1. Organization

 

XBiotech, Inc. (“XBiotech” or “the Company”) was incorporated in Canada on March 22, 2005. XBiotech USA Inc., a wholly-owned subsidiary of the Company, was incorporated in Delaware, United States (“U.S.”) in November 2007. XBiotech Schweiz AG, a wholly-owned subsidiary of the Company, was incorporated in Zug, Switzerland in August 2010. XBiotech Japan KK, a wholly-owned subsidiary of the Company, was incorporated in Tokyo, Japan in March 2013. XBiotech GmbH, a wholly-owned subsidiary of the Company, was incorporated in Germany in January 2014. The Company’s headquarters are located in Austin, Texas.

 

Since its inception, XBiotech has focused on advancing technology to rapidly identify and clone antibodies from individuals that have resistance to disease. At the heart of the Company is a proprietary technical knowhow to translate natural human immunity into therapeutic product candidates.

 

In 2005, the Company began to develop a new framework for commercial manufacturing, using technology that required less capital and fewer operators and provided greater flexibility than standard industry practices.

 

With the manufacturing capability to produce its True Human^TM antibody therapy, in 2010 the Company began a clinical trial program. The first clinical trial program at MD Anderson Cancer Center began treating the sickest cancer patients irrespective of tumor type. Soon thereafter, the Company used the same antibody therapy in various clinical studies at treatment centers around the U.S. and abroad to investigate the antibody effect in patients that had vascular disease, leukemia, type 2 diabetes, psoriasis or acne. As of September 30, 2016, XBiotech's lead product, Xilonix™ is in Phase III clinical trials in the United States with a Fast Track designation by the U.S. Food and Drug Administration (FDA). In Europe, Xilonix™ Phase III clinical trials have been completed, and the therapy is under review following the validation of its Market Authorization Application by the European Medicines Agency (EMA).

 

The Company continues to be subject to a number of risks common to companies in similar stages of development. Principal among these risks are the uncertainties of technological innovations, dependence on key individuals, development of the same or similar technological innovations by the Company’s competitors and protection of proprietary technology. The Company’s ability to fund its planned clinical operations, including completion of its planned trials, is expected to depend on the amount and timing of cash receipts from future collaboration or product sales and/or financing transactions.

2. Significant Accounting Policies

 

Basis of Presentation

 

These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, or US GAAP.

 

These interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or US GAAP, and Securities and Exchange Commission, or SEC, requirements for interim financial statements. In the Company’s opinion, the accompanying unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting of normal, recurring adjustments, necessary for a fair presentation. Certain information and disclosures normally included in the notes to the annual consolidated financial statements prepared in accordance with US GAAP have been omitted from these interim unaudited consolidated financial statements pursuant to the rules and regulations of the SEC. Accordingly, these interim unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the accompanying notes for the fiscal year ended December 31, 2015, which are included in the Company’s Annual Report on Form 10-K, filed with the SEC on March 30, 2016. The results of operations for the three month and nine month periods ended September 30, 2016 are not necessarily indicative of the results to be expected for the year ending December 31, 2016 or for any other period.

 

Basis of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated upon consolidation.

 

Use of Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported values of amounts in the financial statements and accompanying notes. Actual results could differ from those estimates.

Prior to the completion of its initial public offering in April 2015, the Company utilized significant estimates and assumptions in determining the fair value of its common stock. The board of directors determined the estimated fair value of the Company’s common stock based on a number of objective and subjective factors, including the prices at which the Company sold shares of its common stock to third parties and external market conditions affecting the biotechnology industry sector. After the initial public offering, the fair market value is calculated by using the closing price of the Company’s common stock as reported by NASDAQ.

 

Research and Development Costs

 

All research and development costs are charged to expense as incurred. Research and development costs include salaries and personnel-related costs, consulting fees, fees paid for contract research services, the costs of laboratory equipment and facilities, license fees and other external costs. Costs incurred to acquire licenses for intellectual property to be used in research and development activities with no alternative future use are expensed as incurred as research and development.

 

Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized. The capitalized amounts are expensed as the related goods are delivered or the services are performed.

 

Income Taxes

 

The Company makes estimates and judgments in determining the need for a provision for income taxes, including the estimation of its taxable income or loss for the full fiscal year. The Company has accumulated significant deferred tax assets that reflect the tax effects of net operating losses and tax credit carryovers and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Realization of certain deferred tax assets is dependent upon future earnings. The Company is uncertain about the timing and amount of any future earnings. Accordingly, the Company offsets these deferred tax assets with a valuation allowance. The Company may in the future determine that certain deferred tax assets will likely be realized, in which case the Company will reduce its valuation allowance in the period in which such determination is made. If the valuation allowance is reduced, the Company may recognize a benefit from income taxes in its statement of operations in that period. The Company classifies interest recognized pursuant to its deferred tax assets as interest expense, when appropriate.

 

Share-Based Compensation

 

The Company accounts for its share-based compensation awards in accordance with ASC Topic 718, Compensation-Stock Compensation (“ASC 718”). ASC 718 requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statements of operations based on their grant date fair values. For stock options granted to employees and to members of the board of directors for their services on the board of directors, the Company estimates the grant date fair value of each option award using the Black-Scholes option-pricing model. The use of the Black-Scholes option-pricing model requires management to make assumptions with respect to the expected term of the option, the expected volatility of the common stock consistent with the expected life of the option, risk-free interest rates and expected dividend yields of the common stock. For awards subject to service-based vesting conditions, the Company recognizes share-based compensation expense, equal to the grant date fair value of stock options on a straight-line basis over the requisite service period.

 

Share-based compensation expense recognized for the three months and nine months ended September 30, 2016 and 2015 was included in the following line items on the Consolidated Statement of Operations (in thousands).

 

 

Share-based compensation expense of each option is estimated on the date of grant using the Black-Scholes method with the following assumptions:

 

 

No related tax benefits were recognized for the three months and nine months ended September 30, 2016 and 2015.

 

Cash and Cash Equivalents

 

The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consisted primarily of cash on deposit in U.S., German, Swiss and Canadian banks. Cash and cash equivalents are stated at cost which approximates fair value.

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject the Company to credit risk consist primarily of cash and cash equivalents. The Company holds these investments in highly-rated financial institutions, and limits the amounts of credit exposure to any one financial institution. These amounts at times may exceed federally insured limits. The Company has not experienced any credit losses in such accounts and does not believe it is exposed to any significant credit risk on these funds. The Company has no off-balance sheet concentrations of credit risk, such as foreign currency exchange contracts, option contracts or other hedging arrangements.

 

Fair Value Measurements

 

The Company follows ASC Topic 820, Fair Value Measurements and Disclosures, which establishes a fair value hierarchy for those instruments measured at fair value that distinguishes between assumptions based on market date (observable inputs) and the Company’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

 

•

Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities.

	•	Level 2—Quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability.

•

Level 3—Unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability in which there is little, if any, market activity for the asset or liability at the measurement date.

 

At September 30, 2016 and December 31, 2015, the Company did not have any assets or liabilities that are measured at fair value on a recurring basis. The carrying amounts reflected in the balance sheets for cash and cash equivalents, prepaid expenses and other current assets, accounts payable, and accrued expenses approximate their fair values at September 30, 2016 and December 31, 2015, due to their short-term nature.

 

Property and Equipment

 

Property and equipment, which consists of land, construction in process, furniture and fixtures, computers and office equipment, scientific equipment, leasehold improvements and vehicles are stated at cost and depreciated over the estimated useful lives of the assets, with the exception of land which is not depreciated and construction in process which has not yet been placed in service. The useful lives are as follows:

 

•    Furniture and fixtures	7 years
•    Computers and office equipment	5 years
•    Scientific equipment	5 years
•    Leasehold improvements	Shorter of asset’s useful life or remaining lease term
•    Vehicles	5 years

 

Costs of major additions and betterments are capitalized. Maintenance and repairs, which do not improve or extend the life of the respective assets, are charged to expense as incurred. Upon retirement or disposal, the cost of the disposed asset and the related accumulated depreciation are removed from the property and equipment, net, accounts and the resulting gain or loss is recognized. As of September 30, 2016, XBiotech plans to spend $1.2 million more on construction and $5.6 million more on equipment, based on the forecast.

 

Building Construction in Progress

 

The Company is currently preparing its new manufacturing facility to produce registration batches of product. Data from these manufacturing runs will be submitted to EMA to support approval of the new facility. The current plan is to submit that filing at the end of Q1 2017.The facility will not be placed into service until approval has been received.

 

Impairment of Long-Lived Assets

 

The Company periodically evaluates its long-lived assets for potential impairment in accordance with ASC Topic 360, Property, Plant and Equipment. Potential impairment is assessed when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Recoverability of these assets is assessed based on undiscounted expected future cash flows from the assets, considering a number of factors, including past operating results, budgets and economic projections, market trends and product development cycles. If impairments are identified, assets are written down to their estimated fair value. The Company has not recognized any impairment through September 30, 2016.

 

Foreign Currency Transactions

 

Certain transactions are denominated in a currency other than the Company’s functional currency of the U.S. dollar, and the Company generates assets and liabilities that are fixed in terms of the amount of foreign currency that will be received or paid. At each balance sheet, the Company adjusts the assets and liabilities to reflect the current exchange rate, resulting in a translation gain or loss. Transaction gains and losses are also realized upon a settlement of a foreign currency transaction in determining net loss for the period in which the transaction is settled.

 

Comprehensive Income (Loss)

 

ASC Topic 220, Comprehensive Income, requires that all components of comprehensive income (loss), including net income (loss), be reported in the financial statements in the period in which they are recognized. Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on investments and foreign currency translation adjustments.

 

Segment and Geographic Information

 

Operating segments are identified as components of an enterprise for which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. The Company’s chief operating decision maker is the Chief Executive Officer. The Company and the chief operating decision maker view the Company’s operations and manage its business as one operating segment. Substantially all of the Company’s operations are in the U.S. geographic segment.

 

Net Loss Per Share

 

Net loss per share (“EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding during each period. Diluted EPS is computed by dividing net loss by the weighted average number of common shares and common share equivalents outstanding (if dilutive) during each period. The number of common share equivalents, which include stock options, is computed using the treasury stock method.

 

Recent Accounting Pronouncements

 

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The ASU is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. For all entities, the ASU is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The Company is currently evaluating the effect that the adoption of ASU 2014-15 will have on its financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core change with ASU 2016-2 is the requirement for the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous US GAAP. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect that the adoption of ASU 2016-02 will have on its financial statements.

 

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting,” or ASU 2016-09, which amends ASC Topic 718, “Compensation – Stock Compensation.” ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The standard is effective for fiscal years beginning after December 31, 2016, and interim periods within those years and early adoption is permitted. The Company is currently evaluating how the adoption of this standard will impact its consolidated financial statements.

 

3. Income Taxes

 

The Company did not provide for income taxes in 2016 because the Company has projected net losses for all jurisdictions for the full year 2016. The Company has recorded a full valuation allowance for its net deferred tax assets in 2016 and 2015.

4. Common Stock

 

Pursuant to its Articles, the Company has an unlimited number of shares available for issuance with no par value.

 

From January to March 2015, warrants to purchase a total of 164,999 shares of common stock were exercised at $15.00 per share for a total of $2.4 million in proceeds. Also, the Company received approximately $8,000 in January 2015 from 15,000 exercised stock options at $0.55 per share.

 

On April 17, 2015, the Company sold 4.0 million shares of common stock at $19.00 per share in its Initial Public Offering (“IPO”) resulting in net proceeds of $70.6 million.

 

From April to June 2015, excluding the IPO, the Company issued 208,333 shares of common stock for total proceeds of approximately $3.1 million from the exercise of warrants by common stock shareholders. Also, the Company received $0.7 million from 106,000 exercised stock options.

 

In July 2015, 12,000 stock options were exercised at a price of $2.50 for total proceeds of $30,000.

 

From October through December 31, 2015, 226,141 shares of common stock were issued upon the exercise of stock option at the price $ 0.53 to $10 per share for a total of $0.6 million.

 

From January through September 2016, 164,686 shares of common stock were issued upon the exercise of stock options at a price of $ 0.78 to $19.09 per share for a total of $0.9 million.

5. Common Stock Options

 

On each of November 11, 2005 and March 13, 2015, the board of directors of the Company adopted a stock option plan (collectively, “the Plans”). Options may no longer be granted under the Plan adopted in 2005, and under the Plan adopted in 2015, the Company may grant incentive or non-qualified stock options to directors, officers, employees or consultants of the Company or its affiliates.

 

All options will be non-transferable and may be exercised only by the participant, or in the event of the death of the participant, a legal representative until the earlier of the options’ expiry date or the first anniversary of the participant’s death, or such other date as may be specified by the Compensation Committee.

 

The term of the options is at the discretion of the Compensation Committee, but may not exceed 10 years from the grant date. The options expire on the earlier of the expiration date or the date three months following the day on which the participant ceases to be a director, officer or employee of or consultant to the Company, or in the event of the termination of the participant with cause, the date of such termination.

 

The number of common shares reserved for issuance to any one person pursuant to the Plans shall not, in aggregate, exceed 5% of the total number of outstanding common shares. The exercise price per common share under each option will be the fair market value of such shares at the time of the grant. Upon stock option exercise, the Company issues new shares of common stock.

 

A summary of changes in common stock options issued under the Plans is as follows:

 

 

As of September 30, 2016, there was approximately $5.1 million of unrecognized compensation cost, related to stock options granted under the Plan which will be amortized to stock compensation expense over the next 2.29 years.

6. Net Loss Per Share

 

The following summarizes the computation of basic and diluted net loss per share for the three months and nine months ended September 30, 2016 and 2015 (in thousands, except share and per share data):

 

 

The following potentially dilutive securities outstanding, prior to the use of the treasury stock method or if-converted method, have been excluded from the computation of diluted weighted-average common shares outstanding, because including them would have had an anti-dilutive effect due to the losses reported.

 

 

 

7. Commitments and Contingencies

 

Regarding the previously disclosed securities class action complaints, a motion to dismiss filed by our counsel in the U.S. District Court for the Western District of Texas was granted with prejudice on October 7, 2016.  Plaintiffs in the California case did not refile in Texas after being given the opportunity, therefore litigation continues in California.  No trial or other dates have been set.  We are unable to estimate the outcome of the California matter or the resulting financial impact to us, if any.

8. Subsequent Events

 

On September 26, 2016, the Company entered into a Common Stock Sales Agreement with H.C. Wainwright & Co. LLC which establishes an at-the-market equity program pursuant to which we may offer and sell shares of our common stock, no par value per share, from time to time as set forth in the Sales Agreement. The Sales Agreement provides for the sale of shares of our Common Stock having an aggregate offering price of up to $50,260,000.  Sales of Shares under the Sales Agreement will be made pursuant to the registration statement on Form S-3, which was declared effective by the U.S. Securities and Exchange Commission on September 1, 2016, and a related Prospectus Supplement filed with the SEC on September 26, 2016. On November 1, 2016, we sold 100,000 shares of common stock at a price of $13.60 per share for a total gross proceeds of approximately $1.36 million

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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

 

Overview

 

XBiotech is a clinical-stage biopharmaceutical company engaged in discovering and developing True Human™ monoclonal antibodies for treating a variety of different diseases. True Human™ monoclonal antibodies are those which occur naturally in human beings—as opposed to being derived from animal immunization technologies 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. While primarily focused on bringing our lead product candidate to market, we have also developed a proprietary True Human™ monoclonal antibody discovery platform and manufacturing system.

 

We have never been profitable and, as of September 30, 2016, we had an accumulated deficit of $167.0 million. We had net losses of $12.5 million and $36.4 million for three months and nine months ended September 30, 2016, respectively, compared to $10.7 million and $25.6 million for three months and nine months ended September 30, 2015, respectively. 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. In addition to these increasing research and development expenses, we expect general and administrative costs to increase as we add personnel and continue to operate as a public company. We will need to generate significant revenues to achieve profitability, and we may never do so. As of September 30, 2016, we had 106 employees.

 

Recent Events:

 

XBiotech's marketing authorization application for Xilonix™ for the treatment of colorectal cancer remains on schedule to possibly achieve a decision in 2016 by the European Medicines Agency (EMA).

 

The phase III colorectal cancer study being conducted under a Fast Track designation from the FDA remains on-track. This study is randomized 2:1 with patients receiving Xilonix™ or placebo plus best supportive care with a primary endpoint of overall survival.

 

The phase 2 study of Xilonix™ in subjects with Pyoderma Gangrenosum has been completed and data is being finalized.

 

The Company’s Phase I/II clinical study assessing 514G3 as a treatment of Staphylococcus Aureus Bacteremia remains on course with potential enrollment completion by end of year.

 

The Company is currently preparing the new manufacturing facility to produce registration batches of product. Data from these manufacturing runs will be submitted to EMA to support approval of the new facility. The current plan is to submit that filing at the end of Q1 2017.The facility will not be placed into service until approval has been received.

 

Revenues

 

To date, we have not generated any revenue. Our ability to generate revenue and become profitable depends on our ability to successfully commercialize our lead product candidate, Xilonix™, or any other product candidate 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, share-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 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, 2016, we have recorded total research and development expenses, including share-based compensation, of $129.9 million. Our total research and development expenses for the three months and nine months ended September 30, 2016 were $9.8 million and $28.8 million, respectively, compared to $9.7 million and $20.9 million for the three months and nine months ended September 30, 2015, respectively. Share-based compensation accounted for $0.6 million and $1.7 million for the three months and nine months ended September 30, 2016, respectively, compared to $0.7 million and $1.7 million for the three months and nine months ended September 30, 2015, respectively.

 

Research and development expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2016 were 78% and 79%, respectively, compared to 90% and 82% for the three months and nine months ended September 30, 2015, respectively. The percentages, excluding share-based compensation, for the three months and nine months ended September 30, 2016 were 81% and 84%, respectively, compared to 91% and 87% for the three months and nine months ended September 30, 2015, respectively.

 

Based on the results of our preclinical studies, we anticipate that we will select drug candidates and research projects for further development on an ongoing basis in response to their preclinical and clinical success as well as 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.

 

Increased research and development costs for the nine months ended September 30, 2016 were anticipated and primarily due to Phase II and Phase III studies related to XBiotech’s research and development programs in Xilonix™ and 514G3 as well as laboratory and manufacturing supplies purchased for general manufacturing activities and for the new facility.

 

Due to the fact that our drug candidates are in the early stage of development, we cannot estimate anticipated completion dates and when we might receive material net cash inflows from our research and development projects.

 

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, stock–based compensation, professional fees for legal services, and public relations expenses. Our total general and administration expenses for the three months and nine months ended September 30, 2016 were $2.7 million and $7.5 million, respectively, compared to $1.0 million and $4.5 million for the three months and nine months ended September 30, 2015, respectively. Stock-based compensation accounted for $0.6 million and $2.3 million for the three months and nine months ended September 30, 2016, respectively, compared to $0.2 million and $1.7 million for the three months and nine months ended September 30, 2015, respectively.

 

Critical Accounting Policies

 

Our Management’s Discussion and Analysis of our 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, or 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.

 

While our significant accounting policies are more fully described in the notes to our financial statements appearing in this prospectus, we believe that the following accounting policies are the most critical to understanding and evaluating our reported financial results.

 

Share-Based Compensation

 

Share-based awards are measured at fair value at each grant date. We recognize share-based compensation expenses ratably over the requisite service period of the option award.

 

Determination of the Fair Value of Share-Based Compensation Grants

 

The determination of the fair value of share-based compensation arrangements is affected by a number of variables, including estimates of the fair value of our common stock, expected stock price volatility, risk-free interest rate and the expected life of the award. We value stock options using the Black-Scholes option-pricing model, which was developed for use in estimating the fair value of traded options that are fully transferable and have no vesting restrictions. Black-Scholes and other option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. If we made different assumptions, our share-based compensation expenses, net loss, and net loss per common share could be significantly different. Prior to our IPO in April 2015, we issued common stock for cash consideration to new investors. We believe that such transactions represent the best evidence of fair value of our common stock. After our IPO, we determine that the fair value of common stock equal to the closing price of the Company’s common stock as reported by NASDAQ on the option grant date.

 

The following summarizes the assumptions used for estimating the fair value of share-based compensation for the stock options granted during the periods indicated:

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2016				2015				2016				2015
Dividend yield			-				-
Expected volatility			70%				66%			65%	-	70%		66%	-	71%
Risk-free interest rate		1.09%	-	1.60%		1.75%	-	1.93%		1.09%	-	1.82%		1.07%	-	2.42%
Expected life (in years)		5.26	-	10.00			10			5	-	10		3	-	10
Weighted-average grant date fair value per share			$8.50				$16.91				$7.09				$17.99

 

We have assumed no dividend yield because we do not expect to pay dividends in the foreseeable future, which is consistent with our past practice. The risk-free interest rate assumption is based on observed interest rates for U.S. Treasury securities with maturities consistent with the expected life of our stock options. The expected life represents the period of time the stock options are expected to be outstanding and is based on the simplified method when the stock option includes “plain vanilla” terms. Under the simplified method, the expected life of an option is presumed to be the midpoint between the vesting date and the end of the agreement term. We used the simplified method due to the lack of sufficient historical exercise data to provide a reasonable basis upon which to otherwise estimate the expected life of the stock options. For stock options that did not include “plain vanilla” terms we used the contractual life of the stock option as the expected life. Such stock options consisted primarily of options issued to our board of directors that were immediately vested at issuance. Due to the lack of sufficient trading history for our common stock, expected volatility is based on historical volatilities for publicly traded stock of comparable companies over the estimated expected life of the stock options.

 

We based our estimate of pre-vesting forfeitures, or forfeiture rate, on historical forfeiture rates. We apply the estimated forfeiture rate to the total estimated fair value of the awards, as derived from the Black-Scholes model, to compute the share-based compensation expenses, net of pre-vesting forfeitures, to be recognized in our consolidated statements of operations.

 

Results of Operations

 

Revenue

 

We did not record any revenue during the three months and nine months ended September 30, 2016 and 2015.

 

Expenses

 

Research and Development

 

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

 

		Three Months Ended September 30,								Increase				% Increase
		2016				2015				(Decrease)				(Decrease)
Salaries and related expenses		$	2,437			$	1,581			$	856				54	%
Laboratory and manufacturing supplies			2,217				1,141				1,076				94	%
Clinical trials and sponsored research			3,598				5,059				(1,461	)			(29	)%
Share-based compensation			565				701				(136	)			(19	)%
Other			957				1,249				(292	)			(23	)%
Total		$	9,774			$	9,731			$	43				0	%

 

		Nine Months Ended September 30,								Increase				% Increase
		2016				2015				(Decrease)				(Decrease)
Salaries and related expenses		$	6,274			$	4,558			$	1,716				38	%
Laboratory and manufacturing supplies			5,755				3,180				2,575				81	%
Clinical trials and sponsored research			11,911				8,463				3,448				41	%
Share-based compensation			1,749				1,677				72				4	%
Other			3,112				3,018				94				3	%
Total		$	28,801			$	20,896			$	7,905				38	%

 

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 to $9.8 million for the three months ended September 30, 2016 compared to $9.7 million for the three months ended September 30, 2015. Research and development expenses increased by 38% to $28.8 million for the nine months ended September 30, 2016 compared to $20.9 million for the nine months ended September 30, 2015.

 

The three months difference in research and development expenses was mainly due to a $1.5 million decrease in clinical trial activities, related to a Europe trial started in 2015 and completed in early 2016, offset by a continued increase in laboratory and manufacturing supplies expense due to an increase in manufacturing activities as well as manufacturing supplies purchased for the new facility. Salaries and related expenses continued to increase due to the growing size of the workforce.

 

Compared to the nine months ended September 30, 2015, the research and development expense increase in the nine months ended September 30, 2016 was primarily caused by substantial growth in laboratory and manufacturing operations which led to an increase in purchased supplies. Labor costs also increased due to a rise in current employees’ salaries as well as an increase in the Research and Development workforce from 58 to 80. Clinical trial expenses increased due to an expansion of clinical sites globally.

 

General and Administrative

 

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

 

		Three Months Ended September 30,								Increase				% Increase
		2016				2015				(Decrease)				(Decrease)
Salaries and related expenses		$	445			$	235			$	210				89	%
Patent filing expense			135				172				(37	)			(22	)%
Share-based compensation			561				185				376				203	%
Professional fees			1,063				58				1,005				1733	%
Other			481				433				48				11	%
Total		$	2,685			$	1,083			$	1,602				148	%

 

		Nine Months Ended September 30,								Increase				% Increase
		2016				2015				(Decrease)				(Decrease)
Salaries and related expenses		$	1,358			$	844			$	514				61	%
Patent filing expense			488				655				(167	)			(25	)%
Share-based compensation			2,291				1,678				613				37	%
Professional fees			1,923				480				1,443				301	%
Other			1,461				885				576				65	%
Total		$	7,521			$	4,542			$	2,979				66	%

 

General and administrative expenses increased 148% to $2.7 million for the three months ended September 30, 2016 compared to $1.1 million for the three months ended September 30, 2015. General and administrative expenses increased 66% to $7.5 million for the nine months ended September 30, 2015 compared to $4.5 million for the nine months ended September 30, 2015.

 

The three months increase was primarily related to a $1.0 million increase in fees related to commercialization activities in Europe. The increase in stock–based compensation expense was due to the grant of stock options to board members in September 2016. The increase is also attributable to salaries and related expenses, which continued to increase due to the onboarding of new employees in 2016.

 

The nine months increase was principally due to a $0.5 million salary increase from growth of our workforce, and a $1.4 million increase in the fees related to commercialization activities in Europe. Share-based compensation also increased by $0.6 million due to the grant of stock options to outside board members in March and September 2016. Other reasons for increases included insurance, travel expense and recruiting activities.

 

Other income

 

The following table summarizes other income (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2016				2015				2016				2015
Foreign exchange gain(loss)		$	(25	)		$	78			$	(41	)		$	(155	)
Total		$	(25	)		$	78			$	(41	)		$	(155	)

 

 

Other income consists primarily of a $25 thousand foreign exchange loss for the three months ended September 30, 2016, compared to a $78 thousand gain for the three months ended September 30, 2015. Also, foreign exchange loss for the nine months ended September 30, 2016 was $41 thousand, compared to $155 thousand for the nine months ended September 30, 2015.

 

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, 2016, we have funded our operations principally through the sales of equity securities in private and public transactions, which have provided aggregate cash proceeds of approximately $287.9 million. The following table summarizes our sources and uses of cash (in thousands):

 

		Nine Months Ended September 30,
		2016				2015
Net cash (used in) provided by:
Operating activities		$	(33,214	)		$	(22,613	)
Investing activities			(11,946	)			(6,646	)
Financing activities			866				77,468
Effect of foreign exchange rate on cash and cash equivalents			36				142
Net change in cash and cash equivalents		$	(44,258	)		$	48,351

 

During the nine months ended September 30, 2016 and 2015, our operating activities used net cash of $33.2 million and $22.6 million, respectively. The use of net cash in each of these periods primarily resulted from our net losses. The increase in net loss from operations for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015 was mainly due to increases in clinical trial activities, labor cost and manufacturing supplies.

 

During the nine months ended September 30, 2016 and 2015, our investing activities used net cash of $11.9 million and $6.6 million, respectively. We spent approximately $3.0 million more on the construction of new facilities during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. We also spent approximately $2.3 million more on scientific equipment during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

 

During the nine months ended September 30, 2016 and 2015, our financing activities provided net cash proceeds of $0.9 million and $77.5 million, respectively. During the nine months ended September 30, 2016, employees exercised stock options to purchase a total of 164,686 shares of common stock. In April 2015, we sold an aggregate of 4,000,000 shares of our common stock at a price of $19.00 per share and received IPO proceeds of $76.0 million and incurred offering costs of $5.4 million, which consisted of underwriters’ commission as well as direct incremental legal, accounting and other professional service fees related to our IPO.

 

On September 26, 2016, we entered into a Common Stock Sales Agreement with H.C. Wainwright & Co. LLC which establishes an at-the-market equity program pursuant to which we may offer and sell shares of our common stock, no par value per share, from time to time as set forth in the Sales Agreement. The Sales Agreement provides for the sale of shares of our Common Stock having an aggregate offering price of up to $50,260,000.  Sales of Shares under the Sales Agreement will be made pursuant to the registration statement on Form S-3, which was declared effective by the U.S. Securities and Exchange Commission on September 1, 2016, and a related Prospectus Supplement filed with the SEC on September 26, 2016.

 

Contractual Obligations and Commitments

 

On January 12, 2008, we entered a lease agreement to lease our facility in Austin, Texas. On September 15, 2010, we entered into a second lease agreement to lease additional space in Austin, Texas. On March 20, 2014, we extended the lease for an additional 21 months on the same terms and rental rates as the current lease. Rent expense was $181 thousand and $164 thousand for the three months ended September 30, 2016 and 2015, respectively. On February 28, 2015, we extended the lease for another 4 years. The future minimum lease payments are as follows as of September 30, 2016 (in thousands):

 

 

Contractual Obligations		Total				Less than 1 Year				1 - 3 Years				More than 3 years
Operating facility leases		$	1,235			$	455			$	645			$	—
Total contractual obligations		$	1,235			$	455			$	645			$	—

 

Concerning the new manufacturing facility, the total estimated future payment to our general contractor is $1.2 million and to purchase new equipment is $5.6 million. The last payment is expected to occur in Q4 2016.

 

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.

 

Item 3. Quantitative and Qualitative Disclosure of Market Risks

 

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 currently engages in no hedging activities.

 

Item 4. Controls and Procedures

 

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. 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, 2016 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.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Regarding the previously disclosed securities class action complaints, a motion to dismiss filed by our counsel in the U.S. District Court for the Western District of Texas was granted with prejudice on October 7, 2016.  Plaintiffs in the California case did not refile in Texas after being given the opportunity, therefore litigation continues in California.  No trial or other dates have been set.  We are unable to estimate the outcome of the California matter or the resulting financial impact to us, if any.

 

Item 1A. Risk Factors

 

There have been no material changes to the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2015. Please carefully consider the information set forth in this Quarterly Report on Form 10-Q and the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K, as well as other risks and uncertainties, could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of shares of our Common Stock. Additional risks not currently known or currently material to us may also harm our business.

 

Item 2. Unregistered Sale of Equity Securities and Use of Proceeds

 

Not Applicable.

 

Item 3. Defaults upon Senior Securities

 

Not Applicable.

 

Item 4. Mine Safety Disclosures

 

Not Applicable.

 

Item 5. Other Information.

 

Not Applicable.

 

Item 6. Exhibits.

 

10.1		Common Stock Sales Agreement, dated September 23, 2016, between XBiotech Inc. and H.C. Wainwright & Co. LLC. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on September 26, 2016).
31.1		Certification of Principal Executive Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2		Certification of Principal Financial Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1		Certification of Principal Executive Officer and Principal Financial Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. §1350.
101		The following financial statements from the XBiotech Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in Extensive Business Reporting Language (XBRL): (i) condensed consolidated balance sheets, (ii) condensed consolidated statements of operations, (iii) condensed consolidated statements of comprehensive loss, (iv) condensed consolidated statements of cash flows and (v) notes to condensed consolidated financial statements (detail tagged).

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Date:  November 14, 2016		XBIOTECH INC.
		By:		/S/ John Simard
				John Simard
				President, Chief Executive Officer and Director (Principal Executive Officer)
Date: November 14, 2016		By:		/S/ Queena Han
				Queena Han
				Vice President, Finance and Human Resources, and Secretary (Principal Financial Officer and Principal Accounting Officer)

 

 

 

 

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