Xenetic Biosciences, Inc. 10-K

Item 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS OVERVIEW We are a biopharmaceutical company focused on progressing XCART ™ , a personalized CAR T platform technology engineered to target patient- and tumor-specific neoantigens. We are initially advancing cell-based therapeutics targeting the unique B-cell receptor on the surface of an individual patient’s malignant tumor cells for the treatment of B-cell lymphomas. The XCART technology, developed by the Scripps Research Institute (“Scripps Research”) in collaboration with the Shemyakin-Ovchinnikov Institute of Bioorganic Chemistry, is believed to have the potential to significantly enhance the safety and efficacy of cell therapy for B-cell lymphomas by generating patient- and tumor-specific CAR T cells. 50 Additionally, we are leveraging our proprietary drug delivery platform, PolyXen ® , by partnering with biotechnology and pharmaceutical companies. PolyXen is an enabling platform technology which can be applied to protein or peptide therapeutics. It employs the natural polymer polysialic acid (“PSA”) to prolong a drug’s circulating half-life and potentially improve other pharmacological properties. We incorporate our patented and proprietary technologies into drug candidates currently under development with biotechnology and pharmaceutical industry collaborators to create what we believe will be the next-generation biologic drugs with improved pharmacological properties over existing therapeutics. Our drug candidates have resulted from our research activities or that of our collaborators and are in the development stage. As a result, we continue to commit a significant amount of our resources to our research and development activities and anticipate continuing to do so for the near future. To date, none of our drug candidates have received regulatory marketing authorization in the United States (“U.S.”) by the Food and Drug Administration nor in any other territories by any applicable agencies. We are receiving ongoing royalties pursuant to a license of our PolyXen technology to an industry partner. Although we hold a broad patent portfolio, the focus of our internal development efforts during the year ended December 31, 2021, was on advancing the development of our XCART platform technology. Critical Accounting Policies and Estimates The preparation of our financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue, costs and expenses during the reporting period. On an ongoing basis, we evaluate our estimates that are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The result of these evaluations forms the basis for making judgments about the carrying values of assets and liabilities and the reported amount of expenses that are not readily apparent from other sources. Because future events and their effects cannot be determined with certainty, actual results and outcomes may differ materially from our estimates, judgments and assumptions. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management’s most difficult subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. The following narrative describes these critical accounting estimates, judgments and assumptions and the effect if actual results differ from these assumptions. Revenue Recognition We enter into supply, license and collaboration arrangements with pharmaceutical and biotechnology partners, some of which include royalty agreements based on potential net sales of approved commercial pharmaceutical products. We recognize revenue in accordance with Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”). This standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as leases, insurance, collaboration arrangements and financial instruments. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue at a point in time, or over time, as it satisfies a performance obligation. We only apply the five-step model to contracts when it is probable that it will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract, determine those that are performance obligations, and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. 51 As part of the accounting for these arrangements, we must use significant judgment to determine: a) the number of performance obligations based on the determination under step (ii) above; b) the transaction price under step (iii) above; and c) the stand-alone selling price for each performance obligation identified in the contract for the allocation of transaction price in step (iv) above. We use judgment to determine whether milestones or other variable consideration should be included in the transaction price as described further below. The transaction price is allocated to each performance obligation on a relative stand-alone selling price basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied. In developing the stand-alone price for a performance obligation, we consider applicable market conditions and relevant entity-specific factors, including factors that were contemplated in negotiating the agreement with the customer and estimated costs. We validate the stand-alone selling price for performance obligations by evaluating whether changes in the key assumptions used to determine the stand-alone selling prices will have a significant effect on the allocation of transaction price between multiple performance obligations. We recognize a contract asset or liability for the difference between our performance (i.e., the goods or services transferred to the customer) and the customer’s performance (i.e., the consideration paid by, and unconditionally due from, the customer). The terms of our license agreements may include delivery of an IP license to a collaboration partner. We may be compensated under license arrangements through a combination of non-refundable upfront receipts, development and regulatory objective receipts and royalty receipts on future product sales by partners. We anticipate recognizing non-refundable upfront license payments and development and regulatory milestone payments received by us in license and collaboration arrangements that include future obligations, such as supply obligations, ratably over our expected performance period under each respective arrangement. We make our best estimate of the period over which we expect to fulfill our performance obligations, which may include technology transfer assistance, research activities, clinical development activities, and manufacturing activities from development through the commercialization of the product. Given the uncertainties of these collaboration arrangements, significant judgment is required to determine the duration of the performance period. When we enter into an arrangement to sublicense some of our patents, we will consider the performance obligations to determine if there is a single element or multiple elements to the arrangement as we determine the proper method and timing of revenue recognition. We consider the terms of the license or sublicense for such elements as price adjustments or refund clauses in addition to any performance obligations for us to provide such as services, patent defense costs, technology support, marketing or sales assistance or any other elements to the arrangement that could constitute an additional deliverable to it that could change the timing of the revenue recognition. Non-refundable upfront license and sublicense fees received, whereby continued performance or future obligations are considered inconsequential or perfunctory to the relevant licensed technology, are recognized as revenue upon delivery of the technology. We expect to recognize royalty revenue in the period of sale, based on the underlying contract terms, provided that the reported sales are reliably measurable, we have no remaining performance obligations, and all other revenue recognition criteria are met. We anticipate reimbursements for research and development services completed by us related to the collaboration agreements to be recognized in operations as revenue on a gross basis. Our license and collaboration agreements with certain collaboration partners could also provide for future milestone receipts to us based solely upon the performance of the respective collaboration partner in consideration of deadline extensions or upon the achievement of specified sales volumes of approved drugs. For such receipts, we expect to recognize the receipts as revenue when earned under the applicable contract terms on a performance basis or ratably over the term of the agreement. These receipts may also be recognized as revenue when continued performance or future obligations by us are considered inconsequential or perfunctory. Research and Development Expenses Research and development expenses consist of expenses incurred in performing research and development activities, including compensation and benefits, facilities expenses, overhead expenses, pre-clinical development, clinical trial and related clinical manufacturing expenses, fees paid to contract research organizations (“CROs”) and contract manufacturing organizations and other outside expenses. We expense research and development costs as incurred. We expense upfront, non-refundable payments made for research and development services as obligations are incurred. The value ascribed to intangible assets acquired but which have not met capitalization criteria is expensed as research and development at the time of acquisition. 52 We are required to estimate accrued research and development expenses at each reporting period. This process involves reviewing open contracts and purchase orders, communicating with our personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual costs. The majority of our service providers invoice us in arrears for services performed, on a pre-determined schedule or when contractual milestones are met. However, some require advanced payments. We make estimates of accrued expenses as of each balance sheet date in the financial statements based on facts and circumstances known at that time. We periodically confirm the accuracy of the estimates with the service providers and make adjustments, if necessary. Examples of estimated accrued research and development expenses include fees paid to: · Collaborative partners performing research and development and pre-clinical activities; · Program managers in connection with overall program management of clinical trials; · CROs in connection with clinical trials; and · Investigative sites in connection with clinical trials. We base our expenses related to research and development, pre-clinical activities and clinical trials on our estimates of the services received and efforts expended pursuant to quotes and contracts with multiple research institutions and CROs that conduct and manage clinical trials on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. There may be instances in which payments made to vendors will exceed the level of services provided and result in a prepayment of the expense. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, we adjust the accrual or prepaid accordingly. Although we do not expect our estimates to be materially different from amounts actually incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in reporting amounts that are too high or too low in any particular period. To date, there have not been any material adjustments to our prior estimates of accrued research and development expenses. Share-based Expense Share-based expense includes grants of options and restricted stock units (“RSUs”) to employees and non-employees to purchase shares of our common stock, Joint Share Ownership Plan awards to employees and agreements to issue common stock in exchange for services provided by non-employees. Share-based expense is based on the estimated fair value of the option or calculated using the Black-Scholes option pricing model. Determining the appropriate fair value model and related assumptions requires judgment, including estimating share price volatility and expected terms of the awards. The expected volatility rates are estimated based on the historical volatility of the Company. To the extent Company data is not available for the full expected term of the awards, we use a weighted average of our historical volatility and of a peer group of comparable publicly traded companies over the expected term of the option. The expected term represents the time that options are expected to be outstanding. We account for forfeitures as they occur and not at the time of grant. We have not paid dividends and do not anticipate paying cash dividends in the foreseeable future and, accordingly, we use an expected dividend yield of zero. The risk-free interest rate is based on the rate of U.S. Treasury securities with maturities consistent with the estimated expected term of the awards. Upon exercise, stock options are redeemed for newly issued shares of our common stock. RSUs are redeemed for newly issued shares of our common stock as the vesting and settlement provisions of the grant are met. For employee options that vest based solely on service conditions, the fair value measurement date is generally on the date of grant and the related compensation expense is recognized on a straight-line basis over the requisite vesting period of the awards. For non-employee options issued in exchange for goods or services consumed in the Company’s operations, the fair value measurement date is the earlier of the date the performance of services is complete or the date the performance commitment has been reached. We generally determine that the fair value of the stock options is more reliably measurable than the fair value of the services received. Compensation expense related to stock options granted to non-employees is recognized on a straight-line basis over requisite vesting periods of the awards. 53 Warrants In connection with certain financing, consulting and collaboration arrangements, we issued warrants to purchase shares of our common stock. The outstanding warrants are standalone instruments that are not puttable or mandatorily redeemable by the holder and are classified as equity awards. We measure the fair value of the awards using the Black-Scholes option pricing model as of the measurement date. Warrants issued to collaboration partners in conjunction with the issuance of Common Stock are initially recorded at fair value as a reduction in additional paid-in capital of the common stock issued. All other warrants are recorded at fair value as expense on a straight-line basis over the requisite service period or at the date of issuance if there is not a service period or if service has already been rendered. For warrants that contain vesting triggers based on the achievement of certain objectives, we apply judgment to estimate the probability and timing of the achievement of those objectives. These estimates involve inherent uncertainties, and as a result, if the probability or timing of the achievement of those objectives change, expense related warrants could be materially different in the future. For warrants issued in connection with financing arrangements we allocate the proceeds based on the relative fair value of the award and other instrument(s). Indefinite-lived Intangible Assets Assets acquired and liabilities assumed in business combinations, licensing and other transactions are generally recognized at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recognized as goodwill. At acquisition, we generally determine the fair value of intangible assets, including in-process research and development (“IPR&D”), using the “income method.” This method starts with a forecast of net cash flows, risk adjusted for estimated probabilities of technical and regulatory success (for IPR&D) and adjusted to present value using an appropriate discount rate that reflects the risk associated with the cash flow streams. IPR&D intangible assets are considered indefinite-lived intangible assets until completion or abandonment of the associated research and development efforts. Subsequent to acquisition, indefinite lived intangibles are not amortized but are reviewed for impairment at least annually as of October 1, or when events or changes in circumstances indicate it is more likely than not that the carrying amount of such assets may not be recoverable. Our annual assessment may consist of a qualitative or quantitative analysis to determine if it is more likely than not that its fair value exceeds the carrying value. When performing the qualitative method, we determine whether the existence of events or circumstances leads us to determine that it is more likely than not (that is, a likelihood of more than 50%) that indefinite lived intangibles are impaired. If we choose to first assess qualitative factors and it is determined that it is not more likely than not that intangible assets are impaired, then we are not required to take further action to test for impairment. We also have the option to bypass the qualitative assessment and perform only the quantitative impairment test, which we may choose to do in some periods but not in others. As the option to perform the qualitative assessment is not a permanent election, we reassess this option during each annual impairment review. An impairment loss, if any, is measured as the excess of the carrying value of the intangible asset over its fair value. When performing quantitative analysis, we use the income and market valuation methods and may weigh outcomes of valuation approaches when estimating fair value. Inputs and assumptions used to determine fair value are determined from a market participant view, which might be different than our specific views. The valuation process is complex and requires significant input and judgment using internal and external sources. Market approaches depend on the availability of guideline companies and representative transactions. When using the income approach, complex and judgmental matters applicable to the valuation process may include estimated useful life, projections, tax rates and discount rates. Intangible assets are highly vulnerable to impairment charges, particularly newly acquired assets for IPR&D. Considering the high risk nature of research and development and the industry’s success rate of bringing developmental compounds to market, IPR&D impairment charges are likely to occur in future periods. Estimating the fair value of IPR&D for potential impairment is highly sensitive to changes in projections and assumptions and changes in assumptions could potentially lead to impairment. 54 We believe our estimates and assumptions are reasonable and otherwise consistent with assumptions that market participants would use in their estimates of fair value. However, if future results are not consistent with our estimates and assumptions, then we may be exposed to an impairment charge, which could be material. Use of different estimates and judgments could yield materially different results in our analysis and could result in materially different asset values or expense. Effects of the COVID-19 Pandemic During March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of a novel strain of coronavirus, or COVID-19. The pandemic has significantly affected economic conditions in the U.S., accelerating during the first half of March 2020 and continuing throughout 2021 and into 2022, as federal, state and local governments react to the public health crisis with mitigation measures, creating significant uncertainties in the U.S. economy. We continue to evaluate the effects of the COVID-19 pandemic on our business, and while our operations were not materially affected during the year ended December 31, 2021 despite social distancing and other measures taken in response to the pandemic, the ultimate impact of the COVID-19 pandemic on our results of operations and financial condition is dependent on future developments, including the duration of the pandemic and the related extent of its severity, the pace and rate at which vaccines are administered, and the continued emergence of new strains of COVID-19, such as the Delta and Omicron variants, as well as its impact on macroeconomic conditions, which are uncertain and cannot be predicted at this time. If the global response to contain the COVID-19 pandemic escalates further or is unsuccessful, or if governmental decisions to ease pandemic related restrictions are ineffective, premature or counterproductive, we could experience a material adverse effect on our business, financial condition, results of operations and cash flows. Results of Operations The table below sets forth the comparison of our historical results of operations for the year ended December 31, 2021 to the year ended December 31, 2020. Description 2021 2020 Increase (Decrease) Percentage Change Revenue: Royalty revenue $ 1,160,692 $ 436,942 $ 723,750 165.6% Operating costs and expenses: Research and development (3,163,485 ) (1,731,406 ) 1,432,079 82.7% General and administrative (3,743,972 ) (3,400,071 ) 343,901 10.1% Asset impairment charges – (9,243,128 ) (9,243,128 ) (100.0)% Total operating costs and expenses (6,907,457 ) (14,374,605 ) (7,467,148 ) (51.9)% Loss from operations (5,746,765 ) (13,937,663 ) (8,190,898 ) (58.8)% Other income (expense): Other income (expense) 1,119 (492 ) 1,611 327.4% Interest income, net 100,467 126,171 (25,704 ) (20.4)% Loss before income taxes (5,645,179 ) (13,811,984 ) (8,166,805 ) (59.1)% Income tax benefit – 2,918,518 (2,918,518 ) (100.0)% Net loss $ (5,645,179 ) $ (10,893,466 ) $ (5,248,287 ) (48.2)% Revenue Revenue for the year ended December 31, 2021 increased by $0.7 million, or 165.6%, to $1.2 million from approximately $0.4 million for the year ended December 31, 2020. The increase represents an increase in royalty revenue related to our sublicense agreement with Takeda Pharmaceuticals Co. Ltd. as compared to the same period in 2020, as Takeda’s sublicensee continued its worldwide launch of the product. 55 Research and Development Expense R&D expenses for the year ended December 31, 2021 increased by $1.4 million, or 82.7%, to $3.2 million from $1.7 million for the year ended December 31, 2020. The table below sets forth the research and development expenses incurred by category of expense for the year ended December 31, 2021, and 2020. Year ended December 31, Category of Expense 2021 2020 Outside services and Contract Research Organizations $ 2,497,190 $ 1,203,582 Personnel costs 457,313 342,883 Share-based expense 68,208 49,191 Other 140,774 135,750 Total research and development expense $ 3,163,485 $ 1,731,406 The increase in outside services and contract research organizations expense was primarily due to increased spending related to our XCART platform technology during the year ended December 31, 2021, as compared to the prior year. Costs related to our XCART program were significantly higher in 2021, as compared to the same period in 2020, as we continued to invest in our pre-clinical developments efforts to advance the technology. Salaries and wages increased during the year ended December 31, 2021 due to higher employee related costs. General and Administrative Expense General and administrative expenses for the year ended December 31, 2021 was $3.7 million, increasing $0.3 million, or 10.1%, compared to the same period in the prior year. Increases in employee related, consulting and insurance costs during the year ended December 31, 2021, compared to the same period in 2020, were partially offset by lower legal and share-based expense. In addition, general and administrative expenses for the year ended December 31, 2020 were lower than the same period in 2021 due to a $0.1 million gain on settlement of certain vendor amounts to close out our XBIO-101 trial recognized during 2020. Asset Impairment Charges Asset impairment charges were $9.2 million for the year ended December 31, 2020, as we recorded an asset impairment charge of $9.2 million related to our IPR&D. There was no similar charge during the year ended December 31, 2021. Other Income (Expense) Other income was approximately $1,100 for the year ended December 31, 2021 compared to other expense of approximately $500 for the same period in 2020. This increase in income was primarily related to changes in foreign currency exchange rates during the year ended December 31, 2021, as compared to the same period in 2020. Interest Income, net Interest income, net decreased to approximately $100,000 during the year ended December 31, 2021, as compared to approximately $126,000 for the same period in the prior year. This decrease is primarily due to lower interest rate yields on invested funds during the year ended December 31, 2021 compared to the same period in 2020. 56 Income Tax Benefit Income tax benefit of $2.9 million for the year ended December 31, 2020 was due to the impairment of IPR&D during 2020. There was no similar benefit during the year ended December 31, 2021. Liquidity and Capital Resources We incurred a net loss of approximately $5.6 million for the year ended December 31, 2021. We had an accumulated deficit of approximately $182.5 million at December 31, 2021, as compared to an accumulated deficit of approximately $176.9 million at December 31, 2020. Working capital was approximately $17.3 million at December 31, 2021, and $11.4 million at December 31, 2020, respectively. During the year ended December 31, 2021, our working capital increased by $5.9 million due to our $12.5 million private placement in July 2021 partially offset by our net loss for the year ended December 31, 2021. We expect to continue incurring losses for the foreseeable future and may need to raise additional capital or pursue other strategic alternatives in the long-term in order to continue the pursuit of our business plan. Our principal source of liquidity consists of cash. At December 31, 2021, we had approximately $18.2 million in cash and $1.4 million in current liabilities. At December 31, 2020, we had approximately $11.5 million in cash and $0.9 million in current liabilities. We have historically relied upon sales of our equity securities to fund our operations. We expect the majority of our funding through equity or equity-linked instruments, debt financings, corporate collaborations, related party funding and/or licensing agreements to continue as a trend for the foreseeable future. Management evaluates whether there are conditions or events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern within one year after the date that the financial statements are issued. We have incurred substantial losses since our inception, and we expect to continue to incur operating losses in the near-term. These factors raise substantial doubt about our ability to continue as a going concern. We believe that we have access to capital resources through possible public or private equity offerings, debt financings, corporate collaborations, related party funding or other means to continue as a going concern. On July 28, 2021, we completed a $12.5 million private placement of our common stock resulting in approximately $11.5 million of net proceeds to us. We believe that this financing, coupled with our existing resources, will be adequate to fund our operations into the second quarter of 2023. However, we anticipate we may need additional capital in the long-term to pursue our business initiatives. The terms, timing and extent of any future financing will depend upon several factors, including the achievement of progress in our clinical development programs, our ability to identify and enter into licensing or other strategic arrangements, and factors related to financial, economic geo-political, industry and market conditions, many of which are beyond our control. The capital markets for the biotech industry can be highly volatile, which make the terms, timing and extent of any future financing uncertain. Cash Flows from Operating Activities Cash flows used in operating activities for the year ended December 31, 2021 totaled approximately $4.7 million, which was primarily due to our net loss for the period, partially offset by non-cash charges associated with share-based expense. Cash flows used in operating activities for the year ended December 31, 2020 totaled approximately $4.3 million, which was primarily due to our net loss for the period, offset by non-cash charges associated with asset impairment charges, deferred income taxes, share-based expense and settlement of certain amounts payable to a vendor related to the close-out of our XBIO-101 trial. Cash Flows from Investing Activities There were no cash flows from investing activities for the years ended December 31, 2021 and 2020. 57 Cash Flow from Financing Activities Cash flows from financing activities for the year ended December 31, 2021 totaled approximately $11.5 million, representing net proceeds from our private placement in July 2021. Cash flows from financing activities for the year ended December 31, 2020 totaled approximately $5.4 million, representing net proceeds from our registered direct common stock offering in December 2020. Contractual Obligations Contractual obligations represent future cash commitments and liabilities under agreements with third-parties and exclude contingent liabilities for which we cannot reasonably predict future payment. Our contractual obligations result from property leases for office space. Although we do have obligations for CRO services, the table below excludes potential payments we may be required to make under our agreements with CROs because timing of payments and actual amounts paid under those agreements may be different depending on the timing of receipt of goods or services or changes to agreed-upon terms or amounts for some obligations, and those agreements are cancelable upon written notice by the Company and therefore, not long-term liabilities. The contracts may also contain variable costs that are hard to predict as they are based on such things as patients enrolled and clinical trial sites, which can vary and, therefore, are also not included in the table below. Additionally, the expected timing of payment of the obligations presented below is estimated based on current information. The following tables represent our contractual obligations as of December 31, 2021, aggregated by type: Payments Due by Period As of December 31, 2021 Total Less than 1 year 1-3 years 3-5 years More than 5 years Lease obligations $ 44,827 $ 44,827 $ – $ – $ – Total $ 44,827 $ 44,827 $ – $ – $ – Recent Accounting Standards Refer to Note 3, Summary of Significant Accounting Policies , of the accompanying financial statements set forth in Item 8. ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are not required to provide the information required by this Item because we are a smaller reporting company. 58