Arrowhead Research updates its shareholders

Nov 3 2009

Arrowhead Research Corporation’s (NASDAQ: ARWR) President and Chief Executive Officer today issued the following letter to the Company’s shareholders:

Dear Arrowhead Shareholders:

It has now been almost three months since our last earnings call, and I wanted to provide our shareholders with a broad strategic and operational update. Following this letter will be individual updates of specific subsidiaries over the next several weeks. We are proud of what we have achieved, where our businesses are right now, and are optimistic about our near- and long-term prospects. I look forward to describing some of this optimism and providing some context to it.

When I joined Arrowhead, I found a company with valuable assets, a powerful business model, and quality management. These are the factors that attracted me to the company and those that I was committed to building on.

Since then, we have made considerable progress and I believe Arrowhead is now at an inflection point based on four primary factors that have the potential to drive significant shareholder value: (1) Unidym is on the brink of breaking into some of its target markets; (2) Calando is at an advanced point in its siRNA clinical trial and we are seeing some exciting results; (3) our restructuring is largely complete and we are now a more flexible and cost efficient company; and (4) amid our aggressive cost-cutting initiatives and increased focus on near-term revenue, we have retained the means to capitalize on longer-term growth opportunities.

Arrowhead

A key challenge when I arrived at Arrowhead nearly 2 years ago was continuing to secure appropriate capital because the model was necessarily capital intensive: we were building relatively young, pre-revenue companies around potentially disruptive technologies. Unfortunately, the capital markets soon changed. They seemed to become less interested in seeking long term yield and increasingly focused on eliminating risk. The markets became less hospitable to small cap companies that were capital intensive, pre-revenue, and considered to be high risk. This is the storm in which we have been operating and that has sunk a great many otherwise promising companies. I am quite proud indeed that we have survived this market dislocation and believe that, from a structural standpoint, we are actually stronger now. Some confront difficult times by shuttering operations in an attempt to outlast them, and this sort of passive strategy did not make sense to us. We were certainly focused on short-term survival, but we were also committed to fundamentally changing the way we do business in order to create a stronger, more flexible institution capable of building long-term shareholder value.

A crisis, though painful, can be an opportunity to do important things that may otherwise be difficult. This has been our approach to protect and then build shareholder value. Of course, we have worked extremely hard to make sure we could survive the market downturn, but we have also worked to restructure our businesses, decrease our costs and increase our focus. A decrease in available capital can help a company become better operationally by requiring it to do more with less and increase its overall capital efficiency. The challenge is to do this without sacrificing strategic opportunities. We believe we have done very well in this balance. We have cut our burn rate significantly, focused our resources on nearer-term revenue and growth opportunities, and retained long-term upside potential. Our recurring burn rate has been slashed by approximately 67% from its high a year ago, we believe Calando and Unidym are at significant inflection points, and our less mature subsidiaries provide longer-term growth potential in a cost-effective way.

In addition to these important steps, last month we held a Special Meeting of Stockholders. We would like to thank everyone for their participation, and I am pleased to report that all proposed measures were passed. Among the measures was the grant of authority to our Board of Directors to effect a reverse split of our common stock. Granting the Board this authority was intended solely as an insurance policy: we currently have no plans to implement a reverse split. As you may know, on September 15, 2009, we received a notice of non-compliance from NASDAQ based on the bid price of Arrowhead’s common stock. We believe that we have ample time for organic growth to drive an increase in our stock price and ensure continued NASDAQ listing. While we have confidence that developments within our businesses will provide these catalysts, we felt it prudent to have the authority to implement a reverse split, if necessary, to maintain our NASDAQ listing.

I will now briefly describe and summarize the current status of each of our subsidiaries:

Unidym

In 2005 Arrowhead sought to consolidate the fragmented carbon nanotube, or CNT, market by licensing key intellectual property and acquiring companies to create a dominant player in the use of CNTs for electronics. We believe we have achieved this by licensing foundational patents from universities and research institutions and through the acquisition of three leading CNT companies. However, acquiring the key intellectual property, know-how, and manufacturing capabilities to address down stream markets are not by themselves sufficient for a sustainable business. Unidym has needed to “push” its technology into potential end markets by establishing partnerships and developing working prototypes.

Unidym is focused on penetrating the display and solar cell industries as initial target markets. A key material used in these industries is indium tin oxide, or ITO. We have seen broad acceptance for the need to replace ITO in these industries, and we believe that Unidym’s CNT materials are a highly attractive replacement. Total addressable markets within these industries alone have been estimated at $2.5 billion, and are forecast to become greater than $3.5 billion by 2012.

We have been focused on this for quite some time now and have made literally dozens of working prototypes in touch panel, E-Paper, and LCD devices. We have joint development agreements with the two largest LCD manufacturers in the world, are sampling prototypes with some of the largest touch panel manufactures in the world, and are working with a large Japanese company on thin film solar cells. We plan to break into the touch panel market first and are pushing to achieve our goal of capturing revenue by the end of calendar 2009. We believe that this will not only be a significant event for Unidym, but also an important step forward for the display industry. To our knowledge, all large-scale commercial touch screen devices rely on ITO, notwithstanding the widespread desire to integrate an effective replacement. Therefore, the first company to offer a scalable and cost-competitive replacement has the potential to create substantial value. It has been our goal to be that company. Although we expect initial revenue contribution from sales into the touch panel markets to be modest, we are optimistic that penetration rates will rise as other touch panel manufacturers see a viable alternative in Unidym’s CNT products.

This is a very attractive market to us. If Unidym prices its material at parity with ITO or even at a slight discount, we believe we will be able to generate highly attractive margins. Therefore, we are optimistic that we will be positioned to drive considerable value growth. Going forward, we believe that we may have favorable pricing power because we expect our product lines to provide significant advantages over ITO including: touch screen life, decreased cost of ownership, increased manufacturing throughput, decreased environmental impact, better supply security, and enhanced design options such as the ability to make flexible screens and seamlessly integrate LCD and touch panel into singular devices.

Because Unidym’s technology may be applied to a wide variety of products across multiple markets, the display industry is by no means our only long-term target. After we begin to penetrate this market, we plan to accelerate our work in the use of films for such applications as solid-state lighting, smart windows and energy storage. For now, we have focused our resources on commercializing printable transparent conductive films and are also expanding efforts to license our patent portfolio for different applications of fullerenes and carbon nanotubes.

From an operational standpoint, Unidym has also made great strides controlling its costs and establishing a scalable and cost effective supply chain. Today, we have successfully reduced Unidym’s burn rate by four times, compared to the third quarter of fiscal 2008, and we have accomplished this without significantly adversely affecting time to initial target markets. It is now a far more nimble company and I am impressed with the progress Unidym has made.

Calando Pharmaceuticals

Calando is our other lead subsidiary that we are focusing on for near-term value growth. Like Unidym, we have worked very hard to contain Calando’s costs while retaining upside potential. We believe we have done that.

Calando is a clinical stage drug delivery company that had developed two drug delivery platforms: one for delivering traditional small molecule drugs; and one for delivering siRNA, or short interfering RNA molecules. Running two clinical programs is an expensive endeavor, and given the extreme softness of the capital markets we determined that the best course of action was to focus our resources on a single program and partner the other. We chose to continue development of the siRNA delivery program and partner the small molecule delivery program along with its associated drug candidate IT-101. We have ceased all pipeline R&D activities and are allocating resources only to our remaining siRNA clinical program. We believe that focusing resources solely on the clinic is an extremely efficient use of capital and will enable us to move most rapidly and cost-effectively to an attractive partnership or sale, assuming continued positive clinical results.

RNAi, or RNA interference, is a process through which target genes may be turned down or “quieted,” and it may be accomplished with siRNA molecules. RNAi is a potentially revolutionary new way of treating diverse disease classes; however, the lack of a proven method of delivering siRNA in humans has held the new field back. In fact, many view the systemic delivery of siRNA as the “Holy Grail” of RNAi therapeutics. We have always believed that the first company to demonstrate effective systemic delivery of siRNA and resulting RNAi in humans has the potential to create significant shareholder value. It has always been Calando’s goal to be that company, and we continue to believe that we are well positioned to achieve this.

We believe that Calando was the first company to initiate a clinical trial using siRNA against cancer and the first to use a delivery vehicle for the systemic delivery of siRNA in humans. Because we are at the leading edge of a field of intense interest to large pharmaceutical companies, Calando has focused its resources on continuing its siRNA clinical program with the ultimate goal of selling or partnering the platform. We are very pleased with the progress of the Phase I clinical trial using CALAA-01, Calando’s first siRNA therapeutic candidate. CALAA-01, and therefore Calando’s proprietary siRNA delivery platform RONDEL, has been very well tolerated by patients thus far. The Phase I is an ascending-dose trial whereby three patients receive a given dose of CALAA-01 and if there are no serious drug-related toxicities, three new patients will receive a higher dose, and so on. Importantly, we have seen no significant drug-related toxicities and we believe we have entered the dose range where we could expect clinical activity. We have some very exciting data from the clinical trial that support our confidence that CALAA-01 and the broader RONDEL platform have significant value and may be attractive acquisition targets.

Tego, Agonn, Nanotope, and Leonardo Biosystems

In addition to our two more mature, primary subsidiaries we have: two wholly owned subsidiaries, Tego Biosciences and Agonn Systems; and two minority-owned holdings, Nanotope and Leonardo Biosystems.

Tego has broad intellectual property relating to modified fullerenes for use in diagnostics, therapeutic, imaging, and other biopharmaceutical-related applications. We believe that Tego’s patent portfolio is potentially quite valuable and its proprietary technology can be used to develop a large number of different products. For instance, there has been encouraging animal data generated using certain modified fullerenes to treat models for Alzheimer’s Disease and Macular Degeneration. In addition, there has been notable interest in using modified fullerenes as next generation contrast agents for MRI. However, because Arrowhead has been committed to drastically decreasing its burn rate and focusing resources on nearer-term opportunities, we moved Tego into a licensing model and ceased most ongoing expenses associated with it. Because of the breadth of the portfolio, we are optimistic that we will be able to realize value from Tego without incurring significant ongoing costs.

Like Tego, Agonn is a virtual company with no operations and minimal capital requirements. Given our experience with Unidym, we identified an opportunity in energy storage using CNTs. We sought to build IP and know-how surrounding the use of CNTs in supercapacitors, a class of energy storage devices that enable the rapid charge and discharge of energy. We continue to believe in the large supercapacitor markets and the potential for CNT technology to positively impact new device engineering; however, this has not been a major focus for us as we have sought to restructure Arrowhead, cut our burn, and focus on nearer-term opportunities.

Nanotope and Leonardo Biosystems are both minority Arrowhead holdings; however, we see compelling opportunities for both companies and intend to explore opportunities to increase our equity positions. With very little current investment, Arrowhead’s downside exposure is limited to amounts already invested, but it has upside potential as the companies grow.

Nanotope is a regenerative medicine company that leverages a core platform technology to regenerate diverse tissue types. In multiple animal models, it has demonstrated the ability to: 1) reverse paralysis by regenerating spinal cord tissue after injury; 2) accelerate wound healing; 3) regenerate bone; and 4) regenerate cartilage. Most recently, it has generated exciting new data in a rodent Parkinson’s Disease model. Nanotope’s business model is to develop product candidates through proof of concept in animals and then source appropriate partners to bring them through clinical trials and to the market. Therefore, Nanotope is able to keep its burn rate low, avoid the expenses associated with clinical trials, and maximize the chances of widespread adoption of approved products by working with best-in-class companies for its target markets.

Leonardo is a cancer drug delivery company built around the work of Dr. Mauro Ferrari. It was built on the philosophy that drug delivery will be far more efficient if multiple vehicles are used, each customized to get through specific biological barriers. The result is a Russian doll approach (a doll-within a doll) whereby a primary vehicle is designed to get specifically to tumor vasculature. Once there, smaller secondary vehicles (embedded within the primary vehicle) are released to specifically target the tumor cells themselves and deliver therapeutics. Importantly, the delivery system is therapeutic-agnostic, hence it can be used for multiple classes of drugs and a virtually infinite number of different products. Leonardo has a very low burn rate because it works closely with Dr. Ferrari’s laboratory, one of the best funded drug delivery groups in the world, to advance the technology. We are very excited about Leonardo and its potential to create value.

While I am not satisfied with our current stock price, I am pleased with what our businesses have achieved over the past 12 plus months, particularly given the recent market. We are focused on enabling Unidym and Calando to provide the near-term value growth we expect and to continue moving forward with our other subsidiaries. In addition, after a year-long suspension of efforts instituted to preserve capital, we have begun exploring new opportunities that could be built once developments at Unidym or Calando allow such growth. Thank you for your ongoing support and interest, and I look forward to providing updates on progress at our subsidiaries in the coming weeks.

Sincerely,
Christopher Anzalone