ARROWHEAD PHARMACEUTICALS, INC. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we intend that such forward-looking statements be subject to the safe harbors created thereby. For this purpose, any statements contained in this Quarterly Report on Form 10-Q except for historical information may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “plan,” “project,” “could,” “estimate,” “target,” “forecast” or “continue” or the negative of these words or other variations thereof or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, trends in our business, or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements include, but are not limited to, statements about the initiation, timing, progress and results of our preclinical studies and clinical trials, and our research and development programs; our expectations regarding the potential benefits of the partnership, licensing and/or collaboration arrangements and other strategic arrangements and transactions we have entered into or may enter into in the future; our beliefs and expectations regarding milestone, royalty or other payments that could be due to or from third parties under existing agreements; and our estimates regarding future revenues, research and development expenses, capital requirements and payments to third parties. The forward-looking statements included herein are based on current expectations of the Company ’ s management based on available information and involve a number of risks and uncertainties, all of which are difficult or impossible to predict accurately, and many of which are beyond the Company’s control. As such, our actual results and timing of certain events may differ materially from the results discussed, projected, anticipated or indicated in any forward-looking statements. Forward-looking statements are not guarantees of future performance and our actual results of operations, financial condition and cash flows may differ materially. Factors that may cause or contribute to such differences include, but are not limited to, those discussed in more detail in “Item 1. Business” and “ Item 1A. Risk Factors” of Part I and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II of the Company’s most recent Annual Report on Form 10-K. Readers should carefully review these risks, as well as the additional risks described in other documents the Company files from time to time with the Securities and Exchange Commission (the “SEC”), including this Quarterly Report on Form 10-Q for the quarter ended December 31, 2022. In light of the significant risks and uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that such results will be achieved, and readers are cautioned not to place undue reliance on such forward-looking information. Statements made herein are as of the date of the filing of this Quarterly Report on Form 10-Q with the SEC and should not be relied upon as of any subsequent date. Except as may be required by law, we disclaim any intent to revise the forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. OVERVIEW The Company 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, the Company’s therapies trigger the RNAi mechanism to induce rapid, deep and durable knockdown of target genes. RNAi is a mechanism present in living cells that inhibits the expression of a specific gene, thereby affecting the production of a specific protein. RNAi-based therapeutics may leverage this natural pathway of gene silencing to target and shut down specific disease-causing genes. The Company has focused its resources on therapeutics that exclusively utilize its high levels of pharmacologic activity in multiple animal models spanning several therapeutic areas. The Company believes that TRiM TM enabled therapeutics offer several potential advantages over prior generation and competing technologies, including: simplified manufacturing and reduced costs; multiple routes of administration including subcutaneous injection and inhaled administration; the ability to target multiple tissue types including liver, lung, muscle and others; and the potential for improved safety and reduced risk of intracellular buildup, because there are fewer metabolites from smaller, simpler molecules. The Company’s pipeline includes: • Hypertriglyceridemia - ARO-APOC3 • Dyslipidemia - ARO-ANG3 • Facioscapulohumeral muscular dystrophy - ARO-DUX4 21 • Complement mediated diseases - ARO-C3 • Muco-obstructive or inflammatory pulmonary conditions - ARO-RAGE and ARO-MUC5AC • Idiopathic pulmonary fibrosis - ARO-MMP7 • Liver disease - ARO-HSD (out-licensed to GSK) • Uncontrolled gout - HZN-457 (formerly ARO-XDH, out-licensed to Horizon) • Non-alcoholic steatohepatitis (NASH) - NJ-75220795 (formerly ARO-JNJ1, out-licensed to Janssen) • Liver disease associated with alpha-1 antitrypsin deficiency (“AATD”) - Fazirsiran (formerly ARO-AAT, a collaboration with Takeda) • Chronic hepatitis B virus - JNJ-3989 (formerly ARO-HBV, out-licensed to Janssen) • Cardiovascular disease - Olpasiran (formerly AMG 890 or ARO-LPA, out-licensed to Amgen) The Company operates lab facilities in San Diego, California and Madison, Wisconsin, where its research and development activities, including the development of RNAi therapeutics, take place. The Company’s principal executive offices are located in Pasadena, California. The Company continues to develop other clinical candidates for future clinical trials. Clinical candidates are tested internally and through GLP toxicology studies at outside laboratories. Drug materials for such studies and clinical trials are either manufactured internally or contracted to third-party manufacturers. The Company engages third-party contract research organizations (“CROs”) to manage clinical trials and works cooperatively with such organizations on all aspects of clinical trial management, including plan design, patient recruiting, and follow up. These outside costs, relating to the preparation for and administration of clinical trials, are referred to as “candidate costs.” As clinical candidates progress through clinical development, candidate costs will increase. The First Quarter Business Highlights Key recent developments during the first quarter of fiscal 2023 included the following: • enrolled the first subject in a Phase 1 randomized, placebo-controlled trial to assess the safety tolerability, pharmacokinetics and pharmacodynamics of a development-stage medicine, HZN-457 (previously known as ARO-XDH), which is out-licensed to Horizon, triggering a $15.0 million milestone payment to the Company which was paid in the second quarter of fiscal 2023; • enrolled the first subject in Amgen’s Phase 3 trial of Olpasiran, which triggered a $25.0 million milestone payment to the Company, which was paid in the second quarter of fiscal 2023; • entered into the Royalty Pharma Agreement on November 9, 2022, pursuant to which Royalty Pharma paid $250.0 million upfront (See Note 11 — Liability Related to the Sale of Future Royalties of Notes to Consolidated Financial Statements of Part I, “Item 1. Financial Statements.”); • announced top line results from SEQUOIA Phase 2 Study of Fazirsiran in Patients with Alpha-1 Antitrypsin Deficiency-Associated Liver Disease in which: ◦ Fibrosis regression was observed in 50% of patients receiving Fazirsiran; ◦ Median reductions of 94% of Z-AAT accumulation in the liver and mean reductions of 68% in histologic globule burden were observed; ◦ Treatment emergent adverse events were generally well balanced between Fazirsiran and placebo groups; ◦ Results were consistent with AROAAT-2002 open-label study previously published in The New England Journal of Medicine. Net loss was $41.3 million for the three months ended December 31, 2022 as compared to net loss of $62.9 million for the three months ended December 31, 2021. Net loss per share – diluted was $0.39 for the three months ended December 31, 2022 as compared to net loss per share – diluted of $0.60 for the three months ended December 31, 2021. The decrease in net loss for the three months ended December 31, 2022 was due to an increase in revenue from the Company’s license and collaboration agreements, primarily from the license agreements with Horizon, Takeda and Amgen, partially offset by increased research and development and general and administrative expenses, which have continued to increase as the Company’s pipeline of candidates has expanded and progressed through clinical trial phases. The Company had $202.2 million of cash, cash equivalents and restricted cash, $299.6 million in short-term investments, $115.8 million of long-term investments and $891.5 million of total assets as of December 31, 2022, as compared to $108.0 million of cash, cash equivalents and restricted cash, $268.4 million in short-term investments, $105.9 million of long-term investments and $691.9 million of total assets as of September 30, 2022. Based upon the Company’s 22 current cash and investment resources and operating plan, the Company expects to have sufficient liquidity to fund operations for at least the next twelve months. Critical Accounting Estimates There have been no significant changes to the Company’s critical accounting estimates disclosed in the most recent Annual Report on Form 10-K for the fiscal year ended September 30, 2022. RESULTS OF OPERATIONS The following data summarizes the Company’s results of operations for the following periods indicated: Three Months Ended December 31, 2022 2021 (in thousands, except per share amounts) Revenues $ 62,546 $ 27,439 Operating loss $ (42,134) $ (63,321) Net loss attributable to Arrowhead Pharmaceuticals, Inc. $ (41,325) $ (62,872) Net loss per share-diluted $ (0.39) $ (0.60) Revenue Total revenue for the three months ended December 31, 2022 increased to $62.5 million, 127.9% from the same period of 2021. The increase was primarily driven by the revenue recognition associated with Horizon, Takeda and Amgen license agreements, as discussed below. The Company has evaluated each agreement in accordance with FASB Topic 808– Collaborative Arrangements and Topic 606- Revenue for Contracts from Customers . Horizon On June 18, 2021, Horizon and the Company entered into the Horizon License Agreement. At the inception of the Horizon License Agreement, the Company identified one distinct performance obligation. The Company determined that the key deliverables included the license and certain R&D services, including the Company’s responsibilities to conduct all activities through the preclinical stages of development of HZN-457 (the “Horizon R&D Services”). Due to the specialized and unique nature of these Horizon R&D Services and their direct relationship with the license, the Company determined that these deliverables represented one distinct bundle and, thus, one performance obligation. Beyond the Horizon R&D Services, which are the responsibility of the Company, Horizon is responsible for managing future clinical development and commercialization of HZN-457. The Company determined the initial transaction price totaled $40.0 million , including the upfront payment. The Company has excluded any future estimated milestones or royalties from this transaction price to date. The Company allocates the total $40.0 million initial transaction price to its one distinct performance obligation for the HZN-457 license and the associated Horizon R&D Services. Revenue is recognized on a straight-line basis over the estimated timeframe for completing the Horizon R&D Services. The Company determined that the straight-line basis was appropriate as its efforts will be expended evenly over the course of completing its performance obligation. On December 8, 2022, Horizon announced that it enrolled the first subject in a Phase 1 randomized, placebo-controlled trial to assess the safety, tolerability, pharmacokinetics and pharmacodynamics of HZN-457, triggering a $15.0 million milestone payment to the Company which was paid in the second quarter of fiscal 2023. Revenue for the three months ended December 31, 2022 and 2021 were $21.7 million and $6.7 million, respectively. There were $15.0 million in contract assets recorded as accounts receivable and $0 in contract liabilities recorded as deferred revenue as of December 31, 2022. Takeda On October 7, 2020, Takeda and the Company entered into the Takeda License Agreement. At the inception of the Takeda License Agreement, the Company identified one distinct performance obligation. The Company determined that the key deliverables included the license and certain R&D services including the Company’s responsibilities to complete the initial portion of the SEQUOIA study, to complete the ongoing Phase 2 AROAAT2002 study and to ensure certain manufacturing of Fazirsiran drug product is completed and delivered to Takeda (the “Takeda R&D Services”). Due to the specialized and unique nature of these Takeda R&D Services and their direct relationship with the license, the Company 23 determined that these deliverables represent one distinct bundle and, thus, one performance obligation. Beyond the Takeda R&D Services, which are the responsibility of the Company, Takeda will be responsible for managing future clinical development and commercialization outside the United States. Within the United States, the Company will also participate in co-development and co-commercialization efforts and will co-fund these efforts with Takeda as part of the 50/50 profit sharing structure within the United States. The Company considers the collaborative activities, including the co-development and co-commercialization, to be a separate unit of account within Topic 808, and as such, these co-funding amounts are recorded as research and development expenses or general and administrative expenses, as appropriate. The Company determined the initial transaction price totaled $300.0 million, which includes the upfront payment. The Company has excluded any future milestones or royalties from this transaction price to date. The Company has allocated the total $300.0 million initial transaction price to its one distinct performance obligation for the Fazirsiran license and the associated Takeda R&D Services. Revenue is recognized using a proportional performance method (based on actual patient visits completed versus total estimated visits completed for the ongoing SEQUOIA and AROAAT2002 clinical studies). The Company recognized $16.3 million and $20.8 million in connection with these efforts for the three months ended December 31, 2022 and 2021, respectively. There were $0 of contract assets recorded as accounts receivable and $107.1 million of contract liabilities recorded as deferred revenue, of which $66.3 million was classified as current deferred revenue, as of December 31, 2022. The Company also recorded $9.8 million as accrued expenses as of December 31, 2022 that was primarily driven by co-development and co-commercialization activities. Amgen Inc. (“Amgen”) On September 28, 2016, Amgen and the Company entered into two collaboration and license agreements and a common stock purchase agreement. Under the Olpasiran Agreement, Amgen received a worldwide, exclusive license to the Company’s novel RNAi Olpasiran program. Olpasiran is designed to reduce elevated lipoprotein(a), which is a genetically validated, independent risk factor for atherosclerotic cardiovascular disease. Amgen is wholly responsible for clinical development and commercialization. The Company has substantially completed its performance obligations under the Olpasiran Agreement. Further, in November 2022, Royalty Pharma and the Company entered into the Royalty Pharma Agreement. In consideration for the payments under the Royalty Pharma Agreement, Royalty Pharma is entitled to receive all royalties otherwise payable by Amgen to the Company under the Olpasiran Agreement. The Company remains eligible to receive any milestone payments potentially payable by Amgen under the Olpasiran Agreement. In December 2022, Amgen enrolled the first subject in its Phase 3 trial of Olpasiran, which triggered a $25.0 million milestone payment to the Company, which was paid in the second quarter of fiscal 2023. The Company is further eligible to receive up to an additional $535 million in aggregate development, regulatory, and sales milestone payments from Amgen and Royalty Pharma. Revenue for the three months ended December 31, 2022 and 2021 were $25.0 million and $0, respectively. There were $25.0 million in contract assets recorded as accounts receivable and $0 in contract liabilities recorded as deferred revenue as of December 31, 2022. 24 Operating Expenses The analysis below details the operating expenses and discusses the expenditures of the Company within the major expense categories. For purposes of comparison, the amounts for the three months ended December 31, 2022 and 2021 are shown in the tables below. Research and Development Expenses R&D expenses are related to the Company’s research and development discovery efforts and related candidate costs, which are comprised primarily of outsourced costs related to the manufacturing of clinical supplies, toxicity/efficacy studies and clinical trial expenses. Internal costs primarily relate to discovery operations at the Company’s research facilities in San Diego, California and Madison, Wisconsin, including facility costs and laboratory-related expenses. The Company does not separately track R&D expenses by individual research and development projects, or by individual drug candidates. The Company operates in a cross-functional manner across projects and does not separately allocate facilities-related costs, candidate costs, discovery costs, compensation expenses, depreciation and amortization expenses, and other expenses related to research and development activities. The following table provides details of research and development expenses for the three months ended December 31: (in thousands) 2022 % of Expense Category 2021 % of Expense Category Increase (Decrease) $ % Candidate costs $ 42,284 51 % $ 32,345 49 % $ 9,939 31 % R&D discovery costs 12,693 15 % 11,000 17 % 1,693 15 % Salaries 14,689 17 % 10,994 17 % 3,695 34 % Facilities related 3,341 4 % 2,038 3 % 1,303 64 % Total research and development expense, excluding non-cash expense $ 73,007 87 % $ 56,377 86 % $ 16,630 29 % Stock compensation 8,402 10 % 7,218 11 % 1,184 16 % Depreciation and amortization 2,286 3 % 2,170 3 % 116 5 % Total research and development expense $ 83,695 100 % $ 65,765 100 % $ 17,930 27 % Candidate costs increased $9.9 million to $42.3 million for the three months ended December 31, 2022 compared to $32.3 million for the same period of 2021. This increase was primarily due to the progression of the Company’s pipeline of candidates into and through clinical trials, which resulted in higher outsourced clinical trial, toxicity study and manufacturing costs. For example, the Company’s cardiometabolic candidates, ARO-ANG3 and ARO-APOC3, have advanced into Phase 2 and Phase 3 clinical trials. R&D discovery costs increased $1.7 million to $12.7 million for the three months ended December 31, 2022 compared to $11.0 million for the same period of 2021. This increase was due to the growth of the Company’s discovery efforts and continued advancement into novel therapeutic areas and tissue types. Salaries and stock compensation expense consist of salary, bonuses, payroll taxes, related benefits and stock compensation for the Company’s R&D personnel. The increases in salaries and stock comp expenses were primarily due to an increase in R&D headcount that has occurred as the Company has expanded its pipeline of candidates, in addition to annual salary increases. Stock compensation expense was based upon the valuation of stock options and restricted stock units granted to employees, directors and certain consultants. Facilities-related expense included lease costs for the Company’s research and development facilities in San Diego, California and Madison, Wisconsin. Facilities-related costs increased $1.3 million to $3.3 million for the three months ended December 31, 2022, compared to $2.0 million for the same period of 2021. This increase was mainly due to the additional lease expense as the Company expands discovery efforts to identify new drug candidates. The increase of depreciation and amortization expense, a non-cash expense, relates to depreciation on lab equipment and leasehold improvements at the facilities. The Company anticipates these R&D expenses to continue to increase as its pipeline of candidates grows and progresses to later phase clinical trials, in addition to inflationary pressure on goods and services and the labor market. General & Administrative Expenses The following table provides details of the Company’s general and administrative expenses for the three months ended 25 December 31: 2022 % of Expense Category 2021 % of Expense Category Increase (Decrease) $ % Salaries $ 4,207 20 % $ 3,430 13 % $ 777 23 % Professional, outside services, and others 4,383 21 % 3,195 13 % 1,188 37 % Facilities related 1,005 5 % 680 3 % 325 48 % Total general & administrative expense, excluding non-cash expense $ 9,595 46 % $ 7,305 29 % $ 2,290 31 % Stock compensation 10,987 52 % 17,287 69 % (6,300) (36) % Depreciation and amortization 403 2 % 403 2 % — — % Total general & administrative expense $ 20,985 100 % $ 24,995 100 % $ (4,010) (16) % Salaries expense increased $0.8 million to $4.2 million for the three months ended December 31, 2022 compared to $3.4 million for the same period of 2021. The increase was driven by the combination of annual salary increases and increased headcount required to support the Company’s growth. Professional, outside services, and others expense includes legal, consulting, patent expenses, business insurance expenses, other outside services, travel, and communication and technology expenses. This expense increased $1.2 million to $4.4 million for the three months ended December 31, 2022 compared to $3.2 million for the same period of 2021. The increase was mainly due to consulting expenses related to software implementation and administrative expenses in support of additional headcount. Facilities related expense primarily includes rental costs and other facilities-related costs for the Company’s corporate headquarters in Pasadena, California. Depreciation and amortization expense, a noncash expense, was primarily related to amortization of leasehold improvements for the Company’s corporate headquarters. Stock compensation expense, a non-cash expense, decreased by $6.3 million to $11.0 million for the three months ended December 31, 2022 compared to $17.3 million for the same period of 2021. The decrease in the current period was mainly due to the reversal of recognized compensation costs related to a performance award where the minimum performance goal was not met. The fair value of market condition-based awards was expensed ratably over the service period and was not adjusted for actual achievement. The Company anticipates these general and administrative expenses to continue to increase as its pipeline of candidates grows and progresses to later phase clinical trials, in addition to inflationary pressure on goods and services and the labor market. Other Income Other income is primarily related to interest income and realized and unrealized gain/loss on investments. Other income decreased $0.1 million to $0.3 million for the three months ended December 31, 2022 compared to $0.4 million for the same period of 2021. The decrease was due to the interest expense on the liability related to the sale of future royalties, offset by higher yields on investments due to increased interest rates as well as credits the Company received during the first quarter of fiscal 2023. 26 LIQUIDITY AND CAPITAL RESOURCES The Company has historically financed its operations through the sale of its common stock, revenue from its licensing and collaboration agreements and the sale of certain future royalties. Research and development activities have required significant capital investment since the Company’s inception and are expected to continue to require significant cash expenditure as the Company’s pipeline continues to expand and matures into later stage clinical trials. Additionally, the Company plans to expand its facilities with its purchase of land in Verona, Wisconsin, and its entry into a new lease in San Diego, California. Each of these expansions is designed to increase the Company’s internal manufacturing and discovery capabilities, and each will require significant capital investment. The Company’s cash, cash equivalents and restricted cash increased to $202.2 million at December 31, 2022 compared to $108.0 million at September 30, 2022. Cash invested in short-term fixed income securities was $299.6 million at December 31, 2022 compared to $268.4 million at September 30, 2022. Cash invested in long-term fixed income securities was $115.8 million at December 31, 2022, compared to $105.9 million at September 30, 2022. On December 2, 2022, the Company entered into the Open Market Sale Agreement, pursuant to which the Company may, from time to time, sell up to $250.0 million in shares of the Company’s common stock through Jefferies LLC, acting as the sales agent and/or principal, in an at-the-market offering. As of December 31, 2022, no shares have been issued under the Open Market Sale Agreement. The Company believes its current financial resources are sufficient to fund its operations through at least the next twelve months. The following table presents a summary of cash flows: Three Months Ended December 31, 2022 2021 (in thousands) Cash Flow from: Operating activities $ (75,516) $ (61,308) Investing activities (80,694) (33,385) Financing activities 250,576 1,885 Net increase (decrease) in cash, cash equivalents and restricted cash $ 94,366 $ (92,808) Cash, cash equivalents and restricted cash at end of period $ 202,249 $ 91,587 During the three months ended December 31, 2022, cash flows used by operating activities was $75.5 million, which was primarily due to the ongoing expenses related to the Company’s research and development programs and general and administrative expenses, partially offset by the receipt of $6.0 million from GSK (see Note 2 — Collaboration and License Agreements to Consolidated Financial Statements of Part I, “Item 1. Financial Statements”) and Horizon. Cash used in investing activities was $80.7 million, which was primarily related to capital expenditures, primarily construction in progress, of $38.9 million and investments of $111.2 million, offset by net sales and maturities of investments of $69.4 million. Cash provided by financing activities of $250.6 million was primarily related to the $250.0 million payment from Royalty Pharma as well as cash received from stock option exercises. See Note 11 — Liability Related to the Sale of Future Royalties of Notes to Consolidated Financial Statements of Part I, “Item 1. Financial Statements.” During the three months ended December 31, 2021, cash flows used by operating activities was $61.3 million, which was primarily related to ongoing expenses related to the Company’s research and development programs and general and administrative expenses. Cash used in investing activities was $33.4 million, which was primarily related to the purchase of property and equipment of $5.8 million and net purchases of investments of $27.6 million. Cash provided by financing activities of $1.9 million was related to cash received from stock option exercises. On December 20, 2021, the Company completed a purchase of 13 acres of land in the Verona Technology Park in Verona, Wisconsin, which is being developed into an approximately 160,000 square foot drug manufacturing facility and an approximately 140,000 square foot laboratory and office facility which will support the Company’s process development and analytical activities. The Company intends to invest between $200.0 million and $260.0 million into the build out of the facilities with cash on hand. As part of this acquisition, the Company entered into a development agreement with the City of Verona to construct certain infrastructure improvements within the tax incremental district and expects to be reimbursed up to $16.0 million by the City of Verona by future tax increment revenue generated from the developed property. The total amount of funding that City of Verona is expected to pay under the Tax Incremental Financing program is not guaranteed and will depend on future tax revenues generated from the developed property. The Company also expects receive up to $2.5 million of refundable Wisconsin state income tax credits from the Wisconsin Economic Development Corporation (WEDC) as incentives to invest in the local community and create new jobs. 27 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no material change in the Company ’ s exposure to market risk from that described in Item 7A of its Annual Report on Form 10-K for the year ended September 30, 2022.