Allon Therapeutics Inc. and Oncothyreon Inc. are both involved

Allon Therapeutics Inc. and Oncothyreon Inc. are both involved in the discovery, research, and development of therapeutic products. Allon Therapeutics focuses mainly on discovering and developing first drugs that impact the progression of neurodegenerative diseases, while Oncothyreon researches and develops therapeutic products for the treatment of cancer.

Instructions

From the company websites, obtain the comparative financial statements of Allon for its year ended December 31, 2009, and of Oncothyreon for its year ended December 31, 2009. Review the financial statements and answer the following questions.

(a) Compare the companies’ statements of operations and comment on their results over the past two fiscal periods. What is the major reason for the results that are reported?

(b) How would you expect companies in this industry and stage of development to be financed? Why? Is this consistent with what is reported on their statement of financial position? Comment.

(c) For the two most recent years reported by each company, write a brief explanation of their cash activities at the subtotal level of operating, investing, and financing flows. Note any similarities and differences.

(d) How do the investments that Allon and Oncothyreon make differ from the investments made by companies in other industries? Describe the difference in general, and then specifically explain how it affects each of the financial statements.

(e) Are the companies liquid? Explain. On what does the solvency and financial flexibility of companies in this industry depend?

(a)    Allon Therapeutics and Oncothyreon are in the biotechnology and pharmaceutical industries. Their primary objective is the discovery and development, through research, of new drugs and products for the treatment of diseases. As such they are not manufacturers or distributors of product and so their sources of revenue (if any) are from the sale of patents or technology developed through their efforts. During the many years in which the investment of the research is performed, very little revenue might be generated.  The statements of operations of Oncothyreon reveal revenue from royalties or licensing of some of its technology to other research firms or to pharmaceutical companies. 

Because of the modest amounts of revenue realized compared to the significant research and development costs expended, predictably, these companies experience continued losses. Since the majority of the activity is basic research, the expenditures do not qualify to be capitalized and later amortized. The conditions under which this would be allowed are very restrictive and are usually only applicable at the end of the development phase of a product or process.

In general, investors in this industry know and expect the operating results to be negative. They continue to invest in these companies on the hopes of realizing a substantial return on their investment in the future when a powerful and lucrative drug is developed and sold to the giant pharmaceutical firms for subsequent sale and distribution.

The large and continued losses on the statements of operations are therefore not a surprise to anyone and are not a sign of failure. Success is measured rather in the progress towards the development of lucrative products, which can bring large royalties or gains from the sale of the product and/or technology itself.

(b)    In order to finance what are expected to be several years of losses, biotechnology companies must obtain long-term financing. Since debt is impractical considering the risks surrounding the company’s future ability to repay debt, the sources of financing are generally from equity.  Large sums of cash are obtained from the sale of shares.  Share offerings are done every few years to replenish cash and cash equivalents to fund the company for the next few years.  In the two years provided in the statement of cash flows of Allon Therapeutics, large cash inflows occurred in fiscal year 2008 of $18.4 million from the sale of common shares. These inflows assisted in offsetting the cash outflows from operations of 2008 and 2009 of $12.4 million and $8.1 million, respectively allowing Allon to invest the remaining cash intended to be used in subsequent years to fund operations.

This approach to financing is similar for Oncothyreon, which had large shares and warrants issues of $24.6 million in 2009.  The statement of financial positions of both companies show high levels of cash and short-term investments and capital stock. For Oncothyreon, the warrants issued in 2009 are reported as liabilities as they have a price that may vary under certain circumstances and may be required to be settled in cash. The high levels of capital stock are needed to offset the huge deficits that have been accumulated over the years.

(c)    For both companies, in the last two fiscal years, cash was mainly used for operations. 

Since these companies do not make substantial investments in property, plant, and equipment, their investment activities are mostly restricted. Oncothyreon invested cash from the issuance of common shares in short-term investments and later liquidated to fund operations. Depending on the timing of the cash received from these investments, this will in turn affect the direction of the cash flows from investing activities. In 2008, the investing cash flow of Oncothyreon was positive as investments were liquidated to fund operations. In 2009, on the other hand, the purchase was more than liquidation, as the company had large cash inflows from the issue of common shares and warrants. In both years, small amounts were invested in property, plant and equipment, representing $1.4 million in 2009 and $744 thousand in 2008.

Allon also shows the sale of short term investment and capital asset purchases in its investing activities.  In 2008, there was $1.1 million realized from the sale of investments, and no related purchases or sales in 2009.  In both years, Allon invested small amounts in property and equipment, totalling $24,976 in 2008 and $22,533 in 2009.

For both companies, financing activities are principal sources of cash. Cash generated from the sale of common shares is used to finance current and future years’ operations.  It appears that Allon invested the cash from the issue of common shares in highly liquid short-term investments, which were classified as cash and cash equivalents (e.g. short-term investments with terms to maturity when acquired for three months or less), as the statement of financial position shows the large balance of cash and cash equivalents and no account for short-term investments. This investment policy or choice of the company resulted in its investing activities being presented on the statements of cash flows relatively simply: the acquisition of property, equipment for 2009.

(d)    Due to the nature of the operations and the expectations of shareholders, biotechnology companies do not have substantial investments in property, plant, and equipment.  Their ability to obtain debt financing is restricted by the risk involved concerning the company’s ability to repay debt from future operations. Therefore, equipment might be financed through capital leases or from the sale of equity instruments. Facilities are rented instead of owned. This provides more flexibility to the companies involved although the overall costs might be higher. This strategy is confirmed by the modest amounts of capital assets reported on the balance sheets.

Other businesses that are able to generate cash from operations and demonstrate an ability to service debt can expect to be financed partially with debt. They can therefore obtain the financing necessary to make long-term investments in plant and facilities. In those industries it would not be surprising to find balance sheets with higher amounts in both capital assets and long-term debt.

(e)    Because of the continued commitment on the part of shareholders to provide the necessary equity financing required by these companies to continue their research activity, Allon and Oncothyreon are in fact very liquid companies. They ensure that the amounts of cash and cash equivalents and short-term investments are at a level adequate to continue operating well into the future to reach their goals. So long as the biotech firms can demonstrate progress toward reaching the discovery and development of new products, investors will continue to fund these businesses by purchasing more common shares and warrants. This explains why investors are not necessarily as concerned about the financial condition of the company in which they invest as they are about the progress reports concerning research results provided by the firms on a regular basis.