ARROWHEAD PHARMACEUTICALS, INC. annual report, FY2016

Business context and reporting period

Arrowhead Pharmaceuticals, Inc. filed this Form 10-K for the fiscal year ended September 30, 2016. The company develops RNA interference (RNAi) medicines and had no approved products. Its clinical programs during the year included ARC-520 and ARC-521 for hepatitis B and ARC-AAT for alpha-1 antitrypsin deficiency; newer candidates were preclinical. The fourth quarter ended September 30, 2016.

Financial performance and position

Revenue was immaterial relative to operating costs, so a meaningful operating margin is not provided. Fourth-quarter revenue was $31,250; net loss was $22.2 million, or $0.34 per share. FY 2016 investing cash flow provided $13.4 million, chiefly from investment maturities, while financing cash flow provided $55.1 million, mainly from equity issuances. Cash increased $4.2 million for the year.

At September 30, 2016, total assets were $128.2 million, current assets $90.5 million, current liabilities $25.6 million, and stockholders’ equity $95.0 million. The company reported a $2.7 million note payable related to its new research facility and $1.6 million of derivative liabilities; it had no capital lease obligation at year-end. Contractual obligations totaled $27.8 million, including $12.4 million of operating leases and $10.4 million of purchase obligations.

Material changes versus the prior comparable period

• Net loss narrowed by $10.2 million and R&D expense fell 12% year over year. Lower clinical-drug manufacturing costs and the absence of the prior-year $10.1 million Novartis acquired in-process R&D charge contributed to the expense decline.
• A $5.9 million reduction in contingent consideration, following the decision to discontinue the acquired clinical programs, also reduced reported operating expense. This was a noncash fair-value adjustment, not operating cash generation.
• Cash and cash equivalents rose $4.2 million despite $64.4 million of operating cash use, primarily because of the August equity financing and Amgen-related proceeds. Shares outstanding increased to 69.7 million at year-end; 74.2 million were outstanding as of December 12, 2016.
• The company entered a 10-year lease for a 60,000-square-foot Madison research facility. Lease and tenant-improvement-note payments are expected to total approximately $15.2 million over the initial term, before certain operating costs.

Outlook, management commentary, risks and unusual items

In November 2016, Arrowhead announced it would discontinue ARC-520, ARC-521 and ARC-AAT, all using its intravenous EX1 delivery vehicle. The company cited expected regulatory delays while investigating deaths in a non-human-primate toxicology study at doses above those planned for humans, as well as advances in its subcutaneous and extra-hepatic platforms. It reduced its workforce by approximately 30% and shifted resources toward preclinical programs, including ARO-HBV and ARO-AAT. These were subsequent events after the fiscal year-end.

Arrowhead licensed ARO-LPA to Amgen and granted Amgen an option for ARO-AMG1. The combined agreements provide $35 million in upfront payments, a $21.5 million equity investment, and eligibility for up to $617 million in option and milestone payments, plus royalties. Arrowhead received $14 million of the upfront/equity proceeds in September 2016; the remaining $42.5 million was received in November 2016. Amgen is responsible for clinical development and commercialization under the agreements. Much of the contingent consideration is milestone-based and is not assured.

Management said existing cash resources and its operating plan were expected to fund operations for at least the next 12 months. It expected near-term R&D costs to decline following program discontinuations, while noting they could rise as preclinical candidates advance; the new facility is also expected to increase facility costs. The filing provides no specific earnings, revenue or product-development guidance.

Key risks include early-stage drug-development and regulatory uncertainty, the safety questions involving EX1, reliance on third-party manufacturers and clinical-trial providers, future financing needs and potential shareholder dilution, intellectual-property and licensing risks, and uncertain market access and reimbursement. The company reported securities and derivative litigation; no liability was accrued for the matters described. A prior consolidated class action was dismissed with prejudice in October 2016, but plaintiffs appealed; a derivative action remained pending. Two additional securities class actions were filed in November and December 2016, and the company said their outcome could not be predicted or reliably estimated. The auditors issued an unqualified opinion, and management and the auditors reported effective internal control over financial reporting as of September 30, 2016.

Most important facts for investors to verify

• Progress, safety and regulatory path for the replacement subcutaneous and extra-hepatic delivery platforms, especially in light of the non-human-primate deaths associated with EX1.
• Whether ARO-HBV, ARO-AAT, ARO-F12 and ARO-HIF2 advance from preclinical development and whether preclinical results translate to human safety and efficacy.
• Amgen agreement terms, timing and conditions for option or milestone payments, and the royalties ultimately payable if products reach market.
• Cash burn, post-November 2016 cash proceeds, and the assumptions underlying management’s stated minimum 12-month liquidity outlook.
• Potential dilution from share issuances, options, warrants and convertible preferred stock, as well as the status and possible financial impact of litigation.