XBiotech Inc.: Form 10-Q for the period ended Sep 30, 2023

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 September 30, 2023 was ($47.7) million. We had net losses before income tax of $7.1 million and $19.6 million for the three months and nine months ended September 30, 2023, respectively, compared to $10.3 million and $31.0 million for the three months and nine months ended September 30, 2022, respectively. During the next year, we don’t expect any revenues. 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. In addition to these increasing research and development expenses, we expect general and administrative costs to increase, particularly in consideration of current inflationary trends. We will need to generate significant revenues to achieve or sustain profitability, and we may never do so. As of September 30, 2023, we had 85 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 manufactured bermekimab for use by Janssen in clinical trials, in exchange for fixed payments, paid in quarterly installments through 2021. In Febuary 2022, we entered a new manufacturing contract with a Janssen-related company whereby we continued to manufacture bermekimab through November 2022. The contract terminated in November 2022. 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 September 30, 2023, we have recorded total research and development expenses, including share-based compensation, of $304.1 million. Our total research and development expenses for the three months and nine months ended September 30, 2023 were $7.5 million and $25.0 million, respectively, compared to $7.0 million and $24.2 million for the three months and nine months ended September 30, 2022, respectively. Share-based compensation related to research and development was $0.8 million and $2.2 million for the three months and nine months ended September 30, 2023, respectively, compared to $0.9 million and $2.8 million for the three months and nine months ended September 30, 2022, respectively.

Research and development expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2023 were 89% and 87%, respectively, compared to 89% and 82% for the three months and nine months ended Septmber 30, 2022, respectively. The percentages of research and development expenses compared to total operating expenses, excluding share-based compensation, for the three months and nine months ended September 30, 2023 were 89% and 87%, respectively, compared to 92% and 84% for the three months and nine months ended September 30, 2022.

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, maintenance expenses, share–based compensation, and professional fees for legal services. Our total general and administration expenses for the three months and nine months ended September 30, 2023 were $1.0 million and $3.9 million, respectively, compared to $0.8 million and $5.2 million for the three months and nine months ended September 30, 2022, respectively. Share-based compensation accounted for $0.1 million and $0.3 million for the three months and nine months ended September 30, 2023, respectively, and $0.3 million and $1.2 million for the three months and nine months ended September 30, 2022, respectively, related to general and administrative expenses.

General and administrative expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2023 were 11% and 13%, respectively, compared to 11% and 18% for the three months and nine months ended September 30, 2022, respectively. The percentages of general and administrative expense compares to total operating expenses, excluding share-based compensation, for the three months and nine months ended September 30, 2023 were 11% and 13%, respectively, compared to 8% and 16% for the three months and nine months ended September 30, 2022.

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 nine months ended September 30, 2023 and 2022 are summarized as follows (in thousands):

Under the clinical manufacturing agreement with Janssen and the addendum, we recorded $1.7 million as manufacturing revenue for the three months ended September 30, 2022. No revenue was recorded in the three months ended September 30, 2023.

We recorded $3.7 million manufacturing revenue for the nine months ended September 30, 2022. No revenue was recorded in the nine months ended September 30, 2023. The three months and nine months decrease was due to the completion of the Janssen Transaction Addendum which was signed in February 2022 and completed in November 2022.

Cost of Goods Sold

Cost of goods sold during the three months and nine months ended September 30, 2023 and 2022 are summarized as follows (in thousands):

The manufacturing cost for the three months ended September 30, 2022 represents cost for the manufacuring department under the February 2022 agreement. There were no cost of goods sold incurred in the three months ended September 30, 2023.

We recorded $0.6 million in manufacturing cost for the nine months ended September 30, 2022. There were no cost of goods sold incurred in the nine months ended September 30, 2023. The three months and nine months decrease was due to the completion of the Janssen Transaction 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 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 $0.5 million to $7.5 million for the three months ended September 30, 2023, compared to $7.0 million for the three months ended September 30, 2022. The rise was mainly due to the increase in the clinical trial activities, related to the new study being initiated in the second quarter of 2023. The laboratory and manufacturing supplies expenses decreased, which was primarily caused by a reduction in raw material purchasing for clinical trial drug manufacturing.

Research and development expenses increased $0.8 million to $25.0 million for the nine months ended September 30, 2023, compared to $24.2 million for the nine months ended September 30, 2022. The increase of salaries and related expenses was mainly due to the $4.5 million bonus to the Chief Executive Officer in June 2023 compared to the $3.8 million bonus in June 2022, in which 85% was allocated to research and development expenses in 2023 compared to 60% in 2022. Clinical trials and sponsored research expense increased because of the new study being initiated in the second quarter of 2023. In addition, the decrease of laboratory and manufacturing supplies was primary caused by a reduction in raw material purchasing for clinical trial drug manufacturing.

General and Administrative

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

General and administrative expenses increased $0.1 million to $1.0 million for the three months ended September 30, 2023 compared to $0.8 million for the three months ended September 30, 2022. General and administrative expenses decreased $1.3 million to $3.9 million for the nine months ended September 30, 2023 compared to $5.2 million for the nine months ended September 30, 2022.

The three months increase was primarily due to the increase of professional fees, related to the stock service and the tax service. The decrease in shared-based compensation was mainly caused by a decline in the grant date fair value of awards being amortized during the respective periods.

Compared to the nine months ended September 30, 2022, the general and administrative expense decrease in the nine months ended September 30, 2023 was primarily driven by the decrease in salaries and related expenses. The bonus to the Chief Executive Officer in June 2023 was $4.5 million compared to the $3.8 million bonus in June 2022, in which 15% was allocated to general and administrative expenses in 2023 compared to 40% in 2022. Share-based compensation decreased $0.9 million mainly due to the termination of VP of Finance and HR in February 2023, which resulted in the forfeiture of unvested awards, and the stock option expense per share of new grants decreased compared to the expense of fully amortized grants. In addition, professional fees increased $0.5 million mainly caused by the service fees related to tender offer in June 2023.

Other income (loss)

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

The interest income for the three months and nine months ended September 30, 2023 and 2022 was mainly generated was from the Company’s Canadian bank account and interest bearing time deposits. The other income during the nine months ended September 30, 2023 was primarily from American Stock Transfer & Trust Company, LLC in accordance with the terms outlined in the settlement agreement. Foreign exchange gain (loss) was due to the fluctuation between the US dollar and the Canadian dollar in the three months and nine months ended September 30, 2023 compared to 2022.

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 September 30, 2023, 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. In July 2022, we purchased interest bearing time deposits in the amount of $59.5 million for a one year term, and upon maturity in July 2023, both the principal amount and the accured interest were returned. At September 30, 2023, we had cash and cash equivalents of $202.2 million as compared to cash and cash equivalents of $160.6 million at September 30, 2022. The following table summarizes our sources and uses of cash (in thousands):

25

During the nine months ended September 30, 2023 and 2022, our operating activities used net cash of $15.3 million and $11.7 million, respectively. The use of net cash in each of these periods primarily resulted from our net losses. The change in the cash from operation was mainly due to the decrease in income tax receivable.

During the nine months ended September 30, 2023 and 2022, our investing activities generated net cash of $61.6 million and used net cash of $60.0 million, respectively. In July 2022, we purchased interest bearing time deposits in the amount of $59.5 million. Upon maturity in July 2023, we obtained both the principal amount and the accured interest.

During the nine months ended September 30, 2023, our financing activities used net cash of $9 thousand. We purchased 3,561 shares of our common stock, at a price of $4.00 per share, for an aggregate cost of approximately $14 thousand. During the nine months ended September 30, 2023, employees exercised stock options to purchase 1250 shares of our common stock for approximately $5 thousand in net proceeds.

We expect to continue to incur operating losses in the future. We do not expect to receive any additional revenue under the clinical manufacturing agreement with Janssen. Further, we may not receive any product revenue until a drug candidate has been approved by the FDA, EMA or similar regulatory agencies in other countries and successfully commercialized. As of September 30, 2023, our principal sources of liquidity were our cash and cash equivalents, which totaled approximately $202.2 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 September 30, 2023 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.