XBiotech Inc.: Form 10-Q for the period ended Jun 30, 2022

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

XBiotech Inc. (“XBiotech” or the “Company) is a pre-market biopharmaceutical company engaged in discovering and developing True Human™ monoclonal antibodies for treating a variety of diseases. True Human™ monoclonal antibodies are those which occur naturally in human beings—as opposed to being derived from animal immunization or otherwise engineered. We believe that naturally occurring monoclonal antibodies have the potential to be safer and more effective than their non-naturally occurring counterparts. XBiotech is focused on developing its True Human™ pipeline and manufacturing system.

Following the Janssen Transaction in December 2019, the tender offer in February 2020, and the dividends paid in July 2021, the accumulated deficit as of June 30, 2022 was ($11.8) million. We had net losses before income tax of $14.3 million and $20.7 million for the three months and six months ended June 30, 2022, respectively, compared to $9.7 million and $12.7 million for the three months and six months ended June 30, 2021, respectively. During the next year, we expect the revenues from 2019 Janssen Transaction Addendum will be used in our research and development activities. In addition, we expect to incur significant and increasing operating losses for the foreseeable future as we advance our drug candidates from discovery through preclinical testing and clinical trials and seek regulatory approval and eventual commercialization. We will need to generate significant revenues to achieve or sustain profitability, and we may never do so. As of June 30, 2022, we had 96 employees.

Revenues

Prior to receiving payments under the clinical manufacturing agreement entered into in connection with the Janssen Transaction, we had not generated any revenue. Under the clinical manufacturing agreement, we manufacture bermekimab for use by Janssen in clinical trials, in exchange for fixed payments, paid in quarterly installments through 2021. In February 2022, we entered a new manufacturing contract with a Janssen-related company whereby we will continue to manufacture bermekimab through December 2023. The contract terminates in December 2023. Our ability to generate any additional revenue and/or to become profitable (or sustain any profitability) depends on our ability to successfully commercialize any product candidates we may advance in the future.

Research and Development Expenses

Research and development expense consists of expenses incurred in connection with identifying and developing our drug candidates. These expenses consist primarily of salaries and related expenses, stock-based compensation, the purchase of equipment, laboratory and manufacturing supplies, facility costs, costs for preclinical and clinical research, development of quality control systems, quality assurance programs and manufacturing processes. We charge all research and development expenses to operations as incurred.

The clinical development costs may further increase going forward with potentially more advanced studies in the future as we evaluate our clinical data and pipeline.

Clinical development timelines, likelihood of success and total costs vary widely. We do not currently track our internal research and development costs or our personnel and related costs on an individual drug candidate basis. We use our research and development resources, including employees and our drug discovery technology, across multiple drug development programs. As a result, we cannot state precisely the costs incurred for each of our research and development programs or our clinical and preclinical drug candidates. From inception through June 30, 2022, we have recorded total research and development expenses, including share-based compensation, of $264.8 million. Our total research and development expenses for the three months and six months ended June 30, 2022 were $10.4 million and $17.2 million, respectively, compared to $9.3 million and $13.9 million for the three months and six months ended June 30, 2021, respectively. Share-based compensation accounted for $1.0 million and $2.0 million for the three months and six months ended June 30, 2022, respectively, compared to $0.4 million and $0.8 million for the three months and six months ended June 30, 2021, respectively, related to research and development.

Research and development expenses, as a percentage of total operating expenses for the three months and six months ended June 30, 2022 were 77% and 80%, respectively, compared to 67% and 70% for the three months and six months ended June 30, 2021, respectively. The percentages, excluding share-based compensation, for the three months and six months ended June 30, 2022 were 79% and 82%, respectively, compared to 69% and 73% for the three months and six months ended June 30, 2021.

We will select drug candidates and research projects for further development on an ongoing basis in response to their preclinical and clinical success and commercial potential. For research and development candidates in early stages of development, it is premature to estimate when material net cash inflows from these projects might occur.

General and Administrative Expenses

General and administrative expense consists primarily of salaries and related expenses for personnel in administrative, finance, business development and human resource functions, as well as the legal costs of pursuing patent protection of our intellectual property and patent filing and maintenance expenses, share–based compensation, and professional fees for legal services. Our total general and administration expenses for the three months and six months ended June 30, 2022 were $3.0 million and $4.3 million, respectively, compared to $4.5 million and $6.0 million for the three months and six months ended June 30, 2021, respectively. Share-based compensation accounted for $0.5 million and $0.9 million for the three months and six months ended June 30, 2022, respectively, and $0.5 million and $1.0 million for the three months and six months ended June 30, 2021, respectively, related to general and administrative expenses.

General and administrative expenses, as a percentage of total operating expenses for the three months and six months ended June 30, 2022 were 23% and 20%, respectively, compared to 33% and 30% for the three months and six months ended June 30, 2021, respectively. The percentages, excluding share-based compensation, for the three months and six months ended June 30, 2022 were 21% and 18%, respectively, compared to 31% and 27% for the three months and six months ended June 30, 2021.

Critical Accounting Policies

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our financial statements, which have been prepared in conformity with generally accepted accounting principles in the United States (US GAAP). The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and expenses incurred during the reported periods.

We base estimates on our historical experience, known trends and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are more fully described in the notes to our financial statements appearing in this Quarterly Report on Form 10-Q.

Income Taxes

We account for income taxes under the asset and liability method. We record deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as for operating loss and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. We recognize the effect of a change in tax rates on deferred tax assets and liabilities in the results of operations in the period that includes the enactment date. We assess the likelihood that deferred tax assets will be realized, and we recognize a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. To date, we have provided a valuation allowance against our deferred tax assets as we believe the objective and verifiable evidence of our historical pretax net losses outweighs any positive evidence of our forecasted future results. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment. We will continue to monitor the positive and negative evidence and will adjust the valuation allowance as sufficient objective positive evidence becomes available.

We account for uncertain tax positions by recognizing the financial statement effects of a tax position only when, based upon technical merits, it is more likely than not that the position will be sustained upon examination. We recognize potential accrued interest and penalties associated with unrecognized tax positions within our global operations in income tax expense.

Results of Operations

Revenue

Revenue during the three months ended and six months ended June 30, 2022 and 2021 are summarized as follows (in thousands):

Under the clinical manufacturing agreement with Janssen and the addendum, we have recorded $1.5 and $4.5 million as manufacturing revenue for the three months ended June 30, 2022 and 2021, respectively. Clinical trial revenue is based on the transition services agreement under which we agreed to continue operational management, on a fee-for-service basis, of certain ongoing clinical trials related to bermekimab, which includes $19 thousand pass-through revenue for the two trials and $6 thousand mark-up revenue for the three months ended June 30, 2021. The clinical trial service agreement was terminated in the year 2022.

We have recorded $2.0 million manufacturing revenue for the six months ended June 30, 2022, compared to $9 million for the six months ended June 30, 2021. Clinical trial revenue for the six months ended June 30, 2021 was $0.4 million, including $0.3 million pass-through expense for two trials and $0.1 million mark-up revenue.

Cost of Goods Sold

Cost of goods sold during the three months and six months ended June 30, 2022 and 2021 are summarized as follows (in thousands):

The manufacturing cost for the three months ended June 30, 2022 represents cost for the manufacuring department under the February 2022 agreement and the cost for the three months ended June 30, 2021 included expense for manufacturing, quality assurance and quality control departments. Clinical trial cost for the three months ended June 30, 2021 is the pass-through expenses for two trials and other related clinical trial department expenses.

We have recorded $0.4 million in manufacturing cost for the six months ended June 30, 2022, compared to $3.4 million for the six months ended June 30, 2021. Clinical trial cost for the six months ended June 30, 2021 was $0.3 million including the pass- through expenses for two trials and other related clinical trial department expenses. The three months and six months decrease was mainly due to the completion of the Janssen clinical manufacturing agreement on December 2021 and the addendum signed in February 2022.

Expenses

Research and Development

Research and Development costs are summarized as follows (in thousands):

We do not currently track our internal research and development costs or our personnel and related costs on an individual drug candidate basis. We use our research and development resources, including employees and our drug discovery technology, across multiple drug development programs. As a result, we cannot state precisely the costs incurred for each of our research and development programs or our clinical and preclinical drug candidates.

Research and development expenses increased $1.1 million to $10.4 million for the three months ended June 30, 2022, compared to $9.3 million for the three months ended June 30, 2021. The increase was mainly due to the reclassification of expense. Manufacturing department expenses were not reclassed to cost of goods sold in 2022 compared to a portion of manufacturing department expenses were reclassed to cost of goods sold in 2021 were related to the clinical trial manufacturing agreement in the Janssen Transaction. The increase of share-based compensation is due to the new grants to employees in the fourth quarter of 2021. In addition, salaries and related expenses decreased because of the $3.8 million bonus to the Chief Executive Officer in June 2022 compared to the $7.0 million bonus in June 2021, in which 60% was allocated to research and development expenses for both periods.

Research and development expenses increased $3.3 million to $17.2 million for the six months ended June 30, 2022, compared to $13.9 million for the six months ended June 30, 2021. The six months increase was also mainly due to the reclassification of expense. Salaries and related expenses decreased because of the $3.8 million bonus to the Chief Executive Officer in June 2022 compared to the $7.0 million bonus in June 2021, in which 60% was allocated to research and development expenses for both periods. The other expense includes the facility allocation and other miscellaneous expense.

General and Administrative

General and administrative costs are summarized as follows (in thousands):

General and administrative expenses decreased $1.5 million to $3.0 million for the three months ended June 30, 2022 compared to $4.5 million for the three months ended June 30, 2021. General and administrative expenses decreased $1.6 million to $4.3 million for the six months ended June 30, 2022 compared to $6.0 million for the six months ended June 30, 2021.

The three months decrease was primarily related to the decrease in salaries and related expenses. The bonus to the Chief Executive Officer in June 2022 was $3.8 millioncompared to the $7.0 million bonus in June 2021, in which 40% was allocated to general and administrative expenses for both periods.

Compared to the six months ended June 30, 2021, the general and administrative expense decrease in the six months ended June 30, 2022 was also primarily caused by the decrease to salaries and related expenses. In addition, professional fees decreased $0.3 million mainly due to the decrease in annual audit fees in 2022.

Other income (loss)

The following table summarizes other income (loss) (in thousands):

The interest income for the three months and six months ended June 30, 2022 and 2021 was mainly from the interest generated from the Company’s Canadian bank account. Foreign exchange gain (loss) was mainly due to the fluctuation between the US dollar and the Canadian dollar in the three months and six months ended June 30, 2022 compared to 2021.

Liquidity and Capital Resources

Our cash requirements could change materially as a result of the progress of our research and development and clinical programs, licensing activities, acquisitions, divestitures or other corporate developments.

Since our inception on March 22, 2005 through June 30, 2022, we have funded our operations principally through private placements and public offerings of equity securities, which have provided aggregate cash proceeds of approximately $118.2 million. We received $675 million in cash proceeds from the Janssen Transaction in the year ended December 31, 2019. In June 2021, we received the remaining $75 million in cash from the escrow receivable from the same transaction. In July 2021, we paid $75 million in dividends to shareholders. During the following 12 months, we expect that the revenues from Janssen Transaction Addendum will generate part of the cash for our research and development activities. At June 30, 2022, we had cash and cash equivalents of $225.8 million as compared to cash and cash equivalents of $315.3 million at June 30, 2021. The following table summarizes our sources and uses of cash (in thousands):

During the six months ended June 30, 2022 and 2021, our operating activities used net cash of $11.5 million and generated net cash $74.6 million, respectively. The cash from operations for the six months ended June 30, 2021 primarily resulted from the $75 million escrow payment received.

During the six months ended June 30, 2022 and 2021, our investing activities used net cash of $0.2 million and $2.3 million, respectively. The use of cash was for building expansion and warehouse in construction.

During the six months ended June 30, 2021, our financing activities provided net cash of $5.0 million. Employees exercised stock options to purchase a total of 720 thousand shares of our common stock for approximately $5.0 million in net proceeds during the six months ended June 30, 2021.

We expect to continue to incur operating losses in the future. Further, the clinical manufacturing agreement with Janssen expires on December 2023, after which we do not expect to receive any additional revenue under that agreement. As of June 30, 2022, our principal sources of liquidity were our cash and cash equivalents, which totaled approximately $225.8 million.

Off-Balance Sheet Arrangements

Since inception, we have not engaged in any off-balance sheet activities, including the use of structured finance, special purpose entities or variable interest entities.

The Company is not currently exposed to material market risk arising from financial instruments, changes in interest rates or commodity prices, or fluctuations in foreign currencies. The Company has no need to hedge against any of the foregoing risks and therefore currently engages in no hedging activities.

Management's Evaluation of our Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended. Based on such evaluation, the Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports the Company files or furnishes under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations, and are operating in an effective manner.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.