What happened

Shares of Arrowhead Pharmaceuticals (NASDAQ:ARWR) jumped as much as 18.1% today after the company reported fiscal full-year 2019 operating results. Arrowhead Pharmaceuticals is a pre-commercial company, but operations have been solidly profitable thanks to a collaboration with Johnson & Johnson subsidiary Janssen.

The gene-silencing company reported revenue of $168 million on the year that resulted in operating income of $61 million. A tax provision resulted in net income that was actually higher than that: $68 million. Arrowhead Pharmaceuticals ended September with $303 million in cash.

As of 12:46 p.m. EST, the pharma stock had settled to a 17% gain.

An arrow bouncing up shelves on a wall.

Image source: Getty Images.

So what

How is it possible for the business to report such healthy operating metrics when it doesn't have a single drug on the market? Well, in October 2018, Arrowhead Pharmaceuticals received an upfront payment of $175 million and an equity investment of $75 million from Janssen for their then-new collaboration deal. The gene-silencing company decided to account for the total transaction price -- technically $252.6 million -- using the proportional performance method. 

The accounting method counts the full amount as deferred revenue (a liability on the balance sheet) and gradually deducts from that total as progress is made within the collaboration (the deducted amount gets counted as revenue on the income statement). It smooths out revenue recognition over several quarters, and has allowed Arrowhead Pharmaceuticals to report solid fiscal full-year 2019 operating results.

Metric

Fiscal 2019

Fiscal 2018

Change

Revenue

$168.8 million

$16.1 million

945%

Operating expenses

$107.6 million

$72.1 million

49%

Operating income

$61.2 million

($55.9 million)

N/A

Data source: SEC filing.

As astute investors will notice, the well will soon run dry. Arrowhead Pharmaceuticals counted just $77.8 million in deferred revenue related to the Janssen collaboration at the end of September (the end of its fiscal year). Given rising operating expenses as clinical trials mature, investors might expect operating profits to swing to operating losses in fiscal 2020. But it might not matter much in the grand scheme of things.

Consider that Arrowhead Pharmaceuticals ended September with $303 million in cash. That can support operations for the foreseeable future. Additionally, even as the proportional performance method exhausts deferred revenue from the Janssen collaboration, it only affects the upfront payment from the deal. The gene-silencing company still stands to receive hefty milestone payments from Janssen as pipeline programs progress. 

In fact, Arrowhead Pharmaceuticals recently received a $25 million payment when a phase 2b study began dosing patients with a triple-combination therapy intended to treat -- or even functionally cure -- chronic hepatitis B infections.

Now what

Investors are certainly beginning to expect big things from Arrowhead Pharmaceuticals. It wields a promising pipeline of drug candidates based on RNA interference (RNAi) and has significantly de-risked drug development with lucrative collaboration deals. Now, at a market valuation of over $6 billion, the company has to deliver.

Don't be surprised if it announces a large public stock offering to pad its balance sheet and wisely take advantage of a soaring stock price.