ARROWHEAD PHARMACEUTICALS, INC. quarterly report, Q1 FY2012

Business context and reporting period

Arrowhead Research Corporation, a development-stage nanomedicine company, filed this unaudited Form 10-Q for the quarter ended December 31, 2011 (fiscal 2012 Q1). Its programs include RNA interference (RNAi) therapeutics, an obesity candidate, and regenerative-medicine materials. The quarter included about nine weeks of operations from the Roche RNAi acquisition. Share and per-share amounts reflect the November 2011 1-for-10 reverse stock split.

Financial results and liquidity

Revenue was minimal relative to operating costs; the filing does not present a meaningful gross margin. The 2011 quarter’s $1.352 million of other income included a $1.576 million noncash gain on the Roche acquisition, partly offset by other items. Revenue came from two acquired license agreements; prior-year revenue primarily reflected grants. Prior-year discontinued-operations income of $1.575 million helped reduce that period’s reported net loss.

At December 31, 2011, cash and cash equivalents were $6.773 million, marketable securities $72,000, current assets $9.174 million, and current liabilities $5.060 million. Working capital was approximately $4.114 million. Total assets were $23.062 million and stockholders’ equity $15.749 million. Cash declined $734,000 during the quarter: operating activities used $2.705 million, investing activities provided $540,000, and financing activities provided $1.432 million. Financing included approximately $1.5 million from equity issuance; investing proceeds included about $509,000 from sale of investments.

Reported liabilities included a $702,695 note payable, $1.654 million in capital lease obligations ($210,000 current), and $1.011 million in derivative liabilities. The filing separately describes Calando’s $500,000-face-value note, bearing 10% interest and due November 2013, with 2x principal payment provisions in specified circumstances.

Material changes versus the prior comparable period

• Operating expenses rose 12%, chiefly reflecting the Roche Madison acquisition, new employees, and facility costs. Salaries increased to $1.321 million from $308,000; general and administrative costs rose to $1.278 million from $632,000.
• Research and development expense fell to $1.141 million from $2.262 million, principally because the prior-year quarter included a $2 million license payment to MD Anderson. Current-quarter costs included Madison operations and outside manufacturing work.
• Arrowhead acquired Roche Madison and related RNAi intellectual property for consideration valued at $5.184 million, including shares, a $50,000 note, and shares to be issued. The acquisition accounting recorded a $1.576 million gain.
• Common shares outstanding increased from 8.642 million at September 30 to 10.531 million at December 31; the company also issued 1,015 preferred shares.

Outlook, commentary, and risks

Management expected available cash, financing collections, and other liquidity sources to fund operations for at least 12 months from the reporting date, but anticipated further equity financing, asset sales, or licensing deals would be needed. The company expected cash expenses to rise in 2012 and beyond as it expanded RNAi development at Madison. It reported no formal financial guidance.

Potential funding sources included $3.9 million in subscription receivables, a $15 million equity purchase facility subject to conditions and stockholder approval, and a convertible Wisepower bond with a $2.5 million face value. These sources are not equivalent to cash already collected. The preferred shares carry a 10% cumulative dividend and senior liquidation preference; conversion into common stock requires stockholder approval and is subject to ownership limits.

Key contingencies include Roche royalties, milestone payments of $2.5–$6 million for specified events, and Roche negotiation rights on certain candidates. Arrowhead also disclosed potential Unidym sale milestone payments of up to $140 million, dependent on future performance. Principal risks include continued losses, limited cash and dependence on future financing, dilution, uncertain clinical and regulatory outcomes, intellectual-property challenges, and reliance on development partners. The company said no material litigation was pending and disclosure controls were effective.

Investor facts to verify

• Whether the $3.9 million subscription receivable was collected and whether the equity facility became available on its stated terms.
• Actual cash burn and hiring, facility, and research costs following the Roche acquisition.
• Terms and timing of Roche royalties, milestones, top-up shares or cash, and negotiation rights.
• Status of the Wisepower bond and any contingent proceeds from the Unidym divestiture.
• Potential dilution from preferred conversion, warrants, options, and further financing; common shares outstanding were 10,530,524 as of February 1, 2012.