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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2013

OR

For the transition period from                      to                     

Commission File Number 0-30739

INSMED INCORPORATED

(Exact name of registrant as specified in its charter)

(732) 997-4600

(Registrant’s telephone number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting Company (See the definitions of “large accelerated filer,” “accelerated filer,” and “small reporting Company” in Rule 12b-2 of the Exchange Act).  Large accelerated filer o Accelerated filer x Non-accelerated filer o Small Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of July 31, 2013, there were 39,012,357 shares of the registrant’s common stock, $0.01 par value, outstanding.

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INSMED INCORPORATED

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2013

INDEX

In this Form 10-Q, we use the words “Insmed Incorporated”  to refer to Insmed Incorporated, a Virginia corporation, and we use the words “Company,” “Insmed,” “Insmed Incorporated,” “we,” “us” and “our” to refer to Insmed Incorporated and its consolidated subsidiaries.  ARIKACE® is a registered trademark and Insmed™ is a trademark of Insmed Incorporated.  This Form 10-Q also contains trademarks of third parties.  Each trademark of another company appearing in this Form 10-Q is the property of its owner.

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PART I.   FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INSMED INCORPORATED

Consolidated Balance Sheets

(in thousands, except par value, share and per share data)

See accompanying notes to consolidated financial statements

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INSMED INCORPORATED

Consolidated Statements of Comprehensive Loss (Unaudited)

(in thousands, except per share data)

See accompanying notes to consolidated financial statements

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INSMED INCORPORATED

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

See accompanying notes to consolidated financial statements

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INSMED INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.                                  Description of the Business and Basis of Presentation

Description of Business - Insmed is a biopharmaceutical company focused on developing and commercializing an inhaled anti-infective to treat patients battling serious lung diseases that are often life-threatening. The Company’s lead product candidate, ARIKACE®, or liposomal amikacin for inhalation, is an inhaled antibiotic treatment that delivers a proven and potent anti-infective directly to the site of serious lung infections.

During July 2013, the Company reported top-line results from its Phase 3 registrational clinical trial of ARIKACE in cystic fibrosis (“CF”) patients who have lung infections caused by Pseudomonas aeruginosa (“Pa”) that was conducted in Europe and Canada.  In summary, once-daily ARIKACE achieved its primary endpoint of non-inferiority when compared to twice-daily “TOBI” (“tobramycin inhalation solution”) for relative change in FEV1 from baseline to the end of the study. The Company is conducting a Phase 2 clinical trial of ARIKACE in patients who have lung infections caused by non-tuberculous mycobacteria (“NTM”) in the U.S. and Canada. The Company is also conducting a two-year, open-label safety study that is enrolling eligible patients who have completed our Phase 3 registrational clinical trial in CF patients in Europe and Canada. The Company’s primary development focus is to obtain regulatory approval for ARIKACE for these two initial indications and to prepare for commercialization initially in Europe and Canada and then in the United States (“US”).  If approved, ARIKACE will be the first once-a-day inhaled antibiotic treatment option available for these CF and NTM indications. The Company’s strategy is to continue to develop ARIKACE for additional indications beyond CF patients with Pa infections and patients with NTM infections.

The Company was incorporated in the Commonwealth of Virginia on November 29, 1999 and its principal executive offices are located in Monmouth Junction, New Jersey.

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

Prior Period Reclassifications - Certain amounts in the prior years’ consolidated financial statements have been reclassified to conform to the current-year presentation. Specifically, the Company allocated a portion of certain operating expenses from general and administrative expense to research and development expense in 2013 and recast prior year amounts to conform to the current year presentation for comparability purposes.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The consolidated balance sheet as of December 31, 2012 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 18, 2013.

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2.                                  Summary of Significant Accounting Policies

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

Investment Income and Interest Expense - Investment income consists of interest and dividend income earned on our cash, cash equivalents and short-term investments, along with realized gains (losses) on the sale of investments. Interest expense consists primarily of interest costs related to our debt and capital lease obligations.

Cash and Cash Equivalents and Short-Term Investments - The Company considers cash equivalents to be highly liquid investments with maturities of three months or less from the date of purchase.  The Company invests its available cash primarily in mutual and money market funds, US treasury obligations, and bank certificates of deposit. For purposes of determining realized gains and losses, the cost of securities sold is based on specific identification.

Fixed Assets, Net - Fixed assets are recorded at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives of three to seven years are used for computer equipment, laboratory equipment, office equipment and furniture and fixtures. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the asset. Long-lived assets, such as lab equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, then an impairment charge is recognized for the amount by which the carrying value of the asset exceeds the fair value of the asset.

Identifiable Intangible Assets and Goodwill - Identifiable intangible assets are measured at their respective fair values and are not amortized until commercialization of the related product commences. Once commercialization occurs, these intangible assets will be amortized over their estimated useful lives. The fair values assigned to our intangible assets are based on reasonable estimates and assumptions given available facts and circumstances. Unanticipated events or circumstances may occur that may require us to review the assets for impairment. Events or circumstances that may require an impairment assessment include negative pre-clinical or clinical trial results, the non-approval of a new drug application by a regulatory agency, material delays in our development program or a sustained decline in market capitalization.

Indefinite-lived intangible assets are not subject to periodic amortization. Rather, indefinite-lived intangibles are reviewed for impairment by applying a fair value based test on an annual basis or more frequently if events or circumstances indicate impairment may have occurred. Events or circumstances that may require an interim impairment assessment are consistent with those described above.  The Company performs its annual impairment test as of October 1 of each year. We are not aware of any indicators of impairment that would necessitate an impairment test as of June 30, 2013.

The Company uses the income approach to derive the fair value of in-process research and development assets. This approach calculates fair value by estimating future cash flows attributable to the assets and then discounting these cash flows to a present value using a risk-adjusted discount rate. The Company did not use a market based valuation approach because the Company lacks revenues and profits. The income approach requires significant management judgment with respect to unobservable inputs such as future volume, revenue and expense growth rates, changes in working capital use, appropriate discount rates and other assumptions and estimates. The estimates and assumptions used are consistent with the Company’s business plans.

Debt Issuance Costs - Debt issuance costs are amortized using the effective interest rate method, and are amortized to interest expense over the term of the debt. Debt issuance costs paid to the lender are reflected as a

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discount to the debt, and debt issuance costs paid to other third parties are reflected as other assets in the consolidated balance sheets.

Fair Value Measurements - The Company categorizes its financial assets and liabilities measured and reported at fair value in the financial statements on a recurring basis based upon the level of judgments associated with the inputs used to measure their fair value.  Hierarchical levels, which are directly related to the amount of subjectivity associated with the inputs used to determine the fair value of financial assets and liabilities, are as follows:

·      Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

·      Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the assets or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

·      Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.  Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Each major category of financial assets and liabilities measured at fair value on a recurring basis are based upon the lowest level of significant input to the valuations.  The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

As of June 30, 2013 and December 31, 2012, the Company did not have any Level 2 or 3 financial assets or liabilities. The following table presents the Company’s Level 1 assets measured at fair value as of June 30, 2013 and December 31, 2012.

The Company’s cash, cash equivalents, and money funds consist of liquid investments with a maturity of three months or less from the date of purchase. The certificate of deposit matured on July 26, 2013. We recognize transfers between levels within the fair value hierarchy, if any, at the end of each quarter. There were no transfers in or out of Level 1, Level 2 or Level 3 during the three and six months ended June 30, 2013 and 2012. As of June 30, 2013 and December 31, 2012, the Company held no securities that were in an unrealized loss or gain position.

The Company reviews the status of each security quarterly to determine whether an other-than-temporary impairment has occurred.  In making our determination, we consider a number of factors, including: (1) the significance of the decline, (2) whether the securities were rated below investment grade, (3) how long the securities have been in an unrealized loss position, and (4) our ability and intent to retain the investment for a sufficient period of time for it to recover.

Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company places its cash equivalents with financial institutions that it believes have high credit quality. The Company has established investment guidelines relative to credit ratings and maturities that seek to maintain safety and liquidity.

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The Company sources each of its raw materials from a single supplier.  In addition, the production of the Company’s lead product candidate is performed by a sole manufacturer. The inability of the suppliers or manufacturer to fulfill supply requirements of the Company could materially adversely affect future operating results or the Company’s business generally. A change in the relationship with the suppliers or manufacturer, or an adverse change in their business, could materially adversely affect the Company’s future operating results.

Revenue Recognition — As disclosed in more detail in Note 7, “License and Collaborative Agreements”, Other revenue during the three months ended June 30, 2013 solely consists of an $11.5 million payment the Company received from Premacure (now Shire plc) in exchange for the Company’s right to receive future royalties under its license agreement with Premacure. The Company recorded this as Other revenue during the three months ended June 30, 2013, since all four revenue recognition criteria (see below) were met and the Company has no continuing performance obligations related to the payment received.

The Company recognizes revenues when all of the following four criteria are present: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured.

Where the Company has continuing performance obligations under the terms of a collaborative arrangement, non-refundable upfront license payments received upon contract signing are recorded as deferred revenue and recognized as revenue as the related activities are performed. The period over which these activities are to be performed is based upon management’s estimate of the development period. Changes in management’s estimate could change the period over which revenue is recognized. Research and/or development payments are recognized as revenues as the related research and/or development activities are performed and when the Company has no continuing performance obligations related to the research and development payment received.

Where the Company has no continuing involvement under a collaborative arrangement, the Company records nonrefundable license fee revenues when the Company has the contractual right to receive the payment, in accordance with the terms of the collaboration agreement, and records milestones upon appropriate notification to the Company of achievement of the milestones by the collaborative partner.

The Company recognizes revenue from milestone payments when earned, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement and (ii) the Company does not have ongoing performance obligations related to the achievement of the milestone earned. Milestone payments are considered substantive if all of the following conditions are met: the milestone payment (a) is commensurate with either the vendor’s performance to achieve the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the vendor’s performance to achieve the milestone, (b) relates solely to past performance, and (c) is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. Any amounts received by the Company under the agreement in advance of the Company’s performance, if deemed substantive, are recorded as deferred revenue and recognized as revenue as the Company completes its performance obligations.

With regard to recognizing revenue for multiple deliverable revenue arrangements, each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting if both of the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control.

In addition, multiple deliverable revenue arrangement consideration is allocated at the inception of an arrangement to all deliverables using the relative selling price method. The Company also applies a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price if neither vendor-specific nor third-party evidence is available.

Deferred revenue associated with a non-refundable payment received under a collaborative agreement that is terminated prior to its completion results in an immediate recognition of the deferred revenue.

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Research and Development - Research and development expenses consist primarily of salaries, benefits and other related costs, including stock based compensation, for personnel serving in our research and development functions, and other internal operating expenses, the cost of manufacturing our drug candidate, including the medical devices for drug delivery, for clinical study, the cost of conducting clinical studies, and the cost of conducting preclinical and research activities. The Company’s expenses related to manufacturing its drug candidate and medical devices for clinical study are primarily related to activities at contract manufacturing organizations that manufacture ARIKACE and the medical devices for the Company’s use.  The Company’s expenses related to clinical trials are primarily related to activities at contract research organizations that conduct and manage clinical trials on the Company’s behalf. These contracts set forth the scope of work to be completed at a fixed fee or amount per patient enrolled. Payments under these contracts primarily depend on performance criteria such as the successful enrollment of patients or the completion of clinical trial milestones as well as time-based fees. Expenses are accrued based on contracted amounts applied to the level of patient enrollment and to activity according to the clinical trial protocol. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts are then recognized as an expense as the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided.

Stock-Based Compensation — The Company recognizes stock-based compensation expense for awards of equity instruments to employees and directors based on the grant-date fair value of those awards.  The grant-date fair value of the award is recognized as compensation expense ratably over the requisite service period, which generally equals the vesting period of the award, and if applicable, is adjusted for expected forfeitures. Stock-based compensation expense is included in both research and development expenses and general and administrative expenses in the Consolidated Statements of Comprehensive Loss.

Certain awards deemed to be granted outside of the Company’s equity incentive plans, require the Company to use liability accounting.  These type of awards are classified as a liability and are remeasured at fair value at the end of each reporting period until such time they are deemed to be granted under the Company’s equity incentive plans.  Changes in fair value are included in compensation expense in the Consolidated Statements of Comprehensive Loss (see additional disclosures related to awards granted outside of the 2000 Stock Incentive Plan in Note 6, Stock-Based Compensation).

Income Taxes - The Company accounts for income taxes under the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to operating loss carryforwards and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

A valuation allowance is recorded to reduce the deferred tax assets to the amount that is expected to be realized. In evaluating the need for a valuation allowance, we take into account various factors, including the expected level of future taxable income and available tax planning strategies. If actual results differ from the assumptions made in the evaluation of our valuation allowance, we record a change in valuation allowance through income tax expense in the period such determination is made.

The Company uses a model for how it measures, presents and discloses an uncertain tax position taken or expected to be taken in a tax return. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based solely on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood to be sustained upon ultimate settlement. The Company has no uncertain tax positions as of June 30, 2013 or December 31, 2012 that qualify for either recognition or disclosure in the consolidated financial statements.

The Company’s policy for interest and penalties related to income tax exposures is to recognize interest and penalties as a component of the income taxes on continuing operations in the Consolidated Statements of Comprehensive Loss.

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Net Income (Loss) Per Common Share - Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of common shares outstanding during the period.  Diluted net income (loss) per common share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of common shares and other dilutive securities outstanding during the period. Potentially dilutive securities from stock options, the restricted stock units and the warrant would be antidilutive as the Company incurred a net loss. Potentially dilutive common shares resulting from the assumed exercise of outstanding stock options and warrants are determined based on the treasury stock method.

The following table sets forth the reconciliation of the weighted average number of shares attributable to common stockholders used to compute basic net income (loss) per share for the three and six months ended June 30, 2013 and 2012.

The following potentially dilutive securities have been excluded from the computations of diluted weighted-average common shares outstanding as of June 30, 2013 and 2012 as their effect would have been anti-dilutive.

Segment Information - The Company currently operates in one business segment, which is the development and commercialization of inhaled therapies for patients with serious lung infections.  A single management team that reports to the Chief Executive Officer comprehensively manages the entire business.  The Company does not operate separate lines of business with respect to its products or product candidates.  Accordingly, the Company does not have separate reportable segments.

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3.                                    Accrued Expenses

                                                Accrued expenses consist of the following:

4.                                     Debt

On June 29, 2012, the Company and its domestic subsidiaries, as co-borrowers, entered into a Loan and Security Agreement that allowed the Company to borrow up $20.0 million in $10.0 million increments (“Loan Agreement”). The Company borrowed the first and second $10.0 million increments by signing two Secured Promissory Notes (“Note A” and “Note B” and collectively, the “Notes”) on June 29, 2012 and December 27, 2012, respectively. Notes A and B bear interest at 9.25%.  Note A was originally scheduled to be repaid over a 42-month period with the first twelve monthly payments representing interest only followed by thirty monthly equal payments of principal and interest. Note B was originally scheduled to be repaid over a 36-month period with the first six monthly payments representing interest only followed by thirty monthly equal payments of principal and interest.  The Loan Agreement provided that in certain circumstances the Company could delay the first principal payment by five months.  In July 2013, subsequent to the completion of certain ARIKACE-related development milestones, the Company elected to extend the interest only period under the Notes from July 31, 2013 to December 31, 2013 and delay the first monthly principal repayments for Notes A and B from August 1, 2013 to January 1, 2014. The election did not change the maturity date for Notes A and B, which is January 1, 2016. The “Current portion of long-term debt” and “Debt, long-term” balances included in the consolidated Balance Sheet as of June 30, 2013 and the future principal repayments summarized in the table below reflect this extension of the interest-only period.

In connection with entering into the Loan Agreement, the Company granted the lender a first position lien on all of the Company’s assets, excluding intellectual property. Prepayment of the loans made pursuant to the Loan Agreement is subject to a prepayment penalty. The Company will be required to pay an “end of term” charge of approximately $0.4 million upon termination of the Loan Agreement, which is being charged to interest expense (and accreted to the debt) using the effective interest method over the term of the Notes. Debt issuance costs paid to the lender were recorded as a discount on the debt and are being amortized to interest expense using the effective interest method over the life of the Loan Agreement. Debt issuance costs paid to third parties were capitalized and are being amortized to interest expense using the effective interest method over the term of the Notes.

The Loan Agreement also contains representations and warranties by the Company and the lender, indemnification provisions in favor of the lender, customary covenants (including limitations on other indebtedness, liens, acquisitions, investments and dividends, but no financial covenants), and events of default (including with respect to payment defaults, breaches of covenants following any applicable cure period, a material impairment in the perfection or priority of the lender’s security interest or in the collateral, and events relating to bankruptcy or insolvency). Upon the occurrence of an event of default, a default interest rate of the base rate plus an additional 5% may accrue on the outstanding loan balances, and the lender may terminate its lending commitment, declare all outstanding obligations immediately due and payable, and take such other actions as set forth in the Loan Agreement. In addition, pursuant to the Loan Agreement, the lender has the right to participate, in an amount of up to $1.0 million, in certain future private equity financing(s) by the Company.

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In conjunction with entering into the Loan Agreement, the Company granted a warrant to the lender to purchase shares of the Company’s common stock. Since the warrant was granted in conjunction with entering into the Loan Agreement, the relative fair value of the warrant was recorded as equity and debt discount.  The portion of the fair value allocated to debt discount is being amortized to interest expense over the term of the related debt using the effective interest method.

The following table presents the components of the Company’s debt balance as of June 30, 2013.

Future principal repayments of the Notes are as follows (in thousands):

The estimated fair value of the debt (categorized as a Level 2 liability for fair value measurement purposes) is determined using current market factors and the ability of the Company to obtain debt at comparable terms to those that are currently in place.  We believe the estimated fair value at June 30, 2013 approximates the gross carrying amount.

5.                                    Shareholders’ Equity

Common Stock — As of June 30, 2013, the Company had 500,000,000 shares of common stock authorized with a par value of $0.01 and 31,999,760 shares of common stock issued and outstanding. Of the shares outstanding as of June 30, 2013, 1,765,271 shares represent holdback shares held by the Company as security for potential indemnification payments, as described in the Agreement and Plan of Merger with Transave, Inc. (the “Merger Agreement”), filed as Exhibit 2.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (see Footnote 9, Commitments and Contingencies, Legal Proceedings, Pilkiewicz v. Transave LLC for additional information regarding these holdback shares). In addition, as of June 30, 2013, the Company has reserved 3,275,156 shares of common stock for issuance upon the exercise of outstanding common stock options and 110,579 shares for issuance upon the vesting of restricted stock units.

Warrant - In conjunction with entering into the Loan Agreement (See Note 4 — Debt),  the Company granted a warrant to the lender to purchase 329,932 shares of the Company’s common stock at an exercise price of $2.94 per share. The fair value of the warrant of $0.8 million was calculated using the Black-Scholes warrant-pricing methodology at the date of issuance and is recorded as equity and as a discount to the debt and is being amortized to interest expense over the term of the promissory notes using the effective interest method. On April 30, 2013, the lender exercised the warrant in full via the “net issuance” method specified in the warrant agreement.  In

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accordance with such provisions, the Company issued and delivered 223,431 shares of common shares to the lender on May 1, 2013.  As a result of the exercise, the warrant is no longer outstanding and there are no additional shares issuable under this instrument.

6.                                    Stock Based Compensation

The Company has three equity compensation plans; the 2013 Incentive Plan, which was approved by shareholders at the Company’s Annual Meeting of Shareholders on May 23, 2013,  the Amended and Restated 2000 Stock Incentive Plan, as amended (the “2000 Stock Incentive Plan”) and the Amended and Restated 2000 Employee Stock Purchase Plan (the “Stock Purchase Plan”). Both the 2000 Stock Incentive Plan and the Stock Purchase Plan were adopted by the Company’s Board of Directors in 2000. Upon the approval of the 2013 Incentive Plan, no additional awards will be issued under the 2000 Stock Incentive Plan and the shares remaining for future grant under the 2000 Stock Incentive Plan were transferred to the 2013 Incentive Plan.

Under the terms of the 2013 Incentive Plan, the Company is authorized to grant a variety of incentive awards based on our common stock, including stock options (both incentive stock options and non-qualified stock options), performance shares and other stock awards, as well as the payment of incentive bonuses to all employees and non-employee directors. The 2013 Incentive Plan provides for a single aggregate per person annual sub-limit of 1,500,000 stock options, performance shares (including RSUs) and shares of restricted stock.  The 2013 Incentive Plan provides for the issuance of a maximum of 3,053,833 shares of common stock, which consists of 3,000,000 shares that were approved by shareholders as part of their approval of the 2013 Incentive Plan at the Annual Meeting of Shareholders on May 23, 2013, and 53,833 remaining shares that were transferred to the 2013 Incentive Plan from the 2000 Stock Incentive Plan. Shares subject to outstanding awards under the 2000 Stock Incentive Plan that are cancelled, expired, forfeited or otherwise not issued will also be added to the number of shares available under the 2013 Incentive Plan. As of June 30, 2013, 2,693,816 shares of the Company’s common stock were reserved for future grants (or issuances) of restricted stock, restricted stock units, stock options, and stock warrants under the 2013 Incentive Plan. The 2013 Incentive Plan will terminate on April 16, 2023 unless it is extended or terminated earlier pursuant to its terms.

Under the terms of the 2000 Stock Incentive Plan, the Company was authorized to grant a variety of incentive awards based on our common stock, including stock options, (both incentive stock options and non-qualified stock options), performance shares, and other stock awards to all employees and non-employee directors. On March 15, 2013, the Company’s Board of Directors amended the 2000 Stock Incentive Plan to provide for a single aggregate per person annual sub-limit for the issuance of a maximum of 1,500,000 stock options, performance shares (including RSUs) and shares of restricted stock.  The 2000 Stock Incentive Plan ceased to be available for additional grants once the Company’s shareholders approved the 2013 Incentive Plan on May 23, 2013.

Under the terms of the Stock Purchase Plan, eligible employees may, from time-to-time, have the opportunity to purchase our common stock at a discount. An option gives its holder the right to purchase shares of our common stock, up to a maximum value of $25,000 per year. The Stock Purchase Plan provides for the issuance of a maximum of 150,000 shares of our common stock to participating employees. Since the Company’s merger with Transave, Inc. in 2010, the Company has not offered employees the right to purchase common stock under the Stock Purchase Plan. As of June 30, 2013, 150,000 shares of the Company’s common stock were reserved for future issuances of common stock under the Stock Purchase Plan.

During the first quarter of 2013, the Company completed a review of equity compensation awards made under its 2000 Stock Incentive Plan and determined that it had inadvertently exceeded the annual per-person sub-limits involving certain awards previously made to certain of its current and past officers and directors (the “excess awards”). The aggregate amount of common stock represented by these excess awards, which consisted of RSUs and stock options, was approximately 1.4 million shares. These awards were deemed to be granted outside of the 2000 Stock Incentive Plan and as such the Company applied liability accounting to these awards and recorded a liability that was included in accrued expenses as of March 31, 2013 and December 31, 2012. On May 23, 2013 (the date of the Company’s 2013 Annual Meeting of Stockholders,), shareholders approved the grants associated with the excess awards, which as of this date, allowed the excess awards to be deemed granted under the 2000 Stock Incentive Plan. As a result, the excess awards were remeasured at fair value on May 23, 2013 and the liability

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was reclassified to Additional paid-in capital. The unrecognized fair value calculated for the excess awards as of May 23, 2013 will be recognized as compensation expense ratably over the remaining requisite service period.

In connection with the appointment of the Company’s Chief Commercial Officer on April 1, 2013, the Company made inducement grants of stock options totaling 300,000 shares of the Company’s common stock.

Stock Options - The Company calculates the fair value of stock options granted using the Black-Scholes valuation model. The Company calculates the fair value of stock options deemed to be granted outside of the 2000 Stock Incentive Plan using liability accounting.  These awards are classified as a liability and remeasured at fair value at the end of each reporting period using the Black-Scholes valuation model and changes in fair value are included in compensation expense in the Consolidated Statements of Comprehensive Loss (see additional disclosures related to stock options granted outside the 2000 Stock Incentive Plan at the end of this Note). The liability was reclassified to Additional paid-in capital when the associated award(s) was deemed to be granted under a shareholder approved incentive plan.  As of June 30, 2013, no outstanding stock options are deemed to be granted outside of the Company’s incentive plans.

The following table summarizes the grant date fair value and assumptions used in determining the fair value of stock options granted under the 2013 Incentive Plan and the 2000 Stock Incentive Plan, as well grants of inducement shares during the three and six months ended June 30, 2013.

For the three and six months ended June 30, 2013, the volatility factor was based on the Company’s historical volatility since the closing of the merger with Transave on December 1, 2010.  The expected life was determined using the simplified method as described in ASC Topic 718, “Accounting for Stock Compensation”, which is the midpoint between the vesting date and the end of the contractual term.  The risk-free interest rate is based on the US Treasury yield in effect at the date of grant.  Forfeitures are based on actual percentage of option forfeitures since the closing of the merger on December 1, 2010, and are the basis for future forfeiture expectations.

The following table summarizes stock option activity for stock options granted under the 2013 Incentive Plan and the 2000 Stock Incentive Plan, as well as grants of inducement shares during the six months ended June 30, 2013 as follows:

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The following table summarizes the stock-based compensation recorded in the Consolidated Statements of Comprehensive Loss related to stock options during the three and six months ended June 30, 2013:

(1) - Included in the $2.9 million is $2.0 million of expense that resulted from the remeasurement of certain stock options that occurred during the three months ended June 30, 2013.

(2) - Included in the $3.6 million is $2.3 million of expense that resulted from the remeasurement of certain stock options that occurred during the six months ended June 30, 2013.

As of June 30, 2013, there was $21.2 million of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 2.96 years. The following table summarizes by range of exercise prices the number of stock options outstanding and exercisable as of June 30, 2013:

Restricted Stock and Restricted Stock Units — The Company grants Restricted Stock Units (“RSUs”) to its directors and to eligible employees, including executives. Each RSU represents a right to receive one share of the Company’s common stock upon the completion of a specific period of continued service or achievement of a certain milestone. RSU awards granted under the Company’s 2000 Stock Incentive Plan are generally valued at the market price of the Company’s common stock on the date of grant.  The Company recognizes compensation expense for the fair values of these RSUs on a straight-line basis over the requisite service period of these awards, which is generally one to three years. In prior years certain RSUs were granted in excess of certain plan sub-limits.  Such awards were considered to be granted outside the 2000 Stock Incentive Plan.  The Company used liability accounting and remeasured these excess awards at fair value at the end of each reporting period, and changes in fair value were included in compensation expense in the Consolidated Statements of Comprehensive Loss. As of June 30, 2013, no outstanding RSUs are deemed to be granted outside of the Company’s incentive plans.

The following table summarizes the RSU activity for awards granted under the 2000 Stock Incentive Plan during the six months ended June 30, 2013:

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The following table summarizes the stock-based compensation recorded in the Consolidated Statements of Comprehensive Loss related to RSUs during the three and six months ended June 30, 2013:

(1) - Included in the $1.1 million is $0.9 million of expense that resulted from the remeasurement of certain RSUs that occurred during the three months ended June 30, 2013.

(2) - Included in the $1.4 million is $0.9 million of expense that resulted from the remeasurement of certain RSUs that occurred during the six months ended June 30, 2013.

As of June 30, 2013, there was $0.6 million of unrecognized compensation expense related to unvested RSUs, which is expected to be recognized over a weighted average period of 0.6 years.

7.                                  License and Collaborative Agreements

Premacure (now Shire plc) - In May, 2012, the Company entered into an agreement with Premacure Holdings AB and Premacure AB of Sweden (collectively, “Premacure”) pursuant to which the Company granted to Premacure an exclusive, worldwide license to develop, manufacture and commercialize IGF-1, with its natural binding protein, IGFBP-3,  for the prevention and treatment of complications of preterm birth in exchange for royalty payments on commercial sales of IGF-1 (the “Premacure License Agreement”).  In March 2013, we amended the Premacure License Agreement to provide Premacure with the option, exercisable by Premacure any time prior to April 30, 2013, to pay us $11.5 million (the “Buyout Amount”) and assume any of our royalty obligations to other parties in exchange for a fully paid license. On April 29, 2013, Premacure exercised this option and paid the Company $11.5 million in exchange for a fully paid license. The Company recorded this payment as Other revenue during the three months ended June 30, 2013.  The Company is not entitled to any additional future royalties from Premacure, and Premacure has assumed the Company’s royalty obligations to other parties under the Premacure License Agreement.

8.                                  Income Taxes

The provision (benefit) for income taxes was $0 during the three months ended June 30, 2013 and 2012, and ($1.2 million) and $0 during the six months ended June 30, 2013 and 2012, respectively. The Company’s effective tax rate was 0% during the three months ended June 30, 2013 and 2012, and (5.1%) and 0% for the six months ended June 30, 2013 and 2012, respectively. The benefit for income taxes recorded and the effective tax rate for the six months ended June 30, 2013 solely reflect the reversal of a valuation allowance previously recorded against the Company’s New Jersey State net operating losses (“NOL”) that resulted from the Company’s sale of

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$27.0 million of its New Jersey State NOLs under the State of New Jersey’s Technology Business Tax Certificate Transfer Program (the “Program”) for cash of $1.2 million, net of commissions. The Program allows qualified technology and biotechnology businesses in New Jersey to sell unused amounts of NOLs and defined research and development tax credits for cash. The remaining net deferred tax asset as of March 31, 2013 remains fully offset by a valuation allowance due to the Company’s history of losses.

As of December 31, 2012, the Company had NOL carryforwards for income tax purposes of $350.0 million available to offset future taxable income, if any. The NOL carryforwards expire in various years beginning in 2013. The Company is not currently subject to any open tax audits and the statute of limitations for tax audits is generally open for the years 2009 and later. However, except in 2009, the Company has incurred net operating losses since inception. Such loss carryforwards would be subject to audit in any tax year in which those losses are utilized, notwithstanding the year of origin.

The Company’s policy is to recognize interest accrued related to unrecognized tax benefits and penalties in income tax expense. The Company has not recorded such expenses.  As of June 30, 2013, the Company did not record any reserves for unrecognized income tax benefits, nor did it record any accrued interest or penalties related to uncertain tax positions. The Company does not anticipate any material changes in the amount of unrecognized tax positions over the next twelve months.

Utilization of the Company’s NOL and general business tax credit carryforwards may be subject to a substantial limitation under Section 382 of the Internal Revenue Code of 1986 due to changes in ownership of the Company that have occurred previously or that could occur in the future. These ownership changes may limit the amount of NOL and general business tax credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. Since the Company’s formation, it has raised capital through the issuance of common stock on several occasions which, combined with the purchasing shareholders’ subsequent disposition of those shares, may have resulted in a change of control, as defined by Section 382, and it issued a substantial amount of shares of common stock as part of its merger with Transave, Inc. in December 2010. Due to the significant complexity and cost associated with a change in control study, and because there could be additional changes in control in the future, the Company has not yet formally assessed whether there has been one or more changes in control since the Company’s formation. If the Company experienced a change of control at any time since Company formation, utilization of its NOL or general business tax credit carryforwards would be subject to the limitation rules under Section 382. Any limitation may result in expiration of a portion of the NOL or general business tax credit carryforwards before utilization which would reduce the Company’s gross deferred tax assets.

9.                                  Commitments and Contingencies

Commitments

The Company has two operating leases for office and laboratory space located in Monmouth Junction, NJ through December 31, 2014.  Future minimum rental payments under these two leases total approximately $1.1 million. We continue to lease office space in Richmond, VA, where the Company’s corporate headquarters were previously located through October 2016. Future minimum rental payments under this lease total approximately $1.6 million.  During 2011, we recorded a net present value charge of $1.2 million in general and administrative expenses associated with vacating the Richmond facility. The remaining accrual for this charge was $0.8 million as of June 30, 2013.

Rent expense charged to operations was $0.2 million for each of the three month periods ended June 30, 2013 and 2012. Future minimum rental payments required under the Company’s operating leases are as follows (in thousands).

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Legal Proceedings

Cacchillo v. Insmed

On October 6, 2010, a complaint was filed against the Company by Angeline Cacchillo (“Plaintiff”) in the U.S. District Court for the Northern District of New York (the “Court”), captioned Cacchillo v. Insmed, Inc., No. 1:10-cv-0199, seeking monetary damages and a court order requiring Insmed to support Plaintiff’s compassionate use application to the FDA and if approved, to provide Plaintiff with IPLEX.  Plaintiff was a participant in the Phase 2 clinical trial of IPLEX sponsored by us evaluating the effectiveness of the investigational drug in patients with type 1 myotonic muscular dystrophy (“MMD”).  In the complaint, Plaintiff alleged (i) violation of constitutional due process and equal protection by depriving Plaintiff of continued access to IPLEX, (ii) fraudulent inducement to enter the Phase 2 clinical trial with the false promise to support Plaintiff’s compassionate use application to the FDA, (iii) negligent representation that the Company would support Plaintiff’s compassionate use application, (iv) breach of contract, seeking monetary and non-monetary damages, (v) intentional infliction of emotional distress by refusing to support Plaintiff’s compassionate use application after providing IPLEX, (vi) violation of an assumed duty of care to Plaintiff, (vii) breach of fiduciary duty to Plaintiff, (viii) negligence and (ix) unjust enrichment.  Plaintiff sought compensatory and punitive monetary damages and injunction relief as noted above.

On October 7, 2010, Plaintiff filed a motion for a preliminary injunction that would require us to provide a written statement supporting the “compassionate use” of IPLEX for Plaintiff and directing us to provide IPLEX to Plaintiff at cost in the event that the compassionate use application were granted by the FDA.  On October 22, 2010, the Court denied Plaintiff’s motion for the preliminary injunction concluding that the Court lacked subject matter jurisdiction with respect to her claim for a preliminary injunction.  Plaintiff appealed the Court’s denial of her motion for a preliminary injunction to the U.S. Court of Appeals for the Second Circuit, which affirmed the trial court’s order denying the Plaintiff’s motion for a preliminary injunction.

We filed a motion with the Court to dismiss all of the outstanding claims, and on June 29, 2011, the Court dismissed six of Plaintiff’s claims, leaving outstanding the claims for (i) fraudulent inducement, (ii) negligent misrepresentation, and (iii) breach of contract.  The Company filed an answer and affirmative defenses with the Court on July 12, 2011, and the parties completed discovery on or about June 1, 2012.  The Company filed a Motion for Summary Judgment on August 1, 2012 seeking judgment in our favor on the three claims remaining in the case. On January 19, 2013, the Court granted the Company’s Motion for Summary Judgment and dismissed all of the outstanding claims. Plaintiff appealed the Court’s decision to the U.S. Court of Appeals for the Second Circuit.  The Company anticipates a decision in the first half of 2014.

Pilkiewicz v. Transave LLC

On March 28, 2011, Frank G. Pilkiewicz and other former stockholders of Transave, Inc. (collectively, the “Petitioners”) filed an appraisal action against the Company’s subsidiary Transave, LLC in the Delaware Court of Chancery captioned Frank G. Pilkiewicz, et al. v. Transave, LLC , C.A. No. 6319-CS. On December 13, 2011, following the mailing of the revised notice of appraisal rights in accordance with the settlement terms of Mackinson et al. v. Insmed, the Petitioners filed an Amended Petition for Appraisal of Stock.

The Petitioners seek appraisal under Delaware law of their total combined common stock holdings representing total dissenting shares of approximately 7.77 million shares of Transave, Inc. common stock (the “Transave Stock”). The Petitioners are challenging the value of the consideration that they would be entitled to receive for their Transave Stock under the terms of the merger.

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Under the terms of the Merger Agreement, certain of the former stockholders of Transave, Inc. (the “Transave Stockholders”) are obligated to indemnify the Company for certain liabilities in connection with the appraisal action. The Company notified the Transave Stockholders in May 2012 that the Company is seeking indemnification in accordance with the Merger Agreement and that it will continue to retain the aggregate amount of the holdback shares totaling 1,765,271 shares, as security for any indemnification payments due under the Merger Agreement.  Discovery is nearly completed and the trial is scheduled to begin in December 2013. The Company believes that the allegations contained in the amended petition are without merit, and we intend to continue to vigorously defend this action.  It is not possible at this time to estimate the amount of loss or range of possible loss, if any, that might result from an adverse resolution of this action.

From time to time, the Company is a party to various other lawsuits, claims and other legal proceedings that arise in the ordinary course of our business.  While the outcomes of these matters are uncertain, management does not expect that the ultimate costs to resolve these matters will materially adversely affect the Company’s business, consolidated financial position, results of operations or cash flows.

10.                           Subsequent Events

Extension of Interest-Only Period - As disclosed in more detail in Note 4. “Debt”, during July 2013, subsequent to the completion of certain ARIKACE-related development milestones, the Company elected to extend the interest only period on its outstanding Notes from July 31, 2013 to December 31, 2013. As a result, the related monthly principal repayments for Notes A and B will now begin on January 1, 2014, instead of August 1, 2013. The election did not change the maturity dates for Notes A and B, which is January 1, 2016. The “Current portion of long-term debt” and “Debt, long-term” balances included in the consolidated Balance Sheet as of June 30, 2013 and the future principal repayments included in Note 4 “Debt” reflect this extension of the interest-only period.

Common Stock Offering - On July 22, 2013, the Company completed an underwritten public offering of 6,900,000 shares of the Company’s common stock, which includes the underwriter’s exercise in full of its over-allotment option of 900,000 shares, at a price to the public of $10.40 per share. The Company’s net proceeds from the sale of the shares, after deducting the underwriter’s discount and estimated offering expenses, is expected to be approximately $67.0 million.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward looking statements.  “Forward-looking statements,” as that term is defined in the Private Securities Litigation Reform Act of 1995, are statements that are not historical facts and involve a number of risks and uncertainties.  Words herein such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,” “potential,” “continues,” and similar expressions (as well as other words or expressions referencing future events, conditions or circumstances) identify forward-looking statements.

Forward-looking statements include, but are not limited to: failure or delay of European, Canadian, U.S. Food and Drug Administration and other regulatory reviews and approvals, competitive developments affecting the Company’s product candidates, delays in product development or clinical trials or other studies, patent disputes and other intellectual property developments relating to the Company’s product candidates, unexpected regulatory actions, delays or requests, the failure of clinical trials or other studies or results of clinical trials or other studies that do not meet expectations, the fact that subsequent analyses of clinical trial or study data may lead to different (including less favorable) interpretations of trial or study results or may identify important implications of a trial or study that are not reflected in Company’s prior disclosures, and the fact that trial or study results or subsequent analyses may be subject to differing interpretations by regulatory agencies, the inability to successfully develop the Company’s product candidates or receive necessary regulatory approvals, inability to make product candidates commercially successful, changes in anticipated expenses, changes in the Company’s financing requirements or ability raise additional capital; our ability to complete development of, receive regulatory approval for, and successfully commercialize ARIKACE®; our estimates of expenses and future revenues and profitability; our plans to develop and market new products and the timing of these development programs; our estimates of the size of the potential markets for our product candidates; our selection and licensing of product candidates; our ability to attract third parties with acceptable development, regulatory and commercialization expertise; the benefits to be derived from corporate license agreements and other third party efforts, including those relating to the development and commercialization of our product candidates; the degree of protection afforded to us by our intellectual portfolio; the safety and efficacy of our product candidates; sources of revenues and anticipated revenues, including contributions from license agreements and other third party efforts for the development and commercialization of products; our ability to create an effective direct sales and marketing infrastructure for products we elect to market and sell directly; the rate and degree of market acceptance of our product candidates; the timing and amount of reimbursement for our product candidates; the success of other competing therapies that may become available; and the availability of adequate supply and manufacturing capacity and quality for our product candidates.

Forward-looking statements are based upon our current expectations and beliefs, and involve known and unknown risk, uncertainties and other factors, which may cause our actual results, performance and achievements and the timing of certain events to differ materially from the results, performance, achievements or timing discussed, projected, anticipated or indicated in any forward-looking statements.  Such factors include, among others, the factors discussed in Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 18, 2013.  We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date they are made.  We disclaim any obligation, except as specifically required by law and the rules of the Securities and Exchange Commission, to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and related notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2012.

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OVERVIEW

Insmed is a biopharmaceutical company focused on developing and commercializing an inhaled anti-infective to treat patients battling serious lung diseases that are often life-threatening. Our lead product candidate, ARIKACE® or liposomal amikacin for inhalation, is an inhaled antibiotic treatment that delivers a proven and potent anti-infective directly to the site of serious lung infections.

Recent Developments and ARIKACE Clinical Summary

In July 2013, Christine Pellizzari was appointed as our General Counsel and Corporate Secretary.  In addition, our Board of Directors determined that Donald J. Hayden, our Chairman since December 2010, was independent and that the designation of Dr. Randall Whitcomb, a director since 2001, as lead independent director was no longer necessary.

In July 2013, we completed an underwritten public offering of 6,900,000 shares of our common stock, which includes the underwriter’s exercise in full of its over-allotment option of 900,000 shares, at a price to the public of $10.40 per share. The net proceeds from the sale of the shares, after deducting the underwriter’s discount and estimated offering expenses, is expected to be approximately $67.0 million.

In July 2013, we announced top-line results from our Phase 3 registrational clinical trial of ARIKACE in cystic fibrosis (“CF”) patients who have lung infections caused by Pseudomonas aeruginosa (“Pa”) that was conducted in Europe and Canada. In summary, once-daily ARIKACE achieved its primary endpoint of non-inferiority when compared to twice-daily “TOBI” (“tobramycin inhalation solution”) for relative change in FEV1 from baseline to the end of the study.

We are conducting a Phase 2 clinical trial in patients who have lung infections caused by non-tuberculous mycobacteria (“NTM”) in the U.S and Canada. We are also conducting a two-year, open-label safety study that is enrolling eligible patients who have completed our Phase 3 registrational clinical trial in CF patients in Europe and Canada. Our primary development focus is to obtain regulatory approval for ARIKACE for these two initial indications and to prepare for commercialization initially in Europe and Canada and then in the United States (“US”).  If approved, ARIKACE will be the first once-a-day inhaled antibiotic treatment option available for these CF and NTM indications.  Our strategy is to continue to develop ARIKACE for additional indications beyond CF patients with Pa infections and patients with NTM lung infections. The following table summarizes the current status of ARIKACE development.

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ARIKACE is considered a new molecular entity (NME) by the FDA primarily due to its proprietary liposomal technology. The key active ingredient, amikacin, is an FDA-approved antibiotic with proven efficacy in the treatment of a broad range of gram-negative infections, including Pa and NTM. ARIKACE is in the aminoglycoside class of antibiotics.

ARIKACE is differentiated from other inhaled antibiotics used to treat serious lung infections by our proprietary advanced liposomal technology, which is designed specifically to enhance the delivery profile, safety and efficacy of pharmaceuticals delivered to the lung via inhalation. We believe ARIKACE provides potential improvements over existing treatments for these indications. In our Phase 3 study in CF patients with Pa lung infections, ARIKACE, administered once-daily demonstrated improvements in patient lung function that were comparable to TOBI (“tobramycin inhalation solution”), administered twice-daily and that remained above baseline at the end of the study.

If approved for CF patients with Pa lung infections, we expect ARIKACE would be the first inhaled antibiotic to be approved for once-daily administration in this indication. If approved for NTM patients, we expect ARIKACE would be the first and only approved treatment for NTM lung infections. ARIKACE has been granted orphan drug designation for CF patients who have Pa lung infections in both the European Union (“EU”) and the US, and for NTM patients in the US. We plan to file for orphan drug designation for NTM lung infections in Europe during the second half of 2013. On June 28, 2013, ARIKACE was granted QIDP designation and Fast Track designation by the FDA for the “treatment of Non-Tuberculous Mycobacterial lung infections.”

Corporate History

We were incorporated in the Commonwealth of Virginia on November 29, 1999. On December 1, 2010, we completed a business combination with Transave, Inc. (or “Transave”) a privately held, New Jersey-based pharmaceutical company focused on the development of differentiated and innovative inhaled pharmaceuticals for the site-specific treatment of serious lung infections. Our current operations are based on the technology and product candidates historically developed by Transave.

Lead Product Candidate - ARIKACE

Our lead product candidate, ARIKACE or liposomal amikacin for inhalation, is a once-a-day inhaled antibiotic treatment engineered to deliver a proven and potent anti-infective directly to the site of serious lung infections. There are two key components of ARIKACE: the liposomal formulation of the drug and the nebulizer device through which ARIKACE is inhaled through the mouth and into the lung. The nebulizer technology is owned by PARI Pharma GmbH (“PARI”), but through our licensing agreement with PARI, we have exclusive access to this technology, which is specifically developed for the delivery of our liposomal encapsulation of amikacin. Our proprietary liposomal technology and nebulizer are designed specifically for delivery of pharmaceuticals to the lung and provides for potential improvements to existing treatments.  We believe that ARIKACE has potential usage for at least two orphan patient populations with high unmet need: CF patients who have Pa lung infections and patients who have NTM lung infections.  We estimate the combined global market potential for these two orphan indications to be approximately $1 billion.

ARIKACE has the potential to be differentiated from other marketed drugs for the treatment of chronic lung infections by improving efficacy, safety and patient convenience. We believe efficacy may be improved for the treatment of certain lung infections due to the ability of ARIKACE to deliver high, sustained levels of amikacin directly to the lung and to the specific site of the underlying infection.  In addition, the inhalation delivery of

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ARIKACE may reduce the potential for adverse events such as ototoxicity (hearing loss, ringing in the ears and/or loss of balance) and nephrotoxicity (toxicity to the kidneys), as compared with intravenous (IV) administration of amikacin.  If approved, we expect that ARIKACE will be administered once daily for approximately 13 minutes via inhalation using the eFlow® Nebulizer System, which has been optimized specifically for ARIKACE by PARI. We believe that this nebulizer system will reduce treatment time or dosing frequency, as compared with the currently marketed inhaled antibiotics, which require dosing two to three times daily with treatment times ranging from approximately 10 to 40 minutes per day.  By easing the patient’s treatment burden we believe that ARIKACE can potentially improve patient compliance, which we believe may in turn lead to a reduction in the development of antibiotic resistance and, ultimately, lead to clinical benefit.

We believe that ARIKACE may provide: (1) improved efficacy resulting from sustained deposition of drug in the lung and improved ability to reach the site of infection (for CF Pa infections, this means penetration of biofilm and facilitated drug release by factors that are secreted by the bacteria, and for NTM, this means enhanced uptake into macrophages, where NTM often grows); (2) decreased adverse events and improved tolerability as compared with amikacin delivered intravenously; and (3) reduced dosing frequency or treatment time as compared to existing products.

ARIKACE for CF Patients with Pseudomonas aeruginosa (“Pa”) Lung Infections

Disease

CF is an inherited chronic disease that affects the lungs and digestive system and is often diagnosed before the age of two.  CF occurs primarily in individuals of central and western European origin.  CF affects roughly 70,000 children and adults worldwide, including 30,000 children and adults in the US (Cystic Fibrosis Foundation Patient Registry, 2011) and 35,000 patients in Europe (Hoiby, BMC Medicine, 2011, 9:32). There is no cure for CF.

Despite extensive treatment with multiple antibiotics, improved nutrition, and other treatments, the life expectancy of a CF patient is only about 37 years (Cystic Fibrosis Foundation Patient Registry, 2011).  Median predicted age of survival is calculated using life table analysis (as calculated by actuaries) given the ages of the patients in the registry and the distribution of deaths. Using this calculation, half of the people in the patient registry are expected to live beyond the median predicted survival age, and half are expected to live less than the median predicted survival age.

Among other issues, in CF patients a defective gene and its protein product cause the body to produce unusually thick, sticky mucus that clogs the lungs.  This creates an ideal environment for various pathogens, such as Pa, to colonize and lead to chronic infection of the lung, inflammation and progressive loss of lung function. In fact, chronic bronchial infections with Pa are a major cause of morbidity and mortality among patients with CF. Once a CF patient acquires a Pa infection, it is difficult to eradicate. The current, best available treatment is chronic administration of antibiotics to suppress the bacteria, reduce inflammation and preserve lung function for as long as possible.  The rate of infection with Pa in CF patients increases with age.  It is estimated that 70% of adult CF patients have chronic infection due to Pa (CFF Patient Registry, 2011).  A study reported in the Journal of Cystic Fibrosis (Liou, 2010) found that deterioration in lung function of CF patients is the main cause of death and that, despite best efforts, lung function declines by 1% to 3% annually.

Current Clinical Program

We recently completed a registrational Phase 3 clinical trial of ARIKACE for CF patients with Pa lung infections in Europe and Canada. The Phase 3 trial was a randomized, open label, multi-center study designed to access the comparative safety and efficacy of once-daily ARIKACE for approximately 13 minutes via the eFlow Nebulizer System and twice-daily TOBI (tobramycin inhalation solution) for approximately 15 minutes per treatment via the PARI LC Plus Nebulizer System for a daily total of approximately 30 minutes per day in CF patients with Pa.  A total of 302 adult and pediatric CF patients with chronic Pa were randomized to receive 28-days of ARIKACE treatment or TOBI delivered twice-daily via the PARI LC Plus® Nebulizer System over a 24-week treatment period. The primary endpoint of the study was relative change in forced expiratory volume in one second (“FEV1”) measured after three treatment cycles, with each cycle consisting of 28 days “on” treatment and 28 days “off” treatment.  The study was designed to demonstrate non-inferiority to TOBI at a 5% non-inferiority margin

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with 80% power agreed upon by us and the European Medicines Agency (EMA). Secondary endpoints measured were relative changes in FEV1 at other time points, time to and number of pulmonary exacerbations, time to antibiotic rescue treatment, change in density of Pa in sputum, respiratory hospitalizations and changes in Patient Reported Outcomes assessing Quality of Life. Top-line results from this study indicated:

·                  ARIKACE achieved its primary endpoint of non-inferiority to TOBI for relative change in FEV1 from baseline to the end of the study;

·                  Overall, secondary endpoints, as summarized above, showed comparability of once-daily ARIKACE compared with twice-daily TOBI; and

·                  The safety profile of ARIKACE was comparable to TOBI during all three treatment cycles, with adverse events consistent with those seen in similar studies and expected in a population of CF patients receiving inhaled antibiotics. There was no difference between arms in the reporting of serious adverse events and there were no unexpected adverse events.

We are conducting a two-year, open label safety study that is enrolling eligible patients that completed our registrational Phase 3 clinical study of ARIKACE for CF patients with Pa lung infections in Europe and Canada.  Approximately 75% of the eligible patients from the registrational Phase 3 clinical study have consented to participate in the safety study. The patients in this study will receive ARIKACE for up to a two year period, using the same cycles of a 28 day on-treatment period and a 28 day off-treatment period. We expect to use interim data from this study as part of our regulatory filings with the EMA and Health Canada, which we expect to submit during the first half of 2014, and we expect to complete this study in mid-2015.

ARIKACE has been granted orphan drug status in the US and Europe for the treatment of Pa lung infections.

Strategy for Commercialization

We currently plan to retain marketing rights for ARIKACE in certain countries in Europe, and in Canada and the US. We believe ARIKACE will require a limited commercial infrastructure in these regions because of the small focused nature of the potential physician prescribing population for CF patients.  We may license ARIKACE for certain indications in certain countries in Europe, as well as outside of Europe, and in Canada and the US.  In 2013, we commenced preparations for the potential commercialization of ARIKACE in Europe and Canada, including hiring Matt Pauls, our chief commercial officer. We plan to fill several other new positions to support our sales and marketing efforts.

ARIKACE for Patients with NTM Lung Infections

Disease

Non-tuberculous mycobacteria, or NTM, are organisms common in soil and water that have been associated with lung disease in select patient groups. NTM have characteristics that are similar to tuberculosis, or TB, but NTM are not contagious.  Many people have NTM in their bodies, but NTM do not normally lead to an infection, perhaps because the body’s immune system successfully overcomes the threat of infection.  It is not completely understood why certain individuals are susceptible to NTM infections. However, the patients who become infected with NTM often are immune-compromised or have structural damage in their lungs at the time of the infection.

NTM are organisms that invade and multiply chiefly within macrophages.  They are characteristically resistant to most antibiotics. NTM lung infections are chronic, debilitating and progressive and often require lengthy, repeat hospitalizations. Signs and symptoms of NTM pulmonary disease are variable and nonspecific.  They include chronic cough, sputum production and fatigue.  Less commonly, malaise, dyspnea, fever, hemoptysis, and weight loss also can occur, usually with advanced NTM pulmonary disease. Evaluation is often complicated by the symptoms caused by co-existing lung diseases.  According to a study published in the American Journal of Respiratory and Critical Care Medicine, these conditions include chronic obstructive airway disease

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associated with smoking, bronchiectasis, previous mycobacterial diseases, CF and pneumoconiosis (Olivier et al. 2003).

Current Clinical Program

We are currently conducting a Phase 2 clinical trial in the US and Canada for ARIKACE in adult patients with NTM lung infections.  We began enrolling patients in June 2012. The Phase 2 clinical trial is a randomized, placebo-controlled study of approximately 100 adult patients with recalcitrant NTM lung infections.  Of the targeted enrollment of 100 patients, 81 patients have been enrolled in this study as of June 30, 2013. There are two parts to the study:  a randomized portion and an open-label portion.

In the randomized portion of the study, patients are screened initially to include in the study those who have NTM lung infections with persistent sputum culture for MAC or M. abscessus while on American Thoracic Society and Infectious Disease Society of America (ATS/IDSA)-guidelines-based treatment regimen for at least six months prior to screening.  Patients who are NTM culture positive and meet the eligibility criteria to enroll in the study will receive, in addition to their ongoing antibiotic treatment regimen, either ARIKACE or a placebo both delivered once daily for approximately 13 minutes via an optimized, investigational eFlow Nebulizer System. The primary efficacy endpoint for this study is the change in mycobacterial density from baseline to the end of 84 days of treatment.  At a public workshop discussion in September 2012, the FDA agreed that the microbiological end-point is an appropriate primary end-point for NTM lung disease. The study will also measure secondary endpoints, including the proportion of patients with culture conversion to negative, the time to “rescue” anti-mycobacterial drugs, the change from baseline in six-minute walk distance and oxygen saturation, the change from baseline in patient reported outcomes, and evaluation of safety and tolerability.

At the conclusion of the randomized portion of the study, eligible patients will receive ARIKACE once daily for an additional 84 days during the open-label portion of the study, primarily to measure longer-term safety and efficacy.  We previously agreed with the FDA on this clinical trial design.

On June 28, 2013, the FDA designated ARIKACE as a Qualified Infectious Disease Product (“QIDP”) for the treatment of NTM. The QIDP designation for ARIKACE will enable us to benefit from certain incentives for the development of new antibiotics, including potentially more frequent and ongoing dialogue with FDA, priority review, and if ARIKACE is ultimately approved by the FDA, a five-year exclusivity extension under the “The Drug Price Competition and Patent Term Restoration Act, also known as the “Hatch-Waxman” Act. These incentives are provided under the “Generating Antibiotic Incentives Now” Act (the “GAIN” Act), which was signed into law in July 2012.

Additionally, on June 28, 2013, the FDA granted Fast Track designation to ARIKACE for the treatment of NTM. The Fast Track designation is intended to expedite the review of new drugs that have the potential to serve unmet medical needs in serious or life-threatening conditions.

ARIKACE has been granted orphan drug designation in the US for the treatment of patients with NTM.

Pursuant to ARIKACE’s recently designated QIDP status, we expect to continue our dialogue with the FDA regarding the regulatory pathway for registration and approval of ARIKACE for the treatment of NTM, and we expect to complete our review of the results from this clinical trial and related dialogue with the FDA by the end of the first quarter of 2014.

In addition to the Phase 2 clinical trial outlined above, we intend to initiate a compassionate use study during the second half of 2013.  We currently anticipate enrolling approximately 25 patients in this study who have NTM lung infections that are not eligible for enrollment into our Phase 2 clinical trial.  We believe that clinical data collected from our experience with these patients will further help regulatory authorities evaluate ARIKACE’s safety and suitability for treating NTM lung infection patients.

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Strategy for Commercialization

We currently plan to retain marketing rights for ARIKACE in certain countries in Europe, and in Canada and the US.  Given the current lack of approved treatments for NTM lung infections, we believe we will immediately have a strong market position if ARIKACE is approved for commercialization in the NTM indication.  We believe ARIKACE will require a limited commercial infrastructure in these regions because of the small focused nature of the potential physician prescribing population for NTM patients.

We may seek to license ARIKACE for certain indications in certain countries in Europe, as well as outside of Europe, Canada and the US.  We believe there will be substantial carryover between lung specialist physicians who treat CF patients with Pa lung infections and those who have NTM lung infections thereby allowing us to leverage our commercial infrastructure across both indications.

ARIKACE for Non-CF Bronchiectasis Patients with Pseudomonas aeruginosa (“Pa”) Lung Infections

Disease

We believe ARIKACE has the potential to be used to treat non-CF bronchiectasis characterized by Pa lung infections.  However, we are currently concentrating our development efforts on the treatment of Pa lung infections in CF patients and patients with NTM lung infections.  We will evaluate our development and commercialization strategies for this indication when we complete our Phase 2 study in patients with NTM infections.

Non-CF bronchiectasis is a serious pulmonary condition characterized by localized, irreversible enlargement of the bronchial tubes.  Accumulation of mucus in the bronchi leads to frequent infections, which causes inflammation and further reduces lung function.  Patients evolve to a chronic inflammation-infection cycle.  Disease burden has primarily been linked to productive cough and high levels of sputum production.

Development Program

In May 2009, we completed our randomized, placebo controlled US Phase 2 study (TR02-107) of ARIKACE for the treatment of chronic Pa infection in non-CF patients with bronchiectasis. In the study, 64 study subjects were randomized (1:1:1) to receive ARIKACE 280 mg, ARIKACE 560 mg or a placebo on a daily basis during a 28-day on-treatment period. The subjects completed follow-up assessments at the end of a 28-day off-treatment period.  This study provided an initial evidence of safety, tolerability and clinically meaningful improvement in pulmonary function throughout the on-treatment period in the treatment of chronic Pa infection in non-CF patients with bronchiectasis.

In the study, both ARIKACE 280 mg and ARIKACE 560 mg were well tolerated.  The adverse events experienced by patients during the study were consistent with underlying chronic lung disease in bronchiectasis patients.  There was no evidence of renal toxicity or ototoxicity.  Patients in the 560-mg cohort appear to have a slightly higher frequency of dry cough post administration than patients in the 280 mg cohort.  Cough was of short duration and self-limiting.  One patient discontinued treatment due to dysphonia (hoarseness or difficulty speaking) and cough.

There was a statistically significant reduction in Pa density observed in the 560 mg ARIKACE cohort relative to the placebo cohort.  Patients receiving ARIKACE experienced fewer pulmonary exacerbations at a rate of 4.7%, as compared to 10.5% in those receiving placebo.  No patients in the ARIKACE cohorts required anti-Pa rescue treatment, whereas 15% of patients in the placebo cohort required treatment.  Hospitalization from any cause occurred at a 5.3% rate for patients in the placebo cohort, as compared to a 2.3% rate for patients in the ARIKACE cohort.  Patients receiving ARIKACE achieved improvements in patient respiratory symptoms and quality of life assessments compared with patients receiving placebo.

Although we believe there is an opportunity to develop ARIKACE for non-CF bronchiectasis, we do not intend to initiate further clinical studies with respect to a non-CF bronchiectasis indication until we have completed additional clinical studies for CF patients with Pa lung infections and for patients with NTM lung infections.  Following those studies, we will evaluate whether to develop ARIKACE further for non-CF bronchiectasis.

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ARIKACE has been granted orphan drug status in the US for the treatment of bronchiectasis in patients with Pa or other susceptible pathogens.

INTELLECTUAL PROPERTY

Patents

In addition to the intellectual property already granted to us, during May 2013, the European Patent Office informed us that they intend to grant us Patent No. 1909759 entitled “Sustained Release of Anti-infective Aminoglycosides” for ARIKACE. The granted patent provides protection for novel anti-infective formulations comprising an aminoglycoside, including ARIKACE, and our liposomal delivery technology. Once granted, the composition of matter patent provides exclusivity in any of the European Patent Office’s member states where we choose to file at least through July 19, 2026. The granted patent also includes claims relating to the use of the aforementioned aminoglycoside/lipid formulations for treating pulmonary infections, including those caused by Pa lung infections and certain mycobacterial infections, among others.

KEY COMPONENTS OF OUR STATEMENT OF OPERATIONS

Other Revenue

Other revenue during the three months ended June 30, 2013 solely consists of an $11.5 million payment the Company received from Premacure (now Shire plc) in exchange for the Company’s right to receive royalties under its license agreement with Premacure (see Note 7. License and Collaborative Agreements to the consolidated financial statements included in Part 1. Financial Information, Item 1. Financial Statements for additional information regarding our agreement with Premacure). The Company recorded this as Other revenue during the three months ended June 30, 2013, since all four revenue recognition criteria (see below) were present and the Company has no continuing performance obligations related to the payment received.

Research and Development Expenses

Research and development expenses consist primarily of salaries, benefits and other related costs, including stock-based compensation, for personnel serving in our research and development functions,  and other internal operating expenses, the cost of manufacturing our drug candidate for clinical study, the cost of conducting clinical studies, and the cost of conducting preclinical and research activities. Our expenses related to manufacturing our drug candidate for clinical study are primarily related to activities at a contract manufacturing organization that manufactures ARIKACE for our use.  Our expenses related to clinical trials are primarily related to activities at contract research organizations that conduct and manage clinical trials on our behalf. These contracts set forth the scope of work to be completed at a fixed fee or amount per patient enrolled. Payments under these contracts primarily depend mainly on performance criteria such as the successful enrollment of patients or the completion of clinical trial milestones as well as time-based fees. Expenses are accrued based on contracted amounts applied to the level of patient enrollment and to activity according to the clinical trial protocol. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts are then recognized as an expense as the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided.

Since 2011, we have focused our development activities principally on our proprietary, advanced liposomal technology designed specifically for inhalation lung delivery. We recently completed a registrational Phase 3 clinical trial of ARIKACE for CF patients with Pa lung infections in Europe and Canada. We are currently conducting two clinical trials: (1) a two-year,  open label safety study that is enrolling eligible patients who completed the Phase 3 trial, and (2) a Phase 2 trial in the US in which we are evaluating ARIKACE for NTM infections.  Since our business combination with Transave through June 30, 2013, our external research and development expenses for our ARIKACE program have been approximately $59.9 million. We expect that our development efforts during the second half of 2013 and 2014 will principally relate to the study of ARIKACE in the CF and NTM indications.

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Our clinical trials with ARIKACE are subject to numerous risks and uncertainties that are outside of our control, including the possibility that necessary regulatory approvals may not be obtained.  In addition, the duration and the cost of clinical trials may vary significantly from trial to trial over the life of a project as a result of differences in the study protocol for each trial as well as differences arising during the clinical trial, including, among others, the following:

·      the number of patients that ultimately participate in the trial;