HALOZYME THERAPEUTICS, INC. annual report, FY2017

Halozyme Therapeutics, Inc. — FY2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017; filed February 20, 2018. The company develops oncology therapies and licenses its ENHANZE technology to enable subcutaneous delivery of other companies’ drugs. Its lead proprietary candidate, PEGPH20, was in Phase 3 testing for high-HA stage IV pancreatic cancer. Hylenex was its marketed proprietary product; commercial royalties came from Roche and Baxalta products.

Financial performance and liquidity

Metric	FY2017	FY2016
Total revenue	$316.6 million	$146.7 million
Product sales, net	$50.4 million	$53.4 million
Royalties	$63.5 million	$51.0 million
Collaborative-agreement revenue	$202.7 million	$42.3 million
Operating income (loss)	$81.0 million	$(83.2) million
Net income (loss)	$63.0 million	$(103.0) million
Research and development expense	$150.6 million	$150.8 million
Operating cash flow	$134.1 million	$(50.4) million

• 2017 revenue growth was driven primarily by collaboration payments: the company recognized $171.4 million in upfront license revenue under the 2017 Roche, BMS and Alexion agreements, plus $15.0 million in Janssen clinical milestones. Revenue was also supported by higher royalties.
• Product sales declined 6%; management anticipated lower bulk rHuPH20 sales to Roche and Baxalta in 2018 as they use existing inventory during manufacturing transitions. Hylenex sales were $15.2 million, down 6%.
• Cost of product sales was $31.2 million against $50.4 million in product sales, implying product gross profit of about $19.2 million (approximately 38%). This is not the company’s total-company operating margin.
• Cash, cash equivalents and available-for-sale securities totaled $469.2 million at year-end; working capital was $379.0 million. Management said existing liquidity would fund operations for at least 12 months.
• Year-end debt, net of discounts, was about $202.4 million: $146.5 million royalty-backed debt and $55.9 million under the Oxford/SVB facility. The royalty-backed loan carried a 10.25% rate at year-end; management estimated repayment in Q1 2020, subject to royalty receipts. Contractual obligations totaled $257.8 million, including estimated principal and interest.
• Net cash used in investing activities was $163.7 million, mainly reflecting purchases of marketable securities. Financing cash flow was $131.7 million, primarily from the May 2017 equity offering, which raised $134.9 million net through issuance of 11.5 million shares.

Material changes and business developments

• Revenue rose 116% year over year, and the company returned to profitability after losses in 2015 and 2016. The swing reflects substantial collaboration license and milestone revenue, rather than a comparable increase in product sales.
• Royalties increased about 25% to $63.5 million, reflecting sales growth for Roche’s Herceptin SC and MabThera SC/RITUXAN HYCELA and Baxalta’s HYQVIA.
• PEGPH20 R&D spending increased 15% to $123.9 million as clinical activity expanded; total R&D remained approximately flat because spending on other programs and ENHANZE manufacturing work declined.
• New or expanded ENHANZE agreements included BMS ($105 million upfront), Alexion ($40 million upfront) and an additional Roche target ($30 million upfront). These agreements broadened the partner base but increased reliance on milestone timing and collaborators’ development decisions.
• In 2017, the FDA approved RITUXAN HYCELA, an additional ENHANZE collaboration product. Janssen initiated a Phase 3 study of daratumumab with ENHANZE.

Outlook, risks and unusual items

• Management expected PEGPH20 R&D expense to rise as development advanced and SG&A to increase moderately. The company projected reaching the HALO-301 interim PFS-event target in Q4 2018, at which point approximately 500 patients were expected to have been enrolled.
• In HALO-202, the combined analysis showed median PFS of 9.2 versus 5.2 months for PEGPH20 combination therapy versus control among HA-High patients (p=0.048). Stage 2 alone showed 8.6 versus 4.5 months; its thromboembolic-event rate in the PEGPH20 arm fell from 43% to 10% after protocol changes and anticoagulant prophylaxis. These were Phase 2 results, not proof of Phase 3 benefit.
• Important counterevidence: the independent SWOG study stopped enrollment in an all-comer pancreatic cancer population after futility and a higher death rate in the PEGPH20 arm; final reported median overall survival was 7.7 versus 14.4 months. Halozyme said its other PEGPH20 studies continued. Separately, the KEYTRUDA combination study required protocol changes and increased liver-safety monitoring after signs of hepatobiliary dysfunction.
• Halozyme’s results remain exposed to clinical, regulatory and safety risk, including thromboembolic events, diagnostic accuracy, patient enrollment and the possibility that trial results will not support approval. The company also relies on collaborators for development and commercialization and on third parties for manufacturing.
• Customer and partner concentration was significant: Roche represented 38% of 2017 revenue, BMS 32% and Alexion 13%. The company reported a history of net losses and negative cash flows, and cautioned that additional financing might be needed despite its stated 12-month liquidity runway.
• Adoption of ASC 606 on January 1, 2018 was expected to materially change revenue timing. The filing estimated that 2017 license revenue would have been $198.4 million and royalty revenue $68.9 million under the new standard, versus amounts recognized under the prior accounting. It also anticipated eliminating $51.8 million of deferred license revenue against accumulated deficit and recording approximately $19.4 million of additional royalty receivables.
• Auditors issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls; no material legal proceedings were disclosed.

Most important facts for investors to verify

• Whether the Phase 3 HALO-301 results confirm a clinically meaningful benefit in the selected HA-High population, including overall survival, safety and the companion diagnostic’s performance.
• How the SWOG all-comer safety and survival findings, and hepatobiliary monitoring in other trials, affect PEGPH20’s risk-benefit profile and development plans.
• Whether growth in collaboration royalties can offset expected 2018 bulk rHuPH20 sales declines and the volatility of upfront and milestone payments.
• Whether liquidity, royalty-backed debt repayment assumptions and future funding needs remain consistent with management’s outlook as clinical spending increases.
• The actual financial-statement effects of ASC 606 adoption and the extent to which reported earnings reflect recurring operations rather than upfront collaboration revenue.