the three months ended September 30, 2018 and 2017, respectively, and $31.2 million and $11.8 million for the nine months ended September 30, 2018 and 2017, respectively.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Research, development and patent		$	18,780		$	16,181		$	57,698		$	48,443
Selling, general and administrative			16,103			5,291			39,512			15,199
Total non-cash stock-based compensation expense		$	34,883		$	21,472		$	97,210		$	63,642

As of September 30, 2018, total unrecognized estimated non-cash stock-based compensation expense related to non-vested stock options and RSUs was $139.5 million and $32.6 million, respectively. We will adjust total unrecognized compensation cost for future forfeitures. We expect to recognize the cost of non-cash stock-based compensation expense related to non-vested stock options and RSUs over a weighted average amortization period of 1.3 years and 1.6 years, respectively.

Impact of recently issued accounting standards

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 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 will adopt this guidance on January 1, 2019. We can choose from two methods of adoption. The first method requires us to reflect our leases on our balance sheet in the earliest comparative period presented in our financial statements. The second method requires us to reflect the impact of adoption on the date we adopt the new guidance and recognize a cumulative-effect adjustment to the opening balance of our accumulated deficit in that period. We are currently determining the method we will use to adopt the new guidance and 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. The new guidance requires us to remeasure 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 plan to adopt this guidance on January 1, 2020. We are currently assessing the effects it will have on our consolidated financial statements and disclosures.

In December 2017, the SEC staff issued guidance to address how companies should account for the Tax Act of 2017, or the Tax Act, when an entity does not have the necessary information to complete the accounting for the Tax Act and gives entities up to one year from the enactment of the Tax Act to finalize their amounts. We recognized provisional amounts in our 2017 financial statements and in these financial statements. The ultimate impact may differ materially from these provisional amounts due to, among other things, additional analysis, changes in our interpretations and assumptions, additional regulatory guidance that may be issued, and other actions we may take resulting from the Tax Act. We will assess and update our provisional amounts and disclosures, as necessary, at year end 2018.

In February 2018, the FASB issued updated guidance for reclassification of tax effects from accumulated other comprehensive income (loss). The updated guidance gives entities an option to reclassify amounts included in accumulated other comprehensive income (loss) that under the Tax Act do not have a way to be relieved, and allows a one-time reclassification to retained earnings. The updated guidance is effective for all entities for fiscal years beginning after December 31, 2018, and interim periods within those fiscal years. Early adoption is permitted, and adoption is optional. We are currently assessing the effects this updated guidance could have on our consolidated financial statements and timing of potential adoption.

In June 2018, the FASB issued updated guidance to simplify the accounting for stock-based compensation expense for nonemployees. Specifically, we are now expensing grants to nonemployees in a similar manner as grants to employees and our Board of Directors. Previously, we had to re-value these grants at each reporting period to reflect the current fair value. Under the amended guidance, we value grants to nonemployees when we grant them and we will not adjust their value for future changes. We adopted this guidance in the second quarter of 2018 on a prospective basis. The updated guidance did not have a material impact to our financial results.

In August 2018, the FASB issued clarifying guidance on how to account for implementation costs related to cloud-servicing arrangements. The guidance states that if these fees qualify to be capitalized and amortized over the service period, they need to be expensed in the same line item as the service expense and recognized in the same balance sheet category. The update can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The updated guidance is effective for fiscal years beginning after December 31, 2019, and interim periods within those fiscal years. Early adoption is permitted in any interim period. We are currently assessing the effects this updated guidance could have on our consolidated financial statements and timing of adoption.

In August 2018, the FASB updated its disclosure requirements related to Level 1, 2 and 3 fair value measurements. The update included deletion and modification of certain disclosure requirements and additional disclosure related to Level 3 measurements. The guidance is effective for fiscal years beginning after December 31, 2019 and early adoption is permitted. We anticipate we will adopt this updated guidance on January 1, 2019 and we do not expect it to have a significant impact on our disclosures.