The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Notes to Consolidated Financial Statements
(unaudited)
Unless otherwise noted, (1) the term “Arrowhead” refers to Arrowhead Pharmaceuticals, Inc., a Delaware corporation and its Subsidiaries, (2) the terms “Company,” “we,” “us,” and “our,” refer to the ongoing business operations of Arrowhead and its Subsidiaries, whether conducted through Arrowhead or a subsidiary of Arrowhead, (3) the term “Subsidiaries” refers collectively to Arrowhead Madison Inc. (“Arrowhead Madison”), Arrowhead Australia Pty Ltd (“Arrowhead Australia”) and Ablaris Therapeutics, Inc. (“Ablaris”), (4) the term “Common Stock” refers to Arrowhead’s Common Stock, (5) the term “Preferred Stock” refers to Arrowhead’s Preferred Stock and (6) the term “Stockholder(s)” refers to the holders of Arrowhead Common Stock.
NOTE 1.
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Business and Recent Developments
Arrowhead Pharmaceuticals, Inc. develops medicines that treat intractable diseases by silencing the genes that cause them. Using a broad portfolio of RNA chemistries and efficient modes of delivery, Arrowhead therapies trigger the RNA interference mechanism to induce rapid, deep and durable knockdown of target genes. RNA interference, or RNAi, is a mechanism present in living cells that inhibits the expression of a specific gene, thereby affecting the production of a specific protein. Deemed to be one of the most important recent discoveries in life science with the potential to transform medicine, the discoverers of RNAi were awarded a Nobel Prize in 2006 for their work. Arrowhead’s RNAi-based therapeutics leverage this natural pathway of gene silencing. The company's pipeline includes ARO-AAT for liver disease associated with alpha-1 antitrypsin deficiency (AATD), ARO-APOC3 for hypertriglyceridemia, ARO-ANG3 for dyslipidemia, ARO-ENaC for cystic fibrosis, and ARO-HIF2 for renal cell carcinoma. ARO-LPA (AMG 890)
for cardiovascular disease was out-licensed to Amgen Inc. in 2016. ARO-AMG1 for an undisclosed genetically validated cardiovascular target is under a license and collaboration agreement with Amgen Inc. ARO-HBV for chronic hepatitis B virus was out-licensed to Janssen Pharmaceuticals, Inc. in October 2018.
Arrowhead operates a lab facility in Madison, Wisconsin, where the Company’s research and development activities, including the development of RNAi therapeutics, are based. The Company’s principal executive offices are located in Pasadena, California.
During fiscal 2018, the Company continued to develop its pipeline candidates. In the first half of fiscal 2018, Clinical Trial Applications (CTAs) were filed for ARO-AAT and ARO-HBV, and the associated phase 1 (ARO-AAT) and phase 1 / 2 (ARO-HBV) studies are ongoing. Dosing has completed for the ARO-AAT phase 1 clinical study. In October 2018, the Company also filed a CTA for ARO-ANG3 and, pending approval, the Company anticipates the startup of this study in 2019. The Company has also achieved substantial progress on its other preclinical candidates including ARO-APOC3, ARO-ENaC and ARO-HIF2, with planned CTA or equivalent filings planned in late calendar 2018 for ARO-APOC3 and in 2019 for ARO-ENaC and ARO-HIF2.
The Company also made significant progress on its business development and partnership collaboration efforts. In October 2018, the Company entered into a License Agreement (“Janssen License Agreement”) and a Research Collaboration and Option Agreement (“Janssen Collaboration Agreement” with Janssen Pharmaceuticals, Inc. (“Janssen”) part of the Janssen Pharmaceutical Companies of Johnson & Johnson. The Company also entered into a Stock Purchase Agreement (“JJDC Stock Purchase Agreement”) with Johnson & Johnson Innovation-JJDC, Inc. (“JJDC”), a New Jersey corporation. Under the Janssen License Agreement, Janssen has received a worldwide, exclusive license to the Company’s ARO-HBV program, the Company’s third-generation subcutaneously administered RNAi therapeutic candidate being developed as a potentially curative therapy for patients with chronic hepatitis B virus infection. Beyond the Company’s ongoing Phase 1 / 2 study of ARO-HBV, Janssen will be wholly responsible for clinical development and commercialization. Under the Janssen Collaboration Agreement, Janssen will be able to select three new targets against which Arrowhead will develop clinical candidates. These candidates are subject to certain restrictions and will not include candidates in the Company’s current pipeline. The Company will perform discovery, optimization and preclinical development, entirely funded by Janssen, sufficient to allow the filing of a U.S. Investigational New Drug application or equivalent, at which time Janssen will have the option to take an exclusive license. If the option is exercised, Janssen will be wholly responsible for clinical development and commercialization. Under the JJDC Stock Purchase Agreement, in October 2018 the Company sold 3,260,869 shares of common stock to JJDC at a price of $23.00 per share. Under the terms of the agreements taken together, the Company has received $175 million as an upfront payment, $75 million in the form of an equity investment by JJDC in Arrowhead common stock, and may receive up to $1.6 billion in development and sales milestones payments for the Janssen License Agreement, and up to $1.9 billion in development and sales milestone payments for the three additional targets covered under the Janssen Collaboration Agreement. The Company is further eligible to receive tiered royalties up to mid teens under the license agreement and up to low teens under the collaboration and option agreement on product sales.
The Company’s collaboration agreements with Amgen also continue to progress as it relates to the AMG 890 (ARO-LPA) and ARO-AMG1 candidates. Under the terms of the agreements taken together, the Company has received $35 million in upfront payments and $21.5 million in the form of an equity investment by Amgen in the Company’s Common Stock and could receive up to
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$617 million in option payments and development, regulatory and sales milestone payments. The Company is further eligible to receive single-digit royalties for sales of products under the ARO-AMG1 agreement and up to
low double-digit royalties for sales of products under the AMG 890 (ARO-LPA) Agreement. On August 1, 2018, the Company announced that it had earned a $10 million milestone payment from Amgen following the administration of the first dose of AMG 890 (ARO-L
PA) in a phase 1 clinical study. This milestone payment was recognized as Revenue in its entirety during the year ended September 30, 2018.
Liquidity
The Consolidated Financial Statements have been prepared in conformity with the accounting principles generally accepted in the United States of America, which contemplate the continuation of the Company as a going concern. Historically, the Company’s primary source of financing has been through the sale of its securities. Research and development activities have required significant capital investment since the Company’s inception. The Company expects its operations to continue to require cash investment to pursue its research and development goals, including clinical trials and related drug manufacturing.
At September 30, 2018, the Company had $30.1 million in cash and $46.4 million in short-term investments to fund operations. During the year ended September 30, 2018, the Company’s cash and investments balance increased by $
10.9
million, which was primarily the result of the $56.6 million net proceeds received from a public offering of 11,500,000 of shares of Common Stock completed in January 2018, and a $10 million milestone payment received from Amgen, discussed further below. These cash inflows were mostly offset by cash outflows related to operating activities.
On January 22, 2018, the Company sold 11,500,000 shares of Common Stock in a fully underwritten public offering, at a public offering price of $5.25 per share. Net proceeds to the Company were approximately $56.6 million after deducting underwriting commissions and discounts and other offering expenses payable by the Company. The Company believes its current financial resources are sufficient to fund its operations through at least the next twelve months.
In addition to the cash proceeds on hand, in October 2018, the Company entered into the Janssen License Agreement, the Janssen Collaboration Agreement and the JJDC Stock Purchase Agreement which yielded a $175 million upfront payment received in November 2018 and a $75 million equity investment received in October 2018. These agreements are discussed further in Note 2 below.
Summary of Significant Accounting Policies
Principles of Consolidation—The Consolidated Financial Statements include the accounts of Arrowhead and its Subsidiaries. Arrowhead’s primary operating subsidiary is Arrowhead Madison, which is located in Madison, Wisconsin, where the Company’s research and development facility is located. All significant intercompany accounts and transactions are eliminated in consolidation.
Basis of Presentation and Use of Estimates—The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates. Additionally, certain reclassifications have been made to prior period financial statements to conform to the current period presentation
.
Cash and Cash Equivalents—The Company considers all liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The Company had no restricted cash at September 30, 2018 and September 30, 2017.
Concentration of Credit Risk—The Company maintains several bank accounts primarily at two financial institutions for its operations. These accounts are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per institution. Management believes the Company is not exposed to significant credit risk due to the financial position of the depository institutions in which these deposits are held.
Investments—The Company may invest excess cash balances in short-term and long-term marketable debt securities. Investments may consist of certificates of deposits, money market accounts, government-sponsored enterprise securities, corporate bonds and/or commercial paper. The Company accounts for its investment in marketable securities in accordance with FASB ASC 320, Investments – Debt and Equity Securities. This statement requires debt securities to be classified into three categories:
Held-to-maturity—Debt securities that the entity has the positive intent and ability to hold to maturity are reported at amortized cost.
Trading Securities—Debt securities that are bought and held primarily for the purpose of selling in the near term are reported at fair value, with unrealized gains and losses included in earnings.
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Availabl
e-for-Sale—Debt securities not classified as either securities held-to-maturity or trading securities are reported at fair value with unrealized gains or losses excluded from earnings and reported as a separate component of shareholders’ equity.
The Company classifies its investments in marketable debt securities based on the facts and circumstances present at the time of purchase of the securities. During the years ended September 30, 2018 and 2017, respectively, all of the Company’s investments were classified as held-to-maturity.
Held-to-maturity investments are measured and recorded at amortized cost on the Company’s Consolidated Balance Sheet. Discounts and premiums to par value of the debt securities are amortized to interest income/expense over the term of the security. No gains or losses on investment securities are realized until they are sold or a decline in fair value is determined to be other-than-temporary.
Property and Equipment—Property and equipment are recorded at cost, which may equal fair market value in the case of property and equipment acquired in conjunction with a business acquisition. Depreciation of property and equipment is recorded using the straight-line method over the respective useful lives of the assets ranging from three to seven years. Leasehold improvements are amortized over the lesser of the expected useful life or the remaining lease term. Long-lived assets, including property and equipment are reviewed for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable.
Intangible Assets Subject to Amortization—Intangible assets subject to amortization include certain patents and license agreements. Intangible assets subject to amortization are reviewed for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable.
Contingent Consideration - The consideration for the Company’s acquisitions may include future payments that are contingent upon the occurrence of a particular event. For example, milestone payments might be based on the achievement of various regulatory approvals or future sales milestones, and royalty payments might be based on drug product sales levels. The Company records a contingent consideration obligation for such contingent payments at fair value on the acquisition date. The Company estimates the fair value of contingent consideration obligations through valuation models designed to estimate the probability of such contingent payments based on various assumptions and incorporating estimated success rates. Estimated payments are discounted using present value techniques to arrive at an estimated fair value at the balance sheet date. Changes in the fair value of the contingent consideration obligations are recognized within the Company’s Consolidated Statements of Operations and Comprehensive Loss. Changes in the fair value of the contingent consideration obligations can result from changes to one or multiple inputs, including adjustments to the discount rates, changes in the amount or timing of expected expenditures associated with product development, changes in the amount or timing of cash flows from products upon commercialization, changes in the assumed achievement or timing of any development milestones, changes in the probability of certain clinical events and changes in the assumed probability associated with regulatory approval. These fair value measurements are based on significant inputs not observable in the market. Substantial judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period. Accordingly, changes in assumptions could have a material impact on the amount of contingent consideration expense the Company records in any given period. The Company determined the fair value of its contingent consideration obligation to be $0 at September 30, 2018 and September 30, 2017.
Revenue Recognition— Revenue from product sales is recorded when persuasive evidence of an arrangement exists, title has passed, and delivery has occurred, a price is fixed and determinable, and collection is reasonably assured.
The Company may generate revenue from technology licenses, collaborative research and development arrangements, research grants and product sales. Revenue under technology licenses and collaborative agreements typically consists of nonrefundable and/or guaranteed technology license fees, collaborative research funding, manufacturing and development services and various milestone and future product royalty or profit-sharing payments. These agreements are generally referred to as multiple element arrangements.
The Company applies the accounting standard on revenue recognition for multiple element arrangements. The fair value of deliverables under the arrangement may be derived using a best estimate of selling price if vendor specific objective evidence and third-party evidence is not available. Deliverables under the arrangement will be separate units of accounting if a delivered item has value to the customer on a standalone basis, if the arrangement includes a general right of return for the delivered item, and if delivery or performance of the undelivered item is considered probable and substantially in the Company’s control.
The Company recognizes upfront license payments as revenue upon delivery of the license only if the license is determined to be a separate unit of accounting from the other undelivered performance obligations. The undelivered performance obligations typically include manufacturing or development services or research and/or steering committee services. If the license is not considered to have standalone value, then the license and other undelivered performance obligations would be accounted for as a single unit of accounting. In this case, the license payments and payments for performance obligations are recognized as revenue
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over the es
timated period of when the performance obligations are performed or deferred indefinitely until the undelivered performance obligation is determined.
Whenever the Company determines that an arrangement should be accounted for as a single unit of accounting, the Company determines the period over which the performance obligations will be performed, and revenue will be recognized. Revenue is recognized using a proportional performance or straight-line method. The proportional performance method is used when the level of effort required to complete performance obligations under an arrangement can be reasonably estimated. The amount of revenue recognized under the proportional performance method is determined by multiplying the total payments under the contract, excluding royalties and payments contingent upon achievement of milestones, by the ratio of the level of effort performed to date to the estimated total level of effort required to complete performance obligations under the arrangement. If the Company cannot reasonably estimate the level of effort to complete performance obligations under an arrangement, the Company recognizes revenue under the arrangement on a straight-line basis over the period the Company is expected to complete its performance obligations. Significant management judgment is required in determining the level of effort required under an arrangement and the period over which the Company is expected to complete its performance obligations under an arrangement.
The Company’s collaboration agreements typically entitle the Company to additional payments upon the achievement of development, regulatory and sales performance-based milestones. If the achievement of a milestone is considered probable at the inception of the collaboration, the related milestone payment is included with other collaboration consideration, such as upfront fees and research funding, in the Company’s revenue calculation. Typically, these milestones are not considered probable at the inception of the collaboration. As such, milestones will typically be recognized in one of two ways depending on the timing of when the milestone is achieved. If the milestone is achieved during the performance period, the Company will only recognize revenue to the extent of the proportional performance achieved at that date, or the proportion of the straight-line basis achieved at that date, and the remainder will be recorded as deferred revenue to be amortized over the remaining performance period. If the milestone is achieved after the performance period has completed and all performance obligations have been delivered, the Company will recognize the milestone payment as Revenue in its entirety in the period the milestone was achieved.
Deferred revenue will be classified as part of Current or Long-Term Liabilities in the accompanying Consolidated Balance Sheets based on the Company’s estimate of the portion of the performance obligations regarding that revenue will be completed within the next 12 months divided by the total performance period estimate. This estimate is based on the Company’s current operating plan and, if the Company’s operating plan should change in the future, the Company may recognize a different amount of deferred revenue over the next 12-month period.
The new revenue recognition guidance (ASC 606) was effective as of October 1, 2018, and it will not have a material impact on the Company’s Consolidated Financial Statements. Please read the discussion of recent accounting pronouncements for the expected impact of this new accounting guidance.
Allowance for Doubtful Accounts—The Company accrues an allowance for doubtful accounts based on estimates of uncollectible revenues by analyzing historical collections, accounts receivable aging and other factors. Accounts receivable are written off when all collection attempts have failed.
Research and Development—Costs and expenses that can be clearly identified as research and development are charged to expense as incurred in accordance with FASB ASC 730-10. Included in research and development costs are operating costs, facilities, supplies, external services, clinical trial and manufacturing costs, overhead directly related to the Company’s research and development operations, and costs to acquire technology licenses.
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Earnings (Loss) per Share—Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share are computed using the weighted-average number of
common shares and dilutive potential common shares outstanding during the period. Dilutive potential common shares primarily consist of stock options and restricted stock units issued to employees and warrants to purchase Common Stock of the Company. All
outstanding stock options, restricted stock units and warrants for the years ended September 30, 2018, 2017 and 2016 have been excluded from the calculation of Diluted earnings (loss) per share due to their anti-dilutive effect.
Stock-Based Compensation—The Company accounts for share-based compensation arrangements in accordance with FASB ASC 718, which requires the measurement and recognition of compensation expense for all share-based payment awards to be based on estimated fair values. The Company uses the Black-Scholes option valuation model to estimate the fair value of its stock options at the date of grant. The Black-Scholes option valuation model requires the input of subjective assumptions to calculate the value of stock options. For restricted stock units, the value of the award is based on the Company’s stock price at the grant date. For performance-based restricted stock unit awards, the value of the award is based on the Company’s stock price at the grant date, with consideration given to the probability of the performance condition being achieved. The Company uses historical data and other information to estimate the expected price volatility for stock option awards and the expected forfeiture rate for all awards. Expense is recognized over the vesting period for all awards and commences at the grant date for time-based awards and upon the Company’s determination that the achievement of such performance conditions is probable for performance-based awards. This determination requires significant judgment by management.
Income Taxes—The Company accounts for income taxes under the liability method, which requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred income tax assets to the amount expected to be realized. The provision for income taxes, if any, represents the tax payable for the period and the change in deferred income tax assets and liabilities during the period.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue recognition guidance under GAAP. ASU No. 2014-09 provides that an entity recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. ASU No. 2014-09 allows for either full retrospective or modified retrospective adoption and will become effective for the Company in the first quarter of fiscal 2019. In April 2016, the FASB issued an amendment to ASU No. 2014-09 with update ASU 2016-10 which provided more specific guidance around the identification of performance obligations and licensing arrangements.
On October 1, 2018, the Company adopted this standard using the modified retrospective method. The Company’s implementation approach included reviewing the status of each of its ongoing collaboration agreements and designing appropriate internal controls to enable the preparation of financial information. The Company has completed its assessment of the impact of the new revenue recognition guidance and determined that there will be no material impact. The Company’s existing performance obligations under its ongoing collaboration agreements were substantially completed prior to September 30, 2018. Any future option, milestone or royalty payments received will be accounted for under the sales-based royalty exception provided for under this new revenue recognition guidance. Additionally, there will be no impact to cash from or used in operating, financing or investing activities on the Company’s Consolidated Statement of Cash Flows as a result of the adoption of the new standard.
In March 2016, the FASB issued ASU No. 2016-02, Leases. Under ASU 2016-02, lessees will be required to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). For income statement purposes, a dual model was retained, requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). ASU 2016-02 becomes effective for the Company in the first quarter of fiscal 2020. The Company expects the adoption of this update to have a material effect on the classification and disclosure of its leased facilities in Madison, Wisconsin.
In May 2017, the FASB issued ASU No. 2017-09, which is an update to Topic 718, Compensation - Stock Compensation. The update provides guidance on determining which changes to the terms and conditions of share-based payment awards, including stock options, require an entity to apply modification accounting under Topic 718. ASU 2017-09 becomes effective for the Company in the first quarter of fiscal 2019. The Company does not expect that ASU 2017-09 will have a material impact on the Company's results of operations and consolidated financial statements.
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In November 2018, the FASB issued ASU No. 2018-18 Collaborative Arrangements (Topic 808). This update provides clarification on the interaction between Revenue Recognition (Topic 606) and Collaborative Arrang
ements (Topic 808) including the alignment of unit of account guidance between the two topics/ ASU 2018-18 becomes effective for the Company in the first quarter of fiscal 2021 with early adoption permitted.
The Company does not expect the adoption of thi
s update to have a material effect on its Consolidated Financial Statements.
NOTE 2.
COLLABORATION AND LICENSE AGREEMENTS
Amgen Inc.
On September 28, 2016, the Company entered into two Collaboration and License agreements, and a Common Stock Purchase Agreement with Amgen Inc., a Delaware corporation (“Amgen”). Under one of the license agreements (the “Second Collaboration and License Agreement” or “AMG 890 (ARO-LPA) Agreement”), Amgen has received a worldwide, exclusive license to Arrowhead’s novel, RNAi ARO-LPA program. These RNAi molecules are designed to reduce elevated lipoprotein(a), which is a genetically validated, independent risk factor for atherosclerotic cardiovascular disease. Under the other license agreement (the “First Collaboration and License Agreement” or “ARO-AMG1 Agreement”), Amgen received an option to a worldwide, exclusive license for ARO-AMG1, an RNAi therapy for an undisclosed genetically validated cardiovascular target. In both agreements, Amgen is wholly responsible for clinical development and commercialization.
Under the Common Stock Purchase Agreement, the Company has sold 3,002,793 shares of Common Stock to Amgen at a price of $7.16 per share. Subject to Amgen’s exercise of the Option, as defined in the ARO-AMG1 Agreement, Amgen has agreed to purchase, and the Company has agreed to sell, an additional $5 million worth of shares of Common Stock based on a 30 trading day formula surrounding the date of the Option exercise.
Under the terms of the agreements taken together, the Company has received $35 million in upfront payments, $21.5 million in the form of an equity investment by Amgen in the Company’s Common Stock and could receive up to $617 million in option payments, and development, regulatory and sales milestone payments. The Company is further eligible to receive single-digit royalties for sales of products under the ARO-AMG1 Agreement and up to low double-digit royalties for sales of products under the AMG 890 (ARO-LPA) Agreement.
Under the terms of the AMG 890 (ARO-LPA) Agreement, the Company has granted a worldwide, exclusive license to AMG 890 (ARO-LPA). The Company is also responsible for assisting Amgen in the oversight of certain development and manufacturing activities (the “AMG 890 (ARO-LPA) R&D Services”), most of which are to be covered at Amgen’s cost. The Company has determined that the significant deliverables under the AMG 890 (ARO-LPA) Agreement include the license and the AMG 890 (ARO-LPA) R&D Services. The Company also determined that, pursuant to the accounting guidance governing revenue recognition on multiple element arrangements, the license and the AMG 890 (ARO-LPA) R&D Services do not have standalone value due to the specialized nature of the activities and services to be provided by the Company. Therefore, the deliverables are not separable and, accordingly, the license and the AMG 890 (ARO-LPA) R&D Services are being treated as a single unit of accounting. The Company recognized revenue on a straight-line basis from November 18, 2016 (the Hart-Scott-Rodino clearance date), through October 31, 2017, which was the date where the AMG 890 (ARO-LPA) R&D Services were substantially completed. The Company received the upfront payment of $30 million due under the AMG 890 (ARO-LPA) Agreement in November 2016. The upfront $30 million payment was initially recorded as Deferred Revenue. During the years ended September 30, 2018 and 2017, $2.7 million and $27.3 million of this upfront payment were recognized into Revenue, respectively. This upfront payment has been recognized as Revenue in its entirety as of September 30, 2018.
On August 1, 2018, the Company announced that it had earned a $10 million milestone payment from Amgen following the administration of the first dose of AMG 890 (ARO-LPA) in a phase 1 clinical study. The Company has recognized this payment as Revenue in its entirety during the year ended September 30, 2018 as the performance obligations had already been substantially completed.
Under the new revenue recognition guidance there would be no change to our historical accounting for the AMG 890 (ARO-LPA) Agreement as the performance obligations have been substantially completed as of September 30, 2018. Additionally, any future milestone or royalty payments due under the AMG-890 (ARO-LPA) Agreement will be recognized in the period the milestone is achieved under the sales-based royalty exception allowed under accounting rules. Finally, the costs to obtain this agreement were immaterial.
Under the terms of the ARO-AMG1 Agreement, the Company has granted an option to a worldwide, exclusive license to ARO-AMG1, an undisclosed genetically validated cardiovascular target. The Company is also responsible for developing, optimizing and manufacturing the candidate through certain preclinical efficacy and toxicology studies to determine whether the candidate the Company has developed meets the required criteria as defined in the agreement (the “Arrowhead Deliverable”). The Company delivered the candidate in August 2018 and Amgen currently has the option to an exclusive license for the intellectual property generated through the Company’s development efforts. If Amgen exercises its option, it would likely assume all development,
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regulatory and commercialization efforts for the candidate. The Comp
any determined that the significant deliverables under the ARO-AMG1 Agreement include the option to license and the development and manufacturing activities toward achieving the Arrowhead Deliverable (the “ARO-AMG1 R&D Services”). The Company also determi
ned that, pursuant to the accounting guidance governing revenue recognition on multiple element arrangements, the option to license and ARO-AMG1 R&D Services do not have standalone value due to the specialized nature of the activities and services to be pr
ovided by the Company. Therefore, the deliverables are not separable and, accordingly, the option to license and ARO-AMG1 R&D Services are being treated as a single unit of accounting.
The Company has recognized revenue on a straight-line basis from Octobe
r 1, 2016, through September 30, 2018, as the Company completed the Arrowhead Deliverable during the three months ended September 30, 2018. The Company received an upfront payment of $5 million due under this agreement in September 2016. The upfront $5
million payment was initially recorded as Deferred Revenue. During the years ended September 30, 2018 and 2017, $2.5 million and $2.5 million of this upfront payment were recognized into Revenue, respectively. This upfront payment has been recognized as
Revenue in its entirety as of September 30, 2018.
Under the new revenue recognition guidance there would be no change to our historical accounting for the ARO-AMG1 Agreement as the Arrowhead Deliverable was completed during the three months ended September 30, 2018. Additionally, any future option, milestone or royalty payments due under the ARO-AMG1 Agreement will be recognized in the period the milestone is achieved under the sales-based royalty exception allowed under accounting rules. Finally, the costs to obtain this agreement were immaterial.
The Company also entered into a separate services agreement and separate statements of work with Amgen to provide certain services related to process development, manufacturing, materials supply, discovery studies, and other consulting services related to AMG 890 (ARO-LPA) and ARO-AMG1. During the years ended September 30, 2018, 2017, 2016, these work orders generated approximately $1.0 million, $1.5 million and $0 of Revenue, respectively.
Janssen Pharmaceuticals, Inc.
On October 3, 2018, the Company entered into a License Agreement (“Janssen License Agreement”) and a Research Collaboration and Option Agreement (“Janssen Collaboration Agreement” with Janssen Pharmaceuticals, Inc. (“Janssen”) part of the Janssen Pharmaceutical Companies of Johnson & Johnson. The Company also entered into a Stock Purchase Agreement (“JJDC Stock Purchase Agreement”) with Johnson & Johnson Innovation-JJDC, Inc. (“JJDC”), a New Jersey corporation. Under the Janssen License Agreement, Janssen has received a worldwide, exclusive license to the Company’s ARO-HBV program, the Company’s third-generation subcutaneously administered RNAi therapeutic candidate being developed as a potentially curative therapy for patients with chronic hepatitis B virus infection. Beyond the Company’s ongoing Phase 1 / 2 study of ARO-HBV, Janssen will be wholly responsible for clinical development and commercialization. Under the Janssen Collaboration Agreement, Janssen will be able to select three new targets against which Arrowhead will develop clinical candidates. These candidates are subject to certain restrictions and will not include candidates in the Company’s current pipeline. The Company will perform discovery, optimization and preclinical development, entirely funded by Janssen, sufficient to allow the filing of a U.S. Investigational New Drug application or equivalent, at which time Janssen will have the option to take an exclusive license. If the option is exercised, Janssen will be wholly responsible for clinical development and commercialization. Under the JJDC Stock Purchase Agreement, in October 2018 the Company sold 3,260,869 shares of common stock to JJDC at a price of $23.00 per share. Under the terms of the agreements taken together, the Company has received $175 million as an upfront payment, $75 million in the form of an equity investment by JJDC in Arrowhead common stock, and may receive up to $1.6 billion in development and sales milestones payments for the Janssen License Agreement, and up to $1.9 billion in development and sales milestone payments for the three additional targets covered under the Janssen Collaboration Agreement. The Company is further eligible to receive tiered royalties up to mid teens under the license agreement and up to low teens under the collaboration and option agreement on product sales.
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The Company has evaluated these agreements in accordance with the new revenue recognition requirements that became effective for the Company on October 1,
2018.
At the inception of these agreements, the Company has identified one distinct performance obligation. Regarding the Janssen License Agreement, the Company determined that the key deliverables included the license and certain R&D services including the Company’s responsibility to complete the ongoing Phase 1 / 2 study of ARO-HBV and the Company’s responsibility to ensure certain manufacturing of ARO-HBV drug product is completed and delivered to Janssen (the “Janssen R&D Services”). Due to the specialized and unique nature of these Janssen R&D services, and their direct relationship with the license, the Company determined that these deliverables represent one distinct bundle and thus, one performance obligation. The Company also determined that Janssen’s option to require the Company to develop up to three new targets is not a material right, and thus, not a performance obligation at the onset of the agreement. The consideration for this option will be accounted for if and when it is exercised.
The Company determined the transaction price totaled approximately $197.8 million which includes the upfront payment, the premium paid by JJDC for its equity investment in the Company, and estimated payments for ARO-HBV drug materials on hand and additional material to be manufactured. The Company has allocated the total $197.8 million initial transaction price to its one distinct performance obligation for the ARO-HBV license and the associated Janssen R&D Services. This revenue will be recognized using a proportional performance method (based on actual labor hours versus estimated total labor hours) beginning in October 2018 and ending as the Company’s efforts in overseeing the ongoing phase 1 / 2 clinical trial are completed.
NOTE 3.
PROPERTY AND EQUIPMENT
The following table summarizes the Company’s major classes of property and equipment:
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September 30,
2018
|
|
|
September 30, 2017
|
|
Computers, office equipment and furniture
|
$
|
600,334
|
|
|
$
|
600,334
|
|
Research equipment
|
|
10,751,627
|
|
|
|
9,660,960
|
|
Software
|
|
152,676
|
|
|
|
132,078
|
|
Leasehold improvements
|
|
12,236,150
|
|
|
|
12,208,380
|
|
Total gross fixed assets
|
|
23,740,787
|
|
|
|
22,601,752
|
|
Less: Accumulated depreciation and amortization
|
|
(9,805,362
|
)
|
|
|
(7,088,733
|
)
|
Property and equipment, net
|
$
|
13,935,425
|
|
|
$
|
15,513,019
|
|
Depreciation and amortization expense for Property and Equipment the for the years ended September 30, 2018, 2017 and 2016 was $2,998,846, $2,990,010, and $1,545,733, respectively.
NOTE 4.
INVESTMENTS
The Company invests a portion of its excess cash balances in short-term debt securities and may, from time to time, also invest in long-term debt securities. Investments at September 30, 2018 consisted of corporate bonds with maturities remaining of less than 12 months. The Company may also invest excess cash balances in certificates of deposits, money market accounts, government-sponsored enterprise securities, corporate bonds and/or commercial paper. The Company accounts for its investments in accordance with FASB ASC 320, Investments – Debt and Equity Securities. At September 30, 2018, all investments were classified as held-to-maturity securities.
The following tables summarize the Company’s short-term and long-term investments as of September 30, 2018, and September 30, 2017.
|
As of September 30, 2018
|
|
|
Amortized Cost
|
|
|
Gross Unrealized Gains
|
|
|
Gross Unrealized Losses
|
|
|
Fair Value
|
|
Commercial notes (due within one year)
|
$
|
46,400,176
|
|
|
|
—
|
|
|
$
|
(429,050
|
)
|
|
$
|
45,971,126
|
|
Total
|
$
|
46,400,176
|
|
|
$
|
—
|
|
|
$
|
(429,050
|
)
|
|
$
|
45,971,126
|
|
|
As of September 30, 2017
|
|
|
Amortized Cost
|
|
|
Gross Unrealized Gains
|
|
|
Gross Unrealized Losses
|
|
|
Fair Value
|
|
Commercial notes (due within one year)
|
$
|
40,769,539
|
|
|
$
|
—
|
|
|
$
|
(334,755
|
)
|
|
$
|
40,434,784
|
|
Total
|
$
|
40,769,539
|
|
|
$
|
—
|
|
|
$
|
(334,755
|
)
|
|
$
|
40,434,784
|
|
F-15
NOTE 5.
INTANGIBLE ASSETS
Intangible assets subject to amortization include patents and a license agreement capitalized as part of the Novartis RNAi asset acquisition in March 2015. The license agreement associated with the Novartis RNAi asset acquisition is being amortized over the estimated life remaining at the time of acquisition, which was 21 years, and the accumulated amortization of the asset is approximately $531,786. The patents associated with the Novartis RNAi asset acquisition are being amortized over the estimated life remaining at the time of acquisition, which was 14 years, and the accumulated amortization of the assets is approximately $5,561,419. Amortization expense for the years ended September 30, 2018, 2017 and 2016 was $1,700,429, $1,700,429 and $1,714,313, respectively. Amortization expense is expected to be approximately $1,700,429 in 2019, $1,700,429 in 2020, $1,700,429 in 2021, $1,700,429 in 2022, $1,700,429 in 2023, and $10,261,865 thereafter.
The following table provides details on the Company’s intangible asset balances:
|
|
Intangible assets
subject to
amortization
|
|
|
Balance at September 30, 2017
|
|
$
|
|
20,464,439
|
|
|
Impairment
|
|
|
|
-
|
|
|
Amortization
|
|
|
|
(1,700,429
|
)
|
|
Balance at September 30, 2018
|
|
$
|
|
18,764,010
|
|
|
NOTE 6.
STOCKHOLDERS’ EQUITY
At September 30, 2018, the Company had a total of 150,000,000 shares of capital stock authorized for issuance, consisting of 145,000,000 shares of Common Stock, par value $0.001 per share, and 5,000,000 shares of Preferred Stock, par value $0.001 per share.
At September 30, 2018,
88,505,302
shares of Common Stock were outstanding. At September 30, 2018, 8,732,569 shares of Common Stock were reserved for issuance upon exercise of options and vesting of restricted stock units granted or available for grant under Arrowhead’s 2004 Equity Incentive Plan and 2013 Incentive Plan, as well as for inducement grants made to new employees.
On January 22, 2018, the Company sold 11,500,000 shares of Common Stock in a fully underwritten public offering, at a public offering price of $5.25 per share. Net proceeds to the Company were approximately $56.6 million after deducting underwriting commissions and discounts and other offering expenses payable by the Company.
In October 2018 the Company sold 3,260,869 shares of Common Stock to JJDC at a price of $23.00 per share as part of the JJDC Stock Purchase Agreement discussed further in Note 2 above. The Company received proceeds of $75.0 million.
NOTE 7.
COMMITMENTS AND CONTINGENCIES
Leases
The Company leases approximately 8,500 square feet of office space for its corporate headquarters in Pasadena, California. The lease will expire in September 2019. Monthly rental payments are approximately $28,100 per month, increasing approximately 3% annually.
The Company also leases approximately 60,000 square feet of office and laboratory space for its research facility in Madison, Wisconsin. The lease will expire in September 2026. As part of this lease, the Company was provided a primary tenant improvement allowance of $2.1 million which is accounted for as Deferred Rent and a secondary tenant improvement allowance of $2.7 million which is accounted for as a Note Payable on the Company’s Consolidated Balance Sheet. Monthly rental payments, including payments of principal and interest on the Note Payable are approximately $186,300 per month. The monthly rental payments (excluding principal and interest on the Note Payable), will increase approximately 2.5% annually.
Facility rent expense for the years ended September 30, 2018, 2017 and 2016 was $1,288,000, $1,441,000 and $839,000, respectively.
F-16
As of September 30, 2018, future minimum lease payments due in fiscal years under operating leases are as follows:
2019
|
$
|
1,435,409
|
|
2020
|
|
1,044,431
|
|
2021
|
|
1,070,496
|
|
2022
|
|
1,097,168
|
|
2023
|
|
1,124,445
|
|
2024
and thereafter
|
|
3,544,882
|
|
Total
|
$
|
9,316,831
|
|
Note Payable
As part of the Company’s lease for its research facility in Madison, Wisconsin discussed above, the Company entered into a $2.7 million promissory note payable with its landlord to finance certain tenant improvements made to the new facility. The note will be amortized over the 10-year term of the lease, commencing on October 1, 2016. The note bears interest at a rate of 7.1% and is payable in equal monthly installments of principal and interest.
As of September 30, 2018, future principal payments due in fiscal years under the note payable are as follows:
2019
|
$
|
223,820
|
|
2020
|
|
240,258
|
|
2021
|
|
257,903
|
|
2022
|
|
276,845
|
|
2023
|
|
297,177
|
|
2024
and thereafter
|
|
1,029,015
|
|
Total
|
$
|
2,325,018
|
|
In October 2018, the Company repaid the entire balance due for the Note Payable associated with its Madison research and development facility lease discussed above.
Litigation –
The Company and certain of its officers and directors were named as defendants in a putative consolidated class action in the United States District Court for the Central District of California regarding certain public statements in connection with the Company’s hepatitis B drug research. The consolidated class action, initially filed as
Wang v. Arrowhead Research Corp., et al.
, No. 2:14-cv-07890 (C.D. Cal., filed Oct. 10, 2014), and
Eskinazi v. Arrowhead Research Corp., et al.
, No. 2:14-cv-07911 (C.D. Cal., filed Oct. 13, 2014), asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and sought damages in an unspecified amount. Additionally, three putative stockholder derivative actions captioned
Weisman v. Anzalone et al
., No. 2:14-cv-08982 (C.D. Cal., filed Nov. 20, 2014),
Bernstein (Backus) v. Anzalone, et al.
, No. 2:14-cv-09247 (C.D. Cal., filed Dec. 2, 2014); and
Johnson v. Anzalone, et al.
, No. 2:15-cv-00446 (C.D. Cal., filed Jan. 22, 2015), were filed in the United States District Court for the Central District of California, alleging breach of fiduciary duty by the Company’s Board of Directors in connection with the alleged facts underlying the securities claims. An additional consolidated derivative action asserting similar claims was filed in Los Angeles County Superior Court, initially filed as
Bacchus v. Anzalone, et al.
, (L.A. Super., filed Mar. 5, 2015); and
Jackson v. Anzalone, et al.
(L.A. Super., filed Mar. 16, 2015). Each of these suits seeks damages in unspecified amounts and some seek various forms of injunctive relief. On October 7, 2016, the federal district court dismissed the consolidated class action with prejudice. Following the dismissal of the consolidated class action, the parties for the Weisman and Johnson actions jointly stipulated to dismiss the actions, with the parties bearing their own fees and costs. The parties to the Bernstein and consolidated derivative action agreed to stay the matters pending the resolution of the Ninth Circuit appeal of the dismissal of the consolidated class action. On February 15, 2018, the Ninth Circuit issued a memorandum affirming the district court’s dismissal of all claims. Plaintiffs in the consolidated derivative action voluntarily dismissed their case. The parties to the Bernstein action filed a stipulation to continue the stay of the action pending resolution of the Ninth Circuit appeal in Meller v. Arrowhead Pharmaceuticals, Inc., Case No. 2:16-cv-08505 (C.D. Cal.). The Company believes it has meritorious defenses and intends to vigorously defend itself in each of these matters. The Company makes provisions for liabilities when it is both probable that a liability has been incurred and the amount can be reasonably estimated. No such liability has been recorded related to these matters. The Company does not expect these matters to have a material effect on its Consolidated Financial Statements.
F-17
The Company and certain executive officers were named as defendants in a putative consolidated
class action in the United States District Court for the Central District of California regarding certain public statements in connection with the Company’s drug research programs. The consolidated class action, initially filed as
Meller v. Arrowhead Pha
rmaceuticals, Inc., et al.
, No. 2:16-cv-08505 (C.D. Cal, filed Nov. 15, 2016 ),
Siegel v. Arrowhead Pharmaceuticals, Inc., et al
., No. 2:16-cv-8954 (C.D. Cal., filed Dec. 2, 2016), and
Unz v. Arrowhead Pharmaceuticals, Inc., et al
., No.2:17-cv-00310 (C.D.
Cal., filed Jan. 13, 2017) asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 regarding certain public statements in connection with the Company’s drug research programs and seek damages in an unspecified amount. Addition
ally, a putative stockholder derivative action captioned
Johnson v. Anzalone, et al
., (Los Angeles County Superior Court, filed January 19, 2017) asserting substantially similar claims is pending in Los Angeles County Superior Court and is stayed pending t
he related consolidated class action. Two additional putative stockholder derivative actions, captioned
Lucas v. Anzalone, et al.,
No. 2:17-cv-03207 (C.D. Cal., filed April 28, 2017), and
Singh v. Anzalone, et al
., No. 2:17-cv-03160 (C.D. Cal., filed April
27, 2017), alleging breach of fiduciary duty by the Company’s Board of Directors in connection with the alleged facts underlying the securities claims, are pending in the United States District Court for the Central District of California. The Lucas and
Singh actions have been consolidated. On December 21, 2017, the federal district court dismissed the consolidated class action with prejudice. On December 27, 2017 the plaintiffs appealed the dismissal to the United States Court of Appeals for the Ninth C
ircuit. The Lucas and Singh actions are stayed pending resolution of the Ninth Circuit appeal. The Company believes it has meritorious defenses and intends to vigorously defend itself in these matters. The Company makes provisions for liabilities when i
t is both probable that a liability has been incurred and the amount can be reasonably estimated. No such liability has been recorded related to these matters. The Company cannot predict the ultimate outcome of this matter and cannot accurately estimate
any potential liability the Company may incur or the impact of the results of this matter on the Company.
With regard to legal fees, such as attorney fees related to these matters or any other legal matters, the Company recognizes such costs as incurred.
Purchase Commitments
In the normal course of business, we enter into various purchase commitments for the manufacture of drug components, for toxicology studies, and for clinical studies. As of September 30, 2018, these future commitments were estimated at approximately $27.5 million, of which approximately $20.1 million is expected to be incurred in fiscal 2019, and $7.4 is expected to be incurred beyond fiscal 2019.
Technology License Commitments
The Company has licensed from third parties the rights to use certain technologies for its research and development activities, as well as in any products the Company may develop using these licensed technologies. These agreements and other similar agreements often require milestone and royalty payments. Milestone payments, for example, may be required as the research and development process progresses through various stages of development, such as when clinical candidates enter or progress through clinical trials, upon NDA and upon certain sales level milestones. These milestone payments could amount to the mid to upper double-digit millions of dollars. During the years ended September 30, 2018, 2017 and 2016, the Company reached milestones amounting to $0, $0 and $3.0 million, respectively, based on progress achieved on the Company’s previous clinical candidates. In certain agreements, the Company may be required to make mid to high single-digit percentage royalty payments based on a percentage of the sales of the relevant products.
NOTE 8.
STOCK-BASED COMPENSATION
Arrowhead has two plans that provide for equity-based compensation. Under the 2004 Equity Incentive Plan and 2013 Incentive Plan, as of September 30, 2018, 1,783,568 and 6,262,690 shares, respectively, of Arrowhead’s Common Stock are reserved for the grant of stock options, stock appreciation rights, restricted stock awards and performance unit/share awards to employees, consultants and others. No further grants may be made under the 2004 Equity Incentive Plan. As of September 30, 2018, there were options granted and outstanding to purchase 1,783,568 and 3,057,022 shares of Common Stock under the 2004 Equity Incentive Plan and the 2013 Incentive Plan, respectively, and there were 2,965,999 restricted stock units granted and outstanding under the 2013 Incentive Plan. Also, as of September 30, 2018, there were 683,809 shares reserved for options and 2,500 restricted stock units issued as inducement grants to new employees outside of equity compensation plans. During the year ended September 30, 2018, no options or restricted stock units were granted under the 2004 Equity Incentive Plan, 467,000 options and 1,243,000 restricted stock units were granted under the 2013 Incentive Plan, and 355,000 options and 2,500 restricted stock units were granted as inducement awards to new employees outside of equity incentive plans.
F-18
The following table summarizes information about stock options:
|
Number of
Options
Outstanding
|
|
|
Weighted-
Average
Exercise
Price
Per Share
|
|
|
Weighted-
Average
Remaining
Contractual
Term
|
|
|
Aggregate
Intrinsic
Value
|
|
Balance At September 30, 201
7
|
|
5,549,543
|
|
|
$
|
6.00
|
|
|
|
|
|
|
|
|
|
Granted
|
|
822,000
|
|
|
|
5.97
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
(242,533)
|
|
|
|
6.83
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
(604,611)
|
|
|
|
4.39
|
|
|
|
|
|
|
|
|
|
Balance At September 30, 2018
|
|
5,524,399
|
|
|
$
|
6.14
|
|
|
|
6.0 years
|
|
|
$
|
72,152,284
|
|
Exercisable At September 30, 2018
|
|
3,998,427
|
|
|
$
|
6.62
|
|
|
|
5.1 years
|
|
|
$
|
50,361,428
|
|
Stock-based compensation expense related to stock options for the years ended September 30, 2018, 2017 and 2016 was $3,265,348, $4,524,833 and $6,361,396, respectively. The Company does not recognize an income tax benefit as the Company is currently operating at a loss and an actual income tax benefit may not be realized. For non-qualified stock options, the expense creates a timing difference, resulting in a deferred tax asset, which is fully reserved by a valuation allowance.
The grant date fair value of the options granted by the Company for the years ended September 30, 2018, 2017 and 2016 was $4,141,318, $
849,816 and
$6,426,707, respectively.
The intrinsic value of the options exercised during the years ended September 30, 2018, 2017 and 2016 was $5,805,317, $35,512 and $142,690, respectively.
As of September 30, 2018, the pre-tax compensation expense for all outstanding unvested stock options in the amount of approximately $5,117,079 will be recognized in the Company’s results of operations over a weighted average period of
2.7
years.
The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which do not have vesting restrictions and are fully transferable. The determination of the fair value of each stock option is affected by the Company’s stock price on the date of grant, as well as assumptions regarding a number of highly complex and subjective variables. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The assumptions used to value stock options are as follows:
|
|
Years ended September 30,
|
|
|
201
8
|
|
201
7
|
|
201
6
|
Dividend yield
|
|
—
|
|
—
|
|
—
|
Risk-free interest rate
|
|
2.05 – 2.99%
|
|
1.34 – 2.31%
|
|
1.05 – 1.89%
|
Volatility
|
|
110%
|
|
79%
|
|
89%
|
Expected life (in years)
|
|
6.25
|
|
5.85
|
|
6.25
|
Weighted average grant date fair value per share of options granted
|
|
$5.04
|
|
$1.33
|
|
$4.58
|
The dividend yield is zero as the Company currently does not pay a dividend.
The risk-free interest rate is based on that of the U.S. Treasury bond.
Volatility is estimated based on volatility average of the Company’s Common Stock price.
F-19
Restricted Stock Units
Restricted stock units (RSUs), including time-based and performance-based awards, were granted under the Company’s 2013 Incentive Plan and as inducement grants granted outside of the Plan. During the year ended September 30, 2018, the Company issued 1,243,000 RSUs under the 2013 Incentive Plan and 2,500 RSUs as an inducement award to a new employee outside of the equity incentive plans. At vesting, each outstanding RSU will be exchanged for one share of the Company’s Common Stock. RSU recipients may elect to net share settle upon vesting, in which case the Company pays the employee’s income taxes due upon vesting and withholds a number of shares of Common Stock of equal value. RSU awards generally vest subject to the satisfaction of service requirements or the satisfaction of both service requirements and achievement of certain performance targets.
The following table summarizes the activity of the Company’s RSUs:
|
Number of
RSUs
|
|
|
Weighted-
Average
Grant
Date
Fair Value
|
|
Unvested at September 30, 2017
|
|
3,108,000
|
|
|
$
|
2.45
|
|
Granted
|
|
1,245,500
|
|
|
|
3.68
|
|
Vested
|
|
(1,335,000
|
)
|
|
|
2.43
|
|
Forfeited
|
|
(50,000
|
)
|
|
|
1.55
|
|
Unvested at September 30, 2018
|
|
2,968,500
|
|
|
$
|
2.99
|
|
During the years ended September 30, 2018, 2017 and 2016, the Company recorded $5,189,259, $3,366,762 and $5,234,420 of expense related to RSUs, respectively. Such expense is included in stock-based compensation expense in the Company’s Consolidated Statement of Operations and Comprehensive Loss. The Company does not recognize an income tax benefit as the Company is currently operating at a loss and an actual income tax benefit may not be realized. For RSUs, the expense creates a timing difference, resulting in a deferred tax asset, which is fully reserved by a valuation allowance.
For RSUs, the grant date fair value of the award is based on the Company’s closing stock price at the grant date, with consideration given to the probability of achieving performance conditions for performance-based awards.
As of September 30, 2018, the pre-tax compensation expense for all unvested RSUs in the amount of approximately $2,451,889 will be recognized in the Company’s results of operations over a weighted average period of 2.6 years.
NOTE 9.
FAIR VALUE MEASUREMENTS
The Company measures its financial assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. Additionally, the Company is required to provide disclosure and categorize assets and liabilities measured at fair value into one of three different levels depending on the assumptions (i.e., inputs) used in the valuation. Level 1 provides the most reliable measure of fair value while Level 3 generally requires significant management judgment. Financial assets and liabilities are classified in their entirety based on the lowest level of input significant to the fair value measurement. The fair value hierarchy is defined as follows:
Level 1—Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—Valuations are based on quoted prices for similar assets or liabilities in active markets, or quoted prices in markets that are not active for which significant inputs are observable, either directly or indirectly.
Level 3—Valuations are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Inputs reflect management’s best estimate of what market participants would use in valuing the asset or liability at the measurement date.
F-20
The following table summarizes fair value measurements at September 30, 2018 and September 30, 2017 for assets and liabilities measured at fair value on a recurring basis:
September 30, 2018:
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Cash and cash equivalents
|
$
|
30,133,213
|
|
$
|
—
|
|
$
|
—
|
|
$
|
30,133,213
|
|
Short-term investments
|
|
45,971,126
|
|
|
—
|
|
|
—
|
|
|
45,971,126
|
|
Derivative liabilities
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Contingent Consideration
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
September 30,
2017
:
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Cash and cash equivalents
|
$
|
24,838,567
|
|
$
|
—
|
|
$
|
—
|
|
$
|
24,838,567
|
|
Short-term investments
|
|
40,434,784
|
|
|
—
|
|
|
—
|
|
|
40,434,784
|
|
Derivative liabilities
|
|
—
|
|
|
—
|
|
|
695,114
|
|
|
695,114
|
|
Contingent Consideration
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
As part of a financing in January 2013, Arrowhead issued warrants to purchase up to 833,530 shares of Common Stock (the “2013 Warrants”) of which 0 warrants were outstanding at September 30, 2018. Further, as part of a financing in December 2012, Arrowhead issued warrants to purchase up to 912,543 shares of Common Stock (the “2012 Warrants”) of which warrants to exercise 143,811 shares remained unexercised and were cancelled at their expiration during the three months ended December 31, 2017. Each of the Warrants contained a mechanism to adjust the strike price upon the issuance of certain dilutive equity securities. If during the terms of the Warrants, the Company issued Common Stock at a price lower than the exercise price for the Warrants, the exercise price would be reduced to the amount equal to the issuance price of the Common Stock. As a result of these features, the Warrants were subject to derivative accounting as prescribed under ASC 815. Accordingly, the fair value of the Warrants on the date of issuance was estimated using an option pricing model and recorded on the Company’s Consolidated Balance Sheet as a derivative liability. The fair value of the Warrants was estimated at the end of each reporting period and the change in the fair value of the Warrants was recorded as a non-operating gain or loss as change in value of derivatives in the Company’s Consolidated Statement of Operations and Comprehensive Loss. During the years ended September 30, 2018, 2017 and 2016, the Company recorded a non-cash gain/(loss) from the change in fair value of the derivative liability of $432,141, $870,760 and $(293,072), respectively.
The following is a reconciliation of the derivative liability related to these Warrants:
Value at September 30, 2017
|
$
|
695,114
|
|
Issuance of instruments
|
|
—
|
|
Change in value
|
|
(432,141
|
)
|
Net settlements
|
|
(262,973
|
)
|
Value at September 30, 2018
|
$
|
—
|
|
|
|
|
|
The derivative assets/liabilities were estimated using option pricing models that are based on the individual characteristics of the warrants or instruments on the valuation date, as well as assumptions for expected volatility, expected life and risk-free interest rate. Changes in the assumptions used could have a material impact on the resulting fair value. The primary input affecting the value of the Company’s derivatives liabilities was the Company’s stock price. Other inputs have a comparatively insignificant effect.
F-21
As of September 30, 2015, the Company had a liability for contingent consideration related to its acquisition of the Roche RNAi business completed in 2011. The fair value measurement of the contingent consideration obligations is determined using Level 3 inputs. The fair value of contingent consideration obligations is based on a discounted cash flow model using a probability-weighted income approach. The measurement is based upon unobservable inputs supported by little or no market activity based on the Company’s assumptions and experience. Estimating timing to complete the development and obtain approval of products is difficult, and there are inherent uncertainties in developing a product candidate, such as obtaining U.S. Food and Drug Administration (FDA) and other regulatory approvals. In determining the probability of regulatory approval and commercial success, the Company utilizes data regarding similar milestone events from several sources, including industry studies and its own experience. These fair value measurements represent Level 3 measurements as they are based on significant inputs not observable in the market. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period. Accordingly, changes in assumptions could have a material impact on the amount of contingent consideration expense the Company records in any given period. In November 2016, the Company announced the discontinuation of its clinical trial efforts for ARC-520, ARC-AAT and ARC-521. Given this development, the Company assessed the fair value of its contingent consideration obligation to be $0 at September 30, 2018 and September 30, 2017.
NOTE 10. -
INCOME TAXES
The Company utilizes the guidance issued by the FASB for accounting for income taxes which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns.
Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.
Components of the net deferred tax asset (liability) at September 30, 2018 and 2017 are as follows:
|
|
2018
|
|
|
2017
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
Accrued compensation
|
$
|
1,085,908
|
|
|
$
|
1,337,619
|
|
Stock compensation
|
|
4,188,368
|
|
|
|
5,670,468
|
|
Capitalized research and development
|
|
1,227,137
|
|
|
|
2,196,542
|
|
Fixed Assets
|
|
404,836
|
|
|
|
203,477
|
|
Net operating losses
|
|
114,142,741
|
|
|
|
132,119,837
|
|
Intangible Assets
|
|
3,854,752
|
|
|
|
5,358,700
|
|
Deferred Revenue
|
|
—
|
|
|
|
1,068,206
|
|
Deferred Rent
|
|
566,535
|
|
|
|
865,675
|
|
Capital Loss
|
|
709,779
|
|
|
|
1,020,162
|
|
Total deferred tax assets
|
|
126,180,056
|
|
|
|
149,840,686
|
|
Valuation allowance
|
|
(116,875,075
|
)
|
|
|
(136,625,436
|
)
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
State taxes
|
|
(9,304,981
|
)
|
|
|
(13,215,250
|
)
|
Total deferred tax liability
|
|
(9,304,981
|
)
|
|
|
(13,215,250
|
)
|
Net deferred tax assets (liabilities)
|
$
|
—
|
|
|
$
|
—
|
|
The Company has concluded, in accordance with the applicable accounting standards, that it is more likely than not that the Company may not realize the benefit of all of its deferred tax assets. Accordingly, management has provided a 100% valuation allowance against its deferred tax assets until such time as management believes that its projections of future profits as well as expected future tax rates make the realization of these deferred tax assets more-likely-than-not. Significant judgment is required in the evaluation of deferred tax benefits and differences in future results from our estimates could result in material differences in the realization of these assets. The Company has recorded a full valuation allowance related to all of its deferred tax assets. The Company has performed an assessment of positive and negative evidence regarding the realization of the net deferred tax asset in accordance with FASB ASC 740-10, “Accounting for Income Taxes.” This assessment included the evaluation of scheduled reversals of deferred tax liabilities, the availability of carry forwards and estimates of projected future taxable income.
F-22
As of September 30, 2017, the Company had available gross federal net operating loss (NOL) carry forwards of $
284.8
million and gross state NOL c
arry forwards of $
196.6
million. Gross federal NOL carry forwards for 2018 are estimated at $62.8 million, and gross state NOL carry forwards for 2018 are estimated at $62.8 million. The NOLs expire at various dates through 2038.
The provisions for income taxes for the years ended September 30, 2018 and 2017 are as follows:
|
2018
|
|
|
2017
|
|
Federal:
|
|
|
|
|
|
|
|
Current
|
|
—
|
|
|
|
—
|
|
Deferred
|
|
—
|
|
|
|
—
|
|
Total Federal
|
|
—
|
|
|
|
—
|
|
State:
|
|
|
|
|
|
|
|
Current
|
$
|
2,400
|
|
|
|
2,400
|
|
Deferred
|
|
—
|
|
|
|
—
|
|
Total State
|
$
|
2,400
|
|
|
|
2,400
|
|
Provision from income taxes
|
$
|
2,400
|
|
|
|
2,400
|
|
The Company’s effective income tax rate differs from the statutory federal income tax rate as follows for the years ended September 30, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
At U.S. federal statutory rate
|
|
21.0
|
%
|
|
|
34.0
|
%
|
State taxes, net of federal effect
|
|
7.9
|
|
|
|
4.9
|
|
Stock compensation
|
|
2.6
|
|
|
|
(5.8
|
)
|
Mark-to-market adjustments
|
|
0.2
|
|
|
|
0.9
|
|
Valuation allowance
|
|
36.2
|
|
|
|
(23.1
|
)
|
True-up on deferred taxes
|
|
—
|
|
|
|
(3.0
|
)
|
State blended rate change
|
|
—
|
|
|
|
(5.7
|
)
|
Federal tax rate change in 2018
|
|
(67.9)
|
|
|
|
—
|
|
Other
|
|
—
|
|
|
|
(2.2
|
)
|
Effective income tax rate
|
|
0.0
|
%
|
|
|
0.0
|
%
|
In December 2017, the President of the United States signed into law the Tax Cuts and Jobs Act, or TCJA, tax reform legislation. The TCJA makes significant changes in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The TCJA reduced the U.S. corporate tax rate from the current rate of 35 percent down to 21 percent starting on January 1, 2018. As a result of the TCJA, we were required to revalue deferred tax assets and liabilities at 21 percent. This revaluation resulted in a provision of $37.0 million to income tax expense in continuing operations and a corresponding reduction in the valuation allowance. As a result, there was no impact to our Consolidated Statements of Comprehensive Loss as a result of the reduction in tax rates. The other provisions of the TCJA did not have a material impact on our Consolidated Financial Statements.
The Company has adopted guidance issued by the FASB that clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold of more likely than not and a measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In making this assessment, a company must determine whether it is more likely than not that a tax position will be sustained upon examination, based solely on the technical merits of the position and must assume that the tax position will be examined by taxing authorities. The Company’s policy is to include interest and penalties related to unrecognized tax benefits in income tax expense. The Company has not recognized any unrecognized tax benefits and does not have any interest or penalties related to uncertain tax positions as of September 30, 2018 and 2017.
The Company files income tax returns with the Internal Revenue Service (“IRS”), the state of California, the Australia Tax Office (“ATO”) and certain other taxing jurisdictions. The Company is subject to income tax examinations by the IRS and by state tax authorities until the net operating losses are settled. During the three months ended September 30, 2016, the IRS commenced an audit for the tax year ended September 30, 2015. The IRS audit concluded without any material adjustments.
F-23
NOTE 11.
EMPLOYEE BENEFIT PLANS
In January 2005, the Company adopted a defined contribution 401(k) retirement savings plan covering substantially all of its employees. The Plan is administered under the “safe harbor” provision of ERISA. Under the terms of the plan, an eligible employee may elect to contribute a portion of their salary on a pre-tax basis, subject to federal statutory limitations. The plan allows for a discretionary match in an amount up to 100% of each participant’s first 3% of compensation contributed plus 50% of each participant’s next 2% of compensation contributed.
For the years ended September 30, 2018, 2017, and 2016, we recorded expenses under this plan of $451,623, $426,470 and $476,835, respectively.
In addition to the employee benefit plans described above, the Company provides certain employee benefit plans, including those which provide health and life insurance benefits to employees.
NOTE 12.
UNAUDITED QUARTERLY FINANCIAL DATA
The following table presents selected unaudited quarterly financial data for each full quarterly period of the years ended September 30, 2018 and 2017:
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
Year ended September 30, 2018
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Revenues
|
|
$
|
3,509,821
|
|
$
|
650,125
|
|
$
|
727,375
|
|
$
|
11,255,000
|
|
Operating Losses
|
|
$
|
(13,813,348)
|
|
$
|
(15,034,059)
|
|
$
|
(15,919,719)
|
|
$
|
(11,169,109)
|
|
Net Loss
|
|
$
|
(13,198,878)
|
|
$
|
(14,884,311)
|
|
$
|
(15,606,017)
|
|
$
|
(10,761,272)
|
|
Loss per share (Basic and Diluted)
|
|
$
|
(0.18)
|
|
$
|
(0.18)
|
|
$
|
(0.18)
|
|
$
|
(0.12)
|
|
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
Year ended September 30, 2017
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Revenues
|
|
$
|
4,365,496
|
|
$
|
8,985,930
|
|
$
|
9,342,498
|
|
$
|
8,713,785
|
|
Operating Losses
|
|
$
|
(14,901,887)
|
|
$
|
(6,129,642)
|
|
$
|
(5,714,164)
|
|
$
|
(10,250,216)
|
|
Net Loss
|
|
$
|
(12,086,108)
|
|
$
|
(6,042,557)
|
|
$
|
(5,519,741)
|
|
$
|
(10,731,889)
|
|
Loss per share (Basic and Diluted)
|
|
$
|
(0.17)
|
|
$
|
(0.08)
|
|
$
|
(0.07)
|
|
$
|
(0.14)
|
|
NOTE 13.
SUBSEQUENT EVENTS
On October 3, 2018, the Company entered into a License Agreement (“Janssen License Agreement”) and a Research Collaboration and Option Agreement (“Janssen Collaboration Agreement” with Janssen Pharmaceuticals, Inc. (“Janssen”) part of the Janssen Pharmaceutical Companies of Johnson & Johnson. The Company also entered into a Stock Purchase Agreement (“JJDC Stock Purchase Agreement”) with Johnson & Johnson Innovation-JJDC, Inc. (“JJDC”), a New Jersey corporation. Under the Janssen License Agreement, Janssen has received a worldwide, exclusive license to the Company’s ARO-HBV program, the Company’s third-generation subcutaneously administered RNAi therapeutic candidate being developed as a potentially curative therapy for patients with chronic hepatitis B virus infection. Beyond the Company’s ongoing Phase 1 / 2 study of ARO-HBV, Janssen will be wholly responsible for clinical development and commercialization. Under the Janssen Collaboration Agreement, Janssen will be able to select three new targets against which Arrowhead will develop clinical candidates. These candidates are subject to certain restrictions and will not include candidates in the Company’s current pipeline. The Company will perform discovery, optimization and preclinical development, entirely funded by Janssen, sufficient to allow the filing of a U.S. Investigational New Drug application or equivalent, at which time Janssen will have the option to take an exclusive license. If the option is exercised, Janssen will be wholly responsible for clinical development and commercialization. Under the JJDC Stock Purchase Agreement, in October 2018 the Company sold 3,260,869 shares of common stock to JJDC at a price of $23.00 per share. Under the terms of the agreements taken together, the Company has received $175 million as an upfront payment, $75 million in the form of an equity investment by JJDC in Arrowhead common stock, and may receive up to $1.6 billion in development and sales milestones payments for the Janssen License Agreement, and up to $1.9 billion in development and sales milestone payments for the three additional targets covered under the Janssen Collaboration Agreement. The Company is further eligible to receive tiered royalties up to mid teens under the license agreement and up to low teens under the collaboration and option agreement on product sales.
In October 2018, the Company repaid the entire balance due for the Note Payable associated with its Madison research and development facility lease discussed in Note 7 – Commitments and Contingencies above.
F-24