1. Organization and Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Isis Pharmaceuticals, Inc. (“we”, “us” or “our”) and our wholly owned subsidiary, Symphony GenIsis, Inc., which is currently inactive. In addition to our wholly owned subsidiary, our consolidated financial statements include our equity investment in Regulus Therapeutics Inc. In October 2012, Regulus completed an initial public offering (IPO). We began accounting for our investment in Regulus at fair value in the fourth quarter of 2012 when our ownership in Regulus dropped below 20 percent and we no longer had significant influence over Regulus’ operating and financial policies.

Organization and business activity

We incorporated in California on January 10, 1989. In conjunction with our initial public offering, we reorganized as a Delaware corporation in April 1991. We were organized principally to develop human therapeutic drugs using antisense technology.

Basic and diluted net loss per share

We compute basic net loss per share by dividing the net loss by the weighted-average number of common shares outstanding during the period. As we incurred a net loss for the years ended December 31, 2013, 2012 and 2011, 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:

· 23¤4 percent convertible senior notes;

· 25/8 percent convertible subordinated notes;

· GlaxoSmithKline, or GSK, convertible promissory notes issued by Regulus;

· Dilutive stock options;

· Unvested restricted stock units; and

· Warrants issued to Symphony GenIsis Holdings LLC.

In April 2011, Symphony GenIsis Holdings LLC exercised its warrants. As a result, the Symphony GenIsis warrants were not common equivalent shares for the years ended December 31, 2013 and 2012. We redeemed all of our 25¤8 percent notes in September 2012 and in October 2012 Regulus completed an IPO, after which we were no longer guarantors of the two convertible notes that Regulus issued to GSK. As a result, the 25¤8 percent notes and GSK convertible promissory notes were not common equivalent shares for the year ended December 31, 2013.

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.

Research and development revenue under collaborative agreements

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. Our collaborations may provide for various types of payments to us including upfront payments, funding of research and development, milestone payments, licensing fees, profit sharing and royalties on product sales. 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 and we allocate the consideration to each unit of accounting based on the relative selling price of each deliverable. Delivered items have stand-alone value if they are sold separately by any vendor or the customer could resell the delivered items on a standalone basis. 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. The 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.

In December 2012, we entered into a collaboration agreement with AstraZeneca to discover and develop antisense therapeutics against five cancer targets. As part of the collaboration, we received a $25 million upfront payment in December 2012 and a $6 million payment in June 2013 when AstraZeneca elected to continue the research collaboration. We are also eligible to receive milestone payments, license fees for the research program targets and royalties on any product sales of drugs resulting from this collaboration. In exchange, we granted AstraZeneca an exclusive license to develop and commercialize ISIS-STAT3Rx and ISIS-ARRx. We also granted AstraZeneca options to license up to three cancer drugs under the separate research program. We are responsible for completing an ongoing clinical study of ISIS-STAT3Rx and IND-enabling studies for ISIS-ARRx. AstraZeneca is responsible for all other global development, regulatory and commercialization activities for ISIS-STAT3Rx and ISIS-ARRx. In addition, if AstraZeneca exercises its option for any drugs resulting from the research program, AstraZeneca will assume global development, regulatory and commercialization responsibilities for such drug. Since this agreement has multiple elements, we evaluated the deliverables in this arrangement and determined that certain deliverables, either individually or in combination, have stand-alone value. Below is a list of the four separate units of accounting under our agreement:

· The exclusive license we granted to AstraZeneca to develop and commercialize ISIS-STAT3Rx for the treatment of cancer;

· The development services we are performing for ISIS-STAT3Rx;

· The exclusive license we granted to AstraZeneca to develop and commercialize ISIS-ARRx and the research services we are performing for ISIS-ARRx; and

· The option to license up to three drugs under a research program and the research services we will perform for this program.

We determined that the ISIS-STAT3Rx license had stand-alone value because it is an exclusive license that gives AstraZeneca the right to develop ISIS-STAT3Rx or to sublicense its rights. In addition, ISIS-STAT3Rx is currently in development and it is possible that AstraZeneca or another third party could conduct clinical trials without assistance from us. As a result, we consider the ISIS-STAT3Rx license and the development services for ISIS-STAT3Rx to be separate units of accounting. We recognized the portion of the consideration allocated to the ISIS-STAT3Rx license immediately because we delivered the license and earned the revenue. We are recognizing as revenue the amount allocated to the development services for ISIS-STAT3Rx over the period of time we perform services. The ISIS-ARRx license is also an exclusive license. Because of the early stage of research for ISIS-ARRx, we believe that our knowledge and expertise with antisense technology is essential for AstraZeneca or another third party to successfully develop ISIS-ARRx. As a result, we concluded that the ISIS-ARRx license does not have stand-alone value and we combined the ISIS-ARRx license and related research services into one unit of accounting. We are recognizing revenue for the combined unit of accounting over the period of time we perform services. We determined that the options under the research program did not have stand-alone value because AstraZeneca cannot develop or commercialize drugs resulting from the research program until AstraZeneca exercises the respective option or options. As a result, we considered the research options and the related research services as a combined unit of accounting. We are recognizing revenue for the combined unit of accounting over the period of our performance.

We determined that the initial allocable arrangement consideration was the $25 million upfront payment because it was the only payment that was fixed and determinable when we entered into the agreement. In June 2013, we increased the allocable consideration to $31 million when we received the $6 million payment. There was considerable uncertainty at the date of the agreement as to whether we would earn the milestone payments, royalty payments, payments for manufacturing clinical trial materials or payments for finished drug product. As such, we did not include those payments in the allocable consideration.

We allocated the allocable consideration based on the relative BESP of each unit of accounting. We engaged a third party, independent valuation expert to assist us with determining BESP. We estimated the selling price of the licenses granted for ISIS-STAT3Rx and ISIS-ARRx by using the relief from royalty method. Under this method, we estimated the amount of income, net of taxes, for each drug. We then discounted the projected income for each license to present value. The significant inputs we used to determine the projected income of the licenses included:

· Estimated future product sales;

· Estimated royalties on future product sales;

· Contractual milestone payments;

· Expenses we expect to incur;

· Income taxes; and

· An appropriate discount rate.

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

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

· The estimated number and cost of studies we will perform;

· The estimated number and cost of studies that we will contract with third parties to perform; and

· The estimated cost of drug product we will use in the studies.

As a result of the allocation, we recognized $9.3 million of the $25 million upfront payment for the ISIS-STAT3Rx license in December 2012 and we recognized $2.2 million of the $6 million payment for the ISIS-STAT3Rx license in June 2013. We are recognizing the remaining $19.5 million of the $31 million over the estimated period of our performance. Assuming a constant selling price for the other elements in the arrangement, if there was an assumed ten percent increase or decrease in the estimated selling price of the ISIS-STAT3Rx license, we determined that the revenue we would have allocated to the ISIS-STAT3Rx license would change by approximately seven percent, or $750,000, from the amount we recorded.

Typically, we must estimate our period of performance when the agreements we enter into do not clearly define such information. 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 the period of time over which we will complete the activities for which we are responsible and use that period of time as our period of performance for purposes of revenue recognition and amortize revenue over such period. We have made estimates of our continuing obligations under numerous agreements and in certain instances the timing of satisfying these obligations is difficult to estimate. Accordingly, our estimates may change in the future. If our estimates and judgments change over the course of these agreements, it may affect the timing and amount of revenue that we recognize in future periods. For example, in 2013 we adjusted the period of performance on our GSK collaboration and our ISIS-SMNRx collaboration with Biogen Idec. As a result of adding two new development candidates, ISIS-GSK3Rx and ISIS-GSK4Rx, to our collaboration with GSK, our period of performance was extended beyond our initial estimate. Therefore, we extended the amortization period to correspond to the new extended period of performance. Similarly, with our ISIS-SMNRx collaboration, we extended the amortization period to correspond to the expansion of the Phase 3 study in infants with SMA. Since we extended the amortization period for our GSK collaboration and our ISIS-SMNRx collaboration, the amortization from the upfront payments for these collaborations will be $2.6 million less in 2014 compared to 2013.

From time to time, we may enter into separate agreements at or near the same time with the same customer. 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, since early 2012 we have entered into four collaboration agreements with Biogen Idec:

· In January 2012, we entered into a collaboration agreement with Biogen Idec to develop and commercialize ISIS-SMNRx for Spinal Muscular Atrophy, or SMA. As part of the collaboration, we received a $29 million upfront payment and we are responsible for global development of ISIS-SMNRx through completion of Phase 2/3 clinical trials.

· In June 2012, we entered into a second and separate collaboration agreement with Biogen Idec to develop and commercialize a novel antisense drug targeting DMPK, or dystrophia myotonica-protein kinase. As part of the collaboration, we received a $12 million upfront payment and we are responsible for global development of the drug through the completion of a Phase 2 clinical trial.

· In December 2012, we entered into a third and separate collaboration agreement with Biogen Idec to discover and develop antisense drugs against three targets to treat neurological or neuromuscular disorders. As part of the collaboration, we received a $30 million upfront payment and we are responsible for the discovery of a lead antisense drug for each of three targets.

· In September 2013, we entered into a fourth and separate collaboration agreement with Biogen Idec to leverage antisense technology to advance the treatment of neurological diseases. We granted Biogen Idec exclusive rights to the use of our antisense technology to develop therapies for neurological diseases as part of this broad collaboration. We received a $100 million upfront payment and we are responsible for discovery and early development through the completion of a Phase 2 clinical trial for each antisense drug identified during the six year term of this collaboration, while Biogen Idec is responsible for the creation and development of small molecule treatments and biologics.

All four of these collaboration agreements give Biogen Idec the option or options to license one or more drugs resulting from the specific collaboration. If Biogen Idec exercises an option, it will pay us a license fee and will assume future development, regulatory and commercialization responsibilities for the licensed drug. We are also eligible to receive milestone payments associated with the research and/or development of the drugs prior to licensing, milestone payments if Biogen Idec achieves pre-specified regulatory milestones, and royalties on any product sales of drugs resulting from these collaborations.

We evaluated all four of the Biogen Idec agreements to determine whether we should account for them as separate agreements. We determined that we should account for the agreements separately because we conducted the negotiations independently of one another, each agreement focuses on different drugs, there are no interrelated or interdependent deliverables, there are no provisions in any of these agreements that are essential to the other agreement, and the payment terms and fees under each agreement are independent of each other. We also evaluated the deliverables in each of these agreements to determine whether they met 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. For all four of these agreements, we determined that the options did not have stand-alone value because Biogen Idec cannot pursue the development or commercialization of the drugs resulting from these collaborations until it exercises the respective option or options. As such, for each agreement we considered the deliverables to be a single unit of accounting and we are recognizing the upfront payment for each of the agreements over the respective estimated period of our performance.

Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and 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 paragraph.

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 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 IND-enabling studies, which are animal studies intended to support an Investigational New Drug, or 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 Phase 1 clinical trials 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 scale studies in patients with the primary intent of determining the efficacy 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 approval from the Food and Drug Administration, or FDA, and/or foreign equivalents. The Phase 3 studies typically involve large numbers of patients and can take up to several years to complete. If the data gathered during the 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 approval. This stage of the drug’s life-cycle is the regulatory stage. If a drug achieves marketing approval, it moves into the commercialization stage, during which our partner will market and sell the drug to patients. Although our partner will ultimately be responsible for marketing and selling the 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 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 regulatory approval and then to commercialization. The process of successfully discovering a new development candidate, having it approved and ultimately sold 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:

· 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;

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

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

· 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:

· Filing of regulatory applications for marketing approval 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.

· Marketing approval 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 approval from the applicable regulatory agency.

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

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

· 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. For our existing 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 all future development, regulatory and commercialization milestones are substantive. For example, for our strategic alliance with Biogen Idec, we are using our antisense drug discovery platform to discover and develop new drugs against targets for neurological diseases. Alternatively, we provide access to our technology to Alnylam Pharmaceuticals, Inc. to develop and commercialize RNA interference, or RNAi, therapeutics. We consider milestones for both of these collaborations to be substantive. In evaluating if a milestone is substantive we consider whether:

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

· 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;

· 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;

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

· 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 the estimated period of performance, if any. We consider milestone payments related to progression of a drug through the development and regulatory stages of its life cycle to be substantive milestones because the level of effort and inherent risk associated with these events is high. All of the milestone payments we earned in 2013 were substantive. Therefore, we recognized the entire amount of those milestone payments in 2013, including a $25 million milestone payment from Genzyme we recognized in the first quarter of 2013 when the FDA approved the KYNAMRO NDA. Further information about our collaborative arrangements can be found in Note 7, Collaborative Arrangements and Licensing Agreements.

Licensing and royalty revenue

We often enter into agreements to license our proprietary patent rights on an exclusive or non-exclusive basis in exchange for license fees and/or royalties. We generally recognize as revenue immediately those licensing fees and royalties for which we have no significant future performance obligations and are reasonably assured of collecting the resulting receivable.

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, 2013, 2012 and 2011, research and development expenses were $173.7 million, $154.6 million and $153.1 million, respectively. A portion of the costs included in research and development expenses are costs associated with our collaboration agreements. For the years ended December 31, 2013, 2012 and 2011, research and development costs of approximately $51.9 million, $39.0 million, and $26.3 million, respectively, were related to our collaborative research and development arrangements.

We capitalize costs consisting principally of outside legal costs and filing fees related to obtaining patents and amortize these 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 9.8 years at December 31, 2013.

The cost of our patents capitalized on our consolidated balance sheet at December 31, 2013 and 2012 was $24.9 million and $31.4 million, respectively. Accumulated amortization related to patents was $9.4 million and $12.8 million at December 31, 2013 and 2012, respectively. Based on existing patents, estimated amortization expense related to patents in each of the next five years is as follows:

Years Ending December 31,	Amortization
	(in millions)

2014	$	1.0
2015	$	0.9
2016	$	0.9
2017	$	0.8
2018	$	0.7

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. In 2013, 2012 and 2011, patent expenses were $10.3 million, $3.9 million and $4.3 million, respectively, and included non-cash charges related to the write-down of our patent costs to their estimated net realizable values of $6.4 million, $817,000 and $1.9 million, respectively.

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 (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 90 days or less when we purchase them to be cash equivalents. Our short-term investments have initial maturities of greater than 90 days 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 in privately- and publicly-held biotechnology companies that we have received as part of a technology license or collaboration agreement. At December 31, 2013 we held ownership interests of less than 20 percent in each of the respective companies.

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 of these publicly-held companies as a separate component of comprehensive income (loss). We account for 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. The cost method investments we hold are in smaller satellite companies and realization of our equity position in those companies is uncertain. In those circumstances 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 deliver the drugs to our partners, or as we provide these drugs for our own clinical trials. We reflect our inventory on the balance sheet at the lower of cost or market value under the first-in, first-out method. We review inventory periodically and reduce 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, 2013, 2012 or 2011. Total inventory, which consisted of raw materials, was $8.0 million and $6.1 million as of December 31, 2013 and 2012, respectively.

Property, plant and equipment

We carry our property, plant and equipment at cost, which consists of the following (in thousands):

	December 31,
	2013			2012
Equipment and computer software	$	44,698		$	44,109
Building and building systems	48,132			48,120
Land improvements	2,846			2,849
Leasehold improvements	35,282			34,931
Furniture and fixtures	5,473			5,342
	136,431			135,351
Less accumulated depreciation	(60,431		)	(54,465		)
	76,000			80,886
Land	10,198			10,198

	$	86,198		$	91,084

We depreciate our property, plant and equipment on the straight-line method over estimated useful lives as follows:

Computer software and hardware		3 years
Manufacturing equipment		10 years
Other equipment		5-7 years
Furniture and fixtures		5-10 years
Building		40 years
Building systems and improvements		10-25 years
Land improvements		20 years

We depreciate our leasehold improvements using the shorter of the estimated useful life or remaining lease term.

Licenses

We obtain licenses from third parties and capitalize the costs related to exclusive licenses. We amortize capitalized licenses over their estimated useful life or term of the agreement, which for current licenses is between approximately five years and 15 years. The cost of our licenses at December 31, 2013 and 2012 was $36.2 million. Accumulated amortization related to licenses was $31.6 million and $29.6 million at December 31, 2013 and 2012, respectively. Based on existing licenses, estimated amortization expense related to licenses is as follows:

Years Ending December 31,	Amortization
	(in millions)

2014	$	1.9
2015	$	1.9
2016	$	0.8

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, patent costs, and exclusive licenses 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. We recorded a charge of $6.4 million, $825,000 and $1.9 million for the years ended December 31, 2013, 2012 and 2011, respectively, related primarily to the write-down of intangible assets.

Equity method of accounting

We accounted for our ownership interest in Regulus using the equity method of accounting until Regulus’ IPO in October 2012. We began accounting for our investment in Regulus at fair value in the fourth quarter of 2012 when our ownership in Regulus dropped below 20 percent and we no longer had significant influence over Regulus’ operating and financial policies. See Note 3, Investments, for additional information regarding our fair value accounting for our investment in Regulus. Under the equity method of accounting, we included our share of Regulus’ operating results on a separate line in our consolidated statement of operations called “Equity in net loss of Regulus Therapeutics Inc.”

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.

Reclassifications

We have reclassified certain prior period amounts to conform to the current period presentation. Certain amounts previously reported as research and development revenue have been reclassified to licensing and royalty revenue to conform to the current period presentation.

Consolidation of variable interest entities

We identify entities as variable interest entities either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. We perform ongoing qualitative assessments of our variable interest entities to determine whether we have a controlling financial interest in the variable interest entity and therefore are the primary beneficiary. As of December 31, 2013 and 2012, we had collaborative arrangements with five and six entities, respectively, that we considered to be variable interest entities. We are not the primary beneficiary for any of these entities as we do not have the power to direct the activities that most significantly impact the economic performance of our variable interest entities, the obligation to absorb losses, or the right to receive benefits from our variable interest entities that could potentially be significant to the variable interest entities. As of December 31, 2013, the total carrying value of our investments in variable interest entities was $53.4 million, and was primarily related to our investment in Regulus. Our maximum exposure to loss related to these variable interest entities is limited to the carrying value of our investments.

Stock-based compensation

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 Employee Stock Purchase Plan, or 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 the 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), an entity recognizes compensation expense over the requisite service period for each separately vesting tranche of the award as though the award were in substance multiple awards, which results in the expense being front-loaded over the vesting period.

In 2012, we began granting RSUs to our employees and our board of directors. 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.

See Note 5, Stockholders’ Equity, for additional information regarding our share-based compensation plans.

Accumulated other comprehensive income (loss)

Accumulated other comprehensive income (loss) is 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, 2013, 2012 and 2011 (in thousands):

	Year Ended December 31,
	2013			2012			2011
Beginning balance accumulated other comprehensive income (loss)	$	12,480		$	(770	)	$	949
Other comprehensive income (loss) before reclassifications, net of tax (1)	10,253			13,250			(1,719		)
Amounts reclassified from accumulated other comprehensive income (2)	(1,653		)	—			—
Net current period other comprehensive income (loss)	8,600			13,250			(1,719		)
Ending balance accumulated other comprehensive income (loss)	$	21,080		$	12,480		$	(770	)

(1) Other comprehensive income includes income tax expense of $5.9 million and $9.1 million for the years ended December 31, 2013 and 2012, respectively.

(2) Included in gain on investments, net on our consolidated statement of operations.

Convertible debt

In August 2012, we completed a $201.3 million offering of convertible senior notes, which mature in 2019 and bear interest at 2¾ percent. In September 2012, we used a substantial portion of the net proceeds from the issuance of the 2¾ percent notes to redeem our 25/8 percent convertible subordinated notes. Consistent with how we accounted for our 25/8 percent notes, we account for our 2¾ percent notes by separating the liability and equity components of the instrument in a manner that reflects our nonconvertible debt borrowing rate. As a result, we assigned a value to the debt component of our 2¾ percent notes equal to the estimated fair value of similar debt instruments without the conversion feature, which resulted in us recording the debt instrument at a discount. We are amortizing the debt discount over the life of these 2¾ percent notes as additional non-cash interest expense utilizing the effective interest method. For additional information, see Note 4, Long-Term Obligations and Commitments.

Segment information

We operate in a single segment, Drug Discovery and Development operations, because our chief decision maker reviews operating results on an aggregate basis and manages our operations as a single operating segment.

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 an entity to develop its own assumptions. Our Level 3 investments include investments in the equity securities of publicly-held biotechnology companies for which we calculated a lack of marketability discount because there were restrictions on when we could trade the securities. The majority of our securities have been classified 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 the years ended December 31, 2013 and 2012 there were no transfers between our Level 1 and Level 2 investments. We use the end of reporting period method for determining transfers between levels.

We measure the following major security types at fair value on a recurring basis. We break down the inputs used to measure fair value for these assets at December 31, 2013 and 2012 as follows (in thousands):

	At December 31, 2013		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents (1)	$	146,357	$	133,233	$	13,124	$	—
Corporate debt securities (2)	394,773		—		394,773		—
Debt securities issued by U.S. government agencies (2)	64,432		—		64,432		—
Debt securities issued by the U.S. Treasury (2)	15,328		15,328		—		—
Debt securities issued by states of the United States and political subdivisions of the states (2)	22,255		—		22,255		—
Investment in Regulus Therapeutics Inc.	52,096		52,096		—		—
Equity securities (3)	1,276		1,276		—		—
Total	$	696,517	$	201,933	$	494,584	$	—

	At December 31, 2012		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents (1)	$	105,496	$	101,496	$	4,000	$	—
Corporate debt securities (2)	193,507		—		193,507		—
Debt securities issued by U.S. government agencies (2)	18,108		—		18,108		—
Debt securities issued by the U.S. Treasury (2)	13,452		13,452		—		—
Debt securities issued by states of the United States and political subdivisions of the states (2)	24,897		—		24,897		—
Investment in Regulus Therapeutics Inc.	33,622		—		—		33,622
Equity securities (3)	4,874		4,146		—		728
Total	$	393,956	$	119,094	$	240,512	$	34,350

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

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

(3) Included in other current assets on our consolidated balance sheet.

As of December 31, 2012, we classified the fair value measurements of our investments in the equity securities of Regulus and Sarepta Therapeutics, Inc., or Sarepta, as Level 3. We calculated a lack of marketability discount on the fair value of these investments because of trading restrictions on the securities. We consider the inputs we used to calculate the lack of marketability discount Level 3 inputs and, as a result, we categorized these investments as Level 3. We determined the lack of marketability discount by using a Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the stock until the restriction ended. As of December 31, 2012, our Level 3 investments in Regulus and Sarepta had a gross fair value of $44.4 million and $1.0 million, respectively, less a lack of marketability discount of $10.8 million and $296,000, respectively, for a net carrying value of $33.6 million and $728,000, respectively. In the first quarter of 2013, we sold all of the common stock of Sarepta that we owned resulting in a realized gain of $1.1 million. In the fourth quarter of 2013, we re-classified our investment in Regulus to a Level 1 investment because we are no longer subject to contractual trading restrictions on the Regulus shares we own. We recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer.

The following is a summary of our investments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2013, 2012 and 2011 (in thousands):

	Year Ended December 31,
	2013			2012		2011
Beginning balance of Level 3 investments	$	34,350		$	—	$	—
Purchases	—			3,040		—
Transfers into Level 3 investments	—			25,198		—
Total gains and losses:
Included in gain on investments	(1,163		)	—		—
Included in accumulated other comprehensive income	32,272			6,112		—
Transfers out of Level 3 investments	(65,419		)	—		—
Cost basis of shares sold	(40		)	—		—
Ending balance of Level 3 investments	$	—		$	34,350	$	—

Income Taxes

We use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities reflect the impact of temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured under enacted tax laws. We record a valuation allowance to offset any net deferred tax assets if, based upon the available evidence, it is more likely than not that we will not recognize some or all of the deferred tax assets.

In our financial statements, we recognize the impact of an uncertain income tax position on our income tax returns at the largest amount that the relevant taxing authority is more-likely-than-not to sustain upon audit. If we feel that the likelihood of sustaining an uncertain income tax position is less than 50 percent, we do not recognize it.

Impact of recently issued accounting standards

In July 2013, the FASB issued accounting guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. We will adopt this guidance in our fiscal year beginning January 1, 2014. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.