XBIOTECH INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

MANAGEMENT REPORT AND ANALYSIS OF THE FINANCIAL SITUATION AND OPERATING RESULTS



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 costs



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.



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



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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 further described in the notes to our financial statements in this Quarterly Report on Form 10-Q.

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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


Turnover during the three months ended and the half-year ended June 30, 2022 and 2021 are summarized as follows (in thousands):



                                              Three Months Ended June 30,           Six Months Ended June 30,
                                               2022                2021              2022               2021
Revenue
Manufacturing revenue                      $       1,530       $       4,500     $      2,030       $      9,000
Clinical Trial revenue                                 -                  25                -                375
Total revenue                              $       1,530       $       4,525     $      2,030       $      9,375




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

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                             Three Months Ended          Six Months Ended
                                  June 30,                   June 30,
                             2022           2021        2022          2021
Cost of goods sold
Manufacturing cost         $    207       $  1,341     $   420       $ 3,376
Clinical trial cost               -             19           -           288
Total cost of goods sold   $    207       $  1,360     $   420       $ 3,664




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 can be summarized as follows (in thousands):


                                              Three Months Ended June 30,          Increase        % Increase
                                                2022                2021          (Decrease)       (Decrease)
Salaries and related expenses              $        4,328       $      5,656     $     (1,328 )            -23 %
Laboratory and manufacturing supplies               2,579              1,137            1,442              127 %
Clinical trials and sponsored research                502                450               52               12 %
Share-based compensation                              979                433              546              126 %
Other                                               2,006              1,578              428               27 %
Total                                      $       10,394       $      9,254     $      1,140               12 %




                                               Six Months Ended June 30,          Increase        % Increase
                                               2022                2021          (Decrease)       (Decrease)
Salaries and related expenses              $       6,455       $       7,212     $      (757 )            -10 %
Laboratory and manufacturing supplies              4,280               2,018           2,262              112 %
Clinical trials and sponsored research               885                 774             111               14 %
Share-based compensation                           1,969                 796           1,173              147 %
Other                                              3,625               3,088             537               17 %
Total                                      $      17,214       $      13,888     $     3,326               24 %




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.



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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 expenses are summarized as follows (in thousands):


                                              Three Months Ended June 30,          Increase        % Increase
                                               2022                2021           (Decrease)       (Decrease)
Salaries and related expenses              $       1,748       $       3,036     $     (1,288 )            -42 %
Patent filing expense                                141                 132                9                7 %
Share-based compensation                             469                 534              (65 )            -12 %
Professional fees                                    226                 350             (124 )            -35 %
Other                                                439                 464              (25 )             -5 %
Total                                      $       3,023       $       4,516     $     (1,493 )            -33 %




                                              Six Months Ended June 30,          Increase        % Increase
                                               2022               2021          (Decrease)       (Decrease)
Salaries and related expenses              $      1,999       $      3,291     $     (1,292 )            -39 %
Patent filing expense                               287                268               19                7 %
Share-based compensation                            927              1,046             (119 )            -11 %
Professional fees                                   519                813             (294 )            -36 %
Other                                               605                563               42                7 %
Total                                      $      4,337       $      5,981     $     (1,644 )            -27 %




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.



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Other income (loss)


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


                                 Three Months Ended          Six Months Ended
                                      June 30,                   June 30,
                                   2022          2021        2022         2021
Interest income                $        241      $ 123     $    343      $   232
Other income (loss)                    (119 )       (2 )       (119 )        (11 )
Foreign exchange gain (loss)         (2,280 )      793         (990 )      1,202
Total                          $     (2,158 )    $ 914     $   (766 )    $ 1,423




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.



Cash and capital resources

Our cash requirements could change significantly due to 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):



                                                                   Six Months Ended June 30,
Net cash (used in) provided by:                                     2022                2021
Operating activities                                           $      (11,500 )     $     74,606
Investing activities                                                     (243 )           (2,349 )
Financing activities                                                        -              4,998
Effect of foreign exchange rate on cash and cash equivalents              553                637
Net change in cash and cash equivalents                        $      (11,190 )     $     77,892




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.



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

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