XBiotech Inc.: Form 10-Q for the period ended Sep 30, 2024

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, 2024 was ($80.3) million. We had net losses before income tax of $5.0 million and $28.0 million for the three months and nine months ended September 30, 2024, respectively, compared to $7.1 million and $19.6 million for the three months and nine months ended September 30, 2023, 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, 2024, we had 92 employees.

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, 2024, we have recorded total research and development expenses, including share-based compensation, of $303.7 million. Our total research and development expenses for the three months and nine months ended September 30, 2024 were $7.1 million and $29.9 million, respectively, compared to $7.5 million and $25.05 million for the three months and nine months ended September 30, 2023, respectively. Share-based compensation related to research and development accounted for $0.2 million and $0.7 million for the three months and nine months ended September 30, 2024, respectively, compared to $0.8 million and $2.2 million for the three months and nine months ended September 30, 2023, respectively.

Research and development expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2024 were 90% and 89%, respectively, compared to 89% and 87% for the three months and nine months ended September 30, 2023, 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, 2024 were 91% and 90%, respectively, compared to 89% and 87% for the three months and nine months ended September 30, 2023.

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, 2024 were $0.8 million and $3.8 million, respectively, compared to $1.0 million and $3.9 million for the three months and nine months ended September 30, 2023, respectively. Share-based compensation related to general and administration accounted for $0.1 million and $0.7 million for the three months and nine months ended September 30, 2024, respectively, and $0.1 million and $0.4 million for the three months and nine months ended September 30, 2023, respectively.

General and administrative expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2024 were 10% and 11%, respectively, compared to 11% and 13% for the three months and nine months ended September 30, 2023, respectively. The percentages of general and administrative expense compared to total operating expenses, excluding share-based compensation, for the three months and nine months ended September 30, 2024 were 9% and 10%, respectively, compared to 11% and 13% for the three months and nine months ended September 30, 2023.

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, with the exception of certain Canada deferred tax assets that will reverse in a period in which they may be carried back, 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.

Clinical Trial Accruals

Expense accruals related to clinical trials are based on actual services received and efforts expended pursuant to contracts with third party service providers which conduct and manage clinical trials on the Company’s behalf. The financial terms of these agreements vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. The Company accrues costs based on the actual services rendered in the period over which services were performed and the level of effort expended in each period based upon patient enrollment, clinical site activations, or information provided to the Company by its vendors on their actual costs incurred. Any estimates of the level of services performed or the costs of these services could differ from actual results.

Results of Operations

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 decreased $0.4 million to $7.1 million for the three months ended September 30, 2024, compared to $7.5 million for the three months ended September 30, 2023. The decrease of in share-based compensation, which was due to the decreased stock option expense per share of new grants compared to the expense of fully amortized grants. Clinical trials and sponsored research expense decreased because of one study fully completed in the second quarter of 2024.

Research and development expenses increased $4.9 million to $29.9 million for the nine months ended September 30, 2024, compared to $25.0 million for the nine months ended September 30, 2023. The increase was primarily due to the rise in the clinical trial activities, related to the new study being initiated in the second quarter of 2023. The increase of salaries and related expenses was mainly due to a company-wide bonus distributed in January 2024 and the bonus to the Chief Executive Officer. In addition, there is a decrease in share-based compensation, which was due to the decreased stock option expense per share of new grants compared to the expense of fully amortized grants.

General and Administrative

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

General and administrative expenses decreased $196 thousand to $0.8 million for the three months ended September 30, 2024 compared to $1.0 million for the three months ended September 30, 2023. General and administrative expenses decreased $92 thousand to $3.8 million for the nine months ended September 30, 2024 compared to $3.9 million for the nine months ended September 30, 2023.

The three months decrease was primarily due to the decrease of professional fees, related to the stock service and the tax service.

Compared to the nine months ended September 30, 2023, the decrease in the general and administrative expense in the nine months ended September 30, 2024 was also primarily caused by the service fees associated with the tender offer in June 2023 and tax service. The increase of salaries and related expenses was due to a company-wide bonus distributed in January 2024 and the bonus to the Chief Executive Officer. In addition, the patent filing expense increased mainly due to the transfer of patents from Janssen to XBiotech.

Other income (loss)

The following table summarizes other income (in thousands):

The interest income for the three months and nine months ended September 30, 2024 and 2023 was from the interest generated from the Company’s Canadian bank account and interest bearing time deposit. The interest expense for the three months and nine months ended September 30, 2024, was the interest for the related party convertible loan. In June 2023, the Company received a sum of $750 thousand from American Stock Transfer & Trust Company, LLC which was recorded as other income, in accordance with the terms outlined in the settlement agreement. Foreign exchange gain (loss) was mainly due to the fluctuation between the US dollar and the Canadian dollar in the three months and nine months ended September 30, 2024 compared to 2023.

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, we have funded our operations principally through private placements and public offerings of equity securities, which have provided aggregate cash proceeds of approximately $118.4 million as of September 30, 2024. 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. At September 30, 2024, we had cash and cash equivalents of $183.1 million as compared to cash and cash equivalents of $202.2 million at September 30, 2023. The following table summarizes our sources and uses of cash (in thousands):

During the nine months ended September 30, 2024 and 2023, our operating activities used net cash of $24.4 million and $15.2 million, respectively. The use of net cash in each of these periods primarily resulted from our net losses. The increase in net cash used in operations for the nine months ended September 30, 2024 in comparison to the nine months ended September 30, 2023 was mainly due to the increase in salaries and related expenses and clinical trial expense.

During the nine months ended September 30, 2024 and 2023, our investing activities used net cash of $1.2 million and generated net cash of $61.6 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 accrued interest.

During the nine months ended September 30, 2024, our financing activities provided net cash of $10.2 million. On January 3, 2024, we entered into a Convertible Loan Agreement (the “Loan”) with John Simard, the Company’s Founder, President, Chief Executive Officer and Chairman, which provided $10 million net cash for the construction of a new, state-of-the-art research and development facility at the Company's property at 5217 Winnebago Lane in Austin, Texas. Additionally, during the nine months ended September 30, 2024, employees exercised stock options to purchase 42,442 shares of our common stock for approximately $167 thousand in net proceeds. On June 20, 2023, we used approximately $14 thousand to purchase 3,561 common shares at a price of $4.00 per share, relating to the tender offer completed in June 2023. During the nine months ended September 30, 2023, employees exercised stock options to purchase 1,250 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, 2024, our principal sources of liquidity were our cash and cash equivalents, which totaled approximately $183.1 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 Director of Finance (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 Director of Finance (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, 2024 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.