The Company is actively monitoring the ongoing COVID-19 pandemic. The financial results for the three months ended December 31, 2021 were not significantly impacted by COVID-19. Operationally, the Company has experienced delays in its earlier stage programs due to a shortage in non-human primates, which are critical to the Company’s preclinical programs. Additionally, the Company has experienced delays in enrollment in its clinical trials. The Company’s operations at its research and development facilities in Madison, Wisconsin and San Diego, California, and its corporate headquarters in Pasadena, California have continued with limited impact, other than for enhanced safety measures, including work from home policies and intermittent lab supply shortages. However, the Company cannot predict the impact the progression of COVID-19 will have on future financial and operational results due to a variety of factors, including the ability of the Company’s clinical sites to continue to enroll subjects, the ability of the Company’s suppliers to continue to operate, the continued good health and safety of the Company’s employees and the length and severity of the COVID-19 pandemic.

Liquidity

The Consolidated Financial Statements have been prepared in conformity with the accounting principles generally accepted in the United States of America (“GAAP”), which contemplate the continuation of the Company as a going concern.  Historically, the Company’s primary sources of financing have been through the sale of its securities and revenue from its licensing and collaboration agreements. Research and development activities have required significant capital investment since the Company’s inception and are expected to continue to require significant cash expenditure in the future, particularly as the Company’s pipeline of drug candidates and its headcount have both expanded significantly.  Additionally, significant capital investment will be required as the Company’s pipeline matures into later stage clinical trials, as well as with the Company’s plans to increase its internal manufacturing capabilities. 

At December 31, 2021, the Company had $91.6 million in cash and cash equivalents (including $3.0 million in restricted cash), $112.5 million in short-term investments, $126.0 million in marketable securities and $217.6 million in long-term investments to fund operations.  During the three months ended December 31, 2021, the Company’s cash and investments balance decreased by $65.7 million, which was primarily due to cash being used to fund the Company’s operations.

In total, the Company remains eligible for $6.2 billion in developmental, regulatory and sales milestones and various royalties on net sales from its licensing and collaboration agreements.  The revenue recognition for these collaboration agreements is discussed further in Note 2 below.  

Summary of Significant Accounting Policies

There have been no changes to the significant accounting policies disclosed in the Company’s most recent Annual Report on Form 10-K.

The Company determined the transaction price totaled approximately $252.7 million, which includes the upfront payment, the premium paid by JJDC for its equity investment in the Company, two $25.0 million milestone payments related to JNJ-3989 (ARO-HBV), and estimated payments for reimbursable Janssen R&D Services to be performed.  The Company has allocated the total $252.7 million initial transaction price to its one distinct performance obligation for the JNJ-3989 (ARO-HBV) license and the associated Janssen R&D Services.  The Company has recognized this transaction price in its entirety as of September 30, 2021, as its performance obligations were substantially completed. Future milestones and royalties achieved will be recognized in their entirety when earned.  During the three months ended December 31, 2021 and 2020, the Company recognized approximately $0 and $12.7 million of revenue associated with this performance obligation, respectively. As of December 31, 2021, there were $0 in contract assets recorded as accounts receivable, and $0 of contract liabilities recorded as current deferred revenue on the Company’s Consolidated Balance Sheets.  

The Company has begun to conduct its discovery, optimization and preclinical research and development of JNJ-75220795 (ARO-JNJ1), ARO-JNJ2 and ARO-JNJ3 under the Janssen Collaboration Agreement.  All costs and labor hours spent by the Company will be entirely funded by Janssen. During the three months ended December 31, 2021 and 2020, the Company recognized $0 and $0.3 million of revenue associated with these efforts, respectively. As of December 31, 2021, there were $0 of contract assets recorded as accounts receivable and $0 of contract liabilities recorded as current deferred revenue on the Company’s Consolidated Balance Sheets.

Takeda Pharmaceuticals U.S.A., Inc.

On October 7, 2020, the Company entered into an Exclusive License and Co-funding agreement (the “Takeda License Agreement”) with Takeda.  Under the Takeda License Agreement, Takeda and the Company will co-develop the Company’s ARO-AAT program, the Company’s second-generation subcutaneously administered RNAi therapeutic candidate being developed as a treatment for liver disease associated with alpha-1 antitrypsin deficiency. Within the United States, ARO-AAT, if approved, will be co-commercialized under a 50/50 profit sharing structure. Outside the United States, Takeda will lead the global commercialization strategy and will receive an exclusive license to commercialize ARO-AAT, while the Company will be eligible to receive tiered royalties of 20% to 25% on net sales.  In January 2021, the Company received $300.0 million as an upfront payment and is eligible to receive potential development, regulatory and commercial milestones of up to $740.0 million.  

The Company has evaluated the Takeda License Agreement in accordance with FASB Topics 808 – Collaborative Arrangements and 606 - Revenue for Contracts from Customers. 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 ARO-AAT 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 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 will be 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 ARO-AAT license and the associated Takeda R&D Services.  Revenue will be 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). Revenue for the three months ended December 31, 2021 and 2020 was $20.8 million and $8.2 million, respectively. As of December 31, 2021, there were $0 in contract assets recorded as accounts receivable, $82.0 million in contract liabilities recorded as deferred revenue and $106.5 million in contract liabilities recorded as deferred revenue, net of the current portion, and $2.9 million in contract liabilities recorded as accrued expenses.  The $2.9 million in accrued expenses was primarily driven by co-development and co-commercialization activities.  

Horizon Therapeutics Ireland DAC

On June 18, 2021, the Company entered into the Horizon License Agreement with Horizon.  Under the Horizon License Agreement, Horizon received a worldwide exclusive license for ARO-XDH, a previously undisclosed discovery-stage investigational RNAi therapeutic being developed by the Company as a potential treatment for people with uncontrolled gout. The Company will conduct all activities through the preclinical stages of development of ARO-XDH, and Horizon will be wholly responsible for clinical development and commercialization of ARO-XDH. In July 2021, the Company received $40 million as an upfront payment and is eligible to receive up to $660 million in potential development, regulatory and sales milestones.  The Company is also eligible to receive royalties in the low- to mid-teens range on net product sales.  

The Company has evaluated the Horizon License Agreement in accordance with FASB Topics 808 – Collaborative Arrangements and 606 - Revenue for Contracts from Customers. 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 ARO-XDH (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 will be responsible for managing future clinical development and commercialization of ARO-XDH.  

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 will allocate the total $40.0 million initial transaction price to its one distinct performance obligation for the ARO-XDH license and the associated Horizon R&D Services. Revenue will be 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. Revenue for the three months ended December 31, 2021 and 2020 was $6.7 million and $0, respectively.  As of December 31, 2021, there were $0.1 million in contract assets recorded as accounts receivable, $26.7 million in contract liabilities recorded as deferred revenue.    

Glaxosmithkline Intellectual Property (No. 3) Limited

On November 22, 2021, the Company entered into an Exclusive License Agreement (the “GSK License Agreement”) with GSK.  Under the GSK License Agreement, GSK has received an exclusive license for ARO-HSD, the Company’s investigational RNAi therapeutic being developed as a treatment for patients with alcohol-related and nonalcohol related liver diseases, such as nonalcoholic steatohepatitis (NASH).  The exclusive license is worldwide with the exception of greater China, for which the Company will retain rights to develop and commercialize.  Beyond the Company’s Phase 1/2 study of (ARO-HSD), which the Company is responsible for completing, GSK is wholly responsible for clinical development and commercialization of ARO-HSD in its territory. Under the terms of the agreement, the Company has received an upfront payment of $120 million and is eligible for additional payments of $30 million at the start of Phase 2 and $100 million upon achieving a successful Phase 2 trial readout and the first patient dosed in a Phase 3 trial. Furthermore, should the Phase 3 trial read out positively, and the potential new medicine receives regulatory approval in major markets, the deal provides for commercial milestone payments to the Company of up to $190 million at first commercial sale, and up to $590 million in sales-related milestone payments. The Company is further eligible to receive tiered royalties on net product sales in a range of mid-teens to twenty percent.

The Company has evaluated the GSK License Agreement in accordance with FASB Topics 808 – Collaborative Arrangements and 606 - Revenue for Contracts from Customers. At the inception of the GSK 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 responsibility to complete the Phase 1/2 study, (the “GSK R&D Services”).  Due to the specialized and unique nature of these GSK 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 GSK R&D Services, which are the responsibility of the Company, GSK will be responsible for managing future clinical development and commercialization in its territory.  

The Company determined the initial transaction price totaled $120.0 million, including the upfront payment. The Company has excluded any future estimated milestones or royalties from this transaction price to date.  The Company has allocated the total $120.0 million initial transaction price to its one distinct performance obligation for the ARO-HSD license and the associated GSK R&D Services.  Revenue will be recognized using a proportional performance method. As of December 31, 2021, no revenue or contract assets or liabilities were recognized as the GSK License Agreement had not yet completed customary closing conditions, including clearance by the relevant competition authorities.  This clearance was achieved in January 2022 and the upfront payment of $120.0 million was also received by the Company in January 2022.

Realized gains for marketable securities recorded at fair value consist of dividends received and re-invested into the associated fund.  

In January 2016, the Company entered into a lease for its research facility in Madison, Wisconsin.  The lease was for approximately 60,000 square feet of office and laboratory space and had an expiration date of September 30, 2026. The lease was amended in January 2019 and May 2020 to expand the rentable square feet by an additional 40,000 square feet and to extend the lease expiration date to September 30, 2031. Lease payments are estimated to total approximately $26.2 million for the term. The Company incurred approximately $11.0 million of leasehold improvements for the additional 40,000 square feet, net of tenant improvement allowances. The lease contains two options to renew for two terms of five years. The exercise of these options were not determined to be reasonably certain and thus was not included in lease liabilities on the Company’s Consolidated Balance Sheet at December 31, 2021.  In November 2020 and December 2020, the Company entered into amendments to expand the rentable square space by an additional 10,743 square feet and these amendments added a total of approximately $1.2 million of lease payments for the remainder of the term.            

In March 2020, the Company entered into a sublease agreement for additional research and development facility space in San Diego, California.  The Sublease provides additional space needed to accommodate the recent growth of the Company’s personnel and discovery efforts. The Sublease is for approximately 21,000 rentable square feet.  The term of the Sublease commenced on April 1, 2020 and will end on January 14, 2023.  Sublease payments are estimated to total approximately $2.0 million over the term.

On November 19, 2021, the Company entered into a new lease for a San Diego, California research facility.  The 15-year lease is for approximately 144,000 square feet of office and research and development laboratory space to be constructed in San Diego, California.  This lease will replace the Company’s current research facility sublease for property located in San Diego, California.  The increased capacity of this new facility compared to the Company’s current research facility in San Diego will accommodate increased personnel for the Company’s expanding pipeline of current and future drug candidates. The estimated rent commencement date for the lease is in May 2023, after construction and leasehold improvements have been completed.  The lease payments, which begin on the rent commencement date, will be approximately $119.0 million over the initial 15-year term.  The Company also estimates payments for operating expenses to be approximately $3.0 million for the first year of the lease, and these payments will continue throughout the initial 15-year term. The Company expects to pay approximately $31.0 million for leasehold improvements, net of tenant improvement allowances.  Pursuant to the lease, within twelve months of the expiration of the initial 15-year term, the Company has the option to extend the lease for up to one additional ten-year term, with certain annual increases in base rent. No lease liabilities have been recorded as of December 31, 2021 as the lease commencement date has not yet occurred.

Operating lease cost during the three months ended December 31, 2021 and 2020 was $1.3 million and $0.9 million, respectively. Variable lease costs for the three months ended December 31, 2021 and 2020 was $0.2 million and $0.2 million, respectively. There was no short-term lease cost during the three months ended December 31, 2021 and 2020.