Investment in Regulus Therapeutics Inc.

12 Months Ended

Dec. 31, 2011

Investment in Regulus Therapeutics Inc.

Investment in Regulus Therapeutics Inc.

2. Investment in Regulus Therapeutics Inc.

In September 2007, we and Alnylam established Regulus as a company focused on the discovery, development and commercialization of microRNA-targeting therapeutics.  Regulus combines our and Alnylam’s technologies, know-how, and intellectual property relating to microRNA-based therapeutics.

We and Alnylam each granted Regulus exclusive licenses to our respective intellectual property for microRNA therapeutic applications, as well as certain early fundamental patents in the microRNA field. Alnylam made an initial investment of $10 million in Regulus to balance both companies’ ownership.  In October 2010, Sanofi invested $10 million in Regulus.  From this investment Sanofi acquired less than 10 percent ownership of Regulus, leaving us with approximately 46 percent ownership.  Alnylam owns the remaining equity.  Regulus operates as an independent company with a separate board of directors, scientific advisory board and management team. We and Alnylam retain rights to develop and commercialize on pre-negotiated terms microRNA therapeutic products that Regulus decides not to develop either by itself or with a partner.

Regulus Collaborations

Regulus’ Collaboration with Sanofi

In June 2010, Regulus established a collaboration with Sanofi to discover, develop, and commercialize microRNA therapeutics, initially focused on fibrosis. The alliance represents the largest microRNA partnership formed to date, valued at potentially over $750 million. The alliance includes a $25 million upfront fee, a $10 million equity investment in Regulus that Sanofi made in October 2010 and annual research support for three years with the option to extend two additional years. In addition, Regulus is eligible to receive royalties on microRNA therapeutic products that Sanofi commercializes.  Sanofi also received an option for a broader technology alliance that provides Regulus certain rights to participate in development and commercialization of resulting products. If exercised, this three-year option is worth up to an additional $50 million to Regulus. We and Alnylam are each eligible to receive 7.5 percent of the upfront payment and all potential milestone payments, in addition to royalties on product sales. As a result, in July 2010 we received from Regulus a payment of $1.9 million representing 7.5 percent of the $25 million upfront fee.

Regulus’ Collaboration with GSK

In April 2008, Regulus entered into a strategic alliance with GSK to discover, develop and commercialize novel microRNA-targeting therapeutics to treat inflammatory diseases such as rheumatoid arthritis and inflammatory bowel disease, and in February 2010, Regulus and GSK expanded this alliance to include microRNA therapeutics targeting microRNA 122, or miR-122, for the treatment of hepatitis C virus infection, or HCV. The alliance utilizes Regulus’ expertise and intellectual property position in the discovery and development of microRNA-targeting therapeutics and provides GSK with an option to license drug candidates directed at four different microRNA targets, including miR-122 for HCV. Regulus received $28 million in upfront payments from GSK, including $18 million in option fees and two $5 million convertible promissory notes. The notes plus interest will convert into Regulus common stock in the future if Regulus achieves a minimum level of financing with institutional investors. In addition, we and Alnylam are guarantors of the notes issued to GSK, and if the notes do not convert or if Regulus does not repay the notes by February 2013, we, Alnylam and Regulus may elect to repay the notes plus interest with shares of each company’s common stock or cash.  In 2009, Regulus earned revenue of $3.0 million related to its collaboration with GSK, which we included in our 2009 consolidated revenue as Regulus was a consolidated subsidiary in 2009.

Equity method of accounting

On January 1, 2010, as a result of adopting the new accounting standard for identifying which enterprise has the power to direct activities of a variable interest entity, we prospectively changed the way we account for our variable interest in Regulus.  Since we and Alnylam share the ability to impact Regulus’ economic performance, we are no longer the primary beneficiary of Regulus.  Beginning in 2010, we deconsolidated Regulus from our consolidated financial statements and began to account for our ownership interest in Regulus using the equity method of accounting.

In October 2010, Sanofi invested $10 million in Regulus.  From this investment Sanofi acquired less than 10 percent ownership of Regulus, leaving us with approximately 46 percent ownership. Under the equity method of accounting, when Regulus issued shares to Sanofi we recorded a gain of $4.7 million and adjusted the carrying value of our investment in Regulus to reflect the increased valuation of Regulus and our new ownership percentage.

Under the equity method of accounting, we will suspend recognizing losses if the carrying amount of our investment in Regulus exceeds the amount of funding we provided to Regulus.  Since we and Alnylam are guarantors of both of the convertible notes that Regulus issued to GSK, we will continue to recognize losses in excess of our net investment in Regulus up to the principal plus accrued interest we guaranteed, which was $5.5 million at December 31, 2011.  At December 31, 2011, the total carrying value of our investment in Regulus is a liability of $4.4 million.

Summarized financial information for Regulus is as follows (in thousands):

	Year Ended December 31,
	2011			2010			2009
Net revenues	$	13,789		$	8,601		$	3,013
Operating expenses	20,926			24,099			11,789
Loss from operations	(7,137		)	(15,498		)	(8,776		)
Other income (expense)	(259		)	(91		)	13
Income tax benefit (expense)	(206		)	30			(141		)
Net loss	$	(7,602	)	$	(15,559	)	$	(8,904	)

	December 31,
	2011		2010
Current assets	$	38,666	$	55,175
Non-current assets	4,215		4,528
Total assets	42,881		59,703
Current liabilities	12,850		14,729
Non-current liabilities	28,834		36,978
Total liabilities	41,684		51,707
Net assets	$	1,197	$	7,996